Examples of such forward looking statements include, but are not limited to, projections or expectations of the Group’s future financial position including profit attributable to shareholders, provisions, economic profit, dividends, capital structure, expenditures or any other financial items or ratios; statements of plans, objectives or goals of Lloyds Banking Group or its management including in respect of the integration of HBOS and the achievement of certain synergy targets; statements about the future business and economic environments in the United Kingdom (UK) and elsewhere including future trends in interest rates, foreign exchange rates, credit and equity market levels and demographic developments and any impact on the Group; statements about strategic goals, competition, regulation, disposals and consolidation or technological developments in the financial services industry; and statements of assumptions underlying such statements.
OUR GROUP Lloyds Banking Group is a leading UK based financial services group providing a wide range of banking and financial services, primarily in the UK, to personal and corporate customers.
The Group is the UK’s largest retail bank and has a large and diversified customer base. Services are offered through a number of well recognised brands including Lloyds TSB, Halifax, Bank of Scotland, Scottish Widows, Clerical Medical and Cheltenham & Gloucester, and via a unique distribution capability comprising the largest branch network in the UK and intermediary channels.
Details of our four primary operating divisions, the key product markets in which they participate and their contribution to the Group’s total income.
OUR CORPORATE STRATEGY Our corporate strategy supports the Group vision of being recognised as the best financial services company in the UK by customers, colleagues and shareholders. The strategy is focused on being a more conservative, ‘through the cycle’ relationship based business.
In delivering a high performance organisation the Group is focused on improving our cost efficiency and utilising our capital more effectively whilst maintaining a prudent approach to risk.
– The Group aspires to have one of the lowest cost to income ratios amongst UK financial institutions and further improving our processing efficiency and effectiveness will remain a priority. The anticipated synergies arising from the acquisition will be key to further improving our efficiency.
The Group now operates a range of well recognised brands across the four divisions with different brands utilised for different customer segments, geographies and markets. The main four brands operated by the Group are Lloyds TSB, Halifax, Bank of Scotland and Scottish Widows though a number of other brands are used in specialist markets.
Resilient core businesses performance despite year-on-year margin pressure and weak economy. £35 billion of gross new mortgage lending, approximately 100,000 new commercial accounts.
Lloyds Banking Group Annual Report and Accounts 2009 2009 HAS BEEN A YEAR OF CHANGE BUT ALSO ONE OF ACHIEVEMENT AS THE BUSINESS HAS POSITIONED ITSELF TO BENEFIT FROM WHAT WE EXPECT TO BE STRONG EARNINGS MOMENTUM OVER THE NEXT FEW YEARS
We are, as you know, primarily a retail and commercial bank. This means that the total payout under our Group bonus schemes for 2009 will be a small percentage of overall revenues. All awards in the Group are subject, where appropriate, to deferral and clawback and agreed with UK Financial Investments and the Financial Services Authority (FSA).
Since February 2009, there have been eleven changes to the board, five new directors and six departures.
We have also seen a number of departures. Ewan Brown, Jan du Plessis, Philip Green, Sir David Manning and Carolyn McCall have all retired from the board. I would like to thank each of them for their contribution to the Group, in some cases for many years, and during a period of great change, and latterly turmoil, in the banking sector. We wish them well for the future. I wish also to pay tribute to my predecessor Sir Victor Blank as chairman of the Group during a tumultuous time. Sir Victor has had a long and distinguished career in financial and professional services and in commerce and industry and he retires with my thanks for his counsel and commitment since his appointment in 2006.
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2009 WAS A YEAR OF SIGNIFICANT ACHIEVEMENT IN SHAPING THE GROUP. WE HAVE ESTABLISHED POSITIVE TRENDS IN MARGIN, COST AND IMPAIRMENTS AND ARE WELL POSITIONED
We believe we have substantial additional growth opportunities from continuing to develop our business model and applying it across the broader franchise. As we realise the potential, it will enable us to further improve our growth trajectory in the coming years.
Our asset margin improved during 2009, although the upturn came earlier than we had expected. We are pricing assets to appropriately reflect risk and our funding costs, and the net interest margin recovered somewhat in the second half. The key drivers influencing our margin in 2010 will be asset pricing, a possible increase in the base rate and the cost of wholesale funding. We expect to be able to achieve a margin of 2 per cent this year, and to be on an upward trajectory after that.
Costs fell by 5 per cent in the year. We have made great strides on delivering the integration of Lloyds TSB and HBOS, one of the largest financial services mergers ever undertaken. We exited the year with a cost synergy run-rate of £766 million. The key programmes we have put in place are: rationalising our businesses to eliminate areas of duplication; leveraging our procurement skills and re-aligning our property requirements. Given we have now achieved half of our cost run-rate target, we have raised our guidance and are now targeting annual run-rate cost synergies of £2 billion by the end of 2011.
– Run-off non-relationship assets to reduce the size of our balance sheet, providing the capacity to re-invest in growing our relationship businesses.
The economic performance last year was worse than most expected, with a 4.8 per cent decline in GDP. Looking forward, we remain cautious but realistic. Our view is that the risk of a severe further downturn in 2010 is lower than a few months ago and we continue to forecast growth in GDP of 1.8 per cent for 2010, with a similar trend in 2011. Against that backdrop, we expect property prices will be broadly flat in 2010 and we remain on the cautious side of the range of market expectations. We anticipate that company failures will peak this year, but do not expect them to reach the heights seen in the last recession due to much lower corporate debt servicing costs. We believe unemployment will also peak in 2010, but at a lower level than seen in the last recession.
Our financial outlook and guidance are based on a range of economic scenarios. Having stressed our portfolios, we are confident of our capital position and the expectation of improving financial performance, albeit the growth would be slower in coming through if there were a second economic downturn, or a weaker than expected economic recovery.
2009 was a year of substantial achievement, in which we shaped the Group to enable us to deliver the growth potential of the enlarged franchise. We achieved this whilst maintaining good momentum in the core business, and as a result the Group is now in a strong position.
The board approved the restructuring plan and is confident that this will not have a materially negative impact on the Group.
The acquisition of HBOS at the beginning of 2009 has undoubtedly improved the strategic positioning of the Lloyds Banking Group and helped position the Group for future growth. We now have market leading positions in many of the financial markets in which we participate, a market leading distribution capability, well recognised brands and a large customer base. The scale of the organisation provides us with the opportunity to further invest in products and services, systems and training, offering unparalleled choice and service to our customers. This strategic positioning along with our strong relationship focus and prudent risk appetite provides the platform for future growth.
ISSUE: THE GROUP DIVIDEND The European Commission state aid review prevents the Group from paying dividends on its ordinary shares. When will you recommence the payment of dividends?
2009 has been a mixed year in terms of economic developments. With an estimated fall of 5 per cent, UK GDP growth was towards the bottom end of our, and the market’s, range of expectations. The UK experienced the biggest recorded single-year GDP fall since the 1930s, and the peak to trough decline in GDP currently matches the early 1980s recession (see chart 1). The downturn in most other industrialised economies was of similar magnitude. In response, official interest rates have fallen to their lowest level since the Bank of England was founded. Interest rates elsewhere have also fallen to extremely low levels.
Companies went into this recession in better shape generally than during the last recession, and seem to have taken early action to cut investment, stocks and working hours. Helped by very low interest rates, the aggregate financial position of the corporate sector has remained strong. This has undoubtedly helped to limit failure rates. And this in turn has probably helped to limit the rise in unemployment – the biggest single cause of job losses in most recessions is business failure.
To enable meaningful comparisons to be made with 2008, the income statement and balance sheet commentaries are on a combined businesses basis. Certain commentaries also exclude the unwind of fair value adjustments.
On a combined businesses basis, the Group reported a loss before tax in 2009 of £6,300 million, compared to a loss before tax of £6,713 million in 2008. Whilst the Group delivered resilient revenues, lower costs and a strong trading surplus performance, up 35 per cent to £12,355 million, profits were adversely impacted by significantly higher impairment losses which increased by £9,108 million to £23,988 million.
In Retail, impairment losses increased by £532 million, or 14 per cent, to £4,227 million, particularly reflecting increases in UK unemployment during 2009 on the unsecured charge, which was partly offset by a lower secured impairment charge as house prices stabilised. Compared to 2009, we expect to see a reduction in the Retail impairment charge in 2010 with further improvements thereafter as the UK economic environment improves and house prices continue to stabilise.
At the Group level, we are confident that the overall impairment charge peaked during 2009. Although we would normally expect that impairments would peak one to two years after the low point of a recession, given the significant Wholesale charge during the year, predominantly driven by the HBOS property and property related portfolios and HBOS (UK and US) corporate portfolios, we believe that the charge in 2010 will be significantly lower than the 2009 charge. The impairment charge in the second half of 2009 was 21 per cent lower than that in the first half of the year. Given our current economic outlook, we expect to see a similar pace of half-yearly improvement throughout 2010, with further substantial reductions in 2011 and beyond.
Fair value adjustments reflected in the calculation of the net assets acquired totalled £1,241 million. Negative adjustments in respect of tangible net assets totalled £2,107 million principally reflecting the write-down of HBOS’s retail and corporate lending portfolios offset by gains on the valuation of HBOS’s own debt. Intangible assets totalling £4,650 million have been recognised, largely reflecting the value of HBOS’s relationship with its retail customer base and the value of its brands. Other acquisition related balance sheet adjustments include the elimination of HBOS’s available-for-sale and cash flow hedging reserves which totalled £6,439 million.
A large proportion of the investments held by the Group’s insurance businesses is invested in assets which are expected to be held on a long-term basis and which are inherently subject to short-term investment market fluctuations. Whilst it is expected that these investments will provide enhanced returns over the longer term, the short-term impact of investment market volatility can be significant. In 2009, higher equity market returns compared to our long-term assumption have contributed to positive insurance and policyholder volatility totalling £478 million.
In addition, during 2009, the Group completed a number of balance sheet liability management transactions that have generated significant core tier 1 capital by redeeming certain securities at a discount to their balance sheet carrying value. A substantial number of note holders have accepted the various offers made and, as a result, the Group has generated a pre-tax profit from these transactions of approximately £1.5 billion.
Relative to the size of its balance sheet, the Group does not have significant senior funding issuance requirements. Over the next three years the Group expects its public capital and senior funding issuance to total in the range of £20 billion to £25 billion per annum. We have made good progress on our 2010 term funding issuance plans following the issuance in December 2009 of US$2 billion tier 1 securities and in January 2010 the Group issued US$5 billion senior unsecured debt, and executed a £2.5 billion Residential Mortgage-Backed Securities (RMBS) transaction which included the first public US$ tranche of RMBS by a UK issuer since 2008.
Our revenue performance has been resilient and we are already beginning to deliver improving interest margins, which we expect to improve further over the next few years. We have an excellent track record in cost management, with a unique opportunity to capture significant acquisition related synergies over the next few years. We believe the Group’s overall impairment charge has now peaked, with a significant reduction expected in 2010. We have a robust capital and funding position. Overall, therefore, based on our current economic outlook, we expect to deliver a significantly improving combined businesses financial performance in 2010, with strong medium-term prospects thereafter.
The Group’s net interest income includes certain amounts attributable to policyholders, in addition to the interest earnings on shareholders’ funds held in the Group’s insurance businesses. In addition, the Group’s net interest income is significantly affected by the accounting treatment of a number of products predominately in Wholesale division where either the funding costs or the related revenues are recognised within other income. In order to enhance comparability in the Group’s banking net interest margin, these items have been excluded in determining net interest income and average interest earning assets.
BY MAKING ITS CUSTOMERS CENTRAL TO ITS STRATEGY RETAIL CONTINUES TO MAKE SUBSTANTIAL STRATEGIC PROGRESS
Net interest income has decreased by 6 per cent to £7,970 million. The banking net interest margin decline of 18 basis points reflected higher wholesale funding costs and lower deposit margins in the low base rate environment, partly offset by higher asset pricing, the benefits from which improved the margin in the second half of the year.
Other operating income has decreased by 34 per cent to £1,804 million, primarily due to lower payment protection income and non-recurring one-off income in 2008.
Good progress was made in integrating the Lloyds TSB and HBOS retail businesses. New management structures have been implemented across Retail and continuing good progress has been made in streamlining, simplifying and integrating back office processes. Retail’s integration synergies of £124 million for 2009 were ahead of expectations.
Good momentum in the business into the second half, with a positive trend in income growth in 2009, tight cost control, good progress being made on integration, and impairment losses peaking.
Retail’s strategic goal is to be recognised by its customers as the UK’s best and most recommended bank. It will achieve this by building deep and enduring customer relationships which deliver real value to customers. Supporting this strategy are a strong stable of brands which provide unparalleled customer reach and choice; deep customer insight based on the strength of the customer franchise; and highly efficient and effective low cost processes as a result of business scale. Real customer understanding and lower cost processes will enable further investment in the products and services that Retail customers want. Last, but not least, investment in effective tools and processes will allow Retail colleagues to focus on meeting customer needs. This strategy will be delivered within clearly defined and prudent risk parameters.
INTEGRATION The immediate priority of the business has been to plan and successfully deliver the integration of the retail activities of Lloyds TSB and HBOS. Good progress has been made in 2009. Organisational structures have been aligned to establish a single management team across Retail. The management of the sales force is now consistent across both heritages. The different mortgage operating models have been integrated and simplified and the number of mortgage operational sites reduced. In Direct Channels the multi-skilling of advisors has commenced enabling advisors to answer both banking and savings calls. Retail has sold Halifax Estate Agencies as part of ongoing initiatives to focus on its core business. Retail is on track to deliver its annualised cost savings target of £378 million for 2011.
Retail’s banking net interest margin decreased by 18 basis points to 1.97 per cent reflecting higher wholesale funding costs and reduced margins on savings products due to the low base rate environment, partly offset by higher asset pricing which led to a stronger margin in the second half of 2009.
The level of impaired loans in the unsecured lending portfolio, as at 31 December 2009, totalled £3.8 billion, or 11.9 per cent of closing advances (after writing off £2.1 billion of loans provided against in earlier years). This compared with £5.4 billion, or 14.7 per cent of closing advances at 31 December 2008; however, on an equivalent basis (adjusting for the £2.1 billion write-off in 2009) impaired loans at 31 December 2008 totalled £3.3 billion, or 8.9 per cent of advances. The underlying increase in impaired loans which occurred in the first half of 2009 reflected the weak economy, particularly rising unemployment. During 2009 a number of actions have been taken which improved delinquency rates on new business.
