Our people A summary of our key people initiatives and how we are recruiting, retaining and rewarding our most valuable resource.
Retail operates the largest retail bank in the UK and is the leading provider of current accounts, savings, personal loans, credit cards and mortgages. It serves over 30 million customers through one of the largest branch and fee free ATM networks in the UK. Retail is also a major general insurance and bancassurance distributor, offering a wide range of long-term savings, investment and general insurance products.
The Wholesale division serves in excess of a million businesses, ranging from start-ups and small enterprises to global corporations, with a range of propositions fully segmented according to customer need. Key product markets: Corporate Banking Services
PRESENTATION OF INFORMATION In order to reflect the impact of the acquisition of HBOS, provide more relevant and meaningful comparatives and better present the underlying business performance, the results of the Group and divisions are presented on a combined businesses basis. The key principles adopted in the preparation of the combined businesses basis of reporting are described below.
A full reconciliation of the combined businesses basis to the statutory basis is given in note 4 on page 170. Unless otherwise stated, the commentaries on pages 13 to 55 are on a combined businesses basis.
Loss attributable to equity shareholders was £320 million; equivalent to a loss per share of 0.5 pence
Continued active support for the UK’s economic recovery by providing £30 billion of gross mortgage lending (including remortgages) and £49 billion of committed gross lending to businesses, of which £11 billion was for SMEs
Capital position significantly improved with core tier 1 ratio increased to 10.2 per cent
Excellent progress against term funding objectives with £50 billion of wholesale term issuance in the year £61 billion reduction in liquidity support from government and central bank facilities
OUR CORPORATE STRATEGY The Group’s business model is focused on the development of customer relationships, which are central to the strategy. We are constantly striving to build deep, lasting customer relationships, that will create value for our customers and subsequently value for us as a business. Customer leadership driven by superior customer insight, tailored products, better service and relationship focus, supported by industry leading efficiency and effectiveness and a prudent ‘through the cycle’ approach to risk is core to our strategy. It is this that will enable us to deliver on our vision of being recognised as the best financial services company in the UK by customers, colleagues and shareholders.
The main focus for the Group remains the financial services markets in the UK and our strategic position was strengthened through the acquisition of HBOS in January 2009. We are a well diversified UK financial services group and the largest retail financial services provider in the UK. We have leading positions in many of the markets in which we participate, a comprehensive distribution capability, well recognised brands and a large customer base. We continue to invest in products and services, systems and training that combined offer unparalleled choice and service to our customers.
– The Group aspires to have one of the lowest cost to income ratios amongst UK financial institutions and further improving our processing efficiency and effectiveness will remain a priority. The effective integration of the HBOS business and the anticipated synergies arising from the acquisition will be key to further improving our efficiency.
We previously outlined our strategy to reduce non relationship assets, including business which is outside our current risk appetite by some £200 billion. Excellent progress continues to be made against this target with a £105 billion reduction achieved to date.
Customer relationships are key to our strategy and important for all our businesses. The significant differences across the divisions/businesses means financial and non-financial strategic indicators for the development of customer relationships are tracked at a divisional level and commentary is included in the specific divisional commentaries.
My second annual statement as Chairman of Lloyds Banking Group comes to you at the end of another challenging year, a year in which we have turned the corner to profitability. In doing so, we made substantial progress towards creating a strong and stable bank, one better able to serve our customers. Only by focusing on their needs and offering them products and services that address those needs, can we expect to be successful and deliver benefit to you our shareholders and to our stakeholders at large.
The level of industry regulation and its speed of change has never been greater. Shareholders will be aware of a number of strategic initiatives which are likely to change the shape of our industry, including the changes to capital requirements arising from Basel III and the fundamental changes to the regulatory environment in the UK, to highlight just a couple. Robust and stable regulation will be an important component in rebuilding confidence and trust and creating a healthy and sound financial system. However, we need to ensure that banks are allowed to fulfil their core purpose in delivering a smooth flow of credit to the economy. That means meeting banks’ obligations to businesses, by helping them to invest, expand, export, innovate, up-skill their workforce, win new contracts and diversify their business models. For individuals, it means supporting their financial needs over their lifetime.
Through the financial services we provide to our customers and the support we give to the businesses that people work for, Lloyds Banking Group plays a role in the lives of nearly everyone in the UK.
Following the recapitalisation of the banking sector, HM Treasury now holds approximately 40.6 per cent of the equity capital of the Group. We are grateful and appreciative for the valuable support we have received from Government and through it the taxpayer, but our objective remains for the Group over time to operate as a wholly privately owned selfsupporting commercial enterprise.
We are delighted that these three outstanding individuals have agreed to contribute their judgement and varied expertise to our Board. On a personal front I am also pleased that we have expanded the proportion of women on the Board and I expect that process to continue.
The successful execution of our strategy demands from us focus on core markets, on customer engagement, on cost leadership, on capital efficiency and on a prudent risk and funding profile. Carried out well these attributes should enable the Group to deliver earnings growth and shareholder value whilst achieving our aim of becoming recognised as the best financial services company in the UK.
In addition, we substantially exceeded our guidance for term wholesale funding issuance, achieving £50 billion of issuance in the year. We also continued to broaden the range of our funding sources, and maintained the proportion of our wholesale funding with a maturity of more than one year at 50 per cent.
Information on key areas such as when the Government may reduce their holding, how the relationship with UKFI operates and the impact of the holding on our strategy is outlined below.
The timing of any share disposal will be at the Government’s discretion, acting on the advice of UKFI.
– An asset reduction programme to achieve a £181 billion reduction in a specified pool of end 2008 assets by 31 December 2014; and
– Behavioural commitments, including commitments; not to make certain acquisitions for approximately three to four years; and not to make discretionary payments of coupons or to exercise voluntary call options on hybrid securities from 31 January 2010 until 31 January 2012, which will also prevent the Group from paying dividends on its ordinary shares for the same duration.
During 2010 the Group continued its policy of actively supporting the UK’s economic recovery through gross new lending to our mortgage and business customers.
We believe the Group’s ‘through the cycle’ relationship based strategy is consistent with the aims of the Commission but at this time it is not possible to gauge the impact of the review on the Group. We have cooperated fully with the ICB to date and are expecting their ‘options paper’, which will set out their initial thoughts on potential reform, during April 2011. Following its publication, there will be a further period of consultation during which the Group will continue to be at the forefront of the debate with the ICB.
We have now completed the second year of our three year integration programme and remain on target to deliver annualised cost savings from synergies and other operating efficiencies of £2 billion by the end of 2011. Substantial wide-ranging progress has been made during 2010, including: Rollout of the Lloyds TSB branch counter system and processes to the Halifax and Bank of Scotland branches – completes March 2011.
Bank of Scotland and Lloyds TSB wealth management functions brought together to form one wealth management team.
Procurement benefits of £236 million achieved in year. Over 90 per cent of Group expenditure consolidated within our top 1,000 suppliers.
79 non-branch properties exited, bringing the total to 162 since the start of the programme.
Businesses also continue to reduce their indebtedness. Non-financial corporations shrunk their borrowings from banks and building societies by 3.9 per cent in 2010 after a 2.2 per cent reduction in 2009. Rising profits and weak investment spending boosted deposit growth in the latter part of 2009 and the first half of 2010, but deposit growth has since weakened to 1.6 per cent over 2010 as a whole, after 4.5 per cent in 2009.
Loss attributable to equity shareholders was £320 million (2009: profit of £2,827 million); equivalent to a loss per share of 0.5 pence (2009: earnings per share of 7.5 pence), after a charge for taxation of £539 million (2009: credit of £1,911 million) and a charge for profit attributable to non-controlling interests of £62 million (2009: £126 million).
Outlook – strong medium-term prospects Given the flexibility and capacity we have for core business growth, we continue to believe that the Group has strong medium-term prospects, notwithstanding the headwinds that we face in 2011. We give detailed comments on our prospects in the following sections.
The present value of new business premiums in our life, pensions and investments businesses decreased by 20 per cent, largely reflecting the focus on improving the profitability of the product set and the withdrawal of certain HBOS legacy products with lower returns. However, as a result of the repositioning of the product set, the benefits of cost savings and a reduction in initial commission on OEICs in 2010, UK new business profit increased by £135 million to £267 million. This improved performance shows through the Insurance division’s UK margins on an EEV basis increasing to 3.7 per cent in 2010, compared to 2.6 per cent in 2009. General Insurance delivered a robust performance after taking account of the impact of the 2010 freeze events and the Group’s decision to cease writing new payment protection business during the year.
Over time, however, we continue to target core businesses income growth of between 6 and 7 per cent per year and believe that our margin is likely to return to more than 2.5 per cent in the medium-term (approximately 2014) reflecting the effect of modest further improvements in asset pricing, higher liability margins facilitated by higher base rates, and greater stability in wholesale funding markets. We also anticipate reducing our wholesale funding requirements over this period. This margin outlook reflects, inter alia, our core economic assumptions for the medium-term, including base rates increasing to 3.75 per cent by the end of this period and no deterioration in consumer spending, the Group’s asset reduction programme, the assumed costs of refinancing as wholesale funding matures, and a narrowing of wholesale market credit spreads over the medium-term. At the same time however, it is not possible to predict what effect current regulatory discussions could have on funding costs and therefore margin.
The Group achieved a significant reduction in the impairment charge in 2010, in both the core and non-core businesses. The impairment charge of £13,181 million was 45 per cent lower than the £23,988 million charge in 2009, with deterioration in Ireland more than offset by substantial improvements elsewhere in the Group, particularly in the Wholesale division.
The decrease in this period generally reflects the significant actions which were taken in the first half of 2009 on the heritage HBOS portfolios (including the identification of large impairments post the HBOS acquisition, especially in corporate real estate, real estate related and Corporate (UK and US) portfolios), together with the stabilising UK and US economic environment in 2010, a low interest rate environment helping to maintain defaults at a lower level and a number of write backs due to asset disposals.
Irish market would affect the timing and level of value realisation from this portfolio.
At the year end, compared to 30 June 2010, given the deterioration in market conditions noted above, a further approximately 10 per cent of the £27 billion Irish portfolio had become impaired, and we have increased the level of provisions against the portfolio, increasing the impairment charge relating to Irish exposures for the full year 2010 to £4.3 billion on a combined businesses basis. This has resulted in an increase in provisions as a percentage of impaired Irish loans to 53.7 per cent at the 2010 year end, in line with our expectations in our statement of 17 December 2010.
Strong capital ratios Our capital ratios improved significantly during the year, primarily reflecting a reduction in risk weighted assets, and balance sheet liability management transactions. Total capital also increased through further subordinated debt issuance and through a repatriation of capital held within our insurance subsidiaries, although this increase was partially reduced by a revised approach to private equity investments which have now been deducted from total capital.
Risk weighted assets reduced by 18 per cent to £406.4 billion, driven by strong management of risk, reduced asset levels and tighter risk criteria for new business. Reductions were also achieved through changes to our credit risk measurement methodology in certain portfolios, including migrating a number of our Wholesale portfolios, which had previously been modelled on an Advanced Internal Ratings-Based Approach, to the Foundation Internal Ratings-Based Approach (FIRB) which will facilitate integration work.
Effects of Basel III on capital During 2010 the Basel Committee on Banking Supervision has substantially refined the details of the so called ‘Basel III’ reforms for an enhanced global capital accord. These include increased minimum levels of, and quality standards for, capital, increased risk weighting of assets, and the introduction of a minimum leverage ratio, as well as the timing and transitional arrangements for implementation. The final details are still to be clarified, particularly as the reforms are implemented within the European and UK regulations, which may include a countercyclical buffer, requiring higher levels of capital to be held at certain points of the economic cycle, and higher capital requirements for systemically important financial institutions.
One of the key reforms impacting the Group arises from a revised treatment of the capital held within our insurance subsidiaries. During 2010, following a strategic review of our capital structure, £0.8 billion of equity was exchanged for subordinated debt within the insurance group and £1.5 billion was repatriated from the insurance group. Whilst this has no overall effect on the Group’s core tier 1 capital under current Basel regulations, it does deliver a material core tier 1 capital benefit under the proposed Basel III reforms.
Outlook – capital resources The effect of the Basel III reforms is uncertain as much will depend on business performance and mitigating actions that can be completed, even before the transition period comes in to effect. Analysis suggests that with no mitigating actions the reforms will reduce the Group’s core tier 1 ratio by approximately 1.2 per cent in 2013, although lower risk weighted assets are expected from the planned reduction in the non-core balance sheet. The additional impact in 2014 of deducting the equity investment in insurance in excess of 10 per cent, transitioning in at 20 per cent per annum from 1 January 2014, would be around 0.3 per cent were the Group to take no further action to mitigate this.
The Group is confident that it is well positioned to maintain a strong capital position, meeting all regulatory requirements as currently formulated.
The balance sheet reduction over time is providing the Group with increased optionality and flexibility from the resultant releases in both funding and capital. Together with initiatives to increase customer deposits in line with market growth, we expect to reduce the proportion of the Group’s funding that is derived from wholesale markets and eliminate our use of government and central bank facilities by the end of 2012. This will provide capacity for core business growth in line with our relationship strategy. In 2011, however, we expect to see a continuation in the trend of customer deleveraging and generally subdued demand for new lending.
As previously guided, over the next couple of years the Group expects its public capital and senior funding issuance to be £20 billion to £25 billion per annum. We made excellent progress in 2010 on our term funding issuance plans, achieving £30 billion of publicly placed term issuance in the year. In addition, the Group issued a further £20 billion of term funding during the year via a series of privately placed funding transactions, a level which we do not expect to repeat in 2011. The Group continues to benefit from a diversity of funding sources. For example, during the year, we established a new funding programme in the US with our SEC Registered Shelf, issued inaugural Japanese Yen Samurai, Swiss Franc and Canadian Dollar bonds, and publicly launched the Lloyds TSB Bank plc Covered Bond Programme. We continue to look for opportunities to diversify our funding sources.
We welcome the proposals on minimum standards for funding liquidity published by the Basel Committee on Banking Supervision in December 2010. The introduction of the Liquidity Coverage Ratio and Net Stable Funding Ratio will raise the resilience of banks to potential liquidity shocks and provide the basis for a harmonised approach to liquidity risk management. These proposals are subject to ongoing refinement and have not yet been enacted into UK and European law. However, the Group monitors compliance against these internal metrics, and as at 31 December 2010, the Group’s Liquidity Coverage Ratio was estimated at 71 per cent and the Net Stable Funding Ratio at 88 per cent. The actions already in place to reduce the size of the balance sheet are expected to ensure compliance with the future minimum standards, which are expected to be 100 per cent for both ratios, by their respective effective dates.
The Group made excellent progress on reducing its liquidity support from governmental and central bank sources, achieving reductions of £60.6 billion in 2010 leaving £96.6 billion outstanding at the year end. The Group currently receives no liquidity support from either the US Federal Reserve or the European Central Bank. The drawings from the UK Special Liquidity Scheme facilities and the issuance under the UK Credit Guarantee Scheme have various maturity dates, the last of which is in the fourth quarter of 2012. The Group is confident that all maturities can be met, and a further £13 billion of government and central bank facilities have been repaid since the year end.
Outlook – liquidity and funding We expect the combination of continued increases in customer deposits and reductions in assets (primarily from non-core asset reduction plans) over the next three years to deliver further improvements in the Group’s liquidity and funding position. As a consequence, we expect steady improvement in the overall loan to deposit ratio (which is expected to fall to below 140 per cent within three years), a reduction in wholesale funding requirements and therefore levels of ongoing term issuance, and liquidity levels to be maintained in excess of regulatory requirements.
