BECOMING THE BEST BANK FOR CUSTOMERS Lloyds Banking Group Annual Report and Accounts
About us Lloyds Banking Group is a leading provider of financial services to individual and business customers in the UK.
Our main business activities are retail and commercial banking, general insurance, and long-term savings, protection and investment. We provide our services under a number of well recognised brands including Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows and through a range of distribution channels including the largest branch network in the UK and a comprehensive digital proposition.
We are a low cost, low risk, customer focused bank operating through four divisions.
For more on our Commercial Banking division’s financial performance go to page 46 or visit www.lloydsbankinggroup.com
For more on our Insurance division’s financial performance go to page 50 or visit www.lloydsbankinggroup.com
Our Consumer Finance division provides asset finance solutions and credit cards to consumer and commercial customers.
Our long-term savings, investment and protection products are offered under the Scottish Widows brand. Products are available through intermediaries, direct channels and also through our Retail division via Lloyds Bank, Halifax and Bank of Scotland.
Home insurance customersOur share of credit card balances Our share of the life and pensions market
Growth in UK consumer finance lending in 2014 £922m£1,010m UNDERLYING PROFIT UNDERLYING PROFIT
STRENGTHEN DELIVERY OF 2011 STRATEGIC PRIORITIES HAS TRANSFORMED THE BUSINESS 12.8%
Our Deputy Chairman, David Roberts, stepped down in May to become Non-Executive Director and Chairman-Elect at Nationwide. I and my colleagues are grateful for the tremendous contribution he made to the Group during his period on the Board. We were pleased to announce the appointment of Anita Frew, a non-Executive Director with the Group since 2010, to this role.
Regaining trust is a business imperative rather than a ‘nice to have’. We are completely committed to achieving this.
This is vitally important. As I noted earlier, trust is not a ‘nice to have’ – it’s a ‘must have’. It provides the foundations on which we can build sustainable success as a responsible business dedicated to meeting our customers’ needs. It is also, I am convinced, a true reflection of the values and commitment of our hardworking staff, all of whom I would like to thank on behalf of the Board for their dedication to serving our customers.
We remain dedicated to our charitable initiatives and I am thrilled that we raised more than £6 million from our two-year partnership with the Alzheimer’s Society and Alzheimer Scotland. The money, which is significantly higher than our 2014 target, will go towards the Dementia Research Leaders Programme, working to improve dementia research and transform our understanding of the condition.
I see increasing evidence that we are returning to the qualities that historically made our bank a pillar of local communities, applying these qualities to meet the changing demands of our customers.
Lloyds Banking Group Annual Report and Accounts 2014 9BECOMING THE BEST BANK FOR CUSTOMERS
On a statutory basis, the Group reported a profit before tax of £1,762 million compared to £415 million in 2013. This was after £2,200 million of charges in respect of PPI (2013: £3,050 million) and other regulatory provisions of £925 million (2013: £405 million).
Read more about our Helping Britain Prosper Plan on page 24 or visit www.lloydsbankinggroup.com
Delivering the best bank to our key stakeholders Our strong performance in 2014 marks the culmination of three years of delivery against our strategic plan that has transformed the business for the benefit of our stakeholders.
In 2014 we achieved our enhanced target of delivering £2 billion of annual run-rate savings through the first phase of our Simplification programme, resulting in a reduction in our cost base from over £11 billion in 2010 to £9.0 billion (excluding TSB). Our cost:income ratio of 51.2 per cent is now the lowest amongst our major UK banking peers, in turn delivering a cost leadership position as a strategic differentiator and source of competitive advantage.
– Non-core assets reduced by more than £140 billion to £17 billion – International presence reduced from more than 30 countries to six – Asset quality ratio of 24 basis points, significantly ahead of original guidance of 50-60 basis points
Finally, we expect to ‘deliver sustainable growth’ by seeking Group-wide growth opportunities while maintaining our prudent risk appetite. We intend to maintain market leadership in our main retail business lines of mortgages and current accounts by growing in line with the market, making the most of our multi-brand, multi-channel strategy to meet customer needs.
The successful delivery of our strategic priorities over the next three years will ensure that we are well placed to anticipate and react to these changes, in turn enabling us to retain our leading position in the UK market while delivering value to our customers and shareholders.
At the root of the economic recovery is the progress that has been made on reducing the high levels of debt that were a key driver of pre-crisis growth. Household debt has fallen back to decade-ago levels relative to incomes, and with interest rates low the burden of debt payments is its lowest since the late 1990s. That has decreased the pace of consumer deleveraging, helping spending growth to recover. The government is broadly half way through its deficit reduction programme, and the pace of fiscal consolidation has also eased markedly, thus reducing its drag on growth. Most of the banking sector, including Lloyds, is on target to meet the new higher capital and liquidity levels mandated by CRD IV and the PRA, so lending supply is able to respond to rising demand.
Robust growth expected to continue in 2015 With inflation low and deleveraging progressing at a manageable rate, UK economic growth is expected to continue at a similar rate in 2015 – the current consensus is 2.6 per cent, still above the economy’s long-term average growth rate of around 2.2 per cent (see chart below). Domestic demand will remain the driver, with households’ real income growth expected to benefit from higher earnings growth, falling unemployment and lower inflation, helped especially by the large fall in oil prices since the middle of 2014. We expect Bank Rate to begin to rise around the end of the year, for the first time in eight years, but the pace of increase is likely to be slow as responsiveness of the economy to interest rates normalises only gradually.
Risks to the recovery remain As the recovery continues, and adjustments in debt levels have progressed, the vulnerability of the economy to renewed weakening has reduced. Similarly, the outcome of the Scottish Referendum has removed a key source of near-term uncertainty for the economy and banks. However, with the General Election in May, political uncertainty remains high. The Eurozone remains a risk to the UK, not only because of its potential impact on UK growth, but also because of the financial market turbulence that would ensue if weak growth translates into election of political parties that favour Eurozone exit for some countries. Crystallisation of some of these risks could impact the UK economy significantly, which would in turn have a negative impact on the Group’s income, funding costs and impairment charges. Positively, the recent fall in oil prices, if sustained, will be a boost for global growth and could be particularly beneficial for Eurozone growth.
New European Union legislation on capital ratios came into force in the UK on 1 January 2014. The Capital Requirements Directive IV (CRD IV) aims to ensure that firms hold enough financial resources to cover the risk associated with their business. The Basel Committee also continued to review its capital framework, including the consistency of Internal Ratings Based (IRB) models, standardised credit calculations and the capital requirements for operational risk. Other recent related capital regulation includes the UK leverage ratio framework announced by the Bank of England in October 2014. The Group has significantly strengthened its capital position in recent years and is now comfortably in excess of minimum requirements on both its CET1 ratio and its leverage ratio. The resilience of our capital position was demonstrated in 2014 when we exceeded the threshold for both the PRA and EBA stress tests. We will continue to be subject to these annual tests going forward.
CUSTOMER DRIVERS AND COMPETITION In the competitive open markets in which we operate, customers are benefiting from an increasing range of products and services from a growing choice of providers and via a range of channels.
The proportion of the UK population with access to the internet has increased significantly over the past few years, as has the proportion of people accessing the internet via their mobile phone. This has changed customer behaviours and expectations in terms of how they shop for goods and undertake banking and these trends are expected to continue.
In the current low interest rate environment, many customers are motivated by their desire to achieve better value for money, but security and reputation remain important factors. Customers want clear and transparent products delivered with good service and access to relevant, expert advice when they need it.
– Regulatory environment: uncertainty remains around the implementation of key elements of the proposals on ring-fencing and the form of new legislation, especially that proposed by the new EU Commission.
– Digital transformation: the pace of change is likely to be significant and we will need to continue to invest to meet evolving customer needs.
To assess progress, we measure customer satisfaction and are publicly committed to reducing complaints.
FCA reportable banking complaints increased during the year due to legacy and historic issues, with the increase largely driven by increased activity from claims management companies.
Given the progress made in recent years, we are in a strong financial and operating position as we enter the next phase of our strategy to become the best bank for customers and shareholders.
LOW COST, LOW RISK, CUSTOMER FOCUSED, UK RETAIL AND COMMERCIAL BANK
Initiatives – Seamless multi-channel distribution across branch, online, mobile and telephony
Expected outcomes – Growth in line with the market in current accounts and mortgages – Growth above market in underrepresented areas – Net lending growth of >£1 billion annually in both SME and Mid Markets
Our Code of Business Responsibility states that we do not finance any activities prohibited by international conventions supported by the UK government. For example, the Oslo Convention on Cluster Munitions and the Ottawa Treaty on Anti-Personnel Landmines. Consequently, we will not enter into or will exit from credit or investment relationships with businesses believed to be in breach of these conventions. You can read about our approach to managing environmental risk, our credit and investment activity and the Equator Principles in the Responsible Business section of our corporate website.
Our Governance framework enables strategic, accountable and responsible decision making by all colleagues.
The Group Board, Group Executive Committee and Responsible Business Committee play key roles in ensuring good governance and defining our responsible business objectives. Our Responsible Business team supports colleagues across the Group in fulfilling our responsible business agenda.
The Helping Britain Prosper Plan sets out public commitments to help Britain’s households, businesses and communities.
People in Britain are facing some big issues today. We’re using our influence and expertise to help them tackle these issues through our Helping Britain Prosper Plan. Playing an active role in helping people address some of the big social and economic issues they face today sows the seeds of a better future for us all. We recognise that when the customers and communities we serve prosper, then we do too.
Looking ahead We’ve always intended to develop the Plan in line with the next phase of our Group Strategy, announced in 2014, and any relevant market changes. We have updated the Plan for 2015 to keep it relevant to our business and our stakeholders. It now includes 28 metrics (with updated targets for 2015 and beyond) including new metrics focused on: supporting smaller house builders’ projects; digital skills; international trade; and infrastructure and investment. You can read more about our 2014 performance and new 2015 metrics in our Helping Britain Prosper Plan Update online.
5.2 Number of new Lloyds Banking Group Apprenticeship positions created with permanent employment
6.2 Number of community organisations supported by our volunteers or funding 8,690 6,500 6.3 £ donated to the Bank’s Foundations to help tackle disadvantage £16.5m £16.5m 6.4 £ raised by colleagues for our Charity of the Year (including Matched Giving) to support those in need in our communities £3.9m £1.7m
7.2 We will consistently increase the engagement levels of ethnic minority colleagues in all roles
We’ll help more customers get on the housing ladder – and more customers climb up it 1.1 Number of first-time buyers supported through delivering the most comprehensive mortgage proposition in the UK mortgage market >89,000 >80,000 1.2 Share proportion of new-build mortgages provided (for first-time buyers, second steppers and private rented) 1 in 4 1 in 4
Read more about these issues in our Responsible Business Review online at www.lloydsbankinggroup.com/RB
Developing our digital channels More than 10 million customers now use our digital banking services. We are the biggest ‘mobile bank’ in the UK with over 5 million customers using their mobile phone to bank with us. We expect these figures to increase in 2015. We want to make digital banking easier and personal for all our customers. We have also made it possible for digital banking customers to open accounts, swap mortgage products, move saving funds and calculate the benefits of making overpayments on mortgages and loans.
Rewarding and remunerating colleagues From 2015 onwards, we have made the decision to remove the last of the sales targets in our Retail customer-facing roles and focus solely on performance metrics based on customers, risk and people. This will help us to do the right thing for customers and rebuild colleagues’ pride in, and sense of commitment to, our Group.
Diversity and inclusion We want our Group to be a genuinely inclusive place to work, with every colleague treated fairly, with dignity and respect. We’ve made public commitments and set bold targets on diversity and inclusion in our Helping Britain Prosper Plan. These include commitments to: increase the proportion of senior management roles held by women; retain our Gold Standard as a disability-confident organisation; and increase the engagement scores of ethnic minority colleagues, disabled colleagues and lesbian, gay, bisexual and transgender colleagues, measured via our Colleague Survey. We plan to make more diversity and inclusion pledges in the future, as we work to build a culture in which all colleagues can be themselves at work and progress solely on the basis of merit.
Ethnic background: Percentage of colleagues from an ethnic minority 6.8% 6.4%
Investors and rating agencies We undertook more than 1,000 meetings with investors in 2014. We regularly engage SRI/ESG investors as well as investment analysts to provide them with information on our performance, strategic plans and how we do business responsibly. In 2014 we held our first responsible business webinar with investors and analysts.
In 2014 we achieved a number of key milestones in our Sourcing Plan, including the launch of our Code of Supplier Responsibility which sets out the minimum standards we expect from all suppliers. These standards are based on the social, ethical and environmental principles that we believe a responsible business should demonstrate. We also introduced our Group-wide Supplier Qualification system, which will help us standardise and manage requests for compliance and assurance data.
ENVIRONMENT Our ability to help Britain prosper is inextricably linked to wider environmental issues. Man made climate change and global trends such as resource scarcity, extreme weather and rising energy and commodity prices have an impact on our stakeholders and our own operations.
Greenhouse gas emissions We have voluntarily reported on our greenhouse gas emissions and environmental performance in our annual Responsible Business Report and Annual Report and Accounts since 2009, but since 2013 we have reported emissions in line with the requirements of the Companies Act 2006. Measuring emissions over time has enabled us to make appropriate investment in targeted reduction activities.
– CO2e emissions (tonnes) We report our emissions in terms of CO2 equivalent tonnes (CO2e). This year our overall carbon emissions have decreased by 2.2 per cent year-on-year and by 20.9 per cent against our 2009 baseline. The majority of this reduction is attributable to the reduction in consumption of gas and electricity, which constitute the largest proportion of our emissions. This reduction is mainly due to energy management activity, for example continued optimisation of building management systems to ensure that heating and ventilation plant and lighting run times are matched to actual building occupancy times, and investment in 2014 of around £3.8 million in specific energy efficiency measures, such as boiler controls, new lighting and building management upgrades.
The only area where we’ve seen an increase in CO2e related to consumption, relates to oil. The main reason is due to the new Horizon data centre becoming operational in the past year and receiving several deliveries of new oil.
Scope 1 emissions include combustion of fuel and operation of facilities.
We report emissions based on an operational boundary. The scope of our reporting is in line with GHG Protocol and covers Scope 1, Scope 2 and Scope 3 emissions. Reported Scope 1 emissions cover emissions generated from gas and oil used in Group buildings, emissions from UK company-owned vehicles used for business travel and emissions from the use of air conditioning and chiller/refrigerant plant. Reported Scope 2 emissions cover emissions generated from the use of electricity. Reported Scope 3 emissions relate to business travel undertaken by colleagues and emissions associated with the extraction and distribution of each of our energy sources – electricity, gas and oil. A detailed definition of these emissions can be found in our environmental criteria statement online.
– Verification We have retained the services of PricewaterhouseCoopers LLP (PwC) to provide an independent and robust assessment of the Group’s Scope 1, 2 and 3 emissions. PwC’s limited assurance report is available online.
– Business focus and accountability Managing risk effectively is a key focus and is one of the five criteria within the Group Balanced Scorecard on which business areas and individual performance are judged. Our 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 help differentiate our risk management approach.
ACHIEVEMENTS IN 2014 The Group strategy laid out in 2011 is now substantially complete. We have reshaped the Group, strengthened the balance sheet and delivered Simplification savings which have enabled reinvestment for growth. The independent Risk Division has played a pivotal role in supporting delivery which includes: Conduct Initiatives spanning the entire Group support the conduct agenda from strategy, insight, product, processes, through to sales and service to drive consistently good customer outcomes. Risk Division has played a key role in shaping this strategy and determining conduct risk measures to monitor performance and continue to support the journey to be market leading in complaint management through robust root cause analysis and remediation.
Capital strength During the year, our common equity tier 1 (CET1) capital position has continued to build to 12.8 per cent, increasing by 2.5 per cent in the year, in line with our capital generative strategy. The Group’s EBA and PRA stress testing exercises exceeded the relevant thresholds and the PRA confirmed no requirement to submit a revised capital plan or undertake additional management actions.
Impairment Through effective risk management our impairment charge improved by 60 per cent to £1,200 million, mainly driven by the reduction in Run-off assets and the sustained improvement in asset quality across the Group.
The framework articulates individual and collective accountabilities for risk management, risk oversight and risk assurance and supports the discharge of responsibilities to customers, shareholders and regulators. It establishes a common risk language which assigns risks to which the Group is exposed, to categories which are used consistently to support risk aggregation and reporting. The frameworks will evolve and be periodically updated to reflect any changes in the nature of our business and the external environment.
Accountability for ensuring risk is managed consistently with the Risk Framework approved by the Board
Determined by the Board and Senior Management. Business units formulate their strategy in line with the Group’s risk appetite
Through Board-delegated Executive Authorities there is effective oversight of risk management consistent with risk appetite
– Clearly defined levels of authority ensure we lend appropriately and responsibly with separation of origination and sanctioning activities.
– Continued reduction in complaint levels through root-cause analysis and improvements in complaints handling.
– A structural hedge programme has been implemented to manage liability margins and margin compression.
– Continually review IT system architecture to ensure that our systems are resilient and that the confidentiality, integrity and availability of our critical systems and information assets are protected against cyber attacks.
– The Legal, Regulatory and Mandatory Change Committee ensures we develop plans for regulatory changes and tracks their progress.
– Continue to support the UK economy through appropriate lending to Retail and Commercial customers including first-time buyers and SMEs, without compromising on risk appetite.
The DBPS are in a surplus of £890 million at 2014 which is an improvement from a £787 million deficit in 2013. Volatility has been reduced due to interest rate and inflation hedging and equity sales.
