By becoming the best bank for customers we believe we can help Britain prosper and deliver strong and sustainable returns for our shareholders.
We have an extensive multi-brand, multi-channel offering. With more than 2,200 branches we have the largest branch network and one of the largest fee free ATM networks in the UK and also provide a comprehensive digital, telephony and mobile service. We serve millions of customers through our Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows brands.
The General Insurance business is a leading provider of home insurance in the UK, with products sold through the branch network, direct channels and strategic corporate partners.
£17bn Run-off portfolio reduced by more than £140 billion to £17 billion
Overview and strategy My first year as Chairman of Lloyds Banking Group saw the achievement of our 2011 strategic plan. We have delivered on our key strategic priorities over the last three years, reshaping the Group to focus on serving our UK customers and returning the balance sheet to strength, while at the same time generating a significant improvement in underlying profitability and recommencing a dividend payment. I would like to extend my thanks to the Board, the management team and all colleagues across the Group for their determination to see this through.
The next phase of our strategy, announced in October, outlined how we will focus on creating the best customer experience, becoming simpler and more efficient and delivering sustainable growth. As a Board, we have spent much time discussing how we could take the business forward, recognising the impact that the evolving regulatory and competitive environment and customers’ changing needs are having on our UK retail and commercial banking focused business. We believe that digital transformation in particular will result in more fundamental change occurring in the banking industry over the next decade than we have seen in the last 200 years.
Our low cost, low risk, customer focused, UK retail and commercial banking strategy is the right one in the current environment.
Regulation As a result of the financial crisis, there has been a great deal of change in the regulatory environment in recent years. The regulators have made good progress in improving financial stability through prudential regulation and they are now putting greater emphasis on protecting consumers and small business customers through conduct and competition regulation.
Directors We were delighted to welcome four new Independent Non-Executive Directors to the Board during the year. Dyfrig John joined in January, Nick Prettejohn and Simon Henry in June and Alan Dickinson in September. These appointments bring a good balance of additional skills and experience to our Board. More information can be found in the corporate governance section and on our website.
One of the principal tasks of the Board is to develop a strategy which can achieve long‑term success and generate sustainable returns for shareholders. This needs to be underpinned by the high standards of corporate governance which are critical to the success of any business today and should be driven by the Board (led by the Chairman) and embedded in the thinking and processes of the business. We are confident we have a strong, experienced management team and a commitment to good governance enabling us to build a business that will deliver sustainable success in the future.
Board oversight – key topics During 2014, the Board continued to review the Group’s corporate strategy, the operation of the business and our results within a framework of prudent and effective controls, including the assessment and management of risks. Key topics arising through the year included: – discussion and oversight of the Group Strategic Update; – the appointment of four Non-Executive Directors in order to strengthen the Board’s experience in the areas of financial services, banking, risk and insurance; – the initial public offering (IPO) of TSB Banking Group plc in order to meet the Group’s commitments to the European Commission; – the banking stress tests conducted by the EBA and the PRA in order to assess banks’ resilience to market downturns; – the resolution of legacy issues with regulators in the UK and US in respect of the manipulation of the London Interbank Offered Rate (LIBOR) and the Sterling Repo Rate and continued focus on Payment Protection Insurance; and
Despite better results in 2014, the total bonus outcomee for the year has decreased by approximately 3.6 per cent (after adjusting for TSB). This reflects the continuing overhang of past conduct issues. Discretionary bonus awards remain a very small percentage of revenues at approximately 2 per cent, and represent approximately 4.5 per cent of pre-bonus underlying profit before tax, compared to 6 per cent in 2013. Cash bonuses are capped at £2,000 with additional amounts paid in shares and subject to deferral and performance adjustment. Average bonus awards across all our staff are approximately £4,500.
Community and culture With a network of more than 2,200 UK branches and a focus on supporting small to medium-sized businesses, we are well positioned to help our local and national communities. Our commitment to invest in the long-term economic future of the UK is highlighted, not just through the significant lending to customers, particularly SMEs and first-time buyers, but also through the many community programmes we run, including our Lloyds Scholars programme, our Social Entrepreneurs programme and our Career Academies.
With a network of more than 2,200 UK branches and a focus on supporting small to medium-sized businesses, we are well positioned to help our local and national communities.
I am also delighted to announce that BBC Children in Need will be the Group’s Charity of the Year partnership for 2015 and 2016. We chose BBC Children in Need because we share the same goal of supporting communities across the UK and we will be working together to change the lives of disadvantaged children and young people.
Given this strong strategic progress and the improvement in our financial performance and position, we have a firm foundation to deliver the new strategic priorities that we set out in October and we are well placed to continue to support and benefit from the strengthening UK economy and to be the best bank for our customers and shareholders.
Financial performance in 2014 We delivered a significant improvement in financial performance at both an underlying and statutory level. Underlying profit increased by 26 per cent to £7,756 million, with the Group’s return on risk-weighted assets (RoRWA) improving by 88 basis points to 3.02 per cent. At a divisional level, all of our banking businesses delivered a robust performance with improvements in underlying profit and RoRWA in our Retail, Commercial Banking and Consumer Finance divisions after increased investment made to deliver growth. Underlying profit was lower in our Insurance division, reflecting the challenging market backdrop and regulatory and legislative changes that have similarly affected the wider industry.
Net interest income increased by 8 per cent, driven by a 33 basis point improvement in the net interest margin to 2.45 per cent and increased lending in our key customer segments. Other income excluding St. James’s Place effects was 9 per cent lower, reflecting business disposals and a challenging operating environment. Underlying costs were reduced by 2 per cent, while the effective management of our lending portfolio, coupled with the benign economic and low interest rate environment, resulted in a substantial 60 per cent reduction in the impairment charge to £1,200 million.
We enter the next phase of our strategic journey from a position of strength, having delivered against our key strategic priorities.
Our strong performance in 2014 marks the culmination of three years of strategic delivery that has transformed the business for the benefit of our customers and shareholders.
Group Chief Executive’s review continued a combination of earnings generation, a reduction in risk-weighted assets as we de-risk the business, and other management actions. Our CET1 ratio is now amongst the strongest within the banking sector worldwide, positioning us well against the backdrop of evolving regulatory requirements for capital and leverage.
At the same time, we have significantly reduced our reliance on wholesale funding through the careful management of our lending portfolio and the growth in our relationship deposit base, with our loan to deposit ratio strengthening from 154 per cent in 2010 to 107 per cent. Our wholesale funding requirement at the end of 2014 of £116 billion compares to £298 billion at the end of 2010 and is broadly matched by our primary liquid asset portfolio of £109 billion.
Being the best bank for customers is at the heart of our strategy. In support of this, we have continued to invest in our product propositions as well as our branches, digital and telephony channels, with key customer benefits from this investment ranging from reduced processing times, improved ease of access and convenience, and greater efficiency. Digital remains a key area of growth and investment for the business and has now been expanded as a Group-wide division spanning across all business areas, reflecting our customers’ evolving preferences in how they interact with us. At the end of 2014, our active online user base was over 10.4 million customers, within which our active mobile users were over 5 million: a 29 per cent increase compared to the end of 2013.
Our success in improving the customer experience has been reflected in net promoter scores (NPS), which have increased by 50 per cent since 2010, and Group reportable banking complaints (excluding PPI), which have reduced significantly over the same period and are now approximately 50 per cent lower than the average of our major banking peers.
Our business has been transformed, with a reshaped, low risk portfolio, a strengthened capital and funding position and a more efficient cost base.
Outlook Thanks to the hard work and commitment of our colleagues, we are entering the next three year phase of our strategy from a position of strength. Together, we have delivered the strategic objectives we set out in 2011 resulting in a business that has been transformed, with a reshaped and low risk portfolio focused on our core UK markets, a strengthened capital and funding position, and a more efficient cost base.
We will invest £1 billion over the next three years in our digital capability across all divisions, delivering better service with greater efficiency.
UK ECONOMIC TRENDS Economic recovery has picked up in 2014 Seven years after the start of the financial crisis, the UK economy is returning to a level of stability. Initial estimates indicate that economic growth rose to 2.6 per cent in 2014 from 1.7 per cent in 2013, the strongest rate of growth since 2006 and above the economy’s long-term average growth rate. Unemployment has fallen rapidly – by twice as much in 2014 as across the previous two years combined – and at 5.7 per cent has now reversed the bulk of its rise during the recession. Consumer spending growth and the level of private car registrations have returned to pre-crisis rates. Rising business confidence in response to the upturn in demand has been reflected in a significant increase in business investment, now higher as a share of GDP than before the crisis. The rate of corporate failure has fallen back after its rise in 2009, and is now the lowest on record (since 1984) at 0.5 per cent.
Conduct and competition remains a focus for our regulators who have been carrying out reviews into the savings and credit cards markets alongside reviewing access to and ownership of payment systems. The Competition and Markets Authority (CMA) is also currently reviewing the UK SME and personal current account markets which will focus on competition, in particular barriers to entry and the ease of comparing and switching accounts. We are also continuing to work to ensure provision of appropriate and fair products for customers with clear, simple and relevant terms.
We are assessing and implementing other regulatory changes including the Foreign Account Tax Compliance Act (FATCA), the UK’s Fair and Effective Markets Review, the Senior Managers’ Regime, and the Solvency II Directive, and will need to consider the legislation for the current EU parliament which is just beginning to be shaped by the new EU Commission.
– Regulatory environment: greater clarity emerging on regulatory requirements and our simple, low risk, UK focused strategy places us in a strong position.
– Competition: an increasingly competitive market for lending and deposits will potentially impact margins and require us to innovate and evolve more quickly.
We also track performance against the commitments of our Helping Britain Prosper Plan, the results of which can be found on page 24.
For more on customer relationships go to page 22 or visit www.lloydsbankinggroup.com
The Lloyds share price fell by 4 per cent in 2014, and this was broadly in line with the FTSE 100 and ahead of the UK banking sector as a whole. Share price performance in the last three years remains significantly ahead of both the sector and the market. Total shareholder return was lower than the FTSE 100 in 2014 as the Group did not pay a dividend.
Our cost:income ratio continued to fall in 2014 due to the continued focus on costs and increased income. The resulting cost leadership position provides competitive advantage for the Group.
Our asset quality ratio continued to improve and we exceeded our 2014 target of 50 basis points in 2014, demonstrating our lower risk position.
1. Creating the best customer experience Customers remain at the heart of our strategy. We want to create the best customer experience through our multi-brand, multi-channel approach, combining comprehensive online and mobile capabilities with face-to-face services. We are transforming our digital presence, providing customers with simpler, seamless interactions across online, mobile and branches while sustaining extensive customer reach through a branch network focused on delivering high quality service and the right outcomes for customers.
Helping Britain prosper As the largest retail and commercial bank in the UK, helping Britain prosper remains central to the Group’s purpose. We are already the largest lender to first-time buyers, providing 1 in 4 mortgages, and we supported over 107,000 business start-ups in 2014. Over the next three years, we expect to commit over £30 billion of additional net lending to UK personal and commercial customers.
Our commitment to the long-term economic future of the UK is also highlighted through the ongoing investment we make in our community programmes such as Lloyds Scholars, Social Entrepreneurs and Career Academies, as well as our charity of the year which for 2015-2016 is BBC Children in Need.
COST LEADERSHIP POSITION – £1 billion of additional run-rate savings per annum – cost:income ratio to exit 2017 at around 45%; targeting reductions in each year
STRONG BALANCE SHEET POSITION – loan to deposit ratio of 105% -110% – steady state CET1 ratio of c.12% – leverage ratio of at least 4.5%
Our Values and Codes of Responsibility provide points of reference as we work to become the best bank for customers through our low risk, UK focused retail and commercial business model.
Our focus on doing business responsibly is recognised by our continued presence in the FTSE4Good socially responsible investment index, our position in the CDP (Carbon Disclosure Project) and our platinum status in the Business in the Community CR Index.
BEING HONEST AND TRANSPARENT We must do the right thing for customers when it comes to dealing with, and learning from, the mistakes of the past
BUILDING A MORE RESPONSIBLE CULTURE We are continuing to change our culture to make sure that all colleagues are empowered, inspired and incentivised to do the right thing for customers
Our Group Values underpin everything we do. They guide how we work and define the standards we set everyday. They are: Putting customers first Making a difference together
Our Codes of Responsibility ensure that we operate responsibly as a business and as individuals. Our Policies address the primary areas of risk we face and support a consistent approach to behaviour and decision making. As such, they are an important part of our Group Risk Management Framework.
Lending to businesses Providing expert training and mentoring for businesses and individuals
3.4 Maintain a category gold award with the Business Disability Forum (BDF) by achieving a high score across the ten areas2 that lead to a disability confident organisation 98% >90% score
We’ll help businesses to start up and scale up, and we will procure responsibly 4.1 Increased amount of net lending to SMEs on an annual basis (total cumulative) £1.27bn (>£31bn)
4.2 Number of start-up businesses we will help to get off the ground 99,133 (107k including TSB) >100k 4.3 Increased amount of new lending provided to support UK manufacturing businesses per year £1bn £1bn 4.4 Number of entrepreneurs supported through Lloyds Bank and Bank of Scotland Social Entrepreneurs programmes
We’ll help our customers plan and save for later life 2.1 Number of customers we help to plan for later life through company pension schemes 1.41m
5.3 % of Lloyds Banking Group Apprenticeships taken up by external candidates from the UK’s most disadvantaged areas3 N/A N/A N/A
Tax contributions We do not interpret tax laws in ways that we believe are contrary to their intention; and we do not promote tax avoidance products to our customers. We comply with the HMRC Code of Practice on Taxation for Banks and the Confederation of British Industry’s statement of tax principles. The tax system covering our activities is complex and wide ranging. Because of this, our decisions and actions regarding tax are based on a considered assessment of long-term costs and risks, including their impact on our relationship with stakeholders and our reputation with customers. The Group’s approach to tax is governed by a Group Board approved tax policy and strategy, which has been discussed with HMRC.
We comply rigorously and consistently with all anti-bribery legislation and regulation wherever we operate, by adopting appropriate procedures and controls to counter the risk of bribery. Our Anti-Bribery Policy applies to all Directors and employees and those acting on the Group’s behalf. All colleagues complete annual anti-bribery training and are encouraged to report instances of suspected bribery via the Whistleblowing service. During 2014, the Group was invited to apply, and was subsequently approved, for membership of Transparency International UK’s Business Integrity Forum.
Addressing and learning from past mistakes We must do the right thing for customers when it comes to dealing with, and learning from, the mistakes of the past. We must respond fairly, honestly and transparently to any concerns our stakeholders may have about our plans for the future. We have publicly acknowledged our past mistakes, many of which were endemic to our industry, and committed to resolve them. We were the first UK retail bank to offer customers PPI mis-selling compensation.
Embedding responsible business We are continuing to change our culture to make sure that all colleagues are empowered, inspired and incentivised to do the right thing for customers. In 2012, we launched our Code of Business Responsibility and Code of Personal Responsibility, setting out behaviours consistent with our Group Values. Since then, we’ve worked hard to embed the Values and Codes across our Group – ensuring that 95 per cent of colleagues completed mandatory training on the Codes in 2014.
In 2014, our annual Colleague Survey achieved its highest response rate to date, with 85 per cent of colleagues participating compared to 76 per cent in 2013. The Employee Engagement Index (EEI) and the Performance Excellence Index (PEI) measure individual motivation and how strongly colleagues believe we are committed to improving customer service, respectively. The Line Manager Index (LMI) shows how our colleagues feel about their line managers. Key feedback included: – A 75 per cent PEI score (down 1 percentage point compared with 2013 but 11 percentage points above the UK norm). – A 60 per cent EEI score (down 4 per cent from 2013 and 2 points below the UK norm). – An 81 per cent LMI score – the same as 2013 (14 percentage points above the UK norm).
Number of colleagues achieving the Foundation Standard for Professional Bankers in 2014
Community investment highlights – £16.5 million donated to the Lloyds Bank and Bank of Scotland Foundations; – £6.5 million raised since 2013 for our Charity of the year, the Alzheimer’s Society and Alzheimer Scotland against our £4 million target; – 1,632 grants to community groups through our Community Fund; – 37,847 colleagues volunteered through our Day to Make a Difference programme; – 4.83 million local people brought together through The Big Lunch, of which Halifax is a partner; – 2,607 nominations for the Halifax Giving Extra Awards; – 881 people trained through Money for Life, bringing the total to 2,035 since 2009; – 120 young people joined our Lloyds Scholars programme; – 297 social entrepreneurs supported through our Social Entrepreneurs programme; and – The equivalent of 18 full time colleagues working as Business Connectors helping local businesses, bringing the total to 42 since 2012.
Children in Need Our new Charity of the Year partnership for 2015 and 2016 is with BBC Children in Need, who share the same goal as the Group in supporting communities across the UK. Our 2015 colleague fundraising target is £2 million.
Learning and development We can only become the best bank for customers if all colleagues are capable of carrying out their roles to the best of their ability. Throughout 2014, we promoted the learning and development opportunities currently available to colleagues by running a series of coordinated campaigns, including road shows at Group locations across the UK, National Learning at Work Week and National Customer Service Week. Increasing digitisation is reflected through our colleagues having access to training in a range of media – how, when and where they need it.
