AnnuAl RepoRt And Accounts 2008 Creating the UK’s leading finanCial serviCes provider
Excellent cost management. The Group’s cost:income ratio, excluding market dislocation, improved by 1.1 percentage points to 47.0 per cent.
Robust capital ratio and a strong liquidity and funding position maintained throughout the recent turbulence in global financial markets.
lloyds Banking Group is quoted on both the london Stock exchange and the New York Stock exchange and is one of the largest companies within the fTSe 100.
– improving processing efficiency – Applying our more prudent ‘through the cycle’ approach to risk to the enlarged Group – Working capital harder – Delivering flawlessly for the customer
Turning to broader societal issues, a great deal has been said in recent months about the role of bonuses in the banking system. We recognise the legitimate public interest in this subject. We have worked closely with the Government to devise a bonus system which is fair to our colleagues and sensitive to the wider needs of society as a whole. We do think that a necessary process is now underway to reassess the way in which some incentives in the banking system were structured and awarded – typically in areas in which we don’t have a great deal of involvement. Specifically, we are very much a retail and commercial banking business with very little in the way of investment banking activity. We also recognise how important it is to align bonus and remuneration schemes with the interests of our shareholders, something we believe we have done over the years. from our perspective, it is particularly important that we retain our best talent both in the uK and overseas and we believe that it is an important factor that should also be taken into account when designing total reward systems.
THe ACQuiSiTioN of HBoS HAS CreATeD THe uK’S leADiNG fiNANCiAl SerViCeS Group. hOw will this influEncE thE gROup’s stRAtEgy?
The strategy for the new lloyds Banking Group will be similar to that successfully adopted by lloyds TSB. We will continue to implement our ‘through the cycle’ customer relationship based approach. The new enlarged entity has significant scale advantage and both organisations enjoy a terrific reputation for managing efficiency. We will adopt the more conservative lloyds TSB risk disciplines, which have served us well, and we will embed them across the combined business. We will also maintain the economic profit disciplines we use to allocate capital efficiently. At the same time, we will continue to invest in people and systems to serve our customers better and we will look to set customer and staff satisfaction standards that are unparalleled in the market.
The Government’s recapitalisation of the banking sector in october 2008 was necessary to restore confidence and stability to the financial services sector at that time, and although they now hold a significant stake in the organisation we are comfortable that the Government’s investment was the right way of achieving that capital increase for our company.
A number of specific requirements stem from Government ownership which primarily relate to corporate governance and lending, as outlined below. Dividend restrictions, as outlined below, have been introduced due to the presence of the Government preference shares.
No, lloyds TSB has clearly demonstrated a strong track record of delivery with a prudent risk appetite and the new lloyds Banking Group has no intention of changing this successful approach.
lloyds Banking Group will continue to take a prudent approach to risk management and our philosophy remains to take a ‘through the cycle’ relationship based approach to lending. We are committed to this relationship approach, are focused on the needs of our customers and recognise that we have a role to play in helping our customers through the economic downturn, particularly when they face financial difficulty. The new Group has already exited a number of non core areas in which HBoS previously participated and will continue to assess participation in business areas on a conservative basis.
Annual report and Accounts 2008 other indicators of households’ financial distress, such as mortgage arrears and repossessions, are at low levels compared with the early 1990s. However, in late 2008 unemployment levels were rising at a faster rate than at a similar point during the early 1990s, with companies seemingly responding more quickly to worsening economic conditions this time around.
The deterioration of economic prospects globally, combined with the initial impact of the financial crisis, has triggered a period of balance sheet adjustment by banks and other financial services companies, by non-bank companies and by individuals. Spreads in wholesale financial markets, on which many banks rely to fund their lending, widened sharply, with negative consequences for the availability and cost of credit for the broader economy. Balance sheet adjustment and high funding costs could, if left unchecked, make the global downturn even steeper and more damaging. Governments worldwide have responded by expansionary budget policy changes, by injecting capital into banks and by providing guarantees and other forms of support for wholesale funding markets.
unemployment will continue to rise, although the extent of that rise is uncertain, depending for instance on how much companies have reacted more quickly on layoffs in this recession than they did last time round. By the end of this year the housing market is expected to bottom out as affordability improves further. it is likely that further house price falls in 2009, combined with growth in average earnings, will reduce the ratio of house prices to average earnings to below the long term average. And very low interest rates, combined with lower house prices, should make borrowing to buy a house more affordable than at almost any time during the last 30 years.
Robust income performance. Income, excluding market dislocation, grew by nine per cent reflecting strong revenue growth from the Group’s relationship banking businesses. On a statutory basis, income was eight per cent lower at £9,872 million.
OUR STRATEGY The strategy for the enlarged Group remains to grow the business through developing long-term customer relationships and building our customer franchise. All our businesses are focused on extending the reach and depth of our customer relationships, whilst enhancing product capabilities to build competitive advantage. The prudent Lloyds TSB ‘through the cycle’ approach to risk will apply to the enlarged Group and will be increasingly important as we strive to improve our processing efficiency and make our working capital work harder. Executing the strategy effectively will only be possible if we manage our most valuable resource, our people, well. By successfully delivering these objectives we are likely to achieve our vision of being the best financial services provider in the United Kingdom.
The focus for the Group remains within the UK and our position was significantly strengthened through the acquisition of HBOS in January 2009. The effective integration of the two businesses will be a significant challenge over the next few years, but the combination of the two businesses provides a real opportunity to create the UK’s leading financial services organisation.
Group net interest income, excluding insurance grossing, increased by £1,457 million, or 26 per cent, to £7,058 million. Over the last 12 months, total assets increased by 23 per cent to £436 billion, with a 16 per cent increase in loans and advances to customers, reflecting strong levels of customer lending growth in Commercial Banking, Corporate Markets and mortgages. Customer deposits increased by nine per cent to £171 billion, supported by good growth in savings balances in the retail bank, where bank savings increased by 12 per cent and wealth management balances by 20 per cent. Customer deposits in our Corporate Markets, Commercial and International businesses increased by 15 per cent.
In UK Retail Banking, impairment losses increased by £248 million, or 20 per cent, to £1,472 million, particularly reflecting the impact of lower house prices on the mortgage impairment charge. In terms of unsecured lending, our asset quality remains satisfactory. However, in the context of the uncertain UK economic environment and the potential for increased consumer arrears and insolvencies, we are continuing to enhance our underwriting, collections and fraud prevention procedures.
The recent arrangements put in place to protect the depositors of Bradford & Bingley and other failed deposit taking institutions involving the Financial Services Compensation Scheme (FSCS) will result in a significant increase in the levies made by the FSCS on the industry. The Group has made a provision of £122 million in its 2008 accounts in respect of its current obligation for the estimated interest cost on the FSCS borrowings. Going forward further provisions in respect of these costs are likely to be necessary until the borrowings are repaid. The ultimate cost to the industry, which will also include the cost of any compensation payments made by the FSCS and if necessary the cost of meeting any shortfall after recoveries on the borrowings entered into by the FSCS, remains uncertain although it may be significant.
During the year, the basis of goodwill allocation in parts of our Asset Finance business has been changed to treat the consumer finance business as a single cash generating unit encompassing the motor and personal finance operations which provide direct and point of sale finance. The markets in which these units operate have been affected by the UK economic downturn, which has been characterised by falling demand and increasing arrears at this point of the cycle. This, together with uncertainties over the likely short term macroeconomic environment, has resulted in a reassessment of the carrying value of the consumer finance cash generating unit and the recognition of a goodwill impairment charge of £100 million at 31 December 2008.
New initiatives introduced during the course of 2008 by The Bank of England and HM Treasury to facilitate banks’ access to senior funding include the Special Liquidity Scheme and Credit Guarantee Scheme, respectively. The Group welcomed these initiatives and, like many of its peers, continues to make use of them for term funding. Going forward, where markets permit and it is economic to do so, the Group expects to reduce this utilisation and further develop and diversify its unguaranteed funding programmes.
Total income, net of insurance claims 5,876 1,494 4,132 (492) 11,010 79 11,089
Provision in respect of certain historic US dollar payments – – (180) – (180) – (180)
Total income, net of insurance claims 5,492 1,333 4,024 (6) 10,843 39 10,882
Good growth in deposits resulted in a five per cent increase in overall deposit balances, with 12 per cent growth in bank savings, and 20 per cent growth in wealth management deposits.
Financial calendar 2009 195 one In foUR neT neW moRTGAGeS In 2008, Lloyds TSB achieved its best-ever performance in mortgages, by providing one in four net new mortgages in the UK last year (total completed mortgage business less redemptions and repayments), demonstrating Lloyds TSB remains very much open to new mortgage business and to supporting customers through difficult economic times.
†The 2007 figures have been restated (see page 17). The 2006 figures are as originally published. ††Excluding the settlement of overdraft claims and the Financial Services Compensation Scheme levy.
Profit before tax from UK Retail Banking increased by £73 million, or four per cent, to £1,793 million, reflecting strong levels of franchise growth and effective cost management which offset the higher impairment charge. Total income increased by £384 million, or seven per cent, whilst operating expenses remained well controlled, increasing by two per cent. The trading surplus increased by 11 per cent to £3,265 million.
In addition to the strong growth in product sales from existing customers, the Group has continued to make progress in expanding its customer franchise. The retail bank opened over one million new current accounts during the year, with a strong performance from the Group’s range of added value current accounts with enhanced product features.
Despite tightened credit criteria and a slowdown in consumer demand, we have maintained our market leading position in personal loans, growing our market share of the unsecured personal loans market whilst remaining primarily focused on lending to our current account customer base. Unsecured consumer credit balances increased by six per cent, with personal loan balances outstanding at 31 December 2008 up nine per cent at £12.2 billion, whilst credit card balances were stable at £6.6 billion.
We have continued to benefit from the recent investment in reducing the levels of administration and processing work carried out in branches. This has enabled us to further increase our focus on meeting the needs of our customers and has supported improved productivity in the branch network sales effort. These improvements have supported a further improvement in the retail banking cost:income ratio to 44.4 per cent, from 46.4 per cent last year. Average sales by staff in the branch network have shown good growth on the levels achieved in 2007.
Mortgage credit quality remains good although the slowdown in economic activity and rising unemployment in the UK has led to arrears rising by 44 per cent over the last 12 months. This compares to a rise of 72 per cent in Council of Mortgage Lenders (CML) industry averages in the 12 months to 31 December 2008. The fall in the house price index over the last 12 months has however led to an increase of approximately £150 million in the secured impairment charge during the year. Looking forward, our view is for a further fall of similar magnitude in house price index during 2009.
Resilient performance by Scottish Widows Investment Partnership, as profit before tax increased against the backdrop of a significant reduction in equity market levels.
Following the acquisition of HBOS, the Insurance and Investments division has been renamed ‘Insurance’ and now includes the Clerical Medical and HBOS General Insurance businesses which were previously part of the HBOS Insurance and Investments division. The investment management business, Scottish Widows Investment Partnership, is being transferred to the new Wealth and International division.
Financial calendar 2009 195 moST TRuSTeD CHoICe Scottish Widows was voted most trusted choice for pensions in an independent survey. (IPSOS, February 2008)
BeST Home InSuRanCe WeBSITe Assessed against 550 different criteria and measured according to 1,000 insurance customer feedback responses, www.lloydstsbinsurance.co.uk has been ranked as the best Home Insurance website for the second year in succession by Global Reviews 2008. (November 2008)
The General Insurance operations are targeting growing share in their chosen customer segments, developing key insurance partnerships, improving margins by better customer management and improving service and efficiency.
