Directors’ remuneration report 74 finAnciAl stAtEMEnts report of the independent auditors on the consolidated financial statements 96
examples of such forward looking statements include, but are not limited to, projections or expectations of the Group’s future financial position including profit attributable to shareholders, provisions, economic profit, dividends, capital structure, expenditures or any other financial items or ratios; statements of plans, objectives or goals of lloyds Banking Group or its management including in respect of the integration of HBoS and the achievement of certain synergy targets; statements about the future business and economic environments in the united Kingdom (uK) and elsewhere including trends in interest rates, foreign exchange rates, credit and equity market levels and demographic developments, competition, regulation, dispositions and consolidation or technological developments in the financial services industry; and statements of assumptions underlying such statements.
Robust income performance. income, excluding market dislocation, grew by nine per cent reflecting strong revenue growth from the Group’s relationship banking businesses. on a statutory basis, income was eight per cent lower at £9,872 million.
in a difficult economic environment, asset quality remains satisfactory. impairment losses increased by 68 per cent to £3,012 million, reflecting the impact of market dislocation, the slowdown in the uK economic environment and the impact of the falling house price index.
The Group is the largest uK retail bank and has a large and diversified customer base. Services are offered through a number of well recognised brands including lloyds TSB, Halifax, Bank of Scotland, Scottish Widows, Clerical Medical and Cheltenham & Gloucester, and via a unique distribution capability comprising the largest branch network in the uK and intermediary channels.
CHAirMAN’S STATeMeNT Sir Victor Blank lloyds Banking Group Annual report and Accounts 2008 thE hBOs tRAnsActiOn lloyds TSB and HBoS had, on a number of occasions over the years, discussed the possibility of a combination. it was only the unique circumstances of last autumn, however, that enabled this transaction to happen. When we decided to acquire HBoS, we were doing so at a time when the economy was already deteriorating with the prospect of further declines to come. We were very mindful of the difficult economic backdrop to this transaction. We were also very aware, however, of the compelling logic of this transaction, including the substantial market positions we would secure and the significant synergies that would be generated. in short, we see the deal as being strategically imperative for us. The size and scale of the new group is very significant indeed and it offers opportunities for growth for the future which a stand-alone lloyds TSB might not have been in a position to deliver to the same degree. our senior management team, given its track record and strength in depth, is very well placed to exploit these opportunities on behalf of all our shareholders.
At times of great economic and financial uncertainty, many apparently settled ideas come under great scrutiny. There is no doubt that there is a great deal of rethinking going on now and a new banking system will emerge both in this country and elsewhere in the coming years. Some certainties continue to prevail, however. for us, our emphasis on our relationship with our customers will remain very much at the core of how we do things as a business. indeed, we believe this emphasis on customer relationships was a great asset to us last year and it will be at the core of how we develop our enlarged business in the future.
At a time when there is a great deal of public debate about the role of the banking system, i think it is important to reflect on the contribution that banks, and lloyds Banking Group in particular, make to our society. our company is the largest provider of social banking accounts in the uK. We provide four million of these accounts and are proud of the way in which we help our low income customers to access the banking system and, where appropriate, move up to a full service current account. We also have a substantial community investment programme through activities within the Company as well as the four lloyds TSB foundations. our overall community investment programme is now somewhere in the region of £100 million a year and is, as a result, one of the most significant contributions by any major corporate to uK society. We are determined to continue to play an important role in the many communities in which we operate up and down the country.
The transaction is essentially an in-market deal, which have historically proven to be amongst the most successful, given they allow greater cost synergies to be captured. We are targeting annualised savings in excess of £1.5 billion in 2011, which represents some 14 per cent of the combined cost base. Work is already underway, with early synergies starting to come from procurement benefits and the more efficient management of the property portfolio. over £100 million of cost efficiencies have been identified immediately from ceasing projects that will no longer be required in the enlarged Group. Clearly, there will be some staffing reductions resulting from the broad range of programmes we will initiate, but we anticipate that we can accommodate the majority of any reductions through natural staff turnover or limited voluntary redundancy programmes.
We are prudently managing the capital base, as has been a hallmark of lloyds TSB. The enlarged Group retains a robust capital position, with an adjusted pro forma core tier 1 capital ratio of 6.4 per cent as of 31 December 2008, which means we are well placed to withstand the impact of any slowdown in the economy.
dividEnd As part of the HM Treasury recapitalisation scheme, the Group was required to suspend the payment of cash dividends to ordinary shareholders until the HM Treasury preference shares issued as part of the scheme are repaid. in the meantime, however, as we indicated in our shareholder circular last year, the board has approved a capitalisation issue of one for 40 ordinary shares held.
We will continue to manage expenses tightly, as you have come to expect of us, but we will incur some additional costs in order to realise the synergies we have announced. impairments will continue to run at high levels, especially in the higher risk parts of the legacy HBoS portfolios.
Despite the outlook for 2009 being tough, we will use this year to make significant progress in our strategy and to build the uK’s leading financial services company. Given the relationship nature of our business, the markets in which we operate, the focus on what i describe as the fundamentals of banking and the return to the more appropriate pricing of risk all play to our strengths and will support our longer-term growth. We are now focused on the integration of the two businesses, which will allow us to offer unparalleled choice and service to our customers, create the platform for the next stage of our growth and provide long-term value for our shareholders.
The success of this organisation is built on the wonderful contributions of our thousands of colleagues, and i am very grateful for all they have achieved this last year in serving our customers and executing our plans. it is this consistent level of performance over the last few years which left us so well placed. The next year will be challenging but i am very confident we will make further substantial progress in building our business, as we begin to establish the uK’s leading financial services company.
Corporate responsibility 36 our people 40 risk management 42 five year financial summary 65 gOvERnAncE
The lloyds TSB management team has a strong track record of delivery built up over the last five years as we have consistently executed against our strategy to attract more customers to our franchise business, to deepen relationships with these customers over time, to deliver sustainable cost and productivity improvements in our operations and to make the most effective use of all our resources. These skills will all remain important for lloyds Banking Group.
AS A reSulT of THe reCApiTAliSATioN of THe BANKiNG SeCTor AND THe ASSoCiATeD plACiNG AND opeN offer, THe GoVerNMeNT NoW HolDS A SiGNifiCANT STAKe iN THe eNlArGeD lloYDS BANKiNG Group. whAt ARE thE iMplicAtiOns Of this And hOw dOEs thE gOvERnMEnt’s shARE OwnERship iMpAct thE gROup’s BusinEss gOing fORwARd?
dividEnd As part of the HM Treasury recapitalisation scheme, the Group was required to suspend the payment of cash dividends to ordinary shareholders until the HM Treasury preference shares issued as part of the scheme are repaid. in the meantime however, as we indicated in our shareholder circular last year, the board has approved a capitalisation issue of one for 40 ordinary shares held.
Against the backdrop of a weakening economy, most major uK banking product markets slowed in 2008. With house prices falling throughout last year, and with some banks withdrawing, mortgage lending growth slowed. By late 2008, growth in mortgage balances outstanding was down to below 4 per cent, and approvals for new mortgages were around 75 per cent below the level of a year earlier. However, those banks, like lloyds TSB, who were still active in the market, were continuing to experience stronger growth due to the withdrawal of other lenders. unsecured personal lending growth also moderated, although balances outstanding on credit cards grew more strongly, suggesting that financial pressures on households were reducing the number paying off credit card outstandings in full each month.
By 2010, our scenarios all project the gradual restoration of growth, as growing confidence that the worst is over feeds through into a weak recovery in consumer spending and business investment, lower spreads in financial markets and a levelling off for asset prices. This will be reflected in some strengthening of growth in our main markets.
Notes to the consolidated financial statements 102 report of the independent auditors on the parent company financial statements 182 parent company financial statements 183
Strong liquidity and funding position maintained throughout the recent turbulence in global financial markets.
Excluding volatility, a provision in respect of certain historic US dollar payments, a provision for the Financial Services Compensation Scheme levy, goodwill impairment; and, in 2007, results of discontinued businesses, profit on sale of businesses and the settlement of overdraft claims.
Excluding volatility, a provision in respect of certain historic US dollar payments, a provision for the Financial Services Compensation Scheme levy, goodwill impairment; and, in 2007, results of discontinued businesses, profit on sale of businesses and the settlement of overdraft claims; and, in 2006, the pension scheme related credit.
The Group’s strategy is to build strong customer franchises and we have continued to extend the reach and depth of our customer relationships, achieving good sales growth, whilst also improving productivity and efficiency. As a result, the Group’s core relationship businesses have continued to perform well, growing market share in many key areas.
Overall income growth of eight per cent, excluding the impact of market dislocation and insurance grossing adjustments, reflected continued good progress in delivering our divisional strategies. We have increased income from both new and existing customers, with strong growth in both assets and liabilities leading to higher net interest income, as well as an increase in fee-related income.
Mortgage credit quality remains good although the slowdown in economic activity and rising unemployment in the UK has led to arrears rising by 44 per cent over the last 12 months, a trend that is expected to continue. The fall in the house price index during the year has led to an increase of approximately £150 million in the secured impairment charge. Looking forward, our view is for a further fall of similar magnitude in house prices during 2009.
Overall, impairment losses increased by 68 per cent to £3,012 million. Our impairment charge on loans and advances expressed as a percentage of average lending was 1.13 per cent, excluding the impact of market dislocation, compared to 0.82 per cent in 2007 (also excluding the impact of the 2007 Finance Act). Impaired assets increased by 64 per cent to £8,700 million and now represent 3.5 per cent of total lending, up from 2.5 per cent at 31 December 2007.
Following the amendment to International Accounting Standards (IAS) 39, the Group has reclassified certain assets for which there is no longer an active market and which are now being managed as lending. Assets totalling £2,993 million previously classified as held for trading (measured at fair value through profit and loss) were transferred to loans and advances with effect from 1 July 2008 and a further £437 million of assets previously classified as available for sale (measured at fair value with changes taken to equity) were transferred to loans and advances with effect from 1 November 2008. If these reclassifications had not been made, the Group’s income statement for 2008 would have included additional losses of £406 million.
