We are a simple, low risk, customer focused bank operating through four divisions
Our Consumer Finance division provides motor finance solutions and credit cards to consumer and commercial customers.
One of my primary roles as Chairman is to ensure we build a business which is commercially successful, helps our customers with their financial needs and plays a valued role in Britain’s long-term economic success.
In achieving this the Board and senior management have a vital role to play in shaping and embedding a healthy corporate culture, and this has been a major focus for the Board’s attention over the last year. The values and standards of behaviour we set are an important influence and there are strong links between governance and establishing a culture that supports long-term success. These values and standards also provide the foundation on which we are seeking to build sustainable success as a responsible business, supporting the communities in which we operate and serve.
Communities Our commitment to invest in the long-term economic future of the UK is highlighted, not just through our lending to customers such as first-time buyers and SMEs, but also through the many community programmes we run and through our four charitable Foundations.
Areas of focus Corporate Governance Framework In late 2014, we undertook an end-to-end review of the Group’s governance arrangements from a fresh perspective. The review was informed by the 2014 annual review of Board Effectiveness as well as the work which is being carried out in the Group in preparation for the Senior Managers and Certification Regime. The review was completed in 2015 and the findings and the Board’s response are set out on page 68.
Remuneration Our approach to reward is intended to provide a clear link between remuneration and delivery of the Group’s key strategic objectives, supporting the aim of becoming the best bank for customers and, through that, for shareholders. We believe in offering fair reward. We are embedding a performance-driven and meritocratic culture where colleagues are rewarded for behaviours aligned to the long-term sustainable success of the business, our commitment to rebuilding trust and to changing the culture of the Group.
Directors We have recently appointed two new Independent Non-Executive Directors to the Board. Deborah McWhinney joined in December and brings an extensive executive background from North America in managing technology, operations and new digital innovations in banking, payments and institutional investment. Stuart Sinclair joined in January and brings experience in retail banking, consumer and asset finance and insurance.
These appointments will help ensure the Board is well placed to address future technology and market risks across the full range of business areas in which we operate.
2015 also saw a number of changes to the Board’s structure and composition, including the establishment of a Responsible Business Committee which underlines our commitment to being a responsible business.
Highlights 2015 was a milestone year for Lloyds Banking Group. In a year in which we celebrated the 250th anniversary of Lloyds Bank and the 200th anniversary of Scottish Widows, we also continued to make strong progress in the next phase of our strategy to become the best bank for customers and shareholders. We improved customer experience, increased net lending in key customer segments, and delivered on key targets within the Helping Britain Prosper Plan. At the same time our financial performance has continued to improve, with an increase in underlying profitability and returns as well as a further strengthening of our already strong capital position, in spite of additional PPI provisions reflecting the Financial Conduct Authority’s (FCA) consultation on time barring. This delivery has, in turn, enabled us to increase the ordinary dividend and to return surplus capital through a special dividend. As a result of our ongoing progress, the UK government has made further substantial progress in returning the Group to full private ownership.
The economic and regulatory environment As a UK retail and commercial bank, we are well placed to continue to support and benefit from the sustainable recovery in the UK economy. While the current prolonged period of low interest rates and increasing competition have created challenges for profitability across the UK banking sector, we are well positioned, given our cost leadership position and low risk business model. The underlying health of the UK economy, to which we are inextricably linked, also remains resilient. This is reflected in strong employment levels, reduced levels of household and corporate indebtedness, and increased house prices, amongst other things, which provide a positive backdrop and underpin the Group’s future prospects. In the face of current market volatility and uncertainties, including the forthcoming EU referendum, our strong balance sheet and low risk approach positions us well, while our differentiated business model continues to provide competitive advantage.
We remain well positioned in a regulatory environment that continues to evolve. 2015 brought greater clarity on a number of issues that are significant for the Group and the wider banking sector. We support the aims of the Competition and Markets Authority (CMA) in ensuring that small business customers and consumers have effective choice and are adequately protected, and we welcome the publication of its notice of possible remedies to ensure these objectives are achieved. Our simple, UK focused business model positions us well for ring-fencing and the Minimum Requirements for own funds and Eligible Liabilities (MREL).
In 2015, we strengthened our provision for PPI by £4.0 billion, with a £2.1 billion increase taken in the fourth quarter primarily reflecting our interpretation of the FCA’s consultation on a proposed time bar as well as the Plevin case. We also charged £745 million in relation to the disposal of TSB, bringing the total cost of delivering this commitment to the EU, which is now complete, to £2.4 billion over the past five years.
Creating the best customer experience As a customer-focused business, we are committed to meeting our customers’ evolving needs and preferences effectively through our multi-brand and multi-channel approach. In an environment where the pace of digital adoption is accelerating, we now have the largest digital bank, with our online customer base amounting to over 11.5 million customers and our mobile banking customer base of 6.6 million customers able to access the UK’s no.1 rated banking app. Our strategic commitments for digital also remain on track, with c.55 per cent of customer needs being met digitally in 2015. We remain focused, however, on our integrated, multi-channel approach that our clients value and have continued to enhance and optimise the branch network to ensure that it meets our customers’ evolving needs. In particular, we have now introduced Wi-fi connectivity and automated solutions for more simple customer transactions in nearly 70 per cent of branches. In addition, we have now launched our remote advice proposition, enabling customers to interact with us from the comfort of their own homes. In 2015 we also enhanced a number of customer processes, having launched an online feature which enables customers to obtain a mortgage agreement in principle in real time, and piloted a new process which has halved the time to open a new business bank account. Our progress in creating the best customer experience has been reflected in our net promoter score across the Group, which has continued to improve in 2015 and is now over 50 per cent higher than at the end of 2011. Group reportable banking complaints (excluding PPI) also remain significantly lower than the average of our major banking peers.
Delivering sustainable growth The Group aims to deliver growth across its key customer segments that is sustainable and consistent with its low risk business model. In 2015 we continued to make good progress in growing above the market in areas where we are underrepresented. Net lending to our SME customers increased by over £1 billion or 5 per cent in the year, continuing the trend of the last five years of significantly outperforming the market overall. Our Consumer Finance business is also generating strong growth with an ahead of plan 17 per cent year-on-year increase in UK lending, with motor finance continuing to deliver double digit growth and our credit card balances growing by approximately 4 per cent compared with the market growth rate of less than 2 per cent. We continue to support first-time buyers and remain the largest lender to this important customer group, providing 1 in 4 first-time buyer mortgages in 2015. We have taken the conscious decision, however, to balance margin considerations with volume growth in the mortgage business, growing our open book by around 1 per cent versus a market that grew by around 2.5 per cent. We believe this is the right approach as the leader in what is, at the moment, a low growth market where growth is predominantly coming from Buy-to-let.
Government stake and TSB sale The combination of the significant progress we have made towards our strategic objectives and our robust financial performance has also enabled the UK government to make further substantial progress in returning the Group to full private ownership during the course of 2015. The government has now reduced its stake from 43 per cent to around 9 per cent, returning approximately £16 billion to the UK taxpayer above their ‘in price’, on top of the dividends paid in 2015. We will continue to support the proposed retail offer, but following the government’s announcement on 28 January 2016, this has been deferred until it determines that the market conditions are appropriate. Separately, the completion of the sale of our interest in TSB to Banco Sabadell in June 2015 represents the continued delivery of our commitment to the European Commission under the terms of the state aid agreement.
Our cost:income ratio further improved to 49.3 per cent and remains the lowest of our major UK banking peers.
We missed our target to help 100,000 customers plan and save for later life through company pension schemes. During 2015, 145,000 new customers started contributing to a corporate pension scheme managed by Scottish Widows. However, 139,000 customers stopped contributions with their existing employer, mainly because they started a new job with a new employer. Consequently, net growth in customer numbers was only 6,000.
In 2011, we outlined our strategy to be the best bank for customers and over the following three years the business was transformed with a reshaped, low risk portfolio, a strengthened balance sheet and a more efficient cost base. This firm foundation enabled us to launch the next phase of our strategy in 2014 which was focused on delivering value and high quality experiences for customers alongside superior and sustainable financial performance within a prudent risk and control framework.
The achievement of our strategy could not happen without the support of our colleagues. We are therefore committed to ‘building the best team’ to create a high performance organisation.
You can read more about each of these priorities and the progress we made during 2015 on pages 20-21.
Evolving the Prosper Plan We’re continually evolving the Plan to reflect changing social and economic needs. A wide range of different stakeholders – including customers, colleagues, community partners, our charitable Foundations and opinion formers – have directly or indirectly contributed to this evolution. As a result, the Plan is simpler, more focused, more ambitious and increasingly measured in terms of the positive outcomes it achieves, not on its reach. Our ambition is to measure and audit the whole Plan on this basis, by 2017.
We recognise that a major challenge for the UK economy is the relatively low level of productivity. Accordingly, in 2016 we are reviewing how we can help Britain become more productive and more globally competitive.
Part of our vision is to help Britain prosper by giving everyone the chance to develop and improve their digital skills. In 2015 we supported the UK’s digital skills charity Go ON UK’s launch of the Digital Inclusion Heatmap. This was developed in conjunction with a number of partners to help ensure everyone in the UK has the basic digital skills they need. The Heatmap displays a measure of digital exclusion at a local level, providing policymakers and those working in the digital skills and inclusion sector with the insight to help drive engagement, action and funding where it is most needed.
Market growth Growth in the markets in which we operate has improved but in aggregate remains much weaker than pre-crisis. Mortgage volumes for house purchases rose 4.7 per cent to a post-crisis high, and their value rose by 10.7 per cent, pushing growth in balances up from 1.6 per cent in 2014 to 2.6 per cent in 2015, its strongest since 2008. Growth in consumer unsecured borrowing balances rose from 4.1 per cent in 2014 to 6.0 per cent in 2015, the strongest since 2005. Small and medium-sized companies (SMEs) have started to increase borrowing from banks again in 2015 for the first time since 2008, while companies’ deposits continued to grow rapidly, up 11.5 per cent in 2015 after an average of 9.3 per cent across 2013-14. Consumer deposit growth fell back slightly from 4.3 per cent in 2014 to 3.8 per cent in 2015, but this was mainly due to the government’s launch of pensioner bonds.
Customer drivers and competition In the competitive open markets in which we operate, customers are benefiting from an increasing range of products and services from a growing choice of providers and via a range of channels. The proportion of the UK population with access to the internet has increased significantly over the past few years, as has the proportion of people accessing the internet via their mobile phone. This has changed customer behaviours and expectations in terms of how they shop for goods and undertake banking and these trends are expected to accelerate.
Our customers require different products and services at different stages of their lives, with younger people requiring help with planning and providing for retirement, while the older generation is becoming increasingly interested in accessing their equity to support their retirement.
Above all it recognises that we operate in a competitive market where additional challengers continue to emerge and the only way of ensuring success is by focusing on the ever-changing needs of our customers. Read more about our strategic priorities on pages 20-21.
COMPETITIVE STRENGTHS THAT DIFFERENTIATE LLOYDS BANKING GROUP We have a number of strengths and capabilities that provide significant advantage and differentiation, driving value creation. Maintaining this through continued investment is key to future success.
Simple, low cost operating model: Our simpler operating model and focus on operational efficiency already provides a cost advantage which benefits both customers and shareholders and will continue to be a key focus for the Group.
Initiatives – Seamless multi-channel distribution across branch, online, mobile and telephony – Tailor product propositions to meet customer needs more effectively – Commitment to conduct and investment in service
Progress in 2015 1 Retail and Home Insurance H2 digital market share of new business flows.
As the UK economy continues to recover, we are further developing Groupwide growth opportunities within our prudent risk appetite. We are maintaining market leadership in our main retail businesses, making the most of our multi-brand, multi-channel strategy whilst also focusing on areas where we can grow.
– Best bank for customers index up 6 points highlighting increased customer focus in the business – Employee engagement up 11 points – 31 per cent of senior roles now held by women – Top private sector company for lesbian, gay, bisexual and transgender people in the Stonewall Top 100 – Agile working programme launched – Over 9,800 managers enrolled on new Line Manager Academy – Enhanced reward proposition including simplified pay ranges
Focusing on what matters most To guide our corporate reporting, we conducted a comprehensive materiality survey to identify and prioritise the issues that matter most to our stakeholders, including colleagues and opinion formers. This process was informed by a survey of more than 2,000 adults in the UK1.
The five issues that most concerned our stakeholders in 2015: – Building trust in our business – Running our business even more responsibly – Improving customer experience – Making our products and services clearer – Explaining our wider economic contribution
Greater transparency We are committed to conducting our business responsibly and dealing transparently and fairly with any queries or concerns our stakeholders may have about our business or our strategy. We know that in order to become the best bank for customers we must be clear, open and visible about these key issues.
97% of colleagues have completed training on our Codes of Responsibility and culture
Building trust in our business We can only achieve sustainable growth if we earn and retain the trust of our customers and other stakeholders. Trust is not a nice to have, it is a must have.
Paying and collecting UK tax We continue to be one of the highest payers of UK tax; rated as second highest in the latest 100 Group PwC Total Tax Contribution Survey. We do not interpret tax laws in ways that we believe are contrary to their intention and we do not promote tax avoidance to our customers. We comply with the HMRC Code of Practice on Taxation for Banks and the Confederation of British Industry’s Statement of Tax Principles. We are also a major tax collector, gathering £2.2 billion on behalf of HMRC in 2015.
Improving customer experience We want to be the best bank for customers, doing the right thing for them by providing products and services that they can afford, understand and trust to achieve the outcomes they want.
Protecting customers’ privacy and data Our customers, including 11.5 million who actively bank digitally, of which 6.6 million who use their mobile to bank with us, trust us with their money and personal details. To protect these assets, we consistently invest in security technologies, processes and training for colleagues. Since 2011 we have invested £157 million to improve security and provide protection for our customers. We also provide our customers with useful information about how they can improve their own money and data security behaviour.
Responsible lending We understand the need to lend responsibly, in line with our own low-risk business model and customers’ ability to meet their repayments. The support we offer all customers and the credit worthiness processes we use, reflect our responsible approach.
£11bn of new mortgage lending to more than 79,000 first-time buyers in 2015
Making our products and services clearer We serve an increasingly diverse customer base of individuals and businesses. To deliver sustainable growth we need to serve them all equally well.
Supporting UK trade and manufacturing Providing support to UK businesses so that they can export and attract international investment is essential to long term economic growth. In 2015, Lloyds Bank Commercial Banking became the first UK bank to enter into a strategic partnership with UK Trade and Investment to support UK businesses to export and to attract inward investment into the UK.
Read more about our business model and wider value creation on page 18.
Criteria used to measure and report Scope 1, 2, 3 emissions is provided in the Lloyds Banking Group criteria statement available online at www.lloydsbankinggroup.com/ResponsibleBusiness
Communities We are an integral part of communities across Britain, and we believe we can use our unique position to help them prosper. This year we raised £5 million (including matched giving) for our Charity of the Year, BBC Children in Need through various fundraising activity. In 2015, colleagues gave 320,000 paid volunteering hours to support community-based organisations. We are doing more to encourage skills-based volunteering.
Risks are identified, managed and mitigated using our Risk Management Framework (see page 29). The principal risks we face, which could significantly impact the delivery of our strategy, are discussed on pages 30 to 33.
Credit rating In recognition of the delivery of the Group’s strategy, the three main credit rating agencies have either reaffirmed or upgraded our credit rating in the year.
Risk governance The Board approves the Group’s overall RMF and sets risk appetite, both of which are designed to ensure that we manage our risks in the right way to achieve our agreed strategic objectives. It has a dedicated risk committee of non-executive directors who keep the design and performance of the Group’s RMF under close and regular scrutiny, and interact closely with the executive risk management committee operating at Group Executive Committee level. The Board and senior management encourage a culture of transparency and openness to ensure that issues are escalated promptly to them where required.
Carried out by all three lines of defence and is an integral part of our control effectiveness assessment
The framework is periodically reviewed, updated and approved by the Board to reflect any changes in the nature of our business and external regulations, law, corporate governance and industry best practice. This helps us to ensure we continue to meet our responsibilities to our customers, shareholders and regulators. Our risk appetite and the policy framework define clear parameters within which our business units must operate in order to deliver the best outcome for customers and stakeholders.
The Board delegates authorities for risk management through the Group Chief Executive and the management hierarchy to individuals, an approach which is consistent with the focus of the Senior Managers and Certification Regime (SM&CR) on the principle of individual accountability. At a senior level, executives are supported in their decision-making by a committee-based governance structure. The concept of individual accountability for risk management is embedded in the RMF and culture at every level, and guides the way all employees approach their work, behave and make decisions. An important element of the framework is the maintenance of strong internal controls which are owned and operated by individual business areas. The Group’s risk governance arrangements will support the effective implementation of the requirements of the SM&CR which comes into force in 2016.
All risks have the potential to impact our strategic priorities and the summary below illustrates the most predominant strategic priority impacted by the principal risks and uncertainties detailed.
