The Group’s main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. The Group operates the uK’s largest retail bank and has a large and diversified customer base.
Group key performance indicators (KPis) 4 divisional overview and KPis 6 chairman’s statement 10
Core business increasingly well positioned for growth and delivering strong returns above cost of equity q core return on risk-weighted assets increased from 2.46 per cent to 2.56 per cent q underlying profit broadly stable at £6,154 million (2011: £6,196 million)
The substantial progress we made in 2012 means that we are now ahead of our plan to transform the Group, and this was reflected in our stronger underlying financial performance in the year. António Horta-Osório Group chief Executive
To enable a better understanding of the Group’s core business trends and outlook, certain income statement, balance sheet and regulatory capital information is analysed between core and non-core portfolios. The non-core portfolios consist of businesses which deliver below-hurdle returns, which are outside the Group’s risk appetite or may be distressed, are subscale or have an unclear value proposition, or have a poor fit with the Group’s customer strategy. The Ec mandated retail business disposal (Project Verde) is included in core portfolios. A full reconciliation of the management to the statutory basis is given in note 4 on pages 229 to 234. unless otherwise stated, the commentaries on pages 44 to 75 are on a management basis.
We have over 30 million customers, iconic brands, including lloyds TsB, Halifax, Bank of scotland and scottish Widows, and high-quality, committed people. We are creating a simpler, more agile, efficient and responsive organisation with a real focus on operating sustainably and responsibly. We will focus on core markets which offer strong returns and attractive growth, while maintaining a prudent approach to risk and further strengthening the Group’s balance sheet.
To assess progress in our aim of becoming the best bank for customers we measure customer satisfaction and are publicly committed to reducing complaints. Our colleagues are a key differentiator and we use an engagement survey to assess individual motivation and organisational processes.
OUTPUT MeASUReS significant progress has been made against our strategic priorities during 2012 which has been reflected in improved underlying profits and a stronger capital position. This was also reflected in an improved statutory performance despite a number of one off items including the £3.6 billion provision for PPi. Further detail on these measures is contained within the business review.
in meeting the financial needs of its customers the division provides a comprehensive product range to ensure differing customer requirements can be effectively met. This includes a range of current accounts including packaged accounts and basic banking accounts. it is also the largest provider of personal loans in the uK, as well as being the uK’s leading credit card issuer. Retail provides one in five new residential mortgages and provided over 55,000 mortgages to help first time buyers in 2012, making it one of the leading uK mortgage lenders. Retail is the largest private sector savings provider in the uK. it is also a major general insurance and bancassurance distributor, offering a wide range of long-term savings, investment and general insurance products.
q The simplification programme has delivered significant improvements in customer experience, process efficiencies and reduced sourcing costs. This contributed to the strong cost performance delivered by Retail.
WEAlTH, AssET FinAncE And inTERnATiOnAl Wealth, Asset Finance and International comprises our UK and international wealth businesses, our UK and international asset finance and online deposit businesses along with our international retail businesses. The Wealth business comprises private banking and asset management. Wealth’s private banking operations cater to the full range of wealth clients from affluent to ultra High net Worth within the uK, channel islands and isle of Man, and internationally. scottish Widows investment Partnership (sWiP) provides asset management services to both internal and external clients.
q divisional performance improved in 2012 with losses reducing by 67 per cent to £929 million primarily driven by lower impairments, mainly in ireland. Profits in the core business increased by 27 per cent, to £459 million driven by strong performance in the Wealth and Asset Finance businesses.
q core return on risk-weighted assets increased from 3.62 per cent to 5.07 per cent.
The General insurance business is a leading distributor of home insurance in the uK, with products sold through the branch network, direct channels and strategic corporate partners. it operates primarily under the lloyds TsB, Halifax and Bank of scotland brands.
q We have delivered balance sheet initiatives that have strengthened the Group’s balance sheet, providing £1.4 billion liquidity and have now mitigated £5.3 billion of the potential impact of cRd iV, whilst improving insurance returns.
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it was also a year of progress for the Group against a still challenging economic and regulatory backdrop. We continued to implement our strategy and are now ahead of our plan to transform the Group and create an efficient, lower-risk retail and commercial bank, focused on being the best bank for customers. This was reflected in our share price, which rose 85 per cent in 2012, substantially outperforming the FTsE 350 banks index, which rose by 34 per cent, and making our shares the best performer in the FTsE 100 over the year. However, we need to continue to manage a number of legacy issues which have had an adverse impact on our financial performance.
Regulation The regulatory framework governing the uK banking industry continued to evolve in 2012, and whilst there was greater clarity, a considerable degree of uncertainty remains about the final outcome of the shape of our industry. We continue to implement regulatory changes alongside the current Basel 3 draft legislation and await its finalisation when we will be able fully to assess the changes required and their effect on the Group. The largest challenge for regulators remains to devise a regulatory framework that strikes the right balance between enhancing financial stability, and encouraging innovation, competition and growth.
We have been a consistent supporter of the proposals to ring-fence systemically important banking operations outlined by the independent commission on Banking (icB), given their close alignment to our simple uK focused retail and commercial banking model. it is our intention, subject to discussions with the regulator and the interests of our shareholders, to become a ring-fenced bank ahead of the 2019 deadline. This will be a step-change for the uK banking industry that should reduce risk and ensure clear distinction between retail and commercial banks on the one hand, and investment banks on the other.
On 22 november 2012 we announced that Martin scicluna, Audit committee chairman, will step down from the Board and leave the Group at the end of March 2013 following his appointment as chairman of RsA plc. i thank him for the substantial contribution he has made as Audit committee chairman and for his constructive views on all aspects of our business. i am pleased nicholas luff has joined us and will be taking over as Audit committee chairman on 1 April 2013. He brings substantial financial and audit committee experience to that role and we look forward to working with him.
Community We believe that businesses should support the communities where they operate. For lloyds Banking Group, this not only strengthens and grows our business, but also helps to rebuild trust and confidence in the banking sector and the positive role banks should play in society as a whole.
Culture We believe culture is values brought to life and is the consequential outgrowth of the strategy of a bank. Ours is to place the customer first. Just as with strategy, the Board has a major role in shaping culture and in setting out principles and values that will drive long-term success. in addition we believe it is the duty of the Board to ensure that these common objectives of management and Board are implemented throughout the institution. in banking there is a place for re-balancing the priorities between shareholders and customers. When customers come first, shareholders will naturally be rewarded.
We continue to believe that the remuneration policy at all levels, including for senior executives, needs to incentivise staff to deliver strong, sustainable growth whilst reflecting the work required to reshape and transform the Group. We have a strong conviction to align reward to the longer term, sustainable success of our business and through this the return of value to shareholders. We are also mindful however both of the economic outlook and the views of our stakeholders.
Outlook We have a strong foundation on which to build our strategy to be the best bank for customers to the benefit of our shareholders. As i have indicated in the past, the first task of the Board was to strengthen the Balance sheet and to have a robust funding profile. now that the Balance sheet has been substantially strengthened and all of the liquidity support received from the uK Government has been repaid, our focus is on increasing profitability and returns to shareholders. Over time, this should in turn allow the government the opportunity to commence the sale of its shareholding, which currently stands at approximately 39.2 per cent. We remain committed to operating as a wholly privately owned Group, which is profitable, self supporting and dividend paying. 2012 has been a year in which that possibility has been enhanced. As for the immediate future i believe that, with a reasonably positive development of the uK economy, we are well positioned for growth.
i am encouraged by and grateful for the ongoing support of all of our shareholders as we implement our strategy. We have many strengths, including iconic brands, strong heritages and great people. consequently, we are well positioned to realise the Group’s full potential for growth, help Britain prosper and deliver sustainable returns for our shareholders.
Board oversight – key topics Throughout 2012 the Board has continued to review the corporate strategy, the operation of the business and our results within a framework of prudent and effective controls, including the assessment and management of risks. This framework has allowed us to deal with key issues arising throughout the year, including: q the Group chief Executive’s return to work in January 2012 following a short leave of absence. Having ensured that he was medically fit to return, the Board has assisted Antonio in making appropriate adjustments to his reporting line and corporate support. it is clear from his energy and commitment to the role that he has made a full recovery q ongoing review of board composition including a number of new appointments which are explained on page 90 q oversight and challenge of the strategy and five year operating plan. This included a two day strategy offsite for the Board and executive team. insurance and commercial Banking have been a particular focus for the year. Performance against plan is reported on pages 4 to 9 q following the appointment of lord Blackwell, changes have been made to the governance and oversight of the insurance board to ensure closer alignment with the Group Board q monitoring of the progress of Project Verde, the Eu mandated divestment of branches q oversight of conduct issues with emphasis on embedding a culture of ‘doing the right thing’
q an ongoing review of the adequacy of provisions, most recently in relation to legacy conduct issues such as PPi and sME derivatives q establishment of a board committee chaired by david Roberts, the chairman of our Risk committee, to oversee the Group’s handling of the process and issues arising from the industry investigation into liBOR setting. This also included implementation of the Wheatley Review to ensure robust processes going forward q close scrutiny and control over executive remuneration arrangements including open and effective engagement with shareholders on a range of remuneration matters. The Board through the Risk and Remuneration committees has been particularly anxious to ensure appropriate risk adjustment. At the Annual General Meeting in May 2012 the Group achieved over 97 per cent votes in favour of its directors’ Remuneration Report86 98
Our drive to enhance operational efficiency and improve service continued at a pace in 2012, notably through the successful execution of our simplification programme. due to the progress made, we are now very close to achieving our original target of around £10 billion of total costs, two years ahead of plan. We are now targeting a further reduction in Group total costs to around £9.8 billion in 2013.
in addition to investing for sustainable growth and returns in our core business, we are reducing risk through substantial reductions in our non-core asset portfolios and a sustainable approach to risk in our core business, which together have resulted in a significant reduction in the impairment charge. We are also continuing to reduce risk and strengthen the balance sheet by reducing wholesale funding, lowering operational leverage and building higher capital ratios. We expect these initiatives, together with our focus on lower-volatility retail and commercial banking, to lower our risk premium over time, and give us a significant competitive advantage.
2012 results overview We delivered Group underlying profit before tax of £2,607 million in 2012, a substantial increase of approximately £2 billion when compared to 2011 reflecting a significant reduction in losses in our non-core business and stable profitability in the core business. income fell by 13 per cent to £18,386 million as a result of customer deleveraging and lower margins in the core business, and the substantial £42.3 billion reduction in the non-core portfolio. However, this was more than offset by our actions to significantly reduce costs, which fell 5 per cent to £10,082 million, and by further improvements in asset quality, which resulted in a 42 per cent reduction in the impairment charge to £5,697 million.
On a statutory basis, the Group reported a loss before tax of £570 million, with the principal reconciling items with underlying profit being provisions taken during the year in relation to the legacy issues of payment protection insurance and interest rate hedging products (iRHP) sold to small and medium-sized businesses (sMEs) of £3,575 million and £400 million respectively, a profit from asset sales of £2,547 million, and simplification and Ec mandated retail business disposal costs together amounting to £1,246 million. Other reconciling items, which are detailed on pages 47 and 48 of this annual report in the Group Finance director’s Review, resulted in a net charge of £503 million. The statutory loss before tax of £570 million represented a significant improvement on last year’s statutory loss of £3,542 million.
Accelerated delivery of strategic initiatives in addition to further strengthening our balance sheet, we have made substantial progress in the execution of the other elements of our strategic plan to be the best bank for our customers, through reshaping and simplifying our business and investing in our core franchise.
Our Simplification programme is central to the successful delivery of our strategy and we continue to make significant progress in driving further cost savings and efficiencies throughout the business. We have reviewed our organisational structures, increasing average spans of control and reducing the average number of management layers, while our cost Board continued to drive a focus on cost efficiency by business line and by functional category. The success of this approach is evidenced by our achievement of run rate cost savings from the programme of £847 million at the end of 2012, ahead of plan, an achievement which gives us confidence in reaching our run rate cost savings target of £1.9 billion by the end of 2014.
Total costs Total costs reduced to £10.1 billion, in line with strategic review target two years ahead of plan.
Greater clarity emerging on UK regulatory framework in October the Government published the draft Financial services Bill, the first step in implementing the recommendations of the independent commission on Banking. We support the recommendation to ring-fence retail banking operations, and recent proposals to ensure its implementation, as we believe that it will result in a safer, more stable uK banking sector and economy, and will therefore require lower capital and liquidity requirements than would otherwise be necessary.
Given the agreement with the FsA reached on 30 January 2013 following the outcome of a pilot review of iRHP sales to small and medium-sized businesses, the Group now believes it is appropriate to increase its provision for iRHP by £310 million in the fourth quarter, based on the revised estimates of redress and related administration costs. The provision in relation to iRHP redress is now £300 million, and we have also provided for £100 million of related administration costs, all of which was accounted for in 2012.
Outlook After a year of challenging economic conditions in 2012, we expect to see some economic growth in 2013, although this is expected to be below-trend, with the Bank of England base rate remaining at current levels. However, house prices are expected to rise slowly and the Fls should progressively have a further impact on lending. some stabilisation in the Eurozone, combined with lower borrowing costs, should see investment start to contribute to the improving environment. Future economic developments do, however, remain dependent on progress in the Eurozone, and the impact of new banking regulation on the supply of credit to the economy.
SMe lending We exceeded our 2012 sME charter lending commitment of £13 billion, while also committing to lend an extra £1 billion to uK manufacturing businesses.
Other financial information core and non-core business analysis 68 Volatility arising in insurance businesses 74 Banking net interest margin 75
The economy 2012 turned out to be a year of two very different halves. The aftermath of the financial crisis continued to influence the global economy during the first half of the year, with worsening conditions in Eurozone sovereign and bank credit markets a particular drag on growth. But an improvement in crisis response in the second half of the year reduced financial market stresses and economic prospects have brightened as a result.
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The weakness of the Eurozone was a significant drag on the UK economy in 2012, with net exports down from the previous year. With inflation squeezing consumer spending power, and government spending growing well below its normal rate, the economy was broadly flat through 2012, excluding the volatility caused by the Olympics and an additional Bank holiday for the Queen’s Diamond Jubilee. As a result, the path of this UK economic recovery has fallen even further behind that seen in previous recoveries.
However, whilst a definitive agreed and fully-implemented solution to the Eurozone crisis remains lacking, there continues to be some risk that ongoing uncertainty around the Eurozone economic outlook, the survival of the Euro currency and the availability of credit could cause return to a recession in the uK and ireland, albeit that risk has declined over the past six months. such a scenario would likely result in higher uK corporate failures, a second leg of falling property prices, albeit by less than during the 2008-9 recession, and rising commercial tenant defaults. irish property prices would also fall further. in turn, this would have a negative impact on the Group’s income, funding costs and impairment charges. The Group has made significant progress in reducing its non-core assets, although our secondary and tertiary commercial real estate portfolios in Business support and leverage finance portfolios do remain vulnerable.
companies have continued to hold back investment spending and prioritise cashflow, feeding both into lower borrowing and higher deposits. non-financial companies made net repayments of 2.6 per cent of sterling lending from banks and building societies in 2012, after repayments of 2.9 per cent in 2011, 3.5 per cent in 2010 and 2.4 per cent in 2009. These aggregates reflect a significant amount of refinancing in capital markets by large companies. company deposits with uK banks rose by 4.9 per cent in 2012, the greatest rate of increase for 5 years.
Capital Requirements Directive iv (CRD iv) in november 2010 the G20 endorsed the recommendations of the Basel committee for Banking supervision to strengthen global capital and liquidity rules. The recommendations are being implemented in the Eu through cRd iV. The new rules will strengthen capital and liquidity standards, change the definition of capital, introduce new definitions for the calculation of counterparty credit risk and leverage ratios, introduce additional capital buffers and develop a global liquidity standard. negotiations on the final text for cRd iV continue in Europe. An implementation date has not yet been confirmed, although current consensus is that it will be 1 January 2014 at the earliest.
Once cRd iV is fully implemented it will make banks more resilient in the face of financial and economic shocks.
Recovery & Resolution Mechanisms The European commission published the Recovery & Resolution directive on 6 June 2012. it requires all firms to develop a recovery plan, proposes new early intervention powers for supervisors and introduces new powers for regulators at resolution stage. This was in line with the recommendations of the Financial stability Board. The uK has pre-empted the European legislative process, with firms already required to prepare recovery plans.
UK Supervisory Structure The Financial services Bill that will reform the uK financial supervisory system received Royal Assent on 19 december 2012. The legislation will formalise the responsibilities of the Financial Policy committee for ‘macro-prudential regulation’ and replace the FsA with the Prudential Regulation Authority and the Financial conduct Authority. The new institutions will assume their regulatory responsibilities on 1 April 2013.
Technological developments are already reshaping the banking industry and we expect this change to accelerate exponentially in the coming years. We anticipate influx of new entrants, with business models that do not rely on expensive branch networks, offering innovative digital banking services. These new entrants are likely to have expertise and experience in digital product offerings, with strong funding positions, credible brands, and pre-existing customer bases.
