Overview Business review Governance Financial statements Other information 1 Group profile 1
OUR VISION IS TO BE RECOGNISED AS THE BEST FINANCIAL SERVICES COMPANY IN THE UK BY SHAREHOLDERS, CUSTOMERS AND COLLEAGUES.
Group Chief Executive’s review We achieved a step change in our financial performance, returning the Group to profitability while absorbing the substantial costs of reducing risk in the business.
The main four brands operated by the Group are Lloyds TSB, Halifax, Bank of Scotland and Scottish Widows though a number of other brands are used in specialist markets.
The Life, Pensions and Investments business is the leading bancassurance provider in the UK and is also a leading player in the intermediary channel. The general insurance business is a leading distributor of home insurance in the UK and also offers a range of other general insurance products. Key product markets: Life assurance, pensions and investments
KEY HIGHLIGHTS OVERVIEW The Group returned to profitability on a combined businesses basis with profit before tax of £2,212 million
We see corporate responsibility as being integral to our business strategy. We need to demonstrate that we are running our business in a responsible way; and are making a sustained, positive contribution to the economy and to society; by playing our part in the UK’s economic recovery and by investing in the communities of which we are a part.
In delivering a high performance organisation, we need to have high levels of staff engagement. Every quarter we run a comprehensive confidential survey across the Group to gauge staff views on key issues and assess overall staff engagement.
In 2010, we achieved a record response rate of 83 per cent (up from 81 per cent in 2009) which is regarded as ‘best in class’ and the overall engagement score increased from 72 to 80 showing the progress being made in this area.
As we emerge from the financial crisis and the economic downturn, we recognise the public concern surrounding the banking industry and know we have much work to do as an industry to rebuild trust and understanding. We also acknowledge the role that we at Lloyds Banking Group must play in that process. We can only earn that trust by addressing the fundamentals, for all our stakeholders, and by being open, transparent and engaged in the broader debate about the role of banking in the UK. We need to demonstrate that we are meeting our obligations to customers and society by proactively – and responsibly – channelling the deposits we gather into productive enterprises and households.
We have also 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). As the largest UK focused bank, we are determined to play a full role in supporting investment by UK businesses and households. Lending is one of our core business functions and it is in our interest and that of our shareholders that we make access to responsible credit as easy as possible.
“ We have a great platform for the future and have established a strong financial and operational trajectory. I am confident that we will be able to grow the business further over the coming years.”
Overview Business review Governance Financial statements Other information 7 Group profile 1
The Board and I are grateful to Eric Daniels for his leadership since June 2003, particularly since the announcement of the acquisition of HBOS in September 2008. The successful integration of the two companies and the sooner than expected return to profitability of the enlarged Lloyds Banking Group are testament to his leadership during a time of unprecedented financial turmoil. It is to Eric’s credit that the Group is in a strong position for the next phase of its development. I personally have valued greatly the considerable management, banking and organisational expertise Eric has brought to Lloyds Banking Group as Group Chief Executive.
In November we announced the appointment of António Horta-Osório as the next Group Chief Executive. He brings with him deep experience in, and understanding of, the UK retail and commercial banking industry, as well as a track record of integrating three well respected UK retail banking franchises. António joined us in January 2011 and took over as Group Chief Executive on 1 March 2011. The Board and I look forward to working with him to ensure the success of the next stage of development of the Group, and I hope many of you will be able personally to meet him at our annual general meeting in Glasgow on Wednesday 18 May 2011.
Our most senior management including our Executive Directors, have made extraordinary efforts both in terms of their time, involvement and personal contribution in achieving these results. I thank all of them for their loyalty in difficult circumstances.
Summary 2010 was a good year for the Group, in which we made significant progress, delivering a strong operating performance, while strengthening the business for the future.
We delivered good momentum across our core businesses through the continued development of our customer relationship strategy, attracting new customers to the Group and broadening and deepening our relationships with existing customers.
We made considerable progress during the year in reducing the Group’s risk. The application of our prudent approach to restructuring of the existing book and our risk standards to all new business is being reflected in the more predictable performance of these portfolios. We also made good progress in reducing the size of our balance sheet and substantially strengthened both our capital and funding positions.
As a result of the significant progress we have made in 2010, Lloyds Banking Group is now a much stronger business and is well positioned to realise the potential within its franchise.
On a statutory basis, the Group delivered a profit before tax of £0.3 billion in 2010. This compared to a profit of £1 billion in 2009, which benefited from an £11.2 billion negative goodwill gain associated with the purchase of HBOS.
We achieved a significant reduction in the impairment charge, which fell 45 per cent, with the deterioration in some of our International businesses more than offset by a substantial improvement in the rest of the Group, notably in the Wholesale division.
The considerable reductions in the Retail and Wholesale impairment charges reflect the benefit of the actions we have taken over the past two years and our ongoing effective risk management, as well as the slowly improving economic environment. While we were disappointed by the increases in the International portfolios, these reflect specific economic challenges facing Ireland, and to some degree Australia, which we are managing closely.
We have seen good momentum across our core business franchise in 2010, supported by the extension of our relationship strategy across the Group, in what remain highly competitive markets.
In Wholesale, our commitment to supporting our customers through the cycle was equally successful, and we attracted over 100,000 new start-up customers and our achievements were recognised in the marketplace by the receipt of a number of awards.
Our progress in 2010 underpins our confidence that we will deliver our target of £2 billion of annual run-rate cost synergies by the end of 2011.
We considerably strengthened our capital position in the year, positioning us well ahead of the implementation of the Basel Committee on Banking Supervision’s so called ‘Basel III’ capital reforms, and changes expected to a number of accounting practices.
Following extensive scrutiny of the Payment Protection Insurance (PPI) market in recent years, the Financial Services Authority issued its final policy statement on PPI complaints handling in August 2010. The application of this policy, which has been challenged by the British Bankers’ Association in a judicial review, could in extremis have a material effect on the Group’s financial position.
However, within the publication ‘An Introduction: Who We Are, What We Do and the Framework Document Which Governs the Relationship Between UKFI and HM Treasury’, it is stated that UKFI is to ‘develop and execute an investment strategy for disposing of the investments in the banks in an orderly and active way through sale, redemption, buy-back or other means within the context of an overarching objective of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and to acting in a way that promotes competition’.
We are making good progress against the agreed asset reduction programme and continue to make good progress in preparing for the disposal of the agreed retail banking business. The final cost of disposal will depend on the buyer and the extent to which substantial IT system and infrastructure development will be necessary. Therefore the total cost is hard to predict but is likely to be substantial.
The assets and liabilities, and associated income and expenses, of the business to be divested (referred to above) cannot be determined with precision until nearer the date of sale.
As a result of our focus, these actions have allowed us to remain ahead of the mortgage and business lending commitments made by the Group to the Government for the year ended 28 February 2011.
In considering these measures the Commission will have regard to the legal and operational requirements of implementing the options under consideration, and the importance of generating practical recommendations. It will also take into account the findings of ongoing EU and international work, and inform the UK Government’s approach to international discussions on the financial system.
Implementation of a single mortgage sales platform across core mortgage brands underway.
The Group’s central scenario is for the modest recovery in the UK to continue – the projection of slightly less than 2 per cent Gross Domestic Product (GDP) growth in 2011 and slightly less than 2.5 per cent in 2012 is close to consensus and slightly below the November 2010 forecasts from the Office for Budget Responsibility. Private and public sector deleveraging, which is expected to suppress economic growth, should be more than offset by a positive contribution from net external trade (reflecting the weakness of sterling), by further rebuilding of stocks by companies and by increased investment. Public spending cuts may increase unemployment slightly in 2011, but if the economy continues to grow, the private sector should be able to more than offset that impact from 2012. Similarly, further declines in corporate insolvencies are likely to be very slow, limited by the public spending cuts and the weakness of consumer spending. House prices and commercial property prices are expected to dip slightly in 2011 and then rise slowly. The US recovery is assumed to continue in 2011, and in the Eurozone there is expected to be a wide divergence in 2011 between recovery in the stronger low-deficit countries and the higher deficit countries that will struggle to grow at all. The Irish economy, to which we have exposure, is not expected to grow materially in 2011. House prices there are expected to fall a little further in 2011 before flattening in 2012; commercial property prices are expected to be flat over 2011 and 2012.
Downside risks around this scenario remain significant. Business and consumer confidence remains fragile, and the extent to which simultaneous fiscal tightening across Europe 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 in the West, prompting short-term interest rates to rise more quickly than anticipated. Since any shock to growth would also worsen the outlook for both public finances and bank capital and funding, a relatively small initial shock could throw economies onto a much weaker path as governments are forced to tighten fiscal policy even further or financial institutions are constrained in their ability to lend. A ‘double-dip’ scenario – a second shallower recession following closely the one that the economy is just emerging from – would result in further significant increases in corporate failures and unemployment during 2011-12. In addition, residential and commercial property would suffer a second period of falling prices, tenant defaults would increase and central banks would have limited ability to cushion the downturn.
On the retail side, net new mortgage lending (all new lending minus repayments) continued to weaken slightly after a 72 per cent fall in 2009, so outstanding market balances grew by just 0.4 per cent. Net new unsecured consumer lending improved in 2010 after turning negative in the second half of 2010, but at £1.4 billion was less than 11 per cent of the 2007 level. Part of the weakness in lending is the natural result of some lenders having left the market, particularly in the higher risk segments of mortgages and personal loans, but we have also seen a continued desire from customers to repay debt early where they are able. Deposit market growth has also remained weak, with balances rising by 3 per cent through 2010, as deteriorating disposable incomes have squeezed savings flows.
Low interest rates have, however, been a key benefit to consumers and businesses throughout 2010. Arrears and defaults rose by much less during the recession than in previous recessions, and began to improve in 2010 despite the weakness of the recovery in the economy. The number of company liquidations in England and Wales fell by nearly 16 per cent in 2010 after a 23 per cent rise in 2009, reducing the rate of failure of active companies to 0.7 per cent from 0.9 per cent in 2009. The number of individual insolvencies rose by a further 0.7 per cent in 2010 after a 26 per cent rise in 2009, but insolvencies during the second half of 2010 were 8.7 per cent lower than a year earlier. The number of mortgages in arrears across the market fell by 10 per cent in 2010, and the share in arrears by more than 3 months fell to its lowest in two years by Q4 2010.
Overview Business review Governance Financial statements Other information 13 Group profile 1
KEY HIGHLIGHTS The Group returned to profitability on a combined businesses basis with profit before tax of £2,212 million (2009: £6,300 million loss).
Good trading performance against the backdrop of modest growth in UK economy.
Banking net interest margin improved to 2.10 per cent (2009: 1.77 per cent) with the majority of the gain achieved in the first half of the year.
Significant reduction in the impairment charge. Impairment charge was 45 per cent lower at £13,181 million (2009: £23,988 million).
Good progress on balance sheet reduction with cumulative non-core asset reduction of £105 billion. On track to meet target of £200 billion over the next three years.
Reduction in liquidity support from government and central bank facilities of £61 billion to £97 billion.
Given the flexibility and capacity we have for core business growth, we continue to believe that the Group has strong medium-term prospects, notwithstanding the economic and regulatory headwinds that we face in 2011.
2010 performance – a return to profitability and a further reduction in risk
The Group delivered a good operating performance in 2010 against the backdrop of modest growth in the UK economy, with good revenue growth in the core business, an improved net interest margin, a further reduction in costs, and continued strong progress on the integration of HBOS. The impairment charge reduced significantly, with deterioration in impairments in Ireland more than offset by substantial improvements elsewhere in the Group, particularly in the Wholesale division. As a result the Group returned to profitability in 2010 on a combined businesses basis, reporting a profit before tax of £2,212 million in 2010, compared to a loss before tax of £6,300 million in 2009.
The increase in profit before tax was primarily generated by Wholesale and Retail. Wholesale returned to profitability in 2010 delivering profit before tax of £3,257 million compared to a loss before tax of £4,703 million in 2009 reflecting a significant reduction in the impairment charge. Retail profit before tax also increased significantly to £4,716 million from £1,382 million in 2009 driven by good income growth and a significantly lower impairment charge. Insurance delivered a 13 per cent increase in profit before tax to £1,102 million as our focus on improved profitability of the product set delivered higher new business profits, despite lower sales. However, these increases were partially offset by a significant increase in loss before tax in Wealth and International to £4,824 million from £2,356 million in 2009, driven by a higher impairment charge, predominantly due to the material deterioration of the economic environment in Ireland in the last quarter of 2010.
Further, to enable a better understanding of the Group’s core business trends and outlook, certain income statement and balance sheet information is analysed between core and non-core portfolios. Non-core portfolios consist of non-relationship assets and liabilities, and assets and liabilities which are outside the Group’s current appetite. The EU mandated retail business disposal is not included in non-core portfolios.
Reduction in fair value of equity conversion feature of ECNs (620) (427)
Group net interest income increased by £1,096 million, or 9 per cent, to £13,822 million. The net interest margin from our banking businesses was 33 basis points higher at 2.10 per cent, as higher asset pricing and reductions in the average spread between base rate and LIBOR more than offset lower deposit margins in Retail and increasing wholesale funding spreads. The incremental costs of wholesale funding have been recorded within Central items. The banking asset margin increased by 45 basis points to 1.56 per cent, and the banking liability margin decreased by 31 basis points to 0.97 per cent.
In Wholesale, core income grew by 4 per cent, driven by an increase in the banking net interest margin, principally from asset margin growth, which largely reflected the repricing of lending business. This was partially offset by lower net interest income in Treasury and Trading, reflecting the more stable interest rate environment. Non-core income decreased by 15 per cent, given lower interest earning asset balances resulting from the excellent progress in targeted balance sheet reductions.
In Wealth and International, core income increased by 5 per cent, driven by the positive effect of foreign exchange movements in the International business and of higher global stock markets in the
Wealth businesses, partially offset by a decline in the banking net interest margin.
Outlook – income Core assets accounted for approximately 82 per cent of income in 2010 (2009: 79 per cent), with core income growing 7 per cent. In 2011, however, we expect income trends will reflect continued customer deleveraging and subdued new lending demand which, with further non-core asset reductions, will result in a continued reduction in the overall size of the Group’s balance sheet. As already stated, we do not expect to see further net interest margin progression in 2011.
To date, costs of preparing for the EU mandated disposal of at least 600 UK branches, associated customer assets and liabilities and a proportion of our mortgage assets, have been modest. However with integration nearing completion, activity preparing for this divestment will accelerate significantly. The final cost will depend on the buyer and the extent to which substantial IT system and infrastructure development will be necessary. Therefore the total cost is hard to predict but is likely to be substantial. These costs will be excluded from combined businesses profits.
The lower secured impairment charge reflected reduced impaired loan levels and improved arrears in the first half of 2010, although in the second half, and particularly in the last quarter, we saw some signs of strain, with fewer customers returning their accounts to order than was the case six months ago. House prices fell slightly in the year and the proportion of the mortgage portfolio with an indexed loan-tovalue of greater than 100 per cent was broadly stable at 13 per cent. The value of the portfolio with an indexed loan-to-value greater than 100 per cent and more than three months in arrears has increased slightly by £0.2 billion and is now £3.2 billion, representing 0.9 per cent of the portfolio. The number of mortgage customers new to arrears has also remained relatively stable in the last twelve months, and is now well below the peak experienced in the second half of 2008. However, as a result of the early signs of strain we saw in the second half of the year and the subdued economic environment, we expect to see an increase in the secured impairment charge in 2011.
The Wholesale impairment charge fell significantly from £15,683 million in 2009 to £4,446 million in 2010. There was a significant reduction in both the core and non-core businesses impairment charge. The impairment charge as a percentage of average loans and advances to customers improved significantly to 2.08 per cent in 2010 compared to 5.92 per cent in 2009.
After the release of the Interim Management Statement on 2 November 2010, the Group saw a further significant deterioration in market conditions in Ireland, with concerns over the country’s fiscal position leading ultimately to the approval of its application for EU-IMF financial support on 21 November 2010. Market sentiment continued to be negatively affected by uncertainty about the political situation and about the economic effect of the austerity measures introduced in the Irish Budget of 7 December 2010. As a result, in a statement dated 17 December 2010, we noted that any economic recovery in Ireland may take longer to achieve, that asset prices will remain depressed for longer than previously anticipated and therefore that we believed that the significant deterioration in the
Overview Business review Governance Financial statements Other information 19 Group profile 1
In Australia, although economic performance has been robust overall, there are significant geographical and sector variations, and property assets situated outside the principal metropolitan areas have been particularly weak. Our exposure to these areas within our Australian portfolio drove increased impairments in 2010.
In Retail, given our expectations for a modest improvement in the UK economic environment, and a further 2 per cent reduction in house prices in 2011, we currently expect that there will be a modest reduction in the overall Retail impairment charge in 2011. The rate of improvement is, however, expected to be significantly slower than in 2010, with the improving performance of the unsecured book more than offsetting additional secured charges.
Previously, we set out our strategy to reduce non-core assets, including non-relationship assets and businesses which are outside our current appetite, by some £200 billion from a non-relationship pool of £300 billion. It continues to be our intention to manage these assets for value and, given the current economic climate, our primary focus remains on running these assets down over time. This strategy has been very effective and so far reductions of £105 billion have been achieved.
