>280,000 customer visits to our Retirement Planning Website. We want to do more to support and guide more of our customers on their retirement options
We already support people, businesses and communities all over Britain through our iconic brands and extensive range of clear and simple products and services, but we want to do even more to play our part in making Britain a more inclusive and prosperous country. To achieve this we must continue to build a culture where our colleagues put customers first.
12.5m customers banking online, making us the UK’s largest digital bank. We are also helping Britain’s charities and small businesses to build their digital skills and capability
Governance Letter from the Chairman 52 Board of Directors 54 Group Executive Committee 58 Corporate governance report 60 Directors' report 81 Directors' remuneration report 84
Right: Sophie Unwin's 'Remade in Edinburgh' which was awarded a grant from the Lloyds Bank Social Entrepreneurs Scale Up Programme, teaches local people, including those who are homeless, unemployed, or refugees, to repair household goods to save money.
UK focus Operating primarily in the UK means we are focused on a single developed market that we truly understand while avoiding the complexities and costs of multijurisdictional operations.
Statutory profit before tax more than doubled to £4.2bn Acquisition of
Our market leading cost:income ratio reduced further, reflecting our operational efficiency
Our Retail division is a leading provider of current accounts, savings and mortgages to personal and small business customers in the UK.
£3,003m market share of current account switchers £11.7bn of lending to first-time buyers
Our Insurance division provides customers with long‑term savings, investment and protection products and general insurance.
£837m 6m life, pensions and investments customers share of the home insurance market
Overview and strategy 2016 was another year of good progress for the Group, both financially and strategically. Our strong financial performance, the strength of our capital position and the progressive return of the Group to private ownership are testament to the hard work of our colleagues to transform and simplify our business since the depths of the financial crisis. On the back of that recovery, the agreement to acquire MBNA is a significant strategic step which reinforces our ability to deliver sustainable growth whilst helping Britain prosper. However, we recognise that future success will depend on adapting our business model to provide the cost and quality of service required to meet customer needs effectively in a rapidly evolving digital future, and we are working hard to ensure we have the strategy and plans to achieve that transformation.
Despite the uncertain environment, the Group continued to perform strongly with good underlying profits, significantly increased statutory profits, strong capital generation and increased ordinary dividends. As a result, the Group’s total bonus outcome has increased to £392.9 million. This is after a 19 per cent collective performance adjustment reflecting additional conduct-related provisions which impacted negatively on profitability and shareholder returns.
Outlook I would like to thank all my colleagues across the Group for their continued hard work and commitment. We have made significant progress. There is always more to do and we will have further challenges to face as we transform the bank to reflect the changing environment. However, we remain committed to our strategy and believe that our customer focus and simple business model with its multi-brand, multi-channel proposition continue to provide the best opportunities for competitive advantage and future success. As we rebuild trust, my ambition is for Lloyds to earn its place as one of the great British institutions, in which both colleagues and customers can take shared pride.
We operate the UK's largest digital bank and, in response to the rapidly evolving digital environment, we have also met our overall target to create 20,000 digital champions (of which 7,000 were in 2016) to help improve the digital skills and financial capability of individuals and organisations.
Read more on corporate culture in the corporate goverance report on page 52
Our balance sheet remains strong with a pro forma CET1 ratio of 13.8 per cent, a total capital ratio of 21.4 per cent and a pro forma leverage ratio of 5.0 per cent. In line with our progressive and sustainable ordinary dividend policy, the Board has recommended a final ordinary dividend of 1.7 pence per share, taking the total ordinary dividend for the year to 2.55 pence per share, an increase of 13 per cent on 2015. The Group has held back c.80 basis points of CET1 capital to cover the estimated capital impact of the MBNA acquisition; however, given our strong capital generation in the year, the Board has also recommended a special dividend of 0.5 pence per share.
Helping Britain prosper We remain committed to supporting the people, businesses and communities in the UK through our Helping Britain Prosper Plan. Notably, we have provided £1.2 billion of new funding to manufacturing businesses, supported 121,000 start-ups and helped 10,000 clients to start exporting in 2016. Our economic contribution to Britain extends beyond the products and services we offer and the funding we provide to our customers and clients. Since we launched our Apprenticeship Scheme we have created more than 4,000 roles, including 1,000 in 2016 and we have committed to creating 8,000 by 2020. We have also exceeded our target to create 20,000 digital champions, a year earlier than expected. Furthermore, we are the highest payer of UK tax in the most recent PwC Total Tax Contribution Survey for the 100 Group, having paid £1.8 billion in 2015. Our tax payment in 2016 was £2.3 billion.
