We are transforming the business into a digitised, simple, low risk, fi nancial services provider whilst creating a responsible business that focuses on customers’ needs. This is key to our long-term success and to fulfi lling our aim to become the best bank for customers, colleagues and shareholders.
About us We are the largest UK retail fi nancial services provider with around 26 million customers and a presence in nearly every community.
The Group’s main business activities are retail and commercial banking, general insurance and long-term savings, provided under well recognised brands including Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows.
The 2018 Annual Report and Accounts incorporates the strategic report and the consolidated fi nancial statements, both of which have been approved by the Board of Directors.
Financial results Summary of Group results 37 Divisional results 44 Other fi nancial information 48
Governance A letter from our Chairman 51 Board of Directors 52 Group Executive Committee 54 Corporate governance report 56 Directors’ report 79 Directors’ remuneration report 82 Other remuneration disclosures 100
Other information Shareholder information 284 Five year fi nancial summary 286 Forward looking statements 287 Abbreviations 288 Alternative performance measures 288 Subsidiaries and related undertakings 289
Group highlights Strong financial and strategic performance 2018 has been a successful year for the Group in which we have continued to Help Britain Prosper, economically, socially and environmentally. In February 2018, we launched the next phase of our strategic plan and have made strong strategic progress with significantly improved financial performance.
During 2018, the Board were excited to see the excellent progress that had been made within the first year of this plan. We are now operating in an industry which is experiencing more change through digitisation than in its entire history. Our aim is not just to maintain our position as Britain’s biggest digital bank by competing more effectively, but also to seize opportunities to create more value from the wider and deeper relationships we can build with our customers through digital channels and service capabilities.
Capital return At each year end the Board makes an assessment of the strength of the Group’s balance sheet and future prospects relative to uncertainties in the external environment. In addition to the increased investment of more than £3 billion over the plan period, I am pleased to announce that, as a result of the financial progress in the year, the Board has recommended an increased final ordinary dividend of 2.14 pence per share, bringing the total ordinary dividend for 2018 to 3.21 pence per share, an increase of 5 per cent on last year. In line with the Group’s policy to deliver a progressive and sustainable ordinary dividend, whilst distributing surplus capital, the Board also intends to implement a share buyback of up to £1.75 billion. More information on the intended share buyback is provided on page 40.
Our purpose At the heart of our success is our continued focus on Helping Britain Prosper. The Group plays a vital role in supporting the prosperity of people, businesses and communities across the UK, and in doing so builds deep, long-term customer relationships. It is also important to the Board that our strategy is fully consistent with our commitments as a responsible business and during the year we have committed to becoming a leader in supporting the UK to transition successfully to a more sustainable low carbon economy. We recognise that the success of the Group is inextricably linked to the health of the UK and in this uncertain economic environment we are working hard to support the whole economy; and to help businesses take advantages of the continuing opportunities we have to build a prosperous future for the nation. Given the UK’s ongoing competitive advantages as an open, innovative economy we remain optimistic about the long-term prospects.
In line with these objectives I am delighted that we have been named as a Top Ten Employer for Working Families, Responsible Business of the Year, and also The Times’ Top 50 Employer for Women – showing that we’re leading the way on gender equality too.
Customers and communities Over the course of the year I have travelled across Britain to meet with colleagues, customers and communities. These visits enable me to see first-hand the work we do to support our customers and respond to their changing needs. Being truly customer focused is a prerequisite for success and I am always impressed by the fact it is an aspiration and commitment shared by everyone I meet in the Group.
I am clearly proud of our customer focus and financial performance. To deliver this sustainable success in the long-term we need to ensure we remain focused on enhancing customer experience. With this in mind, in February 2018 we announced our ambitious strategy to transform the Group for success in a digital world, with a significant increase in strategic investment. We have already made a great start in implementing the strategic initiatives which will further digitise the Group, enhance customer experience, maximise our capabilities as an integrated financial services provider and transform the way we work. In addition, towards the end of the year we also announced a strategic partnership with Schroders to create a market leading wealth proposition. Continued delivery against our strategic priorities positions us well for future success and our confidence is reflected in our guidance.
Financial performance Statutory profit after tax of £4.4 billion was 24 per cent higher than 2017 and earnings per share at 5.5 pence per share was 27 per cent higher. This was driven by improved underlying profit including lower remediation charges and we continue to narrow the gap between underlying and statutory profit, a trend we expect to continue as statutory profits increase further. As a result of this performance the Group has delivered a further increase to our return on tangible equity, which is now a market leading 11.7 per cent. Underlying profit of £8.1 billion increased 6 per cent, reflecting growth in income and lower costs, partly offset by the expected increase in the impairment charge. Our relentless focus on cost efficiency led to a reduction in operating costs despite increased strategic investment, and our cost:income ratio improved further to 49.3 per cent. Asset quality remains strong with the Group’s gross asset quality ratio remaining flat at 28 basis points, while the net asset quality ratio increased to 21 basis points, from 18 basis points, driven by expected lower releases and write-backs.
The Group’s loans and advances were stable at £444 billion with growth in targeted segments including SME, Mid Markets and consumer lending offset by the sale of the £4 billion Irish mortgage portfolio in the first half of 2018. The Group’s capital position remains strong with a pro forma CET1 ratio of 13.9 after allowing for ordinary dividends and the share buyback.
We are building a market leading digital experience, and in 2018 launched API-enabled Open Banking aggregation functionality as well as enhanced security and anti-fraud features. As part of our multi-channel model we also remain committed to maintaining the UK’s largest branch network, with one out of five branches in the country, whilst tailoring it to meet customers’ complex needs more effectively. In the year we opened our flagship Halifax branch, increased our mobile branch fleet to 44 and extended our remote advice coverage to 270 branches. We are also delivering increasingly targeted customer propositions.
Capital build is expected to remain strong at 170 to 200 basis points per year with the Board's view of our CET1 capital requirement remaining at around 13 per cent plus a management buffer of around 1 per cent. As a result we continue to expect to deliver progressive and sustainable ordinary dividends whilst maintaining the flexibility to return surplus capital to shareholders
Strategic priorities and focus for 2019 on pages 12 to 15
An increased ordinary dividend of 3.21 pence per share, in line with our progressive and sustainable dividend policy. In addition, the Board intends to implement a share buyback of up to £1.75 billion.
The statutory return on tangible equity increased reflecting the increase in statutory profit after tax, and slightly lower average tangible equity.
Our values and behaviours index comprises metrics related to continuous improvement, collaboration, innovation, inclusiveness with a strong focus on customers. We continue to see high numbers of colleagues believing we are demonstrating these values. The survey in 2018 was completed by more than 57,000 colleagues (83 per cent of the Group headcount).
The UK housing market has been broadly flat in 2018 in aggregate, although weakness has been centred around London and the South East where high prices are constraining affordability. Improved households’ spending power should support the housing market in 2019, as would resolution of uncertainty about the immediate political and economic concerns.
Operational impacts of the UK’s exit from the EU present risks for some of our customers’ businesses. With the future trading arrangements between the UK and EU unlikely to become finalised for a few years, businesses’ investment decisions are more difficult and postponement of investment may weigh on future growth capacity of the economy. Uncertainty is also challenging the UK’s attractiveness to foreign investors, although many qualities that have attracted investors in the past remain.
Barring sudden shocks stemming from these challenges, the UK economy is expected to grow through 2019 to 2021 at a pace similar to that of the past three years, around 1.5 per cent. The unemployment rate is expected to rise only a little from its current 43 year low, and further mild increases in house prices are expected. The Bank Rate is expected to rise only slowly, as the uncertainty drag on the economy fades. Growth in many of our markets is expected to pick up, although the consumer credit market should continue to slow after its strong growth through 2014 to 2017. Impairments are expected to increase in 2019 as we continue to see lower write-backs and recoveries but remain at relatively low levels.
Customer treatment A number of specific product reviews are currently being undertaken by the regulators to ensure product clarity and pricing transparency. These include reviews of the mortgage market, overdraft charging and savings accounts.
Link to principal risks Conduct Governance Operational Regulatory and Legal Capital
Customer behaviours continue to change, with an increasing focus on personalised customer experiences and convenient, instantly accessible services, with these developments enabling customers to exert greater control over their finances than ever before
Evolving demographics and life patterns are changing the financial needs of our customers, in particular increasing focus on financial planning for retirement
Market dynamics The needs and expectations of our customers continue to evolve, driven by changing demographics and life patterns along with increased choice, both in terms of provider and channel. The increasing use of digital has provided more brand choice for the customer across a number of sectors, with technology developments also raising customer expectations for control of their finances, both in terms of seeing their accounts in one place and monitoring transactions.
Our response We have a proven track record of providing products and services that our customers value but it is imperative that we keep pace with market developments in order to maintain relevance with our customer base.
While we have a number of competitive advantages in the current environment, including our differentiated multi-channel and multi-brand propositions, securing and enhancing the relationships with our customers will be paramount to our future success.
Harnessing new technology is enabling us to respond to customers' needs more rapidly and efficiently
Our response As the UK's largest digital bank, we are embracing technological developments to enhance customer experience. The increasing use of intelligent systems provides an opportunity to respond to customers growing expectations for personalisation, relevance and control, while the automation of simple transactions increases our capacity to focus on complex, value adding transactions. In addition, the use of technology provides organisational benefits in terms of efficiency, our ability to respond quickly to an evolving operating environment, as well as aiding risk taking decisions and mitigating fraud. We remain focused on further enhancing the customer experience and building on our market leading efficiency position through the use of technology, supported by a significant increase in investment over this strategic plan. In doing this, we must ensure that we continue to respond to innovation and meet the needs of our diverse customer base whilst ensuring system resilience and security.
The competitive landscape is changing with new entrants such as fintechs and tech giants continuing to increase disruption through innovation, while incumbent banks continue to re-focus
While greater competition increases choice for consumers and reinforces the need to further improve the customer experience, the breadth of our multi-brand and multi-channel offering along with our market leading efficiency and customer focused business model means we continue to compete from a position of strength.
Link to strategic priorities Delivering a leading customer experience Maximising the Group’s capabilities
We are a simple, low-risk, customer focused UK financial services provider...
As previously discussed on pages 08 to 09, the main external challenges we face are: Evolving and uncertain economic environment, including EU exit uncertainty
Helping Britain Prosper Our success is interwoven with the UK’s prosperity and we aim to Help Britain Prosper through creating a responsible business that focuses on customers’ needs, and delivering long-term sustainable success.
Market leading efficiency through tech-enabled productivity improvements Our simpler operating model and focus on operational efficiency provide a cost advantage, which benefits both customers and shareholders.
Offering our services through a number of recognised brands enables us to address the needs of different customer segments more effectively.
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...that underpin our clear strategy to transform the Group for success in a digital world...
Transforming ways of working Enhancing colleague skills and processes, investing in agile working practices and embracing new technology to drive better outcomes for customers.
Focus for 2019 We will build on these strong foundations by continuing to enhance our digital functionality to meet customers’ simple needs, while also ensuring that our branch network continues to meet complex needs effectively. In 2019, we have already made our Open Banking capability available to all our Lloyds, Halifax and Bank of Scotland mobile app customers, with the significant broadening of the range of products they are able to aggregate later in the year putting them more in control of their finances . In addition we will retain our focus on using our significant data insight to develop products that are more tailored to our customers’ specific needs.
Adopting new technologies In order to improve processes and deliver better outcomes for customers, we are increasingly adopting new technologies. Key highlights in the year include the introduction of robotics for simple, repetitive tasks such as performing customer rectifications, with the resultant release of approximately 780,000 colleague hours creating additional capacity to improve processes and propositions for customers. In addition, we have introduced machine learning capabilities in a number of areas, which has also led to significant improvements to back office processes and further operational efficiencies.
Deeper end-to-end transformation targeting 70 per cent of our cost base
Year-on-year increase in technology spend c.100 Applications migrated to private cloud
Numman Miah volunteered at his local community centre at a session supporting those with limited IT skills. Many of the attendees were unemployed – improving their digital capabilities helps them in their job searches.
Working as a Group Digital Champion is a source of joy for Numman, providing him with the opportunity to give something valuable back to his own community.
The Group is uniquely placed in the UK to help customers throughout their whole life. Single Customer View helps our customers see everything that is important to them, including their bank account, pension and other insurance products, in one place, whether that is online, in branch or over the phone. 2018 saw us help over 3 million customers engage with their insurance and pension products more simply, alongside their banking. In 2019 we want to reach many more customers and help them to do more with us, like make a top up to their pension or start a home insurance claim.
+£6 billion of additional net lending to start-ups, SMEs and Mid Market customers
Progress in 2018 In 2018 we have continued to enhance and leverage the Group’s capabilities to meet our customers’ banking and insurance needs more effectively.
Meeting our customers’ growing financial planning and retirement needs As the UK’s sole integrated financial services provider we are unique in being able to show and serve all of our customers’ financial needs in one place. In the year we have begun the roll out of a Single Customer View capability, with over 3 million customers now able to view in one place the insurance and pension products they hold with the Group alongside their more traditional banking products. This single home for banking and insurance needs builds on our Open Banking aggregation capability and is supported by levels of digital engagement that significantly surpass those of standalone insurers. We have also made a number of improvements to our customer propositions, including the expansion of our workplace pensions and savings offering following the Zurich acquisition in 2017. These and other developments have enabled us to achieve net inflows of £13 billion open book assets under administration in the year. We embrace innovation and are working with external parties to develop potential solutions that will enable customers to consolidate their pension pots from multiple providers digitally, making it quicker and easier for them to review their retirement savings in one place.
Reflecting the needs of our stakeholders Our Board actively engages with our stakeholders
On occasion, some decisions may not provide a positive outcome for all stakeholders however we aim to act in the best interests of the Group and all stakeholders and be fair and balanced in our approach.
The Group is focused on doing the right thing for customers and the Board receives regular updates and reports on progress. In particular the Board reviews the Customer Dashboard results on a quarterly basis, and approves the annual customer plans
Our new strategy launched in February 2018 with the aim of meeting customers’ needs more effectively in a digital world. The Board was heavily engaged in its development and ensuring the customer was at the heart of strategic investment
Investor Relations has primary responsibility for managing and developing the Group’s external relationships with existing and potential institutional equity investors and analysts. With support from senior management, they achieved this through more than 400 meetings in 2018, covering approximately 800 institutions in various locations including the UK, North America, Europe and Asia
– More information on the 2018 AGM advisory vote can be found on page 03
In October, the Chairman and a number of Non-Executive Directors hosted a governance lunch with various major institutional investors covering key topics such as responsible business, remuneration and risk enabling us to provide an update on progress whilst enabling investors to provide feedback on these subjects
In addition to these meetings the Group communicates with its shareholders through regular results and strategy announcements and has a comprehensive website on which detailed company information is available. To ensure effective communication with all shareholders, the Group Chief Executive specifically writes to all shareholders, updating them on progress every six months
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The Group held its biggest ever live communication event, Helping Britain Prosper LIVE, which was attended by 4,000 colleagues. This event, hosted by the Group Chief Executive, Chairman and key members of the executive leadership team, provided the opportunity for our colleagues to see first-hand how we are Helping Britain Prosper every day. Speeches were broadcast live on our intranet and sessions were run in five key hub locations to provide opportunities for members of our colleagues in those locations to experience the event
We held meetings throughout the year with our recognised unions, attended by the Chair of the Remuneration Committee and the Group Chief Executive. Key topics included the Living Wage, which applies to our whole workforce
All material contracts are subject to rigorous cost management governance and updates on key supplier risks are provided to the Board
As the largest retail and commercial bank in the UK, we have representation across the country. We specifically invest in local communities across Britain to help them prosper economically and build social cohesion by tackling disadvantage.
In partnership with Macmillan, our Cancer Support Team has helped support 3,100 customers and identified £411,000 in benefits from a range of products and services, to help them reduce the financial impact of a cancer diagnosis. We are also raising awareness of financial and domestic abuse through our ‘Acknowledge, Respond, Refer’ campaign, developed with support from the Lloyds Bank Foundation for England & Wales, and working closely with Business in the Community and UK Finance
FCA contact during the year with members of the Board focused on governance, culture and strategy
The newly appointed ring-fenced bank Directors went through a rigorous approval process including interviews with the PRA ahead of appointment to ensure they met regulatory requirements
From a tax perspective in 2018, we paid £2.6 billion in tax, one of the largest contributors to UK tax revenues. We are also a major tax collector, gathering £2 billion in 2018. We have a clear Tax Policy which is part of our Board-approved Group Risk Management Framework. We comply with HMRC Code of Practice on Taxation for Banks and the Confederation of British Industry’s Statement of Tax Principles. You can read more about our Tax Strategy online www.lloydsbankinggroup.com/ our-group/responsible-business/reportingcentre /
Our approach to responsible business ensures that colleagues are equipped to make the right decisions supported by our values-based culture, and the way we embed responsible business in our policies, processes and training.
Stakeholders also identified building capability and digital skills as a key issue, alongside tackling social disadvantage, inclusion and diversity and sustainability. We believe that the way we are addressing these issues places us in a unique position to Help Britain Prosper: We are using our own capabilities in digital banking to help develop the skills of people, businesses and charities
We have taken a leading role in championing diversity and mental health, setting public goals for increasing Black, Asian & Minority Ethnic (BAME) representation at all levels
The CFRB’s work aligns with our purpose to Help Britain Prosper, and our support for the UN’s Sustainable Development Goals. The Centre was established to help learn lessons from the past and to help us and others work in a different way going forward. It will play a pivotal role in ensuring the worlds of academia, business and policy-making work together more effectively to drive change. One area of focus will be exploring the regulatory, operational and ethical barriers to the implementation of artificial intelligence.