Proportion of wholesale funding with maturity of greater than one year 50% 50%
A strengthened liquidity and funding position The Group made excellent progress against its funding objectives in 2010 and further enhanced its liquidity position which is supported by a robust and stable customer deposit base. While total customer deposits fell 3 per cent, deposits excluding repurchase agreements increased by 3 per cent, reflecting good growth in relationship deposits in Retail and in Wealth and International.
Pension curtailment gain A net curtailment gain of £910 million was recognised in 2010 following changes to the Group’s UK defined benefit pension schemes. In the first half of 2010 the Group implemented changes to the terms of its UK defined benefit pension schemes. As a result of these changes, the amount of any future salary increases that will be deemed pensionable will be capped each year at the lower of Retail Price Index inflation; each employee’s actual percentage increase in pay; and 2 per cent of pensionable pay. This resulted in a curtailment gain of £1,019 million, but was partially offset in the second half of 2010 from a change in the commutation factors in certain defined benefit schemes.
We have made a customer goodwill payments provision in 2010 of £500 million in relation to the contact programme. This provision, which has been excluded from combined businesses profits, is expected to fully cover the costs of the programme. Further detail is given in note 45 on page 216.
Loss on disposal of businesses During 2010, the Group recorded a loss of £365 million on the disposal of two wholly-owned subsidiary companies, acquired from a previous lending relationship, each of which owned an oil drilling rig under construction. Consistent with the Group’s previous treatment, this loss has been reported outside of the Group’s combined businesses results.
Financial Services Compensation Scheme (FSCS) costs in respect of certain investment company failures have now started to emerge and, although relevant costs cannot be predicted, we expect that during the course of 2011 the Group will be required to make contributions towards such costs as required by the FSCS.
The Group continues to actively support the UK economy by lending to UK households and businesses. In 2010, we have extended £30 billion of gross mortgage lending (including remortgages) and £49 billion of committed gross lending to businesses, of which £11 billion was for SMEs.
Under the terms of our lending commitments to the UK Government, we agreed to make available gross new lending of £67 billion in the 12 months to 28 February 2011, of which £23 billion would be extended to homeowners and £44 billion to UK businesses. In the ten months from 1 March to 31 December 2010, we have extended lending that qualifies under the programme totalling over £20 billion to UK homeowners and over £42 billion to UK businesses, of which £10 billion has been extended to SMEs and we are on track to meet our lending commitments in full.
Given the flexibility and capacity we have for core business growth, we continue to believe that the Group has strong medium-term prospects, notwithstanding the headwinds that we face in 2011.
Our medium-term targets remain unchanged. However, having joined the Group in January, António Horta-Osório will be appointed Group Chief Executive on 1 March, and will be reviewing the business to further develop the strategy and actions needed to realise its full potential. He expects to report to the Board and subsequently to shareholders on the outcome of his strategic review and his plans at the end of the first half of 2011.
Overview Business review Governance Financial statements Other information 25 Group profile 1
The impairment charge reduced significantly to £2,747 million, down by 35 per cent, supported by prudent risk management, a stabilising economy, broadly stable house prices and low interest rates. The improvement in credit performance was faster than expected a year ago.
Loans and advances to customers: Customer deposits: Risk-weighted assets 109.3 128.6 (15)
Mobile banking is another key growth area and Retail is investing to make financial services more accessible and to increase the range of options available to customers. Lloyds TSB has launched a mobile banking application that allows customers to manage their money on the move, including transferring funds between accounts via their mobiles. Lloyds TSB now also offers a range of free text alerts, including balance updates and near limit alerts, thereby helping customers to better control their finances.
Total customer deposits increased by £11.5 billion, or 5 per cent, to £235.6 billion in the year. The growth was predominantly from instant access and tax free cash ISA accounts, rather than more expensive term deposits. This approach has helped support the net interest margin. Retail continues to perform well in the savings market, with a strong stable of savings brands which can be tailored to customer demands.
Other income decreased marginally to £4,136 million, primarily reflecting a reduction from the higher market volatility in 2009 in Wholesale Markets and lower operating lease income in Asset Finance, partially offset by investment gains in Wholesale Equity.
Impairment charges on financial assets decreased significantly to £4,446 million, compared to £15,683 million in the previous year. The total impairment charge is 72 per cent lower than last year and continues to be primarily driven by the HBOS heritage corporate real estate and real estate related asset portfolios.
Overview Business review Governance Financial statements Other information 31 Group profile 1
Integrating the businesses Progress towards creating a single Wholesale Bank by the end of 2011 continues on track, with several notable milestones passed in 2010. Internal business structures are in place across Wholesale, and around 30 customer and data migrations successfully took place in 2010, representing assets of approximately £50 billion. The new Lloyds Bank Corporate Markets brand was launched in December, providing a single, comprehensive and consistent corporate banking and financial markets service for our customers. In the Asset Finance business, the successful integration of Lex and Autolease brands has created one of the UK’s leading car leasing firms.
A number of disposals of non-core assets were completed during 2010 in line with the planned reduction of Wholesale’s total assets, which includes part of the Group’s commitment under the state aid restructuring plan. Wholesale continues to operate under an oversight and governance framework with the intention always of maximising long-term shareholder value from any asset sale.
Banking net interest income, which excludes trading activity, increased by £330 million, to £3,683 million as lending business continued to be re-priced to reflect customer risk profiles, with lending margins increasing by 26 basis points. Deposit margins increased moderately, by 13 basis points, reflecting favourable internal liquidity rates, which was partially offset by the impact of lower LIBOR to base rate spreads. As a result, the banking net interest margin increased by 36 basis points to 1.88 per cent in 2010. The impact of re-pricing was only partially offset by a decrease in average interest earning assets and liability balances.
Other income decreased by £63 million, or 2 per cent, to £4,136 million, primarily reflecting higher levels of market volatility in 2009 which resulted in mark to market gains in Wholesale Markets, whilst 2010 experienced losses on sale of assets in targeted balance sheet reductions and lower operating lease income. Other income in 2010 benefited from investment gains in Wholesale Equity as a result of stabilisation in market conditions and improved fund investment performance, strong fee income across structuring and capital markets and more favourable performance in Treasury and Trading.
Overview Business review Governance Financial statements Other information 33 Group profile 1
As at 31 December 2010, operations and portfolios considered to be non-core included assets of £126.9 billion (2009: £158.3 billion) which included £71.2 billion (2009: £83.1 billion) of loans and advances to customers, £25.4 billion (2009: £31.5 billion) of debt securities, £22.2 billion (2009: £32.0 billion) of available-for-sale financial assets and other assets of £8.1 billion (2009: £11.7 billion). Non-core risk-weighted assets were £94.8 billion (2009: £135.4 billion). Non-core portfolios and businesses include £4.9 billion (2009: £4.9 billion) of customer deposits.
Overview Business review Governance Financial statements Other information 35 Group profile 1
Operating expenses increased by £31 million to £218 million reflecting the investment in people and systems, in particular back office infrastructure, to support internal risk management and the customer franchise.
Loss before tax and fair value unwind increased by £1,898 million to £5,196 million, compared to £3,298 million in 2009, due to a higher impairment charge, predominantly in Ireland.
The impairment charge amounted to £5,988 million, compared to £4,078 million in 2009, reflecting the material deterioration in the economic environment in Ireland in the last quarter of 2010 that resulted in EU-IMF financial support in late November 2010 and the tightening of liquidity in the second half of 2010 in regional Australian property markets to which the Group is exposed.
Impairment as a % of average advances 8.90% 6.04% As at 31 December 2010 2009 Change £bn £bn %
Deep and enduring customer relationships In Wealth, the focus has been on driving additional income growth from the Group’s affluent and high net worth client base through more effective use of the opportunities afforded by the Retail and Wholesale franchises to cross sell Wealth products to these customers. During 2010, customer segmentation across the Wealth businesses has been implemented and businesses transferred as appropriate to align to this segmentation, the customer referrals model has been formalised, and a new UK investment proposition launched. Continuing progress was demonstrated through a 7 per cent increase in Wealth relationship customers in 2010, including a 12 per cent increase in UK Wealth, and a 16 per cent increase in Wealth’s customer deposits.
Integration Wealth and International is making excellent progress with the integration of its businesses with an annual synergies run-rate as at 31 December 2010 of £240 million, substantially achieving the end of 2011 run rate target of £242 million. The transfer of £50 billion of funds under management from Insight Investment to Scottish Widows Investment Partnership was successfully completed in the first half of 2010 along with the sale of Employee Equity Solutions and Bank of Scotland Portfolio Management Service. In the second half of 2010 the division successfully completed the integration of its Spanish businesses, while the UK Private Banking, Channel Islands and Wholesale Europe integration programmes are progressing well ensuring Wealth and International is on track to deliver targeted cost savings by the end of 2011.
Overview Business review Governance Financial statements Other information 39 Group profile 1
Total income decreased by 2 per cent to £1,363 million. Net interest income decreased by 10 per cent, reflecting continued margin pressure driven by low base rates and a competitive deposit market. Other income increased by 1 per cent, as growth was constrained by lower asset management fee income following the sale of the external fund management business of Insight Investment in November 2009.
Operating expenses decreased by 6 per cent, driven by cost savings from integration, particularly in the Asset Management business and also include the effect of the sale of Insight Investment. On a like for like basis, excluding the costs of Insight Investment operating expenses decreased by 1 per cent.
Funds under management of £192.0 billion increased by £7.9 billion. Net outflows of £6.4 billion reflect an exceptional withdrawal from a single institutional investor in Scottish Widows Investment Partnership (SWIP), partially offset by strong net inflows in St. James’s Place plc. Increases in global equity values, particularly in the second half of 2010, increased funds under management by a further £15.1 billion.
The lower credit in respect of the fair value unwind reflects the unwind profile of the original fair value adjustment which anticipated a peak in the impairment charge in 2009 based on a faster economic recovery in Ireland than is now being experienced.
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Overview Business review Governance Financial statements Other information 43 Group profile 1
Consolidated financial statements 146 notes to the consolidated financial statements 153
Parent company financial statements 273 notes to the parent company financial statements 276 shareholder information 284
Lloyds Banking Group Annual Report and Accounts 2010 key OperatInG BranDs prOFILe the Insurance division provides long term savings, protection and investment products and general insurance products to customers in the uk and europe and consists of three business units: life, Pensions and investments uK (lP&i uK): the uK life, Pensions and investments business is the leading bancassurance provider in the uK and has one of the largest intermediary channels in the industry. the business provides long-term savings, protection and investment products distributed through the bancassurance, intermediary and direct channels through the lloyds tsB, Halifax, Bank of scotland and scottish Widows brands.
profit before tax and fair value unwind increased by 19 per cent, to £1,215 million, before a non-recurring charge of £70 million in respect of the Group’s decision to cease writing new payment protection insurance (PPi) business.
total income, net of insurance claims decreased by £11 million to £2,009 million, primarily reflecting lower PPi income and claims arising from the freeze events in 2010, which are offset by reduced payment protection insurance claims and improved investment markets.
Good progress continues to be made on integration, including the launch of a single bancassurance proposition in June 2010.
Lp&I uk margins increased to 3.7 per cent from 2.6 per cent in 2009. the improved margin reflects strategic choices made in respect of product and channel propositions as the legacy businesses are integrated in order to focus on value. the iRR on new business continues to improve and was in excess of 15 per cent in the year.
General Insurance profits increased by 1 per cent to £372 million primarily due to improved unemployment claims experience and integration synergies after taking account of continuing lower income resulting from ceasing to write new PPi business and claims related to the freeze events in 2010.
The above result includes certain Group and divisional costs and income not allocated to business units, as well as the division’s share of results of joint ventures and associates. The year ended 31 December 2010 includes an accounting gain on disposal of £13 million from the sale of the Group’s joint venture investment in esure.
The insurance division’s strategic vision is to be recognised as the leading insurance business by its customers, the Group’s shareholders and staff. The division has four strategic objectives to achieve its vision: – complete the integration of the businesses; – continue to strengthen its leading brands and grow sales profitably in its targeted markets; – enhance the capital management and operational efficiency of existing and future business; and
Integrating the business The integrations of the legacy Life, Pensions and Investments businesses and the legacy General Insurance businesses have continued to progress well. The division achieved run-rate synergies of £197 million by the end of 2010 and is on track to deliver run-rate synergies of £239 million by the end of 2011.
In the General Insurance business an integrated supply chain model was implemented and includes the introduction of personal claims consultants, across all brands, since July 2010.
Overview Business review Governance Financial statements Other information 45 Group profile 1
Life, Pensions and Investments UK delivered profit growth, before tax and fair value unwind, of £136 million, or 22 per cent, before taking into account the non-recurring £70 million charge from the Group’s decision to cease writing new payment protection business. After this charge, profit before tax and fair value unwind was £683 million, an increase of 11 per cent compared to 2009.
LP&I UK margins on an EEV basis increased to 3.7 per cent in 2010 from 2.6 per cent in 2009. The improved margin reflects the strategic choices made in respect of product and channel propositions as the legacy businesses have been integrated in order to focus on value. The IRR on new business was in excess of 15 per cent in the year.
Profits arising from experience and assumption changes decreased by £32 million to £22 million mainly reflecting the non-recurrence of benefits recognised in 2009, including a liability management gain of £30 million. During 2010 a review was undertaken into the charging between the funds of Clerical Medical prior to the acquisition of HBOS, giving rise to a charge of £132 million. Additionally assumptions regarding future maintenance expenses within the Clerical Medical business were aligned to reflect the heritage Lloyds TSB approach, giving rise to a charge of £119 million. These charges relate to pre-acquisition matters and were largely offset by the release of fair value provisions.
The present value of new business premiums reduced by 20 per cent, to £10,828 million. This largely reflects the withdrawal in 2009 of certain HBOS legacy products with lower returns.
Other items represent amounts not considered attributable to the underlying performance of the business. In 2010 this includes a charge of £70 million following the Group’s decision to cease writing new payment protection insurance business and a charge of £132 million arising from the review of charging between the funds of Clerical Medical prior to the acquisition of HBOS.
The figure for taxation in 2010 reflects the actual shareholder tax charged. This approach differs from 2009 where the tax charge was estimated based on the standard rate of corporation tax. The prior year figures have not been adjusted to reflect this change as the adjustment is between the volatility and taxation lines.
Sensitivity analysis The table below shows the sensitivity of the EEV and the new business profit before tax to movements in some of the key assumptions. The impact of a change in the assumption has only been shown in one direction as the impact can be assumed to be reasonably symmetrical.
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Support function costs decreased by 3 per cent, primarily driven by the completion of payments filtering investment in 2009. Underlying support function costs increased largely as a result of further strengthening of the Risk function in line with increasing regulatory requirements.
STRATEGY Group Operations aims to be recognised as a world class operations business by colleagues, customers, stakeholders and peers whilst ensuring value through cost and process efficiency. This will be achieved by providing excellent technology and effective process to support the businesses; driving simplification, automation and continuous improvement; developing world class operations, leadership and capability; and maintaining strong controls to protect the Group.
During 2010, the Group’s statutory profit before tax included positive insurance and policyholder interests volatility of £306 million compared to positive volatility of £478 million in 2009 primarily reflecting the more significant improvements in financial markets in 2009. The volatility in 2010 reflects the strong performance of equity markets, partially offset by lower than expected returns on cash and fixed interest assets.
Includes volatility relating to the Group’s interest in St James’s Place.
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The sustainable run-rate synergies achieved as at 31 December 2010 totalled £1,379 million excluding a number of one-off savings. The table below analyses the run-rate synergies as at 31 December 2010 by division and the 2011 target run-rate of £2 billion.
Integration activities have continued at pace over 2010 with delivery being wide ranging and spanning Group activities. Examples include the rollout of the Lloyds TSB model of day time cash deliveries to Halifax and Bank of Scotland branches; implementation of an improved online mortgage application process for mortgage brokers; delivery of a single scalable secure Internet Banking platform; launch of an integrated product proposition for our market leading bancassurance business; migration of Asset Finance Lex customer and Bank of Scotland dealer finance books onto a single platform; and harmonisation of our loss notification and loss adjusting service processes for household insurance within our General Insurance business.
Insurance 1,990 – – – – Group Operations and Central items (125) – 0.6 15.5 0.2
Non-core portfolios primarily comprise loans and advances to customers. However, certain portfolios of debt securities, available for sale financial assets and other assets in Wholesale are also considered to be non-core. The Group’s total non-core assets are shown in the table below.
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‘Your Performance’ was launched early in 2010 providing a Group wide on-line approach for managing performance with 96 per cent colleague coverage. ‘Your Learning’ was launched providing one integrated learning tool helping colleagues develop learning plans and record training and accreditation. ‘Your Tomorrow’, the first Lloyds Banking Group Defined Contribution pension scheme launched in 2010 and we auto-enrolled over 8,000 colleagues. We also completed development of an integrated Pay and Bonus tool for managing Pay 2011 and Bonus 2010 aligned directly with Performance Management.
One of our highest priorities is recruiting, retaining and developing talented people. Developing colleagues and succession planning are vital in supporting our strategy and have been a major focus in 2010. During the year we have undertaken detailed talent reviews and succession planning for our most senior leaders. Through internal promotion and attracting new talent to the Group in 2010 we have improved the talent profile and succession pipeline, while mitigating the retention risks of our senior leaders.
Business focus Our learning strategy is aligned to our goal of outperformance through cost and customer leadership. It aims to help drive high performance, greater productivity and deep lasting customer relationships by supporting the development of highly engaged, skilled colleagues and capable leaders.