STAKEHOLDERS We have an active stakeholder engagement plan to ensure, through two-way dialogue, we listen to, and understand our stakeholders’ requirements.
Suppliers We want to work together with our suppliers and others in our supply chain to ensure we source goods and services in ways that are responsible, sustainable, mutually beneficial and provide best value for our customers and shareholders.
Our approach to risk is founded on an effective control framework and a strong risk management culture which guides how our employees approach their work, the way they behave and the decisions they make. The amount and type of risk that we are prepared to seek, accept or tolerate, otherwise known as risk appetite, works in tandem with our strategy and is approved by the Board. Our risk appetite is then embedded within policies, authorities and limits across the Group.
RISK AS A STRATEGIC DIFFERENTIATOR The Group strategy and risk appetite were developed together to ensure one informed the other in creating a strategy that delivers on becoming the best bank for our customers whilst helping Britain prosper and creating sustainable growth over time.
Operational agility Risk Division has continued to invest via the Risk Transformation Programme, driving improvements in supporting systems, simplified processes, improved customer experience and improved credit decision engines in order to deliver the most efficient and effective returns for the Group, underpinning the Group’s targeted objective of sustainable growth.
– Enabling and delivering sustainable growth Helping the business make the right decisions through proactive support and constructive challenge to the business areas whilst delivering the right risk and customer outcomes.
– Creating the best customer experience Putting our customers at the heart of our decisions throughout the Group through continued embedding of the conduct strategy and cultural change.
Supporting a consistent approach to the Group-wide behaviour and risk decision making. Consistency is delivered through the policy framework and risk committee structures
– Customer focused conduct strategy implemented to ensure customers are at the heart of everything we do.
Primary and secondary liquidity assets provide a substantial buffer in the event of an extended market dislocation.
– In addition to accumulating retained profits we can raise additional capital in a variety of ways.
Conduct risk We face significant potential conduct risk, including selling products to customers which do not meet their needs; failing to deal with customers’ complaints effectively; not meeting customers’ expectations; and exhibiting behaviours which do not meet market or regulatory standards.
Funding and liquidity risk Our funding and liquidity position is supported by a significant and stable customer deposit base. A deterioration in either our or the UK’s credit rating, or a sudden and significant withdrawal of customer deposits would adversely impact our funding and liquidity position.
Excluding St. James’s Place, operating lease depreciation deducted from income and costs and excluding TSB running costs.
The Group has also revised its forecast for uphold rates and average redress and increased its estimate for the associated administrative expenses connected with the above which combined have resulted in an increase in the provision of £570 million, of which £215 million was in the fourth quarter.
Other items The Group made a number of changes to its defined benefit pension scheme arrangements in the first half of the year. These changes and other actions resulted in a £710 million net credit which was recognised in the second quarter.
The Group’s leverage ratio exceeds the aggregate minimum levels proposed by the Financial Policy Committee (FPC) which require major domestic banks to meet a minimum ratio of 3 per cent, a supplementary systemic risk based buffer of up to 1.05 per cent (to apply from 2016 for G‑SIBs and from 2019 for major domestic banks) and a time‑varying countercyclical leverage buffer of up to 0.9 per cent (currently set at zero per cent).
The remaining issued ECNs were not taken into account for the purpose of core capital for the PRA stress test. A Capital Disqualification Event (CDE) occurred allowing the Group, under certain conditions, to redeem, with the permission of the PRA, any series of ECNs. The Group has also indicated its intention to redeem those series of ECNs listed in the announcement, resulting in a reduction in tier 2 capital resources of £0.5 billion.
Excludes reverse repos of £5.1 billion (31 December 2013: £0.1 billion). Loans and advances comparative restated, see note 1, page 188.
The Group’s liquidity position remains strong, with primary liquid assets of £109.3 billion (31 December 2013: £89.3 billion). Primary liquid assets represent almost six times our money‑market funding with a maturity of less than one year, and just under three times our total short‑term wholesale funding, in turn providing a substantial buffer in the event of market dislocation. In addition to primary liquid assets, the Group has significant secondary liquidity holdings of £99.2 billion (31 December 2013: £105.4 billion). Total liquid assets represent approximately five times our short‑term wholesale funding with primary liquid assets broadly equivalent to total wholesale funding.
Conclusion The Group has delivered a strong underlying performance and a statutory profit after tax of £1.5 billion in 2014 despite recognising further PPI and other regulatory provisions. At the same time, the Group has continued to reduce balance sheet risk, with significantly improved credit quality supported by a further £16 billion reduction in the Run‑off portfolio. These achievements have helped strengthen the Group’s funding position, key capital and leverage ratios and enabled the Board to recommend a dividend in respect of 2014.
Segment information has been restated to reflect the changes made to the Group’s operating structure that came into effect from 1 January 2014. Loans and advances to customers and customer deposits have been restated, see note 1, page 188.
31 December 2013 comparatives reflect CRD IV rules on a fully loaded basis as implemented by the PRA at 1 January 2014.
Number of ordinary shares in issue (millions)4 71,374 71,368 70,343 68,727 68,074
Total dividend for the year divided by earnings attributable to ordinary shareholders.
– Total costs increased by 3 per cent driven by investment in growth initiatives and increased operating lease depreciation as a result of growth in the Lex Autolease fleet, offset by cost savings and increased gains for end of life lease asset sales. In 2014 a further £45 million was invested in improving propositions and customer’s digital experience. – Impairment charges reduced by 37 per cent to £215 million, with a substantial improvement in the asset quality ratio. This has been driven by a continued underlying improvement of portfolio quality supported by the sale of recoveries assets in the Credit Cards and Asset Finance portfolios. – Return on risk‑weighted assets increased to 4.87 per cent. This reflected a 5 per cent improvement in underlying profit, while risk‑weighted assets increased by only 4 per cent driven by increased customer assets partially offset by an improved credit risk profile of customers.
Financial performance – Resilient performance against a backdrop of significant change throughout the industry in 2014. – Operating cash generation increased by £55 million, to £737 million, primarily reflecting lower commission paid on corporate pensions and increased returns on shareholder free assets offset by reduced General Insurance premiums. – Underlying profit down 15 per cent to £922 million impacted by the cost of structural changes in the corporate pensions book, primarily the cap on pension charges and lower life new business and General Insurance premiums offset by improved economics and an increase in yields on assets backing annuity business as a result of the strategy to invest in long‑term, low risk, higher yielding assets. – A 10 per cent increase in corporate pensions funds under management has driven a £3 billion increase in unit linked pension funds under management to £79 billion. – LP&I sales (PVNBP) reduced by 13 per cent in the year with sales of auto‑enrolment corporate pension business higher than expected but more than offset by an overall reduction in sales in 2014 following the Retail Distribution Review. – General Insurance Gross Written Premiums (GWP) down 8 per cent, reflecting the run off of legacy products and a competitive market during 2014.
Restated to reflect changes to the Group operating structure that came into effect from 1 January 2014.
General Insurance income net of claims − − 400 − 400 457
Existing business income has increased by £85 million reflecting improved economics benefiting the life and pensions business.
General Insurance profit has fallen by £41 million, due to the continued run‑off of legacy books and the impact of storms during the first quarter, offset by good prior year experience. During the year underwriting of the Home Insurance business was brought in‑house, ensuring delivery of a first class service to all our customers and continued sustainable growth in the underwritten customer base. Excellent technical capabilities and scale have enabled Insurance to respond to competitive pressures and a number of severe weather events in the early part of 2014, and maintain a strong combined ratio.
– Central items include income and expenditure not recharged to divisions, including the costs of certain central and head office functions. – Underlying income in 2014 included the benefit relating to the reduction in interest payable following the ECN exchange in the second quarter, which has not been passed onto divisions.
Volatility arising in insurance businesses The Group’s statutory result before tax is affected by insurance volatility caused by movements in financial markets, and policyholder interests volatility, which primarily reflects the gross up of policyholder tax included in the Group tax charge.
Insurance volatility The Group’s insurance business has policyholder liabilities that are supported by substantial holdings of investments, including equities, property and fixed interest investments, all of which are subject to variations in their value. The value of the liabilities does not move exactly in line with changes in the value of the investments, yet IFRS requires that the changes in both the value of the liabilities and investments be reflected within the income statement. As these investments are substantial and movements in their value can have a significant impact on the profitability of the Group, management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to results based on the actual return.
The expected gross 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.
Policyholder interests volatility The application of accounting standards results in the introduction of other sources of significant volatility into the pre‑tax profits of the life, pensions and investments business. In order to provide a clearer representation of the performance of the business, and consistent with the way in which it is managed, adjustments are made to remove this volatility from underlying profits. The effect of these adjustments is separately disclosed as policyholder interests volatility.
TSB The financial results for TSB are presented on a Lloyds Banking Group basis and differ to those reported by TSB for the reasons shown below. Investors in TSB should only rely on financial information published by TSB.
This represents corporate head office and similar costs incurred by TSB. The Group has excluded these from underlying profit to provide a more meaningful view of underlying business costs as they represent the duplicated costs of running two corporate head offices. These costs form part of the continuing TSB cost base and are reflected in the Group’s statutory profit before tax.
The Board places great emphasis on ensuring that its membership reflects diversity in the broadest sense. The combination of personalities provides a comprehensive range of perspectives and challenge and improves the quality of decision making.
Skills and experience: Highly regarded retail and commercial banker having spent 37 years with the Royal Bank of Scotland. External appointments: Non-Executive Director of Willis Limited and Chairman of its Risk Committee, Chairman of Brown, Shipley & Co Limited, Senior Independent Director of Urban & Civic plc and a Governor of Motability. Former appointments: Chief Executive of RBS UK, Non-Executive Director of Nationwide Building Society and Chairman of its Risk Committee, Non-Executive Director of Carpetright plc.
Skills and experience: International experience in board level strategy and execution. His extensive knowledge of financial markets, treasury and risk management and his qualification as an Audit Committee Financial Expert is of particular value in our Board Risk and Audit Committees. He was Shell’s Chief Financial Officer for Exploration & Production, Head of Group Investor Relations and held various finance posts within Shell prior to these appointments. External appointments: Chief Financial Officer and an Executive Director of Royal Dutch Shell plc, member of the Main Committee of the 100 Group of UK FTSE CFOs and Chair of the European Round Table CFO Taskforce. Also a member of the Advisory Panel of CIMA, the Multi Practitioner Panel Steering Committee – UK Fair and Effective Markets Review and of the Advisory Board of the Centre for European Reform.
Skills and experience: Significant banking and risk management experience, having spent 29 years working in these fields both internationally and in the UK. He held a number of senior risk, control and business management roles across the Corporate, Investment, Retail and Risk Divisions of the Santander Group. External appointments: Member of the International Financial Risk Institute Executive Committee. Former appointments: Chief Risk Officer and Executive Director of Santander’s UK business.
Andrew joined the Group in 2012 from Standard Chartered Bank where he held a variety of senior roles including Global COO and, later, Chief Financial Officer of Consumer Banking. Previously, Andrew worked at Xchanging Plc and Deutsche Bank. He trained as a Chartered Accountant.
Mary joined the Group in 2014 from KPMG where she held various senior roles including Canadian Industry Leader for Financial Services, Canadian National Banking Sector Leader, Canadian Regulatory Risk Management Advisory Leader and Chair of KPMG’s Global New Banking Entrants Committee.
Miguel holds a ‘Cum Laude’ degree in Business Administration from the University of Barcelona and an MBA from IESE Business School. He is a Board Member of Go-On UK.
Appointed in 2014, David has responsibility for Group IT, Customer Operations, Customer Services and Global Payments along with Sourcing, Property, Security & Fraud and the Divestment and Development functions. David joined Lloyds Bank in 1984 on the graduate entry scheme. His previous senior leadership roles have included Group IT, SME and Mid Markets Banking, Asset Finance, COO Commercial Banking, Offshore Banking and Group Procurement.
Toby joined the Group in 2011 from Aviva where he spent three years, most recently as UK Life CEO and before that, Chief Operating Officer for UK Life.
Our aim is to be the best bank for our retail and commercial customers, and we are determined to make it a company of the highest integrity and standards.
Group strategy The Board spent considerable time in 2014 debating the strategic priorities for the business over the next three years. There were several meetings which focused entirely on Group strategy, including a two day off-site. The Group announced in October that, having successfully rebuilt the Group’s financial strength, its future focus will remain on continuously improving the customer experience. Through our multi-brand, multi-channel distribution, we will transform our digital capability, continue to simplify our operations and processes, and invest in the business to become the best bank for customers and thereby deliver strong, sustainable returns to shareholders.
The divestment of TSB occupied a considerable amount of the Board’s time in 2014. It is an important step for the Group as we act to meet our commitments to the European Commission.
HM Treasury sell down In 2014, HM Treasury’s interest in the Group was further reduced from approximately 32.7 per cent of the ordinary share capital by way of an accelerated bookbuilding process to institutional investors and a pre-arranged trading plan. On 20 February 2015, the Company was advised that HM Treasury’s interest in the Group had reduced to 23.9 per cent.
Deputy Chairman Anita Frew was appointed Deputy Chairman on 14 May 2014 following the retirement of David Roberts. The Deputy Chairman: – ensures continuity of effective Board Chairmanship during any change of chairmanship; – supports the Chairman in representing the Board and acting as spokesperson; – deputises for the Chairman in the discharge of his duties; – is available to the Board for consultation and advice; and
Executive Directors The Executive Directors are listed on page 59. Executive Directors: – under the leadership of the Group Chief Executive, make and implement decisions in all matters affecting the operation, performance and strategy of the Group’s business.
Discussions linked in with those for the five-year operating plan and included economic trends, the competitive and regulatory environment, Group culture and values, the need to rebuild trust with customers, digital transformation, the future of distribution, financial planning and retirement, organisational capability, simplification, IT delivery and risk oversight.
Background Since 2010 the Group has been engaged with a number of government agencies in the UK, US and elsewhere, who are conducting investigations into the manipulation several years ago of submissions made by panel members to the bodies that set various interbank offered rates, including the London Interbank Offered Rate (LIBOR) and Sterling Repo Rate, along with other reference rates.
Directors’ and Officers’ liability insurance Throughout 2014 the Group had appropriate insurance cover in place to protect Directors, including former Directors who retired during the year, from liabilities that may arise against them personally in connection with the performance of their role. As well as insurance cover, the Group agrees to indemnify the Directors to the maximum extent permitted by law. Further information on the Group’s indemnity arrangements is provided on page 104.
After diligent processes, the persons selected with the best ‘fit’ and the most relevant skills and experience were Alan Dickinson, Simon Henry, Dyfrig John and Nick Prettejohn. Following these appointments, female representation on the Board has dropped from 27 per cent last year to 23 per cent – although the actual number of women on the Board remains the same at three.
The following table details the percentage of women employed at various levels of seniority within the Group as at 31 December 2013 and 2014 at all levels of the organisation: Female Board members
More information on the Group’s diversity programmes, including details of the Group’s commitment to raise the percentage of women employed in senior management roles to 40 per cent by 2020, is provided in the Responsible Business section of our website at www.lloydsbankinggroup.com.
Carolyn Fairbairn is a Non-Executive Director of the Competition and Markets Authority (CMA). She recuses herself from all discussions at the CMA on their investigation into banking competition.
Professional development The Board receives regular refresher training and information sessions throughout the year to address current business or emerging issues. This is done under the leadership of the Chairman who will also regularly review and agree with each Director their training and development needs. Information sessions are delivered through a variety of business updates, including sessions on: – capital and liquidity (including stress testing requirements); – the Senior Persons’ Regime; – accounting developments; – the structural hedge; and – credit rating agency developments.
The Non-Executive Directors also receive regular updates from the Group Chief Executive’s office and hold regular one-to-one meetings with the Group Chief Executive in the form of a weekly email or briefing call.
In 2014, a total of 15 Board meetings were held, eight of which were scheduled and seven of which were ad hoc meetings. Ad hoc Board meetings are called at short notice to discuss a matter that cannot wait until the next scheduled Board meeting. Where a Director is unable to attend a meeting, the Chairman discusses the matter with the Director and seeks their support for the proposed recommendation. He also represents their views at the meeting. Also, any Director unable to attend a meeting has the opportunity to review any papers and provide comments to the Chairman.
Current Directors who served during 20141 Attended/Held Attended/Held Attended/Held Attended/Held Attended/Held Attended/Held
The reviews concluded that the performance of the Board, its Committees, the Chairman and each of the Directors continues to be effective. All Directors demonstrated commitment to their roles.
The mechanisms to ensure appropriate escalation of issues to the Board (outside the matters reserved for the Board or risk appetite) can be improved.
Refocusing the Board agenda Devote more time to strategic and customer issues.
Background The Audit Committee confirmed in the Group’s 2013 Annual Report and Accounts that it was considering conducting an audit tender during 2014 with a view to reappointing a new firm, or PricewaterhouseCoopers (PwC), with effect from 1 January 2016. A final decision was to be made once there was further clarity on the likely requirements of the proposed EU Directive concerning the mandatory change of auditors.
The EU Directive was approved by the European Parliament on 3 April 2014 and introduced a requirement for Public Interest Entities to retender their audits at least every 10 years and to change the auditor at least every 20 years. The Directive contained transitional rules which, given PwC’s length of service in its role as auditors to the Group, meant that the Group would not be able to reappoint PwC after the 2020 year end audit.