In January 2009, the Group announced that it had reached a settlement with both the US Department of Justice and the New York County District Attorney’s Office in relation to a previously disclosed investigation involving those agencies into certain historic US dollar payment practices by Lloyds TSB. The Group disclosed in its interim results for the first half of 2008 that it was in discussions regarding a resolution of the investigation and that it had provided £180 million in respect of this matter. The provision was hedged into US dollars at the time and fully covers the settlement amount announced in January 2009. The Group is continuing discussions with the Office of Foreign Assets Control (OFAC) regarding the terms of the resolution of its investigation. OFAC has confirmed to the Group that the amount paid to the US Department of Justice and the New York County District Attorney’s Office will be credited towards satisfying any penalty it imposes. The Group does not currently believe that any additional liability requiring provision will arise following the conclusion of the discussions with OFAC. The Group does not anticipate any further enforcement actions as to these issues.
The Group’s tax for 2008 was a credit of £38 million. This primarily reflects a significant policyholder interests related tax credit offsetting in full the charge for policyholder interests included in the Group’s profit before tax.
2008 has been an immensely challenging period for all banks, and the assets on the enlarged Group’s balance sheet have shown increasing signs of stress during the year. Whilst our risk management and business support culture is strong, the continuing economic deterioration in the UK will make 2009 another difficult year. We currently expect retail impairment levels to rise significantly in 2009, largely reflecting the expected increase in unemployment levels in the UK and the impact of further house price falls. Corporate impairment levels are expected to remain at the high levels seen during 2008, whilst Treasury asset and investment portfolio write-downs are expected to be significantly lower. Overall, before the recognition of negative goodwill, we expect the enlarged Group to report a loss for 2009.
Provision for Financial Services Compensation Scheme levy (119) (3) – – (122) – (122)
Retail and International group insurance Insurance Banking Investments ** Banking items gross up gross up ** Group 2007† £m £m £m £m £m £m £m
Good profit performance, against a backdrop of slowing economic activity. Profit before tax increased by four per cent to £1,793 million.
Strong income momentum maintained, up seven per cent, supported by overall sales growth of seven per cent.
The quality of new lending continues to be good, reflecting continued strong credit criteria, although the fall in the house price index over the last 12 months has led to an increase of approximately £150 million in the secured impairment charge during the year. We currently expect retail impairment levels to rise significantly in 2009, largely reflecting the expected increase in unemployment levels in the UK and the impact of further house price falls.
Following the acquisition, the wealth management business is being transferred to the new ‘Wealth and International’ division.
no 1 foR UK CURRenT ACCoUnTS Lloyds TSB took on over 1 million new customers for the second year in a row, maintaining the position of No 1 UK Current Account provider (GfK Financial Research Survey ‘FRS’ data). This success has been driven by launching innovative new products and services, such as Vantage and Control accounts and the market leading mobile banking services.
‘Retail’s’ strategic goal is to create Britain’s best retail bank. This will be achieved by building deeper relationships with our customers through providing products that they need, at prices they can afford, as well as delivering a high quality service. At the same time, we will seek to improve the management of our costs and capital by continuing to apply a prudent approach to risk.
Customer deposits have increased by five per cent during the year, with particularly strong progress in growing our relationship focused bank savings and wealth management deposit balances, with increases of 12 per cent and 20 per cent respectively. The retail bank opened over two million new savings accounts during 2008.
The demand for the Lloyds TSB Airmiles Duo credit card account has continued to be strong, with 1.4 million customers now signed up to use the account. Duo customers tend to be higher quality, more transactional customers. As a result, Lloyds TSB has maintained its position as a UK market leader in new credit card issuance during 2008, and has maintained an estimated new business market share of 13 per cent. In addition, Lloyds TSB was the leading consumer debit card issuer in the UK during the year.
In Cheltenham & Gloucester, the average indexed loan-to-value ratio on the mortgage portfolio was 56 per cent, and the average loan-tovalue ratio for new mortgages and further advances written during 2008 was 63 per cent. At 31 December 2008, 15 per cent of balances had an indexed loan-to-value ratio in excess of 100 per cent reflecting the significant fall in house prices during the year. Compared to the CML industry averages at 31 December 2008, UK Retail Banking had less than half the industry average for properties in possession and new repossessions as a percentage of total cases in 2008. In addition, arrears in the Group’s buy-to-let portfolio represent only a small fraction of our prime portfolio and CML industry averages. We extensively stress-test our lending to changes in macroeconomic conditions and we remain confident in the quality of our mortgage portfolio.
Good income growth and strong cost management. Income increased by three per cent, whilst operating expenses decreased by three per cent.
Lloyds TSB General Insurance was the leading distributor of home insurance in Britain, with products distributed through Lloyds TSB branches and strategic corporate partners.
Lloyds Banking Group is now the major bancassurance provider in the UK and provides a full range of equity based long-term savings and investment products.
– Increasing the proportion of business sold through the Lloyds Banking Group franchise whilst profitably growing independent financial adviser (IFA) sales
During 2008, the value of Scottish Widows’ bancassurance new business premiums increased by four per cent, building on the success of the simplified product range for distribution through the Lloyds TSB branch network, commercial banking and wealth management channels. Sales of OEICs through the wealth segment were particularly strong, offsetting a reduction in volumes through the mass market segment, where a reduction in the sales of equity-backed OEICs has been partly offset by strong sales of capital protected savings products. Sales of protection products also increased significantly reflecting the benefit of product enhancements during the year.
The business has made further improvements in service and operational efficiencies, and the benefits can be seen in a further reduction of three per cent in operating expenses, notwithstanding ongoing investment in product and distribution enhancements. In addition, the strength of Scottish Widows’ product and service proposition was recognised through an increased number of industry awards and ratings in 2008; the Company was voted best personal pensions provider, achieved two ‘5 star’ service awards and was rated highly for its strong e-commerce platform.
Impact of capital repatriation to Group – 21 profit before tax* 818 818 –
Profit before tax from Scottish Widows Investment Partnership (SWIP) increased to £42 million (2007: £41 million). The adverse impact on income of volatile equity and bond markets was more than offset by strong cost management. With the FTSE All-Share Index falling to levels not seen since 2003, SWIP’s assets under management decreased by £14.6 billion to £83.0 billion.
Including assets under management within our UK Wealth Management and International Private Banking businesses, groupwide funds under management decreased by 10 per cent to £109 billion.
The table below shows the sensitivity of the EEV and the new business profit before tax to movements in some of the key assumptions. The impact of a change in the assumption has only been shown in one direction as the impact can be assumed to be reasonably symmetrical.
This sensitivity shows the impact on our annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
This sensitivity shows the impact of a 25 basis point reduction in the allowance for illiquidity premia. It assumes that the overall corporate bond spreads are unchanged and hence market values are unchanged. Government bond yields and the risk-free rate are both assumed to be unchanged.
resilient profit performance despite the turbulence in global financial markets. The division remained profitable even after absorbing the increased impact of its exposure to assets affected by current capital markets uncertainties and a significant rise in corporate impairments. The impact of recent market dislocation, however, has been to reduce profit before tax in 2008 by £1,270 million (2007: £280 million), to £274 million.
Following the acquisition of hBOS, the Wholesale and International Banking division has been renamed ‘Wholesale’. The Group’s international businesses, with the exception of corporate in North America (including Canada), will form part of the new Wealth and International division.
Financial calendar 2009 195 corporate bank of the year Lloyds TSB (Commercial/Corporate Markets) won Bank of the year for the fourth consecutive year, receiving great feedback for the quality of service and degree to which relationship managers understood the customers’ business. (Real FD/CBI FDs’ Excellence Awards, April 2008)
The way we manage our customer relationships is the vital ingredient which differentiates us from our competition.
Operating expenses increased by nine per cent to £691 million, reflecting significant further investment in people to support the substantial business growth in our Corporate Markets relationship business. The substantial increase in the impairment charge reflects an increase in the level of impairments as a result of the economic slowdown in the UK, market dislocation and the impact of a number of high profile financial services company collapses during the second half of the year.
This charge mainly reflects the significant falls in global equities markets during the year, which resulted in total returns some 33 percentage points lower than expected. These lower than expected returns reduced the value of in-force business held on the balance sheet. The impact of the widening corporate bond credit spreads more than offset the inclusion of an allowance for the illiquidity premium referred to above, and resulted in a net reduction in the value of the annuity portfolio. Lower equities and bond prices also affected the valuation of the Group’s investments held within the funds attributable to the shareholder; there was no exposure to assets held at fair value through profit or loss valued using unobservable market inputs.
In May 2008, the UK implemented the EU Unfair Commercial Practices Directive through the Consumer Protection from Unfair Trading Regulations. In addition, a number of EU directives, including the Payment Services Directive and Consumer Credit Directive are currently being implemented in the UK. The EU is also considering regulatory proposals for, inter alia, Mortgage Credit, Deposit Guarantee Schemes, expanding the Single European Payments Area, conducting a Retail Financial Services Review, including Financial Inclusion issues and reviewing capital adequacy requirements for insurance companies (Solvency II).
Overall, the board is satisfied that the systems in place to manage corporate responsibility risks are effective and that the relevant risks have been assessed during 2008 and managed in compliance with relevant policies and procedures.
The framework mirrors the priorities developed in Lloyds Banking Group in recent years with an emphasis on colleagues, customers and innovation, community and suppliers, the environment and corporate governance. It is subject to consultation and final proposals will be published in the first half of 2009 but we intend using the framework as the basis of our 2008 corporate responsibility report.
Lloyds Banking Group is rooted in local communities throughout the UK and we take our responsibilities to those communities very seriously. By investing in the communities where we operate we not only create economic value but we also make a positive social contribution. Through the Lloyds TSB Foundations, over £37 million was distributed to local charities in 2008.
We want to build a great organisation, which is recognised for operating to high standards and is built on strong customer relationships. We want to be the bank recommended most by customers and staff. We have put in place the essential building blocks; providing excellent customer service from well-trained staff; appropriate products that meet real needs; treating customers appropriately at all times; and following ethical business practices to build a sustainable, profitable business.
For seven years, we have measured our customers’ satisfaction with the service they receive using our CARE Index. After extensive research and consideration we have decided to move from CARE to a new advocacy programme to help us achieve our vision. We will monitor our progress using a Net Promoter Score, which measures the customers’ likelihood of recommending Lloyds Banking Group to a friend or colleague.