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Report of the independent auditors on the consolidated financial statements 144
During 2010 the GEM Network for ethnic minority colleagues marked its launch across the enlarged Group with an inspirational event held in Leeds. Themed ‘Your Time to Shine’ almost 300 colleagues from across the Group came together to hear from the Group’s Executive Sponsor for Ethnic Diversity, Angie Risley, fellow ethnic minority colleagues’ inspirational career success stories and celebrity guest speaker Tim Campbell, first winner of BBC’s ‘The Apprentice’.
With regards to disability, we have implemented new development programmes, grown our colleague network by over 100 per cent and conducted research to better understand our disabled customer experience. In addition, we launched and sponsor the Radiate Network1, the UK’s first national network of senior disabled leaders.
We have also achieved excellent colleague network growth under our sexual orientation strand, with membership tripling in 2010. Externally, we continue to be active and prominent members of Stonewall3, participating in their annual Workplace Equality Index. The Group has also achieved some firsts; our Home Loan advert featuring a gay couple was the first gay imagery from a UK financial services organisation in national press. And our sponsorship of the largest ever lesbian, gay, bisexual and transgender consumer survey – covering 23 countries and with over 8,000 UK respondents, will yield deep insights into the opportunities to strengthen our customer relationships.
A new area of focus for the Group has been the establishment of a People Risk function within Group Human Resources. This function aims to ensure the management of people risks are central to the development and delivery of the Group’s business strategy.
People Risk is fundamental to our ongoing success as an organisation. Consequently we have built people risk management into our overall accountability framework including our Group Risk Appetite and incorporating it into our Group People Strategy.
Corporate responsibility is integral to our business strategy. We need to ensure that we are running our business in a responsible way. We need to demonstrate that we are making a sustained, positive contribution to the economy and to society; by playing our part in the UK’s economic recovery and by investing in the communities of which we are a part. Finally, as a relationship-led business, we need to work on building deep and lasting relationships with our customers, employees and suppliers; by engaging with them, listening to their needs and, if appropriate, making changes to the way we do business.
We also established a new Environmental Steering Group, chaired by our Group Property Director. With senior representation from across the Group, this drives our environmental strategy, targets and performance. This year, we have established a Financial Inclusion Steering Group.
We have an ongoing programme to train colleagues to provide guidance and support to customers on managing their borrowing. We help them find an appropriate solution, whether through more effective budgeting, or by rescheduling their borrowing with us. We have trained over 7,000 financial health specialists available to help our customers in branches. Where appropriate, we refer customers to free and independent money advice charities. In 2010, we contributed £12.5 million to money advice and debt charities, including the Money Advice Trust and the Consumer Credit Counselling Service.
Environmental management We believe that we have an important role to play in facilitating and financing the transition to a low carbon, resource efficient economy. Our vision is to be recognised by our stakeholders as a leading environmentally responsible organisation.
Managing environmental risks in lending We have introduced policies and procedures to reduce the environmental impact of our lending activities. Our groupwide Environmental Risk Policy requires all business loans to be assessed for material environmental risks as part of the credit sanctioning process. Our policy is supported by a robust process which ensures that there is a consistent approach to identifying, assessing, mitigating and reporting environmental risks. Lending officers are responsible for ensuring that environmental risks are assessed and that action is taken where a risk is identified. Employees are trained in environmental risk management as part of our standard credit risk training course and have access to relevant guidance documents. In 2011, we will further strengthen our risk management process with the implementation of an online environmental risk screening tool.
For 2009, we have reported emissions for January to December. For 2010 and future years, we will report annual emissions from October to September. Our CO2 emissions have been independently verified by environmental consultants by RPS Group.
Supporting the UK’s economic recovery We know that there are those who believe that the banks are not lending enough, and that it is difficult for people to obtain loans. We believe that at Lloyds Banking Group we are playing a very active part in the economic recovery. Indeed, as a UK-focused bank, we have a vital interest in supporting its recovery.
In 2010, we launched ‘Money for Life’, our new £4 million financial capability programme for the further education sector. We are partnering with the Consumer Financial Education Body and skills agencies in each of the four nations of the UK to promote and deliver the programme. Money for Life aims to develop the capacity of the further education sector to improve the financial capability and personal money management skills of the three million people they serve. Over the next two years we will also aim to train 500 of our employees through the programme. This training will provide them with the skills they need to support our financial education agenda in their local communities.
Lloyds Banking Group Annual Report and Accounts 2010 15 specialist BHF Heart Nurses and 12 healthcare assistants, nurses, psychologists and health educators, who will support 14,400 patients and their families across the UK.
Listening to our customers Every month we contact 75,000 customers as part of a systematic customer feedback process. We listen carefully to what our customers tell us, both good and bad, and use this to make changes where necessary. Often, we learn about the small things that cause irritation to customers. By listening to our customers, we can quickly put things right.
Delivering innovative products and services We work hard to introduce new and innovative products that respond to customers’ evolving needs, underlining our commitment to building long-term relationships with our customers.
industry-wide complaints that ISA transfers take too long, costing consumers millions in lost interest. Lloyds TSB and Bank of Scotland have also committed to paying customers interest upon receipt of their ISA applications.
Lloyds TSB’s unique ‘Lend a Hand’ mortgage enables buyers to take out a mortgage with a deposit of as little as 5% at an equivalent rate to borrowers with a significantly bigger deposit. The mortgage is linked to the savings of a helper, such as a family member, to ‘top up’ the deposit to 25% of a property’s value.
Increasing transparency We took a number of industry leading steps in 2010 to improve transparency for savers. Lloyds TSB and Halifax have taken steps to: – Ensure current interest rate information is clearly visible online and on paper statements. – Offer existing savings customers access to all savings deals ensuring that no barriers exist for those wishing to switch to a better-paying savings account. – Ensure that an online calculator is available to help customers work out exactly how much interest they can earn in different accounts.
During 2011, all of the Group’s main savings brands, including Lloyds TSB, Halifax, Bank of Scotland, Cheltenham & Gloucester and Birmingham Midshires will publish savings interest rates on customer statements.
Number/amount of compensation payments for late settlement Nil Nil Nil Nil 2010 and 2009 data represents Lloyds Banking Group. Historical data is Lloyds TSB only.
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The Group Business Risk Committee and the Group Asset and Liability Committee are chaired by the Group Chief Executive and include all members of the Group Executive Committee. The aggregate group wide risk profile and portfolio appetite are discussed at these monthly meetings. The Risk Committee, chaired by a Non-Executive Director, comprises other Non-Executive Directors and oversees the Group’s risk exposures. This Second-Line-Of-Defence Committee is supported by the Chief Risk Officer, who is independent of the front line business units, is a full member of the Group Executive Committee and reports to the Group Chief Executive. The Chief Risk Officer regularly informs the Risk Committee of the aggregate risk profile and has direct access to the Chairman and members of the Risk Committee.
The Group continues to enhance its capabilities by providing to the Board both qualitative and quantitative data including stress testing analysis on risks associated with strategic objectives to facilitate more informed and effective decision making. The Group‘s ability to take risks which are well understood, consistent with its strategy and plans and which are appropriately remunerated, is a key driver of shareholder return.
Risk analysis and reporting capabilities support the identification of opportunities as well as risks and it provides an aggregate view of the overall risk portfolio. Risk mitigation strategies clearly aligned with responsibilities and timescales are monitored at group and divisional level.
In addition, the Group is subject to European state aid obligations in line with the restructuring plan agreed with HM Treasury and the EU College of Commissioners in November 2009, which is designed to support the
The Group Executive Committee assisted by the Group Business Risk Committee and the Group Asset and Liability Committee, supports the Group Chief Executive in ensuring the effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, whilst also reviewing the Group’s aggregate risk exposures and concentrations of risk.
The Group Asset and Liability Committee is responsible for the strategic management of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. It is also responsible for the risk management framework for market risk, liquidity risk, capital risk and earnings volatility. The Group Asset and Liability Committee is supported by the Senior Asset and Liability Committee. This Senior Level Committee is responsible for the review of documentation relating to the management of assets and liabilities in the Group’s balance sheet and the escalation of issues of group-level significance to the Group Asset and Liability Committee. It is also supported by the Group Market Risk Forum which escalates matters relating to the strategic management of the Group’s structural market risks, including market risks held in the Group’s insurance companies.
– The Group Credit Risk Committee, which is responsible for the development and effectiveness of the Group’s credit risk management framework, clear description of the Group’s credit risk appetite, setting of high-level Group credit policy, and compliance with regulatory credit requirements. On behalf of the Group Business Risk Committee, the Group Credit Risk Committee monitors and reviews the Group’s aggregate credit risk exposures and concentrations of risk.
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The Group uses an enterprise-wide risk management framework for the identification, assessment, measurement and management of risk. It seeks to maximise value for shareholders over time by aligning risk management with the corporate strategy, assessing the impact of emerging risks from legislation, new technologies or the market, and developing risk tolerances and mitigating strategies. The framework seeks to: strengthen the Group’s ability to identify and assess risks, aggregate group-wide risks and define the group risk appetite, develop solutions for reducing or transferring risk, and where appropriate, exploit risks to gain competitive advantage, thereby seeking to increase shareholder value. The principal elements of the risk management framework are shown in table 1.2. The framework above comprises 11 interdependent activities which map to the components of the internal control integrated framework issued by the Committee of Sponsoring Organisations of the Treadway Commission.
Divisional and business unit policy is only produced by exception and is not necessary unless there is a specific area for which a particular division or business unit requires a greater level of detail than is appropriate for group level policy. The governance arrangements for development of, and compliance with, group, divisional and business unit policy and the associated accountabilities are clearly outlined to all colleagues.
Colleagues are expected to be aware of policies and procedures which apply to them and their work and to observe the relevant policies and procedures. Line management in each business area has primary responsibility for ensuring that group policies and the relevant local policies and procedures are known and observed by all colleagues within that area.
Risk reporting is standardised through the use of standard definitions to enable risk aggregation. Divisions monitor their risk levels against their risk appetite, seeking to ensure effective mitigating action is being taken where appropriate. Divisional risk reports are reviewed by each divisional executive committee to ensure that respective senior management are satisfied with the overall risk profile, risk accountabilities and progress on any necessary action plans and tracking. Reporting, including that of performance against relevant limits or policies, is in place to provide a level of detail appropriate to the exposures concerned and regular information is provided to Group Risk for review and aggregate reporting. The monitoring process requires that significant issues are appropriately reported, and an escalation process is in place to report significant losses to appropriate levels of management. Regular reports are prepared by Group Risk on risk exposures and material issues to the Group Asset and Liability Committee, Group Business Risk Committee, Group Executive Committee, Risk Committee and the Board.
At present the most significant risks faced by the Group, which are derived from the primary risk drivers detailed in table 1.3 below, are: Risk: Definition Features
Credit: The risk of reductions in earnings and/or value, through financial 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).
Arising in the Retail, Wholesale and Wealth and International divisions, reflecting the risks inherent in the Group’s lending activities and, to a much lesser extent in the Insurance division in respect of investment of own funds. Adverse changes in the credit quality of the Group’s UK and/or international borrowers and counterparties, or in their behaviour, would be expected to reduce the value of the Group’s assets and materially increase the Group’s write-downs and allowances for impairment losses. Credit risk can be affected by a range of factors, including, inter alia, increased unemployment, reduced asset values, increased personal or corporate insolvency levels, reduced corporate profits, increased interest rates or higher tenant defaults. Over the last three years, the global banking crisis and economic downturn has driven cyclically high bad debt charges. These have arisen from the Group’s lending to: – Wholesale customers (including those in Wealth and International): where companies continue to face difficult business conditions, resulting in elevated corporate default levels, illiquid commercial property markets and heightened impairment charges. The Group has high levels of exposure in both the UK and internationally, including Ireland, USA and Australia. There are particular concentrations to financial institutions and commercial real estate, including secondary and tertiary locations.
– Retail customers (including those in Wealth and International). UK bad debts have reduced materially in 2010 as a result of risk management activity and more stable, low interest rate UK economic conditions. This portfolio will remain strongly linked to the economic environment, with inter alia house prices fall, unemployment increases, consumer over-indebtedness and rising interest rates all likely to impact both secured and unsecured retail exposures.
The Group follows a through the economic cycle, relationship based, business model with risk management processes, appetites and experienced staff in place.
Evolving capital and liquidity requirements continue to be a priority for the Group. In September 2010 and further clarified in December 2010, the Basel Committee on Banking Supervision put forward proposals for a reform package which changes the regulatory capital and liquidity standards, the definition of ‘capital’, introduces new definitions for the calculation of counterparty credit risk and leverage ratios, additional capital buffers and development of a global liquidity standard. Implementation of these changes is expected to be phased in between 2012 and 2018.
Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.
The primary insurance risk carried by the Group’s defined benefit pension schemes is related to longevity.
The FSA continues to drive focus on conduct of business activities and has established a new approach to supervision of Conduct Risk, replacing the previous ‘Treating Customers Fairly’ initiative for retail customers. Under this new regime the FSA has indicated that it will seek to place greater emphasis on product governance and contract terms in general, and will seek to intervene much earlier in the product lifecycle to prevent customer detriment. The FSA also continues to carry out thematic reviews on a variety of issues across the industry as a whole, for example complaints handling. The Group actively engages with the regulatory authorities and other stakeholders on these key customer treatment challenges, which includes for example, PPI (see note 54 to the financial statements on page 237 ‘Contingent liabilities and commitments’).
The Group’s remuneration arrangements encourage compliant and appropriate behaviour from colleagues, in line with group policies, values and short and long term people risk priorities. The Group has continued to work closely with regulators, to seek to ensure compliance with our obligations. However, there is recognition that international consensus must be achieved to avoid UK institutions being significantly disadvantaged in attracting and retaining the highest calibre talent.
The Group continues to manage union relationships actively and the majority of colleagues are now on harmonised Terms and Conditions. There is strong ongoing commitment to support and retain colleagues throughout a period of significant integration and organisational change. Active monitoring of the Colleague Engagement Survey, allows the Group to understand engagement levels. These continue to increase and are now exceeding industry benchmarking for high performing organisations.
The integration of the two heritage organisations continues to be one of the largest integration challenges that has been seen in the UK financial services industry. The Group’s Integration Execution Board, chaired by the Group Operations Director, continues to oversee the integration process and progress is being regularly reviewed by the Group Executive Committee and Group Board. While there continue to be delivery risks to the programme, not least the risk of new regulatory requirements which may have an effect on resourcing, the Group is now two years into the integration programme and has a fully developed and functioning governance framework to manage these risks. There is a clear understanding of the phased deliverables to ensure effective delivery through to 2012.
EXPOSURES The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions and corporate clients. The credit risk exposures of the Group are set out in note 56 to the financial statements on page 251. Credit risk exposures are categorised as ‘retail’ arising in the Retail and Wealth and International Divisions and ‘wholesale’ arising in the Wholesale and Wealth and International Divisions.
Credit risk can also arise from debt securities, private equity investments, derivatives and foreign exchange activities. Note 19 to the financial statements on page 184 shows the total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2010. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 56 on page 251.
The Group’s rating systems assess probability of default and if Advanced, exposure at default and loss given default, in order to derive an expected loss. (If not Advanced, regulatory prescribed exposure at default and loss given default values are used in order to derive an expected loss). In contrast, impairment allowances are recognised for financial reporting purposes only for loss events that have occurred at the balance sheet date, based on objective evidence of impairment (see note 2(H) to the financial statements on page 158). Due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements differs from the amount determined from the expected loss models that are used for internal operational management and banking regulation purposes.
The Group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of counterparty. In its principal retail portfolios and a number of wholesale lending portfolios, exposure at default and loss given default models are also in use. They have been developed internally and use statistical analysis, combined, where appropriate, with external data and subject matter expert judgement. Each rating model is subject to a validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. The most material rating models are approved by the Group Model Governance Committee.
Credit principles and policy: Group Risk sets out the Group credit principles and policy according to which credit risk is managed, which in turn is the basis for divisional and business unit credit policy. Principles and policies are reviewed at least annually, and any changes are subject to a review and approval process. Divisional and business unit policies include lending guidelines, which define the responsibilities of lending officers and provide a disciplined and focused benchmark for credit decisions.
Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market movements. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.
Individual credit assessment and sanction: Credit risk in wholesale portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty underwriting are the same as that for assets intended to be held over the period to maturity.
Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite. Credit policy is aligned to the Group’s risk appetite and restricts exposure to certain high risk countries and more vulnerable sectors and segments. Note 21 to the financial statements on page 188, provides an analysis of loans and advances to customers by industry (for wholesale customers) and product (for retail customers). Exposures are monitored to prevent an excessive concentration of risk. These concentration risk controls are not necessarily in the form of a maximum limit on lending, but may instead require new business in concentrated sectors to fulfil additional hurdle requirements. The Group’s large exposures are reported in accordance with regulatory reporting requirements.
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Collateral The principal collateral types for loans and advances are: – mortgages over residential and commercial real estate; – charges over business assets such as premises, inventory and accounts receivables; – charges over financial instruments such as debt securities and equities; and
Other credit risk transfers The Group also undertakes asset sales, securitisations and credit derivative based transactions as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.