Outlook Our financial targets reflect our confidence in the future prospects of the Group. In 2017 we expect the net interest margin to be greater than 2.70 per cent and the asset quality ratio to increase to around 25 basis points (before MBNA). We continue to target a cost:income ratio of around 45 per cent exiting 2019, with reductions every year. We now expect a return on required equity of between 12.0 and 13.5 per cent and a return on tangible equity of between 13.5 and 15.0 per cent in 2019. Going forward, the Group expects to generate between 170 and 200 basis points of CET1 capital per annum, pre dividend.
DECEMBER MBNA acquisition The Group announced it is to buy the credit card business, MBNA, from Bank of America, subject to competition and regulatory approval
The Group was named as one of the UK’s Top 10 Employers for Working Families
JULY Euromoney awards We won Best Bank in the UK for the fourth year running and World’s Best Bank for Adapting to the Regulatory Environment
ECONOMIC ENVIRONMENT Resilient UK economy post referendum During 2016 the UK economy performed broadly in line with market expectations at the start of the year despite the decision to leave the European Union and significant changes in the political landscape, both in the UK and abroad.
Growth in our markets Household and business deleveraging since 2009 has created capacity for an increased pace of borrowing and the markets in which we operate continued to grow in 2016. Specifically: – Mortgage market growth increased to 3 per cent, from 2.7 per cent in 2015, the strongest since 2007, and although buy-to-let growth was impacted by the change in stamp duty policy in April, it still grew significantly faster than the market as a whole – Unsecured consumer credit growth rose to 8 per cent led by motor finance. Although the strongest growth since before the financial crisis, the level of unsecured debt remains close to a 20 year low relative to households’ income
– Business borrowing from banks increased by 2 per cent, the first growth since 2008, and SMEs by 2 per cent also – Household deposit growth rose to 6 per cent, the strongest since 2008 – Business deposit growth weakened, to 6 per cent, but remains strong after three years of elevated growth and a very high level of liquidity
Interest rates low for longer Interest rates remain at historical lows with the base rate having been cut to 0.25 per cent in August, and are expected to remain low in the foreseeable future. Market rates currently imply an increase to the base rate to 0.5 per cent during 2018, and to 0.75 per cent a year later. This flattening of the yield curve along with continued competition has meant bank margins remain under pressure. Significant competition has meant lending rates across the market remain low, particularly in mortgages, although deposit rates have fallen further during the year, offsetting the impact of lower lending rates.
The expected mild rise in unemployment is likely to lead to an increase in impairment from the very low level of 2016, but it should remain low over the longer term.
We have seen an influx of new entrants to the market, with a variety of business models. Many of these have expertise and experience in digital product offerings, with strong funding positions, credible brands, and in some cases pre-existing customer bases and branch networks. In addition, non-banks such as technology firms and supermarkets are disrupting the banking industry.
Key opportunities – Customer needs: our differentiated customer focused strategy along with our multi-channel distribution network, in particular our evolving digital capability, position us well to address changing customer needs. – Regulatory environment: greater clarity is emerging on regulatory requirements and our simple, low risk, UK focused strategy places us in a strong position. – Low cost position: this enables us to provide competitive differentiation for the benefit of customers and shareholders.
We are adapting to changing customer behaviour such as the increased adoption of digital products.
Low risk business Being a low risk bank is fundamental to our business model. Our low risk appetite is reflected through the low level of nonperforming loans and non-core assets and our credit default swap spread, which is amongst the best in the banking sector worldwide.