Delivering sustainable growth We have a UK customer focused, low risk, conservative and well balanced credit portfolio, managed through the economic cycle and supported by strong credit portfolio management.
We support sustainable growth and meet our targets in the Helping Britain Prosper Plan while staying within prudent risk appetite.
Regulatory and legal risk The risks of changing legislation, regulation, policies, voluntary codes of practice and their interpretation in the markets in which we operate can have a significant impact on the Group’s operations, business prospects, structure, costs and/or capital requirements and ability to enforce contractual obligations.
– Customer focused conduct strategy implemented to ensure customers are at the heart of everything we do. – Product approval, review processes and outcome testing supported by conduct management information. – Clear customer accountabilities for colleagues, with rewards driven by customer-centric metrics. – Learning from past mistakes through root cause analysis of crystallised issues.
FCA reportable complaints per 1,000 accounts (excl. PPI)1 1 This key risk indicator is also a key performance indicator (KPI).
Availability of core systems Creating the best customer experience We recognise the role that resilient technology plays in enabling us to create the best customer experience, and in maintaining banking services and trust across the wider industry. As such, the availability, resilience and security of our IT systems remains a key focus.
The current regulatory regime presents some far reaching people implications in terms of personal accountability and remuneration arrangements. This coincides with the ongoing challenge of maintaining colleague capacity and capability to deliver our change agenda.
We respond as appropriate to impending legislation and regulation and associated consultations and participate in industry bodies. We continue to be subject to significant ongoing and new legislation, regulation and court proceedings, with numerous developments in each of these areas.
Conduct risk Conduct risk can arise from a number of areas including selling products to customers which do not meet their needs; failing to deal with customers’ complaints effectively; not meeting customers’ expectations; and exhibiting behaviours which do not meet market or regulatory standards.
Creating the best customer experience As we transform and simplify our business, minimising conduct risk is critical to achieving our strategic goals and meeting market and regulatory standards. Our customer focused conduct strategy forms the foundation of our vision to be the best bank for customers, allowing us to create the best customer experience through learning from past mistakes.
– Continual review of our IT environment to ensure that systems and processes can effectively support the delivery of services to customers. – Addressing the observations and associated resilience risks raised in the Independent IT Resilience Review (2013), with independent verification of progress on an annual basis. – Investing in enhanced cyber controls to protect against external threats to the confidentiality or integrity of electronic data, or the availability of systems. Responding to findings from third party industry testing.
– Focused action on strategy to attract, retain and develop high calibre people. – Maintain compliance with legal and regulatory requirements relating to the SM&CR, embedding compliant and appropriate colleague behaviours. – Continued focus on our culture, delivering initiatives which reinforce behaviours to generate the best long-term outcomes for customers and colleagues. – Maintain organisational people capability and capacity levels in response to increasing volumes of organisational and external market changes.
We already have a strong culture of ownership and accountability, and compliance with the SM&CR will enable us to further strengthen our ability to clearly demonstrate the responsibilities of Senior Managers and how these are discharged.
Creating the best customer experience We are committed to meeting the changing needs of customers by working to provide a range of insurance products via multiple channels. The focus is on creating the best customer experience by helping customers protect themselves today whilst preparing for a secure financial future.
– A comprehensive capital management framework that sets and monitors capital risk appetite using a number of key metrics. – Close monitoring of capital and leverage ratios to ensure we meet current and future regulatory requirements. – Comprehensive stress testing analysis to evidence sufficient levels of capital adequacy under various adverse scenarios. – Accumulation of retained profits and managing dividend policy appropriately.
There is a risk that our options to fund our balance sheet are reduced in future, or that the cost of funding may increase which could impact our performance versus our strategic plans.
Total income of £17,637 million was 1 per cent higher than 2014, with growth in net interest income partly offset by lower other income.
Net interest income increased 5 per cent to £11,482 million, reflecting the improved net interest margin. Net interest margin of 2.63 per cent was up 23 basis points, driven by a combination of lower deposit and wholesale funding costs, partly offset by continued pressure on asset prices. Average interest-earning banking assets fell by £19 billion, or 4 per cent, to £442 billion, largely as a result of the reduction of £15.6 billion in run-off assets. Excluding run-off, average interest-earning banking assets were 1 per cent lower with lending growth in key customer segments offset by reductions in portfolios closed to new business.
In 2016, the Group expects to benefit from its continued disciplined approach to the management of credit and the resilient UK economy. The asset quality ratio for the 2016 full year is expected to be around 20 basis points, comprising a marginally lower level of gross impairments at around 25 basis points, compared with 28 basis points in 2015 and a much reduced level of write-backs and provision releases.
Asset sales and other items: Asset sales and volatility (182) (1,190)
Lloyds Banking Group Annual Report and Accounts 2015 Strateg ic rep o rt Financial results
TSB The Group’s results in 2015 include TSB for the first quarter only, following the agreement in March to sell our remaining stake in the business to Banco Sabadell. The charge of £745 million includes £660 million relating to the sale of TSB which covers the net costs of the Transitional Service Agreement between the Group and TSB and the contribution to be provided by the Group to TSB in migrating to an alternative IT platform, partially offset by the gain on sale.
Weekly complaint trends could vary significantly throughout this period, given they are likely to be impacted by a number of factors including the potential impact of the FCA’s proposed communication campaign as well as changes in the regulation of CMCs.
Taxation The tax charge for the year to 31 December 2015 was £688 million (2014: £263 million), representing an effective tax rate of 42 per cent (2014: 15 per cent).
The Group’s liquidity position remains strong, with liquidity coverage ratio (LCR) eligible assets of £123 billion. LCR eligible assets represent almost 5.7 times the Group’s money-market funding with a maturity of less than one year and were in excess of total wholesale funding at 31 December 2015 thus providing a substantial buffer in the event of market dislocation. The Group’s LCR ratio already exceeds regulatory requirements and is greater than 100 per cent.
2 Including Insurance dividend relating to 2015, paid in 2016. Excluding the Insurance dividend the leverage ratio was the same at 4.8 per cent.
The Group further strengthened its capital position in 2015, with the pro forma CET1 ratio increasing to 13.9 per cent before taking account of dividends in respect of 2015 and 13.0 per cent after dividends. The pro forma ratio recognises the 2015 Insurance dividend paid in February 2016 following the implementation of Solvency II. The improvement in the pro forma CET1 ratio was driven by a combination of underlying profit and lower risk-weighted assets offset by charges relating to PPI and other conduct issues.
The Group continues to be strongly capital generative, generating, on a pro forma basis, 300 basis points of capital before dividends and PPI in 2015. This has benefited from a significant reduction in risk-weighted assets, which is unlikely to be repeated. Going forward, we now expect to generate around 200 basis points of capital annually pre dividends. This will enable us to support sustainable growth in the business and help Britain prosper whilst delivering sustainable returns for shareholders.
The special dividend of 0.5 pence per share represents the distribution of surplus capital over and above the Board’s view of the current level of capital required to grow the business, meet regulatory requirements and cover uncertainties. This level is consistent with our capital requirement guidance of around 12 per cent plus an amount broadly equivalent to a further year’s ordinary dividend.
As a result of the strategic and financial progress, the Board has recommended the payment of an increased ordinary dividend and a special dividend and we are enhancing our guidance for the 2016 net interest margin and annual capital generation. Although the delivery of the cost:income ratio and return on required equity guidance has been deferred, we remain confident in the Group’s prospects and its ability to generate capital and believe the Group is well positioned to deliver sustainable growth and superior returns.
2 Excludes reverse repos of £nil (31 December 2014: £5.1 billion).
Retail offers a broad range of financial service products, including current accounts, savings and mortgages, to UK personal customers, including Wealth and small business customers. It is also a distributor of insurance, and a range of long-term savings and investment products. Our aim is to be the best bank for customers in the UK, by building deep and enduring relationships that deliver value to customers, and by providing them with greater choice and flexibility. We will maintain our multi-brand and multi-channel strategy, and continue to simplify the business and provide more transparent products, helping to improve service levels and reduce conduct risks.
– Increased return on risk-weighted assets to 2.33 per cent, exceeding our 2013 strategic commitment of returns of greater than 2 per cent and on track to exceed 2.40 per cent by the end of 2017. This reflected income growth and cost management in challenging markets, with disciplined capital and credit management as recognised by the award of Credit Portfolio Manager of the Year by Risk Awards. – Awarded Business Bank of the Year at the FD’s excellence Awards for the 11th consecutive year.
– Deposits up 5 per cent with growth in SME, Mid Markets and Global Corporates transactional deposits underpinned by continued investment in the transaction banking platform and the improved credit rating of Lloyds Bank, offset by the optimisation of Financial Institutions deposits. – 3 per cent decrease in risk-weighted assets despite increased lending to SMEs and Mid Market clients, driven by continued optimisation initiatives, improved credit quality and reduced operational risk risk-weighted assets.
Financial performance – Underlying profit of £1,005 million with growth in better quality but lower margin lending, resulting in broadly flat income but lower impairments. This was offset by increased cost of investment in growth initiatives. – Net interest income in line with prior year at £1,287 million (2014: £1,290 million) with 9 per cent growth in average interest-earning banking assets offset by a lower net interest margin down 55 basis points to 5.94 per cent. – Net interest margin was down due to the acquisition of lower risk but lower margin new business, an increased proportion of Cards interest free balance transfer balances as we grow the business and the impact of the planned reduction in deposits in line with Group’s balance sheet funding strategy. Despite this, return on risk-weighted assets was down only 6 basis points reflecting the portfolio quality. – Other income of £1,358 million (2014: £1,364 million) with higher income from Lex Autolease fleet growth offset by the impact of lower interchange income in Credit Cards as a result of the recent EU ruling. – Operating costs increased by 1 per cent, to £768 million as efficiency savings were more than offset by continued investment spend. Operating lease depreciation increased 8 per cent driven by Lex Autolease fleet growth. – Impairment charges reduced by 29 per cent to £152 million, driven by the continued improvement in portfolio quality, supported by the sale of Credit Card recoveries assets; asset quality ratio improved by 37 basis points to 0.68 per cent. – Net lending increased by 13 per cent driven by Black Horse and Credit Cards. UK Consumer Finance lending growth of 17 per cent year-on-year. – Customer deposits reduced by 26 per cent, of which 4 per cent was due to foreign exchange movements, to £11.1 billion driven by the Group’s funding strategy. – Risk-weighted assets down 4 per cent despite a 13 per cent increase in customer assets reflecting the continued improvement in portfolio quality and a reduced allocation of operational risk risk-weighted assets.
Capital – Our internal model for Solvency II was successfully implemented on 1 January 2016 with the capital position remaining robust. The estimated solvency ratio for the insurance business at 1 January 2016 was 148 per cent before allowing for dividends.
The fall in existing business income reflects a reduction in the expected rate of return used to calculate life and pensions income. The rate of return is largely set by reference to an average 15 year swap rate (2.57 per cent in 2015 and 3.48 per cent in 2014).
General Insurance income net of claims has fallen by £95 million. This reflects the run-off of products closed to new customers, the impact of becoming a sole underwriter of the home insurance business (which has resulted in a short term reduction from the loss of commission recognised upfront) and the impact of adverse weather. The anticipated launch in early 2016 of a more flexible Home product is expected to lead to an improvement in general insurance sales going forward.
Costs are £30 million higher, reflecting significant investment spend as part of an ongoing programme of growth and simplification initiatives. In 2015 this included the launch of Protection to IFAs and our bulk annuities business alongside the Part VII transfer as well as a significant regulatory change agenda in particular to support pensions freedoms and transition to Solvency II. Excluding investment related expenditure, underlying costs fell by 3 per cent during 2015 reflecting ongoing operational efficiencies.
3 Restated to align with the revised product offerings and how the Insurance business supports customers.
The Insurance business generated £676 million of operating cash in 2015, £61 million lower than the prior year. The initial cash strain from writing new bulk annuity business, reduced volumes within General Insurance and a reduction in the expected rate of return used to calculate life and pensions income, drove the reduction in cash generated in the year. These impacts have been partly offset by £185 million of cash benefits recognised in respect of the acquisition of attractive higher yielding assets to match long duration annuity liabilities and a £48 million benefit from the sale of a reinsurance asset.
Banking net interest margin Banking net interest margin is calculated by dividing banking net interest income by average interest-earning banking assets. A reconciliation of banking net interest income to Group net interest income showing the items that are excluded in determining banking net interest income follows: 2014 £m
Average interest-earning banking assets (year to date) 441.9 442.8 444.8 446.5
Net asset value per ordinary share 57.9p 60.7p 54.6p 59.5p 66.1p
Post-tax return on average shareholders’ equity 1.3 2.9 (2.0) (3.3) (6.7)
Common equity tier 1 capital/Core tier 1 capital 12.8 12.8 14.0 12.0 10.8 1 Restated in 2013 for IAS 19 (Revised) and IFRS 10.
Skills and experience: Anita has significant board, financial and general management experience across a range of sectors, including banking, asset management, manufacturing and utilities. Her extensive board level experience makes her an effective Deputy Chairman. Anita was Chairman of Victrex plc, having previously been its Senior Independent Director. She was also the Senior Independent Director of Aberdeen Asset Management and IMI plc, an Executive Director of Abbott Mead Vickers, Director of Corporate Development at WPP Group and a Non-Executive Director of Northumbrian Water. She has held various investment and marketing roles at Scottish Provident and the Royal Bank of Scotland. External appointments: Chairman of Croda International Plc and a Non-Executive Director of BHP Billiton.
Skills and experience: Alan is a highly regarded retail and commercial banker having spent 37 years with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK. Alan’s strategic focus and core banking experience complements the balance of skills on our Board. More recently, he was Chairman of Brown, Shipley & Co. Limited, a Non-Executive Director of Nationwide Building Society and Chairman of its Risk Committee and a Non-Executive Director of Carpetright plc. External appointments: Non-Executive Director of Willis Limited and Chairman of its Risk Committee, Senior Independent Director of Urban & Civic plc and a Governor of Motability.
Skills and experience: Simon has deep international experience in board level strategy and execution. His extensive knowledge of financial markets, treasury and risk management and his qualification as an Audit Committee Financial Expert is of particular value in our Board Risk and Audit Committees. He was previously Shell’s Chief Financial Officer for Exploration & Production and prior to that Head
Skills and experience: António brings extensive experience in, and understanding of, both retail and commercial banking. This has been built over a period of more than 25 years, working both internationally as well as in the UK. António’s drive, enthusiasm and commitment to customers, along with his proven ability to build and lead strong management teams, brings significant value to all stakeholders of Lloyds Banking Group. Previously he worked for Goldman Sachs, Citibank and held various senior management positions at Grupo Santander before becoming its Executive Vice President. He was a Non-Executive Director of Santander UK and subsequently Chief Executive. He is also former NonExecutive Director of the Court of the Bank of England and Governor of the London Business School. External appointments: Non-Executive Director of EXOR S.p.A., Fundação Champalimaud and Sociedade Francisco Manuel dos Santos in Portugal, a member of the Board of Stichting INPAR and Chairman of the Wallace Collection.
Skills and experience: George is a chartered accountant with extensive operational and financial expertise including strategic and financial planning and control. He has worked in financial services in the UK and overseas for over 20 years. George was an Executive Director and Chief Financial Officer of RSA Insurance Group, the former Head of Capital Management of Zurich Financial Services and Chief Financial Officer of its UK operations as well as holding various senior management positions at Prudential. He is a Non-Executive Director of Scottish Widows. External appointments: None.
Skills and experience: Previously General Counsel and Company Secretary of Standard Life after a career as a corporate lawyer in private practice in London and Edinburgh. He has a wealth of experience in governance, policy and regulation. He is a Fellow of the Institute of Chartered Secretaries and Administrators and a Member of the Chartered Institute for Securities and Investment and the GC100.
07 Antonio Lorenzo Interim Chief Executive, Scottish Widows and Interim Group Director, Insurance
Antonio joined the Group in 2011 as head of the Wealth and International division and Group Corporate Development, leading the Group’s strategic review and subsequent programme of reducing non-core assets and exiting international locations. From 2013, he assumed the role of Group Director, Consumer Finance & Group Corporate Development, leading the division’s growth strategy whilst completing the sale of TSB. In October 2015 he was appointed Interim Chief Executive, Scottish Widows and Group Director, Insurance. Antonio is also Group Executive Sponsor for Emerging Talent.
Simon joined the Group in 2016 from Linklaters LLP where he was Firmwide Managing Partner, a position he held from January 2008. Prior to this, Simon spent 12 years in Asia, specialising in M&A and securities advice, serving terms in each of Hong Kong and Tokyo and was Managing Partner for Asia from 2003-2007. He is a Solicitor of the High Court of the Hong Kong Special Administrative Region, as well as a Solicitor of the Senior Courts of England and Wales.
Simon joined Linklaters in London in 1990, having studied at Emmanuel College, Cambridge. He is a trustee of the National Youth Theatre of Great Britain and a member of TheCityUK China Market Advisory Group.