These specialist support teams utilise a range of techniques (including debt for equity swaps, sale of business and restructuring options) to preserve viable companies wherever possible and undertake regular reviews so that the customer receives the appropriate level of support. The reviews are also designed to ensure that support strategies continue to be relevant and are being executed.
To support UK retail customers who are encountering financial difficulties, the Group has launched a cross-channel support programme. The Group provides support to customers in difficulty via trained colleagues in branches and dedicated telephony units, and via online guidance material. For those customers requiring more intensive help, assistance is provided through dedicated support units where tailored repayment programmes can be agreed. Customers are actively supported and referred to free money advice agencies where they have multiple credit facilities including those external to the Group, that require restructuring.
– Homeowner Mortgage Support Scheme: This is a medium-term Government initiative that enables borrowers affected by temporary reductions in income to access reduced payments for a period of up to two years. The Government provides a partial guarantee to the Group whilst a customer participates in the plan. Decisions on eligibility, principally whether the Group expects the borrower’s earnings to recover fully, initially rest with the Group and must be made on the basis of detailed information received from an independent fee-free advisor. After a year, the customer must undergo a further full assessment made by the advice agency. The customer must pay at least 30 per cent of the interest due. Any shortfall in payments made during the period covered by the scheme is collected through increased payments over the remaining term.
– HomeBuy Direct: The HomeBuy Direct scheme covers certain newly built homes on specific housing developments across England. The scheme is provided through ‘HomeBuy agents’. HomeBuy agents are housing associations that have been authorised to run schemes for people who have difficulty buying a home. Customers can only buy a home through HomeBuy Direct if their household earnings are no more than £60,000 per annum, and they cannot otherwise afford to buy a home in their area. The HomeBuy Direct scheme is open to people who rent council or housing association properties; ‘key workers’ in the public sector (e.g. teachers) and first-time buyers. The scheme provides up to 30 per cent of the purchase price through an equity loan that has no repayments for the first five years. After this there is an annual fee of 1.75 per cent, which will increase annually with inflation. The customer can increase their share of ownership at any time.
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– Term extensions: This allows customers to extend their mortgage term in order to reduce their contractual monthly payment. The maximum term is aligned to the overall standard term limits for mortgages and there is no forbearance of any debt.
In addition to these household-related initiatives, the Group, through its banking businesses, participates in a number of initiatives designed to assist small and medium-sized enterprises. These include: – The Lending Code: Introduced by the British Bankers’ Association in November 2009, the Lending Code is a voluntary set of commitments and standards of good practice to ensure that lenders act fairly and reasonably in all dealings with customers.
– As part of the Group’s commitment to the Statement of Principles, it issues a Letter of Concern to customers when it has concerns about their business or the Group’s relationship with them. This ensures that the customer understands the Group’s concerns; the approach aims to generate early dialogue between the customer and the Group, so that a joint approach to the situation can be developed.
OVERVIEW – The Group achieved a significant reduction in the impairment charge in 2010 to £13,181 million (from £23,988 million in 2009), due to the stabilisation of the wholesale portfolios and good retail affordability and performance. Improvements in Wholesale and Retail more than offset increased impairment charges in Ireland and Australia, caused by difficult market conditions.
– The Group’s level of impairment is being managed successfully in the current challenging economic environment by the Wholesale business support units and Retail collection and recovery units. The business support model has been expanded from Wholesale across Wealth and International division, with a central team established to manage its business support activity globally. The Group has also strengthened resources within Retail collections and recoveries to enable more timely engagement with customers experiencing difficulties to drive more effective customer outcomes.
– The Group actively reduced limits to Portugal, Ireland, Italy, Greece and Spain over the last two years, with the associated country risk profile modest in the context of the Group’s asset base. Except for Ireland, the 2011 base case impairment forecast for these countries is de-minimis in the context of the Group.
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SECURED IMPAIRED LOANS (unaudited) Impaired loans decreased by £0.4 billion to £6.8 billion at 31 December 2010 and, as a percentage of closing loans and advances to customers, reduced to 2.0 per cent from 2.1 per cent at 31 December 2009. The reduction in the value of impaired loans reflects the continued ability of customers to afford their mortgage payments in a low interest rate environment.
SECURED ARREARS (unaudited) The percentage of mortgage cases greater than three months in arrears (excluding repossessions) remained stable at 2.3 per cent at 31 December 2010 compared to 31 December 2009.
Secured loan to value analysis (unaudited) Management actions have resulted in new lending quality remaining strong. The average loan-to-value ratio (LTV) for new mortgages and further advances written in 2010 was 60.9 per cent compared with 59.3 per cent for 2009. This is primarily driven by a greater proportion of new lending to first-time buyers and home movers delivering on the Group’s commitment to support new home owners. The average indexed LTV on the mortgage portfolio at 31 December 2010 was 55.6 per cent compared with 54.8 per cent at 31 December 2009. House prices, having initially increased, fell in the second half of 2010 resulting in the indexed LTV in excess of 100 per cent ending 2010 at 13.2 per cent of the mortgage portfolio (£44.9 billion), compared with 13.0 per cent (£44.8 billion) at 31 December 2009. The tables below show LTVs across the principal mortgage portfolios.
The increased average LTVs for impaired Buy to let mortgages, is driven by the modest net fall in house prices and the seasoning of higher risk lending that was closed at the start of 2009.
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– Impairment experience in 2010 was better than guided a year ago as stabilising economic conditions led to lower impairment charges especially in the corporate real estate, real estate related and Corporate (UK and US) portfolios.
– A robust credit risk management and control framework is in place across the combined portfolios and a prudent risk appetite approach (largely based on Lloyds TSB’s model) continues to be embedded across the division. Significant resources have been deployed into the business support units focused on key and vulnerable obligors and asset classes.
IMPAIRED LOANS AND PROVISIONS (audited) Wholesale’s impaired loans reduced by £600 million to £34,514 million compared with 31 December 2009. The reduction is due to new impaired assets (mainly in the Corporate Real Estate Business Support Unit) being offset by write-offs on irrecoverable assets and the sale of previously impaired assets. Impairment provisions also reduced as a result of the write-offs and a lower impairment rate on recently impaired assets. As a result, impairment provisions as a percentage of impaired loans reduced to 45.9 per cent from 48.9 per cent at 31 December 2009. As a percentage of closing loans and advances to customers, impaired loans increased to 18.4 per cent from 16.6 per cent at 31 December 2009. This increase is essentially a factor of the reducing level of total loans and advances to customers as at 31 December 2010 compared with 31 December 2009. We continue to monitor our vulnerable portfolios within Wholesale and, where appropriate, remedial risk mitigating actions are being undertaken.
OUTLOOK – WHOLESALE (unaudited) The potential effects of the UK Government’s austerity measures on portfolios vulnerable to Government spending cuts are currently unknown. Although appropriate early warning indicators and action plans are in place to help mitigate against this, we would expect some negative effect on the portfolio. This is especially so in the traditional customer lending businesses, which are vulnerable to reduced consumer spending as a result of tax rises, and other UK Government austerity measures. As previously guided, we expect the overall net impairment charges in our traditional lending businesses (especially in the trading and manufacturing sectors) to increase in 2011, driven in part by a lower benefit from write backs on asset disposals and the effect of the UK Government austerity measures on the wider economy.
Wholesale retains some material single obligor concentrations on weaker credits, especially from the heritage HBOS real estate and real estate related portfolios. These portfolios (especially the secondary and tertiary assets which comprise a large part of the heritage HBOS corporate real estate and real estate related portfolio) remain vulnerable to an increase in tenancy defaults and reduced capital values from an already depressed level, particularly in the regions. However, against our base case assumptions, we expect our impairment charges in corporate real estate to be lower than 2010 as a result of a continuing stabilisation of the existing portfolio and actions taken in 2009 and 2010. Whilst we therefore remain cautious in respect of the outlook for 2011, we do expect a modest reduction in the total impairment charge for 2011 as a whole.
Overview Business review Governance Financial statements Other information 85 Group profile 1
Mid-market Corporate – As anticipated, the slightly more benign conditions experienced in the first half of 2010 were not sustained in the second half in the corporate mid-market. Impairments rose during the second half of the year, albeit to levels still significantly below those experienced in 2009, with legacy issues in the heritage HBOS portfolio continuing to be a significant driver of impairments in 2010. Although a number of exporters have been able to take advantage of a beneficial exchange rate, the corporate middle market is dominated by domestically focused businesses and the prospect of public sector spending cuts, tax increases and continuing high commodity and import prices is likely to see confidence remain fragile in 2011.
Financial Institutions – As part of the Group’s funding, liquidity and general hedging requirements, Corporate maintains relationships with many major financial institutions throughout the world. During the second half of 2010, concerns about sovereign fiscal deficits and public sector debt levels increased our scrutiny of the European banking sector, in particular the weaker Eurozone countries. Trading exposures are in large part collateralised and interbank activity is mainly with high investment grade counterparties.
TREASURY AND TRADING Treasury and Trading acts as the link between the wholesale markets and the Group’s balance sheet management activities and provides pricing and risk management solutions to both internal and external clients.
– As part of the closure of Bank of Scotland (Ireland) Limited, a dedicated UK based business support unit credit team has been put in place to manage the wind down of the Irish book.
Impairment provisions as a percentage of impaired loans increased to 52.5 per cent from 39.4 per cent at 31 December 2009. In the International business the increase in impairment provisions is due to a higher level of impaired loans and an increased coverage level, particularly in Ireland.
TABLE 1.14: IMPAIRMENTS ON WEALTH AND INTERNATIONAL LOANS AND ADVANCES (audited) As at 31 December 2010
TABLE 1.15: IMPAIRMENTS ON IRELAND LOANS AND ADVANCES As at 31 December 2010
The most significant contribution to impairment in Ireland is the commercial real estate portfolio. Impairment provisions provide 52 per cent coverage on impaired commercial real estate loans – reflecting peak to trough falls in commercial property and house prices widening to 60 per cent and 38 per cent respectively. Mortgage lending at the year end comprised 96 per cent of the retail portfolio with impaired loans of £0.8 billion and impairment coverage of 65 per cent.
Following the closure of the Irish business, the portfolio is in run-off although current levels of redemptions and recoveries are low due to a severe lack of liquidity.
WHOLESALE EUROPE Total impaired loans increased by £470 million, or 88 per cent to £1,007 million compared with £537 million at 31 December 2009 and as a percentage of closing loans and advances increased to 13.8 per cent from 6.1 per cent at 31 December 2009. Impairment charges increased by £81 million to £210 million compared to £129 million in 2009. Impairment charges as a percentage of average loans and advances to customers increased to 2.8 per cent from 2.3 per cent in 2009. Commercial real estate is the primary driver of the impairment charge in Wholesale Europe reflecting a small number of specific transactions.
DEFINITION The risk of reductions in earnings, value and/or reserves, through financial or reputational loss, arising from unexpected changes in financial prices, including interest rates, inflation rates, exchange rates, credit spreads and prices for bonds, commodities, equities, property and other instruments. It arises in all areas of the Group’s activities and is managed by a variety of different techniques.
Banking – non-trading Market risk in non-trading books consists almost entirely of exposure to changes in interest rates including the margin between interbank and central bank 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.
TABLE 1.18: INSURANCE PORTFOLIOS As at 31 December 2010 2009 £m £m
Market risk in the Group’s retail portfolios and in the Group’s capital and funding activities is managed centrally within limits defined in the detailed Group policy for interest rate risk in the banking book, which is reviewed and approved annually.
– Investment strategy for surplus assets held in excess of liabilities takes account of the legal, regulatory and internal business requirements for capital to be held to support the business now and in the future.
Insurance risk is primarily controlled via the following processes: – Underwriting (the process to ensure that new insurance proposals are properly assessed)
The most significant insurance risks in the life assurance companies are longevity risk and persistency risk. The merits of longevity risk transfer and hedging solutions are regularly reviewed. By their nature persistency risks are difficult to hedge.
Financial crime The risk of reductions in earnings and/or value, through financial or reputational loss, associated with financial crime and failure to comply with related legal and regulatory obligations, these losses may include censure, fines or the cost of litigation.
Security The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft of or damage to the Group’s assets, the loss, corruption, misuse or theft of the Group’s information assets or threats or actual harm to the Group’s people. This also includes risks relating to terrorist acts, other acts of war, geopolitical, pandemic or other such events.
Change The risk of reductions in earnings and/or value, through financial or reputational loss, from change initiatives failing to deliver to requirements, budget or timescale, failing to implement change effectively or failing to realise desired benefits.
RISK APPETITE The Group has developed an impact on earnings approach to operational risk appetite. This involves looking at how much the Group could lose due to operational risk losses at various levels of certainty.
The Group encourages and maintains an appropriately balanced legal and regulatory compliance culture and promotes policies and procedures to enable businesses and their staff to operate in accordance with the laws, regulations and voluntary codes which impact on the Group and its activities.
Customer treatment and how the Group manages its customer relationships affects all aspects of the Group’s operations and is closely aligned with achievement of the Group’s strategic aim – to create deep long lasting relationships with its customers. There is currently a high level of scrutiny regarding the treatment of customers by financial institutions from the press, politicians and regulatory bodies, which includes, for example PPI (see note 54 to the financial statements on page 237 ‘Contingent Liabilities and Commitments’).
MEASUREMENT Both Lloyds TSB and HBOS had operational risk Advanced Measurement Approach Waivers, granted by the FSA, enabling the use of an internal capital model for calculating regulatory capital. As part of its integration programme, Lloyds Banking Group is in the process of moving to The Standardised Approach (TSA) and, in anticipation of this, calculated regulatory capital for the year ended 31 December 2010 on the basis of TSA.
Overview Business review Governance Financial statements Other information 93 Group profile 1
RISK APPETITE (audited) Liquidity and funding risk appetite for the banking businesses is set by the Board and reviewed on an annual basis. This statement of the Group’s overall appetite for liquidity risk is reviewed and approved annually by the Board. With the support of the Group Asset and Liability Committee, the Group Chief Executive allocates this risk appetite across the Group. It is reported through various metrics that enable the Group to manage liquidity and funding constraints. The Group Chief Executive, assisted by the Group Asset and Liability Committee and its sub-committee the Senior Asset and Liability Committee, regularly reviews performance against risk appetite.
EXPOSURE (audited) Liquidity exposure represents the amount of potential outflows in any future period less committed inflows. Liquidity is considered from both an internal and regulatory perspective.
The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and has been supported by stable funding from the wholesale markets with a reduced dependence on short-term funding. A substantial proportion of the retail deposit base is made up of customers’ current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to raise interbank deposits and to issue certificates of deposit and commercial paper to meet short-term obligations. The Group’s short-term money market funding is based on a qualitative analysis of the market’s capacity for the Group’s credit. The Group has developed strong relationships with certain wholesale market segments, and also has access to corporate customers to supplement its retail deposit base.
In June 2010, the FSA introduced a new liquidity framework (Individual Liquidity Adequacy Standards – ILAS) bringing in enhanced systems and controls, quantitative requirements, reporting requirements and stress testing. As part of the ILAS framework, the FSA has issued an Individual Liquidity Guidance (ILG) to the Group, representing a new regulatory requirement, which was effective from 1 June 2010. The Group has maintained its liquidity levels above the ILG regulatory minimum since inception.
Excludes £3.1 billion (31 December 2009: £1.1 billion) of reverse repurchase agreements.
A reconciliation to the Group’s balance sheet is provided on page 97.
Overview Business review Governance Financial statements Other information 97 Group profile 1
RISK APPETITE Capital risk appetite is set by the Board and reported through various metrics that enable the Group to manage capital constraints and market expectations. The Group Chief Executive, assisted by the Group Asset and Liability Committee, regularly reviews performance against risk appetite. A key metric is the Group’s core tier 1 capital ratio. The Group’s target for this and other aspects of appetite will be reviewed in 2011 in the light of further clarity of regulatory and accounting reforms.
A number of limits are imposed by the FSA on the proportion of the regulatory capital base that can be made up of subordinated debt and preferred securities; for example the amount of qualifying tier 2 capital cannot exceed that of tier 1 capital.
MONITORING Capital is actively managed and regulatory ratios are a key factor in the Group’s budgeting and planning processes. 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, including those that would occur under stressed scenarios, is made to the Senior Asset and Liability Committee, the Group Asset and Liability Committee and the Board.
Overview Business review Governance Financial statements Other information 99 Group profile 1
TIER 1 CAPITAL Core tier 1 capital increased by £1,567 million largely reflecting the issue of ordinary shares in exchange for certain preference shares, preferred securities and undated subordinated debt issued by the Group. This has been partially offset by a deduction in respect of post-retirement benefits reflecting the impact of the curtailment gain, which is not allowed for capital purposes and a commitment to make increased deficit contributions to the HBOS final salary pension scheme following the completion of an actuarial valuation.
SUPERVISORY DEDUCTIONS Supervisory deductions mainly consist of investments in subsidiary undertakings that are not within the banking group for regulatory purposes. These investments are primarily the Scottish Widows and Clerical Medical life and pensions businesses, together with the general insurance business. Supervisory deductions relating to these businesses have benefitted from repatriation of capital during the year. Also included within deductions for other unconsolidated investments at 31 December 2010 are investments in non-financial entities that are held by our private equity (including venture capital) businesses. These investments were previously risk weighted in accordance with industry wide guidance provided by the FSA. This guidance has now expired.