In a poll of finance directors across the UK, Lloyds TSB Corporate Banking was voted ‘Bank of the Year’ for the fourth year running at the Real Finance/Confederation of British Industry FDs’ Excellence Awards, in recognition of our quality of service and understanding of our customers’ businesses.
Our colleagues are trained to offer the necessary advice and support to help customers manage their borrowing. Over 1,500 customer advisers have been specifically trained over the last year to counsel customers with concerns about their financial circumstances. We actively look at our customers’ account behaviour and proactively contact those that show signs of pressure on their finances. We can then help them to find an appropriate solution through more effective budgeting or rescheduling their borrowing. We have a customer support unit that can deliver more intensive help and we also support independent money advice networks including the Money Advice Trust and Consumer Credit Counselling Service. Payments totalling more than £3.4 million were made in 2008.
We also work to ensure our customers are aware of how to protect themselves including dedicating a section of our website to information on common internet fraud types, an annual fraud awareness campaign, support of industry education initiatives and through our sponsorship of the charity Crimestoppers.
Our share of customers belonging to the lowest income groups is higher than our normal market share, reflecting our commitment to greater financial inclusion. By the end of 2008, nearly 540,000 Cash Accounts have been opened for those customers who prefer a basic bank account or who do not meet our standard account opening criteria but are not undischarged bankrupts. We now also offer an added value account with enhanced customer features for customers prepared to pay a modest fee while retaining the simplicity of a basic bank account.
We support community finance initiatives and loan and venture capital funds which offer funding to individuals and businesses in some of the most deprived areas in the UK. Lloyds Banking Group has currently committed £12 million to the community finance sector. Our Public and Community Sector team within Corporate Banking is one of the largest funders of the UK social housing sector with £8 billion committed in 2008.
Lloyds Banking Group welcomes and fully supports the FSA’s initiatives to increase financial capability in the UK. We have seconded a senior executive to develop, launch and manage the financial capability in the workplace project, to deliver the parents’ guide to money initiative and help develop the operational delivery capability within the FSA programmes. These two initiatives have provided educational material and training to over three million adults throughout the UK. Feedback from all parties has been very encouraging and these initiatives are helping to improve financial capability.
Lloyds TSB Bank has nearly 600,000 small business customers. They are an important part of our business and we are committed in supporting them in current economic conditions while seeking opportunities to grow our position in the market. Total lending to small businesses increased by 20 per cent over 2008.
The main grants programmes are designed to address essential community needs and in particular, to support small under-funded charities. 35 per cent of the charities supported by the England and Wales Foundation in 2008 had a total income of £100,000 or less and over 90 per cent had an income of £500,000 or less.
For every Olympic or Paralympic medallist, there are thousands of genuine hopefuls without recognition or funding. Lloyds TSB Local Heroes has been set up to help more of those young hopefuls when they need it most.
– created an on-line guide to help customers taking out a car loan to select a model with lower CO2 emissions.
We pride ourselves in our people and we commit to giving them the training and tools to develop themselves, and to develop the relationships they have with customers and colleagues throughout the Group. We believe that to create a high commitment, high performance organisation, we need to have high levels of colleague engagement. In order to do this, we listen to what our colleagues tell us and act on the results. The Group uses a comprehensive, confidential online engagement survey to help us to measure and assess current levels of colleague engagement across the organisation. Our Group Chief Executive personally agrees the content of our colleague engagement survey, demonstrating our commitment to and investment in understanding their views. Over the last three years, the overall engagement index has continued to rise and in 2008, the Group achieved a record response rate and an all-time high engagement index, which put us above both the financial services norm and the high performance norm for the UK. In addition, our approach to colleague engagement saw us recognised in The Sunday Times as ‘One to Watch’ within their annual Best Big Company survey and accreditation.
Recruitment, retention and development of talented people continues to be one of the highest priorities for our leaders. Top performers are attracted to the Group because of our strong brand and values; together with top class development and career opportunities.
Developing our current colleagues and succession planning are vital in supporting our growth strategy. In Autumn 2008, an Organisational Capability Review was completed. As a result, we have strong succession and development plans for all our senior leaders across the Group and have collected qualitative data on our top 300 colleagues. We are retaining people for an average tenure across our business of 13 years.
Overall, we have taken a conservative approach to remuneration levels and we have differentiated reward for our high performing colleagues through a number of performance measures, including the management of risk and other balanced scorecard objectives.
Overall, through aligning reward to our balanced scorecard, our aim is to recognise performance against factors including how well our colleagues manage risk and therefore the long term health of the business. We have structured our reward arrangements with this in mind. We will continue to differentiate our reward for colleagues who fulfil our commitment to building relationships for the long-term.
Equality and diversity is not just about complying with equality legislation. We believe that it is vital for achieving competitive advantage. We need to be close to our customers and provide them with the right products and services. By attracting and retaining a diverse workforce, we will better understand the needs of all our customers and be able to build lasting relationships.
The Group seeks to optimise performance by allowing divisions and business units to operate within capital and risk parameters and the Group’s policy framework. They must do so in a way which is consistent with realising the Group’s strategy and meeting agreed business performance targets. The Group’s approach to risk management seeks to ensure the business remains accountable for risk whilst also ensuring there is effective independent oversight.
The Group has continued to focus on enhancing its capabilities in providing both qualitative and quantitative data to the board on risks associated with strategic objectives and facilitating more informed and effective decision making. The Group‘s ability to take risks which are well understood and consistent with its strategy and plans, is a key driver of shareholder return.
There is a matrix approach to risk management which includes group risk directors being responsible for individual risk types in aggregate across the Group and divisional risk officers being responsible for the aggregate risk profile within their respective divisions. The group risk directors and divisional risk officers all have a direct reporting line to the chief risk officer. This matrix approach enables the group executive committee members to fulfil their accountabilities for risk management and enables the chief risk officer to inform the risk oversight committee of the aggregate risk profile of the Group.
The Group maintains a risk governance structure that is intended to strengthen risk evaluation and management, whilst also positioning the Group to manage the changing regulatory environment in an efficient and effective manner. This structure has been tried and tested by Lloyds TSB and will remain the same for Lloyds Banking Group. The risk governance structure for Lloyds TSB is shown in Table 1.1.
The group credit risk committee is responsible for the development and effectiveness of the Group’s credit risk management framework; clear description of the Group’s credit risk appetite; setting of high level Group credit policy; and compliance with regulatory credit requirements. On behalf of the group business risk committeee, the group credit risk committee monitors and reviews the Group’s aggregate credit risk exposures and concentrations of risk.
Group risk directors are allocated responsibility for specifi c risk types and are responsible for ensuring the adequacy of risk resources as well as the oversight of the risk profi le across the Group.
Divisional and business unit policy is only produced by exception and is not necessary unless there is a specific area for which a particular division or business unit requires a greater level of detail than is appropriate for group level policy. The governance arrangements for development of, and compliance with, group, divisional and business unit policy and the associated accountabilities are clearly outlined. All staff are expected to be aware of the policies and procedures which apply to them and their work and to observe the relevant policies and procedures. Line management in each business area has primary responsibility for ensuring that group policies and the relevant local policies and procedures are known and observed by all staff within that area.
The Group follows a through the economic cycle, relationship based, business model with robust risk management processes, appropriate appetites and experienced staff in place.
legal and regulatory risk: arising in all divisions and reflecting the legal and regulatory environment in which the Group operates and the volume and pace of change from within the UK and the rest of the world. This impacts the Group, both operationally in terms of cost of compliance with uncertainty about legal and regulatory expectations, and strategically through pressure on key earnings streams. The latter could potentially result in changes to business and pricing models, particularly in the UK retail and smaller business markets. Our business planning processes continue to reflect change to the legal and regulatory environment. Major current legal and regulatory reviews and proceedings are described on page 35. In addition, the Group faces risk where legal or regulatory proceedings are brought against it. Regardless of whether such claims have merit, the outcome of such proceedings is inherently uncertain and could result in financial loss.
Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers.
– Credit principles and policy: group risk sets out the Group credit principles and policy according to which credit risk is managed, which in turn is the basis for divisional and business unit credit policy. Principles and policy are reviewed regularly and any changes are subject to a review and approval process. Divisional and business unit policy includes lending guidelines, which define the responsibilities of lending officers and provide a disciplined and focused benchmark for credit decisions. Credit policy also specifies maximum holding period limits for the credit trading portfolios.
– Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market movements. Aggregate facility levels by counterparty are considered and limit breaches are subject to escalation procedures.
– Individual credit assessment and sanction: Credit risk in wholesale portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty underwriting are the same as that for assets intended to be held over the period to maturity.
– Controls over rating systems: The Group has established a robust and independent process built on a set of common minimum standards designed to challenge the discriminatory power of the systems, accuracy of calibration and ability to rate consistently over time and across obligors. The internal rating systems are developed and implemented by independent risk functions either in the business units or divisions with the business unit managing directors having ownership of the systems. They also take responsibility for ensuring the validation of the respective internal rating systems, supported and challenged by specialist functions in their respective division.
– For other insurance liabilities the aim is to invest in assets such that the cash flows on investments will match those on the projected future liabilities. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.
During the year the Group introduced group wide stress testing to measure exposure to credit spread widening across all businesses in response to the market dislocation that has impacted the observable inputs to asset pricing.
In addition, limits are used as a control mechanism for insurance risk at policy level.
The risk of reductions in earnings and/or value, through financial or reputational loss, or from failing to comply with the laws, regulations or codes applicable.
The Group’s operational risk management framework consists of five key components: – Identification of the key operational risks facing a business area. – Evaluation of the effectiveness of the control framework covering each of the key risks to which the business area is exposed. – Evaluation of the non-financial exposures (e.g. reputational risk) for each of the key risks to which the business area is exposed. – For material risks identified, an estimate of the exposure to financial losses that could result within the coming financial year, together with an estimate of losses in a stressed environment. – For material risks identified, an estimate of exposure to high impact, low frequency events through a scenario.
Liquidity risk is defined as the risk that the Group does not have sufficient financial resources to meet its commitments when they fall due, or can secure them only at excessive cost. Funding risk is further defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.
Consistent with regulatory requirements, the Banking and Insurance parts of the Group manage their liquidity independently on a standalone basis. Liquidity for all UK based banking business is managed centrally. Liquidity for International banking entities are managed on a standalone basis Liquidity risk in the Insurance business is managed at business unit level and is not considered further in this section.