The tax charge for the year to 31 December 2010 was £539 million. This reflects a higher effective tax rate than the UK statutory rate primarily due to the effect of partially unrelieved losses in Ireland and Australia, policyholder tax, and the effect on deferred tax of the reduction in the UK corporation tax rate from 28 per cent to 27 per cent with effect from 1 April 2011.
Profit before tax includes the unwind of £3,118 million of acquisition related fair value adjustments, of which £2,229 million relates to impairments. This is ahead of our previous expectation of approximately £2,500 million due to the acceleration of amounts held against the Group’s securities portfolios as expectations of future credit losses have improved. In 2011, we expect a further benefit of some £2 billion broadly in line with previous guidance. Thereafter, over the medium term, declining annual benefits are expected to accrue.
We continue to believe that a slow recovery over the next couple of years remains the most likely outcome for the UK economy. Our central planning scenario reflects a number of economic assumptions including that GDP growth will recover to approximately 1.9 per cent in 2011 with a further increase to 2.4 per cent in 2012. We expect a decrease of 2 per cent in UK house prices in 2011, with a 2 per cent increase in 2012. We also expect a decrease of 2 per cent in commercial property prices in 2011 and a recovery of 3 per cent in 2012. Finally, we believe that unemployment will peak at 8.1 per cent in 2011.
The net credit in 2010 of £3,118 million is mainly attributable to a reduction in the impairment charge of £2,229 million and an increase in other income of £1,195 million, as losses reflected in the acquisition balance sheet valuations of the lending and securities portfolios have been incurred, together with other hedging adjustments. This has been partly offset by a charge to net interest income of £301 million. The impact of the fair value unwind on net interest income is lower than in 2009 because the liability management exercises undertaken by the Group have had the effect of crystallising a proportion of the gains reflected in the opening balance sheet valuation of HBOS’s own debt; there has also been a benefit from revised expectations of future impairment losses likely to emerge from certain retail lending portfolios.
The calculation basis for banking net interest margins is set out on page 54.
PROFILE Retail operates the largest retail bank in the UK and is the leading provider of current accounts, savings, personal loans, credit cards and mortgages. With its strong stable of brands including Lloyds TSB, Halifax, Bank of Scotland and Cheltenham & Gloucester, it serves over 30 million customers through one of the largest branch and fee free ATM networks in the UK.
Retail is focused on effectively meeting the needs of its customers. The division has over 22 million current account customers and provides social banking to over four million people through basic banking or social banking accounts. It is also the largest provider of personal loans in the UK, as well as being the UK’s leading credit card issuer. Retail provides over one in five new residential mortgages making it one of the leading UK mortgage lenders and provided over 50,000 mortgages to help first time buyers in 2010. Retail is the largest private sector savings provider in the UK. It is also a major general insurance and bancassurance distributor, offering a wide range of long-term savings, investment and general insurance products.
Other income decreased by £197 million or 11 per cent to £1,607 million, relating particularly to changes to current account overdraft structures.
Retail’s goal is to be recognised by customers as the UK’s best bank. This will be achieved by building deep and enduring customer relationships which deliver real value to customers. Retail believes this strategy will drive sustainable long term value for all stakeholders. A deep understanding of customers and their needs combined with highly efficient and effective processes will allow more investment in products and services that customers really value. Retail is increasing its capabilities through the integration of Lloyds TSB and HBOS which presents a great opportunity to use the best from each heritage and significantly improve systems and processes. This includes extending Lloyds TSB’s strong customer insight capabilities to Halifax and Bank of Scotland. Success for Retail will be reflected in enhanced customer service resulting in strong customer advocacy which in turn leads to lower customer acquisition costs, increased share of wallet and improved customer retention.
Creating products and services that customers value A focus on customers, including active use of Retail’s strong customer insight capability, ensures that products and services are customerled in a highly competitive market. Retail has a strong record of award-winning products and services.
Continually improving customer service Retail continues to benefit from the opportunities afforded by its heritage businesses and is taking the best from the Lloyds TSB and HBOS franchises to create ‘one best way’ of doing things. Integration, together with changes in working practices, will deliver significant increases in efficiency which will allow further investment in the products and services that customers really value and will deliver a better customer experience.
As part of the integration Lloyds TSB’s Protection for Life bancassurance product range was extended into Halifax and Bank of Scotland. The impact of these changes has already been significant with close to 50 per cent uplift in protection new business premiums in Halifax and Bank of Scotland.
Other income decreased by 11 per cent in 2010 to £1,607 million from £1,804 million largely as a result of changes to current account overdraft charges. Retail continues to focus on having fees and rates that customers understand. It is believed that this will result in stronger customer relationships as well as supporting the deepening of these relationships. An example of this focus is the changes to the overdraft charging structure for Halifax and Bank of Scotland personal current accounts at the end of 2009, which delivers a more suitable product proposition and an improved customer experience and resulted in a reduction in other income of approximately £90 million. Similarly, the changes to the Lloyds TSB current account pricing model, which became effective at the end of 2010, provide a simpler, more sustainable proposition for customers, resulting in an overall reduction in the cost of overdraft usage.
Total income is analysed as follows and reflects the trends discussed above: Mortgages and Savings 4,739 3,667 29
PROFILE The Wholesale division serves in excess of a million businesses, ranging from start-ups and small enterprises to global corporations, with a range of propositions fully segmented according to customer need. The division comprises Corporate Markets, Treasury and Trading and Asset Finance.
Profit (loss) before tax 3,257 (4,703) Banking net interest margin 1.88% 1.52% Banking asset margin 1.28% 1.02% Banking liability margin 1.29% 1.16% Cost:income ratio (excl. impairment of tangible fixed assets) 43.7% 46.1% Impairment losses as a % of average advances 2.08% 5.92% As at 31 December 2010 2009 Change £bn £bn %
Wholesale’s strategic goal is to be recognised as the UK’s leading, through-the-cycle, relationship-focused wholesale bank. The mission is to retain and deepen recurring, multi-product customer relationships building on deep insight into customer needs to provide a broad range of banking, risk management and capital market products.
Supporting customers through the cycle Wholesale’s through-the-cycle commitment to businesses is evidenced by key initiatives such as the SME Business Charter which was awarded the prize for innovation in SME finance by Business Moneyfacts in March 2010. In 2010, over 100,000 new Commercial start-up customers were attracted and over 200 regional customer events were held across the country, demonstrating our commitment to this segment. Wholesale’s focus on deepening customer relationships and continued commitment to businesses was again recognised by Finance Directors of commercial and corporate companies who voted Lloyds TSB as Bank of the Year in the CBI/Real FD awards for the sixth year running in May 2010. In September 2010, our Commercial Finance business was voted as winner in the InterContinental Finance Magazine’s global awards for Alternative Finance Provider of the year – United Kingdom.
Continued investment in Wholesale Markets capabilities has helped customers to diversify their funding sources and manage their interest rate and currency risks. This successful investment provides the foundations for deeper customer relationships and is earning external recognition which includes the Group being named ‘The most improved European Debt Capital Markets and Syndicate team’ by Euroweek in May 2010 and awarded ‘Best Arranger of UK Loans’ and ‘Best Arranger Mid-Corporate Loans’ at the 2010 Euroweek Syndicated Loan & Leveraged Finance Awards.
Profit before tax and fair value unwind of £127 million was an £11,727 million improvement on the loss of £11,600 million in 2009, driven by a significant decrease in the impairment charge reflecting the stabilising economic climate, continuing to support previous guidance that the impairment charge peaked in first half of 2009.
The impairment charge decreased by £11,237 million to £4,446 million in December 2010. As a percentage of average loans and advances to customers, impairment charge improved to 2.08 per cent in 2010 compared to 5.92 per cent in 2009. The decrease reflects reductions, notably in the heritage HBOS corporate real estate and real estate related portfolios and heritage HBOS Corporate (UK and US) portfolios and write backs from asset disposals, due to the stabilising economic environment, low interest rates which helped to maintain defaults at reduced levels, the stabilisation of UK real estate prices and provisioning against base case assumptions undertaken on the acquired heritage HBOS portfolios in the first half of 2009. The decrease further confirms the Group’s belief that the impairment charge peaked in the first half of 2009 under base case assumptions.
The share of losses from joint ventures and associates comprises a small loss of £95 million, a decrease of £625 million. This represents a net reduction in both the value and size of the portfolio compared to the prior year. The majority of the portfolio is now valued at nil with a remaining portfolio carrying value of approximately £128 million.
Fair value unwind decreased £3,767 million to £3,130 million, mainly due to lower impairments in 2010 relating to the HBOS assets that were fair valued on acquisition. The decrease was partially offset by charges relating to the expected losses on acquired debt securities and by fair value releases on sales.
Loss before tax and fair value unwind decreased by £11,039 million to £697 million, due to a significant decrease in the impairment charge. Net interest income decreased by £87 million or 2 per cent. This reflected lower interest earning asset balances as a result of the ongoing focus on reducing the balance sheet. Despite increased funding costs net interest income benefited from improved margins from customer re-pricing.
Other income was £70 million or 3 per cent lower, primarily due to increased market volatility in 2009 which resulted in mark to market gains in Wholesale Markets which did not reoccur in 2010. Additionally other income benefited from investment gains in Wholesale Equity as a result of stabilising market conditions, and strong fee income across structuring and capital markets.
Profit before tax and fair value unwind decreased by £167 million to £428 million due to lower net interest income.
Total income decreased by £136 million, or 17 per cent. Interest income reduced as the highly volatile interest rate market evident in early 2009 was not repeated in 2010. Other income performance benefited from strong customer demand for interest rate, foreign exchange and risk management products in 2010. Trading flows are managed with the overriding aim of providing a service to customers, whilst maintaining Treasury and Trading’s conservative risk appetite.
Operating expenses decreased by £342 million, or 23 per cent, to £1,116 million, reflecting reduced depreciation charges on assets held under operating leases due to lower fleet size and a year on year improvement in used car values, and strong cost management and savings achieved from integration.
The Wealth business comprises private banking, wealth management and asset management. Wealth’s global private banking and wealth management operations cater to the full range of wealth clients from affluent to Ultra High Net Worth within the UK, Channel Islands and Isle of Man, and internationally. Our private banking and wealth management business operates under the Lloyds TSB and Bank of Scotland brands. Our asset management business, Scottish Widows Investment Partnership, has a broad client base, managing assets for Lloyds Banking Group customers as well as a wide range of clients including pension funds, charities, local authorities, Discretionary Managers and Financial Advisers. In addition, the Group holds a 60 per cent stake in St James’s Place, the UK’s largest independent listed wealth manager and a 55 per cent stake in Invista Real Estate.
Operating expenses decreased by 1 per cent to £1,536 million, with cost savings achieved from integration, particularly in the asset management businesses in Wealth, partly offset by investment in International’s German deposit taking operation, increased resources in business support functions and the effect of stronger foreign currency rates.
Loans and advances to customers decreased by £8.2 billion, or 13 per cent, to £55.3 billion, reflecting net repayments of £4.1 billion, and additional impairment provisions in the International businesses, partly offset by foreign exchange movements of £1.1 billion.
Wealth provides strong growth opportunities for the Group and, through deepening the relationships with existing Group clients alongside targeted external customer acquisition, Wealth’s goal is to be recognised as the trusted adviser to expatriate and private banking clients both in the UK and selected international markets. Wealth’s initial focus in the UK is to increase the penetration of its offering into the Group’s existing customer base by the referral of wealthier customers to its private banking businesses where their wider financial needs can be more effectively met. Outside the UK, Wealth will be building on the strengths of its brand portfolio and existing expatriate, wealth management and private banking propositions.
In the International businesses, the priority is to maximise value in the medium term. International’s immediate focus is on close management of the lending portfolio, particularly in the Irish business, and re-pricing assets where appropriate. At the same time International is delivering operational efficiencies, reshaping its business models and rightsizing the balance sheet to reflect the ongoing environment.
Closing funds under management 192.0 184.1 Year ended 31 December 2010 2009 £bn £bn
In October 2010, Invista Real Estate announced that its contracts to manage the Group’s funds had been terminated on 12 months notice and that these contracts, representing £2.4 billion of Invista’s total funds under management, will be managed in future by SWIP. Invista Real Estate has commenced an orderly realisation of its assets, including the remaining investment management business, and plans to return the proceeds of these realisations to shareholders.
Loss before tax and fair value unwind increased by £1,969 million to £5,465 million due to a higher impairment charge, reflecting an increase of £1,315 million in Ireland and £513 million in Australia.
The impairment charge increased by £1,935 million, or 48 per cent, to £5,942 million due to increased impairment charges in Ireland, particularly in the last quarter of 2010 as a result of downward revisions in the Group’s Irish economic assumptions, and increased impairment charges in Australia as a result of significant contractions in liquidity in regional property markets to which the Group has exposure in the second half of 2010.
capital management initiatives resulted in £2.3 billion mitigation of the potential impact of Basel iii.
In the Life, Pensions and Investments UK business good progress was made in integrating the legacy distribution functions in both the Intermediary and bancassurance channels. Following the integration of the Scottish Widows and Clerical Medical intermediary sales forces in July 2009, a single bancassurance proposition was launched in June 2010.
In General Insurance, the combined ratio improved from 83 per cent to 79 per cent. Home insurance delivered a resilient underwriting performance in the year. Adverse weather conditions at the beginning and end of the year impacted the performance of the home book, however this was partially mitigated by improvements made to the efficiency of the claims processes.
Capital management and operational efficiency Managing the use of the Group’s capital remains a key objective of the business. Significant work has been undertaken to optimise the Insurance division’s contribution to Group capital and in 2010 this resulted in £2.3 billion mitigation of the potential impact of Basel III. The Insurance division remains well capitalised as assessed via the Insurance Groups Directive regulatory measure of surplus capital. The division is progressing its plans to achieve Solvency II compliance.
In the bancassurance channel the reduction reflects the removal from sale of an HBOS guaranteed investment plan sold in 2009 and, since the integrated bancassurance proposition was launched in June 2010, a change in mix away from savings products towards more profitable protection business in line with the legacy Lloyds TSB strategy. Sales of OEICs have been further adversely affected by a reduction in the volume of capital protected products given improved investment markets. However, sales of protection products have increased by 11 per cent and the aggregate new business margin has increased.
Within the intermediary channel the reduction in volumes primarily reflects the withdrawal of low returning HBOS individual pension products, partly offset by an increase in sales of the on-going Retirement Account pension product and strong sales of corporate pensions.
A bottom-up approach is used to determine the economic assumptions for valuing the business in order to determine a market consistent valuation.
Non-market risk 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, reinsurer default and with profit funds, these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.
The reduction in market values is assumed to have no corresponding impact on dividend yields.
The reduction in market values is assumed to have no corresponding impact on rental yields.
Claims were 15 per cent lower than 2009 at £542 million reflecting lower unemployment claims experience. The home book has been particularly affected by the freeze events experienced in January and December 2010. This has been partly offset by the benefits of ongoing claims processing improvements and integration.
2010 HIGHLIGHTS 2010 direct costs decreased by £109 million, or 4 per cent, to £2,973 million reflecting the continued focus on cost management and the delivery of integration synergy savings.
Information Technology costs decreased by 4 per cent, with integration savings offsetting inflationary rises.
Operations costs decreased by 7 per cent, through the continuing rationalisation of our major Operations functions and lower charges in respect of joint ventures.
Group Property costs decreased by 2 per cent, with the continuing consolidation of the heritage property portfolios delivering further integration benefits.
Procurement costs decreased by 2 per cent, reflecting the effect of negotiated lower third party costs on centrally managed contracts. In addition, Procurement has helped to deliver Group wide synergies.