Miguel holds a ‘Cum Laude’ degree in Business Administration from the University of Barcelona and an MBA from IESE Business School. He is a Board member of Go ON UK.
During 2015, succession planning and the composition of the Board and its Committees remained a key focus. I am pleased to welcome Deborah McWhinney and Stuart Sinclair as independent Non-Executive Directors in December 2015 and January 2016 respectively. They bring deep banking and wider financial services experience, helping ensure the Board is well placed to address future technology and market risks across the full range of business areas in which we operate. Carolyn Fairbairn, an independent Non-Executive Director, retired from the Board in October 2015 to take up the position of Director-General of the Confederation of British Industry in November 2015. Dyfrig John, an independent Non-Executive Director, has notified the Board that he wishes to reduce his workload and therefore does not intend to seek re-election at the 2016 annual general meeting (AGM). Both Carolyn and Dyfrig leave with our thanks and best wishes for the future.
2015 has also seen a number of changes to our Committee structure and composition, including the establishment of a Responsible Business Committee, underlining the Group’s commitment to being a responsible business. Rebuilding trust and delivering our vision of being the best bank for customers are integral to our strategy. Full details of all Committee changes during the year are on page 62.
2015, our milestone year, was a year of continued delivery for the Group and included the reinstatement of dividends. The decision to resume dividends bears testament to the successful transformation and improved risk profile of the business. Read more on page 63.
Read more in the Directors’ remuneration report on pages 82 to 106 82
Risk management and viability statement The Board is responsible for the Group’s risk management and internal controls systems and for reviewing their effectiveness. The Board is also responsible for assessing the going concern and longer term viability of the Company and the Group.
IT resilience and digital transformation There is an ever increasing understanding of the criticality of technology in delivering customer service. During the year, the Board spent considerable time reviewing the delivery of the three-year IT resilience investment and digital transformation programmes.
Senior Independent Director – Anthony Watson – Sounding board for the Chairman and Group Chief Executive – Acts as a conduit for the views of other Non-Executive Directors – Conducts the Chairman’s annual performance appraisal – Helps resolve shareholders’ concerns – Attends meetings with major shareholders and financial analysts to understand issues and concerns
The Non-Executive Directors are listed on pages 56 and 57. 56
Group Chief Executive – António Horta-Osório – Manages the Group on a day-to-day basis – Makes decisions on matters affecting the operation, performance and strategy of the Group’s business – Provides leadership and direction to senior management – Coordinates all activities to implement the strategy and for managing the business in accordance with the Group’s risk appetite and business plan set by the Board
Company Secretary – Malcolm Wood – Advises the Board – Ensures good information flows and comprehensive practical support are provided to Directors – Maintains the Group’s corporate governance framework – Organises Directors’ induction and training – Communicates with shareholders as appropriate and ensures due regard is paid to their interests
Carolyn Fairbairn4 8 8 1 The number of Board meetings includes two ad hoc meetings, one held in October in relation to the Group’s preparation for the SM&CR and one in December to provide updates on the Court of Appeal decision on the regulatory par call of Enhanced Capital Notes and the 2015 PRA stress test result.
Prior to each Board meeting the Chairman, Company Secretary and the Chief of Staff, who assists the Group Chief Executive and runs his executive office, review the agenda, the arrangements for the Board meeting and the time allocation for individual agenda items. A similar comprehensive process is in place for each of the Board Committees.
Access to advice The Group provides access, at its expense, to the services of independent professional advisers in order to assist Directors in their role. Board Committees are also provided with sufficient resources to undertake their duties.
– Responsible Business review and creation of the Responsible Business Committee
– Continuing development and monitoring of key metrics of customer dashboard
– Conduct, culture and values – IT resilience and digital transformation
The Board in action The Non-Executive Directors see attendance at Board and Committee meetings as only one part of their role. The NonExecutive Directors regularly meet with senior management and spend time increasing their understanding of the business through formal briefing sessions or more informal events such as breakfast briefings, dinners and site visits.
Non-Executive Directors’ office The Non-Executive Directors frequently visit the Group’s offices on Group business and to meet with senior management outside of Board and Committee meetings. To support the Non-Executive Directors in fulfilling their role, the Group provides an office, with administrative support, and a meeting room for the Non-Executive Directors’ use.
Deep dives During the year the Board held eight ‘deep dives’ which provided the opportunity for presentations from senior management and an in-depth review of key areas of focus including: – Customer experience – Group Digital (two updates) – IT transformation update and outlook – Group Operations, including IT strategy – Retail performance and products – Commercial Banking – The changing UK payments landscape
More about the appointment of new Directors and the Group’s approach to succession planning can be found in the Nomination & Governance Committee report. Changes to Board Committee memberships are set out on page 62.
Bespoke programme The Chairman personally ensures a new Director receives a tailored induction. In the case of Ms McWhinney, she requested that the risk induction include an overview of the UK regulatory landscape, reflective of her career having been spent in the United States to date.
Development and training programme at a glance During the year a comprehensive programme, under the leadership of the Chairman, was in place comprising both formal and informal training and information sessions. These included: – ‘Deep dive’ sessions detailed on page 65 – Site visits, Board dinners and breakfast meetings – Training and information sessions on the SM&CR, ring-fencing and resolution and stress testing – Management meetings and one-to-one meetings with key executives from across the Group’s operations – Briefing material on the Board portal
Board effectiveness The Chairman of the Board leads the rolling review of the Board’s effectiveness and that of its Committees and individual Directors with the support of the Nomination & Governance Committee, which he also chairs. The annual evaluation, which is facilitated externally at least once every three years, provides an opportunity to consider ways of identifying greater efficiencies, maximising strengths and highlighting areas for further development.
Corporate Governance Review In late 2014 the Chairman commissioned the newly appointed Company Secretary to undertake an end-to-end review of the Group’s governance arrangements from a fresh perspective. The Company Secretary’s review was informed by, amongst other matters, the 2014 annual review of Board Effectiveness as well as the work which is being carried out in the Group in preparation for the SM&CR. The Company Secretary completed his review in 2015 and his findings and the Board’s response are set out on page 69.
2015 review process – Meeting between JCA Group and the Senior Independent Director
– Questionnaire completed by each Director broadly in the same format as for the 2014 review for comparability – Individual meetings between each Director and a representative from JCA Group – Presentation by JCA Group of the highlights to the Nomination & Governance Committee in November 2015 – Presentation by JCA Group to the Board in January 2016
– New Board template and guidelines rolled out – Further targeted training for authors to ensure papers are delivered in a timely manner, present a balanced view of all issues and are concise – Improved 2015 effectiveness review scores
Outcome of 2015 Board Effectiveness Review The outcome of the effectiveness review has been discussed by the Board and each of the Committees. The outcome of the evaluation of the Chairman‘s performance was discussed by the Directors in the absence of the Chairman.
EFFECTIVENESS continued Officer, Executive Directors and Non-Executive Directors and had performed his role to a high standard. The Board had high regard for the Chief Executive Officer and the transformation of the business he had led. The increasing depth of debate at meetings was welcomed but the review identified a number of actions that will continue to maintain and improve the Board’s effectiveness and ensure the effort and time given by the Board translates into creating real impact for the business, shareholders and customers. The review recommendations are summarised below.
Service contracts and letters of appointment The Executive Directors have service contracts which may be terminated on 12 months’ notice by the Company or six months’ notice by the Executive Director. The Chairman has a letter of appointment which may be terminated on six months’ notice by either the Company or the Chairman. The Non-Executive Directors all have letters of appointment and are appointed for an initial term of three years after which their appointment may continue subject to an annual review. Non-Executive Directors may have their appointment terminated, in accordance with statute and the articles of association, at any time with immediate effect and without compensation. All Directors are subject to annual re-election by shareholders.
Directors’ and Officers’ liability insurance Throughout 2015 the Group had appropriate insurance cover in place to protect Directors, including the former Director who retired during the year, from liabilities that may arise against them personally in connection with the performance of their role. As well as insurance cover, the Group agrees to indemnify the Directors to the maximum extent permitted by law. Further information on the Group’s indemnity arrangements is provided on page 107. No Director or former Director sought to recover costs or expenses under their indemnity in 2015.
Time commitments Non-Executive Directors are required to devote such time as is necessary for the effective discharge of their duties. The estimated minimum time commitment set out in the terms of appointment is 35-40 days per annum including attendance at Committee meetings. For Committee Chairmen and the Senior Independent Director, this increases to a minimum of 45 to 50 days. The time devoted on the Group’s business by the Non-Executive Directors is in reality considerably more than the minimum requirements. As described elsewhere, the Non-Executive Directors see preparation for and attendance at Board and Committee meetings as only one part of their role. Outside of formal meetings, they meet regularly with senior management and attend briefing sessions and more informal events.
The purpose of the review was to provide the Board with an assessment of the Group’s corporate governance together with recommendations on steps to improve it. The Nomination & Governance Committee considered the review in April 2015 prior to the Chairman and the Company Secretary reporting on the conclusions to the Board.
The review found that the framework was generally aligned with the requirements of the SM&CR and, as relevant to the Scottish Widows Group, the SIMR, but a number of changes were recommended. These included amendments to the statements of responsibilities of the Directors and members of the GEC and minor amendments to the terms of reference of a number of Board and Group Chief Executive Committees.
INTERNAL CONTROL Board responsibility The Board is responsible for the Group’s risk management and internal control systems, which are designed to facilitate effective and efficient operations and to ensure the quality of internal and external reporting and compliance with applicable laws and regulations. The Directors and senior management are committed to maintaining a robust control framework as the foundation for the delivery of effective risk management. The Directors acknowledge their responsibilities in relation to the Group’s risk management and internal control systems and for reviewing their effectiveness.
Reviews by the Board The effectiveness of the risk management and internal control systems is reviewed regularly by the Board and the Audit Committee, including an annual review. The Audit Committee also receives reports of reviews undertaken by the Risk Division and Group Audit. The Audit Committee receives reports from the Company’s auditor, PricewaterhouseCoopers LLP (which include details of significant internal control matters that they have identified), and has a discussion with the auditor at least once a year without executives present, to ensure that there are no unresolved issues of concern.
Conclusion The Group has enhanced the control environment during the last year in a number of key respects, such as IT, cyber security and Anti-Money Laundering (AML) controls. This is reflected in the 2015 CER assessment which provides reasonable assurance that the Group’s controls are effective or that where control weaknesses are identified, they are subject to management oversight and action plans. This conclusion is consistent with the delivery of previously initiated action plans and an improvement in the operational risk profile of the Group. The Audit Committee, in conjunction with the Board Risk Committee, concluded that the Group’s risk management and internal control systems were effective and adequate having regard to the Group’s risk profile and strategy, and recommended that the Board approve them accordingly.
At the Group’s AGM in May 2015, shareholders gave an advisory ‘for’ vote of 97.68 per cent in favour of the implementation during 2014 of the Directors’ Remuneration Policy. Shareholders will be asked to provide an advisory vote on the Directors’ Remuneration Implementation Report for the financial year ended 31 December 2015 at the AGM in 2016, and in 2017 when shareholders will also be asked to consider and approve a new Directors Remuneration Policy.
Group Secretariat provides feedback to the Board and appropriate committees to ensure the views of retail shareholders are received and considered.
A number of changes to our Committee structure and composition were recommended to the Board, including the establishment of a Responsible Business Committee, underlining the Group’s commitment to being a responsible business. Full details of all Committee changes during the year are set out on page 62.
December. 3 Mr Watson was unable to attend the July Committee meeting due to a prior commitment.
The Committee considers the adequacy of succession arrangements for Executive Directors, members of the GEC and their direct reports. The Chairman is responsible for developing and maintaining a succession plan in relation to the Group Chief Executive who is in turn, primarily responsible for developing and maintaining a succession plan for key leadership positions in the senior executive team.
During 2015, the Committee received regular corporate governance updates from the Company Secretary, considered the impact of emerging regulation on the Board and its corporate governance practices, received a report from the Chairman on communications from shareholders and approved the appointment of Trustees to the Bank’s Foundations.
Ensuring the continued effectiveness of the external audit has also been a focus for the Committee. We reviewed the plan for the external audit, considered the reports from the external auditor on accounting and control matters, and engaged with them on key judgments. We are working with the auditors to ensure a smooth transition to a new lead audit partner for the 2016 audit.
Whilst the Committee’s membership comprises the Non-Executive Directors noted above, all Non-Executive Directors may attend meetings as agreed with the Chairman. The Group Audit Director, the external auditor, the Group Chief Executive, the Chief Financial Officer and the Chief Risk Officer also attend meetings of the Committee as appropriate.
Payment Protection Insurance (PPI) Determining the adequacy of the provision for redress payments and administration costs in connection with the mis-selling of PPI is highly judgmental. The Group makes a number of assumptions about the number of future complaints that will be received including uphold rates for complaints received; average redress payments; and related administrative costs.
– As in previous years, the Committee considered the assumptions underlying the calculation of the defined benefit liabilities, in particular the discount rate and mortality assumptions which, following the completion of the triennial funding valuation, have been updated to reflect recent experience. – The Committee was also satisfied that the Group’s quantitative and qualitative disclosures made in respect of retirement benefit obligations are appropriate. The relevant disclosures are set out in note 37: ‘Retirement benefit obligations’ on page 226 of the financial statements.
Following the offer made by Visa Inc to purchase Visa Europe Limited, management judgement was required to determine an appropriate carrying value of the Group’s interest in Visa Europe.
– The Committee sought management’s input to its assessment of the viability of the Company and the Group. The assessment, which was based on the Group’s operating, capital and funding plans, also included consideration of the principal and emerging risks which could impact the performance of the Group, and the liquidity and capital projections over the period. – The Committee was satisfied that the viability statement be provided and agreed that three years was a suitable period of review.
Group Audit In monitoring the activity, role and effectiveness of the internal audit function and their audit programme the Committee: – monitored the effectiveness of Group Audit and their audit programme through quarterly reports on the activities undertaken and a report from the Quality Assurance function within Group Audit; – approved the annual audit plan and budget and reviewed progress against the plan through the year; – considered the major findings of significant internal audits, and management’s response; and – reviewed thematic audits completed during the period which included topics on customer outcomes, operational resilience and embedding of the Risk Management Framework.
In some cases, PwC are selected over another service provider due to their detailed knowledge and understanding of the business. Any allowable non-audit service with a value above a defined fee limit requires prior approval from the Committee Chairman. The total amount of fees paid to the auditor for both audit and non audit related services in 2015 is disclosed in note 11 to the financial statements on page 206. The decrease against the prior year largely relates to fees incurred in 2014 in respect of assurance services provided by PwC ahead of the Initial Public Offering of TSB in June 2014.
The Committee also considered the effectiveness and performance of the auditor and the audit process. These assessments considered data and information from a number of sources including: – the results of an internal effectiveness survey; and – the Financial Reporting Council’s (FRC) 2015 Audit Quality Inspection Report (AQIR) on PwC published in May 2015.
I would also like to highlight the Committee’s work in helping to achieve the core aim of operating as a safe, low risk bank, where we consider the Group has made good progress. We have seen deeper embedding of a strong risk culture helping to deliver further reduction in overall risk levels compared to 2014.
Considerable time has also been spent in the review of risks relating to the resilience of IT systems and cyber security, an area of major importance to the Group. Management has taken material action to address these issues, a position the Committee will continue to monitor closely in 2016.
More details on the Group’s wider approach to risk management can be found in the Risk Management section on pages 111 to 169. Full details of the Committee’s responsibilities are set out in its terms of reference, which can be found at www.lloydsbankinggroup.com/our-group/corporate-governance
Whilst the Committee is made up of the Non-Executive Directors noted above, the Non-Executive Directors who were
Sara Weller 8 8 1 Mr Henry was unable to attend the May Risk Committee meeting due to prior executive commitments.
3 Mr Prettejohn was unable to attend the May Risk Committee meeting due to prior executive commitments.
How Committee meetings are run The management of the Committee is in keeping with the basis on which meetings of the Board are managed, as detailed on page 63, with a structure which facilitates open discussion and debate. Steps are taken to ensure adequate time for members to consider proposals which are put forward.
As highlighted in several of the individual sections below, the Committee seeks to ensure that conduct risk is considered and reviewed to ensure the highest standards are applied. For further detail see the sections on Low Risk Bank, Consolidated Risk Report and Divisional Risk Profiles. In addition the Committee considered reports on complaints, rectifications, conduct risk appetite metrics and product governance.
Conclusion: The Group continues to move further towards achieving its stated aim of operating as a low risk bank, and compares favourably in most related areas of assessment with its peer group, with particularly good progress in lowering levels of risk in respect of conduct, capital management and credit quality. As further management initiatives to deliver the Group’s low risk aims are implemented, the Committee will continue to review progress made during the course of the coming year.
Assessment was made of the impacts in these scenarios on a range of metrics relating to resilience in adverse conditions, including amongst others impacts on the Group’s capital and liquidity positions, in particular the impact on the tier one common capital ratio. Comparison in each scenario of the Group’s position relative to its competitors was also undertaken, with detailed review of the mitigating actions proposed by management in each scenario.
