This icon appears throughout this report highlighting how we are Helping Britain Prosper. Read more online at lloydsbankinggroup.com
This Annual Report and Accounts contains forward looking statements with respect to certain of the Group’s plans and its current goals and expectations relating to its future fi nancial condition, performance, results, strategic initiatives and objectives. For further details, reference should be made to the forward looking statements on page 287.
Risk management 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
Tackling social disadvantage across Britain >3,000 charities supported, one of the largest corporate donors in the UK
Our focus on customers also continues to be recognised through various awards which this year included being awarded Bank of the Year for the sixth year running at The Banker awards; and for the third year in a row Scottish Widows won five stars at the Financial Adviser Service Awards, a reflection on how financial advisers rate our products and services.
During the year our colleagues raised close to £4 million for Mental Health UK, our charity partner, bringing our total to over £8 million since the partnership began in 2017. Seeing first-hand how our Foundations and colleague fund raising is helping charities all over the UK really brings perspective to the positive impact we are having in keeping with our purpose to Helping Britain Prosper.
In addition, we’re also pleased to announce that Nigel Hinshelwood, Sarah Bentley and Brendan Gilligan joined as independent Non-Executive Directors of the Group’s RingFenced Banks on 1 January 2019 where they serve alongside the Group Board Directors. More information on the ring-fencing restructure is provided on page 58.
Despite the Group’s strong financial performance, the annual Group Performance Share (GPS) award for Executive Directors has decreased relative to last year. As set out in the Remuneration Report, this reflects the assessed performance against other stretching operational and strategic goals, which, while strong in 2018, was a step down from the higher rating achieved in 2017.
Tax £2.6 billion paid in 2018 The UK’s largest corporate tax payer
Lending £64 billion SME and Mid Markets lending portfolio Biggest mortgage lender in UK with c.£290 billion portfolio
In 2018 the Group has again delivered significant benefits for our customers and a strong financial performance, with increased profits and returns. As a result of this performance, we have been able to recommend an increased dividend and share buyback. Our differentiated, customer focused, UK business model continues to position us well for sustainable success and continuing to deliver our purpose of Helping Britain Prosper.
Given our UK focus, our performance is inextricably linked to the health of the UK economy. Over 2018, economic performance has remained resilient with record employment and continued GDP growth and, whilst the near-term outlook remains unclear, particularly given the ongoing EU withdrawal negotiations, our strategy will continue to deliver for our customers. Our strategy is framed by our purpose of Helping Britain Prosper, being the bank with the largest retail and commercial presence throughout the country. Our unique business model and market leading efficiency will ensure we can continue to invest in customer propositions and grow our leading digital bank whilst delivering strong financial performance and market leading returns.
Given the Group’s capital build of 210 basis points in the year, the Board has recommended a final ordinary dividend of 2.14 pence per share, bringing the total ordinary dividend for the year to 3.21 pence per share. This represents an increase of 5 per cent on 2017 and is in line with our progressive and sustainable ordinary dividend policy. In addition, the Board has announced its intention to implement a share buyback programme of up to £1.75 billion, equivalent to 2.46 pence per share, up 76 per cent from last year.
Over the first year of the plan we have delivered significant progress against our strategic priorities of Leading customer experience, Digitising the Group, Maximising the Group's capabilities and Transforming ways of working as outlined on the next page.
Helping Britain Prosper Plan The Group’s success is intertwined with the UK’s prosperity and we acknowledge we have a responsibility to help address the economic, social and environmental challenges the country faces. We do this through our Helping Britain Prosper Plan, which was simplified and updated in 2018 to support our three year strategy and focus on metrics that have the most impact on people, businesses and communities.
We have also strengthened our client relationship model and improved online functionality for Commercial Banking clients. Our Schroders partnership announced in October is a key part of our strategy to accelerate growth in Wealth by leveraging our multichannel customer reach and Schroders’ investment expertise, with the aim of becoming a top three UK financial planning business within five years.
In 2018 we have increased training hours by over 50 per cent, including more than 1 million hours dedicated to developing skills of the future. We have also introduced more modern collaborative working environments, simplified people processes by replacing several HR systems with a single platform and developed a new performance management system ‘Your Best’ which launched in January 2019. We are also transforming the way in which change is delivered with 15 per cent of teams now using Agile methodologies.
Outlook Over 2018 the UK economy has proven itself to be resilient with record employment and continued GDP growth. Whilst the near term outlook for the UK economy remains unclear, we continue to believe that our simple, low risk business model will deliver strong financial performance and market leading returns with a resilient net interest margin, lower operating costs enabling increased investment, strong asset quality and lower remediation costs. Our guidance demonstrates our confidence in the business model and the future prospects of the Group: We are already delivering a market leading return on tangible equity and expect further improvement in 2019 to 14 to 15 per cent
Our net interest margin is expected to be c.2.90 per cent in 2019 and, as previously guided, remain resilient through the plan period
Significant progress has been made against our strategic priorities since the launch of our strategic plan in February 2018 15.7m Digitally active customers
CURRENT TARGET Capital build 170-200bps per annum with a regulatory capital requirement of around 13% and a management buffer of around 1% 1 Pro forma, reflecting Insurance dividend. Also includes ordinary dividend and share buyback. 2016 reflects MBNA.
Colleague engagement remains strong despite a slight decline since 2017 (our highest ever score). Both the engagement and performance excellence indices are above UK high performing norms with colleagues scoring pride, advocacy and teamwork favourably.
Reflecting the pace of digital adoption, the number of active digital customers increased in the year. The number of mobile banking users also increased in the year, to 11.4 million, many of whom use our award winning Lloyds Bank app.
Overview As the largest provider of UK banking services, our prospects are closely aligned to the outlook for the UK economy. In the period following the decision to leave the EU, the economy has been resilient. Growth has slowed only slightly below its trend rate, the unemployment rate has continued to fall to a 43 year low, and property prices have continued to rise slowly. This resilience is expected to continue in 2019 and the next few years, barring any sudden shocks to business or consumer confidence particularly in connection with the UK’s exit from the EU during 2019.
More widely, the global economy is transitioning away from the exceptionally low interest rates in place in most advanced economies since the financial crisis. This process will not always be constant, with different countries at different stages of their economic cycle, and unwinding of ‘quantitative easing’ may increase volatility in financial markets. The widespread trend to increasingly populist politics, of which the US-China trade war is a prime example, poses a challenge to appropriate economic policy.
Market dynamics A number of key regulatory changes have been implemented in the last 12 months including ring-fencing and GDPR. The key areas of focus for 2019 are as below: Open banking Open Banking regulation was implemented in January 2018 with the aim of increasing competition by enabling customers to view personal financial data from different providers in one place. Although currently just relating to current accounts it will be extended to other products in 2019 and beyond. Customer data protection is integral to this with new EU wide technical standards (PSD2) due to be implemented by September 2019.
Capital regulation The Group continues to prepare for a number of regulatory capital developments with uncertainty remaining around the implementation and impact of the final Basel III reforms.
Market dynamics The pace of digital adoption continues to surpass expectations and this trend is likely to accelerate further, transforming the way in which customers interact with banks. New entrants to the financial services market are increasing disruption through the innovative use of technology and data, often specifically targeting small, profitable niches. These new entrants have also been increasingly collaborating with incumbent banks, while established peers have more recently launched their own standalone propositions designed to increase disruption. Security and resilience remain important factors, with the ability to respond to heightened cyber and fraud risks key to retaining customer trust in a digital environment, particularly given the introduction of Open Banking and API-enabled propositions which are changing the manner in which customers are able to share their data.
Link to strategic priorities Delivering a leading customer experience Digitising the Group
Looking ahead, competition is likely to remain high, increasing focus on innovation and placing pressure on earnings across the sector.
Rigorous execution and management discipline focusing on key skills of the future Experience of delivering change and transformation in recent years provides benefit as we further transform the business.
...enabling us to Help Britain Prosper and deliver for all our stakeholders. Successful implementation of our strategy will ensure we Help Britain Prosper and deliver sustainable success for all stakeholders including customers, colleagues and shareholders.
In February 2018, we launched our new three year strategy to transform the Group for success in a digital world. We identified four strategic priorities focused on the financial needs and behaviours of the customer of the future and are investing more than £3 billion in these strategic initiatives over the plan period.
15.7 million Digitally active customers >£4 billion Balance growth in underrepresented segments
Personalising our customer proposition Given our extensive insight, we are well positioned to meet the growing demand for personalised customer propositions. As part of our overall response to this significant opportunity, we recently launched our Lend a Hand mortgage proposition that meets the needs of borrowers without a deposit to get onto the housing ladder, while also offering market leading savings rates to family members or other supporters who are willing to provide this deposit on their behalf. In addition, the strength of our Club Lloyds proposition has enabled strong deposit growth. These and other initiatives have enabled us to increase personalisation and to achieve growth of over £4 billion in underrepresented segments.
Increasing investment in technology To position the Group for success in a digital world, we have embarked on one of the largest transformation programmes in financial services. Consistent with this, we have increased our investment in technology by 24 per cent, placing us in the top quartile amongst peers. Over two-thirds of this spend related to enhancing existing capabilities and creating new ones, in line with our chosen approach of simplifying and modernising our IT and data architecture in a progressive manner.
In 2018, the Group also made targeted investments in both public and private cloud solutions, with around 100 applications migrated to private cloud. These investments will deliver a more efficient, scalable and flexible infrastructure going forward and act as enablers for further investment in 2019 and beyond. This leaves us well positioned to deliver further enhancements for the benefit of customers, colleagues and shareholders.
Digital Champions are colleagues who pledge to improve the digital skills and financial capability of at least two individuals or organisations each year. Thousands of colleagues have already signed up. Digital Champions are one way we are committed to Help Britain Prosper.
£3 billion Net lending to starts ups, SME and Mid Market customers >3 million Customers with access to Single Customer View >£13 billion Open book assets under administration net customer inflows
Improving the experience of our Commercial Banking clients In Commercial Banking we have increased net lending by £3 billion and have exceeded start-ups, SMEs and Mid Market clients our sustainability target through support for renewable energy projects capable of powering over 2.6 million homes. We have also delivered improvements to the client experience by simplifying our client relationship model and enhancing our online functionality, with SME clients now able to check instantly whether they will be approved for loans or overdrafts of up to £25,000 before they apply.
Focus for 2019 In 2019 we will extend the roll out of Single Customer View, with the expectation of reaching over 9 million customers by the end of the plan period, with other areas of focus including the further development and formal launch of our wealth partnership, Schroders Personal Wealth. We will also improve the digital banking experience of our Commercial Banking clients, including significantly reducing the time to cash for unsecured lending to less than two hours.
I had to stop making contributions to my pension, so seeing this online alongside my bank account now has reminded me I need to take some action and start saving again.
Our colleagues are crucial to the success of our business. In order to deliver our transformation during the current strategic plan and beyond, our colleagues will require new skills and capabilities to reflect the changing needs of the business as it adapts to the evolving operating environment. At the same time, colleague expectations of their employers are changing. As a result, we are making our biggest ever investment in colleagues to ensure that we continue to attract, develop and retain these skills and capabilities, while fostering a culture that supports a way of working that is agile, trustbased and reinforces the Group’s values.
I genuinely feel much more valued as a colleague than before the move. It’s great to see Lloyds Banking Group making such an investment in colleagues and it’s just a much more pleasant experience coming into the office.
Investing in our people We are making the biggest ever investment in our people. As part of this, we have increased training hours by over 50 per cent to 4.3 million hours, with over 1 million of these relating to developing key skills for the future. We are on course to deliver our target of cumulative 4.4 million training hours relating to skills for the future by 2020.
Focus for 2019 We will continue to roll out Agile as we move towards our target of more than 50 per cent of change delivered through these methodologies by the end of this strategic plan. This combined with changes that will bring our colleagues closer together, boosting innovation and increasing simplicity, will make it easier for our people to focus on delivering greater value for customers. We will also further up-skill our colleagues alongside targeted recruitment to ensure our colleagues have the required capabilities to deliver our transformation. The attraction, retention and development of talent will be supported by further improvements to our colleague proposition, ensuring that this remains compelling and aligns to our culture.
KEY OBJECTIVES FOR 2018 TO 2020 50 per cent increase in training and development to 4.4 million hours per year
Our aim is to be the best bank for customers, colleagues and shareholders. As the UK’s leading financial services provider we operate in, and support, communities across the country and help British people and businesses prosper. We have around 26 million customers, 2.4 million shareholders and around 65,000 colleagues. Engaging and responding to all our stakeholders is fundamental to the way we operate and maintaining the highest standards of business conduct is vital to our corporate culture and the long-term success of the Group. This therefore remains a major focus for senior management and the Board.
One of the primary tasks of the Board is to develop a strategy which can achieve long-term success and generate sustainable returns and this is only possible if we engage, consult and act on the needs of stakeholders.
We aim to treat all customers fairly and have specifically looked to ensure vulnerable customers are not disadvantaged. Our websites and mobile banking apps are being accessibility accredited by AbilityNet and we have provided more than 90,000 hours of vulnerable customer training this year. We are the UK’s largest provider of basic bank accounts, opening around 33 per cent of all basic bank accounts in 2018. We also work with many support organisations to remove the barriers to accessing banking services
In January 2019 we launched Lend a Hand, specifically designed to help address the biggest challenges that first time buyers face whilst getting onto the property ladder. Lend a Hand mortgage removes the need for a first time buyer deposit - with this instead coming from savings from family or other supporters. Owning a home remains the number one life goal for 18 to 35 year olds, but half say saving for a deposit is the biggest barrier.
Ensuring all colleagues act in the right way is key to embedding a customer focus culture. Our Code of Responsibility outlines the values and behaviours which colleagues should follow. Colleagues review the code annually during mandatory training, alongside Anti-Bribery training based on our Anti-Bribery Policy. We have a zero tolerance approach to bribery, and expect the same from all colleagues and third parties providing services for, and on behalf of the Group. Any non-compliance with codes, policies or standards will result in colleagues facing disciplinary action
Investor Relations also provides regular reports and feedback to the executive team and the Board on key market issues and shareholder concerns. This includes a six monthly update on reputation and an annual presentation by our corporate brokers on market dynamics and corporate perception
Given the size of our organisation we are reliant on external suppliers for a number of key services. Dealing with suppliers in the right way is important for future success.
We assess how significant each supplier is to our operations across the various components of our extended supply chain and we conduct an annual programme of assurance reviews based on the risk criticality the supplier represents. We require suppliers to adhere to relevant Group policies and comply with our Code of Supplier Responsibility. This defines our expectations of responsible business and behaviour, underpinning our efforts to share and extend best practice
Our four independent charitable Foundations are key to our vision of tackling social disadvantage. Sara Weller, Non-Executive Director and Chair of the Responsible Business Committee joined the Lloyds Bank Foundation for England and Wales as trustee during 2018 for an initial term of three years
Individual meetings took place between the PRA and members of the Board during the year to discuss subjects such as the Audit and Risk Committees, IT Resilience and Cyber and ring-fencing
We have served Britain through our products and services for more than 250 years, across every community, and millions of households. Our success is interwoven with the UK’s prosperity and we aim to Help Britain Prosper by operating as a responsible, sustainable and inclusive Group. This underpins our purpose and the way we deliver our strategy.
Our areas of focus Each year we gather stakeholder views through a dedicated materiality study. In 2018, they identified demonstrating responsibility at our core as a key priority, including how we keep customers’ data safe, support vulnerable customers, lend responsibly, support businesses and work with suppliers. Read more on our stakeholders on pages 16 to 18.
We are one of the UK’s largest corporate donors and use our scale and reach to tackle some of society’s more complex challenges through our independent charitable Foundations
Helping Britain get a home Amount of lending committed to help people buy their first home £12.4bn £10bn £30bn 17 ICONS: BLACK/WHITE VERSION
Helping people save for the future Growth in assets that we hold on behalf of customers in retirement and investment products £7.4bn £32bn2 £50bn 17 ICONS: BLACK/WHITE VERSION
Championing Britain’s diversity Percentage of senior roles held by women 17 ICONS: BLACK/WHITE VERSION
Launched in 2014 and revised annually, the Plan focuses on the areas in which we can make the biggest difference.
To combat these challenges we have several key initiatives: 23,000 colleagues volunteered to become Digital Champions supporting local communities; we delivered Digital Knowhow workshops to over 3,000 organisations covering fraud and digital marketing with an online toolkit signposting key resources; we co-created a digital curriculum and delivered events in schools to inspire over 800 students and teachers with our ReDiscover programme; and colleague volunteers hosted over 1,000 code clubs in schools.
Tackling social disadvantage across Britain As one of the UK’s largest corporate donors, we use our scale to reach millions of people and help tackle social disadvantage in communities across the UK. Our four independent charitable Foundations are fundamental to our vision of tackling social disadvantage. They cover the UK and the Channel Islands, partnering with small and local charities to help people overcome complex social issues and rebuild their lives.
Championing Britain’s diversity We champion inclusion and diversity (I&D) to reflect the diverse communities we serve. We were the first FTSE100 company to set a public goal on gender diversity and this year became the first FTSE100 company to set public goals to increase Black, Asian and Minority Ethnic (BAME) representation at all levels. Additionally, this year we enhanced our focus on mental health, as this is key to economic prosperity and social inclusion, and therefore to Helping Britain Prosper.
Ethnicity We have a comprehensive Ethnicity Strategy to help us meet our goals, which focus on attracting and retaining talented BAME colleagues; building cultural awareness at all levels; and increasing visibility of authentic role models from a wide range of ethnic backgrounds. By the end of the year 6.4 per cent of senior managers were BAME colleagues, compared with 5.6 per cent in 2017, while BAME colleagues made up 9.5 per cent of our total workforce, compared with 8.3 per cent in 2017.
To achieve this, activities in 2018 included: developing our Authentic Leadership Programme for BAME senior managers and our Career Development Programme for BAME middle managers; actively promoting our Race, Ethnicity and Cultural Heritage Network, which now has around 4,000 members; and promoting our Ethnicity Role Models List. In October, we signed the UK Government’s Race at Work Charter and already meet and exceed its principle requirements. In 2018 we won the overall Outstanding Employer Award at the inaugural Investing in Ethnicity Awards.