Building capability and digital skills Number of individuals, SMEs and charities trained in digital skills, including internet banking 17 ICONS: BLACK/WHITE VERSION
When an icon is on a square, that square must be proportional 1 x 1.
Tackling social disadvantage across Britain Number of charities we support as a result of our £100m commitment to the Group’s independent charitable Foundations 17 ICONS: BLACK/WHITE VERSION
Helping the transition to a sustainable low carbon economy Average number of homes that could be powered as a result of our support of UK renewable energy projects 17 ICONS: BLACK/WHITE VERSION
In 2018 we set specific targets aligned to our 3 year strategy. It continues to unite and inspire our colleagues and for 2019, we have included a specific sustainability metric, alongside the six existing priority metrics, highlighted in bold below.
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Supporting business to start up and grow Supporting UK businesses of all types is key to Helping Britain Prosper. In 2018, we helped more than 124,000 businesses start up, increased the amount of net lending to start up, SME and Mid Market businesses by £3 billion and doubled our financial investment at the Lloyds Bank Advanced Manufacturing Training Centre (AMTC).
Building capability and digital skills Our ambition is to enhance capability and digital skills, helping 1.8 million people with skills training by 2020 alongside investing in apprenticeship schemes. Working with over 50 partners, in 2018 we provided digital skills training to over 700,000 individuals and organisations.
Britain is renowned for its manufacturing expertise. The sector accounts for 10 per cent of UK GDP, for 44 per cent of all UK exports and directly creates 2.7 million jobs. Yet there is a lack of qualified workers. The shortfall could reach 220,000 by 2020 so it is vital to train new talent.
We are helping to address this. In 2018, we doubled our financial investment at the Lloyds Bank Advanced Manufacturing Training Centre in Coventry to £10 million over 10 years and committed to train 3,500 apprentices, graduates and engineers by 2024. We have already created 178 apprenticeships and trained 80 graduates and 295 engineers, including many women and individuals from a Black, Asian and Minority Ethnic background.
A career at the MTC has allowed me to work on high profile and challenging manufacturing projects, applying all the skills I’ve learnt, and also learn new ones. Rishi Chohan MTC Graduate 2018
Having a 5 minute chat with a student today has changed her outlook on the future. That’s what makes #ReDiscover so worthwhile. Rachel Colleague volunteer
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 23
Ethnic Background Percentage of colleagues from a BAME background 9.5% 8.3%
Through a targeted communication campaign and personal stories shared at all levels, we have encouraged colleagues to freely discuss mental health, with the number of those who tell us they have mental health issues up by 22 per cent over the past three years.
1 2017 reporting scope excludes MBNA colleagues, who became part of Lloyds Banking Group plc in June 2017, as their separate grading structure could not be aligned to LBG grades at that point.
Helping the transition to a sustainable low carbon economy Following a Board level review of our approach to environmental sustainability, we have developed a new sustainability strategy which focuses on the opportunities and threats related to climate change and the need for the UK to transition to a sustainable low carbon economy.
Emissions in tonnes CO2e in line with the GHG Protocol Corporate Standard (2004). We are now reporting to the revised Scope 2 guidance, disclosing a market-based figure in addition to the location-based figure. The measure and reporting criteria for Scope 1, 2, 3 emissions is provided in the Lloyds Banking Group Reporting Criteria statement available online at www.lloydsbankinggroup.com/ResponsibleBusiness
Indicator is subject to Limited ISAE3000 (revised) assurance by Deloitte LLP for the 2018 Annual Responsible Business Reporting. Deloitte’s 2018 assurance statement and the 2018 Reporting Criteria are available online at www.lloydsbankinggroup.com/our-group/responsible-business
Forward looking scenario analysis incorporating physical and transition risk will be utilised across the Group to systematically identify risks and opportunities. During 2018, Commercial Banking undertook forward looking scenario analyses including business as usual and low carbon transition scenarios, identifying sectors with a higher level of climate related risk and opportunity. Detailed assessments are now being undertaken on higher risk sectors to understand the potential financial impact to our customers and to the Group. We will be completing further reviews of higher risk sectors in 2019 to inform portfolio analytics, counterparty risk and financial product development, while increasing the scope to also include other divisions.
Metrics and targets As part of our TCFD implementation plan we are developing our approach to reporting metrics and targets. This will include a long term reporting framework, enabling us to track our performance against our sustainability strategy, and disclose the financial impact of climate change related risks and opportunities. We will define metrics linked to our green finance propositions and the carbon exposure of our activities. Our targets will have specific time horizons against defined baseline years and will consider the level of historical and forward looking projections that can be made available. We aim to develop this new reporting framework in the first half of 2019 and will start to include key quantified metrics in our next annual report.
Reflecting the needs of our stakeholders: Communities and environment, page 18
Helping Britain get a home, Helping people save for the future,
Non-financial key performance indicators Key performance indicators, pages 6 to 7
– Launched card controls increasing customer security with functionality to cancel or temporarily freeze card use
– Introduced cheque image clearing, providing customers with the ability to pay in cheques remotely
Creating warm informal spaces to meet, work and learn £4,272m Underlying profit increased by 13%
Commercial Banking has a client-led, low risk, capital efficient strategy, and is committed to supporting UK-based clients and international clients with a link to the UK. Through its segmented client coverage model, it provides clients with a range of products and services such as lending, transaction banking, working capital management, risk management and debt capital markets services. Continued investment in capabilities and digital propositions enables the delivery of a leading customer experience, supported by increasingly productive relationship managers, with more time spent on valueadding activity.
Commercial Banking >5m We have committed to a further one million square feet in 2018, and five million square feet by 2020.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 29
Our approach to risk is founded on an effective control framework, which guides how our colleagues work, behave and the decisions they make. As part of this framework, risk appetite – the amount and type of risk that the Group is prepared to seek, accept or tolerate in delivering our Group Strategy – is embedded in policies, authorities and limits across the Group.
Our prudent risk culture and appetite, along with close collaboration between Risk division and the business, supports decision-making and has enabled us to continue to deliver against our strategic priorities in 2018.
Our approach to risk plays a key role in the Group’s strategy of becoming the best bank for customers, colleagues and shareholders.
We believe effective risk management can be a strategic differentiator, in particular: Prudent approach to risk Being low risk is fundamental to our business model and drives our participation choices. Strategy and risk appetite are developed in tandem and together outline the parameters within which the Group operates.
Business focus and accountability Risk management is an integral feature of how we measure and manage performance – for individuals, businesses and the Group. In the first line of defence, business units are accountable for managing risk with oversight from a strong and independent second line of defence Risk division.
Monitoring, oversight and assurance ensure effective risk management across the Group
Accountability for ensuring risk is managed consistently within the Risk Management Framework approved by the Board
Within Commercial Banking we look specifically at how industry risks impact success, and tailor advice and lending based on the dynamics of a segment or sector. One such example is in our SME dairy sector which has experienced significant pressures due to falling milk prices. Our relationship managers and risk teams have been working together to understand each client’s farm and its changing needs so we can provide the best support possible. This may be through extending working capital or restructuring facilities, in order to drive better outcomes for the businesses we serve.
Transforming ways of working Our nationwide Fraud analytics and insight team looks after the systems which detect fraud for the Group.
The team has embraced agile working due to the nature of its role: at short notice they might be called upon to respond to a new fraud attack, which can require working long hours or into the night. The team also supports a large number of the Group’s change programmes, often working outside regular hours. To meet the needs of the colleague, the team and the Group, working patterns are agreed on an individual basis.
Credit policy, incorporating prudent lending criteria, aligned with Board-approved risk appetite, to effectively manage risk
Robust risk assessment and credit sanctioning to ensure we lend appropriately and responsibly
Embedding Group-wide processes to monitor ongoing compliance with new legislation, rules and regulation
Ongoing engagement with regulatory authorities and industry bodies on forthcoming regulatory changes, market reviews and investigations, ensuring programmes are established to deliver new regulation and legislation
Full analysis of risk categories page 114 £993m Mandatory, legal and regulatory investment spend 2017: £886m
Impairments remain below long-term levels and are expected to increase as the level of write-backs and releases reduces and impairments normalise. 1 Underlying total gross lending.
Read more pages 115 to 135 £937m Impairment charge 2017: £795m £9,215m Stage 3 assets1 1 Jan 2018: £9,055m
Conduct risk appetite metrics provide a granular view of how our products and services are performing for customers through the customer lifecycle
Product approval, continuous product review processes and customer outcome testing in place (across products and services)
Further enhancements and embedding of our framework to support all customers, including those in vulnerable circumstances
Enhancing the resilience of systems that support critical business processes with independent verification of progress on an annual basis
Working with industry bodies and law enforcement agencies to identify and combat fraud and money laundering
People Key people risks include the risk that we fail to maintain organisational skills, capability, resilience and capacity levels in response to organisational, political and external market change and evolving business needs.
Managing organisational capability and capacity to ensure there are the right skills and resources to meet our customers’ needs
Regulatory requirements relating to personal accountability and remuneration rules could affect the Group’s ability to attract and retain the calibre of colleagues required to meet changing customer needs. We recognise the challenges in delivering the Group’s strategic priorities and we will continue to invest in the development of colleague capabilities and agile working practices. This investment will deliver a leading customer experience and allow the Group to respond quickly to customers’ rapidly changing decision-making in a digital era. 1 Formerly known as Best bank for customers index.
A comprehensive capital management framework that includes setting of capital risk appetite and dividend policy
Ensuring we hold an appropriate level of capital to maintain financial resilience and market confidence underpins our strategic objectives of supporting the UK economy, and growth in targeted segments through the cycle. 1 Pro forma.
Undertaking daily monitoring against a number of market and Group-specific early warning indicators
Maintaining a contingency funding plan detailing actions and strategies available in stressed conditions
We maintain a strong funding position in line with our low risk strategy, and the loan to deposit ratio remains within our target range. Our funding position allows the Group to grow targeted business segments, and better address our customers’ needs.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 35
Ring-fencing ensures that we are safer and continue to deliver a leading customer experience by providing further protection to core retail and SME deposits, increasing transparency of our operations and facilitating the options available in resolution.
Narrowing credit spreads will increase the cost of pension scheme benefits
The Group’s defined benefit pension schemes continue to monitor their credit allocation as well as the hedges in place against nominal rate and inflation movements
The bursary support is extremely valuable to me. It means that I do not have to feel anxious about making financial decisions such as joining new clubs and societies, and I feel like it puts me on a level playing field with everyone else. I also appreciate that a firm genuinely wants to help my development and it is not simply about taking up a job with them at the end, as it allows me to be more open with my mentor about my personal development. Suzanne Norman, Law, Jesus College
Strong and sustainable financial performance with continued growth in profits and returns The Group’s statutory profit after tax of £4,400 million was 24 per cent higher than in 2017, driven by increased underlying profit, a reduction in the payment protection insurance charge and a lower effective tax rate. Statutory return on tangible equity increased by 2.8 percentage points to 11.7 per cent.
The Group manages the risk to its earnings and capital from movements in interest rates centrally by hedging the net liabilities which are stable or less sensitive to movements in rates. As at 31 December 2018 the Group’s hedge had a nominal balance of £180 billion (31 December 2017: £165 billion) and an average duration of around four years (31 December 2017: around three years). The Group generated £2.7 billion of income from the structural hedge balances in the year (2017: £2.5 billion). The benefit from the hedge in the year was £1.4 billion over LIBOR (2017: £1.9 billion) with a fixed earnings rate of approximately 0.7 per cent over LIBOR (2017: 1.1 per cent).
Other income of £6,010 million was slightly lower excluding the £146 million gain on sale of Vocalink in 2017. Strong growth in new business within Insurance and Wealth, largely driven by increased workplace pensions income, was offset by slightly lower clients market activity in Commercial Banking while Retail remained stable, due in part to the launch of a simpler overdraft fee structure, which has now been fully implemented. Other income includes a gain of £270 million on the sale of £18 billion of gilts and other liquid assets, compared with a £274 million gain on sale of such assets in 2017.
Total ECL2 allowances as a % of drawn balances 0.9 1.0 (0.1)pp 1 Underlying basis (including purchased and originated credit impaired assets in Stage 2 and 3).
Overall credit performance in the UK mortgage book remains strong with average mortgage loan to value ratios broadly stable at 44.1 per cent and new to arrears as a proportion of the total book remaining low. New business average loan to value was 62.5 per cent and around 88 per cent of the portfolio continues to have loan to value ratios of less than 80 per cent. The consumer finance portfolios continue to perform well with credit card business new to arrears as a proportion of the total book remaining low whilst the UK motor finance book continues to benefit from the Group’s conservative approach to residual values and resilient used car prices. In Commercial Banking, the book continues to benefit from effective risk management, including reduced single name and key sector exposures. Together with a resilient economic environment, this has resulted in impairment charges remaining at a low level.
There have been no significant changes to the Group’s economic assumptions included in its IFRS 9 models. IFRS 9 is procyclical and introduces additional volatility but through the cycle expectations remain unchanged. The Group’s expected credit loss (ECL) allowance reflects a probability weighted view of future economic scenarios including a 30 per cent weighting of downside and a 10 per cent weighting of severe downside. The weighted impact of these negative scenarios is already included within the Group’s ECL allowance, which includes £0.6 billion in respect of the severe downside scenario.
Lloyds Banking Group Annual Report and Accounts 2018 39 Strateg ic rep ort
The increase in amortisation of purchased intangibles to £108 million (2017: £91 million) and fair value unwind and other items to £319 million (2017: £270 million) were both largely driven by the inclusion of MBNA.
Taxation The tax expense was £1,560 million (2017: £1,728 million) representing an effective tax rate of 26 per cent (2017: 33 per cent). The lower effective tax rate was driven by the reduction in non-deductible conduct provisions, including remediation. The Group continues to expect the effective tax rate to reduce to around 25 per cent in 2020.
Of which money-market funding <1 year maturity 4 £21bn £15bn 44 £15bn 44
3 Excludes repos of £1.8 billion (1 January 2018: £2.6 billion; 31 December 2017: £2.6 billion).
Loans and advances to customers were stable at £444 billion with growth in targeted segments offset by the £4 billion sale of the Irish mortgage portfolio and a reduction of £2 billion in the closed mortgage book. The growth in targeted segments included £3 billion from start-ups, SME and Mid Markets and £1 billion from UK Motor Finance whilst the open mortgage book remained broadly flat at £267 billion.
The Group continues to optimise funding and target current account balance growth, with Retail current accounts up 5 per cent to £74 billion (31 December 2017: £70 billion) and Commercial current account balances at £35 billion (31 December 2017: £30 billion).
2 Capital build is reported on a pro forma basis before ordinary dividends and share buyback.
The Group’s balance sheet remains strong with capital build of 210 basis points, pre 2018 dividends, and a pro forma CET1 ratio of 13.9 per cent post proposed buyback and Insurance dividend.
The capital build included 195 basis points from underlying performance, 25 basis points from earnings related dividends received from the Insurance business and 25 basis points in relation to the sale of the Irish mortgage portfolio. Other movements, resulting in a net increase of 3 basis points, included the impact of structural changes arising from transfers between Insurance and the ring-fenced bank, risk-weighted asset reductions, market movements and expected pension deficit contributions. This was partly offset by 38 basis points for PPI charges.
In July 2018, the Prudential Regulation Authority (PRA) reduced the Group’s Pillar 2A CET1 requirement from 3.0 per cent to 2.6 per cent, increasing to 2.7 per cent with effect from 1 January 2019 to reflect commencement of the UK’s ring-fencing regime. In addition the countercyclical capital buffer rate on UK credit exposures increased to 1.0 per cent in November 2018 resulting in a countercyclical capital buffer for the Group of 0.9 per cent.
The Board’s current preference is to return surplus capital by way of a buyback programme given the amount of surplus capital, the normalisation of ordinary dividends, and the flexibility that a buyback programme offers.
Average Retail current accounts £71.6bn £67.5bn 6 1 Adjusted to reflect the implementation of IFRS 9 and IFRS15.
Risk-weighted assets £91.4bn £88.1bn £1.3bn £30.1bn £210.9bn 1 Excludes reverse repos of £40.5 billion (31 December 2017: £16.8 billion).
2 Excludes repos of £1.8 billion (31 December 2017: £2.6 billion).
Alternative performance measures The Group uses a number of alternative performance measures, including underlying profit, in the discussion of its business performance and financial position. Further information is provided on page 288.
6 At 31 December 2017 the customer segment balances included lower risk loans that were originated by Commercial Banking and subsequently sold to the Insurance business to back annuitant liabilities. These loans were reported in Central items but included in the table to aid comparison with prior periods. Since the implementation of IFRS 9 these loans are no longer classified as loans and advances to customers.
Net income 1,988 1,979 1 Prior period restated to include remediation.
4 No material impact from application of IFRS 9 – adjusted assets are unchanged from those reported at 31 December 2017.
Lloyds Banking Group Annual Report and Accounts 2018 47 Strateg ic rep ort
The volatility movements in the period were largely driven by insurance volatility arising from equity market movements and credit spreads. The capital impact of equity market movements is hedged within Insurance and this also reduces the IFRS earnings exposure.
Lloyds Banking Group Annual Report and Accounts 2018 49 Strateg ic rep ort
Statutory return on tangible equity (%) 11.7 8.9 1 Prior period restated to include remediation.
Anita Frew stepped down as Chairman of the Remuneration Committee in September and was replaced by Stuart Sinclair. Anita will continue to be a member of the Committee, and remains as the Group’s Deputy Chairman and Senior Independent Director. Further to the announcement in October that George Culmer would be retiring from the Group in the third quarter of 2019, the Group announced, in February 2019 that, subject to regulatory approvals, William Chalmers will succeed George as Executive Director and Chief Financial Officer.