PROFILE Group Operations manages the Group’s technology platforms, property estate, operations, procurement services and security. Through these areas Group Operations drives efficiencies and supports income growth across multiple brands and channels using scalable platforms, common processes and leveraging the Group’s purchasing power.
Fair value unwind improved by £673 million to £(1,446) million primarily due to the effect of the liability management transactions leading to a reduced amortisation rate. Gains on liability management transactions included accelerated fair value amortisations.
INTEGRATION The Group remains on target to deliver annualised cost savings from synergies and other operating efficiencies of £2 billion by the end of 2011.
Savings to date continue to be driven largely from role reductions resulting from deployment of the new Group organisation design adopting the Lloyds TSB approach. The overwhelming majority of role reductions have been achieved through re-deployment, natural turnover and voluntary redundancy. In addition the Group has exited 79 non-branch properties during 2010, bringing the total to 162 since the start of the integration programme.
One-off integration costs of £1,653 million were incurred in 2010 which have been excluded from the combined businesses results. This brings the total integration costs since the HBOS acquisition to £2,749 million. The integration costs relate to severance, IT and business costs of implementation. The severance provisions are for 26,000 role reductions announced to the end of 2010, of which 22,000 have been achieved to date.
(Loss) profit for the year attributable to equity shareholders (320) 2,827 772 3,288 2,804
Total dividend for the year1 – – 648 2,026 1,927 31 December 31 December 31 December 31 December 31 December
Post-tax return on average shareholders’ equity (0.7) 8.8 7.0 28.1 26.6 31 December 31 December 31 December 31 December 31 December
This year we delivered a significant milestone in our integration when we harmonised Terms and Conditions for most employees in the Group. In addition, over 87,000 employees selected benefits available through our Flexible Benefits plan. Over 52,000 people showed their confidence in the Group by electing to take part in Sharesave, our employee share ownership plan that offers everyone the opportunity to buy shares over a three year period and have a long term investment in the Group’s success. We made some changes to our pension schemes in April and our new scheme, ‘Your Tomorrow’, was awarded the Pension Quality Mark Plus – the highest quality mark available from the National Association of Pension Funds.
Our new Diversity and Inclusion strategy was launched in January 2010 and our sponsorship of London 2012 offers employees a unique opportunity to be involved both in the Games and the legacy they leave.
We continue to move toward establishing a single organisation and by 1 December 85 per cent of eligible colleagues were on the newly harmonised Terms and Conditions. This is a significant step forward on our journey towards becoming ‘One Bank’.
These changes have been made with Group wide engagement, with line managers and colleagues embracing the changes.
Every quarter we run a comprehensive and confidential colleague survey to gauge colleagues’ views on key issues. The scope of the colleague survey includes all UK and International colleagues across the Group. In 2010, we achieved record response rates of 83 per cent (up from 79 per cent in 2009) which is regarded as ‘best in class’. The overall Engagement Index finished the year at 80 index points, which is an increase of 8 index points from 2009. The results to individual
questions continued to improve compared with 2010, most notably in areas such as Performance Management, Learning, Customer and Leadership. The level of engagement now exceeds all of the external benchmarks, including the UK Financial Services and UK High Performance norms for the first time.
To further simplify access to business aligned learning we have continued to deploy our Academies approach supported by a redesigned Learning @ Lloyds Banking Group website, which attracts around 1.7 million visits per month.
We remain committed to supporting a range of programmes linked to professional qualifications or relevant external certification. These programmes enable us to develop our colleagues in line with recognised industry standards and provide confidence to customers and other stakeholders.
We also continue to make great progress on matters of disability, ethnicity and sexual orientation.
As we enter the final year of our integration programme, we continue to make excellent progress towards becoming ‘One Bank’. We will go on building a diverse, talented and engaged workforce and equipping it with the skills it needs to provide the best customer service. By rewarding great service and strong performance appropriately, we will embed the values needed to build deep and enduring customer relationships that are at the heart of our business.
Trust in the banking industry has been eroded over the past few years. Rebuilding stakeholders’ trust in financial institutions will be central to us achieving our corporate goal.
We believe that we can make our greatest contribution to society by being good at what we do, and by doing it in a responsible way. Our approach to responsible business management is founded on robust corporate governance practices and a risk management culture which guides the way all employees approach their work, the way they behave and the decisions they make. This helps us focus on building and sustaining long-term relationships with customers. Over time, we believe that this will enable us to deliver superior, more sustainable shareholder value.
Corporate responsibility governance We strengthened our governance framework in 2010, establishing Board representatives for key strands of our Corporate Responsibility agenda. Sir Winfried Bischoff, Chairman of Lloyds Banking Group, has overall Board responsibility for Corporate Responsibility. Truett Tate, Group Executive Director, Wholesale, is Executive Sponsor for Climate Change and Environmental Issues and Helen Weir, Group Executive Director, Retail, is Executive Sponsor for Financial Inclusion.
Risk management We have rolled out Lloyds TSB’s conservative approach to risk across the entire Group. This prudent attitude to risk is core to the Group’s business model. It is the foundation for responsible business management. The Group’s risk management framework is set out on pages 69 to 70.
Each customer’s circumstances are different so we use an affordability model, to better assess a customer’s ability to repay. We take into account customers’ current and past management of financial products. We also consider their ability to make repayments both at the time the account is opened, and throughout the duration of the loan, to ensure that the borrowing remains suitable to their circumstances.
Engaging our employees Employees play a key role in delivering our environmental agenda. One of the main areas where colleagues can have a real impact is in business travel. We have a common travel policy in place across the Group which supports a focus on reducing travel. This has helped us increase the volume of teleconferences by 73 per cent in 2010 compared with 2009.
In 2010, we extended over £79 billion of new lending to homeowners and businesses. As a predominantly UK bank, the vast majority of this lending was conducted in this country. We remain ahead of the mortgage and business lending commitments made by the Group to the Government for the year ending February 2011.
During 2010 we extended £30 billion of gross mortgage lending (including remortgages) to UK homeowners, representing around 1 in 5 of all new mortgages in the UK. We extended more than £5 billion in new lending to first time buyers, helping over 50,000 customers buy their first homes in 2010. We also support various schemes which help first time buyers, including Right to Buy, Shared Equity and Shared Ownership.
Financial inclusion Our approach to financial inclusion is aligned with the Government’s aims to increase access to banking and credit, while, at the same time, developing consumers’ financial literacy and understanding. We aim to lead the banking sector in reaching those that are financially excluded and equip them with the confidence and capability to manage their money effectively. We also have a strong commercial interest in helping to create a nation of consumers who are both comfortable and confident in dealing with the financial services sector.
We are currently providing the Government’s Financial Inclusion Taskforce with insights and data we gain from our significant market share of social bank accounts, to help them understand the behaviour of vulnerable social banking customers.
Financial capability We recognise that we are one of the most important sources of financial information and guidance for consumers. We take seriously our responsibility to raise levels of general financial understanding across the communities we serve and work closely with the Government, the FSA and other stakeholders to deliver this.
Community investment Our economic contribution to society is supported by active investment in communities and our community giving programme. We invested £148 million in communities across the UK in 2010, including support for financial inclusion and social banking, sponsorship of sports for young people and donations through the Group’s charitable Foundations.
Funding grassroots charities Much of the Group’s charitable giving is channelled through the Lloyds TSB Foundations and Bank of Scotland Foundation – five independent charitable Foundations funded solely by the Group. In the last 25 years, more than £450 million has been distributed to small, grassroots charities across the UK through the Lloyds TSB Foundations. In 2010, we established the Bank of Scotland Foundation to take forward our long term community investment in Scotland.
Last year, we donated more than £29 million to the Foundations. This enabled the Foundations to distribute 1,278 grants to charities across the UK. These grants often cover charities’ core costs, such as wages for key employees. In the current economic climate, when many charities are finding it difficult to attract funding, the Foundations’ grants are helping many charities to survive.
In October 2010, colleagues voted for Save the Children as our Charity of the Year for 2011.
Lloyds Banking Group’s Charity of the Year for 2011 is Save the Children. Working together we aim to raise at least £1 million to fund 52 Save the Children Families and Schools Together (FAST) projects in some of the UK’s most disadvantaged communities. FAST is a unique programme that works with three- to five-year-olds and their families to ensure that children get the best possible start to their school life. It brings together children and their parents, schools and community volunteers to help coach parents on how to support their children’s development, ultimately helping them to break out of the cycle of poverty.
Employee volunteering Our employees are our strongest link with the local communities in which we operate. We are committed to enabling employees to make a contribution to communities.
Community sponsorship As the Official Banking and Insurance Partner of the London 2012 Olympic and Paralympic Games, we are using the power of the London 2012 Games to inspire young people to take part in more sport through Lloyds TSB and Bank of Scotland National School Sport Week, delivered in partnership with the charity Youth Sport Trust in England and Wales and Sport Scotland in Scotland. In 2010, almost 50 per cent of UK schools, and five million young people, took part.
We also support the future stars of Team GB and ParalympicsGB through our Local Heroes programme which will have provided funding to more than 1,000 emerging young athletes across Britain by 2012. Athletes receive £1,000 to help towards their training, equipment and travel costs.
We know we have much work to do as an industry to rebuild trust and relationships with our stakeholders. Our starting point is with our customers. As a bank, we have long term, sometimes lifelong, relationships with our customers. We are entrusted with peoples’ money – their savings, their mortgages, their business bank accounts. Ensuring we maintain and build customers’ trust is core to the sustainability of our business.
Only by focusing on customers’ needs, and addressing those needs, can we expect to deliver benefit to all our stakeholders.
Our customer treatment standards are aligned to the FSA’s best practice standards. We conduct regular testing and monitoring to check adherence with our customer treatment policies and have systems in place, such as our Whistleblowing helpline, which allow colleagues to identify and report behaviours which do not meet our high standards.
Addressing customers’ complaints The vast majority of our customers are happy with the service we provide. When we do receive complaints, we take them seriously, and ensure that they are dealt with quickly, fairly and consistently. Our 40,000 customer-facing and call-centre employees have also received extra, in-depth training on handling of customer complaints. We now resolve 90 per cent of complaints at first touch in a branch or over the phone with the support of our new ‘Phone a Friend’ complaints resolution team. Overall, we improved our customers’ view of complaint handling by 10 points in 2010. However, we know we have to work hard to reduce the number of complaints we receive in the first place if we are to achieve our goal of becoming the UK’s best and most recommended bank.
We are also investing in tools to help customers have greater control of their money. Lloyds TSB’s cutting edge online ‘Money Manager’ service helps customers track spending patterns and manage their finances. It provides a combined view of spending across Lloyds TSB personal current accounts and credit cards, and can break down customers’ expenditure under categories such as bills and shopping, helping them to budget.
Supporting Britain’s businesses We support corporate and commercial customers throughout the economic cycle to ensure their financial health, stability and growth. Through this approach we are able to build deep and lasting relationships with customers, and support their ongoing contributions to the UK economy.
Our dedicated Business Support Unit provides bespoke help to business customers that are facing difficulty. Wherever possible, we work to turn these businesses around and restore their financial stability so that they are able to return to mainstream banking. By focusing on helping these businesses recover, we have an opportunity to deepen relationships and retain loyal customers.
This section contains both audited and non audited information. The audited information is that required to comply with the requirements of relevant International Financial Reporting Standards. All other information is unaudited. Each page in this section identifies which information is audited and which is not audited.
The Group’s approach to risk is founded on robust corporate governance practices and a risk management culture which guides the way all employees approach their work, the way they behave and the decisions they make. The Board takes the lead by establishing the ‘tone at the top’ and approving professional standards and corporate values for itself, senior management and other colleagues. The Board ensures that senior management implements strategic policies and procedures designed to promote professional behaviour and integrity. The Board also ensures that senior management implements risk policies and risk appetites that either limit, or where appropriate, prohibit activities, relationships, and situations that could diminish the quality of corporate governance. All colleagues including the Group Chief Executive are assessed against a balanced scorecard that explicitly includes their risk performance, as a component of overall performance.
The Group uses an enterprise-wide risk management framework for the identification, assessment, measurement and management of risk. It seeks to maximise value for shareholders over time by aligning risk management with the corporate strategy, assessing the impact of emerging risks from legislation, new technologies or the market, and developing risk tolerances and mitigating strategies. The framework seeks to: strengthen the Group’s ability to identify and assess risks, aggregate group-wide risks and define the corporate risk appetite, develop solutions for reducing or transferring risk, and where appropriate, exploit risks to gain competitive advantage, thereby seeking to increase shareholder value.
The Group has made a number of undertakings to HM Treasury arising from the capital and funding support, including the provision of additional lending to certain mortgage and business sectors until 28 February 2011, and other matters relating to corporate governance and colleague remuneration. However the commitments in respect of lending are subject to normal prudent commercial lending criteria and pricing, the availability of funding to support such lending and the availability of sufficient demand from creditworthy customers and potential customers. The new agreement between the leading UK banks and the Government in relation to gross business lending in the 2011 calendar year is subject to a similar set of criteria.
Lloyds Banking Group Annual Report and Accounts 2010 long-term viability of the Group and address any competition distortions arising from the benefits of state aid. This has placed a number of requirements on the Group including asset reductions in certain parts of its balance sheet by the end of 2014 and the disposal of certain portions of its business by the end of November 2013, including in particular the disposal of some parts of its retail banking business. The Group is working closely with the EU Commission, HM Treasury and the Monitoring Trustee appointed by the EU Commission.
In particular, the Risk Committee, (formerly Risk Oversight Committee) which comprises non-executive directors, oversees the development, implementation and maintenance of the Group’s overall risk management framework and its risk appetite, strategy, principles and policies, to ensure that these are in line with emerging regulatory, corporate governance and industry best practice. The Risk Committee regularly reviews the Group’s risk exposures across the primary risk drivers and the detailed risk types.
– The Group Insurance Risk Committee, which is responsible for the development and effectiveness of the Group’s insurance risk management framework, clear articulation of the Group’s insurance risk appetite, setting of high-level insurance risk policy, and ensuring compliance with regulatory insurance requirements. On behalf of the Group Business Risk Committee, the Group Insurance Risk Committee monitors and reviews the Group’s aggregate insurance risk exposures and provides proactive and robust challenge around insurance risk and business activities giving rise to insurance risk.
Group Executive Directors have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are required to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within the parameters set by the Board, Group Executive Committee and Group Risk. Compliance with policies and parameters is overseen by the Risk Committee, the Group Business Risk Committee, the Group Asset and Liability Committee, Group Risk and the Divisional Risk Officers.
Functional reporting line from BU Risk Officer or function to Divisional Risk Officers Functional reporting line to support the Committees
All business units, divisions and group functions complete a control self assessment annually (see page 122), reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. Managing directors of each business and each Group Executive Committee member certify the accuracy of their assessment.
Risk management in the business forms part of a tiered risk management model, as shown above, with the Divisional Risk Officers and Group Risk providing oversight and challenge, as described above, and the Chief Risk Officer and group committees establishing the group-wide perspective.
This approach seeks to provide the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also seeks to facilitate effective communication on these matters across the Group.
The Group is currently assessing the impacts of these regulatory developments and will participate in the consultation and calibration processes to be undertaken by the various regulatory bodies during 2011. The insurance division is progressing its plans to achieve Solvency II compliance. The Group continues to work closely with the regulatory authorities and industry associations to ensure that it is able to identify and respond to proposed regulatory changes and mitigate against risks to the Group and its stakeholders.
