NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) – Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources. – Credit derivatives which are valued using standard models with observable inputs, except for the items classified as level 3, which are valued using publicly available yield and credit default swap (CDS) curves. – 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 one per cent rise in the CDS spread would lead to an increase in the DVA of £122 million to £207 million.
The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise. A 1 per cent rise in interest rates would lead to a £183 million fall in the overall valuation adjustment to £300 million. The CVA model used by the Group does not assume any correlation between the level of interest rates and default rates.
The Group has also recognised a Funding Valuation Adjustment to adjust for the net cost of funding certain uncollateralised derivative positions where the Group considers that this cost is included in market pricing. This adjustment is calculated on the expected future exposure discounted at a suitable cost of funds. A ten basis points increase in the cost of funds will increase the funding valuation adjustment by approximately £7 million.
Unlisted equity, venture capital investments and investments in property partnerships The valuation techniques used for unlisted equity and venture capital investments vary depending on the nature of the investment. Reasonably possible alternative valuations for these investments have been calculated by reference to the approach taken, as appropriate to the business sector and investment circumstances and as such the following inputs have been considered: – for valuations derived from earnings multiples, consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple; – the discount rates used in discounted cash flow valuations; and – in line with International Private Equity and Venture Capital Guidelines, the values of underlying investments in fund investments portfolios.
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) (4) FINANCIAL ASSETS AND LIABILITIES CARRIED AT AMORTISED COST
At 31 December 2014 Loans and receivables: Loans and advances to customers: unimpaired 472,036 – – 472,036 Loans and advances to customers: impaired 8,595 – – 8,595 Loans and advances to customers 480,631 – – 480,631 Loans and advances to banks 26,031 – – 26,031
Reverse repos included in above amounts: Loans and advances to customers 5,148 – – 5,148 Loans and advances to banks 1,899 – – 1,899
Reverse repurchase agreements The carrying amount is deemed a reasonable approximation of fair value given the short‑term nature of these instruments.
(5) RECLASSIFICATION OF FINANCIAL ASSETS No financial assets have been reclassified in 2014 or 2013.
The table below sets out the carrying values of the transferred assets and the associated liabilities. For repurchase and securities lending transactions, the associated liabilities represent the Group’s obligation to repurchase the transferred assets. For securitisation programmes, the associated liabilities represent the external notes in issue (note 32). Except as otherwise noted below, none of the liabilities shown in the table below have recourse only to the transferred assets.
Loans and receivables: Loans and advances to customers 75,970 11,908 80,878 18,613
Trading and other financial assets at fair value through profit or loss: Loans and advances to banks: Loans and advances to customers: Available‑for‑sale financial assets 56,493 – 56,493 – (10,299) 46,194
Trading and other financial liabilities at fair value through profit or loss:
NOTE 54: FINANCIAL RISK MANAGEMENT As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.
In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the commercial business. Note 16 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2014 was £518,746 million (2013: £559,690 million) with a net fair value liability of £930 million (2013: liability of £1,347 million) (note 16). In 2014, ineffectiveness recognised in the income statement that arises from cash flow hedges was a gain of £56 million (2013: loss of £60 million).
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) CREDIT RISK The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom. Credit risk appetite is set at Board level and is described and reported through a suite of metrics devised from a combination of accounting and credit portfolio performance measures, which include the use of various credit risk rating systems as inputs and measure the credit risk of loans and advances to customers and banks at a counterparty level using three components: (i) the probability of default by the counterparty on its contractual obligations; (ii) the current exposures to the counterparty and their likely future development, from which the Group derives the exposure at default; and (iii) the likely loss ratio on the defaulted obligations, the loss given default. The Group uses a range of approaches to mitigate credit risk, including internal control policies, obtaining collateral, using master netting agreements and other credit risk transfers, such as asset sales and credit derivative based transactions.
Loans and receivables: Loans and advances to banks, net1 26,155 – 26,155 25,365 – 25,365
Assets arising from reinsurance contracts held 682 – 682 732 – 732
Performance bonds and other transaction‑related contingencies 2,293 – 2,293 1,966 – 1,966
At 31 December 2014 the most significant concentrations of exposure were in mortgages (comprising 68 per cent of total loans and advances to customers) and to financial, business and other services (comprising 9 per cent of the total). For further information on concentrations of the Group’s loans, refer to note 18.