Governance and the ring-fenced bank structure Building on the work carried out last year to create our non-ring fenced bank, Lloyds Bank Corporate Markets plc, the Group has now completed the new regulatory requirements by establishing new governance around its ring-fenced banking activities – Lloyds Bank plc and Bank of Scotland plc (together the ‘RingFenced Banks’). These companies serve the Group’s personal and business clients in the UK and contain the vast majority of the Group’s UK banking activities. Further information on the governance structure for the Ring-Fenced Banks can be found on page 58. Group Directors are also Directors of the Ring-Fenced Banks and, in addition, we have appointed three Non-Executive Directors to the Ring-Fenced Banks, who are independent of the Group (the ‘Ring-Fenced Bank only Directors’). These three Ring-Fenced Bank only Directors were recruited during 2018 and took up their formal roles on 1 January 2019. They are Nigel Hinshelwood and Brendan Gilligan, who both have extensive experience of the financial sector, and Sarah Bentley, who has significant experience in consumer-focused industries as well as in digital technology. More information is provided in the Nomination and Governance Committee report on pages 67 to 69. Nigel Hinshelwood has been appointed as the Senior Independent Director of the Ring-Fenced Bank Boards.
Comprising Directors with the right mix of skills and experience, the Board is collectively responsible for overseeing delivery of the Group’s strategy 1. Lord Blackwell Chairman Appointed: June 2012 (Board), April 2014 (Chairman) Skills and experience: Deep financial services knowledge including insurance and banking Significant experience with strategic planning and implementation Regulatory and public policy experience gained from senior positions in Downing Street, Regulators and a wide range of industries Credibility with key stakeholders Strong leadership qualities Lord Blackwell is an experienced Chairman and Non-Executive Director within the financial services sector having previously been Chairman of Scottish Widows Group. He was previously Senior Independent Director and Chairman of the UK Board for Standard Life and Director of Group Development at NatWest Group. His past Board roles have also included Chairman of Interserve plc, and Non-Executive Director of Halma plc, Dixons Group, SEGRO and Ofcom. He was Head of the Prime Minister’s Policy Unit from 1995 to 1997 and was appointed a Life Peer in 1997. External appointments: Governor of the Yehudi Menuhin School and a member of the Governing Body of the Royal Academy of Music.
5. Lord Lupton CBE Independent Director and Chairman of Lloyds Bank Corporate Markets plc Appointed: June 2017 Skills and experience: Extensive international corporate experience, especially in financial markets Strong board governance experience, including investor relations and remuneration Regulatory and public policy experience Significant experience in strategic planning and implementation
12. Juan Colombás Executive Director and Chief Operating Officer Appointed: November 2013 (Board), January 2011- September 2017 (Chief Risk Officer), September 2017 (Chief Operating Officer) Skills and experience: Significant banking and risk management experience International business and management experience Juan is responsible for leading a number of critical Group functions and driving the transformation activities across the Group in order to build the Bank of the Future. He was previously the Chief Risk Officer and an Executive Director of Santander’s UK business. Prior to this, he held a number of senior risk, control and business management roles across the Corporate, Investment, Retail and Risk Divisions of the Santander Group. He was previously the Vice Chairman of the International Financial Risk Institute. External appointments: None.
Skills and experience: Kate was appointed Group General Counsel in January 2015. Kate joined the Group in 2005 from Linklaters, where she was a corporate lawyer specialising in M&A transactions. Before her current role, Kate held a number of senior positions
Skills and experience: Paul joined the Group as a contractor in September 2016 and was formally employed by the Group in June 2017. He joined from Deloitte where he was a partner in the UK Financial Services practice and led the UK Financial Services Internal Audit business. Paul has specialised in internal and external audit roles across financial services for over 20 years, including 10 years in various leadership roles in Barclays Internal Audit.
Skills and experience: David was appointed as Group Director for the Commercial Banking division in September 2017 responsible for supporting corporate clients from SMEs and mid corporates through to large corporates and financial institutions. David started his career with Lloyds Bank in 1986 on the graduate entrant programme and has held a number of key leadership roles across all Divisions of the Group since that time. Immediately prior to his current role he was Group Director Retail and Consumer Finance, responsible for the Lloyds, Halifax, Bank of Scotland, Lex Autolease and Black Horse Brands including the retail branch networks, customer products and telephone banking, in addition to Retail Business Banking and UK Wealth businesses. David is a Fellow of the Chartered Institute of Bankers. He is also Group Executive Sponsor for Disability.
10. Janet Pope Chief of Staff and Group Director, Responsible Business and Inclusion
Skills and experience: Janet joined the Group in 2008 to run the Savings business. She was previously Chief Executive at Alliance Trust Savings, prior to which she was EVP Global Strategy at Visa International. Janet spent 10 years at Standard Chartered Bank where she held a variety of roles including Retail Banking MD for Africa and non-executive directorships at Standard Chartered Bank Zimbabwe, Kenya, Zambia and Botswana. Janet is Chair of the Charities Aid Foundation Bank and a Non-Executive Director of the Banking Standards Board. She is also the Group’s Executive Sponsor for Sexual Orientation and Gender Identity.
Skills and experience: Stephen was appointed Chief Risk Officer in September 2017. He joined the Group in May 2011 as Chief Credit Officer for Wholesale, Commercial and International. In October 2012 he became Risk Director, Commercial Banking Risk and was also a member of the Commercial Banking Management Group. Prior to joining the Group Stephen was Chief Risk Officer at Barclays Corporate and prior to that was Chief Credit Officer for the UK Retail and Corporate business in Barclays. In a 21-year career at Barclays, Stephen undertook a variety of roles in the front office and risk. He was also a member of the Group Risk Executive team and a Chair of Group Credit Committees. Stephen is also the Group’s Executive Sponsor for Gender Diversity and Equality.
1 Amanda Mackenzie joined the Board and respective Committees on 1 October 2018.
4 Where a Director is unable to attend a meeting s/he receives papers in advance and has the opportunity to provide comments to the Chair of the Board, or to the relevant Committee Chair.
People and ways of working (initial deep dive in April, and update meeting in October)
As part of the structure of the partnership, the Board considered two primary elements: The management of the insurance and wealth related assets; and
Management of the assets was largely the responsibility of the Insurance Business. In July 2018, a recommendation was made to the Insurance Board (and the Boards of all the other entities that were to be parties to the arrangements) proposing that Schroders be appointed as core investment management and investment advisory partner following a structured Request for Proposal process, involving two rounds of bidding, due diligence, site visits, client references and joint implementation workshops. An evaluation process indicated that Schroders would be the preferred bidder, with Schroders standing out on strategic alignment as well as investment performance, which was seen as key to building a successful long-term relationship. The recommendation included the proposed strategic partnership with the Wealth business, which would benefit the Insurance business. The recommendation to appoint Schroders to manage the funds was accepted in principle by the Insurance Board, subject to approval of the proposed JV arrangements by the Group Board. Group Board approval of the JV proposals was obtained on 2 October 2018.
The JV element of the partnership was considered by the main Group Board. Initially papers were presented at scheduled Board meetings, but as the proposal progressed, a Committee of the Board considered and approved the project to provide flexibility, to better respond to the needs of the business and engage in governance of the project, which was important for the implementation of the Group’s strategy in the area of insurance and wealth, and for the Group as a whole. The Board scrutinised the proposal to satisfy itself that the establishment of the JV was in the best interests of the Group’s customers. The Board considered, amongst other things, the process for referring Group customers to the JV and that the standards of customer service would meet the Group’s values and standards, ensuring that customers were at the heart of the decision being made.
Consistent with the existing independent Scottish Widows Limited Board, Lloyds Bank Corporate Markets plc also has an independent Board. Further detail on the risk management framework of the Group and of each sub-group is set out on page 106.
New directors of the Ring-Fenced Banks During the first quarter of the year the Nomination and Governance Committee oversaw the selection process and recommendation for appointment of three new Non-Executive Directors to the Boards of Lloyds Bank plc and Bank of Scotland plc. As described in the Chairman’s introduction on page 51, Sarah Bentley, Brendan Gilligan and Nigel Hinshelwood were recruited during the year, and took office with effect from 1 January 2019. All the Ring-Fenced Bank only Directors sit on the Board Risk Committees of each of the Ring-Fenced Banks and two are members of the relevant Audit and Remuneration Committees. Nigel Hinshelwood, who is the Senior Independent Director of each of the Ring-Fenced Banks with effect from 1 January 2019, is also a member of the Nomination Committee of each of the Ring-Fenced Banks.
A: Taking risk is a critical part of what any bank must do. How well it does that determines how well it meets the needs of its customers and how successful it will be as an organisation.
Aside from the balance sheet impacts of such events, operational resilience has become ever more important as the processes and systems by which banks provide their services become ever more technologically reliant and dependent upon continued smooth running of services provided in-house and through expert third parties. The demand for change and more sophisticated services in itself brings operational risk as platforms are changed. Add on the increasing risk of cyber attacks and operational resilience is receiving a very considerable amount of attention from the Board Risk Committee.
Beyond Board meetings Non-Executive Directors regularly meet with senior management and spend time increasing their understanding of the business through site visits, formal briefing sessions or more informal events including breakfast meetings with senior staff. These informal meetings allow Directors greater time to discuss business in an informal setting, ensuring that there is sufficient time for the Board to discuss matters of a material nature at Board meetings.
Non-Executive Directors see attendance at Board and Committee meetings as only one part of their role. In addition to the annual schedule of Board and Committee meetings, the Non-Executive Directors undertake a full programme of activities and engagements each year, please see pages 16 to 18 for more information.
A: I have a number of different stakeholders to whom I am accountable, being shareholders, the Chairman, the other Directors and the Group as a whole. I make myself available to shareholders when there are concerns that have not or cannot be dealt with through the usual channels of the Chairman or Executive Directors. I also attend regular meetings with major shareholders to ensure that there is a balanced understanding of the issues and concerns that this group of shareholders have. I act as a sounding board for the Chairman and Group Chief Executive on Board and shareholder matters, and have regular meetings with both. In matters relating to the Chairman such as his performance and conduct evaluation, agreeing his objectives and succession planning, I will Chair the Nomination and Governance Committee in his place to ensure independence. I will also conduct his annual appraisal, and deal with any concerns regarding the Chairman that other members of the Board have.
The Chairman met with a number of teams, including the Group Customer Services Customer Solutions Centre, which is designing and developing a new customer management system which utilises artificial intelligence, and colleagues from Black Horse, including the Complaints team. Lord Blackwell sat with colleagues and went through some live cases with them, discussing the challenges they face in ensuring fair and reasonable outcomes.
This was followed by a networking lunch with the Commercial Banking SME and the Mid Markets Team, who deliver local face-toface relationships across five geographical areas of Wales.
To end his visit in Cardiff, Lord Blackwell hosted a colleague recognition dinner. The evening recognised the achievements of colleagues who demonstrate the Group values of making a difference together, keeping things simple and putting customers first.
A yearly planner is prepared by the Company Secretary to map out the flow of key items of business to the Board.
Meeting packs are uploaded and communicated to all Directors via a secure electronic Board portal typically a week in advance of the meeting to ensure sufficient time to review the matters which are to be discussed and seek clarification or any additional information.
Executive meetings are held ahead of all Board and Committee meetings to ensure all matters being presented to the Board have been through a thorough discussion and escalation process.
Topics for deep dives or additional items are discussed when required and include business, governance and regulatory updates.
The Board meetings offer the Board the chance to meet colleagues within the business, and if any additional meetings are required to provide more details, these are arranged.
Minutes and matters arising from the meeting are produced and circulated to the Directors for review and feedback. Those responsible for matters arising are asked to provide updates to a subsequent meeting.
Highlights from the 2018 review The evaluation concluded that the performance of the Board, its Committees, the Chairman and each of the Directors continues to be effective. All Directors demonstrated commitment to their roles.
The key findings and areas for consideration include the following: Findings Areas for consideration
Despite strong engagement in strategy the Board agenda is perceived to be still overly rooted in regulatory compliance and risk mitigation. Looking ahead, there is an opportunity for the Board to become more outwardly-focused.
If Directors have concerns about the Company or a proposed action which cannot be resolved, it is recorded in the Board minutes. Also on resignation, Non-Executive Directors are encouraged to provide a written statement of any concerns to the Chairman, for circulation to the Board. No such concerns were raised in 2018 and up to the date of this report.
Initial meetings with the Chairman took place to build on the existing questionnaire and establish a discussion guide. Analysis of the existing skills matrix was undertaken. This enabled Egon Zehnder to understand the Board’s purpose and scope out the effectiveness review.
Terms of Reference to be reviewed and updated to avoid duplication of effort in areas covered by other Committees.
Amanda Mackenzie, appointed in October 2018 has a substantial amount of experience in respect of change management.
Professional development and training programme at a glance In addition to the existing methods of training for the Directors, the Board agreed in 2017 that the Non-Executive Directors should be provided with a mandatory training programme. This was trialled by members of the Nomination and Governance Committee and has since been rolled out to the rest of the Directors.
Control Effectiveness Review An annual Control Effectiveness Review (CER) is undertaken to evaluate the effectiveness of the Group’s control framework with regard to its material risks, and to ensure management actions are in place to address key gaps or weaknesses in the control framework. Business areas and head office functions assess the controls in place to address all material risk exposures across all risk types. The CER considers all material controls, including financial, operational and compliance controls. Senior management approve the CER findings which are reviewed and independently challenged by the Risk Division and Group Internal Audit and reported to the Board. Action plans are implemented to address any control deficiencies.
The Group’s risk management and internal control systems are regularly reviewed by the Board and are consistent with the guidance on Risk Management, Internal Control and Related Financial and Business Reporting issued by the Financial Reporting Council and compliant with the requirements of CRD IV. They have been in place for the year under review and up to the date of the approval of the Annual Report. The Group has determined a pathway to compliance with BCBS 239 risk data aggregation and risk reporting requirements and continues to actively manage enhancements.
Engagement activity and developing dialogue Board members already participate in a number of key engagement activities such as site visits, Q&A sessions, colleague feedback sessions, Chairman’s breakfasts, and the Helping Britain Prosper Live events. Enhancements to current engagement activities have been agreed to provide the opportunity for feedback, themes and viewpoints of the wider workforce to be brought to the attention of the Board for discussion and debate to encourage a meaningful dialogue between the Board and the workforce.
Under the leadership of the Group Chief Executive, George Culmer and Juan Colombás make and implement decisions in all matters affecting operations, performance and strategy. They provide specialist knowledge and experience to the Board. Together with António Horta-Osório, George Culmer and Juan Colombás design, develop and implement strategic plans and deal with day-to-day operations of the Group.
As Deputy Chairman, Anita Frew would ensure continuity of chairmanship during any change of chairmanship. She supports the Chairman in representing the Board and acts as a spokesperson. She deputises for the Chairman and is available to the Board for consultation and advice. The Deputy Chairman may represent the Group’s interests to official enquiries and review bodies. As Senior Independent Director, Anita Frew is also a sounding board for the Chairman and Chief Executive. She acts as a conduit for the views of other Non-Executive Directors and conducts the Chairman’s annual performance appraisal. She is available to help resolve shareholders’ concerns and attend meetings with major shareholders and financial analysts to understand issues and concerns.
B1. The Board’s composition The balance of skills, experience, independence, and knowledge on the Board is the responsibility of the Nomination and Governance Committee, and is reviewed annually or whenever appointments are considered. Having the right balance on the Board and its Committees helps to ensure that those bodies discharge their respective duties and responsibilities effectively.
More information on Directors’ attendance at Board and Committee meetings can be found on page 56.
The Directors’ viability statement and confirmation that the business is a going concern can be found on page 80.
D1. Level and elements of remuneration The Group is committed to offering all colleagues a reward package that is competitive, performance-driven and fair and its Remuneration Policy is designed to promote the long term success of the Company. The Directors’ Remuneration Report on pages 82 to 99 provides full details regarding the remuneration of Directors. The Remuneration Policy can be found in the 2016 Annual Report and Accounts and remains unchanged since last approved by shareholders at the 2017 AGM.
D2. Procedure The work of the Remuneration Committee and its focus during the year can be found on page 96.
Following the announcement in October that George Culmer would be retiring from the Group in the third quarter of 2019, the Nomination and Governance Committee conducted a rigorous search process for his successor. This led to the announcement in February 2019 that, subject to customary regulatory approvals, William Chalmers would join the Group in June 2019, becoming an Executive Director and Chief Finance Officer when George steps down.
The GEC characteristics will become the benchmark for the assessment of, and development planning for, GEC members and attendees as well as successors into those roles. The characteristics will be considered in addition to knowledge and experience criteria around breadth of banking/financial services and governance experience. Work was undertaken in September 2018 to support identified successors in reviewing and refreshing their development plans to ensure that these directly support their succession readiness in line with the characteristics.
During the year GEC members and attendees have been assessed against the GEC characteristics, with both a desktop assessment and self-assessments by GEC members and attendees. These have been reviewed by the Group Chief Executive and me, and formed the basis for discussion with the Committee and other Board members about executive capabilities and succession plans.
The Group’s Corporate Governance Framework The Corporate Governance Framework was updated in 2017 to anticipate the governance requirements of ring-fencing on the basis of discussions at that time. During 2018, the Corporate Governance Framework was further updated to include additional amendments to reflect commitments made to the Regulator. These amendments included wording to reflect the role of Risk Officer for the Ring-Fenced Banks, particularly in relation to the Risk Committees, additional detail on the conduct of aligned Board and Committee meetings, and clarification of the management of conflict issues. More information on the aligned meetings can be found on page 58.