Compared to 2009, Retail expects to see a reduction in its impairment charge in 2010 as house prices continue to stabilise, with further improvements thereafter as the UK economic environment improves.
The Wholesale division serves in excess of a million businesses, ranging from start-ups and small enterprises to global corporations, with a range of propositions fully segmented according to customer need. The division comprises Corporate Markets, Treasury and Trading, and Asset Finance.
Treasury and Trading’s role is to provide access to financial markets in order to meet the Group’s balance sheet management requirements, and provides trading infrastructure to support execution of customer-driven risk management transactions, whilst operating within a well controlled and conservative risk appetite.
Strong cost management delivering benefits, excluding the cost of settlement of certain historic US dollar payments practices incurred in 2008, total operating expenses decreased by 7 per cent, reflecting reduced levels of operating lease business and cost savings achieved from the integration programme, partly offset by increased investment in Wholesale’s customer focused business support functions.
Impairment losses amounted to £15,683 million, compared to £10,394 million in 2008, reflecting the continued weak economic climate and the application of Lloyds Banking Group prudent impairment assumptions, primarily in HBOS Corporate Real Estate and HBOS (UK and US) Corporate businesses. Total impairment losses are expected to have peaked in the first half of 2009, with a significant reduction in the impairment charge delivered in the second half of 2009 of 39 per cent.
Cross-selling from deepening relationships has increased by 26 per cent reflecting increased product competencies and opportunities through a single sales force on the combined customer base.
Good progress was made in integrating the Lloyds TSB and HBOS wholesale businesses. Wholesale’s integration synergies for 2009 were ahead of expectations.
INTEGRATING THE BUSINESSES The Corporate and Commercial businesses have made substantial progress in building on the strengths of both heritages to provide a single relationship face to its strategic customer segments. Risk management processes within all the former HBOS businesses have been brought into line with the more conservative appetite of the Group. The balance sheet capacity of Wholesale Markets has been better aligned with the needs of customers by reducing exposure to assets not specifically required to support its strategic customer segments. The treasury activities of both heritages have been brought under one Treasury and Trading business so that Wholesale is able to provide a single, consistent face to the market. Consolidation and rationalisation of Asset Finance businesses continues, bringing together consumer finance businesses under the Black Horse brand and further centralisation of its sales channel and merging the market-leading Lex and Autolease contract hire businesses.
Wholesale’s integration programme is making good progress and synergies for the year are ahead of expectations. The initial planning and organisational design stage has been completed, and the Wholesale Operating Model has been defined. All major systems platform decisions have been made and the first product migrations have been completed. The focus for 2010 is on planning and execution of additional product migrations and strengthening risk systems. Wholesale is on track to deliver its annualised cost savings target by 2011.
PRIORITISING BUSINESSES Wholesale is investing in product and service capability in businesses where it believes it can grow in a capital and liquidity efficient manner, build competitive customer propositions drawing on its existing strengths, and thereby increase the breadth and depth of trusted customer relationships. Wholesale is building this capability within a prudent risk framework.
Total income increased by £3,459 million, or 63 per cent, to £8,909 million driven by a large increase in other income. Prior year income was significantly lower due to the effect of the market dislocation which resulted in investment valuation write-downs in Wholesale Markets, which were not repeated in the current year. Excluding these amounts total income decreased by 4 per cent as strong performances in Wholesale Markets and Treasury and Trading due to a more favourable interest rate environment, good transaction volumes in capital markets and strong flows of client-driven derivative transactions at improved spreads were more than offset by higher funding costs.
Impairment losses have increased by £5,289 million to £15,683 million in 2009. Impairment losses for loans and advances as a percentage of average loans and advances to customers were 5.92 per cent in 2009 compared to 3.32 per cent in 2008. Higher levels of failures, and application of prudent Lloyds Banking Group provisioning policy, notably in HBOS Corporate Real Estate and HBOS Corporate (UK and US) transactions, drove a significant increase in impairments in these portfolios. However, total impairment losses are expected to have peaked in the first half of 2009, amounting to £9,738 million, compared to £5,945 million in the second half, a reduction of 39 per cent.
Following detailed in depth reviews of all higher risk portfolios, especially HBOS, Wholesale has applied appropriate assumptions, particularly on HBOS Corporate Real Estate lending which resulted in prudent and significant impairment charges in 2009. As a result, Wholesale is expecting total impairments in 2010 to be significantly lower than 2009 in line with the Group’s base economic assumptions. Wholesale
Debt securities and available-for-sale financial assets balances reduced by £15 billion as Corporate Markets de-risked the balance sheet by either selling down or not replenishing total holdings after amortisations or maturities.
Impairment losses of £92 million in 2008 reflected the impact of a number of high profile financial services company failures in the second half of 2008.
Operating expenses decreased by £362 million, or 20 per cent, to £1,458 million, reflecting the impact of lower business volumes reducing depreciation charges on assets held under operating lease, year-on-year improvement in used car values and cost savings achieved from integration.
Targeted cost management has delivered benefits, excluding the impact of foreign exchange movements and additional costs associated with transitional services in the Australian business, underlying costs were slightly lower than 2008 due to cost savings achieved from integration partly offset by investments into higher growth areas and business support functions.
Customer deposits have decreased by 15 per cent to £29 billion, primarily due to outflows in Ireland reflecting aggressive pricing from competitors who have also benefited from the Irish Government deposit guarantee.
MAXIMISING VALUE IN THE SHORT TO MEDIUM TERM In International, the focus is on managing the impaired asset portfolio with redeployment of resource from front line activity and the wider Group to manage arrears and collections. The business is responding to the challenging environment through strong portfolio management and repricing assets as opportunities arise.
Total income decreased by £155 million, or 10 per cent, to £1,386 million. Net interest income decreased by £62 million, or 14 per cent, to £383 million reflecting margin compression driven by reducing base rates and a very competitive deposit market which led to an outflow in deposits of £3.5 billion. Other income decreased by £93 million, or 8 per cent, to £1,003 million driven by falls in global stock markets particularly in the first half of 2009, impacting sales volumes and fee income across all Wealth businesses.
Impairment losses have increased by £3,299 million to £4,007 million. Of the total impairment losses £2,949 million arose in Ireland which experienced a significant deterioration in asset values driven by the collapse in liquidity and severe decline in the property sector which saw commercial real estate values fall by over 50 per cent and house prices by over 25 per cent from their peak. A further £849 million of the total impairment losses arose in Australia driven by concentrations in property and in other sectors such as media, printing and transport which have been hardest hit by the downturn. Business Support Units have been established in both Ireland and Australia, supplemented by a divisional sanctioning process, to provide independent divisional oversight and control of the portfolios.
The European Life, Pensions and Investments business distributes products primarily in the German market under the Heidelberger Leben and Clerical Medical brands.
The capital position of the two life insurance groups within the division remains robust with increases in Insurance Group Directive (IGD) capital surpluses.
Includes certain divisional costs and income not allocated to business units, as well as the division’s share of results of joint ventures and associates.
Expected returns on shareholders net assets were impacted both by a lower assumed rate of return and reduced asset values as a result of severe market falls in 2008.
Profit before tax and fair value unwind from General Insurance decreased by £170 million to £367 million.
Claims were £156 million higher than 2008, primarily due to higher payment protection insurance claims related to unemployment. This also reflects the reclassification of Lloyds TSB Insurance Claims Handling expenses into claims paid in 2009. Whilst property claims were impacted by flooding and freeze claims in the final quarter of the year, benefits from ongoing investments in claims processes continue to be realised.
Operating expenses decreased by £98 million, or 27 per cent, to £262 million. Adjusting for the reclassification of claims handling expenses into claims paid and non-recurring marketing spend in 2008, costs improved by 10 per cent year-on-year, reflecting continued focus on cost management and cost savings achieved through the integration.
Group Operations manages the Group’s technology platforms, property estate, operations, procurement services and security. Through these areas Group Operations drives efficiencies and supports income growth across multiple brands and channels using scalable platforms, common processes and leveraging the Group’s purchasing power.
A great deal of centralisation activity occurred in the second half of the year which resulted in increased spend within the division compared to the first half of the year but in doing so significant efficiencies have been realised which will become evident in the 2010 run-rate. In addition increased recruitment in the Collections and Recoveries business meant that the Group was able to offer pro-active assistance to customers in financial difficulty thereby helping to minimise the impact of impairment losses on the Retail, Wholesale and Wealth and International divisions.
Property costs have decreased by £40 million, or 4 per cent, to £979 million primarily due to the realisation of synergy savings as a result of the integration and the consolidation of premises, which has been achieved at a faster rate than originally anticipated. Procurement costs have increased by £7 million, or 4 per cent, to £166 million due to an £11 million charge in respect of joint ventures.
The Group’s statutory profit before tax is significantly affected by two items that impact the underlying financial performance of the Group, namely 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.
The most significant of these additional sources of volatility is policyholder tax. Accounting standards require that tax on policyholder investment returns should be included in the Group’s tax charge rather than being offset against the related income. The impact is, therefore, to either increase or decrease profit before tax with a corresponding change in the tax charge. Over the longer term the charges levied to policyholders to cover policyholder tax on investment returns and the related tax provisions are expected to offset. In practice, timing and measurement differences exist between provisions for tax and charges made to policyholders. Consistent with the normalised approach taken in respect of insurance volatility, differences in the expected levels of the policyholder tax provision and policyholder charges are adjusted through policyholder interests volatility. Other sources of volatility include the minorities’ share of the profits earned by investment vehicles which are not wholly owned by the long-term assurance funds.
Procurement benefi ts totalling £174 million were achieved, split £126 million against the ongoing cost base and £48 million within the £1,096 million integration costs.
For example, the Group has published proposals to harmonise employee terms and conditions across the Group, launched a single Group Intranet to improve communication and ease contact between colleagues and enhanced the IT infrastructure to allow colleagues full connectivity at the Group’s buildings. A single consistent framework of risk policies is in place, comprising 71 detailed risk policies applicable across the combined Group.
The Group has progressed well through the IT design and is now focused on building and delivering an integrated technical infrastructure. Preparations for system integration and data migration are in full flight with the scale up of IT equipment to handle increased volumes. Detailed plans are in place, along with testing requirements that are fully commensurate with an integration of this scale.
Developing colleagues and having depth in our leadership succession plans is vital in supporting our growth strategy. In autumn 2009, an ‘Organisational Capability Review’ was completed to review the succession pipeline, identify top talent and review capability gaps and development plans. As a result, we have strong succession and development plans for all our senior leaders across the Group and have collected qualitative data on our top 500 colleagues. We are retaining people for an average tenure across our business of 12 years.
In 2009 we recruited 141 people into our Graduate Leadership Programme, offered 42 internships and 10 industrial placements under the five generalist and specialist streams. Following the launch of the new Lloyds Banking Group Graduate Programme in 2009, our focus has been on attracting top talent into the organisation who have the potential to become senior business leaders of the future. We have also introduced a ‘customer facing’ element to the main programme so that all our graduates gain core banking ‘front-line’ experience.
This year the quality of our programmes has been recognised with two external awards; ‘Best use of synchronous e-learning’ at the annual E-Learning Age Awards and the 2009 Security Training Initiative of the Year Award at the Security Excellence Awards.
In 2009 we sponsored Doing Seniority Differently, a groundbreaking piece of research by RADAR2 into the career experiences of senior managers with a disability or long-term health condition. We will sponsor a new network of senior disabled professionals in 2010.
Our harmonised reward package will support our ‘One Bank’ approach and reflect the importance of linking individual and Group performance to rewards within a strong risk framework. Reward is a key element of how Lloyds Banking Group sets out what it means to work for the Company and reflects the relationship we have with our people and the culture of the organisation.
– Understanding, engaging, and investing in the communities in which our business is based; – Being committed to environmental protection and better managing our impacts.
Our vision is to be the best financial services company in the UK. We will know we have achieved this when our customers tell us so by recommending us more than any other bank. So we have put in place several initiatives to improve customer advocacy. These include Net Promoter Score targets for each of our main brands, and linking these targets to retail colleagues’ performance – particularly those colleagues in customer-facing roles.
Lloyds Banking Group is UK’s largest retail bank. We have over 30 million individual and corporate customers. We play a very active part in the UK economy and its recovery. We take part in 12 of the Government’s various financial initiatives aimed at: helping customers enter the housing market; helping small businesses start up; and helping customers in financial difficulty.
We are the biggest provider of finance to the social housing sector. We are committed to funding housing associations to improve existing housing stock and build new affordable housing, both for rental and shared ownership. By the end of 2009 we had committed £14 billion to social housing and had a market share of around 23 per cent.
WORKING WITH SMALL AND MEDIUM SIZED ENTERPRISES We are committed to helping small to medium sized enterprises (SMEs) in the difficult current economic climate. We grew our market share in lending to SMEs in 2009. Bank of Scotland has returned to lending and is open for business. We approved over 59,000 overdrafts and over 47,000 loans for small businesses with a turnover of less than £1 million. During the year we opened in excess of 100,000 new accounts for SMEs, including a 23 per cent share of the start-up market.
We have a responsible lending programme with internal management reporting and accountability. Our customer-facing employees are trained to offer the necessary advice and support to help customers manage their borrowing.
We will only offer a loan facility after carefully assessing customers’ financial circumstances and believe that a loan would be appropriate. We take into account customers’ current and past management of financial products to ensure we make the most informed decision possible.
Our financial inclusion strategy is aligned with the Government’s aims to increase access to banking and credit while, at the same time, developing consumers’ financial capability.
We have a 40 per cent market share of customers belonging to the lowest income groups. With over 4 million accounts, the Group is the largest provider of social banking accounts in the UK. These accounts offer facilities such as direct debits but do not provide overdrafts. Through these accounts, customers are able to pay household bills by direct debit, saving them money when compared with other methods of payment. We also work with credit unions throughout the UK, managing their accounts and offering practical advice and support to help them improve and extend their service to communities.
We take protecting our customers and their assets extremely seriously. We continue to invest in activities to deter, detect and prevent fraud and we operate systems designed to ensure that our products and services are not abused for the purposes of laundering the proceeds of crime or for facilitating terrorism. These include transaction monitoring tools to identify and analyse suspicious account activity; and processes to verify customers and check the transactions that they make.
OUR COLLEAGUES IN THE COMMUNITY Our Charity of the Year relationship with the British Heart Foundation (BHF) went from strength to strength in 2009. Over £2 million has been raised between June 2008 and December 2009 through a variety of colleague, customer and shareholder fundraising initiatives. The funds are already being used to fund 15 specialist BHF Heart Nurses in communities across the UK, supporting over 8,400 heart patients.