Arising in the banking business of the Group through the Retail, Wholesale and Wealth and International divisions reflecting the risk that the Group is unable to attract and retain either retail, wholesale or corporate deposits or issue debt securities. Like all major banks, the Group is dependent on confidence in the short and longer term wholesale funding markets; should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding and provide liquidity when necessary, the Group’s ability to fund its financial obligations could be impacted.
Market Risk: The risk of reductions in earnings and/or value, through financial or reputational loss, from unfavourable market moves; including changes in, and increased volatility of, interest rates, market-implied inflation rates, credit spreads, foreign exchange rates, equity, property and commodity prices.
The main equity market risks arise in the life assurance companies and staff pension schemes. Credit spread risk arises in the life assurance companies, pension schemes and banking businesses. Equity market movements and changes in credit spreads impact the Group’s results.
Insurance Risk: The risk of reductions in earnings and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity of insured/ underwritten events and to fluctuations in the timing and amount of claims settlements.
The major sources of insurance risk are within the insurance businesses and the staff defined benefit pension schemes.
Customer treatment and how the Group manages its customer relationships affects all aspects of the Group’s operations and is closely aligned with achievement of the Group’s strategic aim – to create deep long lasting relationships with its customers. There is currently a high level of scrutiny regarding the treatment of customers by financial institutions from the press, politicians and regulatory bodies.
The Group aims to attract, retain, and develop high calibre talent. Failure to do so would present a significant risk to delivering the Group’s overall strategy and is affected by a range of factors including: – Ongoing regulatory and public interest in remuneration practices
– Uncertainty about EU state aid requirements and the Independent Commission on Banking’s proposals for banking reform.
DEFINITION Business risk is defined as the risk that the Group’s earnings are adversely impacted by a sub optimal business strategy or the sub optimal implementation of the strategy. In assessing business risk, consideration is given to internal and external factors.
MONITORING The Group’s strategy is reviewed and approved by the Board. Reputational risk is covered at a number of levels throughout the organisation, which includes the Group Executive Committee and the Group Business Risk Committee. Regular reports are provided to the Group Executive Committee and the Board on the progress of the Group’s key strategies and plans. Group Risk conducts oversight to seek to ensure that business plans remain consistent with the Group’s strategy.
Stress testing and scenario analysis: The credit portfolio is also subjected to stress testing and scenario analysis, to simulate outcomes and calculate their associated impact. Events are modelled at a group-wide level, at divisional and business unit level and by rating model and portfolio, for example, within a specific industry sector.
Risk assurance and oversight: Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes, and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators. Group credit risk assurance, a group level function comprising forty seven experienced credit professionals, is also in place. In conjunction with divisional and group risk senior management, this team carries out independent risk based credit reviews, providing individual business unit assessment of the effectiveness of risk management practices and adherence to risk controls across the diverse range of the Group’s wholesale and retail businesses and activities, facilitating a wide range of audit, assurance and review work. These include cyclical (‘standard’) credit reviews, non-standard reviews, project reviews, credit risk rating model reviews and bespoke assignments, including impairment reviews as required. The work of group credit risk assurance continues to provide executive and senior management with assurance and guidance on credit quality, effectiveness of credit risk controls and accuracy of impairments.
Collateral held as security for financial assets other than loans and advances is determined by the nature of the instrument. Debt securities, treasury and other eligible bills are generally unsecured, with the exception of asset-backed securities and similar instruments, which are secured by portfolios of financial assets. Collateral is generally not held against loans and advances to financial institutions, except where securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement. Collateral or other security is also not usually obtained for credit risk exposures on derivative instruments, except where the Group requires margin deposits from counterparties.
Where a turnaround is not feasible, exposure is minimised through a combination of appropriate asset sales, restructuring and work-out strategies.
Within collections and recoveries, the sharing of best practice and alignment of policies across the Group has helped to drive more effective customer outcomes and achieve operational efficiencies. The Group has strengthened resources in collections and recoveries to help customers in distress by offering advice and access to a wider range of options such as short-term repayment plans or the government backed Homeowners Mortgage Support and Mortgage Rescue schemes.
A core element of our relationship management approach is to contact customers showing signs of financial distress, discussing with them their circumstances and offering solutions to prevent their accounts falling into arrears.
– Delay Repossession: Under this initiative lenders will not begin repossession proceedings for at least three months when a customer is in arrears. This does not apply to fraud cases. The undertaking comes alongside an existing agreement under which mortgage providers are obliged to explore a range of options, such as payment holidays and altering the terms of a mortgage, before resorting to repossession.
– Contractual repayment: This scheme allows customers in arrears, but who have made sufficient payments in a six month period, to capitalise their arrears. The contractual repayment is then adjusted to provide full repayment of the loan and full interest within the agreed original term.
– Statement of Principles: The Group through a number of its businesses has signed up to the Statement of Principles outlining an agreed approach to working with micro-enterprises (entities with fewer than 10 employees and having a turnover of less than €2 million). The principles include how to ensure that the right relationship is established from the start, how to help if the business faces difficulties and how businesses can work most effectively with their bank.
– Prudent, ‘through the cycle’ credit policies and procedures are in place throughout the Group, focusing on development of enduring client relationships. This resulted in higher quality new business being originated across the UK. Very little new origination took place outside the UK.
– New lending quality continues to be good with subsequent early arrears at pre-recessionary levels.
– Average loan-to-value on new mortgage lending in the year was 60.9 per cent (59.3 per cent for 2009) while the average indexed loan-to-value on the mortgage portfolio was 55.6 per cent (54.8 per cent at 31 December 2009) consistent with a net fall in house prices since December 2009.
– Overall volume of customers entering arrears in 2010 compared to 2009 was lower for unsecured lending and flat for secured lending. Secured early arrears balances increased in the second half of 2010.
IMPAIRED LOANS AND PROVISIONS (audited) Retail impaired loans decreased by £1.2 billion to £9.8 billion compared with 31 December 2009 and, as a percentage of closing loans and advances to customers, decreased to 2.6 per cent from 2.9 per cent at 31 December 2009. The reduction in the value of impaired loans reflected the continuing low interest rate environment for mortgages and fewer unsecured loans going into arrears. Impairment provisions, as a percentage of impaired loans, reduced to 31.8 per cent from 34.6 per cent at 31 December 2009 largely driven by more stringent criteria for new and existing unsecured collections repayment plans resulting in highly provided assets being written-off.
Value of debt represents total book value of mortgages in arrears but not repossessed.
As at 31 December 2009 Mainstream Buy to let Specialist1 Total % % % %
UNSECURED (unaudited) In 2010 the impairment charge on loans and advances to customers reduced by £983 million to £2,455 million compared with 2009. This reflected a continuation of the improving portfolio trends resulting from the Group’s prudent risk appetite, with a focus on lending towards existing customers, combined with stable unemployment.
TABLE 1.12: IMPAIRMENTS ON WHOLESALE LOANS AND ADVANCES (audited) As at 31 December 2010
Of which Wholesale Markets is £25,120 million, Wholesale Equity £487 million, Treasury and Trading £163 million, Asset Finance £7 million, Corporate £2 million and Commercial £2 million.
Of which Wholesale Markets is £21,279 million, Wholesale Equity £2,109 million, Treasury and Trading £6,011 million and Corporate £59 million.
Impairment provisions as a % of impaired loans loans as a % of closing advances
The management of the distressed portfolio remains key not only to mitigating loss for the Group, but also for the Group as a major lender within the property sector to ensure that the strategies adopted do not adversely impact on a market that remains fragile. During 2010, a number of restructurings, good level of asset reduction, and continued active management led to a fall in impairments compared to the previous year.
On the property investment side there have been signs of recovery in capital values, specifically at the prime end of the commercial market and in London generally. Since the half year, this recovery has slowed as investor activity and sentiment cooled. Rental values remain fragile across most property sectors.
WHOLESALE EQUITY The Wholesale Equity portfolio (assets representing ‘Equity Risk’ including ordinary equity, preference shares and debt securities) totals £5.6 billion (split £4.2 billion on balance sheet commitments and £1.4 billion as yet undrawn, the majority of which relates to the Funds Investment business). The portfolio comprises the two core businesses, Lloyds Development Capital and Project Finance with the remaining businesses (Joint Ventures Equity, BSU Investment portfolios and Fund Investments) all now categorised as non-core.
In terms of market sentiment, the second half of 2010 saw a gradual uptick in main share indices (UK, Europe and USA) which, despite episodic volatility has contributed to a relatively stable valuation position combined with some indication that there may be a slow recovery in market activity. While signs are on balance currently positive, we remain cautious on prospects for value recovery looking into 2011.
ASSET FINANCE The credit quality of the retail portfolios continues to be relatively stable with key risk indicators continuing to show signs of improvement. Impairments in 2010 were lower than anticipated, particularly in the second charge secured portfolio and the retail motor loans portfolio. Asset quality also continues to improve in response to the continuing strategy to enhance the quality of new business written and following the closure of new business by the Personal Financial Services business. The credit quality profile across the non-retail portfolios also continues to be relatively stable, and impairment levels significantly less than 2009, reflecting a material slow down in new default cases. Exposures to the Fleet Operator sector, particularly a small number of daily/flexi rental operators, continue to require intensive management to support customers through their financial difficulties, but have not affected impairment levels to the extent seen in 2009.
OVERVIEW (unaudited) – Increased impairment charges in commercial real estate portfolios in Ireland and Australia were the primary drivers of a divisional increase in impairment of 47 per cent in 2010 compared with 2009.
IMPAIRED LOANS AND PROVISIONS (audited) Total impaired loans increased by £7,638 million to £20,342 million compared with £12,704 million at 31 December 2009 and as a percentage of closing loans and advances to customers increased to 30.7 per cent from 18.3 per cent at 31 December 2009. The level of impaired loans in the International business is supported by detailed portfolio reviews conducted during 2010.
In December 2010, responsibility for impaired assets in Ireland was transferred from the local BSU team to a dedicated UK based BSU credit team to manage the wind down of the lending book. In Australia, this activity continues to be managed locally and strengthened through deployment of additional staff. Responsibility for these areas has been consolidated within a new central team, which has considerable experience in work-out strategies and will manage this activity globally for the Group.
WEALTH Total impaired loans increased by £72 million, or 26 per cent to £353 million compared with £281 million at 31 December 2009 and as a percentage of closing loans and advances increased to 3.7 per cent from 3.0 per cent at 31 December 2009. Impairment charges decreased by £25 million to £46 million compared to £71 million in 2009. This reduction is primarily due to the mortgage lending business in Spain where there has been improved credit management of the book during 2010.
Further deterioration in the Irish economy resulted in increased impaired loans in 2010 and coverage levels significantly increased in the last quarter of 2010 reflecting downward revisions in the Group’s Irish economic assumptions.
The Group’s insurance activities also expose it to market risk, encompassing interest rate, exchange rate, property, credit spreads and equity risk: – With Profit Funds are managed with the aim of generating rates of return consistent with policyholders’ expectations and this involves the mismatch of assets and liabilities.
2009 VaR has been restated to reflect trading risk only. Risk relating to the funding of the lending business is reported in the Banking-Non-Trading section of the report.
The following table shows, split by material currency, Lloyds Banking Group sensitivities as at 31 December 2010 to an immediate up and down 25 basis points change to all interest rates.
The schemes’ main exposures are to equity risk, real rate risk and credit spread risk. Accounting for the pension schemes under International Accounting Standard (IAS)19 spreads any adverse impacts of these risks over time.
Insurance portfolios The Group’s market risk exposure in respect of insurance activities described above is measured using EEV as a proxy for economic value. The pre-tax sensitivity of EEV to standardised stresses is shown below for the years ended 31 December 2010 and 2009. Foreign exchange risk arises predominantly from overseas holdings of equities. Impacts have only been shown in one direction but can be assumed to be reasonably symmetrical. Opening and closing numbers only have been provided as this data is not volatile and consequently is not tracked on a daily basis.
MONITORING The Senior Asset and Liability Committee and the group market risk forum regularly review high level market risk exposure including, but not limited to, the data described above. They also make recommendations to the Group Chief Executive concerning overall market risk appetite and market risk policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits are monitored locally by independent risk functions and at a high level by Group Risk. Where appropriate, escalation procedures are in place.
Insurance activities Market risk exposures from the insurance businesses are controlled via approved investment policies and triggers set with reference to the Group’s overall risk appetite and regularly reviewed by the Senior Asset and Liability Committee and the Group Market Risk Forums: – The With Profit Funds are managed in accordance with the relevant fund’s principles and practices of financial management and legal requirements.
EXPOSURES The major sources of insurance risk within the Group are the insurance businesses and the Group’s defined benefit staff pension schemes. The nature of insurance business involves the accepting of insurance risks which relate primarily to mortality, longevity, morbidity, persistency, expenses, property damage and unemployment. The prime insurance risk carried by the Group’s staff pension schemes is related to longevity.
MEASUREMENT Insurance risks are measured using a variety of techniques including stress and scenario testing; and, where appropriate, stochastic modelling.
DEFINITION The risk of reductions in earnings and/or value, through financial or reputational loss, from inadequate or failed internal processes and systems, operational inefficiencies, or from people related or external events.
Customer processes The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from poor externally facing business processes. Customer process risk includes customer transaction and processing errors due to incorrect capturing of customer information and/or system failure.
Money laundering and sanctions The risk of reductions in earnings and/or value, through financial or reputational loss, associated with failure to comply with prevailing legal and regulatory obligations on activities related to money laundering, sanctions and counter terrorism, these losses may include censure, fines or the cost of litigation.
Organisational infrastructure The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from poor internally facing business processes at group, divisional or business unit level. Organisational infrastructure in this context embraces the structures, systems and processes that provide direction, control and accountability for the enterprise.
EXPOSURES By its very nature, operational risks can arise from a wide range of the Group’s activities that involve people, processes and systems. The Group’s principal operational risks relate to the Group’s ability to attract, retain and motivate its people, the rate and scale of change arising from the Group’s integration programme, the way in which the Group treats its customers and the legal and regulatory environment in which it operates.
Financial soundness risk has three key risk components covering liquidity and funding risk; capital risk; and financial and prudential regulatory reporting, disclosure and tax risk.
DEFINITION (audited) 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.
The key dependencies on successfully funding the Group’s balance sheet include the continued functioning of the money and capital markets; successful right-sizing of the Group’s balance sheet; the repayment of Government and central bank facilities in accordance with the agreed terms; no more than limited further deterioration in the UK’s and the Group’s credit rating; and no significant or sudden withdrawal of deposits resulting in increased reliance on wholesale funding markets. Additionally, the Group has entered into a number of EU state aid related obligations to achieve reductions in certain parts of its balance sheet by the end of 2014. The requirement to meet this deadline may result in the Group having to provide funding to support these asset reductions and/or disposals and may also result in a lower price being achieved.
Despite the market disruption as a result of European sovereign risk concerns during 2010, the Group outperformed its term wholesale issuance plans, allowing an accelerated repayment of Government and central bank facilities and thus reducing the on-going reliance on short term funding. The Group continued to fund itself successfully in the short term money markets, extending the maturity profile of this source of funding. The Group anticipates that wholesale markets will remain vulnerable to periods of disruption during 2011. To mitigate the impact of such events, the Group has been actively diversifying its funding sources and investor base.
Late in 2010, the Basel Committee on Banking Supervision refined the details of the Basel III reforms to ensure the strengthening of global liquidity standards. This supplemented the 2008 published Principles of Sound Liquidity Risk Management and Supervision (‘Sound Principles’). These principles have been strengthened by the development of two principal liquidity measures.
Primary liquidity assets are FSA eligible liquid assets including UK Gilts, US Treasuries, Euro AAA government debt and unencumbered cash balances held at central banks.