Total loans and advances which are neither past due nor impaired 25,219 318,668 36,789 107,764 463,221 29,443
The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and commercial are not the same, reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Commercial lending has been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models. Further information about the Group’s internal probabilities of default rating models can be found on page 117.
Loans and advances designated at fair value through profit or loss £m
Total loans and advances which are past due but not impaired 152 10,311 674 488 11,473 –
Total loans and advances which are past due but not impaired 146 12,329 580 786 13,695 –
Total debt securities held at fair value through profit or loss 39,329 583 1,927 41,839
Total debt securities held at fair value through profit or loss 36,496 619 1,738 38,853
At 31 December 2014 70 per cent to 80 per cent 58,837 1,998 726 61,561 80 per cent to 90 per cent 32,771 1,526 702 34,999 90 per cent to 100 per cent 15,858 1,005 486 17,349
Unimpaired non‑mortgage retail lending amounted to £38,560 million (2013: £37,369 million). Lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the time of loan origination and are thereafter monitored in accordance with business unit credit policy.
Impaired secured lending The value of collateral is re‑evaluated and its legal soundness re‑assessed if there is observable evidence of distress of the borrower; this evaluation is used to determine potential loss allowances and management’s strategy to try to either repair the business or recover the debt.
At 31 December 2014, impaired secured commercial lending amounted to £2,539 million, net of an impairment allowance of £3,799 million (2013: £9,845 million, net of an impairment allowance of £11,063 million). The fair value of the collateral held in respect of impaired secured commercial lending was £2,517 million (2013: £6,915 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation. For the purposes of determining the total collateral held by the Group in respect of impaired secured commercial lending,
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over‑collateralisation and to provide a clearer representation of the Group’s exposure.
Lending decisions in respect of irrevocable loan commitments are based on the obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. For commercial commitments, it is the Group’s practice to request collateral whose value is commensurate with the nature of the commitment. For retail mortgage commitments, the majority are for mortgages with a loan‑to‑value ratio of less than 100 per cent. Aggregated collateral information covering the entire balance of irrevocable loan commitments over which security will be taken is not provided to key management personnel.
Securities lending transactions The following financial assets on the balance sheet have been pledged as collateral as part of securities lending transactions: 2014 £m 2013 £m
Securitisations and covered bonds In addition to the assets detailed above, the Group also holds assets that are encumbered through the Group’s asset‑backed conduits and its securitisation and covered bond programmes. Further details of these assets are provided in notes 19 and 20.
For exposures that are judged to be impaired, provisions are determined through modelling the expected cure rates, write‑off propensity and cash flows with segments explicitly relating to repayment plans and refinance loans treatments. Payments of less than the monthly contractual amount are reflected in reduced cash flow forecasts when calculating the impairment allowance for these accounts.
The outputs of the models are monitored and challenged on an ongoing basis. The models are run monthly meaning that current market conditions and customer processes are reflected in the output. Where the risks identified are not captured in the underlying models, appropriate additional provisions are made.
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Consumer Finance At 31 December 2014, Consumer credit card advances currently or recently subject to forbearance were 2.6 per cent (31 December 2013: 3.7 per cent) of total Consumer credit card advances. At 31 December 2014, Asset Finance retail loans and advances on open portfolios currently or recently subject to forbearance were 2.1 per cent (31 December 2013: 4.0 per cent) of total Asset Finance loans and advances. Further analysis of the forborne loans and advances is set out below: Total loans and advances which are currently or recently forborne
Consumer Credit Cards and Asset Finance forborne loans have reduced in 2014 by £92 million and £40 million respectively, driven primarily by improvements in the underlying quality of the portfolios. The movements in forborne loans and advances during the year were as follows: Consumer credit cards £m Asset Finance1 £m
Impairment provisions as % of loans and advances which are currently or recently forborne 2014 £m 2013 £m 2014 £m 2013 £m
Depending on circumstances and when operated within robust parameters and controls, the Group believes forbearance can help support the customer in the short to medium‑term. The Group expects to have unimpaired forborne assets within its portfolios, although the majority of these cases will be managed in the Business Support Unit, where more intensive management and monitoring is available.