Alongside these market developments the regulatory environment will also change this year, with new bodies for prudential and conduct regulation. The new conduct regulator, the Financial conduct Authority, will have a competition duty giving it a strong and explicit mandate to tackle competition issues, such as hurdles to switching or barriers to entry, swiftly and effectively.
simple, tailored products and services strong customer relationships superior customer insight
We are creating a simpler, more agile, efficient and responsive customer focused organisation with a real focus on operating sustainably and responsibly and helping Britain prosper. We are reshaping and simplifying the business and investing a portion of the savings realised from our simplification programme in customer related growth initiatives. Whilst focusing on core markets which offer strong returns and attractive growth we are maintaining a prudent approach to risk and further strengthening the Group’s balance sheet and liquidity position.
Our action plan for success The four key elements of our action plan to deliver our strategy are outlined in more detail on the next few pages:
A prudent appetite for risk Across the business we have embedded a conservative approach to, and prudent appetite for, risk, and have in place disciplined controls over the risk profile of all new business. We are comfortable that our existing portfolios are adequately provisioned.
We are streamlining our international presence from around 30 countries to less than half that number by 2014 and have already made good progress having completed or announced our exit from 12 countries to date.
As a result of the repositioning we continue to believe the strategy will deliver a statutory return on equity of between 12.5 and 14.5 per cent.
Aim We continue to strengthen the Group’s balance sheet ensuring the financial strength and security of the Group. We are enhancing our capital ratios and ensuring we exceed regulatory liquidity requirements, whilst maintaining a stable funding base and ensuring loan to deposit ratios remain close to our long term target.
Strong capital position in 2012 our core tier 1 capital ratio increased to 12.0 per cent providing us with a strong capital position prudently in excess of our 10 per cent target and substantially above that currently required by regulation. On an estimated fully loaded cRd iV basis our core tier 1 capital ratio was 8.1 per cent.
Key initiatives and progress in 2012 Much of the additional investment we intend to make in the business will be delivered from the cost savings delivered from our simplification initiatives and we were able to invest an additional £337 million in 2012 due to the simplification savings already made. This investment in the core franchise is allowing us to provide greater levels of service and support to customers.
investing to be the best bank for personal customers in 2012 Retail made a real investment in customer initiatives, in particular our product proposition and distribution channels. We refurbished 421 branches and extended our opening hours which have had a significant effect on the service provided, as demonstrated through substantial increases in our net Promoter scores.
significant investment has also been made in our digital proposition including the expansion of services available on smart phones. These have supported continued growth in active internet customers of 1.2 million in 2012 to 9.5 million whilst our mobile banking apps now have 3.3 million users representing substantial growth since their launch in October 2011. We also reached a significant milestone of over one billion customer logons during the year.
Across commercial Banking, as part of our programme to enhance our capabilities in capital efficient products, we have continued to invest in the Transaction Banking platform delivering product enhancements in card Payments & Acceptance, currencies and international cash Management. We also continued to invest in enhancing our online capabilities, with the number of customers using our foreign exchange and money market e-portal ‘Arena’ tripling in 2012. We also launched a number of specialised products, including a deposit account tailored to the needs of businesses in the agricultural sector.
With over 30 million personal and business customers and a presence in communities across the country, we are very well placed to help unlock the potential of families, businesses and communities we serve, and make a significant contribution to the future strength and prosperity of the uK. Being the best bank for customers, alongside a focus on operating sustainably and responsibly, underpins our approach to business. in order to meet our ambitions to be the best bank for customers and to help Britain prosper we need strong relationships with our customers as well as our colleagues and communities. This section of our report explains why and how we nurture these relationships.
At lloyds Banking Group, we see ourselves as having a clear role to play in helping Britain prosper. As the uK’s largest retail and commercial bank, we are already doing more than our peers to help people manage their finances.
lloyds Banking Group brands offer essential services to our customers – helping people to buy their first homes, offering sMEs support, and using our people’s skills to give uK communities access to appropriate financial products. But with faith in the sector at a low level, we recognise the need to rebuild trust with our customers.
Rebuilding trust Recent external research undertaken by ipsos MORi1 on behalf of lloyds Banking Group showed that, through the eyes of our customers and potential customers, relationships and responsibility are inseparable.
The RBSG also guides and focuses the areas that are most material to our business. The top priorities at present are: customer care; supporting financial inclusion; and helping UK business and households. The Steering Group will continue to review areas of focus in 2013, with a particular view to integrating stakeholder interests on material issues.
Lloyds Banking Group has retained our position in the FTSE4Good socially responsible investment index and our overall scores remained broadly stable in the Dow Jones Sustainability Index. In addition we maintained our position in the Carbon Disclosure Project and retained Platinum status in the Business in the Community CR Index. We are looking to build a leadership position in responsible business and developing a roadmap which will help us improve our performance and related rankings going forward.
The day-to-day implementation of our responsible business strategy is managed by the Group Community & Sustainable Business team. During 2012 we continued to develop our Community Strategy around the themes of Education, Employability and Enterprise. More detail on our approach to corporate responsibility and future plans will be described in our 2012 Responsible Business report which will be published in May 2013. Our 2011 report along with further information on our approach to corporate responsibility and our codes of responsibility can be found on our website at www.lloydsbankinggroup-cr.com.
BE THE BEsT FOR OuR cusTOMERs… SMEs and fast growing enterprises play a vital role in creating jobs and generating growth in the UK. We demonstrated our support for SME customers with gross lending of £13.2 billion in 2012, delivering year on year net lending growth of 4 per cent in this business area. This was in contrast to a decline in the stock of lending of 4 per cent across the industry.
We have continued to support our SME and Mid Market customers throughout the economic cycle in order to ensure their financial health, viability and growth. In cases where businesses have experienced financial difficulties, our Business Support Unit (BSU) is specifically tasked with providing help. Since 2009 the BSU has restructured facilities for around 10,000 businesses and has protected more than 250,000 UK jobs.
As further evidence of the long-term assistance that we offer to enterprise, at the start of 2010 we launched our SME Charter. Within this we pledged to support 300,000 new businesses set up by the end of 2012. We are delighted to say that this target was exceeded with 350,000 such businesses being helped across the three year period.
We have extended the innovative lloyds TsB lend a Hand Mortgage to help customers purchase a home with the help of their local authority. We also launched our Best for Business campaign and reaffirmed our continued support for the sME charter to respond to 90 per cent of lending appeals within 15 working days which will exceed the industry standard of 30 days. in addition we have made significant investments in the Business Growth Fund, scottish investment Bank and Big society capital.
– sales: our sales processes consider affordability and are designed to minimise the risk of customers buying products they do not need or cannot afford. We review these processes continuously and update them as necessary.
Making a difference together means working together to deliver for customers, listening to how we can improve what we do; treating all people fairly and acting responsibly at all times; and contributing to the communities we serve. We see our involvement in the work we do in fundraising for charity as an important part of our contribution. colleagues have raised £3.6 million for save the children since the beginning of 2011. As part of our involvement with the national school sport Week initiative, over 5,000 colleagues have volunteered their support over the last four years. Overall 32,000 colleagues have volunteered their time this year to communities.
The outputs provide two separate and measurable scores, the Employee Engagement index (EEi), which measures the individual motivation of colleagues, and the Performance Excellence index (PEi), measuring how strongly colleagues believe the Group is committed to improving customer service. These inform Group wide and local action plans that will prioritise the things that will make the Group a better place to work.
Our EEi score shows that we have more to do to engender trust in the organisation and in its future. The current economic climate and the constant external focus on the financial services sector and banks have undoubtedly contributed to a lack of confidence and trust in the organisation. Building colleagues’ pride and trust in the Group and our future is something the senior leadership team is fully committed to and an area that we will continue to focus on throughout 2013.
We have four recognised unions who we have consulted about these actions and have been involved in discussions on a series of changes that we have made this year. We value the partnerships we have with these organisations.
The Group significantly increased its focus on its Emerging Talent programmes in 2012. We launched two new Group wide programmes. in its inaugural year our Apprenticeship scheme made 500 places available offering a range of career opportunities across the Group. We are building on the success of the scheme by offering more places in 2013. At the more senior level we launched our Future Executives Programme giving 23 MBA graduates the chance to fast track their careers through a structured leadership programme. in addition, the Group maintained its focus on hiring significant numbers of uK graduates, with a 20 per cent increase on 2011 hires across its six core schemes.
Reflecting the regulatory environment, continued good progress has been made in the strengthening of reward governance, particularly incentives, and the alignment of long term incentives with our strategic goals. The performance management process ensures we calibrate between colleagues and take full account of risk at all levels to assess risk stewardship by all our senior executives.
As part of our objective to ensure that colleagues were engaged in the Games we launched a Group wide Reward and Recognition programme, Go for Gold, in July 2010. colleagues were recognised for supporting and living our Group Values. 500 colleagues were rewarded with a pair of tickets to the Olympic or Paralympic Games. in addition we provided 250 colleagues with the unique opportunity to be an Olympic Torchbearer for making a difference in their community. Beyond these Group wide recognition programmes we awarded around 2,500 colleagues with tickets to the Olympic or Paralympic Games for exceptional performance through other divisional Recognition Programmes. Also 500 colleagues were given places in the lOcOG Volunteer Programme, giving a once in a lifetime opportunity to support the Games by being a Gamesmaker. Further to this approximately 145 of our best customer service colleagues were given the unique opportunity to work in the Athlete Village and Media centre branches at the Olympic Park during the Games.
The Torch Relay was a key event for us as part of the london 2012 build-up and over 350 colleague volunteers supported the colleague Advance Tour and the Evening celebration Events as part of our Olympic Torch Relay campaign. Many more branch staff and other colleagues lined the streets to support the Relay as it passed through their communities and at sponsor stops.
Lloyds Banking Group Annual Report and Accounts 201238 cOMMuniTiEs One of the ways Lloyds Banking Group helps Britain prosper is by contributing positively to the communities we serve. Our scale and reach through our brands and branches means we are doing more to help communities across the UK.
Our response to this is Money for Life, an award-winning personal money management programme, targeted at young people and adults in the wider Further Education, work-based learning and community learning sectors. lloyds Banking Group has invested £4 million in the programme since 2009 and has committed a further £4 million over the next two years.
in september 2012 we announced a partnership with Family Action to train our employees to deliver money management workshops to 1,500 vulnerable families by August 2013.
Lloyds Banking Group Annual Report and Accounts 201240 employability Lloyds Scholars, our social mobility programme aimed at uK students, was established in 2011. in partnership with six leading universities across the uK, we offer students from lower income households a complete support package, helping them manage the financial strain of university whilst improving their employability.
enterprise in January 2012 the School of Social Entrepreneurs and the bank launched the lloyds Banking Group social Entrepreneurs programme. supporting this programme demonstrates lloyds Banking Group’s commitment to aiding the uK’s economic recovery by enabling social entrepreneurs to realise their ambitions and thereby supporting enterprise and strengthening communities.
The aim over the next five years is to help over 1,300 social entrepreneurs to start up or scale up their social enterprise, creating jobs across the uK and helping local communities to help themselves. The programme offers grants of between £4,000 - £25,000 as well as a lloyds Banking Group mentor to help them be sustainable and successful in their ideas. Additional funding for this project is provided by the Big lottery.
We are a major sponsor of the Business Connectors programme in partnership with Business in the community, a Prince of Wales charity. in 2012 we made a commitment to second up to 20 senior managers per year to become Business connectors, working in their local communities to help broker relationships between charities, community groups and local business, with the goal of helping to build thriving communities across the uK.
Funding local organisations The 2012 community Fund provided grants to local community organisations supporting young people. nominated by our colleagues and voted on by members of the public, 132 organisations across the uK each won a community Fund award worth £5,000. The Group’s sponsorship of london 2012 allowed us to promote nominated organisations at Olympic Torch Relay events. This raised their profile and encouraged communities to support them by voting. We estimate 100,000 young people across the uK will be positively impacted as a result of the awards.
All programmes are on track to meet their 2020 targets with some delivering early. More detail on the progress of our initiatives will be described in our 2012 Responsible Business Report, which will be published in May 2013.
Supporting the Green economy in supporting the Green Economy, we need to create ‘real’ opportunities for the provision of finance for low carbon products, services and green technologies in a socially inclusive way. To achieve this we recognise the need to work with governments and other stakeholders to address the global sustainability mega trends that will impact our future.
Risk achievements in 2012 significant progress has been made in reducing the risk in the business in 2012 through the consistent application of our prudent approach to risk. Key deliverables have been aligned to the delivery of our customer focused strategy and the four pillars of our action plan.
We have made good progress in reshaping the business portfolio to fit our resources, capabilities and risk appetite. A conservative approach to, and prudent appetite for risk is fully embedded across the organisation and effective controls over the risk profile of all new business are in place. We have continued to take a disciplined approach to the management and reduction of our non-core assets, which reduced by £42.3 billion in the year, ahead of plan, whilst also being capital generative. Asset sales in total were within impairment provisions demonstrating the prudence of our approach to credit risk management and the adequacy of our provisioning. The reduction of non-core assets and prudent management of risk have led to significantly lower impairment, down 42 per cent, and the core Asset Quality Ratio, (impairment as a percentage of average advances), at 0.44 per cent is already in line with target.
We have continued to strengthen and de-risk the Group’s balance sheet by improving our capital ratios and funding and liquidity position. The Group’s funding position has now been transformed with wholesale funding of £170 billion reduced by £81 billion in the year. At the same time we have reduced the level of short term wholesale funding which at £51 billion now accounts for less than 30 per cent of total wholesale funding. Our liquidity position also continued to improve and our liquidity is now greater than wholesale funding and covers short term funding by more than four times. Our core tier 1 capital ratio further increased to 12.0 per cent in the year and we remain confident in our capital position.
The Group’s approach to risk is founded on an effective control framework and a strong risk management culture which guides the way all employees approach their work, the way they behave and the decisions they make. The amount and type of risk that the organisation is prepared to seek, accept or tolerate, otherwise known as risk appetite, is driven by our strategy and approved by the Board. This risk appetite is then embedded within policies, authorities and limits across the Group.
We believe effective risk management can be a strategic differentiator, in particular: q Conservative approach to risk: The Group has a fully embedded conservative approach to, and prudent appetite for risk with risk culture and appetite driven from the top.
q Business focus and accountability: Managing risk effectively is a key focus for the Group and is one of the five principal criteria within the Group Balanced scorecard on which business areas and individual performance are judged. The Group’s approach to risk means that businesses remain accountable for risk but a strong and independent risk function also helps ensure adherence to the Group’s risk and control frameworks. continued investment in risk systems and processes will also help differentiate our risk management approach.
PRinCiPAL RiSKS AnD UnCeRTAinTieS The most significant risks faced by the Group are detailed below.
Operational risk The principal operational risks currently facing the Group are: information security – The risk of information leakage, loss or theft. The threat profile related to this is rapidly changing; with increasingly sophisticated attacks by cybercrime groups; iT systems – The risk of loss resulting from the failure to develop, deliver or maintain effective iT solutions; and customer Process – The risk of process weaknesses and control deficiencies within the Group’s customer facing processes as the business continues to evolve.
Further substantial non-core asset reduction and lower non-core losses We delivered a further substantial reduction in non-core assets of £42.3 billion (30 per cent) in 2012, significantly ahead of our original guidance for the year, resulting in a remaining non-core asset portfolio of £98.4 billion. The percentage reduction in risk weighted assets on the portfolio was in line with that of non-core assets. continued high wholesale funding costs were the main driver behind a reduction in the non-core margin of 46 basis points to 0.55 per cent. Given a substantial improvement in the impairment charge, which reduced by 45 per cent to £3,778 million, and a further 7 per cent cost reduction, the non-core business delivered a reduced underlying loss of £3,547 million (2011: £5,558 million).
Trends in total underlying income were more stable in the second half of the year, as the effect on non-core income from the reduction of non-core assets was broadly offset by core income growth which, having reduced by 5 per cent in the first half of 2012, increased by 2 per cent in the second half.
Group income Group net interest income for the year fell by 15 per cent to £10,335 million due to lower asset balances and a decline in margin. Average interest-earning banking assets fell 7 per cent, mainly due to further non-core asset reductions, while the banking net interest margin reduced 14 basis points to 1.93 per cent, due to competitive deposit markets and higher wholesale funding costs continuing into 2012, with the average cost of new funding continuing to be higher than the average cost of maturing funds. These effects were partly mitigated by the benefits of re-pricing certain lending portfolios, an improving funding mix, and the reduction in lower margin non-core banking assets.
Total costs £m change simplification savings annual run rate 847 242
The charge to the Group in respect of the Financial services compensation scheme costs was £175 million (2011: £179 million). The Bank levy was £179 million (2011: £189 million), in spite of an increase in the rate of the levy, as a consequence of the lower levels of wholesale funding a reduction in the Group’s balance sheet and an increase in the proportion of funding with a maturity of greater than one year.
Fair value unwind 650 1,206 net of associated fair value unwind of £689 million (2011: £737 million).
liability management losses of £229 million arose on transactions undertaken as part of the Group’s management of wholesale funding and capital, including a loss of £397 million in the second half resulting from debt repurchases and a gain of £168 million relating to the exchange of certain capital securities for other subordinated debt instruments in the first half.
Management profit also includes a gain of £650 million relating to an unwind of acquisition-related fair value adjustments. The unwind of fair value relating to assets disposed of in the period is included in the asset sales line.
Statutory loss statutory loss before tax was £570 million in 2012. Management profit was offset by provisions relating to legacy PPi business totalling £3,575 million, other regulatory provisions of £650 million, and other charges totalling £1,172 million. Further detail on the reconciliation to management and statutory results is included in note 4 on page 233.