SHAREHOLDER RELATIONSHIPS The Board recognises the need for a programme of engagement which offers all shareholders opportunities to receive information directly and to enable them to share their views with the Board.
Governance and executive remuneration Both the Chairman and Anthony Watson, the Group’s Senior Independent Director and Chairman of the Remuneration Committee, have participated in discussions with investors regarding governance and the strategic direction of the Group. Anthony Watson, supported by Investor Relations and the Human Resources Reward team, has engaged extensively with proxy advisors and the Group’s larger shareholders to consult on issues relating to executive remuneration.
In establishing and reviewing the systems of risk management and internal control, the Directors consider the nature and extent of the risks facing the Group, the likelihood of a risk event occurring and the costs of control. A system of internal control is designed to manage, rather than eliminate, the risk of failure to achieve business objectives, and can therefore only provide reasonable but not absolute assurance against the risk of material misstatement or loss. The process for identification, evaluation, escalation and management of the principal risks faced by the Group is integrated into the Group’s overall framework for risk governance. The Group is forward-looking in its risk identification processes to ensure emerging risks are identified. The risk identification, evaluation and management process also identifies whether the controls in place result in an acceptable level of risk.
In 2014 the Board was strengthened through the appointment of four Non-Executive Directors, each of whom share our values, have the behavioural characteristics to contribute constructively to our Board, and the self-confidence and analytic capability to form and share independent judgements. Lord Blackwell Chairman, Nomination & Governance Committee
The Committee recommended that the Board appoint a number of new directors. More on the appointments of Dyfrig John, Nicholas Prettejohn, Simon Henry and Alan Dickinson can be found on the next page.
The Committee monitored changes in regulation, most notably regulation brought about by the implementation of the Capital Requirements Directive IV which covers prudential rules for banks, building societies and investment firms.
To ensure a broad representation of experienced and independent Directors, membership of the Nomination & Governance Committee comprises the Chairman, the Deputy Chairman, the Senior Independent Director (also the Chairman of the Remuneration Committee) and the Chairman of the Audit Committee. The Group Chief Executive attends meetings as appropriate.
During the year the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.
HOW THE NOMINATION & GOVERNANCE COMMITTEE SPENT ITS TIME IN 2014 Corporate governance The Committee: – oversaw the Board’s governance arrangements to ensure that they paid due regard to best practice principles and remain appropriate; – received regular corporate governance updates from the Company Secretary; – monitored developing trends, initiatives or proposals in relation to board governance issues in the UK and elsewhere; – considered the impact of emerging regulation on the Board and its corporate governance practices; – reviewed and approved the annual corporate governance report; – monitored Board governance issues including the establishment of appropriate policies and practices to enable the Board to operate effectively and efficiently; and – reviewed the Group’s corporate governance framework, comprising the board authority and the delegated executive authority.
The Board response To address this situation, the Board sought to recruit new Non-Executive Directors to strengthen coverage in these critical areas.
The Nomination & Governance Committee oversees the Board’s arrangements for the longer-term succession of Board and Committee members. The recruitment of new or replacement directors is organised with the assistance of executive search firms.
Dyfrig John and Alan Dickinson brought deep understanding of retail and corporate banking as well as risk management. Furthermore, Dyfrig John has a wealth of IT experience.
High quality internal and external audit are key to the Group. This year, the Audit Committee has overseen a tender for the external audit and the appointment of a new head of internal audit.
Chairman’s overview The Committee has met its key objectives and has carried out its responsibilities effectively, as confirmed by the annual effectiveness review.
The Committee also looked at other areas of significant judgement or complexity that are relevant to the financial statements. These include other conduct provisions, other loan impairments, deferred tax assets, hedging, actuarial assumptions for insurance and pension accounting, and the accounting for one-off transactions such as the sell down of TSB.
The Committee continues to be satisfied with the activity, role and effectiveness of the internal audit function. The Committee oversaw the process for the recruitment of the new Group Audit Director, Mary Hall.
The Audit Committee was satisfied that internal controls over financial reporting were appropriately designed and operating effectively.
Group Audit In monitoring the activity, role and effectiveness of the internal audit function and their audit programme the Committee: – monitored the effectiveness of Group Audit and their audit programme through quarterly reports on the activities undertaken in the period; – approved the annual audit plan and budget and reviewed progress against the plan in detail at the half year including consideration of the audits that had been undertaken and in relation to the adequacy of resources within Group Audit and the standing of Group Audit in the Group; – considered the major findings of significant internal audits, and management’s response; – oversaw the process for recruitment of a new Group Audit Director, and approved the appointment of Mary Hall to the role; – received the views of Group Audit on the reports submitted to the Committee to act as a check and balance on the information provided to the Committee; and – reviewed thematic audits completed during the period – e.g. embedding risk appetite, integrity of the Risk Management Framework, customer outcomes, corporate culture, business application and strategic risks.
In the 2014 full year results, further provisions were made for derivatives mis-sold to small and medium-sized enterprises (SMEs), the Group’s insurance branch business in Germany, and a number of other smaller provisions across the divisions in relation to other conduct and compliance matters.
– The Audit Committee received regular reports in relation to impairment provisioning from management during 2014, presented by the division’s Credit Risk Officers. – Key assumptions challenged by the Audit Committee included the criteria for determining when a loan was impaired and whether any previous provisions were appropriate when these subsequently changed. – Group Audit performed work to assess the effectiveness of impairment governance and processes and reported their findings to the Audit Committee. The audits considered whether management oversight, review processes and key judgements were adequately supported by quantitative analysis and detailed management information. The work carried out by Group Audit considered the basis for adjustments and calibrations to model output results and found these to be reasonable and supported by observed performance. – The Audit Committee was satisfied that the impairment provisions were appropriate. The disclosures relating to impairment provisions are set out in note 54: ‘Financial risk management’ on page 293 of the financial statements.
– In the first half of 2014, the Group recognised a curtailment gain following the implementation of a freeze on pensionable pay for the Group’s principal defined benefit pension schemes. The gain was dependent on a number of assumptions, including an estimate of the proportion of then current members who opt out of these schemes as a result of the freeze. The Audit Committee was satisfied that the gain and Annual Report and Accounts disclosures associated with the freeze on pensionable pay are appropriate. – As in previous years, the Audit Committee considered the assumptions underlying the calculation of the defined benefit assets and liabilities, in particular the discount rate applied to future cash flows. The Audit Committee was satisfied that the value and disclosures made in respect of retirement benefit obligations are appropriate. The relevant disclosures are set out in note 38: ‘Retirement benefit obligations’ on page 240 of the financial statements.
Value-In-Force (VIF) asset and insurance liabilities Determining the value of the VIF asset and insurance liabilities is judgemental and requires the Group to determine a number of economic and non-economic actuarial assumptions, including longevity, persistency, expenses, credit risk and illiquidity premiums.
Liability management Determining the loss recognised on exchanging a proportion of the Group’s enhanced capital notes for additional tier 1 securities.
Notwithstanding these external challenges, I am pleased to report the Group’s strategy and risk discipline has led to a safer, low risk bank.
Committee composition, skills and experience The Chair of the Board Risk Committee, Anita Frew took over interim responsibility as Chairman of the Board Risk Committee from David Roberts on 14 May 2014. Anita has extensive board, financial and general management experience across a number of sectors, including banking. Anita was supported on the Committee by Non-Executive Directors members who have a variety of industry backgrounds, including banking, financial services and retail, who bring scrutiny and fresh perspective to the risk management framework of the Group. The Chief Risk Officer has full access to the Committee and attends the meeting.
Matters considered by the Board Risk Committee Over the course of the year the Board Risk Committee considers a wide variety of aspects of risk across the Group. Set out below is a summary of the key matters that the Board Risk Committee considered in 2014, followed by an outline of the principal risks that were considered by the Committee.
HOW THE BOARD RISK COMMITTEE SPENT ITS TIME IN 2014 Risk management The Committee considered the Group’s approach to risk management, including the overall framework review and regulatory developments. In particular the Committee: – considered the annual review of the Group’s governance and internal control framework – the Risk Management Framework – which includes the arrangements for the cascade of authority from the Board to its Committees and the Group Chief Executive, and the status of the Group’s risk governance and the Group policy frameworks. The review concluded that the Group’s Risk Management Framework is effective in design and the Group’s corporate governance arrangements and the policy framework are stable; – considered the approach and key findings of the annual control effectiveness review (see pages 69 and 70), before referring it to the Audit Committee to review in conjunction with Group Audit’s control framework assessment; – received reports and monitored the Group’s approach to regulatory developments including the Banking Reform Act; and – oversaw the Group’s approach to managing culture with particular reference to risk culture within the context of the Risk Management Framework.
Risk appetite The Committee considered the Group’s risk appetite. In particular, the Committee: – carried out the annual review of the Group’s risk appetite. The review considered the statements and risk appetite metrics under each category of identified risk; – received regular detailed consolidated risk reports, analysis of the Group’s performance against risk appetite and divisional risk profiles; – monitored the embedding of risk appetite across the Group; and – considered the Group’s approach to Structural Hedging to ensure that the approach remained within risk appetite.
More information on the Group’s approach to risk management can be found on pages 108 and 109.
Conduct risk The Committee spent considerable time in 2014 reviewing reports at every meeting from management on conduct risk including reviews of prior conduct issues and regulatory investigations. The Committee also reviewed the Group’s conduct strategy and its embedded status including reports from Group Audit.
The Committee monitored the macro economic conditions as they affect the Group. The Committee received regular updates on the macro economic conditions and risks from the Chief Economist, and considered these in its risk appetite and strategies.
Regulatory developments The Committee received regular updates from management on regulatory developments and assessed the impact of those developments on the Group’s risk profile and actions proposed by management.
What the Risk Committee did By way of example for the PRA and EBA stress testing exercises: Given the complexity and timescales for finalisation of each of the stress test exercises, the Board Risk Committee set up a Sub-Committee to oversee, on behalf of itself and the Board, the Group’s detailed assumptions and results for each exercise. The Sub-Committee reported the stress test outcomes to the Board Risk Committee and the full Board.
The Sub-Committee met regularly to review and challenge the stress testing exercises and the recommendations of the independent review. In turn the Board Risk Committee received detailed reports to consider the process and preliminary results in advance of the finalisation of each of the stress testing submissions.
Outcome The Committee was satisfied with the results and recommended the detailed submissions to each of the PRA and EBA to the Board.
– Our annual bonus plan will continue to reward the delivery of financial targets and balanced scorecard objectives in line with our operating plan. During 2014, we reviewed our performance adjustment framework and made enhancements in line with current regulatory expectations. Further details on this are provided below. Performance adjustment is the process by which variable remuneration is adjusted to take into account matters that fall outside the Board’s specified risk appetite. Individual and collective performance adjustment is now based on new guidelines and principles, ensuring adjustments reflect accountability and are sufficient to change colleague behaviours. Collective performance adjustment is intended to encourage positive risk behaviour across the Group by adjusting all bonuses for material risk failings. – Our long-term incentive plan continues to support value creation for shareholders with appropriate focus on the customer, financial health and the achievement of long-term strategic aims.
All of the above actions will ensure that there is full alignment between risk, reward and the performance of the Bank when determining variable pay outcomes.
In determining 2014 bonus outcomes for Lloyds Banking Group (excluding TSB), the Remuneration Committee has balanced the need to remunerate appropriately for the Bank’s strong performance in 2014, and ensure that appropriate adjustments are made for legacy issues. The Committee has applied collective adjustments to the bonus outcome and individual adjustments to bonus awards where necessary.
Having implemented the new process, it is critical that our colleagues understand how variable remuneration is determined and adjusted for risk matters. We have therefore made significant enhancements to communications and training to support the embedding of the performance adjustment approach.
The collective adjustment reflects the level of provisions for legacy conduct-related matters, principally relating to PPI, legacy retail issues and SME derivatives. These have declined significantly from the previous year, but still have a material impact on our statutory profit. The risk failure which led to regulatory settlement on LIBOR and Repo rate setting was also a significant element in determining the level of the collective adjustment.
The overall assessment of collective adjustment also takes into account certain positive factors that are not otherwise captured in the bonus calculation, but which benefited the Group’s shareholders or improved the Group’s reputation. These include progress with non-core disposals, the SWIP sale, the TSB separation/IPO and the reduction in the Government shareholding.
At this level, the bonus outcome reflects the achievement of the plan for the year set by the Board. The total outcome is less than was paid in 2013 and is less than 5 per cent of the underlying profit from which it is derived, which is a considerably lower figure than other UK banks. Average bonus payments across all our staff are approximately £4,500, with fewer than 3 per cent of our staff receiving a bonus in excess of £25,000, of which £2,000 is paid in cash, the balance being deferred in shares and released periodically over subsequent months and years.
As outlined in the 2013 Directors’ remuneration report, our policy is intended to ensure that our remuneration proposition is both cost effective and enables us to attract and retain executives of the highest calibre. Our objective is to align individual reward with the Group’s performance, the interests of its shareholders and a prudent approach to risk management. In this way, we balance the requirements of our major stakeholders: our customers, shareholders, employees, and regulators.
Base salary reflects the role of the individual taking account of responsibilities and experience, and pay in the Group as a whole. It helps to recruit and retain Directors and forms the basis of a competitive remuneration package.
– Operation Base salaries are typically reviewed annually with any increases normally taking effect from 1 January. When determining and reviewing base salary levels, the Committee ensures that decisions are made within the following two parameters: – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.
– Operation Executive Directors are entitled to participate in the Group’s defined contribution scheme with company contributions set as a percentage of salary.
An individual may elect to receive some or all of their pension contribution as a cash allowance.
When determining and reviewing the level of benefits provided, the Committee ensures that decisions are made within the following two parameters: – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies.
– Performance measures Measures and targets are set annually by the Committee in line with the Group’s strategic business plan and further details are set out in the Implementation Report for the relevant year.
– Performance measures Measures and targets are set by the Committee annually and are set out in the Implementation Report each year.
For future awards, the Committee will disclose in the Implementation Report for the relevant year historic measure and target information, together with how the Group has performed against those targets, unless this information is deemed to be commercially sensitive.
NEDs are paid a basic fee plus additional fees for the chairmanship/membership of committees and for membership of Group companies/boards/non-board level committees.
Any increases normally take effect from 1 January of a given year.
The Committee’s purpose is to consider, agree and recommend to the Board an overall remuneration policy and philosophy for the Group that is aligned with its long-term business strategy, its business objectives, its risk appetite, values and the long-term interests of the Group that recognises the interests of relevant stakeholders. A full list of the Committee’s responsibilities is detailed in its terms of reference, which can be found on our website at www.lloydsbankinggroup.com
The Committee is comprised of Non-Executive Directors from a wide background to provide a balanced and independent view on remuneration matters.
Deloitte’s fees for services to the Committee in 2014 were on a time and materials basis and amounted to £526,000. In addition, Deloitte LLP provided the Group with advice on taxation and other consulting services, and assurance services.
The Committee believes that the structure of the Group’s remuneration is appropriate, given the regulatory requirements. We have consulted extensively with our major shareholders but we also welcome feedback from all of our shareholders on our remuneration arrangements and on this report.
IMPLEMENTATION OF THE POLICY IN 2015 It is proposed to operate our policy in the following way in 2015: Base salary In line with our policy, when determining and reviewing base salary levels, the Committee ensures that decisions are made within the following two parameters: – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective job-sizing methodologies. – Pay for comparable roles in comparable publicly listed financial services groups, of a similar size.
Fixed share award Fixed Share Awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for Executive Directors, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements.
The actual levels of award set for 2015 are as follows (which will be released in shares over a five year period): GCE: £900,000
All employee plans Executive Directors are eligible to participate in the Sharesave and Sharematch scheme on the same basis as other employees.
– Opportunity The maximum annual bonus opportunity is 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance for the financial measure is not met and the individual is rated ‘Developing performer’ or below. The expected value of the bonus is 30 per cent of the maximum opportunity.
The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance in determining the final BSC rating.
– Opportunity The maximum annual long-term incentive award for Executive Directors is 300 per cent of salary.
– Performance measures and targets 2015 awards will be subject to a three-year performance period, and a two-year holding period following vesting.
During 2014 and early 2015, the Committee consulted widely with various shareholders on appropriate performance measures and, in particular, on how management can be incentivised through the long-term incentive plan to successfully deliver the objectives set out in the Group Strategic Review.
The awards made in 2015 will vest based on Lloyds Banking Group’s performance against the following key measures: – Economic profit (25 per cent) – Absolute Total Shareholder Return (30 per cent) – Cost:income ratio (10 per cent) – Strategic measures (35 per cent)
Colleague engagement score Set relative to 2017 targets Threshold: 62% Maximum: 70%
CHAIRMAN AND NON-EXECUTIVE DIRECTOR FEES IN 2015 The annual fee for the Chairman is unchanged at £700,000.