†The 2007 figures have been restated (see page 17). The 2006 figures are as originally published. *EEV basis. ◆Excluding volatility and insurance grossing.
Financial calendar 2009 195 reSultS on a european eMbedded value (eev) baSiS
Existing business profit increased by 24 per cent to £377 million. Expected return increased to £321 million driven by an increase in expected income from our annuity portfolio. The net impact of experience variances in both years is broadly comparable and reflects adverse lapse experience being more than offset by other favourable experience. The net impact of assumption changes in the current year is not significant and reflects a charge from more pessimistic lapse assumptions in life and pensions business which is broadly offset by favourable lapse assumptions in OEICs and other modelling changes. The expected return on shareholders’ net assets decreased by £20 million as a result of a lower volume of free assets, driven by lower investment markets.
The valuation of the Group’s annuity business has been affected by the recent upheaval in the capital markets which has caused a significant widening in corporate bond spreads. Based on available market analysis, an element of this widening in corporate bond spreads has been assessed as arising from an increase in the illiquidity premium. As a result, in 2008 the value of the in-force business asset for annuity business has been calculated after taking into account an estimate of the market premium for illiquidity derived using a portfolio of investment grade bonds with similar cash flow characteristics as the annuity liabilities.
Risk-free rate (financial options and guarantees) 1.11 to 4.24 4.28 to 4.81
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.
This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.
In sensitivities (4) to (7) and (9) assumptions have been flexed on the basis used to calculate the value of in-force business and the realistic and the statutory reserving bases. A change in risk discount rates is not relevant as the risk discount rate is not an input to a market consistent valuation.
Restated, see page 17. Within the above analysis, profit share receivable has been allocated across product groups, whereas it was previously allocated to other. Comparative figures have been restated accordingly.
continued strong relationship banking momentum. Excluding the impact of market dislocation, profit before tax decreased by two per cent, to £1,544 million, reflecting good levels of core business momentum which were offset by a significant increase in corporate impairment levels reflecting the challenging economic environment and additional write-offs relating to a number of high profile financial services company collapses.
Strong progress in expanding our corporate Markets franchise, with a 34 per cent increase in Corporate Markets income, excluding market dislocation, supported by an 85 per cent increase in cross-selling income. This was largely offset however by the significant rise in impairments.
good franchise growth in commercial banking, with a further increase in our market share of higher value customers, supporting a seven per cent growth in income, which was partially offset by an £89 million increase in impairments.
Significant lending growth, as our Corporate Markets and Commercial Banking businesses continued to provide substantial support to our mid-corporate market and SME customers.
The new ‘Wholesale’ division operates a multi brand strategy primarily through the Lloyds TSB and Bank of Scotland brands but also trades through a number of more specialist brands including Lloyds TSB Development Capital and Black horse.
Net interest income 3,303 2,380 39 profit before tax 274 1,300 (79)
Making ‘Wholesale’ a great place for our customers to bank remains our number one priority and we seek to achieve this by deepening and maintaining profitable customer relationships. Building insight into customer needs and providing them with a broad range of banking and capital markets solutions will enable us to become our customers’ first choice so we prosper together.
In Wholesale and International Banking, the Group has continued to make progress in its strategy to develop the Group’s strong corporate and small to medium business customer franchises, however the division has continued to be significantly affected by the impact of market dislocation and the increase in impairments relating to the deteriorating economic environment and a number of high profile financial services company collapses. In Corporate Markets, further good progress has been made in developing our relationship banking franchise supported by a strong cross-selling performance and in Commercial Banking, strong growth in business volumes, further customer franchise improvements and good progress in improving operational efficiency, were offset by the significant increase in impairment levels.
Overall, the division remained profitable, however profit before tax decreased by 79 per cent to £274 million, largely reflecting the £990 million reduction in profits, compared to last year, as a result of market dislocation. A strong revenue performance in our relationship banking businesses contributed to overall income growth, excluding the impact of market dislocation, of 20 per cent, driven by strong Corporate Markets and Commercial Banking income growth of 34 per cent and seven per cent respectively. This exceeded cost growth of nine per cent, which largely reflected further investment in building the Corporate Markets business, higher depreciation charges in Asset Finance and the impact of exchange rate movements. The cost:income ratio, excluding the impact of market dislocation, improved to 46.5 per cent, from 51.1 per cent last year.
– investment grade bank financial instruments held at fair value through profit or loss – ABS
– monoline hedged** – – 275 – 470 – major global bank cash
Items reclassified from trading to loans and advances on 1 July 2008 in accordance with amendment to IAS 39.
Restructured ABS CDO removing monoline wrap and recorded within loans and advances.
Costs were three per cent higher. Cost management remains a priority and the business is now starting to capture significant benefits from recent investments in improved IT infrastructure, allowing further improvement in relationship manager productivity. Asset quality in the Commercial Banking portfolios has remained satisfactory with 90 per cent of the portfolio supported by security, however the impairment charge rose by £89 million partly reflecting the impact of recent deterioration in the UK economy. The impairment charge as a percentage of average lending remained below one per cent in 2008.
The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly those disabled and disadvantaged, to play a fuller role in society. The Foundations receive 1 per cent of Lloyds Banking Group’s pre-tax profit after adjusting for gains and losses on the disposal of businesses and pre-tax minority interests, averaged over three years, instead of a dividend on their shareholdings. In 2008, £27 million was accrued for payment to registered charities.
In the year ended 31 December 2008, the contribution from Central group items was a negative £552 million compared to a negative contribution of £12 million in 2007. The result in 2008 has been significantly affected by the impact of yield curve volatility on the fair value of derivatives entered into for risk management purposes after taking into account the effect of hedge accounting adjustments. In addition, there were increased central costs that were not recharged to the divisions in connection with professional advice received during the year and an impairment charge in respect of an available-for-sale investment.
The valuation of the Group’s annuity business has been affected by the recent upheaval in the capital markets which has caused a significant widening in corporate bond spreads. Based on available market analysis, an element of this widening in corporate bond spreads has been assessed as arising from an increase in the illiquidity premium. Annuity contracts cannot be surrendered and have reasonably certain cashflows best matched by assets of equivalent maturity with similar liquidity characteristics. As a result, in 2008 the value of in-force business for the annuity business has been calculated after taking into account an estimate of 154 basis points for the market premium for illiquidity, which has been derived using a portfolio of investment grade bonds with similar cash flow characteristics as the annuity liabilities. The effect of this has been to increase the value of in-force business by £842 million as at 31 December 2008 with a similar increase in profit before tax. This amount is reported within volatility and does not therefore impact profit before tax on a continuing business basis.
The expected investment returns used to determine the normalised profit of the business, which are based on prevailing market rates and published research into historical investment return differentials, are set out below: Gilt yields (gross) 3.74 4.55 4.62
Corporate bonds in unit linked and With Profit funds (gross) 4.34 5.15 5.22
During 2008, profit before tax included negative insurance volatility of £746 million, being a credit of £9 million to net interest income and a charge of £755 million to other income (2007: negative volatility of £277 million, being a credit of £7 million to net interest income and a charge of £284 million to other income).
The application of accounting standards results in the introduction of other sources of significant volatility into the pre-tax profits of the life and pensions business. In order to provide a clearer representation of the performance of the business and consistent with the way in which it is managed, equalisation adjustments are made to remove this volatility from underlying profits. The effect of these adjustments is separately disclosed as policyholder interests volatility; there is no impact upon profit attributable to equity shareholders.
Our corporate vision is to be recognised as the best financial services organisation by customers, colleagues and shareholders. Our corporate responsibility strategy is to support that vision by creating value for all our stakeholders through: – increased colleague engagement; – increased customer satisfaction; – more effective risk management.
Around 2,000 customers are contacted monthly and their view of the bank measured. The percentage of those with the highest scores are set against those with the lowest to give the net promoter score*. Over 2008, the average score increased by 10 points.
We take protecting our customers and their assets extremely seriously and continue to invest in activities to deter, detect and prevent fraud. These include transaction monitoring tools to identify suspicious account activity and procedures to verify customer transactions.
In November 2008, we issued a six-point charter of commitments to small business customers which promises that: future reductions in base rates over 2009 will be passed on in full; there will be no change in price or availability of overdrafts for customers operating within agreed terms; reasonable requests for short term finance will be agreed; overdraft limits or prices will only change if there is a material change in the customer’s risk profile; lending rates will continue to be linked to base rate; and we will provide expert guidance and support for small firms.
The England and Wales Foundation has a particular focus on supporting charities that improve social and community involvement, improve life choices and chances and help disadvantaged people to be heard. In 2008, funding focused on areas of geographical deprivation and the needs of both individuals and multiple communities. Where possible, the Foundation used its size and presence to facilitate the voice of smaller groups within their local, regional and national networks.
In addition to the Foundations’ support for local community causes, thousands of our colleagues volunteer to help in their communities, raise funds for the Group’s Charity of the Year or make direct donations to charity using the UK’s Give As You Earn system. In 2008, the Foundations provided matched funding for nearly 41,000 hours of time volunteered by Lloyds Banking Group colleagues in the community and also matched over £937,000 funds raised by colleagues for charities.
Research amongst staff and customers showed a real interest in supporting young athletes in their local community and helping them share in the excitement of Britain’s journey to 2012. Thus, the vision for our Partnership was created, to inspire and support young people, communities and businesses all over Britain on their journey to London 2012 and beyond.
Our suppliers are important to us and we want to ensure that we treat them fairly and pay them on time. Our supplier relationships are governed by a strict Code of Purchasing Ethics that defines the way we do business. We have been working throughout 2008 to update our long-established supplier review process that allows us to consider our suppliers’ social, ethical and environmental performance as part of the tendering process.
We have also been working with a number of other financial services companies to develop an industry wide corporate responsibility questionnaire which is available on-line and benefits suppliers who only have to complete one questionnaire for all participating financial services companies, as well as benefiting Lloyds Banking Group by providing comparable information across different suppliers.
emissions by 30 per cent by 2012 based on 2002 levels. We are very pleased to report that by the end of 2008 we have achieved a 31 per cent reduction in CO
, meeting our target four years ahead of schedule. We identified specific projects and prioritised investment to deliver significant CO
reductions. We have also purchased renewable electricity and electricity from combined heat and power (CHP) sources, which have a lower carbon footprint than standard grid electricity.
During 2008, we have improved our systems for collecting car mileage information and energy consumption data. Using actual mileage and engine sizes rather than fleet averages gives a more accurate travel total. This, allied to a 40 per cent increase in teleconferencing to 422,000 meetings, has significantly reduced our travel related CO
Beyond managing our own immediate impact, Lloyds Banking Group can be part of the response to climate change by engaging customers and suppliers. Lloyds Banking Group provides finance to all sectors of industry and by understanding the risks and opportunities our customers face, we are better able to help them develop appropriate solutions.
In 2008 DEFRA introduced changes to the conversion factors to be used for calculating CO
Our business strategy is translated into the Group’s balanced scorecard and this is aligned at each level of the organisation. This ensures colleagues understand how their personal objectives relate to the strategy and that their contribution is measured against a range of factors, including long term growth of the business; customer service; risk management and personal development, as well as financial success.
BUILDING LONG LASTING RELATIONSHIPS THROUGH PEOPLE We are a business based on building strong and long lasting relationships through the efforts of our people. Colleagues are our most valuable resource. It is our colleagues who build long lasting relationships with our customers and, therefore, managing our colleagues effectively is fundamental to the success of the business and achieving our vision of being the best financial services organisation in the UK.