Any concession granted to a customer is reviewed and must be approved by Risk. If Risk determine that the customer is in, or about to be in, financial difficulty, then any concession granted outside the Group’s current risk appetite is treated as forbearance and in most cases, the obligor is transferred to Business Support Unit (BSU).
All non‑retail impaired assets are considered as having been granted some form of forbearance. Impaired loans and advances exist only in the BSU within Commercial Banking Division; and Run‑off Division.
A portfolio approach is taken for SME customers with exposures below £1 million managed in BSU. All customers with exposures below £1 million are reported as forborne whilst they are managed by BSU (whether impaired or unimpaired).
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) All reviews performed in the good book, Business Support Unit within Commercial Banking or in the Run‑off division include analysis of latest financial information, a consideration of the market and sector the customer operates in, performance against plan and revised terms and conditions granted as part of the forbearance concession.
Once a customer evidences acceptable performance over a period of time (of not less than the minimum cure period), the customer may be returned to the mainstream good classification and would no longer be considered forborne. It is important to note that such a decision can be made only by the independent Risk Division.
The table below sets out the largest unimpaired forborne loans and advances to customers in Run‑off corporate real estate, other corporate and Specialist Finance (exposures over £5 million) as at 31 December 2014 by type of forbearance, together with a breakdown of exposures classified as Direct Real Estate: Direct Real Estate £m
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Run off: Ireland commercial real estate and corporate All loans and advances in (whether impaired or unimpaired) are treated as forborne.
Loans and advances to banks 10,709 4,926 3,107 1,274 1,170 1,107 2,579 1,283 26,155
Trading and other financial assets at fair value through profit or loss 15,874 6,966 5,868 3,892 2,630 5,601 2,989 98,863 142,683
Loans and advances to banks 11,853 5,980 3,310 553 1,038 344 1,827 460 25,365
Available‑for‑sale financial assets 139 642 26 390 142 1,933 2,932 37,772 43,976
Liabilities arising from non‑participating investment contracts 27,590 – – – – 27,590
Derivative financial liabilities: Gross settled derivatives – net flows 765 2,356 1,048 1,461 1,142 6,772
The Group’s financial guarantee contracts are accounted for as financial instruments and measured at fair value on the balance sheet. The majority of the Group’s financial guarantee contracts are callable on demand, were the guaranteed party to fail to meet its obligations. It is, however, expected that most guarantees will expire unused. The contractual nominal amounts of these guarantees totalled £7,161 million at 31 December 2014 (2013: £8,591 million) with £4,133 million expiring within one year; £1,823 million between one and three years; £674 million between three and five years; and £531 million over five years (2013: £4,233 million expiring within one year; £837 million between one and three years; £2,039 million between three and five years; and £1,482 million over five years).
NOTE 55: CONSOLIDATED CASH FLOW STATEMENT (CONTINUED) (C) NON-CASH AND OTHER ITEMS
These OEICs (Open‑ended investment companies) are mutual funds which are consolidated if the Group manages the funds and also has a majority beneficial interest. The population of OEICs to be consolidated varies at each reporting date as external investors acquire and divest holdings in the various funds. The consolidation of these funds is effected by the inclusion of the fund investments and a matching liability to the unitholders; and changes in funds consolidated represent a non‑cash movement on the balance sheet.
Trading and other assets at fair value through profit or loss 11 35,159 –
The hedge accounting requirements of IFRS 9 are more closely aligned with risk management practices and follow a more principle‑based approach than IAS 39. The revised requirements are not expected to have a significant impact on the Group.
Replaces IAS 18 Revenue and IAS 11 Construction Contracts. IFRS 15 establishes principles for reporting useful information about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. Revenue is recognised at an amount that reflects the consideration to which the entity expects to be entitled in exchange for goods and services. Financial instruments, leases and insurance contracts are out of scope and so this standard is not expected to have a significant impact on the Group.
The directors approved the parent company financial statements on 26 February 2015.
Value of employee services: Share option schemes – – – 116 116 – 116
NOTE 2: DEFERRED TAX ASSET The movement in the net deferred tax asset is as follows: £m £m
NOTE 3: AMOUNTS DUE FROM SUBSIDIARIES These comprise short-term lending to subsidiaries, repayable on demand. The fair values of amounts owed by subsidiaries are equal to their carrying amounts. No provisions have been recognised in respect of amounts owed by subsidiaries.