Overview Business review Governance Financial statements Other information 101 Group profile 1
TABLE 1.29: ANALYSIS OF CAPITAL RATIOS As at 31 December Lloyds TSB Bank
Capital ratios for Lloyds TSB Bank Group reflect a change in shareholding completed during the year whereby HBOS plc and its subsidiaries are now subsidiaries of Lloyds TSB Bank plc. Capital ratios of both Lloyds TSB Bank Group and BOS Group have improved during the year primarily due to reductions in risk weighted assets.
DEFINITION The risk of reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies, ineffective controls over financial, prudential regulatory and tax reporting, failure to manage the associated risks of changes in taxation rates, law, ownership or corporate structure and the failure to disclose accurate information about the Group on a timely basis.
MITIGATION The Group maintains a system of internal controls, which is designed to be consistently applied and to enable the preparation and disclosure of financial, prudential regulatory and tax reporting in accordance with applicable International Financial Reporting Standards, statutory and regulatory requirements. The system of internal control is designed to ensure that accounting policies are consistently applied, transactions are recorded and undertaken in accordance with delegated authorities, that assets are safeguarded and liabilities are properly recorded.
REGULATORY CAPITAL REQUIREMENTS Each life insurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FSA; the basis of calculating the regulatory capital requirement is given below. Except for Scottish Widows and Clerical Medical, the regulatory capital requirement is a combination of amounts held in respect of actuarial reserves, sums at risk and maintenance expenses (the Long-Term Insurance Capital Requirement) and amounts required to cover various stress tests (the Resilience Capital Requirement). The regulatory capital requirement is deducted from the available capital resources to give ‘statutory excess capital’.
The realistic valuation of liabilities includes an allowance for future bonuses. Options and guarantees are valued using a stochastic simulation model which values these liabilities on a basis consistent with tradable market option contracts (a ‘market-consistent’ basis). The model takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given in the section entitled ‘Options and guarantees’ on page 107.
The determination of realistic liabilities of the With Profit Funds includes the value of internal transfers expected to be made from each With Profit Fund to the Non Profit Fund held within the same life insurance entity. These internal transfers may include charges on policies where the associated costs are borne by the Non Profit Fund. The With Profit Insurance Capital Component may be reduced by the value, calculated in the stress test scenario, of these internal transfers, but only to the extent that credit has not been taken for the value of these charges in deriving actuarial reserves for the relevant Non Profit Fund.
Shareholders’ funds: Held outside the long-term funds – – – 1,048 651 1,699
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 according 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 on traditional with-profits business. 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.
Available capital in the Clerical Medical With Profit Fund has decreased from £732 million at 31 December 2009 to an estimated £263 million at 31 December 2010. The fund commenced a distribution of the excess estate from 1 February 2010 by enhancing the level of future expected benefit payments
UK LIFE SHAREHOLDER FUNDS Available capital in the UK Life Shareholder Funds has increased from £2,059 million at 31 December 2009 to an estimated £2,486 million at 31 December 2010. The receipt of £410 million proposed transfers from the UK Non Profit Fund and the £176 million impact of a capital restructuring exercise in the Scottish Widows Group to help mitigate the potential impacts of Basel III have been partially offset by the payment of coupons on subordinated debt and a dividend of £210 million from Scottish Widows plc to its parent company.
TABLE 1.32: ANALYSIS OF POLICYHOLDER LIABILITIES Scottish Widows With Profit Fund
Insurance and participating investment contract liabilities 13,845 10,394 47,173 8,101 79,513
Overview Business review Governance Financial statements Other information 107 Group profile 1
WITH PROFIT FUNDS The with-profit realistic liabilities and the available capital for the WithProfit Funds are sensitive to both market conditions and changes to a number of non-economic assumptions that affect the valuation of the liabilities of the fund. The available capital resources (and capital requirements) are sensitive to the level of the stock market, with the position worsening at low stock market levels as a result of the guarantees to policyholders increasing in value. However, the exposure to guaranteed annuity options increases under rising stock market levels. An increase in the level of equity volatility implied by the market cost of equity put options also increases the market consistent value of the options given to policyholders and worsens the capital position. Various hedging strategies are used to manage these exposures.
The Group has sold insurance products that contain options and guarantees, both within the With Profit Funds and in other funds.
Joined the Board in March 2009. President and Chief Executive of the Securities Industry and Financial Markets Association. Held a number of senior appointments in JP Morgan Chase from 1993 to 2008 including Vice Chairman, financial institutions and governments, from 2005. A Director of the US-Japan Foundation, Great-West Life Annuity Insurance Co. and Putnam Investments and a member of the Global Markets Advisory Committee for the National Intelligence Council. A former Director in the Office of Thrift Supervison, US Department of the Treasury and Koram Bank and the International Foundation of Election Systems. Aged 65.
Joined the Board in 2001 as Group Executive Director, UK retail banking before his appointment as Group Chief Executive in June 2003. Served with Citibank from 1975 and held a number of senior and general management appointments in the USA, South America and Europe before becoming Chief Operating Officer of Citibank Consumer Bank in 1998. Following the Citibank/Travelers merger in 1998, he was Chairman and Chief Executive Officer of Travelers Life and Annuity until 2000. A Non-Executive Director of BT Group. Aged 59.
Joined the Group in 2003 as Managing Director, Corporate Banking before being appointed to the Board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was President and Chief Executive Officer of eCharge Corporation from 1999 to 2001 and co-founder and Vice Chairman of the Board of Chase Cost Management Inc from 1996 to 2003. A Non-Executive Director of BritishAmerican Business Inc and AFME. Chairman of Arora Holdings and a Director of Business in the Community and a Director and Trustee of In Kind Direct. Aged 60.
Archie G Kane Group Executive Director, Insurance (Board Representative for Scotland)
DIRECTORS’ INDEMNITIES The directors, including the former director who retired during the year, have entered into individual deeds of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ for the purposes of the Companies Act 2006. These deeds were in force during the whole of the financial year or from the date of appointment in respect of the directors who joined the Board in 2010 and 2011. The indemnities remain in force for the duration of a director’s period of office. Deeds for existing directors are available for inspection at the Company’s registered office.
In addition, 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 47 on page 224). 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.
EMPLOYEES Lloyds Banking Group is committed to providing employment practices and policies which recognise the diversity of our workforce and ensure equality for employees regardless of sex, race, disability, age, sexual orientation or religious belief.
– the management report contained in the Business Review includes a fair review of the development and performance of the business and the position of the Company and Group, together with a description of the principal risks and uncertainties that they face.
We understand the reliance that investors, customers and other stakeholders place on our corporate governance arrangements and the need to ensure the integrity of those processes. At the same time, I am aware from discussions with shareholders that there is a strong desire to understand more about the Board’s thinking in this area, not just the end result. By way of response, I want to use this statement to explain our approach to corporate governance and how we have ensured compliance with all the principles of the Financial Reporting Council’s Combined Code (the Code), for our financial year ended 31 December 2010.
We operate a unitary Board with all Directors collectively responsible for the long term success of the Company. The Chairman ensures that Directors are kept advised of key developments, that they receive timely and relevant information and are involved in relevant decisions. It is expected that all Directors, but particularly the Non-Executive Directors, constructively challenge proposals that come to the Board for decision.
In addition to the matters that it reserves to itself, the Board delegates certain matters to its Committees. This delegation ensures that adequate time is devoted by Board members to the independent oversight of key controls.
All Committees report to the Board through reports from Committee Chairmen with respect to each meeting. During 2010, the Chairman’s Committee was disbanded. Matters previously delegated to the Chairman’s Committee were either transferred to the Nomination & Governance Committee which reports to the Board, or a Board agenda review meeting. Further information on the membership, role and activities of each of the Committees during 2010 is detailed on pages 120 and 121.
Since joining the Board in September 2009, one of my priorities has been to review the composition of the Board to ensure that the overall Board and Committee structure is appropriate for an organisation of the breadth and scale of Lloyds Banking Group.
BOARD CHANGES The Nomination & Governance Committee has overseen a number of changes to the Board during the year. For new Non-Executive Directors, the process was conducted by the Nomination & Governance Committee with the support of an executive search firm, JCA Group. The Group Chief Executive’s succession process was managed by a special sub-committee; details of which are set out in Group Chief Executive Succession.
– António Horta-Osório joined the Board as an Executive Director on 17 January 2011 and succeeds Eric Daniels as Group Chief Executive on 1 March 2011. The process leading to his appointment is explained in Group Chief Executive Succession.
Biographies for all current directors can be found on pages 110 and 111.
Overview Business review Governance Financial statements Other information 117 Group profile 1
Lloyds Banking Group Annual Report and Accounts 2010 to plan for longer term succession. The average tenure of our Non-Executive Directors is nearly three years. Non-Executive Directors are currently appointed for three year terms. Following the move to annual re-election of Directors, Non-Executive Directors will in future be appointed on a rolling 12 months basis.
– a bespoke induction plan prepared in consultation with me, tailored to the individual needs of the Director, to the specific role that they will carry out, and their skills/experience to date.
Board training The Board receives regular refresher training and information sessions to address current business or emerging issues. During 2010, Non-Executives undertook approximately five days of training, including 12 hours of structured training during Board meetings. This is delivered through a variety of means, including sessions on matters such as liquidity and funding, stress testing, living wills, the Bribery Act and special Board sessions covering matters such as the Individual Capital Adequacy Assessment Process and training for Approved Persons. In addition, the Audit Committee arranged a series of ‘deep dives’ to which all Board members were invited, and which provided an in-depth review of the operations of each of the business divisions and of the latest accounting standards and operating methodologies. Half day sessions were delivered for each division amounting to three days in total.
The Company Secretary oversees communications with private shareholders. The Group’s annual general meeting provides an opportunity to meet the Group’s Directors and to hear more about the strategy of the Group. Shareholders are encouraged to attend the annual general meeting and to raise any questions at the meeting or in advance, using the email address shown in the pack which will be sent to shareholders in March 2011.
Overview Business review Governance Financial statements Other information 119 Group profile 1
In conclusion, I am pleased to confirm that the Group complied with all relevant provisions of the Code throughout the year ending 31 December 2010. As an early adopter of several of the recommendations contained in the Walker Review, I believe the Group is well placed to comply with new provisions contained in the UK Corporate Governance Code which will apply to future reports, and to benefit thereby.
Number of meetings during the year 9 8 17 7 1 3 2 4 11 4
The table below sets out a summary of the membership and role of each of the Board Committees, along with the activities they performed during 2010. There is a standing invitation for all Non-Executive Directors to attend Committee meetings of which they are not members. All Committee terms of reference are available from the Company Secretary and are displayed on our website, www.lloydsbankinggroup.com.
Overview Business review Governance Financial statements Other information 121 Group profile 1
– reviewed litigation and regulatory risks; – received reports from the Divisional Financial Control Committees and the Group Business Risk Committee; – received reports from the internal audit department on internal controls, including SOX reports; – reviewed the Group’s key finance programmes; – reviewed details of the Group’s whistle blowing procedures and incidents; – discussed the mis-selling of PPI; and
The Board of Directors is responsible for the establishment and review of the Group’s system of internal control, which is designed to ensure effective and efficient operations, quality of internal and external reporting, internal control, and compliance with laws and regulations. It should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control, the Directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss.
(The split in the components in the above chart are for executive directors. Comparable numbers for the Group Chief Executive are: long-term incentive 40 per cent, short-term incentive 32 per cent and salary 28 per cent)
CONCLUSION During the course of 2010 our consultation with shareholders on executive remuneration has helped ensure that: – We are rewarding executives for delivery of the most important drivers of the business, improving both the financial and non-financial health of the business and with a medium and longer term focus on risk, capital and liquidity of the business.
The Committee determines the pensions policy for the Group and advises on other major changes to employee benefits schemes. It also agrees the policy for authorising claims for expenses from the Group Chief Executive and the Chairman. It has delegated power for settling remuneration for the Chairman, the Group Executive Directors, the Company Secretary and any group employee whose salary and bonus exceeds a specified amount, currently £750,000. To ensure compliance with the FSA Code of Practice, the Committee approves remuneration for remuneration Code Staff and that of senior risk and compliance officers.
– Glen Moreno (from 1 March 2010 to 17 June 2010)
– Determination of the appropriate remuneration packages for the new Group Chief Executive and a number of other senior new hires
– Bonus and salary awards for Executive Directors and key senior managers
Our objective is to align individual reward with the Group’s performance, the interests of its shareholders, and a prudent approach to risk management. In this way we balance the requirements of our various stakeholders: our customers, shareholders, employees, and regulators. This approach is in line with the Association of British Insurers best practice code on remuneration and the FSA Remuneration Code of Practice, as the policy seeks to reward long-term value creation whilst not encouraging excessive risk taking.
We build relationships with our customers and people. Working for Lloyds Banking Group is about more than pay. Our relationship with our people means that we want to pay them fairly and competitively, but our pay is positioned conservatively against the market and we do not seek to align with the highest payers in the sector. In setting pay for Executive Directors and senior managers, we take account of relative pay positioning and target levels of variable remuneration opportunity for all levels of employees in the Group.
We operate tough contract provisions relative to market practice, whereby no executive has an entitlement to more than 12 months’ notice (not taking into account recruitment provisions), pay in lieu of notice is limited to basic salary, is paid monthly over 12 months and is mitigated if the executive gets another job. This approach avoids the risk of payment for failure. These requirements are among the toughest in the FTSE 100.
Economic profit measures profit relative to the risk taken to generate that profit. Its use in our incentive plans encourages executives to take a prudent approach to risk.
We aim to ensure that the totality of remuneration for executive directors is competitive against our benchmark groups. These groups are other major UK banks and the top 20 companies in the FTSE 100, reflecting practices in large UK companies across all sectors. We aim to be competitively but conservatively positioned against the market, although for executive directors we have taken the decision to adopt a position that is behind market for 2011 in view of public concern.
His outstanding long-term incentive awards will continue to vest at the end of the relevant three year performance period to the extent the performance conditions have been met and will be pro-rated for service.
António Horta-Osório António Horta-Osório was appointed to the Board on 17 January 2011 and succeeds Eric Daniels as Group Chief Executive on 1 March 2011. In line with the Group’s prudent remuneration policy and the current operating environment, his salary was set on recruitment at the same level as the outgoing Group Chief Executive’s at £1,035,000. Recognising that this is behind the market, the committee decided to award an increase in line with the the other Executive Directors, effective from his start date. He also has a ‘reference salary’ of £1,220,000 that will be used to calculate certain elements of long-term remuneration, including his LTIP from 2012 and pension.
The Group agreed, as a condition of his accepting the appointment of Group Chief Executive on 1 March 2011, to grant him an LTIP award over the Group’s shares with a market value equal to 420 per cent of his base salary as at 7 March.
In order to fully promote alignment with shareholders, this pension provision will accrue over the first six years’ of service and is entirely dependent on the achievement of share price targets as follows: – At retirement, a percentage of reference salary (or basic salary if higher) for each of the first five calendar years of employment if in the last 90 days of that year the average share price of Lloyds Banking Group exceeds 75p (‘Average Share Price’). The percentage applicable is 4 per cent in year 1, 3.5 per cent in year 2 and 3 per cent in years 3, 4 and 5.
BASE SALARY Base salaries are reviewed annually, taking into account individual performance and market information (which is provided by Towers Watson and supplemented with information from Deloitte LLP) and normally adjusted from 1 January of the relevant year. The remuneration committee confirmed during the 2010 review that the FTSE 20 was the most appropriate comparator group to use to benchmark overall competitiveness of the remuneration package whilst taking particular account of the remuneration practice of our direct competitors, namely the major UK banks.
Our review showed that salary levels are significantly below market. However, we have continued to show restraint and made a moderate increase to base salaries in 2011, in line with the salary increase budget for other employees in the Group.
These targets are weighted differently for each of the Executive Directors, reflecting differing strategic priorities. The non-financial measures include key performance indicators relating to risk management, SME lending, process efficiency, service quality and employee engagement.
The remuneration committee believes that the structure of the incentive – in particular the use of risk-adjusted and non-financial measures – has been highly successful in promoting a long-term focus within the senior management team.
The maximum annual incentive opportunity is 200 per cent (225 per cent for the Group Chief Executive) of basic salary for the achievement of exceptional performance targets.
Report of the independent auditors on the consolidated financial statements 144 consolidated financial statements 146 notes to the consolidated financial statements 153
LONG-TERM INCENTIVE AWARD the current Ltip rules allow for awards to be made of up to 400 per cent of base salary. under normal circumstances, awards can be made of up to 300 per cent of salary with the additional 100 per cent available for circumstances that the Remuneration committee deems to be exceptional. in 2010, awards were made of up to 275 per cent of base salary to the executive directors. in 2011, the committee intends to make awards of 300 per cent of salary. As noted, for António Horta-osório his award for 2011 will be 420 per cent of his base salary.
LONG-TERM INCENTIVE PERFORMANCE MEASURES During the 2010 review, the committee was particularly mindful of driving sustainable performance through the cycle without encouraging excessive risk taking. the committee has consulted widely with shareholders on the topic of performance measures and sharing the growth in the company appropriately between shareholders and management. the committee believes that the performance measures for the 2011 Ltip award for the executive committee should be economic profit (ep), earnings per share (eps) and absolute total shareholder Return. these measures capture risk measurement, profit growth and shareholder experience and align shareholder experience and management reward.