We are building a high commitment, high performance organisation. We are clear about what we expect from our colleagues. Our values guide us in all our dealings with colleagues, customers and the wider community. In Lloyds Banking Group, our values are that we: take ownership; act wisely; make it simple; stretch ourselves; and succeed together.
total reward We take a broader view on reward than financial benefits and our 2008 flexible benefits scheme enabled colleagues to select from a range of non-cash benefits including medical and life-assurance, additional pension, education vouchers, matched learning and childcare vouchers. In 2008, 68 per cent of colleagues participated in the scheme. In addition, in 2008, over 95 per cent of colleagues opted to participate in one of our various employee share plans. The vast majority of our colleagues are therefore shareholders and have a vested interest in our long term success.
Race for Opportunity (RfO) is a national business network of over 150 UK organisations from the private and public sectors working on race and diversity as a business imperative.
Shows percentage of whole workforce although not all colleagues have supplied information on race, disability or sexual orientation.
Our objective is to provide great facilities and a safe environment for colleagues and customers, in all our business locations.
Lloyds Banking Group Annual Report and Accounts 2008 risk as a strategiC differentiator
There can be no assurance that the measures so far announced by the Government, will be sufficient to prevent any future strain on the Group’s ability to meet its financial obligations as they fall due. The recovery of wholesale and capital markets will depend upon renewed confidence in the UK banking system particularly if market conditions revert to the reduced levels of wholesale market liquidity and the availability of traditional sources of funding become more limited.
The key dependencies on successfully funding the Group’s balance sheet include the continued functioning of the money and capital markets at their current levels; the continued access of the Group to central bank and Government sponsored liquidity facilities, including issuance under HMT’s credit guarantee scheme (CGS) and access to the Bank of England’s various facilities; limited further deterioration in the Group’s credit ratings; and no significant or sudden withdrawal of deposits resulting in increased reliance on money markets or Government support schemes.
OUR APPROACH TO RISK The Lloyds TSB approach to risk is founded on strong corporate governance practices whereby the board takes the lead in 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 prohibit and, where appropriate, limit activities, relationships, and situations, that might diminish the quality of corporate governance. All colleagues from the group chief executive down are assessed against a balanced scorecard that explicitly addresses their risk performance.
The paragraphs that follow set out the risk management policies, practices and structures that applied during the past year to Lloyds TSB Group plc. These policies, practices and structures were adopted by Lloyds Banking Group from the date of completion of the HBOS plc transaction.
In respect of credit risk, Lloyds TSB has reduced exposure via timely exit or scaling back of positions. In wholesale and capital market exposure, the Group has restricted investment policy for the Lloyds TSB conduit ‘Cancara’ (for example: no CDOs of asset backed securities); restricted exposure to monolines and leveraged loans; reviewed liquidity risk appetite and enhanced liquidity reporting; reduced holdings of equities in the insurance companies; progressed its pension scheme de-risking strategy and tightened policy parameters for US sub-prime mortgages. Also, all exposures were sanctioned on the basis of Lloyds TSB being content to hold the risk to maturity. In retail banking, risk mitigation activities and a prudent lending stance were maintained in the context of the changing environment: tightening of maximum loan to value criteria on all mortgage books; withdrawal of higher risk mortgage products; tightening of credit card eligibility criteria and tightening of policy rules and scorecard cut offs across all retail portfolios.
Consistent with our ‘through the cycle’ approach, Lloyds TSB has a proactive and supportive approach to assist customers through difficult periods. We have also invested significantly in our highly successful collections and recoveries and business support units.
The group model governance and approvals committee is responsible for setting the control framework and standards for models across the Group, including establishing appropriate levels of delegated authority; the approval of models that are considered to be material to the Group (including credit risk rating systems); and the principles underlying the Group’s economic capital framework.
Divisional risk offi cers provide oversight of risk management activity for all risks within each of the Group’s divisions. Reporting directly to the group executive directors responsible for the divisions and the chief risk offi cer, their day-to-day contact with business management, business operations and risk initiatives seeks to provide an effective risk oversight mechanism.
The director of group audit provides the required independent assurance to the audit committee and the board that risks within the Group are recognised, monitored and managed within acceptable parameters. Group audit is fully independent of group risk, seeking to ensure objective challenge to the effectiveness of the risk governance framework.
The Group’s risk management principles and risk management framework cover the full spectrum of risks that a group, that encompasses both banking and insurance businesses, would encounter.
The Group uses an enterprise-wide risk management framework for the identification, assessment, measurement and management of risk, designed to meet its customers’ needs. 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, where appropriate; and exploit risks to gain competitive advantage, thereby seeking to increase shareholder value. The principal elements of the risk management framework are shown in Table 1.2.
The risk management framework above comprises 10 interdependent activities which map to the components of the internal controlintegrated framework issued by the committee of Sponsoring Organisations of the Treadway Commission (COSO).
Business unit policy – local policy that specifically applies to a business unit
Proportionate control activity strategy is in place to design mitigating controls, to transfer risk where appropriate and ensure executives are content with the residual level of risk accepted.
risk and control assessments are undertaken to assess the effectiveness of current mitigations and whether risks taken are consistent with the Group’s risk appetite (this includes the annual control self-assessment exercise).
At group level a consolidated risk report is produced which is reviewed and debated by the group business risk committee, group executive committee, risk oversight committee and the board to ensure senior management and the board are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The consolidated risk report provides a regular assessment of the aggregate residual risk for the primary risk drivers, comparing the assessment with the previous quarter and providing a forecast for the next 12 months.
market risk: In terms of potential impact on economic value, the principal market risks are a fall in equity markets reducing the value of assets in the Group’s pension schemes and in the Insurance and Investments division, and exposure to a fall in real interest rates increasing the value of liabilities in the Group’s pension schemes. In terms of potential impact on earnings, the principal market risks are exposure to a fall in equity markets reducing the value of assets in the Insurance and Investments division, and exposure to a widening of credit spreads reducing the value of assets in the Insurance and Investment division and in the Trading Book. Also, in the retail banking businesses, there is a potential impact on earnings arising from margin compression in a lower base rate environment. All risks are subject to regular review and mitigation activity via specific initiatives monitored by the group and senior asset and liability committees, including engagement with the pension scheme trustees.
insurance risk: arising in Insurance and Investments division and the Group’s pension schemes reflecting the exposure to increasing longevity of annuitants and pensioners. The main mitigation option open to the Group is to hedge the risk in the reinsurance or the capital markets and the Group actively monitors the attractiveness of potential opportunities in these markets.
The way we manage risk is central to the success of Lloyds Banking Group. The board takes its responsibility for risk management very seriously and all of the Group’s senior executives are actively involved in overseeing the risk profile for Lloyds Banking Group.
– external factors: economic, technological, political, social and ethical, environmental, legal and regulatory, market expectations, reputation and competitive behaviour.
An annual business planning process is conducted at group and business unit level which includes a quantitative and qualitative assessment of the risks that could impact the Group’s plans. Within the planning round, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams. Over the last few years, the Group has made significant progress with embedding stress testing and scenario analysis into its risk management practice with the dual objectives of adding value to the business whilst also meeting regulatory requirements. The Group assesses a wide array of scenarios including economic recessions, regulatory action scenarios, pandemics and scenarios specific to the operations of each part of the business.
Credit risk appetite is set by the board and is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio model parameters which in turn use the various credit risk rating systems as inputs. These metrics are supplemented by a variety of policies, sector caps and limits to manage concentration risk at an acceptable level.
Credit risk can also arise from debt securities, derivatives and foreign exchange activities. Note 17 to the financial statements shows the total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2008. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 49 on page 168.
Each probability of default rating model segments counterparties into a number of rating grades, each representing a defined range of default probabilities. Exposures migrate between classifications if the assessment of the obligor probability of default changes. Each rating system is required to map to a master scale, which supports the consolidation of credit risk information across portfolios through the adoption of a common rating scale. Given the differing risk profiles and credit rating considerations, the underlying risk reporting has been split into two distinct master scales, a retail master scale and a wholesale master scale. (Note 49 to the financial statements provides an analysis of the portfolio.)
The Group maintains guidelines on the acceptability of specific classes of collateral.
– Portfolio monitoring and reporting: In conjunction with group risk, businesses and divisions identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Group risk in turn produces an aggregated review of credit risk throughout the Group, including reports on significant credit exposures, which are presented to the group business risk committee.
The risk of reductions in earnings and/or value, through financial or reputational loss, arising from unexpected changes in financial prices, including interest rates, exchange rates, credit spreads and prices for bonds, commodities, equities, property and other instruments. It arises in all areas of the Group’s activities and is managed by a variety of different techniques.
The Group’s banking activities expose it to the risk of adverse movements in interest rates, credit spreads, exchange rates and equity prices, with little or no exposure to commodity risk.
Foreign currency risk also arises from the Group’s investment in its overseas operations.
– Unit-linked liabilities are matched with the same assets that are used to define the liability but future fee income is dependent upon the performance of those assets.
Based on the commonly used 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding 300 business days, the VaR for the years ended 31 December 2008 and 2007 based on the Group’s global trading positions was as detailed in table 1.4.
The Group’s market risk exposure in respect of insurance activities described above is measured using European Embedded Value (EEV) as a proxy for economic value. The pre-tax sensitivity of EEV to standardised market stresses is shown below for the years ended 31 December 2008 and 2007. Foreign exchange risk arises predominantly from overseas equity holdings. 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 or tracked on a daily basis.
Various mitigation activities are undertaken across the Group to manage portfolios and ensure they remain within approved limits.
The senior asset and liability committee regularly reviews high level market risk exposure including, but not limited to, the data described above. It also makes 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.
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.
Insurance risks are measured using a variety of techniques including stress and scenario testing; and, where appropriate, stochastic modelling.
The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate or poor customer treatment.
The risk of reductions in earnings and/or value, through financial or reputational loss, from poor corporate governance at group, divisional or business unit level. Corporate governance in this context embraces the structures, systems and processes that provide direction, control and accountability for the enterprise.
The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft of or damage to the Group’s assets, the loss, corruption, misuse or theft of the Group’s information assets or threats or actual harm to the Group’s people.
For legal and regulatory issues there are significant reputational impacts associated with potential censure which drive the Group’s stance on appetites referred to above. There are clear accountabilities and processes in place for reviewing new and changing requirements. Each business has a nominated individual with ‘compliance oversight’ responsibility under FSA rules. The role of such individuals is to advise and assist management to ensure that each business has a control structure which creates awareness of the rules and regulations, to which the Group is subject, and to monitor and report on adherence to these rules and regulations.
Throughout 2008, there was ongoing development of operational risk appetites and metrics to ensure both current and potential future operational risk exposures are understood in terms of both risk and reward potential.
The Group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through both short-term liquidity management and long-term funding strategy. Short-term liquidity management is considered from two perspectives; business as usual and crisis liquidity, both of which relate to funding in the less than one year time horizon. Longer term funding is used to manage the Group’s strategic liquidity profile which is determined by the Group’s balance sheet structure. Longer term is defined as having an original maturity of more than one year.
– Secondly, the Group has a contingency funding plan embedded within the Group Liquidity Policy Statement which has been designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing.
Wholesale assets comprise balances arising from banking business and include loans and advances to banks, trading and other financial assets at fair value through profit and loss and available for sale assets. Non-bank deposits comprise balances arising from banking businesses and include customer accounts.