Conclusion: The Group’s capital and liquidity positions remained above required minimums in testing against both internal and external scenarios, with outcomes in most scenarios remaining above the wider risk appetite targets set by the Board. The implementation and assessment of robust and well managed stress testing arrangements will remain a key area of focus for the Committee in the coming year.
Conclusion: The Consolidated Risk Report has assisted the Committee in its assessment of the Group’s management of both existing and emerging risks, with ongoing progress being made to embed policies and practice required to mitigate common areas of risk, and sufficient levels of agility within the organisation to address emerging risks as the Group’s operating plan continues to develop.
Conclusion: Key risks continue to be well managed within each of the Group’s main operating divisions, with action taken within each business to address risks which are specific to that division. Such action is aided by the unified approach taken in addressing risks which are common across all areas of the Group, including improving management of conduct risks.
Conclusion: The Group has a good understanding and oversight of its emerging risk position, and takes steps to mitigate the impacts of new risks as they appear, ensuring close alignment in its assessment of emerging risks with developments in both the Group’s business model and its external regulatory and economic environment.
The Committee has made progress in establishing its working patterns and reporting arrangements since its first meeting in July 2015. We look forward to continuing our work in 2016 when our focus will be on: the evolution of the HBPP and stakeholder reaction to it; tracing the Group’s reputation and trust amongst a wide range of stakeholder groups; measuring our progress on building a culture that puts customers at the heart of what we do; and supporting work to embed responsible business activities with all our colleagues across the business.
A recommendation to establish the Board level Responsible Business Committee (RBC) was accepted by the Board in April 2015. The Company Secretary worked with colleagues to ensure the RBC’s remit met current good practice standards that aligned with, but did not overlap, the responsibilities of the executive level Group Customer First Committee (see page 119).
Responsible Business Committee and external stakeholders The members of the Committee have an ongoing dialogue with key stakeholders with an interest in the Committee’s activities. During 2015, the Committee invited a representative of the Group’s Stakeholder Advisory Panel to provide feedback on the 2015 HBPP and recommendations for areas of focus in the 2016 Plan. Representatives of the Financial Conduct Authority were invited to attend a meeting to observe the Committee at work. In 2016, the Committee will be inviting representatives of the Banking Standards Board and the Competition and Markets Authority, amongst others, to join a meeting to discuss their respective work programmes.
In the context of improving financial performance and a return to dividend payments, the Committee continues to ensure clear alignment between remuneration and delivery of the Group’s strategic objectives.
A summary of the remuneration policy approved at the 2014 Annual General Meeting (AGM) is included for information only. No changes have been made to the policy this year. My introductory statement and the annual report on remuneration will be subject to an advisory vote at the 2016 AGM.
I took over as Chair of the Remuneration Committee from Tony Watson in October 2015. On behalf of the Group, I would like to take the opportunity to thank Tony for the significant contribution he has made in his chairmanship of the Committee since 2011, a period that has seen profound change both for the Group and the wider UK economy.
Remuneration outcomes for 2015 As set out in detail in the annual report on remuneration, both the financial and strategic measures set by the Committee for the 2015 bonus were exceeded, with underlying profit of £8,112 million and dividends in respect of 2015 of £1.6 billion and a total capital distribution of £2.0 billion, demonstrating the Group’s return to financial health. In addition, the Group has completed the sale of the remaining holding in TSB (at a premium of around £200 million), whilst the strong financial performance has enabled the Government to make further substantial progress in returning the Group to full private ownership and has resulted in rating agency upgrades and improved feedback from the regulators.
The long-term incentive plan (LTIP) awards made in 2013 are proposed to vest at 94.18 per cent, reflecting performance in the period to 31 December 2015. This vesting outcome reflects the significant shareholder value created over the period. Awards were granted at 49.29 pence.
Overall, the total remuneration for the Executive Directors is down by around 20 per cent compared to 2014. Further details on the reward outcomes for Executive Directors are outlined in the annual report on remuneration.
In addition, during 2015, the remuneration requirements of the AIFMD Remuneration Code took effect. Alongside the specific remuneration rules, the Committee has also considered the impact of the introduction of the Senior Manager and Certification Regimes from March 2016 and other significant regulatory changes.
In particular, from 2016, there will be a regulatory requirement to extend deferral from three years to seven years. At least 60 per cent of total variable pay must be deferred. Currently the Group defers all bonuses awarded to the Executive Directors entirely in shares, an approach which is significantly more conservative than the market practice and current regulations require. In order to implement longer deferral of variable remuneration, the Group will make modest changes to the delivery of variable remuneration for the 2016 performance period. In addition to these changes for the 2016 performance period, the Committee is conducting a full review of the Group’s approach to variable remuneration and is considering making changes to deliver a simpler and more efficient structure. Any changes would apply from the 2017 performance period and it is intended that the Group will consult on these changes during 2016.
REMUNERATION AT A GLANCE How Lloyds Banking Group performed The Group has had a successful 2015 with a number of strategic milestones achieved, notably improved dividend returns, increase in underlying profit and completion of the sale of TSB at a premium to market value.
The Group’s approach to reward is to provide a clear link between remuneration and delivery of the Group’s strategy and the aim of becoming the best bank for customers.
Bonus amount post adjustment £m Dividend £m (Dividend in respect of 2015 includes ordinary and special dividend)
Base salary Base salary reflects the role of the individual taking account of responsibilities and experience, and pay in the Group as a whole. It helps to recruit and retain Executive Directors and forms the basis of a competitive remuneration package.
It is intended that approval of the remuneration policy will be sought at three year intervals, unless amendments to the policy are required, in which case further shareholder approval will be sought. No changes are proposed for 2016, therefore shareholders will not be asked to vote on the remuneration policy at the AGM this year.
As outlined in the 2013 Directors’ remuneration report, the Group’s policy is intended to ensure that the remuneration proposition is both cost effective and enables the Group to attract and retain executives of the highest calibre. The 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, the requirements of the major stakeholders are balanced: customers, shareholders, employees, and regulators.
Operation Base salaries are typically reviewed annually with any increases normally taking effect from 1 January. When determining and reviewing base salary levels, the Committee ensures that decisions are made within the following two parameters: – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.
Operation The fixed share award will be delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award.
Maximum potential Participation levels may be increased up to HMRC limits as amended from time to time. With effect from April 2014, the monthly savings limits for Save As You Earn (SAYE) is £500. The maximum value of shares that may be purchased under the Share Incentive Plan (SIP) in any year is £1,800 with a two for one match. Currently a three for two match is operated up to a maximum employee investment of £30 per month. The maximum value of free shares that may be awarded in any year is £3,600.
At the time of the release, Executive Directors receive an amount (in cash or shares) equal to the interest that would have accrued on the deferred component, if deferral is made in notes or debt instruments, or dividends paid or payable if deferred in shares, between the date of grant and the vesting of the award on the number of shares which have vested.
At least 50 per cent of the awards are weighted towards financial measures, with the balance on strategic objectives. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance is not met for financial measures or the individual is rated ‘Developing performer’ or below. The expected value of the bonus is 30 per cent of maximum opportunity.
Operation Awards are made in the form of conditional shares or nil cost options. Award levels are set at the time of grant, in compliance with regulatory requirements, and may be subject to a discount in determining total variable remuneration under the rules set by the European Banking Authority.
Shareholding guidelines Executive Directors are required to build up a holding of a value of 200 per cent of base salary and fixed share award for the GCE and 150 per cent for other Executive Directors. Details of holdings are shown in the annual report on remuneration.
Deferral of variable remuneration Operation The annual bonus and long-term incentive plans are both considered variable remuneration for the purpose of regulatory payment and deferral requirements. The payment of variable remuneration and deferral levels are determined at the time of award and in compliance with regulatory requirements (which currently require that at least 60 per cent of total variable remuneration is deferred and at least 50 per cent of total variable remuneration is paid in shares or other equity linked instruments).
The Directors who served on the Committee during the year and their attendance at Committee meetings is set out in the table below. Remuneration
Statement of voting at Annual General Meeting The Group’s remuneration policy was detailed within the Directors’ remuneration report for 2013 and voted on at the 2014 AGM. The remuneration offered to the Executive Directors in 2015 was disclosed in last year’s remuneration implementation report and was voted on at the 2015 AGM. The shareholder votes submitted at the meetings, either directly, by mail or by proxy, were as follows: Votes cast in favour Votes cast against Votes withheld
4 The LTIP vesting and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 16 February 2016. The average share price between 1 October 2015 and 31 December 2015 (73.72 pence) has been used to indicate the value. The shares were awarded in 2013 based on a share price of 49.29 pence. LTIP figures for 2014 have been adjusted for the share price on the date of vesting (79.2 pence).
6 Under terms agreed when joining the Group, the CRO is entitled to a conditional lump sum benefit of £718,996 either (i) on reaching normal retirement age unless the CRO voluntarily resigns or is dismissed for cause, or (ii) on leaving due to long term sickness or death.
To ensure fairness for the Group’s shareholders, the total bonus outcome is subject to a limit of 10 per cent of pre-bonus underlying profit. For 2015, the bonus outcome of £353.7 million is significantly below the limit of £835 million.
– Strong performance on 2015 stress tests, comfortably exceeding the PRA capital threshold.
George Culmer The Chief Financial Officer’s (CFO) personal performance assessment for 2015, as confirmed by the Committee, reflected a number of considerations including: – Maintaining a sound performance of the Finance Division, continuing to improve key risk metrics in liquidity, funding and capital. – Playing a key role in the continued improvement in the Group’s common equity tier 1 ratio (13 per cent compared to 12.8 per cent for 2014), whilst increasing ordinary dividend payments to 2.25 pence per share, with an additional special dividend of 0.5 pence per share.
Juan Colombás The Chief Risk Officer’s (CRO) personal performance assessment for 2015, as confirmed by the Committee, reflected a number of considerations including: – Significant progress in the Group’s Risk Management, delivering important steps forward in the governance of the business.
– Prudent lending criteria, leading to improved credit quality across all portfolios.
– Further improved RWA/Capital management and further reductions in the run-off portfolio.
– Continued strengthening and enhancement of the Group’s policy, standards and control framework.
Based on a full assessment of performance, the Committee agreed an individual rating for 2015 of Strong Plus for the CRO.
Expected outcomes are based on individual performance, before taking into account a modifier based on underlying profit and the Risk division’s BSC, as follows: Rating Under Developing Good Strong Top
The Group has implemented clawback, covering all material risk takers, in line with PRA requirements. Vested variable remuneration can be recovered from employees for a period of up to seven years after the date of award in the case of a material or severe risk event. The Committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if it deems appropriate.
Non-core assets at end of 2015 (excluding UK Retail) 10% of award £37.2bn £28.4bn 25% 100% £10.3bn 10% SME lending 5% of award at market 4% 25% 100% 8.1% 5%
Chairman and Non-Executive Directors (audited) Fees £000 Taxable benefits £000 Total £000
Sir Winfried Bischoff (retired April 2014) – 183 – 104 – 193
SWG Board fees1 Other fees 2015 Total 1 Scottish Widows Group Ltd.
Sara Weller 200,000 – – – – 200,000 n/a n/a 1 Shareholdings held by António Horta-Osório and Deborah McWhinney are either wholly or partially in the form of ADRs.
António Horta-Osório 1,961 200% 5,155,439 456% 11,759,547 Yes 1 Number of shares required and current shareholding percentage of base salary plus fixed share award figures are calculated using the average share price for the period 1 April 2014 to 31 March 2015 (76.075 pence).
2 Includes shares owned outright reduced by forfeitable ‘matching’ shares under the Share Incentive Plan, plus the estimated net number of vested unexercised options.
Set relative to 2017 targets Threshold: 12.7m active users Maximum: 13.3m active users
Fixed share award Fixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for Executive Directors, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements.
– any other circumstances where the Committee consider adjustments should be made.
The application of clawback will generally be considered when: – there is reasonable evidence of employee misbehaviour or material error; or
Performance measures and targets 2016 awards will be subject to a three-year performance period, and a two-year holding period following vesting.
LTIP awards may be subject to clawback for a period of up to seven years after the date of award. This period may be extended to 10 years where there is an ongoing internal or regulatory investigation.
1 The reduction in economic profit compared to the 2015 LTIP (for 2017 performance) reflects the introduction of the corporation tax surcharge for banks of 8 per cent.
2 Measure excludes PPI complaints and any complaints received via Claims Management Companies, but includes Banking, Home Finance, General Insurance, Life, Pensions and Investment complaints. The FCA has issued guidance which applies from 2016. The threshold and maximum for total reportable complaints are subject to validation, based on experience in H1 2016 and will be disclosed to shareholders later in the year.
The following table sets out the emoluments of the eight highest paid senior executives (excluding Executive Directors) in respect of the 2015 performance year.
Directors’ indemnities The Directors of the Company, 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’ for the purposes of the Companies Act 2006. The deeds indemnify the Directors to the maximum extent permitted by law and remain in force for the duration of a Director’s period of office. The deeds were in force during the whole of the financial year or from the date of appointment in respect of the Director appointed in 2015. In addition, the Group had appropriate Directors and Officers liability insurance cover in place throughout 2015. Revisions are being made to the existing Deeds of Indemnity to take account of the Senior Managers and Certification Regime. Deeds for existing Directors are available for inspection at the Company’s registered office.
Internal control and financial risk management systems in relation to financial reporting
– The final operating plan, Risk Division assessment and the results of the stress testing are presented to the Board for approval. Once approved, the operating plan drives detailed divisional and Group targets for the following year.
Deloitte LLP has reviewed a selection of non-financial KPIs, indicated by providing limited assurance using the International Standard on Assurance Engagements (ISAE) 3000 (Revised). Their full, independent assurance statement is available online at www.lloydsbankinggroup.com/ RBdownloads
– Risk appetite is embedded within principles, policies, authorities and limits across the Group and continues to evolve to reflect external market developments and composition of the Group. – Performance is optimised by allowing business units to operate within approved risk appetite and limits.
THE GROUP’S APPROACH TO RISK The Group operates a prudent approach to risk with rigorous management controls to support sustainable business growth and minimise losses. Through a strong and independent risk function (Risk Division) a robust control framework is maintained to identify and escalate emerging risks to support sustainable business growth within risk appetite and through good risk reward decision making.
Data integrity, IT and cyber: Cyber remains an evolving threat to the Group and its strategic objectives. Increased digital interconnectivity across the Group, its customers and suppliers has the potential to heighten our vulnerability to cyber-attacks, which could disrupt service for customers, and cause financial loss and reputational damage.
Other stress testing activity The Group’s stress testing programme also involves undertaking assessment of operational risk scenarios, liquidity scenarios, market risk sensitivities and business specific scenarios (see the principal risks on pages 120 to 169 for further information on risk specific stress testing). If required, ad hoc stress testing exercises are also undertaken to assess emerging risks, as well as in response to regulatory requests. This wide ranging programme provides a comprehensive view of the potential impacts arising from the risks to which the Group is exposed and reflects the nature, scale and complexity of the Group.
Role of the Board and senior management – key responsibilities of the Board and senior management include: – setting risk appetite and approval of the RMF; – approval of Groupwide risk principles and policies; – the cascade of delegated authority (for example to Board sub-committees and the Group Chief Executive); and – effective oversight over risk management consistent with the risk appetite.
– Risk appetite is defined within the Group as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate’. – Risk appetite is documented in a Board Risk Appetite Statement reviewed by the Board Risk Committee and approved annually by the Board. The Board Risk Appetite is aligned to the Risk Appetite Framework, and in turn the RMF and Group Risk Principles. An updated Board Risk Appetite Statement was approved by the Board in 2015. – The Board metrics are supported by more detailed sub-Board appetite functional risk metrics and sub-Board appetite divisional risk metrics. – The Group’s strategy operates in tandem with the Board Risk Appetite and business planning is undertaken with a view to meeting the requirements of the Board Risk Appetite. – Risk appetite is embedded within principles, policies, authorities and limits across the Group and continues to evolve to reflect external market developments and composition of the Group.
Risk Division, headed by the Chief Risk Officer, consists of six risk directors and their specialist teams. These teams provide oversight and independent challenge to business management and support senior management and the Board with independent reporting on risks and opportunities. Risk directors, responsible for each risk type, meet on a regular basis under the chairmanship of the Chief Risk Officer to review and challenge the risk profile of the Group and to ensure that mitigating actions are appropriate.
The Group Chief Executive is supported by the following: Committees Risk focus
Responsible for monitoring breaches, material events and risk issues and conducting deep dive assessments on specific Conduct, Compliance or Operational Risk subjects to inform corrective action along with the sharing of information and best practice.
Group Financial Risk Committee Responsible for reviewing, challenging and recommending to GEC/GRC, the Group Individual Liquidity Adequacy Assessment and Internal Capital Adequacy Assessment Process submissions, the Group Recovery Plan, and the annual stress testing of the Group’s operating plan, PRA and EBA stress tests, and any other analysis as required.