We were a top ten Trans-Inclusive employer and fifth employer overall in the Stonewall Top 100 2018, the highest ranked financial services company in the UK. Through our Rainbow network colleagues raised almost £100,000 to support key charities and we continued our sponsorship for Stonewall Young Campaigners, empowering young people aged 16 to 21 to become campaigners for Lesbian, Gay, Bisexual and Transgender equality.
The charity Behind Closed Doors (BCD) helps people in Leeds exit harmful situations relating to domestic abuse. Lloyds Bank Foundation for England and Wales provides financial support to help them deliver their vital services to vulnerable people. To deepen the support they can provide, the Foundation matched BCD with a senior Group colleague, Dave Moore, who has joined them as a charity mentor and valued Board member, helping them become sustainable, develop their offering and reach more people in need.
Dave is dynamic and energetic, and he’s motivated the Board to become more proactive. He’s encouraged a business-like approach, where we can more easily consider the long-term future, setting clear goals and a strategy for achieving them, and he’s supported the Board to become more strategic in their governance role. It’s been great having his support.
Mental health & wellbeing As a Group we believe that a shift in mindset is needed amongst UK employers when it comes to mental health. We all have mental health as well as physical health and our approach focuses on removing the stigma attached to mental ill health, addressing it in the same way as we would any physical condition; through a culture of conversation and support.
Our mental health strategy supports colleagues and leaders through a mental health resource centre and this year we stepped up mental health training for colleagues at all levels. To date more than 40,000 colleagues have completed training on mental health and we are training 2,500 colleagues to become mental health advocates by 2020. We enrolled 200 leaders in our new Optimal Resilience Leadership Programme, which covers personal, mental and physical wellbeing and are now working on extending this to the next level of 2,000 senior managers.
Recognition that mental health is an issue for our customers and the communities we serve, inspired us to create our ‘Get the Inside Out’ advertising campaign to challenge mental health stereotypes.
3 Reporting scope: payroll headcount includes established and fixed term contract colleagues, parental leavers, MBNA colleagues and Internationals. Excludes Leavers, Group Non-Executive Directors, contractors, temps, and agency staff.
Diversity scope: Payroll headcount including parental leavers. Excludes contractors, temps and agency staff. Gender information includes International colleagues and MBNA. All other diversity information is UK Payroll only. Senior Managers: Grades F+. Managers: Grade D-E. Data source: HR system (Workday). Apart from gender data, all diversity information is based on colleagues’ voluntary self-declaration. As a result this data is not 100 percent representative; our systems do not record diversity data for the proportion of colleagues who have not declared this information.
More than £8 million raised since 2017 has helped our charity partner, Mental Health UK, open the Mental Health and Money Advice Service – the UK’s first dedicated advice service for people with mental health and money problems. These two issues are often inter-related, so the new service is urgently needed. It comprises a public website providing information across a number of issues including benefits, debt problems and managing mental health. It also operates a referral only telephone advice service. Since its launch in November 2017, the website has received around 180,000 views and more than 1,000 people have been referred for confidential advice. More than 2,400 cases have been handled, with each client on average about £1,000 better off as a result. By November 2018 a total annual saving of over £1.3 million had been delivered.
Strategy Our commitment The UK is committed to the vision of a sustainable, low carbon economy, and has placed clean growth at the heart of its industrial strategy. This will require a radical reinvention of the way people, work, live and do business.
We have a unique position within the UK economy with our purpose of Helping Britain Prosper. The successful transition to a sustainable, low carbon economy that is resilient to climate change impacts and sustainably uses resources is of strategic importance to us. We support the aims of the 2015 Paris Agreement on Climate Change, and the UK Government’s Clean Growth Strategy.
Identify and manage material sustainability and climate related risks across the Group, disclosing these and their impacts on the Group and its financial planning processes in line with the TCFD recommendations
For the implementation of the TCFD recommendations across the Group, we have established a senior executive group TCFD forum. We aim to expand the consideration of sustainability and climate related issues into relevant Board and governance committees including processes to monitor and oversee progress against goals and targets related to climate issues. We will also consider how sustainability might be incorporated into our remuneration policies.
Green bonds: be a leading UK bank in the green/sustainable bonds market
Our own footprint: be a leading UK bank in reducing our own carbon footprint and challenging our suppliers to ensure our own consumption of resources, goods and services is sustainable
Improving our own environmental footprint is an important foundation for our activity. We’ve consistently reduced our environmental impacts, thanks to the ambitious Environmental Action Plan we launched in
Risk management Each division within the Group is responsible for identifying and prioritising relevant climate related risks and opportunities and integrating them into their risk management processes, which determine materiality and classify risks into traditional risk categories. This includes identifying potential risks through horizon scanning of changes in regulation, technology and consumer demand. Risks are classified in terms of whether they impact the Group in the short, medium or long term. Examples include possible changes in the sustainability of homes, how vehicles are powered, changes in UK energy mix, through to changes in the frequency and severity of extreme weather events. The Group sustainability team facilitates collaboration across divisions to increase understanding of consistent issues, as well as our risk, opportunities and financial impact on an aggregated basis.
During 2018, we reviewed our external sector statements to confirm that they align to our sustainability strategy and consider appropriate climate related risk. We introduced a position statement for coal and revised statements for defence, mining, oil and gas, power, and forestry. For more information on our sector statements www.lloydsbankinggroup.com/ our-group/responsible-business/sustainabilityin -lloyds-banking-group. In 2019, we will review these statements again, and consider developing statements for other sectors and topics. We will review ways to embed sustainability in the Group’s key policies.
Reporting requirement Policies and standards which govern our approach Information necessary to understand our business and its impact, policy due diligence and outcomes
Supporting business to start up and grow, Building capability and digital skills, page 21
Maximising the Group’s capabilities Helping Britain Prosper with over £12 billion of gross mortgage lending to first time buyers and over 120,000 start-up businesses supported Halifax was the first UK bank to reach 1 million switchers since the Current Account Switching Service began in 2013
Risk-weighted assets increased to £94 billion reflecting changing asset mix, along with model refinements
Retail offers a broad range of financial service products to personal and business banking customers, including current accounts, savings, mortgages, credit cards, unsecured loans, motor finance and leasing solutions. Its aim is to be the best bank for customers in the UK, by building deep and enduring relationships that deliver value, and by providing them with choice and flexibility, with propositions increasingly personalised to their needs. Retail operates a multi-brand and multi-channel strategy and continues to simplify its business and provide more transparent products, helping to improve service levels and reduce conduct risks, whilst working within a prudent risk appetite.
>£12bn Lending to first time buyers 1m Halifax was the first UK bank to reach 1 million switchers since the current account switching service began in 2013
Banking is often quick and transactional but we know that some financial decisions need more thought and that’s why branches remain vitally important.
Maximising the Group’s capabilities Increased net lending to start-ups, SMEs and Mid Market clients by £3 billion, having provided over £18 billion of gross new lending to businesses in the year and committed to the same level in 2019 Exceeded the commitment to provide £750 million of funding to support social housing projects in the UK Provided £1.5 billion of funding to the UK manufacturing sector, supporting increased production capacity, investment in plant and machinery and research and development, allowing clients to remain innovative and competitive Exceeded sustainability targets through support for renewable energy projects capable of powering over 2.6 million homes and the financing of energy efficiency improvements across 1.4 million square feet of real estate
Financial performance Return on risk-weighted assets of 2.50 per cent, up 6 basis points with lower risk-weighted assets driven by continued balance sheet optimisation more than offsetting a reduction in underlying profit Net interest income was slightly lower at £3,004 million, with the net interest margin slightly lower at 3.27 per cent, and marginally higher average interest earning assets Other income of £1,653 million was 8 per cent lower reflecting challenging market conditions leading to lower levels of client markets activity. 2017 included a number of significant one-off refinancing and hedging transactions Operating lease depreciation significantly lower given accelerated depreciation of legacy assets in 2017 Operating costs 3 per cent lower, with efficiency savings more than offsetting increased investment Improved asset quality ratio of 9 basis points reflecting good credit quality across the portfolio Continued lending growth in SME of 3 per cent including loans and advances now transferred to Business Banking as part of the client re-segmentation Increased customer deposits of £149 billion, reflecting continued success in attracting high quality transactional deposits with improved current account mix
Leading customer experience Successfully completed first stage of Zurich transfer and on track to conclude transfers in the second half of 2019 Commenced roll out of a new suite of annual benefit statements to over 50 per cent of longstanding customers, making it simpler for them to understand their products, as well as the options available to them Simplifying systems and processes through our long-term partnership with Diligenta. Good progress towards initial systems migration in first half of 2019, enabling customers to better manage their policies with Scottish Widows Scottish Widows won 5 star service awards at the Financial Adviser Service Awards for the third consecutive year
Maximising the Group’s capabilities Launched Single Customer View; a unique capability, already enabling over 3 million customers to view in one place the pension and insurance products they hold with the Group alongside their banking products. Announced strategic partnership with Schroders to create a market leading wealth management proposition. Target for the partnership, Schroders Personal Wealth, to become a top 3 UK financial planning business within five years Good progress towards the target of growing open book assets under administration by £50 billion by the end of 2020, with strong customer net inflows of £13 billion achieved in the year, partly offset by £5.5 billion of negative market movements, mainly in the fourth quarter Strong progress towards one million new pension customers by end 2020, with over 630,000 new customers in 2018
Financial performance Strong growth in life and pensions sales, up 45 per cent, driven by increases in new members in existing workplace schemes, increased auto enrolment workplace contributions and bulk annuities New underwritten household premiums increased 27 per cent, reflecting progress of Direct and Corporate Partnership propositions; total underwritten premiums decreased 6 per cent driven by a competitive renewal market Significant growth in life and pensions new business income, up 87 per cent to £526 million partly offset by £26 million decrease in total general insurance income net of claims, including around £60 million impact from higher weather related claims. Lower experience and other items primarily due to non recurrence of £170 million income from the addition of death benefits in 2017 Underlying profit increased by 3 per cent to £927 million. Net income increased by £9 million to £1,988 million whilst operating costs decreased by £19 million, with cost savings more than offsetting higher investment in the business 2014
Risk as a strategic differentiator Risks are identified, managed and mitigated using our comprehensive Risk Management Framework, and our well-articulated risk appetite provides a clear framework for decision-making. The principal risks we face, which could significantly impact the delivery of our strategy, are discussed on pages 32 to 35.
The Board is responsible for approving the Group’s risk appetite statement at least annually. Group Board-level metrics are cascaded into more detailed business appetite metrics and limits.
Effective risk analysis, management and reporting Regular close monitoring and comprehensive reporting to all levels of management and the Board ensures appetite limits are maintained and subject to stressed analysis at a risk type and portfolio level, as appropriate.
Confirmation of the effectiveness of the Risk Management Framework and underlying risk and control
This year Risk division increased the use of automated property valuations for the mortgage application process through Halifax, reducing the time it takes for us to offer customers a mortgage to buy a property by an average of one week. By speeding up this part of the process and removing an extra step, our customers have more time to focus on what matters most during life-changing events such as buying a home.
Maximising the Group’s capabilities We remain committed to supporting our customers and their businesses across the country.
We have already implemented a number of significant enhancements across various products and services. For example, from a risk perspective we have changed how we authenticate suspicious transactions across personal debit and credit cards. Rather than decline the payment and request that the customer contact us, we send a text with a unique code which enables our customer to quickly and easily verify that the transaction is genuine. This has helped to protect our customers and made the experience simpler by communicating in a method convenient to them.
Cyber Cyber threats are increasingly complex and like all financial services providers, attempts are made on a regular basis to attack our systems and services, and to steal customer and bank data. Given the significant threat we continue to strengthen the resilience of our IT systems and invest in our cyber control framework.
We are simplifying and modernising our IT architecture, alongside deploying technologies such as cloud computing which offer greater levels of resilience, capacity management and speed of processing. We are a member of the UK’s Cyber Defence Alliance, where a number of UK-based banks and law enforcement agencies collaborate in the fight against cyber-attacks, sharing expertise, intelligence and knowledge. Within Lloyds Banking Group, our Chief Security Office engenders a culture whereby colleagues are considered to be our first line of defence. Vigilance and training are key to preventing cyber-attacks.
Risk management – enhancing the customer experience We recognise that the primary role of risk management is to protect our customers, colleagues and the Group, whilst enabling sustainable growth. We are able to fulfil this purpose whilst also supporting the Group’s strategic priorities and delivering better outcomes for customers. Here are some of the ways we have contributed to the Group’s strategic priorities and enhancing the customer experience this year.
During the year we strengthened affordability buffers and improved controls to restrict lending to consumers with higher risk of over-indebtedness
Failure to deliver key regulatory changes or to comply with ongoing requirements
We are committed to better addressing our customers’ banking needs through consistent, fair and responsible credit risk decisions, aligned to customers’ circumstances, whilst staying within prudent risk appetite.
The most significant conduct cost in recent years has been PPI mis-selling
Conduct policies and procedures are in place to ensure appropriate controls and processes that deliver fair customer outcomes
The dynamic threat posed by cyber risk to the confidentiality and integrity of electronic data or the availability of systems
Effective remuneration arrangements to promote appropriate colleague behaviours and meet regulatory expectations
During 2018 we enhanced our colleague wellbeing strategies to ensure support is in place to meet colleague needs, and to help achieve the skills and capability growth required to build a workforce for the ‘Bank of the Future’
Insurance underwriting Key insurance underwriting risks within the Insurance business are longevity, persistency and property insurance. Longevity risk is expected to increase as our presence in the bulk annuity market increases.
Strategic decisions made consider the maintenance of the current well-diversified portfolio of insurance risks
Inadequate or complex governance arrangements to address ring-fencing requirements and the potential impact of EU exit could result in a weaker control environment, delays in decision-making and lack of clear accountability
A dedicated change programme is in place and addressing the additional SM&CR requirements which will come into force during 2019
Evolving risk and governance arrangements to ensure they continue to be appropriate to comply with regulatory objectives
Earnings are impacted by our ability to forecast and model customer behaviour accurately and establish appropriate hedging strategies
We actively manage our exposure to movements in market rates, to drive lower volatility earnings and offer a comprehensive customer proposition with hedging strategies to support strategic aims. Mitigating actions are implemented to reduce the impact of market movements, resulting in a more stable capital position. Effective interest rate and inflation hedging has kept volatility in the Group’s defined benefit pension schemes low. This combined with improved market conditions has helped keep the schemes in IAS 19 surplus in 2018. This allows us to more efficiently utilise available capital resources to better enable the Group to maximise its capabilities.
Model The risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application and ongoing operation of models and rating systems.
Financial results Summary of Group results 37 Divisional results 44 Other financial information 48
Given the strong capital build of 210 basis points this year, the Board has recommended a final ordinary dividend of 2.14 pence per share, making a total ordinary dividend of 3.21 pence per share, an increase of 5 per cent on 2017 and in line with our progressive and sustainable ordinary dividend policy. In addition, the Board intends to implement a share buyback of up to £1.75 billion, equivalent to 2.46 pence per share. The Group’s pro forma CET1 ratio was 13.9 per cent post dividend and allowing for the proposed share buyback (31 December 2017: 13.9 per cent).
The Group’s market leading cost:income ratio continues to provide competitive advantage and improved by 2.5 percentage points to 49.3 per cent (or 0.8 percentage points to 46.0 per cent, excluding remediation) with positive jaws of 5 per cent.
The Group continues to target a cost:income ratio including remediation in the low 40s exiting 2020, with reductions every year, and now expects operating costs to be less than £8 billion in 2019, a year ahead of the original target.
Credit quality remains strong with no deterioration in credit risk. The Group’s loan portfolios continue to be well positioned, reflecting the Group’s continued prudent, through the cycle approach to credit risk, and benefiting from continued low interest rates and a resilient UK economy.
The gross asset quality ratio remains stable at 28 basis points, in line with full year 2017 and 2016. On a net basis the asset quality ratio increased to 21 basis points and the impairment charge increased by 18 per cent to £937 million, both reflecting expected lower releases and write-backs.
The Group continues to expect a return on tangible equity of 14 to15 per cent in 2019.
Tangible net assets per share 53.0p 51.7p 1.3p 53.3p (0.3)p 1 Adjusted to reflect the impact of applying IFRS 9 from 1 January 2018, with transitional arrangements applied for capital.
3 The CET1, total, leverage and MREL ratios at 31 December 2018, 1 January 2018 and 31 December 2017 are reported on a pro forma basis, reflecting the dividends paid up by the Insurance business in February 2019 and February 2018 respectively in relation to prior year earnings. The CET1 ratio is also reported post dividends and share buyback.
Tangible net assets per share of 53.0 pence (1 January 2018: 51.7 pence) was up 1.3 pence with an increase of 4.4 pence before dividends of 3.1 pence paid in 2018, driven by increased statutory profit after tax partly offset by the effects of the share buyback and other reserve movements.
Ring-fencing The Group successfully launched its new non ring-fenced bank, Lloyds Bank Corporate Markets plc in 2018, transferring in non ring-fenced business from the rest of the Group, thereby meeting its legal requirements under ring-fencing legislation.
As a predominantly UK retail and commercial bank, the effect on the Group has been relatively limited, with minimal impact on the majority of the Group’s retail and commercial customers. As the vast majority of the Group’s business has continued to be held by Lloyds Bank plc and its subsidiaries there has not been a material impact on the financial strength of Lloyds Bank plc.
2 Excludes reverse repos of £40.5 billion (1 January 2018: £16.8 billion).
4 Excludes reverse repos of £40.5 billion (1 January 2018: £16.8 billion).
Underlying basis In order to allow a comparison of the Group’s underlying performance, the results are adjusted for certain items including restructuring, severance related costs, the costs of implementing regulatory reform including ring-fencing, the rationalisation of the non-branch property portfolio, the integration of MBNA and Zurich’s UK workplace pensions and savings business, volatility and other items, which includes the effects of certain asset sales, the volatility relating to the Group’s own debt and hedging arrangements and that arising in the insurance businesses, insurance gross up, the unwind of acquisition-related fair value adjustments and the amortisation of purchased intangible assets and payment protection insurance (PPI) provisions.