Wholesale funding has been analysed between that monitored by the London Treasury operations and the Group’s overseas Treasury operations. The wholesale funding shown excludes any repo activity.
The composition and quality of wholesale deposits are regularly reviewed by management and comprises deposits from corporates and government agencies that roll over on a regular basis and are reinvested.
as at as at As at As at £bn % £bn %
taBle 1.9: residual maturity of london treasury wholesale funding as at as at As at As at £bn % £bn %
Debt securities in issue and trading and other liabilities at fair value through profit or loss 51.3 3.5 – – 54.8
Capital risk is defined as the risk that the Group has insufficient capital to provide a sufficient resource to absorb predetermined levels of losses or that the capital structure is inefficient.
A capital exposure arises where the Group has insufficient regulatory capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. The Group’s capital management policy is focused on optimising value for shareholders.
A number of limits are imposed by the FSA on the proportion of the regulatory capital base that can be made up of subordinated debt and preferred securities. The unpredictable nature of movements in the value of the investments supporting the long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate.
The FSA sets Individual Capital Guidance (ICG) for each UK bank calibrated by references to its Capital Resources Requirement (CRR), broadly equivalent to 8 per cent of risk weighted assets and thus representing the capital required under Pillar 1 of the Basel II framework.
The Group is also able to raise equity either via a rights issue, placing or an open offer. A share placing was undertaken in September and the board also announced in October a further placing and open offer to shareholders as part of its participation in the recapitalisation of the banking sector. The Group is able to raise funds by issuing subordinated liabilities. The cost and availability of subordinated liability finance are influenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access.
The risk appetite is set by the board and reviewed on an annual basis. It includes the avoidance of the need for restatement of published financial and prudential regulatory data, public disclosures about the Groups financial, including tax, performance and its legal constitution.
The Group has in place a disclosure committee whose responsibility is to review all significant disclosures made by the Group and to assist the group chief executive and group finance director fulfill their responsibilities under the Listing Rules and regulations emanating from the Sarbanes-Oxley Act of 2002. A programme of work is undertaken and designed to support an annual assessment of the effectiveness of internal controls over financial reporting, in accordance with the requirements of section 404 of the US Sarbanes-Oxley Act; it also has in place an assurance mechanism over its prudential regulatory reporting; additionally, monitoring activities are designed to identify and maintain tax liabilities and to assess emerging regulation and legislation.
The valuation of with-profits assets in a with-profits fund on a realistic basis differs from the valuation on a statutory basis as, in respect of nonprofits business written in a with-profits fund (a relatively small amount of business in the case of Scottish Widows), it includes the present value of the anticipated future release of the prudent margins for adverse deviation. The realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above.
The realistic valuation of liabilities is carried out using a stochastic simulation model which values liabilities on a basis consistent with tradable market option contracts (a ‘market-consistent’ basis). The model takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given in the section entitled ‘Options and guarantees’ on page 64.
Adjustments to remove differences between IFRS and regulatory valuation of assets and liabilities – (708) (708) (581) (1,289)
Adjustment to replace ‘realistic’ liabilities with statutory liabilities 811 – 811 – 811
For Scottish Widows, no amount is required to cover the impact of stress tests on the actuarial reserves. However, a further test is required in respect of the With Profit Fund, which compares the level of ‘realistic excess capital’ to the ‘statutory excess capital’ of the With Profit Fund. In circumstances where the ‘realistic excess capital’ position is less than ‘statutory excess capital’, the Company is required to hold additional capital to cover the shortfall, but only to the extent it exceeds the value, calculated in a prescribed way, of internal transfers from the With Profit Fund. Any additional capital requirement under this test is referred to as the With -Profits Insurance Capital Component. The ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the With Profit Fund with a further deduction to cover various stress tests.
Scottish Widows has a formal arrangement with one of its subsidiary undertakings, Scottish Widows Unit Funds Limited, whereby the subsidiary company can draw down capital from Scottish Widows to finance new business which is reinsured from the parent to its subsidiary. Scottish Widows has also provided subordinated loans to its fellow group undertaking Scottish Widows Bank plc.
requirement to maintain a support account: The Scheme requires the maintenance of a ‘Support Account’ within the Non-Participating Fund. The quantum of the Support Account is calculated with reference to the value of assets backing current with-profits policies which also existed at the date of demutualisation and must be maintained until the value of these assets reaches a minimum level. Assets can only be transferred from the Non-Participating Fund if the value of the remaining assets in the fund exceeds the value of the Support Account. Scottish Widows has obtained from the FSA permission to include the value of the Support Account in assessing the realistic value of assets available to the With Profit Fund. At 31 December 2008, the estimated value of surplus admissible assets in the Non-Participating Fund was £1,854 million (31 December 2007: £1,908 million) and the estimated value of the Support Account was £200 million (31 December 2007: £827 million).
The primary reasons for the movement in total available capital resources during the year are as follows: WITH PROFIT FUND
The financial information calculated on a ‘realistic’ basis reconciles to the capital statement as follows: with Profit long term With Profit Long Term fund fund Fund Fund £m £m £m £m
Adjustments to replace statutory liabilities with ‘realistic’ liabilities (811) (779) (3,695) (3,575)
Outside the With Profit Fund, 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 assurance contracts. In addition, poor cost control would gradually depreciate the available capital and lead to an increase in the valuation of the liabilities (through an increased allowance for future costs).
The most significant options and guarantees provided from within the With Profit Fund are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
The most significant economic assumptions included in the model are: – Risk-free yield. The risk-free yield is defined as spot yields derived from the UK gilt yield curve. – Investment volatility. The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2008, the 10 year equity-implied at-the-money assumption was set at 34.6 per cent (31 December 2007: 25.5 per cent). The assumption for property volatility was 15 per cent (31 December 2007: 15 per cent). The volatility of interest rates has been calibrated to the implied volatility of swaptions which was broadly 16 per cent (31 December 2007: 11 per cent).
OPTIONS AND GUARANTEES OUTSIDE THE WITH PROFIT FUND OF SCOTTISH WIDOWS
The financial information set out in the table below has been derived from the annual report and accounts of Lloyds Banking Group plc for each of the past four years. 2005 was the first year in which the annual report and accounts were prepared under International Financial Reporting Standards (IFRS). 2004 figures have been derived from the comparative information disclosed in the 2005 annual report and accounts. Under IFRS, accounting standards dealing with financial instruments (IAS 32 and IAS 39) and insurance (IFRS 4 and FRS 27) were applied only from 1 January 2005. To aid comparison, IFRS balance sheet data is presented as at 1 January 2005 rather than 31 December 2004; the 2004 IFRS income statement data is not comparable to the data for the other years presented. The financial statements for each of the years presented have been audited by PricewaterhouseCoopers LLP, independent auditors.
Profit for the year attributable to equity shareholders 819 3,289 2,803 2,493 2,392
Loans and advances to customers 242,735 209,814 188,285 174,944 161,162 share information
Joined the board in 2005. Held a number of senior and general management appointments in Vodafone from 1984 to 2006 including a directorship of that company from 1996 and deputy chief executive officer from 2005. Previously held positions in Rediffusion from 1972 to 1978, Philips from 1978 to 1982 and Mars GB from 1982 to 1984. A non-executive director of Digicel Group, a member of the Altimo International advisory board and a senior adviser to UBS in relation to the global telecommunications sector. A former chairman of The Sage Group. Aged 60
Member of the nomination committee and chairman of the remuneration committee
Joined the board in 2003. Joined Procter and Gamble in 1967 and held a number of senior and general management appointments in Europe, South America and North America, before retiring in 2001. A non-executive director of Cadbury, GfK AG and MIBA AG. Aged 66
Ewan Brown cbe frse Senior Independent director (retiring at the AGM in 2009)
T Timothy Ryan, Jr Independent director and member of the audit and risk oversight committees (from 1 March 2009)
Previously chief executive of Hermes Pensions Management. Held a number of senior appointments in AMP Asset Management from 1991 to 1998. Retiring as chairman of the Strategic Investment Board (Northern Ireland) at the end of March 2009. A non-executive director of Hammerson,
PRINCIPAL ACTIVITIES, BUSINESS REVIEW, FUTURE DEVELOPMENTS AND FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES The Company is a holding company and its subsidiary undertakings provide a wide range of banking and financial services through branches and offices in the UK and overseas. A review of the development and performance of the business during the financial year and an indication of the likely future developments are given on pages 2 to 64. Key performance indicators are shown on page 11. Information regarding the financial risk management objectives and policies of the Company and its subsidiary undertakings, in relation to the use of financial instruments, is given on pages 42 to 64 and in note 49 on pages 165 to 177.
DIRECTORS Biographical details of directors are shown on pages 66 and 67. Particulars of their emoluments and interests in shares in the Company are given on pages 74 to 95.
Sir Victor Blank, Mr A G Kane and Lord Leitch retire at the annual general meeting and offer themselves for re-election.
CHANGE OF CONTROL The Company is party to significant contracts that are subject to change of control provisions in the event of a takeover bid as follows: The Company is party to a deed of covenant with each of the four Lloyds TSB Foundations (the ‘Foundations’) which hold limited voting shares in the Company (the limited voting shares are further described in note 41 on page 153). Under the terms of the deeds of covenant, the Company makes an annual payment to each of the Foundations. In the event of a successful offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting share would convert to an ordinary share under the terms of the Company’s articles of association. The payment obligation under the deeds of covenant would come to an end one year following the conversion of the limited voting shares.
Report of the independent auditors on the consolidated financial statements 96
The number of days required to be shown in this report, to comply with the provisions of the Companies Act 1985, is 23. This bears the same proportion to the number of days in the year as the aggregate of the amounts owed to trade creditors at 31 December 2008 bears to the aggregate of the amounts invoiced by suppliers during the year.
AUDITORS AND AUDIT INFORMATION Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no relevant audit information of which the Company’s auditors are unaware and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 234ZA of the Companies Act 1985.
COMPLIANCE WITH THE COMBINED CODE The board is committed to ensuring that the Group has a robust governance structure in place. That has been uppermost in directors’ minds when applying the principles contained in section 1 of the 2006 combined code on corporate governance issued by the Financial Reporting Council. The Group has complied with the provisions of the code and has done so throughout the year regarding the provisions where the requirements are of a continuing nature.
The board, as permitted by the Group’s articles of association, has authorised all potential conflicts of interest declared by individual directors. Decisions regarding these conflicts of interest could only be taken by directors who had no interest in the matter. In taking the decision, the directors acted in a way they considered, in good faith, would be most likely to promote the Company’s success. The directors had the ability to impose conditions, if thought appropriate, when granting authorisation. Any authorities given will be reviewed at least every 15 months. No director is permitted to vote on any resolution or matter where he or she has an actual or potential conflict of interest.
The committee exercises specific powers delegated to it by the board from time to time. To comply with the Company’s articles of association, only committee members who are also directors of the Company participate in the exercising of any powers delegated by the board.
The nomination committee, comprising Sir Victor Blank (chairman), Dr Berndt, Mr du Plessis, Sir Julian Horn-Smith, Lord Leitch and Sir David Manning, reviews the structure, size and composition of the board, taking into account the skills, knowledge and experience of directors and considers and makes recommendations to the board on potential candidates for appointment as directors. The committee also makes recommendations to the board concerning the re-appointment of any independent non-executive director by the board at the conclusion of his or her specified term; the re-election of any director by the shareholders under the retirement provisions of the articles of association; any matters relating to the continuation in office of a director; and the appointment of any director to executive or other office in the Company, although the chairman of the Company would not chair the committee when it was dealing with the appointment of a successor to the chairmanship of the Company.