Total wholesale funding is analysed by residual maturity as follows: TABLE 1.22: WHOLESALE FUNDING BY RESIDUAL MATURITY
LIQUIDITY PORTFOLIO The table below illustrates the Group’s holding of highly liquid unencumbered assets. This liquidity is available for deployment at immediate notice, subject to complying with regulatory requirements, and is a key component of the Group’s liquidity management process.
Primary liquidity is defined as FSA eligible liquid assets (UK Gilts, US Treasuries, Euro AAA government debt; unencumbered cash balances held at central banks).
TABLE 1.25: RECONCILIATION OF GROUP FUNDING FIGURE FROM TABLE 1.21 TO THE BALANCE SHEET As at 31 December 2010 Included in funding analysis (above)
MEASUREMENT The Group’s regulatory capital is divided into tiers depending on level of subordination and ability to absorb losses. Core tier 1 capital as defined in the FSA letter to the British Bankers’ Association in May 2009, comprises mainly shareholders’ equity and non-controlling interests, after deducting goodwill, other intangible assets and 50 per cent of the net excess of expected loss over accounting provisions and certain securitisation positions. Accounting equity is adjusted in accordance with FSA requirements, particularly in respect of pensions and Available-for-Sale assets. Tier 1 capital, as defined by the European Community Banking Consolidation Directive as implemented in the UK by the FSA’s General Prudential Sourcebook (GENPRU), is core tier 1 capital plus tier 1 capital securities. Tier 2 capital, defined by GENPRU, comprises qualifying subordinated debt after deducting 50 per cent of the excess of expected loss over accounting provisions, and certain securitisation positions. Total capital is the sum of tier 1 and tier 2 capital after deducting investments in subsidiaries and associates that are not consolidated for regulatory purposes. In the case of Lloyds Banking Group, this means that the net assets of its life assurance and general insurance businesses and the non-financial entities that are held by our private equity (including venture capital) businesses, are excluded from its total regulatory capital.
it clear that ICG remains a confidential matter between each bank and the FSA.
During 2010 the Basel Committee on Banking Supervision has substantially refined the details of the so called ‘Basel III’ reforms for an enhanced global capital accord. These include increased minimum levels of and quality standards for capital, increased risk weighting of assets, and the introduction of a minimum leverage ratio, as well as the timing and transitional arrangements for implementation. The final details are still to be clarified, particularly as the reforms are implemented within the European and UK regulations, which may include a countercyclical buffer, requiring higher levels of capital to be held at certain points of the economic cycle, and higher capital requirements for systemically important financial institutions.
The effect of the Basel III reforms is uncertain as much will depend on business performance and mitigating actions that can be completed, even before the transition period comes in to effect. However lower risk weighted assets are expected from the planned reduction in the non-core balance sheet. Analysis suggests that with no mitigating actions the reforms will reduce the Group’s core tier 1 ratio by approximately 1.2 per cent in 2013. The additional impact in 2014 of deducting the equity investment in insurance in excess of 10 per cent, transitioning in at 20 per cent per annum from 1 January 2014, would be around 0.3 per cent were the Group to take no further action to mitigate this. The Group is confident that it is well positioned to maintain a strong capital position, meeting all regulatory requirements as currently formulated.
The Group has in issue as part of tier 2 capital resources, enhanced capital notes which will convert to core tier 1 capital in the event that Group’s published core tier 1 ratio (as defined by the FSA in May 2009) falls below 5 per cent.
Tier 1 capital has decreased by £252 million over the year. The increase in core tier 1 capital was more than offset by the redemption of the preference shares and preferred securities as part of the liability management exercises referred to above.
RISK WEIGHTED ASSETS The following table sets out the Group’s risk weighted assets that primarily arise in its banking businesses.
TABLE 1.28: ANALYSIS OF RISK WEIGHTED ASSETS As at 31 December 2010 2009 £m £m
CAPITAL STATEMENT The following table provides more detail regarding the capital resources available to meet regulatory capital requirements in the life insurance businesses. The figures quoted are based on management’s current expectations pending completion of the annual financial returns to the FSA. The figures allow for a transfer of £150 million and an anticipated transfer of £260 million from the UK non-profit funds to the UK life shareholder funds. They also allow for a transfer of £115 million from the UK non-profit funds to the Scottish Widows With Profit Fund relating to closure under the Scottish Widows’ demutualisation scheme of an account in respect of unclaimed compensation payments. Within the With Profit Fund the £115 million transfer is fully offset by an increase in liabilities. An equal liability is released from the holding company of Scottish Widows plc leading to a broadly neutral impact on the Group’s net assets.
Other differences between IFRS and regulatory valuation of assets and liabilities – – 625 (919) 111 (183)
OTHER LIFE INSURANCE BUSINESSES Except as described above capital held in UK Non Profit Funds is potentially transferable to other parts of the Group, subject to meeting the regulatory requirements of these businesses. There are no prior arrangements in place to allow capital to move freely between life insurance entities or other parts of the Group.
UK NON PROFIT FUNDS Available capital in the UK Non Profit Funds has decreased from £2,397 million at 31 December 2009 to an estimated £2,138 million at 31 December 2010. Increases in available capital from new business were offset by changes in assumptions and proposed transfers to the UK Life Shareholder Funds. A transfer to the Scottish Widows With Profit Fund also resulted in a decrease of £115 million in available capital.
Analysis of policyholder liabilities reported in the balance sheet in respect of the group’s life insurance business is as follows. With Profit Fund liabilities are valued in accordance with FRS 27.
Unit-linked business (excluding that accounted for as non-participating investment contracts) – – 38,641 8,011 46,652
Unit-linked business (excluding that accounted for as non-participating investment contracts) – – 32,816 6,864 39,680
The most critical non-economic assumptions are the level of take-up of options inherent in the contracts (higher take-up rates are more onerous), mortality rates (lower mortality rates are generally more onerous) and lapses prior to dates at which a guarantee would apply (lower lapse rates are generally more onerous where guarantees are in the money). The sensitivity of the capital position and capital requirements of the With Profit Funds is partly mitigated by the actions that can be taken by management.
OTHER LONG-TERM FUNDS Outside the With Profit Funds, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are broadly matched. The most critical non-economic assumptions are mortality rates in respect of annuity business written (lower mortality rates are more onerous). Reinsurance arrangements are in place to reduce the Group’s exposure to deteriorating mortality rates in respect of life insurance contracts. In addition, poor cost control would gradually reduce the available capital and lead to an increase in the valuation of the liabilities (through an increased allowance for future costs).
Joined the Board in 2008. Chairman of Deloitte UK from 1995 to 2007 and a member of the Board from 1991 to 2007. Joined the firm in 1973 and was a partner from 1982 until he retired in 2008. A member of the Board of directors of Deloitte Touche Tohmatsu from 1999 to 2007. Chairman of Great Portland Estates. A member of the council of Leeds University and a Governor of Berkhamsted School. Aged 60.
Audit Committee To monitor and review the formal arrangements established by the Board in respect of the financial statements and reporting of the Group; internal controls and the Risk Management Framework; internal audit; and the Group’s relationship with its external auditors.
RESULTS The consolidated income statement shows a loss attributable to equity shareholders for the year ended 31 December 2010 of £320 million.
Ms A M Frew and Mr A Horta-Osório were appointed to the Board after the annual general meeting held in 2010 and will therefore stand for election at the forthcoming annual general meeting. Under the articles of association, Sir Julian Horn-Smith and Mr G T Tate are required to retire from the Board at the annual general meeting. However, in the interests of good corporate governance and in accordance with the provisions of the UK Corporate Governance Code, effective from 2012, the Board has decided that all of the directors will retire voluntarily and submit themselves for re-election at the annual general meeting.
CORPORATE GOVERNANCE REPORT The corporate governance report can be found on pages 114 to 123 and forms part of this directors’ report.
Rebuilding trust in financial institutions generally is central also to achieving our aim of being recognised as the UK’s best bank. We are judged on how we do business, and how we respond to our stakeholders’ issues and needs. In particular, we are judged on the effectiveness of our decision making.
I meet regularly with the Non-Executive Directors without the Executive Directors being present, either in private sessions held following Board or Committee meetings or in separately arranged meetings. The Executive Directors are aware of such meetings through our Board calendar. At the same time, we have provision for the Non-Executive Directors to meet with the Group Chief Executive without the Chairman, so that there can be feedback both ways.
The Board Governance Framework is the Board’s operating manual and sets out the matters that the Board has reserved to itself, including the development and setting of strategy and long term objectives; approval of the medium term plan and financial budgets; capital and structure of capital; significant contracts and various statutory and regulatory approvals.
All Committees act under terms of reference which are proposed by the Nomination & Governance Committee and then approved by the Board and reviewed regularly. During 2010, all terms of reference were reviewed and updated. Copies of the current terms of reference are available on our website, www.lloydsbankinggroup.com.
Details of attendance at meetings are set out on page 119. When meetings are called at short notice, it is not always possible for all Directors to attend. As Chairman, it is my practice to seek to contact any Directors that are unable to attend to obtain their views before any decision is taken.
All Directors participate in the development of strategy. In addition to discussions at regular Board meetings, we held two strategy development sessions in 2010, one in April and the other in November. Each lasted two days. The time spent at these meetings not only enables the Board to devote time to its strategic priorities but also to foster closer working relationships between Board members.
BOARD COMPOSITION In 2010, the Nomination & Governance Committee formulated a board composition policy statement which lays down the principles that are applied when reviewing Board composition. The policy has been adopted by the Board and covers matters such as: Skills and experience In reviewing composition, the Board aims to ensure that its membership represents a mix of backgrounds and experience that will enhance the quality of its deliberations and decisions. As part of our ongoing review, we identify specific skills that we look for in prospective new Directors, having regard to the skills of the Board overall at the time, and the need to address longer term succession and current business priorities. The annual Board evaluation is instrumental in identifying any new skills requirements, as well as possible shortcomings, gaps and inefficiencies. We conducted Board evaluations in 2009 and 2010 with the help of outside consultants.
All Directors are required to have good – and in most cases have deep – experience and understanding of the banking and financial services sector. The complexity of the Group means that broader skills are also required. Maintaining the right balance is an ongoing priority. The appointments of Glen Moreno and David Roberts in March 2010 enhanced the Board’s collective banking skills with the majority of the Non-Executives, including myself, having substantial banking experience. This is complemented by the strong financial, accounting and commercial backgrounds of other Non-Executive Directors. The changes made to the Board during 2010 are explained in Board Changes below.
As one of the founding Chairmen of The 30% Club, I am committed to improving the representation of women on UK corporate boards, including the goal of ensuring at least 30 per cent representation of women on boards by 2015. Chairmen, I believe, have an obligation to speed up the pace of change and to influence the board selection process to widen the talent pool for consideration. To do this, we need to champion diversity within our own organisations, and as part of that, develop our female talent and be prescriptive with search agencies to work towards an aspirational target for better female representation on boards.
In assessing independence, the Committee does not rely solely on the Code criteria but considers whether, in fact, the Non-Executive is demonstrably independent and free of relationships and other circumstances that could affect their judgement. It does this with reference to the individual performance and conduct in reaching decisions. It also takes account of any relationships that have been disclosed and authorised by the Board. In the view of the Nomination & Governance Committee, Glen Moreno, who was between January 2009 and August 2009 acting Chairman of United Kingdom Financial Investments which manages the Government’s shareholding in the Group, continues to exercise his own and robustly independent judgement at all times.
Succession planning This is a key aspect of our overall review of Board composition and is explained fully in Succession Planning below.
In addition to the above appointments, the following retirements were announced in the year: – Dr Wolfgang Berndt retired from the Board at the annual general meeting in May 2010. Dr Berndt joined the Board in 2003 and during his tenure made a significant contribution to the Group particularly in the areas of strategy and measurement of results. As Chairman of the Remuneration Committee, he advocated a constructive and open dialogue with shareholders. He was succeeded as Chairman of the Remuneration Committee by Anthony Watson.
ELECTION AND RE-ELECTION Anita Frew and António Horta-Osório were appointed to the Board after the annual general meeting held in 2010 and will therefore stand for election at the forthcoming annual general meeting. Under the articles of association, Sir Julian Horn-Smith and Truett Tate are required to retire from the Board at the annual general meeting. However, in the interests of good corporate governance and in accordance with provisions of the UK Corporate Governance Code, effective from 2012, we have decided that all of the directors will retire voluntarily and submit themselves for re-election at the annual general meeting.
Group Chief Executive Succession As Chairman, I am responsible for the succession arrangements relating to the Group Chief Executive, including process and the production of a plan. It is important to maintain a thorough understanding of the market to ensure that the plan is regularly reviewed and refreshed. If not already known to me, I take the time to get to know potential candidates so that I can assess their suitability for our Board.
The Succession Committee’s remit was to appoint a successor who would be capable of leading the Group to the next stage of its development. It was agreed that an extensive search should be conducted encompassing internal, external and international candidates. Given the profile, breadth and challenges of the role, together with the need to be able successfully to lead the Group in the next phase of its development, it was clear that an exceptional candidate was required.
António Horta-Osório stood out in an excellent short list. His skills closely match the role specification agreed by the Succession Committee including: – strong retail and commercial banking experience gained in the UK and internationally, including experience at chief executive officer level, of running large scale, multi-product, multi-brand businesses; – a proven track record of successful integration of retail banks in the UK and in Europe as part of a multi-jurisdictional, multi-brand organisation; – strong understanding of the operational and regulatory environment in which banks operate both in the UK and globally, including a deep understanding of capital and liquidity management and the potential impacts of global regulatory change initiatives; – the ability to foster a culture of fairness for customers, shareholders and colleagues; and
Following an intensive interview process and extensive due diligence, António Horta-Osório was named as our new Group Chief Executive in November 2010.
BOARD EVALUATION AND PERFORMANCE The Nomination & Governance Committee recommended to the Board that, as in 2009, the 2010 evaluation should again be facilitated externally. Given the number of new entrants to this market, we agreed that we should explore the range of services available. Following a tender process and interviews, Dr Tracy Long of Boardroom Review was appointed to conduct the 2010 process. Boardroom Review has no other relationship with the Company.
The review was conducted between October 2010 and February 2011 through confidential interviews with all Board directors and the Company Secretary, observation of a Board meeting and a review of selected papers. The review was designed to be forward looking, assessing the quality of the Board’s decision making and debate, and its overall contribution to, and impact on, the long term health and success of the business. The review identified the strengths of the Board and its Committees and highlighted areas for the Board to work on in order to prepare for future challenges. The Board evaluation also provides feedback on the individual performance of Directors which informs a general assessment and my assessment which is used for individual feedback.
As Senior Independent Director, Glen Moreno leads the review of my performance with the Board and provides feedback in a face-to-face meeting.
The Remuneration Committee, chaired by Anthony Watson, is responsible for overseeing the Group’s remuneration arrangements and compliance with the FSA’s Remuneration Code. The Remuneration Committee’s terms of reference were amended in 2010 to address the recommendation of the Walker Review and, more recently, the FSA Remuneration Code, that performance related pay should be more closely aligned to the long term interests of the Company and its risk management systems. The Remuneration Committee’s terms of reference are available on our website, www.lloydsbankinggroup.com.
The attendance of directors at Board meetings and at meetings of the Audit, Nomination & Governance, Remuneration and Risk Committees of which they were members during 2010 are shown in the table. Some Directors attended relevant Committee meetings as attendees periodically throughout the year, which are not shown below. In addition, the Audit Committee arranged six half day ‘deep dive’ meetings during 2010 which were open to and attended by other members of the Board.
Appointed to the Board, Nomination & Governance, Remuneration and Risk Committees on 1 March 2010. Stood down from the Remuneration Committee on 17 June 2010 and the Risk Committee on 1 September 2010.