4 SME portfolio re-segmented in the first half of 2018 moving £1.0 billion of loans and advances to customers and £2.0 billion of customer deposits to Business Banking in Retail. Comparatives not restated.
5 Equivalent regulatory view of ratio (including With Profits funds) at 31 December 2018 was 156 per cent (31 December 2017: 154 per cent).
The Group’s insurance business has policyholder liabilities that are supported by substantial holdings of investments. IFRS requires that the changes in both the value of the liabilities and investments are reflected within the income statement. The value of the liabilities does not move exactly in line with changes in the value of the investments. As the investments are substantial, movements in their value can have a significant impact on the profitability of the Group. Management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to results based on the actual return. The impact of the actual return on these investments differing from the expected return is included within insurance volatility.
Add back amortisation of purchased intangible assets (post tax) (£m) 111 101
Working in partnership with frontline charities across Manchester has opened my eyes to the size and scale of the challenge. Overcoming barriers associated with identification and opening a bank account allows clients to claim benefits, get accommodation, start work and live a normal life and I’m delighted that our efforts across Greater Manchester have helped over 100 people open bank accounts. James Hargreaves Local Director for Lloyds Bank Manchester
Working with the charities and the Manchester Homelessness Partnership to understand the social, economic, and health issues associated with homelessness, Market Street Branch were able to respond in a way that met the needs of their clients. The success of this partnership has given way to developing further relationships between branches and local charities in Glasgow, Cardiff and London as we move into 2019.
Board and Committee changes There have been a number of changes to the Board and Committees during the year. Amanda Mackenzie was appointed to the Board in October, and became a member of the Board Risk Committee and the Responsible Business Committee. She is also joining the Remuneration Committee with effect from 1 March 2019. Also, Nick Prettejohn is joining the Nomination and Governance Committee with effect from 1 March 2019. After three years on the Board, Deborah McWhinney decided to leave the Group, for personal reasons, with effect from 31 December 2018. Deborah provided valuable insight to the Board during her tenure, especially in respect of IT infrastructure and cyber security. She left with our thanks and best wishes for the future.
Board evaluation In accordance with the UK Corporate Governance Code the Board engaged Egon Zehnder to facilitate the annual review of the Board and its Committees, following two years in which we had undertaken internal reviews of board effectiveness. This process ran between August 2018 and January 2019, and was overseen by the Nomination and Governance Committee. The process which was undertaken and the findings of the review can be found on pages 62 to 63, together with information about our progress against the 2017 review actions.
Corporate Governance Code During the year under review, the Group applied and was fully compliant with the UK Corporate Governance Code 2016. Additionally, in preparation for our adoption of the UK Corporate Governance Code 2018 from 1 January this year, the Group undertook a review of its Corporate Governance Framework. We also considered our approach to workforce engagement. Further information on workforce engagement can be found on page 17 and 64. We will report on our application of the UK Corporate Governance Code 2018 in next year’s annual report. The Board has engaged with the Group’s stakeholders during the year, and further details on this can be found on pages 16 to 18.
4. Simon Henry Independent Director Appointed: June 2014 Skills and experience: Deep international experience in board level strategy and execution Extensive knowledge of financial markets, treasury and risk management Qualification as an Audit Committee Financial Expert Strong board governance experience, including investor relations and remuneration Simon was formerly Chief Financial Officer and Executive Director of Royal Dutch Shell plc. He was also previously Chair of the European Round Table CFO Taskforce and a Member of the Main Committee of the 100 Group of UK FTSE CFOs. External appointments: Non-Executive Director of Rio Tinto plc and Rio Tinto Limited, Independent Director of PetroChina Company Limited, Member of the Defence Board and Chair of the Defence Audit Committee, UK Government, Member of the Advisory Panel of CIMA and of the Advisory Board of the Centre for European Reform.
Ri 1 Deborah McWhinney served as a Director throughout the year and retired from the Board on 31 December 2018. 2 Amanda Mackenzie is to be appointed to the Remuneration Committee with effect from 1 March 2019. 3 Nick Prettejohn is to be appointed to the Nomination and Governance Committee with effect from 1 March 2019.
6. Amanda Mackenzie OBE Independent Director Appointed: October 2018 Skills and experience: Extensive experience in responsible business Considerable customer engagement experience Strong digital technology experience Significant marketing and brand background Amanda was a member of Aviva’s Group Executive for seven years and Chief Marketing and Communications Officer. Prior to her current role, Amanda was seconded from Aviva as Executive Adviser to Project Everyone, to help launch the United Nations Sustainable Development Goals. She has over 25 years’ of commercial business practice, including director roles at British Airways AirMiles, BT, Hewlett Packard Inc, British Gas and Mothercare plc. External appointments: Chief Executive of Business in the Community – The Prince’s Responsible Business Network, a Life Fellow of the Royal Society of Arts and Fellow of the Marketing Society.
Skills and experience: Since joining the Group in October 2015, Carla led the 2018 to 2020 Group Strategic Review and, prior to that, the work on the Bank of the Future. Carla is responsible for supporting senior management with strategic decision making such as recommendations on mergers, acquisitions/disposals, joint ventures and partnerships and also manages the Group’s relationships with shareholders, analysts and the wider investment community. Carla joined from Credit Suisse where she headed the European Banks equity research team, with lead coverage of UK banks. Carla has over 18 years of financial analysis, strategy and management experience from her time with JPMorgan, Deutsche Bank and Credit Suisse Group. Carla currently serves as a Non-Executive Director of Lloyds Bank Corporate Markets plc.
Executive Director members The depth of diverse experience and complementary skills in our management team strengthens our ability to adjust to changing market environments and deliver our strategy to become the best bank for customers, colleagues and shareholders.
Lloyds Banking Group Annual Report and Accounts 2018 55 Strateg ic rep ort
5. Antonio Lorenzo Chief Executive, Scottish Widows and Group Director, Insurance and Wealth
Skills and experience: Vim was appointed Group Director, Retail in September 2017. He joined the Group in June 2011 as Managing Director, Customer Products. Vim is also a UK Finance Board member, leading on Retail Banking. Previously Vim worked for over 12 years at Santander, in a range of roles in Corporate Strategy, Mergers & Acquisitions, the Life Division and most recently held the position of Director, Retail Products.
Skills and experience: Zak joined the Group in 1989 as a Business Analyst in IT and has carried out multiple roles involving Retail CIO, Head of IT Architecture and leading the Digital Transformation programme. He was appointed Group Director, Digital and Transformation in 2016 and his responsibilities increased in September 2017 as the Group Director, Transformation. He is responsible for the digital transformation of the Group, including all IT and business change, and ensuring we are ready to meet the future expectations of our customers.
‘Deep dive’ sessions The Board regularly takes the opportunity to hold ‘deep dive’ sessions with senior management outside formal Board meetings. The purpose of the sessions is to provide the Board with deeper insight into key areas of strategic focus, whilst providing Directors with a greater understanding and appreciation for the subject matter to help drive better quality of debate and enhance knowledge. The sessions are structured to allow plenty of opportunity for discussion and include presentations and videos.
The board structure To facilitate effective governance, the boards of Lloyds Banking Group plc, Lloyds Bank plc, Bank of Scotland plc and HBOS plc are run on an aligned basis as the business of the Ring-Fenced Banks accounts for the majority of the Group’s operations. This involves the Directors of Lloyds Banking Group plc also sitting on the Boards of the other three companies. To provide further support to the fulfilment of the three key principles of governance of the Ring-Fenced Banks outlined above, three additional independent Non-Executive Directors have been appointed to the Ring-Fenced Bank Boards.
Lloyds Banking Group Annual Report and Accounts 2018 59 Strateg ic rep ort
The sheer scale of our balance sheet and the nature of banking in taking deposits and lending those deposits on to other customers means that we are mindful of the risks in the UK economy at any time and indeed in the global economy given that, as a trading nation, what goes on in the world will very rapidly impact the UK. The geopolitical situation and, closer to home, EU exit are very important risk factors to be considered when assessing the Group’s Risk Appetite.
The greater concerns lie where it is simply impossible to be in control of events be they geopolitical or, say, operational such as cyber-security. It is much easier to predict with accuracy potential losses from lending on mortgage or credit card than the reputational and financial losses that might arise from a successful cyber-attack.
A full schedule of matters reserved for the Board and Terms of Reference for each of the principal Committees can be found at www.lloydsbankinggroup.com
Q: Are you satisfied the Company has a robust process in place in respect of whistleblowing?
A: The Group’s whistleblowing arrangements are subject to annual review by Group Internal Audit. This provides an opportunity for an independent party to review the whistleblowing processes and test whether they are effective. The results to date from these reviews have been positive compared to our peers. The Audit Committee and Board also receive regular reports regarding whistleblowing.
Board venues are agreed and colleagues in the areas that the Board will visit are engaged at both senior management and operational level.
The Chairman holds monthly meetings to review the draft agenda and planner with the Company Secretary and Chief of Staff, as well as quarterly meetings with a wider group of central functions, to identify emerging issues.
Committee meetings are held prior to Board meetings, with the Chairman of each Committee then reporting matters discussed to the Board.
Purpose of creating the conditions for sound governance and renewed stakeholder confidence has been well executed through tight controls and disciplined risk management; The strategy is clear and the Directors are aligned on strategic priorities.
Consideration as to whether there is scope for bringing further technology know-how to the Board in due course; Non-Executive Directors would like to offer greater support to the Chairman by leveraging their unique skills and experience more fully.
2018 evaluation of the Board’s performance The 2018 effectiveness review sought the Directors’ views on a range of topics including: strategy; planning and performance; risk and control; Board composition and size; balance of skills and experience; diversity; culture and dynamics; the Board’s calendar and agenda; the quality and timeliness of information; and support for Directors and Committees.
Lloyds Banking Group Annual Report and Accounts 2018 63 Strateg ic rep ort
Progress against the 2017 internal Board effectiveness evaluation During the year, work focused particularly on Board papers and presentations. A summary of the Board’s progress against the actions arising from the 2017 evaluation are set out below.
In order to allow more time for discussion, challenge and debate, certain items of the agenda at Board meetings had no presentations although the responsible executives were available at the meeting to respond to queries from the Board.
Increased feedback from stakeholders other than regulators and customers, including shareholders and bondholders.
The bi-annual presentation to the Board on reputation contained information on shareholder sentiment and was attended by the Group Director of Investor Relations.
A governance lunch was held in November with key institutional shareholders. This was hosted by the Chairman and the Chairmen of the Board Committees, and feedback was reported to the Board.
The Terms of Reference were reviewed, and considered by the Nomination and Governance Committee in April, and approved by the Board in November.
At Group level, a consolidated risk report and risk appetite dashboard are reviewed and regularly debated by the executive Group Risk Committee, Board Risk Committee and the Board to ensure that they are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The report and dashboard provide a monthly view of the Group’s overall risk profile, key risks and management actions, together with performance against risk appetite and an assessment of emerging risks which could affect the Group’s performance over the life of the operating plan. Information regarding the main features of the internal control and risk management systems in relation to the financial reporting process is provided within the risk management report on pages 105 to 159. The Board concluded that the Group’s risk management arrangements are adequate to provide assurance that the risk management systems put in place are suitable with regard to the Group’s profile and strategy.
Reviews by the Board The effectiveness of the risk management and internal control systems is reviewed regularly by the Board and the Audit Committee, which also receives reports of reviews undertaken by the Risk Division and Group Internal Audit. The Audit Committee receives reports from the Company’s auditor, PricewaterhouseCoopers LLP (which include details of significant internal control matters that they have identified), and has a discussion with the auditor at least once a year without executives present, to ensure that there are no unresolved issues of concern.
Raising concerns in confidence The Group’s existing whistleblowing channel provides an opportunity for both colleagues and the wider workforce to raise concerns in confidence.
1 Amanda Mackenzie joined the Board with effect from 1 October 2018.
2 Deborah McWhinney left the Board with effect from 31 December 2018.
The Non-Executive Directors challenge management constructively and help develop and set the Group’s strategy.
In particular, the Nomination and Governance Committee monitors whether there are any relationships or circumstances which may affect a Director’s independence. Following the most recent review of independence the Committee concluded that all Non-Executive Directors are independent in character and judgement as shown on page 65.
More details about succession planning can be found on page 67.
B3. Time commitments Non-Executive Directors are advised of time commitments prior to their appointment and they are required to devote such time as necessary to discharge their duties effectively. The time commitments of the Directors are considered by the Board on appointment and annually, and following the most recent review, the Board is satisfied that there are no Directors whose time commitments are considered to be a matter for concern. External appointments, which may affect existing time commitments for the Board’s business, must be agreed with the Chairman, and prior Board approval must be obtained before taking on any new external appointments.
Directors who take on or change roles during the year attend induction meetings in respect of those new roles. The Company Secretary maintains a training and development log for each Director.
Board Committees are also provided with sufficient resources to discharge their duties.
B6. Board and Committee performance and evaluation An externally facilitated performance evaluation was completed in 2018, with internally facilitated evaluations having taken place in 2016 and 2017. More information can be found on pages 62 to 63, along with the findings, actions, and progress made during the year.
C3. Role and responsibilities of the Audit Committee The Board has delegated a number of responsibilities to the Audit Committee, including oversight of financial reporting processes, the effectiveness of the internal controls and the risk management framework, whistleblowing arrangements and the work undertaken by the external and internal auditors. The Audit Committee Report which can be found on pages 70 to 73, sets out how the Committee has discharged its duties and areas of focus during the year.
A webcast of the AGM is carried out to allow shareholders who cannot attend in person to view the meeting live.
Board effectiveness review As highlighted in my letter on page 51, an externally facilitated Board effectiveness review was conducted during the year. This was overseen by the Committee, and full details are provided on pages 62 to 63.
Succession planning The Committee continued its work on succession planning during the year, focusing on the level below the Group Executive Committee (GEC). This has included working with Egon Zehnder to review the changing role requirements and characteristics for bank leadership in the context of the Bank of the Future.
The Committee has overseen further development of the Group’s senior management succession planning programme.
The external search firm Russell Reynolds Associates1 provided a shortlist of candidates for consideration. Interviews with various members of the Board were held, and the process resulted in the appointment of Amanda Mackenzie in October.
The Diversity Policy was a consideration in recruitment during the year
Diversity, in its broadest sense as detailed in the Policy, was taken into consideration as part of the recruitment of Amanda Mackenzie and the Ring-Fenced Bank only Directors during the year.
2 The Chairman was independent on appointment. Under the Code, thereafter the test of independence is not appropriate in relation to the Chairman.
Q: What did you think of the appointment and induction process?
A: Exceedingly thorough! It gave ample opportunity for Lloyds Banking Group to learn about me and vice versa. A Non-Executive Director role today comes with a much greater amount of obligation and scrutiny, rightly so, but it does mean you have to be assured of the company you are joining and of course they of you. I have to say the Group’s very clear purpose of ‘Helping Britain Prosper’ and the determination of everyone I met to make that a reality was very appealing. The Group is prepared to make some tough decisions to deliver on its purpose. The induction process has been wholehearted, open, thorough and interesting. Given my background there are clearly some areas in which I am not an expert and never will be, but I do need to know enough and the induction process has not made me feel foolish for the need to ask basic questions and by contrast has been very welcoming of my knowledge where it is greatest and can help.
The wider external environment as we head into 2019 continues to be challenging, with an ongoing focus on regulation in the financial sector, and recent proposals for change in respect of audit practice. I am nonetheless pleased to report that in the opinion of the Committee, the Company continues to meet its obligations in respect of financial reporting and disclosure, and continues to operate an effective internal control framework.
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. A full list of responsibilities is detailed in the Committee’s terms of reference, which can be found at www.lloydsbankinggroup.com/ourgroup /corporate-governance. In satisfying its purpose, the Committee undertakes the functions detailed within Disclosure Guidance and Transparency Rule 7.1.3R.
The Committee continued to challenge management’s assumptions used to calculate the Group’s provision for PPI redress and associated administration costs. The overall cost remains uncertain and the Committee reviewed management’s use of sensitivities used to evaluate this uncertainty.
There were relatively few new conduct matters in 2018 and the majority of the provisions raised in 2018 related to issues caused prior to the implementation of the Group’s Conduct Strategy in 2013.
The Committee has also reviewed management’s assessment of the provision required for packaged bank accounts, including estimates made in respect of future complaint volumes and uphold rates.
The Committee discussed the controls and accounting aspects of the Group’s activities to establish its non ring-fenced bank, including the intra-group transfers made to ensure that the Group’s activities were appropriately separated. Two examples of these transfers included the transfer of Scottish Widows from Lloyds Bank plc to Lloyds Banking Group plc and the migration of a number of businesses and customer assets from Lloyds Bank plc to LBCM.
Financial reporting During the year, the Committee considered the following issues in relation to the Group’s financial statements and disclosures, with input from management, Risk Division, Group Internal Audit and the external auditor:
The value of the Group’s defined benefit pension plan obligations is determined by making financial and demographic assumptions, both of which are significant estimates made by management.
A deferred tax asset can be recognised only to the extent that it is more likely than not to be recoverable. The recoverability of the deferred tax asset in respect of carry forward losses requires consideration of the future levels of the Group’s taxable profit and the legal entities in which the profit will arise.
The Committee agreed with management’s judgement that the deferred tax assets were appropriately supported by forecast taxable profits, taking into account the Group’s long-term financial and strategic plans. The disclosures relating to deferred tax are set out in note 36: ‘Deferred tax’ of the financial statements. The Group’s net deferred tax asset at 31 December 2018 was £2,453 million (31 December 2017: £2,284 million).
The Committee took account of the respective views of both management and the relevant tax authorities when considering the uncertain tax positions of the Group. The Committee also understood the external advice obtained by management to support the views taken.
The Committee was satisfied that the provisions and disclosures made in respect of uncertain tax positions were appropriate. The relevant disclosures are set out in note 47: ‘Contingent liabilities and commitments’ of the financial statements.
Determining the value of the VIF asset and insurance liabilities requires management to make significant estimates for both economic and non-economic actuarial assumptions.