During the year, in accordance with the plans for the orderly succession for appointments to the board, the committee recommended the appointment of one executive director and three non-executive directors. In that regard, detailed role specifications were drawn up, external search consultants were engaged and candidates were interviewed by committee members and other directors.
CONTENT OF REMUNERATION REPORT – Statement from remuneration committee chairman – Remuneration decisions for 2008/9 key highlights – Governance and risk management, including the role, membership and advisers to the committee – Directors’ remuneration policy – Remuneration for 2009 – Remuneration for 2008 – Dilution limits – Pensions – Service agreements – External appointments – Performance graph – Audited information
2008 was a year of unprecedented change and turmoil in financial services, in reality probably one of the most dramatic years that the sector has ever been through. The erosion of trust in the financial system, triggered by high profile failures both here and abroad, led to a change in business circumstances that no bank could escape. The problems in the financial sector have fed into the real economy and we now face a severe recession. This has understandably led to public anger and to questions being raised about the role of banks in the financial crisis.
For some years now we have adopted a strategy based on building long-term relationships with our customers and through managing our business decisions based on our assessment of how they will perform through an entire economic cycle. This strategy is inherently long-term and requires a prudent approach to managing risk. It resulted in Lloyds TSB avoiding many of the more high-risk lending areas and funding strategies, even though this could have led to higher profits in the short-term during the boom years.
Participation in this programme has clearly impacted on our remuneration approach as well as our commitment to comply with the Financial Service Authority’s (FSA) principles on remuneration. In light of a review of the Group’s remuneration polices earlier in 2008 and following consultation with the FSA in October, we developed an approach which is aligned to these principles. Our approach is currently under further detailed review and any subsequent changes will be made as required to ensure our compliance with the FSA’s draft Code of Practice.
There are clearly many things to be learned by all banks from the current crisis. One of the areas receiving a lot of attention is the whole area of remuneration and risk management. During the year the committee reviewed an analysis of Lloyds TSB incentive schemes and the extent to which they support sound risk-management, and are aligned with customer and shareholder interests. This was started in the first half of the year, predating the HBOS acquisition and the Financial Services Authority’s project looking at remuneration in the banking sector.
The committee advises on major changes of employee benefits schemes and it also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated power for settling remuneration for the chairman, the group executive directors, the company secretary and any group employee whose salary exceeds a specified amount, currently £350,000.
We welcomed Sir David Manning to the committee in May 2008, which was the only change to the committee membership during the year.
– We will be enhancing the formal role of control functions in the oversight of remuneration. Input is already sought from the risk and finance functions into remuneration design and decisions. However, we believe that our governance would benefit from a more formalised role for control functions in our remuneration processes.
We build relationships with our customers and people rather than viewing them as counterparties in a money-making transaction and will be seeking to extend this philosphy across the integrated Group. This means that working for the Lloyds Banking Group should be about more than pay. While our relationships with our people means that we will pay them fairly and competitively, our pay is positioned conservatively against the market and we will not seek to be among the highest payers in the sector. In setting pay for executive directors, we take account of the terms and conditions applying to other employees of the Group.
Our incentive measures are not just financial. Half of the annual incentive for executives is linked to a scorecard including how we performed against targets that measure how satisfied our customers are with us, and the extent to which our employees feel engaged with and committed to working for the Lloyds Banking Group, both of which are important foundations of a relationship-based strategy.
Managing the financial consequences of our business through the economic cycle
Therefore, for example, in good times, when default rates on loans are low, we adjust the economic profit measure downwards based on a higher average expected default experience over the economic cycle. This encourages us to avoid business and funding strategies that are only profitable during boom times but turn bad in a recession. Economic profit plays a prominent role in our incentive plans for executives, a role which will be further enhanced in 2009, with its inclusion in the long-term incentive plan performance measures.
The combination of incentive plans is designed to enable executives to achieve pay levels within the top 25 per cent of comparable companies, provided that performance is also in the top 25 per cent.
We have a robust governance framework with an independent remuneration committee reviewing all compensation decisions. This robust approach to governance and review is cascaded through the organisation.
We aim to choose incentive plan targets that are directly linked to the business strategy and priorities. This not only ensures alignment with company performance, but also means that the targets are meaningful to executives and therefore motivating. This ensures that incentive packages are valued by executives and therefore cost effective.
Base salary Set competitively relative to FTSE 20 and banking sector competitors
Long-term incentive plan 200 per cent of salary maximum, 175 per cent of salary less than the maximum award level in 2008, split as follows: 120 per cent of salary Normal LTIP Award based: – 50 per cent on Earnings per Share – 50 per cent on Economic Profit 80 per cent of salary Integration Award based: – 50 per cent on financial synergy savings – 50 per cent on non-financial measures of the success of the HBOS
Pension A mixture of final salary and defined contribution pension arrangements
The Lloyds TSB annual incentive plan already had many good features, such as the combination of financial and non-financial measures, which supported our prudent approach to managing risk. We are proposing to keep these features, while enhancing the operation of the plan in order to increase the alignment between risk and reward still further.
The maximum annual incentive opportunity remains unchanged at 200 per cent (225 per cent for Mr Daniels) of basic salary for the achievement of exceptional performance targets.
Performance targets will be set by reference to analysts’ expectations, internal business plans, competitive performance assessments and probability modelling. Stretch performance will be equated to the remuneration committee’s assessment of an upper quartile performance level or greater. Non-financial targets will be fully disclosed, and payments against them justified, in the year of vesting.
The committee believes that an excessive focus on financial targets can potentially reward short-term actions that are detrimental to the long-term health of the business. For this reason a balanced scorecard has been operated in the annual incentive plan for a number of years, with great success. The committee has decided that this success should be built upon by measuring part of the 2009 LTIP on a long-term balanced scorecard of non-financial measures underpinning the success of the integration over 2009 to 2011. These measures will be grouped under the categories by which the integration is being managed: – Risk – Customer – People – Build business
The chairman’s salary is reviewed annually, usually in December, taking into account performance and market information and then adjusted from 1 January of the following year. No adjustments will be made from 1 January 2009 and his salary remains unchanged at £640,000.
The fees of the independent non-executive directors are agreed by the board within a total amount determined by the shareholders. To accommodate a potentially larger board following the acquisition of HBOS, a resolution was passed at the General Meeting on 19 November 2008 to increase this amount to £1 million. 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 from 1 January 2009 are unchanged and are listed below.
In 2008, following shareholder consultation, three directors were granted enhanced awards of 375 per cent of basic salary. This was to ensure that for these directors, where there was a concern about retention, we continued to provide a fully market competitive remuneration framework.
DILUTION LIMITS The following charts illustrate the shares available for the Group’s share schemes.
Rebased to 100 on 31 December 2003 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Notes: The cash column under ‘other benefits’ includes flexible benefits payments (4 per cent of basic salary), the tax planning and education allowances for Mr Daniels, the housing allowance and pension scheme allowance for Ms Dial (paid until 30.6.08) , payments to certain directors who elect to take cash rather than a company car under the car scheme and the cash balance of a pension allowance for Mrs Weir. Sir Victor Blank has elected to take cash rather than a company car.
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2008 and 2007, respectively.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2008 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme. The basic method used to arrive at the factors has not changed during the year, although minor adjustments have been made following the introduction of new requirements applicable to transfer calculations effective from 2008.
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 £1.65 million which is equivalent to an annual pension of £82,500. Any benefit in excess of this amount will incur a tax charge for the individual. 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.
DIRECTORS’ INTERESTS The interests, all beneficial, of those who were directors at 31 December 2008 in shares in Lloyds Banking Group were: SHARES
T J W Tookey 35,305 35,305 (see page 95) 20/4/2009 19/10/2009 h
f) Exercisable to the extent at which the performance condition vested. g) Not exercisable as the performance conditions had not been met. h) Not exercisable as the option has not been held for the period required by the relevant scheme. i) Option lapsed on notice of resignation tendered prior to 31 May 2008. j) Option lapsed as not exercised by 10th anniversary of date of grant. k) Mr Kane exercised his 2003A Sharesave option on 7 August 2008. Market price on day of exercise was 318.75p. In that regard Mr Kane made a gain of £2,009.59. l) Exercisable Sharesave option. m) Lapsed on resignation. n) Cancelled Sharesave option.
Mr Tookey was appointed to the board on 30 October 2008.
Under the plan, executive directors were required to defer 50 per cent of their bonus awards in 2005 and 2006 into shares in the Company, known as bonus shares. The number of bonus shares awarded was calculated after the deduction of income tax and national insurance from the deferred element of the bonus.
The following table details the number of bonus and performance shares released in respect of their 2004 bonus and the number of bonus and performance shares remaining under the plan relating to the 2005 bonus.
The performance condition attached to the March 2005 award was met, with Lloyds TSB ranked in fifth place. Bonus shares were released on 18 March 2008, with one performance share awarded for every bonus share. Performance shares were released on 10 April 2008.
The following are conditional share awards available under the plan. Further information regarding this plan can be found on page 81.
Notes a) share price for the award made 6 March 2008 was 428.25p.
b) share price for the award made 4 April 2008 was 462.75p.
d) Ms Dial’s LTIP awards lapsed following her resignation from the Group.
May 2006 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 must be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the retail price index over the same period. If it is less than 3 per cent per annum, the EPS Award will lapse. If the increase is more than 3 but less than 6 per cent per annum, then the proportion of shares released will be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
For the other 50 per cent of the award (the ‘TSR Award’) – it will be necessary for the Company’s TSR 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 will vest where the Company’s TSR is equal to median and vesting will occur on a straight line basis in between these points. Where the Company’s TSR is below the median of the comparator group, the TSR Award will lapse. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
March 2007 For 50 per cent of the award (the ‘EPS Award’) – the performance condition was as described for May 2006 with the relevant performance period commencing on 1 January 2007 and ending on 31 December 2009.
For the other 50 per cent of the award (the ‘TSR Award’) – the performance condition was as described for May 2006 with the relevant performance period commencing on 8 March 2007 (the date of award) and ending on 7 March 2010.
basis of audiT opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the consolidated financial statements. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the consolidated financial statements, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the consolidated financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the consolidated financial statements.
pricewaterhousecoopers LLp Chartered Accountants and Registered Auditors Southampton, England 26 February 2009
The directors approved the consolidated financial statements on 26 February 2009.
Liabilities arising from insurance contracts and participating investment contracts 32 33,792 38,063
– proceeds from shares issued 119 – – 119 – 119
Repayment of capital to minority shareholders – – – – (3) (3)
net cash provided by operating activities 33,841 10,484 cash flows from investing activities
Proceeds from sale and maturity of available-for-sale financial assets 110,470 19,468
1 basis of preparaTion During 2008, global financial markets experienced difficult conditions which have been characterised by a marked reduction in liquidity. As a consequence of this, Governments and central banks carried out a series of actions to address the lack of liquidity within their respective banking systems. In the UK these actions have included the introduction of the Bank of England’s Special Liquidity Scheme whereby banks and building societies can exchange eligible securities for UK Treasury bills; and the creation of a credit guarantee scheme by HM Treasury, providing a Government guarantee for certain short and medium term senior debt securities issued by eligible banks. During 2008 the Group has made use of these measures in order to maintain and improve a stable funding position. The Group’s management of liquidity and funding risks is described on pages 55 and 56.