Total remuneration less buy-outs 10,832 6,571 5,506 1,954 5,082 206 21,420 8,731
Pension and benefits (audited) Pension/Benefit £ António Horta-Osório George Culmer Juan Colombás
ANNUAL BONUS The 2014 annual bonus outcome for Lloyds Banking Group (excluding TSB) was determined by adjusting the Group’s target outcome (£400 million in 2014) according to: – Group underlying profit performance: a target of £5,615 million was approved by the Board in advance of the performance year, with threshold and maximum set at 20 per cent above and below target. The outcome for 2014 was as follows: MaximumOn-Target
– Collective performance adjustment: consideration was given to items not factored into the Group underlying profit or divisional balanced scorecards. These included the provisions for legacy conduct-related matters and regulatory settlements on LIBOR and Repo rate setting. It also considered positive factors, such as non-core disposals, the SWIP sale, the TSB separation/IPO and the reduction in government shareholding.
Individual outcomes for Executive Directors The individual bonus awards for Executive Directors are determined in the same way as for colleagues across the Group, with outcomes based on: – Group underlying profit performance – Balanced Scorecard performance – Collective performance adjustment – Individual performance – On-target award
Following the Committee’s assessment of performance against the underlying profit target and Group balanced scorecard objectives, and taking into account the collective performance adjustment of 24.9 per cent and the individual rating of ‘Strong’, the Committee determined a 2014 bonus award to the Group Chief Executive of £800,000 (75 per cent of base salary). In arriving at this award, the Committee exercised its discretion to apply a reduction to reflect the external environment.
George Culmer The Chief Financial Officer’s personal performance assessment for 2014, as confirmed by the Committee, reflected a number of considerations including: – Effective management and contribution to underlying income and profit to ensure they were significantly ahead of target. – Ensuring Core Tier 1 and cost:income ratios were strong (ratios at end of 2014 were 12.8 per cent and 51.2 per cent respectively). – Excellent management and delivery of the Group Strategic Review.
Consistent with the aim of ensuring that short-term financial results are only rewarded if they promote sustainable growth, the 2014 annual bonus is subject to deferral in shares until at least 2018. This deferred amount is subject to performance adjustment (malus).
The Group has implemented clawback, covering all Remuneration Code Staff, in line with PRA requirements. Vested variable remuneration can be recovered from employees up to seven years after the date of award in the case of a material or severe risk event. Clawback will be used alongside other performance adjustment processes and applies to variable remuneration awarded from 1 January 2015.
Long-term awards made in March 2012 vesting for the period ended on December 2014 The Group’s financial performance over the three year performance period was very strong, with significant shareholder value created as the Group’s market capitalisation trebled from c.£18 billion to c.£54 billion. This has justifiably led to significant payouts to participants, due not only to the delivery of targets but also the increase in share price. Awards were granted in shares at 34.786 pence so the increase over the period has more than doubled the value for recipients in line with the increase realised by shareholders.
At the end of the performance period, it has been assessed that awards will vest at 96.6 per cent of maximum.
Non-core assets at end of 2014 10% of award <=£95bn <=£80bn 25% 100% £47.1bn 10.0%
Economic profit threshold and maximum targets were initially set at £160 million and £1,653 million respectively. These were subsequently increased by the Committee.
Alan Dickinson (appointed September 2014) 33 – – – 33 –
Simon Henry (appointed June 2014) 53 – – – 53 –
Sir Winfried Bischoff (retired April 2014) 183 700 102 173 193 717 2014 taxable benefits are made up of car allowance of £8,909.
The fees shown in the table above reflect the period of service prior to becoming Chairman of the Board.
Number of shares required and current shareholding percentage of base salary figures are calculated using the 31/12/14 closing price of 75.82 pence.
Financial Economic profit Set relative to 2016 targets Threshold: £2,154m Maximum: £3,231m
Absolute TSR Growth in share price including dividends over 3 year period
For each measure, 25 per cent will vest for threshold performance, 50 per cent for on-target performance and 100 per cent for maximum performance.
The market price for a share in the Group at 1 January 2014 and 31 December 2014 was 79.12 pence and 75.82 pence, respectively. The range of prices between 1 January 2014 and 31 December 2014 was 70.94 pence to 86.3 pence.
28/03/14 2,118,332 Exercise of Share Buy Out award 27/06/14 315,330 Fixed Share Award 25/09/14 156,416 Fixed Share Award 19/12/14 156,990 Fixed Share Award
Corporate governance statement The corporate governance report found on pages 58 to 81 and, together with this report of which it forms part, fulfils the requirements of the Corporate Governance Statement for the purpose of the Financial Conduct Authority’s Disclosure and Transparency Rules (DTR).
Directors’ indemnities The Directors of the Company, including the former Directors who retired during the year have entered into individual deeds of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ for the purposes of the Companies Act 2006. The deeds indemnify the Directors to the maximum extent permitted by law and remain in force for the duration of a Director’s period of office. The deeds were in force during the whole of the financial year or from the date of appointment in respect of the Directors appointed in 2014. Deeds for existing Directors are available for inspection at the Company’s registered office. In addition, the Group had appropriate Directors and Officers liability Insurance cover in place throughout 2014.
Information included in the strategic report The following information that would otherwise be required to be disclosed in the directors’ report and which is incorporated into this report by reference can be found on the following pages in the strategic report: Pages
Disclosures required under Listing Rule 9.8.4R Additional information required to be disclosed by Listing Rule 9.8.4, where applicable to the Group, can be found in the following sections of the annual report: Pages
Share capital and control Information about share capital, restrictions on the transfer of shares or voting rights and special rights with regard to control of the Company is shown in note 42 on pages 257 and 258 and is incorporated into this report by reference.
As at 31 December 2014, the Company was notified under Rule 5 of the DTR that The Solicitor for the Affairs of Her Majesty’s Treasury had a direct interest in 17,771,118,604 ordinary shares, representing 24.9 per cent in the issued share capital with rights to vote in all circumstances at general meetings. On 20 February 2015, the Company was notified that the interest of The Solicitor for the Affairs of Her Majesty’s Treasury had reduced to 17,093,553,260 ordinary shares, representing 23.9 per cent in the issued share capital. No other notification has been received under Rule 5 of the DTR.
Each of the current Directors, who are in office and whose names and functions are listed on pages 58 and 59 of this annual report, confirm that, to the best of his or her knowledge: – the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and Group; and – the management report contained in the strategic report and the directors’ report includes a fair review of the development and performance of the business and the position of the Company and Group, together with a description of the principal risks and uncertainties that they face.
The Directors consider that the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy. The Directors have also separately reviewed and approved the Strategic Report.
The risk overview (pages 30 to 33) provides a summary of risk management within the Group. It highlights the important role of risk as a strategic differentiator, risk achievements in 2014 and priorities for 2015 along with a brief overview of the Group’s risk governance structure and the principal risks faced by the Group and key mitigating actions.
This full risk management section provides a more in-depth picture of how risk is managed within the Group, detailing the Group’s emerging risks, approach to stress testing, risk governance and committee structure and the Group’s appetite for risk (pages 110 to 115) and a full analysis of the primary risk drivers (pages 116 to 170) – the framework by which risks are identified, managed, mitigated and monitored.
Run-off includes assets that are outside of the Group’s risk appetite, and were previously classified as non-core
TSB risk-weighted assets are on a Lloyds Banking Group reporting basis and differ to those reported by TSB as a standalone regulated entity.
– A full review of digital offering and related business plans to ensure the Group is fully able to respond. – Addressing the Group’s digital solutions in all relevant policies, standards, governance and control models.
– Group investments will continue to address data integrity and security. – Assessment of the possible impacts of EU Data Protection Regulation legislation is ongoing and the Group expects to deliver enhanced systems to fulfil related regulatory requirements.
Geopolitical shocks Geopolitical uncertainties could impact the current gradual global recovery, market risk pricing, asset price valuations and oil prices leading to tighter financial conditions, higher funding costs and therefore potentially reducing returns.
At least on an annual basis, the Group conducts a detailed macroeconomic stress testing exercise based on the five-year operating plan, which is supplemented with higher-level refreshes of the stress testing exercise if necessary. The exercise aims to highlight the key vulnerabilities of the Group to adverse changes in the economic environment and to ensure that there are adequate financial resources in the event of a downturn. The exercise includes a range of economic scenarios, including a severe stress scenario modelled on the UK-wide PRA stress scenario. Ad hoc stress testing exercises are also undertaken to assess emerging risks, as well as in response to regulatory requirements.
The stress tests at all levels must comply with all regulatory requirements, and are put through a rigorous review and challenge process. This is supported by analysis and insight into impacts on customers and business drivers. The engagement of all required risk and control areas is built into the preparation process, so that the appropriate analysis of each risk drivers’ impact upon the business plans are understood and documented.
The stress test outputs go through a rigorous review and challenge process at divisional level, including sign-off by the divisional Finance Directors and Risk Directors. The outputs are then presented to GFRC, GRC and BRC for review and challenge, before being approved by the Board.
The review and challenge process includes the detailed stress forecasts, the key assumptions behind these, and the methodology used to translate the economic assumptions into stressed outputs.
Risk Management Framework (RMF) The RMF (see risk overview, page 30) is structured around nine components which meet and align with the industry-accepted internal control framework issued by the Committee of Sponsoring Organisations of the Treadway Commission (COSO).
The Group’s strategy operates in tandem with the Board risk appetite and business planning is undertaken with a view to meeting the requirements of the Board risk appetite.
Board: – Approves the type and level of risk the Group is prepared to accept and the boundaries within which management must operate when setting strategy and executing the business plan. – Holds the Group Chief Executive and other Senior Executives accountable for the integrity of the Board Risk Appetite Statement. – Reviews and approves reporting, against the Board risk appetite Statement. – Ensures executive remuneration is aligned with risk appetite adherence.
Assisted by the Board Risk and Audit Committees, the Board approves the Group’s overall governance, risk and control frameworks and risk appetite. Refer to the Corporate Governance section on pages 58 to 81, for further information on Board committees.
The divisional/functional risk committees review and recommend divisional/functional risk appetite and monitors local risk profile and adherence to appetite.
Pensions Committee Assists the Chief Financial Officer in relation to Group pension arrangements, all-employee share plans and benefits, except for executive and senior management incentive plans, which are specifically reserved to the Remuneration Committee.
The Group Risk Committee is supplemented by the following committees to ensure effective oversight of risk management: Credit Risk Committees Responsible for the development and effectiveness of the relevant credit risk management framework, clear description of the Group’s credit risk appetite, setting of credit policy, and compliance with regulatory credit requirements.
Group Market Risk Committee Monitors and reviews the Group’s aggregate market risk exposures and concentrations and provides a proactive and robust challenge around business activities giving rise to market risks.
Group Operational Risk Committee Responsible for identifying significant current and emerging operational risks or accumulation of risks and control deficiencies across the Group and reviewing associated oversight plans to ensure pre-emptive risk management action. The committee also seeks to ensure that adequate business area engagement occurs to develop, implement and maintain the Group’s operational risk management framework.
CREDIT RISK Definition Credit risk is defined as the risk that parties with whom the Group has contracted fail to meet their obligations (both on and off-balance sheet).
Credit risk appetite statements and credit policies are regularly reviewed to ensure that the metrics continue to reflect the Group’s risk appetite appropriately.
In terms of loans and advances, credit risk arises both from amounts lent and commitments to extend credit to a customer or bank as required. These commitments can take the form of loans and overdrafts or credit instruments such as guarantees and standby, documentary and commercial letters of credit. With respect to commitments to extend credit, the Group is potentially also exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail commitments to extend credit can be cancelled without notice and the creditworthiness of customers is monitored frequently. Most commercial term commitments to extend credit are contingent upon customers maintaining specific credit standards, which are monitored regularly.
Credit risk exposures in the Insurance business largely result from holding bond and loan assets in the shareholder funds (including the annuity portfolio) and from exposure to reinsurers. Second order credit risk exposure exists within the unit-linked funds, through the value of future fee income, and with-profits funds, through any guarantees.
Loans and advances, contingent liabilities, commitments, debt securities and derivatives also expose the Group to refinance risk. Refinance risk is the possibility that an outstanding exposure cannot be repaid at its contractual maturity date. If the Group does not wish to refinance the exposure then there is refinance risk if the obligor is unable to repay by securing alternative finance. This may be because the borrower is in financial difficulty, or because the terms required to refinance are outside acceptable appetite at the time. Refinance risk exposures are managed in accordance with the Group’s existing credit risk policies, processes and controls, and are not considered to be material given the Group’s prudent and through the cycle credit risk appetite. Where refinance risk exists (such as in the Run-off book) exposures are minimised through intensive account management and are impaired or forborne where appropriate.
Each rating model is subject to a validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. The most material rating models are approved by the Group Risk Committee. Responsibility for the approval of the remaining material rating models, and the governance framework in place around all Group models, is delegated to the Group Model Governance Committee.
Credit principles, risk policies and appetite statements: Risk Division sets out the credit principles, risk policies and appetite statements. Principles and policies are reviewed regularly, and any changes are subject to a review and approval process. Policies and risk appetite statements, where appropriate, are supported by lending guidelines, which provide a disciplined and focused benchmark for credit decisions. Collectively they define chosen target market and risk acceptance criteria. Risk Division also use early warning indicators to help anticipate future areas of concern and allow the Group to take early and proactive mitigating actions. Risk oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes, and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key appetite tolerances. Oversight and reviews are also undertaken by Group Audit and Credit Risk Assurance.
Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite as well as individual, customer and bank limit guidelines. Credit policies and appetite statements are aligned to the Group’s risk appetite and restricts exposure to higher risk countries and more vulnerable sectors and segments. Note 18 on page 222, provides an analysis of loans and advances to customers by industry (for commercial customers) and product (for retail customers). Exposures are monitored to prevent an excessive concentration of risk and single name concentrations. These concentration risk controls are not necessarily in the form of a maximum limit on lending, but may instead require new business in concentrated sectors to fulfil additional certain minimum policy and/or guideline requirements. The Group’s large exposures are reported in accordance with regulatory reporting requirements.
The Group’s approach to underwriting applications for unsecured products ensures that lending is affordable and sustainable. The Group takes reasonable steps to validate information used in the assessment of a customer’s income and expenditure. The Group rejects any application for an unsecured product where a customer is registered as bankrupt or insolvent, or has a County Court Judgment registered at a CRA used by the Group. In addition, for credit cards the Group rejects any applicant with total unsecured debt greater than £50,000 registered at the CRA; revolving debt-to-income ratio greater than 75 per cent; or total unsecured debt-to-income ratio greater than 100 per cent. For unsecured personal loan applications, the Group rejects any applicant with total unsecured debt greater than £50,000 registered at the CRA.
Credit scoring: In its principal retail portfolios, the Group uses statistically based decisioning techniques (primarily credit scoring models). The Risk Division reviews model effectiveness, while new models and model changes are referred by them to the appropriate Model Governance Committees for approval. The most material changes are approved in accordance with the governance framework set by the Group Model Governance Committee.
It is the Group’s policy that collateral should always be realistically valued by an appropriately qualified source, independent of both the credit decision process and the customer, at the time of borrowing. Collateral values are reviewed on a regular basis and will vary according to the type of lending and collateral involved. For residential mortgages, the Group adjusts open market property values to take account of the costs of realisation and any discount associated with the realisation of the collateral. In order to minimise the credit loss, the Group may seek additional collateral from the counterparty as soon as impairment indicators are identified for the relevant individual loans and advances.
Monitoring In conjunction with Risk Division, businesses identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed and monitored in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Risk Division in turn produces an aggregated review of credit risk throughout the Group, including reports on significant credit exposures, which are presented to the Divisional Risk Committees, GRC and the BRC.
Intensive care of customers in financial difficulty The Group operates a number of treatments to assist borrowers who are experiencing financial stress. The material elements of these treatments through which the Group has granted a concession, whether temporarily or permanently, are set out below and in note 54 on page 293.
Commercial customers Early identification, control and monitoring are key in order to support the customer and protect the Group. With the exception of small exposures on SME customers all non-retail loans and advances in the Commercial Banking and Run-off Divisions are reviewed at least annually by the independent Risk Division (and more frequently where required). As part of the Group’s established Credit Risk Classification system, every loan and advance in the good book is categorised as either ‘good’ or ‘watchlist’. This complements the Group’s risk rating tools and is designed to identify and highlight portfolio levels of asset quality as well as individual problem credits. All watchlist names are reviewed by the business and Risk Division regularly, and the classification is updated if required. This process seeks to ensure that relationship managers act promptly to identify, and highlight to senior management those customers who have the possibility to become higher risk in the future.
Low risk culture and prudent risk appetite – The Group is delivering sustainable growth by maintaining the Group’s lower risk origination discipline. The overall quality of the portfolio has improved over the last 12 months. – The Group continues to deliver above market lending growth in SME whilst maintaining the Group’s prudent risk appetite. Portfolio credit quality has remained stable or improved across key metrics. – The Group continues to adopt a conservative stance across the Eurozone, maintaining close portfolio scrutiny and oversight. Detailed contingency plans are in place and exposures to financial institutions domiciled in peripheral Eurozone countries remain modest and managed within tight risk parameters.