Following Anita Frew’s decision to step down as the Remuneration Committee Chair, the Committee recommended to the Board that Stuart Sinclair replace her in this role. This recommendation was based on Board succession planning and the fact that Stuart is an experienced Non-Executive Director, has been a member of the Remuneration Committee since he joined the Company in January 2016, and has external experience of chairing Board committees.
From the ongoing assessment of the Board members, the Chairman creates a skills matrix which the Committee uses to track the Board’s strengths and identify gaps in the desired collective skills profile of the Board, giving due weight to diversity in its broadest sense. Recommendations are made to the Board as appropriate. The skills matrix was considered in the appointment of Amanda Mackenzie, and the appointment of the Ring-Fenced Bank only Directors.
Russell Reynolds Associates was engaged to shortlist candidates for the positions of three Ring-Fenced Bank only Non-Executive Directors. The recruitment process, led by the Chairman, included interviews with various members of the Board and resulted in the appointment of Nigel Hinshelwood, Sarah Bentley and Brendan Gilligan with effect from 1 January 2019.
During the year the Committee selected Egon Zehnder to facilitate the review by the Board and its Committees of their effectiveness and provided oversight for the process. The Committee also reviewed its own effectiveness and found that it met its key objectives and carried out its responsibilities effectively. Full details of the review can be found on pages 62 to 63.
Governance The Committee provides oversight for various aspects of corporate governance, and during the year key activities included the following: Annual review of the Corporate Governance Framework, amendments which took into account the Group’s approach to compliance with the PRA’s Ring Fenced Banks Governance Principles, and the requirements of recent regulatory developments including the terms of the revised UK Corporate Governance Code. Our application of the New Code will be reported upon next year; Continuing oversight of the governance structure for the Ring-Fenced Banks; A review of the Board/Committee responsibilities and the matters reserved for the Board to assess any instances of overlap or gaps in coverage or escalation; In the light of the increasing importance of IT in the Group’s GSR3 strategy, a review of the governance and oversight of the IT Programme; Considering correspondence with shareholders; Approval of the appointment of Trustees to the Bank’s Foundations.
Lloyds Banking Group Annual Report and Accounts 2018 69 Strateg ic rep ort
The Committee reports to the Board on how it discharges its responsibilities and makes recommendations to the Board, all of which have been accepted during the year. The Committee’s terms of reference can be found at www.lloydsbankinggroup.com/our-group/corporate-governance.
Details of Committee memberships and meeting attendance can be found on page 56.
A: I left the first Board strategy away day I attended with one overarching thought: the combined Board and Group Executive are an incredible group of people and Lloyds Banking Group is an amazing company. Of course there’s much to be done, but, with the right approach, it will be. And no I wouldn’t say that if I didn’t believe it or if I hadn’t seen some comparisons. So far I feel the Board functions extremely well and the governance framework is clear, as simple as it can be and the various lines of defence operate the way one should expect they do.
A: I certainly hope I can bring my expertise to the Board. I am very thrilled to be part of it and play my part in Helping Britain Prosper.
In 2018, the Group made provisions totalling £600 million in respect of other conduct matters, including £151 million for secured and unsecured arrears handling activities; and £45 million in respect of packaged bank accounts.
The disclosures relating to impairment provisions are set out in note 20: ‘Allowance for impairment losses’ and note 52: ‘Financial risk management’ of the financial statements. The allowance for impairment losses on loans and advances to customers at 31 December 2018 was £3,150 million (1 January 2018: £3,223 million).
The Committee was satisfied that the Group’s quantitative and qualitative disclosures made in respect of retirement benefit obligations are appropriate. The relevant disclosures are set out in note 35: ‘Retirement benefit obligations’ of the financial statements. The defined benefit obligation at 31 December 2018 was £41,092 million (31 December 2017: £44,384 million).
During the first half of 2018, the Group sold its Irish residential mortgage portfolio for approximately £4 billion of cash consideration. The Committee reviewed the accounting proposed by management, including the recognition of a £105 million loss on disposal and the derecognition of the assets from the Group’s balance sheet, and was satisfied that it was appropriate.
The Committee has discussed the requirements of IFRS 16 (Leases), which the Group adopted on 1 January 2019; and IFRS 17 (Insurance Contracts), which is expected to come into force for the year ending 31 December 2022.
The Committee was satisfied that the viability statement could be provided and advised the Board that three years was a suitable period of review. The viability statement is disclosed within the Directors’ report on page 80.
Other significant issues The following matters were also considered by the Committee during the year: Risk management and internal control systems Full details of the internal control and risk management systems in relation to the financial reporting process are given within the risk management section on pages 105 to 159. Specific matters that the Committee considered for the year included: the effectiveness of systems for internal control, financial reporting and risk management the extent of the work undertaken by the Finance teams across the Group to ensure that the control environment continued to operate effectively the major findings of internal investigations into control weaknesses, fraud or misconduct and management’s response along with any control deficiencies identified through the assessment of the effectiveness of the internal controls over financial reporting under the US Sarbanes-Oxley Act
Statutory Audit Services compliance The Company and the Group confirm compliance with the provisions of The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 (the ‘Order’) for the year to 31 December 2018. PwC has been auditor to the Company and the Group since 1995, having previously been auditor to certain of the Group’s constituent companies.
During the year, the Committee gave detailed consideration to a wide range of existing and emerging risks, recognising that the environment within which the Group operates is increasingly subject to considerable change. This is achieved through effective planning of the agenda which ensures specific attention is given to those emerging risks which are considered to be of ongoing importance to the Group and its customers, alongside standing areas of risk management. The Committee continues to make use of dedicated sub-committees to provide additional focus on particular areas of significance.
The Committee considered delivery of key regulatory change programmes such as ring-fenced banking, together with other areas of regulatory attention such as data governance and operational resilience, where the Group continues to strengthen its control environment. Focus was also given to management of customer rectifications, where good progress continued to be made with reduction of the volume of rectification programmes and customers impacted. Stress testing undertaken by the Group, which included the impacts of IFRS 9 for the first time and considered the potential impacts of severe economic scenarios on the Group’s business model, also continued to be reviewed and challenged by the Committee. Each of these areas will be subject to ongoing focus in 2019.
During 2018, the Committee continued to utilise established sub-committees to provide additional focus on areas such as IT resilience and cyber, and stress testing and recovery planning. These sub-committees enable members of the Committee to dedicate additional time and resource to achieving a more in-depth understanding of the topics covered, and enable further review and challenge of the associated risks.
The environment within which the Group operates is increasingly subject to considerable change.
Lloyds Banking Group Annual Report and Accounts 2018 75 Strateg ic rep ort
Conclusion: The Committee will continue to closely monitor economic uncertainties, particularly arising from EU Exit. The Committee will also focus on risks emerging from the EU due to slower growth and political challenges, as well as risks from wider global events.
Key areas of focus for the Committee have included updates on the Group’s cloud strategy, review of the updated operational resilience strategy and response to the Bank of England’s discussion paper. In addition, the Committee has reviewed papers relating to key risk reduction programmes including Identity and Access Management, insider risk and updates to the Group’s approach to managing its third-party suppliers.
Conclusion: The Committee takes the operational resilience of its services very seriously and has taken valuable insight from having independent advice and guidance. It has agreed risk appetite statements for critical services and has strengthened these over the last period to reflect the increased focus on resilience. The Committee considers that governance of operational resilience risk is robust and that activities in plan will ensure the ongoing resilience of key services to the Group’s customers.
Data risk continues to be an area of significant regulatory and media attention and the Committee has overseen the implementation of robust governance, to ensure compliance with GDPR. Clear accountabilities have been established by the creation of Divisional Data Privacy Accountable Persons, driving a culture of compliance. A Group Data Protection Office (GDPO) has been established to independently oversee compliance. The Group continues to drive enhancements to the control environment to ensure value is harnessed from the data that we hold, enabling delivery against key strategic priorities, whilst ensuring transparency and trustworthiness to our customers and colleagues.
Conclusion: The Group continues to place significant focus on complex regulatory changes, as well as ensuring effective horizon scanning of upcoming trends. Regulatory risk will remain a priority area of focus for the Committee in 2019.
Conclusion: The Group continues to make good progress however focus needs to remain on reducing the reasons for customers to complain in 2019 and to learn from root cause analysis.
The Committee noted the actions in train, including enhanced guidance, more detailed evidencing of embedding, enhancement of the control framework and developing improved management information.
Business; the approach to communicating the Company’s role as a responsible business; the Company’s policies relating to responsible business including the Code of Responsibility and the Statement on compliance with the Modern Slavery Act.
The four Lloyds Banking Group charitable Foundations do critical work to tackle disadvantage across the UK. The Committee met with Baroness Fritchie, chair of the Lloyds Bank Foundation for England and Wales, to discuss how we could jointly do more to support activity in key areas such as domestic abuse or homelessness.
The report that follows gives more examples of our activity to Help Britain Prosper in 2018, and I hope you find it both interesting and informative.
In other activities, the Committee considered reports on: an outline for an assurance process on responsible business activities within business areas; colleague engagement in responsible business activities; the partnership with the University of Birmingham’s Centre for Responsible
Profit and dividends The consolidated income statement shows a statutory profit before tax for the year ended 31 December 2018 of £5,960 (2017: £5,275 million). The Directors have recommended a final dividend for 2018, which is subject to approval by the shareholders at the AGM, of 2.14 pence per share (2017: 2.05 pence per share) totalling £2,288 for the year (2017: £1,475 million). The final dividend will be paid on 21 May 2019.
Amanda Mackenzie has been appointed to the Board since the 2018 AGM and will therefore stand for election at the forthcoming AGM. In the interests of good governance and in accordance with the provisions of the UK Corporate Governance Code, all other Directors will retire, and those wishing to serve again will submit themselves for re-election at the forthcoming AGM.
Power of Directors in relation to shares The Board manages the business of the Company under the powers set out in the articles of association, which include the Directors’ ability to issue or buyback shares. The Directors were granted authorities to issue and allot shares and to buyback shares at the 2018 AGM. Shareholders will be asked to renew these authorities at the 2019 AGM. The authority in respect of purchase of the Company’s ordinary shares is limited to 7,219,629,615 ordinary shares, equivalent to 10 per cent of the issued ordinary share capital of the Company as at the latest practicable date prior to publication of the 2018 AGM circular.
Share capital and restrictions on the transfer of shares or voting rights Special rights with regard to the control of the Company Employee share schemes – exercise of voting rights 1 Deborah McWhinney also served as a director during the year, retiring from the Company on 31 December 2018.
Viability statement The Directors have an obligation under the UK Corporate Governance Code to state whether they believe the Company and the Group will be able to continue in operation and meet their liabilities as they fall due over a specified period determined by the Directors, taking account of the current position and the principal risks of the Company and the Group. In making this assessment, the Directors have considered a wide range of information, including: the principal and emerging risks which could impact the performance of the Group; the 2017 Group Strategic Review, which sets out the Group’s customer and business strategy for the three year period from 2018 to 2020 inclusive; and the Group’s four year operating plan which comprises detailed customer, financial, capital and funding projections together with an assessment of relevant risk factors for the period from 2019 to 2022 inclusive.
In particular, the Board considered a range of possible impacts arising from the uncertain economic and geopolitical outlook, notably the implications of the possible outcomes of the EU exit negotiations. The Group’s four year operating plan also incorporated the impact of the IFRS 9 ‘Financial Instruments’ and the continuing low interest rate environment. Group, divisional and business unit operating plans covering a period of four years are produced and subject to rigorous stress testing on an annual basis. The planning process takes account of the Group’s business objectives, the risks taken to seek to meet those objectives and the controls in place to mitigate those risks to remain within the Group’s overall risk appetite. The Group’s annual planning process comprises the following key stages: The Board reviews and revises the Group’s strategy, risk appetite and objectives in the context of the operating environment and external market commitments.
The Directors have specifically assessed the prospects of the Company and the Group over the first three years of the current plan. The uncertain global economic and political environment, including the longer-term impact of the UK’s plans to leave the EU, together with the pace of regulatory change mean that the assumptions supporting
Lloyds Banking Group Annual Report and Accounts 2018 81 Strateg ic rep ort
Methodology The Group follows the principles of the Greenhouse Gas (GHG) Protocol Corporate Accounting and Reporting Standard to calculate our Scope 1, 2 and 3 emissions from our worldwide operations. The reporting period is 1 October 2017 to 30 September 2018, which is different to that of our Directors’ report (January 2018 – December 2018). This is in line with Regulations in that the majority of the emissions reporting year falls within the period of the Directors’ report. Emissions are reported based on an operational boundary. The scope of reporting is in line with the 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 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, calculated using both the location and marketbased methodologies. 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 2018 Reporting Criteria online at www.lloydsbankinggroup.com/rbdownloads.
GHG emissions (CO2e) per £m of underlying income (Location Based)1 13.1 15.5 19.4
Executive Director single figure remuneration outcomes are approximately 2 per cent lower than prior year
Gender pay gap reduced 1.3 per cent to 31.5 per cent – better than the average for Financial Services
Pay budget increase of 2.6 per cent for all colleagues – increases for Executive Directors and other senior colleagues set lower at 2 per cent
Group Performance Share outcome is down 3 per cent year-on-year when adjusted for changes to eligible population. The total pool for 2018 is £464.5 million.
2016 Long Term Incentive Plan is vesting at 68.7 per cent
To provide greater clarity on the process for determining variable remuneration for Executive Directors, on page 87 we have provided a step-by-step walk-through of the approach to bonus awards. This shows how we determine the proportion of profit allocated to variable pay for on target performance, which remained at 5.1 per cent for 2018, and the mechanical approach to determining individual awards.
To ensure that the Committee understands the views of a broad range of stakeholders, I have consulted with the Group’s recognised unions who represent the interests of around 30,000 colleagues. I am pleased to confirm that the unions have agreed our pay approach for 2019 receiving overwhelming support from their members. The total pay budget of 2.6 per cent for 2018 for all colleagues has been allocated such that higher pay increases are made to colleagues who are positioned lower in the pay range for their role, supporting a policy of real wage growth and pay progression. Increases range from 0.25 per cent to 9.9 per cent. The proposed salary increases for Executive Directors for 2019 have been set at 2 per cent, in line with other senior colleagues but lower than the overall colleague population.
In 2018, the Group made significant business progress, providing a strong platform for the Group’s strategic development and delivery of key priorities. The Group delivered strong financial performance in a period of political and economic uncertainty. This uncertainty weighed heavily on the Group’s share price during 2018; however, the Group’s resilient and low risk business model enabled strong underlying performance. Underlying Profit increased by 6 per cent and the Group’s capital position strengthened. The Group’s cost:income ratio remains market leading at 49.3 per cent.
As a result of taking on the role of Chief Executive of the Ring-Fenced Bank from 1 January 2019 in addition to his existing responsibility as Group Chief Executive, it has been determined that the Fixed Share Award for António Horta-Osório should be increased to £1.05 million. At the same time, the Group Chief Executive has agreed to reduce his Pension Allowance to bring this closer to that of the majority of the colleagues. His Pension Allowance will reduce from its current contractual level of 46 per cent of base salary to 33 per cent of base salary. This results in a decrease in total remuneration and greater value delivered in shares subject to a longerterm release schedule. Details are provided on page 93.
Final awards: To ensure fairness with all other colleagues, awards are adjusted to reflect the final pool funding.
In 2018, the Committee did not exercise any discretion over remuneration outcomes. Further details on how the use of discretion was considered can be found on page 89 in respect of the 2016 LTIP vesting outcome and page 87 in respect of the 2018 Group Performance Share awards.
I hope you find the additional explanation in this report helpful in clarifying our approach.
For 2019: The Group has applied a total pay budget of 2.6 per cent for the wider colleague population. GCE: £1,269,288 (1 January 2019) (2 per cent) CFO: £779,351 COO: £794,938 (1 January 2019) (2 per cent).
Benefits remain unchanged from 2018. Executive Directors receive a flexible benefits allowance in line with colleagues, (4 per cent of salary). This can be used to select benefits including life assurance and critical illness cover. Other benefits include car allowance, transportation and private medical cover.
For 2019 the following awards are being made: GCE: 300 per cent of base salary. CFO: No award COO: 275 per cent of base salary. Awards will be subject to a three year performance period with vesting between the third and seventh anniversary of award. Any shares released are subject to a further holding period in line with regulatory requirements and market practices.2 See page 94.
1 All references to CFO refer to George Culmer in role on 1 January 2019.
Variable remuneration awards are subject to a balance of financial and strategic measures as summarised below.
For details of all Group KPIs, see pages 6 to 7 £8,066m +6% Underlying profit
46.1% or less 100% payout 1st place 100% payout 16% p.a. or more 100% payout 14.0m 100% payout £3,308m or more 100% payout 100% payout
2018 Group Balanced Scorecard A balanced scorecard approach is used to assess Group performance and divisional performance. The Group Balanced Scorecard is made up of 20 measures with clearly defined performance targets agreed by the Committee in Q1 2018. Each receives a mechanical score of 1 to 5 depending on performance against those targets, resulting in an overall score and performance rating, see table on page 87. The Group Chief Executive’s individual performance is measured through the Group Balanced Scorecard.
The Group has optimised the majority of its customer journeys with the remainder being standardised.
Successful delivery of Major Group Core Programmes (based on time, cost and quality approach)
Outcome 4.15/5 Group Balanced Scorecard Modifier. £466.9m x 1.15 = £536.9m Reduction for conduct, and other factors. £536.9m – £72.4m = £464.5m
Awards are based on pre-determined formulaic pay out ranges commensurate with performance as follows: Based on the mechanical outturn of individual scorecards, a recommendation is made on the award level within the pre-determined pay out range. This was the mid point of the range and no discretion was applied.
Effective management of the establishment of the non-ring fenced bank, Lloyds Bank Corporate Markets plc.