Recognising the value of longer-term relationships, we have extended our partnership with the BHF for a further 6 months to conclude at the end of 2010. During this time we will continue to engage our colleagues in fundraising activities and raise additional funds for the BHF.
Over 10,500 schools and three million young people across England and Wales took part in the programme in 2009. 71 per cent of pupils tried a new sport and 91 per cent of teachers said the week inspired young people to do more sport. In 2010 the programme will be launched in Scotland in partnership with sportscotland, under our Bank of Scotland brand.
In 2009 Bank of Scotland partnered with the Scottish Football Association, the Scottish Government’s ‘cashback for communities’ scheme and the Scottish Sun newspaper to launch ‘Coaches for Communities’; an initiative which aims to get more people involved in youth football in Scotland by providing free football coaching. ‘Coaches for Communities’ provided training to 1,250 people, including 30 of our employees, leading to a Level One Early Touches qualification. Once qualified, the Scottish FA and the Scottish Schools’ Football Association will link participants up with a local community group or team in their area.
In 2009 we chaired an initiative with Business in the Community and the Cambridge Programme for Sustainability Leadership to create a Guide for Carbon Management in the Supply Chain. The guide has helped inform our approach and, as a freely downloadable resource, we are also encouraging our suppliers and customers to use it to help manage carbon risks in the supply chain.
BUSINESS TRAVEL In 2009 we introduced a common travel policy across the organisation. It supports a focus on sustainable travel and helped us deliver a 13 per cent reduction in the costs of travel.
We regularly communicate with employees on corporate responsibility issues. Indeed, engaging colleagues in our corporate responsibility agenda is central to its success and we will focus on this throughout 2010.
The Group continues to enhance its capabilities by providing to the board both qualitative and quantitative data including stress testing analysis on risks associated with strategic objectives to facilitate more informed and effective decision making. The Group‘s ability to take risks which are well understood, consistent with its strategy and plans and which are appropriately remunerated, is a key driver of shareholder return.
In addition, the Group has made a number of undertakings to HM Treasury associated with the state aid it has received, including the provision of additional lending to certain mortgage and business sectors, and other matters relating for instance to corporate governance and staff remuneration. These commitments could limit the operational fl exibility of the Group or lead HM Treasury to seek to infl uence the strategy of the Group in other ways.
The group asset and liability committee is responsible for the strategic management of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. It is also responsible for the risk management framework for market risk, liquidity risk, capital risk and earnings volatility. Group asset and liability committee is supported by the senior asset and liability committee this senior level committee, which is responsible for the review of documentation relating to the management of assets and liabilities in the Group’s balance sheet and the escalation of issues of group level significance to group asset and liability committee.
The group business risk committee reviews and recommends the Group’s risk appetite and risk management framework, high-level group policies and the allocation of risk appetite. Group business risk committee periodically reviews risk exposures and risk/reward returns and monitors the development, implementation and effectiveness of the Group’s risk governance framework. Within the scope of its work the committee also considers reputational risk and any issues which could have a materially adverse impact on the Group.
All business units, divisions and group functions complete a control self assessment annually (see page 104), reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. Managing directors of each business and each group executive committee member certify the accuracy of their assessment.
PRINCIPAL RISKS At present the most significant risks faced by the Group, which are derived from the primary risk drivers detailed in table 1.3 below, include: Risk: Definition Features
This poses a major risk to the Group and its lending to: – Retail customers (including those in Wealth and International), where reducing affordability and/or asset values arising from a combination of house price falls, continuing high, or increasing levels of unemployment, consumer over-indebtedness, and rising interest rates impacts both secured and unsecured retail exposures.
Risk reporting is standardised through the use of standard definitions to enable risk aggregation. Divisions monitor their risk levels against their risk appetite, seeking to ensure effective mitigating action is being taken where appropriate. Divisional risk reports are reviewed by each divisional executive committee to ensure that respective senior management are satisfied with the overall risk profile, risk accountabilities and progress on any necessary action plans and tracking. Reporting, including that of performance against relevant limits or policies, is in place to provide a level of detail appropriate to the exposures concerned and regular information is provided to group risk for review and aggregate reporting. Any significant issues identified in the monitoring process are appropriately reported, and an escalation process is in place to report significant losses to appropriate levels of management. Regular reports are prepared by group risk on risk exposures and material issues to the group asset and liability committee, group business risk committee, group executive committee, risk oversight committee and the board.
The Group has made good preparations for the FSA’s new liquidity regime (ILAS) and is ready to meet the reporting implications later in the year.
Customer treatment: The risk of regulatory censure and/or a reduction in earnings/value, through financial or reputational loss, from inappropriate or poor customer treatment.
The Group regularly reviews its product range to ensure that it meets regulatory requirements and is competitive in the market place. Treating Customers Fairly remains the key principle underpinning the FSA’s consumer protection objective. An additional challenge for Lloyds Banking Group is ensuring the fair treatment of customers during integration of the two heritage businesses. As a result the customer relationship management risks posed by integration are carefully considered through the integration governance process in place. If Lloyds Banking Group is unable to demonstrate the fair treatment of its customers there is the risk of increased complaints from customers, the potential for regulatory action (which could include reviews of past business and/or the payment of fi nes and compensation) and adverse media coverage (leading to reputational damage in the marketplace). The Group has policies, procedures and governance arrangements in place to facilitate the fair treatment of customers.
People: The risk of reduction in earnings and/or value, through financial or reputational loss, from failure to retain, train, reward, recruit and incentivise appropriately skilled staff, inappropriate staff behaviour or industrial action.
The Group has created an integration executive board, chaired by the group operations director, to oversee the integration process. The Group is now one year into the integration programme and has a fully developed and functioning governance framework to manage these risks, with clear understanding of the dependencies and phased deliverables through to 2012. The programme is ahead of plan.
This statement of the Group’s overall appetite for credit risk is reviewed and approved annually by the board. With the support of the group credit risk committee and group business risk committee, the group chief executive allocates this risk appetite across the Group. Individual members of the group executive committee ensure that credit risk appetite is further delegated to an appropriate level within their areas of responsibility.
EXPOSURES The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions and corporate clients. The credit risk exposures of the Group are set out in note 54 to the financial statements. Credit risk exposures are categorised as ‘retail’ arising in the Retail and Wealth and International Divisions and ‘wholesale’ arising in the Wholesale and Wealth and International Divisions.
– Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite. Credit policy is aligned to the Group’s risk appetite and restricts exposure to certain high risk and more vulnerable sectors and segments. Note 20 to the accounts provides an analysis of loans and advances to customers by industry (for wholesale customers) and product (for retail customers). Exposures are monitored to prevent excessive concentration of risk. 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 hurdle requirements. The Group’s large exposures are reported in accordance with regulatory reporting requirements.
– Risk assurance and oversight: Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators. Risk assurance teams are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.
Collateral The principal collateral types for loans and advances are: – mortgages over residential and commercial real estate; – charges over business assets such as premises, inventory and accounts receivable; – charges over financial instruments such as debt securities and equities; and
Following a prioritised appointment process an integrated credit risk management structure is in place throughout the Group, using the most experienced and skilled resources from both heritages. Substantial work has been undertaken to analyse portfolios and where necessary the Group has taken actions to manage effectively its exposure through the economic downturn. These actions have included revised credit criteria for key products and a withdrawal from those business sectors that are outside of the Group’s risk appetite.
To support corporate customers that encounter difficulties during the current economic downturn the Group has continued to expand its dedicated Business Support Unit (BSU) model. Teams have been strengthened in both Wholesale and Wealth and International to deal with the rise in work loads experienced during the year as the recessionary conditions took hold both in the UK and overseas. In Wholesale three teams have been created to cover Corporate Real Estate, Corporate and Commercial, and Specialist Finance customers experiencing difficulties. In Wealth and International teams have been created in Ireland and Australia. Under this model, relationship management passes early and fully to BSU; because the BSU specialists receive the customers at an earlier stage in the process they have more time to develop effective solutions. The strategy is to work alongside management teams and key stakeholders to turnaround businesses in distress and re-establish these as viable entities. Where a turnaround is not feasible, exposure is minimised through a combination of appropriate asset sales, restructuring and work out strategies.
To understand how the above portfolios are classified for internal monitoring purposes the following table sets out the Group’s loans and advances according to asset quality. Please also refer to page 232 of the financial statements.
The definitions used below of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale customers are not the same, reflecting the different characteristics of these exposures and the way they are managed internally. Wholesale lending has predominantly been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending have predominantly been determined using internal rating models and for Retail mortgages also incorporate expected recovery levels and, where applicable expert judgement. Good quality lending includes the lower assessed default probabilities and all loans with low expected losses in the event of default, with other categories reflecting progressively higher risks and lower expected recoveries.
Retail’s gross loans and advances have reduced by £8 billion to £378 billion, as a result of management actions to align heritage risk appetites with a focus on lending to lower risk segments, such as unsecured franchise customers, and the write-off of £2.1 billion of unsecured loans and advances which had been provided against in earlier years, as reported at the half-year.
The Group is cautious about a number of potential downside risks, including lagged effects of high unemployment, a potential for recent house price increases to reverse, the challenges to affordability if interest rates were to rise ahead of real wage growth and other potential pressures on future affordability. However, based on its latest economic assumptions, the Group’s expectation is for recent trends to continue and for Retail to report a lower impairment charge in 2010 compared to 2009.
The reduction in unsecured advances and impairment provisions reflects the write-off of £2.1 billion of unsecured loans and advances to customers which had been provided against in prior years.
Following the Group’s acquisition of the remaining shares in the joint venture with AA, unsecured lending by that entity is now reported in ‘Personal Loans’ and ‘Credit Cards’ headings, previously these balances were included in ‘Others’.
In March 2009, the Group committed to increasing its planned gross lending to homebuyers by £3 billion in the following 12 months. The lending provided under this commitment continues to adhere to the Group’s risk appetite. The Group’s risk appetite is consistent with the criteria that had proved to be a prudent and successful approach for Lloyds TSB.
The possessions stock has fallen by 32 per cent in 2009, from 4,011 to 2,720 properties. Currently, average proceeds from the sale of repossessed properties are in excess of average valuations assumed in Retail’s provisioning models.
Wholesale division impairment losses increased by £5,289 million to £15,683 million in 2009. Impairment losses for loans and advances as a percentage of average loans and advances to customers increased to 5.92 per cent in 2009 from 3.32 per cent in 2008. Higher levels of failures, notably in HBOS Corporate Real Estate and real estate related transactions, and the HBOS (UK and US) Corporate portfolio, drove a significant increase in impairments. However, impairment losses reduced significantly in the second half of 2009, amounting to £5,945 million, compared with £9,738 million in the first half, a reduction of £3,793 million, or 39 per cent.
Total impaired loans increased by £16,644 million to £35,114 million at 31 December 2009. Impaired loans as a percentage of closing advances was 16.6 per cent as at 31 December 2009 compared with 7.5 per cent as at 31 December 2008, with impairment provisions as a percentage of impaired loans increasing to 48.9 per cent as at 31 December 2009 from 44.7 per cent as at 31 December 2008. Detailed reviews of vulnerable portfolios have largely been completed and, where appropriate, remedial risk mitigating actions are underway. The HBOS impairment methodology has now been aligned with the Group’s methodology, and this is reflected in the impairment charge for the year and the first half in particular. The position has stabilised during the second half with a lower rate of impairment compared with the first half.
The Lloyds TSB approach to credit risk management, with a focus on ensuring its risk appetite and credit policies reflect a prudent through the cycle approach to lending, impairment assessment and review is being embedded across the enlarged Wholesale division and remains a key focus in 2010.
As part of its funding, liquidity and general hedging requirements Lloyds Banking Group maintains relationships with many major financial institutions throughout the world. Credit quality in general is improving in the sector, helped significantly by the support mechanisms established by Governments, Central Banks and regulators. This is reflected in the firmer trend in market prices now quoted for bank debt. Some economies continue to experience difficulties, either through low growth or high borrowing levels, and banking sectors in these countries remain under strain.
Portfolio metrics and stress testing analysis suggest continued material impairments through the short to medium term, as expected at this stage of the economic cycle. Over time, impairment losses as a percentage of advances are expected to trend towards more normalised levels reflective of the historic performance of the Lloyds TSB heritage portfolio. However, in line with past experience, the impairment improvement is expected to show some lag behind the upturn in the economy.
CORPORATE REAL ESTATE The Corporate Real Estate portfolio has endured a significant level of stress as a consequence of the unprecedented scale and pace of deterioration in the property sector coupled with the previous aggressive lending appetite in the heritage HBOS business. Whilst we remain cautious, the current outlook for the property sector is now a little more positive with higher levels of equity being raised, yields stabilising and negative rental growth abating. However, a sustained recovery is not predicted until 2011. Against this backdrop, Corporate Real Estate is focusing its attention on improving the risk profile of the existing portfolio and applying conservative and prudent lending policies in relation to new business. Clearly the management of the distressed portfolio is key not only to mitigating loss but also for Lloyds Banking Group as a significant player within the property sector to ensure that the strategies adopted do not adversely impact on a market that remains fragile. The Group’s BSU is making great progress in the achievement of these balanced objectives with a substantial number of restructurings undertaken over the last six months.
On the property investment side there are signs of recovery in capital values but this is most evident at the prime end of the commercial market. The key concern remains the potential for an increasing level of tenant defaults against a backdrop of already depressed capital values and a continuing lack of liquidity in the market. Sustainability of cash flow has been key to the relative resilience seen in the investment market to date but a significant rise in tenant defaults would impact adversely on debt service capability and could lead to increased impairments beyond those forecast, based on the Group’s current economic assumptions.
Corporate Equity – The risk capital (assets representing ‘Equity Risk’ including ordinary equity, preference shares and institutional stock) portfolio comprises the Lloyds TSB heritage Lloyds Development Capital (LDC) business, a small Project Finance business, and the HBOS heritage Integrated Finance Investments, Joint Ventures and Fund Investments businesses. All new private equity investment activity will in future be made in the name of LDC, which will continue taking equity stakes, primarily in privately owned UK businesses. With the exception of Project Finance the remaining Specialist Finance Risk Capital businesses are not considered as continuing businesses to Lloyds Banking Group and as a result are being managed for value. As a result, excluding LDC and Project Finance, there will be no ‘new’ investments in the portfolios and they will reduce over time as existing investments are exited.