Responsible for setting the framework and standards for model governance across the Group, including establishing appropriate levels of delegated authority and principles underlying the Group’s risk modelling framework, specifically regarding consistency of approach across business units and risk types. It approves risk models other than material models which are approved by GRC.
Exposures The principal sources of credit risk within the Group arise from loans and advances, contingent liabilities, commitments, debt securities and derivatives to customers, financial institutions and sovereigns. The credit risk exposures of the Group are set out in note 53 on page 266. Credit risk exposures are categorised as ‘retail’, arising primarily in the Retail, Consumer Finance and Run-off divisions, and some small and medium sized enterprises (SMEs) and ‘corporate’ (including corporates, banks, financial institutions, sovereigns and larger SMEs) arising primarily in the Commercial Banking, Run-off and Insurance divisions and Group Corporate Treasury (GCT).
Credit risk exposures in the Insurance business largely result from holding bond and loan assets in the shareholder funds (including the annuity portfolio) and from exposure to reinsurers.
The models vary, inter alia, in the extent to which they are ‘point in time’ versus ‘through the cycle’. The models are subject to rigorous validation and oversight/governance including, where appropriate, benchmarking to external information.
In commercial portfolios the PD models segment counterparties into a number of rating grades, with each grade representing a defined range of default probabilities, and there are a number of different model rating scales. Counterparties/exposures migrate between rating grades if the assessment of the PD changes. The modelled PDs ‘map’ through local scales to a single Corporate (non-retail) Master Scale comprising of 19 non-default ratings. Together with four default ratings the Corporate Master Scale forms the basis on which internal reporting is completed.
Robust country risk management: The Board sets country risk appetite. Within this, country limits are authorised by the country risk appetite committee, taking into account economic, financial, political and social factors. Group policies stipulate that these limits must be consistent with, and support, the approved business and strategic plans of the Group.
Additional mitigation for Retail and Consumer Finance customers The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using information held by Credit Reference Agencies (CRA). The Group also assesses the affordability of the borrower under a stressed interest rate scenario. In addition, the Group has in place quantitative limits such as product maximum limits, the level of borrowing to income and the ratio of borrowing to collateral. Some of these limits relate to internal approval levels and others are hard limits above which the Group will reject the application. The Group also has certain criteria that are applicable to specific products such as for applications for a mortgage on a property that is to be let by the applicant, Retail and Consumer Finance affordability assessments are compliant with relevant regulatory conduct guidelines.
For UK mortgages, the Group’s policy is to reject all standard applications with a Loan to Value (LTV) greater than 90 per cent. Applications with an LTV up to 95 per cent are permitted for certain schemes, for example the UK government’s Help to Buy scheme. For mainstream mortgages the Group has maximum per cent LTV limits which depend upon the loan size. These limits are currently: Table 1.4: UK mainstream loan to value analysis Loan size From To Maximum LTV
Collateral values are rigorously assessed at the time of loan origination. It is the Group’s policy that collateral should always be realistically valued by an appropriately qualified source, independent of both the credit decision process and the customer, at the time of borrowing. Collateral values are reviewed on a regular basis and will vary according to the type of lending and collateral involved. For residential mortgages, the Group adjusts open market property values to take account of the costs of realisation and any discount associated with the realisation of the collateral when estimating credit losses. In order to minimise the credit loss, the Group may seek additional collateral from the counterparty as soon as early warning signs are identified for the relevant individual loans and advances.
Intensive care of customers in financial difficulty The Group operates a number of treatments to assist borrowers who are experiencing financial stress. The material elements of these treatments through which the Group has granted a concession, whether temporarily or permanently, are set out below.
Customers receiving support from UK government sponsored programmes To assist customers in financial distress, the Group also participates in, or benefits from, the following UK government sponsored programmes for households: – Income Support for Mortgage Interest – This is a government medium term initiative that provides certain defined categories of customers, principally those who are unemployed, access to a benefit scheme, paid for by the government, which covers all or part of the interest on the mortgage. Qualifying customers are able to claim for mortgage interest on up to £200,000 of the mortgage. All decisions regarding an individual’s eligibility and any amounts payable under the scheme rest solely with the government. Payments are made directly to the Group by the Department of Work and Pensions. – Mortgage Rescue Schemes – This is a government initiative for borrowers in difficulty and facing repossession, who would have priority for re-housing by a local authority (e.g. the elderly, disabled, single parents). Eligible customers can have their property bought in full or part by the social rented sector and then remain in their home as a tenant or shared equity partner. If the property is sold outright the mortgage is redeemed in full. Government sponsored Mortgage Rescue Scheme (MRS) options are currently available in Wales and Scotland (in Scotland the MRS option is called the Home Owner’s Support Fund). No MRS options are available in Northern Ireland although one may be launched by the government in the future. In England, the government ceased funding and closed its MRS option in the second quarter of 2015.
Forbearance identification, classification and measurement The Group classifies a retail account as forborne at the time a customer in financial difficulty is granted a concession. Accounts are classified as forborne only for the period of time which the exposure is known to be, or may still be, in financial difficulty. Where temporary forbearance is granted, exit criteria are applied to include accounts until they are known to no longer be in financial difficulty. Details of the exit criteria are shown in the analysis on page 126. Where the treatment involves a permanent change to the contractual basis of the customer’s account such as a capitalisation of arrears or term extension, the Group classifies the balance as forborne for a period of 24 months, after which no distinction is made between these accounts and others where no change has been made.
Those customers deemed higher risk where there is cause for concern over future repayment capability or where there is a risk of impairment will lead to the customer being transferred to the Business Support Unit (BSU) at an early stage. The over-arching aim of the BSU is to provide support and work consensually with each customer to try and resolve the issues, to restore the business to a financially viable position and thereby bring about a business turnaround. This may involve a combination of restructuring, work out strategies and other types of forbearance.
The level of Commercial Banking division BSU gross lending to customers reduced from £5.0 billion to £4.2 billion between 31 December 2014 and 31 December 2015. The net reduction of £0.8 billion in BSU managed lending in Commercial Banking was driven by returns to mainstream, disposals, write-offs and repayments.
Forbearance identification, classification and measurement All non-retail loans and advances on the watchlist are further categorised depending on the current and expected credit risk attaching to the customer and the transaction. All watchlist names are reviewed by the business and independent Risk function regularly, and the classification is updated if required.
All of a customer’s impaired loans are treated as forborne as they are considered as having been (or will be) granted some form of forbearance. Most impaired loans and advances exist only in the BSU within Commercial Banking division, and Run-off division.
Exit from forbearance A customer where forbearance has been granted will remain treated and recorded as forborne until it evidences acceptable performance over a period of time. This period will depend on a number of factors such as whether the customer is trading in line with its revised plan, it is operating within the new terms and conditions (including observation to revised covenants and contractual payments), its financial performance is stable or improving, and there are no undue concerns over its future performance. As a minimum, this cure period is currently expected to be at least 12 months following a forbearance event.
Total impairment charge excluding TSB 621 (2) 4 (55) 568 1,102 48
4 The fair value adjustments relating to loans and advances were made on the acquisition of HBOS to reflect the fair value of the acquired assets and took into account both the expected losses and market liquidity at the date of acquisition. The unwind relating to future impairment losses requires management judgement to assess whether the losses incurred in the current period were expected at the date of the acquisition and assessing whether the remaining losses expected at the date of the acquisition will still be incurred. The element relating to market liquidity unwinds to the income statement over the estimated expected lives of the related assets (until 2014 for commercial loans and 2018 for retail loans) although if an asset is written-off or suffers previously unexpected impairment then this element of the fair value will no longer be considered a timing difference (liquidity) but permanent (impairment). The fair value unwind in respect of impairment losses incurred was £97 million for the period ended 31 December 2015 (31 December 2014: £251 million). The fair value unwind in respect of loans and advances is expected to continue to decrease in future years as fixed-rate periods on mortgages expire, loans are repaid or written-off, and will reduce to zero over time.
Interest only balances as a % of owner occupier balances 33.9 37.2
Value of loans as at 31 December 20151 2.0 9.1 14.5 45.2
Treatment strategies exist to help customers who may not be able to fully repay the principal balance at maturity. Of the owner occupier interest only mortgages that have missed the payment of principal at the end of term, balances of £1,313 million remain at 31 December 2015 (£1,117 million at 31 December 2014). The average indexed loan to value of these accounts is 28.0 per cent at 31 December 2015 (28.7 per cent at 31 December 2014). Of these accounts, 9.1 per cent are impaired (8.4 per cent at 31 December 2014).
Further analysis of the forborne loan balances is set out below: Table 1.16: UK retail forborne loans and advances (audited)
Permanent treatments 1 Includes accounts where the customer is currently benefiting from a forbearance treatment or the treatment has recently ended.
5 Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the previous six months. Permanent changes which commenced during the last 24 months for existing customers as at 31 December are also included.
UK secured forborne loans and advances have reduced by £1,292 million in 2015 to £3,102 million, driven primarily by an improvement in the underlying quality of the portfolio, with a greater value exiting forbearance than entering. Loans and Overdrafts forborne loans and advances have reduced by £15 million in 2015.
SME – The SME Banking portfolio continues to grow within prudent credit risk appetite parameters. – Portfolio credit quality has remained stable or improved across all key metrics. – There was a net impairment release of £22 million compared to a net charge of £15 million in 2014 with lower new impairment offset by writebacks and releases.
– Trading exposures continue to be predominantly short-term and/or collateralised with inter-bank activity mainly undertaken with acceptable investment grade counterparties. – The Group continues to adopt a conservative stance across the Eurozone maintaining close portfolio scrutiny and oversight particularly given the current macro environment and horizon risks.
UK exposures >£5 million 1 Exposures exclude £0.3 billion (31 December 2014: £0.4 billion) of gross UK Direct Real Estate lending in Wealth (within Retail division) and £1.1 billion (31 December 2014: £3.3 billion) of UK Direct Real Estate lending in Run-off. Also excludes Social Housing and Housebuilder lending.
3 Recoveries assets are written down to the present value of expected cash flows on these assets.
Impairment provisions as % of loans and advances which are forborne1 1 Includes accounts where the customer is currently benefiting from a forbearance treatment or the treatment recently ended.
Run-off Ireland retail lending At 31 December 2015, £169 million or 4.2 per cent (31 December 2014: £280 million or 6.3 per cent) of Irish retail secured loans and advances were subject to current or recent forbearance. Of this amount £26 million (31 December 2014: £41 million) were impaired.
Impaired loans and advances The movements in Run-off corporate real estate, other corporate and Specialist Finance impaired forborne loans and advances were as follows: Table 1.31: Movement in Run-off corporate real estate, other corporate and Specialist Finance impaired forborne loans and advances (audited)
The movements in forborne loans and advances were: Table 1.32: Movement in Run-off: Ireland commercial real estate and corporate forborne loans and advances (audited)
Exposures to Eurozone countries are detailed in the following tables and are based on balance sheet exposures, net of provisions. Derivative balances are included within exposures to financial institutions or corporates, as appropriate, at fair value adjusted for master netting agreements at obligor level and net of cash collateral in line with legal agreements. Exposures in respect of reverse repurchase agreements are included on a gross IFRS basis and are disclosed based on the counterparty rather than the collateral (repos and stock lending are excluded); reverse repurchase exposures are not, therefore, reduced as a result of collateral held. Reverse repurchase exposures to Institutional funds secured by UK Gilts are excluded from all Eurozone exposures as detailed in the footnotes. Exposures to central clearing counterparties are shown net.
assets TotalBanks Other1 £m £m £m £m £m £m £m £m £m
Environmental risk management The Group ensures appropriate management of the environmental impact of its lending activities. The Groupwide credit risk principles require all credit risk to be incurred with due regard to environmental legislation and the Group’s Code of Business Responsibility.
CONDUCT RISK Definition Conduct risk is defined as the risk of customer detriment or regulatory censure and/or a reduction in earnings/value, through financial or reputational loss, from inappropriate or poor customer treatment or business conduct.
Mitigation The Group takes a range of mitigating actions with respect to this risk; it has implemented a customer-focused, UK-centric strategy, strengthened its culture and values, improved systems and processes, and implemented more effective controls. These actions are being further embedded throughout the Group (across all business areas and all supporting functional areas) as part of the transition of the Group’s Conduct Strategy from a programme to business as usual supported by the GCFC, including: – Conduct risk appetite established at Group and business area level; – Customer needs explicitly considered within business and product level planning and strategy; – Cultural transformation, supported by strong direction and tone from senior executives and the Board. This is underpinned by the Group’s values and Codes of Responsibility, to deliver the best bank for customers; – Enhanced product governance framework to ensure products continue to offer customers fair value, and meet the needs of the relevant target market throughout their life cycle; – Sales processes and governance framework to deliver consistently fair outcomes; – Enhanced complaints management through effectively responding to, and learning from, root causes to reduce complaint volumes and the Financial Ombudsman Service change rate; – Enhanced recruitment and training, and a focus on how the Group manages colleagues’ performance with clearer customer accountabilities; and – Application of the Conduct Strategy to third parties involved in serving the Group’s customers.
Balance sheet linkages The information provided in table 1.36 (below) aims to facilitate the understanding of linkages between banking, trading, and insurance balance sheet items and the positions disclosed in the Group’s market risk disclosures. This breakdown of financial instruments included and not included in trading book Value at Risk (VaR) provides a linkage with the trading book market risk measures reported later on in the market risk section. It is important to highlight that this table does not reflect how the Group manages trading book market risk, since it does not discriminate between assets and liabilities in its VaR model.
Available-for-sale financial assets 33,032 – 33,030 2 Interest rate, credit spread, foreign exchange
Measurement Group market risk is managed within a Board approved framework and risk appetite. Board risk appetite is calibrated primarily to five economic multi-risk scenarios, and is supplemented with sensitivity based measures. The scenarios assess the impact of unlikely, but plausible adverse stresses on income, with the worst case for banking activities, defined benefit pensions, insurance and trading portfolios reported against independently, and across the Group as a whole.
Credit spread risk Credit spread risk arises largely from i) liquid asset portfolio held in the management of Group liquidity comprising government, supranational, and other eligible assets; and ii) the Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA) sensitivity to credit spreads.
The market value sensitivity is driven by temporary customer flow positions not yet hedged plus other positions occasionally held within limits, by the Group’s wholesale funding desks in order to minimise overall funding and hedging costs. The level of risk is low relative to the size of the total balance sheet.
Table 1.39 below shows supplementary value sensitivity to a steepening and flattening in the yield curve. This ensures there are no unintended consequences to managing risk to parallel shifts in rates.
Mitigation The Group’s policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The Group Market Risk policy and procedures outlines the hedging process, and the centralisation of risk from divisions into GCT, e.g. via Transfer Pricing Framework. GCT is responsible for managing the centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of GALCO within the Board risk appetite. Derivative desks in Financial Markets will then externalise the hedges to the market. The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. Consistent with the Group’s strategy to deliver stable returns, GALCO seeks to minimise large reinvestment risk, and to smooth earnings over a range of investment tenors. The amount and duration of the hedging activity is reviewed regularly by GALCO, with current target duration of around four years.
Whilst the bank faces margin compression in the current low rate environment, its exposure to pipeline and prepayment risk are not considered material, and are hedged in line with expected customer behaviour. These are appropriately monitored and controlled through Divisional ALCOs.
Insurance portfolios Exposures The main elements of market risk to which the Group is exposed through the Insurance business are equity, credit spread, interest rate and inflation.
– Equity risk arises indirectly through the value of future management charges on policyholder funds. These management charges form part of the value of in-force business (see note 25 on page 218). Equity risk also arises in the with-profits funds but is less material. – Credit spread risk mainly arises from annuities where policyholders’ future cashflows are guaranteed at retirement. Exposure arises if the assets which are held to back these liabilities, mainly corporate bonds and loans, do not perform in line with expectations. Within the Group accounts a large amount of this exposure is removed as accounting rules require that assets Insurance have acquired from Group are maintained at the original amortised book value. – Interest rate risk arises through holding credit and interest assets mainly in the annuity book and also to cover general insurance liabilities, capital requirements and risk appetite. – Inflation exposure is from a combination of inflation linked policyholder benefits and inflation assumptions used to project future expenses.
Measurement Current and potential future market risk exposures within Insurance are assessed using a range of stress testing exercises and scenario analyses. Risk measures include 1-in-200 year stresses used for regulatory capital assessments and single factor stresses for profit before tax.
Trading market risk measures are applied to all the Group’s regulatory trading books and they include daily VaR (table 1.42), sensitivity based measures, and stress testing calculations.
Table 1.42 shows some relevant statistics for the Group’s 1-day 95 per cent confidence level VaR that are based on 300 historical consecutive business days to year end 2015 and year end 2014.