Appointed as Chairman of the Remuneration Committe and to the Nomination & Governance Committee, and stood down from the Risk Committee, on 6 May 2010.
Remuneration Anthony Watson Sir Winfried Bischoff Sir Julian Horn-Smith Lord Leitch David Roberts Tim Ryan
– reviews 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; – reviews the scope of the work of the group audit department, reports from that department and the adequacy of its resources; – reviews the effectiveness of the systems for internal control, risk management and compliance with financial services legislation and regulations; – approves the external auditors’ terms of engagement and remuneration; – assesses the external auditors’ independence and objectivity; – recommends the external auditors’ appointment, re-appointment and removal; – reviews the results of the external audit and its cost effectiveness; – reviews reports from the auditors on audit planning and their findings on accounting and internal control systems; and
– reviews procedures for handling complaints regarding accounting, internal accounting controls or auditing matters and for staff to raise concerns in confidence.
– reviewed and recommended to the Board the Group annual and interim reports and accounts; – reviewed significant accounting matters as discussed with the auditors; – reviewed the Group’s position as a going concern; – reviewed the appointment of the auditors and approved their remuneration; – attended six half day ‘deep dive’ sessions with each of the divisions
Information about the Remuneration Committee’s responsibilities is given in the Directors’ remuneration report on pages 124 to 141.
Information about the Remuneration Committee’s activities during 2010 is given in the Directors’ remuneration report on pages 124 to 141.
Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Group and parent Company financial statements in accordance with IFRSs as adopted by the European Union. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the Company and of the profit or loss of the Company and Group for that period. In preparing these financial statements, the Directors are required to: select suitable accounting policies and then apply them consistently; make judgements and accounting estimates that are reasonable and prudent; state whether applicable IFRSs as adopted by the European Union have been followed.
The Directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of published policies and procedures and regular management briefings. A requirement to comply with internal control risk policies is a key component of individual staff objectives expressed in the balanced scorecard. Key business risks are identified, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. In addition, there is an annual control self assessment exercise whereby the key businesses and head office functions review specific controls and attest to the accuracy of their assessments. The assessment covers all enterprise-wide risk management categories and is in accordance with the principles of the Code. As in previous years, this exercise was completed for the year ended 31 December 2010. All returns have been satisfactorily completed and appropriately certified.
There is an ongoing process for identifying, evaluating and managing the significant risks faced by the Company. This process has been in place for the year under review and up to the date of the approval of the annual report and is regularly reviewed by the Board.
Information regarding the main features of the internal control and risk management systems in relation to the financial reporting process is given within the risk management report on pages 65 to 108.
There continues to be a high level of interest in remuneration in both the sector as a whole and Lloyds Banking Group arrangements. Throughout the year we have sought to take this into account along with shareholders’ views on remuneration, ensuring continued compliance with the FSA Code of Practice on Remuneration whilst balancing these factors with what is right for our business. We held fifteen Remuneration Committee meetings during the year, at which a wide range of matters were discussed. This gives an indication of the importance we place on ensuring the effectiveness of the Group’s remuneration structures.
Our conclusion, following the considerable amount of consultation and an in depth analysis of performance, was that 2010 outcomes should demonstrate the exercise of restraint rather than fully reflect improved performance and we should retain a broadly similar structural approach for 2011.
– To ensure a prudent approach is applied in practice we have exercised downward discretion on the annual bonuses; the payouts are lower than if they were calculated on a purely formulaic basis. Exercising its discretion, the Committee has been mindful, amongst other things, of the appropriate balance of profit between shareholders and staff, key balance sheet metrics, share price performance, the quality of profits and future risks as well as the competitive environment.
OUR APPROACH TO REMUNERATION FOR 2011 The changes at Board level, including my appointment as Chairman of this Committee, provided us with an excellent opportunity to review the structure and quantum of our remuneration. This review included an open and transparent dialogue with shareholders and I intend to maintain the renewed commitment to shareholder engagement that we have demonstrated.
We are also proposing a change to the delivery of remuneration and shareholders will be asked at the annual general meeting to approve a resolution to use newly issued shares to settle deferred bonus and LTIP awards, rather than market purchased shares. In response to concerns about the level of risk in the banking sector, we believe that this is an effective way of improving our capital position.
– Our approach is fully aligned with the FSA Remuneration Code of Practice.
We therefore recommend this report to shareholders and ask for your support at the forthcoming annual general meeting.
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 2010.
The Committee’s terms of reference are available from the Company Secretary and are displayed on the Group’s website, www.lloydsbankinggroup.com. These terms were updated in January 2011 to ensure continued compliance with the FSA Code.
– Approval of remuneration and terms of service that fall within the Committee’s terms of reference, including new executive appointments
Economic profit is a key measure by which we manage our business. This measure takes into account the level of capital required to generate profits as well as the risks taken. The same level of profit generated at lower risk results in higher economic profit. Economic profit also measures risk based on an assessment of how the business will perform through the economic cycle.
For the 2010 annual incentive plan we increased the alignment to long-term prudent risk management by deferring 100 per cent of the award subject to malus over two years. If the performance is unsustainable during the deferral period some or all of the award may be forfeited.
SUMMARY Following extensive consultation with shareholders, the Remuneration Committee is proposing a package for Executive Directors for 2011 that is closely based on the structure and principles of 2010 as follows: Element Level/design for 2011 Key purpose
A higher award will be made to António Horta-Osório as detailed on page 129
From April 2012, any executive director in office at that time with a legacy final salary pension will move to a defined contribution pension arrangement
– If at the end of the fifth year of employment the aggregate percentage pension accrued is less than 26.5 per cent, he may accrue up to a further 4.5 per cent in the sixth year (to an overall maximum of 26.5 per cent of base salary) if the Average Share Price for that year exceeds 75p and up to a further 2 per cent if the Average Share Price for that year exceeds 114p.
Consistent with the aim of ensuring that short-term financial results are only rewarded if they promote sustainable growth, the 2010 annual incentive is subject to deferral in shares until at least March 2013. This deferred amount is subject to malus if the performance that generated the incentive is found to be unsustainable.
The key achievements of the Group are set out in the Group Chief Executive’s review on pages 8 and 9 of this Annual Report.
Addressing the key issues 10 marketplace trends 12 summary of Group results 14
Report of the independent auditors on the parent company financial statements 272 parent company financial statements 273 notes to the parent company financial statements 276 shareholder information 284
OTHER SHARE PLANS the executive directors are also eligible to participate in the Group’s ‘sharesave’ and ‘share incentive’ plans. these are ‘all-employee’ share plans.
CHAIRMAN’S REMUNERATION the chairman’s remuneration comprises salary and benefits. He does not participate in the annual bonus and long-term incentive arrangements, nor is he entitled to pension benefits.
INDEPENDENT NON-EXECUTIVE DIRECTORS’ FEES The fees of the Independent Non-Executive Directors are agreed by the Board within a total amount determined by the shareholders. Non-Executive Directors may also receive fees, agreed by the Board, for membership of Board Committees. The fees are designed to recognise the various responsibilities of a Non-Executive Director’s role and to attract individuals with relevant skills, knowledge and experience. The fees are neither performance related nor pensionable and are comparable with those paid by other companies. The annual fees were reviewed in 2010 and remain unchanged as listed below.
The cash column under ‘other benefits’ includes flexible benefits payments (4 per cent of basic salary), the tax planning allowance for Eric Daniels, payments to certain directors who elect to take cash rather than a company car under the car scheme and a spouse’s travel allowance for Truett Tate.
The disclosures in columns (a) to (d) are as required under section 421 of the Companies Act 2006.
The disclosures in columns (e) and (f) are as required by the UK Listing Authority listing rules. The requirements of the listing rules differ from those of the Companies Act. The listing rules require the additional pension earned over the year to be calculated as the difference between the pension accrued at the end of the financial year and the pension accrued at the start of the financial year less the increase in the pension earned over the year solely due to inflation. The transfer value in column (f) can differ significantly from the change in transfer value as required by the Companies Act because the additional pension accrued over the year calculated in accordance with the listing rules makes allowance for inflation, and the change in the transfer value required by the Companies Act will be significantly influenced by changes in the assumptions underlying the transfer value calculation at the beginning and end of the financial year.
Major changes to the legislation governing the provision of pensions in the UK (known as pension simplification) came into effect in April 2006. Benefits from an approved pension scheme will be limited to the Lifetime Allowance, currently £1.8 million which is equivalent to an annual pension of £90,000. Any benefit in excess of this amount will incur a tax charge for the individual. The Government has announced that the life time allowance will decrease to £1.5 million from April 2012. The Group has agreed that if an Executive Director has benefits in excess of the Lifetime Allowance they may cease to accrue benefits in the Scheme and receive a salary supplement as an alternative. This will not cost the Group more than the current arrangements. The Group will not compensate any individual in respect of any increased tax liability arising from pension simplification. To date, the Executive Directors affected have elected to continue to accrue benefits in the approved scheme.
i Options granted under these plans were adjusted on 13 August 2010, as a result of the capital raising activities of 2009. The adjustment was made using a standard HMRC formula, to negate the dilutionary impact of the capital raising events.
For the other 50 per cent of the award (the ‘TSR Award’) – the Group’s TSR needed to exceed the median of a comparator group (14 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award would vest where the Group’s TSR was equal to median and vesting would occur on a straight line basis in between these points. Where the Group’s TSR was below the median of the comparator group, the TSR Award would lapse. The relevant period commenced on 8 March 2007 (the date of award) and ended on 7 March 2010.
As indicated in last year’s report, and as a consequence of the Group’s non participation in GAPS, in June 2010 the Remuneration Committee determined that it was appropriate for the performance measures relative to those conditions to be restated: EPS Vesting % Growth in EPS
Economic Profit: Relevant to 36 per cent of the award. Performance will be measured based on the compound annual growth rate of adjusted Economic Profit over the three financial years starting on 1 January 2010 relative to 2009 adjusted Economic Profit base.
Alithos Limited provided information for the testing of the TSR performance conditions for the Company’s long-term incentive plan. EPS is the Group’s normalised earnings per share as shown in the Group’s report and accounts, subject to such adjustments as the Remuneration Committee regards as necessary for consistency.
Pension cost based on an average pension cost of 25 per cent of salary.
FINANCIAL STATEMENTS Report of the independent auditors on the consolidated financial statements 144
OPINION ON OTHER MATTERS PRESCRIBED BY THE COMPANIES ACT 2006 In our opinion: – the information given in the Directors’ Report for the financial year for which the group financial statements are prepared is consistent with the group financial statements; and – the information given in the Corporate Governance Statement set out on pages 114 to 123 with respect to internal control and risk management systems and about share capital structures is consistent with the financial statements.
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income (1,048) (530)
Trading and other financial liabilities at fair value through profit or loss 36 26,762 28,271
Movement in cash flow hedging reserve, net of tax – (86) – (86) – (86)
Balance at 1 January 2009: Prior year adjustment1 – 131 (131) – – –
(iii) IFRIC 17 Distributions of Non-cash Assets to Owners. Provides accounting guidance for non-reciprocal distributions of non-cash assets to owners (and those in which owners may elect to receive a cash alternative).
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2010 and which have not been applied in preparing these financial statements are given in note 58.
(A) CONSOLIDATION The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures.
Intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
Revenue recognition policies specific to life insurance and general insurance business are detailed below (see (O) below).
– where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise need to be separately accounted for.
The Group has entered into securitisation and similar transactions to finance certain loans and advances to customers. These loans and advances to customers continue to be recognised by the Group, together with a corresponding liability for the funding.
(6) Sale and repurchase agreements Securities sold subject to repurchase agreements (repos) continue to be recognised on the balance sheet where substantially all of the risks and rewards are retained. Funds received under these arrangements are included in deposits from banks, customer deposits, or trading liabilities. Conversely, securities purchased under agreements to resell (reverse repos), where the Group does not acquire substantially all of the risks and rewards of ownership, are recorded as loans and receivables or trading securities. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method.
Impairment allowances are assessed individually for financial assets that are individually significant. Such individual assessment is used primarily for the Group’s wholesale lending portfolios in the Wholesale and Wealth and International divisions. Impairment allowances for portfolios of smaller balance homogenous loans such as most residential mortgages, personal loans and credit card balances in the Group’s retail portfolios in both the Retail and Wealth and International divisions that are below the individual assessment thresholds, and for loan losses that have been incurred but not separately identified at the balance sheet date, are determined on a collective basis.
INDIVIDUAL ASSESSMENT In respect of individually significant financial assets in the Group’s wholesale lending portfolios, assets are reviewed on a regular basis and those showing potential or actual vulnerability are placed on a watch list where greater monitoring is undertaken and any adverse or potentially adverse impact on ability to repay is used in assessing whether an asset should be transferred to a dedicated Business Support Unit. Specific examples of trigger events that would lead to the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of additional impairment allowances) include (i) trading losses, loss of business or major customer of a borrower, (ii) material breaches of the terms and conditions of a loan facility, including non-payment of interest or principal, or a fall in the value of security such that it is no longer considered adequate, (iii) disappearance of an active market because of financial difficulties, or (iv) restructuring a facility with preferential terms to aid recovery of the lending (such as a debt for equity swap).
For unsecured personal lending portfolios, the impairment trigger is generally when the balance is two or more instalments in arrears or where the customer has exhibited one or more of the impairment characteristics noted above. While the trigger is based on the payment performance or circumstances of each individual asset, the assessment of future cash flows uses historical experience of cohorts of similar portfolios such that the assessment is considered to be collective. Future cash flows are estimated on the basis of the contractual cash flows of the assets in the cohort and historical loss experience for similar assets. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.
The collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been identified at the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. An assessment is made, based on statistical techniques, of the likelihood of each account becoming recognised as impaired within an emergence period, with the economic loss that each portfolio is likely to generate were it to become impaired. The emergence period is the time between the loss event and the date the impairment is recognised. The emergence period is determined by local management for each portfolio. In general the periods used across the Group vary between one month and twelve months based on historical experience.
(2) As lessor Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee but not necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments, together with any unguaranteed residual value, is recognised as a receivable, net of provisions, within loans and advances to
The Group’s balance sheet includes the net surplus or deficit, being the difference between the fair value of scheme assets and the discounted value of scheme liabilities at the balance sheet date adjusted for any cumulative unrecognised actuarial gains or losses. Surpluses are only recognised to the extent that they are recoverable through reduced contributions in the future or through refunds from the schemes.
(M) SHARE-BASED COMPENSATION The Group operates a number of equity-settled, share-based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting period, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated as non-vesting conditions and in accordance with IFRS 2 (Revised) the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement over any remaining vesting period.
or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax is determined using tax rates that have been enacted or substantially enacted by the balance sheet date which are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
Non-participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for claims incurred but not reported at the balance sheet date. Claims liabilities are not discounted.
Given the relative size of the mortgage portfolio, a key variable is UK house prices which determine the collateral value supporting loans in such portfolios. The value of this collateral is estimated by applying changes in house price indices to the original assessed value of the property. If average house prices were 10 per cent lower than those estimated at 31 December 2010, the Retail division’s impairment charge would increase by approximately £250 million.
In addition, a collective unimpaired provision is made for loan losses that have been incurred but have not been separately identified at the balance sheet date. This provision is sensitive to changes in the time between the loss event and the date the impairment is specifically identified. This period is known as the loss emergence period. In the Wholesale division, an increase of one month in the loss emergence period in respect of the loan portfolio assessed for collective unimpaired provisions would result in an increase in the collective unimpaired provision of approximately £333 million.