Liquidity exposure represents the amount of potential outflows in any future period less committed inflows. Liquidity is considered from both an internal and regulatory perspective.
The ability to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of high grade marketable debt securities set out on page 172 of the financial statements which can be sold to provide, or used to secure, additional short term funding should the need arise from either market counterparties or central bank facilities (ECB, Federal Reserve, Bank of England). During the year the Group increased its stock of liquid assets by £47 billion to £63 billion (2007: £16 billion), which includes government securities, mortgage backed securities, corporate and other debt securities.
Capital is actively managed at an appropriate level of frequency and regulatory ratios are a key factor in the Group’s budgeting and planning processes with updates of expected ratios reviewed regularly during the year by the Group asset and liability committee. Capital raised takes account of expected growth and currency of risk assets. Capital policies and procedures are subject to independent oversight. Regular reporting of actual and projected ratios is made to the senior asset and liability committee and to the group asset and liability committee.
A firm is permitted to include innovative tier 1 capital in its tier 1 capital resources for the purposes of GENPRU1.2 (adequacy of financial resources) but is required to exclude these amounts from tier 1 for the purposes of meeting the main BIPRU firm Pillar 1 rules.
statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. Liabilities are calculated using a projection of future cash flows after making prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the FSA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for with-profits policies that are at the discretion of management, but does include a value for policyholder options likely to be exercised.
‘realistic’ basis. The FSA requires each life assurance company which contains a With Profit Fund in excess of £500 million, including Scottish Widows, to carry out a ‘realistic’ valuation of that fund. The word ‘realistic’ in this context reflects the terminology used for reporting to the FSA and is an assessment of the financial position of a with-profits fund calculated under a prescribed methodology.
Assets attributable to the shareholder held within the long-term funds – 2,562 2,562 – 2,562
Adjustment to remove the value of future profits recognised in respect of non-participating contracts written in the With Profit Fund (49) – (49) – (49)
The figures shown above for available capital resources within the insurance business relate to Scottish Widows plc only. The estimated total additional resources relating to the other life assurance subsidiaries within the Group as at 31 December 2008 are £310 million.
other restrictions in the non-Participating fund: In addition to the policies which existed at the date of demutualisation, the With Profit Fund includes policies which have been written since that date. As a result of statements made to policyholders that investment policy will usually be the same for both types of business, there is an implicit requirement to hold additional regulatory assets in respect of the business written after demutualisation. The estimated amount required to provide such support at 31 December 2008 is £162 million (31 December 2007: £183 million). Scottish Widows has obtained from the FSA permission to include the value of this support in assessing the realistic value of assets available to the With Profit Fund. There is a further test requiring that no amounts can be transferred from the NonParticipating Fund of Scottish Widows unless there are sufficient assets within the Long Term Fund to meet both policyholders’ reasonable expectations in light of liabilities in force at a year end and the new business expected to be written over the following year.
Available capital in the Non-Participating Fund has decreased from £1,908 million at 31 December 2007 to an estimated £1,854 million at 31 December 2008. This is primarily a result of the anticipated transfer from the Non-Participating Fund to the Shareholder Fund at the year end of £110 million, and market movements offset by the return generated from the business.
working capital for fund 249 3,603 945 4,026 working capital ratio for fund 1.8% 21.6% 5.3% 19.2%
Adjustments to include the value of future profits recognised in respect of Non-Participating business written in the With Profit Fund 49 49 23 23
For those policies written pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up within the With Profit Fund of Scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2008 of £2.0 billion (2007: £1.7 billion). The eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
Chairman of the nomination and risk oversight committees and a member of the remuneration committee
Joined the board in 2006 as deputy chairman and became chairman in May 2006. Former partner in Clifford-Turner (now Clifford Chance) from 1969 to 1981 and chairman and chief executive of Charterhouse until 1997. Director of The Royal Bank of Scotland from 1985 to 1993 and of GUS from 1993 to 2006 (chairman from 2000). Chairman of Trinity Mirror from 1999 to 2006. A member of the Financial Reporting Council from 2002 to 2007 and a member of the Council of Oxford University from 2000 to 2007. A senior adviser to the Texas Pacific Group and appointed by the Prime Minister as a Business ambassador. Chairs two charities, WellBeing of Women and UJS Hillel, as well as the Council of University College School. Aged 66
Joined the board in 2005. Appointed chairman of Scottish Widows in 2007. Held a number of senior and general management appointments in Allied Dunbar, Eagle Star and Threadneedle Asset Management before the merger of Zurich Group and British American Tobacco’s financial services businesses in 1998. Subsequently served as chairman and chief executive officer of Zurich Financial Services United Kingdom, Ireland, Southern Africa and Asia Pacific, until his retirement in 2004. Chairman of the Government’s Review of Skills (published in December 2006) and deputy chairman of the Commonwealth Education Fund. Chairman of BUPA and Intrinsic Financial Services and a non-executive director of Paternoster. Former chairman of the National Employment Panel. Aged 61
Joined the board on 1 May 2008. Entered the Foreign and Commonwealth Office in 1972 and held senior appointments, including HM ambassador to Israel between 1995 and 1998, foreign policy adviser to the Prime Minister from 2001 to 2003 and HM ambassador to the USA from 2003 to 2007. A non-executive director of BG Group and Lockheed Martin UK Holdings. Aged 59
Joined the board in 2005. Chairman of British American Tobacco. Held a number of senior and general management appointments in Rembrandt Group from 1981, before joining Compagnie Financière Richemont as group finance director in 1988, a position he held until 2004. A non-executive director of Rio Tinto and Marks and Spencer Group. A former chairman of RHM from 2005 to 2007 and group finance director of Rothmans International from 1990 to 1995. Aged 55
Joined the Group in 1986 and held a number of senior and general management appointments before being appointed to the board in 2000, as group executive director, IT and operations. Appointed group executive director, insurance and investments in October 2003. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as finance director in the UK from 1983 to 1985. Chairman of the Association of British Insurers and a member of the Chancellor’s Financial Services Global Competitiveness Group, The Takeover Panel and the Chancellor’s Insurance Industry Working Group. Aged 56
RESULTS AND DIVIDENDS The consolidated income statement shows a profit attributable to equity shareholders for the year ended 31 December 2008 of £819 million.
Ms T A Dial and Mr M E Fairey left the board on 18 April 2008 and 30 June 2008, respectively. Mr Ewan Brown will retire at the annual general meeting in 2009.
DIRECTORS’ INDEMNITIES The directors, including two former directors who left during the year, have entered into individual contracts of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ for the purposes of the Companies Act 2006. These contracts were in force during the whole of the financial year or from the date of appointment in respect of the four directors who joined the board in 2008. The contracts remain in force and are available for inspection at the Company’s registered office.
EMPLOyEES Lloyds Banking Group is committed to providing employment practices and policies which recognise the diversity of our workforce and ensure equality for employees regardless of sex, race, disability, age, sexual orientation or religious belief.
– the management report contained in the business review includes a fair review of the development and performance of the business and the position of the Company and Group, together with a description of the principal risks and uncertainties they face.
Resolutions concerning the re-appointment of PricewaterhouseCoopers LLP as auditors and authorising the audit committee to set their remuneration will be proposed at the annual general meeting.
THE BOARD AND ITS COMMITTEES The Group is led by the board comprising executive and non-executive directors with wide experience. The appointment of directors is considered by the board and, following the provisions in the articles of association, they must stand for election by the shareholders at the first annual general meeting following their appointment and must retire, and may stand for re-election by the shareholders, at least every three years. Independent non-executive directors are appointed for three-year renewable terms, which may, in accordance with the articles of association, be terminated without notice or payment of compensation.
The board usually meets at least nine times a year. It has a programme designed to enable the directors regularly to review corporate strategy and the operations and results of the businesses and discharge their duties within a framework of prudent and effective controls relating to the assessing and managing of risk.
The remuneration committee reviewed the performance of the chairman, the group chief executive and the other group executive directors, when considering their remuneration arrangements. The nomination committee reviewed the performance of all the directors and the independence of non-executive directors. Like all board committees, the nomination committee and remuneration committee report to the board on their deliberations, including the results of the performance and independence evaluations.
The chairman has a private discussion at least once a year with every director on a wide range of issues affecting the Group, including any matters which the directors, individually, wish to raise.
Each resolution considered at the annual general meeting in May 2008 and the general meeting in November 2008 was decided on a poll. Votes representing approximately 50 per cent of the total number of shares in issue were cast at both meetings and each resolution was passed by a substantial majority. Details of the poll results were announced following the meetings and displayed on our website, www.lloydsbankinggroup.com. They are available from the company secretary.
The resolutions to be considered at the annual general meeting in 2009 will also be decided on a poll. Details of the results will be announced following the meeting and will be displayed on our website, www.lloydsbankinggroup.com. They will also be available from the company secretary.
During the year, the audit committee received reports from, and held discussions with, management and the auditors. In discharging its duties, the committee has approved the auditors’ terms of engagement, including their remuneration and, in discussion with them, has assessed their independence and objectivity (more information about which is given in note 11 to the consolidated financial statements, in relation to the procedure for approving fees for audit and non-audit work) and recommended their re-appointment at the annual general meeting. The committee also reviewed the financial statements published in the name of the board and the quality and acceptability of the related accounting policies, practices and financial reporting disclosures; the scope of the work of the group audit department, reports from that department and the adequacy of its resources; the effectiveness of the systems for internal control, risk management and compliance with financial services legislation and regulations (more information about which is given in the note about internal control on page 73); the results of the external audit and its cost effectiveness; and reports from the external auditors on audit planning and their findings on accounting and internal control systems. Procedures for handling complaints regarding accounting, internal accounting controls or auditing matters and for staff to raise concerns in confidence have been established by the committee. The committee also had a meeting with the auditors, without executives present, and a meeting with the group audit director alone.
GOING CONCERN The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the foreseeable future, the directors have considered a number of key dependencies as discussed in note 1 on page 102. Having considered projections of the Group’s capital and funding position, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the accounts.
This is a report made by the board of Lloyds Banking Group plc, on the recommendation of the remuneration committee. It covers the current and proposed components of the remuneration policy and details the remuneration for each serving director during 2008.