The Committee was satisfied that the value and associated disclosures of the VIF asset (2018: £4,762 million; 2017: £4,839 million) and liabilities arising from insurance contracts and participating investment contracts (2018: £98,874 million; 2017: £103,413 million) were appropriate.
The Committee discussed the Group’s approach to the new leasing standard (IFRS 16) noting that the principal impact of the standard on the Group was to bring its property leases ‘on-balance sheet’. The impact on the Group’s balance sheet at 1 January 2019 was to recognise a right of use asset and a corresponding liability of approximately £1.8 billion.
It also discussed the Group’s approach to the changes required by IFRS 17 noting that this standard will fundamentally change the accounting for insurance products, requiring that the profit be recognised over the life of the contract rather than permitting immediate up-front profit recognition.
During 2018 the Group carried out a formal review to choose its auditor for the year ended 31 December 2021. In accordance with the Order, PwC was excluded from this review. In October 2018, the Board (following the recommendation of the Audit Committee) approved the proposed appointment of Deloitte LLP. A recommendation for approval of this appointment will be made to the shareholders at the 2021 Annual General Meeting and subject to shareholder approval, Deloitte LLP will undertake the Group audit for the year ending 31 December 2021.
Dear Shareholder I am pleased to report on how the Board Risk Committee (the ‘Committee‘) has discharged its responsibilities throughout 2018.
The Committee has concluded that the Group continues to have strong discipline in the management of both emerging and existing risks, and the Committee’s work continues to help support the Group in achieving its core aim of operating as a digitised, simple, low risk financial services provider.
More details on the Group’s wider approach to risk management can be found in the risk management section on pages 105 to 159. Full details of the Committee’s responsibilities are set out in its terms of reference, which can be found at www.lloydsbankinggroup.com/ our-group/corporate-governance
Throughout 2018 the Committee has considered reports on the Group’s rectifications portfolio performance, particularly the initiatives to reduce the number of customers with outstanding remediation. The Committee has noted substantial progress in the pace and quality of remediation in delivering a reduction in the number of customers awaiting redress and expect improvements in the time taken to deliver the right customer outcomes. The Committee has remained close to progress on material rectifications, including HBOS Reading. Conclusion: Root cause analysis and read-across activities continue to improve and embed across the Group with good progress in reducing the volume of rectification programmes and customers impacted. This will remain a key focus for the Committee.
Reviews were undertaken of the Commercial Banking credit portfolio with a focus on sectors that have been impacted by slower economic growth.
The Committee reviewed risks associated with the Group’s UK mortgage portfolio including interest only and buy-to-let lending.
Operational resilience is one of the Group’s most important non-financial risks. Key focus in 2018 has been to enhance the existing approach to operational resilience and strengthen the control environment, to improve the Group’s ability to respond to incidents and continue delivering key services to our customers.
The effectiveness and model for change oversight has been reviewed and refreshed to ensure that there is risk-based assessment of strategic change activity. Similarly, the risk governance with respect to strategic change has been reviewed.
The ongoing uncertainty regarding the options, timing and the process itself could affect the outlook for the UK and global economy.
The Committee considered the unprecedented volume of regulatory and legislative change, noting the Group’s response to the updated Money Laundering Regulations and UK Criminal Finances Act. Accordingly, the Committee reviewed the Annual Group Money Laundering Officer’s Report (MLRO report) and was satisfied with the standard of compliance detailed within. Additionally, the Committee acknowledged the strategic plans in place to continually improve the Group’s Financial Crime control framework.
Fraud The Committee continues to closely monitor the Group’s management of fraud risk, whilst minimising the impact of controls on genuine customer journeys.
The Committee has continued focus on ensuring effective controls and oversight to comply with existing regulatory obligations, as well as receiving regular updates on emerging legal trends. There have been ongoing significant regulatory change programmes in which the Board has placed increased focus in order to ensure successful execution, including the Basel Committee on Banking Supervision (BCBS 239) and Markets in Financial Instruments Directive II. Due consideration to the governance and compliance of the ring-fenced bank has also been considered by the Committee, including monthly programme reporting until the ring-fencing legislation took effect.
Complaints The Committee continues to focus on ensuring the Group is resolving customer complaints in a timely manner and eradicating the causes for complaints.
The Committee considered progress on implementing the Group’s strategy for vulnerable customers which is aligned to UK Finance Vulnerability Taskforce Principles.
The Group’s signature actions for 2019 will focus on Mental Health, Critical Illness, Financial Abuse, Age Vulnerability and Access to Service.
Conclusion: The Committee recognise the ongoing activity and the progress made, coupled with the significant focus required to deliver effectively on both the Group’s aspirations and external expectations.
At each meeting, updates have been provided on the performance against the metrics of the Helping Britain Prosper Plan on which a report is provided on page 20.
Committee composition, attendance at meetings and effectiveness review Representatives from Group Internal Audit and the Chief Operating Office are invited to meetings as appropriate.
During the year, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review. The Committee will consider the output from the 2018 effectiveness review and whether amendments could be made to its current working arrangements.
During the year, as well as overseeing progress against the Helping Britain Prosper Plan as a whole, the Committee focused on some major and emerging Responsible Business themes.
In conclusion, I would like to thank the many colleagues across the Group for their hard work and extraordinary commitment to supporting Responsible Business activity in their ‘day jobs’, as well as by volunteering over 235,000 hours of their time and helping to raise £3.8 million for our charity of the year, Mental Health UK.
How the Committee spent its time in 2018 During the year, the Committee undertook a detailed exercise to consider how its role and remit would develop to ensure it remained best placed to assist with the delivery of the Company’s strategy by concentrating on overseeing the key initiatives to deliver the responsible business strategy.
Digital Skills has been a significant area for review and debate during the year, with regular updates provided on the direction of and progress with the establishment of the Lloyds Bank Academy. The Committee has provided input and challenge to the team working on the Academy programme and supported the pilot programmes undertaken in Manchester.
The development of the Company’s Sustainability strategy was considered with input from external advisers. The Committee engaged with the leaders of business areas on the application of the approach to helping customers in a sustainable way. These included the assistance provided for customers who are victims of flooding, work to support the transition to a low carbon economy and the development of green loans. The Company’s sustainability strategy was recommended to the Board for approval in September 2018 and published on the Company’s website www.lloydsbankinggroup. com/our-group/responsible-business/ sustainability-in-Lloyds-banking-group.
The alignment of the working relationship between the Company and the charitable Foundations was a key area of focus. The Committee considered and supported the development of plans to work in partnership with the Foundations to support the Charitable Sector through strengthening skills-based volunteering across Foundationssupported charities.
The share buyback programme is intended to commence in March 2019 and is expected to be completed during 2019. Given the total ordinary dividend of 3.21 pence per share and the intended share buyback, the total capital return for 2018 will be up to 5.67 pence per share, an increase of 27 per cent on the prior year, equivalent to up to £4.0 billion.
Board composition changes Changes to the composition of the Board since 1 January 2018 up to the date of this report are shown in the table below: Joined the Board Left the Board
Directors’ indemnities The Directors of the Company, including the former Director who retired during the year, have entered into individual deeds of indemnity with the Company which constituted ‘qualifying third-party indemnity provisions’ for the purposes of the Companies Act 2006. The deeds indemnify the Directors to the maximum extent permitted by law and remain in force. The deeds were in force during the whole of the financial year or from the date of appointment in respect of the Director appointed in 2018. Deeds for existing Directors are available for inspection at the Company’s registered office.
The Company undertook a share buyback programme, between 8 March 2018 and 24 August 2018, repurchasing in aggregate 1,577,908,423 ordinary shares for an aggregate consideration of £1 billion (aggregate nominal value of the shares £157,790,842.30) as a means by which to return capital to shareholders, given the amount of surplus capital. The 2018 buyback also assisted in the normalisation of ordinary dividends, and gave the flexibility that a buyback programme offers. All of the repurchased shares were cancelled, and together represented 2.22 per cent of the called up share capital of the Company at completion of the programme. Further information in relation to the 2018 share buyback programme is provided on page 49.
Conflicts of interest The Board has a comprehensive procedure for reviewing, and as permitted by the Companies Act 2006 and the Company’s articles of association, approving actual and potential conflicts of interest. Directors have a duty to notify the Chairman and Company Secretary as soon as they become aware of actual or potential conflict situations. Changes to commitments of all Directors are reported to the Nomination and Governance Committee and the Board and a register of potential conflicts and time commitments is regularly reviewed and authorised by the Board to ensure the authorisation status remains appropriate.
Stuart Sinclair is a Senior Independent Director at QBE UK Limited, a general insurance and reinsurance company. Lord Lupton is a senior advisor to Greenhill Europe, an investment bank focused on providing financial advice on significant mergers, acquisitions, restructurings, financings and capital raising to corporations, partnerships, institutions and governments. The Board has recognised that potential conflicts may arise as a result of these positions. The Board has authorised the potential conflicts and requires Mr. Sinclair and Lord Lupton to recuse themselves from discussions, should the need arise.
As at 31 December 2018, the Company had been notified by its substantial shareholders under Rule 5 of the DTR of the following interests in the Company’s shares: Interest in shares
2 The most recent notification provided by BlackRock Inc. under Rule 5 of the DTR identifies (i) an indirect holding of 3,599,451,380 shares in the Company representing 5.04 per cent of the voting rights in the Company, and (ii) a holding of 69,305,385 in other financial instruments in respect of the Company representing 0.09 per cent of the voting rights of the Company. BlackRock Inc.’s holding most recently notified to the Company under Rule 5 of the DTR varies from the holding disclosed in BlackRock Inc.’s Schedule 13-G filing with the US Securities and Exchange Commission dated 5 February 2019, which identifies beneficial ownership of 4,598,344,792 shares in the Company representing 6.5 per cent of the issued share capital in the Company. This variance is attributable to different notification and disclosure requirements between these regulatory regimes.
Going concern The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the foreseeable future, the Directors have considered a number of key dependencies which are set out in the risk management section under principal risks and uncertainties: funding and liquidity on page 34 and pages 147 to 152 and capital position on pages 139 to 147. Additionally, the Directors have considered the capital and funding projections of the Company and Group. Accordingly, the Directors conclude that the Company and the Group have adequate resources to continue in operational existence for a period of at least 12 months from the date of the approval of the financial statements and therefore it is appropriate to continue to adopt the going concern basis in preparing the accounts.
The final four year operating plan, Risk Division assessment and the results of the stress testing are presented to the Board for approval. Once approved, the operating plan drives detailed divisional and Group targets for the following year.
ther inform ation the fourth year of the operating plan are likely to be less reliable. As a result, the Board considers that a three year period continues to present a reasonable degree of confidence over expected events and macroeconomic assumptions, whilst still providing an appropriate longer-term outlook, although the remaining period of the operating plan contains no information which would cause different conclusions to be reached over the longer-term viability of the Company and Group. Information relevant to the assessment can be found in the following sections of the annual report and accounts: The Group’s principal activities, business and operating models and strategic direction are described in the strategic report on pages 1 to 35; Emerging risks are disclosed on pages 108 to 109; The principal risks, including the Group’s objectives, policies and processes for managing credit, capital, liquidity and funding, are provided in the risk management section on pages 115 to 159; and
The Group’s approach to stress testing and reverse stress testing, including both regulatory and internal stresses, is described on page 110.
Additionally, we are now disclosing market based emissions figures. For 2018, this is equal to 115,467 tCO2e – a comparative decrease of 62 per cent year on year and 79% against 2009 baseline. Further reductions in market emissions are attributable to the purchase of solar, wind, hydro and biomass Renewable Energy Guarantees of Origin (REGOs) equivalent to total UK electricity consumption in 2018.
Each of the current Directors who are in office as at the date of this report, and whose names and functions are listed on pages 52 to 53 of this annual report, confirm that, to the best of his or her knowledge: the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and Group; and the management report contained in the strategic report and the Directors’ report includes a fair review of the development and performance of the business and the position of the Company and Group, together with a description of the principal risks and uncertainties that they face.
This report covers the information required to meet the Group’s regulatory disclosures, but also provides additional context and detail on the Group’s broader remuneration framework, its alignment with our strategy and other factors considered relevant by the Committee.
Responding to feedback We were disappointed that our report for 2017 did not receive the high level of support from shareholders at the 2018 AGM that we had previously experienced. We place great importance on the opinions of our shareholders and other stakeholders when considering our remuneration policy and its implementation.
During 2018, I took the opportunity to meet a broad selection of shareholders and other key stakeholders, to obtain feedback on our approach. This included shareholders who opposed the 2017
The remuneration awarded to Executive Directors is heavily weighted towards the delivery of long-term, sustainable performance that aligns with shareholder experience. For the variable awards made under the Group Performance Share and Group Ownership Share plans in respect of performance in 2018, over 95 per cent is awarded in shares, and 70 per cent is subject to performance conditions applying over three years.
Our colleagues are the stewards of the Group’s future. We are therefore investing significantly in transforming ways of working to enhance our colleagues’ skills and capabilities. All eligible colleagues in the Group will receive a Colleague Group Ownership Share award in 2019, continuing our practice of promoting long-term ownership and alignment to shareholder interests. 99 per cent of colleagues hold shares in the Group.
2018 remuneration in the context of business performance and the perspective of our wider stakeholders We have taken on board feedback received in 2018 that suggests our approach to measurement of Group performance was overly complex. For 2018, we operated a scorecard with 20 measures across five blocks (as set out in full on page 86), but have reduced this to 15 measures and four blocks for 2019. We have weighted the scorecard measures to provide a balance of performance expectations across financial, customer and colleague related outcomes. We will disclose details of the 2019 targets in 2020, but the revised balance of measures is summarised as follows: Financial
The ‘Remuneration Overview’ section on the following pages provides a summary of the 2018 remuneration outcomes and policy for Executive Directors.
The value of the 2016 Long Term Incentive Plan awards has vested at 68.7 per cent in respect of the three-year performance period ending 31 December 2018. This reflects the significant progress made by the Group towards its strategic and financial goals, while reflecting the fall in share price over the performance period.
How we determine remuneration for Executive Directors and our wider colleague population The Committee seeks to be transparent in its approach to setting and delivering remuneration. Our policy for 2019 and the implementation report for 2019 can be found on pages 97 and 93.
2 The 2016 LTIP vesting and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 14 February 2019. 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.
For 2019: GCE: 33 per cent of base salary CFO: 25 per cent of base salary COO: 25 per cent of base salary
2 Variable remuneration is subject to malus and clawback. See page 94.
Lloyds Banking Group Annual Report and Accounts 2018 85 Strateg ic rep ort
Customer satisfaction / Digital active customer growth / Customer complaints Colleague engagement
Less than 75% of change indicators rated Green, over 15% rated Red
Over 92.5% of change indicators rated Green, less than 5% rated Red
Common Equity Tier 1 generation 210bps <140bps >200bps 1 Banking Standards Board measure combines the absolute and relative movement in one metric. Overall
Lloyds Banking Group Annual Report and Accounts 2018 87 Strateg ic rep ort
Group underlying profit target determined. Threshold set 20 per cent below target, below which no bonus payable.
Percentage of underlying profit used to fund Group Performance Share determined.
Executive Directors’ Group Performance Share outcome for 2018 (audited) Individual awards for Executive Directors are determined through the assessment of individual performance using the Group or their divisional balanced scorecard. Personal contribution may be considered where it diverges from scorecard outcomes. Awards will not be made if the Group does not meet threshold financial performance or if an individual is rated Developing or below.
Group Scorecard Rating Under Developing Good Minus Good Good Plus Strong
The Chief Operating Officer’s individual performance assessment for 2018 reflected the Chief Operating Office objectives, assessed as Strong. The individual block ratings and assessment are shown above.
Launched the third stage of the Group’s strategic plan with strategic investment of more than £3 billion over three years. Increased customer ‘net promoter’ score, with reduction in compliants, set against continuing legacy conduct issues and remediation. Further progress in building market leading savings and wealth proposition with agreed Schroders JV. Maintained colleague engagement above UK high-performing norm, with significant increase in skills training. Continued progress against Helping Britain Prosper targets. Financial performance above plan, allowing for increased return of capital to shareholders.
Very strong leadership of the Finance, Legal and Strategy division with excellent colleague engagement.
Fully supported the People transformation activities across the Group, delivering in excess of 1 million training and development hours for colleagues.
The Committee has an overarching discretion to reduce the level of award that will vest, regardless of whether the performance condition for partial or full vesting has been met. This qualitative judgement ensures that vesting is not simply driven by a formula that may give an unexpected or unintended remuneration outcome compared to Group performance. The Committee considers this discretion carefully, taking into account circumstances that are relevant to the performance measures and the period under consideration. No discretion has been applied in respect of the vesting outcome for the 2016 LTIP. This was discussed, but it was agreed that the formulaic outcomes were fair and reflective against the original targets set in 2016. Executive Directors are required to retain any vested shares for a further two years after vesting.
2 The FCA changed the approach to complaint classification and reporting from 30 June 2016. The Committee determined that the original target should be translated on a like-for-like basis into the new reporting requirement. The Committee was satisfied that the revised targets, set on a mechanical basis, were no less stretching.
Loss of office payments and payments within the reporting year to past Directors (audited) There were no payments for the loss of office during 2018. In April 2018, following a Court judgment in relation to Integration Awards granted under the Group’s Long-Term Incentive Plan (the LTIP) in 2009, 2,063,640 shares were released and £271,169 paid to John Eric Daniels, former Group Chief Executive and 1,424,778 shares were released and £386,167 paid to Truett Tate, former Executive Director.
Dec 2018Dec 2017Dec 2016Dec 2015Dec 2014Dec 2013Dec 2012Dec 2011Dec 2010Dec 2009Dec 2008
Sara Weller CBE 340,000 – – – – 340,000 n/a7 n/a 1 Including holdings of connected persons.
3 Deborah McWhinney resigned 31 December 2018. Shares held as at date of resignation.
5 Shareholdings held by Deborah McWhinney are either wholly or partially in the form of ADRs.
7 The changes in beneficial interests for António Horta-Osório (705 shares), George Culmer (614 shares) and Juan Colombás (615 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2018 and 20 February 2019. There have been no other changes up to 20 February 2019.