In order to help Britain prosper and to achieve our aim of becoming the best bank for customers, we are focusing on three strategic priorities. These are supported by our commitment to building the best team
– Largest UK digital bank and enhanced digital offering - 12.5 million active online users including 8 million mobile users with more than 2 billion logons in 2016 - Increasing market share - Number 1 rated UK banking app for functionality – Faster and easier banking - Introduction of 'selfie' verification for account applications - Video meetings and live webchat support for mortgage and remortgage applicants - Instant mortgage lending decisions through our online
Agreement in Principle – Further investment in UK's largest branch network - Branches reformatted to reflect changing customer needs with the number of mobile banking vans increased – Net promoter score of 62.7 points, an increase of nearly 50 per cent since the end of 2011 – Total customer complaints have been on a downward trend since 2012
– Cost leadership with continued reductions in cost:income ratio to 48.7 per cent – Actively responding to lower interest rates through accelerated cost delivery and targeting further efficiency savings – On track to deliver £1.4 billion of Simplification run-rate savings: £0.9 billion achieved to date – Transforming our key customer journeys, making it simpler, faster and more convenient to meet our customers’ financial needs - Time taken to open savings account in branch down from 45 minutes to 15-30 minutes - 55 per cent of approved mortgage applications proceed to offer in less than 14 calendar days, up from 37 per cent - Introduced a flexible online home insurance offering with new functionality and more choice for customers - Launched a new digital service for employers, significantly reducing processing times for monthly corporate pension scheme management - Simplification of SME on-boarding process from 15 paper application forms to 1 digital form
DELIVERING SUSTAINABLE GROWTH – Further developing Group-wide growth opportunities within our prudent risk appetite
BUILDING THE BEST TEAM – Committed to building a business our colleagues are proud to work for by creating the best environment for our colleagues to succeed
– Providing colleagues with the right skills and tools; and giving them the opportunity to share their views
Customer relationships are key to our strategy and we specifically measure customer satisfaction and complaint levels. We also track our performance against the targets of our Helping Britain Prosper Plan, about which you can read more on page 17.
This year an additional key performance indicator has been included to reflect our performance on employee engagement, a key metric for becoming the best bank for customers.
Pre-tax statutory profit increased significantly to £4,238 million in 2016 compared to £1,644 million in 2015, with the increase largely driven by lower PPI charges.
Manufacturing: we provided £1.2 billion in new funding to Britain’s manufacturing businesses – helping support a crucial sector of the UK economy
Digital: we reached our target to recruit more digital champions in local communities – we now have 23,000 colleagues helping to build Britain’s digital capability
Lending: we increased our net lending to SME and Mid Markets companies by £1.6 billion, despite the challenging market conditions, meaning we missed our £2 billion Plan target1 this year. We remain open for business and committed to helping businesses prosper in the UK and globally
Disabled colleagues: we maintained the engagement scores of disabled colleagues at 2015 levels but didn’t increase them – so we’ll do more to help them in 2017 through training, development and our award-winning workplace adjustment programme
Through our independent charitable Foundations, which support thousands of charities, we help some of the most disadvantaged people in Britain. In 2016 we invested £18.5 million in our Foundations and our colleagues donated their skills and expertise to help the charities they support become more sustainable.
We supported 75,000 first-time homebuyers, but missed our target to support 1 in 4. We want to do more to support the whole housing market by making first-time buyer mortgages easier to access and by being a leading supporter of new build mortgages. Our 2017 Plan reflects this ambition. Our new mortgage lending totalled £38.7 billion in 2016 and we are a leading supporter of the government’s Help to Buy scheme, having advanced £5.3 billion under the mortgage guarantee element since 2013.
Progress in 2016 £955m 23,000 new funding support for social housing colleague digital champions
Helping the homeless Edinburgh charity Fresh Start helps previously homeless people to resettle when they find a home. A Bank of Scotland Foundation grant helped them to pay an Operations Manager’s salary and fund project work.
Key actions We have provided £1.2 billion of new funding support to manufacturing businesses and, through our £5 million investment in the Lloyds Bank Advanced Manufacturing Training Centre in Coventry, we are helping to train the next generation of highly skilled manufacturing apprentices, graduates and engineers.
Our colleagues completed more than 260,000 hours of volunteering putting us on track to deliver 2.3 million hours by 2020. We are doing more to encourage colleagues to use their skills and expertise, though mentoring and skills-based volunteering, which accounted for 35 per cent of all colleague volunteering hours in 2016.
In 2016 the number of Digital Champions reached 23,000 and we have trained almost 10,000 of these to offer digital support to people and organisations in their local communities. This means we have achieved our Helping Britain Prosper Plan target of 20,000 Digital Champions early. We’ve set a new target for 2017 to train 700,000 individuals, SMEs and charities in digital skills, including internet banking.
1 The Plan target excludes net lending to the Social Housing and CRE sectors. Social Housing is included under a separate target in the 2016 Plan: we delivered £955 million of new funding support.
Responding to a changing Britain 2016 was a year of significant change in Britain and considerable change worldwide. As Britain faces an uncertain period it is vitally important that we help people, businesses and communities to address the challenges they face: challenges related to housing, employability, savings, business growth, international trade, financial exclusion and disadvantage.
Engaging with stakeholders We know that engaging with different stakeholder groups is extremely important. It enables us to understand the issues they face and their expectations of the Group. Their contributions influence our strategic thinking and also help us to shape our corporate reporting.