UNWIND OF HBOS ACQUISITION FAIR VALUE ADJUSTMENTS The acquisition of HBOS in January 2009 required the Group to recognise the identifiable assets acquired and liabilities assumed at their acquisition-date fair values. The overall effect was to increase the book value of HBOS’s net assets by £1,241 million primarily reflecting a reduction in the value of HBOS’s debt securities and subordinated liabilities of £15,439 million, partially offset by a reduction in the carrying value of HBOS’s loans and receivables of £14,880 million, including loans and advances to customers of £13,512 million (see note 14).
In the periods subsequent to the acquisition, many of the fair value adjustments unwind and are recognised in the Group’s income statement. The fair value adjustments made to debt securities and subordinated liabilities unwind over the expected remaining life of the related securities except in the event that the liability is extinguished, in which case the remaining unamortised fair value adjustment is recognised in the income statement immediately. The fair value adjustment relating to loans and receivables broadly comprises two elements; an element reflecting expected future impairment losses at the date of acquisition and an element reflecting market liquidity. The element relating to market liquidity unwinds to the income statement over the estimated useful lives of the related assets. However, significant management judgement is required to determine the timing of the unwind of the element relating to future credit losses. This includes the identification of losses which were expected at the date of acquisition and assessing whether anticipated losses will still be incurred. In 2010, a net credit of £3,118 million to the income statement relates to the unwind of HBOS acquisition fair value adjustments. Of that amount, £2,229 million relates to impairment losses incurred which were expected at the date of acquisition and £845 million relates to a reassessment of future credit losses.
Lloyds Banking Group provides a wide range of banking and financial services in the UK and in certain locations overseas.
Wealth and International was created in 2009 to give increased focus and momentum to the Group’s private banking and asset management activities and to closely co-ordinate the management of its international businesses. Wealth comprises the Group’s private banking, wealth and asset management businesses in the UK and overseas. International comprises corporate, commercial, asset finance and retail businesses, principally in Australia and Continental Europe.
Other income (net of fee and commission expense) 1,607 4,136 1,160 2,814 447 10,164
Other segment items reflected in income statement above: Increase in value of in-force business – – 2 787 – 789
Share of results of joint ventures and associates (6) (720) (21) (22) 2 (767)
Profit (loss) before tax and fair value unwind 975 (11,600) (3,298) 1,024 499 (12,400)
Customer goodwill payments provision and loss on disposal of businesses Fair value unwind Reported basis £m £m £m £m £m £m £m
There was no individual non-UK country contributing more than 5 per cent of total income or total assets.
Net expense arising on liabilities held at fair value through profit or loss – debt securities in issue (231) (125)
GAINS ON CAPITAL TRANSACTIONS During 2010 and 2009, as part of the Group’s management of capital, the Group exchanged certain existing subordinated debt securities for new securities. These exchanges resulted in a gain on extinguishment of the existing liabilities of £423 million (2009: £1,498 million), being the difference between the carrying amount of the securities extinguished and the fair value of the new securities issued together with related fees and costs.
In addition, during May and June 2010 the Group completed the exchange of a number of outstanding capital securities issued by Lloyds Banking Group plc and certain of its subsidiaries for ordinary shares in Lloyds Banking Group plc, generating additional core tier 1 capital for the Group. The securities subject to exchange were cancelled, generating a total profit of £318 million for the Group.
The average number of persons on a headcount basis employed by the Group during the year was as follows: Following changes by the Group to the terms of its defined benefit pension schemes, all future increases to pensionable salary will be capped each year at the lower of: Retail Prices Index inflation; each employee’s actual percentage increase in pay; and 2 per cent of pensionable pay. In addition to this, during the second half of the year there was a change in commutation factors in certain defined benefit schemes. The combined effect of these changes is a reduction in the Group’s defined benefit obligation of £1,081 million and a reduction in the Group’s unrecognised actuarial losses of £171 million, resulting in a net curtailment gain of £910 million recognised in the income statement and a reduction in the balance sheet liability. £52 million of the impairment of tangible fixed assets relates to integration activities.
The following types of services are included in the categories listed above: Audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with regulatory filings. Other services supplied pursuant to legislation relate primarily to the costs associated with the Sarbanes-Oxley Act audit requirements together with the cost of the audit of the Group’s Form 20-F filing. Audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of prospectuses and circulars required by the UKLA listing rules. Services relating to taxation: This category includes tax compliance and tax advisory services.
Audits of the unconsolidated Open Ended Investment Companies managed by the Group 0.8 0.6
The table below sets out the fair value of the identifiable net assets acquired.
The (charge) credit for tax on the profit for 2010 and 2009 is based on a UK corporation tax rate of 28.0 per cent. The above income tax (charge) credit is made up as follows: £m £m
Tax charge thereon at UK corporation tax rate of 28.0 per cent (2009: 28.0 per cent) (79) (292)
Tax (charge) credit on profit on ordinary activities (539) 1,911 17 EARNINGS PER SHARE
Asset-backed securities: Corporate and other debt securities 4,919 16,190 21,109 3,097 17,571 20,668
The Group holds derivatives as part of the following strategies: – Customer driven, where derivatives are held as part of the provision of risk management products to Group customers; – To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by the Group is to utilise a combination of fair value, cash flow and net investment hedge approaches as described in note 56; and
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £4,185 million (2009: £4,188 million). Collateral is held with a fair value of £3,909 million (2009: £4,167 million), all of which the Group is able to repledge.
Total loans and advances to customers before allowance for impairment losses 610,970 641,770
Lloyds Banking Group Annual Report and Accounts 2010 21 LOANS AND ADVANCES TO CUSTOMERS continued
COVERED BOND PROGRAMMES Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of covered bonds by the Group. The Group retains all of the risks and rewards associated with these loans and the partnerships are consolidated fully with the loans retained on the Group’s balance sheet and the related covered bonds in issue included within debt securities in issue.
The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to securitisation and the carrying value of the notes in issue at 31 December, are listed below. The notes in issue are reported in note 37.
Debt securities classified as loans and receivables: Asset-backed securities 1,448 – 6,957 – 8,405
OTHER SPECIAL PURPOSE ENTITIES During 2009, the Group established Lloyds TSB Pension ABCS (No 1) LLP and Lloyds TSB Pension ABCS (No 2) LLP and transferred approximately £5 billion of assets, primarily comprising notes in certain of the Group’s securitisation programmes, in aggregate to these entities. Further details are provided in note 43.
In 2009, the markets in which the Consumer Finance unit of Asset Finance operates had deteriorated further with both macroeconomic and market conditions worsening, leading to a fall off in demand and increasing arrears. This, together with continuing uncertainties over the likely short-term macroeconomic environment, had resulted in a reassessment of the carrying value of the consumer finance cash generating unit and the recognition of a goodwill impairment charge of £240 million during 2009, reflecting the write down of the entire balance of goodwill allocated to the Consumer Finance unit of Asset Finance and leaving goodwill of £170 million in the Autolease unit of Asset Finance.
Lloyds Banking Group Annual Report and Accounts 2010 30 VALUE OF IN-FORCE BUSINESS continued
Movement in the value of in-force business taken to income statement (note 9) 789 1,169
A market consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. The risk-free rate used for the value of financial options and guarantees is defined as the spot yield derived from the relevant government bond yield curve in line with FSA realistic balance sheet assumptions. Further information on options and guarantees can be found on page 107.
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds. The value of the in-force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of these corporate bond holdings. The illiquidity premium is estimated to be 75 basis points as at 31 December 2010 (31 December 2009: 75 basis points).
NON-ECONOMIC ASSUMPTIONS Future mortality, morbidity, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and on management’s view of future experience. These assumptions are intended to represent a best estimate of future experience.
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £11,112 million (2009: £35,504 million) and a fair value of £11,278 million (2009: £35,468 million).
Liabilities held at fair value through profit or loss (debt securities) 6,665 6,160
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements 14,612 21,389
Total debt securities in issue 228,866 233,502 38 LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS
Life insurance (see (1) below): Non-life insurance contracts (see (2) below): Reinsurance balances are reported within other assets (note 33).1
Change in liabilities charged to the income statement (note 10) 5,426 496 5,922 (177) 5,745
– Change in the assumption in respect of future mortality rates (£40 million increase)
Change in provision for unearned premiums charged to income statement (note 8) (171) (26) (197)
Liability recognised in the balance sheet 13 11 15 28 96 383 546
Change in unallocated surplus recognised in the income statement (note 10) (439) 318
Defined benefit schemes The Group has established a number of defined benefit pension schemes in the UK and overseas, the three most significant being the defined benefit sections of the Lloyds TSB Group Pension Schemes No’s 1 and 2 and the HBOS Final Salary Pension Scheme. These schemes provide retirement benefits calculated as a percentage of final salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2010 was generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
The Group currently expects to pay contributions of approximately £625 million to its defined benefit schemes in 2011.
Lloyds Banking Group Annual Report and Accounts 2010 43 RETIREMENT BENEFIT OBLIGATIONS continued £m £m
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 2010 is assumed to live for, on average, 27.2 years for a male and 28.3 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.
Increase (decrease) in the net defined benefit pension scheme asset £m £m £m £m
At 31 December 2010, the assumed discount rate is 5.5 per cent (31 December 2009 5.7 per cent).
The Finance (No. 2) Act 2010 includes legislation to reduce the main rate of corporation tax from 28 per cent to 27 per cent with effect from 1 April 2011. This resulted in a reduction in the Group’s net deferred tax asset at 31 December 2010 of £132 million.
The proposed further reductions in the rate of corporation tax by 1 per cent per annum to 24 per cent by 1 April 2014 are expected to be enacted separately each year starting in 2011. The effect of these further changes upon the Group’s deferred tax balances and leasing business cannot be reliably quantified at this stage.
In addition, deferred tax assets have not been recognised in respect of unrelieved foreign tax carried forward as at 31 December 2010 of £62 million (31 December 2009: £53 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised. These tax credits can be carried forward indefinitely.
CUSTOMER REMEDIATION PROVISIONS The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales, in those cases where the original sales processes have been found to be deficient. During 2010 management has again reviewed the adequacy of the provisions held having regard to current complaint volumes and the level of payments being made and £83 million has been charged to the income statement. At 31 December 2010 the remaining provisions held relate to past sales of a number of products, including mortgage endowment policies, sold through the branch networks.
Total preference shares 1,165 1,983 a 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. The holder of the 400 25p 6 per cent preference shares has waived its right to payment for the period from 1 March 2010 to 1 March 2012.
b As part of the Group’s recapitalisation and exit from the Government Asset Protection Scheme, following an exchange offer, on 1 December , 10 December and 15 December 2009, certain holders of certain series elected to exchange some or all of the preference shares they held for equity issued by Lloyds Banking Group plc on 18 February 2010.
Preferred securities 6.90% Perpetual Capital Securities (US$1,000 million) a, c 249 645 7.375% Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (€430 million) a, b 16 306 6.35% Step-up Perpetual Capital Securities callable 2013 (€500 million) a 241 456 7.834% Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015 (£250 million) a, b 4 43 4.385% Step-up Perpetual Capital Securities callable 2017 (€750 million) a, b 85 82 13.00% Step-up Perpetual Capital Securities callable 2019 (£784 million) a, b 10 9 13.00% Euro Step-up Perpetual Capital Securities callable 2019 (€532 million) b 56 47 12% Fixed to Floating Rate Perpetual Tier 1 Capital Securities callable 2024 (US$2,000 million) 1,288 1,235 13.00% Sterling Step-up Perpetual Capital Securities callable 2029 (£700 million) a, b 662 666 6.071% Non-cumulative Perpetual Preferred Securities of US$1,000 each (US$750 million) 336 240 6.85% Non-cumulative Perpetual Preferred Securities of US$1,000 each (US$1,000 million) c 107 –
Total preferred securities 4,538 5,078 a As part of the Group’s recapitalisation and exit from the Government Asset Protection Scheme, following an exchange offer, on 1 December 2009, 10 December and 15 December 2009 certain holders of certain series elected to exchange some or all of the notes they held for equity issued by Lloyds Banking Group plc on 18 February 2010.
b In November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to 31 January 2012.
Enhanced capital notes 7.5884% Enhanced Capital Notes due 2020 (Series 1) (£732 million) 694 690 7.8673% Enhanced Capital Notes due 2019 (Series 2) (£331 million) 336 316 7.975% Enhanced Capital Notes due 2024 (Series 3) (£102 million) 98 96 7.869% Enhanced Capital Notes due 2020 (Series 8) (£596 million) 589 572 8.875% Enhanced Capital Notes due 2020 (Series 12) (€125 million) 116 117 9.334% Enhanced Capital Notes due 2020 (Series 14) (£208 million) 233 218 6.439% Enhanced Capital Notes due 2020 (Series 15) (€710 million) 562 557 6.385% Enhanced Capital Notes due 2020 (Series 18) (€662 million) 525 517 11.04% Enhanced Capital Notes due 2020 (Series 19) (£736 million) 872 871 15% Enhanced Capital Notes due 2019 (Series 21) (£775 million) 1,145 1,125 15% Enhanced Capital Notes due 2019 (Series 22) (€487 million) 635 646 15% Enhanced Capital Notes due 2029 (Series 23) (£68 million) 111 108 9.125% Enhanced Capital Notes due 2020 (Series 27) (£148 million) 158 153 11.125% Enhanced Capital Notes due 2020 (Series 31) (£39 million) 45 45 7.375% Enhanced Capital Notes due 2020 (Series 32) (€95 million) 82 80
Subordinated Step-up Floating Rate Notes 2016 callable 2011 (£300 million) b 296 296 Subordinated Step-up Floating Rate Notes 2016 callable 2011 (€500 million) b 432 445 Callable Floating Rate Subordinated Notes 2016 (€500 million) b 401 374
5.374% Subordinated Fixed Rate Notes 2021 (€160 million) 139 132 6.45% Fixed/Floating Subordinated Guaranteed Bonds 2023 (€400 million) (Clerical Medical Finance plc) 173 171 7.07% Subordinated Fixed Rate Notes 2023 (€175 million) 162 128 5.75% Subordinated Step-up Notes 2025 callable 2020 (£350 million) 324 322 4.50% Fixed Rate Step-up Subordinated Notes due 2030 (€750 million) 463 478 7.625% Dated Subordinated Notes 2025 (£750 million) 763 – 6.00% Subordinated Notes 2033 (US$750 million) 275 477 Total dated subordinated liabilities 19,292 15,954 a Issued by a group undertaking under the Company’s subordinated guarantee.
Information regarding significant direct or indirect holdings of shares in the Company can be found on page 284.
In January 2010, the Company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital redemption reserve and a transfer of £11 million from the merger reserve to the share premium account. Details of the preference shares repurchased are set out in note 46. In December 2009, the Group redeemed eight issues of preference shares in exchange for the issuance of enhanced capital notes. This resulted in a transfer of £26 million from the merger reserve to the capital redemption reserve and a transfer of £2,684 million from the merger reserve to the share premium account.
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 Banking Group Share Incentive Plan (holding at 31 December 2010: 5,744,722 shares, at 31 December 2009: 3,028,623 shares, waived right to all dividends), the Lloyds TSB Group Employee Share Ownership Trust (holding at 31 December 2010: 283,109,984 shares, at 31 December 2009: 1,301,968 shares, waived right to all dividends), Lloyds TSB Group Holdings (Jersey) Limited (holding at 31 December 2010: 42,846 shares, at 31 December 2009: 42,846 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 2010: 1,398 shares, at 31 December 2009: 1,398 shares, waived right to all but a nominal amount of 1 penny in total).