We have received a number of claims in the German courts relating to policies issued by clerical Medical investment Group limited, principally during the late 1990s and early 2000s, and recognised an additional provision of £150 million in respect of this litigation in the third quarter of 2012, taking the total provision to £325 million.
Further detail on these matters is contained in note 44 on page 278 of this annual report.
interbank offered rate setting investigations We continue to co-operate with investigations by government agencies in the uK, us and overseas into submissions made to the bodies that set various interbank offered rates. in addition the Group, together with other panel banks, has been named in private lawsuits in the us including with regard to the setting of BBA london interbank offered rates. it is currently not possible to predict the scope and ultimate outcome of the various regulatory investigations or private lawsuits, including the timing and scale of the potential impact of any investigations and private lawsuits on the Group.
When applying the draft July 2011 cRd iV rules on both transitional and fully loaded bases, the Group’s pro forma common equity tier 1 (cET1) capital ratios would have been 11.6 per cent and 8.1 per cent respectively as at 31 december 2012. The pro forma capital resources are based on our interpretation of the draft July 2011 cRd iV rules with risk-weighted assets estimates updated to reflect the Group’s best expectation of how these rules will be amended for subsequent Basel announcements and Eu discussions. Our calculation now includes a benefit of approximately 30 basis points from the expected favourable resolution of the definition of corporate exceptions from derivative valuation adjustments and of changes to the definition of default for retail mortgages. in addition, if the alternative treatment was allowed under cRd iV in relation to insurance holdings, we believe this would increase the fully loaded pro forma cRd iV cET1 ratio by approximately 1.0 per cent assuming application of the July 2011 text.
We are pleased with the progress made on our balance sheet reduction plans, given challenging market conditions. in 2012, we achieved a substantial reduction of £42.3 billion in the non-core portfolio, resulting in the portfolio at 31 december 2012 amounting to £98.4 billion. The reduction continues to be managed in a capital efficient manner, and was capital accretive in 2012. it included reductions of £14 billion in treasury assets, £6 billion in uK commercial real estate and £9 billion in international assets of which £4 billion was in ireland and £2 billion in Australasia.
Of which money market funding <1 year maturity £31.0bn £69.1bn (55)
in August 2012, we announced our support for the uK Government’s Funding for lending scheme. We were the first bank to draw on the scheme in september 2012, drawing down £1 billion, with a further £2 billion during the last quarter of 2012.
Key balance sheet items at 31 december 2011 £bn £bn £bn £bn £bn £bn loans and advances to customers excluding reverse repos 352.8 155.7 40.2 0.1 548.8
RETAil 2012 highlights q in 2012, Retail further increased its profits and returns, and made substantial progress towards its goal of being the best bank for customers.
We are also investing in the channels our customers use to interact with the Group. in particular we have made significant developments to our digital proposition and branches. This includes the expansion of services available on smart phones and mobile devices, which has contributed to the continued growth of our online customer base to 9.5 million and our mobile banking services which are now used by 3.3 million customers.
Finally, Retail has continued to support the uK economy and local communities through its contribution to Group programmes, and through commitments made by Retail colleagues. in 2012 over 8,500 colleagues volunteered using the Bank’s ‘day to Make a difference’ programme. in addition, Retail played a key role in the Group’s Partnership with the london 2012 Olympic and Paralympic Games as official sponsors. Our colleagues were involved in many community activities, including the Olympic and Paralympic Torch Relays, and national school sport Week.
Financial performance in 2012, Retail’s return on risk weighted assets increased to 3.21 per cent, a significant improvement on 2.56 per cent in 2011. This improvement was supported by a 16 per cent increase in underlying profit, and a 21 per cent increase in core underlying profit. The increase in profit in both core and total Retail was the result of strong cost control and continued significant improvements to credit performance. The core performance was very similar to the total performance given that non-core in Retail covers only 4 per cent of customer balances and 1 per cent of income.
q commercial Banking was created in the fourth quarter of 2012 bringing small and Medium-sized Enterprises (sME) together with larger corporate uK and global clients to ensure consistent and effective client coverage. The former Wholesale division has been combined with the Australian and European corporate businesses previously reported in the international segment of Wealth, international and Asset Finance.
Banking net interest margin 1.58% 1.86% (28)bp impairment charge as a % of average advances 1.85% 2.32% (47)bp
Key balance sheet items loans and advances to customers excluding reverse repos customer deposits excluding repos 109.7 116.7 (6)
We have sharpened our focus on strengthening the balance sheet and improving capital efficiency through the development of more considered client participation and controlled reduction of the non-core portfolio. Within our core business, we have further refined our client participation and will rationalise exposure to capital-intensive businesses. in 2012, for example we discontinued our origination of new Project Finance business in the us and restricted new origination in Australia to key clients with strong uK linkage only, and reduced our exposure to parts of the corporate real estate portfolio that do not deliver acceptable returns. We have continued to reduce our exposure to non-core assets, achieving a substantial reduction of £33.2 billion in 2012, a decrease of 44 per cent.
Financial performance divisional underlying loss reduced by £488 million due to the significant reduction in impairments as a result of lower charges in most of the businesses, increased other income, and lower total costs partially offset by reduced net interest income. core underlying profit increased by £14 million with core return on risk-weighted assets increasing by 4 basis points.
q We continue to reshape our operations by further streamlining our international footprint through the announced exits from five countries (following seven exits last year) and a significantly reduced presence in a further four.
Banking net interest margin 1.65% 1.72% (7)bp impairment charge as a % of average advances 3.12% 6.48% (3.36)pp
– Asset Finance – our uK and international Asset Finance and on-line deposit businesses.
– international – our non-core businesses in ireland, Europe, Asia and the rest of the world (excluding businesses transferred to the commercial Banking division in the year).
underlying profit increased by 25 per cent to £358 million driven by increased income, reflecting strong deposit and margin growth and lower costs, driven by cost saving initiatives across the business.
in international, underlying loss reduced by £1,754 million to £1,623 million largely driven by ireland where there was a decrease in the impairment charge from £3,187 million in 2011 to £1,245 million in 2012.
Risk-weighted assets fell by 17 per cent from £43.6 billion to £36.2 billion reflecting continued focus in the year on non-core asset run-off and balance sheet de-risking.
Key balance sheet items loans and advances to customers excluding reverse repos 4.2 4.8 9.3 10.4 19.9 25.0 33.4 40.2
Lloyds Banking Group Annual Report and Accounts 201262 insuRAncE 2012 highlights q in 2012 we combined our uK life Pensions and investments and General insurance businesses and restructured our operation to enable greater customer and market focus which contributed to an 8 per cent decrease in costs and leaves us well placed to realise benefits from risk diversification.
Progress against strategic initiatives 2012 has been characterised by huge changes in the insurance industry which has been reflected in our insurance business. Our strategy of Simplification is in line with the direction of regulation, which has removed complex commission structures, gender discrimination and tax cross subsidies. By combining our uK life Pensions and investment (lP&i uK) business with our General insurance business, we have a single leadership team, a simpler, flatter structure and a lower cost base. We have also transferred most of our operations to the Group Operations functions, where we expect scale economies and depth of expertise to yield further cost savings and improvements to customer service. This simplified business model has already strengthened our position as a cost leader in the industry.
We are strengthening our balance sheet and achieving capital efficiencies, realising synergies between insurance and the rest of the Group. Our business model positions us to maximise the capital benefits from risk diversification available under the proposed individual capital Assessment Plus regime and ultimately solvency ii. Activities within insurance during 2012 contributed further to a total £5.3 billion mitigation of the potential impact of cRd iV within the Group since 2010 and enabled £1.4 billion of excess liquidity within insurance to be provided to the Group.
We have delivered a number of significant improvements to our core processes and are seeing the benefits come through in terms of improved customer experience and reduced complaints. These include re-engineering our account switching and closure processes; streamlining our commercial lending process; and a quicker General insurance claims experience with dedicated advisers managing claims end-to-end.
Key balance sheet items at 31 December 2012 £bn £bn £bn £bn £bn £bn loans and advances to customers excluding reverse repos 317.3 102.0 5.3 0.7 425.3 insurance claims – – – (343) – (343)
in 2012 the Group’s statutory result before tax included positive insurance and policyholder interests volatility totalling £306 million compared to negative volatility of £838 million in 2011.
The expected sterling investment returns used to determine the normalised profit of the business, which are based on prevailing market rates and published research into historical investment return differentials, are set out below: Gilt yields (gross) 2.48 3.99
A reconciliation of banking net interest income to Group net interest income showing the items that are excluded in determining banking net interest income follows: Banking net interest income – management basis 10,480 12,094
Marketplace trends 19 Business model and strategy 22 Delivering our action plan 24 Relationships and responsibility 28 Risk overview 42 Summary of Group results 44 Divisional results 52 Group Operations and Central items 67 Other financial information 68 Five year financial summary 76
The financial statements for each of the years presented have been audited by Pricewaterhousecoopers llP, independent auditors.
Total dividend for the year2 – – – – 648 31 December 31 december 31 december 31 december 31 december
Restated in 2012 to reflect the share of results of joint ventures and associates within total income.
The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims).
Skills and experience: Anita has extensive board, financial and general management experience across a range of sectors, including banking, asset management, manufacturing and utilities. Her breadth of experience and strong leadership qualities make her an effective non-Executive director.
Former appointments: nick was previously the Finance director of The Peninsular & Oriental steam navigation company and chief Financial Officer of P&O Princess cruises plc. until december 2010, he served as a non-Executive director and was the Audit committee chair of QinetiQ Group. nick started his career with KPMG where he qualified as a chartered accountant in 1991.
Sir Winfried Bischoff chairman chairman of the nomination & Governance committee. Member of the Remuneration committee and the Risk committee
Age: 55 nicholas Luff independent director Member of the Audit committee and Risk committee (with effect from 5 March 2013). chairman of the Audit committee (with effect from 1 April 2013)
Skills and experience: Tim is a senior investment banker with international board and management experience and a strong background in the us government sector. Tim brings an international perspective to the Board with a strong focus on financial markets and securities, government relations and international emerging best practice.
external appointments: Martin is the chairman of RsA insurance Group and Great Portland Estates and a Governor of Berkhamsted school.
external appointments: sara is a non-Executive director of united utilities Group and chair of their Remuneration committee.
Former appointments: António joined Grupo santander in 1993 and held various senior management positions culminating in Executive Vice President of Grupo santander and a member of its Management committee. in november 2004 he was appointed as a non-Executive director of santander uK and from August 2006 until november 2010, served as its chief Executive. António is also a former non-Executive director of the court of the Bank of England.
chairman of the Audit committee. Member of the Risk committee and nomination & Governance committee
António joined the Board in January 2011 as an Executive director and became Group chief Executive in March 2011.
George joined the Board as Finance director on 16 May 2012.
Her last role was as Executive director for Retail distribution and a Board director at santander uK. she previously worked at Barclays for 19 years in various roles including director of Barclays and Woolwich Retail networks, and as Managing director of Barclays Business Banking.
Antonio has over 20 years of experience in the financial services industry. He worked for Arthur Andersen for over nine years before joining santander in 1998. during his time at santander, he was working in a number of different finance and business roles. Antonio was part of the management team in 2004 that took over Abbey national whilst also becoming chief Financial Officer of santander uK.
Matt joined lloyds Banking Group in February 2011 as Group corporate Affairs director. He has responsibility for internal and External communications, Public Affairs, Regulatory developments, competition, community investment including the Group’s Archives and Museums. Prior to joining the Group, he was the communications director at santander uK and has also held senior positions with Abbey national and natWest.
Prior to joining Mark was chief Executive Officer of ABn AMRO and was appointed as chairman of the Managing Board in november 2007. Mark was a director of The Royal Bank of scotland Group from March 2006, and chief Executive of the Manufacturing division at RBs since 2000. Other achievements have included: chairman of the Association for Payment clearing services (2003 – 2007).
Mark is a career banker having joined natWest in 1981. He was Retail Finance director and later chief Operating Officer before natWest was bought by RBs.
Toby joined lloyds Banking Group in October 2011 as Group director for insurance and cEO of scottish Widows. Before joining the Group, Toby was uK life cEO at Aviva and prior to this he was chief Operating Officer for uK life, having joined Aviva in 2008. He previously worked at charcol, becoming Managing director, before moving to Js & P (now Towry) as chief Executive. Before that, Toby spent a number of years at McKinsey, specialising in the financial services and technology sectors.
Financial risk management objectives and internal control policies 115 to 202 and page 92
Going concern The going concern of the company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of capital. in order to satisfy themselves that the company and the Group have adequate resources to continue to operate for the foreseeable future, the directors have considered a number of key dependencies which are set out in the risk management section under principal risks and uncertainties: liquidity and funding on page 123 and pages 177 to 184 and capital position on pages 187 to 200 and additionally have considered projections for the Group’s capital and funding position. Having considered these, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the accounts.
in the interests of good corporate governance and in accordance with the provisions of the uK corporate Governance code, all of the other directors will retire and those willing to serve again will submit themselves for re-election at the forthcoming annual general meeting.
Directors’ indemnities The directors of the company, including the former directors who retired during the year and since the year end, have entered into individual deeds of indemnity with the company which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ for the purposes of the companies Act 2006. in addition, the company has granted a deed of indemnity through deed poll which constituted ‘third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ to the directors of the Group’s subsidiary companies, including to former directors who retired during the year and since the year end. The deeds were in force during the whole of the financial year or from the date of appointment in respect of the directors who joined the Boards in 2012 and 2013. The indemnities remain in force for the duration of a director’s period of office. The deeds indemnify the directors to the maximum extent permitted by law. deeds for existing directors are available for inspection at the company’s registered office. in addition, the Group has in place appropriate directors and Officers liability insurance cover which was in place throughout 2012.
Donations The income statement includes a charge for charitable donations totalling £33,657,000 in 2012 (2011: £32,972,000), including £28,228,000 (2011: £28,228,000) which will be paid under the deeds of covenant to the four lloyds TsB Foundations during 2013 and £1,000,000 paid to the Bank of scotland Foundation during 2012.
The company’s policy is to agree terms of payment with suppliers and these normally provide for settlement within 30 days after the date of the invoice, except where other arrangements have been negotiated. it is the policy of the company to abide by the agreed terms of payment, provided the supplier performs according to the terms of the contract.
The number of days required to be shown in this report, to comply with the provisions of the companies Act 2006, is 25 (2011: 23 days). This bears the same proportion to the number of days in the year as the aggregate of the amounts owed to trade creditors at 31 december 2012 bears to the aggregate of the amounts invoiced by suppliers during the year.
Statement of directors’ responsibilities 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 Group and parent company financial statements in accordance with international Financial Reporting standards (iFRss) as adopted by the European union. under company law, the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the company and of the profit or loss of the company and Group for that period. in preparing these financial statements, the directors are required to: select suitable accounting policies and then apply them consistently; make judgements and accounting estimates that are reasonable and prudent; and state whether applicable iFRss as adopted by the European union have been followed.
A copy of the financial statements is placed on our website www.lloydsbankinggroup.com. The directors are responsible for the maintenance and integrity of the company’s website. legislation in the uK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
– the respective roles and responsibilities of each of the chairman, Group chief Executive, senior independent director and non-Executive directors.
The 2012 Board Effectiveness Review summarised the chairman’s contribution as follows: “The Chairman has brought the Board through an exceptionally difficult time. He is much respected for his wisdom and experience, and for rebuilding the Board to its present high quality. He has been instrumental in the Group establishing good relationships with external stakeholders and is widely trusted.”
in addition to the Board Effectiveness Review (the process for which is described on page 89), a separate review of the chairman’s performance is undertaken annually by the non-Executive directors. For 2012, the review was led by Anthony Watson, senior independent director, who also provided feedback to the chairman on the findings. The review focused on three key areas: leadership of the Board; effectiveness; and relations with shareholders. The review was carried out through a questionnaire sent to all directors, follow up meetings with individual directors and a detailed discussion with the non-Executive directors in the absence of the chairman.
– making decisions in all matters affecting the operations, performance and strategy of the Group’s businesses, with the exception of those matters reserved to the Board.
independence The Board’s preference is to ensure a strong majority of independent directors. At year end, the Board comprised two Executive directors, eight independent non-Executive directors and the chairman who was independent on appointment.
The nomination & Governance committee is responsible for the ongoing assessment of the independence of non-Executive directors. in assessing independence, the committee does not rely solely on the code criteria but considers whether, in fact, the non-Executive director is demonstrably independent and free of relationships and other circumstances that could affect their judgement. it does this with reference to the individual performance and conduct in reaching decisions. it also takes account of any relationships that have been disclosed and authorised by the Board. Based on its assessment for 2012, the nomination & Governance committee is satisfied that, throughout the year, all non-Executive directors remained independent as to both character and judgement.
The Board continues to focus on improving gender diversity. With the appointments of sara Weller and carolyn Fairbairn as non-Executive directors in 2012, the Board has shown demonstrable progress, raising the percentage of female representation on the Board from 8 per cent to 27 per cent, exceeding the 2015 target of 25 per cent recommended by the davies Review.
To assist in its search for non-Executive directors, the nomination & Governance committee engaged the services of JcA Group and Egon Zehnder, who are both signatories to the 30% club’s voluntary code of conduct and which promotes best practice for related search processes. neither JcA Group nor Egon Zehnder are connected with the Group in any other capacity.