The aim of operational risk management is to manage operational risks in line with defined appetites, and to protect both customers and the Group whilst delivering sustainable growth. The Group Operational Risk Management Framework is the method by which operational risks are managed in terms of setting risk appetite, evaluating key exposures, measuring risk, mitigating risk, and monitoring risks on an ongoing basis, as set out below.
The risks below also have potential to negatively impact customers and the Group’s future results: – Terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events and responses to those acts/events may create economic and political uncertainties, which could have a material adverse effect on UK and international macroeconomic conditions generally, and more specifically on the Group’s results of operations, financial condition or prospects in ways that cannot necessarily be predicted. – Systems and procedures are implemented and maintained by the Group to comply with increasingly complex and detailed anti-money laundering and anti-terrorism laws and regulations. However, these may not always be fully effective in preventing third parties from using the Group as a conduit for money laundering, terrorist financing and other illegal or prohibited activities. Should the Group be associated with money laundering, terrorist financing or breaches of financial crime regulations and prohibitions, its reputation could suffer and/or it could become subject to fines, sanctions and legal enforcement; any one of which could have a material adverse effect upon operating results, financial condition and prospects.
Based on data captured on the Group’s Operational Risk System, in 2015, the highest frequency of events occurred in external fraud (71.96 per cent) and execution, delivery and process management (15.81 per cent). Clients, products and business practices accounted for 83.43 per cent of losses by value, driven by legacy issues where impacts materialised in 2015 (excluding PPI).
Table 1.43 below shows high level loss and event trends for the Group using Basel II categories.
Measurement Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturity. Note 53 on page 265 sets out an analysis of assets and liabilities by relevant maturity grouping. In order to reflect more accurately the expected behaviour of the Group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. Divisional teams form a view of customer behaviour based on quantitative and qualitative analysis. The analysis takes into account items such as early repayment, forbearance and impairment for assets; rollover and early withdrawal for liabilities. The assumptions are subject to governance via divisional asset and liability committees. The behavioural reviews form the foundation of the Group’s Liquidity Transfer Pricing (LTP) and are applied to the contractual profile of the Group for the liquidity risk stress testing framework.
Total funded assets reduced by £22.2 billion to £471.2 billion during 2015. Loans and advances to customers, excluding reverse repos, reduced by £22.4 billion. Mortgage lending increased by 1 per cent, slightly below market growth, reflecting the Group’s focus on protecting margin in a low growth environment. UK loan growth in Consumer Finance was strong at 17 per cent and SME lending growth was 5 per cent, both outperforming the market. The growth was offset by the sale of TSB, the further reduction in run-off and other lending portfolios which are closed to new business.
In 2015 Standard and Poor’s (S&P), Moody’s and Fitch completed their exceptional reviews of Lloyds Bank’s ratings following the UK implementation of the EU Bank Recovery and Resolution Directive. In all cases, Lloyds Bank’s ratings were either affirmed or upgraded due to the delivery of our strategy to be a low risk, customer focused UK bank and/or recognition of the protection Lloyds’ sizeable subordinated debt buffer provides to senior creditors. In particular, Fitch upgraded Lloyds Bank to ‘A+’ from ‘A’ and revised the outlook to ‘Stable’ from ‘Negative’. Moody’s affirmed Lloyds’ rating at ‘A1’ with a ‘Positive’ outlook. S&P affirmed Lloyds’ rating at ‘A’ with a ‘Stable’ outlook. Following these rating actions, Lloyds Bank’s median rating has improved to ‘A+’ (previously ‘A’). The effects of a potential downgrade from all three rating agencies are included in the Group liquidity stress testing.
Cash and balances at central banks – non LCR eligible4 4.7 3.6 31
2 Comprises £0.3 billion of subordinated liabilities issued by the holding company, Lloyds Banking Group plc. In addition Lloyds Banking Group plc issued c.£1.2 billion of subordinated liabilities as part of an exchange of outstanding operating company securities for new holding company securities.
At 31 December 2015, the Banking business had £123.4 billion of highly liquid unencumbered LCR eligible assets, of which £122.9 billion is LCR level 1 eligible and £0.5 billion is LCR level 2 eligible. These assets are available to meet cash and collateral outflows and PRA regulatory requirements. A separate liquidity portfolio to mitigate any insurance liquidity risk is managed within the Insurance business. LCR eligible liquid assets represent 5.7 times the Group’s money market funding less than one year maturity (excluding derivative collateral margins and settlement accounts) and is broadly equivalent to total wholesale funding, and thus provides a substantial buffer in the event of continued market dislocation. During 2015 the Group has increased regulatory liquidity to strengthen the overall liquidity position.
Total LCR eligible assets 123.4 124.2 1 Average for fourth quarter 2015 only.
The Banking business also had £98.9 billion of secondary, non-LCR eligible liquidity, the vast majority of which, however, is eligible for use in a range of central bank or similar facilities and the Group routinely makes use of as part of its normal liquidity management practices. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.
The following sub analyses have been provided for unencumbered assets not pre-positioned at central banks: – Unencumbered – Readily realisable: Assets regarded by the Group to be readily realisable in the normal course of business, to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes. – Unencumbered – Other realisable: Assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but are not readily realisable in the normal course of business in their current form. – Unencumbered – Cannot be used: Assets that have not been pledged but which the Group has assessed could not be pledged and therefore could not be used to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements.
The Board and GALCO monitor and manage total balance sheet encumbrance via a number of risk appetite metrics. At 31 December 2015, the Group had £77.4 billion (31 December 2014: £105.2 billion) of externally encumbered on balance sheet assets with counterparties other than central banks. The reduction in encumbered assets was driven by securitisation and covered bond maturities. The Group also had £573.7 billion (31 December 2014: £641.8 billion) of unencumbered on balance sheet assets, and £155.6 billion (31 December 2014: £107.8 billion) of pre-positioned and encumbered assets held with central banks. Primarily the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks.
Derivative financial instruments – – – – – – – 36,128 36,128 36,128
The capital conservation buffer is a general buffer of 2.5 per cent of risk-weighted assets designed to provide for losses in the event of stress and is being phased in over the period from 1 January 2016 to 1 January 2019.
In addition to the risk-based capital framework outlined above, the Group is also subject to minimum capital requirements under the UK’s leverage ratio framework. The leverage ratio is calculated by dividing ‘fully loaded’ tier 1 capital resources by a defined measure of on-balance sheet assets and off-balance sheet items.
The minimum leverage ratio is 3 per cent, in line with current Basel Committee proposals. In addition the UK framework requires two buffers to be maintained: The Additional Leverage Ratio Buffer (ALRB), which it is proposed should be up to 0.9 per cent, and a time-varying Countercyclical Leverage Buffer (CCLB) of up to 0.9 per cent (currently negligible for the Group). At least 75 per cent of the minimum 3 per cent requirement and the entirety of any buffers that may apply must be met by CET1 capital. The ALRB applies from 1 January 2016 but only for G-SIBs and as the Group is not categorised as a G-SIB it is not currently subject to the ALRB. Final rules are awaited on the wider application of the ALRB to ring-fenced banks and large building societies within the UK from 2019.
Monitoring Capital is actively managed and regulatory ratios are a key factor in the Group’s planning processes and stress analyses. Multi-year forecasts of the Group’s capital position, based upon the Group’s operating plan, are produced at least annually to inform the Group’s capital strategy whilst shorter term forecasts are more frequently undertaken to understand and respond to variations of the Group’s actual performance against the plan. The capital plans are tested for capital adequacy using a range of stress scenarios covering adverse economic conditions as well as other adverse factors that could impact the Group and the Group maintains a Recovery Plan which sets out a range of potential mitigating actions that could be taken in response to a stress.
The Group continues to monitor these developments very closely, analysing the potential capital impacts to ensure that, through organic capital generation, the Group continues to maintain a strong capital position that exceeds the minimum regulatory requirements and the Group’s risk appetite and is consistent with market expectations.
Stress testing In addition to the internal stress testing activity undertaken in 2015, the Group participated in the UK-wide concurrent stress testing run by the Bank of England, comfortably exceeding both the capital and leverage minimum thresholds.
– The CET1 ratio before dividends in respect of 2015 increased 0.9 percentage points from 12.8 per cent to 13.7 per cent. – The CET1 ratio after dividends in respect of 2015 was unchanged at 12.8 per cent, increasing to 13.0 per cent on a pro-forma basis upon recognition of the dividend paid by the Insurance business in February 2016 in relation to its 2015 earnings. – The leverage ratio after dividends in respect of 2015 reduced from 4.9 per cent to 4.8 per cent. – The transitional total capital ratio after dividends in respect of 2015 reduced 0.5 percentage points from 22.0 per cent to 21.5 per cent.
The ability of the Group to pay a dividend is also subject to constraints including the availability of distributable reserves, legal and regulatory restrictions and the financial and operating performance of the entity.
Capital position at 31 December 2015 The Group’s capital position as at 31 December 2015 is presented in the following section applying CRD IV transitional arrangements, as implemented in the UK by the PRA, and also on a fully loaded CRD IV basis.
The table below summarises the consolidated capital position of the Group. The Group’s Pillar 3 Report provides a comprehensive analysis of the own funds of the Group.
1 For regulatory capital purposes, the Group’s Insurance business is deconsolidated and replaced by the amount of the Group’s investment in the business. A part of this amount is deducted from capital and the remaining amount is risk weighted, forming part of threshold risk-weighted assets.
2 Other comprehensive income related to the Group’s Insurance business defined benefit pension scheme has been reclassified from common equity tier 1 other adjustments to deconsolidation of insurance entities.
2 Differences may arise between transitional and fully loaded threshold risk-weighted assets where deferred tax assets reliant on future profitability and arising from temporary timing differences and significant investments exceed the fully loaded threshold limit, resulting in an increase in amounts deducted from CET1 capital rather than being risk-weighted. At 31 December 2014 the fully loaded threshold was not exceeded and therefore no further adjustment was applied to the transitional threshold risk-weighted assets.
Key movements The Group’s fully loaded leverage ratio reduced by 0.1 per cent to 4.8 per cent reflecting the impact of the reduction in tier 1 capital offset by the £28.5 billion reduction in the exposure measure, the latter largely reflecting the reduction in balance sheet assets arising, in part, from the disposal of TSB.
The SFT exposure measure, representing SFTs per the balance sheet inclusive of deconsolidation adjustments and counterparty credit risk add-on, reduced by £9.7 billion primarily reflecting active balance sheet management and reduced trading volumes.
On 31 December 2015, the long-term insurance business of seven life insurance companies within the Group were transferred to Clerical Medical Investment Group Limited (CMIG) pursuant to an insurance business transfer scheme, under Part VII of the Financial Services and Markets Act 2000. Scottish Widows plc and CMIG hold the only with-profit funds managed by the Group, and the Scottish Widows plc with-profit fund was transferred to a new with-profit fund within CMIG. On 31 December 2015, CMIG changed its name to Scottish Widows Limited (SW Ltd), and Scottish Widows plc changed its name to SW Funding plc.
During the year Scottish Widows Group Limited (SWG) was also subject to the capital adequacy requirements of the Insurance Group Directive (IGD), which comprises the consolidated surplus of the Group’s regulated insurance subsidiaries.
All minimum regulatory requirements of the life insurance companies are expected to be met during the year.
REGULATORY AND LEGAL RISK Definition Regulatory and legal risk is defined as the risk that the Group is exposed to fines, censure, legal or enforcement action, civil or criminal proceedings in the courts (or equivalent) and risk that the Group is unable to enforce its rights as anticipated.
Mitigation Mitigation is undertaken across the Group and comprises the following key components: – The Board establishes a group wide risk appetite and metrics for Regulatory and Legal Risk.
– Material risks and issues are escalated to divisional and then Group-level bodies which challenge and support the business on its management of them. – Business units produce regularly management information to assist in the identification of issues and test management controls are working effectively.
Monitoring Business unit risk exposure is reported to Risk Division where it is aggregated at Group level and a report prepared. The report forms the basis of challenge to the business at the monthly Group Conduct, Compliance and Operational Risk Committee. This committee may escalate matters to the Chief Risk Officer, or higher committees. The report also forms the basis of the regulatory and legal sections in the Group’s consolidated risk reporting.
Definition Insurance risk is defined as the risk of adverse developments in the timing, frequency or severity of claims for insured/underwritten events and in customer behaviour, leading to reductions or volatility in earnings and/or value.
Risk appetite Insurance risk appetite in the Insurance business is set by the Insurance Board and includes capital and earnings limits on insurance risk drivers.
Mitigation Insurance risk in the Insurance business is mitigated in a number of ways: – Longevity risk transfer and hedging solutions are considered on a regular basis. A team of longevity and bulk pricing experts has been built to support the new bulk annuity proposition. – General insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements. – Insurance processes on underwriting, claims management, pricing and product design. – Exposure limits by risk type are assessed through the business planning process and used as a control mechanism to ensure risks are taken within risk appetite.
Risk appetite The Group’s people risk appetite and corresponding measures enable the Group to lead responsibly and proficiently, manage people resources effectively, support and develop colleague talent, and meet legal and regulatory obligations related to its people.
The appetite is reviewed and approved annually by the Board. To stay within appetite, the Group has policies, processes and standards which provide the framework for business and colleagues to operate in accordance with the laws, regulations and voluntary codes which apply to the Group and its activities.
Mitigation The Group takes many mitigating actions with respect to people risk. Key areas of focus include: – Working with the regulators to ensure their guidance on increased accountability in the new SM&CR strengthens remuneration governance to balance implementation costs with the benefits gained from enhanced governance;
– Continued focus on the Group’s culture by developing and delivering initiatives that reinforce the appropriate conduct behaviours which generate the best possible long-term outcomes for customers and colleagues; – Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations; – Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning; – Ensuring compliance with legal and regulatory requirements related to SM&CR, embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities; and – Ongoing consultation with the Group’s recognised unions on changes which impact their members.
Audit scope The scope of our audit and the nature, timing and extent of audit procedures performed were determined by our risk assessment, the financial significance of reporting units and other qualitative factors (including history of misstatement through fraud or error).
The risks of material misstatement that had the greatest effect on our audit, including the allocation of our resources and effort, are identified as ‘areas of focus’ in the table below. We have also set out how we tailored our audit to address these specific areas in order to provide an opinion on the financial statements as a whole, and any comments we make on the results of our procedures should be read in this context. This is not a complete list of all risks identified by our audit. We discussed these areas of focus with the Audit Committee. Their report on those matters that they considered to be significant issues in relation to the financial statements is set out on page 75.
The scope of our audit and our areas of focus We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (‘ISAs (UK & Ireland)’).
Impairment is a subjective area due to the level of judgement applied by management in determining provisions.
Based on the evidence obtained we found that the impairment model assumptions, data used within the models and overlays to modelled outputs were reasonable.
We engaged our actuarial specialists to assess the actuarial assumptions, including the consideration and challenge of management’s rationale for the judgements applied and any reliance placed on industry information. The assessment included reference to our independent benchmarking data which considers each of these principal areas. For persistency, longevity and expenses we considered recent experience and the appropriateness of the judgements applied by management on how future experience will evolve. For persistency, we also considered the appropriateness of assumptions set by management in light of regulatory changes. In particular, we considered how the assumptions reflect expected persistency improvements from the removal of commission for qualifying pension schemes and greater outflows of funds expected as a result of increased options available to pension policyholders (Finance Act 2014). For longevity and expenses we assessed the appropriateness of the assumptions by comparing them to experience and latest industry data.
We understood and tested key controls over the designation and ongoing management of hedge accounting relationships, including testing of hedge ineffectiveness. We found the key controls were designed, implemented and operated effectively, and therefore we determined that we could place reliance on these controls for the purposes of our audit. We examined hedge documentation to assess whether the documentation complied with all the requirements of IAS 39.
Management’s judgements in respect of the Group’s positions on uncertain tax items are supportable in the context of the information currently available.
We found that the utilisation period and the related disclosures were appropriate.
The Group operates a number of defined benefit schemes which in total are significant in the context of both the overall balance sheet and results of the Group.
The treatment of curtailments, settlements, past service costs and measurements and other amendments can significantly impact the balance sheet and results of the Group.
We assessed the models used by management to calculate the fair value adjustments. Where there have been no significant changes to models over the year, we challenged management to demonstrate to us that the models and the underlying methodologies remained appropriate.
For the data inputs used in the models, such as the creditworthiness of the Group’s counterparties, we challenged management to demonstrate their appropriateness. We also performed procedures to obtain evidence to support the inputs used in the model.
The Group is structured into five segments being Retail Banking, Commercial Banking, Insurance, Consumer Finance and Run-off and Central Items. Each of the segments comprises a number of business reporting units. The consolidated financial statements are a consolidation of the business reporting units.
Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: Overall group materiality £300 million (2014: £268 million)
How we determined it 5 per cent of the 3 year average of adjusted profit before tax.
Going concern Under the Listing Rules we are required to review the directors’ statement, set out on page 108, in relation to going concern. We have nothing to report having performed our review.