Historically our prudent business strategy has also been reflected in our approach to remuneration. Overall, we have taken a conservative approach to remuneration levels. We have typically positioned our base salaries and incentive levels at or below the levels offered by our direct competitors or by other UK companies of a similar size. The termination provisions within our contracts are among the toughest in the FTSE 100, ensuring no payment for failure.
Our annual incentive plan also reflects the fact that you cannot run a successful bank by entirely focusing on financial performance. The plan includes measures relating to how well we serve our customers, how committed and engaged our employees are, the success with which we are growing our franchise, and how we are managing risk. These are factors that have a direct and measurable impact on the future success of our business.
This combination of financial and non-financial annual incentive targets encapsulated in a balanced scorecard reinforces to all of our executives the importance of doing business for the long-term in a way that is sustainable. This reflects our commitment to basing our business on building long-term relationships.
In October last year Lloyds TSB participated in a recapitalisation programme launched by the UK Government to ensure the stability of the UK banking system. Details of this arrangement are included in the Chairman’s statement.
Although we believe that our approach to remuneration has served the business well, we recognise that we are now operating in an entirely different environment for banks. This will be reflected in the changes we are making to our remuneration approach.
In line with our prudent approach to remuneration we had already announced that for 2009 there would be no salary increases for the board and at their own request the executive directors would not be awarded any bonus for 2008. In addition long-term incentive awards for 2009 have been reduced by 175 per cent of salary.
The following key decisions have been made for 2008/2009 remuneration: – at their own request, the executive directors will not be awarded any bonus for 2008 – base salaries for executive directors frozen at 2008 levels – reduced the maximum level of incentives from 2008 levels by 175 per cent of salary – strengthened the role for non-financial measures, introducing a balanced scorecard into the long-term incentive plan focused on the HBOS integration – increased the role of risk-adjusted economic profit, by introducing it as a measure in the long-term incentive plan, in addition to its current use in the annual incentive – changed the annual incentive plan so that the payment is deferred over three years, and subject to claw-back if the performance on which the incentive is based is found not to be sustainable – determined that, from April 2012, executive directors will no longer participate in the final salary pension plan
Based half on financial measures and half on a balanced scorecard of non-financial measures 33% Deferred and paid in tranches over three years subject to clawback
GOVERNANCE AND RISK MANAGEMENT An essential component of our approach to remuneration is the governance process that underpins it. This ensures that our policy is robustly applied and risk is managed appropriately.
All the independent non-executive directors are invited to attend meetings if they wish, and they receive the minutes and have the opportunity to comment and their views taken into account before the committee’s decisions are implemented.
In addition to their advice on executive remuneration, during 2008 Towers Perrin also provided market remuneration data as well as other remuneration consulting services to the Group, Hewitt New Bridge Street provided pension consulting services and PwC were the Group’s auditors.
Following the FSA’s approach to a number of major UK banks in October 2008, we submitted an analysis of our current remuneration policies against their proposed good practice criteria. The assessment showed a generally favourable comparison. We have met with representatives from the FSA and will continue to co-operate with them as they develop their updated guidance in 2009. Their draft Code of Conduct was published as this report was being finalised. Although we believe our approach is well aligned with the Code of Conduct, our approach will be subject to a further detailed review.
– We will be reviewing the oversight of divisional remuneration. Already we apply independent oversight of divisional remuneration from the Group’s centre function. During the year, the group HR function, in conjunction with the risk function, undertook the group wide review of remuneration practices summarised above, and we will be reviewing the oversight processes and governance controls relating to divisions to identify areas where they can be further strengthened. Our particular emphasis will be on ensuring that the linkage between good risk practices and remuneration can be robustly demonstrated.
– Regulators have identified the remuneration of risk officers as one of their areas of interest. The decision on risk officer remuneration is already held at the Group’s centre function. We will be reviewing the remuneration setting processes for all of our control functions to ensure that all potential conflicts of interest are identified and managed.
DIRECTORS’ REMUNERATION POLICy The Group’s remuneration policy supports our business strategy, which is based on building long-term relationships with our customers and employees, and managing the financial consequences of our business decisions across the entire economic cycle. The policy is designed to ensure that cost effective packages are provided which attract and retain executive directors and senior management of the highest calibre and motivate them to perform to the highest standards. At the same time, the objective is to align individual rewards with the Group’s performance, the interests of its shareholders, and a prudent approach to risk management. In this way we balance the requirements of our various stakeholders: customers, shareholders, employees, and regulators. We believe that this approach is in line with the Association of British Insurers best practice code on remuneration as well the draft Financial Services Authority’s Code of Practice, as the policy seeks to reward long-term value creation whilst not encouraging excessive risk taking.
We summarise below how each of these policy objectives is met by our remuneration packages.
We pay competitively but not excessively. Our prudent approach to positioning compensation means that we reduce the incentives where excessive risk may be taken for personal gain. This means that we do not attract employees with an extreme appetite for risk.
REMUNERATION FOR 2009 The remuneration committee had already started a review of executive remuneration during 2008 prior to the announcement of the HBOS acquisition. This was in the light of concerns about the competitiveness of the package, which had led to the committee making long-term incentive awards of 375 per cent of salary in 2008, above the normal maximum of 300 per cent. The scope and context of this review was naturally altered by the acquisition of HBOS and by the rapidly evolving environment in the financial services sector.
The remuneration committee has considered the preliminary guidance from the FSA relating to good practice criteria, and has reviewed emerging practice in other banks within the sector both in the UK and overseas. Although more than half of our total incentive opportunity was already deferred, through our long-term incentive plan, we have decided that the annual incentive for executive directors should be deferred also. Consistent with the aim of ensuring that short-term financial results are only achievable sustainably, the committee has decided that the incentive will be deferred and released in tranches over a three year period. The deferral will be on the same basis as for senior staff with the first tranche being released in June 2011. The deferred incentive will be subject to 100 per cent claw back if the performance that generated the incentive is found to be unsustainable.
The remuneration committee believes that the structure of the incentive – in particular the use of risk-adjusted and non-financial measures – has been highly successful in promoting a long-term focus within the senior management team. Introducing this deferral element further enhances these aspects of the plan.
The current LTIP rules allow for awards to be made of up to 400 per cent of base salary. Under normal circumstances awards are made of 300 per cent of salary with the additional 100 per cent available for circumstances that the remuneration committee deems to be exceptional. In 2008, awards were made of 375 per cent of base salary to the CEO and two of the executive directors for retention purposes, and in light of data reviewed by the committee which showed total remuneration to be behind median both for the FTSE 20, and the other major UK banks.
Further information viewed by the committee through 2008 continued to show that total remuneration for the executive directors was materially behind the median of our peer groups, even before allowing for the increased responsibilities of running the combined bank and the magnitude of the task of integrating the two businesses.
ECONOMIC PROFIT (APPLyING TO AWARD OF 60 PER CENT OF SALARy, BEING HALF THE REGULAR LTIP AWARD)
Economic profit replaces relative total shareholder return within the LTIP. The committee is of the view that at the current time, with extreme market volatility and the level of disruption in our peer group, TSR is not a robust performance measure. Moreover, the committee is concerned that relative TSR measures may not have been supportive of sound risk management policies during economic upswings. Indeed, such a measure can encourage a ‘strategic herd mentality’, with banks encouraged to take on more risk in order to improve the prospects of significantly out-performing their peers. Economic profit, by measuring risk-adjusted performance with targets reflecting the Company’s specific risk appetite, is, in the view of the committee, a better incentive for sustainable performance.
These measures are distinct from the similarly named areas under the annual incentive plan. The annual incentive measures focus on excellence of performance in business as usual activities. The non-financial measures in the integration balanced scorecard are specific to the integration. There is a major change programme to be undertaken within HBOS, particularly in relation to systems and processes for measuring and managing risk. The integration balanced scorecard will be built around outperformance of this change agenda.
Independent non-executive directors who serve on the boards of subsidiary companies may also receive fees from the subsidiaries. The fees paid in 2008 to the current non-executive directors are shown in the table below: REMUNERATION FOR 2008 2008 ANNUAL INCENTIVE SCHEME
The maximum annual incentive opportunity is 200 per cent (225 per cent for Mr Daniels) of basic salary for the achievement of exceptional performance targets. The maximum payment under the corporate half of the annual incentive is only available if exceptional performance is achieved against the stretching corporate budget. An amount equal to 50 per cent of this element of the incentive is available on the achievement of the stretching corporate budget. Failure to achieve at least 90 per cent of the stretching budget would result in no payment under the corporate half of the incentive.
PENSIONS Executive directors are either entitled to participate in the Group’s defined benefit pension schemes (based on salary and length of service, with a maximum pension of two thirds of final salary), or the Group’s defined contribution scheme (under which their pension entitlement will be based upon both employer and employee contributions). The defined benefit schemes are closed to new entrants on recruitment.
EXTERNAL APPOINTMENTS The Group recognises that executive directors may be invited to become non-executive directors of other companies and that these appointments may broaden their knowledge and experience, to the benefit of the Group. Fees are normally retained by the individual directors as the post entails personal responsibility.
The non cash column includes amounts relating to the use of a company car, use of a company driver and private medical insurance. It also includes the value of any matching shares which are received under the terms of Shareplan, through which employees have the opportunity to purchase shares up to a maximum of £125 per month and receive matching shares on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share.
Mr Brown waived fees payable to him as a director and chairman of Lloyds TSB Group Pension Trust (No.1) Limited and Lloyds TSB Group Pension Trust (No.2) Limited for the period 1 January – 30 June 2008, which totalled £7,000 in 2008 (2007: £15,500 waived).
Column (d) is the equivalent transfer value, but calculated as at 31 December 2007 on the assumption that the director left service at that date.
Funds from this Sharesave option were repaid to Mr Fairey after he left the board.
Ms Dial resigned from the board on 18 April 2008 and left the Group on 30 June 2008.
None of the other directors at 31 December 2008 had options to acquire shares in Lloyds TSB Group plc or its subsidiaries.
The following table contains information on the performance conditions for executive options granted since 1998. The remuneration committee chose the relevant performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
March 2000 – March 2001 As for March 1998 – August 1999 except that there must have been growth in the earnings per share equal to the change in the retail price index plus three percentage points for each complete year of the relevant period.