Maintained a strong operational environment including developing and implementation of Change, Information and Cyber Security risk control, reporting and insight.
Maintained colleague engagement at levels in excess of the UK high performing norm.
António Horta-Osório George Culmer Juan Colombás Total 1 The 2016 LTIP vesting (see page 89) at 68.7 per cent and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 14 February 2019. The total number of shares vesting were 3,445,449 and 509,271 shares delivered in respect of dividend equivalents for António Horta-Osório, 1,901,209 shares vesting and 281,017 shares delivered in respect of dividend equivalents for George Culmer and 1,874,804 shares vesting and 277,114 shares delivered in respect of dividend equivalents for Juan Colombás. The average share price between 1 October 2018 and 31 December 2018 (56.04 pence) has been used to indicate the value. The shares were awarded in 2016 based on a share price of 72.978 pence and as such no part of the reported value is attributable to share price appreciation. LTIP and dividend equivalent figures for 2017 have been adjusted to reflect the share price on the date of vesting (67.1043 pence) instead of the average price (66.75 pence) reported in the 2017 report.
2016 LTIP vesting (audited) Awards in the form of conditional rights to free shares in 2016 were made over shares with a value of 300 per cent of reference salary for the GCE and 275 per cent of salary for the CFO and COO. These LTIP awards are vesting at 68.7 per cent, as detailed in the table below. This reflects the Group’s strong financial and strategic performance over the three financial years ended 31 December 2018, balanced against significant uncertainty in the economic and political environment impacting negatively on share price performance, resulting in no vesting for the Total Shareholder Return component.
J E Daniels Waived 62% 0% – – – – – – –
Amanda Mackenzie OBE4 – – – – – – n/a7 n/a
The current Shareholding Policy does not take into account post-employment requirements. Consideration of how post-employment shareholding will be incorporated into the Policy will be undertaken in 2019, ahead of a revised policy being implemented in 2020.
3 All LTIPs /GOS have performance periods ending 31 December at the end of the three-year period. Awards were made in the form of conditional rights to free shares.
6 Options exercised on 14 June 2018. The closing market price of the Group’s ordinary shares on that date was 63.13 pence.
2018 Group Ownership Share performance measures (for awards made in March 2018) As requested in the 2017 Directors’ Remuneration report, (see implementation of the policy in 2018), the following awards were granted in March 2018.
Cost:income ratio Set relative to 2020 targets Threshold: 46.4% Maximum: 43.9%
Threshold: +5% vs UK Norm Maximum: +2% vs UK High Performing Norm 1 A measure of profit taking into account Expected Losses, tax and a charge for equity utilisation.
The Group has applied a total pay budget of 2.6 per cent including a minimum pay award of £600 for eligible colleagues. This is considered an appropriate and competitive budget in the current economic and business climate. Salary increases for the Group Chief Executive (GCE) and Chief Operating Officer (COO) are set below the budget for the wider colleague population at 2 per cent. Following confirmation that the Chief Financial Officer (CFO) is due to retire in 2019, his salary is due to remain in line with 2018.
Any new Executive Director appointments in 2019 will attract a maximum allowance of 25 per cent of base salary.
The approach to determining the Group Performance Share outcome for 2019 will remain unchanged from 2018. It will be based on a percentage of the Group’s underlying profit, adjusted by a scorecard modifier commensurate with Group Balanced Scorecard performance. Adjustments for conduct and risk factors will also be considered.
A financial performance threshold will be set at 20 per cent below the Group’s underlying profit target, at which no award will be payable. The Group Balanced Scorecard must also exceed a threshold score of 1.6, below which no award will be payable.
There are no changes to proposed financial and strategic measures to provide consistency with the 2018 plan, while aligning to the key strategic priorities as set out in the third Group Strategic Review.
Threshold: +5% vs. UK norm Maximum: +2% vs. UK high Performing norm 1 A measure of profit taking into account expected losses, tax and a charge for equity utilisation.
The application of malus will generally be considered when: there is reasonable evidence of employee misbehaviour or material error or that they participated in conduct which resulted in losses for the Group or failed to meet appropriate standards of fitness and propriety; there is material failure of risk management at a Group, business area, division and/or business unit level; the Committee determines that the financial results for a given year do not support the level of variable remuneration awarded; and/or any other circumstances where the Committee consider adjustments should be made.
Awards are subject to clawback for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation.
Chairman and Non-Executive Director fees in 2019 The annual fee for the Chairman was increased by 2 per cent to £757,700, in line with the overall salary budget for the executive population.
The annual Non-Executive Director fees were increased by 2 per cent, in line with the base salary increase awarded to the senior management of the Group. These changes took effect from 1 January 2019.
2 Including payments to Chairmen of other Committees who are members.
GCE (salary increase effective 1 January 2019) 2 (11)1 2 1 Reflects the increase in base salary from 1 January 2018 against which the award is determined. 2 Adjusted for movements in staff numbers and other impacts to ensure a like-for-like comparison. Salary increases effective 1 April 2019.
The colleague identified at P50 is not eligible to receive a car benefit unless required for role and does not participate in the long term incentive plan, therefore the ratio does not provide a like-for-like comparison to the total remuneration of the Group Chief Executive. Each of the three individuals identified was a full-time employee during the year.
For details of membership and attendance at meetings, please see pages 52 to 53 and 56.
Group wide remuneration approach: Determination of the overall 2017 Group Performance Share outcome
Approval of a simplified 2019 Balanced Scorecard approach following stakeholder feedback
Consideration for ensuring a clear link between pay and performance following the launch of the Group’s new approach to performance, ‘Your Best’
Operation Base salaries are typically reviewed annually with any increases normally taking effect from 1 January. When determining and reviewing base salary levels, the Committee takes into account base salary increases for employees throughout the Group and ensures that decisions are made within the following two parameters: An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective jobsizing methodologies.
An individual may elect to receive some or all of their pension allowance as cash in lieu of pension contribution.
Benefits for comparable roles in comparable publicly listed financial services groups of a similar size.
Maximum potential Participation levels may be increased up to HMRC limits as amended from time to time. The monthly savings limits for Save As You Earn (SAYE) is currently £500. The maximum value of shares that may be purchased under the Share Incentive Plan (SIP) in any year is currently £1,800 with a two-for-one match. Currently a three-for-two match is operated up to a maximum employee investment of £30 per month.
Purpose and link to strategy To incentivise and reward the achievement of the Group’s annual financial and strategic targets whilst supporting the delivery of long-term superior and sustainable returns.
The Committee retains full discretion to amend the payout levels should the award not reflect business and/or individual performance. The Committee may reduce (including to zero) the level of the award, apply additional conditions to the vesting, or delay the vesting of awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of a risk matter coming to light before vesting. Awards may be subject to malus and clawback for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation.
Lloyds Banking Group Annual Report and Accounts 2018 99 Strateg ic rep ort
Further detail can be found in the DRR. In particular, see pages 86 to 87, 89, 92 to 94 and 97 to 99 of the DRR.
Lloyds Banking Group Annual Report and Accounts 2018 101 Strateg ic rep ort
Non-Executive Director fees are reviewed periodically by the Board. Further information on fees can be found on page 94 of the DRR.
Further information on fixed share awards can be found on page 97 of the DRR.
Details of NEDs’ benefits are set out on page 99 of the DRR.
Applies to: Senior Management, Executive Directors, members/ attendees of the GEC and their respective direct reports
At least 40 per cent of MRTs’ variable remuneration above certain thresholds is deferred into Lloyds Banking Group Shares. For all MRTs, variable remuneration is deferred in line with the regulatory requirements for three, five or seven years, (depending on MRT category). At least 50 per cent of each release is subject to a 12 month holding period.
Non-MRTs 1 Eligibility based on seniority, grade and role 2 Requirement based on seniority and grade
Lloyds Banking Group Annual Report and Accounts 2018 103 Strateg ic rep ort
Number of Material Risk Takers paid €1 million1,2 or more 2018 Material Risk
4 2018 and 2017 data has been calculated using methodology consistent with EBA guidelines.
Other Material Risk Takers 40.4 40.4 – 9.6 1 Deferred in this context refers only to any unvested remuneration.
Risk management All narrative and quantitative tables are unaudited unless otherwise stated. The audited information is required to comply with the requirements of relevant International Financial Reporting Standards. The Group’s approach to risk 106 Emerging risks 108 Capital stress testing 110 How risk is managed 110 Risk governance 112 Full analysis of risk categories 114
Risk management is at the heart of our strategy to become the best bank for customers. Our mission is to protect our customers, colleagues and the Group, whilst enabling sustainable growth in targeted segments. This is achieved through informed risk decision-making and superior risk and capital management, supported by a consistent risk-focused culture. The risk overview (pages 30 to 35) provides a summary of risk management within the Group. It highlights the important role of risk as a strategic differentiator, key areas of focus for risk during 2018, and the role of risk management in enhancing the customer experience, along with an overview of the Group’s Risk Management Framework, and the principal risks faced by the Group and key mitigating actions.
Group strategy and risk appetite are developed in tandem. Business planning aims to optimise value within our risk appetite parameters and deliver on our promise to Help Britain Prosper.
Regulatory and legal – the Group complies with all relevant regulation and all applicable laws (including codes of practice which have legal implications) and/or legal obligations.
Operational – the Group has robust controls in place to manage operational losses, reputational events and regulatory breaches. It identifies and assesses emerging risks and acts to mitigate these.
Governance is maintained through delegation of authority from the Board down to individuals through the management hierarchy. Senior executives are supported by a committee based structure which is designed to ensure open challenge and support effective decision-making.
Regulatory and legal: The financial sector continues to witness an increased pace, volume and complexity of oversight and regulation from various bodies including government and regulators.
Political uncertainties including EU exit: The continued lack of clarity over the UK’s eventual relationship with the EU allied to ongoing challenges in the Eurozone, including protests in France and changes in government in Italy, raise additional uncertainty for the UK economic outlook. Growing public concern over perceived income inequality has also led to a rise in political populism. There also remains the possibility of a further referendum on Scottish independence.
– The Group has a robust through the cycle credit risk appetite, including appropriate product, sector and single name concentration parameters, robust sector appetite statements and policies, as well as affordability and indebtedness controls at origination. In addition to ongoing focused monitoring, we conduct portfolio deep dives and quarterly larger exposure reviews. We have enhanced our use of early warning indicators including sector specific indicators. – The Group is well positioned against an uncertain economic outlook and is able to withstand potential market volatility and/or downturn due to its selective and pre-emptive credit tightening, robust affordability controls and close monitoring of internal and external trends.
– Risk appetite criteria limits single counterparty bank and non-bank exposures complemented by a UK-focused strategy. – The Chief Security Office develops and maintains an Emerald Response Process to respond to external crisis events. This is a rapid reaction group, incorporating Financial Stability Response where appropriate. – The Chief Security Office also maintains the operational resilience framework to embed resilience activities across the Group and limit the impact of internal or external events. – Hedging of market risk considers, inter alia, potential shocks as a result of geopolitical events.
Financial services transformation impact on customers: The risk that transformation of the financial services industry and the Group does not adequately consider vulnerable customers. As technology and innovation move at increasing pace, the more vulnerable could be at a disadvantage.
Inform the setting of risk appetite by assessing the underlying risks under stress conditions.
Risk Mitigation: Drive the development of potential actions and contingency plans to mitigate the impact of adverse scenarios. Stress testing also links directly to the recovery planning process of the Group and its legal entities.
Internal stress tests On at least an annual basis, the Group conducts macroeconomic stress tests of the operating plan, which are supplemented with higher level refreshes if necessary. The exercise aims to highlight the key vulnerabilities of the Group’s and its legal entities’ business plans to adverse changes in the economic environment, and to ensure that there are adequate financial resources in the event of a downturn.
Other stress testing activity The Group’s stress testing programme also involves undertaking assessments of liquidity scenarios, market risk sensitivities and scenarios, and business specific scenarios (see the primary risk categories on pages 114 to 159 for further information on risk-specific stress testing). If required, ad hoc stress testing exercises are also undertaken to assess emerging risks, as well as in response to regulatory requests. This wide ranging programme provides a comprehensive view of the potential impacts arising from the risks to which the Group is exposed and reflects the nature, scale and complexity of the Group.
The RMF applies to every area of the business and covers all types of risk. It is reviewed, updated and approved by the Board at least annually to reflect any changes in the nature of our business and external regulations, law, corporate governance and industry best practice. The RMF provides the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also seeks to facilitate effective communication on these matters across the Group.
The primary role of Group Internal Audit (third line) is to help the Board and executive management protect the assets, reputation and sustainability of the Group. Group Internal Audit is led by the Group Chief Internal Auditor. Group Internal Audit provides independent assurance to the Audit Committee and the Board through performing reviews and engaging with committees/executive management, providing opinion and challenge on risk and the state of the control environment. Group Internal Audit is a single independent internal audit function, reporting to the Board Audit Committee of the Group and the Board Audit Committee of the key subsidiaries.
Risk resources and capabilities Appropriate mechanisms are in place to avoid over-reliance on key personnel or system/technical expertise within the Group. Adequate resources are in place to serve customers both under normal working conditions and in times of stress, and monitoring procedures are in place to ensure that the level of available resource can be increased if required. Colleagues undertake appropriate training to ensure they have the skills and knowledge necessary to enable them to deliver fair outcomes for customers.
Group Customer First Committee Provides a Group-wide perspective on the progress of implementation of initiatives to enhance the delivery of customer outcomes and customer trust, and sets and promotes the appropriate tone from the top to fulfil the Group’s vision.
Group Cost Management Committee Leads and shapes the Group’s approach to cost management, ensuring appropriate governance and process over Group-wide cost management activities and effective control of the Group’s cost base.
Sustainability Committee Recommends and implements the strategy and plans for delivering the Group’s aspiration to be viewed as a trusted responsible business as part of the objective of Helping Britain Prosper.
Acts as a Risk community forum to independently challenge and oversee the Group-wide risk and control environment, focusing on read-across of material events, key areas of regulatory focus and emerging horizon risks. Uses lessons learned and undertakes read-across from the three lines of defence to ensure that the Group-wide risk profile adapts to emerging risks, trends and themes, and the control environment is sustainable to deliver the Bank of the Future.
Ring-Fenced Bank Perimeter Oversight Committee The Committee escalates perimeter control breaches to the Ring-Fenced Banks’ Board Risk Committee and Boards.
Full analysis of risk categories The Group’s risk framework covers all types of risk which affect the Group and could impact on the achievement of its strategic objectives. A detailed description of each category is provided on pages 115 to 159.
Risk categories recognised by the Group are periodically reviewed to ensure that they reflect the Group risk profile in light of internal and external factors, such as the Group Strategy and the regulatory environment in which it operates. As part of a review of the Group’s risk categories, the secondary risk categories in the table below of Change, Data management and Operational resilience have been elevated to primary risk categories, and Strategic risk has been included as a new primary risk category, in the Group’s Risk Management Framework. These changes will be embedded during 2019.
The Group considers both reputational and financial impact in the course of managing all its risks and therefore does not classify reputational impact as a separate risk category.
Credit risk also arises from debt securities and derivatives. The total notional principal amount of interest rate, exchange rate, credit derivative and other contracts outstanding at 31 December 2018 is shown on page 134. 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 52 on page 255.
Additionally, credit risk arises from leasing arrangements where the Group is the lessor. Note 2(J) on page 181 provides details on the Group’s approach to the treatment of leases.
Credit risk exposures in the Insurance and Wealth division largely result from holding bond and loan assets, together with some related swaps, shareholder funds (including the annuity portfolio) and exposure to reinsurers.
The investments held in the Group’s defined benefit pension schemes also expose the Group to credit risk. Note 35 on page 219 provides further information on the defined benefit pension schemes’ assets and liabilities.
Loans and advances, contingent liabilities, commitments, debt securities and derivatives also expose the Group to refinance risk. Refinance risk is the possibility that an outstanding exposure cannot be repaid at its contractual maturity date. If the Group does not wish to refinance the exposure then there is refinance risk if the obligor is unable to repay by securing alternative finance. This may occur for a number of reasons which may include: the borrower is in financial difficulty, because the terms required to refinance are outside acceptable appetite at the time or the customer is unable to refinance externally due to a lack of market liquidity. Refinance risk exposures are managed in accordance with the Group’s existing credit risk policies, processes and controls and are not considered to be material given the Group’s prudent and through the cycle credit risk appetite. Where heightened refinance risk exists exposures are minimised through intensive account management and, where appropriate, are impaired and/or classed as forborne.
Credit risk is measured from different perspectives using a range of appropriate modelling and scoring techniques at a number of levels of granularity, including total balance sheet, individual portfolio, pertinent concentrations and individual customer – for both new business and existing lending. Key metrics such as total exposure, risk-weighted assets, new business quality, concentration risk and portfolio performance, are reported monthly to Risk Committees.
The Group also assesses the affordability and sustainability of lending for each borrower. For secured lending this includes use of an appropriate stressed interest rate scenario. Affordability assessments for all lending are compliant with relevant regulatory and conduct guidelines. The Group takes reasonable steps to validate information used in the assessment of a customer’s income and expenditure.
Monitoring In conjunction with Risk division, businesses identify and define portfolios of credit and related risk exposures and the key behaviours and characteristics by which those portfolios are managed and monitored. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Risk division in turn produces an aggregated view of credit risk across the Group, including reports on material credit exposures, concentrations, concerns and other management information, which is presented to the divisional risk committees, Group Risk Committee and the Board Risk Committee.
Forbearance The Group’s aim in offering forbearance and other assistance to customers in financial distress is to benefit both the customer and the Group by supporting its customers and acting in their best interests by, where possible, bringing customer facilities back into a sustainable position.