In drawing our conclusion, we critically assessed the going concern assessment undertaken by management and approved by the Board or directors. As part of our assessment we have: – critically assessed and challenged the appropriateness of the stress scenarios used and their impact on the Group’s capital and liquidity position; – understood and challenged key economic and other assumptions used in both the capital and liquidity plan and the Group’s operating plan; and – substantiated the Group’s unencumbered collateral position and potential to access central bank liquidity facilities.
The directors’ assessment of the prospects of the Group and of the principal risks that would threaten the solvency or liquidity of the Group Under ISAs (UK & Ireland) we are required to report to you if we have anything material to add or to draw attention to in relation to: – the directors’ confirmation on page 108 of the Annual Report, in accordance with provision C.2.1 of the Code, that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity.
Corporate governance statement Under the Companies Act 2006 we are required to report to you if, in our opinion, a corporate governance statement has not been prepared by the parent company. We have no exceptions to report arising from this responsibility.
Items that may subsequently be reclassified to profit or loss: Movements in revaluation reserve in respect of available-for-sale financial assets: Change in fair value (318) 690 (680)
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income 537 3,896 (1,229)
Total comprehensive income attributable to other equity holders 394 287 –
Trading and other financial assets at fair value through profit or loss 15 140,536 151,931
Loans and receivables: Loans and advances to banks 17 25,117 26,155
Post-retirement defined benefit scheme remeasurements, net of taxation – – (215) (215) – – (215)
Post-retirement defined benefit scheme remeasurements, net of taxation – – 539 539 – – 539
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts. As stated on page 108, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements.
The Group utilises the venture capital exemption for investments where significant influence or joint control is present and the business unit operates as a venture capital business. These investments are designated at initial recognition at fair value through profit or loss. Otherwise, the Group’s investments in joint ventures and associates are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Group’s share of the post-acquisition results of the joint venture or associate based on accounts which are coterminous with the Group or made up
Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of associates and joint ventures is included in the Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal.
Revenue recognition policies specific to life insurance and general insurance business are detailed below (see (N) below); those relating to leases are set out in (J)(2) below.
The Group is permitted to transfer a financial asset from the available-for-sale category to the loans and receivables category where that asset would have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been classified as available-for-sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a financial asset from the available-for-sale category to the held-to-maturity category is permitted when the Group has the ability and intent to hold that financial asset to maturity.
O ther info rm atio n hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.
Where such an event has had an impact on the estimated future cash flows of the financial asset or group of financial assets, an impairment allowance is recognised. The amount of impairment allowance is the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the asset’s original effective interest rate. If the asset has a variable rate of interest, the discount rate used for measuring the impairment allowance is the current effective interest rate.
Subsequent to the recognition of an impairment loss on a financial asset or a group of financial assets, interest income continues to be recognised on an effective interest rate basis, on the asset’s carrying value net of impairment provisions. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower’s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the income statement.
For such individually identified financial assets, a review is undertaken of the expected future cash flows which requires significant management judgement as to the amount and timing of such cash flows. Where the debt is secured, the assessment reflects the expected cash flows from the realisation of the security, net of costs to realise, whether or not foreclosure or realisation of the collateral is probable.
Homogenous groups of loans 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, industry sector, 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.
Incurred but not yet identified impairment The collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been separately identified at the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. Risk drivers for secured retail lending include the current indexed loan-to-value, previous mortgage arrears, internal cross-product delinquency data and external credit bureau data; for unsecured retail lending they include whether the account is up-to-date and, if not, the number of payments that have been missed; and for commercial lending they include factors such as observed default rates and loss given default. An assessment is made of the likelihood of each account becoming recognised as impaired within the loss emergence period, with the economic loss that each portfolio is likely to generate were it to become impaired. The loss emergence period is determined by local management for each portfolio and the Group has a range of loss emergence periods which are dependent upon the characteristics of the portfolios. Loss emergence periods are reviewed regularly and updated when appropriate. In general the periods used across the Group vary between one month and twelve months based on historical experience. Unsecured portfolios tend to have shorter loss emergence periods than secured portfolios.
Debt for equity exchanges Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity securities, held as available-for-sale. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.
(I) Property, plant and equipment Property, plant and equipment (other than investment property) is included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): – Freehold/long and short leasehold premises: shorter of 50 years and the remaining period of the lease. – Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease.
Equipment: – Fixtures and furnishings: 10-20 years. – Other equipment and motor vehicles: 2-8 years.
Financial statements pension liability. The Group’s income statement charge includes the current service cost of providing pension benefits, past service costs, net interest expense (income), and plan administration costs that are not deducted from the return on plan assets. Past service costs, which represents the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment, are recognised when the plan amendment or curtailment occurs. Net interest expense (income) is calculated by applying the discount rate at the beginning of the period to the net defined benefit liability or asset.
The accounting for share-based compensation is set out in (L) below.
For the Group’s long-term insurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on shareholders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under current UK tax rules.
O ther info rm atio n 1) Life insurance business (i) Accounting for insurance and participating investment contracts
Financial statements may be relevant to claims received. Consequently the continued appropriateness of the underlying assumptions is reviewed on a regular basis against actual experience and other relevant evidence and adjustments made to the provisions where appropriate.
Fair value of financial instruments At 31 December 2015, the carrying value of the Group’s financial instrument assets held at fair value was £203,035 million (2014: £244,552 million), and its financial instrument liabilities held at fair value was £78,212 million (2014: £95,340 million). Included within these balances are derivative assets of £29,467 million (2014: £36,128 million) and derivative liabilities of £26,301 million (2014: £33,187 million). The group’s accounting policy for its financial instruments is set out in note 2(E) and 2(F).
In accordance with IFRS 13 Fair Value Measurement, 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. In addition, in line with market practice, the Group applies credit, debit and funding valuation adjustments in determining the fair value of its uncollateralised derivative positions. A description of these adjustments is set out in note 50, on page 257. These valuation techniques involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information. Valuation techniques for level 2 financial instruments use inputs that are based on observable market data. Level 3 financial instruments are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Determining the appropriate assumptions to be used for level 3 financial instruments requires significant management judgement. Further details of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair value are set out in note 50. Details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the Risk Management section on page 144.
The segmental results and comparatives are presented on an underlying basis, the basis reviewed by the chief operating decision maker. The effects of asset sales, volatile items, liability management, simplification costs, TSB build and dual running costs, regulatory provisions, certain past service pension credits or charges, the amortisation of purchased intangible assets and the unwind of acquisition-related fair value adjustments are excluded in arriving at underlying profit.
Commercial Banking is client led, focusing on SME, Mid Markets, Global Corporates and Financial Institution clients providing products across Lending, Global Transaction Banking, Financial Markets and Debt Capital Markets and private equity financing through Lloyds Development Capital.
Consumer Finance comprises the Group’s consumer and corporate Credit Card businesses, along with the Black Horse motor financing and Lex Autolease car leasing businesses in Asset Finance. The Group’s European deposits, German lending and Dutch retail mortgage businesses are managed within Asset Finance.
Other segment items reflected in income statement above: Increase (decrease) in value of in-force business – – – 425 (9) 416
2 Comprises the payment protection insurance provision (£2,200 million) and other regulatory provisions (£925 million). 3 Comprises the underlying results of TSB, dual running and build costs.
Other income, net of insurance claims 11,140 (146) – (163) (3,074) – 7,757
Debt securities held as loans and receivables 1.87 2.57 1.52 40 42 32
Customer deposits, excluding liabilities under sale and repurchase transactions 0.87 1.15 1.54 (3,299) (4,781) (6,119)
Total interest and similar expense 1.19 1.51 2.32 (6,297) (8,551) (13,825)
Movement in value of in-force business (note 25) (162) (428) 416
Other During 2013 the Group had completed a number of disposals of assets and businesses, including the sale of its shareholding in St James’s Place plc (profit of £540 million), a portfolio of US residential mortgage-backed securities (profit of £538 million), its Spanish retail banking operations (loss of £256 million), its Australian operations (profit of £49 million) and its German life insurance business (this disposal completed in the first quarter of 2014, but an impairment of £382 million was recognised in the year ended 31 December 2013).
Pensions and other post-retirement benefit schemes (note 37): Past service (credits) charges1 – (822) 104
In 2013, the Group agreed certain changes to early retirement and commutation factors in two of its principal defined benefit pension schemes, resulting in a curtailment cost of £104 million recognised in the Group’s income statement in the year ended 31 December 2013.
Reviews of the financial position of corporate and other borrowers 3.1 5.0 6.5
UK corporation tax: Current tax on profit for the year (485) (162) (226)
(B) Factors affecting the tax charge for the year A reconciliation of the charge that would result from applying the standard UK corporation tax rate to the profit before tax to the actual tax charge for the year is given below: 2015 £m 2014 £m 2013 £m
Factors affecting charge: UK corporation tax rate change and related impacts (27) (24) (594)
Deferred tax on Australian tax losses not previously recognised – – 60
Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS 39. Derivatives are held at fair value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 50.
Derivatives designated as fair value hedges: Options purchased – – – 553 17 –
Hedged forecast cash flows expected to occur: Hedged forecast cash flows affect profit or loss: There were no transactions for which cash flow hedge accounting had to be ceased in 2015 or 2014 as a result of the highly probable cash flows no longer being expected to occur.
The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to these arrangements and the carrying value of the notes in issue at 31 December, are listed below. The notes in issue are reported in note 32.
The Group has not voluntarily offered to repurchase assets from any of its public securitisation programmes during 2015 (2014: none). Such repurchases are made in order to ensure that the expected maturity dates of the notes issued from these programmes are met.
NOTE 20: STRUCTURED ENTITIES The Group’s interests in structured entities are both consolidated and unconsolidated. Detail of the Group’s interests in consolidated structured entities are set out in: note 19 for securitisations and covered bond vehicles, note 37 for structured entities associated with the Group’s pension schemes, and below in part (A) and (B). Details of the Group’s interests in unconsolidated structured entities are included below in part (C).
(A) Asset-backed conduits In addition to the structured entities discussed in note 19, which are used for securitisation and covered bond programmes, the Group sponsors an active asset-backed conduit, Cancara, which invests in debt securities and client receivables. The total consolidated exposure of Cancara at 31 December 2015 was £7,295 million (2014: £5,245 million), comprising £6,440 million of loans and advances (2014: £4,605 million) and £855 million of asset-backed securities (2014: £640 million).
In addition, the Group sponsors a further asset-backed conduit, which is being run down. This asset-backed conduit has no commercial paper in issue and no external liquidity providers.
Recoveries of advances written off in previous years 764 4 768 681 – 681
Charge (release) to the income statement (note 12) 443 (2) 441 735 2 737
On 1 May 2015, the Group reclassified £19,938 million of government securities from available-for-sale financial assets to held-to-maturity investments.
NOTE 25: VALUE OF IN-FORCE BUSINESS The gross value of in-force business asset in the consolidated balance sheet is as follows: 2015 £m 2014 £m
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. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below).
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds and illiquid loan assets. The value of the in-force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of corporate bond holdings and relevant illiquid loan assets. The determination of the market premium for illiquidity reflects actual asset allocation and relevant observable market data, and has been checked for consistency with the capital markets. The illiquidity premium is estimated to be in the range of 85 to 144 basis points at 31 December 2015 (2014: 120 basis points).
Cost or valuation: Expenditure on investment properties (see below) 376 – – – 376
Rental income of £268 million (2014: £269 million) and direct operating expenses arising from properties that generate rental income of £27 million (2014: £37 million) have been recognised in the income statement.
At 31 December the future minimum rentals receivable under non-cancellable operating leases were as follows: 2015 £m 2014 £m
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2015 and 2014 no contingent rentals in respect of operating leases were recognised in the income statement.
In addition, total future minimum sub-lease income of £72 million at 31 December 2015 (£45 million at 31 December 2014) is expected to be received under non-cancellable sub-leases of the Group’s premises.
Included in the amounts reported above are deposits of £230,110 million (2014: £260,129 million) which are protected under the UK Financial Services Compensation Scheme.
Trading and other financial liabilities at fair value through profit or loss 51,863 62,102
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2015 was £12,034 million, which was £4,156 million higher than the balance sheet carrying value (2014: £10,112 million, which was £3,373 million higher than the balance sheet carrying value). At 31 December 2015 there was a cumulative £67 million increase in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount a decrease of £114 million arose in 2015 and a decrease of £33 million arose in 2014.
With-profit fund realistic liabilities (i) Business description During the year the Group had with-profit funds within Scottish Widows plc and Clerical Medical Investment Group Limited (CMIG) containing both insurance contracts and participating investment contracts. On 31 December 2015, the long-term insurance businesses of seven life insurance companies within the Group were transferred to CMIG pursuant to an insurance business transfer scheme, under Part VII of the Financial Services and Markets Act 2000, and the Scottish Widows plc with-profit fund was transferred to a with-profit fund within CMIG. On 31 December 2015, CMIG changed its name to Scottish Widows Limited, and Scottish Widows plc changed its name to SW Funding plc. From 31 December 2015, Scottish Widows Limited has the only with-profit funds within the Group.
(iii) Assumptions Key assumptions used in the calculation of with-profit liabilities, and the processes for determining these, are: Investment returns and discount rates The realistic capital regime dictates that with-profit fund liabilities are valued on a market-consistent basis. This is achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with-profit fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk-free yield and all cash flows are discounted using the risk-free yield. The risk-free yield is defined as the spot yield derived from the relevant swap curve, adjusted for credit risk. Further information on significant options and guarantees is given below.
(iv) Options and guarantees within the With-Profit Funds The most significant options and guarantees provided from within the With-Profit Funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
(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.
The expense (credit) recognised in the income statement for the year ended 31 December comprises: 2015 £m 2014 £m 2013 £m
Increase (decrease) in the net defined benefit pension scheme liability £m £m £m £m
2 At 31 December 2015, the assumed discount rate is 3.87 per cent (2014: 3.67 per cent).
The deferred tax charge in the income statement comprises the following temporary differences: 2015 £m 2014 £m 2013 £m
The Finance (No. 2) Act 2015 (the Act) was substantively enacted on 26 October 2015. The Act reduced the main rate of corporation tax to 19 per cent from 1 April 2017 and 18 per cent from 1 April 2020.
Deferred tax assets of £140 million (2014: £190 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
Payment protection insurance The Group increased the provision for PPI costs by a further £4,000 million in 2015, bringing the total amount provided to £16,025 million. This included an additional £2,600 million in the second half of 2015, largely to reflect the impact of our interpretation of the proposals contained within the Financial Conduct Authority’s (FCA) consultation paper regarding a potential time bar and the Plevin case. As at 31 December 2015, £3,458 million or 22 per cent of the total provision, remained unutilised with £2,950 million relating to reactive complaints and associated administration costs.
Monthly complaints trends could vary significantly throughout this period, given they are likely to be impacted by a number of factors including the potential impact of the FCA’s proposed communication campaign as well as changes in the regulation of CMCs.
The provision includes an estimate to cover redress that would be payable under the FCA’s proposed new rules and guidance in light of Plevin.
Customer claims in relation to insurance branch business in Germany The Group has received a number of claims from customers relating to policies issued by Clerical Medical Investment Group Limited (recently renamed Scottish Widows Limited) but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. Following decisions in July 2012 from the Federal Court of Justice (FCJ) in Germany the Group recognised provisions totalling £520 million during the period to 31 December 2014. Recent experience has been slightly adverse to expectations and the Group has noted decisions of the FCJ in 2014 and 2015 involving German insurers in relation to a German industry-wide issue regarding notification of contractual ‘cooling off’ periods. Accordingly, a provision increase of £25 million has been recognised giving a total provision of £545 million. The remaining unutilised provision as at 31 December 2015 is £124 million (31 December 2014: £199 million).
Interest rate hedging products In June 2012, a number of banks, including the Group, reached agreement with the FSA (now FCA) to carry out a review of sales made since 1 December 2001 of interest rate hedging products (IRHP) to certain small and medium-sized businesses. As at 31 December 2015 the Group had identified 1,735 sales of IRHPs to customers within scope of the agreement with the FCA which have opted in and are being reviewed and, where appropriate, redressed. The Group agreed that it would provide redress to any in-scope customers where appropriate. The Group continues to review the remaining cases within the scope of the agreement with the FCA and has met all of the regulator’s requirements to date.
Other legal actions and regulatory matters In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints and claims from customers in connection with its past conduct and, where significant, provisions are held against the costs expected to be incurred as a result of the conclusions reached. During 2015, the Group charged an additional £655 million (2014: £430 million), including £225 million (2014: £nil) in response to complaints concerning packaged bank accounts and £282 million (2014: £318 million) in respect of other matters within the Retail division. In addition, the Group has charged a further £148 million (2014: £112 million) in respect of a number of other product rectifications primarily in Insurance and Commercial Banking.
At 31 December 2015, provisions for other legal actions and regulatory matters of £813 million (31 December 2014: £521 million) remained unutilised, principally in relation to the sale of bancassurance products and packaged bank accounts and other Retail provisions. The ultimate financial effect, which could be different from the current provision, of these matters will only be known once they have been resolved, the timing of which is uncertain.