Options granted in 2004 became exercisable as the performance condition was met on the re-test. The performance condition vested at 24 per cent for Mr Tate’s March option and at 14 per cent for all other options granted to executive directors during 2004.
Executives received a further award of ’performance shares’ on the basis of two performance shares for each bonus share. The receipt of the performance shares is dependent on the satisfaction of a TSR performance condition measured over three financial years of the Company.
The following table contains information on the performance conditions for performance shares. The remuneration committee chose the relevant performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
Whilst income tax was deducted from the deferred bonus before the conversion to bonus shares, where a match of performance shares is justified, these shares will be awarded as if income tax had not been deducted. This maintains the original design of the plan prior to the issue of guidance from HM Revenue & Customs in December 2004.
c) Mr Fairey’s LTIP awards will continue to vesting dates, but will be pro-rated depending on the number of months worked during each award. For the award made on 12 May 2006, this would be 30 months. For the award made on 8 March 2007, the half subject to the EPS performance condition would be over 18 months and the half subject to the TSR performance condition would be over 16 months.
Mr Tookey was granted an option under this plan to acquire 35,305 ordinary shares in Lloyds TSB Group plc. The option was not subject to any performance condition but would normally become exercisable only if he remains an employee, and has not given notice of resignation, on 19 April 2009.
The register of directors’ interests, which is open to inspection, contains full particulars of directors’ shareholdings and options to acquire shares in Lloyds Banking Group.
respecTive responsibiLiTies of direcTors and audiTors The directors’ responsibilities for preparing the annual report and the consolidated financial statements in accordance with applicable law and International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union are set out in the statement of directors’ responsibilities on page 73.
We report to you our opinion as to whether the consolidated financial statements give a true and fair view and whether the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation. We also report to you whether, in our opinion, the information given in the directors’ report is consistent with the consolidated financial statements. The information given in the directors’ report includes that specific information presented in the Overview and the Business Review that is cross referred from the principal activities, business review, future developments and financial risk management objectives and policies section of the directors’ report.
– the information given in the directors’ report is consistent with the consolidated financial statements.
Report of the independent auditors on the consolidated financial statements 96 consolidated financial statements 97
Trading and other liabilities at fair value through profit or loss 30 6,754 3,206
– transferred to income statement in respect of impairment – 102 – 102 – 102
Financial assets and liabilities are designated as at fair value through profit or loss on acquisition in the following circumstances: – When doing so results in more relevant information because either: – it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on different bases; or – the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, with management information also prepared on this basis.
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Refer to note 3 (Critical accounting estimates and judgements: Valuation of financial instruments) and note 49 (Financial risk management: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
The Group is permitted to transfer, at fair value at the date of 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 designated as available-for-sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. For assets transferred, gains or losses recognised in equity in respect of these assets as at the date of transfer are amortised to profit or loss over the remaining life of the asset using the effective interest method.
Securities sold subject to repurchase agreements (‘repos’) are recognised on the balance sheet where all of the risks and rewards are retained; the counterparty liability is included in deposits from banks or customer accounts, as appropriate. Securities purchased under agreements to resell (‘reverse repos’) are recorded as loans and advances to banks or customers, as appropriate. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method.
At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition, there is objective evidence that a financial asset or group of financial assets has become impaired.
Directly incremental commissions that vary with and are related to either securing new or renewing existing non-participating investment contracts are deferred; all other costs are recognised as expenses when incurred. This asset is subsequently amortised over the period of the provision of investment management services and is reviewed for impairment in circumstances where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written down immediately through expenses in the income statement.
The consolidated financial statements are presented in sterling, which is the Company’s functional currency.
Financial calendar 2009 195 3 criTicaL accounTing esTimaTes and JudgemenTs The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are discussed below.
The Group regularly reviews its loan portfolios to assess for impairment. Impairment allowances are established to recognise incurred impairment losses in its loan portfolios carried at amortised cost. In determining whether an impairment has occurred at the balance sheet date the Group considers whether there is any observable data indicating that there has been a measurable decrease in the estimated future cash flows or their timings; such observable data includes information as to whether there has been an adverse change in the payment status of borrowers or changes in economic conditions that correlate with defaults on loan repayment obligations. Where this is the case, the impairment loss is the difference between the carrying value of the loan and the present value of the estimated future cash flows discounted at the loan’s original effective interest rate.
The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Assumptions are made regarding the expected lifetime of scheme members based upon recent experience, however given the rate of advance in medical science and increasing levels of obesity, it is uncertain whether they will ultimately reflect actual experience. An increase of one year in the expected lifetime of scheme members would increase the overall deficit by approximately £318 million and the annual cost by approximately £22 million; a reduction of one year would reduce the overall deficit by approximately £323 million and the annual cost by approximately £24 million.
At 31 December 2008 the Group carried goodwill on its balance sheet totalling £2,256 million (2007: £2,358 million), substantially all of which relates to acquisitions made a number of years ago.
The valuation of the Group’s annuity business has been affected by the recent upheaval in the capital markets which has caused a significant widening in corporate bond spreads. Based on available market analysis, an element of this widening in corporate bond spreads has been assessed as arising from an increase in the illiquidity premium. Annuity contracts cannot be surrendered and have reasonably certain cash flows best matched by assets of equivalent maturity with similar liquidity characteristics. As a result, in 2008 the value of in-force business asset for annuity business has been calculated after taking into account an estimate of the market premium for illiquidity derived from market and other published sources using a portfolio of investment grade bonds with similar cash flow characteristics as the annuity liabilities. The effect of this has been to increase the value of in-force business by £842 million as at 31 December 2008 with a similar increase in profit before tax disclosed within other operating income. It is not practicable to estimate the effect of this change on the results of future periods.
The assumptions made to derive the discount rates and cash flows are inherently uncertain and changes could significantly affect the value attributed. The process for determining key assumptions that have been made at 31 December 2008 is detailed in notes 24 and 32.
Total income, net of insurance claims 5,876 392 (36) 356 4,132 (492) – 9,872
Other segment items: Movement in value of in-force business – – (325) (325) – – – (325)
Total income, net of insurance claims 5,492 257 781 1,038 4,182 (6) – 10,706
Total net (expense) income arising on assets held at fair value through profit or loss (6,821) 3,118
During 2007 the Group completed the sale of the business and assets of Lloyds TSB Bank plc’s company registration business, Lloyds TSB Registrars; the sale of Abbey Life Assurance Company Limited, a UK life operation which had been closed to new business since 2000; and the sale of The Dutton-Forshaw Group Limited, a medium-size car dealership. In addition, provision was made for payments under an indemnity given in relation to a business sold in an earlier year. The businesses sold in 2007 did not represent separate material lines of business and consequently they were not treated as discontinued operations.
In addition to the income statement current tax charge, a total of £674 million of current tax has been credited to equity (2007: a total of £131 million credit to equity); a debit of £1 million (2007: a credit of £3 million) in respect of share based payments, a credit of £584 million (2007: a credit of £103 million) in respect of foreign exchange differences and a net credit of £91 million (2007: a net credit of £25 million) in respect of the revaluation of available-for-sale financial assets.
Tax charge thereon at UK corporation tax rate of 28.5 per cent (2007: 30 per cent) (230) (1,200)
Equity shares: At 31 December 2008 £44,046 million (2007: £55,729 million) of trading and other financial assets at fair value through profit or loss had a contractual residual maturity of greater than one year.
17 derivaTive financiaL insTrumenTs The principal derivatives used by the Group are interest rate and exchange rate contracts; particular attention is paid to the liquidity of the markets and products in which the Group trades to ensure that there are no undue concentrations of activity and risk.
Derivatives designated as fair value hedges: Interest rate swaps (including swap options) 50,734 263 460
Derivatives designated as cash flow hedges: Derivatives designated as net investment hedges: Cross currency swaps 5,302 – 316
At 31 December 2008 £5,459 million (2007: £5,773 million) of loans and advances to banks had a contractual residual maturity of greater than one year.
The Group holds collateral with a fair value of £10,739 million (2007: £9,109 million), which it is permitted to sell or repledge, of which £5,492 million (2007: £8,482 million) was repledged or sold to third parties for periods not exceeding three months from the transfer.
During 2008 the Group’s Corporate Markets business wrote down the value of its structured investment vehicle (SIV) exposures by £95 million (2007: £22 million) and now has no residual exposure to SIV Capital Notes (2007: exposure of £78 million). Additionally, at 31 December 2008 the Group’s Corporate Markets business had a commercial paper back up liquidity facility totalling £22 million (2007: £370 million).
The Group holds collateral with a fair value of £1,736 million (2007: £1,975 million), which it is permitted to sell or repledge, of which £366 million (2007: £1,818 million) was repledged or sold to third parties for periods not exceeding three months from the transfer.
Recoveries of advances written off in previous years 2 133 2 137 – 137
Charge to the income statement 171 1,687 860 2,718 158 2,876 19 Loans and advances To cusTomers continued
The recoverable amount of Scottish Widows has been based on a value in use calculation. The calculation uses projections of future cash flows based upon budgets and plans approved by management covering a five-year period, and a discount rate of 12 per cent (gross of tax). The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. Cash flows beyond the five-year period have been extrapolated using a steady 3 per cent growth rate which does not exceed the longterm average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
The table below shows the range of resulting yields and other key assumptions at 31 December: Risk-free rate (value of in-force non-annuity business) 3.74 4.65
An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk and the With Profit Fund there are asymmetries in the range of potential outcomes for which an explicit allowance is made.
Further information about the effect of changes in key assumptions is given in note 32.
In addition, total future minimum sub-lease income of £102 million at 31 December 2008 (£113 million at 31 December 2007) is expected to be received under non-cancellable sub-leases of the Group’s premises.
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2008 was £6,517 million, which was £231 million lower than the balance sheet carrying value (2007: £3,131 million, which was £24 million higher than the balance sheet carrying value). At 31 December 2008 there was a cumulative £44 million decrease 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 TSB Bank plc, the issuing entity within the Group. Of the £44 million, £36 million arose in 2008 and £8 million arose in 2007.
At 31 December 2008 £16,120 million (2007: £18,604 million) of debt securities in issue had a contractual residual maturity of greater than one year.