There is a risk that, despite the substantial measures taken by Governments, further deterioration in the markets could occur. In addition the economic conditions in the UK are deteriorating more quickly than previously anticipated placing greater strain on the Group’s capital resources. The key dependencies on successfully funding the Group’s balance sheet include the continued functioning of the money and capital markets at their current levels; the continued access of the Group to central bank and Government sponsored liquidity facilities, including issuance under HM Treasury’s credit guarantee scheme and access to the Bank of England’s various facilities; limited further deterioration in the Group’s credit ratings; and no significant or sudden withdrawal of deposits resulting in increased reliance on money markets or Government support schemes.
Based upon projections prepared by management which take into account the acquisition on 16 January 2009 of HBOS plc together with the Group’s current ability to fund in the market and the assumption that the announced Government sponsored schemes will continue to be available, the directors are satisfied that the Company and the Group have adequate resources to continue in business for the foreseeable future. Accordingly, the financial statements of the Company and the Group have been prepared on a going concern basis.
(ii) IFRIC 14 IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirement and their Interaction. This interpretation provides guidance on assessing the amount of a pension surplus that can be recognised as an asset and explains how a minimum funding requirement might either affect the availability of reductions in future contributions or give rise to a liability. The application of this new interpretation has not had any impact for amounts recognised in these financial statements.
Interest income and expense are recognised in the income statement for all interest-bearing financial instruments, except for those classified at fair value through profit or loss, using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. The effective interest rate is calculated on initial recognition of the financial asset or liability, estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts paid or received by the Group including expected early redemptions and related penalties and premiums and discounts that are an integral part of the overall return as well as direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see J).
Dividend income is recognised when the right to receive payment is established.
Revenue recognition policies specific to life assurance and general insurance business are detailed below (see R).
(e) Trading securiTies, oTher financiaL asseTs and LiabiLiTies aT fair vaLue Through profiT or Loss, and avaiLabLe-for-saLe financiaL asseTs
Debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short-term gains are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.
The criteria that the Group uses to determine that there is objective evidence of an impairment loss include: – Delinquency in contractual payments of principal and/or interest; 2 accounTing poLicies continued
Property held for long-term rental yields and capital appreciation within the long-term assurance funds is classified as investment property. Investment property comprises freehold and long leasehold land and buildings and is carried in the balance sheet at fair value, being the open market value as determined in accordance with the guidance published by the Royal Institution of Chartered Surveyors. If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices on less active markets. These valuations are reviewed at least annually by an independent valuation expert. Investment property being redeveloped for continuing use as investment property, or for which the market has become less active, continues to be measured at fair value. Changes in fair value are recorded in the income statement.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued credited to the income statement over the employees’ expected average remaining working lives. Past service costs are charged immediately to the income statement, unless the charges are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight-line basis over the vesting period.
Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset 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.
(i) Accounting for insurAnce And pArticipAting investment contrActs premiums And clAims
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 2 accounTing poLicies continued
In determining whether an impairment loss has been incurred in respect of an available-for-sale financial asset, the Group performs an objective review of the current financial circumstances and future prospects of the issuer and, in the case of equity shares, considers whether there has been a significant or prolonged decline in the fair value of that asset below its cost. This consideration requires management judgement. Among factors considered by the Group is whether the decline in fair value is a result of a change in the quality of the asset or a downward movement in the market as a whole. An assessment is performed of the future cash flows expected to be realised from the asset, taking into account, where appropriate, the quality of underlying security and credit protection available. The reduction in the fair value of available-for-sale financial assets during the year was £2,721 million (2007: £483 million). Impairment losses in respect of available-for-sale financial assets transferred from reserves to the income statement totalled £130 million (2007: £70 million).
Trading securities, other financial assets and liabilities at fair value through profit or loss, derivatives and available-for-sale financial assets are stated at fair value. The fair value of these financial instruments is the amount for which an instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The fair values of financial instruments are determined by reference to unadjusted quoted prices in active markets where these are available. Where market prices are not available or are unreliable because of poor liquidity, fair values are determined using valuation techniques which, to the extent possible, use market observable inputs. Valuation techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to similar instruments.
The size of the overall deficit is also sensitive to changes in the discount rate, which is affected by market conditions and therefore potentially subject to significant variations. At 31 December 2008 the discount rate used was 6.3 per cent (2007: 5.8 per cent); a reduction of 0.2 per cent would increase the overall deficit by approximately £469 million and the annual cost by approximately £7 million, while an increase of 0.2 per cent would reduce the net deficit by approximately £393 million and the annual cost by approximately £9 million.
The Group carries in its balance sheet an asset representing the value of in-force business in respect of life insurance and participating investment contracts of £1,893 million at 31 December 2008 (2007: £2,218 million). This asset, which is presented gross of attributable tax, represents the present value of future profits expected to arise from the portfolio of in-force life insurance and participating investment contracts. This is determined after making appropriate assumptions about future economic conditions and other matters such as future mortality and persistency rates and includes allowances for both non-market risk and for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets.
At 31 December 2008 the Group also carried substantial liabilities to holders of life, pensions and investment contracts in its balance sheet. The methodology used to value the liabilities is described in note 2 (R) (1). Liabilities arising from insurance contracts and participating investment contracts were £21,518 million and £11,619 million respectively (2007: £22,526 million and £14,874 million) and those arising from non-participating investment contracts totalled £14,243 million (2007: £18,197 million). Elements of the liabilities require assumptions about future investment returns, future mortality rates and future policyholder behaviour. The impact on profit before tax of changes in key assumptions is detailed in note 33.
While management believes that the liability carried at year end is adequate, the application of statistical techniques requires significant judgement. An increase of 10 per cent in the cost of claims would result in the recognition of an additional loss of approximately £18 million. Similarly, an increase of 10 per cent in the ultimate number of such claims would lead to an additional loss of approximately £18 million; some relief would arise from reinsurance contracts held.
Inherent in this exercise has been management’s assessment of legal and professional advice, case law and other relevant guidance. The various risks are categorised and appropriate weightings applied in arriving at the numbers. Where the expected tax outcome of these tax risks is different from the amounts that were initially recorded, such differences will impact the current and deferred tax numbers in the period in which such determination is made.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 5 neT inTeresT income weighted average effective interest rate
Interest receivable: Loans and advances to customers 6.31 6.89 13,855 13,209
Included within interest receivable is £435 million (2007: £395 million) in respect of impaired financial assets. Net interest income also includes a charge of £16 million (2007: credit of £1 million) transferred from the cash flow hedging reserve (see note 43).
Net (losses) gains on financial instruments held for trading (1,216) 286
Non-life insurance gross written premiums can be further analysed as follows: £m £m
Life insurance gross claims can also be analysed as follows: A non-life insurance claims development table is included in note 32.
Provision in respect of certain historic US dollar payments (note 48) 180 –
Provision for Financial Services Compensation Scheme levy (note 48) 122 –
Consolidated financial statements 97 notes to the consolidated financial statements 102
Other non-audit fees: Services relating to corporate finance transactions 0.4 0.7
Total fees payable to the Company’s auditors by the Group 19.5 14.6
The weighted average number of anti-dilutive share options and awards excluded from the calculation of diluted earnings per share was 59 million at 31 December 2008 (2007: 3 million).
Other financial assets at fair value through profit or loss represent the following assets designated into that category: (i) financial assets backing insurance contracts and investment contracts which are so designated because the related liabilities either have cash flows that are contractually based on the performance of the assets or are contracts whose measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise arise; (ii) certain loans and advances to customers which are economically hedged by interest rate derivatives which are not in hedge accounting relationships and where significant measurement inconsistencies would otherwise arise if the related derivatives were treated as trading liabilities and the loans and advances were carried at amortised cost; and
At 31 December 2008, the Group’s Corporate Markets business had fair value exposure to one monoline financial guarantor in the form of credit default swap (CDS) protection bought against a £256 million collateralised loan obligation (CLO) (2007: exposure to one monoline against a £198 million CLO and one monoline against a £467 million collateralised debt obligation). The exposure on this CDS was £10 million, following a £28 million adverse credit valuation adjustment. A restructuring of Corporate Markets’ other monoline hedged ABS CDO during 2008 has eliminated any reliance on the financial guarantor and has resulted in a much improved risk profile (AA) on a reduced holding of £128 million, included in loans and advances. Credit valuation adjustments and restructuring costs related to the cancelled CDS in the amount of £275 million were recognised in the income statement.
Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date.
The principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and options pricing models, as appropriate.
At 31 December 2008 £16,200 million of total recognised derivative assets and £15,215 million of total recognised derivative liabilities (2007: £3,573 million of assets and £4,112 million of liabilities) had a contractual residual maturity of greater than one year.
Contract/notional Fair value Fair value amount assets liabilities £m £m £m
Included in loans and advances to customers are £6,342 million (2007: £4,201 million) held in Cancara, the Group’s hybrid Asset Backed Commercial Paper conduit (see note 21).
Gross investment in finance leases, receivable: Not later than 1 year 542 620
Later than 1 year and not later than 5 years 978 1,004
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 2008 and 2007 no contingent rentals in respect of finance leases were recognised in the income statement. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £15 million (2007: £16 million). The unguaranteed residual values included in finance lease receivables were as follows: Not later than 1 year 1 –
Later than 1 year and not later than 5 years 29 7
Charge (credit) to the income statement 18 1,518 186 1,722 (1) 1,721
The analysis of allowances for impairment between retail and wholesale has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within wholesale are exposures to corporate customers and other large institutions.
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(J). All impaired loans which exceed a certain threshold, principally within the Group’s corporate banking business, are individually assessed for impairment having regard to expected future cash flows including those that could arise from the realisation of security. Included in loans and advances to customers and to banks were loans and advances individually determined to be impaired whose gross amount before impairment allowances was £2,699 million (2007: £684 million) and in respect of which collateral with a fair value of £518 million (2007: £193 million) was held.
21 avaiLabLe-for-saLe financiaL asseTs cancara other Total Cancara Other Total £m £m £m £m £m £m
Debt securities: Other public sector securities – 12 12 – 5 5
Bank and building society certificates of deposit – 9,602 9,602 – 1,825 1,825
Corporate and other debt securities 2,244 4,346 6,590 3,117 3,153 6,270
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,256 million (2007: £2,358 million), £1,836 million (or 81 per cent of the total) has been allocated to Scottish Widows and £410 million (or 18 per cent of the total) to Asset Finance.
During 2008, the basis of goodwill allocation and the related value in use calculation has been changed to treat the consumer finance business as a single cash generating unit encompassing the motor and personal finance operations which provide direct and point of sale finance; this reflects the strategic and operational interdependencies and shared market dynamics of these units. The markets in which these units operate have been affected by the UK economic downturn, which has been characterised by a fall off in demand and increasing arrears at this point of the cycle. This, together with continuing uncertainties over the likely short-term macroeconomic environment, has resulted in a reassessment of the carrying value of the consumer finance cash generating unit and the recognition of a goodwill impairment charge of £100 million at 31 December 2008.
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below: economic assumpTions
The valuation of the Group’s annuity business has been affected by the recent upheaval in the capital markets which has caused a significant widening in corporate bond spreads in 2008. Based on available market analysis, an element of this widening in corporate bond spreads has been assessed as arising from an increase in the illiquidity premium. Annuity contracts cannot be surrendered and have reasonably certain cash flows best matched by assets of equivalent maturity with similar liquidity characteristics. As a result, in 2008 the value of in-force business asset for annuity business has been calculated after taking into account an estimate of 154 basis points for the market premium for illiquidity, which has been derived from market and other published sources using a portfolio of investment grade bonds with similar cash flow characteristics as the annuity liabilities. The effect of this has been to increase the value of in-force business by £842 million as at 31 December 2008 with a similar increase in profit before tax. This is reflected as an economic variance in the table above, together with other market movements.