Female Board Members Female Senior Managers Female Managers All Female Staff
– Continuing development. After the induction period, ongoing training is primarily provided at Board meetings or via ‘deep dive’ sessions. A more structured approach to continuing development will be introduced along similar lines to the induction programme which includes a series of half day workshops and focused training sessions.
Attendance at meetings in 2012, a total of 10 Board meetings were held of which eight were scheduled at the start of the year. in addition, Board members attended the annual general meeting held in Edinburgh and a two day off-site strategy session. The attendance of directors at Board meetings and at meetings of the Audit, nomination & Governance, Remuneration and Risk committees is shown in the table below. Whilst all directors are invited to, and regularly attend other committee meetings, only their attendance at committees of which they are members is recorded in the table below.
Board training The Board receives regular refresher training and information sessions to address current business or emerging issues. in the course of 2012, non-Executives directors undertook approximately 16 to 18 hours of training. This was delivered through a variety of means, including: sessions on matters such as capital and liquidity (including stress testing requirements); regulatory updates for approved persons; accounting development updates; and updates on credit rating agency developments. in addition, the Audit committee hosted a series of ‘deep dives’ to which all Board members were invited, and which provided an in-depth review of the operations of each of the business divisions and of the latest accounting standards and operating methodologies.
Accountability internal control The Board is responsible for the establishment and review of the Group’s system of internal control, which is designed to ensure effective and efficient operations; quality of internal and external reporting; internal control; and compliance with laws and regulations. it should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. in establishing and reviewing the system of internal control, the directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. it follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss.
Shareholder engagement The Board recognises the importance of promoting mutual understanding between the company and its shareholders through greater engagement. in 2012, there was regular dialogue with institutional shareholders with more than 400 equity investor meetings undertaken in the year. Many of these meetings were undertaken by senior management (primarily the Group chief Executive and Group Finance director) or other Board members. The chairman has also attended a number of meetings with shareholders to discuss governance and the Group's strategic direction. Anthony Watson, the chairman of the Remuneration committee and the senior independent director, regularly meets the larger shareholders to listen to their views and discuss executive remuneration issues.
The Board is kept advised of the views of major shareholders by means of regular updates at Board and committee meetings. it also receives monthly reports on market and investor sentiment and shareholder analysis.
The company secretary oversees communications with private shareholders. The Group’s annual general meeting provides an opportunity to meet the Group’s directors and to hear more about the strategy of the Group. shareholders are encouraged to attend the annual general meeting and to raise any questions at the meeting or in advance, using the email address shown in the pack which will be sent to shareholders in March 2013.
Scottish Widows investment Partnership scottish Widows investment Partnership, one of Europe’s largest asset managers and a Group company, complies with the principles of the Financial Reporting council’s stewardship code. details of scottish Widows investment Partnership’s approach to stewardship and corporate governance can be found on its website, www.swip.com.
The Group has adopted the disclosure code and its 2012 financial statements have been prepared in compliance with the disclosure code’s principles.
Board committees set out below is a summary of the membership and role of each of the Board committees, along with the activities they performed during 2012. There is a standing invitation for all non-Executive directors to attend committee meetings of which they are not members. non-Executive directors routinely attend committees of which they are not members. All committee terms of reference are available on the website, www.lloydsbankinggroup.com or from the company secretary.
– reviews the Group’s arrangements by which staff of the company may, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters.
Reviewed and challenged the impairment methodologies and assumptions and were satisfied that they were appropriate.
Valuation of assets and liabilities arising from life insurance business considered and challenged the assumptions underlying the calculation of assets and liabilities arising from the life insurance business and were satisfied that they were appropriate.
RiSK To review and report its conclusions to the Board on the Group’s risk appetite (the extent and categories of risk which the Board regards as acceptable for the company to bear) and the Group’s risk management framework (embracing principles, policies, methodologies, systems, processes, procedures and people), taking a forward looking perspective and anticipating changes in business conditions.
The ongoing economic challenges currently encountered in our industry and across all aspects of life naturally lead to continuing attention being placed on executive remuneration. As a committee we have a strong belief in aligning the pay delivered to our executives with the successful performance of the business and, through this, the return of value to our shareholders as set out in our 2011 strategic Review. To this end, we have continued to develop our performance management process, with the close participation of our Risk team, to embed meaningful challenging but responsible performance measures across our reward structure, which reflect Group and divisional achievement in addition to personal contribution. in order to further align reward to the longer-term, sustainable success of the business we plan to introduce changes to our annual incentive scheme from 2014 to better connect the interests of colleagues with shareholders and to ensure a fair distribution between all stakeholders of the benefits which result from the Group meeting its performance targets.
With respect to the proposed reporting of supplementary data – including comparative tables to show the movement of Group chief Executive pay against TsR, or the relative growth in the total cost of pay against Group profit and dividend performance – we have taken the decision not to incorporate the proposals of these draft regulations in advance of enactment. Whilst the inclusion of illustrative examples of these tables may add value by enabling a year-on-year comparison to be drawn in next year’s report, as consultations on the nature and scope of these new disclosures and graphs are still ongoing, there remains a possibility that these may change significantly over the course of the year.
Deferred into shares until at least March 2015, subject to malus
Based on financial measures and on a balanced scorecard of non-financial measures (based on actual award value)
The committee firmly believes that fixed pay should be positioned competitively but conservatively against the market and that the variable pay offered to our executives should be directly aligned to the delivery of value to our shareholders. Although shareholder return and operational effectiveness have been very positive over the course of the year, we feel it is appropriate that the fixed pay elements for our directors should remain unchanged for a further 12 months in recognition of the continuing economic climate and the need to deliver further, sustained economic growth to our shareholders. in addition, bonus awards in respect of the 2012 year have been determined conservatively against the robust performance measures set. The bonus awards will be deferred into shares for varying periods according to the seniority or role of the individual (see page 103 for further information) with attached malus provisions to enable the adjustment of awards where such awards are subsequently considered by the committee not to reflect appropriately the performance in the period to which they relate. We have demonstrated through the adjustment of bonus payments made in respect of previous years that we are comfortable executing the malus provisions for these awards in situations where it is appropriate to do so.
Across the business as a whole, the Remuneration committee feels it is important to recognise the contribution of our colleagues in achieving success against our strategic goals and to enable them to share in that success through the payment of bonuses. The assessment of the value of bonus pool to be made available has been undertaken in consideration of our relative, risk-adjusted performance for the year and with a focus on ensuring that the reward is weighted towards our more junior staff. The total bonus pool of £365 million in 2012, which reflects the final statutory results for the Group, is down 3 per cent on 2011 and represents 7 per cent of the pre-bonus management profit before tax compared to 12.5 per cent in the prior year. The average value of bonus per employee is similar to the prior year at £3,900.
As a committee we are keen to continually review our policy approach and to explore ways in which we may strengthen and simplify the alignment of the Group’s remuneration package with the company’s business performance and relative value to shareholders. Over recent years we have introduced to our bonus scheme a mandatory deferral into shares for awards made to our Executive directors and for any awards in excess of a specific threshold made to other staff. As noted above, our aim is that from 2014 we will implement a restructure of our package which will more effectively recognise the connection between the impact of short-term and long-term goals in driving forward our business and will also further facilitate the adjustment of awards for malus.
This is a report made by the Board of lloyds Banking Group plc, on the recommendation of the Remuneration committee. it covers the current and proposed components of the remuneration policy and details the remuneration for directors during 2012.
Directors’ remuneration policy The Group’s remuneration policy continues to support our business values and strategy, based on building long-term relationships with our customers and employees and managing the financial consequences of our business decisions across the entire economic cycle.
Our policy is intended to ensure that our remuneration proposition is both cost effective and enables us to attract and retain Executive directors and senior management of the highest calibre, motivating them to perform to the highest standards.
We build relationships with our customers and people. Working for lloyds Banking Group is about more than pay. Our relationship with our people means that we want to pay them fairly and competitively, but our pay is positioned conservatively against the market and we do not seek to align with the highest payers in the sector. in setting pay for Executive directors and senior managers, we take account of relative pay positioning and target levels of variable remuneration opportunity for all levels of employees in the Group.
Our incentive measures are not just financial. Our Balanced scorecards, which are incorporated into the performance objectives of all of our senior executives for the year, include objectives that cover effective risk management, lending to corporates including sMEs and retail customers, performance against targets that measure how satisfied our customers are with our service and the extent to which our employees feel engaged with and committed to working for lloyds Banking Group.
Executives are also aligned with shareholders through the lTiP, which pays out in shares based on performance against Group financial targets over a three year period. in addition to purely financial metrics of Economic Profit and Total shareholder Return, the performance conditions for the 2013 lTiP will comprise measures linked to the strategic Review that reflect the wider Group objectives. These measures are sME lending, customer satisfaction, total costs at the end of 2015 and non-core assets (excluding uK Retail) at the end of 2015.
We also have non-financial measures of performance against risk objectives in both the annual and long-term incentive plans for executives.
When setting the policy for directors’ remuneration, the committee seeks confirmation from the company’s shareholders that its approach is acceptable and over the course of 2012 we have entered into frequent consultation with shareholders and representative bodies who control a significant majority of the Group's share base and all views are taken into consideration in relation to remuneration policy and implementation. We do not directly consult with employees as part of the process of reviewing executive pay, however we are kept informed on general remuneration feedback across the Group in addition to receiving updates on employee engagement surveys and take these into account.
Summary Following extensive consultation with shareholders, the Remuneration committee is proposing a package for Executive directors for 2013 that is closely based on the structure and principles applied in previous years as follows: element Level/design for 2013 Key purpose
Base salary Base pay should be set relative to FTsE 20 and banking sector competitors
Motivation and retention of executives Alignment with sound risk management Alignment with long-term shareholder interests
Base salary Base salaries are reviewed annually, taking into account individual performance and market information (which is provided by Towers Watson and supplemented with information from deloitte llP) and normally adjusted from 1 January of the relevant year. The remuneration committee confirmed during the 2012 review that the FTsE remains the most appropriate comparator group to use to benchmark overall competitiveness of the remuneration package whilst taking particular account of the remuneration practice of our direct competitors, namely the major uK banks.
The maximum annual incentive opportunity is 200 per cent (225 per cent for the Group chief Executive) of base salary for the achievement of exceptional performance targets.
Deferral consistent with the aim of ensuring that short-term financial results are only rewarded if they promote sustainable growth, the 2012 annual incentive is subject to deferral in shares until at least 2015. This deferred amount is subject to malus if the performance that generated the incentive is found to be unsustainable. in 2012 the FsA has reviewed the Group’s Risk-adjusted Performance assessment process and advised that it is considered a sound framework.
independent non-executive Directors’ fees The fees of the independent non-Executive directors are agreed by the Board within a total amount determined by the shareholders. non-Executive directors may also receive fees, agreed by the Board, for membership of Board committees. The fees are designed to recognise the various responsibilities of a non-Executive director’s role and to attract individuals with relevant skills, knowledge and experience. The fees are neither performance related nor pensionable and are comparable with those paid by other companies.
All the independent non-Executive directors are invited to attend meetings and have the opportunity to comment on proposals and have their views taken into account before the committee’s decisions are implemented.
The members of the committee during 2012 were as follows: – Anthony Watson (chairman)
during 2012, deloitte provided information on behalf of the committee for the testing of TsR performance conditions for the Group’s long-term incentive plans (calculated by reference to both dividends and growth in share price).
The proposals for the package to be offered to our Executive directors in 2012 were detailed within the directors’ Remuneration Report for 2011 and were voted upon within the 2012 Annual General Meeting. The shareholder votes submitted at the meeting, either directly, by mail or by proxy, were as follows: votes cast (number of shares – millions) Percentage of votes cast
Dilution limits The following charts illustrate the shares available for the Group’s share plans.
Benefits from a registered pension scheme are subject to the lifetime Allowance, currently £1.5 million, which is equivalent to an annual pension of £75,000. Any benefit in excess of this amount will incur a tax charge for the individual. The Group has agreed that if an Executive director has benefits in excess of the lifetime Allowance he may cease to accrue benefits in the scheme and receive a salary supplement as an alternative. This will not cost the Group more than the current arrangements. The Group will not compensate any individual in respect of any tax liability arising from the provision of pension.
Lloyds Banking Group Annual Report and Accounts 2012108 interests in share options (audited) At
Lloyds Banking Group long-term incentive plan (audited) The following table shows conditional shares awarded under the plan.
c Mr Tookey’s unvested awards all lapsed upon his departure from the Group on 24 February 2012.
At the end of the relevant period, neither of the performance conditions had been met and the Awards lapsed.
Synergy Savings: The release of 50 per cent of the shares was dependent on the achievement of target run rate synergy savings in 2009 and 2010 as well as the achievement of sustainable synergy savings of at least £1.5 billion by the end of 2011. The award was broken down into three equally weighted annual tranches. Performance was assessed at the end of each year against annual performance targets based on a trajectory to meet the 2011 target. The extent to which targets were achieved determined the proportion of shares to be banked each year. Any release of shares was subject to the Remuneration committee judging the overall success of the delivery of the integration programme.
integration Balanced Scorecard: The release of the remaining 50 per cent of the shares was dependent on the outcome of a Balanced scorecard of non-financial measures of the success of the integration in each of 2009, 2010 and 2011. The Balanced scorecard element was broken down into three equally weighted tranches. The tranches were crystallised and banked for each year of the performance cycle subject to separate annual performance targets across the four measurement categories of Building the Business, customer, Risk and People and Organisation development.
March 2010 ePS: Relevant to 36 per cent of the award. Performance to be measured based on absolute improvement in adjusted EPs over the three financial years starting on 1 January 2010 relative to an adjusted fully diluted 2009 EPs base.
March 2011 ePS: Relevant to 331/3 per cent of the award. Performance will be based on 2013 EPs outcome.
Anthony Watson 376,357 476,357 shareholdings held by Mr A Horta-Osório and Mr T T Ryan are either wholly or partially in the form of AdRs.
A summary of transactions undertaken in the year, including share plan awards vested plus open market purchases and sales made by directors is shown on page 114.
none of those who were directors at the end of the year had any other interest in the capital of lloyds Banking Group plc or its subsidiaries.
M G culmer 872,475 16/5/12 872,169 872,169 shares purchased on appointment monthly 2,491 2012 share incentive Plan purchase and matching shares non-executive Directors sir Winfried Bischoff 1,100,000 2/8/12 200,000 Purchase 1,300,000 lord Blackwell – 12/6/12 50,000 Purchase 50,000 c J Fairbairn – –
This section highlights the Principal Risks and Uncertainties as well as the Emerging Risks faced by the Group and explains how all risk types are managed.
Further information can be found under note 2(H) (Accounting Policies) on page 219 and note 55 (Financial Risk Management) on page 318.
q Prudent approach to underwriting and provisioning has made portfolios resilient to future stresses.
Priorities for 2013 q strategy: continue to support delivery of the Group’s customer focused strategic plan within risk appetite.
q Risk culture: Maintain and strengthen the Group’s strong risk culture by managing performance to ensure risk based behaviours.
We believe effective risk management can be a strategic differentiator, in particular: – Conservative approach to risk: The Group has a fully embedded conservative approach to, and prudent appetite for risk with risk culture and appetite driven top down.
– Strong control framework: The Group has a strong risk control framework which is the foundation for the delivery of effective risk management. This framework ensures appropriate engagement in developing risk appetite whilst also ensuring business units operate within approved parameters.
– The Group’s risk culture is embedded within its approach to managing credit risk: Board level credit risk appetite is supported by more detailed metrics at divisional and business level; measurement of credit risk for loans and advances to customers at counterparty level; internal systems of control such as credit policies, assurance and review, controls over rating systems, stress testing and scenario analysis; collateral; master netting agreements and support for customers in difficulty.
Prudent risk appetite and strong risk management resulted in a reduction of 42 per cent in the Group’s impairment charge.
non-core assets reduced by £42.3 billion and international presence was reduced in line with the Group’s strategy to focus on the uK.
Further detail on the Group’s Risk drivers and how the Group manages risk can be found on page 131.
For further information on the economy see pages 19 and 20.
Arising mainly in the Retail, commercial Banking, and Wealth, Asset Finance and international divisions, reflecting the risks inherent in the Group’s lending activities and, to a lesser extent in the insurance business in respect of investment holdings and exposures to reinsurers. Adverse changes in the credit quality of the Group’s uK and/or international borrowers and counterparties, or in their behaviour, would be expected to reduce the value of the Group’s assets and increase the Group’s write-downs and allowances for impairment losses. credit risk can be affected by a range of macroeconomic environment and other factors, including, inter alia, increased unemployment, reduced asset values, lower consumer spending, increased personal or corporate insolvency levels, reduced corporate profits, increased interest rates and/or higher tenant defaults.
The Group has a number of market risks, the principal ones being: – interest rate risk: This risk to the Group’s banking income arises from competitive pressures on product terms in existing loans and deposits, which sometimes restrict the Group in its ability to change interest rates applying to customers in response to changes in interbank and central bank rates. A further related risk arises from the level of interest rates and the margin of interbank rates over central bank rates.
– Equity risk: This risk arises from movements in equity market prices. The main equity market risks arise in the insurance business and defined benefit pension schemes.
in addition, profit and loss triggers are used in the Trading Books in order to ensure that mitigating action is discussed if profit and loss becomes volatile.
The principal operational risks currently facing the Group are: – iT systems and resilience: The risk of loss resulting from the failure to develop, deliver or maintain effective iT solutions. The resilience of iT in terms of its availability to customers and colleagues is of paramount importance to the Group.