Re-shaping of the Group is substantially complete – Run-off net assets have reduced from £33.3 billion to £16.9 billion at the end of 2014. This reduction was capital accretive. – The Run-off portfolio now represents only 3.0 per cent of the overall Group’s total loans and advances and poses substantially less downside risk to the Group. The remaining assets are the subject of frequent review, and are impaired to appropriate levels based on external evidence and internal reviews. – The Group’s UK Direct Real Estate gross lending at 31 December 2014 in Commercial Banking, Wealth (within Retail division) and Run-off divisions was £21.6 billion (31 December 2013: gross £27.8 billion). The portfolio continues to reduce significantly, and the higher risk Run-off element of the book has reduced from gross £7.6 billion to gross £3.3 billion during 2014. The remaining gross lending of £18.3 billion (31 December 2013: £20.2 billion) is the lower risk element in Commercial Banking and Wealth, where the Group continues to write new business within conservative risk appetite parameters. The loan to value (LTV) profile of the UK Direct Real Estate portfolio in Commercial Banking continues to improve. – The Group continues to reduce its exposure to Ireland with gross loans and advances reducing by £7.5 billion during 2014 mainly due to strategic transactions, disposals, write-offs and net repayments. The Group has disposed of two significant impaired portfolios in 2014, with a combined gross book value of £2.4 billion. – The Irish commercial portfolio remains significantly impaired at 89 per cent, with provision coverage of 81 per cent. Net exposure in Ireland commercial has fallen to £1.0 billion (31 December 2013: £3.4 billion). – The Irish Retail portfolio has reduced from £5,944 million at 31 December 2013 to £4,464 million at 31 December 2014. Within this portfolio, impaired loans have reduced from £1,002 million (16.9 per cent) at 31 December 2013 to £120 million (2.7 per cent) at 31 December 2014, driven primarily by the disposal of the majority of impaired assets in the second half of 2014.
Impact of disposal of business and asset sales (64) (357) (96) (6,771) – (7,288) (9,377)
Includes £4.4 billion (31 December 2013: £2.6 billion) of lower risk loans (social housing, infrastructure and education) transferred from Commercial Banking division into Insurance division shareholder funds to support the Group’s annuity portfolio.
Retail – The Retail impairment charge was £599 million in 2014, a decrease of 21 per cent compared to 2013. The decrease was primarily driven by underlying improvements in portfolio quality and the sale of recoveries assets in the Loans and Overdrafts portfolios. – The Retail impairment charge, as an annualised percentage of average loans and advances to customers, decreased to 19 basis points in 2014 from 24 basis points in 2013. – Retail impaired loans decreased by £1,803 million to £4,927 million compared with 31 December 2013, driven by the Secured portfolio. Retail impaired loans represent 1.6 per cent of closing loans and advances to customers compared with 2.1 per cent at 31 December 2013.
Interest only balances as a % of total mortgage book 37.2 41.1
Commercial Banking – Commercial Banking net impairment charge was £83 million in 2014, substantially lower than £398 million in 2013. The material reduction reflects better quality origination, improving economic conditions, continued low interest rates and provision releases. – The obligor credit quality of the Commercial Banking lending portfolio is predominantly rated good or better. New business is of good quality and generally better than the back book average. – Impaired loans reduced substantially by 35.8 per cent to £3,241 million compared with 31 December 2013 mainly due to disposals and write-offs. As a percentage of closing loans and advances to customers, impaired loans reduced to 3.2 per cent from 4.7 per cent at 31 December 2013. – Impairment provisions reduced to £1,594 million (31 December 2013: £2,384 million) and includes collective unimpaired provisions of £338 million (31 December 2013: £436 million).
SME – The SME portfolio continues to grow within prudent and consistent credit risk appetite parameters. Net lending has increased 5 per cent since 2013 reflecting the Group’s commitment to the UK economy and the Funding for Lending Scheme.
– The Mid Markets portfolio remains UK-focused and dependent on the performance of the domestic economy. Overall credit quality remained stable during 2014. – The real estate business within Mid Markets is focused predominantly upon unquoted private real estate portfolios. Credit quality continues to improve and the number of new impaired connections is minimal.
Run-off – Run-off impairment charge was £203 million in 2014, substantially lower than £1,389 million in 2013. The material reduction reflects continued proactive management and deleveraging (for example, disposals and write-offs). – Impaired assets reduced substantially by 73 per cent to £5,215 million compared with 31 December 2013, mainly due to disposals and write-offs.
Table 1.25: Ireland Commercial real estate LTV analysis At 31 December 2014 loans and advances
Eurozone exposures The following section summarises the Group’s direct exposure to Eurozone countries at 31 December 2014. The exposures comprise on-balance sheet exposures based on their balance sheet carrying values and off-balance sheet exposures, and are based on the country of domicile of the counterparty unless otherwise indicated.
The Group Financial Stability Forum (GFSF) monitors developments within the Eurozone, carries out stress testing through detailed scenario analysis and completes appropriate due diligence on the Group’s exposures.
Within Commercial Banking, an electronic environmental risk screening system has been the primary mechanism for assessing environmental risk in lending transactions. This system provides screening of location specific and sector based risks that may be present in a transaction. Identified risk sees the transaction referred to the Group’s expert in-house Environmental Risk team for further review and assessment, as outlined below. Where required, the Group’s panel of environmental consultants provide additional expert support.
Risk appetite The Group has no appetite for systemic unfair customer outcomes arising from any of its activities: through product design, sales or other after sales processes.
Exposures Conduct risk affects all aspects of the Group’s operations, all types of customers and other stakeholders. The Group faces significant conduct risks, for example, through products or services not meeting the needs of its customers; sales processes resulting in poor advice; failure to deal with a customer’s complaint effectively where the Group has got something wrong and not met customer expectations; or engaging in conduct which disrupts the fair and effective operation of a market in which it is active. Given the high level of scrutiny regarding financial institutions’ treatment of customers and business conduct from regulatory bodies, the media, politicians and consumer groups, there is a risk that certain aspects of the Group’s current or legacy business may be determined by the Financial Conduct Authority (FCA) and other regulatory bodies or the courts as not being conducted in accordance with applicable laws or regulations, or in a manner that fails to deliver fair and reasonable treatment. The Group may also be liable for damages to third parties harmed by the conduct of its business.
The Group’s leadership team is committed to embedding the Conduct Strategy within the business and to creating the right customer centric culture. The Board and Group Risk Committee receive regular reports and metrics to track progress on how the Group is meeting customer needs and minimising conduct risk.
Exposures Table 1.30 below shows relevant balance sheet items relating to banking, trading and insurance activities. The trading book Value at Risk (VaR) sensitivity inputs are separately identified.
Table 1.31: Key market risks for the Group by individual business activity (profit before tax impact measured against Group single stress scenarios)
For further information on defined benefit pension scheme assets and liabilities please refer to note 38 on page 240.
Trading market risk measures are applied to all the Group’s regulatory trading books where positions arise from supporting customer flow and market making. All positions are held with trading intent. Measures include daily VaR (table 1.32), sensitivity based measures, and stress testing.
Interest rate risk in the Group’s divisional portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.30 above) and off balance sheet positions of the Group. Interest rate risk arises predominantly from the mismatch between interest rate sensitive assets and liabilities, but also to the reinvestment rate on the Group’s structural hedging of rate insensitive liabilities comprising customer deposits and net free reserves, and the need to minimise income volatility.
Prepayment risk arises, predominantly in the Retail division, as customer balances amortise more quickly or slowly than anticipated due to economic conditions or customer’s response to changes in economic conditions.
Trading book VaR (1-day 99 per cent) is compared daily against both forecast and actual profit and loss. 1-day 99 per cent VaR charts for Lloyds Bank, HBOS and Lloyds Banking Group models can be found in the Group’s Pillar 3 Report.
(c) Market Value notional limit: this caps the amount of conventional and inflation-linked government bonds held by the Group for liquidity purposes.
A limit structure exists to ensure that risks stemming from residual and temporary positions or from changes in assumptions about customer behaviour remain within the Group’s risk appetite.
Table 1.33 below shows, split by material currency, the Group’s market value sensitivities to an instantaneous parallel up and down 25 and 100 basis points change to all interest rates.
Table 1.35 demonstrates the impact of the Group’s Fiscal Solvency stress scenario (with no diversification benefit) on Insurance’s portfolio; this is the most onerous scenario for Insurance out of the Group scenarios. The amounts include movements in assets, liabilities and the value of in-force business in respect of insurance contracts and participating investment contracts. Impacts can be assumed to be reasonably symmetrical.
Table 1.35: Insurance activities: profit before tax sensitivities Increase (reduction) in profit before tax £m
The key market risks within Insurance are equity and credit spread risks. The majority of Insurance’s equity risk exposure relates to unit-linked funds, through the value of future fee income, and with-profits funds, through burnthrough. Credit spread risk exposure largely results from holding bond and loan assets in the annuity portfolio with the aim of providing additional returns.
Trading portfolios and banking activities Trading is restricted to a number of specialist centres, the most important centre being the Financial Markets business in London. These centres also manage market risk in the Commercial Banking non-trading portfolios, both in the UK and internationally. The level of exposure is strictly controlled and monitored within approved limits. Active management of the portfolios is necessary to meet customer requirements and changing market circumstances.
Table 1.36: Operational risk events by risk category (losses greater than or equal to £10,000) % of total volume % of total losses
– An independent review of the Group’s IT Resilience and supporting capabilities was completed in 2013. This highlighted areas of strength alongside known risks that have the potential to impact resilience, and a three year investment programme of strategic enhancements was initiated. The first year of this programme has been completed. Additionally the Group has developed a customer focused risk appetite for IT systems that support the Group’s Critical Customer and Business Processes and continues to monitor these on a regular basis. – The threat landscape associated with Cyber risk has continued to evolve alongside an increasing industry and Regulator focus. The Board is developing a revised Cyber Risk Appetite and is supporting incremental investment to help mitigate this risk. – In addition to initiatives that protect the Group against a malicious Cyber attack the Group continues to invest in enhanced protection of customer information, including limiting access to key systems and enhancing the security, durability and accessibility of critical information. – The Group adopts a risk based approach to mitigate the external fraud risks it faces, reflecting the current and emerging external fraud risks within the market. This approach drives an annual programme of enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Through Group-wide policies and operational control frameworks, the Group has developed a robust fraud operating model with centralised accountability. The Group’s fraud awareness programme remains a key component of its fraud control environment. – The Group remediates issues that are identified in its Customer Processes, addressing root cause and rectifying customers as required. Enhancing the overall servicing environment remains a focus of dedicated Group programmes such as Simplification. – Following the successful divestment of TSB the Group retains responsibility for the ongoing provision of key services which are managed via robust change management governance and a consolidated strategic change plan. There are separate governance arrangements in place to oversee the impacts of the divestment on the retained business customers, operations and controls.
Measurement A series of measures are used across the Group to monitor both short and long-term liquidity, including: ratios, cash outflow triggers, wholesale funding maturity profile, early warning indicators and stress test survival periods from two weeks out to a year.
Details of contractual maturities for assets and liabilities form an important source of information for the management of liquidity risk. Liquidity risk is managed through a series of measures, tests and reports that are primarily based on contractual maturity. Contractual maturities also form the basis of the Group’s liquidity stress testing. Note 54 on page 293 sets out an analysis of assets and liabilities by relevant maturity grouping. In order to reflect more accurately the expected behaviour of the Group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. Divisional teams form a view of customer behaviour based on quantitative and qualitative analysis. The analysis takes into account items such as early repayment, forbearance and impairment for assets and rollover and early withdrawal for liabilities. The assumptions are subject to governance via divisional asset and liability committees. The behavioural reviews form the foundation of the Group’s Liquidity Transfer Pricing (LTP) and are applied to the contractual profile of the Group for the liquidity risk stress testing framework.
Non marketable assets Loan repayments under stress and possible liquidity value of less liquid assets
Wholesale funding Outflows calculated based on contractual maturity of wholesale funding with limited roll over
Funding and liquidity management in 2014 The Group’s funding position has been significantly strengthened and the Group has transformed its balance sheet structure in recent years. Total funded assets reduced by £14.5 billion to £493.4 billion. The Group loan to deposit ratio has improved to 107 per cent compared with 113 per cent at 31 December 2013. Customer deposits, excluding repos, increased by £10.6 billion and, excluding reverse repos, loans and advances to customers reduced by £15.3 billion primarily driven by a continued reduction in the Run-off portfolio (31 December 2014: £16.9 billion; 31 December 2013: £33.3 billion). The increase in customer deposits along with the continued reduction in the Run-off portfolio has enabled the Group to make changes in wholesale funding which reduced by £21.1 billion to £116.5 billion, with the volume with a residual maturity less than one year reducing to £41.1 billion (£44.2 billion at 31 December 2013). The Group’s term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total wholesale funding) reduced to 65 per cent (68 per cent at 31 December 2013) as expected in line with maturities of wholesale term funding and limited term wholesale issuance in 2014.
The combination of a strong balance sheet and access to a wide range of funding markets, including government and central bank schemes, provides the Group with a broad range of options with respect to funding the balance sheet in the future.
Excludes £5.1 billion (31 December 2013: £0.1 billion) of reverse repurchase agreements.
Primary liquidity assets are PRA eligible liquid assets, including: UK Gilts, US Treasuries, Euro AAA government debt, designated multilateral development bank debt and unencumbered cash balances held at central banks.
Term issuance for 2014 totalled £10.6 billion with the majority across medium-term notes and private placements. Utilisation of the UK government’s Funding for Lending Scheme (FLS) has further underlined the Group’s support to the UK economic recovery and the Group remains committed to passing the benefits of this low cost funding on to its customers. The Group drew down £2.0 billion in January 2014, under the 2013 FLS and a further £10.0 billion over the remainder of the year as part of the 2014 scheme, bringing total drawings under the FLS to £20.0 billion.
In addition the Banking business had £99.2 billion (31 December 2013: £105.4 billion) of secondary liquidity, the vast majority of which is eligible for use in a range of central bank or similar facilities and the Group routinely makes use of as part of its normal liquidity management practices. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.
Stress testing results Internal stress testing results at 31 December 2014 showed that the Banking business had liquidity resources representing 148 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intra-day requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario (the three month PRA combined scenario). Assets and liabilities within the TSB Banking Group were not included as their stress testing is managed separately.
Encumbered assets: Assets recognised on the Group’s balance sheet which have been pledged as collateral against an existing liability, and as a result are assets which are unavailable to the Group to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements.
Assets held within the Group’s Insurance businesses are generally held to either back liabilities to policyholders or to support the solvency of the Insurance subsidiaries; accordingly all Insurance assets are classified as unencumbered – cannot be used.
Assets held within consolidated limited liability partnerships to provide security for the Group’s obligations to its pension schemes are classified as unencumbered – cannot be used.
The above table sets out the carrying value of the Group’s encumbered and unencumbered assets, separately identifying those that are available to support the Group’s funding needs. It should be noted that the table does not include collateral received by the Group that is not recognised on its balance sheet, some of which the Group is permitted to repledge.
CAPITAL RISK Definition Capital risk is defined as the risk that the Group has a sub-optimal amount or quality of capital or that capital is inefficiently deployed across the Group.
Under Pillar 2A, additional minimum requirements are set through the issuance of bank specific Individual Capital Guidance (ICG), which adjusts the Pillar 1 minimum for those risks not covered or not fully covered under Pillar 1. A key input into the PRA’s ICG setting process is a bank’s own assessment of the amount of capital it needs, a process known as the Internal Capital Adequacy Assessment Process (ICAAP). The Group’s Pillar 2A ICG equates to 3.8 per cent of RWAs, of which 2.1 per cent must be covered by CET1 capital. This reflects a point in time estimate by the PRA, which may change over time, of the total amount of capital that is needed and includes risks that are not fully covered by Pillar 1 such as credit concentration and operational risk, and those risks not covered by Pillar 1 such as pensions and interest rate risk.
The Group is able to accumulate additional capital through the accumulation of profits over time, by raising new equity via, for example, a rights issue or debt exchange and by raising additional tier 1 and tier 2 capital by issuing subordinated liabilities. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time. The Group is also able to manage the demand for capital through management actions including adjusting its lending strategy, risk hedging strategies and through business disposals.
Capital policies and procedures are subject to independent oversight. Regular reporting of actual and projected ratios, including those in stressed scenarios, is undertaken, including submissions to the Group Asset and Liability Committee, the Group Risk Committee, Board Risk Committee and the Board.
At a global level the Basel Committee has set out a summary of various policy and disclosure initiatives that it expects to undertake during 2015 themed around reducing excessive variability in banks’ regulatory capital ratios. Proposed revisions to the Standardised Approach risk-weight framework in addition to early stage proposals on the design of a new capital floors framework were issued toward the end of 2014.
At a European level a number of capital related CRD IV technical standards and guidelines were published by the European Banking Authority (EBA) during the year, with further technical standards and guidelines expected to be published in 2015, which the Group will continue to be required to meet.
In the UK the Financial Policy Committee (FPC) finalised proposals for a UK leverage ratio framework. In January 2015 the PRA issued a consultation on proposals to reform the Pillar 2 framework, including new approaches for determining Pillar 2A capital requirements and the setting of Pillar 2B capital requirements (the PRA buffer).
The directors have recommended a dividend of 0.75 pence per share. The dividend, amounting to approximately £535 million, will be recognised in the Group’s 2015 financial statements.
At 31 December 2014 the Company had accumulated distributable reserves of approximately £8,500 million. Substantially all of the Company’s merger reserve is available for distribution under UK company law as a result of transactions undertaken to recapitalise the Company in 2009.