The risk free rate assumed in valuing the in-force asset for annuity business is presented as a single risk free rate to allow easier comparison to the rate used for other business. That single risk free rate has been derived to give the equivalent value to the annuity book, had the book been valued using the UK gilt yield curve increased to reflect the illiquidity premium as described above. For 2008, the risk-free rate assumed in valuing the in-force asset for non-annuity business is the 15-year gilt yield.
Acquisition costs deferred, net of amounts amortised to the income statement (16) (22)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 29 cusTomer accounTs continued
Liabilities held at fair value through profit or loss (debt securities) 6,748 3,107
Trading and other liabilities at fair value through profit or loss 6,754 3,206
Financial calendar 2009 195 32 LiabiLiTies arising from insurance conTracTs and parTicipaTing invesTmenT conTracTs £m £m
The movement in life insurance contract liabilities over the year can be analysed as follows: Gross Reinsurance Net £m £m £m
These policy liabilities can be split into With Profit Fund liabilities, accounted for using the FSA’s realistic capital regime (realistic liabilities) and Non-Profit Fund liabilities, accounted for using a traditional prospective actuarial discounted cash flow methodology as described in the accounting policies.
The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2008, the 10 year equity-implied at-the -money assumption was set at 34.6 per cent (31 December 2007: 25.5 per cent). The assumption for property volatility was 15 per cent (31 December 2007: 15 per cent), with swaption volatility of broadly 16 per cent (31 December 2007: broadly 11 per cent).
Lapse rates refer to the rate of policy termination and the rate at which policyholders stop paying regular premiums. These rates are based on a combination of historical experience and management’s views on future experience taking into consideration potential changes in future experience that may result from guarantees and options becoming more valuable under adverse market conditions.
Generally, assumptions used to value Non-Profit Fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement of Non-Profit Fund liabilities are: INTEREST RATES
Increase (decrease) in liabilities: Arising from current year claims 341 (9) 332
The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The top half of the table below illustrates how the Group’s estimate of total claims outstanding for each accident year has changed at successive year ends. The bottom half of the table reconciles the cumulative claims to the amount appearing in the balance sheet. The accident year basis is considered the most appropriate for the business written by the Group.
Estimate of ultimate claims costs: At end of accident year 227 211 208 317 205 1,168
Liability recognised in the balance sheet 2 5 9 46 106 168
32 LiabiLiTies arising from insurance conTracTs and parTicipaTing invesTmenT conTracTs continued
Widening of credit default spreads on corporate bonds8 0.25% addition (82) (59)
This sensitivity shows the impact of a flat 1 per cent addition to the expected rate. This sensitivity shows the impact of a 25 basis point increase in credit default spreads on corporate bonds and the corresponding reduction in market values. Government bond yields, the risk-free rate and illiquidity premia are all assumed to be unchanged. This sensitivity shows the impact of a 25 basis point reduction in the allowance for illiquidity premia. It assumes the overall corporate bond spreads are unchanged and hence market values are unchanged. Government bond yields and the risk-free rate are both assumed to be unchanged.
Money market instruments, cash and other assets and liabilities 669 445
Experience adjustments history (since the date of adoption of IAS 19): £m £m £m £m £m
The Group operates a number of schemes which provide post-retirement healthcare benefits to certain employees, retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of postretirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future insurance premiums payable.
Amount charged (credited) to equity: Available-for-sale financial assets (note 43) (566) (1)
Deferred tax liabilities have not been recognised for tax that may be payable if earnings of certain subsidiaries were remitted to the UK. Such amounts are either reinvested for the foreseeable future or can be remitted free of tax. Unremitted earnings totalled £1,196 million (2007: £928 million).
Future transfers from Scottish Widows plc’s long-term business funds to its Shareholder Fund will be subject to a shareholder tax charge. Under IAS 12, no provision is required to be made to the extent that the timing of such transfers is under Scottish Widows plc’s control. Accordingly, deferred tax liabilities of £90 million (2007: £90 million) have not been recognised.
Series 3 (US$600 million) 412 299 11¾% Perpetual Subordinated Bonds (£100 million) 100 100 55/8% Undated Subordinated Step-up notes callable 2009 (€1,250 million) d, k 1,212 915
Subordinated Step-up floating Rate notes 2016 callable 2011 (£300 million) e 300 300
Subordinated fixed to floating Rate notes due 2020 callable 2015 (£750 million) k, p 754 –
a) Any repayment of preference shares would require prior notification to the financial Services Authority. In certain circumstances, the shares may be mandatorily exchanged for qualifying non-innovative tier 1 securities. The Company may declare no dividend or a partial dividend on these preference shares. Dividends may be reduced if the distributable profits of the Company are insufficient to cover the payment in full of the dividends and also the payment in full of all other dividends on shares issued by the Company.
c) Dividends will accrue at a rate of 6.267 per cent per annum up to 13 november 2016 and, unless redeemed, at a rate reset quarterly equal to 1.035 per cent per annum above the London interbank offered rate for three-month sterling deposits thereafter. These preference shares can be redeemed at the option of the Company on 14 november 2016 or every 10 years thereafter.
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued 41 share Capital authorised share capital
Euro: em em 160 million Preference shares of 25 cents each 40 40
Where, under an employee share plan operated by the Company, participants are the beneficial owners of shares but not the registered owners, the voting rights are normally exercised by the registered owner at the direction of the participant. All of the Company’s share plans contain provisions relating to a change of control. outstanding awards and options would normally vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions at that time.
Index to annual report 192 financial calendar 2009 195 41 share Capital continued
private plaCement of ordinary shares during 2008 on 19 September 2008, the Company entered into a placing agreement whereby a total of 284,400,000 new ordinary shares of 25 pence each with an aggregate nominal value of £71,100,000 were placed with institutional investors at a price of 270 pence per share. The proceeds of the placing, after costs, were £760 million. The issue represented an increase of approximately 5 per cent in the issued share capital at the time. The capital was raised to allow Lloyds Banking Group to strengthen its capital and support the development of business strategies.
issued and fully paid preferenCe shares Since 2004, the Company has had in issue 400 6 per cent non-cumulative redeemable preference shares of 25 pence 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 at a rate 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 holders of the 6 per cent non-cumulative redeemable preference shares held less than 0.1 per cent of the total share capital as at 31 December 2008. In accordance with IfRS, these shares are reported within liabilities.
In addition, during 2006 the Company issued 600,000 fixed/floating Rate non-Cumulative Callable Preference Shares of 25 pence each with a liquidation preference of £1,000 per share and 1,000,000 fixed/floating Rate non-Cumulative Callable Preference Shares of 25 cents each with a liquidation preference of US$1,000 per share. Both issues of preference shares are perpetual, although the two issues can be redeemed at the option of the Company on or after 25 August 2015 and 14 november 2016 respectively and carry the right to non-cumulative dividends which are fixed until those first redemption dates. The terms of these two issues of preference shares are such that the Company cannot declare and pay a dividend on any other junior class of share (including the mandatory dividend on the 400 6 per cent non-cumulative redeemable preference shares mentioned above) until the coupon has been paid on these preference shares. As the Company is effectively committed to the payment of a coupon on these shares they are classified as liabilities on the balance sheet in accordance with IfRS (see note 40). The holders of the fixed/floating rate non-cumulative callable preference shares, who held less than 0.1 per cent of the total share capital as at 31 December 2008, do not have the right to receive notice of, attend, speak or vote at any general meetings other than on resolutions relating to the variation or abrogation of any of the rights or restrictions attached to the preference shares or the winding up or dissolution of the Company or if, at the date of the notice of meeting, the dividend payable at the immediately preceding dividend payment date has failed to be declared and paid in full. Upon winding up, the fixed/floating rate non-cumulative callable preference shares shall rank equally with the most senior class of preference shares and any other class of shares which are expressed to rank equally.
Premium arising on private placement of ordinary shares (note 41) 689 –
movements in other reserves were as follows: £m £m merger reserve
Value of employee services includes a credit of £12 million (2007: £30 million) reflecting the income statement charge in respect of SAYE and executive options, together with a related tax charge of £16 million (2007: tax charge £14 million). Purchase/sale of treasury shares includes a credit of £31 million (2007: £29 million) relating to the cost of other share scheme awards.
Shares granted in prior years 21 17 share based payment sCheme details
The performance conditions for awards made in march, April, August and September 2008 are as follows: (i) for 50 per cent of the award (the EPS Award) – the performance condition is as described for may 2006 with the relevant performance period commencing on 1 January 2008 and ending on 31 December 2010.
The performance condition attached to the march 2005 award was met, with the Group ranked in fifth place. Bonus shares were released on 18 march 2008, with one performance share granted for each bonus share. Performance shares were released on 10 April 2008.
The Group undertakes to match shares purchased by employees up to the value of £30 per month; these shares are held in trust for a mandatory period of three years on the employees’ behalf. The award is subject to a non-market based condition: if an employee leaves within this three year period for other than a ‘good’ reason or the accompanying partnership shares are sold within that time, 100 per cent of the matching shares are forfeited (or the portion relating to the shares sold).
Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of Lloyds Banking Group plc group executive committee together with its non-executive directors.
At 31 December 2008, the Group’s pension funds had call deposits with Lloyds TSB Bank plc amounting to £23 million (2007: £23 million).
The Group has provided information relating to its review of historic US dollar payments involving countries, persons or entities subject to US economic sanctions administered by the office of foreign Assets Control (ofAC) to a number of authorities including ofAC, the US Department of Justice and the new York County District Attorney’s office which, along with other authorities, have been reported to be conducting a broader review of sanctions compliance by non-US financial institutions. At 31 December 2008, the discussions with those authorities had advanced towards resolution of their investigations and the Group held an accrual of £180 million in respect of this matter. on 9 January 2009, the Group announced that it had reached a settlement with both the US Department of Justice and the new York County District Attorney’s office in relation to their investigations. The settlement documentation contains details of the results of the investigations including the identification of certain activities 47 related party transaCtions continued
Where a Group company is the lessee the future minimum lease payments under non-cancellable premises operating leases are as follows: £m £m not later than 1 year 216 212
Later than 1 year and not later than 5 years 647 677
Later than 5 years 774 764 operating lease payments represent rental payable by the Group for certain of its properties. Some of these operating lease arrangements have renewal options and rent escalation clauses, although the effect of these is not material. no arrangements have been entered into for contingent rental payments.
The accounting policies in note 2 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 financial assets and liabilities by category and by balance sheet heading.