ASSET FINANCE The credit quality profile across the heritage Lloyds TSB Asset Finance non-retail portfolios has remained broadly stable over the last 12 months. In line with the wider economic difficulties and rise in corporate failures, there has been a rise in the number of cases requiring Business Support management although the level of defaults is no greater than in 2008. However, there has been an increased level of default in the heritage HBOS Asset Finance non-retail portfolios with the need for higher impairment charges during 2009, particularly in the daily/flexi rental end of the Fleet Operator sector and marine sector.
– Tightening of Risk Appetite following divisional and Business Unit reviews and independent Group Credit Risk Assurance reviews of all material heritage HBOS portfolios.
Wealth and International’s impairment losses have increased by £3,347 million to £4,078 million in 2009. The result was primarily driven by a severe deterioration in economic conditions in the Irish economy and to a lesser extent the Australian economy. Impairment losses for loans and advances as a percentage of average gross loans and advances to customers increased to 6.04 per cent from 1.05 per cent in 2008. Included within the total impairment charge was £2,949 million related to Ireland, £849 million related to Australia with a further £129 million arising in Wholesale Europe. The impairment charge for Wealth and International is expected to have peaked in 2009, although the Group continues to monitor economic conditions in the eurozone and Ireland in particular.
Total impaired loans increased by £9,976 million to £12,704 million at 31 December 2009. As a percentage of gross loans and advances to customers impaired loans increased to 18.3 per cent from 4.0 per cent at 31 December 2008. This increase was driven by deteriorating economic conditions, particularly in Ireland, as well as the impact of the downturn on property loans and advances, in both Ireland and Australia, and concentrations in other sectors most impacted by the downturn, such as printing, media and transport.
The tables below highlight the International credit exposure in Ireland and Australia which represent approximately 60 per cent of the division’s lending assets. As at December 2009 37 per cent of customer advances in Wealth and International division relate to personal lending, including mortgages. Loans to individuals are by their nature well diversified amongst a wide range of borrowers. Wholesale assets comprise 63 per cent of assets with a good spread of risk outwith the property sector. Wealth and International are seeking to reduce property concentrations to rebalance the lending portfolio, with Commercial Real Estate lending currently comprising 31 per cent of the total portfolio.
WEALTH Impairment losses within Wealth have increased to £71 million for 2009 (June 2009: £26 million) primarily reflecting difficult economic conditions in Spain as well as the impact of the economic downturn on the UK Private Banking and ‘Expatriates’ businesses.
MEASUREMENT The primary market risk measure used within the Group is the Value at Risk (VaR) methodology, which incorporates the volatility of relevant market prices and the correlation of their movements. This is used for determining the Group’s overall market risk appetite and for the high level allocation of risk appetite across the Group.
Although an important measure of risk, VaR has limitations as a result of its use of historical data, assumed distribution, holding periods and frequency of calculation. In addition, the use of confidence levels does not convey any information about potential loss when the confidence level is exceeded. Where VaR models are less well suited to the nature of positions, the Group recognises these limitations and supplements its use with a variety of other techniques. These reflect the nature of the business activity, and include interest rate repricing gaps, open exchange positions and sensitivity analysis. Stress testing and scenario analysis are also used in certain portfolios and at group level, to simulate extreme conditions to supplement these core measures.
The following table shows, split by material currency, Lloyds Banking Group sensitivities as at 31 December 2009 to an immediate up and down 25 basis points change to all interest rates.
DEFINITION The risk of reductions in earnings and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity of insured/underwritten events and to fluctuations in the timing and amount of claim settlements. This includes fluctuations in profits due to customer behaviour.
Customer treatment risk The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate or poor customer treatment.
People risk The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate colleague actions and behaviour, industrial action, legal action in relation to people, or health and safety issues. Loss can also be incurred through failure to recruit, retain, train, reward and incentivise appropriately skilled staff to achieve business objectives and through failure to take appropriate action as a result of staff underperformance.
Integration risk The risk that Lloyds Banking Group fails to realise the business growth opportunities, revenue benefi ts, cost synergies, operational effi ciencies and other benefi ts anticipated from, or incurs unanticipated costs and losses associated with, the acquisition of HBOS plc.
Financial crime risk The risk of reductions in earnings and/or value, through financial or reputational loss, associated with financial crime and failure to comply with related legal and regulatory obligations (which includes compliance with economic sanctions), these losses may include censure, fines or the cost of litigation.
Security risk The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft of or damage to the Group’s assets, the loss, corruption, misuse or theft of the Group’s information assets or threats or actual harm to the Group’s people. This also includes risks relating to terrorist acts, other acts of war, geopolitical, pandemic or other such events.
Change risk The risk of reductions in earnings and/or value, through financial or reputational loss, from change initiatives failing to deliver to requirements, budget or timescale, failing to implement change effectively or failing to realise desired benefits.
Governance risk The risk of reductions in earnings and/or value, through financial or reputational loss, from poor corporate governance at group, divisional or business unit level. Corporate governance in this context embraces the structures, systems and processes that provide direction, control and accountability for the enterprise.
In setting operational risk appetite, the Group looks at both impact on solvency and the Group’s reputation.
Lloyds Banking Group welcomes the regulation of remuneration provided there is international consensus and we will comply with the FSA code.
The Lloyds TSB Group capital model calculations are driven by actual loss data (internal and external) and forward looking scenarios which value potential future risk events. External industry-wide data is collected to help with validating scenarios.
Adjusted to reflect the completion of the assessment of the fair value of the identifiable net assets of the HBOS Group.
TERM FUNDING The Group has been able to take advantage of the improved market sentiment, by extending the duration of its money market funding, and by successfully accessing the term debt markets in unguaranteed format and through the issuance of Permanent RMBS. The reduction in the volume of money market funding has contributed to an improvement in the Group’s term funding ratio (wholesale funding with a remaining life of over one year) which has improved to 50 per cent at 31 December 2009 from 44 per cent at the previous year end. The Group’s long term target for this ratio is 40 per cent, this seeks to ensure that maturing liabilities are spread over subsequent years.
Lloyds Banking Group will continue to access the term capital markets, and has already successfully executed benchmark transactions in January 2010: – US$5 billion equivalent of public senior term funding
The Group had limited access to the term capital markets for large periods of 2009 due to highly market sensitive on-going negotiations around the Government Asset Protection Scheme and market recapitalisation.
The table below illustrates the Group’s holding of highly liquid unencumbered assets. This liquidity is available for deployment at immediate notice and is a key component of the Group’s liquidity management process.
RISK APPETITE Capital risk appetite is set by the board and reported through various metrics that enable the Group to manage capital constraints and shareholder expectations. One of the key metrics is the Group’s core tier 1 capital ratio for which the board has set a target of more than 7 per cent. The chief executive, assisted by the group asset and liability committee, regularly reviews performance against risk appetite. The board formally reviews capital risk on an annual basis.
MEASUREMENT The Group’s regulatory capital is divided into tiers depending on level of subordination and ability to absorb losses. Core tier 1 capital as defined in the FSA letter to the British Bankers Association in May 2009, comprises mainly shareholders’ equity and minority interests, after deducting goodwill, other intangible assets and 50 per cent of the net excess of expected loss over accounting provisions and certain securitisation positions. Accounting equity is adjusted in accordance with FSA requirements, particularly in respect of pensions and available for sale assets. Tier 1 capital, as defined by the European Community Banking Consolidation Directive as implemented in the UK by the Financial Services Authority’s General Prudential Sourcebook (GENPRU), is core tier 1 capital plus tier 1 capital securities. Tier 2 capital, defined by GENPRU, comprises qualifying subordinated debt after deducting 50 per cent of the excess of expected loss over accounting provisions, and certain securitisation positions. Total capital is the sum of tier 1 and tier 2 capital after deducting investments in subsidiaries and associates that are not consolidated for regulatory purposes. In the case of Lloyds Banking Group, this means that the net assets of its life assurance and general insurance businesses are excluded from its total regulatory capital.
A number of limits are imposed by the FSA on the proportion of the regulatory capital base that can be made up of subordinated debt and preferred securities, for example the amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. The Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate.
The Group undertook an extensive series of stress analysis during the year to determine the adequacy of the Group’s capital resources against the FSA minimum requirements.
As part of the exchange offer announced in November 2009, certain preference shares, preferred securities and undated subordinated notes issued by the Group were exchanged for new ordinary shares with settlement in February 2010. Had the exchange settled in December 2009, the core tier 1 ratio would have been 8.4 per cent (unaudited).
RISK WEIGHTED ASSETS – (unaudited) The following table sets out the Group’s risk weighted assets that primarily arise in its banking businesses.
MITIGATION The Group maintains a system of internal controls, which is designed to be consistently applied and enable the preparation and disclosure of financial reporting, prudential regulatory reporting and tax returns in accordance with International Financial Reporting Standards, statutory and regulatory requirements. The system of internal control is designed to ensure that accounting policies are consistently applied, transactions are recorded and undertaken in accordance with delegated authorities and that assets are safeguarded and liabilities are properly recorded.
Statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. Liabilities are calculated using a projection of future cash flows after making prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the FSA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for with-profits policies that are at the discretion of management, but does include a value for policyholder options likely to be exercised.
For Scottish Widows and Clerical Medical, no amount is required to cover the impact of stress tests on the actuarial reserves. However, a further test is required in respect of the with-profit funds, which compares the level of ‘realistic excess capital’ to the ‘statutory excess capital’ of each with-profit fund. In circumstances where the ‘realistic excess capital’ position is less than ‘statutory excess capital’, the company is required to hold additional capital to cover the shortfall, but only to the extent it exceeds the value, calculated in a prescribed way, of internal transfers from the with-profit fund. Any additional capital requirement under this test is referred to as the With-Profits Insurance Capital Component. The ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the withprofit fund with a further deduction to cover various stress tests.
The determination of realistic liabilities of the with-profit funds includes the value of internal transfers expected to be made from each with-profit fund to the non-profit fund held within the same life insurance entity. These internal transfers include charges on policies where the associated costs are borne by the non-profit fund. The With-Profits Insurance Capital Component may be reduced by the value, calculated in the stress test scenario, of these internal transfers, but only to the extent that credit has not been taken for the value of these charges in deriving actuarial reserves for the relevant non-profit fund.
Adjustments onto a regulatory basis: Unallocated surplus within insurance business 310 772 – – – 1,082
Other differences between IFRS and regulatory valuation of assets and liabilities – – 253 (154) 108 207
FORMAL INTRA-GROUP CAPITAL ARRANGEMENTS Scottish Widows has a formal arrangement with one of its subsidiary undertakings, Scottish Widows Unit Funds Limited, whereby the subsidiary company can draw down capital from Scottish Widows to finance new business which is reinsured from the parent to its subsidiary. Scottish Widows has also provided subordinated loans to its fellow group undertaking Scottish Widows Bank plc.
Further Support Account: The Further Support Account is an extra tier of capital support for the with-profits policies in existence at the date of demutualisation. The Scheme requires that assets can only be transferred from the Non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the Support Account and Further Support Account. Unlike the Support Account test, the economic value used for this test includes both admissible assets and the present value of future profits of business written in the Non-Participating Fund or by any subsidiaries of that fund. The balance of the Further Support Account is expected to reduce to nil by the year 2030. At 31 December 2009, the estimated net economic value of the Non-Participating Fund and its subsidiaries for the purposes of this test was £3,823 million (31 December 2008: £3,605 million) and the estimated combined value of the Support Account and Further Support Account was £2,495 million (31 December 2008: £2,582 million).
Other differences between IFRS and regulatory valuation of assets and liabilities – 25 (317) (4) (296)
Estimated share of ‘realistic’ liabilities consistent with the FSA reporting treatment (406) – – – (406)
WITH-PROFIT FUNDS Available capital in the Scottish Widows With Profit Fund has decreased from £258 million at 31 December 2008 to an estimated £257 million at 31 December 2009.
Available capital in the Clerical Medical With Profit Fund has increased from £511 million at acquisition to an estimated £732 million at 31 December 2009.
OVERSEAS LIFE BUSINESS The acquisition of Clerical Medical business resulted in a £250 million increase. Further increases were due to new business and changes in assumptions.
OTHER LIFE INSURANCE BUSINESSES Except as described above capital held in UK non-profit funds is potentially transferable to other parts of the Group, subject to meeting the regulatory requirements of these businesses. There are no prior arrangements in place to allow capital to move freely between life insurance entities or other parts of the Group.
The movements in the Group’s available capital resources in the life business can be analysed as follows: TABLE 1.27: MOVEMENTS IN AVAILABLE CAPITAL RESOURCES Scottish Widows With Profit Fund £m
Analysis of policyholder liabilities reported in the balance sheet in respect of the group’s life insurance business is as follows. With-profit fund liabilities are valued in accordance with FRS 27.
SHAREHOLDERS’ FUNDS Shareholders’ funds outside the long-term business fund, other than those used to match regulatory requirements, are mainly invested in assets that are less sensitive to market conditions.
OPTIONS AND GUARANTEES WITHIN THE WITH-PROFIT FUNDS The most significant options and guarantees provided from within the with-profit funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
For those policies written in Scottish Widows pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up within the With Profit Fund of Scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2009 of £1.6 billion (2008: £2.0 billion). The eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
OPTIONS AND GUARANTEES OUTSIDE THE WITH-PROFIT FUNDS 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 £64 million (31 December 2008: £65 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 some £3 million. If yields were 0.5 per cent lower than assumed, the liability would increase by some £11 million.
Chairman of the nomination and governance committee and a member of the remuneration and risk oversight committees
Joined the board in September 2008. Chairman of Deloitte UK from 1995 to 2007 and a member of the board from 1991 to 2007. Joined the fi rm in 1973 and was a partner from 1982 until he retired in 2008. A member of the board of directors of Deloitte Touche Tohmatsu from 1999 to 2007. Chairman of Great Portland Estates. A member of the council of Leeds University and a governor of Berkhamsted School. Aged 59.
Join ed the group in 2006 as deputy group fi nance director, before being appointed acting group fi nance director in April 2008. Appointed to the board in October 2008 as group fi nance director. Previously fi nance director for the UK and Europe at Prudential from 2002 to 2006 and group fi nance director of Heath Lambert Group from 1996 to 2002. Prior to that, he spent 11 years at KPMG. Aged 47.
Executive director, member of the group executive committee and chief executive, International Retail and Commercial Banking at Barclays until December 2006. He joined Barclays in 1983 and held various senior management positions, including chief executive, Personal Financial Services and chief executive, Business Banking. He was also a non-executive director of BAA until June 2006 and a non-executive director of Absa Group Limited, one of South Africa’s largest fi nancial services groups, until October 2006. From 2007 to 2009 he was also the chairman and chief executive of BAWAG P.S.K. AG, the second largest retail bank in Austria. He is currently a member of the strategy board for Henley Business School, non-executive chairman of The Mind Gym and a non-executive director of Campion Willcocks. Aged 47.