Lord Leitch’s composite fee of £300,000 was amended to a fee of £200,000 from 1 March plus a £60,000 fee for Scottish Widows Services Ltd. The Scottish Widows fee was increased to £120,000 from 27 April 2010. Lord Leitch stood down as Senior Independent Director on 28 February 2010.
Overview Business review Governance Financial statements Other information 133 Group profile 1
The Group’s policy is for Executive Directors to have service agreements with notice periods of no more than one year. All current Executive Directors are entitled to receive 12 months’ notice from the Group, but would be required to give six months’ notice if they wished to leave.
António Horta-Osório’s initial contract will be for a two year term, diminishing to 12 months notice over the first year of employment.
Bonuses awarded in respect of 2010 performance will be subject to 100 per cent deferral into shares until at least March 2013.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2010 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme.
Column (d) is the equivalent transfer value, but calculated as at 31 December 2009 on the assumption that the director left service at that date.
At 1 January 2010 (or later date of appointment) At 31 December
None of the other directors at 31 December 2010 had options to acquire shares in Lloyds Banking Group plc or its subsidiaries.
As the performance conditions for those options granted in March 2000 and August 2000 were not met, the options lapsed in March 2010 and August 2010 respectively.
d Award vested at 31 per cent for Tim Tookey as he was not a director at the time the award was made. At vesting his award was adjusted to 106,586 from 69,242 to reflect the Capitalisation Issue and Rights Issue of 2009. The ‘vested during the year’ figure includes 6,298 dividend shares accumulated prior to the stopping of dividend payments. Award price adjusted to 267.3p from 539p. The closing market price of the Group’s ordinary shares on the date of release was 64.05p.
Tim Tookey was not an Executive Director when his award was made in 2007, and as such his award vested at 31 per cent on the same basis as other award recipients below the Group Executive Committee level.
For the other 50 per cent of the award (the ‘TSR Award’) – the performance condition was as described for March 2007 with the relevant performance period commencing on 6 March 2008 (the date of the March award) and ending on 5 March 2011.
Overview Business review Governance Financial statements Other information 141 Group profile 1
The aggregate amount set aside or accrued to provide pension, retirement or similar benefits for Directors and Senior Management for the year ended 31 December 2010 was £1,273,750 based on average pension cost of 25 per cent of salary.
Overview Business review Governance Financial statements Other information 143 Group profile 1
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As explained more fully in the Directors’ Responsibilities Statement on page 122, the directors are responsible for the preparation of the group financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the group financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
OPINION ON FINANCIAL STATEMENTS In our opinion the group financial statements: – give a true and fair view of the state of the group’s affairs as at 31 December 2010 and of its loss and cash flows for the year then ended; – have been properly prepared in accordance with IFRSs as adopted by the European Union; and – have been prepared in accordance with the requirements of the Companies Act 2006 and Article 4 of the lAS Regulation.
Under the Listing Rules we are required to review: – the directors’ statement, on page 113, in relation to going concern; – the part of the Corporate Governance Statement relating to the company’s compliance with the nine provisions of the June 2008 Combined Code specified for our review; and – certain elements of the report to shareholders by the Board on directors’ remuneration.
Share of results of joint ventures and associates 13 (88) (752)
Overview Business review Governance Financial statements Other information 147 Group profile 1
The directors approved the consolidated financial statements on 24 February 2011.
Liabilities arising from insurance contracts and participating investment contracts 38 80,729 76,179
The accompanying notes are an integral part of the consolidated financial statements. Restated (see note 1).1
Share capital Other Retained Non-controlling and premium reserves profits Total interests Total £ million £ million £ million £ million £ million £ million
Proceeds from sale and maturity of available-for-sale financial assets 45,999 490,561
Effects of exchange rate changes on cash and cash equivalents 479 (210)
(ii) IAS 27 Consolidated and Separate Financial Statements. Requires the effects of all transactions with non-controlling interests to be recorded in equity if there is no change in control; any remaining interest in an investee is remeasured to fair value in determining the gain or loss recognised in profit or loss where control over the investee is lost.
Investment vehicles, such as Open Ended Investment Companies (OEICs), where the Group has control, typically through acting as fund manager and the life funds having a beneficial interest greater than 50 per cent, are consolidated. The non-controlling unitholders’ interest is reported in other liabilities.
The treatment of transactions with non-controlling interests depends on whether, as a result of the transaction, the Group loses control of the subsidiary. Change in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions; any difference between the amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent entity. Where the group loses control of the subsidiary, at the date when control is lost the amount of any non-controlling interest in that former subsidiary is derecognised and any investment retained in the former subsidiary is remeasured to its fair value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.
The acquisition method of accounting is used to account for business combinations by the Group. The consideration for the acquisition of a subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interests issued by the Group. The consideration includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred except those relating to the issuance of debt instruments (see (E)(5) below) or share capital (see (R)(1) below). Identifiable assets acquired and liabilities assumed in a business combination are measured initially at their fair value at the acquisition date.
Overview Business review Governance Financial statements Other information 155 Group profile 1
– it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on different bases. The main type of financial assets designated by the Group at fair value through profit or loss are assets backing insurance contracts and investment contracts issued by the Group’s life insurance businesses. Fair value designation allows changes in the fair value of these assets to be recorded in the income statement along with the changes in the value of the associated liabilities, thereby significantly reducing the measurement inconsistency had the assets been classified as available-for-sale financial assets.
Securities lent to counterparties are retained in the financial statements. Securities borrowed are not recognised in the financial statements, unless these are sold to third parties, in which case the obligation to return them is recorded at fair value as a trading liability.
(7) Derecognition of financial assets and liabilities Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has transferred its contractual right to receive the cash flows from the assets and either: – substantially all of the risks and rewards of ownership have been transferred; or
(G) OFFSET Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. In certain situations, even though master netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.
COLLECTIVE ASSESSMENT In respect of portfolios of smaller balance, homogenous loans, the asset is included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. Segmentation takes into account factors such as the type of asset, geographical location, collateral type, past-due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.
LOAN RENEGOTIATIONS AND FORBEARANCE In certain circumstances, the Group will renegotiate the original terms of a customer’s loan, either as part of an ongoing customer relationship or in response to adverse changes in the circumstances of the borrower. There are a number of different types of loan renegotiation, including the capitalisation of arrears, payment holidays, interest rate adjustments and extensions of the due date of payment. Where the renegotiated payments of interest and principal will not recover the original carrying value of the asset, the asset continues to be reported as past due and is considered impaired. Where the renegotiated payments of interest and principal will recover the original carrying value of the asset, the loan is no longer reported as past due or impaired provided that payments are made in accordance with the revised terms. In other cases, renegotiation may lead to a new agreement, which is treated as a new loan.
Lloyds Banking Group Annual Report and Accounts 2010 banks and customers. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance lease income. Finance lease income is recognised in interest income over the term of the lease using the net investment method (before tax) so as to give a constant rate of return on the net investment in the leases. Unguaranteed residual values are reviewed regularly to identify any impairment.
Investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets.
Liabilities for unit-linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Changes in the value of the liability are recognised in the income statement through insurance claims. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
Overview Business review Governance Financial statements Other information 163 Group profile 1
(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.
Overview Business review Governance Financial statements Other information 165 Group profile 1
ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES At 31 December 2010 gross loans and receivables totalled £667,555 million (2009: £710,362 million) against which impairment allowances of £18,951 million (2009: £15,380 million) had been made (see note 25). The Group’s accounting policy for losses arising on financial assets classified as loans and receivables is described in note 2(H)(1); this note also provides an overview of the methodologies applied.
Individual impairment allowances are generally established against the Group’s wholesale lending portfolios. The determination of individual impairment allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions and the resulting trading performance of the customer, and the value of the security held, for which there may not be a readily accessible market. In particular, significant judgement is required by management in the current economic environment in assessing the borrower’s cash flows and debt servicing capability together with the realisable value of real estate collateral. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.
FAIR VALUE OF FINANCIAL INSTRUMENTS In accordance with IFRS 7, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models. These require management judgement and contain significant estimation uncertainty.
RECOVERABILITY OF DEFERRED TAX ASSETS At 31 December 2010 the Group carried deferred tax assets on its balance sheet of £4,164 million (2009: £5,006 million) and deferred tax liabilities of £247 million (2009: £209 million) (note 44). This presentation takes into account the ability of the Group to net deferred tax assets and liabilities only where there is a legally enforceable right of offset. Note 44 presents the Group’s deferred tax assets and liabilities by type. The largest category of deferred tax asset relates to tax losses carried forward. At 31 December 2010, the Group recognised a deferred tax asset of £6,572 million (2009 £5,925 million) in respect of tax losses carried forward.
The recognition of a deferred tax asset in respect of tax losses is permitted 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 management’s projections of future taxable income which are based on business plans. 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 2010, 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.
RETIREMENT BENEFIT OBLIGATIONS The net asset recognised in the balance sheet at 31 December 2010 in respect of the Group’s retirement benefit obligations was £313 million (comprising an asset of £736 million and a liability of £423 million) (2009: a liability of £780 million) of which an asset of £479 million (2009: a liability of £619 million) related to defined benefit pension schemes. As explained in note 2(L), the Group adopts the corridor approach to the recognition of actuarial gains and losses in respect of its pension schemes and as a consequence has not recognised actuarial losses of £959 million (2009: £2,936 million). The defined benefit pension schemes’ gross deficit totalled £480 million (2009: £3,555 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
The value of the Group’s defined benefit pension schemes’ liabilities requires significant management judgement in determining the appropriate assumptions to be used. The key areas of estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The size of the deficit is sensitive to changes in the discount rate, which is affected by market conditions and therefore potentially subject to significant variation. The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Assumptions are made regarding the expected lifetime of scheme members based upon recent experience, however given the rate of advance in medical science and increasing levels of obesity, it is uncertain whether they will ultimately reflect actual experience. Assumptions used by management reflect recent longevity experience and extrapolate the improving trend.
Lloyds Banking Group Annual Report and Accounts 2010 4 SEGMENTAL ANALYSIS
The Insurance division provides long-term savings, investment and protection products distributed through the retail branch network, intermediary and direct channels in the UK. It is also a distributor of home insurance in the UK with products sold through the retail branch network, direct channels and strategic corporate partners. The division consists of three business units: Life, Pensions and Investments UK; Life, Pensions and Investments Europe; and General Insurance.
For those derivative contracts entered into by business units for risk management purposes, the business unit retains the amount that would have been recognised on an accrual accounting basis (an amount equal to the interest element of the next payment on the swap) and transfers the remainder of the fair value of the swap to the central group segment where the resulting accounting volatility is managed though the establishment of hedge accounting relationships. Any change in fair value of the hedged instrument attributable to the hedged risk is also recorded within the central group segment. This allocation of the fair value of the swap and change in fair value of the hedged instrument attributable to the hedged risk avoids accounting asymmetry in segmental results and records volatility in the central group segment where it is managed.
Investments in joint ventures and associates at end of year 139 127 158 – 5 429
Overview Business review Governance Financial statements Other information 169 Group profile 1
Other segment items reflected in income statement above: (Decrease) increase in value of in-force business – – (5) 1,097 – 1,092
Loss on disposal of businesses (365) – – – 365 – –
Comprises the pension curtailment gain (£910 million, see note 43), integration costs (£1,653 million) and amortisation of purchased intangibles (£629 million).
Scheme fee Volatility arising Group Pre-acquisition and acquisition in insurance Insurance Fair value Reported statutory results of HBOS related items1 businesses gross up unwind basis £m £m £m £m £m £m £m
UK Non-UK Total UK Non-UK Total £m £m £m £m £m £m
Debt securities held as loans and receivables 4.41 3.68 1,377 1,469
Customer deposits, excluding liabilities under sale and repurchase transactions 1.51 1.23 (5,381) (4,410)
Total net income arising on assets held at fair value through profit or loss 12,625 15,772
During March 2010 the Group entered into a bilateral exchange, under which certain Enhanced Capital Notes denominated in Japanese yen were exchanged for an issue of new Enhanced Capital Notes denominated in US dollars; the securities subject to the exchange were cancelled and a profit of £20 million arose.
Lloyds Banking Group Annual Report and Accounts 2010 10 INSURANCE CLAIMS
Pensions and other post-retirement benefit schemes (note 43): Curtailment gain1 (910) –
Depreciation and amortisation: Depreciation of tangible fixed assets (note 32) 1,635 1,716
Total operating expenses excluding Government Asset Protection Scheme fee 13,270 13,484
Other non-audit fees include the costs associated with the Group’s preparations for ensuring that the heritage HBOS businesses complied fully with the requirements of the Sarbanes-Oxley Act by 31 December 2010.
Reviews of the financial position of corporate and other borrowers 17.2 19.3
Total impairment losses on loans and receivables (note 25) 10,771 16,028
Lloyds Banking Group Annual Report and Accounts 2010 13 INVESTMENTS IN JOINT VENTURES AND ASSOCIATES continued
The Group’s unrecognised share of losses of associates for the year is £8 million (2009: £64 million) and of joint ventures is £180 million (2009: £424 million). 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 £104 million (2009: £64 million) and of joint ventures is £339 million (2009: £424 million).
On 16 January 2009, the Group acquired 100 per cent of the ordinary share capital of HBOS plc, which together with its subsidiaries undertakes banking, insurance and other financial services related activities in the UK and in certain overseas locations.
As the fair value of the identifiable net assets acquired was greater than the total consideration paid, negative goodwill arose on the acquisition. The negative goodwill was recognised as a ‘Gain on acquisition’ in the income statement for the year ended 31 December 2009. In accordance with accounting requirements, the measurement period for the fair values of the acquired assets and liabilities ended on 15 January 2010 (one year from the date of acquisition); no further fair value adjustments were made beyond those reflected in the Group’s 31 December 2009 financial statements.
On 16 January 2009, the Group cancelled the following HBOS preference share issuances in exchange for preference shares issued by Lloyds Banking Group plc: 6.475 per cent non-cumulative preference shares of £1 each, 6.3673 per cent non-cumulative fixed to floating preference shares of £1 each and 6.0884 per cent non-cumulative preference shares of £1 each. The fair value of the Lloyds Banking Group preference shares issued was deducted from the net assets acquired for the purposes of calculating the gain arising on acquisition.
Foreign tax: Current tax on profit for the year (82) (221)
Deferred tax (note 44): Origination and reversal of temporary differences (393) 2,429
Weighted average number of ordinary shares in issue – diluted 67,117 37,929
Overview Business review Governance Financial statements Other information 183 Group profile 1
Loans and advances to customers 9,486 325 9,811 13,579 166 13,745
Included in the amounts reported above are assets subject to repurchase agreements with a carrying value of £824 million (2009: £3,250 million); the value of the related liability is £828 million (2009: £3,009 million). In all cases the transferee has the right to sell or repledge the assets concerned.
Lloyds Banking Group Annual Report and Accounts 2010 19 DERIVATIVE FINANCIAL INSTRUMENTS continued
Derivatives designated as cash flow hedges: Interest rate swaps 112,507 2,199 3,042
Derivatives designated as net investment hedges: Cross currency swaps 86 2 –
The embedded equity conversion feature of £1,177 million (31 December 2009: £1,797 million) reflects the value of the equity conversion feature contained in the Enhanced Capital Notes issued by the Group in 2009; the loss of £620 million arising from the change in fair value over 2010 (2009: loss of £427 million) is included within net gains on financial instruments held for trading within net trading income (note 7).
Derivatives designated as cash flow hedges: Interest rate swaps 222,548 4,749 7,285
HEDGED CASH FLOWS For designated cash flow hedges the following table shows when the Group’s hedged cash flows are expected to occur and when they will affect income.
Included in the amounts reported above are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £4 million (2009: £19 million).
Later than 1 year and not later than 5 years 2,522 3,577
Commitments for expenditure in respect of equipment to be leased (21) (8)
Later than 1 year and not later than 5 years 1,965 2,403
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 2010 and 2009 no contingent rentals in respect of finance leases were recognised in the income statement. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £287 million (2009: £123 million).
The unguaranteed residual values included in finance lease receivables were as follows: Not later than 1 year 11 4
Total unguaranteed residual values 61 55 22 SECURITISATIONS AND COVERED BONDS
Cash deposits of £36,579 million (31 December 2009: £31,480 million) held by the Group are restricted in use to repayment of the debt securities issued by the SPEs, the term advances relating to covered bonds and other legal obligations.
Overview Business review Governance Financial statements Other information 191 Group profile 1
Debt securities classified as loans and receivables – 15 9,867 698 10,580
Debt securities classified as available-for-sale financial assets (note 26): Asset-backed securities – 5,382 – – 5,382
Charge (release) to the income statement (note 12) 10,727 (13) 57 10,771
Included within asset-backed securities are £9,392 million (31 December 2009: £12,421 million) managed by the Wholesale division. Further information on these exposures is provided in note 56.
Lloyds Banking Group Annual Report and Accounts 2010 26 AVAILABLE-FOR-SALE FINANCIAL ASSETS continued
On 1 November 2010, the Group reclassified £3,601 million of government securities from available-for-sale financial assets to held-to-maturity investments.
The movement in the acquired value of in-force non-participating investment contracts over the year is as follows: 2010 £m 2009 £m
The acquired value of in-force non-participating investment contracts includes £356 million (2009: £379 million) in relation to OEIC business.
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below: ECONOMIC ASSUMPTIONS Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate.