The relevant period for the performance conditions began at the end of the financial year preceding the date of grant and continued until the end of the third subsequent year following commencement or, if not met, the end of such later year in which the conditions were met. Once the conditions were satisfied the options remained exercisable without further conditions. If they were not satisfied by the tenth anniversary of the grant the options would lapse.
FOR OPTIONS GRANTED FROM AUGUST 2001 TO AUGUST 2004 The performance condition was linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 17 companies including Lloyds Banking Group plc.
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.
Movements in the number of share options outstanding under the executive share option schemes during 2009 and 2010 are set out below: Weighted average Weighted average Number of exercise price Number of exercise price options (pence) options (pence)
Options granted under this plan were adjusted on 13 August 2010 as a result of the Capitalisation Issue, the Placing and Compensatory Open Offer and the Rights Issue of 2009. The adjustment was made using a standard Her Majesty’s Revenue & Customs (HMRC) formula, to negate the dilutionary impact of these corporate actions.
Options granted under this plan were adjusted on 2 July 2009 as a result of the Placing and Compensatory Open Offer and on 13 August 2010 as a result of the Capitalisation Issue and Rights Issue of 2009. The adjustments were made, where applicable, using a standard HMRC formula, to negate the dilutionary impact of these corporate actions.
No options were exercised during 2010 or 2009. The options outstanding under the HBOS Share Option Plan and St James’s Place Share Option Plan at 31 December 2010 had exercise prices in the range of £0.5183 to £8.7189 (2009: £1.05 to £17.576) and a weighted average remaining contractual life of 3.0 years.
The performance conditions for awards made in March and August 2007 are as follows: (i) For 50 per cent of the award (the EPS Award) – the percentage increase in earnings per share of the Group (on a compound annualised basis) over the relevant period needed to be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the Retail Prices Index over the same period. If it was less than 3 per cent per annum the EPS Award would lapse. If the increase was more than 3 per cent but less than 6 per cent per annum then the proportion of shares released would be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2007 and ended on 31 December 2009.
The performance conditions for awards made in March, April and August 2008 are as follows: (i) For 50 per cent of the award (the EPS Award) – the performance condition is as described for the 2007 awards with the relevant performance period commencing on 1 January 2008 and ending on 31 December 2010.
If the absolute improvement in adjusted Economic Profit reaches 100 per cent, 25 per cent of this element of the award, being the threshold, will vest. If the absolute improvement in adjusted Economic Profit reaches 202 per cent, 100 per cent of this element will vest.
The performance conditions for awards made in March and August 2010 are as follows: (i) EPS: relevant to 50 per cent of the award. Performance will be measured based on EPS growth over a three-year period from the baseline EPS of 2009.
The fair value of the share awards granted in 2010 was £0.61 (2009: £0.68).
Lloyds Banking Group Annual Report and Accounts 2010 52 SHARE-BASED PAYMENTS continued insurance were deducted from the bonus before deferral into the plan, where a match of performance shares was justified, these shares would have been awarded as if income tax and national insurance had not been deducted.
The performance condition attached to the March 2006 award was not met, with Lloyds Banking Group ranked in ninth place. Bonus shares were released on 20 March 2009, at which time the performance shares lapsed.
The table below details, on an aggregated basis, key management personnel compensation: £m £m
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 0.50 per cent and 17.90 per cent in 2010 (2009: 1.28 per cent and 24.90 per cent).
HM TREASURY In January 2009, HM Treasury became a related party of the Company following its subscription for ordinary shares issued under a placing and open offer. As at 31 December 2010, HM Treasury held a 41 per cent interest (December 2009: 43 per cent) in the Company’s ordinary share capital and consequently HM Treasury remained a related party of the Company throughout 2010.
Credit Guarantee Scheme HM Treasury launched the Credit Guarantee Scheme in October 2008 as part of a range of measures announced by the UK Government intended to ease the turbulence in the UK banking system. It charges a commercial fee for the guarantee of new short and medium-term debt issuance. The fee payable to HM Treasury on guaranteed issues is based on a per annum rate of 50 basis points plus the median five-year credit default swap spread. At 31 December 2010, the Group had £45,308 million (2009: £49,954 million) of debt issued under the Credit Guarantee Scheme. During 2010, the Group redeemed £4,987 million of bonds. The Group’s income statement includes fees of £454 million (2009: £498 million) payable to HM Treasury in respect of guaranteed funding.
Joint ventures and associates The Group provides both administration and processing services to its principal joint venture, Sainsbury’s Bank plc. The amounts receivable by the Group during the year were £31 million (2009: £34 million), of which £8 million was outstanding at 31 December 2010 (2009: £10 million). At 31 December 2010, Sainsbury’s Bank plc also had balances with the Group that were included in loans and advances to banks of £1,277 million (2009: £1,218 million) and deposits by banks of £1,358 million (2009: £1,405 million).
At 31 December 2010 there were loans and advances to customers of £5,660 million (2009: £12,235 million) outstanding and balances within customer deposits of £151 million (2009: £254 million) relating to other joint ventures and associates.
Lloyds Banking Group Annual Report and Accounts 2010 54 CONTINGENT LIABILITIES AND COMMITMENTS
PAYMENT PROTECTION INSURANCE There has been extensive scrutiny of the Payment Protection Insurance (PPI) market in recent years.
This legal challenge has affected the implementation of the Policy Statement, since the challenge has called into question the standards to be applied when assessing PPI complaints. As a result of that challenge, a large number of complaints cannot be decided until the outcome of the legal challenge is clear and implemented.
On 26 February 2009 a purported shareholder filed a derivative civil action in the Supreme Court of New York, Nassau County against certain current and former directors, and nominally against Lloyds TSB Bank plc and Lloyds Banking Group plc, seeking various forms of relief. The derivative action is at an early stage and settlement is being discussed and the ultimate outcome is not expected to have a material impact on the Group.
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: Mortgage offers made 8,113 9,058 1 year or over original maturity 47,515 53,693
Liabilities arising from non-participating investment contracts – – – – – – 51,363 51,363
Derivatives through profit or loss designated Designated Held at as hedging Held for upon initial Available- Loans and amortised Insurance instruments trading recognition for-sale receivables cost contracts Total £m £m £m £m £m £m £m £m
Items in course of transmission to banks – – – – – 1,037 – 1,037
Because a variety of estimation techniques are employed and significant estimates made, comparisons of fair values between financial institutions may not be meaningful. Readers of these financial statements are thus advised to use caution when using this data to evaluate the Group’s financial position.
HELD-TO-MATURITY INVESTMENTS The fair values of government securities are based on market prices.
Valuation of financial instruments carried at fair value The valuations of financial instruments have been classified into three levels according to the quality and reliability of information used to determine the fair values.
There were no significant transfers between level 1 and level 2 during the year.
– A number of earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before interest, tax, depreciation and amortisation. The particular multiple selected being appropriate for the type of business being valued and is derived by reference to the current market-based multiple. Consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple.
Derivatives Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include: – Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are developed from publicly quoted rates.
– Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available interest rate cap, interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more complex option products, the Group calibrates its models using observable at-the-money data; where necessary, the Group adjusts for out-of-the-money positions using a market standard consensus pricing service.
A Credit Valuation Adjustment (CVA) is applied to the Group’s over-the-counter uncollateralised derivative exposures to adjust the derivative valuations provided by standard interbank interest rate curves. The Group uses a bilateral simulation model to develop expected future exposures. This calculates a CVA for scenarios where the Group has a positive future exposure (asset) and a Debit Valuation Adjustment (DVA) where the Group has a negative future exposure (liability).
(ii) Uncollateralised derivative valuation adjustments – monoline counterparties The Group has no significant derivative exposures remaining against monoline counterparties as shown in note 56(3). The remaining valuation adjustment on these limited positions is shown in the table below.
No credit valuation adjustment is taken on collateralised swaps (31 December 2009: £25 million).
Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However, a significant proportion of the Group’s lending assets, for example many personal loans and mortgages, bear interest rates which are contractually fixed for periods of up to five years or longer.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 89.
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.
This represents the element of the charge on loans and advances to customers in HBOS’s results that was included within the Group’s fair value adjustments in respect of the acquisition of HBOS on 16 January 2009.
The Group operates schemes that allow customers to repay a monthly amount which is lower than their contractual monthly payment for a short period. These forbearance arrangements include short-term reduced or nil payment arrangements and transfers to interest only mortgages, as described on page 79. During the period of forbearance, there is no clearing down of arrears such that, unless the customer is paying more than their contractual minimum payment, arrears balances will remain and the loan will continue to be reported as impaired. When customers come to the end of their arrangement period they will continue to be managed as a mainstream collections case and if unable to recover then will move toward possession.
Under the Group’s contractual repayment scheme, also described on page 79, customers can have their arrears balance capitalised once they have demonstrated they can pay the original contractual minimum payment, but are unable to clear their arrears. This is usually demonstrated by the customer making six consecutive contractual monthly payments. Customers are not, however, able to recapitalise more than twice in a five year period. Such recapitalised loans are not considered to be impaired as the Group continues to expect to recover the original carrying amount of the loan. Consequently, recapitalised mortgages will return to the non-impaired book and will be managed in accordance with the recapitalised terms of the mortgage.
In addition, the Group participates in a number of UK Government sponsored programmes designed to support households, which are described on page 78. Where these schemes provide borrowers with a state benefit that is used to service the loan, there is no change in the reported status of the loan which is managed and reported in accordance with its original terms.
In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets held as collateral against wholesale lending. In such cases, the assets are carried on the Group’s balance sheet and are classified according to the Group’s accounting policies.
Analysis by loan-to-value ratio of the Group’s residential mortgage lending which is neither past due nor impaired: Less than 70 per cent 140,267 142,614 70 per cent to 80 per cent 57,979 54,079 80 per cent to 90 per cent 53,732 52,238
Lloyds Banking Group Annual Report and Accounts 2010 56 FINANCIAL RISK MANAGEMENT continued
Total other assets held at fair value through profit or loss 21,489 2,415 5,576 3,790 1,327 3,218 37,815
Asset-backed securities: Corporate and other debt securities – 439 823 69 306 986 2,623
Bank and building society certificates of deposit 22 499 452 22 19 – 1,014
Asset-backed securities: Corporate and other debt securities 2,002 7,342 8,802 1,350 228 180 19,904
Maturities of assets and liabilities 1 month months months years years Total £m £m £m £m £m £m
The principal amount for undated subordinated liabilities with no redemption option is included within the over five years column; interest of approximately £448 million (2009: £555 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond five years.
Further information on the Group’s liquidity exposures is provided on pages 93 to 97.
Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-day operations.
Lloyds Banking Group Annual Report and Accounts 2010 57 CONSOLIDATED CASH FLOW STATEMENT continued
Cash proceeds from issue of share capital: Placing and open offer – 4,430
Derivatives, trading and other financial liabilities at fair value through profit or loss – (62,158)
Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 (8) (35)
Requires additional disclosures in respect of risk exposures arising from transferred financial assets.
Amendments to IAS 12 Income Taxes – ‘Deferred Tax: Recovery of Underlying Assets’
Introduces a rebuttable presumption that investment property measured at fair value is recovered entirely through sale and that deferred tax in respect of such investment property is recognised on that basis.
IFRS 9 is the initial stage of the project to replace IAS 39. Future stages are expected to result in amendments to IFRS 9 to deal with changes to the impairment of financial assets measured at amortised cost and hedge accounting. Until all stages of the replacement project are complete, it is not possible to determine the overall impact on the financial statements of the replacement of IAS 39. The effective date of the standard is annual periods beginning on or after 1 January 2013.
The consolidated financial statements were approved by the directors of Lloyds Banking Group plc on 24 February 2011.
OPINION ON OTHER MATTERS PRESCRIBED BY THE COMPANIES ACT 2006 In our opinion: – the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and
Sir Winfried Bischoff J Eric Daniels Tim J W Tookey Chairman Group Chief Executive Group Finance Director
Employee share option schemes: Value of employee services – – – 74 74
PARENT COMPANY CASH FLOW STATEMENT at 31 December 2010 £ million £ million
Details of the Company’s share capital and share premium account are as set out in notes 47 and 48 to the consolidated financial statements.
The derivative assets designated as hedging instruments represent level 2 portfolios. Of derivative assets classified as held for trading (not being designated as hedging instruments) shown above, £157 million (31 December 2009: £120 million) represents level 2 portfolios and £1,177 million (31 December 2009: £1,797 million) represents level 3 portfolios. The level 3 derivatives reflect the value of the equity conversion feature of the Enhanced Capital Notes issued in December 2009 as part of Lloyds Banking Group’s recapitalisation and exit from the Government Asset Protection Scheme.
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £302 million (2009: £282 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years.
SHARE PRICE INFORMATION 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.
SHAREHOLDER ENQUIRIES The Company’s share register and the Lloyds Banking Group Shareholder Account are maintained by Equiniti Limited. Contact them if you have enquiries about your Lloyds Banking Group shareholding, including those concerning the following matters: – Change of name or address
Equiniti operates a web based enquiry and portfolio management service for you to receive shareholder communications electronically. You can change your address or bank details either by telephone or online. Additionally you can register proxy appointments and voting instructions on your shareholding online. Visit www.shareview.co.uk for details.
Calls to 09058 and 0871 numbers are charged at 55p and 8p per minute, respectively, from a BT landline. The price of calls from mobiles and other networks may vary. Calls from outside the United Kingdom are charged at applicable international rates. The call prices we have quoted were correct in February 2011.
Arrears A customer is in arrears when they are behind in fulfilling their obligations with the result that an outstanding loan is unpaid or overdue. Such a customer is also said to be in a state of delinquency. When a customer is in arrears, the entire outstanding balance is said to be delinquent, meaning that delinquent balances are the total outstanding loans on which payments are overdue.
Core Tier 1 capital As defined by the FSA mainly comprising shareholders’ equity and equity non-controlling interests after deducting goodwill, other intangible assets and other regulatory deductions. Further details are given in the Capital Risk section on page 97.
Core Tier 1 ratio Core Tier 1 capital as a percentage of risk weighted assets.
Enhanced Capital Notes (ECNs) The Group’s ECN’s are subordinated notes issued by the Group that contain an embedded equity conversion feature. Further details of these are given in note 46.
Credit enhancement facilities are used to enhance the creditworthiness of financial obligations and cover losses due to asset default. Two general types of credit enhancement are third-party loan guarantees (such as guaranteed mortgages) and self-enhancement through overcollateralisation (in the case of covered bonds). Liquidity enhancement makes funds available if required, for other reasons than asset default, eg to ensure timely repayment of maturing commercial paper.
Loss given default (LGD) The estimated loss that will arise if a customer defaults. It is calculated after taking account of credit risk mitigation and includes the cost of recovery.
Net Interest Income The difference between interest received on assets and interest paid on liabilities.
Student loan related assets Assets which are referenced to underlying student loans. (See note 56).
Value at Risk Value at Risk is an estimate of the potential loss in earnings which might arise from market movements under normal market conditions, if the current positions were to be held unchanged for one business day, measured to a confidence level of 95 per cent.
Wrapped loans and bonds If a loan or bond (usually an ABS security) is originally issued with a credit default swap already attached, the package is called a ‘wrapped bond’ or ‘wrapped loan’. The Group’s exposure to wrapped loans and bonds is set out in note 56.
CASH FLOW STATEMENT Consolidated 152 Notes to the consolidated financial statements 265 Parent company 275
DERIVATIVE FINANCIAL INSTRUMENTS Accounting policy 157 Notes to the consolidated financial statements 184 Valuation 244
TAXATION Accounting policy 161 Critical accounting estimates and judgements 166 Notes to the consolidated financial statements 181, 213