Operational risk We face significant operational risks which may result in financial loss, disruption or damage to the reputation of the Group. These include the availability, resilience and security of our core IT systems and the potential for failings in our customer processes.
– At 31 December 2014 the Group had £109.3 billion of unencumbered primary liquid assets and the Group maintains a further large pool of secondary assets that can be used to access Central Bank liquidity facilities.
– Daily monitoring against a number of market and Group specific early warning indicators and regular stress tests.
– We expect to generate between 1.5 per cent and 2.0 per cent of CET1 per annum (pre-dividend).
Regulatory risk We are subject to industry wide investigations and reviews into a perceived lack of competition in UK banking and financial services. The outcomes of the UK General Election in May 2015 and the investigations by the CMA and FCA are presently unclear and their impact therefore remains uncertain. Other initiatives under review include the ring-fencing proposals in the Banking Reform Act 2013, the new FCA Consumer Credit regime and CRD IV.
Overview: strong underlying profitability and balance sheet The Group’s underlying profit increased by 26 per cent in the year to £7,756 million, with a 2 per cent fall in income more than offset by a 2 per cent reduction in costs and a 60 per cent improvement in impairments. Excluding the effects of St. James’s Place, which benefited the 2013 results, total underlying income was up 1 per cent, and expenses were down 2 per cent with underlying profit up 40 per cent.
Statutory profit before tax in 2014 was £1,762 million (2013: £415 million) after provisions for PPI of £2,200 million (2013: £3,050 million) and other regulatory matters of £925 million (2013: £405 million), liability management losses of £1,386 million (2013: £142 million), Simplification and TSB build and dual running costs of £1,524 million (2013: £1,517 million) and a pension credit of £710 million (2013: charge £104 million). The statutory profit after tax in 2014 was £1,499 million compared to a loss after tax of £802 million in 2013. In the 2014 half year results news release we stated that we expected the full year statutory profit to be significantly ahead of the first half. Statutory profit before tax in the year was £1,762 million compared with £863 million in the first half.
The combination of strong underlying profitability and continued reduction in risk‑weighted assets resulted in a further improvement in the Group’s common equity tier 1 ratio to 12.8 per cent at 31 December 2014 after the 0.2 per cent impact of the recommended dividend (31 December 2013: 10.3 per cent pro forma) and the leverage ratio to 4.9 per cent post dividend (31 December 2013: 3.8 per cent pro forma). The increase in the leverage ratio also reflects the issue of additional tier 1 securities (AT1) in the second quarter.
The Group expects the net interest margin for the 2015 full year will be around 2.55 per cent.
Excluding St. James’s Place effects, other income in the year was 9 per cent lower at £6,607 million. The reduction was due to lower insurance income which was affected by changes in the pensions and annuities markets, the continued challenging market conditions experienced by the Debt Capital Markets and Financial Markets businesses and lower valuations in the private equity business within Commercial Banking, and the impact of business disposals and the smaller Run‑off portfolio. The Group expects other income will be broadly stable in 2015 compared with 2014.
Impaired loans as a percentage of closing advances reduced from 6.3 per cent at the end of December 2013 to 2.9 per cent at the end of December 2014, driven by reductions within both the continuing and the Run‑off portfolios. Provisions as a percentage of impaired loans increased from 50.1 per cent to 56.4 per cent.
Asset sales and other items The net gain from asset sales of £138 million included a gain of £122 million from the sale of Scottish Widows Investment Partnership. In 2013 there was a net loss from asset sales of £687 million and a £787 million gain on the sale of government securities.
The loss for liability management in 2014 of £1,386 million largely related to the Group’s ECN exchange offers completed in the second quarter. This was partly offset by the credit from own debt volatility of £398 million which mainly reflected the change in value of the equity conversion feature of the ECNs.
There was a charge for other volatile items of £112 million (2013: charge of £457 million) relating to the change in fair value of interest rate derivatives and foreign exchange hedges in the banking book not mitigated through hedge accounting.
In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints and claims from customers in connection with its past conduct, and where significant, provisions are held against the costs expected to be incurred as a result of the conclusions reached. In 2014, the Group made further provisions of £430 million in respect of a number of matters affecting the Retail, Commercial Banking and Consumer Finance divisions, including potential claims and remediation in respect of products sold through the branch network and continuing investigation of matters highlighted through industry wide regulatory reviews, as well as legacy product sales and historical systems and controls such as those governing legacy incentive schemes. Of the additional provision, £205 million was recognised in the fourth quarter. The increase reflected the Group’s assessment of a limited number of matters under discussion, none of which are individually considered financially material in the context of the Group.
The high tax charge in 2013 was driven by the write down of deferred tax assets following the changes in corporation tax rates and the sale of the Australian business.
Common equity tier 1 ratio is the same on both fully loaded and transitional bases. 31 December 2013 comparatives reflect CRD IV rules as implemented by the PRA at 1 January 2014.
The regulatory framework in which the Group operates has continued to evolve following the implementation of the Capital Requirements Directive (CRD IV) on 1 January 2014. The Group’s Pillar 2A requirement at 31 December 2014 was 3.8 per cent of risk‑weighted assets of which 2.1 per cent must be covered by CET1 capital. This reflects a point in time estimate by the PRA, which may change over time, of the total capital that is needed in relation to risks that are not covered or fully covered by Pillar I. The Group is now assuming a steady state CET1 ratio requirement of around 12 per cent.
Risk‑weighted assets reduced by 12 per cent, or £32.2 billion, in the year, to £239.7 billion (31 December 2013: £271.9 billion pro forma), primarily due to asset reductions in the Run‑off portfolio, active portfolio management in Commercial Banking and improvements in economic conditions.
Includes off‑balance sheet liquid assets; includes TSB £4.5 billion (31 December 2013: £nil).
Key balance sheet items at 31 December 2014 £bn £bn £bn £bn £bn £bn
Loans and advances to customers excluding TSB, Run‑off and other5,6 £406bn £402bn 1
In calculating underlying earnings per share, tax has been assumed at the standard UK corporation tax rate for the year.
Underlying profit before tax divided by average quarter end risk‑weighted assets and total assets respectively.
Lloyds Banking Group Annual Report and Accounts 2014 43BECOMING THE BEST BANK FOR CUSTOMERS
Post‑tax return on average shareholders’ equity 2.9 (2.0) (3.3) (6.7) (0.8)
This figure excludes the limited voting ordinary shares owed by the Lloyds Bank Foundations.
Capital ratios for 2012 and earlier years have not been restated to reflect the adoption of IAS 19 (Revised).
– Continued to attract new customers through positive switching activity, particularly through the Halifax challenger brand which has attracted around 250,000 customers in 2014. – Launch of a number of new products, including the Club Lloyds current account proposition which has attracted over 600,000 customers since launch, and the Club Lloyds Saver and Monthly Saver Accounts. – Launched two new unsecured lending products, enhancing account flexibility and online functionality. – Announced the simplification of the existing savings products range, which will lead to the consolidation of 47 accounts into three standard products. – Achieved £40 billion of gross new mortgage lending in 2014, providing 1 in 5 of all mortgage loans to customers buying their homes in the UK. Exceeded our lending commitment to first‑time buyers, lending £11.9 billion to over 89,000 customers, providing 1 in 4 of all mortgages. Retail continues to be a leading supporter of the UK government’s Help to Buy scheme, lending £1.9 billion in 2014. – Improved proposition to small business customers through the launch of a new mobile App, online account opening and online lending and successfully transferred 120,000 customers onto a new multi‑channel model in Retail. Exceeded its lending commitment by supporting over 100,000 new business start‑ups.
Restated to reflect the changes to the Group operating structure that came into effect from 1 January 2014.
Progress against strategic initiatives – Continued its support of SMEs, growing lending by 5 per cent in a contracting market. Its network of local and key markets relationship managers enables a quick response to the needs of the significant client base. – Strengthened the capabilities and increased the number of relationship managers in Mid Markets, resulting in an increase in client numbers particularly in the local authority, business services and education sectors.
– Enhanced returns in Global Corporates as a result of continued capital optimisation and increased profitability due to resilient income performance in challenging market conditions. – Further developed the Financial Institutions franchise, meeting a broader range of client needs, delivering growth in income and profitability whilst supporting financial services in the UK.
– Continued to invest in digital capability, with CB Online launching in 2015 and the continued development of mobile services to clients. – Continued to help Britain prosper; committing over £15.5 billion of UK lending through Funding for Lending, over £1 billion of funding support to UK manufacturing. In line with the Group’s focus on sustainability and responsible lending Commercial Banking became the first UK bank to issue an Environmental, Social and Governance (ESG) bond. The Debt Capital Markets team also pioneered market leading product innovation with the first green loan and first ESG bond for a housing association. – Its community based actions include the Enterprise Mentoring scheme, with over 400 Group colleagues now trained as Enterprise Mentors, providing support to over 700 SME businesses to date.
Financial performance – Underlying profit of £2,206 million, up 17 per cent on 2013, driven by strong income growth in SME, Mid Markets and Financial Institutions and lower impairments. – Income increased by 1 per cent to £4,436 million as a result of increased net interest income in all client segments offset by declining performance in other income reflecting challenging market conditions and lower income from Lloyds Development Capital. – Net interest margin increased by 46 basis points to 2.67 per cent as a result of disciplined pricing of new lending, customer repricing in deposits and a reduction in funding costs helped by the increase in Global Transaction Banking deposits. – Other income decreased 13 per cent driven by lower client income in Debt Capital Markets and Financial Markets due to the continued low interest rate and low volatility environment in 2014 and a lower level of revaluation gains in Lloyds Development Capital. – Asset quality ratio of 8 basis points improved by 29 basis points reflecting lower gross charges, improved credit quality and progress in executing its strategy of building a low risk commercial bank. – Return on risk‑weighted assets increased by 39 basis points to 1.92 per cent, making good progress towards achieving its 2015 target of 2 per cent by the end of 2015.
Balance sheet – Lending decreased by 5 per cent as a result of selective participation in Global Corporates partially offset by growth in SME and Financial Institutions. – Customer deposits increased by 10 per cent with Global Transaction Banking balances growing year‑on‑year in all client segments. – Risk‑weighted assets decreased by £17.8 billion with reductions in credit and market risk‑weighted assets as a result of active portfolio management, including reductions in Global Corporates reflecting the successful progress on improving returns.
Restated to reflect the changes to the Group operating structure that came into effect from 1 January 2014. Loans and advances to customers and customer deposits have been restated, see note 1, page 188.
Balance sheet – Net lending increased by 9 per cent to £20.9 billion driven by growth across both the underlying and the Jaguar Land Rover portfolios within UK Asset Finance where net lending increased by 43 per cent, and within Credit Cards following eight years of decline where net lending increased by 2 per cent. Balances in the European businesses were down 9 per cent, driven largely by foreign exchange rate movements. – Operating lease assets increased by 11 per cent to £3.1 billion reflecting Lex Autolease fleet growth of 7 per cent. – Customer deposits reduced by 20 per cent within Online Deposits driven by deposit re‑pricing activity in response to European Central Bank policy actions and foreign exchange rate movements. – Risk‑weighted assets increased by 4 per cent.
The Insurance division is focused on helping customers protect themselves today whilst preparing for a secure financial future. The division provides a range of simple, trusted, value for money insurance, protection and retirement products to Retail and Corporate customers, primarily through the Bank and Intermediary networks.
Assumption changes and experience variances (219) 277 − (24) 34 70
‘Other’ is primarily income from return on free assets, interest expense, certain provisions plus a small element of European business.
Full 2013 comparator tables for the profit and cash disclosures can be found on the Lloyds Banking Group investor site.
The new business income of £268 million includes a reduction in pensions new business income due to lower volumes relative to the spike in 2013 sales as pre‑Retail Distribution Review sales completed. In calculating new business income on auto‑enrolment schemes, allowance has been made for low initial contribution levels and does not include future automatic increases in contribution levels. These increases will be reported in future years. In addition Protection & retirement new business income has reduced following the 2014 Budget announcement which led to industry wide reductions in annuities volumes following changes to the freedoms consumers have in accessing their pension savings.
Cash generated from General Insurance − − 256 − 256 297
Restated to reflect the changes to the Group’s operating structure that came into effect from 1 January 2014.
– Run‑off includes certain assets previously classified as non‑core and the results and gains or losses on sale of businesses sold in 2013 and 2014. – The reduction in income and costs largely related to the sales of St. James’s Place in 2013 and Scottish Widows Investment Partnership in the first quarter of 2014. – The reduction in the impairment charge reflects continued proactive risk management and the success in managing down the Run‑off portfolios.
Includes volatility relating to the Group’s interest in St. James’s Place in 2013.
The impact on the results due to the actual return on these investments differing from the expected return (based upon economic assumptions made at the beginning of the year, adjusted for significant changes in asset mix) is included within insurance volatility. Changes in market variables also affect the realistic valuation of the guarantees and options embedded within the with‑profits funds, the value of the in‑force business and the value of shareholders’ funds.
Insurance hedging arrangements The Group purchased put option contracts in 2014 to protect against deterioration in equity market conditions and the consequent negative impact on the value of in‑force business on the Group balance sheet. These were financed by selling some upside potential from equity market movements. A charge of £26 million was taken on hedging contracts in 2014 (2013: £114 million).
Profit before tax: On a Lloyds Banking Group reporting basis (underlying profit) 458 106
In 2013, TSB was allocated costs on the same basis as the other business segments. In 2014, costs have been charged to TSB in accordance with the Transitional Service Agreement and the costs that were previously allocated to TSB have been charged to the other business segments.
Adjustment to reflect the change in timing of the FSCS charge.
The TSB risk‑weighted asset for operational risk is determined by TSB as a standalone organisation.
Skills and experience: An international career in banking, principally at HSBC where he worked for 37 years. During that time he held a number of senior management and Board positions in the UK and overseas. He gained a wealth of experience in most areas of the business including the day-to-day running of the bank with specific responsibility for employees, IT, finance and the branch network. External appointments: Member of the Welsh Rugby Union’s Audit Committee. Former appointments: Chairman of Principality Building Society, Director of HSBC Bank PLC and subsequently, Chief Executive Officer and Deputy Chairman. Prior to this he held a number of senior roles including Group Managing Director and member of the Group Management Board. Board member of the Wales Millennium Centre.
Skills and experience: Previously General Counsel and Company Secretary of Standard Life after a career as a corporate lawyer in private practice in London and Edinburgh. He has a wealth of experience in governance, policy and regulation. He is a member of the Advisory Forum of The Institute of Chartered Secretaries and Administrators and in 2014 was made a Fellow of the Institute. He is also a Member of the Company Law Committee of The Law Society of Scotland, the Chartered Institute for Securities and Investment and the GC100.
Alison is a member of the FCA’s Practitioner Panel and a Non-Executive Director for Marks and Spencer Group plc. Alison attended university in Scotland and the USA and has an MBA from Cambridge University’s Judge Institute.
António joined the Board in January 2011 as an Executive Director and became Group Chief Executive in March 2011.
David joined the Group in 2008. He has responsibility for the Halifax business, its branch network and 10,500 colleagues.
Read more about each member of the Board on our website at www.lloydsbankinggroup.com
Set out below are some of the principal corporate governance matters considered in 2014.
Finally I would like to thank the Board and our employees for their support and commitment throughout the year.
The role of the Directors Set out below are the roles of the Chairman and other Board members. Further details can be found on the website at www.lloydsbankinggroup.com. There is a clear division of responsibility at the head of the Company. The Chairman has overall responsibility for the leadership of the Board while the Group Chief Executive manages and leads the business.
Non-Executive Directors The Non-Executive Directors are listed on pages 58 and 59. Non-Executive Directors: – challenge constructively; – help develop and set the Group’s strategy; – participate actively in the decision-making process of the Board; – scrutinise the performance of management in meeting agreed goals and objectives; – provide entrepreneurial leadership of the Group within a framework of prudent effective controls; – satisfy themselves on the integrity of financial information; and
– determine appropriate levels of remuneration of Executive Directors via the Remuneration Committee.
Board authority The board authority sets out the matters reserved to the Board. These include decisions concerning the strategy and long-term objectives of the Group, the Group’s capital, medium-term plan and financial budgets, significant contracts and transactions and various statutory and regulatory approvals.
The Group Audit Director, Group HR Director and the Company Secretary attend the weekly GEC meetings to ensure that there is appropriate internal audit oversight, that employee interests and people strategy matters are considered and that the highest standards of corporate governance are maintained, including the escalation of matters to the Board and its Committees.
Governance The Board: – carried out an annual review of the corporate governance framework, Board Committee terms of reference and key Group policies; – determined Board and Committee structure, size and composition; – analysed the Group’s performance against the 34 ‘Salz’ recommendations, embedding changes to the Group’s governance arrangements where necessary; – considered the findings of an annual review of the Board’s effectiveness, implementing action plans where necessary and tracking performance; – monitored the Group’s performance against EU State Aid Commitments; – appointed a new Deputy Chairman and four new Non-Executive Directors to the Board; and
Risk management The Board: – approved the Group’s risk appetite and risk management framework; – monitored the Group’s aggregate risk exposures, risk/return and emerging risks; – scrutinised the results and approved the submission of the Group’s stress tests conducted by the PRA and EBA; – reviewed the effectiveness of the Group’s risk management and internal control systems; – considered the findings of the annual control effectiveness review; – received reports on risk compliance and risk appetite dashboard performance; and
– considered the impact of a ‘yes’ vote in Scotland on the Group’s operations.