There is no appetite for non-compliance with the Shareholding Policy. In the event that exceptional individual circumstances exist resulting in an Executive not being able to comply with the Policy, the Remuneration Committee will consider whether an exception should apply.
Juan Colombás 1 Calculated using the average share price for the period 1 January 2018 to 31 December 2018 (62.554 pence). Includes ordinary shares acquired through the vesting of the deferred Group Performance Share plan, Fixed Share Awards as the shares have no performance conditions; American Deposit Receipts (ADRs) with each one ADR equating to four shares, Executive Share Awards which have vested but have not been exercised; shares held in the Share Incentive Plan (SIP) Trust, i.e. Free, Partnership, Matching and Dividend shares which are no longer subject to forfeiture, as defined in the SIP Rules. Shares held by Connected Persons, as defined by the Companies Act, but broadly meaning spouse or partner and children, may also be included.
None of those who were Directors at the end of the year had any other interest in the capital of Lloyds Banking Group plc or its subsidiaries.
Juan Colombás 1 The shares awarded in March 2015 vested on 12 March 2018. The closing market price of the Group’s ordinary shares on that date was 67.50 pence. Shares vested are subject to a further two-year holding period.
2 2015 LTIP award was eligible to receive an amount equal in value to any dividends paid during the performance period. Dividend equivalents have been paid based on the number of shares vested and have been paid in shares. The dividend equivalent shares were paid on 12 March 2018. The closing market price of the Group’s ordinary shares on that date was 67.50 pence. The dividend equivalent shares are not subject to any holding period.
4 Awards (in the form of conditional rights to free shares) in 2018 were made over shares with a value of 300 per cent of reference salary for António Horta-Osório (6,725,221 shares with a face value of £3,660,000); 275 per cent for George Culmer (3,860,925 shares with a face value of £2,101,193); and 275 per cent for Juan Colombás (3,807,302 shares with a face value of £2,072,010). The share price used to calculate face value is the average price over the five days prior to grant (27 February to 5 March 2018), which was 68.027 pence. As regulations prohibit the payment of dividend equivalents on awards in 2018 and subsequenet years, the number of shares awarded has been determined by applying a discount factor to the share price on award. An adjustment of 25 per cent was applied. Performance conditions for this award are set out in the table below.
Statutory economic profit1 Set relative to 2020 targets Threshold: £2,300m Maximum: £3,451m
Benefits remain unchanged from 2018. Executive Directors receive a flexible benefit 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 tax preparation and private medical cover.
Individual awards will be based on pre-determined formulaic pay out ranges commensurate with performance and will be determined by the Remuneration Committee through the assessment of individual performance via a balanced scorecard and personal performance considerations. The Group Chief Executive’s individual performance will be measured through the Group Balanced Scorecard, the Chief Financial Officer will be measured through the Finance Division scorecard and the Chief Operating Officer will be measured through the Chief Operating Office scorecard.
Additional disclosures CEO pay ratio The Group is committed to ensuring remuneration is competitive, performance-driven and fair. The Group has decided to publish the CEO pay ratio in advance of the formal disclosure requirement using the prescribed Methodology A, as shown in the table below together with an alternative view based on fixed pay.
2018 237:1 169:1 93:1 113:1 81:1 48:1 2017 245:1 177:1 97:1 113:1 82:1 48:1
Notes to the calculation: The P25, P50 and P75 colleagues were determined based on calculating total remuneration for all UK employees as at 31 December 2018. This methodology was selected on the basis that it provided the most accurate means of identifying the median, lower and upper quartile colleagues.
Annual effectiveness review During 2018, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.
Purpose and link to strategy To support the recruitment and retention of Executive Directors of the calibre required to develop and deliver the Group’s strategic priorities. Base salary reflects the role of the individual, taking account of market competitiveness, responsibilities and experience, and pay in the Group as a whole.
Core benefits include a company car or car allowance, private medical insurance, life insurance and other benefits that may be selected through the Group’s flexible benefits plan.
Maximum potential The Committee will make only increases in the benefits currently provided which it believes are consistent with the two parameters above. Executive Directors receive a flexible benefits allowance, in line with all other employees. The flexible benefits allowance does not currently exceed 4 per cent of base salary.
The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance. The Committee may reduce the level of award (including to zero), apply additional conditions to the vesting, or delay the vesting of deferred awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of 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.
Measures consist of both financial and non-financial measures and the weighting of these measures will be determined annually by the Committee. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance (as determined by the Committee) is not met for financial measures or the individual is rated ‘Developing performer’ or below. The expected value of the Group Performance Share is 30 per cent of maximum opportunity.
The measures are chosen to support the best bank for customers strategy and to align management and shareholder interests. Targets are set by the Committee to be stretching within the context of the strategic business plan. Measures are selected to balance profitability, achievement of strategic goals and to ensure the incentive does not encourage inappropriate risk-taking.
Operation The Group Performance Share and Group Ownership Share plans are both considered variable remuneration for the purpose of regulatory payment and deferral requirements. The payment of variable remuneration and deferral levels are determined at the time of award and in compliance with regulatory requirements (which currently require that at least 60 per cent of total variable remuneration is deferred for seven years with pro-rata vesting between the third and seventh year, and at least 50 per cent of total variable remuneration is paid in shares or other equity linked instruments subject to a holding period in line with current regulatory requirements).
The GCE and the Chairman are responsible for evaluating and making recommendations to the Board in relation to the fees of the NEDs.
When determining and reviewing fee and benefit levels, the Committee ensures that decisions are made within the following parameters: The individual’s skills and experience.
Fees and benefits for comparable roles in comparable publicly listed financial services groups of a similar size.
The Group has applied the EBA Delegated Regulation (EU) No 604/2014 to determine which colleagues should be identified as MRTs. MRTs are colleagues who are considered to have a material impact on the Group’s risk profile, and include, but are not limited to: Senior management, Executive Directors, members and attendees of the Group Executive Committee (GEC) and their respective executive level direct reports; Non-Executive Directors
Design and structure of remuneration When establishing the remuneration policy and associated frameworks, the Group is required to take into account its size, organisation and the nature, scope and complexity of its activities. For the purpose of remuneration regulation, Lloyds Bank plc is treated as a proportionality level I firm and therefore subject to the more onerous remuneration rules.
The table below summarises the different remuneration elements for MRTs (this includes control function staff) and non-MRTs.
Base salaries are reviewed annually, taking into account individual performance and market information. Further information on base salaries can be found on page 97 of the DRR.
Core benefits for UK-based colleagues include pension, private medical insurance, life insurance, car or car allowance (eligibility dependent on grade) and other benefits that may be selected through the Group’s flexible benefits plan. Further information on benefits and all-employee share plans can be found on pages 97 to 98 of the DRR. Benefits can be amended or withdrawn in the following circumstances: to reflect a change to colleague contractual terms; to reflect a change of grade; termination of employment with the Group; to reflect a change of Reward Strategy/benefit provision; if the award would be inconsistent with any statutory or tax requirements.
Senior Management, Executive Directors, members/ attendees of the GEC and their respective direct reports
The Group Performance Share (GPS) plan is an annual discretionary bonus plan. The plan is designed to reflect specific goals linked to the performance of the Group. The majority of colleagues and all MRTs participate in the GPS plan.
Individual GPS awards are based upon individual contribution, overall Group financial results and Balanced Scorecard ratings over the past financial year. The Group’s total risk-adjusted GPS outcome is determined by the Remuneration Committee annually as a percentage of the Group’s underlying profit, modified for: Group Balanced Scorecard performance
The GOS pays out in shares based on performance against Group financial and other non-financial strategic targets measured over a three-year period. Shares are released over a minimum three to five-year period and are then subject to a holding period (MRTs only) in line with regulatory requirements and market practice.
Further information on the GOS plan can be found on pages 98 and 99 of the DRR.
Approved Persons performing SIFs and/or all colleagues performing a Senior Management Function1
Guarantees, such as sign-on awards, may only be offered in exceptional circumstances to new hires for the first year of service and in accordance with regulatory requirements.
Takers4 1 Converted to Euros using the exchange rate €1 = £0.89135 (average exchange rate 1 December 2018 – 31 December 2018 based on the European Commission Budget exchange rates). The exchange rate used for 2017 was €1 = £0.88293.
3 Total number of Material Risk Takers earning more than €1m has decreased from 57 in 2017 to 53 in 2018.
Table 4 Total outstanding deferred variable remuneration Remuneration £m Total outstanding deferred variable remuneration at 31 December 2018
Table 5 Other payments awarded in relation to the 2018 performance year Guaranteed bonuses Sign-on awards Severance payments
Group risk appetite includes the following areas: Credit – the Group has a conservative and well-balanced credit portfolio through the economic cycle, generating an appropriate return on equity, in line with the Group’s target return on equity in aggregate.
The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by both the Board and senior management.
Financial reporting risk management systems and internal controls The Group maintains risk management systems and internal controls relating to the financial reporting process which are designed to: ensure that accounting policies are appropriately and consistently applied, transactions are recorded accurately, and undertaken in accordance with delegated authorities, that assets are safeguarded and liabilities are properly stated; enable the calculation, preparation and reporting of financial, prudential regulatory and tax outcomes in accordance with applicable International Financial Reporting Standards, statutory and regulatory requirements; enable annual certifications relating to maintenance of appropriate tax accounting by the Senior Accounting Officer in accordance with the 2009 Finance Act; ensure that disclosures are made on a timely basis in accordance with statutory and regulatory requirements (for example UK Finance Code for Financial Reporting Disclosure; US Sarbanes Oxley Act) and, as far as possible, consistent with best practice; ensure ongoing monitoring to assess the impact of emerging regulation and legislation on financial, prudential regulatory and tax reporting; and ensure an accurate view of the Group’s performance to allow the Board and senior management to appropriately manage the affairs and strategy of the business as a whole and each of its sub-groups.
The Chief Risk Officer regularly informs the Board Risk Committee of the aggregate risk profile and has direct access to the Chairman and members of Board Risk Committee.
– We work closely with regulatory authorities and industry bodies to ensure that the Group can identify and respond to the evolving regulatory and legal landscape. – We actively implement programmes to deliver legal, regulatory and mandatory change requirements. – We have implemented a programme to assess the legal impacts and risks of an EU exit (including a no deal outcome) and to identify appropriate mitigants, such as establishing EU entities to ensure continuity of certain business activities.
Specifically for the potential impacts of EU exit: – Executive forum considering and tracking developments and activity – Committed investments to establish new Group entities in the EU to ensure continuity of certain business activities, and contingency planning in relation to wider areas of impact – Group Corporate Treasury tracking market conditions closely and actively managing the Group’s balance sheet – Credit applications and sector reviews include assessment of EU exit risk. Initiatives to help clients effectively identify and manage associated risks – Review of the Group’s top EU suppliers to identify any impact on service provision and drive appropriate mitigating action – No deal EU exit outcome analysed to identify impacts and assess robustness of the Group’s contingency plans.
Competition: Adoption of technological trends is accelerating with customer preferences increasingly shaped by tech giants and other challengers who are able to exploit their own infrastructure and are impacted by different market dynamics. Regulation is focusing on lowering barriers for new entrants, which could have an adverse impact on our market position.
– The Group is transforming the business to improve customer experience by digitising customer journeys and leveraging branches for complex needs, in response to customers’ evolving needs and expectations. – The Group will deepen insight into customer segments, their perception of brands and what they value. – Agility will be increased by consolidating platforms and building new architecture aligned with customer journeys. – The Group is responsive to changing customer behaviour/business models and adjusts its risk management approach as appropriate
Transition from IBORs to Alternative Risk Free Reference Rates: Widely used benchmark rates, such as the London Interbank Offered Rate (‘LIBOR’), have been subject to increasing regulatory scrutiny, with regulators signalling the need to use alternative benchmark rates. As a result, existing benchmark rates may be discontinued or the basis on which they are calculated may change.
Scenario stress testing is used for: Risk Identification: Understand key vulnerabilities of the Group and its key legal entities under adverse economic conditions.
Strategic and Capital Planning: Allow senior management and the Boards of the Group and its applicable legal entities to adjust strategies if the plan does not meet risk appetite in a stressed scenario.
Support the Internal Capital Adequacy Assessment Process (ICAAP) by demonstrating capital adequacy, and meet the requirements of regulatory stress tests that are used to inform the setting of the Prudential Regulation Authority (PRA) and management buffers (see capital risk on pages 139 to 147) of the Group and its separately regulated legal entities.
Regulatory stress tests In 2018 the Group participated in both the concurrent UK stress test run by the Bank of England (BoE) and in the European Banking Authority’s (EBA) bi-annual EU-wide stress test. The EBA stress test did not contain a pass/ fail threshold and as announced in November, the Group demonstrated its ability to meet applicable capital requirements under stress conditions. In the case of the BoE stress test, despite the severity of the scenario, the Group exceeded the capital and leverage hurdles after the application of management actions and as a consequence was not required to take any capital actions.
Governance Clear accountabilities and responsibilities for stress testing are assigned to senior management and the Risk and Finance functions throughout the Group and its key legal entities. This is formalised through the Group Business Planning and Stress Testing Policy and Procedure, which are reviewed at least annually.
Risk appetite Risk appetite is defined within the Group as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate’ in delivering our Group Strategy (see the Group’s approach to risk page 106).
The Risk Directors reporting to the Chief Risk Officer: provide independent advice, oversight and challenge to the business; design, develop and maintain policies, specific functional risk type frameworks and guidance to ensure alignment with business imperatives and regulatory requirements; establish and maintain appropriate governance structures, culture, oversight and monitoring arrangements which ensure robust and efficient compliance with relevant risk type risk appetites and policies; lead regulatory liaison on behalf of the Group including horizon scanning and regulatory development for their risk type; and recommend risk appetite and provide oversight of the associated risk profile across the Group.
All business areas complete a Control Effectiveness Review (CER) annually, reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. The CER reports are approved at divisional risk committees or directly by the relevant member of the Group Executive Committee to confirm the accuracy of the assessment. This key process is overseen and independently challenged by Risk division, reviewed by Group Internal Audit against the findings of its assurance activities, and reported to the Board.
Company Secretariat supports senior and Board-level committees, and supports the Chairs in agenda planning. This gives a further line of escalation outside the three lines of defence.
Executive Credit Approval Committees Commercial Banking Credit Risk Committees Retail Credit Risk Committees
Conduct, compliance and operational risk Group Conduct, Compliance and Operational Risk Committee
Fraud and financial crime risk Group Fraud and Financial Crime Prevention Committee
Group Risk Committee (GRC) Responsible for the development, implementation and effectiveness of the Group’s Risk Management Framework, the clear articulation of the Group’s risk appetite and monitoring and reviewing of the Group’s aggregate risk exposures and concentrations of risk.
Group Asset and Liability Committee (GALCO) Responsible for the strategic direction of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. The committee reviews and determines the appropriate allocation of capital, funding and liquidity, and market risk resources and makes appropriate trade-offs between risk and reward.
Group Financial Risk Committee Responsible for oversighting, reviewing, challenging and recommending to senior executives and Board committees internal and Regulatory stress tests, Internal Capital Adequacy Assessment Process, Pillar 3 Disclosures, Recovery and Resolution Plans, and other analysis as required.
Group Capital Risk Committee Responsible for providing oversight of all relevant capital matters within the Group including the Group’s latest capital position and plans, risk appetite proposals, Pillar 2 developments, and the impact from regulatory reforms and accounting developments specific to capital.
In terms of loans and advances (for example mortgages, term loans and overdrafts) and contingent liabilities (for example credit instruments such as guarantees and documentary letters of credit), credit risk arises both from amounts advanced and commitments to extend credit to a customer or bank. With respect to commitments to extend credit, the Group is potentially exposed to a loss up to an amount equal to the total unutilised commitments. However, the likely amount of loss may be less than the total unutilised commitments, as most retail and certain commercial lending commitments may be cancelled based on regular assessment of the prevailing creditworthiness of customers. Most commercial term commitments are also contingent upon customers maintaining specific credit standards.
Limitations on concentration risk: there are portfolio controls on certain industries, sectors and products to reflect risk appetite as well as individual, customer and bank limit risk tolerances. Credit policies and appetite statements are aligned to the Group’s risk appetite and restrict exposure to higher risk countries and potentially vulnerable sectors and asset classes. Note 18(A) on page 255 provides an analysis of loans and advances to customers by industry (for commercial customers) and product (for retail customers). Exposures are monitored to prevent both an excessive concentration of risk and single name concentrations. These concentration risk controls are not necessarily in the form of a maximum limit on exposure, but may instead require new business in concentrated sectors to fulfil additional minimum policy and/or guideline requirements. The Group’s largest exposures are regularly monitored by the Board Risk Committee and reported in accordance with regulatory requirements.
Collateral held as security for financial assets other than loans and advances is determined by the nature of the underlying exposure. Debt securities, including treasury and other bills, are generally unsecured, with the exception of asset-backed securities and similar instruments such as covered bonds, which are secured by portfolios of financial assets. Collateral is generally not held against loans and advances to financial institutions. However, securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement. Derivative transactions with financial counterparties are typically collateralised under a Credit Support Annex (CSA) in conjunction with the International Swaps and Derivatives Association (ISDA) Master Agreement. Derivative transactions with non-financial customers are not usually supported by a CSA.
Additional mitigation for Retail customers The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using internal data and information held by Credit Reference Agencies (CRA).
The Group’s policy is to reject any application for a lending product where a customer is registered as bankrupt or insolvent, or has a recent County Court Judgment or financial default registered at a CRA used by the Group above de minimis thresholds. In addition, the Group typically rejects applicants where total unsecured debt, debt-to-income ratios, or other indicators of financial difficulty exceed policy limits.
Group loans and advances to customers The following pages contain analysis of the Group’s loans and advances to customers by sub-portfolio. Loans and advances to customers are categorised into the following stages: Stage 1 assets comprise newly originated assets (unless purchased or originated credit impaired), as well as those which have not experienced a significant increase in credit risk. These assets carry an expected credit loss (ECL) allowance equivalent to the ECL that result from those default events that are possible within 12 months of the reporting date (12 month ECL).