The Company is a holding company and its subsidiary undertakings provide a wide range of banking and financial services through branches and offices in the UK and overseas. A review of the development and performance of the business during the financial year and an indication of the likely future developments are given on pages 4 to 94. Key performance indicators are shown on page 5. Information regarding the financial risk management objectives and internal control policies of the Company and its subsidiary undertakings in relation to the preparation of consolidated financial statements is given within the corporate governance report on pages 100 to 104. The financial risk management objectives and internal control policies in relation to the use of financial instruments, is given on pages 56 to 94 and in notes 53 and 54 on pages 221 to 243.
On 16 January 2009, Lloyds TSB Group plc changed its name to Lloyds Banking Group plc, following the acquisition of HBOS plc.
Dr W C G Berndt, Mr J E Daniels and Mrs H A Weir retire at the annual general meeting and offer themselves for re-election.
Lloyds Banking Group is committed to providing employment practices and policies which recognise the diversity of our workforce and ensure equality for employees regardless of sex, race, disability, age, sexual orientation or religious belief.
The Company has signed up to the ‘Prompt Payment Code’ published by the Department for Business Innovation and Skills (BIS), regarding the making of payments to suppliers. A copy of the code and information about it may be obtained from BIS as shown on page 261.
Lloyds Banking Group aspires to the highest standards of corporate governance. The events of the past two years have led to unprecedented challenges for the Group and the markets as a whole. Throughout this period we have constantly reviewed and refreshed our approach to corporate governance to ensure that it is robust, well embedded and at the forefront of best practice.
The chairman is responsible for leading the board and ensuring its effectiveness while the group chief executive manages the Group’s business – these are distinct functions.
MEETINGS Responding to the challenges faced by the Company, the board held 28 meetings during 2009. In addition there was regular contact with directors outside of these meetings. The time commitment demanded of directors, in particular, non-executive directors, was far in excess of that anticipated in the normal course of business. All directors showed themselves to be willing and able to devote the additional time required often at short notice and at unsociable hours.
The review was conducted during a period of significant change for the board with several members leaving and a number of relatively new members.
RELATIONS WITH SHAREHOLDERS The investor relations team has primary, day-to-day responsibility for managing communications with institutional shareholders through a combination of briefings to analysts and institutional shareholders (both at the interim and year end results and throughout the year), site visits and individual discussions between institutional shareholders and board members and key senior executives. Regular dialogue with shareholders helps to ensure that the Company’s strategy is understood and that any queries or other issues are addressed in a constructive way. In 2009, there has been extensive and regular engagement with institutional shareholders and UKFI, the body set up to manage the Government’s investments in banks. The board receives weekly reports on market and investor sentiment and opinion which helps it develop a balanced understanding of the views of major shareholders.
AUDIT COMMITTEE The audit committee comprises Mr Scicluna (chairman), Lord Leitch, Mr Ryan and Mr Watson. The committee’s terms of reference are available from the company secretary and are displayed on our website, www.lloydsbankinggroup.com.
The committee is responsible for overseeing the process for appointments of new non-executive directors and making recommendations to the board. In 2009, two new non-executive director appointments were announced. A further two appointments were announced on 11 February 2010. All appointments are subject to a rigorous search and selection process.
Following a tender process, the committee appointed Jan Hall of JCA Group, as executive search advisor.
The sub-committee met 10 times. Activities included agreeing the role specification and selection criteria; reviewing applicant profiles and agreeing short lists; reviewing shareholder feedback and ultimately recommending the appointment of Sir Winfried Bischoff to the board. In conjunction with the remuneration committee, the committee also proposed the terms and conditions of appointment for the new chairman. Between meetings, there were regular updates on progress.
J P du Plessis7 2 6 8 (max 9) 3 (max 4) 1 (max 1) 1 (max 2)
Appointed to the board, nomination and governance, remuneration and risk oversight committees on 15 September 2009.
The directors are responsible for preparing the annual report, the directors’ remuneration report and the financial statements in accordance with applicable law and regulations.
Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have prepared the consolidated and parent company financial statements in accordance with International Financial Reporting Standards as adopted by the European Union. The financial statements are required by law to give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss of the Group for that period. The directors consider that in preparing the financial statements on pages 127 to 260 the Company and the Group have used appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider applicable have been followed.
The Group and other major UK banks have voluntarily adopted the draft Disclosure Code in their 2009 financial statements. The Group’s 2009 financial statements have therefore been prepared in compliance with the draft Disclosure Code’s principles.
DIRECTORS’ REMUNERATION REPORT continued 2010 REMUNERATION DESIGN The committee has determined that the design of remuneration for 2010 will remain broadly as for 2009. There will again be no base pay increases for executive directors in 2010, with base pay levels held at 2008 levels. The structure and annual incentive opportunity remain unchanged from 2009. The maximum LTIP opportunity has been increased from the 2009 level (which reflected the extraordinary circumstances of that year). However, the maximum level of award made to executive directors remains below 2008 levels, by up to 100 per cent of base salary and is lower than the historical sector average. Performance conditions for the LTIP will continue to be based on EPS and economic profit, with an additional performance measure for 2010 related directly to achieving stretching share price performance over the next three years. Following discussions with shareholders two key changes have been made to the proposed design of the 2010 LTIP. Firstly the performance conditions have been made even more stretching. Secondly, further alignment of the interests of the executive directors with those of the shareholders has been created through an additional requirement that any shares vesting in 2013 as a result of the share price performance element of the 2010 LTIP must be retained for a further two years. Furthermore, and reflecting shareholder representation on this matter, the committee will review performance against the targets for the 2010 annual incentive plan at the end of the year, taking into account the overall operating performance of the business in determining how much of any bonus will be paid out. The committee also reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if they deem this appropriate.
– Awards under the annual incentive plan for 2009 for executive directors amounted to between 150 per cent and 185 per cent of salary
– All awards under the annual incentive plan are deferred into shares and subject to clawback, with any awards released in 2012
– LTIP award below historic award levels at a maximum of 275 per cent of salary subject to stretching performance conditions based on EPS, economic profit and the achievement of stretching share price targets
– Any shares vesting as a result of the element of the LTIP relating to the share price targets must be retained for a further two years post vesting
– Economic profit, which is a risk-adjusted profit measure, is a core financial target target used in both the annual incentive plan and the LTIP
The committee welcomed Lord Leitch and Ms Carolyn McCall to the committee and Sir Winfried Bischoff, on his appointment as chairman of the Group. We thank Sir Victor Blank, Mr Philip Green, Ms Carolyn McCall and Sir David Manning for their contributions to the committee during 2009 up until their departures from the Group.
The committee appoints independent consultants to provide advice on specific matters according to their particular expertise. Towers Perrin, Hewitt New Bridge Street and Kepler Associates were retained by the committee during 2009 to advise on various matters relating to executive remuneration. In addition, PricewaterhouseCoopers LLP (PwC) were also retained in 2009 specifically to complete the committee’s project to review executive remuneration arrangements in light of the acquisition of HBOS, given their particular expertise in the remuneration aspects of transactions. This project had commenced in 2008. As PwC are also the auditors to Lloyds Banking Group and to mitigate any threat to audit independence, Kepler Associates continue to be retained as the remuneration committee’s primary independent advisors, and were commissioned to provide comment on PwC’s advice.
– The chief risk officer will attend the remuneration committee for at least two meetings a year.
Our incentive measures are not just financial. Half of the annual incentive for executives is linked to a scorecard including how they perform against targets that measure how satisfied our customers are, and the extent to which our employees feel engaged with and committed to working for the Lloyds Banking Group, both of which are important foundations of a relationship-based strategy.
This objective of aligning the interests of executives with those of shareholders throughout the economic cycle can be seen through the vesting outcomes of awards made to executives under the LTIP plans. In 2009, historic LTIP and option plans from 1999, 2005 and 2006 lapsed as their performance conditions were not met. The same outcome is envisaged for the 2007 LTIP with a performance period ending in 2010.
Economic profit measures profit relative to the risk taken to generate that profit. Its use in our incentive plans therefore encourages executives to take a prudent approach to risk.
We pay competitively but not excessively. Our prudent approach to positioning compensation means that we reduce the incentives to take excessive risk for personal gain. This means that we do not attract employees with an extreme appetite for risk.
We have a robust governance framework with an independent remuneration committee reviewing all compensation decisions. This approach to governance and review is cascaded through the organisation.
The review process has highlighted the concern on how to maintain an appropriately competitive incentive for the senior executives of the Group, following the significant reduction in incentive levels in 2009, whilst recognising the sensitivity of the operating environment and the fact that the Group is still in a loss-making position. Following consultation with shareholders, the remuneration committee is proposing a package for 2010 that is closely based on the structure and principles of 2009, but with an additional LTIP performance measure based on the achievement of stretching share price targets. With the addition of this performance measure, the maximum LTIP award for 2010 will be 275 per cent of salary, still 100 per cent of salary lower than the 2008 maximum level. To achieve maximum vesting of this award, not only will stretching EPS and economic profit targets need to be achieved but also stretching share price targets.
Base salary Base pay should be set competitively relative to FTSE 20 and banking sector competitors
ANNUAL INCENTIVE PLAN The combination of financial and non-financial measures, which support our prudent approach to managing risk, are retained in the annual incentive plan, whilst the operation of the plan is enhanced in order to increase the alignment between risk and reward still further. The committee recognises the challenges of setting robust targets in the current operating environment. Furthermore, the committee will review the performance against the targets for the 2010 annual incentive plan at the end of the year, taking into account the overall operating performance of the business in determining how much of any bonus will be paid out. The committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if they deemed this appropriate.
LONG-TERM INCENTIVE PERFORMANCE MEASURES In continuing with the same financial performance measures as for 2009, the remuneration committee has continued to create a focus on long-term performance, taking appropriate account of risk.
Performance targets have been set by reference to analysts’ expectations, internal business plans, competitive performance assessments and probability modelling. Stretch performance will be equated to the remuneration committee’s assessment of an upper quartile performance level or greater. Shareholders have been consulted on the targets and the targets have been made more stretching as a consequence of those discussions.
Any shares vesting as a result of this element of the 2010 award will be required to be held for a further two years post vesting.
Vesting between threshold and maximum will be on a straight line basis for all three elements.
OTHER SHARE PLANS The executive directors are also eligible to participate in the Group’s ‘sharesave’ and ‘shareplan’ schemes. These are ‘all-employee’ share schemes.
The chairman’s salary was reviewed at the time of the appointment of Sir Winfried Bischoff in 2009. The review took into account the market information and also the significant amount of time the chairman would be expected to focus on the Group’s activities particularly during the current period. The chairman was appointed on a salary of £700,000 per annum. His salary will next be reviewed at the end of 2010, with any adjustments effective 1 January 2011.
Independent non-executive directors who serve on the boards of subsidiary companies may also receive fees from the subsidiaries. The fees paid in 2009 to the current non-executive directors are shown in the table in the following section.
The calculation of the annual incentive plan payments for executive directors, based on the achievement of performance against targets in respect of performance in 2009, has been independently checked. The bonuses awarded to directors are shown in the table below: Name A G Kane G T Tate T J W Tookey H A Weir
Further information viewed by the committee through 2008 continued to show that total remuneration for the executive directors was materially behind the median of our peer groups, even before allowing for the increased responsibilities of running the combined bank and the magnitude of the task of integrating the two businesses. However, due to the external environment and following extensive consultation with shareholders, the committee determined that for 2009 the grant level for executive directors should be set at 200 per cent of base salary, 175 per cent less than the maximum award for 2008.
Executive directors are either entitled to participate in the Group’s defined benefit pension schemes (based on salary and length of service, with a maximum pension of two thirds of final salary), or the Group’s defined contribution scheme (under which their pension entitlement will be based upon both employer and employee contributions). The defined benefit schemes are closed to new entrants on recruitment.
The Group recognises that executive directors may be invited to become non-executive directors of other companies and that these appointments may broaden their knowledge and experience, to the benefit of the Group. Fees are normally retained by the individual directors as the post entails personal responsibility.
For those directors who are members of a defined benefit pension scheme, pension will continue to accrue until 5 April 2012. On 6 April 2012, defined benefit pension accrual will cease and directors will be offered the option to participate in the defined contribution pension scheme in operation at that date. Alternatively, they may choose not to join the scheme and elect to receive a pension cash allowance.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2009 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme. The basic method used to arrive at the factors has not changed during the year.
The following table contains information on the performance conditions for executive options granted since 1999. The remuneration committee chose the relevant performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
March 1999 – August 1999 Growth in earnings per share which is equal to the aggregate percentage change in the retail price index plus two percentage points for each complete year of the relevant period plus a further condition that the Company’s ranking based on TSR over the relevant period should be in the top 50 companies of the FTSE 100.
Whilst income tax and national insurance was deducted from the deferred bonus before the conversion to bonus shares, where a match of performance shares is justified, these shares will be awarded as if income tax and national insurance had not been deducted. This maintains the original design of the plan prior to the issue of guidance from HM Revenue & Customs in December 2004.
Alithos Limited provided information for the testing of the TSR performance conditions for the Company’s long-term incentive schemes. EPS is the Group’s normalised earnings per share as shown in the Group’s report and accounts, subject to such adjustments as the remuneration committee regards as necessary for consistency.
In addition, on 26 March 2008 (prior to his appointment as an executive director), Mr Tookey was granted an award under the Lloyds TSB Executive Retention Plan 2006. The award is satisfied in cash only and, subject to continued employment, gives Mr Tookey the right to receive an amount equal to the value of 141,880 Lloyds Banking Group shares on the date of vesting. The award was adjusted on 2 July 2009 as a result of the placing and compensatory open offer. The adjustment was made using a standard HMRC formula, to negate the dilutionary impact of the capital raising event. The award vests as to 50 per cent on 26 March 2011 and 50 per cent on 26 March 2013. Mr Tookey has agreed to reinvest the cash proceeds into Lloyds Banking Group shares. As an executive director, he is no longer eligible to be granted awards under this plan.
Under the Listing Rules we are required to review: – the directors’ statement, on page 104, in relation to going concern; and – the part of the Corporate Governance Statement relating to the company’s compliance with the nine provisions of the June 2008 Combined Code specified for our review.