Finance, statutory and regulatory requirements The Board: – considered regulatory changes to be introduced by the Banking Reform Act including retail ring-fencing; – approved the annual report and accounts and significant accounting changes; and
Scotland plc, comprise the same Directors. The Board meetings for these companies are held concurrently with the agenda split between the companies to allow decisions to be taken and scrutinised by the appropriate Board.
Monitors and reviews the Group’s financial reporting arrangements, the effectiveness of the internal controls and the risk management framework, and the internal and external audit process; manages all aspects of the relationship with the external auditor
Monitors the Group’s compliance with the Board’s approved risk appetite, risk management framework and risk culture
In 2014 settlement negotiations commenced with UK and US federal authorities. To manage this process, first the Board Risk Committee and then a specifically established Market Practices Sub-Committee of the Board Risk Committee investigated the issues, which were restricted to a specific area of the business and during a limited time period. The Market Practices Sub-Committee met five times during 2014, reporting to the Board Risk Committee with updates to the Board. The Chairman of the Risk Committee acted as the Chairman of the Sub-Committee.
Outcome In July 2014 the Group announced the payment of £217 million in settlements to UK and US federal authorities in connection with its manipulation several years ago of LIBOR and Sterling Repo Rate between May 2006 and 2009.
Fees paid to Non-Executive Directors reflect the time commitment and responsibilities of the role. Non-Executive Directors do not receive share options or other performance related pay. Executive Directors are restricted to taking on no more than one non-executive director role in a FTSE 100 company. The Chairman is required to commit to this being his primary role, limiting his other commitments to ensure he can spend as much time as the role requires. Since the announcement of his appointment to the role of Chairman in December 2013, Lord Blackwell has taken steps to ensure that he can adequately meet the time commitments of the role and has resigned from his positions at Halma plc and Ofcom, in March and July 2014 respectively. The Chairman’s biography can be found on page 58.
Directors are also invited to attend courses, management meetings and one-to-one meetings with key executives.
Effective use of the Board’s time To ensure that there is sufficient time for the Board to discuss matters of a material nature, Board dinners and/or breakfast meetings are held prior to each scheduled Board meeting. This allows the Directors greater time to discuss their views and, where relevant, form a consensus ahead of the meeting. These pre-meetings are normally attended by all members of the Board but often the pre-meetings are held without the Executive Directors present and separately, at least once a year, without the Chairman in attendance.
Group strategy In addition to routine strategic discussion at Board meetings throughout the year, the Directors spent two days off site in 2014 focusing entirely on the Group’s strategic priorities.
Number of meetings held during the period the member held office.
2014 evaluation of the Board’s performance Evaluation of the Board is externally facilitated at least every three years. The last externally facilitated evaluation was in 2012. This year’s evaluation was conducted internally between December 2014 and January 2015 by the Company Secretary, led by the Chairman and overseen by the Nomination & Governance Committee. The 2014 review considered the following areas: strategy; risk and control; planning and performance; Board composition and size; culture and dynamics; balance of skills and experience; diversity; relationships between management and independent directors; governance; the Board’s calendar and agenda; the quality and timeliness of information and support for Directors and Committees. The process for the review consisted of: – a detailed questionnaire, prepared by the Company Secretary in conjunction with the Chairman, to assess the effectiveness of the Board, its Committees and individual Directors; – follow up interviews by the Company Secretary with each Director; – feedback to the Nomination & Governance Committee; and – a recommended action plan.
Despite some improvement, timeliness and clarity of papers remains an issue.
Further targeted training for authors is needed to ensure papers are delivered in a timely manner, present a balanced view of all issues and are concise.
The formation of a Responsible Business Board Committee is being considered.
The quality and timeliness of Board and Committee papers continues to challenge the business. Further improvement is required.
Governance The proposal to tender for the audit work of the Group was overseen by the Audit Committee Chairman. The tender process involved three stages, these are summarised below.
– Submission of a written proposal document. Each firm was asked to provide detailed information in writing on certain matters in support of their proposal which were key to the Audit Committee’s assessment of each bid. This included matters such as: any independence issues faced by the firm in connection with their ability to serve the Group as auditors; the outcome of recent internal or external reviews to assess the quality of their firm’s audits; details on their audit methodology and areas of audit focus with regards to the Group; and an analysis of their expected level of audit effort (by grade of staff and hours) per year.
– Tender presentations. All three of the firms were invited to present their audit proposition to a Selection Committee. The Selection Committee was comprised of Mr Luff, Ms Fairbairn and Ms Frew. A number of the Board members were also in attendance for these presentations.
Investor Relations Investor Relations has primary responsibility for managing and developing the Group’s external relationships with existing and potential institutional equity investors. Supported by the Group Chief Executive, Chief Financial Officer, and other members of the senior management team, and the Senior Independent Director where appropriate, they achieve this through a combination of briefings to analysts and institutional investors (both at results briefings and throughout the year), as well as individual discussions with institutional investors.
Further, the team ensures that the Group’s Board and Group Executive Committee are informed of key messages, market developments and perception of the Group in the market. The primary responsibility for managing and developing relationships with existing and potential debt investors rests with the Group Corporate Treasury team with support from Investor Relations.
Investor contact During 2014, the Group held over 1,000 meetings with institutional equity and debt investors in the UK and overseas. Typical discussion points for institutional investors during the year included the Group’s financial performance; the Group’s strategy as outlined within the Strategic Update announced in October 2014; performance against strategy; progress in meeting regulatory requirements; as well as a number of issues that were pertinent at different times in the year such as the Initial Public Offering of TSB and the Scottish Referendum.
Key facts at 31 December 2014: – The Group has the largest number of registered ordinary shareholders in the UK
– Retail shareholders represent approximately 98.3 per cent of the total number of shareholders
– Institutional shareholders held approximately 95.5 per cent of the issued share capital on the share register, including approximately 7 per cent held on behalf of retail shareholders
The 2014 CER found that, overall, the Group is well controlled and that the control environment has improved year-on-year, with no significant failings or weaknesses identified. This conclusion is consistent with the delivery of previously initiated action plans and an improvement in the operational risk profile of the Group. The Audit Committee, in conjunction with the Board Risk Committee, concluded that the Group’s risk management systems and internal controls were effective and adequate having regard to the Group’s risk profile and strategy, and recommended that the Board approve them accordingly.
STATEMENT OF COMPLIANCE UK Corporate Governance Code The UK Corporate Governance Code 2012 (the Code) applied to the 2014 financial year. The Group confirms that it applied the main principles and complied with all provisions of the 2012 Code throughout the year, as required by the Listing Rules of the Financial Conduct Authority (FCA).
Chairman’s overview During 2014, the Committee continued to keep under review the Group’s governance arrangements, succession planning and the effectiveness of the Board and its Committees.
The Committee considered progress against the action plan to address the issues identified out of the 2013 Board effectiveness review and oversaw an internal review for 2014, led by the Chairman and conducted by the Company Secretary. Details of the effectiveness review can be found on pages 69 and 70.
JCA Group assisted with the search in respect of the appointments of Dyfrig John and Nick Prettejohn. Egon Zehnder facilitated the search for Simon Henry and Odgers Berndtson supported the search which resulted in the appointment of Alan Dickinson. None of the executive search firms have any other connection with the Group.
The outcome The Board appointed four new directors in 2014, all of whom share our values, have the behavioural characteristics to contribute constructively to our Board, and the capability to form and share independent judgements.
Simon Henry has extensive financial expertise and international experience in board level strategy and execution.
All members of the Committee are independent Non-Executive Directors, the majority with recent and relevant experience in finance and/or banking. Nick Luff is a chartered accountant and has significant financial experience in the UK listed environment enabling him to fulfil the role of Audit Committee Chair and for SEC purposes the role of Audit Committee Financial Expert. Simon Henry joined the Board in June 2014 as a member of the Audit Committee and the Risk Committee. Simon has extensive knowledge of financial markets, treasury and risk management and also qualifies as an Audit Committee Financial Expert under SEC rules.
In particular the Committee: – approved the annual audit plan including methodology and risk identification processes; – reviewed the findings of the external audit including key judgements such as impairment and conduct provisions and the level of challenge provided by the external auditor; – considered management’s responsiveness to the auditor’s findings and recommendations; – considered the continued effectiveness of the audit process; and – considered the external auditors’ performance, including technical competence, strategic knowledge, quality control, capabilities, communication and reporting through the recent tender process (see case study) and an internal effectiveness questionnaire.
Other conduct provisions The Group has a number of other provisions for conduct related matters, all of which are judgemental and require the Group to make a number of assumptions.
– The Audit Committee considered the recognition of deferred tax assets, in particular the forecast taxable profits based on the Group’s five year operating plan and the split of these forecasts by legal entity and the likely impact of the Chancellor of the Exchequer’s December 2014 statement concerning the restriction on banks’ ability to use their carry forward losses. – The Audit Committee agreed with management’s judgement that the deferred tax assets were appropriately supported by forecast taxable profits, taking into account the Group’s long-term financial and strategic plans. The disclosures relating to deferred tax are set out in note 3: Critical accounting estimates and judgements on page 199 and note 39: ‘Deferred tax’ on page 247 of the financial statements.
Uncertain tax positions The Group has a number of open tax matters which requires the Group to make judgements as to the likely outturn for the purposes of calculating its tax position.
– The Audit Committee understood the uncertain tax positions of the Group, including the respective views of the Group and the relevant tax authorities. The Audit Committee also understood the external advice obtained by management to support the views taken by the Group. – The Audit Committee was satisfied that the disclosures made in respect of uncertain tax positions were appropriate. The relevant disclosures are set out in note 50: ‘Contingent liabilities and commitments’ on page 271 of the financial statements.
Retirement benefit obligations Determining the value of the defined benefit obligation is judgemental and requires the Group to determine a number of economic and non-economic actuarial assumptions.
Committee purpose, responsibilities and composition The purpose of the Board Risk Committee is to monitor: the Group’s compliance with the Group risk appetite as approved by the Board covering the extent and categories of risk which the Board regards as acceptable for the company to bear; the Group’s risk management framework embracing principles, policies, methodologies, systems, processes, procedures and people; and the Group’s risk culture to ensure that it supports the Group’s risk appetite. Full details of the Committee’s responsibilities are set out in its terms of reference, which can be found on our website at www.lloydsbankinggroup.com.
Further details on the Group’s risk appetite can be found in the risk management section on pages 107 to 170.
Consolidated risk report The Committee reviewed this report at each meeting. It provides the Committee with a monthly summary of the main risks measure within the business, providing supporting quantitative data and additional commentary to inform the Committee in considering and challenging management’s assessment and future projected status of key risks against appetite.
It received reports on sales processes and product governance, including the progress of annual product risk assessments, the results of outcome testing including mystery shopping results and complaint metrics, rewards and incentives.
In regards to IT resilience/cyber risk, the Committee set the framework for, and oversaw, the response to an external review of IT resilience carried out in 2013 and considered the Group’s exposure to cyber risk. The Committee also discussed investment in incremental improvements in IT resilience and our cyber controls.
Financial and market risk The Committee considered the controls in place for financial markets and reviewed the structural hedge risk appetite. The Committee reviewed the liquidity and funding position including the stress testing analysis undertaken, and the Group’s stress testing reports against internal and regulator driven economic scenarios, and their impact on the Group’s plans.
Controls Group Audit’s review of the process and controls used in the PRA and EBA stress test exercises did not identify any material control weaknesses.
In order to support the Group’s journey to become the Best Bank for Customers, the Committee has adjusted the performance targets for the 2015 long-term incentive plan (LTIP) so that they are closely aligned with the areas of focus under the Group Strategic Review (GSR): – Creating the best customer experience – Becoming simpler and more efficient – Delivering sustainable growth – Building the best team
In addition, the Group has now incorporated clawback provisions for all Material Risk Takers in line with Prudential Regulation Authority (PRA) requirements from 1 January 2015. Variable remuneration can now be recovered from employees up to seven years after the date of award in the case of a material or severe risk event.
We continue to believe that our remuneration policies and practices fairly reward our directors, and support the delivery of the Group’s strategy and the creation of shareholder value. I therefore hope you will support the resolution relating to remuneration at the 2015 AGM.
– Maximum potential The maximum award is 100 per cent of base salary.
Our pension policy aims to support Executive Directors in building long-term retirement savings.
– Operation Benefits may include those currently provided and disclosed in the Implementation Report.
– Operation Measures and targets are set annually and awards are determined by the Committee after the year end based on performance against the targets set. The annual bonus may be delivered partly in cash and partly deferred into cash, shares, notes or other debt instruments including contingent convertible bonds. Deferral levels are set at the time of award and in compliance with regulatory requirements (which currently require that at least 60 per cent of variable pay is deferred and at least 50 per cent of variable pay is paid in shares or other instruments). Deferred awards normally vest after three years and the Committee may adjust awards in the event of any variation of share capital, demerger, special dividend or distribution or amend the terms of the plan in accordance with the plan rules.
The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance. The Committee may reduce the level of deferred award (including to zero), apply additional conditions to the vesting, or delay the vesting of deferred awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of an event occurring before vesting.
– Maximum potential The maximum annual award for Executive Directors will normally be 300 per cent of salary excluding dividend equivalents (this being the reference salary in the case of the GCE). Under the plan rules, awards can be made up to 400 per cent of salary in exceptional circumstances excluding dividend equivalents.
Measures and targets are set annually by the Committee and limited details can therefore be provided in the remuneration policy.
When determining fee levels, the following are considered: – The individual’s skills and experience.
– Maximum potential The Committee will make no increase in fees or benefits currently provided which it believes is inconsistent with the two parameters above.
SERVICE AGREEMENTS The service contracts of all current Executive Directors are terminable on 12 months’ notice from the Group and six months’ notice from the individual. The Chairman also has a service agreement. His engagement may be terminated on six months’ notice by either the Group or the individual.
The members of the Committee during 2014 were: – Anthony Watson (chairman) – Lord Blackwell – Sir Winfried Bischoff (retired April 2014) – Carolyn Fairbairn – Anita Frew (also chairman of the Board Risk Committee from May 2014) (from May 2014) – Dyfrig John (from June 2014) – David Roberts (also chairman of the Board Risk Committee until May 2014) (retired May 2014) – Sara Weller
One of the observations was that the introduction of Fixed Share Awards for Executive Directors in 2014 was not accompanied by a sufficient reduction in total remuneration to reflect increased certainty of rewards. The Committee considered this point and ensured that the expected value of bonus awards was reduced so that total remuneration remained consistent for equivalent levels of performance. It also maintained the value of long-term incentives and instead made significant reductions to short-term bonus opportunity, thereby further weighting reward towards long-term performance. The Committee is satisfied that its approach, and the revised maximum remuneration opportunity, is positioned conservatively against peers and will provide a fair and competitive level of remuneration for outstanding performance.
The Committee also takes into account base salary increases for employees throughout the Group. We are proposing a 2.5 per cent overall salary budget increase for the general population differentiated by performance and market position (increases generally range from 0 per cent to 6.5 per cent).
As disclosed in previous reports, since his appointment, the Group Chief Executive has a reference salary of £1.22 million which is used to calculate certain elements of long-term remuneration and the pension allowance.
For 2015 the annual bonus will be based on: – Financial underlying profit – 50 per cent – Balanced scorecard (BSC) objectives comprising five categories (finance, building the business, customer, risk and people) – 50 per cent
A revised performance adjustment policy has been fully implemented. Performance adjustment is determined by the Remuneration Committee and Board Risk Committee and may result in a reduction of up to 100 per cent of the bonus opportunity. The Independent Performance Adjustment Committee (IPAC) reviews the balanced scorecard outcomes and submits a report to the Remuneration Committee and Board Risk Committee to assist in this process.
Absolute Total Shareholder Return (TSR) Growth in share price including dividends over 3 year period
Measure excludes PPI complaints and any complaints received via Claims Management Companies, but includes Banking, Home Finance, General Insurance, Life, Pensions and Investment complaints.
With regard to the economic profit measure, which remains a core financial measure, the Group is currently reviewing the calculation methodology for financial reporting purposes in order to better align with current expectations of the Group’s forward-looking plan, including the Group’s capital requirement and asset quality ratio. We are seeking to complete this review as soon as possible and will consult with shareholders in respect of any proposed changes during 2015.
REMUNERATION OUTCOME FOR 2014 Executive directors (audited) The following table summarises the total remuneration delivered during 2014 in relation to service as an Executive Director.
Following changes to the amount of tax relief available on pension contributions in each year, Directors may elect to receive some or all of their allowances as cash. The breakdown of payments made in cash and contributions into the pension scheme are shown below. Note that the amount for 2013 in respect of George Culmer includes £106,000 carried over from 2012 and delivered in 2013.
The long-term incentive vesting was confirmed by the Remuneration Committee at its meeting on 25 February 2015. The closing share price on that date of 79.24 pence has been used to calculate the value. The shares were awarded in 2012 based on a share price of 34.786 pence.
The GCE has a conditional unfunded pension commitment, subject to share price performance. This was a partial buyout of a pension forfeited on joining from Santander. It is an unfunded unapproved retirement benefit scheme (UURBS). The UURBS provides benefits on a defined benefit basis at a normal retirement date of 65. The UURBS applies for a maximum of six years following the commencement of employment and the maximum allowance over that period is 26.5 per cent of the higher of the GCE’s base salary and reference salary in the 12 months before retirement or leaving, subject to performance conditions. No additional benefit is due in the event of early retirement. The rate of pension accrual in each year depends on share price conditions being met. An annual pension entitlement of £35,610 was accrued in 2014.