– customer process: The risk of new issues, process weaknesses and control deficiencies within the Group’s customer facing processes as the business continues to evolve.
People risk is defined as the risk that the Group fails to lead, manage and enable colleagues to deliver to customers, shareholders and regulators leading to reductions in earnings and/or value.
LiqUiDiTy AnD FUnDinG RiSK Definition liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost.
Mitigating actions liquidity and funding risk appetite for the banking businesses is set by the Board and this statement of the Group’s overall appetite for liquidity risk is reviewed and approved annually by the Board.
Lloyds Banking Group Annual Report and Accounts 2012124 inSURAnCe RiSK Definition insurance risk is defined as the risk of adverse developments in the timing, frequency and severity of claims for insured/underwritten events and in customer behaviour, leading to reductions in earnings and/or value.
insurance risk has the potential to significantly impact the earnings and capital position of the insurance business of the Group. For the Group’s defined benefit pension schemes, insurance risk could significantly increase the cost of pension provision and impact the balance sheet of the Group.
– insurance risk is controlled by robust processes including underwriting, pricing-to-risk, claims management, reinsurance and other risk mitigation techniques.
in addition, the Group is subject to European union state Aid obligations in line with the Restructuring Plan agreed with HM Treasury and the Eu college of commissioners in november 2009, which is designed to support the long-term viability of the Group and remedy any distortion of competition and trade in the European union (Eu) arising from the state Aid given to the Group. This has placed a number of requirements on the Group including an asset reduction target from a defined pool of assets by the end of 2014, known as Project Atlantic, and the divestment of certain portions of its Retail business by the end of november 2013, known as Project Verde. There is a risk that if the Group does not deliver its divestment commitments by november 2013, a divesture Trustee would be appointed to dispose of the divestment, which could be sold at a negative price.
The Group continues to make good progress in respect to its state Aid commitments. in line with the strengthening of the balance sheet, the Group has made excellent progress against its asset reduction commitment and reached the reduction total required in december 2012, two years ahead of the mandated completion date. The Group is currently working with the European commission to achieve formal release from this commitment.
Mitigating actions The Group is actively supporting sustainable growth in the uK economy through the focused range of products and services provided to business and personal customers, as well as through partnerships with industry and Government. capital, liquidity and credit risk are managed conservatively and non-core asset reductions remain ahead of schedule ensuring the Group is better placed to address macroeconomic shocks.
One such area of potential regulatory change relates to the Bank of England’s interim Financial Policy committee (FPc) which published its Financial stability Report on 29 november 2012. The report recommended that the Financial services Authority takes action to ensure that the capital of uK banks and building societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights. The FsA is expected to respond prior to the March FPc meeting.
Mitigating actions The Group has made significant progress and continues to deliver on its strategy of strengthening the balance sheet, including its capital position, to improve the resilience of the Group.
– Prudent internal models, based on empirical data, that meet regulatory and stringent internal requirements.
Group product governance controls – potential risks are monitored through product management information, new product approvals and annual product reviews leading to identification and mitigation of risks at an early stage.
Mitigating actions The Group continues to monitor potential changes and where appropriate provide feedback.
Further information can be found under note 57 on page 342: Future accounting developments.
Risk governance lloyds Banking Group Enterprise Risk Management (ERM) framework provides a robust and consistent approach to risk management across the Group and is a core component of the Group’s internal Governance framework. Throughout 2012 the integrated governance, risk and control frameworks were further embedded continuing the use of a consistent approach to risk appetite, delegated authorities and governance committee structures.
Group Functions Executive committees sWiP Risk committee commercial Banking Risk committee
Board, executive and Risk Committees The Group’s risk governance structure (see table 1.1) strengthens risk evaluation and management, while also positioning the Group to manage the changing regulatory environment in an efficient and effective manner.
insurance Risk committee Monitors, reviews and makes recommendations on the risk management framework, risk strategy and appetite for the insurance business, ensuring that the policy and oversight framework for insurance risk management is appropriate. The committee reviews and challenges relevant insurance reporting and issues arising, including: the Group’s aggregate portfolio of insurance risk against approved plans and risk appetite and the need and opportunity for effecting insurance risk mitigation.
Risk management oversight Risk division, headed by the chief Risk Officer, consists of thirteen Risk directors and their specialist teams. These teams provide oversight and independent challenge to business management and support senior management and the Board with independent reporting on risks and opportunities. Risk directors, responsible for each risk type, meet on a regular basis under the chairmanship of the chief Risk Officer to review and challenge the risk profile of the Group and to ensure that mitigating actions are appropriate.
Re g ul at or y ris k c ap ita l r is k
The risk appetite is proposed by the Group chief Executive following review by the Group Risk committee and Group Asset and liability committee, and is approved by the Board. The approved high level appetite and limits are delegated to the Group chief Executive and then cascaded in consultation with the Group Risk committee and Group Asset and liability committee to members of the Group Executive committee and the business.
Risk assessment and measurement – risks are defined and categorised using a common risk language (see page 131). The impact of risks and issues is determined through effective risk measurement; including modelling, stress testing and scenario analysis to assess financial, reputational and regulatory capital implications (both qualitative and quantitative).
Control activities – robust frameworks are established across the Group covering policies, accountabilities and governance. Proportionate control activities mitigate or transfer risk where appropriate. The outcomes of independent reviews (including internal and external audit and regulatory reviews) are reflected in risk management activities and action plans. Risk and control assessments including the annual control effectiveness review assess the effectiveness of mitigating actions and whether risk exposures are consistent with the Group’s risk appetite.
Monitoring and oversight – regular checks are carried out to ensure the Group’s risk management approach and controls are effective with sufficient oversight in place. Risk division oversees the effective implementation of policy, and Group Audit provides independent assurance to the Board about the effectiveness of the Group’s internal control framework and adherence to policy. Monitoring processes are in place supporting the reporting and escalation of significant issues or losses to appropriate levels of management. Business areas monitor and report on their risk levels against risk appetite and their performance against relevant limits or policies.
Full analysis of risk drivers The Group’s risk framework covers all types of risk which affect the Group and could impact on the achievement of its strategic objectives. Following a review in 2012 the Group has moved from six to eleven risk categories to provide greater focus over significant areas of risk. A detailed description of each category is included below.
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Risk appetite credit risk appetite is set at Board level and is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio performance measures, which may include the use of various credit risk rating systems as inputs. These metrics are supported by more detailed appetite metrics at divisional and business level and by a comprehensive suite of policies, sector caps, product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite.
in terms of loans and advances, credit risk arises both from amounts lent and commitments to extend credit to a customer as required. These commitments can take the form of loans and overdrafts, or credit instruments such as guarantees and standby, documentary and commercial letters of credit. With respect to commitments to extend credit, the Group is potentially also exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail term commitments to extend credit can be cancelled without notice and the creditworthiness of customers is monitored frequently. in addition, most corporate commitments to extend credit are contingent upon customers maintaining specific credit standards, which are monitored regularly.
The quality definition of both retail and non-retail counterparties/exposures is largely based on the outcomes of credit risk (probability of default – Pd) models. The Group operates a significant number of different rating models, typically developed internally using statistical analysis and may use management judgement – retail models rely more on the former; non-retail models include more of the latter, especially in the larger corporate and more specialised lending portfolios. internal data is supplemented with external data in model development, where appropriate.
concentration risk: credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite as well as individual limit guidelines. credit policy is aligned to the Group’s risk appetite and restricts exposure to certain high risk countries and more vulnerable sectors and segments. note 20 on page 251, provides an analysis of loans and advances to customers by industry (for wholesale customers) and product (for retail customers). Exposures are monitored to prevent an excessive concentration of risk and single name concentrations. in addition correlated concentration risks to sectors and movements in such concentrations are monitored regularly to guide risk appetite and limit setting, identify unwanted concentrations, and provide an early warning indicator for potential excesses. 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.
credit risk assurance and review: Group credit Risk Assurance, a team within Group Audit comprising experienced credit professionals, is also in place. in conjunction with Risk senior management, this team carries out independent risk based credit reviews, providing individual business unit assessment of the effectiveness of risk management practices and adherence to risk controls across the diverse range of the Group’s wholesale businesses and activities, facilitating a wide range of audit, assurance and review work. These include cyclical (‘standard’) credit reviews, non-standard reviews, and bespoke assignments, including impairment adequacy reviews as required. The work of Group credit Risk Assurance continues to provide executive and senior management (and Audit committee) with assurance and guidance on credit quality, effectiveness of credit risk controls and Business support unit work out strategies as well as accuracy of impairments.
The Group’s approach to underwriting applications for unsecured products in Retail takes into account the total unsecured debt held by a customer and their affordability. The Group rejects any application for an unsecured product where a customer is registered as bankrupt or insolvent, or has a county court Judgment registered at a cRA used by the Group. in addition, for credit cards the Group rejects any applicant with total unsecured debt greater than £50,000 registered at the cRA; or revolving debt-to-income ratio greater than 75 per cent; or total unsecured debt-to-income ratio greater than 100 per cent. For unsecured personal loan applications, we reject any applicant with total unsecured debt greater than £50,000 registered at the cRA. Rules around refinancing of debt have also been made more stringent since 2009 as a result of the application of rules relating to the total unsecured debt held by a customer and the Group’s approach in assessing affordability. This has resulted in fewer customers being eligible to refinance unsecured debt.
The performance of all rating models is monitored on a regular basis, in order to seek to ensure that models provide appropriate risk differentiation capability, the generated ratings remain as accurate and robust as practical, and the models assign appropriate risk estimates to grades/pools. All models are monitored against a series of agreed key performance indicators. in the event that the monitoring identifies material exceptions or deviations from expected outcomes, these will be escalated in accordance with the governance framework set by the Group Model Governance committee.
– income support for Mortgage interest – This is a Government medium-term initiative that provides certain defined categories of customers, principally those who are unemployed, access to a benefit scheme, paid for by the Government, which covers all or part of the interest on the mortgage. Qualifying customers are able to claim for mortgage interest on up to £200,000 of the mortgage. All decisions regarding an individual’s eligibility and any amounts payable under the scheme rest solely with the Government. Payments are made directly to the Group by the appropriate Government department. – Homeowner Mortgage support scheme – This is a Government medium-term initiative that enables borrowers affected by temporary reductions in income to access reduced payments for a period of up to two years. The Government provides a partial guarantee to the Group whilst a customer participates in the plan. decisions on eligibility, principally whether the Group expects the borrower’s earnings to recover fully, initially rest with the Group and must be made on the basis of detailed information received from an independent fee-free advisor. After a year, the customer must undergo a further full assessment made by the advice agency. The customer must pay at least 30 per cent of the interest due. Any shortfall in payments made during the period covered by the scheme is collected through increased payments over the remaining term. The scheme was closed to new customer applications in April 2011 by the department of communities and local Government. – Mortgage Rescue scheme – This is a Government short-term initiative for borrowers in difficulty and facing repossession, who would have priority for re-housing by a local authority (e.g. the elderly, disabled, single parents). Eligible customers can have their property bought in full or part by the social rented sector and then remain in their home as a tenant or shared equity partner. if the property is sold outright the mortgage is redeemed in full.
in order to support commercial customers that encounter difficulties during the current economic downturn, the Group increased the size of its dedicated Business support unit (Bsu) to cover all its uK and international portfolios.
The over-arching aim of Bsu is to work with each customer to try and resolve the issues, to restore the business to a financially viable position and facilitate a business turnaround. This could be through a number of channels, including providing advice on how to develop and implement turnaround strategies, and considering potential restructuring of debt and forbearance.
– determining the most appropriate corporate and capital structure suitable for the work-out strategy concerned.
The Group recognises that forbearance alone is not necessarily an indicator of impairment but is a trigger point for it to review the customer’s credit profile.
in addition, the Group, through its banking businesses, participates in a number of initiatives designed to assist small and medium-sized enterprises. These include: – The lending code: A voluntary code of practice covering its subscribers’ dealings with consumers, micro-enterprises and charities with an income of less than £1 million, in respect of current account overdrafts, loans, credit cards and lending. it sets standards for financial institutions to follow in order to ensure that firms act fairly and reasonably in all dealings with uK customers. in addition to providing protection for customers, it also gives guidance as to how firms should treat them on both a day to day basis, and when they suffer times of financial difficulty. – Business Finance Taskforce: The Group, through its banking businesses, has taken a leading role in the Business Finance Taskforce, which committed to a number of key actions in three broad areas: (i) improving customer relationships; (ii) ensuring better access to finance (for example, through regular in-depth surveys of sME customers, including Ethnic Minority Businesses and Female led Businesses); and (iii) providing better information and promoting customer understanding (including sponsorship of the Enterprise Research centre). – The lending appeals process: if a lending application is declined, customers have the right to appeal that decision. The Group has committed to go beyond industry agreed standards in this area and has pledged to respond to 90 per cent of appeals with a decision within 15 working days. in addition to this, customers will receive a goodwill payment for each overturned decline. The appeals process is overseen by the independent External Reviewer of Appeals. – Business mentoring: Businesses may benefit from the support of a business mentor. A free online service, offered by ‘mentorsme’ enables businesses to locate local independent mentoring organisations that suit their specific business needs. The Group has committed to having 400 trained mentors across the uK available to businesses free of charge through a network of not for profit mentoring agencies. We also partner several mentoring initiatives to support sME including the EdA (Enterprise diversity Alliance), young enterprise through our Enterprise Awards and social enterprise through work with Business in the community and the school of social Entrepreneurs. – The Government’s national loan Guarantee scheme (nlGs) through which the Group will provide discounted funding to sMEs with a turnover of up to £250 million over the next five years. The Group issued its full allocation of funding for the scheme and is continuing to market these facilities in order to ensure that the full benefit of the scheme is passed on to sME customers. – 2013 sME charter: The 2013 sME charter details the Group’s commitment to supporting uK business and, amongst others, includes pledges that: – The Group will deliver net lending that is positive and ahead of the industry as a whole.
Wealth, Asset Finance and international 1,480 3,604 59 impairment charge as a % of average advances 1.02% 1.62% (60)bp
Wealth, Asset Finance and international 1,458 3,571 59 non-core impairment charge 3,778 6,900 45 impairment charge as a % of average advances 3.08% 4.60% (1.52)pp
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions1 impairment provisions as a % of impaired loans2
Overview – The Retail impairment charge was £1,270 million in 2012, a decrease of 36 per cent, against 2011 primarily driven by the unsecured portfolio as a result of the Group’s sustainable risk appetite and ongoing effective portfolio management.
impairment provisions as a percentage of impaired loans are calculated excluding unsecured loans in recoveries.
Table 1.16: impairments on Retail loans and advances – non-core (unaudited)
secured The secured impairment charge decreased to £377 million from £463 million in 2011 reflecting further reductions in impaired loans. The annualised impairment charge, as a percentage of average loans and advances to customers, decreased to 0.12 per cent in 2012 from 0.14 per cent in 2011. Provision coverage has remained stable at 25.6 per cent compared to 31 december 2011.
The value of mortgages greater than three months in arrears (excluding repossessions) increased to £9,637 million at 31 december 2012 compared to £9,560 million at 31 december 2011. The value of mortgages subject to forbearance (reduced contractual monthly payment treatment) reduced from £3,923 million (1.2 per cent) at 31 december 2011 to £2,706 million (0.8 per cent) at 31 december 2012.
unsecured The impairment charge on unsecured loans and advances to customers reduced by £614 million in 2012 to £893 million compared with 2011. The impairment charge as a percentage of annualised average loans and advances to customers decreased to 3.74 per cent in 2012 from 5.65 per cent in 2011.
core impaired loans reduced by £807 million to £5,907 million compared with 31 december 2011. This arose from a number of factors, including the sale of previously impaired assets. An increase in the core coverage ratio to 48.5 per cent from 47.3 per cent at 31 december 2011 was seen as a result of a few specific cases. As a percentage of closing core advances, core impaired loans reduced to 5.6 per cent compared to 6.1 per cent at 31 december 2011.
Total 172,439 loans and advances to banks 8,461 debt securities 12,490
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions impairment provisions as a % of impaired loans
Available-for-sale financial assets 9,400 corporate Real Estate Bsu includes direct real estate and other real estate related sectors (such as hotels, care homes and housebuilders).
supporting its clients through the cycle remains a key aim and the Group continues to operate control and monitoring activities which play an important role in identifying customers showing early signs of financial stress and bringing them into the Group’s support model so prompt and supporting actions can be taken.
Global Corporates – The core portfolio continues to be predominantly investment grade focused, the overall portfolio asset quality remains strong and Major corporate balance sheets continue to de-lever. This year has seen a limited number of mergers and acquisitions. These are being selectively targeted by corporates, with conservative structuring approaches being adopted, and subsequent focus on rapid deleveraging. The Group continues to see softness in sectors such as Media, Retail, leisure and construction across the uK and continental Europe. Public sector austerity continues to impact on recovery prospects, although the long lead-in times to these cuts have allowed corporates to adjust their own structures and cost bases.
Acquisition Finance (leveraged lending) – The Group’s core portfolio is performing in line with expectations given the economic environment. Many customers are prepaying facilities ahead of schedule. The portfolio is predominantly within the good book business and all such loans are performing. The Group continues to write new business within its through the cycle credit risk appetite parameters.