Share capital Other Retained Minority and premium reserves profits1 interests Total1 £ million £ million £ million £ million £ million
(ii) Amendment to IFRS 2 Share-based Payment – ‘Vesting Conditions and Cancellations’. This amendment to IFRS 2 restricts the definition of ‘vesting condition’ to a condition that includes an explicit or implicit requirement to provide services. Any other conditions are non-vesting conditions, which have to be taken into account to determine the fair value of the equity instruments granted. In the case that the award does not vest as the result of a failure to meet a non-vesting condition that is within the control of either the entity or the counterparty, this must be accounted for as a cancellation. The main impact of this amendment for the Group arises from cancellations by employees of contributions to the Group’s Save-As-You-Earn (SAYE) schemes; in the event of a cancellation the Group must recognise immediately the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Under the former IFRS 2, such cancellations would have resulted in the reversal of the costs recognised in current and prior periods in respect of the SAYE schemes concerned for the relevant employees. The amendment is applied retrospectively and has resulted in a restatement of the 2008 comparatives. The effect has been to increase operating expenses and reduce profit before tax by £43 million in 2009 (2008: £47 million) but has had no effect on the Group’s balance sheet or shareholders’ equity as the increased expense is offset by movements in retained profits.
(iii) Amendments to IFRS 7 Financial Instruments: Disclosures – ‘Improving Disclosures about Financial Instruments’. The amendments require enhanced disclosures about fair value measurement and liquidity risk. In particular, the amendment requires disclosure of a three level fair value measurement hierarchy for financial instruments carried on the Group’s balance sheet at fair value. As the amendments only result in additional disclosures, the amendments have not had any impact on amounts recognised in these financial statements.
– Amendments to IAS 32 and IAS 1 Puttable Financial Instruments and Obligations Arising on Liquidation. The amendments require some puttable financial instruments (being those which give the holder the right to put the instrument back to the issuer for cash or another financial asset) and some financial instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation to be classified as equity.
– the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, with management information also prepared on this basis. As noted in accounting policy 2(A)(2), certain of the Group’s investments are managed as venture capital investments and evaluated on the basis of their fair value and these assets are designated at fair value through profit or loss.
Index to annual report 266 flows are estimated on the basis of the contractual cash flows of the assets in the Group and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.
(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.
(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 for investment property within the life insurance funds and as other operating income for other investment property.
(L) PENSIONS AND OTHER POST-RETIREMENT BENEFITS 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.
Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised. Income tax payable on profits is recognised as an expense in the period in which those profits arise. The tax effects of losses available for carry forward are recognised as an asset when it is probable that future taxable profits will be available against which these losses can be utilised. Deferred tax related to gains and losses on the fair value re-measurement of available-for-sale investments and cash flow hedges, where these gains and losses are recognised in other comprehensive income, is also recognised in other comprehensive income. Such deferred tax is subsequently transferred to the income statement together with the deferred gain or loss.
(O) INSURANCE The Group undertakes both life insurance and general insurance business.
Investment contracts containing a discretionary participation feature (‘participating investment contracts’) – these contracts do not transfer significant insurance risk, but contain a contractual right which entitles the holder 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 and based upon the performance of specified assets.
– Insurance and participating investment contracts which are not unit-linked or in the Group’s with-profi t funds
(ii) ACCOUNTING FOR NON-PARTICIPATING INVESTMENT CONTRACTS The Group’s non-participating investment contracts are primarily unit-linked. These contracts are accounted for as financial liabilities whose value is contractually linked to the fair values of financial assets within the Group’s unitised investment funds. The value of the unit-linked financial liabilities is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet date. Their value is never less than the amount payable on surrender, discounted for the required notice period where applicable. Investment income allocated to non-participating investment contracts are included in insurance claims.
VALUATION OF FINANCIAL INSTRUMENTS Financial instruments classified by management as trading and other financial assets and liabilities at fair value through profit or loss, derivative financial instruments and available-for-sale financial assets are carried at fair value which is determined as being the amount for which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Management judgement is required in determining the appropriate classification of financial instruments.
In 2009, the Group adopted ‘Amendments to IFRS 7 ‘Financial Instruments: Disclosures – Improving Disclosures about Financial Instruments’ which, among other matters, established a three level valuation hierarchy for disclosure of fair value measurements of financial instruments carried on the Group’s balance sheet at fair value.
PENSIONS The net liability recognised in the balance sheet at 31 December 2009 in respect of the Group’s retirement benefit obligations was £780 million (2008: £1,771 million) of which £619 million (2008: £1,657 million) related to defined benefit pension schemes. As explained in note 2(L), the Group adopts the corridor approach to pensions accounting and consequently does not recognise actuarial losses of £2,936 million (2008: £267 million). The defined benefit pension schemes’ gross deficit totalled £3,555 million (2008: £1,924 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
The fair value adjustments to the HBOS Group’s assets principally reflect a reduction of £13,512 million in the value of customer lending. For a significant proportion of these balances there was no active market and therefore in determining the acquisition-date fair values discounted cash flow models have been used. The calculations were performed using benchmark interest rates and market-based credit spreads for the different lending portfolios, having regard to management’s view of the level of expected credit losses. The size of the adjustment reflects the market-wide reduction in interest rates since the lending was originated and a deterioration in the credit quality of the portfolio in the worsening economic environment.
The Group’s goodwill is allocated to cash generating units in the Insurance division (Scottish Widows) and in the Asset Finance business in the Wholesale division. Goodwill attributable to the Group’s Asset Finance business, for which an impairment charge was recognised in the Group’s financial statements for the year ended 31 December 2008, has been reviewed for impairment due to the continuing uncertainties over the short-term macroeconomic environment. As a consequence, the carrying value of the consumer finance cash generating unit within Asset Finance has been reassessed and has resulted in the related element of the goodwill being written off and the Group recognising a further impairment charge of £240 million in the year ended 31 December 2009. Further details are given in note 27.
At 31 December 2009 the Group carried substantial liabilities to holders of life, pensions and investment contracts in its balance sheet. Liabilities arising from insurance contracts and participating investment contracts were £56,800 million and £18,089 million respectively (2008: £21,518 million and £11,619 million) and those arising from non-participating investment contracts totalled £46,348 million (2008: £14,243 million). The methodology used to value the liabilities is described in note 2(O)(1). Elements of the liability valuations require assumptions to be made about future investment returns, future mortality rates and future policyholder behaviour.
The group executive committee has been determined to be the chief operating decision maker for the Group. The Group’s operating segments reflect its organisational and management structures. The group executive committee reviews the Group’s internal reporting based around these segments in order to assess performance and allocate resources. This assessment includes a consideration of each segment’s net interest revenue and consequently the total interest income and expense for all reportable segments is presented on a net basis. The segments are differentiated by the type of products provided, by whether the customers are individuals or corporate entities and by the geographical location of the customer.
The Retail division, with its brands including Lloyds TSB, Halifax, Bank of Scotland, Birmingham Midshires and Cheltenham & Gloucester, is a UK provider of current accounts, savings, personal loans, credit cards and mortgages serving over 30 million customers through a large branch network in the UK. The division is also a general insurance and bancassurance distributor selling a wide range of long-term savings, investment and general insurance products.
Total income, net of insurance claims 9,774 8,909 2,345 2,020 916 23,964
Investments in joint ventures and associates at end of year 78 1,032 117 (38) 50 1,239
RECONCILIATION OF REPORTED BASIS TO STATUTORY RESULTS The reported basis is the basis on which financial information is presented to the chief operating decision maker which excludes certain items included in the statutory results. The table below reconciles the statutory results to the reported basis.
Total income, net of insurance claims 9,868 9,804 102 (672) 2,349 – (96) 21,355
GEOGRAPHICAL AREAS The Group’s activities are focused in the UK and the analyses of income and assets below are based on the location of the branch or entity recording the income or assets.
Interest and similar expense: Debt securities in issue 2.56 4.10 (6,318) (2,227)
Securities and other gains (losses) comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows: £m £m
Net income (expense) arising on assets held at fair value through profit or loss: Debt securities, loans and advances 4,297 938
Total net income (expense) arising on assets held at fair value through profit or loss 15,772 (6,821)
Life insurance gross claims can also be analysed as follows: A non-life insurance claims development table is included in note 36.
Fees payable for the audit of the Company’s current year annual report 2.2 1.1
Total fees payable to the Company’s auditors by the Group 40.7 19.5
During the year, the auditors also earned fees payable by entities outside the consolidated Lloyds Banking Group in respect of the following: £m £m
Total impairment charged to the income statement 16,673 3,012 13 INVESTMENTS IN JOINT VENTURES AND ASSOCIATES
Lloyds Banking Group Annual Report and Accounts 2009 13 INVESTMENTS IN JOINT VENTURES AND ASSOCIATES continued
The Group’s principal joint venture investments at 31 December 2009 were: Nature of business
Liabilities arising from insurance contracts and participating investment contracts 36,405 282 36,687
On 16 January 2009, the Group cancelled the following HBOS preference share issuances in exchange for preference shares issued by Lloyds Banking Group plc: 6.475 per cent non-cumulative preference shares of £1 each, 6.3673 per cent non-cumulative fixed to floating preference shares of £1 each and 6.0884 per cent non-cumulative preference shares of £1 each. The fair value of the Lloyds Banking Group preference shares issued is deducted from the net assets acquired for the purposes of calculating the gain arising on acquisition.
The calculation of consideration is based on the closing price of Lloyds TSB ordinary shares of 98.4p on 16 January 2009; 12,852 million HBOS shares were exchanged for Lloyds Banking Group shares at a ratio of 0.605 shares per HBOS share.
DISPOSAL OF BUSINESS On 12 August 2009, the Group announced the sale of Insight Investment Management Limited, a subsidiary in which the Group held a 100 per cent interest. The sale completed on 8 November 2009 and resulted in no gain or loss on disposal. Customer related intangible assets of £170 million that arose on the acquisition of HBOS were included in the disposal (note 29).
Deferred tax (note 42): Origination and reversal of temporary differences 2,429 625
The above income tax credit is made up as follows: £m £m
(B) FACTORS AFFECTING THE TAX CREDIT FOR THE YEAR A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the tax credit for the year is given below: £m £m
Profi t attributable to equity shareholders – basic and diluted 2,827 772 million million
Weighted average number of ordinary shares in issue – basic 37,674 11,581
Weighted average number of ordinary shares in issue – diluted 37,929 11,660
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 10 million (2008: 11 million restated) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
The weighted-average number of ordinary shares in issue have been restated to reflect the adjustment factor of 1.025 arising from the capitalisation issue on 11 May 2009, the adjustment factor of 1.310 arising from the placing and compensatory open offer on 16 June 2009, and the adjustment factor of 1.502 arising from the rights issue on 27 November 2009. The impact of these adjustments on the previously published comparatives is as follows: £m
Other financial assets at fair value through profit or loss represent the following assets designated into that category: (i) financial assets backing insurance contracts and investment contracts of £118,573 million (31 December 2008: £39,899 million) which are so designated because the related liabilities either have cash flows that are contractually based on the performance of the assets or are contracts whose measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise arise; (ii) loans and advances to customers of £166 million (31 December 2008: £325 million) which are economically hedged by interest rate derivatives which are not in hedge accounting relationships and where significant measurement inconsistencies would otherwise arise if the related derivatives were treated as trading liabilities and the loans and advances were carried at amortised cost; and
Derivatives designated as net investment hedges: Cross currency swaps 2,507 44 19
The Group holds collateral with a fair value of £4,171 million (31 December 2008: £10,739 million), which it is permitted to sell or repledge, of which £4,171 million (2008: £5,492 million) was repledged or sold to third parties for periods not exceeding three months from the transfer. The Group is obliged to return collateral with a fair value of £4,171 million (2008: £5,492 million).
Later than 1 year and not later than 5 years 3,577 1,775
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 2009 and 2008 no contingent rentals in respect of finance leases were recognised in the income statement. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £123 million (2008: £15 million). The unguaranteed residual values included in finance lease receivables were as follows: Not later than 1 year 4 1
Later than 1 year and not later than 5 years 46 29
24 ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES Loans and advances to customers
Recoveries of advances written off in previous years 112 – – 112
Recoveries of advances written off in previous years 110 – – 110
The recoverable amount of Asset Finance has also been based on a value in use calculation using cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 18.75 per cent (gross of tax). 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. 27 GOODWILL
The acquired value of in-force non-participating investment contracts includes £379 million in relation to OEIC business.
This breakdown shows the movement in the value of in-force business only, and does not represent the full contribution that each item in the breakdown contributes to profit before tax, which would also contain changes in the other assets and liabilities of the relevant businesses. Economic variance is the element of earnings which is generated from changes to economic experience in the period and to assumptions over time. The presentation of economic variance includes the impact of financial market conditions being different at the end of the reporting period from those included in assumptions used to calculate new and existing business returns.
Accumulated amortisation: Charge for the year – – – 7 31 38
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2009 and 2008 no contingent rentals in respect of operating leases were recognised in the income statement.
In addition, total future minimum sub-lease income of £79 million at 31 December 2009 (£102 million at 31 December 2008) is expected to be received under non-cancellable sub-leases of the Group’s premises.
Costs deferred, net of amounts amortised to the income statement (84) (16)
Lloyds Banking Group Annual Report and Accounts 2009 34 TRADING AND OTHER FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS
Trading and other fi nancial liabilities at fair value through profi t or loss 28,271 6,754
(1) LIFE INSURANCE The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows: Insurance contracts
(i) Business description The Group has with-profit funds within Scottish Widows plc and Clerical Medical Investment Group Limited containing both insurance contracts and participating investment contracts.
LAPSE RATES (PERSISTENCY) Lapse rates are allowed for on some non-profit fund contracts. The process for setting these rates is as described for with-profit liabilities, however a prudent scenario is assumed by the inclusion of a margin for adverse deviation within the non-profit fund liabilities.
MAINTENANCE EXPENSES Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs plus a margin for adverse deviation. Explicit allowance is made for future expense inflation. For German business appropriate cost assumptions have been set in accordance with the rules of the local regulatory body.
– Change in the assumption in respect of future mortality rates (£44 million increase)
These amounts include the impacts of movements in liabilities and value of the in-force business in respect of insurance contracts and participating investment contracts.
Increase (decrease) in liabilities: Arising from current year claims 623 (15) 608
Change in liabilities charged to income statement (note 10) 111 (3) 108
NON-LIFE INSURANCE CLAIMS DEVELOPMENT TABLE The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The top half of the table below illustrates how the Group’s estimate of total claims outstanding for each accident year has changed at successive year ends. The bottom half of the table reconciles the cumulative claims to the amount appearing in the balance sheet. The accident year basis is considered the most appropriate for the business written by the Group.