Building a more responsible culture We have established a clear and simple view of the culture we want to build, which is based on our Values. Throughout 2016, we continued to reinforce these Values and the behaviours that define them, through our Group Culture plan. We have created a Culture Dashboard, which helps us to monitor progress and a Group Customer First Committee, which ensures that ‘Customer, Culture and Conduct’ remain key considerations. We also encourage colleagues to share their concerns, without fear of reprisal, if they believe the codes, policies and procedures that support our culture are being contravened. They can do this in a number of ways, including through our Speak Up service which is managed independently of the Group. During 2016, 286 concerns were raised with the Speak Up team and 171 progressed to investigations. Of the investigations completed by year end 57 per cent were upheld and remedial action was taken where appropriate.
Sustainable business performance and growth During 2016 we have made good progress against our strategic priorities whilst delivering strong financial performance. Our cost leadership and lower risk positioning provide competitive advantage. Our differentiated, UK focused business model continued to deliver for customers and shareholders.
Operating sustainably and responsibly is critical to the long-term success of the business and creating value for our stakeholders, and benefits the wider UK economy.
4. SERVING OUR CUSTOMERS FAIRLY We serve a diverse customer base through many different channels. Ensuring our products and services are accessible and suitable to the individual needs of our customers is at the heart of everything we do; consistently offering the best experience, providing products and services when they need our support.
Tackling money laundering and terrorist financing We take steps to make sure our products are not used for criminal purposes such as money laundering and terrorist financing, in liaison with legislators and regulators. We undertake due diligence on customers throughout the duration of their relationship with us, and monitor unusual activity on all accounts using advanced technology to detect potential criminal activity. If we spot anything suspicious we take immediate and appropriate action. All our colleagues are aware of our Anti-Money Laundering and Counter Terrorist Policy and have access to training to help them understand what is required of them.
In 2016, we paid £2.3 billlion in tax. We are also a major tax collector, gathering £2 billion on behalf of HMRC in 2016 (2015: £2.2 billion).
Gold rated by the Business Disability Forum for our work with customers and colleagues
As part of our commitment to help financially disadvantaged people across Britain, we announced a further £1 million to support 21 credit unions in January 2016, the third stage of our £4 million four year commitment. Our support should allow each credit union to lend additional funds, resulting in an increase in sustainable sector lending of around £20 million from 2014 to 2017.
Digital technology also offers an important opportunity to make financial services more accessible. Almost 6 million adults in the UK have never used the internet and just under 50 per cent of charities and more than 1 million small and medium-sized businesses lack basic digital skills. Increasing digital capability is one of the most important factors that will drive financial inclusion over the coming years, so we aim to use our expertise and reach to promote wider understanding and access, as shown in our Lloyds Bank Consumer Digital Index which surveys 1 million customers.
Improving customer experience and satisfaction Improving our customers’ experience of and satisfaction with our products and services is central to our Customer Journey Transformation (CJT) initiative. CJT involves rethinking and redesigning customer journeys to meet our customers’ evolving needs, particularly as digital becomes more mainstream in the way people and businesses bank.
5. HUMAN RIGHTS, DIVERSITY AND WELLBEING We believe that everyone should have the opportunity to reach their full potential at Lloyds Banking Group – whatever their role or background. Our aim is to build a bank that represents modern Britain where colleagues' talents are recognised, and their human rights are respected. We aim to align our activity and policies with international best practice and recognised standards, such as the UN Declaration on Human Rights.
We aim to appoint the best person available into any role and to attract talented people from diverse backgrounds. We encourage and give full and fair consideration to job applications from people with a disability and are unbiased in the way we assess, select, appoint, train and promote people. We offer a guaranteed interview scheme for candidates who declare a disability and meet the minimum requirements of the role. We continue to run a work a Disability Work Experience Programme in partnership with Remploy. This is one of the largest disability-focused work experience initiatives in the financial services sector.
Agile working As a founder member of a group of leading employers supporting workforce agility in the UK, we’ve been looking closely at ways to become more agile as an organisation over the past 18 months. To bring agile working to life we launched a ‘Getting Smart about Agile Working’ campaign, which had a high profile across the whole Group. Our most recent survey indicates that over 26,000 of our colleagues work in an agile way. In 2016 we’ve also implemented a new job sharing website, a new approach to agile hiring and agile working training for all colleagues.
Percentage of colleagues who disclose they have a disability 2.2% 1.1%
1 Colleague scope of reporting: UK payroll headcount includes established and fixed term contract colleagues. Excludes parental leavers, Non-Executive Directors, contractors, temp, agency and internationals.