The provision and review of such assistance is controlled through the application of an appropriate policy framework and associated controls. Regular review of the assistance offered to customers is undertaken to confirm that it remains appropriate, alongside monitoring of customers’ performance and the level of payments received.
The net asset quality ratio increased to 21 basis points (2017: 18 basis points) and the impairment charge increased to £937 million in 2018 (2017: £795 million), driven by expected lower releases and write-backs, the inclusion of MBNA for a full year and a low impairment charge in Secured compared to one-off write-backs in 2017
The closed mortgage book continued to run off, reducing by a further £2.4 billion during 2018
The Group continues to grow lending to targeted segments while maintaining a prudent risk appetite
Sector concentrations within the portfolios are closely monitored and controlled, with mitigating actions taken where appropriate. Sector and product caps limit exposure to certain higher risk and vulnerable sectors and asset classes.
Total ECL allowance 3,362 3,533 2,257 1 Prior period comparatives are on an IAS 39 basis.
ECL allowance (drawn and undrawn) as a percentage of gross lending (%)2 0.7 0.1 4.2 28.4
ECL allowance (drawn and undrawn) as a percentage of gross lending (%)2 0.9 0.2 4.1 24.3
3 Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
2 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA related acquisition adjustments.
At 1 January 20182 1 Total and Stage 3 ECL allowances as a percentage of drawn balances are calculated excluding loans in recoveries for Retail (31 December 2018: £250 million; 1 January 2018: £291 million).
2 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances exclude the impact of the HBOS and MBNA related acquisition adjustments.
Central items 6 6 – – – – – – –
The Group’s assessment of a significant increase in credit risk, and resulting categorisation of Stage 2, includes customers moving into early arrears as well as a broader assessment that an up to date customer has experienced a level of deterioration in credit risk since origination. A more sophisticated assessment is required for up to date customers, which varies across divisions and product type. This assessment incorporates specific triggers such as a significant proportionate increase in probability of default relative to that at origination, recent arrears, forbearance activity, internal watch lists and external bureau flags. Up to date exposures in Stage 2 are likely to show lower levels of expected credit loss (ECL) allowance relative to those that have already moved into arrears given that an arrears status typically reflects a stronger indication of future default and greater likelihood of credit losses.
Retail The credit quality of the Retail portfolios remains strong and continues to benefit from robust credit risk management, including affordability and indebtedness controls at origination and a prudent approach to risk appetite. The economic environment remains resilient with record employment rates, falling inflation, positive real wage growth and household indebtedness remaining below pre-crisis levels.
– New business quality remains strong; – The flow of loans entering arrears remains at low levels; – Stage 3 balances are broadly flat at 1.7 per cent; and
ECL allowances (drawn and undrawn) as a percentage of gross lending (%)4 0.5 0.2 3.8 22.6
ECL allowances (drawn and undrawn) as a percentage of gross lending (%)4 0.8 0.2 3.9 19.7
Table 1.10b: Reconciliation between statutory and underlying basis of Retail gross loans and advances to customers
4 UK Motor Finance for Stages 1 and 2 include £99 million (1 January 2018: £84 million) relating to provisions against residual values of vehicles subject to finance leasing agreements. These provisions are included within the calculation of coverage ratios.
6 Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
At 1 January 20181,4 1 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances exclude the impact of the HBOS and MBNA related acquisition adjustments.
Table 1.13: Retail secured loans and advances to customers (statutory basis)
Table 1.15: Period end and average LTVs across the Retail mortgage portfolios (underlying basis)
Average loan to value (%) 35.2 33.4 1 Balances are stated on an IFRS 9 basis and include the impact of HBOS acquisition related adjustments.
The main customer treatments included are: repair, where arrears are written on to the loan balance and the arrears position cancelled; instances where there are suspensions of interest and/or capital repayments; Past Term Interest Only mortgages; and refinance personal loans.
UK Motor Finance (Retail) 51 26 24 – 36.1 1 ECL as a percentage of total loans and advances which are forborne are calculated excluding loans in recoveries for Unsecured (31 December 2018: £107 million; 1 January 2018: £147 million).
Notwithstanding the current stable performance of the portfolio, impairments are likely to increase from their current levels, driven mainly by lower levels of releases and write-backs and an element of credit normalisation.
ECL allowances (drawn and undrawn) as a percentage of gross lending (%) 1.5 0.1 5.1 32.3
Through clearly defined sector strategies, Financial Institutions serves predominantly investment grade counterparties with whom relationships are either client driven or held to support the Group’s funding, liquidity or general hedging requirements.
The LTV profile of the UK Direct Real Estate portfolio in Commercial Banking continues to improve.
4 Predominantly Investment grade lending where the Group is relying on the corporate covenant.
5 December 2018 investment exposures <£1m have an LTV profile broadly similar to the investment exposures >£1m.
Business units identify, assess and implement policy and regulatory requirements and establish local controls, processes, procedures and resources to ensure appropriate governance and compliance.
Business units regularly produce management information to assist in the identification of issues and test management controls are working effectively.
There is a high level of scrutiny regarding financial institutions’ treatment of customers, including those in vulnerable circumstances, from regulatory bodies, the media, politicians and consumer groups.
There continues to be a significant focus on market misconduct, resulting from previous issues relating to London Inter-bank Offered Rate (LIBOR) and foreign exchange (FX).
Focus on proactive identification and mitigation of conduct risk in the Group Strategic Review 3.
A number of these risks could increase where there is a reliance on third-party suppliers to provide services to the Group or its customers.
Mitigation The Group’s strategic review considers the changing risk management requirements, adapting the change delivery model to be more agile and develop the people skills and capabilities needed to be a ‘Bank of the Future’. The Group continues to review and invest in its control environment to ensure it addresses the inherent risks faced. Risks are reported and discussed at local governance forums and escalated to executive management and Board as appropriate to ensure the correct level of visibility and engagement. The Group employs a range of risk management strategies, including: avoidance, mitigation, transfer (including insurance) and acceptance. Where there is a reliance on third-party suppliers to provide services, the Group’s sourcing policy ensures that outsourcing initiatives follow a defined process including due diligence, risk evaluation and ongoing assurance.
The Group has adopted policies and procedures designed to detect and prevent the use of its banking network for money laundering, terrorist financing, bribery, tax evasion, human trafficking, and modernday slavery, and activities prohibited by legal and regulatory sanctions. Against a background of increasingly complex and detailed laws and regulations, and of increased criminal and terrorist activity, the Group regularly reviews and assesses its policies, procedures and organisational
Monitoring Monitoring and reporting of operational risk is undertaken at Board, Group and divisional risk committees. Each committee monitors key risks, control effectiveness, key risk and control indicators, events, operational losses, risk appetite metrics and the results of independent testing conducted by Risk and/or Internal Audit.
Definition The risk that the Group fails to provide an appropriate colleague and customer-centric culture, supported by robust reward and wellbeing policies and processes; effective leadership to manage colleague resources; effective talent and succession management; and robust control to ensure all colleague-related requirements are met.
Measurement People risk is measured through a series of quantitative and qualitative indicators, aligned to key sources of people risk for the Group such as succession, retention, colleague engagement, wellbeing and performance management. In addition to risk appetite measures and limits, people risks and controls are monitored on a monthly basis via the Group’s risk governance framework and reporting structures.
Mitigation The Group takes many mitigating actions with respect to people risk. Key areas of focus include: Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning; Continued focus on the Group’s culture by developing and delivering initiatives that reinforce the appropriate behaviours which generate the best possible long-term outcomes for customers and colleagues; Managing organisational capability and capacity through divisional people strategies to ensure there are the right skills and resources to meet our customers’ needs and deliver our strategic plan; Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations; Ensuring colleague wellbeing strategies and support are in place to meet colleague needs, and that the skills and capability growth required to build a workforce for the ‘Bank of the Future’ are achieved; Ensuring compliance with legal and regulatory requirements related to SM&CR, embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities; and
Ongoing consultation with the Group’s recognised unions on changes which impact their members.
Monitoring People risks from across the Group are monitored and reported through Board and Group Governance Committees in accordance with the Group’s Risk Management Framework. Risk exposures are discussed monthly via the Group People Risk Committee with upwards reporting to Group Risk and Executive Committees. In addition, oversight, challenge and reporting are completed at Risk division level to assess the effectiveness of controls, recommending follow up remedial action if required. 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 Director, Conduct, Compliance and Operational Risk.
Insurance underwriting risk exposures within the Insurance business are monitored against risk appetite. The Insurance business monitors experiences against expectations, for example business volumes and mix, claims and persistency experience. The effectiveness of controls put in place to manage insurance underwriting risk is evaluated and significant divergences from experience or movements in risk exposures are investigated and remedial action taken.
Systemic buffers are designed to hold systemically important banks to higher capital standards, so that they can withstand a greater level of stress before requiring resolution.
All buffers are required to be met with CET1 capital. A breach of the PRA buffer would trigger a dialogue between the Group and the PRA to agree what action is required whereas a breach of the CRD IV combined buffer (all other regulatory buffers) would give rise to mandatory restrictions upon any discretionary capital distributions by the Group.
Target capital ratios The Board’s view of the current level of CET1 capital required remains at around 13 per cent plus a management buffer of around 1 per cent to provide capacity for growth, meet regulatory requirements and cover uncertainties.
Lloyds Banking Group plc acts as a holding company which also issues capital and other securities to capitalise and fund the activities of the Group. The profitability of the holding company, and consequently its ability to sustain dividend payments, is therefore dependent upon the continued receipt of dividends from its main operating subsidiaries, including Lloyds Bank plc (the ring-fenced bank), Lloyds Bank Corporate Markets plc (the non-ring-fenced bank), LBG Equity Investments Limited (the non-ring-fenced investments business) and Scottish Widows Group Limited (the insurance business). A number of Group subsidiaries, principally those with banking and insurance activities, are subject to regulatory capital requirements which require minimum amounts of capital to be maintained relative to their size and risk. The principal operating subsidiary is Lloyds Bank plc which, at 31 December 2018, had a consolidated CET1 capital ratio of 14.9 per cent (31 December 2017: 15.8 per cent). The Group actively manages the capital of its subsidiaries, which includes monitoring the regulatory capital ratios for its banking and insurance subsidiaries and, on a consolidated basis, the RFB sub-group against approved risk appetite. The Group operates a formal capital management policy which requires all subsidiary entities to remit surplus capital to their parent companies.
From 2022, 2 times Pillar 1 plus 2 times Pillar 2A, equivalent to 25.4 per cent of risk-weighted assets
Dividends paid by the Insurance business in July 2018 and in February 2019, in relation to 2018 earnings generating an increase of 0.25 per cent
Adjustment to retained earnings for foreseeable dividends (1,523) (1,475) (1,523) (1,475)
Adjustment for own credit (280) 109 (280) 109 less: deductions from common equity tier 1
Adjustments for transitional limit and non-eligible instruments 1,504 1,617 (1,266) (1,252)
Eligible provisions – 120 – 120 less: deductions from tier 2
Movements in capital resources The key difference between the transitional capital calculation as at 31 December 2018 and the fully loaded equivalent is primarily related to capital securities that previously qualified as tier 1 or tier 2 capital, but that do not fully qualify under CRD IV, which can be included in additional tier 1 (AT1) or tier 2 capital (as applicable) up to specified limits which reduce by 10 per cent per annum until 2022. The key movements on a transitional basis are set out in the table below.
Restatement of retained earnings on adoption of IFRS 9 (929) – – (929)
IFRS 9 transitional adjustment to retained earnings 478 – – 478
Fair value through other comprehensive income reserve (401) – – (401)
Total risk-weighted assets as at 31 December 2018 206,366 1 Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of being deducted from CET1 capital. Significant investments primarily arise from investments in the Group’s Insurance business.
Credit risk, risk-weighted assets: Asset size net increase of £0.3 billion includes targeted growth in some key customer segments
Operational risk, risk-weighted assets increased following the annual update of the income based Standardised Approach operational risk calculation.
The derivatives exposure measure, representing derivative financial instruments per the balance sheet net of deconsolidation and derivatives adjustment, increased by £5.0 billion during the period, predominantly reflecting a reduction in the regulatory netting benefit and a higher volume of trades through central counterparties, including longer dated trades, which has contributed to the increase in the regulatory potential future exposure. The movements in part reflect the impact of the separation of derivative portfolios between the ring-fenced and non-ringfenced banks and the establishment of the latter through Lloyds Bank Corporate Markets.
Off-balance sheet items reduced by £2.0 billion during the period, primarily reflecting a net reduction in securitisation financing facility commitments, including drawdowns, and a small reduction in new residential mortgage offers placed.
The average UK leverage ratio of 5.5 per cent over the quarter, compared to 5.3 per cent at the start of the quarter, primarily reflected the issuance of a new AT1 capital instrument in October 2018, partially offset by a marginally higher average exposure measure over the quarter when compared to the position at the end of the quarter.
The Group has opted to apply paragraph 4 of CRR Article 473a (the transitional rules) which allows for additional capital relief in respect of any post 1 January 2018 increase in Stage 1 and Stage 2 IFRS 9 expected credit loss provisions (net of regulatory expected losses) during the transition period. As at 31 December 2018 no additional capital relief has been recognised.
G-SIB indicators Although the Group is not currently classified as a Global Systemically Important Bank (G-SIB), by virtue of the Group’s leverage exposure measure exceeding €200 billion the Group is required to report G-SIB indicator metrics to the PRA. The Group’s indicator metrics used within the 2018 Basel G-SIBs annual exercise will be disclosed from April 2019 and the results are expected to be made available by the Basel Committee later this year.
148 Lloyds Banking Group Annual Report and Accounts 2018 business including reflecting emerging horizon risks to the Group, such as a further sovereign downgrade. For further information on the Group’s 2018 liquidity stress testing results refer to page 151.
Cash and balances at central banks5 48.9 53.7 (9) 53.7 (9)
Trading and fair value through profit and loss 11.9 1.7 1.7
3 Excludes nil (31 December 2017: £1.7 billion) of loans and advances to banks within the Insurance business and £0.4 billion (1 January 2018: £0.8 billion; 31 December 2017: £0.8 billion) of reverse repurchase agreements.
Table 1.36: Analysis of 2018 total wholesale funding by residual maturity
High quality government/MDB/agency bonds1 78.7 65.8 20 66.2 72.0 1 Designated multilateral development bank (MDB).
The above scenario considers a two notch downgrade of the Group’s current long-term debt rating and accompanying one notch short-term downgrade implemented instantaneously by all major rating agencies, which could result in a contractual outflow of £1.3 billion of cash over a period of up to one year, £2.2 billion of collateral posting related to customer financial contracts and £6.1 billion of collateral posting associated with secured funding.
The Board and the Group Asset and Liability Committee (GALCO) monitor and manage total balance sheet encumbrance using a number of risk appetite metrics. At 31 December 2018, the Group had £53.4 billion (31 December 2017: £64.6 billion) of externally encumbered on-balance sheet assets with counterparties other than central banks. The decrease in encumbered assets was primarily driven by a decrease in repo encumbrance. The Group also had £584.3 billion (31 December 2017: £587.5 billion) of unencumbered on-balance sheet assets, and £159.8 billion (31 December 2017: £160.1 billion) of pre-positioned and encumbered assets held with central banks. Primarily, the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks.
Loans and advances to customers 5,023 26,414 6,610 38,047 160,060 13,927 170,771 89,693 274,391 472,498
2 Assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but are not readily realisable in the normal course of business in their current form.
4 Other comprises: items in the course of collection from banks; investment properties; goodwill; value in-force business; other intangible assets; tangible fixed assets; current tax recoverable; deferred tax assets; retirement benefit assets and other assets.
The Group’s code of responsibility embodies its values and reflect its commitment to operating responsibly and ethically both at a business and an individual level. All colleagues are required to adhere to the code in all aspects of their roles.
For further information on Corporate Governance see pages 56 to 78.
Derivative financial instruments 23,595 14,734 6,898 1,963 Interest rate, foreign exchange, credit spread
Loans and advances to banks 6,283 – 6,242 41 Interest rate
Liabilities arising from insurance and investment contracts 112,727 – – 112,727 Credit spread
1 Banking activities, Pensions and Insurance stresses; Interest rate -100 bps, Basis Risk 3 month London Interbank Offered Rate (LIBOR) +100bps / bank base rate -25bps, Foreign Exchange (FX) -15 per cent GBP, Credit Spread +100 per cent, Equity -30 per cent, Inflation +50 bps 2 Trading Portfolios; Interest rate -70bps, FX -5 per cent GBP, Credit Spread +20 per cent, Inflation +50bps.
Measurement In addition to measuring single factors, Group risk appetite is calibrated primarily to five multi-risk Group economic scenarios, and is supplemented with sensitivity based measures. The scenarios assess the impact of unlikely, but plausible, adverse stresses on income with the worst case for banking activities, defined benefit pensions, insurance and trading portfolios reported against independently, and across the Group as a whole.
Mitigation GALCO is responsible for approving and monitoring group market risks, management techniques, market risk measures, behavioural assumptions, and the market risk policy. Various mitigation activities are assessed and undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits. The mitigation actions will vary dependent on exposure but will, in general, look to reduce risk in a cost effective manner by offsetting balance sheet exposures and externalising through to the financial markets dependent on market liquidity. The market risk policy is owned by Group Corporate Treasury (GCT) and refreshed annually. The policy is underpinned by supplementary market risk procedures, which define specific market risk management and oversight requirements.
Reported sensitivities are not necessarily predictive of future performance as they do not capture additional management actions that would likely be taken in response to an immediate, large, movement in interest rates. These actions could reduce the net interest income sensitivity, help mitigate any adverse impacts or they may result in changes to total income that are not captured in the net interest income.