Risk-free rate (financial options and guarantees) 0.63 to 4.50 0.87 to 4.76
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2010 and 2009 no contingent rentals in respect of operating leases were recognised in the income statement.
Lloyds Banking Group Annual Report and Accounts 2010 36 TRADING AND OTHER FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS
Insurance contract and participating investment contract liabilities are comprised as follows: Gross Reinsurance1 Net Gross Reinsurance1 Net £m £m £m £m £m £m
Liabilities for insurance contracts and participating investment contracts can be split into with-profit fund liabilities, accounted for using the FSA’s realistic capital regime (realistic liabilities) and non-profit fund liabilities, accounted for using a prospective actuarial discounted cash flow methodology, as follows: With-profit fund £m
Lloyds Banking Group Annual Report and Accounts 2010 38 LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued
(III) ASSUMPTIONS Generally, assumptions used to value non-profit fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement of non-profit fund liabilities are: Interest rates The rates used are derived in accordance with the guidelines set by local regulatory bodies. These limit the rates of interest that can be used by reference to a number of factors including the redemption yields on fixed interest assets at the valuation date.
Overview Business review Governance Financial statements Other information 203 Group profile 1
For non-life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims provisioning levels are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or expected outcome. There has been no significant change in the assumptions and methodologies used for setting reserves.
The movements in non-life insurance contract liabilities and reinsurance assets over the year have been as follows: Gross Reinsurance Net £m £m £m
38 LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued
Increase (decrease) in liabilities: Arising from current year claims 581 (12) 569
Overview Business review Governance Financial statements Other information 205 Group profile 1
NON-LIFE INSURANCE CLAIMS DEVELOPMENT TABLE The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The top half of the table below illustrates how the Group’s estimate of total claims outstanding for each accident year shown has changed at successive year ends. The bottom half of the table reconciles the cumulative claims to the amount appearing in the balance sheet. The accident year basis is considered the most appropriate for the business written by the Group.
Current estimate of claims relating to general insurance business acquired in 2009 284 326 394 263 – – 1,267
Widening of credit default spreads on corporate bonds8 0.25% addition (152) (110)
In 2010, the amount is shown net of a credit of £910 million following the Group’s decision to cap all future increases to pensionable salary in its principal UK defined benefit pension schemes, together with a change in commutation factors in certain schemes (note 11).
The Group’s obligations in respect of its defined benefit schemes are funded. During 2009, the Group’s contributions to its defined benefit schemes of £1,859 million included one-off contributions to the Lloyds TSB Group Pension Scheme No 1 and Lloyds TSB Group Pension Scheme No 2 of approximately £1 billion in aggregate. These contributions took the form of interests in limited liability partnerships for each of the two schemes which contained assets of approximately £5 billion in aggregate entitling the schemes to annual payments of approximately £215 million in aggregate until 31 December 2014. Thereafter, assuming that all distributions have been made, the value of the partnership interests will equate to a nominal amount. At 31 December 2010, the limited liability partnerships held assets of approximatey £4.9 billion; cash payments of £215 million were made to the pension schemes during the year. The limited liability partnerships are fully consolidated in the Group’s balance sheet (see note 23).
Overview Business review Governance Financial statements Other information 209 Group profile 1
ASSUMPTIONS The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 5.50 5.70
Overview Business review Governance Financial statements Other information 211 Group profile 1
Money market instruments, cash and other assets and liabilities 3,554 3,904
Experience gains (losses) on scheme assets 1,624 886 (3,520) 139 314
Overview Business review Governance Financial statements Other information 215 Group profile 1
DEFERRED TAX LIABILITIES Future transfers from Scottish Widows plc’s long-term business funds to its Shareholder Fund will be subject to a shareholder tax charge. Under IAS 12, no provision is required to be made to the extent that the timing of such transfers is under Scottish Widows plc’s control. Accordingly, deferred tax liabilities of £90 million (2009: £90 million) have not been recognised.
45 OTHER PROVISIONS Provisions for contingent Customer Customer Vacant liabilities and remediation goodwill Restructuring leasehold commitments provisions payments provisions property Other Total £m £m £m £m £m £m £m
The securities in this note will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preferred shares and securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated enhanced capital notes ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the year (2009: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Financial Services Authority.
d Following conclusion of a limited number of privately negotiated bilateral exchanges on 7 May 2010, certain holders of certain series elected to exchange some or all of the preference shares they held for equity issued by Lloyds Banking Group plc.
6½% Undated Subordinated Step-up Notes callable 2029 (£450 million) b – –
Floating Rate Undated Subordinated Notes (€500 million) b 42 41 5.375% Undated Fixed to Floating Rate Subordinated Notes (US$1,000 million) b 12 3 5.125% Undated Subordinated Fixed to Floating Notes (€750 million) b 47 39 5.75% Undated Subordinated Step-up Notes (£600 million) 3 2 6.05% Fixed to Floating Rate Undated Subordinated Notes (€500 million) d 57 50 7.5% Undated Subordinated Step-up Notes (£300 million) 3 4 3.50% Undated Subordinated Yen Step-up Notes (JPY 42.5 billion) c – 267 8.625% Perpetual Subordinated Notes (£200 million) b 21 18 7.375% Undated Subordinated Guaranteed Bonds (£200 million) (Clerical Medical Finance plc) 35 35
Floating Rate Undated Subordinated Step-up Notes (€300 million) d 63 58
Total undated subordinated liabilities 2,002 2,665 a Scottish Widows plc may elect to defer interest on these securities although in that event Scottish Widows plc cannot declare or pay a dividend on any ordinary share capital until any deferred payments have been made.
d These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the FSA. In November 2009, as part of the state aid restructuring plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012.
Floating Rate Enhanced Capital Notes due 2020 (Series 33) (€53 million) a 41 42 12.75% Enhanced Capital Notes due 2020 (Series 34) (£57 million) 75 74 8.07% Enhanced Capital Notes due 2020 (Series 35) (¥20,000 million) c – 156 7.625% Enhanced Capital Notes due 2020 (Series 36) (€226 million) 189 193 6.75% Enhanced Capital Notes due 2020 (Series 37) (¥17,000 million) c – 121 7.625% Enhanced Capital Notes due 2019 (Series 39) (£151 million) 142 142 9% Enhanced Capital Notes due 2019 (Series 40) (£97 million) 103 100 8.125% Enhanced Capital Notes due 2019 (Series 41) (£4 million) 4 4 14.5% Enhanced Capital Notes due 2022 (Series 42) (£79 million) 115 115 9.875% Enhanced Capital Notes due 2023 (Series 44) (£57 million) 67 62 11.25% Enhanced Capital Notes due 2023 (Series 45) (£95 million) 115 115 10.5% Enhanced Capital Notes due 2023 (Series 46) (£69 million) 79 78 11.875% Enhanced Capital Notes due 2024 (Series 47) (£35 million) 45 45 9% Enhanced Capital Notes due 2029 (Series 49) (£107 million) 112 108 8.5% Enhanced Capital Notes due 2032 (Series 50) (£104 million) 105 100 16.125% Enhanced Capital Notes due 2024 (Series 52) (£61 million) 99 100 7.875% Enhanced Capital Notes due 2020 (US$986 million) 631 599 8% Fixed to Floating Rate Undated Enhanced Capital Notes callable 2022 (US$1,259 million) b 674 639 8.5% Undated Enhanced Capital Notes callable 2021 (Series 2) (US$277 million) b 150 143 7.875% Enhanced Capital Notes due 2020 (US$408 million) 288 –
c Following conclusion of a privately negotiated bilateral exchange on 19 March 2010, certain holders elected to exchange some or all of the notes they held for enhanced capital notes issued by Lloyds Banking Group Capital No. 2 plc.
Notes 2016 (US$750 million) b 440 367 Subordinated Lower Tier II Notes 2017 (€1,000 million) 758 704 Subordinated Callable Notes 2017 (US$1,000 million) 548 464 Subordinated Callable Floating Rate Instruments 2017 (Aus$400 million) 255 209 6.75% Subordinated Callable Fixed/Floating Rate Instruments 2017 (Aus$200 million) 127 101 5.109% Callable Fixed to Floating Rate Notes 2017 (Can$500 million) 305 263 6.305% Lower Tier II Subordinated Notes 2017 (£500 million) 486 474 5.625% Subordinated Fixed to Floating Rate Notes due 2018 callable 2013 (€1,000 million) 946 979 6.75% Subordinated Fixed Rate Notes 2018 (US$2,000 million) 1,176 917 4.375% Callable Fixed to Floating Rate Subordinated Notes 2019 (€750 million) 600 602 6.5% Dated Subordinated Notes 2020 (€1,500 million) 1,353 – 6.9625% Subordinated Fixed to Floating Rate Notes due 2020 callable 2015 (£750 million) 715 755 Subordinated Floating Rate Notes 2020 (€100 million) 86 89 7.375% Dated Subordinated Notes 2020 4 – 6.5% Subordinated Fixed Rate Notes 2020 (US$2,000 million) 1,202 –
b These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval of the FSA. In November 2009, as part of the state aid restructuring plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012.
Overview Business review Governance Financial statements Other information 223 Group profile 1
Lloyds Banking Group Annual Report and Accounts 2010 47 SHARE CAPITAL continued
Share issuances On 18 February 2010, the Company issued 3,141 million ordinary shares as consideration for the redemption of certain preference shares and preferred securities.
Limited voting ordinary shares The limited voting ordinary shares are held by the Lloyds TSB Foundations (the Foundations). The holders of the limited voting ordinary shares, who held 0.1 per cent of the total ordinary shares as at 31 December 2010, are entitled to receive copies of every circular or other document sent out by the Company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary shares in all respects from the date of conversion.
Distributable reserves of £1,000 million arose on the issue of preference shares in January 2009 which were classified as debt. In June 2009, these preference shares were redeemed out of the proceeds of the placing and compensatory open offer of ordinary shares and the distributable element of this issue was transferred from the share premium account to the merger reserve.
Overview Business review Governance Financial statements Other information 225 Group profile 1
Lloyds Banking Group Annual Report and Accounts 2010 49 OTHER RESERVES
Distributable reserves of £1,000 million arose on the issue of preference shares in January 2009 which were classified as debt. In June 2009, these preference shares were redeemed out of the proceeds of the placing and compensatory open offer of ordinary shares and the distributable element of this issue was transferred to the merger reserve.
Lloyds Banking Group Annual Report and Accounts 2010 50 RETAINED PROFITS
Employee share option schemes – value of employee services 154 116
Value of employee services includes a credit of £134 million (2009: £111 million) reflecting the income statement charge in respect of SAYE and executive options, together with a related tax credit of £20 million (2009: tax credit £5 million). Purchase/sale of treasury shares includes a credit of £409 million (2009: £128 million) relating to the cost of other share scheme awards.
CHARGE TO THE INCOME STATEMENT The charge to the income statement is set out below: £m £m
DEFERRED BONUS PLANS Bonuses in respect of the performance in 2010 of employees within certain of the Group’s bonus plans have been recognised in these financial statements in full. The amounts to be settled in shares are included within the total charge to the income statement detailed above.
Options granted to senior executives other than Executive Directors were not so highly leveraged and, as a result, different performance multipliers were applied to their options. For the majority of executives, options were granted with the performance condition but with no performance multiplier.
FOR OPTIONS GRANTED IN 2005 The same conditions applied as for grants made up to August 2004, except that: – the performance condition was linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 15 companies including Lloyds Banking Group plc; – if the performance condition was not met at the end of the third subsequent year, the options would lapse; and
Options granted in 2005 became exercisable as the performance condition was met when tested. The performance condition vested at 82.5 per cent for all options granted.
Overview Business review Governance Financial statements Other information 229 Group profile 1
No options were exercised during 2010 or 2009. The weighted average remaining contractual life of options outstanding at the end of the year was 3.6 years (2009: 4.3 years).
The weighted average fair value of SAYE options granted during 2010 was £0.33 (2009: £nil). The values for the SAYE options have been determined using a standard Black-Scholes model.
The weighted average fair value of options granted in the year was £0.63 (2009: £0.68). The weighted average share price at the time that the options were exercised during 2010 was £0.63 (2009: £0.71). The weighted average remaining contractual life of options outstanding at the end of the year was 2.4 years (2009: 3.0 years).
HBOS share option plans The table below details the outstanding options for the HBOS Share Option Plan, the St James’s Place Share Option Plan, and the 1995 and 1996 Bank of Scotland Executive Stock Option schemes. The final award under the HBOS Share Option Plan was made in 2004. Under this plan, options over shares, at market value with a face value equal to 20 per cent of salary, were granted to employees with the exception of certain senior executives. A separate option plan exists for some partners of St James’s Place, which grants options in respect of Lloyds Banking Group plc shares. The final award under the St James’s Place Share Option Plan was made in 2009. Movements in the number of share options outstanding under these schemes are set out below: Number of options
Lloyds Banking Group Annual Report and Accounts 2010 52 SHARE-BASED PAYMENTS continued
(ii) For the other 50 per cent of the award (the TSR Award) – the performance condition is as described for the 2007 awards, except that the comparator group comprises of 13 companies, with the relevant performance period commencing on 6 March 2008 (the date of the first award) and ending on 5 March 2011.
As for the 2007 LTIP awards, as a consequence of the acquisition of HBOS and the general market turmoil, in March 2009 the Remuneration Committee decided that the performance test for the 2008 awards should be based on the performance of the Group up to 17 September 2008, the date prior to the announcement of the HBOS acquisition. The performance test was on a fair value basis, on the estimated probability, as at that date, of achieving the performance conditions. As a consequence, for all participants, other than those who were Executive Directors at the time the award was granted and a small number of other senior executives, the share awards will vest at 29 per cent in March 2011.
The EPS and economic profit performance measures applying to this 2009 LTIP award were set on the basis that the Group would enter into the Government Asset Protection Scheme. As the Group is not participating in the Government Asset Protection Scheme, in June 2010 the Remuneration Committee approved restated performance measures on a basis consistent with the EPS and economic profit measures used for the 2010 LTIP awards.
For awards made to Executive Directors, a third performance condition was set, relating to Absolute Share Price, relevant to 28 per cent of the award. Performance will be measured based on the Absolute Share Price on 26 March 2013, being the third anniversary of the award date. If the share price at the end of the performance period is 75 pence or less, none of this element of the award will vest. If the share price is 114 pence or higher, 100 per cent of this element will vest. Vesting between threshold and maximum will be on a straight line basis, provided that shares comprised in the Absolute Share Price element may only be released if both the EPS and Economic Profit performance measures have been satisfied at the threshold level or above. The EPS and Economic Profit performance conditions will each relate to 36 per cent of the total award.
Conditional awards of shares made under this plan were adjusted on 2 July 2009 as a result of the Placing and Compensatory Open Offer and on 13 August 2010 as a result of the Capitalisation Issue and Rights Issue of 2009. The adjustments were made, where applicable, using a standard HMRC formula, to negate the dilutionary impact of the above corporate actions.
Performance share plan Under the performance share plan, introduced during 2005, participating executives were eligible for an award of free shares, known as performance shares, to match the bonus shares awarded as part of their 2004 and 2005 bonus. The maximum match was two performance shares for each bonus share, awarded at the end of a three year period. The actual number of shares awarded was dependent on the Group’s total shareholder return performance measured over a three year period, compared to other companies in the comparator group. The maximum of two performance shares for each bonus share would be awarded only if the Group’s total shareholder return performance placed it first in the comparator group; one performance share for each bonus share would be granted if the Group was placed fifth; and one performance share for every two bonus shares if the Group was placed eighth (median). Between first and fifth position, and fifth and eighth position, sliding scales would apply. If the total shareholder return performance was below median, no performance shares would be awarded. There was no retest. Whilst income tax and national
The fair value calculations at 31 December 2010 for grants made in the year are based on the following assumptions: Other option Other share SAYE schemes plans
Matching shares The Group undertakes to match shares purchased by employees up to the value of £30 per month; these shares are held in trust for a mandatory period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The award is subject to a non-market based condition: if an employee leaves within this three year period for other than a ‘good’ reason, 100 per cent of the matching shares are forfeited. Similarly if the employees sell their purchased shares within three years, their matching shares are forfeited.
The number of shares awarded relating to matching shares in 2010 was 17,411,651 (2009: 16,746,310), with an average fair value of £0.63 (2009: £0.69), based on market prices at the date of award.
Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £0.4 million (2009: £0.4 million).
Granted, including certain adjustments1 (includes entitlements of appointed directors) 39 17
At 31 December 2010, the Group did not provide any guarantees in respect of key management personnel (2009: none).
Pensions funds The Group provides banking and some investment management services to certain of the Group pension funds. At 31 December 2010, customer deposits of £64 million (2009: £99 million) and investment and insurance contract liabilities of £850 million (2009: £691 million) related to the Group’s pension funds.
Open Ended Investment Companies (OEICs) The Group manages 402 (2009: 382) OEICs, and of these 111 (2009: 108) are consolidated. The Group invested £1,460 million (2009: £1,271 million) and redeemed £982 million (2009: £1,076 million) in the unconsolidated OEICs during the year and had investments, at fair value, of £7,920 million (2009: £6,954 million) at 31 December. The Group earned fees of £271 million from the unconsolidated OEICs (2009: £217 million). The Company held no investments in OEICs at any time during 2009 or 2010.