Excess of expected losses over impairment provisions and value adjustments 301 301
Key differences between risk-weighted assets at 31 December 2014 and 31 December 2013 under transitional rules are as follows: – Retail division risk-weighted assets reduced by £5.2 billion in the year primarily due to improvements in credit quality arising from active portfolio management and the impact of positive economic factors (including favourable movements in UK house prices and reduced unemployment) as well as the exit from its joint venture banking operations with Sainsbury’s. These movements are partially offset by risk-weighted asset increases arising from model changes. – Consumer Finance division risk-weighted assets increased by £0.8 billion largely due to new business lending and model changes partially offset by reductions arising from improvements in credit quality and economic factors. – Commercial Banking risk-weighted assets reduced by £17.8 billion mainly reflecting market risk reductions, active portfolio management and methodology refinements. The market risk-weighted asset reduction of £6.3 billion is primarily due to the removal of a temporary capital buffer applied to the Group’s internal market risk models on completion of specific market risk infrastructure projects. – Central Items risk-weighted assets primarily comprise the Group’s liquidity portfolio and strategic equity investments and other balance sheet assets such as fixed assets and sundry debtors. The increase in the year of £4.4 billion is primarily due to equity received in consideration for the disposal of Scottish Widows Investment Partnership (SWIP). – The reduction in Run-off risk-weighted assets of £13.8 billion is mainly due to disposals, including the sale of loans in the Irish retail mortgage portfolio and movements in external economic factors.
Management of the balance sheet includes risk-weighted asset movements arising from new lending and asset run-off and management of market risk positions. During the year risk-weighted assets decreased £6.9 billion primarily in Commercial Banking, partially offset by business growth in Consumer Finance and equities received in consideration for the disposal of Scottish Widows Investment Partnership within Central Items.
Calculated in accordance with the revised Basel III leverage ratio framework issued in January 2014, as interpreted through the July 2014 Basel III Quantitative Impact Study instructions and related guidance.
Securities financing transactions, predominantly comprising repurchase transactions, are subject to the netting rules imposed by the framework. These are considered to be similar to current IFRS accounting rules on netting. In addition a counterparty credit risk amount is calculated and added to the SFT measure, representing the extent to which a SFT is under-collateralised.
Other regulatory adjustments consist of other balance sheet assets that are required under CRD IV rules to be deducted from tier 1 capital such as deferred tax asset amounts, pension assets and goodwill and intangibles. The removal of these assets from the exposure measure ensures consistency is maintained between the capital and exposure components of the ratio.
Life insurance businesses The business transacted by the life insurance companies within the Group comprises unit-linked business, non-profit business and with-profits business. Several companies transact either unit-linked and/or non-profit business, but Scottish Widows plc (Scottish Widows) and Clerical Medical Investment Group Limited (Clerical Medical) hold the only With-Profit Funds managed by the Group.
Adjustments onto a regulatory basis: Unallocated surplus within Insurance business 267 53 – – – 320
Other differences between IFRS and regulatory valuation of assets and liabilities – – (564) (1,328) (20) (1,912)
Estimated share of realistic liabilities consistent with the PRA reporting treatment (389) (55) – – – (444)
Changes in estimations and in demographic assumptions used to measure life assurance liabilities – 1 431 – 11 443
With-Profit Funds Available capital in the Scottish Widows With-Profit Fund has decreased from £157 million at 31 December 2013 to an estimated £125 million at 31 December 2014 mainly due to a decrease in the liabilities of the transferred business. Available capital in the Clerical Medical With-Profit Fund is estimated to be zero at 31 December 2014 (no change from 31 December 2013). This is because the fund is in the process of distributing the free estate and all surplus will ultimately be distributed to policyholders.
Overseas life business Available capital has increased during 2014 due to profits emerging on in force business and the impact of assumption charges.
Unit-linked business (excluding that accounted for as non-participating investment contracts) – – 45,310 4,064 49,374
Other long-term funds Outside the With-Profit Funds, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are broadly matched. The most critical non-economic assumptions are mortality rates in respect of annuity business written (lower mortality rates are more onerous). Assumptions relating to future expenses are also significant with increases in the expected level of future costs leading to increases in the value of the liabilities and consequently leading to a reduction in available capital. Reinsurance arrangements are in place to reduce the Group’s exposure to deteriorating mortality rates in respect of non-annuity life insurance contracts such that assured life mortality is a less significant assumption. For Clerical Medical, assumptions relating to the provision in relation to German insurance business litigation are also significant.
Assets held in excess of those backing reserves are invested in readily tradable assets (e.g. cash and fixed interest securities), cash and a range of less liquid fixed interest instruments, at levels consistent with the liquidity risk appetite of the Insurance business.
Options and guarantees outside the With-Profit Funds A number of typical guarantees are provided outside the With-Profit Funds such as guaranteed payments on death (e.g. term assurance) or guaranteed income for life (e.g. annuities). In addition, certain personal pension policyholders in Scottish Widows, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £61 million (2013: £63 million) in respect of those guarantees. If future salary growth were 0.5 per cent per annum greater than assumed, the liability would increase by approximately £1 million. If yields were 0.5 per cent lower than assumed, the liability would increase by approximately £9 million.
REGULATORY RISK Definition Regulatory risk is defined as the risk that the Group is exposed to fines, censure, or legal or enforcement action due to failing to comply with applicable laws, regulations, codes of conduct or legal obligations.
Mitigation Mitigation is undertaken across the Group and comprises the following key components: – Risks are assessed by the business and controls put in place to mitigate them; – Enhanced regulatory reporting; – Implementation of systems, processes and effective controls including mandatory training for colleagues; – Regulatory horizon scanning; – Oversight and assurance of the regulatory risks within the business; – Quality assurance theme reviews to assess compliance with rules, regulations and policies; – Continued investment in the Group’s IT systems is enabling the Group to meet its regulatory commitments; – Senior business leaders monitor the progress of these assessments and mitigations; – Material risks and issues are escalated to Group-level bodies which challenge the business on its management of risks and issues; and – Mandated policies and processes require appropriate control frameworks, management information and standards to be implemented.
Exposures The Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives and to be the best bank for customers. Over the coming year the Group anticipates the following key people risk exposures: – The pending introduction of a new Senior Managers’ Regime and Certification Regime which introduces a reverse burden of proof and increased accountability may impact the Group’s ability to attract and retain talent through appropriate incentive and reward schemes; – Attracting and retaining talent may be impacted by a more active external market alongside regulatory changes which impact remuneration and reward arrangements; – Colleague engagement may be challenged by ongoing media attention on banking sector culture, sales practices and ethical conduct; – Maintaining organisational people capability in response to an increasingly digital business environment; and – Resource stretch due to pace and volume of organisational change.
Risk appetite Governance risk appetite is defined and embedded through the Group’s Governance Principle and Policy which are reviewed and approved by the Board on an annual basis. The Group has governance arrangements that support the effective long-term operation of the business and the vision of being the best bank for customers, maximise shareholder value and meet regulatory and social expectations.
Mitigation The Group’s Risk Management Framework establishes robust arrangements for risk governance, in particular by: – defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a Three lines of Defence model which supports the discharge of responsibilities to customers, shareholders and regulators; – outlining governance arrangements which articulate the enterprise-wide approach to risk management; and – supporting a consistent approach to Group-wide behaviour and risk decision making through a Group Policy Framework which helps everyone understand their responsibilities by clearly articulating and communicating rules, boundaries and risk appetite measures which can be controlled, enforced and monitored.
Areas of focus The areas of focus for our audit which involved the greatest allocation of our resources and effort were: – Credit risk and impairment of loans and advances to customers – Conduct risk and provisions – Actuarial assumptions used in the valuation of insurance contracts
We found the key controls were designed, implemented and operated effectively, and therefore we determined that we could place reliance on these key controls for the purposes of our audit.
From the testing performed we concluded that specific impairment provisions had been made in respect of incurred losses in the Commercial Banking loan portfolios.
For overlays to the modelled output, we challenged management who provide objective evidence that the overlays were appropriate.
OUR OPINION In our opinion: – Lloyds Banking Group plc’s Group financial statements and Parent Company financial statements (the ‘financial statements’) give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2014 and of the Group’s profit and the Group’s and the Parent Company’s cash flows for the year then ended; – the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union; – the Parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and – the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
Conduct risk and provisions Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), page 199 (Critical Accounting Estimates and Judgements) and page 248 (notes).
Given the continued regulatory focus on the financial services sector there is a significant risk that further claims or regulatory investigations will emerge that impact the financial statements.
There is a risk across the Group that emerging conduct risk areas have not yet been identified or appropriately assessed by management for financial reporting purposes, including whether a provision is required or a contingent liability disclosed.
We found the key controls were designed, implemented and operated effectively and therefore we determined that we could place reliance on these key controls for the purposes of our audit.
We understood customer complaints received and assessed the trends. We tested a sample of complaints to understand whether there were indicators of more systemic issues being present for which provisions or disclosures may need to be made in the financial statements.
The majority of our detailed audit work was on the significant conduct provisions in relation to past sales of Payment Protection Insurance (PPI) policies, interest rate hedging products to small and medium-sized businesses and insurance products in the German branch of Clerical Medical. We also examined other areas of compensation payments made to customers.
For those assumptions based on historic information, we challenged whether this was appropriate for future experience. Where management made adjustments to historical experience, we challenged the basis for and appropriateness of such changes. We also independently performed sensitivity analysis on the key assumptions.
Uncertain tax positions Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), and page 271 (notes).
We assessed whether the extent of the disclosures made, in particular, in relation to contingent liabilities, was based on the relevant facts and circumstances.
We also tested management’s basis for allocating forecast profits between legal entities by testing the allocation methodology, challenging significant assumptions and using our experience of the Group’s activities.
We understood and tested key controls over the completeness and accuracy of data extracted and supplied to the Group’s actuary, which is used to calculate the pension scheme surplus or deficit. We also tested the controls for approving the fair value of the scheme assets and the actuarial assumptions and valuations. We found the key controls were designed, implemented and operated effectively, and therefore we determined that we could place reliance on these controls for the purposes of our audit.
We understood and tested the key controls over derivative valuations, which included the derivative valuation adjustments. In particular, we tested: – the key governance controls management had over the derivative valuation adjustments; – the controls over the completeness and accuracy of data inputs to the valuation models; and
We assessed the methodology for calculating FVA and compared it to our knowledge of current industry practices. The methodology, which is consistent with that used in the previous year, is acceptable. There is, however, no consensual industry practice currently for calculating FVA.
We also read and assessed the disclosures made in the financial statements for valuation adjustments and concluded they are sufficient.
Our starting point was 5 per cent of profit before tax, a generally accepted auditing practice. However, profit before tax was adjusted to remove the disproportionate effect of non-recurring items, such as the costs associated with the disposal of TSB, conduct and litigation expenses and liability management losses.
As part of our audit we have concluded that the directors’ use of the going concern basis is appropriate. However, because not all future events or conditions can be predicted, these statements are not a guarantee as to the Group’s and the Parent Company’s ability to continue as a going concern. In drawing our conclusion, we critically assessed the going concern assessment undertaken by management and approved by the Board of Directors. As part of our assessment we have: – critically assessed and challenged the appropriateness of the stress scenarios used and their impact on the Group’s capital and liquidity position; – understood and challenged key economic and other assumptions used in both the capital and liquidity plan and the Group’s five year operating plan; and – substantiated the Group’s unencumbered collateral position and potential to access central bank liquidity facilities.
ADEQUACY OF ACCOUNTING RECORDS AND INFORMATION AND EXPLANATIONS RECEIVED Under the Companies Act 2006 we are required to report to you if, in our opinion: – we have not received all the information and explanations we require for our audit; or – adequate accounting records have not been kept by the Parent Company, or returns adequate for our audit have not been received from branches not visited by us; or – the Parent Company financial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns.
CORPORATE GOVERNANCE STATEMENT Under the Companies Act 2006 we are required to report to you if, in our opinion, a corporate governance statement has not been prepared by the Parent Company. We have no exceptions to report arising from this responsibility.
Issue of other equity instruments (note 46) – – (21) (21) 5,355 – 5,334
Further details of movements in the Group’s share capital, reserves and other equity instruments are provided in notes 42, 43, 44, 45 and 46.
NOTE 1: BASIS OF PREPARATION The consolidated financial statements of Lloyds Banking Group plc have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is no difference in application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available‑for‑sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts. As stated on page 104, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements.
(1) Subsidiaries Subsidiaries are entities controlled by the Group. The Group controls an entity when it has power over the entity, is exposed to, or has rights to, variable returns from its involvement with the entity, and has the ability to affect those returns through the exercise of its power. This generally accompanies a shareholding of more than one half of the voting rights although in certain circumstances a holding of less than one half of the voting rights may still result in the ability of the Group to exercise control. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. The Group reassesses whether or not it controls an entity if facts and circumstances indicate that there are changes to any of the above elements. Subsidiaries are fully consolidated from the date on which control is transferred to the Group; they are de‑consolidated from the date that control ceases. Details of the principal subsidiaries are given in note 9 to the parent company financial statements.
(C) OTHER INTANGIBLE ASSETS Other intangible assets include brands, core deposit intangible, purchased credit card relationships, customer‑related intangibles and both internally and externally generated capitalised software enhancements. Intangible assets which have been determined to have a finite useful life are amortised on a straight line basis over their estimated useful life as follows: Capitalised software enhancements up to 7 years
Revenue recognition policies specific to life insurance and general insurance business are detailed below (see (O) below); those relating to leases are set out in (K)(2) below.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) – if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at initial recognition), they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the foreseeable future or until maturity; or – if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available‑for‑sale financial assets in ‘rare circumstances’.
(2) Available-for-sale financial assets Debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss, held‑to‑maturity investments or as loans and receivables are classified as available‑for‑sale financial assets and are recognised in the balance sheet at their fair value, inclusive of transaction costs. Available‑for‑sale financial assets are those intended to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of investments classified as available‑for‑sale are recognised directly in other comprehensive income, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement. Interest calculated using the effective interest method and foreign exchange gains and losses on debt securities denominated in foreign currencies are recognised in the income statement.
(4) Held-to-maturity investments Held‑to‑maturity investments are non‑derivative financial assets with fixed or determinable payments and fixed maturities that the Group’s management has the positive intention and ability to hold to maturity other than: – those that the Group designates upon initial recognition as at fair value through profit or loss; – those that the Group designates as available‑for‑sale; and – those that meet the definition of loans and receivables.
A sale or reclassification of a more than insignificant amount of held‑to‑maturity investments would result in the reclassification of all held‑to‑maturity investments to available‑for‑sale financial assets.
The Group designates certain derivatives as either: (1) hedges of the fair value of the particular risks inherent in recognised assets or liabilities (fair value hedges); (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges of net investments in foreign operations (net investment hedges). These are accounted for as follows: (1) Fair value hedges Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk; this also applies if the hedged asset is classified as an available‑for‑sale financial asset. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the income statement. The cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using the effective interest method over the period to maturity.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) (G) OFFSET Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set‑off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. Cash collateral on exchange traded derivative transactions is presented gross unless the collateral cash flows are always settled net with the derivative cash flows. In certain situations, even though master netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.
Incurred but not yet identified impairment The collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been separately identified at the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. Risk drivers for secured retail lending include the current indexed loan‑to‑value, previous mortgage arrears, internal cross‑product delinquency data and external credit bureau data; for unsecured retail lending they include whether the account is up‑to‑date and, if not, the number of payments that have been missed; and for commercial lending they include factors such as observed default rates and loss given default. An assessment is made of the likelihood of each account becoming recognised as impaired within the loss emergence period, with the economic loss that each portfolio is likely to generate were it to become impaired. The loss emergence period is determined by local management for each portfolio and the Group has a range of loss emergence periods which are dependent upon the characteristics of the portfolios. Loss emergence periods are reviewed regularly and updated when appropriate. In general the periods used across the Group vary between one month and twelve months based on historical experience. Unsecured portfolios tend to have shorter loss emergence periods than secured portfolios.
Loan renegotiations and forbearance In certain circumstances, the Group will renegotiate the original terms of a customer’s loan, either as part of an ongoing customer relationship or in response to adverse changes in the circumstances of the borrower. Where the renegotiated payments of interest and principal will not recover the original carrying value of the asset, the asset continues to be reported as past due and is considered impaired. Where the renegotiated payments of interest and principal will recover the original carrying value of the asset, the loan is no longer reported as past due or impaired provided that payments are made in accordance with the revised terms. Renegotiation may lead to the loan and associated provision being derecognised and a new loan being recognised initially at fair value.
Write offs A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement. For both secured and unsecured retail balances, the write‑off takes place only once an extensive set of collections processes has been completed, or the status of the account reaches a point where policy dictates that forbearance is no longer appropriate. For commercial lending, a write‑off occurs if the loan facility with the customer is restructured, the asset is under administration and the only monies that can be received are the amounts estimated by the administrator, the underlying assets are disposed and a decision is made that no further settlement monies will be received, or external evidence (for example, third party valuations) is available that there has been an irreversible decline in expected cash flows.