As a result of these items, the Remuneration Committee applied an overall adjustment of approximately 25 per cent, resulting in a final bonus outcome of £369.5 million (a reduction of 3.6 per cent from the total outcome in 2013 (after adjusting for TSB).
Awards are approved by the Remuneration Committee, which has discretion to adjust outcomes for any reason.
The introduction of the Fixed Share Awards in 2014 resulted in a reduction in the annual bonus opportunity for the Group Chief Executive (the maximum award reduced from 225 per cent to 140 per cent of base salary). Expected outcomes are based on individual performance before taking into account a modifier based on underlying profit and the Group balanced scorecard, as follows: Rating Under Developing Good Strong Top
The introduction of the Fixed Share Awards in 2014 resulted in a reduction in the annual bonus opportunity for the Chief Financial Officer (the maximum award reduced from 200 per cent to 100 per cent). Expected outcomes are based on individual performance before taking into account a modifier based on underlying profit and the Group balanced scorecard, as follows: Rating Under Developing Good Strong Top
Following the Committee’s assessment of performance against the underlying profit target and the Finance function’s balanced scorecard objectives, and taking into account the collective performance adjustment of 24.9 per cent and the individual rating of ‘Strong’, the Committee determined a 2014 bonus award to the Chief Financial Officer of £496,000 (69 per cent of base salary).
– Positive achievements in impairment charge, reduction in non-core assets, RWAs and leverage ratio.
Following the Committee’s assessment of performance against the underlying profit target and the Risk division’s balanced scorecard objectives, and taking into account the collective performance adjustment of 24.9 per cent and the individual rating of ‘Strong’, the Committee determined a 2014 bonus award to the Chief Risk Officer of £467,892 (66 per cent of base salary).
Application of the Committee’s judgement As described above, the Committee used its judgement to apply a collective adjustment to reflect the level of provisions for legacy conduct related matters.
The bonuses awarded are summarised in the table below: Name António Horta-Osório George Culmer Juan Colombás
% awarded for 2014 (as % of maximum) 54% 69% 66%
Deferral The Group Chief Executive’s award is deferred into shares for five years and subject to performance adjustment and clawback. The award is subject to an additional condition that the share price must remain above 75.5 pence on average for any 126 consecutive trading days in the five years following grant or the UK government sells 100 per cent of its shareholding during the three years following grant.
Bonus awards for other Executive Directors are deferred into shares until at least March 2017 and subject to performance adjustment and clawback. They are also subject to remaining in the Group’s employment, as set out in the approved policy from the 2013 Directors’ Remuneration Report.
Percentage change in remuneration of GCE versus the wider employee population Figures for ‘All Employees’ are calculated using figures for UK-based colleagues subject to the Group Annual Bonus Plan. This population is considered to be the most appropriate group of employees for these purposes because its remuneration structure is consistent with that of the Group Chief Executive.
OUTSTANDING SHARE AWARDS Directors’ interests (audited) – Shareholding guidelines Executive Directors are required to build up a holding in Lloyds Banking Group plc shares of value equal to 150 per cent of base salary and fixed share award (200 per cent for the GCE) and are expected to achieve these targets within three years from the later of 1 January 2012 and their date of joining the Board. They are required to retain any shares vesting from LTIP awards granted from 2012 onwards for a further two years post vesting (although vested shares would count towards the shareholding requirement). Members of the Executive Committee are required to build up a shareholding of 100 per cent of their gross salary. As at 31 December 2014, all Executive Directors significantly exceeded the requirements.
The changes in beneficial interests for António Horta-Osório (415 shares), George Culmer (415 shares) and Juan Colombás (414 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2014 and 26 February 2015. There have been no other changes up to 26 February 2015.
SME lending Set relative to targets for SME lending growth over 3 year period
Measure excludes PPI complaints, but includes Banking, Home Finance, General Insurance, Life, Pensions and Investment complaints.
Variable pay in respect of performance year 2014. LTIP values shown reflect awards for which the performance period ended on 31 December 2014. Pension costs based on a percentage of salary according to level.
Directors’ interests – summary of awards vested, purchases and sales made by directors in 2014 (unaudited)
Results The consolidated income statement shows a statutory profit before tax for the year ended 31 December 2014 of £1,762 million. A summary of the Group’s results can be found on pages 35 to 43 and is incorporated into this report by reference.
Directors The names and biographical details of the current Directors are shown on pages 58 to 59. Particulars of their emoluments and interests in shares in the Company are given on pages 82 to 103. Changes to the composition of the Board since 1 January 2014 up to the date of this report are shown in the table below: Joined the Board Retired from the Board
Appointment and retirement of Directors The appointment of Directors is governed by the Company’s articles of association, the UK Corporate Governance Code and the Companies Act 2006. The Company’s articles of association may only be amended by a special resolution of the shareholders in a general meeting.
The Company is party to a deed of covenant with each of the four Lloyds Foundations (the Foundations) which hold limited voting shares in the Company (the limited voting shares are further described in note 42 on pages 257 and 258). Under the terms of the deeds of covenant, the Company makes an annual payment to each of the Foundations. In the event of a successful offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting share would convert to an ordinary share under the terms of the Company’s articles of association. The payment obligation under the deeds of covenant would come to an end one year following the conversion of the limited voting shares.
Resolutions concerning the re-appointment of PricewaterhouseCoopers LLP as auditor and authorising the Audit Committee to set its remuneration will be proposed at the annual general meeting.
RISK CULTURE The Board ensures that senior management implements risk policies and risk appetites that either limit or, where appropriate, prohibit activities, relationships and situations that could be detrimental to the Group’s risk profile.
The Retail division is a leading provider of financial service products, including current accounts, savings, personal loans and mortgages to UK personal customers, including Wealth and small business customers
– Counterparty credit risk3 – £11.0bn – – £0.3bn – –
As a separate regulated business, Insurance maintains its own regulatory solvency requirements, including appropriate management buffers, and reports directly to Insurance Board. Insurance does not hold any RWAs, as its assets are removed from the Banking Group’s regulatory capital calculations. However, part of the Group’s investment in Insurance is included in the calculation of Threshold RWAs, subject to the CRD IV rules, while the remainder is taken as a capital deduction.
These risks are considered alongside the Group’s five year operating plan. Risk Key mitigating actions
Compliance and Competition Regulation There is a material volume of regulatory change including market studies undertaken by the FCA and Competition and Markets Authority, overhaul of the Senior Managers’ Regime and evolving regulatory oversight on the Payments agenda. All of these could impact on the Group’s direction, structure and returns.
Data integrity and systems infrastructure The Group must continue to invest to maintain robust data integrity, security to ensure the quality, flow and consistency of data to meet regulatory and internal standards including the EU Data Protection Regulation requirements.
– Impact assessments will continue to be undertaken and subsequent plans put in place to ensure the Group is compliant with this new 2018 reporting standard which will be deployed in a controlled and effective manner.
STRESS TESTING OVERVIEW Stress testing is recognised as an essential risk management tool within the Group by the Board, senior management, the businesses and the risk and finance functions. Stress testing is embedded in the planning process of the Group as a key activity in medium term planning. This allows senior management and Board to assess the base case plan in adverse circumstances and to adjust strategies/propose mitigating actions if the plan does not meet risk appetite in a stressed scenario. A rigorous review and challenge process ensures that senior management is actively involved in the stress testing process.
HOW RISK IS MANAGED IN LLOYDS BANKING GROUP The following section describes how Lloyds Banking Group manages risk. As a separate standalone entity, TSB Banking Group independently manages its own risks.
All business areas complete a Control Effectiveness Review (CER) annually, reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. Executives from each business area and each GEC member challenge and certify the accuracy of their assessment. This key process is overseen and independently challenged by Policy Owners, Risk Division and Group Audit.
Risk appetite – the business plan is aligned to the Risk Appetite Statement so that the Group’s short and medium-term business objectives match its risk tolerances which are translated into relevant risk limits for business units.
The Risk directors: – provide independent advice, oversight and challenge to the business; – design, develop and maintain policies, specific risk frameworks and guidance to ensure alignment with business imperatives and regulatory requirements; – establish and maintain appropriate governance structures, culture, oversight and monitoring arrangements which ensure robust and efficient compliance with relevant risk-type risk appetites and policies; – lead regulatory liaison on behalf of the Group including horizon scanning and regulatory development for their risk type; and – propose risk appetite and oversight of the associated risk profile across the Group.
There is ongoing investment in risk systems and models alongside the Group’s investment in customer and product systems and processes. This drives improvements in risk data quality, aggregation and reporting leading to effective and efficient risk decisions.
BOARD, EXECUTIVE AND RISK COMMITTEES The Group’s risk governance structure (see table 1.2) strengthens risk evaluation and management, while also positioning the Group to manage the changing regulatory environment in an efficient and effective manner.
Group Rectification Committee Ensures appropriate control and oversight of material events which have a customer impact.
The Group considers reputational impact in the course of managing all its risks and therefore does not classify reputational impact as a separate risk driver.
Exposures The principal sources of credit risk within the Group arise from loans and advances, contingent liabilities, commitments, debt securities and derivatives to customers, financial institutions and sovereigns. The credit risk exposures of the Group are set out in note 54 on page 293. Credit risk exposures are categorised as ‘retail’, arising primarily in the Retail, Consumer Finance and Run-off divisions, and small and medium sized enterprises (SMEs) and corporate (including corporates, banks, financial institutions and sovereigns) arising primarily in the Commercial Banking, Run-off and Insurance divisions.
Credit risk can also arise from debt securities, private equity investments and derivatives. The total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2014 is shown on page 124. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 54 on page 293.
Credit risk exposure also arises in the Group’s defined benefit pension schemes from holding investments. Note 38 on page 240 provides further information on the defined benefit schemes’ assets and liabilities.
The quality measurement of both retail and commercial 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 management judgement – retail models rely more on the former, commercial 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.
In the principal retail portfolios, exposure at default and loss given default models are also in use. They have been developed internally and use statistical analysis combined, where appropriate, with external data and subject matter expert judgement.
For reporting purposes, counterparties are also segmented into a number of rating grades, each representing a defined range of default probabilities and exposures migrate between rating grades if the assessment of the counterparty probability of default changes.
Cross-border exposures: The Board sets country risk appetite. Within this, country limits are authorised by the country risk appetite committee, taking into account economic, financial, political and social factors. Group policies stipulate that these limits must be consistent with, and support, the approved business and strategic plans of the Group.
Specialist expertise: Credit quality is managed and controlled by a number of specialist units within Risk Division providing, for example: intensive management and control (see Intensive care of customers in financial difficulty); security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector specific expertise; and legal services applicable to the particular market place and product range offered by the business.
Credit risk assurance and review: A specialist team within Group Audit, comprising experienced credit professionals, is in place to perform credit risk assurance. This team carries out independent risk based internal control audits and credit quality reviews, providing an assessment of the effectiveness of internal controls, risk management practices, credit risk classification, as well as the accuracy of impairment provisions. These audits and reviews cover the diverse range of the Group’s businesses and activities, and include both ‘standard’ risk based audits and reviews as well as bespoke assignments to respond to any emerging risks or regulatory requirement. The work of Group Audit therefore 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 (BSU) work out strategies, as well as accuracy of impairments.
For mainstream mortgages greater than £5,000,000 the maximum LTV is 50 per cent. Buy-to-let mortgages are limited to a maximum of £1,000,000 and 75 per cent LTV. All mortgage applications above £500,000 are subject to manual underwriting.
Collateral The principal collateral types for loans and advances, contingent liabilities and derivatives with commercial and bank counterparties/customers are: – mortgages over residential and commercial real estate; – charges over business assets such as premises, inventory and accounts receivables; – financial instruments such as debt securities; – cash; and – guarantees received from third parties (such as export credit agencies).
The specific tools available to assist customers vary by product and the customer’s status. In defining the treatments offered to customers who have experienced financial distress, the Group distinguishes between the following categories: – Reduced contractual monthly payment: a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original contractual payments, for example temporary interest only arrangements and short-term payment holidays granted in collections. Any arrears existing at the commencement of the arrangement are retained. – Reduced payment arrangements: a temporary arrangement for customers in financial distress where arrears accrue at the contractual payment, for example short-term arrangements to pay. – Term extensions: a permanent account change for customers in financial distress where the overall term of the mortgage is extended, resulting in a lower contractual monthly payment.
– Repair: a permanent account change used to repair a customer’s position when they have emerged from financial difficulty, for example capitalisation of arrears.
BSU case officers manage non-retail distressed assets in Commercial Banking and Run-off Divisions, and are part of the independent Risk Division. They are highly experienced and operate in a closely controlled and monitored environment, including regular oversight and close scrutiny by senior management. The BSU case officers will continue to work in partnership with Relationship Managers throughout the process to achieve the shared common goals.
– The Acquisition Finance (leverage lending) portfolio has materially reduced and gross loans and advances totalled £1,910 million as at 31 December 2014. The Run-off element of the Acquisition Finance portfolio totalled only £40 million (net £22 million) as at 31 December 2014.
Classified as impaired during the year 2,067 963 262 1,397 136 4,825 9,552
Table 1.8: Group impaired loans and provisions Loans and advances to customers £m
Impairment provisions as a percentage of impaired loans are calculated excluding Retail and Consumer Finance loans in recoveries (31 December 2014: £437 million in Retail loans and overdrafts, £26 million in Retail Business Banking and £282 million in Consumer Finance credit cards; 31 December 2013: £476 million in Retail loans and overdrafts, £34 million in Retail Business Banking and £405 million in Consumer Finance credit cards).
Secured – Impaired loans reduced to £3,911 million at 31 December 2014 compared to £5,503 million at 31 December 2013.
Table 1.12: Retail secured and unsecured loans and advances to customers At £m
The stock of repossessions decreased to 1,740 cases at 31 December 2014 compared to 2,179 cases at 31 December 2013.
Retail has reduced its exposure to residential interest only mortgages throughout 2014. New residential interest only mortgages are limited to a maximum loan to value of 75 per cent, with a verifiable repayment vehicle sufficient to repay the loan. Interest only mortgages represented 0.1 per cent of new residential mortgages in 2014 (0.4 per cent in 2013).
For existing interest only mortgages, a contact strategy is in place throughout the term of the mortgage to ensure that customers are aware of their obligations to repay the principal upon maturity of the loan. The weighted average term to maturity of the interest only balances included in the table above is 12 years; the profile of residential interest only maturities is shown below.
Other Commercial Banking – Other Commercial Banking comprises £74,203 million of gross loans and advances to customers in Mid Markets, Global Corporates and Financial Institutions.
– The Global Corporate portfolio continues to be predominantly investment grade focused. – The real estate business within Global Corporate is focused on the upper end of the UK property market with a bias to the quoted publicly listed and funds sector. Portfolio credit quality remains good being underpinned by seasoned management teams with proven asset management skills. – The Financial Institutions portfolio relates to relationships which are either client focused or held to support the Group’s funding, liquidity or general hedging requirements. – Traded products continue to be predominantly short-term and/or collateralised with inter-bank activity mainly undertaken with strong investment grade counterparties.
Commercial Banking UK Direct Real Estate LTV analysis – The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities such as hotels, care homes and housebuilders). – The Group manages its exposures to Direct Real Estate across a number of different coverage segments. – Approximately three quarters of loans and advances to UK Direct Real Estate relate to commercial real estate with the remainder residential real estate. – The Group makes use of a variety of methodologies to assess the value of property collateral, where external valuations are not available. These include use of market indexes, models and subject matter expert judgement.
Exposures exclude £0.4 billion of gross UK Direct Real Estate lending in Wealth (within Retail division).1
Corporate real estate and other corporate 11,571 8,131 70.3 3,320 40.8
Run-off UK Direct Real Estate LTV analysis – The Group considers this portfolio to be appropriately provided for after taking into account the provisions held for each loan and the value of the collateral held. – In the case of impaired UK Direct Real Estate exposures (over £5 million), there is a net property collateral shortfall of approximately £60 billion. This figure excludes benefits of credit mitigants such as cross collateralisation and cross guarantees, The Group makes use of a variety of methodologies to assess the value of property collateral, where external valuations are not available. These include use of market indexes, models and subject matter expert judgement.
Insurance shareholder assets are assets where the Group is directly exposed to risk of loss and are held outside the with-profits and unit-linked funds. These exposures relate to direct investments where the issuer is resident in Spain, Italy, Greece, Portugal or Ireland and the credit rating is consistent with the tight credit criteria defined under the appropriate investment mandate. Insurance also has interests in two funds domiciled in Ireland (Global Liquidity Fund and the Investment Cash Fund) where, in line with the investment mandates, cash is invested in short term financial instruments. For these funds, the exposure is analysed on a look through basis to the country risk of the obligors of the underlying assets rather than treating the insurance holding in the funds as exposure to Ireland.
Insurance assets TotalBanks Other1 £m £m £m £m £m £m £m £m £m
In addition to the exposures detailed above, the Group has the following exposures to sovereigns, financial institutions, asset backed securities, corporates and personal customers in the following Eurozone countries: Table 1.28: Other Eurozone exposures Sovereign debt
All other Eurozone countries – – 5 – – 57 – 163 225
The Group’s Conduct Strategy continues to evolve and be enhanced. The Group actively engages with regulatory bodies and other stakeholders in developing its understanding of current customer treatment concerns, and those relating to the fairness and effectiveness of markets, to ensure that the implementation of the Group’s conduct strategy meets evolving stakeholder expectations.