In October 2010, the UK Competition Commission (Competition Commission) confirmed its decision to prohibit the active sale of PPI by a distributor to a customer within seven days of a sale of credit. This followed the completion of its formal investigation into the supply of PPI services (other than store card PPI) to non-business customers in the UK in January 2009 and a referral of the proposed prohibition to the Competition Appeal Tribunal. Following an earlier decision to stop selling single premium PPI products, the Group ceased to offer PPI products to its customers in July 2010.
On 1 July 2008, the Financial Ombudsman Service (FOS) referred concerns regarding the handling of PPI complaints to the Financial Services Authority (FSA) as an issue of wider implication. On 29 September 2009 and 9 March 2010, the FSA issued consultation papers on PPI complaints handling. The FSA proposed new guidance on the fair assessment of a complaint and the calculation of redress and a new rule requiring firms to reassess historically rejected complaints. The FSA published its Policy Statement on 10 August 2010, setting out a new set of rules for PPI complaints handling and redress which had to be implemented by 1 December 2010.
On 8 October 2010, the British Bankers Association (BBA), the principal trade association for the UK banking and financial services sector, filed an application for permission to seek judicial review against the FSA and the FOS. The BBA is seeking an order quashing the FSA Policy Statement and an order quashing the decision of the FOS to determine PPI sales in accordance with the guidance published on its website in November 2008. The Judicial hearing was held in late January 2011 and the judgment (which may be subject to appeal) is expected shortly.
US SANCTIONS In January 2009 Lloyds TSB Bank plc announced the settlement it had reached with the US Department of Justice and the New York County District Attorney’s Office in relation to their investigations into historic US dollar payment practices involving countries, persons or entities subject to the economic sanctions administered by the US Office of Foreign Assets Control (OFAC). On 22 December 2009 OFAC announced the settlement it had reached with Lloyds TSB Bank plc in relation to its investigation and confirmed that the settlement sum due to OFAC had been fully satisfied by Lloyds TSB Bank plc’s payment to the Department of Justice and the New York County District Attorney’s Office. No further enforcement actions are expected in relation to the matters set out in the settlement agreements.
EUROPEAN UNION GENDER DIRECTIVE An opt-out clause to the European Union Gender Directive currently permits insurers to take gender into account as a risk factor when pricing contracts. In March 2011, the European Court of Justice is expected to rule on whether this infringes fundamental European rights for equal treatment. If the European Court of Justice rules that the opt-out clause does infringe such rights, it could alter the market and alter prices for insurance products to a significant extent. At the date of these financial statements, no provision has been made for the potential costs of rectifying contracts in existence at 31 December 2010, should this ultimately be required. The ultimate impact on the Group can only be known following the European Court of Justice’s ruling. However, the Group does not expect the final outcome of this matter to have a material adverse effect on its financial position.
OTHER LEGAL ACTIONS AND REGULATORY MATTERS In the course of its business, the Group is engaged in discussions with the FSA in relation to a range of conduct of business matters, especially in relation to retail products including packaged bank accounts, mortgages, structured products and pensions. The Group is keen to ensure that any regulatory concerns regarding product governance or contract terms are understood and addressed. The ultimate impact on the Group of these discussions can only be known at the conclusion of such discussions.
Overview Business review Governance Financial statements Other information 239 Group profile 1
Lloyds Banking Group Annual Report and Accounts 2010 54 CONTINGENT LIABILITIES AND COMMITMENTS continued £m £m
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £63,630 million (2009: £74,477 million) was irrevocable.
Available-for-sale financial assets – – – 42,955 – – – 42,955
Derivative financial instruments 9,430 40,498 – – – – – 49,928
Available-for-sale financial assets – – – 46,602 – – – 46,602
Carrying value and fair value of reclassified assets The table below sets out the carrying value and fair value of reclassified financial assets
From held for trading to loans and receivables – – (34) (34) – 208 208 (347) (347)
Overview Business review Governance Financial statements Other information 243 Group profile 1
(3) FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES The following table summarises the carrying values of financial assets and liabilities presented on the Group’s balance sheet. The fair values presented in the table are at a specific date and may be significantly different from the amounts which will actually be paid or received on the maturity or settlement date.
LEVEL 2 PORTFOLIOS Level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not considered to be active or valuation techniques are used to determine fair value and where these techniques use inputs that are based significantly on observable market data. Examples of such financial instruments include most over-the-counter derivatives, financial institution issued securities, certificates of deposit and certain asset-backed securities.
Overview Business review Governance Financial statements Other information 245 Group profile 1
Trading and other financial assets at fair value through profit or loss 103,853 43,246 2,912 150,011
Transfers out of the level 3 portfolio (1,742) (2,174) – (3,916)
Included within the gains (losses) recognised in the income statement are losses of £597 million (2009: £1,542 million) related to financial instruments that are held in the level 3 portfolio at the year end. These amounts are included in other operating income.
Overview Business review Governance Financial statements Other information 247 Group profile 1
Effect of reasonably possible alternative assumptions Effect of reasonably possible alternative assumptions
Asset-backed securities Lead manager or broker quote/consensus pricing from market data provider
DERIVATIVE VALUATION ADJUSTMENTS Derivative financial instruments which are carried in the balance sheet at fair value are adjusted where appropriate to reflect credit risk, market liquidity and other risks.
Valuation adjustments are applied to the Group’s over-the-counter derivative exposures with counterparties that are not subject to standard interbank collateral arrangements. These valuation adjustments reflect the different credit and funding exposures that such counterparties represent.
(1) INTEREST RATE RISK In the Group’s retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. There is a relatively small volume of deposits whose rate is contractually fixed for their term to maturity.
At 31 December 2010 the aggregate notional principal of interest rate swaps designated as fair value hedges was £75,831 million (2009: £80,085 million) with a net fair value asset of £3,166 million (2009: asset of £3,004 million) (note 19). The gains on the hedging instruments were £280 million (2009: losses of £995 million). The losses on the hedged items attributable to the hedged risk were £452 million (2009: gains of £1,181 million).
A general description of collateral held in respect of financial instruments is disclosed on page 77.
Derivative assets – the Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. An analysis of derivative assets is given in note 19. Of the net derivative assets of £19,037 million (31 December 2009: £28,230 million), cash collateral of £1,429 million (31 December 2009: £6,645 million) was held and a further £8,385 million was due from OECD banks (31 December 2009: £13,004 million).
The disclosures in the table above and those on pages 255 to 257 are produced under the combined businesses approach used for the Group’s segmental reporting. The Group believes that, for reporting periods immediately following a significant acquisition such as the acquisition of HBOS in 2009, this combined businesses basis, which includes the allowance for loan losses at the acquisition date on a gross basis, more fairly reflects the underlying provisioning status of the loans. The remaining acquisition-related fair value adjustments in respect of this lending are therefore identified separately in this table.
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(H). All impaired loans which exceed certain thresholds, principally within the Group’s Wholesale division, are individually assessed for impairment by reviewing expected future cash flows including those that could arise from the realisation of security. Included in loans and receivables are advances individually determined to be impaired with a gross amount before impairment allowances of £51,608 million (31 December 2009: £44,675 million) which have associated collateral with a fair value of £14,869 million (31 December 2009: £10,217 million).
Loans and advances designated Loans and Loans and advances to customers at fair value advances Retail – Retail – through to banks mortgages other Wholesale Total profit or loss £m £m £m £m £m £m
The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale are not the same, reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Wholesale lending has been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models.
Total loans and advances which are past due but not impaired – 12,587 1,873 5,118 19,578 –
Overview Business review Governance Financial statements Other information 257 Group profile 1
An analysis of the Group’s debt securities, treasury and other bills and derivative financial instruments by credit rating is provided below.
Overview Business review Governance Financial statements Other information 259 Group profile 1
Other assets held at fair value through profit or loss: Other public sector securities 675 16 – – – 9 700
Total held at fair value through profit or loss 24,945 4,949 8,088 4,138 1,399 3,260 46,779
Negative basis means bonds held with separate matching credit default swap protection.1
The table below sets out Wholesale division’s net exposure to US residential mortgage-backed securities (RMBS) by vintage.
Total net exposure to US RMBS 354 980 1,503 1,405 4,242 4,826
Exposures to monolines During 2009 all exposure to sub-investment grade monolines on CDS contracts was written down to zero, leaving limited exposure to monoline insurers as set out below.
In addition, the Group has £1,985 million (31 December 2009: £2,703 million) of monoline wrapped bonds and £425 million ( 31 December 2009: £791 million) of monoline liquidity commitments on which the Group currently places no reliance on the guarantor.
Non-US residential mortgage-backed securities 7,898 6,170 1,415 237 76 – – –
Overview Business review Governance Financial statements Other information 263 Group profile 1
(4) LIQUIDITY RISK The table below analyses assets and liabilities of the Group into relevant maturity groupings based on the remaining contractual period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
Cash and balances at central banks 37,737 70 308 – – 38,115
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 11,938 4,313 8,469 20,003 24,197 68,920
Liabilities arising from non-participating investment contracts 12,944 91 265 1,743 36,320 51,363
In addition, the Group has a maximum credit risk exposure of £22,975 million (2009: £18,021 million) in respect of financial guarantees.
Overview Business review Governance Financial statements Other information 265 Group profile 1
Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows: Up to 1-3 3-12 1-5 Over 5 1 month months months years years Total £m £m £m £m £m £m
Within 1-3 3-5 Over 5 1 year years years years Total £m £m £m £m £m 57 CONSOLIDATED CASH FLOW STATEMENT
Net (credit) charge in respect of defined benefit schemes (455) 529
Overview Business review Governance Financial statements Other information 267 Group profile 1
Net assets acquired: Cash and balances at central banks – 2,123
Overview Business review Governance Financial statements Other information 269 Group profile 1
The following pronouncements will be relevant to the Group but were not effective at 31 December 2010 and have not been applied in preparing these financial statements. The full impact of these accounting changes is being assessed by the Group.
Clarifies that when an entity renegotiates the terms of its debt with the result that the liability is extinguished by the debtor issuing its own equity instruments to the creditor, a gain or loss is recognised in the income statement representing the difference between the carrying value of the financial liability and the fair value of the equity instruments issued; the fair value of the financial liability is used to measure the gain or loss where the fair value of the equity instruments cannot be reliably measured. This interpretation is consistent with the Group’s existing accounting policy.
Lloyds Banking Group has been in discussion with the FSA regarding the application of an interest variation clause in certain Bank of Scotland plc variable rate mortgage contracts where the wording in the offer documents received by certain customers had the potential to cause confusion. The relevant mortgages were written between 2004 and 2007 by Bank of Scotland plc under the ‘Halifax’ brand. In February 2011, the Group reached agreement with the FSA in relation to initiating a customer review and contact programme and making goodwill payments to affected customers. In order to make these goodwill payments, Bank of Scotland plc has applied for a Voluntary Variation of Permission to carry out the customer review and contact programme to bring it within section 404F(7) of FSMA 2000. The Group has made a provision of £500 million in relation to this programme.
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As explained more fully in the Directors’ Responsibilities Statement on page 122, the directors are responsible for the preparation of the parent company financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the parent company financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
SCOPE OF THE AUDIT OF THE FINANCIAL STATEMENTS An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the parent company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements.
Non-current liabilities: Current liabilities: Debt securities in issue 8 549 326
PARENT COMPANY STATEMENT OF CHANGES IN EQUITY at 31 December 2010
Overview Business review Governance Financial statements Other information 275 Group profile 1
The merger reserve comprises the premium on shares issued on 13 January 2009 under the placing and open offer and shares issued on 16 January 2009 on the acquisition of HBOS plc.
Movements in other reserves were as follows: 2010 £m 2009 £m
In January 2010, the Company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital redemption reserve and a transfer of £11 million from the merger reserve to the share premium account. Details of the preference shares redeemed are set out in note 46 to the consolidated financial statements. In December 2009, the Group redeemed eight issues of preference shares in exchange for the issuance of enhanced capital notes. This resulted in a transfer of £26 million from the merger reserve to the capital redemption reserve and a transfer of £2,684 million from the merger reserve to the share premium account.
Dated subordinated liabilities 57/8% Subordinated Guaranteed Bonds 2014 (€750 million) 749 768
KEY MANAGEMENT PERSONNEL The key management personnel of the Group and the Company are the same. The relevant disclosures are given in note 53 to the consolidated financial statements.
Investment in HBOS plc: Acquisition of ordinary share capital – 7,787
As part of a reorganisation of the Lloyds Banking Group on 1 January 2010, the Company transferred its direct investment in 100 per cent of the issued ordinary share capital of HBOS plc to its subsidiary, Lloyds TSB Bank plc. The consideration for this transfer was the issue of 21.4 million shares by Lloyds TSB Bank plc to the Company for a total value of £21,395 million.
In addition the Company carried out banking activities through its subsidiary, Lloyds TSB Bank plc. At 31 December 2010, the Company held deposits of £375 million with Lloyds TSB Bank plc (2009: £2,837 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. Included within subordinated liabilities is £2,073 million (2009: £1,899 million) and within other liabilities is £7,988 million (2009: £6,999 million) due to subsidiary undertakings. In addition, at 31 December 2010 the Company had interest rate and currency swaps with Lloyds TSB Bank plc with an aggregate notional principal amount of £2,504 million and a net positive fair value of £1,664 million (2009: notional principal amount of £11,373 million and a net positive fair value of £2,260 million), of which contracts with an aggregate notional principal amount of £1,754 million and a net positive fair value of £330 million (2009: notional principal amount of £1,460 million and a net positive fair value of £343 million) were designated as fair value hedges to manage the Company’s issuance of subordinated liabilities and debt securities in issue.
Overview Business review Governance Financial statements Other information 281 Group profile 1
Note 55 to the consolidated financial statements outlines the valuation hierarchy into which financial instruments measured at fair value are categorised.
FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES The valuation techniques for the Company’s financial instruments are as discussed in note 55 to the consolidated financial statements.
The parent company financial statements were approved by the directors of Lloyds Banking Group plc on 24 February 2011.
Overview Business review Governance Financial statements Other information 283 Group profile 1
SUBSTANTIAL SHAREHOLDINGS At the date of this report a notification had been received that The Solicitor for the Affairs of Her Majesty’s Treasury had a direct interest of 40.56 per cent in the issued share capital with rights to vote in all circumstances at general meetings. No other notification has been received that anyone has an interest of 3 per cent or more in the issued ordinary share capital.
INDIVIDUAL SAVINGS ACCOUNTS (ISAS) The Company provides a number of options for investing in Lloyds Banking Group shares through an ISA. For details contact: Lloyds TSB Share Dealing, Halifax Share Dealing or Equiniti Limited.
Conduits A financial vehicle that holds asset-backed securities which are financed with short-term deposits (generally commercial paper) that use the asset-backed securities as collateral. The conduit will often have a liquidity line provided by a bank that it can draw down on in the event that it is unable to issue funding to the market. The Group sponsors four asset-backed conduits, Argento, Cancara, Grampian and Landale. Further details are provided in note 23.
An embedded equity conversion feature is a derivative contained within the terms and conditions of a debt instrument that enables or requires the instrument to be converted into equity under a particular set of circumstances. The Group’s enhanced capital notes (ECNs) contain such a feature whereby these notes convert to ordinary shares in the event that the consolidated Core Tier 1 ratio of the Group falls below 5 per cent.
Overview Business review Governance Financial statements Other information 287 Group profile 1
Retail Loans Money loaned to individuals rather than institutions. These include both secured and unsecured loans such as mortgages and credit card balances.
Securitisation Securitisation is a process by which a group of assets, usually loans, are aggregated into a pool, which is used to back the issuance of new securities. Securitisation is the process by which ABS are created. A company sells assets to an special purpose entity which then issues securities backed by the assets. This allows the credit quality of the assets to be separated from the credit rating of the original company and transfers risk to external investors. Assets used in securitisations include mortgages to create mortgage-backed securities or residential mortgage-backed securities (RMBS) as well as commercial mortgage-backed securities. The Group has established several securitisation structures as part of its funding and capital management activities. These generally use mortgages, corporate loans and credit cards as asset pools. A listing of these programmes with the amounts secured and associated funding raised is given in note 22.
Overview Business review Governance Financial statements Other information 289 Group profile 1
Overview Business review Governance Financial statements Other information 291 Group profile 1
DEBT SECURITIES IN ISSUE Consolidated 199 Parent company 279 Valuation 244
DIRECTORS Attendance at Board and committee meetings 119 Biographies 110 Directors’ report 112 Emoluments 134 Interests 136 Remuneration policy 127 Service agreements 133
HELD AT FAIR VALUE THROUGH PROFIT OR LOSS Accounting policy 155 Notes to the consolidated financial statements 183, 199 Valuation 244
IMPAIRMENT Accounting policy 158 Critical accounting estimates and judgements 165 Notes to the consolidated financial statements 178
INSURANCE BUSINESSES Accounting policy 162 Basis of determining regulatory capital 102 Capital sensitivities 107 Capital statement 103 Critical accounting estimates and judgements 166 Financial information calculated on a ‘realistic’ basis 103 Liabilities arising from insurance contracts and Participating investment contracts 199 Liabilities arising from non-participating investment contracts 207
RISK MANAGEMENT FRAMEWORK Business risk 74 Credit risk 75 Financial soundness 93 Insurance risk 91 Market risk 88 Principal risks and uncertainties 70 Operational risk 91 Risk governance 67 Risk management 65
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