Liability recognised in the balance sheet 6 8 26 57 369 466
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.
The latest full valuations of the two Lloyds TSB schemes were carried out as at 30 June 2008; the latest full valuation of the HFSPS was carried out as at 31 December 2007. The provisional results have been updated to 31 December 2009 by qualified independent actuaries. The last full valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2009 by qualified independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows.
The Group’s obligations in respect of its defined benefit schemes are funded. During 2009, the Group’s contributions to its defined benefit schemes of £1,859 million included one-off contributions to the Lloyds TSB Group Pension Scheme No 1 and Lloyds TSB Group Pension Scheme No 2 of approximately £1 billion in aggregate. These contributions took the form of interests in limited liability partnerships for each of the two schemes which contain assets of approximately £5 billion in aggregate entitling the schemes to annual payments of approximately £215 million in aggregate until 31 December 2014. Thereafter, assuming that all distributions have been made, the value of the partnership interests will equate to a nominal amount. The limited liability partnerships are fully consolidated in the Group’s balance sheet (see note 22).
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 41 RETIREMENT BENEFIT OBLIGATIONS continued
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 30 June 2008; this valuation has been updated to 31 December 2009 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 7.33 per cent (2008: 7.50 per cent).
Amount credited (charged) to equity: Available-for-sale financial assets (note 47) (395) 566
Deferred tax assets of £487 million (31 December 2008: £252 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
7.875% Non-cumulative callable preference shares (US$1,250 million) c, d, e 680 –
6.0884% fi xed-to-fl oating rate non-cumulative callable preference shares (£745 million) b, c, e 10 –
b On 16 January 2009 so as to improve the position of HBOS preference shareholders and simplify the Group’s capital structure following the acquisition of HBOS the Group replaced certain HBOS preference share issuances in exchange for preference shares with similar terms and conditions issued by the Company.
7.881% Guaranteed Non-voting Non-cumulative Preferred Securities (£245 million) b, c 151 –
d As described in note 9, in November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to 31 January 2012.
Series 3 (US$600 million) e 326 412 11¾% Perpetual Subordinated Bonds (£100 million) e 102 100 55/8% Undated Subordinated Step-up Notes callable 2009 (€1,250 million) b, e – 1,212
12% Fixed to Floating Rate Perpetual Tier 1 Capital Securities callable 2024 (US$2,000 million) 1,235 –
6.05% Fixed to Floating Rate Undated Subordinated Notes (€500 million) b, c, d, e 50 –
3.50% Undated Subordinated Yen Step-up Notes (JPY 42.5 billion) d 267 –
10.25% Subordinated Undated Instruments (£100 million) b, c, d, e 1 –
7.8673% Enhanced Capital Notes due 2019 (Series 2) (£331 million) 316 –
7.975% Enhanced Capital Notes due 2024 (Series 3) (£102 million) 96 –
9.334% Enhanced Capital Notes due 2020 (Series 14) (£208 million) 218 –
6.439% Enhanced Capital Notes due 2020 (Series 15) (€710 million) 557 –
6.385% Enhanced Capital Notes due 2020 (Series 18) (€662 million) 517 –
15% Enhanced Capital Notes due 2019 (Series 22) (€487 million) 646 –
9.125% Enhanced Capital Notes due 2020 (Series 27) (£148 million) 153 –
11.125% Enhanced Capital Notes due 2020 (Series 31) (£39 million) 45 –
Floating Rate Enhanced Capital Notes due 2020 (Series 33) (€53 million) a 42 –
12.75% Enhanced Capital Notes due 2020 (Series 34) (£57 million) 74 –
7.625% Enhanced Capital Notes due 2020 (Series 36) (€226 million) 193 –
6.75% Enhanced Capital Notes due 2020 (Series 37) (¥17,000 million) 121 –
8.125% Enhanced Capital Notes due 2019 (Series 41) (£4 million) 4 –
10.5% Enhanced Capital Notes due 2023 (Series 46) (£69 million) 78 –
11.875% Enhanced Capital Notes due 2024 (Series 47) (£35 million) 45 –
9% Enhanced Capital Notes due 2029 (Series 49) (£107 million) 108 –
8.5% Enhanced Capital Notes due 2032 (Series 50) (£104 million) 100 –
16.125% Enhanced Capital Notes due 2024 (Series 52) (£61 million) 100 –
In June 2009 the Company issued 10,409 million shares under a placing and compensatory open offer which raised £3,905 million (net of £95 million issue costs), the proceeds of which were used to redeem the £4,000 million of 12 per cent fi xed-to-fl oating rate non-cumulative callable preference shares of 25 pence each issued to HM Treasury earlier in the year as described in note 44. This issue resulted in an increase of £2,602 million in share capital and an increase of £1,303 million in the share premium account.
The capital redemption reserve represents transfers from the merger reserve in accordance with companies’ legislation.
The cash fl ow hedging reserve represents the cumulative after tax gains and losses on effective cash fl ow hedging instruments that will be reclassifi ed to the income statement in the periods in which the hedged item affects profi t or loss.
The foreign currency translation reserve represents the cumulative after-tax gains and losses on the translation of foreign operations and exchange differences arising on fi nancial instruments designated as hedges of the Group’s net investment in foreign operations.
Amounts transferred to income statement in respect of hedge ineffectiveness – 14
Deferred bonus scheme 2009 Bonuses in respect of the performance in 2009 of certain employees within the Group’s Wholesale division have been recognised in these fi nancial statements in full. Individual bonus payments of up to £2,000 for employees earning up to £39,000 are not subject to deferral and as they will be settled in cash are not included in the preceding table.
Options granted to senior executives other than executive directors were not so highly leveraged and, as a result, different performance multipliers were applied to their options. For the majority of executives, options were granted with the performance condition but with no performance multiplier.
Save-As-You-Earn schemes Eligible employees may enter into contracts through the Save-As-You-Earn schemes to save up to £250 per month and, at the expiry of a fixed term of three, five or seven years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a discounted price of no less than 80 per cent of the market price at the start of the invitation.
No options were exercised during 2009 therefore the weighted average share price was £nil (2008: £3.70). The weighted average remaining contractual life of options outstanding at the end of the year was 2.7 years (2008: 3.4 years).
Similarly as no SAYE options were granted during the year, the weighted share price was £nil (2008: £0.61). The values for the SAYE options have been determined using a standard Black-Scholes model.
HBOS share option plans The table below includes details of the outstanding options for the HBOS Share Option Plan, the St James’s Place Share Option Plan, and the 1995 and 1996 Bank of Scotland Executive Stock Option schemes. The fi nal award under the HBOS Share Option Plan was made in 2004. Under this plan, options over shares, at market value with a face value equal to 20 per cent of salary, were granted to employees with the exception of certain senior executives. A separate option plan exists for some of the partners of St James’s Place, which grants options in respect of Lloyds Banking Group plc shares. Movements in the number of share options outstanding under these schemes are set out below: Number of options
The performance conditions for awards made in May and August 2006 are as follows: (i) For 50 per cent of the award (the ‘EPS Award’) – the percentage increase in earnings per share of the Group (on a compound annualised basis) over the relevant period must be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the Retail Price Index over the same period. If it is less than 3 per cent per annum the EPS Award will lapse. If the increase is more than 3 per cent but less than 6 per cent per annum then the proportion of shares released will be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
The current LTIP rules allow for awards to be made of up to 400 per cent of base salary. Under normal circumstances awards are made of 300 per cent of salary with the additional 100 per cent available for circumstances that the remuneration committee deems to be exceptional. In 2008, awards were made of 375 per cent of base salary to the chief executive and two of the executive directors for retention purposes, and in light of data reviewed by the committee which showed total remuneration to be behind median both for the FTSE 20, and the other major UK banks.
(ii) Economic profit: The release of the remaining 50 per cent of shares will be dependent on the extent to which Lloyds Banking Group achieves cumulative economic profit targets over a three-year period.
Report of the independent auditors on the parent company financial statements 249
The fair value of the share awards granted in 2009 was £0.68 (2008: £2.28).
Conditional awards of shares made under this plan were adjusted on 2 July 2009 as a result of the placing and compensatory open offer. The adjustment was made using a standard HMRC formula, to negate the dilutionary impact of the capital raising event.
Performance share plan Under the performance share plan, introduced during 2005, participating executives will be eligible for an award of free shares, known as performance shares, to match the bonus shares awarded as part of their 2004 and 2005 bonus. The maximum match was two performance shares for each bonus share, awarded at the end of a three year period. The actual number of shares awarded was dependent on the Group’s total shareholder return performance measured over a three year period, compared to other companies in the comparator group. The maximum of two performance shares for each bonus share was awarded only if the Group’s total shareholder return performance placed it fi rst in the comparator group; one performance share for each bonus share was granted if the Group was placed fi fth; and one performance share for every two bonus shares if the Group was placed eighth (median). Between fi rst and fi fth position, and fi fth and eighth position, sliding scales would apply. If the total shareholder return performance was below median, no performance shares were awarded. There was no retest. Whilst income tax and national insurance was deducted from the bonus before deferral into the plan, where a match of performance shares was justifi ed, these shares were awarded as if income tax and national insurance had not been deducted.
Expected volatility is a measure of the amount by which the Group’s shares are expected to fl uctuate during the life of an option. The expected volatility is estimated based on the historical volatility of the closing daily share price over the most recent period that is commensurate with the expected life of the option. The historical volatility is compared to the implied volatility generated from market traded options in the Group’s shares to assess the reasonableness of the historical volatility and adjustments made where appropriate.
HM TREASURY On 13 January 2009, HM Treasury subscribed for approximately 2,597 million shares in the Company which gave it a 30.2 per cent interest in the Company’s ordinary share capital and consequently HM Treasury became a related party of the Company from this date. On 16 January 2009, the Company acquired HBOS plc in an all share acquisition which, together with the shares subscribed for on 13 January 2009, gave HM Treasury a 43.4 per cent interest in the Company’s ordinary share capital. The material transactions entered into with HM Treasury from 13 January 2009 are described below: Capital transactions On 15 January 2009, the Company issued £1,000 million 12 per cent non-cumulative fi xed to fl oating rate preference shares to HM Treasury. In addition, £3,000 million non-cumulative 12 per cent fi xed to fl oating rate preference shares were issued by the Company to HM Treasury on 16 January 2009 in exchange for the £3,000 million non-cumulative 12 per cent fi xed to fl oating rate preference shares which had been issued by HBOS plc to HM Treasury on 15 January 2009.
Pursuant to its obligations to HM Treasury under the 2009 Open Offer Agreement, the Company entered into a Resale Rights Agreement with HM Treasury with effect from 11 June 2009, in which it agreed to provide its assistance to HM Treasury in connection with any proposed sale by HM Treasury of ordinary shares and other securities held by HM Treasury in the Company from time to time and of any securities caused by HM Treasury to be issued by any person which are exchangeable for, convertible into, give rights over or are referable to such ordinary shares or other securities issued by the Group, to be sold in such jurisdictions (other than the United States) and in such manner as HM Treasury may determine. Such assistance may include the provision by the Company of assistance with due diligence and the preparation of marketing and such other documentation (including any offering memorandum, whether or not a prospectus) as HM Treasury may reasonably request.
Government Asset Protection Scheme The Company entered into a Pre-Accession Deed dated 7 March 2009 and a Lending Commitments Deed dated 6 March 2009 with HM Treasury both relating to the Company’s proposed participation in GAPS. Under the Lending Commitments Deed, the Company agreed to support lending to creditworthy borrowers in the UK in a commercial manner with effect from 1 March 2009 and agreed to increase lending by £14,000 million in the 12 months commencing 1 March 2009 to support UK businesses (£11,000 million) and homeowners (£3,000 million) and to maintain similar levels of lending in the 12 months commencing 1 March 2010, subject to adjustment to refl ect circumstances at the start of the 12 month period commencing 1 March 2010. This additional lending is expressed to be subject to the Group’s prevailing terms and conditions (including pricing and risk assessment) and, in relation to mortgage lending, the Group’s standard credit and other acceptance criteria.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 51 RELATED PARTY TRANSACTIONS continued
Joint ventures and associates In the year ended 31 December 2009, the Group provided both administration and processing services to its principal joint venture, Sainsbury’s Bank plc. The amounts receivable by the Group during the year were £34 million (2008: £nil), of which £10 million was outstanding at 31 December 2009 (2008: £nil). At 31 December 2009, Sainsbury’s Bank plc also had balances with the Group that were included in loans and advances to banks of £1,218 million (2008: £nil) and deposits by banks of £1,405 million (2008: £nil).
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 profi t or loss. At 31 December 2009, these companies had total assets of approximately £14,840 million (2008: £5,838 million), total liabilities of approximately £15,300 million (2008: £5,780 million) and for the year ended 31 December 2009 had turnover of approximately £10,570 million (2008: £2,088 million) and made a net loss of approximately £572 million (2008: net loss of £80 million). In addition, the Group has provided £6,014 million (2008: £825 million) of fi nancing to these companies on which it received £191 million (2008: £46 million) of interest income in the year.
The statement on 29 September 2009 also announced that several fi rms had agreed to carry out reviews of past sales of single premium loan protection insurance. The Group has subsequently agreed in principle that it will undertake a review in relation to sales of single premium loan protection insurance made through its branch network since 1 July 2007. The precise details of the review are still being discussed with the FSA. The ultimate impact on the Group of any review and/or reassessment can only be known at the conclusion of these discussions and on publication of the FSA’s fi nal rules.
US ECONOMIC SANCTIONS Starting in 2007 Lloyds TSB Bank plc provided information in relation to its review of historic US Dollar payments involving countries, persons or entities subject to US economic sanctions administered by the Offi ce of Foreign Assets Control (OFAC) to a number of authorities reported to be conducting a review of sanctions compliance by non-US fi nancial institutions. On 9 January 2009 the settlement reached by Lloyds TSB Bank plc with both the US Department of Justice and the New York County District Attorney’s Offi ce in relation to their investigations was announced. The settlement documentation contains details of the results of the investigations including the identifi cation of certain activities relating to Iran, Sudan and Libya which Lloyds TSB Bank plc conducted during the relevant period. In 2008, Lloyds TSB Bank plc made a provision of £180 million which fully covered the settlement amount paid to the Department of Justice and the New York County District Attorney’s Offi ce. On 22 December 2009 OFAC announced the settlement it had reached with Lloyds TSB Bank plc in relation to its investigation and confi rmed that the settlement sum due to OFAC had been fully satisfi ed by Lloyds TSB Bank plc’s payment to the Department of Justice and the New York County District Attorney’s Offi ce. No further enforcement actions are expected in relation to the matters set out in the settlement agreements. A purported shareholder fi led a derivative civil action in the Supreme Court of New York, Nassau County on 26 February 2009 against certain current and former directors, and nominally against the Lloyds TSB Bank plc and Lloyds Banking Group, seeking various forms of relief following the settlement. The derivative action is at a very early stage but the ultimate outcome of the action is not expected to have a material impact on the Group.