In 2016 our UK-based team was responsible for financing renewable projects with a combined capacity of more than 1.78GW. Globally, our investments in renewable energy are in excess of 7.4GW in capacity and cover solar, offshore and onshore wind, waste to energy and biomass.
In 2016 Lloyds Bank played a key part in financing a major offshore wind farm off the Norfolk coast, with operations in Grimsby. Race Bank will provide enough energy to power 400,000 homes with a potential capacity of 573MW. It is anticipated the project, when in operation, will create more than 100 jobs associated with building and maintaining turbines for the Humber region.
Supporting communities and tackling social disadvantage We are an integral part of communities across the UK and believe we are in a unique position to help them prosper through our community programmes and investment. These programmes are focused on three themes: education, employability and enterprise. Our total community investment in 2016 was over £63 million which includes our colleagues’ time, direct donations and the money we give to our independent charitable Foundations. The Foundations receive a share of the Group’s profits annually.
The impact we‘re making of supplier invoices paid within 30 days
As a Group, managing risk effectively is fundamental to our strategy and to operating successfully. We are a simple, low risk, UK focused, retail and commercial bank with a culture founded on a prudent through-the-economic-cycle appetite for risk.
The Group was also subject to the UK stress testing run by the Bank of England; passing on all levels, with no capital inadequacies identified.
Confirmation of the effectiveness of the Risk Framework and underlying risk and control
Monitoring, oversight and assurance ensures effective risk management across the Group Three Lines of defence model Mandate of the
In line with our Codes of Responsibility. Culture ensures performance, risk and reward are aligned
The Board approved RMF and risk appetite are put into effect using an enterprise-wide framework which applies to every area of the business and covers all types of risk. The framework is designed to ensure we follow a consistent approach to risk management and reporting throughout the Group, so that all risks are fully understood and managed in relation to our agreed risk appetite. It includes our policies, procedures, controls and reporting.
Operational risk We face significant operational risks which may result in financial loss, disruption of services to customers, and damage to our reputation. These include the availability, resilience and security of our core IT systems and the potential for failings in our customer processes.
– Focused action to attract, retain and develop high calibre people. Delivering initiatives which reinforce behaviours to generate the best outcomes for customers and colleagues. – Managing organisational capability and capacity to ensure there are the right skills and resources to meet our customers’ needs. – Effective remuneration arrangements to promote appropriate colleague behaviours and meet regulatory expectations.
The successful transition of our customer-focused Conduct Strategy into Business as Usual, following robust review by the Group Customer First Committee, supports our vision of being the best bank for customers, enabling the creation of the best customer experience through learning from past mistakes.
Continued regulatory change relating to personal accountability and remuneration rules could affect the Group’s ability to attract and retain the calibre of colleagues required to meet our changing customer needs. We continue to focus on developing colleagues, their capabilities and skills in order to create the best customer experience and to respond quickly to the rapidly evolving change in customers’ decision making, in an increasingly digital marketplace.
The most significant risks which could impact the delivery of our long-term strategic objectives and our response, are detailed below The Group has considered many of the potential implications following the UK’s vote to leave the European Union and the impact to its customers, colleagues and products − as well as legal, regulatory, tax, finance and capital implications.
Continued uncertainty surrounding the political and macroeconomic environment remains but the potential impacts of external factors have been considered in all principal risks and uncertainties to ensure any material uncertainties continue to be monitored and are appropriately mitigated.
Principal risks and uncertainties are reviewed and reported regularly and no new risks have been identified in the year.
The availability and resilience of IT systems remains a key strategic priority and the Cyber programme continues to focus on enhancing cyber security controls. The control environment is regularly assessed through internal and third party testing.
– A comprehensive capital management framework that sets and monitors capital risk appetite, including dividend policy appropriately. – Close monitoring of capital and leverage ratios to ensure we meet current and future regulatory requirements. – Comprehensive stress testing analysis to evidence capital adequacy under various adverse scenarios.
Market risk The risk that our capital or earnings profile is affected by adverse market rates, in particular interest rates and credit spreads in the Banking business, equity and credit spreads in the Insurance business, and credit spreads in the Group’s Defined Benefit Pension Schemes.
Afaque Quareshi is retraining for a career in construction thanks to the collaboration between Lloyds Bank, London Borough of Newham and Lendlease. The Group has provided £1 million to support training and recruitment through its Construction Skills Fund, which was established to address the skills gap in the construction sector.