There were no movements in other reserves in 2014, 2013 or 2012.
Details of the Company’s dividends are as set out in note 47 to the consolidated financial statements.
NOTE 9: RELATED PARTY TRANSACTIONS In January 2009 HM Treasury became a related party of the Company and has remained so during 2013 and 2014. From 1 January 2011, in accordance with IAS 24, UK Government-controlled entities also became related parties of the Group. Further information on the relationship and transactions with HM Treasury and UK Government-controlled entities is given in note 49 to the consolidated financial statements.
GUARANTEES The Company guarantees certain of its subsidiaries’ liabilities to the Bank of England.
MEASUREMENT BASIS OF FINANCIAL ASSETS AND LIABILITIES The accounting policies in note 2 to the consolidated financial statements describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the Company’s financial assets and liabilities by category and by balance sheet heading.
NOTE 10: FINANCIAL INSTRUMENTS (CONTINUED) INTEREST RATE RISK AND CURRENCY RISK The Company is exposed to interest rate risk and currency risk on its debt securities in issue and its subordinated debt.
CREDIT RISK The majority of the Company’s credit risk arises from amounts due from its wholly owned subsidiary, Lloyds Bank plc, and subsidiaries of that company.
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £1 million (2013: £1 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years. 10 FINANCIAL INSTRUMENTS
Lloyds Banking Group Annual Report and Accounts 2014 333BECOMING THE BEST BANK FOR CUSTOMERS
REPORTS AND COMMUNICATIONS The Group issues regulatory announcements through the Regulatory News Service (RNS); shareholders can subscribe for free via the ‘Investors & Performance’ section of our website at www.lloydsbankinggroup.com, where you can also find our statutory reports and shareholder communications. A summary of these are listed below: Available format
SHARE PRICE INFORMATION Shareholders can access both the latest and historical share prices via our website at www.lloydsbankinggroup.com as well as listings in most national newspapers. For a real time buying or selling price, you will need to contact a stockbroker, or you can contact the share dealing providers detailed above.
INDIVIDUAL SAVINGS ACCOUNTS (ISAs) There are a number of options for investing in Lloyds Banking Group shares through an ISA. For details of services and products provided by the Group please contact: Bank of Scotland Share Dealing, Halifax Share Dealing or Lloyds Bank Direct Investments using the contact details above.
SECURITY – SHARE FRAUD AND SCAMS Shareholders should exercise caution when unsolicited callers offer the chance to buy or sell shares with promises of huge returns. If it sounds too good to be true, it usually is and we would ask that shareholders take steps to protect themselves. We strongly recommend seeking advice from an independent financial adviser authorised by the Financial Conduct Authority (FCA). Shareholders can verify whether a firm is authorised via the Financial Services Register which is available at www.fca.org.uk
Shareholder helpline 0871 384 2990* from within the UK, 0871 384 2255 Textphone +44 121 415 7066 from outside the UK *Lines are open 8.30 am to 5.30 pm, Monday to Friday, Calls cost 8p per minute plus network extras. Calls to +44 121 415 7066 from outside the UK are charged at applicable international rates.
Lloyds Banking Group Annual Report and Accounts 2014 335BECOMING THE BEST BANK FOR CUSTOMERS
Write downs The depreciation or lowering of the value of an asset in the books to reflect a decline in their value, or expected cash flows.
DISCLOSURES ARISING FROM ENHANCED DISCLOSURE TASK FORCE (EDTF) RECOMMENDATIONS The 32 recommendations listed below are made in the report ‘Enhancing the Risk Disclosures of Banks’ issued by the Enhanced Disclosure Task Force of the Financial Stability Board on 29 October 2012.
Funding 19 Tabulate encumbered and unencumbered assets by balance sheet categories 151-152 20 Tabulate consolidated total assets, liabilities and off-balance sheet commitments by remaining contractual maturity at the balance sheet date. 149, 315-317 21 Discuss the bank’s funding strategy, including key sources and any funding concentrations. 147-150 Market risk 22 Describe linkages between line items in the balance sheet with positions included in the traded and non-traded market risk disclosures.
Other 31 Describe ‘other risk’ types and discuss how each one is identified, governed, measured and managed. 136-137, 166-170 32 Discuss publicly known risk events related to other risks. 136-137, 166-170