OTHER LEGAL PROCEEDINGS In addition , during the ordinary course of business the Group is subject to threatened or actual legal proceedings both in the UK and overseas. All such material cases are periodically reassessed, with the assistance of external professional advisors where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed to properly assess the merits of the case and no provisions are held against such cases. However the Group does not currently expect the fi nal outcome of any such case to have a material adverse effect on its fi nancial position.
CONTINGENT LIABILITIES AND COMMITMENTS ARISING FROM THE BANKING BUSINESS Acceptances and endorsements arise where Lloyds Banking Group agrees to guarantee payment on a negotiable instrument drawn up by a customer.
Performance bonds and other transaction-related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs & Excise bonds and standby letters of credit relating to a particular contract or non-fi nancial transaction) are undertakings where the requirement to make payment under the guarantee depends on the outcome of a future event.
Later than 1 year and not later than 5 years 1,213 647
Derivative fi nancial instruments 9,430 40,498 – – – – – 49,928
Trading and other fi nancial liabilities at fair value through profi t or loss – 22,111 6,160 – – – – 28,271
Debt securities in issue – – – – – 233,502 – 233,502
Trading and other fi nancial assets at fair value through profi t or loss – 857 44,207 – – – – 45,064
Derivative fi nancial instruments 435 28,449 – – – – – 28,884
Trading and other fi nancial liabilities at fair value through profi t or loss – 6 6,748 – – – – 6,754
Derivative fi nancial instruments 4,169 22,723 – – – – – 26,892
On the basis that there was no longer an active market for some of those assets, which are therefore more appropriately managed as loans, with effect from 1 July 2008, the Group transferred £2,993 million of assets previously classifi ed as held for trading into loans and receivables. With effect from 1 November 2008, the Group transferred £437 million of assets previously classifi ed as available-for-sale into loans and receivables. At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity. As at the date of reclassifi cation, the weighted average effective interest rate of the assets transferred was 6.3 per cent with the estimated recoverable cash fl ows of £3,524 million.
Carrying amount and fair values of reclassifi ed assets The table below sets out the carrying value and fair value of reclassifi ed fi nancial assets.
During the year ended 31 December 2009, the carrying value of reclassifi ed assets decreased by £1,110 million due to sales and maturities of £990 million, accretion of discount of £61 million and foreign exchange and other movements of £181 million.
The table below shows the additional gains/(losses) that would have been recognised in the Group’s income statement if the reclassifi cations had not occurred.
Loans and receivables: Loans and advances to banks 35,361 38,733 35,335 37,954
Loans and receivables The Group provides loans and advances to commercial, corporate and personal customers at both fi xed and variable rates. The carrying value of the variable rate loans and those relating to lease fi nancing is assumed to be their fair value. For fi xed rate lending, several different techniques are used to estimate fair value, as considered appropriate. For commercial and personal customers, fair value is principally estimated by discounting anticipated cash fl ows (including interest at contractual rates) at market rates for similar loans offered by the Group and other fi nancial institutions. The fair value for corporate loans is estimated by discounting anticipated cash fl ows at a rate which refl ects the effects of interest rate changes, adjusted for changes in credit risk. Certain loans secured on residential properties are made at a fi xed rate for a limited period, typically two to fi ve years, after which the loans revert to the relevant variable rate. The fair value of such loans is estimated by reference to the market rates for similar loans of maturity equal to the remaining fi xed interest rate period. The fair values of asset-backed securities and secondary loans, which were previously within assets held for trading and were reclassifi ed to loans and receivables (see page 222), are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data.
Level 2 portfolios level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not considered to be active or valuation techniques are used to determine fair value and where these techniques use inputs that are based signifi cantly on observable market data, the instrument is considered to be level 2. Examples of such fi nancial instruments include most over-the-counter derivatives, fi nancial institution issued securities, certifi cates of deposit and certain asset-backed securities.
Trading and other fi nancial assets at fair value through profi t or loss
Derivative fi nancial liabilities Industry standard model / consensus pricing from market data provider
Equity investments Unlisted equities and funds accounted for as available-for-sale assets are valued using different techniques as a result of the variety of investments across the portfolio. A valuation technique is selected for each investment in accordance with the Group’s valuation policy. Depending on the business sector and the circumstances of the investment unlisted equity valuations are based on earnings multiples, net asset values or discounted cash fl ows.
– Credit derivatives, except for the items classifi ed as level 3, are valued using publicly available yield and credit default swap (CDS) curves; the Group uses standard models with observable inputs.
In addition, credit valuation adjustments have been applied to the Group’s credit derivative exposures with monoline insurance counterparties leaving a net exposure of £75 million as shown in note 54 on page 239.
Trading and other fi nancial assets at fair value through profi t or loss Availablefor -sale Derivative assets Total fi nancial assets £m £m £m £m
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 3. All impaired loans which exceed certain thresholds, principally within the Group’s Wholesale division, are individually assessed for impairment by reviewing expected future cash fl ows including those that could arise from the realisation of security. Included in loans and receivables are advances individually determined to be impaired with a gross amount before impairment allowances of £44,675 million (31 December 2008: £2,699 million) which have associated collateral with a fair value of £10,217 million (31 December 2008: £518 million).
The defi nitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale are not the same, refl ecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Wholesale lending has been classifi ed using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifi cations refl ecting progressively higher default risk. Classifi cations of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models. Good quality lending includes the lower assessed default probabilities and all loans with low expected losses in the event of default, with other categories refl ecting progressively higher risks and lower expected recoveries.
Loans and advances designated Loans and Loans and advances to customers at fair value advances Retail – Retail – through to banks mortgages other Wholesale Total profi t or loss £m £m £m £m £m £m
Forbearance Forbearance or repayment arrangements allow a mortgage customer to repay a monthly amount which is lower than their contractual monthly payment for a short period. This period is usually for no more than 12 months and is negotiated with the customer by the mortgage collectors. During the period of forbearance, there is no clearing down of arrears such that unless the customer is paying more than their contractual minimum payment, arrears balances will remain. When customers come to the end of their arrangement period they will continue to be managed as a mainstream collections case and if unable to recover then will move toward possession.
Corporate and other debt securities 1,025 312 1,328 348 72 12 3,097
Other assets held at fair value through profi t or loss: Other public sector securities 675 16 – – – 9 700
Total held at fair value through profi t or loss 24,945 4,949 8,088 4,138 1,399 3,260 46,779
Treasury bills and other bills 269 2,263 – – – – 2,532
Total debt securities classifi ed as loans and receivables 21,007 5,374 3,077 1,028 1,453 1,143 33,082 54 FINANCIAL RISK MANAGEMENT continued
Total held at fair value through profi t or loss 10,842 1,903 3,501 2,504 791 1,641 21,182
Total debt securities classifi ed as loans and receivables 522 1,282 1,825 198 20 702 4,549
Negative basis means bonds held with separate matching credit default swap protection.1 54 FINANCIAL RISK MANAGEMENT continued
Notional Exposure1 Notional Exposure2 Notional Exposure3 £m £m £m £m £m £m
Derivative fi nancial liabilities: Gross settled derivatives – outfl ows 10,707 4,844 8,309 35,793 38,505 98,158
Liabilities arising from non-participating investment contracts 14,243 – – – – 14,243
Derivative fi nancial liabilities: Gross settled derivatives – outfl ows 5,210 284 4,602 990 1,154 12,240
Gross settled derivatives – infl ows (3,136) (33) (3,248) – – (6,417)
Cash fl ows for undated subordinated liabilities whose terms give the Group the option to redeem at a future date are included within the table on the basis that the Group will exercise its option to redeem.
The following tables set out the amounts and residual maturities of Lloyds Banking Group’s off balance sheet contingent liabilities and commitments.
Net charge in respect of defi ned benefi t schemes 529 164
Less: amounts with a maturity of three months or more (7,937) (12,461)
Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to fi nance the Group’s day-to-day operations.
Included within cash and cash equivalents at 31 December 2009 is £13,323 million (2008: £8,255 million) held within the Group’s life funds, which is not immediately available for use in the business.
Derivatives, trading and other fi nancial liabilities at fair value through profi t or loss (62,158) –
Dealt with on a standard by standard basis but not earlier than annual periods beginning on or after 1 January 2010.
At the date of this report, these pronouncements are awaiting EU endorsement.1
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 57 POST BALANCE SHEET EVENTS
OPINION ON FINANCIAL STATEMENTS In our opinion the parent company fi nancial statements: – give a true and fair view of the state of the Company’s affairs as at 31 December 2009 and of its cash fl ows for the year then ended; – 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 – have been prepared in accordance with the requirements of the Companies Act 2006.
OPINION ON OTHER MATTERS PRESCRIBED BY THE COMPANIES ACT 2006 In our opinion: – the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and – the information given in the Directors’ Report for the fi nancial year for which the parent company fi nancial statements are prepared is consistent with the parent company fi nancial statements.
The parent company has applied International Financial Reporting Standards as adopted by the European Union in its fi nancial statements for the year ended 31 December 2009. IFRS comprises accounting standards prefi xed IFRS issued by the International Accounting Standards Board and those prefi xed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Company has not taken advantage of this relaxation, and therefore there is no difference in application to the Company between IFRS as adopted by the EU and IFRS as issued by the IASB.
The accounting policies of the parent company are the same as those of the Group which are set out in note 2 to the consolidated fi nancial statements, except that it has no policy in respect of consolidation and investments in subsidiaries are carried at historical cost, less any provisions for impairment.
Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2015 (£600 million) a – 584 7.875% Non-Cumulative Preference Shares (€500 million) a 115 –
Undated subordinated liabilities 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million) b 117 497 6.475% Undated Subordinated Notes callable 2024 (£102 million) 72 –
INVESTMENT IN SUBSIDIARIES On 16 January 2009, the Company acquired 100 per cent of the ordinary share capital of HBOS plc. From this date, HBOS plc and its subsidiaries became controlled entities.
Subject to the foregoing, there were no further significant restrictions on any of the parent company’s subsidiaries in paying dividends or repaying loans and advances. All regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may impact those subsidiaries’ ability to make distributions.
FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES The valuation techniques for the Company’s financial instruments are as discussed in note 53 to the consolidated financial statements.
Lloyds Banking Group plc was incorporated as a public limited company and registered in Scotland under the UK Companies Act 1985 on 21 October 1985 with the registered number 95000. Lloyds Banking Group plc’s registered offi ce is The Mound, Edinburgh EH1 1YZ, Scotland, and its principal executive offi ces in the UK are located at 25 Gresham Street, London EC2V 7HN.
Contact details for Equiniti Limited can be found on the back cover.
Asset-Backed Securities Asset-Backed Securities are securities that represent an interest in an underlying pool of referenced assets. The referenced pool can comprise any assets which attract a set of associated cash flows but are commonly pools of residential or commercial mortgages but could also include leases, credit card receivables, motor vehicles, student loans. Further information on the Group’s investments in ABS is given in Note 54.
Arrears A customer is in arrears when they are behind in fulfilling their obligations with the result that an outstanding loan is unpaid or overdue.
Conduits A fi nancial vehicle that holds asset-backed securities which are fi nanced with short-term loans (generally commercial paper) that use the asset-backed securities as collateral. The conduit will often have a liquidity lines provided by a bank that it can draw down on in the event that it is unable to issue funding to the market. The Group sponsors three asset-backed conduits, Cancara, Grampian and Landale. Further details are provided in note 22.
Contractual maturities Contractual maturity refers to the fi nal payment date of a loan or other fi nancial instrument, at which point all the remaining outstanding principal will be repaid and interest is due to be paid.
Debt restructuring This is when the terms and provisions of outstanding debt agreements are changed. This is often done in order to improve cash fl ow and the ability of the borrower to repay the debt. It can involve altering the repayment schedule as well as reducing the debt or interest charged on the loan.
Delinquency A debt or other fi nancial obligation is considered to be in a state of delinquency when payments are overdue.
Impaired loans Impaired loans are loans where the Group does not expect to collect all the contractual cash fl ows or to collect them when they are contractually due.
Credit enhancement facilities are used to enhance the creditworthiness of fi nancial obligations and cover losses due to asset default. Two general types of credit enhancement are third-party loan guarantees (such as guaranteed mortgages) and self-enhancement through overcollateralisation (in the case of covered bonds). Liquidity enhancement makes funds available if required, for other reasons than asset default, eg to ensure timely repayment of maturing commercial paper.
Negative Equity Mortgages Negative equity occurs when the value of the property purchased using the mortgage is below the balance outstanding on the loan. Negative equity is the value of the asset less the outstanding balance on the loan.
Short-term funding agreements which allow a borrower to sell a fi nancial asset, such as ABS or Government bonds as collateral for cash. As part of the agreement the borrower agrees to repurchase the security at some later date, usually less than 30 days, repaying the proceeds of the loan.
Securitisation Securitisation is a process by which a group of assets, usually loans, are aggregated into a pool, which is used to back the issuance of new securities. Securitisation is the process by which ABS are created. A company sells assets to an special purpose entity which then issues securities backed by the assets. This allows the credit quality of the assets to be separated from the credit rating of the original company and transfers risk to external investors. Assets used in securitisations include mortgages to create mortgage-backed securities or residential mortgage-backed securities (‘RMBS’) as well as commercial mortgage-backed securities. The Group has established several securitisation structures as part of its funding and capital management activities. These generally use mortgages, corporate loans and credit cards as asset pools. A listing of these programmes with the amounts secured and associated funding raised is given in note 22.
Subordinated liabilities Liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer. Details of the Group’s subordinated liabilities are set out in note 44.
Uncovered ABS ABS held without the benefi t of separately purchased matching credit default swaps to protect against the risk of default of the security. Details of the Group’s uncovered ABS are given in note 54.
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REGISTERED OFFICE The Mound Edinburgh EH1 1YZ Registered in Scotland no 95000
REGISTRAR Equiniti Limited Aspect House Spencer Road Lancing West Sussex BN99 6DA