Stage 2 assets are those which have experienced a significant increase in credit risk since origination. These assets carry an ECL equivalent to the ECL arising over the lifetime of the asset (lifetime ECL).
Purchased or originated credit-impaired assets – – (15,290) (3,802) 19,092 1 Gross lending and ECL allowances are stated on IFRS 9 basis.
Table 1.7a: Group expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers (underlying basis)
Table 1.8a: Group Stage 2 loans and advances to customers (underlying basis)
At 1 January 20181,2 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 acquisition related adjustments.
2 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.
Asset quality ratio 0.25% 0.21% 4bp 1 Prior period comparatives are on an IAS39 basis. Includes Run-off, previously reported as a separate segment.
ECL allowances (drawn and undrawn) as a percentage of gross lending (%) 0.9 0.2 3.2 18.5 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 acquisition related adjustments.
Table 1.10c: Reconciliation between statutory and underlying basis of Retail expected credit loss allowances on drawn balances
Table 1.12: Retail Stage 2 loans and advances to customers (statutory basis)
5 Secured days past due segmentation restated to align with IFRS 9 classifications.
Table 1.12a: Retail Stage 2 loans and advances to customers (underlying basis)
Portfolios Secured credit quality remained strong, with flow to arrears stable at low levels. The average indexed loan to value (LTV) remained stable at 44.1 per cent (1 January 2018: 43.6 per cent) and the proportion of balances with an LTV of greater than 90 per cent remained low at 2.9 per cent (1 January 2018: 2.5 per cent). The average LTV of new business improved to 62.5 per cent (31 December 2017: 63.0 per cent). The closed Specialist mortgage portfolio continued to run off, reducing by a further £1.7 billion (11.0 per cent). Total Secured loans and advances decreased by £2.9 billion (1.0 per cent) to £289 billion (1 January 2018: £292 billion), due to reductions in the Buy-to-let and closed Specialist portfolios. The impairment charge was £38 million compared to a release of £15 million in 2017 arising from one-off write-backs. Total expected credit loss allowance as a percentage of loans and advances (coverage) remained flat.
Table 1.14: Mortgages greater than three months in arrears (excluding repossessions) (underlying basis)
Number of cases Total mortgage accounts Value of loans1 Total mortgage balances
1 Value of loans represents total gross book value of mortgages more than three months in arrears; the balances exclude the impact of HBOS related acquisition adjustments.
Average loan to value1: Stock of residential mortgages 41.7 53.0 47.4 43.6
New residential lending 63.7 59.1 n/a 63.0 1 Average loan to value is calculated as total loans and advances as a percentage of the total indexed collateral of these loans and advances; the balances exclude the impact of HBOS related acquisition adjustments.
Interest only mortgages The Group provides interest only mortgages to owner occupier mortgage customers whereby only payments of interest are made for the term of the mortgage with the customer responsible for repaying the principal outstanding at the end of the loan term. At 31 December 2018, owner occupier interest only balances as a proportion of total owner occupier balances had reduced to 26.7 per cent (31 December 2017: 29.0 per cent). The average indexed loan to value improved to 41.3 per cent (31 December 2017: 41.7 per cent).
Treatment strategies are in place to help customers anticipate and plan for repayment of capital at maturity and support those who may have difficulty in repaying the principal amount. A dedicated specialist team supports customers who have passed their contractual maturity date and are unable to fully repay the principal. A range of treatments are offered such as full (or part) conversion to capital repayment and extension of term to match the maturity dates of any associated repayment vehicles.
Total forbearance for the major retail portfolios has improved by £578 million to £7.0 billion driven by customers exiting probation and returning to order on the Secured portfolio. As a percentage of loans and advances, forbearance loans improved to 2.2 per cent at 31 December 2018 (1 January 2018: 2.4 per cent). 98.1 per cent of forbearance loans are captured in Stage 2 or Stage 3 for IFRS 9 and hold provision on a lifetime basis. Total expected credit losses (ECL) as a proportion of loans and advances which are forborne has increased to 9.4 per cent (1 January 2018: 8.6 per cent) due to prudent provisioning on the Secured portfolio.
The Group measures the success of a forbearance scheme for Retail Secured customers based upon the proportion of customers performing (less than or equal to three months in arrears) over the 24 months following the exit from a forbearance treatment. For temporary treatments, 80.4 per cent of UK Secured customers accepting reduced payment arrangements are performing. For permanent treatments, 83.2 per cent of UK Secured customers who have accepted capitalisations of arrears and 84.4 per cent of customers who have accepted term extensions are performing.
Internal and external key performance indicators are monitored closely to help identify early signs of any deterioration. Portfolios remain subject to ongoing risk mitigation actions as appropriate.
Net impairment charge for 2018 of £92 million compared with a net charge of £89 million in 2017.
Net impairment releases in Stage 1 and 2 were weighted towards non-SME portfolios and reflect a number of factors including transfers between stages (including to and from Stage 3), refinements to the IFRS 9 model methodology as well as adjustments to Multiple Economic Scenario impacts to reflect any changes to the underlying economic outlook.
Stage 2 loans as a proportion of total loans and advances to customers reduced to 6.5 per cent (1 January 2018: 7.7 per cent) as a result of transfers to Stage 1 and Stage 3. The proportion of Stage 1 loans increased to 90.3 per cent (1 January 2018: 89.6 per cent). Stage 2 ECL allowances as a percentage of Stage 2 drawn balances were lower at 5.1 per cent (1 January 2018: 5.6 per cent) due to changes in the mix of assets classified as Stage 2 and revisions to model assumptions.
ECL allowances (drawn and undrawn) as a percentage of gross lending (%) 1.5 0.1 5.6 35.3 1 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.
The Global Corporates business continues to have a predominance of multi-national investment grade clients who are primarily UK-based. The portfolio remains of good quality and is well positioned for the current economic outlook.
Focus remains on the UK market, on good quality customers, with a proven track record in Real Estate and where cash flows are robust.
Approximately 70 per cent of loans and advances to UK Direct Real Estate relate to commercial real estate with the remainder related to residential real estate. The portfolio continues to be heavily weighted towards investment real estate (c. 90 per cent) over development.
Investment Exposures > £1m 1 Excludes Commercial Banking UK Direct Real Estate exposures subject to protection through Significant Risk Transfer transactions.
The total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2018 and 31 December 2017 is shown in the table above. 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.
The Chief Security Office monitors developments within the Eurozone, carries out stress testing through detailed scenario analysis and completes appropriate due diligence on the Group’s exposures. The Group has predetermined action plans that would be executed in certain scenarios which set out governance requirements and responsibilities for the key actions which would be carried out and cover risk areas such as payments, liquidity and capital, communications, suppliers and systems, legal, credit, delivery channels and products, employees and the impact on customers.
Excluding reverse repurchase exposure to Institutional funds secured by UK gilts, the Group continues to have minimal exposure, in aggregate, which could be considered to be direct recourse to the sovereign risk of the selected countries Ireland, Spain, Portugal, Italy and Greece and following the £4 billion sale of the Irish residential mortgage portfolio during the year, exposures to the selected countries are significantly reduced.
In 2018 we developed an implementation plan to address key recommendations of the Task Force on Climate-related Financial Disclosure (TCFD). Further detail on planned activities is provided in the Sustainability Strategy and Task Force on Climate-related Financial Disclosure Statement (see pages 24 to 25).
Regulatory and legal risk Definition Regulatory and legal risk is defined as the risk that the Group is exposed to financial loss, fines, censure, or legal or enforcement action; or to civil or criminal proceedings in the courts (or equivalent) and/or the Group is unable to enforce its rights due to failing to comply with applicable laws (including codes of practice which could have legal implications), regulations, codes of conduct, legal obligations, or a failure to adequately manage actual or threatened litigation, including criminal proceedings.
Exposures Whilst the Group has a zero risk appetite for material regulatory breaches or material legal incidents, the Group remains exposed to them, driven by significant ongoing and new legislation, regulation and court proceedings in the UK and overseas which in each case needs to be interpreted, implemented and embedded into day-to-day operational and business practices across the Group.
Each of the tolerances for the metrics are agreed for the individual product or service and are regularly tracked. At a consolidated level these metrics are part of the Board risk appetite. The Group continues to evolve its approach to measurements supporting customer vulnerability, process delivery and customer journeys.
Conduct policies and procedures in place to ensure appropriate controls and processes that deliver fair customer outcomes.
Customer needs explicitly considered within business and product level planning and strategy, through divisional customer plans, with integral conduct lens, reviewed and challenged by Group Customer First Committee (GCFC).
Enhanced recruitment and training, with a focus on how the Group manages colleagues’ performance with clearer customer accountabilities.
Active engagement with regulatory bodies and other stakeholders to develop understanding of concerns related to customer treatment, effective competition and market integrity, to ensure that the Group’s strategic conduct focus continues to meet evolving stakeholder expectations.
Exposures The principal operational risks to the Group which could result in customer detriment, unfair customer outcomes, financial loss, disruption and/or reputational damage are: A cyber-attack; Change and execution risk in delivering the Group’s change agenda; Failure in IT systems, due to volume of change, and/or aged infrastructure; Failure to protect and manage the Group’s and customers’ data;
Execution, delivery and process management 25.52 24.26 30.03 8.91 1 2017 breakdowns have been restated to reflect a number of events that have been reclassified following an internal review.
The Group acknowledges the challenges faced with delivering new strategic initiatives and programmes alongside the extensive agenda of regulatory and legal changes whilst enhancing systems and controls. To address this, impacts of change are assessed in terms of the ability of the business to execute effectively and the potential impact on its risk profile. Key elements are monitored, including identifying resources and skills required to deliver change, critical dependencies and change readiness, while controls are also put in place to manage change activity and are monitored in line with the Group Change Policy. Execution and change risks and controls are reported through Group Transformation governance up to Board Risk Committee, and are recorded on key risk systems to allow for consolidation and aggregation. To supplement this, the Group takes a risk based approach to change oversight across the three lines of defence, encompassing delivery assurance, risk oversight and audit reviews focused on a combination of specific change activity and broad overarching themes.
The Group is making a significant investment to improve data, including the security of data and oversight of third-parties. The Group’s strategy is to introduce advanced data management practices, based on Group-wide standards, data-first culture and modern enterprise data platforms, supported by a simplified modern IT architecture.
Longevity and persistency are key risks within the life and pensions business. Longevity risk arises from the annuity portfolios where policyholders’ future cash flows are guaranteed at retirement and increases in life expectancy, beyond current assumptions, will increase the cost of annuities. Longevity risk exposures are expected to increase with the Insurance business growth in the annuity market. Persistency assumptions are set to give a best estimate; however customer behaviour may result in increased cancellations or cessation of contributions.
Mitigation Insurance underwriting risk in the Insurance business is mitigated in a number of ways: Strategic decisions made consider the maintenance of the current welldiversified portfolio of insurance risks; Processes for underwriting, claims management, pricing and product design seek to control exposure. Experts in demographic risk (for example longevity) support the propositions; General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements; Longevity risk transfer and hedging solutions are considered on a regular basis and since 2017 Insurance has reinsured £2.7 billion of annuitant longevity; and
Exposures A capital risk exposure arises when the Group has insufficient capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. This could arise due to a depletion of the Group’s capital resources as a result of the crystallisation of any of the risks to which it is exposed. Alternatively a shortage of capital could arise from an increase in the amount of capital that needs to be held either at Group level or at regulated entity or sub-group levels under the Group’s post ring-fence structure. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures while optimising value for shareholders.
At least 75 per cent of the 3.25 per cent minimum leverage ratio requirement and all regulatory buffers must be met by CET1 capital.
The capital plans also consider the impact of IFRS 9 which has the potential to increase bank capital volatility. Under stress this is primarily a result of provisioning for assets that are not in default at an earlier stage than would have been the case under IAS 39. In addition it currently remains unclear as to how the IFRS 9 requirement to reflect the outcome of multiple future economic scenarios within the calculation of the expected credit losses (ECL) allowance should be reflected in capital stress tests.
the Group’s Pillar 2A ICR set by the PRA. During the year the PRA reduced the Group’s ICR from 5.4 per cent to 4.6 per cent of riskweighted assets at 31 December 2018, of which 2.6 per cent must be met by CET1 capital. The requirement has increased to 4.7 per cent of risk-weighted assets, of which 2.7 per cent must be met by CET1 capital, from 1 January 2019 to reflect the commencement of the UK’s ringfencing regime.
the introduction of the SRB during 2019 for the RFB sub-group, which will require the Group to hold an equivalent monetary amount of capital.
Dividend policy The Group has established an ordinary dividend policy that is both progressive and sustainable, based on growing the ordinary dividend per share over time. The rate of growth of the ordinary dividend will be decided by the Board in light of the circumstances at the time.
Applying the Bank of England’s MREL policy to minimum capital requirements from 1 January 2019, the Group’s indicative MREL requirement, excluding regulatory capital buffers, is as follows: From 2020, 2 times Pillar 1 plus Pillar 2A, equivalent to 20.7 per cent of risk-weighted assets
Analysis of capital position The Group’s CET1 capital ratio increased by 2.10 per cent on a pro forma basis before ordinary dividends and the share buyback, primarily as a result of: Strong underlying capital build, net of remediation costs, of 1.95 per cent, largely driven by underlying profits
Excluding the Insurance dividend paid in February 2019 the Group’s CET1 ratio has strengthened to 15.8 per cent before ordinary dividends and the share buyback and 14.6 per cent after ordinary dividends (31 December 2017: 14.1 per cent).
The transitional total capital ratio, after ordinary dividends, increased by 1.7 per cent to 22.9 per cent, largely reflecting the issuance of new AT1 and dated subordinated debt instruments, foreign exchange movements on subordinated debt instruments, the reduction in the significant investments deduction from tier 2 capital, the increase in CET1 capital and the reduction in risk-weighted assets, partially offset by the amortisation of dated tier 2 instruments and the annual reduction in the transitional limit applied to grandfathered AT1 capital instruments.
Total capital requirement The Group’s total capital requirement (TCR) as at 31 December 2018, being the aggregate of the Group’s Pillar 1 and current Pillar 2A capital requirements, was £26,124 million (31 December 2017: £28,180 million).
Capital resources An analysis of the Group’s capital position as at 31 December 2018 is presented in the following section on both a CRD IV transitional arrangements basis and a CRD IV fully loaded basis. In addition the Group’s capital position reflects the application of the transitional arrangements for IFRS 9.
Table 1.27: Capital resources (audited) The table below summarises the consolidated capital position of the Group. The Group’s Pillar 3 Report will provide a comprehensive analysis of the own funds of the Group.
Excess of expected losses over impairment provisions and value adjustments (27) (498) (27) (498)
1 For regulatory capital purposes, the Group’s Insurance business is deconsolidated and replaced by the amount of the Group’s investment in the business. A part of this amount is deducted from capital (shown as ‘significant investments’ in the table above) and the remaining amount is risk-weighted, forming part of threshold risk-weighted assets.
Pension movements: Removal of defined benefit pension surplus (453) – – (453)
Excess of expected losses over impairment provisions and value adjustments 471 – – 471
Other movements 176 – – 176 1 Under the regulatory framework, profits made by Insurance are removed from CET1 capital. However, when dividends are paid to the Group by Insurance these are recognised through CET1 capital. The £750 million of dividends received from Insurance during the year include £600 million in respect of their 2017 full year ordinary dividend and £150 million in respect of their 2018 interim ordinary dividend.
2 Includes the accrual for the 2018 full year ordinary dividend and the reversal of the accrual for the 2017 full year ordinary dividend which was paid during the year.
CET1 capital resources have increased by £520 million over the year, primarily reflecting: – profit generation during the year – receipt of the dividends paid by the Insurance business in February 2018 and July 2018 – movements in treasury shares and the employee share schemes – a reduction in the deferred tax asset deduction – a reduction in excess expected losses resulting from the partial absorption of the increase in impairment provisions following the adoption of IFRS 9 on 1 January 2018 (remaining expected losses deducted from capital relate specifically to equity exposures), offset by the impact on retained earnings (net of transitional relief) – largely offset by the interim dividend paid in September 2018, the accrual for the 2018 full year ordinary dividend, the completion of the share buyback programme during the year, the increase in the defined benefit pension scheme surplus deduction, movements through the fair value through other comprehensive income (FVOCI) reserve and an increase in intangible assets which are deducted from capital
Tier 2 capital resources have increased by £1,365 million in the period largely reflecting the issuance of new dated subordinated debt instruments, foreign exchange movements and a reduction in the significant investments deduction following the redemption by Scottish Widows of a subordinated debt instrument issued to the Group, partially offset by the amortisation of dated instruments.
2 Until 2022, externally issued regulatory capital in operating entities can count towards the Group’s MREL to the extent that such capital would count towards the Group's consolidated capital resources.
3 The MREL ratio is 32.6 per cent on a pro forma basis reflecting the dividend paid by the Insurance business in February 2019 in relation to its 2018 earnings (31 December 2017: 26.0 per cent pro forma).
Total risk-weighted assets 206,366 210,919 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 investment in the Group’s Insurance business.
Asset quality increase of £1.1 billion captures movements due to changes in borrower risk, including moves in and out of default, and changes in the economic environment
The Solvency II regime for insurers and insurance groups came into force from 1 January 2016. The insurance businesses are required to calculate solvency capital requirements and available capital on a risk-based approach. The Insurance business of the Group calculates regulatory capital on the basis of an internal model, which was approved by the PRA on 5 December 2015, with the latest major change to the model approved in November 2018.
Definition Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding. Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due.
Mitigation The Group manages and monitors liquidity risks and ensures that liquidity risk management systems and arrangements are adequate with regard to the internal risk appetite, Group strategy and regulatory requirements. Liquidity policies and procedures are subject to independent internal oversight by Risk. Overseas branches and subsidiaries of the Group may also be required to meet the liquidity requirements of the entity’s domestic country. Management of liquidity requirements is performed by the overseas branch or subsidiary in line with Group Policy. Liquidity risk of the Insurance business is actively managed and monitored within the Insurance business. The Group plans funding requirements over the life of the funding plan, combining business as usual and stressed conditions. The Group manages its liquidity position with regard to its internal risk appetite and the Liquidity Coverage Ratio (LCR) required by the PRA and Capital Requirements Directive and Regulation (CRD IV) liquidity requirements.