Debt securities in issue at 31 December 2008 included £9,824 million (2007: £12,403 million) in respect of the securitisation of mortgages and £226 million (2007: £98 million) in respect of the securitisation of corporate and commercial banking loans (see note 19).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 32 LiabiLiTies arising from insurance conTracTs and parTicipaTing invesTmenT conTracTs continued
The process for determining the key assumptions for insurance contracts and participating investment contracts is set out below.
The guaranteed annuity option take-up rates are set with regard to the Group’s actual experience and make allowance for potential increases in takeup rates when the Guaranteed Annuity Options become more valuable to the policyholder.
Lapse rates, set with regard to the Group’s actual experience and with a margin for adverse deviation, are allowed for on some Non-Profit Fund contracts.
non-Life insurance aLL risks – gross £m £m £m £m £m £m accident year
The liability of £176 million shown in the above table excludes £7 million of unallocated claims handling expenses.
At 31 December 2008 £5,454 million (2007: £4,427 million) of other liabilities had a contractual residual maturity of greater than one year.
The Group’s obligations in respect of its defined benefit schemes are funded. The Group currently expects to pay contributions of at least £525 million to its defined benefit schemes in 2009.
Liability in the balance sheet 1,657 2,033 £m £m movements in the defined benefit obligation
The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 6.30 5.80
Life expectancy for member aged 60, on the valuation date: Life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 as at 31 December 2008 is assumed to live for, on average, 26.4 years for a male and 27.2 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
The expected return on scheme assets has been calculated using the following assumptions: Fixed interest gilts 4.5 4.6
Income statement (credit) charge: Due to change in UK corporation tax rate – (110)
Deferred tax assets of £252 million (2007: £33 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.
In addition, deferred tax assets have not been recognised in respect of Eligible Unrelieved Foreign Tax (EUFT) and other foreign tax credits carried forward as at 31 December 2008 of £60 million (2007: £104 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised. EUFT can be carried forward indefinitely.
Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s ability to meet its repayment obligations.
Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biennial basis and will normally run off over the period of under-recovery of the leases concerned, currently averaging five years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
Index to annual report 192 financial calendar 2009 195 40 subordinated liabilities note £m £m preferred securities 6.90% Perpetual Capital Securities (US$1,000 million) d, g 756 471 fixed/floating Rate non-Cumulative Callable Preference Shares callable 2015 (£600 million) a, b 584 593 fixed/floating Rate non-Cumulative Callable Preference Shares callable 2016 (US$1,000 million) a, c 824 515 6% non-cumulative Redeemable Preference Shares o – –
Euro Step-up non-Voting non-Cumulative Preferred Securities callable 2012 (€430 million) d, m 459 335 7.875% Perpetual Capital Securities (€500 million) d, f, p 472 –
6.35% Step-up Perpetual Capital Securities callable 2013 (€500 million) d, f, k 512 365
These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the period (2007: nil).
At 31 December 2008 £17,156 million (2007: £11,577 million) of subordinated liabilities had a contractual residual maturity of greater than one year.
h) In certain circumstances the interest payments on these securities can be deferred although in this case Scottish Widows plc cannot declare or pay a dividend until any deferred payments have been made.
l) In the event that these notes are not redeemed at the callable date, the coupon will be reset to a margin of 1.60 per cent over the five year Yen swap rate.
o) Since 2004, the Company has had in issue 400 6 per cent non-cumulative preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a fixed rate non-cumulative preferential dividend of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company.
Changes in the issued preference share capital of the Group during January 2009 are discussed in note 52.
Sterling: £m £m 6,911 million ordinary shares of 25p each 1,728 1,728 79 million Limited voting ordinary shares of 25p each 20 20 175 million Preference shares of 25p each 44 44
US dollars: us$m US$m 160 million Preference shares of 25 cents each 40 40
In addition, the Company has authority to purchase, in the market, (i) the £1,000,000,000 fixed to floating non-cumulative callable preference shares issued by the Company to Hm Treasury on 15 January 2009 pursuant to the preference share subscription agreement entered into with effect from 13 october 2008 by the Company and Hm Treasury and (ii) the preference shares issued by the Company in exchange for the £3,000,000,000 fixed to floating non-cumulative callable preference shares issued by HBoS plc to Hm Treasury on 15 January 2009 pursuant to the preference share subscription agreement entered into with effect from 13 october 2008 by HBoS plc and Hm Treasury (together with the £1,000,000,000 Hm Treasury preference shares, the Preference Shares) provided that (a) the maximum number of Preference Shares which may be purchased is 4,000,000 (b) the minimum price which may be paid for each Preference Share is 25 pence (exclusive of expenses) (c) the maximum price which may be paid for each Preference Share is an amount equal to 120 per cent of the liquidation preference of the Preference Share and (d) the authority expires 18 months after 19 november 2008 (except in relation to the purchase of Preference Shares the contracts for which are concluded before such expiry and which are executed wholly or partly after such expiry) unless such authority is renewed prior to that time.
limited voting ordinary shares The limited voting ordinary shares are held by the Lloyds TSB foundations (the foundations). The holders of the limited voting ordinary shares, who held 1.3 per cent of the total share capital as at 31 December 2008, are entitled to receive copies of every circular or other document sent out by the Company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary shares in all respects from the date of conversion. Lloyds Banking Group plc has entered into deeds of covenant with the foundations, under the terms of which the Company makes annual donations to the foundations equal, in total, to 1 per cent of the Group’s pre-tax profits (after certain adjustments) averaged over three years. The deeds of covenant can be cancelled by the Company at nine years’ notice. This donation is payable on or before the last day of february in each year (the payment date). In the event of conversion of the limited voting ordinary shares, the foundations shall be entitled to receive a donation, on the same basis as set out above, on the payment date following conversion.
Index to annual report 192 financial calendar 2009 195 43 other reserves continued £m £m
Currency translation differences arising in the year 2,533 257 foreign currency losses on net investment hedges (3,310) (342)
Bank of new York nominees Limited have waived the right to all dividends on Lloyds Banking Group plc shares that they hold (holding at 31 December 2008 and at 31 December 2007: 10 shares).
In addition, the trustees of the following holdings of Lloyds Banking Group plc shares in relation to employee share schemes retain the right to receive dividends but chose to waive their entitlement to the dividends on those shares as indicated: the Lloyds TSB Group Shareplan (holding at 31 December 2008: 972,151 shares, at 31 December 2007: 931,478 shares, waived right to all dividends), the Lloyds TSB Group Employee Share ownership Trust (holding at 31 December 2008: 1,442,116 shares, at 31 December 2007: 1,935,141 shares, waived right to all dividends), Lloyds TSB Group Holdings (Jersey) Limited (holding at 31 December 2008 and 31 December 2007: 41,801 shares, waived right to all but a nominal amount of 1 penny in total) and the Lloyds TSB Qualifying Employee Share ownership Trust (holding at 31 December 2008 and 31 December 2007: 1,364 shares, waived right to all but a nominal amount of 1 penny in total).
Executive and SAYE schemes: options granted in the year 8 6 options granted in prior years 4 24
march 2000 – march 2001 As for march 1998 – August 1999 except that there must have been growth in the earnings per share equal to the change in the Retail Price Index plus three percentage points for each complete year of the relevant period.
To meet the performance conditions, the Group’s ranking against the comparator group must be at least ninth. The full grant of options will only become exercisable if the Group is ranked first. A performance multiplier (of between nil and 100 per cent) will be applied below this level to calculate the number of shares in respect of which options granted to executive directors will become exercisable, and will be calculated on a sliding scale. If Lloyds Banking Group plc is ranked below median the options will not be exercisable.
options granted to senior executives other than executive directors are not so highly leveraged and, as a result, different performance multipliers are applied to their options. for the majority of executives, options are granted with the performance condition but no performance multiplier.
options granted in 2004 became exercisable as the performance condition was met on the re-test. The performance condition vested at 14 per cent for executive directors, 24 per cent for managing directors, and 100 per cent for all other executives.
options granted in 2005 became exercisable as the performance condition was met when tested. The performance condition vested at 82.5 per cent for all options granted.
The weighted average share price at the time that the options were exercised during 2008 was 453.42 pence (2007: 574.39 pence). The weighted average remaining contractual life of options outstanding at the end of the year was 5.1 years (2006: 6.2 years).
Eligible employees may enter into contracts through the Save-As-You-Earn (SAYE) schemes to save up to £250 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 price equal to 80 per cent of the market price at the date the options were granted. Grants in periods up to 31 December 2001 also had options exercising after seven years.
movements in the number of share options outstanding under the SAYE schemes are set out below: weighted average Weighted average number of exercise price number of exercise price options (pence) options (pence)
The plan was adopted in December 2003 and under the plan share options may be granted to senior employees. options granted to date under this scheme were granted specifically to facilitate recruitment. options granted under this plan are not subject to any performance conditions.
(ii) for the other 50 per cent of the award (the TSR Award) – the performance condition is as described for may 2006, except that the comparator group comprises of 13 companies, with the relevant performance period commencing on 6 march 2008 (the date of the first award) and ending on 5 march 2011.
number of shares number of shares outstanding at 1 January 13,209,081 5,788,108 outstanding at 31 December 22,237,282 13,209,081
The weighted average share price at the date the shares were released during 2008 was 446.13 pence.
Weighted Weighted Weighted Weighted Weighted Weighted average average average average average average exercise price remaining life number of exercise price remaining life number of exercise price remaining life number of (pence) (years) options (pence) (years) options (pence) (years) options
The number of shares awarded relating to matching shares in 2008 was 4,475,264 (2007: 2,073,018), with an average fair value of £2.56 (2007: £5.49), based on market prices at the date of award.
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued
At 31 December 2008, the Group did not provide any guarantees in respect of key management personnel (2007: £6,154 in respect of one director).
Parent company financial statements 183 notes to the parent company financial statements 186 shareholder information
Index to annual report 192 financial calendar 2009 195 relating to Iran, Sudan and Libya which the Group conducted during the relevant period. The provision made by the Group in respect of this matter during 2008 was hedged into US dollars at the time and fully covers the settlement amount. The Group is continuing discussions with ofAC regarding the terms of the resolution of its investigation. ofAC has confirmed to the Group that the amount paid to the US Department of Justice and the new York County District Attorney’s office will be credited towards satisfying any penalty it imposes. The Group does not currently believe that any additional liability requiring provision will arise following the conclusion of the discussions with ofAC. The Group does not anticipate any further enforcement actions as to these issues.