MARKET RISK 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 bond prices, foreign exchange rates, equity, property and commodity prices and other instruments), lead to reductions in earnings and/or value.
Items in the course of collection from banks 1,173 – 1,173 – Interest rate
Trading and other financial assets at fair value through profit or loss 151,931 48,494 9,123 94,314
Loans and advances to customers 482,704 – 482,704 – Interest rate
Available-for-sale financial assets 56,493 – 56,491 2 Interest rate, credit spread, foreign exchange
Items in course of transmission to banks 979 – 979 – Interest rate
Derivative financial instruments 33,187 27,811 3,616 1,760 Interest rate, foreign exchange, credit spread
Derivative assets and liabilities are held for three main purposes; to provide risk management solutions for clients, to manage portfolio risks arising from client business and to manage and hedge the Group’s own risks. The majority of derivatives exposure arises within Financial Markets.
Key: Profit before tax: >£500m l £250m to £500m l £50m to <£250m l <£50m l
Credit spread risk arises largely from the following: – The assets held mainly within the liquid asset portfolio; and – The credit and debit valuation adjustments (CVA and DVA) sensitivity to credit spreads. As explained within the notes to the Consolidated Financial Statements CVA and DVA are applied to the Group’s over-the-counter derivative exposures with counterparties that are not subject to standard interbank collateral arrangements. These exposures largely relate to the provision of risk management solutions for corporate customers within the Commercial Banking Division.
Internal market risk models for trading book activities comprise VaR, Stressed VaR and Incremental Risk Charge and these are explained in detail in the Group’s Market Risk section of the Pillar 3 Report.
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 2014 and 2013 based on the Group’s global trading positions is detailed in table 1.32.
The risk of loss measured by the VaR model is the minimum expected loss in earnings given the confidence level and assumptions noted above. The total and average trading VaR reported below does not assume any diversification benefit across the five risk types. The Group internally uses VaR as the primary measure for all trading book positions arising from short term market facing activity. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported as a whole. The average VaR for 2014 was similar to the average over 2013.
The Group ensures that it has adequate stock of high-quality liquid assets (for example Gilts or US Treasury Securities) that can be converted easily into cash to meet liquidity requirements. The interest rate risk in these portfolios is hedged with interest rate swaps on an asset swap basis.
Insurance portfolios Current and potential future market risk exposures within Insurance are assessed using a range of stress testing exercises and scenario analyses. Risk measures include 1-in-200 year stresses for Insurance’s Individual Capital Assessment (ICA) and single factor stresses for profit before tax.
Further stresses that show the effect of reasonably possible changes in key assumptions, including 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 are set out in note 34 on page 238.
Customer facing divisions incur foreign exchange risk in the course of providing services to their customers. GCT incurs foreign exchange risk through its various debt and capital management programmes. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled within the trading risk appetite and any residual risk is hedged in the market.
The surplus or deficit in the schemes is tracked on a monthly basis along with various single factor and scenario stresses which consider the assets and liabilities holistically. The impact on Group capital resources of the schemes is monitored monthly. Performance against risk appetite triggers is also regularly monitored. Hedges are in place and asset/liability matching positions are also actively monitored.
Exposures The principal operational risks to the Group are: – The risk that the Group is unable to provide services to customers as a result of an IT systems failure; – Cyber risks associated with malicious attacks on the confidentiality or integrity of electronic data, or the availability of systems; – External fraud arising from an act of deception or omission; – Risks arising from inadequate delivery of services to customers; – The risk associated with the ongoing provision of services to TSB and other organisations.
In 2014, the highest frequency of events occurred in external fraud (63.17 per cent) and execution, delivery and process management (20.70 per cent). Clients, products and business practices accounted for 75.86 per cent of losses by value driven by legacy issues where impacts materialised in 2014 (excluding PPI).
Clients, products and business practices (excl. PPI) 14.05 11.02 75.86 39.66
FUNDING AND LIQUIDITY RISK Definition Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient. 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.
The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and is supported by strong relationships with corporate customers and certain wholesale market segments. A substantial proportion of the retail deposit base is made up of customers’ current and savings accounts which, although mostly repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to raise interbank deposits and to issue debt securities to meet short-term obligations. Funding concentration by counterparty and currency is monitored on an ongoing basis. Where concentrations do exist (for example, maturity profile); these are limited by the internal risk appetite and considered manageable.
The ability to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s Banking businesses. In addition to central bank reserves, the Group holds sizeable balances of high grade marketable debt securities and other assets, as set out in table 1.43. The assets can be sold to provide, or used to secure, additional cash inflows should the need arise from either market counterparties or central bank facilities (Bank of England, European Central Bank and Federal Reserve).
To assist in managing the balance sheet the Group operates a LTP Policy which: allocates relevant interest expenses from GCT to the Group’s Banking businesses within the internal management accounts in a manner consistent with the Group Funding and Liquidity Policy; helps drive the correct inputs to customer pricing and supports the overall Group balance sheet strategy; and is consistent with regulatory requirements.
Liquidity risk within the Insurance business may result from the inability to sell financial assets quickly at their fair values; or from an insurance liability falling due for payment earlier than expected; or from the inability to generate cash inflows as anticipated; or from an unexpected large operational event; or from a general insurance catastrophe e.g. a significant weather event. The shareholder is exposed to liquidity risk through the shareholder business. This is predominantly the annuity portfolio, where the aim is to invest in assets such that the cash flows on investments will match those on the projected future liabilities. Unit-linked and with-profits funds are normally expected to meet their own liquidity obligations. Liquidity risk is actively managed and monitored within the Insurance business to ensure that, even under stress conditions, there is sufficient liquidity to meet obligations and remains within approved risk appetite. In addition, liquidity risk is controlled via approved funding and liquidity policies.
Marketable assets Haircut widening and repos assumed not to roll on contractual maturity
Secondly, the Group maintains a Contingency Funding Plan which is designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing. Contingency Funding Plan invocation and escalation processes are based on analysis of five major quantitative and qualitative components, comprising assessment of: early warning indicators, prudential and regulatory liquidity risk limits and triggers, stress testing results, event and systemic indicators and market intelligence.
During 2014, the Group has experienced stable term issuance costs that have remained significantly lower than in previous years. The Group has had a limited demand for term wholesale funding in recent years but this may increase in the future as the Group continues to optimise the balance sheet structure.
Excluding repurchase agreements at 31 December 2014 of £nil (31 December 2013: £3.0 billion).
Table 1.39: Reconciliation of Group funding to the balance sheet (audited)
Liquidity portfolio At 31 December 2014, the Banking business had £109.3 billion (2013: £89.3 billion) of highly liquid unencumbered assets in its primary liquidity portfolio which are available to meet cash and collateral outflows and PRA regulatory requirements. A separate liquidity portfolio to mitigate any insurance liquidity risk is managed within the Insurance business. Primary liquid assets of £109.3 billion represent 5.8 times (31 December 2013: 4.2 times) the Group’s money market funding less than one year maturity (excluding derivative collateral margins and settlement accounts) and are 2.7 times (31 December 2013: 2.0 times) all wholesale funding less than one year maturity, and thus provides a substantial buffer in the event of continued market dislocation.
The Board and GALCO monitor and manage total balance sheet encumbrance and readily realisable unencumbered assets via a number of risk appetite metrics. At 31 December 2014, the Group had £134,916 million (31 December 2013: £118,446 million) of encumbered and £719,980 million (31 December 2013: £723,934 million) of unencumbered on balance sheet assets. Of the unencumbered assets, £355,298 million (31 December 2013: £384,502 million) was classified as realisable for potential future funding requirements with a large pool (£188,141 million; 31 December 2013: £201,191 million) of readily realisable assets, from which if needed the Group could meet potential funding requirements at short notice. Primarily the Group encumbers mortgages and term lending through the issuance programmes and tradable securities through securities financing activity.
Cash and balances at central banks – 48,302 – 48,302 – 2,190 2,190 50,492
Loans and receivables: Loans and advances to banks 26 424 712 1,136 1,899 23,094 24,993 26,155
Loans and advances to customers 102,333 94,220 161,458 255,678 5,148 119,545 124,693 482,704
Loans and advances to customers 106,416 106,079 177,103 283,182 120 103,234 103,354 492,952
Available-for-sale financial assets 6,195 36,857 26 36,883 – 898 898 43,976
Risk appetite Capital risk appetite is set by the Group Board, reflecting the Group’s strategic plans, regulatory capital constraints and market expectations. It is defined by a number of minimum capital ratios in normal and stressed conditions, a minimum leverage ratio and a minimum buffer over regulatory solvency requirements for the Insurance business set by the Insurance Board. The Group monitors its actual and forecast capital positions aiming to remain within its appetite at all times.
Exposures A capital exposure arises where the Group has insufficient capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. This could arise due to a depletion of the Group’s capital resources as a result of the crystallisation of any of the risks to which it is exposed. Alternatively a shortage of capital could arise from an increase in the amount of capital that is needed to be held. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures while optimising value for shareholders.
Additional measures to manage the Group’s capital position include seeking to strike an appropriate balance of capital held within its Insurance and Banking subsidiaries and through improving the quality of its capital through liability management exercises.
Monitoring Capital is actively managed and regulatory ratios are a key factor in the Group’s planning processes and stress analyses. Five year forecasts of the Group’s capital position, based upon the Group’s operating plan, are produced at least annually to inform the Group’s capital strategy whilst shorter term forecasts are more frequently undertaken to understand and respond to variations of the Group’s actual performance against the plan. The capital plans are tested for capital adequacy using a range of stress scenarios covering adverse economic conditions as well as other adverse factors that could impact the Group and the Group maintains a Recovery Plan which sets out a range of potential mitigating actions that could be taken in response to a stress.
Capital management in 2014 The Group continued to strengthen its capital position during 2014 through capital-efficient profit generation, further dividends from the Insurance business, changes to and improved valuations of the Group’s defined benefit pension arrangements and a reduction in risk-weighted assets. The positive impact of these items was partly offset by the recommended dividend, charges relating to legacy issues and the Enhanced Capital Notes (ECNs) exchange and tender offers where the Group repurchased the equivalent of £5 billion nominal (£4 billion regulatory value) of ECNs and issued £5.3 billion of new CRD IV compliant additional tier 1 (AT1) securities.
– The CET 1 ratio increased 2.5 percentage points from 10.3 per cent (pro forma) to 12.8 per cent. – The leverage ratio increased 1.1 percentage points from 3.8 per cent (pro forma) to 4.9 per cent. – The transitional total capital ratio increased 3.2 percentage points from 18.8 per cent (pro forma) to 22.0 per cent. – The Group is now assuming a steady state CET 1 ratio requirement of around 12 per cent.
As the parent company of a banking group payment of a dividend is also dependent upon the maintenance of an adequate level of regulatory capital. The Group remains strongly capitalised, increasing its CET 1 capital ratio from 10.3 per cent at 31 December 2013 to 13.0 per cent (pre dividend) at 31 December 2014. The payment of a dividend reduces an entity’s CET 1 capital and, as a result, reduces its CET 1 capital ratio. The current recommended dividend reduces the Group’s CET 1 ratio to 12.8 per cent.
The amount of post-acquisition reserves for the Group’s Insurance business are excluded from shareholders’ equity. The remaining cost of the Group’s investment in the equity of the Insurance business is risk-weighted as part of threshold risk-weighted assets up to a limit based on the size of the Group’s common equity tier 1 capital position, with the residual amount deducted from common equity tier 1 capital.
31 December 2013 comparatives reflect CRD IV rules as implemented by the PRA at 1 January 2014 and are reported on a pro forma basis that includes the benefit of the sales of Heidelberger Leben, Scottish Widows Investment Partnership and the Group’s 50 per cent stake in Sainsbury’s Bank. 31 December 2013 common equity tier 1 ratios, excluding the benefit of these sales, were 10.0 per cent fully loaded and 10.1 per cent on transitional rules, while risk-weighted assets under fully loaded rules were £271.1 billion and under transitional rules were £272.1 billion.
Other movements 276 – – 276 31 December 2013 comparatives reflect CRD IV transitional rules as implemented by the PRA at 1 January 2014 and are reported on a pro forma basis that includes the benefit of the sales of Heidelberger Leben, Scottish Widows Investment Partnership and the Group’s 50 per cent stake in Sainsbury’s Bank.
AT1 capital resources have increased by £5,060 million in the period, mainly due to the ECN exchange and tender offers that resulted in the issuance of £5.3 billion of CRD IV compliant AT1 instruments, partially offset by other movements in grandfathered tier 1 subordinated debt, including foreign exchange movements and fair value unwind.
Tier 2 capital resources have reduced by £5,962 million in the period. This primarily reflects the ECN exchange and tender offers, which resulted in £4.0 billion of existing tier 2 ECN instruments being redeemed in exchange for the issuance of AT1 instruments as outlined above and the Group’s stated intention to approach the PRA to seek the appropriate permission to redeem a number of remaining ECN instruments following the Capital Disqualification Event that occurred upon the release of the PRA stress test results which resulted in a further reduction of £0.5 billion. Additional factors contributing to the reduction in tier 2 capital resources included a reduction in eligible provisions and other movements in tier 2 subordinated debt, including foreign exchange, fair value unwind, amortisation of dated instruments and other calls and redemptions. The reduction in tier 2 capital resources was partially offset by the issuance of a £0.6 billion CRD IV compliant tier 2 dated subordinated debt instrument in November 2014.
Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of deducted from CET1 capital under threshold rules. Significant investments primarily arise from the investment in the Group’s Insurance business.
Differences may arise between transitional and fully loaded threshold risk-weighted assets where deferred tax assets reliant on future profitability and arising from temporary timing differences and significant investments exceed the fully loaded threshold limit, resulting in an increase in amounts deducted from CET1 rather than being risk-weighted. At 31 December 2014 the fully loaded threshold was not exceeded and therefore no further adjustment was applied to the transitional threshold risk-weighted assets.
Disposals include risk-weighted asset reductions arising from the sale of assets, portfolios and businesses. Disposals reduced risk-weighted assets by £10.0 billion, primarily in the Run-off portfolio, including the sale of loans in the Irish retail mortgage portfolio as well as exiting the joint venture banking operation with Sainsbury’s, in Retail.
External economic factors captures movements driven by changes in the economic environment. The reduction in risk-weighted assets of £9.2 billion is mainly due to positive macroeconomic factors including favourable movements in UK house prices and reduced unemployment which have led to improvements in the credit risk profile of customers.
Leverage ratio The leverage ratio is calculated by dividing tier 1 capital (excluding grandfathered tier 1 securities) by a defined measure of on-balance sheet assets and off-balance sheet items.
Off-balance sheet items primarily consist of undrawn credit facilities, including facilities that may be cancelled unconditionally at any time without notice. The leverage ratio exposure value for off-balance sheet items is determined by applying set credit conversion factors to the nominal values of the items, based on the classification of the item. In accordance with the requirements of the framework the credit conversion factors applied to off-balance sheet items follow those prescribed by Standardised credit risk rules, subject to a floor of 10 per cent.
The determination of realistic liabilities of the With-Profit Funds includes the value of internal transfers expected to be made from each With-Profit Fund to the Non-Profit Fund held within the same life insurance entity. These internal transfers may include charges on policies where the associated costs are borne by the Non-Profit Fund.
Shareholders’ funds: Held outside the long-term funds – – – 1,081 4 1,085
Available capital resources for With-Profit Funds are presented in the table on a realistic basis as this is more onerous than on a regulatory basis.1
Constraints over available capital resources 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.
Further Support Account: The Further Support Account is an extra tier of capital support for the with-profits policies in existence at the date of demutualisation. The Scheme requires that assets can only be transferred from the Non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the Support Account and Further Support Account. Unlike the Support Account test, the economic value used for this test includes both admissible assets and the present value of future profits of business written in the Non-Participating Fund or by any subsidiaries of that fund. The balance of the Further Support Account is expected to reduce to nil by the year 2030. At 31 December 2014, the estimated net economic value of the Non-Participating Fund and its subsidiaries for the purposes of this test was £3,676 million (2013: £6,784 million) and the estimated combined value of the Support Account and Further Support Account was £1,930 million (2013: £2,070 million).
Clerical Medical The surplus held in the Clerical Medical With-Profit Fund can only be applied to meet the requirements of the fund itself or distributed according to the prescribed rules of the fund. Shareholders are entitled to an amount not exceeding one ninth of the amount distributed to policyholders in the form of bonuses on traditional with-profits business. The use of capital within the fund is also subject to the terms of the Scheme of Demutualisation effected in 1996 and the conditions contained in the Principles and Practices of Financial Management of the fund. In extreme circumstances capital within the Clerical Medical Non-Profit Fund may be made available to support the With-Profit Fund.
New business and other factors (8) (1) 172 171 10 344
Unit-linked business (excluding that accounted for as non-participating investment contracts) – – 48,475 3,932 52,407
Insurance and participating investment contract liabilities 13,539 7,427 57,012 4,064 82,042
Capital sensitivities Shareholders’ funds Shareholders’ funds outside the long-term business fund are invested in readily tradable assets (e.g. cash and fixed interest securities), cash and a range of less liquid fixed interest instruments, at levels consistent with the liquidity risk appetite of the Insurance business.
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 2014 of £2.6 billion (2013: £2.2 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.
As noted above, under the realistic capital regime of the PRA, the liabilities of both the Clerical Medical and Scottish Widows With-Profit Funds are valued using a market-consistent stochastic simulation model. This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
The most significant insurance risks within the Insurance business are longevity risk, persistency risk and expenses. Longevity risk transfer and hedging solutions, as potential risk mitigants, are considered on a regular basis. It is not practical to hedge persistency risk. General insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses with significant mortality risk and morbidity risk being transferred to different reinsurers (with limits on the level of risk placed with each reinsurer).