(2) Available-for-sale financial assets The Group assesses, at each balance sheet date, whether there is objective evidence that an available‑for‑sale financial asset is impaired. In addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and future prospects of the issuer, assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. If an impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available‑for‑sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the income statement; any excess is taken to other comprehensive income. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) (I) INVESTMENT PROPERTY Investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital appreciation or both. The Group’s investment property primarily relates to property held for long‑term rental yields and capital appreciation within the life insurance funds. Investment property 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. 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 recognised in the income statement as net trading income.
Equipment: – Fixtures and furnishings: 10‑20 years. – Other equipment and motor vehicles: 2‑8 years.
(1) As lessee The leases entered into by the Group are primarily operating leases. Operating lease rentals payable are charged to the income statement on a straight‑line basis over the period of the lease.
The Group operates a number of post‑retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation to pay further contributions.
Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening years; these valuations are updated to 31 December each year by qualified independent actuaries. For the purposes of these annual updates scheme assets are included at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the balance sheet date on high‑quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) The Group’s income statement charge includes the current service cost of providing pension benefits, past service costs, net interest expense (income), and plan administration costs that are not deducted from the return on plan assets. Past service costs, which represents the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment, are recognised when the plan amendment or curtailment occurs. Net interest expense (income) is calculated by applying the discount rate at the beginning of the period to the net defined benefit liability or asset.
(M) SHARE-BASED COMPENSATION The Group operates a number of equity‑settled, share‑based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black‑ Scholes option pricing model or a Monte Carlo simulation. The determination of fair values excludes the impact of any non‑market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated as non‑vesting conditions and the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement.
(N) TAXATION Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
For the Group’s long‑term insurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on shareholders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under current UK tax rules.
(O) INSURANCE The Group undertakes both life insurance and general insurance business. Insurance and participating investment contracts are accounted for under IFRS 4 Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and participating investment contracts that applied prior to the adoption of IFRS. The Group, therefore, continues to account for these products using UK GAAP, including FRS 27 Life Assurance, and UK established practice.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) – Investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets. – Non‑participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
Unallocated surplus Any amounts in the with‑profit funds not yet determined as being due to policyholders or shareholders are recognised as an unallocated surplus which is shown separately from liabilities arising from insurance contracts and participating investment contracts.
The results and financial position of all group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: – The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into sterling at foreign exchange rates ruling at the balance sheet date. – The income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.
(S) CASH AND CASH EQUIVALENTS For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non‑mandatory balances with central banks and amounts due from banks with a maturity of less than three months.
ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES At 31 December 2014 gross loans and receivables totalled £516,612 million (2013: £531,763 million) against which impairment allowances of £6,540 million (2013: £12,091 million) had been made (see note 21). The Group’s accounting policy for losses arising on financial assets classified as loans and receivables is described in note 2 (H)(1); this note also provides an overview of the methodologies applied.
Individual impairment allowances are generally established against the Group’s commercial lending portfolios. The determination of individual impairment allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions and the
RECOVERABILITY OF DEFERRED TAX ASSETS At 31 December 2014 the Group carried deferred tax assets on its balance sheet of £4,145 million (2013: £5,104 million) and deferred tax liabilities of £54 million (2013: £3 million) (note 39). This presentation takes into account the ability of the Group to net deferred tax assets and liabilities only where there is a legally enforceable right of offset. Note 39 presents the Group’s deferred tax assets and liabilities by type. The largest category of deferred tax asset relates to tax losses carried forward.
At 31 December 2014, the Group carried total liabilities arising from insurance contracts and participating investment contracts of £86,918 million (2013: £82,777 million). The methodology used to value these liabilities is described in note 33. Elements of the liability valuations require assumptions to be made about future investment returns, future mortality rates and future policyholder behaviour and are subject to significant management judgement and estimation uncertainty. The key assumptions that have been made in determining the carrying value of these liabilities are set out in note 33.
FAIR VALUE OF FINANCIAL INSTRUMENTS In accordance with IFRS 13 Fair Value Measurement, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models. These valuation techniques involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information.
The segmental results and comparatives are presented on an underlying basis, the basis reviewed by the chief operating decision maker. The effects of asset sales, volatile items, liability management, simplification costs, TSB build and dual running costs, regulatory provisions, certain past service pension credits or charges, the amortisation of purchased intangible assets and the unwind of acquisition‑related fair value adjustments are excluded in arriving at underlying profit.
Other includes certain assets previously reported as outside of the Group’s risk appetite and the results and gains on sale relating to businesses disposed in 2013 and 2014. Other also includes income and expenditure not recharged to divisions, including the costs of certain central and head office functions and the costs of managing the Group’s technology platforms, branch and head office property estate, operations (including payments, banking operations and collections) and sourcing, the costs of which are predominantly recharged to the other divisions. It also reflects other items not recharged to the divisions.
Other segment items reflected in income statement above: (Decrease) increase in value of in‑force business – – – 425 – (9) 416
Other segment items reflected in income statement above: Increase (decrease) in value of in‑force business – – – 273 – (4) 269
Comprises the effects of asset sales (gain of £100 million), volatile items (loss of £678 million), liability management (loss of £142 million), Simplification costs related to severance, IT and business costs of implementation (£830 million), TSB build and dual running costs (£687 million), the amortisation of purchased intangibles (£395 million) and the past service pensions charge (£104 million, see note 11).
Comprises the effects of asset sales (gain of £2,547 million), volatile items (loss of £748 million), liability management (loss of £229 million), Simplification costs related to severance, IT and business costs of implementation (£676 million), TSB build and dual running costs (£570 million), the amortisation of purchased intangibles (£482 million) and the past service pensions credit (£250 million, see note 11).
Interest and similar income: Loans and advances to customers 3.53 3.84 3.94 17,806 19,928 21,600
Customer deposits, excluding liabilities under sale and repurchase transactions 1.15 1.54 1.69 (4,781) (6,119) (6,637)
Total net income arising on assets held at fair value through profit or loss 8,621 15,868 14,889
Claims and surrenders: Change in insurance and participating investment contracts (note 33(1)): Change in gross liabilities (4,392) (5,184) (4,284)
NOTE 11: OPERATING EXPENSES (CONTINUED) PERFORMANCE-BASED COMPENSATION The table below analyses the Group’s performance‑based compensation costs (excluding branch‑based sales incentives) between those relating to the current performance year and those relating to earlier years.
Performance‑based compensation expense comprises: Awards made in respect of the year ended 31 December 324 394 362
Fees payable for the audit of the Company’s current year annual report 1.4 1.5 1.6
Acquisition due diligence and other work performed in respect of potential venture capital investments 1.0 2.1 0.7
Factors affecting (charge) credit: UK corporation tax rate change and related impacts (24) (594) (320)
Taxation of certain insurance assets arising on transition to new tax regime – – (221)
Deferred tax on losses no longer recognised following sale of Australian operations – (348) –
The weighted‑average number of anti‑dilutive share options and awards excluded from the calculation of diluted earnings per share was 7 million at 31 December 2014 (2013: 28 million; 2012: 37 million).
NOTE 16: DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) The fair values and notional amounts of derivative instruments are set out in the following table: Contract/ notional amount £m
For amounts included above which are subject to reverse repurchase agreements see note 54.
(A) ASSET-BACKED CONDUITS In addition to the structured entities discussed in note 19, which are used for securitisation and covered bond programmes, the Group sponsors an active asset‑backed conduit, Cancara, which invests in debt securities and client receivables. The total consolidated exposure of Cancara at 31 December 2014 was £5,245 million (2013: £5,081 million), comprising £4,605 million of loans and advances (2013: £4,781 million) and £640 million of asset‑backed securities (2013: £300 million).
(C) UNCONSOLIDATED COLLECTIVE INVESTMENT VEHICLES AND LIMITED PARTNERSHIPS The Group’s direct interests in unconsolidated structured entities comprise investments in collective investment vehicles, such as Open‑Ended Investment Companies, and limited partnerships with a total carrying value of £27,255 million at 31 December 2014 (2013: £24,552 million), included within financial assets designated at fair value through profit and loss (see note 15). These investments include both those entities managed by third parties and those managed by the Group. At 31 December 2014, the total asset value of these unconsolidated structured entities, including the portion in which the Group has no interest, was £620 billion (2013: £543 billion).
Of the total allowance in respect of loans and advances to customers, £1,482 million (2013: £2,217 million) was assessed on a collective basis.
The recoverable amount of the goodwill relating to Asset Finance has also been based on a value‑in‑use calculation using pre‑tax cash flow projections based on financial budgets and plans approved by management covering a five‑year period and a discount rate of 14 per cent. The cash flows beyond the five‑year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long‑term average growth rates for the markets in which Asset Finance participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Asset Finance to fall below the balance sheet carrying value.
The movement in the acquired value of in‑force non‑participating investment contracts over the year is as follows: £m £m
The acquired value of in‑force non‑participating investment contracts includes £251 million (2013: £277 million) in relation to OEIC business.
NOTE 25: VALUE OF IN-FORCE BUSINESS (CONTINUED) The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in‑force business are set out below: ECONOMIC ASSUMPTIONS Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk‑free rate and all cash flows are discounted at a risk‑free rate. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below).
A market‑consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. Further information on options and guarantees can be found on page 164.
NON-ECONOMIC ASSUMPTIONS Future mortality, morbidity, expenses, 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.
For the fair value of collateral pledged in respect of repurchase agreements see note 54.
NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS Insurance contract and participating investment contract liabilities are comprised as follows: Gross £m
Change in liabilities charged to the income statement (note 10) 7,238 (2,054) 5,184 48 5,232
Change in liabilities charged to the income statement (note 10) 4,705 (313) 4,392 (8) 4,384
(ii) Method of calculation of liabilities With‑profit liabilities are stated at their realistic value, the main components of which are: – With‑profit benefit reserve, the total asset shares for with‑profit policies; – Cost of options and guarantees (including guaranteed annuity options); – Deductions levied against asset shares; – Planned enhancements to with‑profits benefits reserve; and – Impact of the smoothing policy.
– Change in the assumption in respect of current and future mortality rates (£23 million increase). – Change in expenses assumptions (£51 million increase).
Change in provision for unearned premiums charged to income statement (note 8) (49) 6 (43)
Assumptions have been flexed on the basis used to calculate the value of in‑force business and the realistic and statutory reserving bases.
This sensitivity shows the impact of reducing mortality and morbidity rates on non‑annuity business to 95 per cent of the expected rate.
This sensitivity shows the impact on the value of in‑force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk‑free rate by 25 basis points.
On 11 March 2014 the Group announced a change to its defined benefit pension schemes, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This has been partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business. In 2013, the Group agreed certain changes to early retirement and commutation factors in two of its principal defined benefit pension schemes, resulting in a cost of £104 million recognised in the Group’s income statement in the year ended 31 December 2013. In 2012, there was a net credit of £250 million following a decision to link discretionary pension increases in certain schemes to the Consumer Price Index.
The total amount recognised in the balance sheet relates to: 2014 £m 2013 £m
The Group operates a number of funded and unfunded pension arrangements, the majority, including the three most significant schemes, are funded schemes in the UK. All schemes are operated as separate legal entities under trust law by the trustees. All UK schemes are funded in compliance with the Pensions Act 2004. A valuation exercise is carried out for each scheme at least every three years, whereby scheme assets are measured at market value and liabilities (‘Technical Provisions’) are measured using prudent assumptions, if a deficit is identified a recovery plan is agreed and sent to the Pensions Regulator for review. The outcome of this valuation process, including agreement of any recovery plans, is agreed between the Group and the scheme Trustee. The Group’s overseas defined benefit pension schemes are subject to local regulatory arrangements.
NOTE 38: RETIREMENT BENEFIT OBLIGATIONS (CONTINUED) The expense recognised in the income statement for the year ended 31 December comprises: 2014 £m 2013 £m 2012 £m
Weighted‑average rate of increase for pensions in payment 2.59 2.80 2014 Years 2013 Years
Risk exposure of the defined benefit schemes Whilst the Group is not exposed to any unusual, entity specific or scheme specific risks in its defined benefit pension schemes, it is exposed to a number of significant risks, detailed below: Inflation rate risk: the majority of the plans’ benefit obligations are linked to inflation both in deferment and once in payment. Higher inflation will lead to higher liabilities although this will be partially offset by holdings of inflation‑linked gilts and, in most cases, caps on the level of inflationary increases are in place to protect against extreme inflation.
Investment risk: Scheme assets are invested in a diversified portfolio of debt securities, equities and other return‑seeking assets. If the assets underperform the discount rate used to calculate the defined benefit obligation, it will reduce the surplus or increase the deficit. Volatility in asset values and the discount rate will lead to volatility in the net pension liability on the Group’s balance sheet and in other comprehensive income. To a lesser extent this will also lead to volatility in the pension expense in the Group’s income statement.
The asset‑liability matching strategy currently mitigates approximately 89 per cent (2013: 54 per cent) of the interest rate volatility and 94 per cent (2013: 71 per cent) of the inflation rate volatility of the liabilities.
NOTE 38: RETIREMENT BENEFIT OBLIGATIONS (CONTINUED) Maturity profile of defined benefit obligation The following table provides information on the weighted average duration of the defined benefit pension obligations and the distribution and timing of benefit payments: Years
During the year ended 31 December 2014 the charge to the income statement in respect of defined contribution schemes was £252 million (2013: £255 million; 2012: £229 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
NOTE 38: RETIREMENT BENEFIT OBLIGATIONS (CONTINUED) Movements in the other post‑retirement benefits obligation: 2014 £m 2013 £m
NOTE 39: DEFERRED TAX (CONTINUED) Deferred tax assets and liabilities are comprised as follows: 2014 £m 2013 £m
Deferred tax assets of £614 million (2013: £593 million) have not been recognised in respect of trading losses carried forward, mainly in certain overseas companies and in respect of other temporary differences in the insurance businesses. Trading losses can be carried forward indefinitely, except for losses in the USA which expire after 20 years.
During 2014 customer initiated complaints have continued to fall, albeit slower than expected. The proactive mailings have been substantially completed and remediation of previously defended cases commenced. A further £2,200 million has been added to the provision in 2014, which brings the total amount provided to £12,025 million, of which approximately £2,520 million relates to anticipated administrative expenses.
As at 31 December 2014, £2,549 million of the provision remained unutilised (21 per cent of total provision) relative to an average monthly spend including administration costs in 2014 of approximately of £205 million. The main drivers of the provision are as follows: Volumes of customer initiated complaints (after excluding complaints from customers where no PPI policy was held) At 31 December 2013, the provision assumed a total of 3.0 million complaints would be received. During 2014, complaint volumes were 22 per cent lower than 2013, but continue to be higher than expected. As a result, the Group is forecasting a slower decline in future volumes than previously expected, largely due to more sustained Claims Management Company (CMC) activity; non‑CMC complaints have declined sharply. This has resulted in a further provision of approximately £1,080 million. At 31 December 2014, approximately 3 million complaints have been received, with the provision assuming approximately a further 0.6 million complaints will be received in the future.
During the fourth quarter the Group has seen a fall of approximately 12 per cent in complaint levels. However, the provision remains sensitive to future trends.
Proactive mailing resulting from Past Business Reviews (PBR) The Group is proactively mailing customers where it has been identified that there was a risk of potential mis‑sale. At 31 December 2014 mailing of the original scope has been completed. During 2014, as a result of ongoing monitoring, some limited additional mailings have been added to the PBR scope. In addition, PBR responses to mailings have been higher than expected resulting in a further provision for PBR of approximately £300 million added during 2014.
Average redress Average redress per policy has increased, reversing the trend seen in the first three quarters of 2014. This higher level is expected to continue going forward and has resulted in an additional provision for the year of £40 million.
Proactive Mailing: – number of policies (m)3 2.7 0.1 0.1 = £45m
Remediation to date is based on cases reviewed as at 31 December 2014, but not necessarily settled and also includes a small portion relating to previously upheld complaints. The average cost included in the sensitivity is based on all cases included within the remediation scope, and is therefore a weighted average of full payments, top‑up payments on previously upheld cases, and nil payouts where the original decision is retained.
The percentage of cases reviewed by the Group that are subsequently referred to the FOS by the customer. A complaint is considered mature when six months have elapsed since initial decision. Actuals are based on decisions made by the Group during January 2014 to June 2014 and subsequently referred to the FOS.
The percentage of complaints referred where the FOS arrive at a different decision to the Group. Actuals are based on the six months to December 2014. The overturn rate to date is high as it continues to include a significant number of cases assessed prior to the implementation of changes to the case review process during 2013.
The provision remains sensitive to future trends; as an example, were reactive complaint levels in the first two quarters of 2015 to remain broadly in line with the fourth quarter of 2014 then the revised modelled total complaints and associated administration costs would increase the provision by approximately £700 million.
NOTE 40: OTHER PROVISIONS (CONTINUED) The validity of the claims facing CMIG depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will only be known once all relevant claims have been resolved.