The Group's strong ratings continue to reflect its robust balance sheet, improved profitability and bail-in capital position. During 2018, S&P upgraded Lloyds Bank plc’s long-term rating by one notch to ‘A+’ and S&P, Moody’s and Fitch assigned definitive ratings to Lloyds Bank Corporate Markets (LBCM) of A/A1/A respectively.
Financial assets at fair value through other comprehensive income – non-LCR eligible4
Cash and balances at central bank – non-LCR eligible5 5.8 4.8 21 4.8 21
2 Excludes reverse repos of £40.5 billion (1 January 2018: £16.8 billion; 31 December 2017: £16.8 billion).
4 Non-LCR eligible liquid assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
5 Cash and balances at central banks are combined in the Group’s balance sheet.
6 Other assets and other liabilities primarily include balances in the Group’s Insurance business and the fair value of derivative assets and liabilities.
The Group continues to access wholesale funding markets across a wide range of products, currencies and investors to maintain a stable and diverse source of funds. In 2019, the Group will continue with this approach to funding, including capital and funding from the holding company, Lloyds Banking Group plc, as needed to transition towards final UK Minimum Requirements for Own Funds and Eligible Liabilities (MREL). The Group will continue to issue funding trades from Lloyds Bank plc, operating company, across senior unsecured, covered bonds, ABS and RMBS. Over the course of 2019, the Group expects to launch an operating company funding programme for LBCM. The maturity of the Funding for Lending and Term Funding Schemes are fully factored into the Group’s funding plans, and in the expected ‘steady state’ wholesale funding requirements of £15-20 billion per annum.
Available-for-sale financial assets – – 19,526 19,526 – 21,514 – 1,058 22,572 42,098 1 Assets regarded by the Group to be readily realisable in the normal course of business, to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes.
The defined benefit pension schemes’ assets and liabilities are included under Other assets and Other liabilities in this table and note 35 on page 219 provides further information.
The Group’s trading book assets and liabilities are originated within the Commercial Banking division. Within the Group’s balance sheet these fall under the trading assets and liabilities and derivative financial instruments. The assets and liabilities are classified as trading books if they meet the requirements as set out in the Capital Requirements Regulation, article 104. Further information on these activities can be found under the Trading portfolios section on page 158.
The non-trading book primarily consists of customer on-balance sheet activities and the Group’s capital and funding activities, which expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices, as described in further detail within the Banking activities section (page 155).
Table 1.43 (below) shows the key material market risks for the Group’s banking, defined benefit pension schemes, insurance and trading activities.
Risk Type 2018 Interest rate Basis risk FX Credit spread Equity Inflation
Foreign exchange risk Economic foreign exchange exposure arises from the Group’s investment in its overseas operations (net investment exposures are disclosed in note 52 on page 255). In addition, the Group incurs foreign exchange risk through non-functional currency flows from services provided by customer-facing divisions and the Group’s debt and capital management programmes.
Credit spread risk Credit spread risk arises largely from (i) the liquid asset portfolio held in the management of Group liquidity, comprising of government supranational and other eligible assets; (ii) the Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA) sensitivity to credit spreads; and (iii) a number of the Group’s structured medium-term notes where we have elected to fair value the notes through the profit and loss account.
Table 1.45 below shows supplementary value sensitivity to a steepening and flattening (c.100 basis points around the 3 year point) in the yield curve. This ensures there are no unintended consequences to managing risk to parallel shifts in rates.
Table 1.45: Group Banking activities: market value sensitivity to a steepening and flattening of the yield curve
The increase in the net interest income sensitivity to a down 100bps shock reflects the additional margin compression risk within retail savings as bank base rate has risen.
The largest residual risk exposure arises from balances that are deemed to be insensitive to changes in market rates (including current accounts, a portion of variable rate deposits and investable equity), and is managed through the Group’s structural hedge. Consistent with the Group’s strategy to deliver stable returns, GALCO seeks to minimise large reinvestment risk, and to smooth earnings over a range of investment tenors. The structural hedge consists of longer-term fixed rate assets or interest rate swaps and the amount and duration of the hedging activity is reviewed regularly by GALCO.
Net investment foreign exchange exposures are managed centrally by GCT, by hedging non-sterling asset values with currency borrowing. Economic foreign exchange exposures arising from non-functional currency flows are identified by divisions and transferred and managed centrally. The Group also has a policy of forward hedging its forecasted currency profit and loss to year end.
Further stresses that show the effect of reasonably possible changes in key assumptions, including the risk-free rate, equity investment volatility, widening of credit default spreads on corporate bonds and an increase in illiquidity premia, as applied to profit before tax are set out in note 32, page 218.
All trading activities are performed within the Commercial Banking division. While the trading positions taken are generally small, any extreme moves in the main risk factors and other related risk factors could cause significant losses in the trading book depending on the positions at the time. The average 95 per cent 1-day trading VaR (Value at Risk; diversified across risk factors) was £0.8 million for 31 December 2018 compared to £0.6 million for 31 December 2017.
Trading market risk measures are applied to all of the Group’s regulatory trading books and they include daily VaR (table 1.48), sensitivity based measures, and stress testing calculations.
Table 1.48: Trading portfolios: VaR (1-day 95 per cent confidence level) (audited)
The market risk for the trading book continues to be low with respect to the size of the Group and compared to our peers. This reflects the fact that the Group’s trading operations are customer-centric and focused on hedging and recycling client risks.
This provides the basis for the Group Model Governance Policy, which defines the mandatory requirements for models across the Group, including: the scope of models covered by the policy; model materiality; roles and responsibilities, including ownership, independent oversight and approval; and key principles and controls regarding data integrity, development, validation, implementation, ongoing maintenance and revalidation, monitoring, and the process for non-compliance.
Monitoring The Group Model Governance Committee is the primary body for overseeing model risk. Policy requires that Key Performance Indicators are monitored for every model to ensure they remain fit for purpose and all issues are escalated appropriately. Material model issues are reported to Group and Board Risk Committees monthly with more detailed papers as necessary to focus on key issues.
Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) and applicable law. Our responsibilities under ISAs (UK) are further described in the Auditors’ responsibilities for the audit of the financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.
The key audit matters which were of most significance in the audit and involved the greatest allocation of our resources and effort were: – Expected credit loss allowances (Group)
Capability of the audit in detecting irregularities, including fraud Based on our understanding of the Group and industry, we identified that the principal risks of non‑compliance with laws and regulations related to breaches of banking laws and regulations such as, but not limited to, regulations relating to consumer credit and unethical and prohibited business practices, and we considered the extent to which non‑compliance might have a material effect on the financial statements. We also considered those laws and regulations that have a direct impact on the financial statements such as the Companies Act 2006, the Consumer Credit Act 1974 and the Banking Reform Act. We evaluated management’s incentives and opportunities for fraudulent manipulation of the financial statements (including the risk of override of controls), and determined that the principal risks were related to posting manual journal entries to manipulate financial performance, management bias through judgements and assumptions in significant accounting estimates and significant one‑off or unusual transactions. The Group engagement team shared this risk assessment with the component auditors referred to in the scoping section of our report below, so that they could include appropriate audit procedures in response to such risks in their work. Audit procedures performed by the Group engagement team and/or component auditors included: – Discussions with management and those charged with governance including consideration of known or suspected instances of non‑compliance with laws and regulation and fraud; – Evaluation and testing of the operating effectiveness of management’s entity level controls designed to prevent and detect irregularities, in particular their code of conduct and whistleblowing helpline; – Assessment of matters reported on the Group’s whistleblowing helpline and the results of management’s investigation of such matters; – Performed testing over period end adjustments; – Incorporated unpredictability into the nature, timing and/or extent of our testing; – Reviewing key correspondence with the FCA and PRA; – Challenging assumptions and judgements made by management in their significant accounting estimates, in particular in relation to expected credit losses; conduct risk and provisions; insurance actuarial assumptions; valuation of certain level 3 financial instruments; and defined benefit obligation (see related key audit matters below); and – Identifying and testing journal entries, in particular any manual journal entries posted by infrequent users or senior management, posted on unusual days, posted with descriptions indicating a higher level of risk, or posted late with a favourable impact on financial performance.
Overall materiality £360 million (2017: £350 million). £360 million (2017: £350 million).
Where the work was performed by component auditors, we determined the level of involvement we needed to have in their audit work to be able to conclude whether sufficient appropriate audit evidence had been obtained as a basis for our opinion on the consolidated financial statements as a whole. This included regular communication with the component auditors throughout the audit, the issuance of instructions, a review of the results of their work on the key audit matters and formal clearance meetings.
We also independently ran the Group’s model and performed testing to evaluate the level of non‑linearity reflected in the expected credit loss allowances.
– The review, challenge and approval of the expected credit loss allowances, including the impairment model outputs, key management judgements and overlays applied.
We performed testing over the measurement of the overlays in place, focusing on the larger overlays and those which we considered to represent the greatest level of audit risk (e.g. overlays relating to past term interest‑only exposures and forbearance on the UK mortgages portfolio). We assessed the appropriateness of methodologies used to determine and quantify the overlays required and the reasonableness of key assumptions. Based on our knowledge and understanding of the weaknesses and limitations in management’s models and industry emerging risks, we critically assessed the completeness of the overlays proposed by management.
Commercial Banking Stage 3 assets We performed the following procedures to test the completeness of credit impaired assets requiring a Stage 3 expected credit loss allowance: – We critically assessed the criteria for determining whether a credit impairment event had occurred; – We tested a risk based sample of Stage 1 and 2 loans, utilising industry and insolvency specialists to support the audit team in identifying sectors or borrowers with risk characteristics which might imply an indicator of impairment. For each risk based sample, as well as an additional haphazardly selected sample of Stage 1 and 2 loans, we independently assessed whether they had indicators of a credit impairment event (e.g. a customer experiencing financial difficulty or in breach of covenant) and therefore whether they were appropriately categorised.
For a sample of stage 3 credit impaired loans, we: – Evaluated the basis on which the allowance was determined, and the evidence supporting the analysis performed by management; – We independently challenged whether the key assumptions used, such as the recovery strategies, collateral rights and ranges of potential outcomes, were appropriate, given the borrower’s circumstances; and
Conduct risk and provisions Group Refer to page 70 (Audit Committee Report), page 177 (Accounting Policies) and page 226 (Note 37 and Critical Accounting Estimates and Judgements). Provisions reflecting the Group’s best estimate of present obligations relating to anticipated customer redress payments, operational costs and regulatory fines as a result of past events, practices and conduct continue to be significant and therefore represent a key audit matter.
The most significant provisions relate to past sales of payment protection insurance (PPI) policies, arrears handling activities, packaged bank accounts and customer claims in relation to insurance products sold by the German branch of Clerical Medical Investment Group Ltd (now Scottish Widows Ltd).
Our work focused on the more significant provisions in relation to past sales of payment protection insurance (PPI) policies, arrears handling activities, packaged bank accounts and customer claims in relation to insurance products sold by the German branch of Clerical Medical Investment Group Ltd (now Scottish Widows Ltd). We also examined other conduct provisions which are individually less significant.
For the provisions which are based on assumptions determined using management judgement with reference to historic experience, we understood and challenged the provisioning methodologies and underlying assumptions, including whether historic information had been appropriately incorporated and whether this was an appropriate indicator of future experience. For example, we challenged the basis that management used for forecasting the volume of PPI complaints that will be received in the future.
For provisions which are dependent upon proactive identification and rectification of affected customers (e.g. provisions for arrears handling activities), we understood the planned management actions, understood the basis for estimating the provision and challenged key assumptions, including those around the costs of identifying and rectifying affected customers.
We considered regulatory developments and reviewed the Group’s correspondence with the Financial Conduct Authority and Prudential Regulation Authority, discussing the content of any correspondence considered to be pertinent to our audit with management. We also met with each regulator.
Insurance actuarial assumptions Group Refer to page 70 (Audit Committee Report), page 177 (Accounting Policies) and pages 210, 215 and 218 (Notes 24, 31, 32 and Critical Accounting Estimates and Judgements). A number of subjective assumptions about future experience contribute as key inputs into the valuation of the Group’s insurance contracts, participating investment contracts (‘insurance contract liabilities‘) and value of in‑force business asset.
For longevity, we assessed the appropriateness of how the Group’s own experience and industry data were used in setting future assumptions and we compared resulting life expectancies to benchmarking data.
For maintenance expenses, we assessed the appropriateness of the judgements in respect of costs deemed to be non‑attributable to insurance business and the resulting per‑policy costs assumptions. We reviewed the adjustments required reflecting the impact of the Group’s outsourcing agreements, including any changes to the cost base that are expected to be required due to Brexit.
We engaged our actuarial experts and met with management and their actuary to understand the judgements made in determining key economic assumptions used in the calculation of the liability. We assessed the reasonableness of those assumptions by comparing to our own independently determined benchmarks and concluded that the assumptions used by management were appropriate.
The Group's application of hedge accounting, including determining effectiveness, is manual in nature, which increases the risk of errors and hence the risk that financial reporting is not in line with IFRS requirements.
As part of our audit work in prior periods, we identified control matters in relation to the management of IT privileged access to IT platforms supporting applications in‑scope for financial reporting. While there is an ongoing programme of activities to address such control matters, the fact that these were open during the period meant there was a risk that automated functionality, reports and data from the systems were not reliable.
We tested the design and operating effectiveness of those key controls identified that manage IT privileged access across the in‑scope IT platforms. Specifically we tested controls over: – The completeness and accuracy of the Access Controls Lists (ACLs) from IT platforms that are used by downstream IT security processes; – The onboarding and management of IT privileged accounts through the privileged access restriction tool (including static IT privileged accounts); – The monitoring of security events on IT platforms by the Security Operations Centre; and
In reviewing the directors’ statement, we have considered the Group and parent company budgets, and the Group and parent company’s capital and liquidity plans, resources and stress tests.
In light of the knowledge and understanding of the Group and parent company and their environment obtained in the course of the audit, we did not identify any material misstatements in the Strategic Report and Directors’ Report. (CA06)
Directors’ Remuneration In our opinion, the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006. (CA06)
Mark Hannam (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 19 February 2019
Diluted earnings per share 15 5.5p 4.3p 2.9p 1 The profit after tax attributable to other equity holders of £433 million (2017: £415 million; 2016: £412 million) is partly offset in reserves by a tax credit attributable to ordinary shareholders of £106 million (2017: £102 million; 2016: £91 million) .
Items that will not subsequently be reclassified to profit or loss: Post‑retirement defined benefit scheme remeasurements: Movements in revaluation reserve in respect of equity shares held at fair value through other comprehensive income: Change in fair value (97)
Other comprehensive income for the year, net of tax (113) (395) 1,574
Financial assets at fair value through other comprehensive income 21 24,815 42,917
Currency translation differences (tax: £nil) – (32) – (32) – – (32)
Cash and cash equivalents at end of year 53(D) 55,224 60,982 62,388
Cash and cash equivalents at 1January 2018 58,708 1 See note 1.
Note 1: Basis of preparation The consolidated financial statements of Lloyds Banking Group plc have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the IFRS Interpretations Committee (IFRS IC) and its predecessor body. As noted below, in adopting IFRS 9, the Group has elected to continue applying hedge accounting under IAS 39. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is no difference in application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.
Impairment: IFRS 9 replaces the IAS 39 ‘incurred loss’ impairment approach with an ‘expected credit loss’ approach. The revised approach applies to financial assets including finance lease receivables, recorded at amortised cost or fair value through other comprehensive income; loan commitments and financial guarantees that are not measured at fair value through profit or loss are also in scope. The expected credit loss approach requires an allowance to be established upon initial recognition of an asset reflecting the level of losses anticipated after having regard to, amongst other things, expected future economic conditions. Subsequently the amount of the allowance is affected by changes in the expectations of loss driven by changes in associated credit risk.
In adopting IFRS 9, the Group has reclassified loans and advances to banks with a maturity of less than three months totalling £2,274 million to financial assets measured at fair value through profit or loss, resulting in a corresponding reduction in cash and cash equivalents at 1 January 2018 compared to the amount previously reported at 31 December 2017.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2018 and which have not been applied in preparing these financial statements are given in note 55.
Notes to the consolidated financial statements continued less than a majority beneficial interest. Where a collective investment vehicle is consolidated the interests of parties other than the Group are reported in other liabilities and the movement in these interests in interest expense.
Financial liabilities are derecognised when the obligation is discharged, cancelled or expires.
(5) Sale and repurchase agreements (including securities lending and borrowing) Securities sold subject to repurchase agreements (repos) continue to be recognised on the balance sheet where substantially all of the risks and rewards are retained. Funds received under these arrangements are included in deposits from banks, customer deposits, or trading liabilities. Conversely, securities purchased under agreements to resell (reverse repos), where the Group does not acquire substantially all of the risks and rewards of ownership, are recorded as loans and advances measured at amortised cost or trading securities. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method.
At initial recognition, allowance (or provision in the case of some loan commitments and financial guarantees) is made for expected credit losses resulting from default events that are possible within the next 12 months (12‑month expected credit losses). In the event of a significant increase in credit risk since origination, allowance (or provision) is made for expected credit losses resulting from all possible default events over the expected life of the financial instrument (lifetime expected credit losses). Financial assets where 12‑month expected credit losses are recognised are considered to be Stage 1; financial
Note 2: Accounting policies continued assets which are considered to have experienced a significant increase in credit risk since initial recognition are in Stage 2; and financial assets which have defaulted or are otherwise considered to be credit impaired are allocated to Stage 3. Some Stage 3 assets, mainly in Commercial Banking, are subject to individual rather than collective assessment. Such cases are subject to a risk‑based impairment sanctioning process, and these are reviewed and updated at least quarterly, or more frequently if there is a significant change in the credit profile.