Monitoring Ongoing monitoring is in place to track the progression of insurance risks. In respect of the Insurance business 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 and the sensitivity of profit before tax to the most significant insurance risks persistency and longevity. The effectiveness of controls put in place to manage insurance risk is evaluated and significant divergences from experience or movements in risk exposures are investigated and remedial action taken. Progress against risk appetite metrics in respect of longevity risk in the Group’s defined benefit pension schemes is regularly reported and reviewed by the relevant committees.
Monitoring People risks from across the Group are monitored and reported through Board and Group Governance Committees in accordance with the Group Risk Management Framework and People Risk Sub-framework. Risk exposures are discussed monthly via the Group HR & People Risk Committee with upwards reporting to Group Risk and Executive Committees. In addition oversight, challenge and reporting is completed at Risk Division level and combined with Risk Assurance reviews, is intended to assess the effectiveness of controls against root cause, recommending follow up remedial action if relevant. At Business level a full assessment of the People Risk Profile is completed to ensure an optimum level of control is in place to protect colleagues, customers and the Group. All material People Risk events are escalated in accordance with the formal Group Operational Risk Policy and People Policies to the respective Divisional Managing Directors and the Group Compliance, Conduct & Operational Risk Director.
Driving adherence to the Group’s Risk Management framework goes ‘hand in glove’ with its approach to risk culture which is embedded in the Group’s approach to recruitment, selection, training, performance management and reward.
For further information on Corporate Governance see pages 62 to 81.
Scope We conducted a full scope audit across individually financially significant business reporting units. Additional business reporting units were selected to increase the level of audit evidence for each account balance, on which a combination of controls and substantive tests of detail was undertaken. Business reporting units that are not subject to specific audit procedures are still subject to audit work on entity level controls and group level analytical review procedures over their financial information.
THE SCOPE OF OUR AUDIT AND OUR AREAS OF FOCUS We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (‘ISAs (UK & Ireland)’).
The risks of material misstatement that had the greatest effect on our audit, including the allocation of our resources and effort, are identified as ‘areas of focus’ in the table below. We have also set out how we tailored our audit to address these specific areas in order to provide an opinion on the financial statements as a whole, and any comments we make on the results of our procedures should be read in this context. This is not a complete list of all risks identified by our audit. We discussed these areas of focus with the Audit Committee. Their report on those matters that they considered to be significant issues in relation to the financial statements is set out on page 77.
Credit risk and impairment of loans and advances to customers Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), page 199 (Critical Accounting Estimates and Judgements) and page 295 (notes).
Management also apply adjustments, or overlays, where they believe the data driven parameters and calculations are not appropriate, either due to emerging trends or models not capturing the risks in the loan portfolio. An example of this is an overlay for the current low interest rates which management apply on top of the impairment model output. These overlays require significant judgement.
We assessed critically the criteria for determining whether an impairment event had occurred and therefore whether there was a requirement to calculate an impairment provision. We tested a sample of performing loans with characteristics that might imply an impairment event had occurred (for example a customer experiencing financial difficulty or approaching a refinancing deadline) to challenge whether all impairment events had been identified by management. We also haphazardly selected an additional sample of performing loans to further challenge whether all impairment events had been identified by management. We did not identify further impairment events.
For a sample of individually impaired loans we understood the latest developments at the borrower and the basis of measuring the impairment provisions and considered whether key judgments were appropriate given the borrowers’ circumstances. We also re-performed management’s impairment calculation. In addition, we tested key inputs to the impairment calculation including the expected future cash flows and valuation of collateral held, and challenged management as to whether valuations were up to date, consistent with the strategy being followed in respect of the particular borrower and appropriate for the purpose. We further challenged management on the value of the provisions held by comparing the gains or losses crystallised when impaired loans have been sold. This provided evidence that provisions held were appropriate.
Certain disclosures have been presented elsewhere in the Annual Report and Accounts (the ‘Annual Report’), rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited.
Where provisions or contingent liability disclosures are made, judgement is required in measuring the liabilities. Judgement is required in estimating future redress payments to be made to customers, regulatory fines, and operational costs of processing complaints and reviewing past business.
We understood and tested the key controls and management’s processes for: – identifying conduct risk exposures and assessing whether provisions or disclosures were necessary; and
We read the Group’s correspondence with the Financial Conduct Authority and Prudential Regulation Authority and discussed the output of any meetings held. We also met with the Financial Conduct Authority and Prudential Regulation Authority on a bilateral basis, and on a trilateral basis with the Prudential Regulation Authority and the Chair of the Group Audit Committee.
We assessed the actuarial assumptions, including the consideration and challenge of management’s rationale for the judgements applied and any reliance placed on industry information. Our assessment included reference to our independent benchmarking data which considers each of these principle areas. For persistency, longevity and expenses we considered recent experience and the appropriateness of the judgements applied by management on how future experience will evolve. For persistency, we also considered the appropriateness of management’s assumptions about future improvements given the regulatory changes removing commission for certain business. In particular, we used historical data on nil commission business and analysis comparing lapse rates by product to initial commission paid. For longevity and expenses we assessed the appropriateness of the assumptions by comparing them to experience and latest industry data.
The Group has a number of open tax matters, for which management is required to make certain judgements as to the likely outturn for the purposes of calculating the Group’s tax liabilities. Such matters include an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary.
We tested the consensus and employee data used in calculating the obligation. We also considered the treatment of curtailments, settlements, past service costs and measurements, and any other amendments made to obligations during the year. We tested the fair value of scheme assets by independently calculating a fair value for a sample of the assets held.
Significant one-off transactions that we focused on this year that had a material impact on the financial statements included the share sales of TSB, including its continuing consolidation and the exchange of Enhanced Capital Notes for Additional Tier 1 securities.
We read the analysis prepared by management for the accounting treatment for all significant one-off transactions, and challenged the appropriateness of assumptions and whether all the relevant accounting implications had been considered. We read the relevant legal contracts and agreed the receipt or payment of cash, where applicable. No issues were noted with the accounting treatments adopted.
These are highly judgemental and complex calculations dependent on market data, and models developed by management. For CVA and DVA, the adjustments are sensitive to factors such as the value of the uncollateralised derivative financial instruments, their expected future market volatility and credit risks. For FVA, the methodology for calculating the adjustments continues to evolve across the banking industry.
– the review of the derivative valuation adjustments calculated by the valuation models.
The Group is structured into five segments being Retail, Commercial Banking, Insurance, Consumer Finance and TSB. Each of the segments comprises a number of business reporting units. The Group financial statements are a consolidation of the business reporting units.
In establishing the overall approach to the Group audit, we determined the type of work that needed to be performed over the business reporting units by us, as the Group engagement team, or auditors within PwC UK and from other PwC network firms operating under our instruction (‘component auditors’). The vast majority of our audit work is undertaken by PwC UK component auditors.
Where the work was performed by component auditors, we determined the level of involvement we needed to have in the audit work at those business reporting units to be able to conclude whether sufficient appropriate audit evidence had been obtained as a basis for our opinion on the Group financial statements as a whole. This included regular communication with the component auditors throughout the audit, the issuance of instructions, a review of the results of their work on the areas of focus and formal clearance procedures.
For the Group’s individually financially significant reporting units a full scope audit was performed over their complete financial information. Additional business reporting units were selected to increase the level of audit evidence on each account balance, on which a combination of controls and substantive tests of detail were undertaken. The level of audit work was determined by our risk assessment for each account balance.
Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: Overall group materiality £268 million.
As noted in the directors’ statement, the directors have concluded that it is appropriate to prepare the financial statements using the going concern basis of accounting. The going concern basis presumes that the Group and Parent Company have adequate resources to remain in operation, and that the directors intend them to do so, for at least one year from the date the financial statements were signed. In drawing this conclusion the directors have considered: – the regulatory capital position of the Group which is critical to the market maintaining confidence in the Group’s ability to absorb losses that it may occur in a market stress; and – the funding and liquidity position of the Group to be able to meet its liabilities as they fall due, including in a market stress.
OUR RESPONSIBILITIES AND THOSE OF THE DIRECTORS As explained more fully in the Statement of directors’ responsibilities set out on page 106, the directors are responsible for the preparation of the Group and Parent Company financial statements and for being satisfied that they give a true and fair view.
Philip Rivett (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 26 February 2015
Items that may subsequently be reclassified to profit or loss: Movements in revaluation reserve in respect of available-for-sale financial assets: Adjustment on transfers from held-to-maturity portfolio – – 1,168
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income 3,896 (1,229) 116
Other comprehensive income for the year, net of tax 3,278 (2,533) (2,563)
Total comprehensive income attributable to other equity holders 287 – –
Liabilities arising from insurance contracts and participating investment contracts 33 86,918 82,777
The directors approved the consolidated financial statements on 26 February 2015.
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax – 548 – 548 – – 548
Currency translation differences (tax: £nil) – (3) – (3) – – (3)
Issue of ordinary shares 3 – – 3 – – 3
Value of employee services: Share option schemes – – 142 142 – 142
Net cash (used in) provided by operating activities 10,353 (15,531) 3,049
Proceeds from sale and maturity of financial assets 4,668 21,552 37,664
Sale of non-controlling interest in TSB (note 56) 634 – –
Net cash (used in) provided by financing activities (4,275) (3,068) (3,104)
Cash and cash equivalents at beginning of year 66,797 101,058 85,889
Cash and cash equivalents at end of year 55(D) 65,147 66,797 101,058
The Group has adopted the following new standards, amendments to standards and interpretations which became effective for financial years beginning on or after 1 January 2014: IFRIC 21 Levies This interpretation clarifies that the obligating event that gives rise to a liability to pay a government levy is the activity that triggers the payment of the levy as set out in the relevant legislation and that an entity’s expectation of operating in a future period, irrespective of the difficulties involved in exiting a market, does not create a constructive obligation to pay a levy. The adoption of this interpretation has not had a material impact on these financial statements.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2014 and which have not been applied in preparing these financial statements are given in note 57.
The Group consolidates collective investment vehicles if its beneficial ownership interests give it substantive rights to remove the external fund manager over the investment activities of the fund. Where a subsidiary of the Group is the fund manager of a collective investment vehicle, the Group considers a number of factors in determining whether it acts as principal and therefore controls the collective investment vehicle including: an assessment of the scope of the Group’s decision making authority over the investment vehicle; the rights held by other parties including substantive removal rights without cause over the Group acting as fund manager; the remuneration to which the Group is entitled in its capacity as decision maker; and the Group’s exposure to variable returns from the beneficial interest it holds in the investment vehicle. Consolidation may be appropriate in circumstances where the Group has less than a majority beneficial interest. Where a collective investment vehicle is consolidated the interests of parties other than the Group are reported in other liabilities.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) The treatment of transactions with non‑controlling interests depends on whether, as a result of the transaction, the Group loses control of the subsidiary. Changes in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions; any difference between the amount by which the non‑controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent entity. Where the group loses control of the subsidiary, at the date when control is lost the amount of any non‑controlling interest in that former subsidiary is derecognised and any investment retained in the former subsidiary is remeasured to its fair value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.
(D) REVENUE RECOGNITION Interest income and expense are recognised in the income statement for all interest‑bearing financial instruments using the effective interest method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.
The effective interest rate is calculated on initial recognition of the financial asset or liability by estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts expected to be paid or received by the Group
(E) FINANCIAL ASSETS AND LIABILITIES On initial recognition, financial assets are classified into fair value through profit or loss, available‑for‑sale financial assets, held‑to‑maturity investments or loans and receivables. Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are held at fair value. The Group initially recognises loans and receivables, deposits, debt securities in issue and subordinated liabilities when the Group becomes a party to the contractual provisions of the instrument. Regular way purchases and sales of securities and other financial assets and trading liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Refer to note 3 (Critical accounting estimates and judgements: Fair value of financial instruments) and note 51(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.
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.
Preference shares and other instruments which carry a mandatory coupon or are redeemable on a specific date are classified as financial liabilities. The coupon on these instruments is recognised in the income statement as interest expense.
Securities which carry a discretionary coupon and have no fixed maturity or redemption date are classified as other equity instruments. Interest payments on these securities are recognised, net of tax, as distributions from equity in the period in which they are paid.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between the original carrying value of the liability and the fair value of the new equity is recognised in the profit or loss.
For unsecured personal lending portfolios, the impairment trigger is generally when the balance is two or more instalments in arrears or where the customer has exhibited one or more of the impairment characteristics set out above. While the trigger is based on the payment performance or circumstances of each individual asset, the assessment of future cash flows uses historical experience of cohorts of similar portfolios such that the
Debt for equity exchanges Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity securities, held as available‑for‑sale. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.
Liabilities – Insurance and participating investment contracts in the Group’s with-profit funds
Liabilities of the Group’s with‑profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Prudential Regulation Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below). Further details on the realistic capital regime are given on page 165. Changes in the value of these liabilities are recognised in the income statement through insurance claims.
– Insurance and participating investment contracts which are not unit-linked or in the Group’s with-profit funds A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by estimating the future cash flows over the duration of in‑force policies and discounting them back to the valuation date allowing for probabilities of occurrence. The liability will vary with movements in interest rates and with the cost of life insurance and annuity benefits where future mortality is uncertain.
Changes in the value of these liabilities are recognised in the income statement through insurance claims.
Costs which are directly attributable and incremental to securing new non‑participating investment contracts are deferred. This asset is subsequently amortised over the period of the provision of investment management services and is reviewed for impairment in circumstances where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written down immediately through fee and commission expense in the income statement. All other costs are recognised as expenses when incurred.
(4) Reinsurance Contracts entered into by the Group with reinsurers under which the Group is compensated for benefits payable on one or more contracts issued by the Group are recognised as assets arising from reinsurance contracts held. Where the underlying contracts issued by the Group are classified as insurance contracts and the reinsurance contract transfers significant insurance risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as insurance contracts. Where the underlying contracts issued by the Group are classified as non‑participating investment contracts and the reinsurance contract transfers financial risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as non‑participating investment contracts.
Assets arising from reinsurance contracts held – Classified as non‑participating investment contracts These contracts are accounted for as financial assets whose value is contractually linked to the fair values of financial assets within the reinsurers’ investment funds. Investment returns (including movements in fair value and investment income) allocated to these contracts are recognised in insurance claims. Deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the assets arising from reinsurance contracts held.
In addition, a collective unimpaired provision is made for loan losses that have been incurred but have not been separately identified at the balance sheet date. This provision is sensitive to changes in the time between the loss event and the date the impairment is specifically identified. This period is known as the loss emergence period. In the Commercial Banking division, an increase of one month in the loss emergence period in respect of the loan portfolio assessed for collective unimpaired provisions would result in an increase in the collective unimpaired provision of approximately £53 million (at 31 December 2013, a one month increase in the loss emergence period would have increased the collective unimpaired provision by an estimated £105 million).
PAYMENT PROTECTION INSURANCE AND OTHER REGULATORY PROVISIONS At 31 December 2014, the Group carried provisions of £3,378 million (2013: £3,815 million) against the cost of making redress payments to customers and the related administration costs in connection with historical regulatory breaches, principally the misselling of payment protection insurance. Determining the amount of the provisions, which represent management’s best estimate of the cost of settling these issues, requires the exercise of significant judgement. It will often be necessary to form a view on matters which are inherently uncertain, such as the number of future complaints, the extent to which they will be upheld and the average cost of redress. Consequently the continued appropriateness of the underlying assumptions is reviewed on a regular basis against actual experience and other relevant evidence and adjustments made to the provisions where appropriate.
At 31 December 2014, the Group classified £8,145 million of financial assets, including £2,771 million of derivatives, and £1,512 million of financial liabilities, including £1,456 million of derivatives, 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 51. Details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the Risk Management section on page 138.
Following a reorganisation effective from 1 January 2014, the Group’s activities are now organised into five financial reporting segments: Retail; Commercial Banking; Consumer Finance; Insurance and TSB. The most significant changes to the segmental structure are: – The Wealth business has been integrated into the Retail division; – The Consumer Finance division now includes credit cards, asset finance and the European online deposits businesses; the Retail and Commercial Banking credit cards businesses have transferred into Consumer Finance; – TSB operates as a standalone listed entity following the IPO; – The remaining portfolio of assets which are outside of the Group’s risk appetite is managed within Other.
Retail offers a broad range of financial service products, including current accounts, savings, personal loans and mortgages, to UK retail customers, incorporating wealth and small business customers. It is also a distributor of insurance, protection and credit cards and a range of long‑term savings and investment products.
Insurance is a core part of Lloyds Banking Group and is focused on four key markets: Corporate Pensions, Protection, Retirement and Home Insurance, to enable customers to protect themselves today and prepare for a secure financial future.
NOTE 4: SEGMENTAL ANALYSIS (CONTINUED) For the majority of those derivative contracts entered into by business units for risk management purposes, the business unit recognises the net interest income or expense on an accrual accounting basis and transfers the remainder of the movement in the fair value of the derivative to the central group segment where the resulting accounting volatility is managed where possible through the establishment of hedge accounting relationships. Any change in fair value of the hedged instrument attributable to the hedged risk is also recorded within the central group segment. This allocation of the fair value of the derivative and change in fair value of the hedged instrument attributable to the hedged risk avoids accounting asymmetry in segmental results and leads to accounting volatility, which is managed centrally and reported within Other.