Derivative financial instruments 435 28,449 – – – – – 28,884
Loans and advances to banks – – – – 40,758 – – 40,758
Loans and advances to customers – – – – 242,735 – – 242,735
Trading and other liabilities at fair value through profit or loss – 6 6,748 – – – – 6,754
Derivative financial instruments 4,169 22,723 – – – – – 26,892
Debt securities in issue – – – – – 75,710 – 75,710
Unallocated surplus within insurance businesses – – – – – – 270 270
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued 49 finanCial risK management continued
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 as at 31 december 2007 financial assets
Derivative financial instruments 264 8,395 – – – – – 8,659
Loans and advances to banks – – – – 34,845 – – 34,845
Loans and advances to customers – – – – 209,814 – – 209,814
Available-for-sale financial assets – – – 20,196 – – – 20,196 financial liabilities
Trading and other liabilities at fair value through profit or loss – 99 3,107 – – – – 3,206
Derivative financial instruments 800 6,782 – – – – – 7,582
Debt securities in issue – – – – – 51,572 – 51,572
Unallocated surplus within insurance businesses – – – – – – 554 554
In accordance with the amendment to lAS 39 as disclosed in note 2, the Group reviewed the categorisation of its assets classified as held for trading and available-for-sale financial assets. on the basis that there was no longer an active market for some of those assets, which are therefore more appropriately managed as loans, the Group reclassified £2,993 million of assets classified as held for trading (measured at fair value through profit or loss immediately prior to reclassification) to loans and receivables with effect from 1 July 2008 and £437 million of assets classified as available-for-sale financial assets (measured at fair value through equity) to loans and receivables with effect from 1 november 2008. At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity.
In respect of the £437 million of assets transferred with effect from 1 november 2008, a negative valuation movement of £261 million, including exchange movements, was recognised in the revaluation reserve in respect of available-for-sale financial assets for the ten months to 31 october 2008 while they were classified as available-for-sale financial assets. If the assets had not been transferred and had been kept as available-for-sale financial assets £3 million would have been recognised in interest income and £209 million would have been recognised in impairment in the income statement for the two months to 31 December 2008.
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 personal loans and mortgages, bear interest rates which are contractually fixed for periods of up to five years or longer.
The Group establishes two types of hedge accounting relationships for interest rate risk: fair value hedges and cash flow hedges. The Group is exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The majority of the Group’s hedge accounting relationships are fair value hedges where interest rate swaps are used to hedge the interest rate risk inherent in the fixed rate mortgage portfolio. At 31 December 2008 the aggregate notional principal of interest rate swaps designated as fair value hedges was £37,243 million (2007: £50,734 million) with a net fair value liability of £1,231 million (2007: £197 million) (see note 17). The losses on the hedging instruments were £584 million (2007: losses of £233 million). The gains on the hedged items attributable to the hedged risk were £426 million (2007: gains of £211 million).
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 Wholesale and International Banking market and Liquidity Risk. Associated VaR and the closing, average, maximum and minimum for 2007 and 2008 are disclosed on page 51.
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued 49 finanCial risK management continued £m £m functional currency of Group operations
Japanese yen: Gross exposure 3,667 2,148 net investment hedge (3,645) (2,136)
The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. no account is taken of any collateral held and the maximum exposure to loss is considered to be the balance sheet carrying amount or, for non-derivative offbalance sheet transactions and financial guarantees, their contractual nominal amounts.
A general description of collateral held in respect of financial instruments is disclosed on page 50.
Impaired – no provision required 479 150 1,253 1,882 – –
neither past due nor impaired 99,828 29,850 73,475 203,153 1,189 34,845
Impaired – no provision required 415 100 293 808 – –
Allowance for impairment losses (note 20) (37) (2,029) (342) (2,408) – –
Corporate and other debt securities 76 187 38 68 87 80 536
Corporate and other debt securities 3,194 864 2,911 2,142 599 1,410 11,120
Total held at fair value through profit or loss 10,842 1,903 3,501 2,504 791 1,641 21,182 available-for-sale financial assets
Corporate and other debt securities 4,111 1,424 304 71 113 567 6,590
Treasury bills and other bills 26,858 2,351 – – – – 29,209
Total held as available-for-sale assets 40,812 13,320 552 91 243 648 55,666
Corporate and other debt securities 268 1,268 1,390 103 59 519 3,607
Corporate and other debt securities 5,118 1,606 2,868 2,528 340 1,104 13,564
Debt securities: other public sector securities – – – – – 5 5
Corporate and other debt securities 3,822 1,170 186 – – 1,092 6,270
Total held as available-for-sale assets 13,938 4,500 348 – 15 1,366 20,167
Derivative financial instruments, trading and other liabilities at fair value through profit or loss 10,286 2,176 3,607 1,589 1,851 19,509
Liabilities arising from non-participating investment contracts 18,197 – – – – 18,197
Trading derivatives (other than those in the insurance companies) and trading liabilities are included in the up to 1 month column at their fair value. Liquidity risk on these items is not managed on the basis of contractual maturity as they are frequently settled on demand at fair value and therefore this is considered a better presentation of the Group’s liquidity risk. Derivatives used in a hedging relationship are included according to their contractual maturity.
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £412 million (2007: £223 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.
fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets, such as the value of the Group’s branch network, the long-term relationships with depositors and credit card relationships; premises and equipment; and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.
Where referred to within the major categories listed, the Group’s use of lead manager quotes and market standard consensus pricing services are as described below: Lead manager quotes for illiquid assets in the current markets do not represent binding levels and are validated for consistency across the same asset class and by reference to discounted cash flow models that use expected loss and discount assumptions.
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued 49 finanCial risK management continued observable or are implied from instrument prices. The fair values of bonds classified as trading assets are determined predominantly from lead manager quotes and, where these are not available, by reference to market standard consensus pricing services, broker quotes and other research data. Certain corporate bonds were valued using credit default swap (CDS) spreads and assumptions around the bond/CDS spread. The fair values of the Group’s venture capital investments are determined using techniques which follow British Venture Capital Association (BVCA) guidelines.
At 31 December 2008, the Group had a portfolio of corporate bonds hedged by CDS. Prior to october 2008, the markets for both corporate bonds and CDS were relatively liquid and both sides of the above position were valued using market observable inputs. During october 2008 bid/offer spreads widened severely and, consequently, the cash market for corporate bonds became inactive. The above position is valued in part using assumptions around the bond/CDS spread. The effect of using reasonably possible alternative adverse assumptions for this valuation would reduce net trading income by up to £105 million.
Interest rate swaps 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. foreign exchange derivatives that do not contain options are priced using rates available from publicly quoted sources. Credit derivatives, except for the items noted below, are valued using publicly available yield and CDS curves; the Group uses standard models with observable inputs. Less complex interest rate and foreign exchange option products 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-themoney data; where necessary, the Group adjusts for out-of-the-money positions using a market standard consensus pricing service.
Listed securities are valued at current bid prices. Unlisted securities and other financial assets are valued based on discounted cash flows, market prices of similar instruments and other appropriate valuation techniques. The fair values of bonds classified as available-for-sale financial assets, including ABS, are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data.
At 31 December 2008, the Group’s available-for-sale financial assets included ABS of £13,938 million. In respect of these assets, the effect of a 100 basis point shift in credit spreads would result in a pre-tax movement of £590 million which would be recognised, net of tax, in the revaluation reserve in respect of available-for-sale assets.
financial guarantees are valued on the basis of cash premiums receivable. The Group considers that it is not meaningful or practical to provide an estimate of the fair value of other contingent liabilities and financial commitments, given the lack of an established market, the diversity of fee structures and the difficulty of separating the value of the instruments from the value of the overall transaction. Therefore only financial guarantees are included in the following table.
Trading and other financial assets at fair value through profit or loss 45,064 57,911 45,064 57,911
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued 50 Consolidated Cash flow statement continued
(e) analysis of Changes in finanCing during the year £m £m
(g) disposal and Closure of group undertaKings and businesses £m £m
Liabilities arising from insurance contracts and participating investment contracts – (4,349)
net cash inflow from disposals – 1,476 50 Consolidated Cash flow statement continued
IAS 23 Borrowing Costs Requires interest and other costs incurred in connection with the borrowing of funds to be recognised as an expense except for those which are directly attributable to the acquisition, construction or production of assets that take a substantial period of time to get ready for their intended use or sale which must be capitalised as part of the cost of those assets.
Dealt with on a standard by standard basis but not earlier than annual periods beginning on or after 1 January 2009.
Removes the definition of the cost method and requires the presentation of dividends as income in the separate financial statements of the investor.
Clarifies how the principles underlying hedge accounting should be applied in particular situations.
At the date of this report, these pronouncements are awaiting EU endorsement.
52 post balanCe sheet events share Capital on 19 november 2008, Lloyds Banking Group plc shareholders approved, subject to certain conditions, an increase in the Company’s share capital by creating 14,911,908,221 new ordinary shares of 25 pence each, and creating 625,000,000 new preference shares of 25 pence each. These conditions were met in January 2009.
So as to improve the position of HBoS preference shareholders following the acquisition of HBoS (see below), on 16 January 2009 the Group cancelled a number of HBoS preference share issuances in exchange for preference shares issued by Lloyds Banking Group plc. In this regard, the Company issued £299,987,729 9.25 per cent fixed rate non-cumulative preference shares, £99,999,942 9.75 per cent fixed rate non-cumulative preference shares, £186,190,532 6.475 per cent fixed rate non-cumulative preference shares, £745,431,000 6.0884 per cent fixed to floating rate non-cumulative callable preference shares, £334,951,000 6.3673 per cent fixed to floating non-cumulative callable preference shares, US$750,000,000 6.413 per cent fixed to floating rate non-cumulative callable preference shares, US$750,000,000 5.92 per cent fixed to floating rate non-cumulative callable preference shares, US$750,000,000 6.657 per cent fixed to floating rate non-cumulative callable preference shares and £3,000,000,000 12 per cent fixed to floating non-cumulative callable preference shares.
respeCtive responsibilities of direCtors and auditors The directors’ responsibilities for preparing the annual report, the directors’ remuneration report and the parent company financial statements in accordance with applicable law and International financial Reporting Standards (‘IfRSs’) as adopted by the European Union are set out in the statement of directors’ responsibilities on page 73.
REPoRT of THE InDEPEnDEnT AUDIToRS on THE PAREnT ComPAnY fInAnCIAL STATEmEnTS
Proceeds from shares issued 119 – 119 no income statement has been shown for the parent company, as permitted by section 230 of the Companies Act 1985.*
The Company’s investment in subsidiaries is carried at cost: there has been no movement in the carrying value during the year and there has been no impairment of the Company’s investment in subsidiaries.
Black Horse Limited England 100%† Consumer credit, leasing and related services
Related party information in respect of other related party transactions is given in note 47 to the consolidated financial statements.
Index to annual report 192 financial calendar 2009 195 9 finanCial instruments measurement basis of finanCial assets and liabilities
Amounts due from subsidiaries – – 216 – 216 financial liabilities: Debt securities in issue – – – 2,644 2,644
Total financial liabilities – – – 5,519 5,519 Derivatives designated as Held for hedging instruments, held trading at fair Held at at fair value through value through Loans and amortised profit or loss profit or loss receivables cost Total £m £m £m £m £m as at 31 december 2007 financial assets: Cash and cash equivalents – – – 58 58
A copy of the code and information about it may be obtained from the BERR Publications orderline 0845 015 0010, quoting ref URn 04/606. Alternatively, visit www.payontime.co.uk for details.
The Company’s share register is 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 – loss of share certificate – dividend information, including loss of dividend warrant or tax voucher.
Contact details for Equiniti Limited can be found on page 195.
Report on the parent company financial statements 182 fees 121 available-for-sale finanCial assets
Accounting policy 103 notes to the consolidated financial statements 124, 136 impairment
Shareholder enquiries 191 insuranCe premium inCome 118 insuranCe Claims 119 investment property
Accounting policy 108 notes to the consolidated financial statements 156 share Capital
Index to annual report 192 financial calendar 2009 195 27 february Results for 2008 announced 8 may Record date for the capitalisation issue 11 may Ex-date for the capitalisation issue and shares admitted to trading. CREST accounts credited 22 may
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