In addition, during the ordinary course of business the Group is subject to threatened or actual legal proceedings. All such material cases are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed properly to assess the merits of the case. no provisions are held against such cases; however the Group does not currently expect the final outcome of these cases to have a material adverse effect on its financial position.
The fSCS fulfils its obligations by raising management expenses levies, which include amounts to cover the interest on its borrowings, and compensation levies on the industry, each deposit-taking institution contributing in proportion to its share of total protected deposits.
Lloyds Banking Group’s maximum exposure to loss is represented by the contractual nominal amount detailed in the table below. Consideration has not been taken of any possible recoveries from customers for payments made in respect of such guarantees under recourse provisions or from collateral held.
Acceptances and endorsements 49 40 other: other items serving as direct credit substitutes 1,870 1,095
Documentary credits and other short-term trade-related transactions 319 306 forward asset purchases and forward deposits placed 613 463
Included in commitments to lend above are not-yet-syndicated leveraged loan underwriting commitments which amounted to £931 million (2007: £1,158 million). All of the underlying assets are performing satisfactorily.
Index to annual report 192 financial calendar 2009 195 49 finanCial risK management As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.
Cash and balances at central banks – – – – – 5,008 – 5,008
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 33,792 33,792
Liabilities arising from non-participating investment contracts – – – – – – 14,243 14,243
In respect of the £2,993 million of assets transferred with effect from 1 July 2008, a loss of £172 million was recognised in the income statement for the six months to 30 June 2008 (year to 31 December 2007: £132 million) while they were classified as held for trading. If the assets had not been transferred and had been kept as held for trading, a loss of £347 million would have been recognised in the income statement for the six months to 31 December 2008 within net trading income.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using cross currency swaps. At 31 December 2008 the aggregate notional principal of these cross currency swaps was £6,318 million (2007: £5,302 million) with a net fair value liability of £2,413 million (2007: liability of £316 million) (see note 17) and they were designated on an after-tax basis as hedges of net investments in foreign operations. In 2008, ineffectiveness of £14 million before tax and £10 million after tax (2007: nil) was recognised in the income statement arising from net investment hedges.
Trading and other financial assets at fair value through profit or loss 21,790 26,165
financial guarantees – these represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards.
loans and advances designated loans and advances to customers at fair value loans and retail – retail – through advances mortgages other wholesale total profit or loss to banks £m £m £m £m £m £m neither past due nor impaired 110,148 33,571 89,208 232,927 608 40,741
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.
Total held as trading assets 114 187 38 68 87 80 574 other assets held at fair value through profit or loss: other public sector securities – – – – – 18 18
Bank and building society certificates of deposit 96 337 – – – – 433
Bank and building society certificates of deposit – 1,683 125 – 15 2 1,825
Liabilities arising from non-participating investment contracts 14,243 – – – – 14,243 as at 31 december 2007
market standard consensus pricing services aggregate price and other market data inputs from leading participants in the relevant markets and provide average mid-level outputs adjusted to exclude prices that are clearly out of line with other prices observed; these levels do not represent binding quotes.
At 31 December 2008, the Group had a credit valuation reserve on its derivative positions that is valued in part using assumptions around credit spreads and recovery risks. The effect of using reasonably possible alternative adverse combinations of assumptions for these risks would reduce net trading income by up to £70 million.
The fair values of financial instruments quoted in active markets are based on quoted prices. The fair values of financial instruments that are not quoted in active markets are determined using valuation techniques including cash flow models which, to the extent practicable, use observable market inputs such as interest rate yield curves, equities and commodities prices, option volatilities and currency rates that are either directly observable or are implied from instrument prices.
Carrying value Carrying value fair value fair value £m £m £m £m financial assets
Share capital (including share premium account): Issue of share capital: Private placement 760 –
Payments to former members of Scottish Widows fund and Life Assurance Society acquired during 2000 19 8
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued 51 future aCCounting developments The following pronouncements will be relevant to the Group but were not effective at 31 December 2008 and have not been applied in preparing these financial statements. The full impact of these accounting changes is being assessed by the Group, however, the initial view is that none of these pronouncements are expected to cause any material adjustments to reported numbers in the financial statements.
Addresses accounting by entities who grant customer loyalty award credits to customers as part of sales transactions and which can be redeemed in the future for free or discounted goods or services.
Provides guidance on accounting for hedges of net investments in foreign operations in an entity’s consolidated financial statements.
Amendment to IAS 27 Consolidated and Separate financial Statements – Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate
IfRS 3 Business Combinations1, 2 The revised standard continues to apply the acquisition method to business combinations, however, all payments to purchase a business are to be recorded at fair value at the acquisition date, some contingent payments are subsequently remeasured at fair value through income, goodwill may be calculated based on the parent’s share of net assets or it may include goodwill related to the minority interest, and all transaction costs are expensed.
Subject to EU endorsement, the Group has not yet made a final decision as to whether it will apply these pronouncements in the 2009 financial statements.
on 19 January 2009, the Company issued US$1,250,000,000 7.875 per cent non-cumulative callable preference shares and e500,000,000 7.875 per cent non-cumulative callable preference shares.
Because of the limited time available between the acquisition and the approval of these financial statements, the Group is still in the process of establishing the fair value of the assets and liabilities acquired. The audited net assets of HBoS at 31 December 2008 as shown in the accounts were £13,499 million.
Lloyds Banking Group Annual Report and Accounts 2008 to the members of lloyds banKing group plC We have audited the parent company financial statements of Lloyds Banking Group plc for the year ended 31 December 2008 which comprise the parent company balance sheet, the parent company statement of changes in equity, the parent company cash flow statement and the related notes. These parent company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the directors’ remuneration report on pages 74 to 95 that is described as having been audited.
Capital and reserves: Share premium account 4 2,096 1,298 total equity 5,756 4,665 non-current liabilities: Debt securities in issue 7 – 50
Derivative financial instruments – 29 total liabilities 5,761 4,230 total equity and liabilities 11,517 8,895
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE PAREnT ComPAnY fInAnCIAL STATEmEnTS
4 share Capital and share premium Details of the Company’s share capital and share premium account are as set out in notes 41 and 42 to the consolidated financial statements.
undated subordinated liabilities 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million)* 497 497 dated subordinated liabilities
further information regarding the fixed/floating rate non-cumulative callable preference shares can be found in note 40 to the consolidated financial statements.
7 debt seCurities in issue These comprise the US$100 million Thirteen-month Extendible Short-Term notes issued by the Company in may 2007 and the US$3,750 million Thirteen-month Extendible Short-Term notes issued by the Company in July 2008.
In addition the parent company carried out all of its banking activities through its subsidiary, Lloyds TSB Bank plc (the Bank). At 31 December 2008, the parent company held deposits of £1,201 million with the Bank (2007: £58 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. In addition, at 31 December 2008 the parent company had interest rate and currency swaps with the Bank with an aggregate notional principal amount of £4,567 million and a net positive fair value of £1,297 million (2007: notional principal amount of £4,032 million and a net positive fair value of £140 million), of which contracts with an aggregate notional principal amount of £1,870 million and a net positive fair value of £501 million (2007: notional principal amount of £4,032 million and a net positive fair value of £140 million) were designated as fair value hedges to manage the Company’s issuance of subordinated liabilities and debt securities in issue.
derivatives designated as held for hedging instruments, held trading at fair held at at fair value through value through loans and amortised profit or loss profit or loss receivables cost total £m £m £m £m £m as at 31 december 2008 financial assets: Cash and cash equivalents – – – 1,201 1,201
The Company is exposed to interest rate risk and currency risk on its debt securities in issue and its subordinated debt.
The majority of the Company’s credit risk arises from amounts due from its wholly owned subsidiary, Lloyds TSB Bank plc, and subsidiaries of that company.
Lloyds Banking Group Annual Report and Accounts 2008 9 finanCial instruments continued noTES To THE PAREnT ComPAnY fInAnCIAL STATEmEnTS continued liquidity risK
1 month months months years years total £m £m £m £m £m £m as at 31 december 2008
Debt securities in issue 75 12 2,601 – – 2,688 as at 31 december 2007
Carrying Carrying fair fair value value value value £m £m £m £m financial assets: Cash and cash equivalents 1,201 58 1,201 58
Amounts due from subsidiaries 216 92 216 92 financial liabilities: Derivative financial instruments – 29 – 29
In addition to listings in the financial pages of the press, the latest price of Lloyds Banking Group shares on the London Stock Exchange can be obtained by telephoning 09058 890 190. Visit www.londonstockexchange.com for details.
A full range of dealing services is available as follows: – Internet dealing. Log on to www.lloydstsbsharedealing.com – Telephone dealing. Call 0845 606 0560 – Internet and telephone dealing services are available between 8.00am and 4.30pm, monday to friday.
for details contact: The Bank of new York mellon Shareowner Services, Po Box 358516, Pittsburgh, Pennsylvania 15252-8516. Telephone: 877-353-1154 (US toll free), international callers: +1 201-680-6825. Alternatively visit www.bnymellon.com or email shrrelations@bnymellon.com individual savings aCCounts (isas)
The Company provides a facility for investing in Lloyds Banking Group shares through an ISA. for details contact: Retail Investor operations, Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex Bn99 6DA. Telephone 0871 384 2244.
Daytime calls monday to friday from BT landlines to 0870 numbers will cost no more than 6p a minute plus an 8p connection fee. Calls to 09058, 0871 and 0845 numbers are charged at 55p, 8p and 5p per minute, respectively, from a BT landline. The price of calls from mobiles and other networks may vary. The call prices we have quoted were correct in february 2009.
The board and its committees 70 group Chief exeCutive’s q&a 6 group Chief exeCutive’s review 4 held at fair value through profit or loss
Henry Duncan House 120 George Street Edinburgh EH2 4LH Registered in Scotland no 95000 internet www.lloydsbankinggroup.com registrar
Equiniti Limited Aspect House Spencer Road Lancing West Sussex Bn99 6DA Telephone 0871 384 2990 Textphone 0871 384 2255 overseas +44 (0)121 415 7066 www.equiniti.com
Mixed Sources Product group from well-managed forests, controlled sources and recycled wood or fiber