Other income (net of insurance claims) 1,212 1,956 1,364 1,725 140 210 6,607
Other income (net of insurance claims) 1,435 2,259 1,359 1,864 163 840 7,920
Total underlying income, net of insurance claims 7,935 4,372 2,692 1,757 778 1,271 18,805
Other segment items: Investments in joint ventures and associates at end of year 23 – 1 – – 77 101
Total underlying income, net of insurance claims 7,443 4,225 2,680 1,793 737 1,508 18,386
Other income, net of insurance claims 5,739 1,141 228 (614) – 113 6,607
Total underlying income, net of insurance claims 16,399 1,134 228 (132) – 739 18,368
Other income, net of insurance claims 11,140 460 (668) (3,074) – 62 7,920
Debt securities held as loans and receivables 2.57 1.52 4.77 42 32 433
Interest receivable on loans and receivables 3.12 3.28 3.38 18,254 20,417 22,636
Total interest and similar income 3.03 3.20 3.31 19,211 21,163 23,548
Liabilities under sale and repurchase agreements 2.61 1.21 1.47 (55) (79) (245)
Total interest and similar expense 1.51 2.32 2.41 (8,551) (13,825) (15,830)
Fee and commission income: Credit and debit card fees 1,050 984 941
Net (losses) gains on financial instruments held for trading 851 136 621
Change in provision for unearned premiums (note 33(2)) 18 49 72
Life insurance gross premiums can be further analysed as follows: £m £m £m
Movement in value of in‑force business (note 25) (428) 416 269
Share of results of joint ventures and associates 32 43 28
Losses of £24 million arose in the year ended 31 December 2014 (2013: losses of £142 million; 2012: losses of £338 million) on other transactions undertaken as part of the Group’s management of its wholesale funding and subordinated debt.
Performance‑based compensation expense deferred until later years comprises: Awards made in respect of the year ended 31 December 152 47 37
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 15.5 17.4 18.0
Other non‑audit fees: Services relating to corporate finance transactions 0.3 0.3 0.5
Services relating to taxation: This category includes tax compliance and tax advisory services.
The Group has procedures that are designed to ensure auditor independence, including that fees for audit and non‑audit services are approved in advance. This approval can be obtained either on an individual engagement basis or, for certain types of non‑audit services, particularly those of a recurring nature, through the approval of a fee cap covering engagements of that type provided the fee is below that cap.
Reviews of the financial position of corporate and other borrowers 5.0 6.5 5.4
The charge for tax on the profit for 2014 is based on a UK corporation tax rate of 21.5 per cent (2013: 23.25 per cent; 2012: 24.5 per cent).
Changes to the taxation of pension business: Policyholder tax cost – – (182)
Effect of results of joint ventures and associates 7 9 23
Tax charge on profit (loss) on ordinary activities (263) (1,217) (781)
The Finance Act 2012 introduced a new UK tax regime for the taxation of life insurance companies which takes effect from 1 January 2013. The new regime, combined with current economic forecasts, had a number of impacts on the tax charge in 2012.
Profit (loss) attributable to equity shareholders – basic and diluted 1,125 (838) (1,471)
Weighted average number of ordinary shares in issue – basic 71,350 71,009 69,841
Weighted average number of ordinary shares in issue – diluted 72,447 71,009 69,841
Asset‑backed securities: Corporate and other debt securities 1,486 20,604 22,090 1,929 18,691 20,620
(iii) private equity investments of £2,350 million (2013: £2,632 million) that are managed, and evaluated, on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis.
Derivatives designated as cash flow hedges: Interest rate swaps 518,746 1,606 2,536
Derivatives designated as fair value hedges: Interest rate swaps 154,657 2,662 1,044
Gross investment in finance leases, receivable: Not later than 1 year 573 557
The net investment in finance leases represents amounts recoverable as follows: £m £m
Later than 1 year and not later than 5 years 763 1,140
SECURITISATION PROGRAMMES Loans and advances to customers and debt securities classified as loans and receivables include loans securitised under the Group’s securitisation programmes, the majority of which have been sold by subsidiary companies to bankruptcy remote structured entities. As the structured entities are funded by the issue of debt on terms whereby the majority of the risks and rewards of the portfolio are retained by the subsidiary, the structured entities are consolidated fully and all of these loans are retained on the Group’s balance sheet, with the related notes in issue included within debt securities in issue.
Includes securitisations utilising a combination of external funding and credit default swaps.
Cash deposits of £11,251 million (2013: £13,500 million) held by the Group are restricted in use to repayment of the debt securities issued by the structured entities, the term advances relating to covered bonds and other legal obligations. Additionally, the Group had certain contractual arrangements to provide liquidity facilities to some of these structured entities. At 31 December 2014 these obligations had not been triggered; the maximum exposure under these facilities was £392 million (2013: £402 million).
In addition, the Group sponsors two further asset‑backed conduits, which are being run down. These asset‑backed conduits have no commercial paper in issue and no external liquidity providers.
(B) CONSOLIDATED COLLECTIVE INVESTMENT VEHICLES The assets and liabilities of the Insurance business held in consolidated collective investment vehicles, such as Open‑Ended Investment Companies and limited partnerships, are not directly available for use by the Group. However, the Group’s investment in the majority of these collective investment vehicles is readily realisable. As at 31 December 2014, the total carrying value of these consolidated collective investment vehicle assets and liabilities held by the Group was £66,070 million (2013: £55,934 million).
Charge (release) to the income statement (note 12) 2,725 – 1 2,726
Recoveries of advances written off in previous years 681 – – 681
For amounts included above which are subject to repurchase agreements see note 54.
Capital expenditure in respect of investment properties which had been contracted for but not recognised in the financial statements was £47 million (2013: £2 million).
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 (2013: £2,016 million), £1,836 million, or 91 per cent of the total (2013: £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 (2013: £170 million, 8 per cent of the total) to Asset Finance in the Group’s Consumer Finance division.
This breakdown shows the movement in the value of in‑force business only, and does not represent the full contribution that each item in the breakdown contributes to profit before tax. This will also contain changes in the other assets and liabilities, including the effects of changes in assumptions used to value the liabilities, of the relevant businesses. The presentation of economic variance includes the impact of financial market conditions being different at the end of the reporting period from those included in assumptions used to calculate new and existing business returns.
The risk‑free rate is derived from the relevant swap curve with a deduction for credit risk.
Risk‑free rate (value of in‑force annuity business)1 1.02 to 4.56 0.64 to 5.06
Balance sheet amount at 31 December 2014 468 610 10 82 900 2,070
The customer‑related intangibles include customer lists and the benefits of customer relationships that generate recurring income.
Balance sheet amount at 31 December 2014 1,519 2,760 3,773 8,052
Liabilities in respect of securities sold under repurchase agreements 1,075 1,874
Liabilities in respect of securities sold under repurchase agreements – 2,978
Life insurance (see (1) below): Non‑life insurance contracts (see (2) below): Reinsurance balances are reported within other assets (note 28).1
Liabilities for insurance contracts and participating investment contracts can be split into with‑profit fund liabilities, accounted for using the PRA’s realistic capital regime (realistic liabilities) and non‑profit fund liabilities, accounted for using a prospective actuarial discounted cash flow methodology, as follows: With-profit fund £m
The realistic assessment is carried out using a stochastic simulation model which values liabilities on a market‑consistent basis. The calculation of realistic liabilities uses best estimate assumptions for mortality, persistency rates and expenses. These are calculated in a similar manner to those used for the value of in‑force business as discussed in note 25.
Key changes in assumptions A detailed review of the Group’s assumptions in 2014 resulted in the following key impacts on profit before tax: – Change in persistency assumptions (£119 million decrease).
(2) NON-LIFE INSURANCE Gross non‑life insurance contract liabilities are analysed by line of business as follows: 2014 £m 2013 £m
The reserving methodology and associated assumptions are set out below: The unearned premium reserve is determined on a basis that reflects the length of time for which contracts have been in force and the projected incidence of risk over the term of each contract.
NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS (CONTINUED) The movements in non‑life insurance contract liabilities and reinsurance assets over the year have been as follows: Gross £m
NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS (CONTINUED) 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.
Estimate of ultimate claims costs: At end of accident year 205 639 609 446 421 349 283 2,952
Current estimate of cumulative claims 437 479 506 367 393 339 283 2,804
The liability of £210 million shown in the above table excludes £10 million of unallocated claims handling expenses and £4 million of unexpired risk reserve.
Widening of credit default spreads on corporate bonds8 0.25% addition (238) (191)
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. Swap curves and the non‑annuity risk‑free rate are both assumed to be unchanged. The increased illiquidity premium increases the annuity risk‑free rate.
Change in unallocated surplus recognised in the income statement (note 10) (74) 123
(i) Characteristics of and risks associated with the Group’s schemes The Group has established a number of defined benefit pension schemes in the UK and overseas. All significant schemes are based in the UK, with the three most significant being the defined benefit sections of the Lloyds Bank Pension Schemes No’s 1 and 2 and the HBOS Final Salary Pension Scheme. These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2014 is generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
The Group currently expects to pay contributions of approximately £425 million to its defined benefit schemes in 2015.
Money market instruments, cash, derivatives and other assets and liabilities 1,179 (632) 547 506 1,524 2,030
An analysis by credit rating of the pension schemes’ debt securities is provided below: Investment grade1
Life expectancy for member aged 60, on the valuation date: Life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 at 31 December 2014 is assumed to live for, on average, 27.5 years for a male and 29.8 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
At 31 December 2014, the assumed rate of RPI inflation is 2.95 per cent and CPI inflation 1.95 per cent (2013: RPI 3.3 per cent and CPI 2.3 per cent).
At 31 December 2014, the assumed discount rate is 3.67 per cent (2013: 4.60 per cent).
Duration of the defined benefit obligation 19 19 2014 £m 2013 £m
Benefits expected to be paid between 2 and 5 years 3,538 3,420
Benefits expected to be paid between 5 and 10 years 7,334 7,207
Benefits expected to be paid between 10 and 15 years 8,831 8,945
Benefits expected to be paid between 15 and 25 years 20,011 21,102
Benefits expected to be paid between 25 and 35 years 18,995 20,851
Benefits expected to be paid between 35 and 45 years 14,434 16,374
The Finance Act 2013 (the Act) was substantively enacted on 2 July 2013. The Act further reduced the main rate of corporation tax to 21 per cent with effect from 1 April 2014 and 20 per cent with effect from 1 April 2015.
Uphold rates Uphold rates have increased following changes to the complaint handling policy. The impact to date and going forward resulted in a £110 million increase to the provision.
An Enforcement team of the FCA is investigating the Group’s governance of third party suppliers and potential failings in the PPI complaint handling process. This investigation is ongoing and it is not possible at this stage to make any assessment of what, if any, additional liability may result from the investigation, although the administration costs of supporting the investigation have been provided for previously.
The Group estimates that it has sold approximately 16 million policies since 2000. These include policies that were not mis‑sold as they were suitable for, and appropriately disclosed to, the customer. Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for approximately 45 per cent of the policies sold since 2000, covering both customer‑initiated complaints and actual and expected proactive mailings undertaken by the Group.
Customer initiated complaints since origination (m)2 3.0 0.6 0.1 = £230m
Interest rate hedging products In June 2012, a number of banks, including the Group, reached agreement with the FSA (now FCA) to carry out a review of sales made since 1 December 2001 of interest rate hedging products (IRHP) to certain small and medium‑sized businesses. As at 31 December 2014 the Group had identified 1,676 sales of IRHPs to customers within scope of the agreement with the FCA which have opted in and are being reviewed and, where appropriate, redressed. The Group agreed that on conclusion of this review it would provide redress to any in‑scope customers where appropriate. The Group continues to review the remaining cases within the scope of the agreement with the FCA but has met all of the regulator’s requirements to date.
These securities will, in the event of the winding‑up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated Enhanced Capital Notes (ECNs) ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during 2014 (2013: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Prudential Regulation Authority.
b The interest rate payable on this security was reset from 6.75 per cent fixed to Bank Bill Swap Rate plus 0.76 per cent with effect from 1 May 2012.
Issued under employee share schemes 5,299,416 312,618,630 1,136,919,962 1 32 114
Where, under an employee share plan operated by the Company, participants are the beneficial owners of shares but not the registered owners, the voting rights are normally exercised by the registered owner at the direction of the participant. Outstanding awards and options would normally vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions at that time.
Information regarding significant direct or indirect holdings of shares in the Company can be found on page 105.
The Company has entered into deeds of covenant with the Foundations under the terms of which the Company makes annual donations. The deeds of covenant can be cancelled by the Company at nine years notice, at which point the limited voting ordinary share capital would convert into ordinary shares. Such notice has been given to the Lloyds Bank Foundation for Scotland.
Preference shares The Company has in issue various classes of preference shares which are all classified as liabilities under IFRS and details of which are shown in note 41.
Issued in relation to the settlement of coupons on certain hybrid capital securities1 – 279 123
Distributions on other equity instruments (net of tax) (note 46) (225) – –
Additional Tier 1 securities issued in the year: Sterling notes (£3,725 million nominal) 3,725 – –
NOTE 48: SHARE-BASED PAYMENTS (CONTINUED) 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.
For options granted in 2005 The same conditions applied as for grants made in 2004, except that: – the performance condition was linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 15 companies including Lloyds Banking Group plc; – if the performance condition was not met at the end of the third subsequent year, the options would lapse; and – the full grant of options became exercisable only if the Group was ranked in the top four places of the comparator group. A sliding scale applied between fourth and eighth positions. If Lloyds Banking Group was ranked below the median (ninth or below) the options would lapse.
Movements in the number of share options outstanding under the executive share option schemes during 2014 and 2013 are set out below: Number of options
SAVE-AS-YOU-EARN SCHEMES Eligible employees may enter into contracts through the Save‑As‑You‑Earn schemes to save up to £500 per month and, at the expiry of a fixed term of three or five years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a discounted price of no less than 80 per cent of the market price at the start of the invitation.
For the HBOS sharesave plan, no options were exercised during 2014 or 2013. The options outstanding at 31 December 2014 had an exercise price of £1.8066 (2013: £1.8066) and a weighted average remaining contractual life of 1.4 years (2013: 1.1 years).
Lloyds Banking Group Executive Share Plan 2003 The Plan was adopted in December 2003 and under the Plan share options may be granted to senior employees. Options under this plan have been granted specifically to facilitate recruitment and as such were not subject to any performance conditions. The Plan is used not only to compensate new recruits for any lost share awards but also to make grants to key individuals for retention purposes with, in some instances, the grant being made subject to individual performance conditions.
NOTE 48: SHARE-BASED PAYMENTS (CONTINUED) HBOS share option plans The table below details the outstanding options for the HBOS Share Option Plan and the St James’s Place Share Option Plan. The final award under the HBOS Share Option Plan was made in 2004. Under this plan, options over shares, at market value with a face value equal to 20 per cent of salary, were granted to employees with the exception of certain senior executives. A separate option plan exists for some partners of St James’s Place, which granted options in respect of Lloyds Banking Group plc shares. The final award under the St James’s Place Share Option Plan was made in 2009. Movements in the number of share options outstanding under these schemes are set out below: During 2013 the Group completed the sale of all of its holding in St James’s Place plc. The participants of the St James’s Place Share Option Plan remain entitled to the Lloyds Banking Group plc shares awarded under the terms of this Plan and these options are included in the table below.
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.
If adjusted EPS reaches 7.8p, 100 per cent of this element will vest.
NOTE 48: SHARE-BASED PAYMENTS (CONTINUED) At the end of the performance period for the EPS and EP measures, the targets had not been fully met and therefore these awards vested in 2014 at a rate of 68 per cent (54 per cent for members of the Group Executive Committee, including Executive Directors).
(vi) FCA reportable complaints: relevant to 10 per cent of the award. Performance will be measured by reference to the total number of FSA reportable complaints per 1,000 customers (excluding PPI complaints) over the three year period to 31 December 2014.
If the adjusted EP reaches £1,881 million, 100 per cent of this element will vest.
The performance conditions for awards made in March and August 2014 are as follows: (i) EP: relevant to 30 per cent of the award. The performance target is based on 2016 adjusted EP outcome.
If complaints per 1,000 accounts average 1.05 per annum or less, 100 per cent of this element will vest.
Scottish Widows Investment Partnership Long-Term Incentive Plan The Scottish Widows Investment Partnership (SWIP) Long‑Term Incentive Plan applicable to senior executives and employees of SWIP, which had previously been a cash‑only scheme, was amended in May 2012 for awards granted on or after that date. The amendment introduced the receipt of shares in Lloyds Banking Group plc as an element of the total award. For awards made in June 2012, the other element continued to be cash‑based, with the split between cash‑based and share‑based determined by the Remuneration Committee. Awards made in June 2013 were fully share‑based. The amendment was aimed at delivering shareholder value by linking the receipt of shares to an improvement in the performance of SWIP over a three year period. Awards were made within limits set by the rules of the Plan, with the maximum limits for combined cash and shares awarded equating to 3.5 times annual salary. In exceptional circumstances this could increase to four times annual salary.
NOTE 48: SHARE-BASED PAYMENTS (CONTINUED) The fair value calculations at 31 December 2014 for grants made in the year, using Black‑Scholes models and Monte Carlo simulation, are based on the following assumptions: Save-As-YouEarn
The Fixed Share Award is not subject to any performance conditions, performance adjustment or clawback. On an employee leaving the Group, there is no change to the timeline for which shares will become unrestricted.
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.