The movement in subordinated liabilities during the year was as follows: 2014 £m £m
6.0884% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2015 (£745 million) 11 10 5.92% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2015 (US$750 million) 136 127 6.267% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2016 (US$1,000 million) 279 274 6.3673% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2019 (£335 million) 2 2 6.475% Non‑cumulative Preference Shares callable 2024 (£186 million) 43 39 6.413% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2035 (US$750 million) 115 51 6.657% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2037 (US$750 million) 54 16 9.25% Non‑cumulative Irredeemable Preference Shares (£300 million) 375 304 9.75% Non‑cumulative Irredeemable Preference Shares (£100 million) 76 53
Preferred securities 6.90% Perpetual Capital Securities (US$1,000 million) a – 209 6.85% Non‑cumulative Perpetual Preferred Securities (US$1,000 million) a 259 121 8.117% Non‑cumulative Perpetual Preferred Securities (Class A) (£250 million) a, b 250 256 7.627% Fixed to Floating Rate Guaranteed Non‑voting Non‑cumulative Preferred Securities (e415 million) a, c 77 66 6.35% Step‑up Perpetual Capital Securities (e500 million) a, d – 212 6.071% Non‑cumulative Perpetual Preferred Securities (US$750 million) – 423 7.834% Sterling Step‑up Non‑voting Non‑cumulative Preferred Securities callable 2015 (£250 million) 5 5 4.939% Non‑voting Non‑cumulative Perpetual Preferred Securities (e750 million) 27 26 7.286% Perpetual Regulatory Tier One Securities (Series A) (£150 million) 138 132 4.385% Step‑up Perpetual Capital Securities callable 2017 (e750 million) 77 89 6.461% Guaranteed Non‑voting Non‑cumulative Perpetual Preferred Securities (£600 million) 481 455 13% Step‑up Perpetual Capital Securities callable 2019 (£785 million) 10 8 13% Step‑up Perpetual Capital Securities callable 2019 (e532 million) 47 50 7.754% Non‑cumulative Perpetual Preferred Securities (Class B) (£150 million) 105 101 12% Fixed to Floating Rate Perpetual Tier 1 Capital Securities callable 2024 (US$2,000 million) 1,326 1,211 7.281% Perpetual Regulatory Tier One Securities (Series B) (£150 million) 117 90 13% Step‑up Perpetual Capital Securities callable 2029 (£700 million) 662 660 7.881% Guaranteed Non‑voting Non‑cumulative Preferred Securities (£245 million) 238 187
Total preferred securities 3,819 4,301 a These securities have passed their first call date, and are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the PRA.
c The fixed rate on this security was reset from 7.627 per cent to 3 month Euribor plus 2.875 per cent with effect from 9 December 2011.
Floating Rate Undated Subordinated Step‑up Notes (e300 million) a 19 16 6.05% Fixed to Floating Rate Undated Subordinated Notes (e500 million) a, c 10 8 4.875% Undated Subordinated Fixed to Floating Rate Instruments (e750 million) – 79
Total undated subordinated liabilities 1,852 1,916 a These securities have passed their first call date, and are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the PRA.
Enhanced Capital Notes 7.625% Enhanced Capital Notes due 2019 (£151 million) 38 145 8.125% Enhanced Capital Notes due 2019 (£4 million) 4 4 9% Enhanced Capital Notes due 2019 (£97 million) 15 102 7.8673% Enhanced Capital Notes due 2019 (£331 million) 17 333 15% Enhanced Capital Notes due 2019 (£775 million) 936 1,064 15% Enhanced Capital Notes due 2019 (e487 million) 514 567 8.875% Enhanced Capital Notes due 2020 (e125 million) 108 116 9.334% Enhanced Capital Notes due 2020 (£208 million) 23 231 7.375% Enhanced Capital Notes due 2020 (e95 million) 76 80
Dated subordinated liabilities Subordinated Step‑up Floating Rate Notes 2016 (e500 million) a – 172 Subordinated Step‑up Floating Rate Notes 2016 (£300 million) a – 183 Callable Floating Rate Subordinated Notes 2016 (e500 million) a 99 109 Callable Floating Rate Subordinated Notes 2016 (e500 million) a 158 156 Subordinated Callable Notes 2016 (US$750 million) a 260 218 Subordinated Callable Notes 2017 (e1,000 million) a 284 276 6.75% Subordinated Callable Fixed to Floating Rate Instruments 2017 (Aus$200 million) a, b – 5 Subordinated Callable Floating Rate Instruments 2017 (Aus$400 million) a – 33 5.109% Callable Fixed to Floating Rate Notes 2017 (Can$500 million) a, c 10 10 Subordinated Callable Notes 2017 (US$1,000 million) a 245 211 6.305% Subordinated Callable Fixed to Floating Rate Notes 2017 (£500 million) a, d 26 23 5.875% Subordinated Guaranteed Bonds 2014 (e750 million) – 658 4.375% Callable Fixed to Floating Rate Subordinated Notes 2019 (e750 million) – 621 6.9625% Callable Subordinated Fixed to Floating Rate Notes 2020 callable 2015 (£750 million) 741 701 11.875% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (e1,147 million) 923 975 10.75% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (£466 million) 465 458 9.875% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (US$568 million) 369 349 10.125% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (Can$387 million) 217 223 13% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (Aus$417 million) 228 234 6.75% Subordinated Fixed Rate Notes 2018 (US$2,000 million) 1,203 1,102 10.375% Subordinated Fixed to Fixed Rate Notes 2024 callable 2019 (e154 million) 130 141 6.5% Dated Subordinated Notes 2020 (e1,500 million) 1,393 1,433 5.75% Subordinated Fixed to Floating Rate Notes 2025 callable 2020 (£350 million) 347 331 6.5% Subordinated Fixed Rate Notes 2020 (US$2,000 million) 1,338 1,231 Subordinated Floating Rate Notes 2020 (e100 million) 78 85 5.374% Subordinated Fixed Rate Notes 2021 (e160 million) 147 147 7.07% Subordinated Fixed Rate Notes 2023 (e175 million) 179 175 5.50% Subordinated Notes 2023 (£850 million) (Scottish Widows plc) 930 794 4.5% Fixed Rate Subordinated Debt Securities due 2024 (US$1,000 million) 649 – 4.50% Fixed Rate Step‑up Subordinated Notes due 2030 (e750 million) 506 445 6% Subordinated Notes 2033 (US$750 million) 433 313 7.00% Subordinated Notes 2043 (£650 million) (Scottish Widows plc) 708 593 Total dated subordinated liabilities 15,597 16,281 a These securities have passed their first call dates, and are callable at specific dates as per the terms of the securities at the option of the issuer and with approval of the PRA.
Issued in relation to the payment of coupons on certain hybrid capital securities – 712,973,022 479,297,215 – 71 47
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 15 May 2014. The authority to issue shares and the authority to make market purchases of shares will expire at the next annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
Ordinary shares The holders of ordinary shares (excluding the limited voting ordinary shares), who held 99.9 per cent of the total ordinary share capital at 31 December 2014, are entitled to receive the Company’s report and accounts, attend, speak and vote at general meetings and appoint proxies to exercise voting rights. Holders of ordinary shares (excluding the limited voting ordinary shares) may also receive a dividend (subject to the provisions of the Company’s articles of association) and on a winding up may share in the assets of the Company.
The revaluation reserve in respect of available‑for‑sale financial assets represents the cumulative after tax unrealised change in the fair value of financial assets classified as available‑for‑sale since initial recognition; in the case of available‑for‑sale financial assets obtained on acquisitions of businesses, since the date of acquisition; and in the case of transferred assets that were previously held at amortised cost, by reference to that amortised cost.
Retained profits are stated after deducting £565 million (2013: £480 million; 2012: £158 million) representing 648 million (2013: 578 million; 2012: 301 million) treasury shares held.
On 6 March 2014 the Group announced concurrent Sterling, Euro and Dollar exchange offers for holders of certain series of its Enhanced Capital Notes (ECNs) to exchange them for new Additional Tier 1 (AT1) securities. The exchange offers completed in April 2014 and resulted in a total of £5,355 million of AT1 securities being issued; issue costs of £21 million, net of tax, have been charged to retained profits.
During the year ended 31 December 2014 the Group operated the following share‑based payment schemes, all of which are equity settled.
DEFERRED BONUS PLANS The Group operates a number of deferred bonus plans that are equity settled. Bonuses in respect of employee performance in 2014 have been recognised in the charge in line with the proportion of the deferral period completed.
The weighted average share price at the time that the options were exercised during 2014 was £0.77 (2013: £0.65). The weighted average remaining contractual life of options outstanding at the end of the year was 2.6 years (2013: 2.9 years).
Movements in the number of options outstanding are set out below: Number of options
The weighted average share price at the time the options were exercised during 2014 was £0.70 (2013: £0.75).
The weighted average share price at the time the options were exercised during 2014 was £0.77 (2013: £0.72).
The performance conditions for awards made in March and September 2012 are as follows: (i) EP: relevant to 30 per cent of the award. The performance target is based on 2014 adjusted EP outcome.
If the ATSR reaches 12 per cent per annum, 25 per cent of this element of the award, being the threshold, will vest.
If the average percentage reaches 20 per cent, 25 per cent of this element of the award, being the threshold, will vest.
(iv) Non-core assets at the end of 2014: relevant to 10 per cent of the award. Performance will be measured by reference to balance sheet non‑core assets at 31 December 2014.
If non‑core assets amount to £95 billion or less, 25 per cent of this element of the award, being the threshold, will vest.
If non‑core assets amount to £80 billion or less, 100 per cent of this element will vest.
If the adjusted EP reaches £1,254 million, 25 per cent of this element of the award, being the threshold, will vest.
In addition, short‑term funding must remain within that stated in the Group’s Risk Appetite throughout the three year period to 31 December 2015.
If the adjusted EP reaches £2,154 million, 25 per cent of this element of the award, being the threshold will vest.
If the adjusted EP reaches £3,231 million, 100 per cent of this element will vest.
(ii) Absolute Total Shareholder Return (ATSR): relevant to 30 per cent of the award. Performance will be measured against the annualised return over the three year period ending 31 December 2016.
If the ATSR reaches 8 per cent per annum, 25 per cent of this element of the award, being the threshold, will vest.
(iii) Cost: income ratio: relevant to 10 per cent of the award.
Performance will be measured against the adjusted total costs (total costs excluding FSCS costs and Bank Levy on underlying basis) as a percentage of total underlying income net of insurance claims based on full year 2016 figures.
(iv) FCA reportable complaints: relevant to 10 per cent of the award. Performance will be measured by reference to the total number of FCA reportable complaints per 1,000 accounts (excluding PPI complaints) over the three year period to 31 December 2016. If complaints per 1,000 accounts average 1.15 per annum or less, 25 per cent of this element of the award, being the threshold, will vest.
(vi) SME lending: relevant to 5 per cent of the award. Performance will be measured by reference to the percentage increase in net lending to SMEs over the three year period ending 31 December 2016.
If the percentage market share reaches 25 per cent, 100 per cent of this element will vest.
The 2012 and 2013 performance conditions were evaluated upon completion of the sale of SWIP to Aberdeen Asset Management PLC, and the awards were pro rated as appropriate. The 2012 award will vest at 155 per cent and 165.6 per cent for Code Staff in March 2015 and the 2013 award will vest at 165.7 per cent in March 2016.
Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £0.1 million (2013: £0.2 million; 2012: £0.1 million).
Granted, including certain adjustments (includes entitlements of appointed key management personnel) – 5 8
Granted, including certain adjustments (includes entitlements of appointed key management personnel) 19 42 45
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other transactions between the Group and its key management personnel: 2014 £m 2013 £m 2012 £m
No provisions have been recognised in respect of loans given to key management personnel (2013 and 2012: £nil).
At 31 December 2014, the Group did not provide any guarantees in respect of key management personnel (2013 and 2012: none).
Business Growth Fund In May 2011 the Group agreed, together with The Royal Bank of Scotland plc (and three other non‑related parties), to commit up to £300 million of equity investment by subscribing for shares in the Business Growth Fund plc which is the company created to fulfil the role of the Business Growth Fund as set out in the British Bankers’ Association’s Business Taskforce Report of October 2010. At 31 December 2014, the Group had invested £118 million (31 December 2013: £64 million) in the Business Growth Fund and carried the investment at a fair value of £105 million (31 December 2013: £52 million).
Help to Buy On 7 October 2013, Bank of Scotland plc entered into an agreement with The Commissioners of Her Majesty’s Treasury by which it agreed that the Halifax Division of Bank of Scotland plc would participate in the Help to Buy Scheme with effect from 11 October 2013 and that Lloyds Bank plc would participate from 3 January 2014. The Help to Buy Scheme is a scheme promoted by the UK government and is aimed to encourage participating lenders to make mortgage loans available to customers who require higher loan‑to‑value mortgages. Halifax and Lloyds are currently participating in the Scheme whereby customers borrow between 90 per cent and 95 per cent of the purchase price.
Central bank facilities In the ordinary course of business, the Group may from time to time access market‑wide facilities provided by central banks.
NOTE 49: RELATED PARTY TRANSACTIONS (CONTINUED) Other government-related entities Other than the transactions referred to above, there were no other significant transactions with the UK Government and UK Government‑controlled entities (including UK Government‑controlled banks) during the period that were not made in the ordinary course of business or that were unusual in their nature or conditions.
In addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2014, these companies had total assets of approximately £5,553 million (2013: £6,913 million), total liabilities of approximately £6,312 million (2013: £7,084 million) and for the year ended 31 December 2014 had turnover of approximately £5,634 million (2013: £6,989 million) and made a net loss of approximately £272 million (2013: net loss of £16 million). In addition, the Group has provided £2,364 million (2013: £3,355 million) of financing to these companies on which it received £149 million (2013: £170 million) of interest income in the year.
On 25 June 2014, Lloyds Bank plc entered into an agreement for the exclusive provision of conveyancing panel services with United Legal Services Limited (ULS), which is a related party of the Company by virtue of ULS Technology plc, ULS’s parent, being an investee company of Lloyds Development Capital, the UK regional equity provider which is part of the Group.
The ultimate impact on the Group of the above investigations, regulatory or legislative developments and the litigation against VISA and MasterCard can only be known at the conclusion of these matters.
NOTE 50: CONTINGENT LIABILITIES AND COMMITMENTS (CONTINUED) LIBOR AND OTHER TRADING RATES As set out in more detail in note 40, on 28 July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate. The settlements in relation to LIBOR are part of an industry‑wide investigation into the setting of interbank offered rates across a range of currencies.
FINANCIAL SERVICES COMPENSATION SCHEME The Financial Services Compensation Scheme (FSCS) is the UK’s independent statutory compensation fund of last resort for customers of authorised financial services firms and pays compensation if a firm is unable or likely to be unable to pay claims against it. The FSCS is funded by levies on the authorised financial services industry. Each deposit‑taking institution contributes towards the FSCS levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March.
NOTE 50: CONTINGENT LIABILITIES AND COMMITMENTS (CONTINUED) TAX AUTHORITIES The Group provides for potential tax liabilities that may arise on the basis of the amounts expected to be paid to tax authorities. This includes open matters where Her Majesty’s Revenue and Customs (HMRC) adopt a different interpretation and application of tax law which might lead to additional tax. The Group has an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary, which ceased trading on 31 December 2010. In the second half of 2013 HMRC informed the Group that their interpretation of the UK rules, permitting the offset of such losses, denies the claim; if HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £600 million and a reduction in the Group’s deferred tax asset of approximately £400 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due.
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: Mortgage offers made 8,809 9,559
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £55,029 million (2013: £56,292 million) was irrevocable.
Later than 1 year and not later than 5 years 945 928
(1) MEASUREMENT BASIS OF FINANCIAL ASSETS AND LIABILITIES 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.
Debt securities in issue – – – – – 76,233 – 76,233
Liabilities arising from non‑participating investment contracts – – – – – – 27,248 27,248
Debt securities in issue – – – – – 87,102 – 87,102
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 82,777 82,777
Liabilities arising from non‑participating investment contracts – – – – – – 27,590 27,590
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) Fair values of financial assets and liabilities The following table summarises the carrying values of financial assets and liabilities presented on the Group’s balance sheet. The fair values presented in the table are at a specific date and may be significantly different from the amounts which will actually be paid or received on the maturity or settlement date.
Valuation hierarchy At 31 December 2014, the Group’s financial assets carried at fair value, excluding derivatives, totalled £208,424 million (31 December 2013: £186,659 million). The table below analyses these financial assets by balance sheet classification, asset type and valuation methodology (level 1, 2 or 3, as described on page 277). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.
Gains recognised in the income statement within other income 296 – 296
Gains recognised in the income statement within other income 579 – 579
Loans and advances and debt securities Loans and advances and debt securities measured at fair value and classified as level 2 are valued by discounting expected cash flows using an observable credit spread applicable to the particular instrument.
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) Unlisted equity investments and investments in property partnerships held in the life assurance funds are valued using third party valuations. Management take account of any pertinent information, such as recent transactions and information received on particular investments, to adjust the third party valuations where necessary.
Valuation hierarchy At 31 December 2014, the Group’s financial liabilities carried at fair value, excluding derivatives, totalled £62,153 million (31 December 2013: £43,675 million). The table below analyses these financial liabilities by balance sheet classification and valuation methodology (level 1, 2 or 3, as described on page 277). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 50,007 – 50,007
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 28,902 – 28,902
Total trading and other financial liabilities at fair value through profit or loss 6,473 37,113 39 43,625
Total level 3 financial liabilities carried at fair value, excluding derivatives £m
Gains recognised in the income statement, within other income, relating to the change in fair value of those liabilities held at 31 December 2013 (10) (3) (13)