Other Following the sale of TSB Banking Group plc (TSB, see note 55) the Group raised a provision of £665 million in relation to the Transitional Service Agreement entered into between Lloyds Bank plc and TSB and the contribution to be provided to TSB in moving to alternative IT provision.
Other provisions also include those arising out of the insolvency of a third party insurer, which remains exposed to asbestos and pollution claims in the US. The ultimate cost and timing of payments are uncertain. The provision held of £30 million at 31 December 2015 represents management’s current best estimate of the cost after having regard to actuarial estimates of future losses.
During the year ended 31 December 2015 the Group operated the following share-based payment schemes, all of which are equity settled.
Save-As-You-Earn schemes Eligible employees may enter into contracts through the Save-As-You-Earn schemes to save up to £500 per month and, at the expiry of a fixed term of three or five years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a discounted price of no less than 80 per cent of the market price at the start of the invitation.
The weighted average share price at the time that the options were exercised during 2015 was £0.77 (2014: £0.77). The weighted average remaining contractual life of options outstanding at the end of the year was 1.9 years (2014: 2.6 years).
At the end of the performance period for the 2012 grant, the targets had not been fully met and therefore these awards vested in 2015 at a rate of 96.6 per cent.
The fair value calculations at 31 December 2015 for grants made in the year, using Black-Scholes models and Monte Carlo simulation, are based on the following assumptions: Save-As-YouEarn
Fixed share awards Fixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for certain Lloyds Banking Group employees, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements. The fixed share awards are delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award. The number of shares purchased in 2015 was 8,237,469 (2014: 7,761,624).
Granted, including certain adjustments (includes entitlements of appointed key management personnel) 3 – 5
Granted, including certain adjustments (includes entitlements of appointed key management personnel) 37 19 42
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 3.99 per cent and 23.95 per cent in 2015 (2014: 0.5 per cent and 23.95 per cent; 2013: 2.5 per cent and 23.9 per cent).
Subsidiaries Details of the Group’s subsidiaries and related undertakings are provided on pages 299 to 307. In accordance with IFRS 10 Consolidated financial statements, transactions and balances with subsidiaries have been eliminated on consolidation.
Enterprise Finance Guarantee Scheme The Group participates in the Enterprise Finance Guarantee Scheme which supports viable businesses with access to lending where they would otherwise be refused a loan due to a lack of lending security. The Department for Business, Innovation and Skills provides the lender with a guarantee of up to 75 per cent of the capital of each loan subject to the eligibility of the customer. As at 31 December 2015, the Group had offered 6,509 loans to customers, worth over £550 million. Under the most recent renewal of the terms of the scheme, Lloyds Bank plc and Bank of Scotland plc, on behalf of the Group, contracted with The Secretary of State for Business, Innovation and Skills.
– The European Commission continues to pursue certain competition investigations into MasterCard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA; – Litigation continues in the English Courts against both Visa and MasterCard. This litigation has been brought by several retailers who are seeking damages for allegedly ‘overpaid’ MIFs. From publicly available information, it is understood these damages claims are running to different timescales with respect to the litigation process, and their outcome remains uncertain. It is also possible that new claims may be issued.
Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar, Japanese Yen and Sterling LIBOR. The lawsuits, which contain broadly similar allegations, allege violations of the Sherman Antitrust Act, the Racketeer Influenced and Corrupt Organizations Act and the Commodity Exchange Act, as well as various state statutes and common law doctrines. Certain of the plaintiffs’ claims, including those asserted under US anti-trust laws, have been dismissed by the US Federal Court for Southern District of New York (the District Court). That court’s dismissal of plaintiffs’ anti-trust claims has been appealed to the New York Federal Court of Appeal. The OTC and Exchange – Based plaintiffs’ claims were dismissed in November 2015 for lack of personal jurisdiction against the Group.
Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. At 31 March 2015, the end of the latest FSCS scheme year, the principal balance outstanding on these loans was £15,797 million (31 March 2014: £16,591 million). Although the substantial majority of this loan will be repaid from funds the FSCS receives from asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted, any shortfall will be funded by deposit-taking participants of the FSCS. The amount of future levies payable by the Group depends on a number of factors including the amounts recovered by the FSCS from asset sales, the Group’s participation in the deposit-taking market at 31 December, the level of protected deposits and the population of deposit-taking participants.
The Financial Conduct Authority’s announcement on time-barring for PPI complaints and Plevin v Paragon Personal Finance Limited On 26 November 2015 the FCA issued a Consultation Paper on the introduction of a deadline by which consumers would need to make their PPI complaints or else lose their right to have them assessed by firms or the Financial Ombudsman Service, and proposed rules and guidance concerning the handling of PPI complaints in light of the Supreme Court’s decision in Plevin v Paragon Personal Finance Limited [2014] UKSC 61 (Plevin). The Financial Ombudsman Service is also considering the implications of Plevin for PPI complaints. The implications of potential time-barring and the Plevin decision in terms of the scope of any court proceedings or regulatory action remain uncertain.
Capital commitments Excluding commitments in respect of investment property (note 27), capital expenditure contracted but not provided for at 31 December 2015 amounted to £388 million (2014: £373 million). Of this amount, £380 million (2014: £368 million) related to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 80,294 80,294
Corporate and other debt securities 7 5,801 – 5,808 25,266 6,518 55 31,839
Losses (gains) recognised in the income statement within other income – (3) (3) (5) 1 (4)
In circumstances where exposures to a counterparty become impaired, any associated derivative valuation adjustment is transferred and assessed for specific loss alongside other non-derivative assets and liabilities that the counterparty may have with the Group.
The combination of a one notch deterioration in the credit rating of derivative counterparties and a ten per cent increase in LGD increases the CVA by £99 million. Current market value is used to estimate the projected exposure for products not supported by the model, which are principally complex interest rate options that are traded in very low volumes. For these, the CVA is calculated on an add-on basis (in total contributing £2 million of the overall CVA balance at 31 December 2015).
(ii) Market liquidity The Group includes mid to bid-offer valuation adjustments against the expected cost of closing out the net market risk in the Group’s trading positions within a timeframe that is consistent with historical trading activity and spreads that the trading desks have accessed historically during the ordinary course of business in normal market conditions.
Derivatives Reasonably possible alternative assumptions have been determined in respect of the Group’s derivative portfolios as follows: – In respect of the embedded equity conversion feature of the Enhanced Capital Notes, the sensitivity was based on the absolute difference between the actual price of the enhanced capital note and the closest, alternative broker quote available plus the impact of applying a 10 bps increase/decrease in the market yield used to derive a market price for similar bonds without the conversion feature. The effect of interdependency of the assumptions is not material to the effect of applying reasonably possible alternative assumptions to the valuations of derivative financial instruments. – Uncollateralised inflation swaps are valued using appropriate discount spreads for such transactions. These spreads are not generally observable for longer maturities. The reasonably possible alternative valuations reflect flexing of the spreads for the differing maturities to alternative values of between 55 bps and 107 bps (2014: 3 bps and 167 bps). – Swaptions are priced using industry standard option pricing models. Such models require interest rate volatilities which may be unobservable at longer maturities. To derive reasonably possible alternative valuations these volatilities have been flexed within a range of 1 per cent to 63 per cent (2014: 4 per cent and 120 per cent).
(B) Financial liabilities Valuation hierarchy The table below analyses the fair values of the financial liabilities of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 251).
NOTE 51: TRANSFERS OF FINANCIAL ASSETS (1) Transferred financial assets that continue to be recognised in full The Group enters into repurchase and securities lending transactions in the normal course of business that do not result in derecognition of the financial assets covered as substantially all of the risks and rewards, including credit, interest rate, prepayment and other price risks are retained by the Group. In all cases, the transferee has the right to sell or repledge the assets concerned.
NOTE 52: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES The following information relates to financial assets and liabilities which have been offset in the balance sheet and those which have not been offset but for which the Group has enforceable master netting agreements in place with counterparties.
Currency risk The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 150.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using currency borrowings. At 31 December 2015 the aggregate principal of these currency borrowings was £670 million (2014: £587 million). In 2015, an ineffectiveness gain of £5 million before tax and £4 million after tax (2014: ineffectiveness loss of £1 million before and after tax) was recognised in the income statement arising from net investment hedges.
Loans and advances Loans and advances designated at fair value through profit or loss £m
Neither past due nor impaired 25,006 302,063 38,886 100,001 440,950 33,174
Neither past due nor impaired 26,003 320,324 37,886 106,768 464,978 36,725
Past due but not impaired 152 10,311 674 488 11,473 –
Impaired – no provision required – 578 938 847 2,363 –
Total debt securities classified as loans and receivables 4,191 1,213 1 Credit ratings equal to or better than ‘BBB’.
2 Other comprises sub-investment grade (2015: £87 million; 2014: £198 million) and not rated (2015: £116 million; 2014: £171 million).
2 Other comprises sub-investment grade (2015: £4 million; 2014: £20 million) and not rated (2015: £nil; 2014: £23 million).
Trading assets: Bank and building society certificates of deposit – – – 554 – 554
Treasury bills and other bills 74 – 74 22 – 22
Total held at fair value through profit or loss 44,466 2,420 46,886 50,910 2,720 53,630 1 Credit ratings equal to or better than ‘BBB’.
2 Other comprises sub-investment grade (2015: £544 million; 2014: £629 million) and not rated (2015: £1,876 million; 2014: £2,091 million).
Credit risk in respect of trading and other financial assets at fair value through profit or loss held within the Group’s unit-linked funds is borne by the policyholders and credit risk in respect of with-profits funds is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back those contract liabilities.
Derivative assets An analysis of derivative assets is given in note 16. 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. In respect of the Group’s maximum credit risk relating to derivative assets of £10,001 million (2014: £14,199 million), cash collateral of £3,228 million (2014: £3,651 million) was held and a further £94 million was due from OECD banks (2014: £2,043 million).
D. Collateral held as security for financial assets A general description of collateral held as security in respect of financial instruments is provided on page 123. The Group holds collateral against loans and receivables and irrevocable loan commitments; qualitative and, where appropriate, quantitative information is provided in respect of this collateral below. Collateral held as security for trading and other financial assets at fair value through profit or loss and for derivative assets is also shown below.
Derivative assets, after offsetting of amounts under master netting arrangements 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. In respect of the net derivative assets after offsetting of amounts under master netting arrangements of £10,001 million (2014: £14,199 million), cash collateral of £3,228 million (2014: £3,651 million) was held.
Collateral repossessed During the year, £203 million of collateral was repossessed (2014: £828 million), consisting primarily of residential property.
In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets held as
Held-to-maturity investments – – – – – 297 3,357 16,154 19,808
Liabilities arising from insurance and investment contracts 1,436 1,693 2,434 2,286 2,303 8,232 20,969 74,813 114,166
Derivative financial liabilities: Gross settled derivatives – net flows 1,688 1,758 1,933 2,533 5,270 13,182
The principal amount for undated subordinated liabilities with no redemption option is included within the over five years column; interest of approximately £39 million (2014: £80 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond five years.
NOTE 54: CONSOLIDATED CASH FLOW STATEMENT (A) Change in operating assets 2015 £m 2014 £m £m
Change in derivative financial instruments, trading and other financial assets at fair value through profit or loss 20,689 (11,767) (5,078)
Up to 1 month £m £m £m £m £m years £m years £m
Total cash and cash equivalents 71,953 65,147 66,797 1 Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-day operations.
IFRS 16 Leases On 13 January 2016 the IASB issued IFRS 16 to replace IAS 17 Leases. IFRS 16 requires lessees to recognise a right of use asset and a liability for future payments arising from a lease contract. Lessor accounting requirements remain aligned to the current approach under IAS 17.
Movement in treasury shares – – – (165) (165) – (165)
Parent company statement of changes in equity for the year ended 31 December
NOTE 1: ACCOUNTING POLICIES The Company has applied International Financial Reporting Standards as adopted by the European Union in its financial statements for the year ended 31 December 2015. IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the IFRS Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Company has not taken advantage of this relaxation, and therefore there is no difference in application to the Company between IFRS as adopted by the EU and IFRS as issued by the IASB.
NOTE 2: AMOUNTS DUE FROM SUBSIDIARIES These comprise short-term lending to subsidiaries, repayable on demand. The fair values of amounts owed by subsidiaries are equal to their carrying amounts. No provisions have been recognised in respect of amounts owed by subsidiaries.
Distributions on other equity instruments, net of tax (314) (225) –
In addition the Company carries out banking activities through its subsidiary, Lloyds Bank plc. At 31 December 2015, the Company held deposits of £24 million with Lloyds Bank plc (2014: £195 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. Included within other liabilities is £10,516 million (2014: £10,944 million) due to subsidiary undertakings. In addition, at 31 December 2015 the Company had interest rate and currency swaps with Lloyds Bank plc with an aggregate notional principal amount of £734 million and a net positive fair value of £45 million (2014: notional principal amount of £1,446 million and a net positive fair value of £106 million). Of this amount an aggregate notional principal amount of £325 million and a net positive fair value of £26 million (2014: notional principal amount of £449 million and a net positive fair value of £43 million) were designated as fair value hedges to manage the Company’s issuance of subordinated liabilities and debt securities in issue.
Other related party transactions Related party information in respect of other related party transactions is given in note 48 to the consolidated financial statements.
Derivatives designated as hedging instruments, held at fair value through profit or loss
Note 50 to the consolidated financial statements outlines the valuation hierarchy into which financial instruments measured at fair value are categorised.
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £1 million (2014: £1 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years. 10 FINANCIAL INSTRUMENTS
Valuation hierarchy The table below analyses the assets and liabilities of the Company. With the exception of derivatives all assets and liabilities are held at amortised cost. They are categorised into levels 1 to 3 based on the degree to which their fair value is observable. No assets or liabilities were categorised as level 1 (2014: nil).
The carrying amount of cash and cash equivalents (2015: £24 million; 2014: £195 million) is a reasonable approximation of fair value.
Annual Report and Accounts, Annual Review or Performance Summary Mar ✔ ✔ ✔
To be published on the Group’s website by 1 July 2016 in accordance with the Capital Requirements (country analysis) Regulations 2013.
Credit derivatives A credit derivative is a financial instrument that derives its value from the credit rating of an underlying instrument carrying the credit risk of the issuing entity. The principal type of credit derivatives are credit default swaps, which are used by the Group as part of its trading activity and to manage its own exposure to credit risk.
of a referendum on its EU membership) and the impact of any sovereign credit rating downgrade or other sovereign financial issues; technological changes and risks to cyber security; natural, pandemic and other disasters, adverse weather and similar contingencies outside the Group’s control; inadequate or failed internal or external processes or systems; acts of war, other acts of hostility, terrorist acts and responses to those acts, geopolitical, pandemic or other such events; changes in laws, regulations, accounting standards or taxation, including as a result of further Scottish devolution; changes to regulatory capital or liquidity requirements and similar contingencies outside the Group’s control; the policies, decisions and actions of governmental or regulatory authorities or courts in the UK, the EU, the US or elsewhere including the implementation and interpretation of key legislation and regulation; the ability to attract and retain senior management and other employees; requirements or limitations imposed on the Group as a result of HM Treasury’s investment in the Group; actions or omissions by the Group’s directors, management or employees including industrial action; changes to the Group’s post-retirement defined benefit scheme obligations; the provision of banking operations services to TSB Banking Group plc; the extent of any future impairment charges or write-downs caused by, but not limited to, depressed asset valuations, market disruptions and illiquid markets; the value and effectiveness of any credit protection purchased by the Group; the inability to hedge certain risks economically; the adequacy of loss reserves; the actions of competitors, including non-bank financial services and lending companies; and exposure to regulatory or competition scrutiny, legal, regulatory or competition proceedings, investigations or complaints. Please refer to the latest Annual Report on Form 20-F filed with the US Securities and Exchange Commission for a discussion of certain factors together with examples of forward looking statements.
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.
Bank Of Scotland Hong Kong Nominees Limited, (Hong Kong) n/a *
23 Provide breakdowns of significant trading and non trading market risk factors. 146-150 24 Describe significant market risk measurement model limitations, assumptions and validation procedures. 146-150, Pillar 3 25 Describe the primary risk management techniques employed to measure and assess the risk of loss beyond reported risk measures and parameters, such as VaR, earnings or economic value scenario results. 146-150, Pillar 3
Name of undertaking % of class held by immediate parent company
Lloyds Banking Group Insurance PCC Limited (In Liquidation), (Guernsey) 77.16% (100%)
# An undertaking external to the Group holds a separate class of share
LCP Baby Investors LP (In process of disposal), (Cayman) n/a *
North American Fund 85% HBOS PROPERTY INVESTMENT FUNDS ICVC UK Property Fund ii 45%
UK Index Linked Gilt Fund 100% SCOTTISH WIDOWS INVESTMENT SOLUTIONS FUNDS ICVC iii