An assessment of whether credit risk has increased significantly since initial recognition considers the change in the risk of default occurring over the remaining expected life of the financial instrument. The assessment is unbiased, probability‑weighted and uses forward‑looking information consistent with that used in the measurement of expected credit losses. In determining whether there has been a significant increase in credit risk, the Group uses quantitative tests based on relative and absolute probability of default (PD) movements linked to internal credit ratings together with qualitative indicators such as watchlists and other indicators of historical delinquency, credit weakness or financial difficulty. However, unless identified at an earlier stage, the credit risk of financial assets is deemed to have increased significantly when more than 30 days past due. Where the credit risk subsequently improves such that it no longer represents a significant increase in credit risk since origination, the asset is transferred back to Stage 1.
Purchased or originated credit‑impaired financial assets (POCI) are financial assets that are purchased or originated at a deep discount that reflects incurred credit losses. At initial recognition, POCI assets do not carry an impairment allowance; instead, lifetime expected credit losses are incorporated into the calculation of the effective interest rate. All changes in lifetime expected credit losses subsequent to the assets’ initial recognition are recognised as an impairment charge.
Scheme assets are included at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the balance sheet date on high‑quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability. The Group’s income statement charge includes the current service cost of providing pension benefits, past service costs, net interest expense (income), and plan administration costs that are not deducted from the return on plan assets. Past service costs, which represents the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment, are recognised when the plan amendment or curtailment occurs. Net interest expense (income) is calculated by applying the discount rate at the beginning of the period to the net defined benefit liability or asset.
Liabilities Changes in the value of liabilities are recognised in the income statement through insurance claims. – Insurance and participating investment contracts in the Group’s with‑profit funds
Provision is made for expected credit losses in respect of irrevocable undrawn loan commitments and financial guarantee contracts (see (H) above).
Significant increase in credit risk Performing assets are classified as either Stage 1 or Stage 2. An ECL allowance equivalent to 12 months expected losses is established against assets in Stage 1; assets classified as Stage 2 carry an ECL allowance equivalent to lifetime expected losses. Assets are transferred from Stage 1 to Stage 2 when there has been a significant increase in credit risk (SICR) since initial recognition.
The table below shows the impact on the Group’s ECL resulting from a decrease/increase in Loss Given Default for a 10 percentage point (pp) increase/ decrease in the UK House Price Index (HPI).
The value of in‑force business asset represents the present value of future profits expected to arise from the portfolio of in‑force life insurance and participating investment contracts. The valuation of this asset requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to this asset. The methodology used to value this asset and the key assumptions that have been made in determining the carrying value of the value of in‑force business asset at 31 December 2018 are set out in note 24.
The Group’s expectations as to the level of future taxable profits take into account the Group’s long‑term financial and strategic plans, and anticipated future tax‑adjusting items. In making this assessment, account is taken of business plans, the Board‑approved operating plan and the expected future economic outlook as set out in the strategic report, as well as the risks associated with future regulatory change.
As disclosed in note 36, deferred tax assets totalling £585 million (2017: £683 million) have not been recognised in respect of certain capital and trading losses carried forward, unrelieved foreign tax credits and other tax deductions, as there are currently no expected future taxable profits against which these assets can be utilised.
Payment protection insurance and other regulatory provisions At 31 December 2018, the Group carried provisions of £2,385 million (2017: £4,070 million) against the cost of making redress payments to customers and the related administration costs in connection with historical regulatory breaches, principally the mis‑selling of payment protection insurance (2018 £1,524 million; 2017: £2,778 million).
Fair value of financial instruments At 31 December 2018, the carrying value of the Group’s financial instrument assets held at fair value was £206,939 million (2017: £230,810 million), and its financial instrument liabilities held at fair value was £51,920 million (2017: £77,001 million).
The Group Executive Committee (GEC) has been determined to be the chief operating decision maker for the Group. The Group’s operating segments reflect its organisational and management structures. The GEC reviews the Group’s internal reporting based around these segments in order to assess performance and allocate resources. GEC considers interest income and expense on a net basis and consequently the total interest income and expense for all reportable segments is presented net. The segments are differentiated by the type of products provided and by whether the customers are individuals or corporate entities.
Segment underlying income, net of insurance claims 11,237 4,657 1,988 842 18,724
Insurance and other, net of insurance claims 247 358 2,146 (1,089) 1,662
Total underlying income, net of insurance claims 10,927 4,828 1,979 791 18,525
Segment underlying income, net of insurance claims 10,927 4,828 1,979 791 18,525
Insurance and other, net of insurance claims 6 27 2,223 (129) 2,127
Segment other income, net of insurance claims 2,221 1,798 1,846 340 6,205
Note 4: Segmental analysis continued Reconciliation of underlying basis to statutory results The underlying basis is the basis on which financial information is presented to the chief operating decision maker which excludes certain items included in the statutory results. The table below reconciles the statutory results to the underlying basis.
Geographical areas Following the reduction in the Group’s non‑UK activities, an analysis between UK and non‑UK activities is no longer provided.
Debt securities held at amortised cost 1.60 1.29 1.47 66 43 56
Fee and commission income: Credit and debit card fees 993 953 875
During the year, the auditors also earned fees payable by entities outside the consolidated Lloyds Banking Group in respect of the following: 2018 £m 2017 £m 2016 £m
Acquisition due diligence and other work performed in respect of potential venture capital investments – 0.1 1.0
Note 14: Taxation (A) Analysis of tax expense for the year 2018 £m 2017 £m 2016 £m
Foreign tax: Current tax on profit for the year (34) (40) (20)
(Derecognition) recognition of losses that arose in prior years (9) – 59
Tax effect of share of results of joint ventures – (1) (1)
Tax credit on distributions to other equity holders 106 102 91 2018 million 2017 million 2016 million
There were no forecast transactions for which cash flow hedge accounting had to cease in 2018 as a result of the highly probable cash flows no longer being expected to occur.
Stage 2 balances show a large reduction in the year largely as a result of the refinements to the transfer criteria approach in mortgages.There is also a reduction from the disposal of the Irish mortgage portfolio together with improvements in credit quality.
Later than 1 year and not later than 5 years 679 887
Other items charged to the income statement (58) (107) 696 – 531
Other items charged to the income statement (14) (43) (8) – (65)
Total financial assets at fair value through other comprehensive income 24,815 42,917
A market‑consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. Further information on options and guarantees can be found in note 31.
Risk‑free rate (value of in‑force annuity business) 1 1.28 to 5.33 1.14 to 5.34
Balance sheet amount at 31 December 2018 3,770 1,000 2,709 4,821 12,300
Total future minimum sub‑lease income of £60 million at 31 December 2018 (£71 million at 31 December 2017) is expected to be received under non‑cancellable sub‑leases of the Group’s premises.
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2018 was £15,435 million, which was £8,350 million higher than the balance sheet carrying value (2017: £14,224 million, which was £6,412 million higher than the balance sheet carrying value). At 31 December 2018 there was a cumulative £386 million decrease in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount a decrease of £533 million arose in 2018 and an increase of £52 million arose in 2017.
The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to these arrangements and the carrying value of the notes in issue at 31 December, are listed below. The notes in issue are reported in note 29.
Note 31: Liabilities arising from insurance contracts and participating investment contracts continued
(ii) Method of calculation of liabilities The non‑profit fund liabilities are determined on the basis of recognised actuarial methods and involve estimating future policy cash flows over the duration of the in‑force book of policies, and discounting the cash flows back to the valuation date allowing for probabilities of occurrence.
The movements in non‑life insurance contract liabilities and reinsurance assets over the year have been as follows: 2018 £m 2017 £m
9 This sensitivity shows the impact of a 10 basis point increase in the allowance for illiquidity premia. It assumes the overall spreads on assets are unchanged and hence market values are unchanged. Swap curves and the non‑annuity risk‑free rate are both assumed to be unchanged. The increased illiquidity premium increases the annuity risk‑free rate.
Pension schemes Defined benefit schemes (i) Characteristics of and risks associated with the Group’s schemes The Group has established a number of defined benefit pension schemes in the UK and overseas. All significant schemes are based in the UK, with the three most significant being the defined benefit section of the Lloyds Bank Pension Schemes No. 1, the Lloyds Bank Pension Scheme No. 2 and the HBOS Final Salary Pension Scheme. At 31 December 2018, these schemes represented 94 per cent of the Group’s total gross defined benefit pension assets (2017: 95 per cent). These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2018 is generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
During 2009, the Group made one‑off contributions to the Lloyds Bank Pension Scheme No 1 and Lloyds Bank Pension Scheme No 2 in the form of interests in limited liability partnerships for each of the two schemes which hold assets to provide security for the Group’s obligations to the two schemes. At 31 December 2018, the limited liability partnerships held assets of approximately £6.7 billion. The limited liability partnerships are consolidated fully in the Group’s balance sheet.
Debt instruments1: Fixed interest government bonds 7,449 – 7,449 5,344 – 5,344
Weighted‑average rate of increase for pensions in payment 2.73 2.73 2018 Years 2017 Years
Investment risk: Scheme assets are invested in a diversified portfolio of debt securities, equities and other return‑seeking assets. If the assets underperform the discount rate used to calculate the defined benefit obligation, it will reduce the surplus or increase the deficit. Volatility in asset values and the discount rate will lead to volatility in the net pension asset on the Group’s balance sheet and in other comprehensive income. To a lesser extent this will also lead to volatility in the pension expense in the Group’s income statement.
2 At 31 December 2018, the assumed discount rate is 2.90 per cent (2017: 2.59 per cent) .
The inflation assumption sensitivity applies to both the assumed rate of increase in the Consumer Prices Index (CPI) and the Retail Prices Index (RPI), and include the impact on the rate of increases to pensions, both before and after retirement. These pension increases are linked to inflation (either CPI or RPI) subject to certain minimum and maximum limits.
Duration of the defined benefit obligation 18 19 2018 £m 2017 £m
For the principal post‑retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 2018 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 6.81 per cent (2017: 6.81 per cent).
Impact of acquisitions and disposals – – – – – 3 3
Adjustment on adoption of IFRS 9 and IFRS 15 (note 54) – – – 322 – 3 325
Other (charge) credit to equity – – – – (5) – (5)
Impact of acquisitions and disposals – (157) – – – (2) (159)
Deferred tax not recognised No deferred tax has been recognised in respect of the future tax benefit of certain expenses of the life assurance business carried forward. The deferred tax asset not recognised in respect of these expenses is approximately £371 million (2017: £470 million), and these expenses can be carried forward indefinitely. The unrecognised deferred tax asset has reduced in 2018, as the Group's utilisation estimate has improved over the year.
The total amount provided for PPI represents the Group’s best estimate of the likely future cost. However a number of risks and uncertainties remain including with respect to future complaint volumes. The cost could differ from the Group’s estimates and the assumptions underpinning them, and could result in a further provision being required. There is also uncertainty around the impact of the regulatory changes, Financial Conduct Authority media campaign and Claims Management Company and customer activity, and potential additional remediation arising from the continuous improvement of the Group’s operational practices.
For every additional 1,000 reactive complaints per week above 13,000 on average from January 2019 through to the industry deadline of the end of August 2019, the Group would expect an additional charge of approximately £85 million.
Payment protection insurance (MBNA) As announced in December 2016, the Group’s exposure is capped at £240 million, which is already provided for through an indemnity received from Bank of America. MBNA increased its PPI provision by £100 million in the year ended 31 December 2018 but the Group’s exposure continues to remain capped at £240 million under the arrangement with Bank of America, notwithstanding this increase by MBNA.
Note 37 Other provisions continued Other provisions for legal actions and regulatory matters In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints in connection with its past conduct and claims brought by or on behalf of current and former employees, customers, investors and other third parties and is subject to legal proceedings and other legal actions. Where significant, provisions are held against the costs expected to be incurred in relation to these matters and matters arising from related internal reviews. During the year ended 31 December 2018 the Group charged a further £600 million in respect of legal actions and other regulatory matters, and the unutilised balance at 31 December 2018 was £861 million (31 December 2017: £1,292 million). The most significant items are as follows.
Customer claims in relation to insurance branch business in Germany The Group continues to receive claims in Germany from customers relating to policies issued by Clerical Medical Investment Group Limited (subsequently renamed Scottish Widows Limited), with smaller numbers received from customers in Austria and Italy. The industry‑wide issue regarding notification of contractual ‘cooling off’ periods continued to lead to an increasing number of claims in 2016 and 2017 levelling out in 2018. Up to 31 December 2017 the Group had provided a total of £639 million, with no further amounts provided during the year ended 31 December 2018. The validity of the claims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will be known only once all relevant claims have been resolved.
Other Following the sale of TSB Banking Group plc, the Group raised a provision of £665 million in relation to various ongoing commitments; £168 million of this provision remained unutilised at 31 December 2018.
The Group carries provisions of £122 million (2017: £136 million) for indemnities and other matters relating to legacy business disposals in prior years.
Preferred securities £m 7.627% Fixed to Floating Rate Guaranteed Non‑voting Non‑cumulative Preferred Securities 4.385% Step‑up Perpetual Capital Securities callable 2017 (€750 million) 74
These securities will, in the event of the winding‑up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during 2018 (2017: none).
Redesignation of limited voting ordinary shares (see below) – 80,921,051 – – 8 –
Information regarding significant direct or indirect holdings of shares in the Company can be found on page 80.
Revaluation reserve in respect of equity shares held at fair value through other comprehensive income 5
The capital redemption reserve represents transfers from distributable reserve in accordance with companies’ legislation upon the redemption of ordinary and preference share capital.
Foreign currency gains on net investment hedges (tax: £nil) – (11) 106
Adjustment on adoption of IFRS 9 and IFRS 15 (note 54) (929)
Issue costs of other equity instruments (net of tax) (note 43) (5) – –
Other employee award schemes 207 332 168 1 In 2017 and 2016, net of a credit in respect of unclaimed dividends written‑back in accordance with the Company’s Articles of Association.
The weighted average fair value of SAYE options granted during 2018 was £0.13 (2017: £0.15). The fair values of the SAYE options have been determined using a standard Black‑Scholes model.
At the end of the performance period for the 2015 grant, the targets had not been fully met and therefore these awards vested in 2018 at a rate of 66.3 per cent.
Share Incentive Plan Free Shares An award of shares may be made annually to employees up to a maximum of £3,000. The shares awarded are held in trust for a mandatory period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The award is subject to a non‑market based condition. If an employee leaves the Group within this three year period for other than a ‘good’ reason, all of the shares awarded will be forfeited.
Matching shares The Group undertakes to match shares purchased by employees up to the value of £45 per month; these matching shares are held in trust for a mandatory period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The award is subject to a non‑market based condition: if an employee leaves within this three year period for other than a ‘good’ reason, 100 per cent of the matching shares are forfeited. Similarly if the employees sell their purchased shares within three years, their matching shares are forfeited.
Granted, including certain adjustments (includes entitlements of appointed key management personnel) – – 3
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other transactions between the Group and its key management personnel: 2018 £m 2017 £m 2016 £m
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 6.70 per cent and 24.20 per cent in 2018 (2017: 6.45 per cent and 23.95 per cent; 2016: 2.49 per cent and 23.95 per cent).
No provisions have been recognised in respect of loans given to key management personnel (2017 and 2016: £nil).
UK shareholder litigation In August 2014, the Group and a number of former directors were named as defendants in a claim by a number of claimants who held shares in Lloyds TSB Group plc (LTSB) prior to the acquisition of HBOS plc, alleging breaches of duties in relation to information provided to shareholders in connection with the acquisition and the recapitalisation of LTSB. The defendants refute all claims made. A trial commenced in the English High Court on 18 October 2017 and concluded on 5 March 2018 with judgment to follow. It is currently not possible to determine the ultimate impact on the Group (if any).
Other commitments and guarantees 85,060 85,015 1 year or over original maturity 37,712 39,074
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £64,884 million (2017: £65,946 million) was irrevocable.
Later than 1 year and not later than 5 years 807 845
During the year the Group has not provided any non‑contractual financial or other support to these entities and has no current intention of providing any financial or other support. There were no transfers from/to these unconsolidated collective investment vehicles and limited partnerships.
Cash and balances at central banks – – – – – 54,663 – 54,663
Debt securities in issue – – – – – 91,168 – 91,168
Liabilities arising from non‑participating investment contracts – – – – – 15,447 15,447
(2) Fair value measurement Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is a measure as at a specific date and may be significantly different from the amount which will actually be paid or received on maturity or settlement date.
Total financial assets at fair value through profit or loss 93,731 50,881 13,917 158,529
(Losses) gains recognised in other comprehensive income within the revaluation reserve in respect of financial assets at fair value through other comprehensive income (2017: available‑for‑sale financial assets) – (4) (4) – (117) (117)
Where credit protection, usually in the form of credit default swaps, has been purchased or written on asset‑backed securities, the security is referred to as a negative basis asset‑backed security and the resulting derivative assets or liabilities have been classified as either level 2 or level 3 according to the classification of the underlying asset‑backed security.
(ii) Market liquidity The Group includes mid to bid‑offer valuation adjustments against the expected cost of closing out the net market risk in the Group’s trading positions within a timeframe that is consistent with historical trading activity and spreads that the trading desks have accessed historically during the ordinary course of business in normal market conditions.
2 Where the exposure to an unobservable input is managed on a net basis, only the net impact is shown in the table.
(4) Financial assets and liabilities carried at amortised cost (A) Financial assets Valuation hierarchy The table below analyses the fair values of the financial assets of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 243). Financial assets carried at amortised cost are mainly classified as level 3 due to significant unobservable inputs used in the valuation models. Where inputs are observable, debt securities are classified as level 1 or 2.
Loans and advances to customers: Stage 2 24,351 25,516 – – 25,516
Loans and advances to customers: Stage 3 4,188 3,289 – – 3,289
Loans and advances to customers: purchased or originated credit‑impaired 15,313 15,313 – – 15,313
(B) Financial liabilities Valuation hierarchy The table below analyses the fair values of the financial liabilities of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 243).
Deposits from banks: Customer deposits: Financial liabilities at fair value through profit or loss:
Note 52: Financial risk management As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.