(iii) Structural hedge limits: the structural hedging programme managing interest rate risk in the banking book relies on a number of assumptions made around customer behaviour. A material mismatch between assumptions and reality could lead to a deterioration in earnings. In order to monitor this risk a number of metrics are in place to enhance understanding of risks within this portfolio.
The Group has an integrated Asset and Liability Management (ALM) system which supports non-traded asset and liability management of the Group. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. The Group is aware that any assumptions based model is open to challenge. A full behavioural review is performed annually, or in response to changing market conditions, to ensure the assumptions remain appropriate and the model itself is subject to annual re-validation, as required under the Group Model Governance Policy. The key behavioural assumptions are (i) embedded optionality within products; (ii) the duration of balances that are contractually repayable on demand, such as current accounts and overdrafts, together with net free reserves of the Group; and (iii) the re-pricing behaviour of managed rate liabilities namely variable rate savings.
Basis risk, foreign exchange, equity, and credit spread risks are measured primarily through scenario analysis by assessing the impact on profit before tax over a 12 month horizon arising from a change in market rates, and reported within the Board risk appetite on a monthly basis. Supplementary measures such as sensitivity and exposure limits are applied where they provide greater insight into risk positions. Frequency of reporting supplementary measures varies from daily to quarterly appropriate to each risk type.
Defined benefit pension schemes Exposures The Group’s defined benefit pension schemes are exposed to significant risks from their assets and liabilities. The liability discount rate provides exposure to interest rate risk and credit spread risk, which are partially offset by fixed interest assets (such as gilts and corporate bonds) and swaps. Equity and alternative asset risk arises from direct asset holdings. Scheme membership provides exposure to longevity risk.
Measurement Management of the schemes’ assets is the responsibility of the Trustees of the schemes who are responsible for setting the investment strategy and for agreeing funding requirements with the Group. The Group is liable for meeting the funding deficit, and as part of a triennial valuation process will agree with the Trustees a funding strategy to eliminate the deficit over an appropriate period.
Mitigation The Group takes an active involvement in agreeing mitigation strategies with the schemes’ Trustees. An interest rate and inflation hedging programme is in place to reduce liability risk. The schemes have also reduced equity allocation and invested the proceeds in credit assets as part of a programme to de-risk the portfolio. The merits of longevity risk transfer and hedging solutions are regularly reviewed.
Monitoring In addition to the wider risk management framework, governance of the schemes includes two specialist pensions committees.
Interest rate risk in the annuity book is mitigated by investing in assets whose cash flows closely match those on the projected future liabilities. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result, the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.
Table 1.48 shows some relevant statistics for the Group’s 1-day 95 per cent confidence level VaR that are based on 300 historical consecutive business days to year end 2018 and year end 2017.
All risk factors before diversification 1.2 1.3 3.0 0.9 1.1 1.3 2.9 0.9
Exposures There are over 300 models in the Group performing a variety of functions including: capital calculation; credit decisioning, including fraud; pricing models; impairment calculation; stress testing and forecasting; and market risk measurement.
Notes to the parent company financial statements 278 1. Basis of preparation and accounting policies 2. Amounts due from subsidiaries 3. Share capital, share premium and other equity instruments 4. Other reserves 5. Retained profits 6. Debt securities in issue 7. Subordinated liabilities 8. Related party transactions 9. Financial instruments 10. Other information
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 161
We have audited the financial statements, included within the Annual Report and Accounts (the Annual Report), which comprise: the consolidated and parent company balance sheets as at 31 December 2018; the consolidated income statement and the consolidated statement of comprehensive income for the year then ended; the consolidated and parent company cash flow statements for the year then ended; the consolidated and parent company statements of changes in equity for the year then ended; and the notes to the financial statements, which include a description of the significant accounting policies. We have also audited the consolidated and parent company balance sheets as at 1 January 2018.
Certain required disclosures have been presented elsewhere in 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.
Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: Group financial statements Parent company financial statements
How we determined it 5 per cent of adjusted profit, which removes the effects of certain items which were considered to have a disproportionate impact.
Rationale for benchmark applied Our starting point was 5 per cent of profit before tax, a generally accepted auditing practice. Profit before tax was adjusted to remove the disproportionate effect of regulatory provisions as they are considered not to reflect the long term performance of the Group.
For each component in the scope of our Group audit, we allocated a materiality that is less than our overall Group materiality. The range of materiality allocated across components was between £50 million and £100 million.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 163
Expected credit loss allowances Group Refer to page 70 (Audit Committee Report), page 177 (Accounting Policies) and page 208 (Note 20 and Critical Accounting Estimates and Judgements). The determination of expected credit loss allowances is highly subjective and judgemental. With the introduction of IFRS 9 in 2018, a number of additional judgements and assumptions are introduced and reflected in the financial statements, including the identification of significant increases in credit risk and the application of forward looking economic scenarios.
Group economics The Group's economics team develops future economic scenarios by using a statistical model and a number of qualitative factors. Four scenarios are chosen from the model output which represent distinct economic scenarios and sensitivities of historical loss experience. These four scenarios together with relative weightings are then provided to the Retail and Commercial Banking divisions for incorporation into the Stage allocation process and the calculation of expected credit loss allowances.
– The review, challenge and approval of the scenarios adopted through the Group’s governance process.
Based on the evidence obtained, we consider that the economic scenarios adopted reflect an unbiased, probability weighted view, that appropriately captures the impact of non‑linearity.
Retail Expected credit loss allowances relating to loans and advances in the Retail division are determined on a collective basis, with the use of impairment models. These models use a number of key assumptions including probability of default, loss given default (including propensity for possession and forced sale discounts for mortgages) and valuation of recoveries. Management also apply overlays where they believe the model calculated assumptions and allowances are not appropriate, either due to emerging trends or the model limitations. An example of this is an overlay to the impairment model output for the UK mortgages portfolio relating to expected credit losses on past term interest‑ only exposures. Our work therefore focused on the appropriateness of modelling methodologies adopted and the significant judgements required to determine the requirement for overlays and the measurement of those overlays.
We used credit risk modelling specialists to support the audit team in the performance of these audit procedures.
Based on the evidence obtained, we found that the methodologies, modelled assumptions, management judgements and data used within the allowance assessment to be appropriate and in line with the requirements of IFRS 9.
Determining the measurement of provisions requires a number of assumptions which are made using a significant degree of management judgement. Key assumptions include the volume of future complaints and related redress costs.
We independently performed sensitivity analysis on the key assumptions and considered alternative scenarios which could be considered reasonably possible.
We understood and tested key controls and governance around the processes for setting actuarial assumptions.
We understood and tested the key controls around the valuation processes including the independent price verification and valuation governance controls.
– assessing the reasonableness of the valuations and performing sensitivity analyses over them.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 167
We understood and tested key controls over the pensions process involving member data, formulation of assumptions and the financial reporting process. We tested the controls for determining the actuarial assumptions and the approval of those assumptions by senior management.
Our actuarial experts have performed testing over the Guaranteed Minimum Pension (‘GMP‘) equalisation impact calculated by management’s actuary, reviewed the approach taken and understood the key assumptions used in the calculations. We used our own independent GMP equalisation modelling tools to support this testing.
Our testing included the following: – examining selected hedge documentation to assess whether it complies with the requirements of IFRS; – testing the key year‑end reconciliations between underlying source systems and the spreadsheets used to manage hedging models; – independently assessing whether management have captured and are monitoring all material sources of ineffectiveness; – re‑performing a sample of hedge effectiveness calculations; and
– testing a sample of manual adjustments posted to record ineffectiveness.
– Approval, recertification and timely removal of access from IT systems.
The directors’ assessment of the prospects of the Group and of the principal risks that would threaten the solvency or liquidity of the Group We have nothing material to add or draw attention to regarding: – The directors’ confirmation on page 81 of the Annual Report that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity.
– The disclosures in the Annual Report that describe those risks and explain how they are being managed or mitigated.
Other required reporting Companies Act 2006 exception reporting Under the Companies Act 2006 we are required to report to you if, in our opinion: – we have not received all the information and explanations we require for our audit; or – adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or – certain disclosures of directors’ remuneration specified by law are not made; or – the parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns.
Consolidated income statement for the year ended 31 December 170 Lloyds Banking Group Annual Report and Accounts 2018
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 171
Movements in revaluation reserve in respect of available for sale financial assets: Adjustment on transfer from held‑to‑maturity portfolio – 1,544
Financial liabilities at fair value through profit or loss 28 30,547 50,935 50,877
Liabilities arising from insurance contracts and participating investment contracts 31 98,874 103,413 103,413
The directors approved the consolidated financial statements on 19 February 2019.
Adjustment on adoption of IFRS 9 and IFRS 151 – (262) (929) (1,191) – – (1,191)
Profit for the year – – 4,302 4,302 – 98 4,400
Issue of other equity instruments (note 43) – – (5) (5) 1,136 – 1,131
Value of employee services: Share option schemes – – 53 53 – – 53
Other employee award schemes – – 207 207 – – 207
Changes in non‑controlling interests – – – – – – –
Total other comprehensive income – 2,602 (1,028) 1,574 – – 1,574
Redemption of preference shares 210 (210) – – – – –
Movement in treasury shares – – (175) (175) – – (175)
Movements in revaluation reserve in respect of available‑for‑sale financial assets, net of tax
Issue of ordinary shares 63 – – 63 – – 63
Other employee award schemes – – 332 332 – – 332
Consolidated cash flow statement for the year ended 31 December 176 Lloyds Banking Group Annual Report and Accounts 2018
Net cash (used in) provided by operating activities (11,107) (3,195) 2,074
Net cash provided by (used in) investing activities 11,921 6,808 (686)
Effects of exchange rate changes on cash and cash equivalents 3 – 21
Cash and cash equivalents at beginning of year 58,708 62,388 71,953
The Group has adopted IFRS 9 and IFRS 15 with effect from 1 January 2018.
(A) Consolidation The assets, liabilities and results of Group undertakings (including structured entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures. Details of the Group’s subsidiaries and related undertakings are given on pages 289 to 295.
(3) Other Dividend income is recognised when the right to receive payment is established.
(F) Derivative financial instruments and hedge accounting As permitted by IFRS 9, the Group continues to apply the requirements of IAS 39 to its hedging relationships. All derivatives are recognised at their fair value. Derivatives are carried on the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 49(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.
Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item, the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued. Note 17 provides details of the types of derivatives held by the Group and presents separately those designated in hedge relationships. Further information on hedge accounting is set out below.
Assets are transferred to Stage 3 when they have defaulted or are otherwise considered to be credit impaired. Default is considered to have occurred when there is evidence that the customer is experiencing financial difficulty which is likely to affect significantly the ability to repay the amount due. IFRS 9 contains a rebuttable presumption that default occurs no later than when a payment is 90 days past due. The Group uses this 90 day backstop for all its products except for UK mortgages. For UK mortgages, the Group uses a backstop of 180 days past due as mortgage exposures more than 90 days past due, but less than 180 days, typically show high cure rates and this aligns with the Group’s risk management practices.
(I) Property, plant and equipment Property, plant and equipment (other than investment property) is included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight‑line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: the shorter of 50 years and the remaining period of the lease for freehold/long and short leasehold premises; the shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease for leasehold improvements; 10 to 20 years for fixtures and furnishings; and 2 to 8 years for other equipment and motor vehicles.
Investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital accretion or both, primarily within the life insurance funds. In accordance with the guidance published by the Royal Institution of Chartered Surveyors, investment property is carried at fair value based on current prices for similar properties, adjusted for the specific characteristics of the property (such as location or condition). If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices in less active markets. These valuations are reviewed at least annually by independent professionally qualified valuers. Investment property being redeveloped for continuing use as investment property, or for which the market has become less active, continues to be valued at fair value.
(J) Leases (1) As lessee The leases entered into by the Group are primarily operating leases. Operating lease rentals payable are charged to the income statement on a straight‑line basis over the period of the lease.
The Group evaluates non‑lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then accounted for separately.
(2) Share-based compensation The Group operates a number of equity‑settled, share‑based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black‑Scholes option pricing model or a Monte Carlo simulation. The determination of fair values excludes the impact of any non‑market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated as non‑vesting conditions and the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement.
For the Group’s long‑term insurance businesses, the tax expense is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on the shareholders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under the current UK tax rules.
– 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.
– Insurance and participating investment contracts which are unit‑linked Liabilities for unit‑linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
(iii) Value of in-force business The Group recognises as an asset the value of in‑force business in respect of insurance contracts and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date. This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency rates and includes allowances for both non‑market risk and for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate
(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.
Origination PDs The assessment of whether there has been a significant increase in credit risk is a relative measure, dependent on an asset's PD at origination. For assets existing at 1 January 2018, the initial application date of IFRS 9, this information is not generally available and consequently management judgement has been used to determine a reasonable basis for estimating the original PD. Management used various information sources, including regulatory PDs and credit risk data available at origination, or where this is not available the first available data. In addition, the Group has not created a forward looking view of PDs at initial recognition for the back book as to do so would involve the use of hindsight and could introduce the risk of bias. The use of proxies and simplifications is not considered to materially impact the ECL allowance on transition.
Post-model adjustments Limitations in the Group’s impairment models or input data may be identified through the on‑going assessment and validation of the output of the models. In these circumstances, management make appropriate adjustments to the Group’s allowance for impairment losses. These adjustments are generally modelled taking into account the particular attributes of the exposure which have not been adequately captured by the primary impairment models. At 31 December 2018, post‑model adjustments were mainly related to UK secured lending with no individual adjustment being material.
For each major product grouping models have been developed which utilise historical credit loss data to produce PDs for each scenario; an overall weighted average PD is used to assist in determining the staging of financial assets and related ECL.
The key UK economic assumptions made by the Group as at 31 December 2018 averaged over a five‑year period are shown below: Economic assumptions Base Case
The Group’s base‑case economic scenario has changed little over the year and reflects a broadly stable outlook for the economy. Although there remains considerable uncertainty about the economic consequences of the UK’s planned exit from the European Union, the Group considers that at this stage the range of possible economic outcomes is adequately reflected in its choice and weighting of scenarios. The averages shown above do not fully reflect the peak to trough changes in the stated assumptions over the period. The tables below illustrate the variability of the assumptions from the start of the scenario period to the peak and trough.
The impact of changes in the UK unemployment rate and House Price Index (HPI) have also been assessed. Although such changes would not be observed in isolation, as economic indicators tend to be correlated in a coherent scenario, this gives insight into the sensitivity of the Group’s ECL to changes in these two critical economic factors. The assessment has been made against the base case with the reported staging unchanged. The changes to HPI and the unemployment rate have been phased in to the forward‑looking economic outlook over three years.
The table below shows the impact on the Group’s ECL resulting from a decrease/increase for a 1 percentage point (pp) increase/decrease in the UK unemployment rate.
At 31 December 2018, the Group carried total liabilities arising from insurance contracts and participating investment contracts of £98,874 million (2017: £103,413 million). The methodology used to value these liabilities is described in note 31.
Elements of the valuations of liabilities arising from insurance contracts and participating investment contracts require management to estimate future investment returns, future mortality rates and future policyholder behaviour. These estimates are subject to significant uncertainty. The methodology used to value these liabilities and the key assumptions that have been made in determining their carrying value are set out in note 31.
The accounting valuation of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The discount rate is required to be set with reference to market yields at the end of the reporting period on high quality corporate bonds in the currency and with a term consistent with the defined benefit pension schemes’ obligations. The average duration of the schemes’ obligations is approximately 18 years. The market for bonds with a similar duration is illiquid and, as a result, significant management judgement is required to determine an appropriate yield curve on which to base the discount rate. The cost of the benefits payable by the schemes will also depend upon the life expectancy of the members. The Group considers latest market practice and actual experience in determining the appropriate assumptions for both current mortality expectations and the rate of future mortality improvement. It is uncertain whether this rate of improvement will be sustained going forward and, as a result, actual experience may differ from current expectations. The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptions is set out in part (iii) of note 35.
Recoverability of deferred tax assets At 31 December 2018 the Group carried deferred tax assets on its balance sheet of £2,453 million (2017: £2,284 million) principally relating to tax losses carried forward.
The Group has recognised a deferred tax asset of £3,778 million (2017: £4,034 million) in respect of UK trading losses carried forward. Substantially all of these losses have arisen in Bank of Scotland plc and Lloyds Bank plc, and they will be utilised as taxable profits arise in those legal entities in future periods.
Note 4: Segmental analysis Lloyds Banking Group provides a wide range of banking and financial services in the UK and in certain locations overseas.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 189
Inter‑segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter‑segment lending and deposits are generally entered into at market rates, except that non‑interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.
Other income, net of insurance claims 2,171 1,653 1,865 321 6,010
Analysis of segment underlying other income, net of insurance claims: Credit and debit card fees 988 4 1 – 993
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 191
Analysis of segment underlying other income, net of insurance claims: Credit and debit card fees 948 4 1 – 953
Gains less losses on disposal of available‑for‑sale financial assets – 29 (3) 420 446
Other segment items reflected in income statement above: Increase in value of in‑force business – – (165) – (165)
Analysis of segment underlying other income, net of insurance claims: Credit and debit card fees 854 4 1 16 875
Gains less losses on disposal of available‑for‑sale financial assets – 17 (2) 76 91
Other segment items: Investments in joint ventures and associates at end of year 9 28 – 22 59 1 Restated – see page 188. 2 Net of profits on disposal of operating lease assets of £58 million.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 193
Total income, net of insurance claims 18,626 259 (161) – 18,724
Other income, net of insurance claims 7,747 (186) (1,356) – 6,205
Total income, net of insurance claims 18,659 42 (176) – 18,525
Other income, net of insurance claims 7,993 121 (2,110) – 6,004
Total income, net of insurance claims 17,267 384 (212) – 17,439
2 The Group’s insurance businesses’ income statements include income and expenditure which are attributable to the policyholders of the Group’s long‑term assurance funds. These items have no impact in total upon the profit attributable to equity shareholders and, in order to provide a clearer representation of the underlying trends within the business, these items are shown net within the underlying results.