Corporate Real Estate Business Support Unit (BSU) strong progress has been maintained in reducing the non-core corporate Real Estate Bsu portfolio with the gross loans and advances falling to £15.7 billion (2011: £21.1 billion) which is ahead of expectations. This is primarily due to the momentum on asset disposals which totalled around £4 billion (net cash proceeds) in the year despite the declining volume of transactions in the regional markets. There has been a material reduction in the level of gross loans and advances through disposals (including write-offs) since 30 June 2009. The full year non-core corporate Real Estate Bsu impairment charge has continued its downward trend to £1.2 billion (2011: £1.3 billion) despite the difficult market conditions.
Lloyds Banking Group Annual Report and Accounts 2012150 corporate Real Estate Bsu has continued to execute its active asset management programme of this complex portfolio making strong progress in a difficult real estate market. The principal aim is to minimise losses for the Group and to support the Group’s clients through difficult periods. This activity can involve the restructuring of loans, seeking deleverage through asset sales and other sale initiatives. A consensual route with its clients is always the Group’s preferred option.
Values in the commercial Real Estate market have trended downwards over the last 12 months, falling on average by 4.2 per cent on the same period last year. investment volumes have by and large been steady, though investor appetite has been concentrated on london. Although values in london continue to climb and are 39 per cent above their 2009 trough, non-london asset values are struggling and are now only 5 per cent above their 2009 trough. With a continuing high level of loan maturities due over the next few years, refinancing risk remains a market wide risk, although loans in non-core Bsu are predominantly bilateral. in assessing the Group’s impairment provisions, allowance is taken for the Group’s greater proportion of secondary real estate assets. consequently a steeper fall in real estate prices, compared to the general market index expectations, is used to calculate impairment provisions.
specialised lending loans and advances to customers of £15.0 billion largely comprise balances in the structured corporate Finance portfolio, which includes the portion of the Acquisition Finance (leveraged lending) portfolio which falls into non-core since it is outside the Group’s risk appetite, and the non-core Asset Based Finance portfolios (ship Finance, Aircraft Finance and Rail capital). While the effects of subdued uK economic conditions and refinancing risk continues to be felt in this portion of the Acquisition Finance portfolio, the non-core portfolio is now smaller in size and has a generally lower risk profile than in previous reporting periods which led to a significantly lower impairment charge during 2012 compared to 2011.
Other loans and advances to customers of £9.2 billion largely comprise balances in non-core Australian corporate (£2.3 billion), Wholesale Europe (£2.2 billion) and Entrepreneurs (£2.0 billion) businesses. The Group significantly reduced its exposure and impaired assets in its Australasian business by £3.4 billion and £2.2 billion respectively during 2012, largely due to asset sales including the successful disposal of a £0.8 billion portfolio of impaired Australasian real estate loans. net corporate Real Estate exposure in Australia now only totals £0.1 billion as at 31 december 2012 (2011: £1.3 billion). The Group was also successful in reducing its Wholesale Europe non-core exposure during 2012, with disposals of £0.4 billion in the period.
UK Direct Real Estate in the Good Book – The Group’s good book exposure incorporates core and non-core, and totalled £18.0 billion at 31 december 2012. Approximately three quarters related to commercial real estate with the remainder mostly residential real estate. A large element of the residential exposure is to professional landlords in the Group’s sME business, where performance has been good. The entire good book portfolio has been fully reviewed and is performing acceptably. Approximately two thirds of the core commercial real estate portfolio was originated under heritage lloyds TsB credit risk criteria. The Group’s risk appetite requires it to look first at the underlying cashflows as part of credit assessment, alongside key requirements for good quality counterparties and a well spread tenant profile. The Group considers the value in security taken as a secondary repayment source, although its origination parameters for lTVs (based on heritage lloyds TsB risk appetite) are considered through the cycle.
Asset Finance: Total impairment charge 1,480 3,604 59 impairment charge as a % of average advances 3.12% 6.48% (3.36)pp
international: latin America and Middle East 46 36 78.3 31 86.1
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions1 impairment provisions as a % of impaired loans
Loans and advances to customers £m impaired loans £m Provisions £m loans and advances to customers £m impaired loans £m Provisions £m
The most significant contribution to impairment in ireland is the commercial Real Estate portfolio. Within the commercial Real Estate portfolio, 90.7 per cent of the portfolio is now impaired (compared to 90.2 per cent at 31 december 2011). The average impairment coverage ratio has increased in the year to 69.9 per cent (63.2 per cent at 31 december 2011) reflecting the continued deterioration in the irish commercial property market. Mortgage lending at 31 december 2012 comprised 99.5 per cent of the retail portfolio with impairment coverage on the mortgage portfolio at 71.2 per cent (2011: 70.4 per cent). impaired loans on the retail portfolio increased by £119 million in 2012 compared to a £545 million increase in 2011. The reduction in growth of impaired loans is primarily due to a less uncertain economic environment.
£1,413 million of gross wholesale lending within the commercial Real Estate and corporate portfolios relates to sterling loans secured on uK property.
Other international Total impaired loans decreased by £128 million to £299 million compared with £427 million at 31 december 2011 and as a percentage of closing loans and advances decreased to 3.3 per cent from 4.0 per cent at 31 december 2011. The reduction in impaired loans is driven by latin America and Middle East. impairment provisions as a percentage of impaired loans have increased in spain Retail, netherlands Retail and Asia Retail, against a backdrop of falling residential property prices.
Asset Finance united Kingdom – the uK Asset Finance impairment charge reduced by 40 per cent to £121 million (of which 100 per cent related to non-core assets) driven by strong credit management and improving credit quality. The retail portfolio saw more customers meeting their payment arrangements resulting in a lower proportion of people falling into arrears. The retail impairments also benefited from debt sale activity during the course of the year. The number of defaults in all areas of the commercial and corporate lending book was low relative to the last three years, reflecting effective previous and ongoing credit risk management actions.
Lloyds Banking Group Annual Report and Accounts 2012158 exposures to eurozone countries The following section summarises the Group’s direct exposure to Eurozone countries at 31 december 2012. The exposures comprise on-balance sheet exposures based on their balance sheet carrying values and off-balance sheet exposures, and are based on the country of domicile of the counterparty unless otherwise indicated.
Exposures to Eurozone countries in addition to the exposures detailed above, the Group has the following exposures to sovereign, financial institutions, asset backed securities, corporates and personal customers in the following Eurozone countries: Table 1.38: Other eurozone exposures (unaudited)
At 31 december 2011 slovakia – – – – – – – – –
Total balances with other Eurozone countries have increased from £44,187 million to £59,557 million. This is due to an increase in sovereign debt balances held, which primarily relate to central bank balances held for regulatory liquidity purposes. Excluding cash at central banks, the remaining overall exposures have reduced by 29 per cent from £34,383 million to £24,514 million. derivatives with sovereigns and sovereign referenced credit default swaps are insignificant.
The Group has considered redenomination risk in respect of its exposures to ireland, spain, Portugal, Greece and italy and in the event of a member exit believes that the risks can be broadly classified as follows: – The Group is not significantly exposed to the redenomination impact of a Greek exit from the Euro as Greek-related exposures are very limited and are in any case predominantly ship finance facilities denominated in us dollar or sterling with contracts subject to English law. The Group’s exposures to italy, ireland, Portugal and spain are considered to be at potential risk of redenomination. Redenomination of contractual liabilities depends on, amongst other things, the terms of relevant contracts, the contents of the legislation passed by the exiting member state, the governing law and jurisdiction of the contract and the nationality of the parties of the contracts.
Projects are categorised depending on the level of perceived environmental and social risk and magnitude of impact they pose. The categories are as follows: category A – Projects with potential significant adverse social or environmental impacts that are diverse, irreversible or unprecedented; category B – Projects with potential limited adverse social or environmental impacts that are few in number, generally site-specific, largely reversible and readily addressed through mitigation measures; and category c – Projects with minimal or no social or environmental impacts.
A B C Total during 2012, no transaction was declined on environmental or social risk grounds, nor approved with exceptions.
Definition conduct risk is defined as the risk of customer detriment or censure and/or a reduction in earnings/value, through financial or reputational loss, from inappropriate or poor customer treatment or business conduct.
Definition Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market-implied inflation rates, credit spreads and prices for bonds, foreign exchange rates, equity, property and commodity prices and other instruments), lead to reductions in earnings and/or value.
defined benefit pension schemes The Group’s defined benefit pension schemes are exposed to significant risks from the constituent parts of their assets and from the present value of their liabilities, primarily equity and real interest rate risk. For further information on defined benefit pension scheme assets and liabilities please refer to note 42 on page 271.
Trading portfolios Based on the 1-day 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding 300 business days, the VaR for the years ended 31 december 2012 and 2011 based on the Group’s global trading positions is detailed in table 1.44.
The Group always seeks to maintain minimal interest rate re-pricing mismatch in its banking books. At any point in time, however, some small level of transitory risk will always exist pending, for example, contrary offsetting customer flows and the efficient hedging of the net position with the external market. in addition, during 2012, a number of risks to income have been managed. These include the potential risk of liBOR rising relative to the Bank of England Base Rate and the risk to net interest Margin of all interest rates remaining lower for longer than is implied by current market prices. such strategic hedges are executed only with the explicit approval of the Group Asset and liability committee. Overall this hedge portfolio has varied during 2012 as the Group Asset and liability committee, in response to changing economic conditions, has periodically reviewed and revised its opinion as to which of these various risks is the most likely to crystallise.
This is a risk based disclosure and the amounts shown would be amortised in the income statement over the duration of the portfolio. The measure, however, is simplified in that it assumes all interest rates, for all currencies and maturities, move at the same time and by the same amount.
insurance portfolios Market risks within the insurance business are measured using a variety of techniques including stress and scenario testing and, where appropriate, stochastic modelling. current and potential future market risk exposures are assessed and aggregated using risk measures based on 1-in-200 year stresses for insurance’s individual capital Assessment (icA) and other supporting measures, including, profit before tax, where appropriate. The stresses include sensitivities on the risk-free rate, equity investment volatility, widening of credit default spreads on corporate bonds and an increase in illiquidity premia, as applied to profit before tax and set out in note 38 on page 269.
Trading portfolios and Banking activities Management of the balance sheet is centralised and overseen by the Group Asset and liability committee. interest rate risk arising from the different repricing characteristics of the Group’s non-trading assets and liabilities, and from the mismatch between interest rate insensitive assets and interest rate sensitive liabilities, is managed centrally. Matching assets and liabilities are offset against each other and interest rate swaps are also used to manage the residual exposure to within the non-traded market risk appetite.
insurance portfolios investment holdings are diversified across markets and, within markets, across sectors. Holdings are diversified to minimise specific risk and the relative size of large individual exposures is monitored closely. For assets held outside unit-linked funds, investments are only permitted in countries and markets which are sufficiently regulated and liquid.
defined benefit pension schemes The Group agrees strategies for the overall mix of pension assets with the defined benefit pension scheme Trustees.
exposures The Group’s success depends on its ability to attract, retain and develop high calibre talent. Achievement of this aim cannot be guaranteed, particularly in light of ongoing regulatory and public interest in remuneration practices. Macroeconomic conditions and negative media attention on the financial services industry may also adversely impact employee retention, colleague sentiment and engagement.
Monitoring Monitoring and reporting is undertaken at Board, Group and business area committee levels, in accordance with delegated limits of authority which are themselves regularly reviewed and refreshed. Business unit risk exposure is reported to Risk division where it is aggregated at Group level and a report prepared. The report is discussed at the monthly Group Operational Risk committee, and matters can be escalated to the chief Risk Officer, or higher committees, if appropriate. A combination of systems, monthly reports from business areas, and oversight and challenge from the Risk division ensures that key risk measures are presented and debated on a monthly basis to an Executive audience.
exposures The major sources of people risk over the course of the next year can be grouped into four key areas; – The ongoing divestment of the bank’s branch network under project Verde continues to stretch resources in parts of the Group and increase operational complexity.
– colleague engagement, in the context of macroeconomic conditions, Group restructuring, and continued media scrutiny.
The quality, effectiveness and engagement of colleagues are fundamental to the Group’s successful delivery of its strategy.
Measurement A series of measures are used across the Group to monitor both short and long-term liquidity including: ratios, cash outflow triggers, wholesale funding maturity profile, early warning indicators and stress test survival period triggers. The Board approved liquidity risk appetite covers a range of metrics considered key to maintaining a strong liquidity and funding position, with regular reporting to GAlcO and the Board. strict criteria and limits are in place to ensure highly liquid marketable securities are available as part of the portfolio of liquid assets.
Mitigation The Group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through both short-term liquidity management and through the life of the funding plan. short-term liquidity management is considered from two perspectives; business as usual and liquidity under stressed conditions, both of which relate to funding in the less than one year time horizon. longer term funding is used to manage the Group’s strategic liquidity profile which is determined by the Group’s balance sheet structure. longer term is defined as having an original maturity of more than one year.
Monitoring liquidity is actively monitored at business unit and Group level. Routine reporting is in place to senior management and through the Group’s committee structure, in particular GAlcO which meets monthly. in a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event. liquidity policies and procedures are subject to independent internal oversight.
Lloyds Banking Group Annual Report and Accounts 2012178 daily monitoring and control processes are in place to address regulatory liquidity requirements. The Group monitors a range of market and internal early warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group. These are a mixture of quantitative and qualitative measures including daily variation of customer balances, changes in maturity profiles, cash outflows, funding concentration, primary liquidity portfolio, credit default swap (cds) spreads and changing funding costs.
in addition, the framework has two other important components: – Firstly, the Group carries out stress testing of its liquidity and potential cash flow mismatch position over both short (up to two weeks) and longer term (up to three months) horizons against a range of scenarios, including those prescribed by the FsA, on an ongoing basis. The scenarios and the assumptions are reviewed at least annually to gain assurance they continue to be relevant to the nature of the business. The Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
Wholesale funding Outflows calculated based on contractual maturity of wholesale funding with limited roll over.
Franchise viability Actions that need to be taken to maintain the Group’s core business franchise and reputation.
Six to nine months £bn nine months to one year £bn
Medium-term notes include funding from the credit Guarantee scheme (2012: £nil; 2011: £23.5 billion) and from the national loan Guarantee scheme (2012: £1.4 billion; 2011: £nil).
The Group has now fully repaid all debt issued under the uK Government’s legacy credit Guarantee scheme. in August the Group announced its support for the Government’s Funding for lending scheme (Fls) and confirmed its intention to participate in the scheme. The Fls represents a further source of cost effective secured term funding available to the Group. The initiative supports the Group’s customers and provides businesses with cheaper finance to invest and grow. The Group was the first uK bank to draw on the scheme in september 2012, drawing down £3 billion in total in 2012.
Excluding reverse repos and repos, loans and advances reduced by £36.7 billion; customer deposits increased by £16.6 billion, representing growth of 4 per cent in 2012. Over the year the Group has seen above market growth in customer deposits (2012: £422.5 billion, 2011: £405.9 billion) and a continued reduction in non-core assets (2012: £98.4 billion, 2011: £140.7 billion).
On the same basis, the Group loan to deposit ratio has improved to 121 per cent compared with 135 per cent at 31 december 2011, driven by strong deposit growth and non-core asset reduction. The core loan to deposit ratio also improved to 101 per cent from 109 per cent at 31 december 2011, close to the Group’s long-term target of 100 per cent for the core, which the Group continues to expect to reach in the first quarter of 2013, at the same time as achieving a 120 per cent ratio in the Group.
Excludes £19.6 billion (2011: £21.8 billion) of loans and advances to banks within the insurance business and £0.7 billion (2011: £0.5 billion) of reverse repurchase agreements.
Other assets and other liabilities primarily include balances in the Group’s insurance business and the fair value of derivative assets and liabilities.
Definition insurance risk is defined as the risk of adverse developments in the timing, frequency and severity of claims for insured/underwritten events and in customer behaviour, leading to reductions in earnings and/or value.
Monitoring Ongoing monitoring is in place to track the progression of insurance risks. This involves monitoring relevant experiences against expectations (for example claims experience, persistency experience, expenses and non-disclosure at the point of sale) as well as tracking the progression of insurance risk capital against limits. As part of this, the effectiveness of controls put in place to manage insurance risk are evaluated and any significant divergences from experience or movements in risk exposures are investigated and remedial action taken.
exposures Regulatory exposure is driven by the significant volume of current legislation and regulation within the uK and overseas with which the Group has to comply, along with new or proposed legislation and regulation which needs to be interpreted, implemented and embedded into day-to-day operational and business practices across the Group. This is particularly the case currently: the industry is witnessing increased levels of government and regulatory intervention in the banking sector.
Mitigation Mitigation is undertaken across the Group and comprises the following key components: – Risks are assessed by the business and controls put in place to mitigate them.
– Theme reviews to assess compliance with rules, regulations and policies.
As part of the capital planning process, capital positions are subjected to an extensive stress analysis to determine the adequacy of the Group’s capital resources against the minimum requirements, including icG, over the forecast period. The outputs from some of these stress analyses are used by the FsA to set a capital Planning Buffer (cPB) for the Group. This comprises minimum levels of capital buffers over and above the minimum regulatory requirements for core tier 1 and total capital that should be maintained in non-stressed conditions as mitigation against potential future periods of stress.
Monitoring capital is actively managed and regulatory ratios are a key factor in the Group’s budgeting and planning processes.