Exercised/lapsed (includes entitlements of former key management personnel) (1) (16) (5)
Exercised/lapsed (includes entitlements of former key management personnel) (22) (7) (33)
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 0.5 per cent and 23.95 per cent in 2014 (2013: 2.5 per cent and 23.9 per cent; 2012: 2.5 per cent and 29.95 per cent).
National Loan Guarantee Scheme The Group has participated in the UK government’s National Loan Guarantee Scheme, which was launched on 20 March 2012. Through the scheme, the Group is providing eligible UK businesses with discounted funding, subject to continuation of the scheme and its financial benefits, and based on the Group’s existing lending criteria. Eligible businesses who have taken up the funding benefit from a 1 per cent discount on their funding rate for a pre‑agreed period of time.
Funding for Lending In August 2012, the Group announced its support for the UK government’s Funding for Lending Scheme and confirmed its intention to participate in the scheme. The Funding for Lending Scheme represents a further source of cost effective secured term funding available to the Group. The initiative supported a broad range of UK based customers, providing householders with more affordable housing finance and businesses with cheaper finance to invest and grow. In November 2013, the Group entered into extension letters with the Bank of England to take part in the extension of the Funding for Lending Scheme until the end of January 2015. The extension of the Funding for Lending Scheme focuses on providing businesses with cheaper finance to invest and grow. £10 billion has been drawn down under this extension. In December 2014, the Bank of England announced a further extension to the end of January 2016 with an increased focus on supporting small businesses. At 31 December 2014, the Group had drawn down £20 billion under the Funding for Lending Scheme.
Enterprise Finance Guarantee Scheme The Group participates in the Enterprise Finance Guarantee Scheme which was launched in January 2009 as a replacement for the Small Firms Loan Guarantee Scheme. The scheme is a UK government‑backed loan guarantee, which supports viable businesses with access to lending where they would otherwise be refused a loan due to a lack of lending security. The Department for Business, Innovation and Skills (formerly the Department for Business, Enterprise and Regulatory Reform) provides the lender with a guarantee of up to 75 per cent of the capital of each loan subject to the eligibility of the customer within the rules of the scheme. As at 31 December 2014, the Group had offered 6,250 loans to customers, worth over £500 million. The Group entities, Lloyds Bank plc, TSB Bank plc, Lloyds Commercial Finance Limited and Bank of Scotland plc contracted with The Secretary of State for Business, Innovation and Skills.
In return for the payment of a commercial fee, HM Treasury has agreed to provide a guarantee to the lender to cover a proportion of any loss made by the lender arising from a higher loan‑to‑value loan being made. £1,950 million of outstanding loans at 31 December 2014 had been advanced under this scheme.
HM Treasury expenses During the year ended 31 December 2014, the Group paid for expenses amounting to £1 million incurred by or on behalf of HM Treasury in connection with the sale or proposed sale of shares by HM Treasury in the Company. The expenses were incurred in accordance with the Resale Rights Agreement and the Registration Rights Agreement entered into with HM Treasury in 2009. The performance by the Company of the Resale Rights Agreement and the Registration Rights Agreement was approved by shareholders of the Company at the 2014 Annual General Meeting.
Joint ventures and associates The Group provided both administration and processing services to Sainsbury’s Bank plc, which was its principal joint venture up until the completion of the sale of the Group’s investment in that company on 31 January 2014. The amounts receivable by the Group during January 2014 were £3 million (year ended 31 December 2013: £35 million, of which £10 million was outstanding at 31 December 2013). At 31 December 2013, Sainsbury’s Bank plc had also had balances with the Group that were included in loans and advances to banks of £806 million and deposits by banks of £927 million.
In parallel: – the European Commission has proposed legislation to regulate interchange fees which continues through the EU legislative process. A political agreement has been reached between the European Parliament and the Council and the legislation is expected to be adopted and come into force in the second quarter of 2015 with certain articles applying six months or a year after that (the adoption and entry into force dates remain subject to change); – the European Commission has adopted commitments proposed by VISA to settle an investigation into VISA’s cross‑border interchange arrangements and aspects of its scheme rules . VISA has, amongst other things, agreed to reduce the level of interchange fees for cross‑border card transactions to: 30 basis points (for credit) and 20 basis points (for debit). VISA has also changed a number of its rules in relation to cross‑border acquiring. MasterCard unilaterally undertook, amongst other things, to reduce the level of cross‑border interchange fees to the same levels as agreed between the Commission and Visa; – the Commission also continues to pursue other competition investigations into MasterCard and Visa probing, amongst other things, interchange paid in respect of cards issued outside the EEA; – litigation continues in the English High Court against both Visa and MasterCard. This litigation has been brought by several retailers who are seeking damages for allegedly ‘overpaid’ MIFs; – the new UK payments regulator may exercise its powers, when these come in to force (in April 2015), to regulate domestic interchange fees. In November 2014, the Competition and Markets Authority (the CMA) announced that it would not reopen the investigation into domestic interchange levels at this time following MasterCard’s agreement to introduce a phased reduction of domestic interchange rates commencing in April 2015. In addition, the FCA has started a market study in relation to the UK credit cards market.
The Group continues to cooperate with various other government and regulatory authorities, including the Serious Fraud Office, the European and Swiss Competition Commissions, and a number of US State Attorneys General, in conjunction with their investigations into submissions made by panel members to the bodies that set LIBOR and various other interbank offered rates.
NOTE 50: CONTINGENT LIABILITIES AND COMMITMENTS (CONTINUED) OPERATING LEASE COMMITMENTS Where a Group company is the lessee the future minimum lease payments under non‑cancellable premises operating leases are as follows: 2014 £m 2013 £m
CAPITAL COMMITMENTS Excluding commitments in respect of investment property (note 23), capital expenditure contracted but not provided for at 31 December 2014 amounted to £373 million (2013: £345 million). Of this amount, £368 million (2013: £344 million) related to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
Derivative financial instruments 4,233 31,895 – – – – – 36,128
Loans and receivables: Loans and advances to banks – – – – 26,155 – – 26,155
Trading and other financial liabilities at fair value through profit or loss – 55,358 6,744 – – – – 62,102
Derivative financial instruments 3,616 29,571 – – – – – 33,187
Derivative financial instruments 4,742 26,062 – – – – – 30,804
Loans and receivables: Loans and advances to banks – – – – 25,365 – – 25,365
Trading and other financial assets at fair value through profit or loss 151,931 151,931 142,683 142,683
Trading and other financial liabilities at fair value through profit or loss 62,102 62,102 43,625 43,625
Debt securities: Bank and building society certificates of deposit – 208 – 208
Total financial assets carried at fair value, excluding derivatives 124,551 57,427 4,681 186,659
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December 2013 70 – 70
– A number of earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before interest, tax, depreciation and amortisation. The particular multiple selected being appropriate for the type of business being valued and is derived by reference to the current market‑based multiple. Consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple. – Discounted cash flow valuations use estimated future cash flows, usually based on management forecasts, with the application of appropriate exit yields or terminal multiples and discounted using rates appropriate to the specific investment, business sector or recent economic rates of return. Recent transactions involving the sale of similar businesses may sometimes be used as a frame of reference in deriving an appropriate multiple. – For fund investments the most recent capital account value calculated by the fund manager is used as the basis for the valuation and adjusted, if necessary, to align valuation techniques with the Group’s valuation policy.
Liabilities held at fair value through profit or loss – 6,739 5 6,744
Liabilities held at fair value through profit or loss – 5,267 39 5,306
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) The table below analyses movements in the level 3 financial liabilities portfolio, excluding derivatives.
Trading and other financial liabilities at fair value through profit or loss £m
Losses (gains) recognised in the income statement within other income 10 3 13
Transfers out of the level 3 portfolio arise when inputs that could have a significant impact on the instrument’s valuation become market observable after previously having been non‑market observable. In the case of asset‑backed securities this can arise if more than one consistent independent source of data becomes available. Conversely transfers into the portfolio arise when consistent sources of data cease to be available.
Liabilities held at fair value through profit or loss These principally comprise debt securities in issue which are classified as level 2 and their fair value is determined using techniques whose inputs are based on observable market data. The carrying amount of the securities is adjusted to reflect the effect of changes in own credit spreads. The resulting gain or loss is recognised in the income statement.
The table below analyses movements in level 3 derivative assets and liabilities carried at fair value: Derivative assets £m
Gains recognised in the income statement within other income 755 (375)
Derecognised pursuant to exchange and retail tender offers in respect of Enhanced Capital Notes (notes 9 and 40) (967) –
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets or liabilities held at 31 December 2014 755 (376)
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) (i) Uncollateralised derivative valuation adjustments, excluding monoline counterparties The following table summarises the movement on this valuation adjustment account during 2014 and 2013: 2014 £m 2013 £m
The combination of a one notch deterioration in the credit rating of derivative counterparties and a ten per cent increase in LGD increases the CVA by £105 million. Current market value is used to estimate the projected exposure for products not supported by the model, which are principally complex interest rate options that are traded in very low volumes. For these, the CVA is calculated on an add‑on basis (in total contributing £2 million of the overall CVA balance at 31 December 2014).
The DVA is sensitive to: – the current size of the mark‑to‑market position on the uncollateralised liability; – expectations of future market volatility of the underlying liability; and – the Group’s own CDS spread.
Lead manager or broker quote/consensus pricing n/a – – – 74 – –
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) Unobservable inputs Significant unobservable inputs affecting the valuation of debt securities, unlisted equity investments and derivatives are as follows: – Interest rates and inflation rates are referenced in some derivatives where the payoff that the holder of the derivative receives depends on the behaviour of those underlying references through time. – Credit spreads represent the premium above the benchmark reference instrument required to compensate for lower credit quality; higher spreads lead to a lower fair value. – Volatility parameters represent key attributes of option behaviour; higher volatilities typically denote a wider range of possible outcomes. – Earnings multiples are used to value certain unlisted equity investments; a higher earnings multiple will result in a higher fair value.
Valuation methodology Loans and advances to customers The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates due to their short term nature. The carrying value of the variable rate loans and those relating to lease financing is assumed to be their fair value.
During 2012 the Group reviewed its holding of government securities classified as held‑to‑maturity and in view of the fact that it was no longer the Group’s intention to hold these to maturity, securities with a carrying amount of £10,811 million and a fair value of £11,979 million were reclassified as available‑for‑sale financial assets in December 2012. At 31 December 2014, the securities reclassified that were still retained by the Group were carried at their fair value of £1,284 million (2013: £1,117 million).
Trading and other financial assets at fair value through profit or loss 16,803 6,673 10,832 927
Related amounts where set off in the balance sheet not permitted3 Potential net amounts if offset of related amounts permitted £mAt 31 December 2014
NOTE 53: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES (CONTINUED) Related amounts where set off in the balance sheet not permitted3
Deposits from banks: Customer deposits: Trading and other financial liabilities at fair value through profit or loss: After impairment allowance.
The Group enters into derivatives and repurchase and reverse repurchase agreements with various counterparties which are governed by industry standard master netting agreements. The Group holds and provides cash and securities collateral in respective of derivative transactions covered by these agreements. The right to set off balances under these master netting agreements or to set off cash and securities collateral only arises in the event of non‑payment or default and, as a result, these arrangements do not qualify for offsetting under IAS 32.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using currency borrowings. At 31 December 2014 the aggregate principal of these currency borrowings was £587 million (2013: £1,695 million). In 2014, an ineffectiveness loss of £1 million before and after tax (2013: ineffectiveness gain of £16 million before tax and £12 million after tax) was recognised in the income statement arising from net investment hedges.
Bank and building society certificates of deposit 298 – – 298
Bank and building society certificates of deposit 554 – – 554
Total debt securities held as trading assets 10,122 46 164 10,332
Bank and building society certificates of deposit 1,491 – – 1,491
Total debt securities held as trading assets 7,808 47 14 7,869
There were reverse repurchase agreements which are accounted for as collateralised loans within loans and advances to banks with a carrying value of £1,899 million (2013: £183 million), against which the Group held collateral with a fair value of £1,886 million (2013: £183 million), all of which the Group is able to repledge.
Loans and advances to customers The Group holds collateral against loans and advances to customers in the form of mortgages over residential and commercial real estate, charges over business assets such as premises, inventory and accounts receivable, charges over financial instruments such as debt securities and equities, and guarantees received from third parties.
Mortgages An analysis by loan‑to‑value ratio of the Group’s residential mortgage lending is provided below. The value of collateral used in determining the loan‑ to‑value ratios has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house prices, after making allowance for indexation error and dilapidations.
The majority of non‑mortgage retail lending is unsecured. At 31 December 2014, impaired non‑mortgage lending amounted to £1,470 million, net of an impairment allowance of £577 million (2013: £1,696 million, net of an impairment allowance of £1,044 million). The fair value of the collateral held in respect of this lending was £110 million (2013: £144 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation and the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over‑collateralisation and to provide a clearer representation of the Group’s exposure.
Collateral repossessed During the year, £828 million of collateral was repossessed (2013: £902 million), consisting primarily of residential property.
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) E. COLLATERAL PLEDGED AS SECURITY The Group pledges assets primarily for repurchase agreements and securities lending transactions which are generally conducted under terms that are usual and customary for standard securitised borrowing contracts.
F. TREATMENT OF CUSTOMERS EXPERIENCING FINANCIAL STRESS The Group operates a number of schemes to assist borrowers who are experiencing financial stress. The material elements of these schemes are described in the Risk Management report on pages 120 and 121 and further details relating to those cases where the Group has granted a concession, whether temporarily or permanently, are set out below.
Forbearance activities The Group classifies the treatments offered to retail customers who have experienced financial difficulty into the following categories: – Reduced contractual monthly payment: a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original contractual payments, for example temporary interest only arrangements and short‑term payment holidays granted in collections. Any arrears existing at the commencement of the arrangement are retained; – Reduced payment arrangements: a temporary arrangement for customers in financial distress where arrears accrue at the contractual payment, for example short‑term arrangements to pay; – Term extensions: a permanent account change for customers in financial distress where the overall term of the mortgage is extended resulting in a lower contractual monthly payment; and – Repair: a permanent account change used to repair a customer’s position where they have emerged from financial difficulty, for example capitalisation of arrears.
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Customers receiving support from UK Government sponsored programmes The Group participates in a number of UK Government sponsored programmes designed to support households, which are described on page 121. Where these schemes provide borrowers with a state benefit that is used to service the loan, there is no change in the reported status of the loan which is managed and reported in accordance with its original terms.
Secured Loans which are forborne are grouped with other assets with similar risk characteristics and assessed collectively for impairment as described below. The loans are not considered as impaired loans unless they meet the Group’s definition of an impaired asset.
UK unsecured lending: £4,128 million of current and recent forborne secured loans and advances were not impaired at 31 December 2014 (31 December 2013: £5,479 million). £23 million of current and recent forborne unsecured loans and overdrafts were not impaired at 31 December 2014 (31 December 2013: £22 million).
Includes temporary interest‑only arrangements and short‑term payment holidays granted in collections where the customer is currently benefiting from the treatment and where the concession has ended within the previous six months (temporary interest‑only) and previous twelve months (short‑term payment holidays).
Includes capitalisation of arrears and term extensions which commenced during the previous 24 months and where the borrowers remain as customers at 31 December.
Impairment provisions as % of loans and advances which are currently or recently forborne 2014 £m 2013 £m 2014 £m 2013 £m £150 million of forborne loans and advances (consumer credit cards: £94 million, Asset Finance: £56 million) were not impaired at 31 December 2014 (31 December 2013: consumer credit cards: £138 million, Asset Finance: £74 million).
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Run‑off: Ireland secured retail lending At 31 December 2014, Irish secured loans and advances subject to current or recent forbearance were 6.3 per cent (31 December 2013: 12.2 per cent) of total Irish retail secured loans and advances. Further analysis of the forborne loan balances is set out below: Total loans and advances which are currently or recently forborne
The Group recognises that forbearance alone is not necessarily an indicator of impaired status but it is a trigger for the review of the customer’s credit profile. If there is any concern over future cash flows and the Group incurring a loss, then forborne loans will be classified as impaired in accordance with the Group’s impairment policy.
Unimpaired forborne assets are included in calculating the overall collective unimpaired provision, which uses the historical observed default rate and loss emergence period of the relevant portfolio as a whole as part of its calculation.
The watchlist is further categorised depending on the current and expected credit risk attaching to the customer and the transaction. All watchlist names are reviewed by the Business and independent Risk function regularly, and the classification is updated if required.
Classified as impaired during the year: UK exposures >£5 million 775
Transferred to unimpaired but still reported as forborne during the year: UK exposures >£5 million (268)
Includes £475 million in respect of two loans transferred from Run‑off.
Transferred to unimpaired but still reported as forborne during the year: UK exposures >£5 million1 (961)
Debt securities held as loans and receivables – – – – – 32 4 1,177 1,213
Liabilities arising from insurance and investment contracts 1,439 1,699 2,443 2,295 2,312 8,266 21,049 74,983 114,486
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 19,209 12,344 3,974 2,165 1,152 5,029 8,408 19,002 71,283
Liabilities arising from insurance and investment contracts 1,486 6,579 2,317 2,244 3,046 8,430 21,300 65,356 110,758
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
Other commitments – – – – 494 – – – 494
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss 24,020 (8,376) 809
Net gain on sale of available‑for‑sale financial assets (131) (629) (3,547)
Accretion of discounts and amortisation of premiums and issue costs 122 286 12
Payments in respect of payment protection insurance provision (2,458) (2,674) (3,299)