3 Net of profits on disposal of operating lease assets of £60 million (2017: £32 million; 2016: £58 million) .
5 Comprises the write‑off of the Enhanced Capital Note embedded derivative and premium paid on redemption of the remaining notes (loss of £790 million) ; the effects of asset sales (gain of £217 million) ; volatile items (gain of £99 million) ; liability management (gain of £123 million) ; the amortisation of purchased intangibles (£340 million) ; restructuring costs (£622 million, principally comprising the severance related costs related to phase II of the Simplification programme) ; and the fair value unwind and other items (loss of £231 million) .
Loans and advances to banks 0.84 0.40 0.46 565 271 381
Interest receivable on financial assets held at amortised cost 2.87 2.81 2.83 15,709 15,026 15,858
Financial assets at fair value through other comprehensive income 1.98 640
Total interest and similar income1 2.82 2.73 2.77 16,349 16,006 16,620
Interest and similar expense: Deposits from banks, excluding liabilities under sale and repurchase transactions 1.39 1.18 0.65 (117) (80) (68)
Interest payable on liabilities held at amortised cost 0.79 0.79 1.07 (3,797) (3,659) (5,289)
Amounts payable to unitholders in consolidated open‑ended investment vehicles (6.07) 9.15 10.85 844 (1,435) (2,057)
Total interest and similar expense3 0.60 1.06 1.44 (2,953) (5,094) (7,346)
Net interest income 13,396 10,912 9,274 1 Includes £31 million (2017: £12 million; 2016: £nil) of interest income on liabilities with negative interest rates.
3 Includes £10 million (2017: £50 million; 2016: £51 million) of interest expense on assets with negative interest rates.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 195
Note 6: Net fee and commission income 2018 £m 2017 £m 2016 £m
The most significant performance obligations undertaken by the Group are the provision of bank account and transactional services and other value added offerings in respect of current accounts; factoring and loan commitments for commercial customers; card services to cardholders and merchants in respect of credit cards and debit cards; and the management and administration of policyholders’ funds in accordance with investment mandates.
Other financial instruments mandatorily held at fair value through profit or loss: Debt securities, loans and advances (26) 1,122 4,771
Gains less losses on disposal of financial assets at fair value through other comprehensive income (2017 and 2016: available‑for‑sale financial assets) (note 41) 275 446 575
Movement in value of in‑force business (note 24) (55) (165) 472
Share of results of joint ventures and associates 9 6 (1)
Depreciation and amortisation: Depreciation of property, plant and equipment (note 26) 1,852 1,944 1,761
Amortisation of acquired value of in‑force non‑participating investment contracts (note 24) 40 34 37
Performance-based compensation The table below analyses the Group’s performance‑based compensation costs between those relating to the current performance year and those relating to earlier years.
Total fees payable to the Company’s auditors by the Group 26.7 27.9 24.3
Services relating to taxation: Following a change in policy in 2017, the Group’s auditors are not engaged to provide tax services except in exceptional circumstances and where permitted by applicable guidance.
Reviews of the financial position of corporate and other borrowers 0.4 0.2 1.2
Other items impacting the impairment charge (86) (150) 688 – 452
Notes to the consolidated financial statements continued 2017 £m 2016 £m
Impairment losses on loans and receivables: Loans and advances to customers 697 592
Deferred tax: Adjustments in respect of prior years (29) (48) (94)
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 201
Note 14: Taxation continued (B) Factors affecting the tax expense for the year The UK corporation tax rate for the year was 19.0 per cent (2017: 19.25 per cent; 2016: 20 per cent). An explanation of the relationship between tax expense and accounting profit is set out below: 2018 £m 2017 £m 2016 £m
Policyholder deferred tax asset in respect of life assurance expenses 73 – (184)
Weighted average number of ordinary shares in issue – basic 71,638 71,710 71,234
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 38 million (2017: 57 million; 2016: 140 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
Note 16: Financial assets at fair value through profit or loss These assets are comprised as follows: Trading assets £m
Other financial assets at fair value through profit or loss £m
Loans and advances to customers 26,886 10,964 37,850 29,976 11,434 41,410 29,976 – 29,976
Other financial assets at fair value through profit or loss include assets backing insurance contracts and investment contracts of £116,903 million (1 January 2018: £126,968 million; 31 December 2017: £117,323 million). Included within these assets are investments in unconsolidated structured entities of £26,028 million (1 January 2018: £28,759 million; 31 December 2017: £28,759 million), see note 48.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 203
Note 17: Derivative financial instruments The fair values and notional amounts of derivative instruments are set out in the following table: Contract/ notional amount £m
Details of the Group’s hedging instruments are set out below: Maturity
Up to 1 month £m £m £m £m Over 5 years £m Total £m
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 205
Accumulated amount of fair value adjustment on the hedged item Cash flow hedge/currency translation reserve
The accumulated amount of fair value hedge adjustments remaining in the balance sheet for hedged items that have ceased to be adjusted for hedging gains and losses is a liability of £170 million.
Gains and losses arising from hedge accounting are summarised as follows: Amounts reclassified from reserves to income statement as: Gain (loss) recognised in other comprehensive income
Customer deposits (49) (1) (69) Interest expense 1 Hedge ineffectiveness is included in the income statement within net trading income.
Note 18: Financial assets at amortised cost (A) Loans and advances to customers
Total loans and advances to customers 441,006 24,351 4,188 15,313 484,858
Transfers between stages are deemed to have taken place at the start of the reporting period, with all other movements shown in the stage in which the asset is held at 31 December, with the exception of those held within Purchased or originated credit‑impaired, which are not transferrable.
Net increase and decrease in balances comprise new loans originated and repayments of outstanding balances throughout the reporting period. Loans which are written off in the period are first transferred to Stage 3 before acquiring a full allowance and subsequent write‑off.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 207
The net investment in finance leases represents amounts recoverable as follows: 2018 £m 2017 £m
Recoveries of advances written off in previous years 553 27 580
Transfers between stages are deemed to have taken place at the start of the reporting period, with all other movements shown in the stage in which the asset is held at 31 December, with the exception of those held within Purchased or originated credit‑impaired, which are not transferrable. As assets are transferred between stages, the resulting change in expected credit loss of £493 million for drawn balances, and £8 million for undrawn balances, is presented separately as Impacts of transfers between stages, in the stage in which the expected credit loss is recognised at the end of the reporting period.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 209
Note 20: Allowance for impairment losses continued For the year ended 31 December 2017
Charge (release) to the income statement (note 13) 697 (6) 691
Of the total allowance in respect of loans and advances to customers at 31 December 2017 £1,201 million was assessed on a collective basis.
All assets have been assessed at Stage 1 at 1 January and 31 December 2018.
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 £2,310 million (2017: £2,310 million), £1,836 million, or 79 per cent of the total (2017: £1,836 million, 79 per cent of the total) has been allocated to Scottish Widows in the Group’s Insurance and Wealth division; £302 million, or 13 per cent of the total (2017: £302 million, or 13 per cent of the total) has been allocated to Cards in the Group’s Retail division; and £170 million, or 7 per cent of the total (2017: £170 million, 7 per cent of the total) to Motor Finance in the Group’s Retail division.
The recoverable amount of the goodwill relating to Motor Finance has also been based on a value‑in‑use calculation using pre‑tax cash flow projections based on financial budgets and plans approved by management covering a five‑year period and a discount rate of 14 per cent. The cash flows beyond the five‑year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long‑term average growth rates for the markets in which Motor Finance participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Motor Finance to fall below the balance sheet carrying value.
The recoverable amount of the goodwill relating to the Cards business has been based on a value‑in‑use calculation using pre‑tax cash flow projections based on financial budgets and plans approved by management covering a five‑year period and a discount rate of 14 per cent. The cash flows beyond the five year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long‑term average growth rates for the markets in which Cards participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of the Cards business to fall below the balance sheet carrying value.
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds and illiquid loan assets. The value of the in‑force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of corporate bond holdings and relevant illiquid loan assets. In determining the market premium for illiquidity, a range of inputs are considered which reflect actual asset allocation and relevant observable market data. The illiquidity premium is estimated to be 128 basis points at 31 December 2018 (2017: 114 basis points).
Risk‑free rate (financial options and guarantees) 1 0.00 to 4.05 0.00 to 4.20
Non-economic assumptions Future mortality, morbidity, expenses, lapse and paid‑up rate assumptions are reviewed each year and are based on an analysis of past experience and on management’s view of future experience. Further information on these assumptions is given in note 31 and the effect of changes in key assumptions is given in note 32.
Note 24: Value of in-force business continued The gross value of in‑force business asset in the consolidated balance sheet is as follows: 2018 £m 2017 £m
Balance sheet amount at 31 December 2017 403 – 662 19 1,751 2,835
Included within brands above are assets of £380 million (31 December 2017: £380 million) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not have an indefinite useful life.
At 31 December the future minimum rentals receivable under non‑cancellable operating leases were as follows: 2018 £m 2017 £m
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2017 and 2018 no contingent rentals in respect of operating leases were recognised in the income statement.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 213
Note 30: Securitisations and covered bonds Securitisation programmes Loans and advances to customers and debt securities carried at amortised cost 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.
The Group has a number of covered bond programmes, for which Limited Liability Partnerships have been established to ring‑fence asset pools and guarantee the covered bonds issued by the Group. At the reporting date the Group had over‑collateralised these programmes as set out in the table above to meet the terms of the programmes, to secure the rating of the covered bonds and to provide operational flexibility. From time‑to‑time, the obligations of the Group to provide collateral may increase due to the formal requirements of the programmes. The Group may also voluntarily contribute collateral to support the ratings of the covered bonds.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 215
(1) Life insurance The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows: Insurance contracts £m
Change in liabilities charged to the income statement (note 10) (2,596) (1,969) (4,565) (153) (4,718)
With-profit fund realistic liabilities (i) Business description Scottish Widows Limited has the only with‑profit funds within the Group. The primary purpose of the conventional and unitised business written in the with‑ profit funds is to provide a smoothed investment vehicle to policyholders, protecting them against short‑term market fluctuations. Payouts may be subject to a guaranteed minimum payout if certain policy conditions are met. With‑profit policyholders are entitled to at least 90 per cent of the distributed profits, with the shareholders receiving the balance. The policyholders are also usually insured against death and the policy may carry a guaranteed annuity option at retirement.
Guaranteed annuity option take‑up rates Certain pension contracts contain guaranteed annuity options that allow the policyholder to take an annuity benefit on retirement at annuity rates that were guaranteed at the outset of the contract. For contracts that contain such options, key assumptions in determining the cost of options are economic conditions in which the option has value, mortality rates and take up rates of other options. The financial impact is dependent on the value of corresponding investments, interest rates and longevity at the time of the claim.
As noted above, the liabilities of the With‑Profit Funds are valued using a market‑consistent stochastic simulation model which places a value on the options and guarantees which captures both their intrinsic value and their time value.
Non-profit fund liabilities (i) Business description The Group principally writes the following types of life insurance contracts within its non‑profit funds. Shareholder profits on these types of business arise from management fees and other policy charges.
Unit‑linked business This includes unit‑linked pensions and unit‑linked bonds, the primary purpose of which is to provide an investment vehicle where the policyholder is also insured against death.
Life insurance The policyholder is insured against death or permanent disability, usually for predetermined amounts. Such business includes whole of life and term assurance and long‑term creditor policies.
(iii) Assumptions Generally, assumptions used to value non‑profit fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement of non‑profit fund liabilities are:
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 217
– Change in the assumption in respect of current and future mortality and morbidity rates (£173 million increase) . – Change in expenses assumptions (£43 million decrease) .
(2) Non-life insurance For non‑life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims provisioning levels are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or expected outcome. There has been no significant change in the assumptions and methodologies used for setting reserves.
Net claims outstanding at 31 December 254 225 1 Of which an increase of £367 million (2017: £350 million) was in respect of current year claims and a decrease of £32 million (2017: a decrease of £13 million) was in respect of prior year claims.
Future maintenance and investment expenses4 10% reduction 262 217 289 240
3 This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.
The most recent triennial funding valuation of the Group’s three main schemes, based on the position as at 31 December 2016, was completed during 2018. The valuation showed an aggregate funding deficit of £7.3 billion (a funding level of 85.6 per cent) compared to a £5.2 billion deficit (a funding level of 85.9 per cent) for the previous valuation as at 30 June 2014. In the light of this funding deficit, and in contemplation of the changes that the Group has made as a result of its Structural Reform Programme, the Group agreed a recovery plan with the trustees. Under the plan, deficit contributions of £412 million were paid during 2018, and these will rise to £618 million in 2019, £798 million in 2020, £1,287 million in 2021 and £1,305 million per annum from 2022 to 2024. Contributions in the later years will be subject to review and renegotiation at subsequent funding valuations. The next funding valuation is due to be completed by March 2021 with an effective date of 31 December 2019. The deficit contributions are in addition to the regular contributions to meet of benefits accruing over the year. The Group currently expects to pay contributions of approximately £1,050 million to its defined benefit schemes in 2019.
The expense recognised in the income statement for the year ended 31 December comprises: 2018 £m 2017 £m 2016 £m
(iv) Assumptions The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 2.90 2.59
Interest rate risk: The defined benefit obligation is determined using a discount rate derived from yields on AA‑rated corporate bonds. A decrease in corporate bond yields will increase plan liabilities although this will be materially offset by an increase in the value of bond holdings.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 223
Expected life expectancy of members: Increase of one year 43 44 1,299 1,404 1 At 31 December 2018, the assumed rate of RPI inflation is 3.20 per cent and CPI inflation 2.15 per cent (2017: RPI 3.20 per cent and CPI 2.15 per cent) .
During the year ended 31 December 2018 the charge to the income statement in respect of defined contribution schemes was £300 million (2017: £256 million; 2016: £268 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
Movements in the other post‑retirement benefits obligation: 2018 £m 2017 £m
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 225
(Charge) credit to other comprehensive income – – (92) (138) – – (230)
Exchange and other adjustments – – – – – 6 6 1 Financial assets at fair value through other comprehensive income (2017: available‑for‑sale financial assets).
Deferred tax assets of approximately £78 million (2017: £76 million) have not been recognised in respect of £438 million of UK tax losses and other temporary differences which can only be used to offset future capital gains. UK capital losses can be carried forward indefinitely.
At 31 December 2018, a provision of £1,329 million remained unutilised relating to complaints and associated administration costs. Total cash payments were £1,859 million during the year ended 31 December 2018.
Sensitivities The Group estimates that it has sold approximately 16 million PPI policies since 2000. These include policies that were not mis‑sold and those that have been successfully claimed upon. Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for approximately 53 per cent of the policies sold since 2000.
HBOS Reading – customer review The Group has now completed its compensation assessment for all 71 business customers within the customer review, with more than 96 per cent of these offers accepted. In total, more than £96 million has been offered of which £78 million has been accepted, in addition to £9 million for ex‑gratia payments and £5 million for the reimbursements of legal fees.
Provisions are made for staff and other costs related to Group restructuring initiatives at the point at which the Group becomes irrevocably committed to the expenditure. At 31 December 2018 provisions of £191 million (31 December 2017: £104 million) were held.
Repurchases and redemptions during the year1 – (237) – (771) (1,008)
There were no repurchases of preference shares or undated subordinated liabilities during 2017 or 2018.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 229
(2) Issued and fully paid share capital 2018 Number of shares 2017 Number of shares 2016 Number of shares 2018 £m 2017 £m 2016 £m
Issued under employee share schemes 768,551,098 518,293,181 – 77 51 –
Share buyback programme (note 41) (1,577,908,423) – – (158) – –
Share issuances In 2018, 769 million shares (2017: 518 million shares) were issued in respect of employee share schemes; no shares were issued in 2016.
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 in effect as at 31 December 2018 provide that such annual donations will cease in certain circumstances, including the Company providing nine years’ notice. Such notice has been given to the Lloyds TSB Foundation for Scotland.
Shares cancelled under share buyback programme (see below) 158 – –
On 8 March 2018 the Group announced the launch of a share buyback programme to repurchase up to £1 billion of its outstanding ordinary shares; the programme ended on 24 August 2018. The Group entered into an agreement with UBS AG, London Branch (UBS) to conduct the share buyback programme on its behalf and to make trading decisions under the programme independently of the Group. UBS purchased the Group’s ordinary shares as principal and sold them to the Group in accordance with the terms of their engagement. The Group cancelled the shares that it purchased through the programme.
Change in fair value of hedging derivatives 234 (363) 2,432 2018 £m 2017 £m 2016 £m
Distributions on other equity instruments (net of tax) (327) (313) (321)
Realised gains and losses on equity shares held at fair value through other comprehensive income (129)
Retained profits are stated after deducting £499 million (2017: £611 million; 2016: £495 million) representing 909 million (2017: £861 million; 2016: £730 million) treasury shares held.
Issued in the year: US dollar notes ($1,500 million nominal) 1,136 – –
Recommended by directors at previous year end: Interim dividend paid in the year 1.07 1.00 0.85 765 720 607
In addition, the Group intends to implement a share buyback of up to £1.75 billion (2017: £1 billion) which will commence in March 2019 and is expected to be completed by 31 December 2019.
The weighted average share price at the time that the options were exercised during 2018 was £0.67 (2017: £0.67). The weighted average remaining contractual life of options outstanding at the end of the year was 2.16 years (2017: 1.4 years).