Core tier 1 shareholders’ equity per balance sheet 43,999 45,920 non-controlling interests per balance sheet 685 674
50% excess of expected losses over impairment provisions (unaudited) (636) (720)
Less: deductions from tier 1 50% of material holdings (46) (94)
Total £m loss attributable to ordinary shareholders (1,427) – – (1,427)
The reduction of commercial Banking risk-weighted assets of £27,676 million primarily reflects further balance sheet reductions of non-core assets.
during 2012 equity portfolios and investments previously measured on the standardised approach were transferred to the internal ratings based approach (Other iRB). The Group anticipates moving further portfolios that are currently measured on the standardised approach over to an iRB methodology during 2013.
unrealised gain on available for sale equity investments 56 56 –
– The deductions to be made from additional tier 1 exceed the amount of available additional tier 1 capital instruments. The excess is deducted from cET1.
– subsidiary surplus within tier 2 relates to the restriction of capital instruments of a subsidiary that can be recognised as capital at the consolidated group level.
The cRd iV impact on risk-weighted assets includes estimates for credit valuation adjustment (cVA) volatility and risk-weighting of the available elements of the deferred tax asset and the investment in the Group’s insurance businesses. it is assumed that Eu corporates are exempt from the cVA volatility charge and that the national discretion over 180 day default remains for uK retail mortgages.
Leverage ratio on CRD iv basis The Basel iii reforms include the introduction of a capital leverage measure defined as the ratio of tier 1 capital to total exposure. This is intended to reinforce the risk based capital requirements with a simple, non-risk based backstop measure. The Basel committee have proposed that final adjustments to the definition and calibration of the leverage ratio be carried out in 2017, with a view to migrating to a Pillar i treatment in 2018.
The Group’s estimates of its leverage ratio at 31 december 2012 are shown in the table below on three different bases: – The ‘cRd iV Transitional’ basis uses the tier 1 capital calculated by applying the rules laid out in the July 2011 draft publication of cRd iV on a transitional basis as if 2012 had been the first year of transition. The tier 1 capital amount corresponds to that shown in the second column of table 1.61.
Tier 1 subordinated debt allowable for leverage 5,009 – 5,607 exposures for leverage ratio
For scottish Widows and clerical Medical, no Resilience capital Requirement is required. However, a further test is required in respect of the With-Profit Funds. This involves comparing the statutory basis of assessment with a realistic basis of assessment as described below.
Other differences between iFRs and regulatory valuation of assets and liabilities – – 101 (175) 152 78
Scottish Widows scottish Widows was created following the demutualisation of scottish Widows Fund and life Assurance society in 2000. The terms of the demutualisation are governed by a court-approved scheme of Transfer (the ‘scheme’) which, inter alia, created a With-Profits Fund and a non-Participating Fund and established protected capital support for the with-profits policyholders in existence at the date of demutualisation. Much of that capital support is held in the non-Participating Fund and, as such, the capital held in that fund is subject to the constraints noted below. The requirements of the scheme sit alongside scottish Widows’ published Principles and Practices of Financial Management of With-Profit business.
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.
new business and other factors 10 (4) (184) (38) 51 (165)
Overseas life business Available capital has decreased during 2012 due to a dividend payment which was partially offset by profits emerging on new and in force business. 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.
Other long-term funds Outside the With-Profit Funds, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are broadly matched. The most critical non-economic assumptions are mortality rates in respect of annuity business written (lower mortality rates are more onerous). Assumptions relating to future expenses are also significant with increases in the expected level of future costs leading to increases in the value of the liabilities and consequently leading to a reduction in available capital. Reinsurance arrangements are in place to reduce the Group’s exposure to deteriorating mortality rates in respect of non-annuity life insurance contracts such that assured life mortality is a less significant assumption. For clerical Medical, assumptions relating to the provision in relation to German insurance business litigation are also significant.
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 2012 of £2.1 billion (2011: £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.
The model includes a matrix of the correlations between each of the underlying modelled asset types. The correlations used are consistent with long-term historical returns. The most significant non-economic assumptions included in the model are management actions (in respect of investment policy and bonus rates), guaranteed annuity option take-up rates and assumptions regarding persistency (both of which are based on recent actual experience and include an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities), and assumptions regarding mortality (which are based on recent actual experience and industry tables).
Measurement Financial reporting risk is measured by the adequacy of and compliance with a number of key controls. identification of potential financial reporting risk also forms a part of the Group’s Operational Risk management framework.
The Ethics Policy and supporting codes of Personal Responsibility and Business Responsibility embody the Group’s values and reflect its commitment to operating responsibly and ethically both at a business and an individual level. All colleagues are required to adhere to the codes in all aspects of their roles.
For further information on corporate Governance see pages 86 to 97.
Notes to the consolidated financial statements 214 1. Basis of preparation 2. Accounting policies 3. Critical accounting estimates and judgements 4. Segmental analysis 5. Net interest income 6. Net fee and commission income 7. Net trading income 8. Insurance premium income 9. Other operating income 10. Insurance claims 11. Operating expenses 13. Investments in joint ventures and associates 14. Loss on disposal of businesses in 2010 15. Taxation 16. Earnings per share 17. Trading and other financial assets at fair value through profit or loss 18. Derivative financial instruments 19. Loans and advances to banks 20. Loans and advances to customers 21. Securitisations and covered bonds 22. Special purpose entities 23. Debt securities classified as loans and receivables 24. Allowance for impairment losses on loans and receivables 25. Available-for-sale financial assets 26. Held-to-maturity investments 27. Investment properties 28. Goodwill 29. Value of in-force business 30. Other intangible assets 31. Tangible fixed assets 32. Other assets 33. Deposits from banks 34. Customer deposits 35. Trading and other financial liabilities at fair value through profit or loss 36. Debt securities in issue 37. Liabilities arising from insurance contracts and participating investment contracts 38. Life insurance sensitivity analysis 39. Liabilities arising from non-participating investment contracts 40. Unallocated surplus within insurance businesses 41. Other liabilities 42. Retirement benefit obligations 43. Deferred tax 44. Other provisions 45. Subordinated liabilities 46. Share capital 47. Share premium account 48. Other reserves 49. Retained profits 50. Ordinary dividends 51. Share-based payments 52. Related party transactions 53. Contingent liabilities and commitments 54. Financial instruments 55. Financial risk management 56. Consolidated cash flow statement 57. Future accounting developments 58. Approval of financial statements
Opinion on other matters prescribed by the Companies Act 2006 in our opinion the information given in the directors’ Report for the financial year for which the group financial statements are prepared is consistent with the group financial statements.
Matters on which we are required to report by exception We have nothing to report in respect of the following: under the companies Act 2006 we are required to report to you if, in our opinion: – certain disclosures of directors’ remuneration specified by law are not made; or
Other matter We have reported separately on the parent company financial statements of lloyds Banking Group plc for the year ended 31 december 2012 and on the information in the directors’ Remuneration Report that is described as having been audited.
(a) The maintenance and integrity of the lloyds Banking Group plc website is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website.
Movements in revaluation reserve in respect of available-for-sale financial assets: Adjustment on transfers from held-to-maturity portfolio 1,168 – –
change in fair value 779 2,603 1,231 income statement transfers in respect of disposals (3,547) (343) (399)
Trading and other financial assets at fair value through profit or loss 17 153,990 139,510 derivative financial instruments 18 56,550 66,013 loans and receivables: loans and advances to banks 19 29,417 32,606 loans and advances to customers 20 517,225 565,638
(loss) profit for the year – – (1,427) (1,427) 84 (1,343)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax – (927) – (927) (2) (929)
Other employee award schemes – – 256 256 – 256 change in non-controlling interests – – – – (15) (15)
Other employee award schemes – – 238 238 – 238 change in non-controlling interests – – – – (189) (189)
(loss) profit for the year – – (320) (320) 62 (258)
currency translation differences (tax: nil) – (129) – (129) – (129)
Lloyds Banking Group Annual Report and Accounts 2012212 note £ million £ million £ million
Tax (paid) received (78) (136) 332 net cash provided by (used in) operating activities 3,049 19,893 (2,037)
Proceeds from sale and maturity of financial assets 37,664 36,523 45,999
Effects of exchange rate changes on cash and cash equivalents (8) 6 479 change in cash and cash equivalents 15,169 23,589 (3,390)
Lloyds Banking Group Annual Report and Accounts 2012214 note 2: Accounting policies The Group’s accounting policies are set out below. These accounting policies have been applied consistently.
The acquisition method of accounting is used to account for business combinations by the Group. The consideration for the acquisition of a subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interests issued by the Group. The consideration includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred except those relating to the issuance of debt instruments (see (E)(5) below) or share capital (see (R)(1) below). identifiable assets acquired and liabilities assumed in a business combination are measured initially at their fair value at the acquisition date.
– the Group has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.
(1) Financial instruments at fair value through profit or loss Financial instruments are classified at fair value through profit or loss where they are trading securities or where they are designated at fair value through profit or loss by management. derivatives are carried at fair value (see (F) below).
When an impairment loss is recognised in respect of available-for-sale assets transferred, the unamortised balance of any available-for-sale reserve that remains in equity is transferred to the income statement and recorded as part of the impairment loss.
lending are retained by the Group, these loans and advances continue to be recognised by the Group, together with a corresponding liability for the funding.
(F) Derivative financial instruments and hedge accounting All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and option pricing models, as appropriate. derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 3 (critical accounting estimates and judgements: Fair value of financial instruments) and note 54(3) (Financial instruments: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
derivatives embedded in financial instruments and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. in accordance with iFRs 4 Insurance Contracts, a policyholder’s option to surrender an insurance contract for a fixed amount is not treated as an embedded derivative.
(3) net investment hedges Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in other comprehensive income, the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of. The hedging instrument used in net investment hedges may include non-derivative liabilities as well as derivative financial instruments.
(G) Offset Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. in certain situations, even though master netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.
(J) Tangible fixed assets Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): – Freehold/long and short leasehold premises: shorter of 50 years and the remaining period of the lease.
(M) Share-based compensation The Group operates a number of equity-settled, share-based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. in the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-scholes option pricing model or a Monte carlo simulation. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement, together with a corresponding adjustment to equity. cancellations by employees of contributions to the Group’s save As You Earn plans are treated as non-vesting conditions and the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement.
For the Group’s long-term insurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on shareholders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under current uK tax rules.
deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. deferred tax is determined using tax rates that have been enacted or substantively enacted by the balance sheet date which are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
(O) insurance The Group undertakes both life insurance and general insurance business. insurance and participating investment contracts are accounted for under iFRs 4 Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and participating investment contracts that applied prior to the adoption of iFRs. The Group, therefore, continues to account for these products using uK GAAP, including FRs 27 Life Assurance, and uK established practice.
– non-participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
Allowance for impairment losses on loans and receivables At 31 december 2012 gross loans and receivables totalled £567,374 million (2011: £629,736 million) against which impairment allowances of £15,459 million (2011: £19,022 million) had been made (see note 24). The Group’s accounting policy for losses arising on financial assets classified as loans and receivables is described in note 2(H)(1); this note also provides an overview of the methodologies applied.
Unwind of HBOS acquisition fair value adjustments The acquisition of HBOs in January 2009 required the Group to recognise the identifiable assets acquired and liabilities assumed at their acquisition-date fair values. The overall effect was to increase the book value of HBOs’s net assets by £1,241 million primarily reflecting a reduction in the value of HBOs’s debt securities and subordinated liabilities of £15,439 million, partially offset by a reduction in the carrying value of HBOs’s loans and receivables of £14,880 million, including loans and advances to customers of £13,512 million.
in the periods subsequent to the acquisition, all of the fair value adjustments unwind. The fair value adjustments made to debt securities and subordinated liabilities unwind over the expected remaining life of the related securities except in the event that the liability is extinguished, in which case the remaining unamortised fair value adjustment is recognised in the income statement immediately. The timing of the unwind of the fair value adjustment relating to loans and receivables requires significant management judgement. This includes the identification of losses which were expected at the date of acquisition and assessing whether anticipated losses will still be incurred. in 2012, there was a benefit of £1,339 million (2011: £1,943 million) to the income statement either from the reversal of a fair value adjustment being credited to the income statement or through a lower impairment charge as a result of the initial HBOs acquisition fair value adjustments.
Fair value of financial instruments in accordance with iFRs 7 Financial Instruments: Disclosure, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models. These valuation techniques involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information.
Valuation techniques for level 2 financial instruments use inputs that are largely based on observable market data. level 3 financial instruments are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. determining the appropriate assumptions to be used for level 3 financial instruments requires significant management judgement.
At 31 december 2012, the Group classified £6,231 million of financial assets and £591 million of financial liabilities as level 3. Further details of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair value are set out in note 54. details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the Risk Management section on page 170.
valuation of assets and liabilities arising from life insurance business At 31 december 2012, the Group recognised a value of in-force business asset of £5,488 million (2011: £5,247 million) and an acquired value of in-force business asset of £1,312 million (2011: £1,391 million). The value of in-force business asset represents the present value of future profits expected to arise from the portfolio of in-force life insurance and participating investment contracts. The acquired value of in-force business asset represents the contractual rights to benefits from providing investment management services in relation to non-participating investment contracts acquired in business combinations and portfolio transfers. The methodology used to value these assets is set out in note 2(O)(1). The valuation or recoverability of these assets requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to these assets. The key assumptions that have been made in determining the carrying value of the value of in-force business assets at 31 december 2012 are set out in note 29.
At 31 december 2012, the Group carried liabilities arising from insurance contracts and participating investment contracts of £82,953 million (2011: £78,991 million). The methodology used to value these 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 and are subject to significant management judgement and estimation uncertainty. The key assumptions that have been made in determining the carrying value of these liabilities are set out in note 37.
– The Group’s continental European wholesale business and the wholesale Australian business have been transferred from Wealth, Asset Finance and international to commercial Banking; during the year ended 31 december 2012 these transferred businesses recorded a management basis loss before tax of £432 million (2011: £1,050 million; 2010: £1,327 million).
Retail offers a broad range of retail financial service products in the uK, including current accounts, savings, personal loans, credit cards and mortgages. it is also a major general insurance and bancassurance distributor, selling a wide range of long-term savings, investment and general insurance products.
insurance provides long-term savings, protection and investment products distributed through the bancassurance, intermediary and direct channels in the uK. it is also a distributor of home insurance in the uK with products sold through the retail branch network, direct channels and strategic corporate partners. The business consists of life, Pensions and investments uK; life, Pensions and investments Europe; and General insurance.
Other includes the costs of managing the Group’s technology platforms, branch and head office property estate, operations (including payments, banking operations and collections) and sourcing, the costs of which are predominantly recharged to the other divisions. it also reflects other items not recharged to the divisions, including hedge ineffectiveness, uK bank levy, Financial services compensation scheme costs, gains on liability management, volatile items such as hedge accounting volatility managed centrally, and other gains from the structural hedging of interest rate risk.
Other segment items: Additions to tangible fixed assets 189 197 1,452 451 806 3,095 investments in joint ventures and associates at end of year 147 155 29 – 3 334
Other income (net of fee and commission expense) 1,624 3,009 2,397 2,789 (62) 9,757 insurance claims – – – (542) – (542)
Other segment items reflected in income statement above: increase in value of in-force business – – 2 787 – 789
Other segment items: Additions to tangible fixed assets 126 496 1,232 585 777 3,216 investments in joint ventures and associates at end of year 139 127 158 – 5 429
Total underlying income, net of insurance claims 20,510 (1,890) (306) (172) 50 194 18,386
comprises the payment protection insurance provision (£3,575 million) and other regulatory provisions (£650 million).
comprises the payment protection insurance provision (£3,200 million) and other regulatory provisions (£175 million).
comprises regulatory provisions (£500 million) and the loss on disposal of businesses (£365 million).
customer deposits, excluding liabilities under sale and repurchase transactions 1.69 1.66 1.56 (6,637) (6,080) (5,381)
interest payable on liabilities held at amortised cost 2.08 2.04 2.22 (13,032) (13,837) (15,896)
during February 2012, the Group completed the exchange of certain subordinated debt securities issued by the HBOs group for new subordinated debt securities issued by lloyds TsB Bank plc by undertaking an exchange offer on certain securities which were eligible for call during 2012. As part of the exchange, the Group announced that all decisions to exercise calls on those original securities that remained outstanding following the exchange offer would be made with reference to the prevailing regulatory, economic and market conditions at the time. These securities will not, therefore, be called at their first available call date which will lead to coupons continuing to be being paid until possibly the final redemption date of the securities. consequently, the Group is required to adjust the carrying amount of these securities to reflect the revised estimated cash flows over their revised life and to recognise this change in carrying value in interest expense. included within net interest income in the year ended 31 december 2012 is a credit of £109 million in respect of the securities that remained outstanding following the exchange offer (2011: gain following a similar adjustment to carrying value of £570 million; 2010: £nil).
Total net earned premiums 8,284 8,170 8,148 life insurance gross premiums can be further analysed as follows: £m £m £m life and pensions 6,755 6,737 6,428 non-life insurance gross written premiums can be further analysed as follows: £m £m £m
during december 2011, the Group completed the exchange of certain subordinated debt securities which resulted in a gain on extinguishment of the existing securities of £599 million.
change in assets arising from reinsurance contracts held – – 65 change in unallocated surplus (note 40) 31 340 439
Amortisation of other intangible assets (note 30) 616 663 721 impairment of tangible fixed assets (note 31) – 65 202
Total audit and audit related fees 23.5 26.3 27.8 services relating to taxation: Taxation compliance services 0.2 0.2 0.3
The following types of services are included in the categories listed above: Audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with regulatory filings. Other services supplied pursuant to legislation relate primarily to the costs associated with the sarbanes-Oxley Act audit requirements together with the cost of the audit of the Group’s Form 20-F filing.
Audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of prospectuses and circulars required by the uKlA listing rules.
during the year, the auditors also earned fees payable by entities outside the consolidated lloyds Banking Group in respect of the following: £m £m £m
Total impairment losses on loans and receivables (note 24) 5,121 8,069 10,771 impairment of available-for-sale financial assets 37 80 106
Movement in investments over the year: share of post-tax results 34 31 (39) (6) – (49) 28 31 (88)
Where entities have statutory accounts drawn up to a date other than 31 december management accounts are used when accounting for them by the Group.
(A) Analysis of tax (charge) credit for the year £m £m £m uK corporation tax: current tax on profit for the year (175) (93) (146)
Lloyds Banking Group Annual Report and Accounts 2012244 15 Taxation (continued)
(B) Factors affecting the tax credit (charge) for the year A reconciliation of the credit (charge) that would result from applying the standard uK corporation tax rate to the (loss) profit before tax to the actual tax (charge) credit for the year is given below: £m £m £m
Further factors affecting the life business1: derecognition of deferred tax on policyholder tax credit (583) (146) –
Taxation of certain insurance assets arising on transition to new tax regime (221) – –
Effect of results of joint ventures and associates 23 8 (25)
note 16: earnings per share £m £m £m loss attributable to equity shareholders – basic and diluted (1,427) (2,787) (320)
included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £14,433 million (2011: £10,990 million). collateral is held with a fair value of £19,629 million (2011: £15,765 million), all of which the Group is able to repledge. At 31 december 2012, £15,640 million had been repledged (2011: £3,740 million).
– derivatives held in policyholder funds as permitted by the investment strategies of those funds.
Options written 21,757 – 605 interest rate contracts: interest rate swaps 2,071,103 32,819 31,880
The principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 55 credit risk.
Lloyds Banking Group Annual Report and Accounts 2012250 note 18: Derivative financial instruments (continued)
Lloyds Banking Group Annual Report and Accounts 2012250 note 20: Loans and advances to customers £m £m
Gross investment in finance leases, receivable: not later than 1 year 1,271 1,287 later than 1 year and not later than 5 years 2,049 3,126 later than 5 years 6,232 7,067 unearned future finance income on finance leases (3,027) (3,594)
The net investment in finance leases represents amounts recoverable as follows: £m £m not later than 1 year 835 724 later than 1 year and not later than 5 years 1,491 2,307 later than 5 years 4,151 4,769 net investment in finance leases 6,477 7,800
Covered bond programmes certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of covered bonds by the Group. The Group retains all of the risks and rewards associated with these loans and the partnerships are consolidated fully with the loans retained on the Group’s balance sheet and the related covered bonds in issue included within debt securities in issue.
Total securitisation and covered bond programmes 68,732 75,608 includes securitisations utilising a combination of external funding and credit default swaps.
At 31 December 2012 debt securities classified as loans and receivables: debt securities classified as available-for-sale financial assets: At 31 december 2011 debt securities classified as loans and receivables: Asset-backed securities 1,022 – 2,004 3,026 debt securities classified as available-for-sale financial assets: corporate and other debt securities 73 – – 73
Total debt securities classified as loans and receivables before allowance for impairment losses 5,479 12,746
Recoveries of advances written off in previous years 421 – 8 429 unwinding of discount (226) – – (226)
included within asset-backed securities are £2,284 million (31 december 2011: £2,867 million) managed by the commercial Banking division and at the Group’s centre. Further information on these exposures is provided in note 55.
Additions: Acquisitions of new properties 428 396 consolidation of new subsidiary undertakings 411 922
For acquisitions made prior to 1 January 2004, the date of transition to iFRs, cost is included net of amounts amortised up to 31 december 2003.
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,016 million (2011: £2,016 million), £1,836 million, or 91 per cent of the total (2011: £1,836 million, 91 per cent of the total) has been allocated to scottish Widows in the Group’s insurance division and £170 million, or 8 per cent of the total (2011: £170 million, 8 per cent of the total) to Asset Finance in the Group’s Wealth, Asset Finance and international division.
note 29: value of in-force business The gross value of in-force business asset in the consolidated balance sheet is as follows: 2012 £m 2011 £m
Lloyds Banking Group Annual Report and Accounts 2012256 note 29: value of in-force business (continued)
The movement in the value of in-force insurance and participating investment contracts over the year is as follows: 2012 £m 2011 £m
The risk-free rate assumed in valuing the non-annuity in-force business is the 15 year government bond yield for the appropriate territory. The risk-free rate assumed in valuing the in-force asset for the uK annuity business is presented as a single risk-free rate to allow a better comparison to the rate used for other business. That single risk-free rate has been derived to give the equivalent value to the uK annuity book, had that book been valued using the uK gilt yield curve increased to reflect the illiquidity premium described above.
An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk, reinsurer default and the with-profit funds these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.
Lloyds Banking Group Annual Report and Accounts 2012260 note 32: Other assets £m £m
included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting to £4 million (2011: £nil).
Trading and other financial liabilities at fair value through profit or loss 35,972 24,955
Lloyds Banking Group Annual Report and Accounts 2012262 note 37: Liabilities arising from insurance contracts and participating investment contracts (continued)
(1) Life insurance The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows: insurance contracts £m
Mortality and morbidity The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this provides a reliable basis, and relevant industry data otherwise, and include a margin for adverse deviation. For German business appropriate industry tables have been considered.
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.
(2) non-life insurance Gross non-life insurance contract liabilities are analysed by line of business as follows: £m £m credit protection 94 206
cash paid for claims settled in the year (455) 1 (454)
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 shown 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 1 2 3 5 11 28 51 194 295 liability in respect of earlier years 1
This sensitivity shows the impact of a 10 basis point increase in the allowance for illiquidity premia. it assumes the overall spreads on assets are unchanged and hence market values are unchanged. Government bond yields and the non-annuity risk-free rate are both assumed to be unchanged. The increased illiquidity premium increases the annuity risk-free rate.
Lloyds Banking Group Annual Report and Accounts 2012270 note 39: Liabilities arising from non-participating investment contracts The movement in liabilities arising from non-participating investment contracts may be analysed as follows: Gross Reinsurance net £m £m £m changes in existing business (5,922) 11 (5,911)
The latest full valuations of the three main schemes were carried out as at 30 June 2011; the results have been updated to 31 december 2012 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 2012 by qualified independent actuaries or, in the case of the scottish Widows Retirement Benefits scheme, by a qualified actuary employed by scottish Widows.
Lloyds Banking Group Annual Report and Accounts 2012272 note 42: Retirement benefit obligations (continued)
sensitivity analysis The effect of changes in key assumptions on the pension charge in the Group’s income statement and on the net defined benefit pension scheme asset or liability is set out below: increase (decrease) in the income statement charge increase (decrease) in the net defined benefit pension scheme asset £m £m £m £m inflation:1 discount rate:2
At 31 december 2012, the assumed rate of inflation is 2.90 per cent (2011: 3.00 per cent).
Fixed interest gilts 2.3 index linked gilts 2.8 non-government bonds 3.1
Money market instruments, cash and other assets and liabilities 4,261 4,936
in 2010 the Group made changes to the terms of its principal uK defined benefit pension schemes, all future increases to pensionable salary will be capped each year at the lower of: Retail Prices index inflation; each employee’s actual percentage increase in pay; and 2 per cent of pensionable pay. in addition to this, during the second half of 2010 there was a change in the commutation factors in certain defined benefit schemes. The combined effect of these changes was a reduction in the Group’s defined benefit obligation of £1,081 million and a reduction in the Group’s unrecognised actuarial losses of £171 million, resulting in a net curtailment gain of £910 million recognised in the income statement in 2010 and an equivalent reduction in the balance sheet liability.
insurance premiums paid 8 5 charge for the year (11) (13)
Lloyds Banking Group Annual Report and Accounts 2012276 note 43: Deferred tax The movement in the net deferred tax balance is as follows: £m £m
Exchange and other adjustments (14) 3 disposals – 10 income statement (charge) credit (note 15): due to change in uK corporation tax rate (308) (404)
deferred tax assets and liabilities are comprised as follows: £m £m deferred tax assets: Accelerated capital allowances 167 –
The Group has calculated the provision by making a number of assumptions based upon current and expected experience. The principal sensitivities are as follows: – the number of claims received: an increase of 100,000 from the level assumed would increase the provision for redress costs by £140 million; – uphold rate of claims reviewed: an increase of one percentage point in this assumption would increase the provision by £20 million; – average future redress payment: an increase of £100 in this assumption would increase the provision by £70 million.
Litigation in relation to insurance branch business in Germany As previously disclosed, clerical Medical investment Group limited (cMiG) has received a number of claims in the German courts, relating to policies issued by cMiG but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. in its accounts for the year ended 31 december 2011 the Group recognised a provision of £175 million with respect to this litigation and following decisions in July 2012 from the Federal court of Justice (FcJ) in Germany the Group has recognised a further provision of £150 million with respect to this litigation, increasing the total provision to £325 million.
Other regulatory provisions vacant leasehold property Other Total £m £m £m £m £m £m
However, there are still a number of uncertainties as to the full impact of the FcJ’s decisions, and the implications with respect to the claims facing cMiG. As a result the ultimate financial effect, which could be significantly different to the provision, will only be known once there is further clarity with respect to a range of legal issues involved in these claims and/or all relevant claims have been resolved.
Other provisions include those arising out of the insolvency of a third party insurer, which remains exposed to asbestos and pollution claims in the us. The ultimate cost and timing of payments are uncertain. The provision held of £37 million at 31 december 2012 represents management’s current best estimate of the cost after having regard to actuarial estimates of future losses.
7.875% non-cumulative Preference shares callable 2013 (us$1,250 million) b 259 249 7.875% non-cumulative Preference shares callable 2013 (e500 million) b 149 150 6.0884% non-cumulative Fixed to Floating Rate Preference shares callable 2015 (£745 million) b 10 10 5.92% non-cumulative Fixed to Floating Rate Preference shares callable 2015 (us$750 million) b 125 11 6.267% non-cumulative Fixed to Floating Rate Preference shares callable 2016 (us$1,000 million) b 280 301 6.3673% non-cumulative Fixed to Floating Rate Preference shares callable 2019 (£335 million) b 2 2 6.475% non-cumulative Preference shares callable 2024 (£186 million) b 39 38 6.413% non-cumulative Fixed to Floating Rate Preference shares callable 2035 (us$750 million) b 104 131 6.657% non-cumulative Fixed to Floating Rate Preference shares callable 2037 (us$750 million) b 14 26 9.25% non-cumulative irredeemable Preference shares (£300 million) b 350 262 9.75% non-cumulative irredeemable Preference shares (£100 million) b 53 36
b These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the FsA. in november 2009, as part of the state aid restructuring plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012.
d The fixed rate on this security was reset from 7.627 per cent to 3 months Euribor plus 2.875 per cent with effect from 9 december 2011.
Undated subordinated liabilities 6.625% undated subordinated step-up notes (£410 million) a, b, c 6 1
12% Perpetual subordinated Bonds (£100 million) a 21 30 5.75% undated subordinated step-up notes (£600 million) 3 3 7.375% subordinated undated instruments (£150 million) a – –
9.375% Perpetual subordinated Bonds (£50 million) a 14 17 5.75% undated subordinated step-up notes (£500 million) 4 3 6.5% undated subordinated step-up notes callable 2029 (£450 million) a – –
d The fixed rate on this security was reset from 6.05 per cent to 3 month Euribor plus 2.25 per cent with effect from 23 november 2011.
c This security was issued in February 2012 as a result of an exchange offer.
e The interest rate payable on this security was reset from 5.109 per cent fixed to canadian dealer Offered Rate plus 0.65 per cent with effect from 21 June 2012.
issued under employee share schemes 1,136,919,962 652,497,658 195,339 114 66 –
subject to any rights or restrictions attached to any shares, on a show of hands at a general meeting of the company every holder of shares present in person or by proxy and entitled to vote has one vote and on a poll every member present and entitled to vote has one vote for every share held.
The merger reserve primarily comprises the premium on shares issued on 13 January 2009 under the placing and open offer and shares issued on 16 January 2009 on the acquisition of HBOs plc.
income statement transfers (note 5) (92) 70 932 £m £m £m
Foreign currency translation reserve currency translation differences arising in the year (69) (58) 33
Lloyds Banking Group Annual Report and Accounts 2012290 note 49: Retained profits £m £m £m loss for the year (1,427) (2,787) (320)
note 50: Ordinary dividends no dividends were paid on ordinary shares during 2010, 2011 or 2012 and the directors do not propose to pay a final dividend in respect of 2012; in november 2009, as part of the restructuring plan that was a requirement for European commission approval of state aid received by the Group, the Group agreed to suspend the payment of coupons and dividends on certain of the Group’s preference shares and preferred securities, for the two year period from 31 January 2010 to 31 January 2012. consequently, the terms of these instruments prevented the company from making dividend payments on ordinary shares up to that date.
Deferred bonus plans Bonuses in respect of the performance in 2012 of employees within certain of the Group’s bonus plans have been recognised in these financial statements in full. The amounts to be settled in shares are included within the total charge to the income statement detailed above.
Options granted in 2004 became exercisable as the performance condition was met on the re-test. The performance condition vested at 14 per cent for Executive directors, 24 per cent for Managing directors, and 100 per cent for all other executives.
Movements in the number of share options outstanding under the executive share option schemes during 2011 and 2012 are set out below: number of options
Lloyds Banking Group Share Buy Out Awards As part of arrangements to facilitate the recruitment of certain Executives, options have been granted by individual deed and, where appropriate, in accordance with the listing Rules of the uK listing Authority.
Movements in the number of options outstanding are set out below: number of options
Outstanding at 31 December 21,321,237 nil 21,321,237 nil exercisable at 31 December 16,509,862 nil 2,398,593 nil no options were granted or exercised in 2012. The weighted average fair value of options granted during 2011 was £0.38. The weighted average share price at the time that the options were exercised during 2011 was £0.54. The weighted average remaining contractual life of options outstanding at the end of the year was 8.6 years (2011: 9.6 years).
Participants may be entitled to any dividends paid during the vesting period if the performance conditions are met. An amount equal in value to any dividends paid between the award date and the date the Remuneration committee determine that the performance conditions were met may be paid, based on the number of shares that vest. The Remuneration committee will determine if any dividends are to be paid in cash or in shares.
The performance conditions for awards made in April, May and september 2009 were as follows: (i) earnings per share (ePS): relevant to 50 per cent of the award. Performance was measured based on EPs growth over a three-year period from the baseline EPs of 2008.
if the growth in EPs reached 26 per cent, 25 per cent of this element of the award, being the threshold, would vest. if growth in EPs reached 36 per cent, 100 per cent of this element would vest.
(ii) integration Balanced Scorecard: The release of the remaining 50 per cent of the shares was dependent on the outcome of a Balanced scorecard of non-financial measures of the success of the integration in each of 2009, 2010 and 2011. The Balanced scorecard element was broken down into three equally weighted tranches. The tranches were crystallised and banked for each year of the performance cycle subject to separate annual performance targets across the four measurement categories of Building the Business, customer, Risk and People and Organisation development.
(ii) eP: relevant to 50 per cent of the award. The performance target is based on 2013 adjusted EP outcome.
if the ATsR reaches 30 per cent per annum, 100 per cent of this element will vest.
if a run rate of net simplification benefits of £1.5 billion is achieved, 25 per cent of this element of the award, being the threshold, will vest.
The performance conditions for share-based awards made in June 2012 are as follows: (i) Profitability: relevant to 40 per cent of the award. The performance target is based on a cumulative 3 year profit before tax. if cumulative profit before tax reaches a specified target level, 100 per cent of this element will vest. if cumulative profit before tax reaches 90 per cent of the target level, 25 per cent of this element of the award, being the threshold, will vest. if cumulative profit before tax reaches 110 per cent of the target level, 200 per cent of this element of the award, being the maximum, will vest.
The relevant period commenced on 1 January 2012 and ends on 31 december 2014.
Key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the lloyds Banking Group plc Group Executive committee together with its non-Executive directors.
Lloyds Banking Group Annual Report and Accounts 2012298 note 52: Related party transactions (continued)
Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £0.1 million (2011: £0.2 million; 2010: £0.4 million).
Advanced (includes loans of appointed key management personnel) 3 1 2
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 2.5 per cent and 29.95 per cent in 2012 (2011: 1.09 per cent and 27.5 per cent; 2010: 0.5 per cent and 17.90 per cent).
Withdrawn (includes deposits of former key management personnel) (35) (15) (12)
Lloyds Banking Group Annual Report and Accounts 2012300 note 52: Related party transactions (continued)
UK Government in January 2009, the uK Government through HM Treasury became a related party of the company following its subscription for ordinary shares issued under a placing and open offer. At 31 december 2012, HM Treasury held a 39.2 per cent (2011: 40.2 per cent) interest in the company’s ordinary share capital and consequently HM Treasury remained a related party of the company during the year ended 31 december 2012.