Given the significant amount of capital generated in the year, the Board has recommended a final ordinary dividend of 1.7 pence per share, making a total ordinary dividend of 2.55 pence per share, an increase of 13 per cent on 2015 and in line with our progressive and sustainable ordinary dividend policy. In addition, the Board has recommended a special dividend of 0.5 pence per share.
Net interest income fell by £47 million to £11,435 million. The net interest margin increased to 2.71 per cent (2015: 2.63 per cent), with lower deposit and wholesale funding costs, including the benefit from the ECN redemptions in the first quarter, more than offsetting the continuing pressure on asset pricing. Average interest-earning banking assets reduced by 1 per cent with growth in SME and Consumer Finance balances more than offset by reductions in the mortgage and run-off portfolios. The Group expects that the net interest margin for 2017 will be greater than 2.70 per cent (before MBNA).
The Group manages the risk to its capital and earnings from adverse movements in interest rates centrally by hedging liabilities which are deemed to be stable or less sensitive to change in market interest rates. As at 31 December 2016, the balance hedged was c.£111 billion with an average duration of c.3 years and an earning rate of approximately 1.6 per cent over LIBOR. In 2016, the benefit from the structural hedge totalled £1.7 billion over LIBOR (2015: £1.8 billion).
Impaired loans as a % of closing advances 1.8% 2.1% (0.3)pp
Asset quality remains strong with no deterioration in the underlying portfolio. The impairment charge increased to £645 million from £568 million in 2015 with the asset quality ratio increasing slightly to 15 basis points. This increase was largely due, as expected, to a reduction in the level of provision releases and write-backs. The gross asset quality ratio (excluding releases and write-backs) remained unchanged at 28 basis points. Looking forward the Group expects a further reduction in releases and write-backs in 2017 and, as a result, the asset quality ratio to increase to around 25 basis points.
Market volatility and asset sales of £439 million included a gain on sale of the Group’s interest in Visa Europe of £484 million and negative insurance volatility of £91 million. The main item in the 2015 charge of £81 million was negative insurance volatility of £105 million.
Restructuring costs were £622 million in 2016 and comprised costs relating to the Simplification programme, the announced rationalisation of the non-branch property portfolio and the work on implementing the ring-fencing requirements.
Wholesale funding decreased by £9 billion to £111 billion as excess liquidity is managed down. Wholesale funding with a residual maturity of less than one year was £35 billion (2015: £38 billion), and the Group’s term funding ratio was unchanged at 68 per cent.
The leverage ratio on a pro forma basis increased to 5.0 per cent (2015: 4.8 per cent), largely reflecting the increase in tier 1 capital.
The special dividend of 0.5 pence per share represents the distribution of capital over and above the Board’s view of the current level of capital required to grow the business, meet regulatory requirements and cover uncertainties, and allows for the estimated capital impact of the MBNA acquisition.
Underlying basis In order to allow a comparison of the Group’s underlying performance, the results are adjusted for certain items including losses on redemption of the Enhanced Capital Notes and the volatility in the value of the embedded equity conversion feature; market volatility and asset sales, 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 and insurance gross up; the amortisation of purchased intangible assets; restructuring costs, comprising severance related costs relating to the Simplification programme, the costs of implementing regulatory reform and ring-fencing and the rationalisation of the non-branch property portfolio; the unwind of acquisition-related fair value adjustments; TSB build and dual-running costs and the loss relating to the TSB sale in 2015; and payment protection insurance and other conduct provisions.
Tangible net assets per share 54.8p 52.3p 2.5p 1 Excludes reverse repos of £8.3 billion (31 December 2015: £nil).
Net asset value per ordinary share 60.2p 57.9p 60.7p 54.6p 59.5p
Diluted earnings (loss) per ordinary share 2.9p 0.8p 1.6p (1.2)p (2.1)p
4 This figure excludes the limited voting ordinary shares owed by the Lloyds Bank Foundations.
Becoming simpler and more efficient – Reduced SME relationship manager hours spent on business account opening from seven to two hours, enabling more time to be spent face to face with clients. – Continued to invest in next generation digital capabilities and client analytics to transform clients’ experiences. The ‘CB Online’ transaction banking platform now has over 2,000 clients registered.
– Impairment charge of £16 million reflects the benefit of active risk management and the continued low interest rate environment. Asset quality ratio remains low at 2 basis points. – Risk-weighted assets decreased by £7.2 billion, reflecting the disciplined approach to capital, including capital efficient securitisation activity and credit management. This has received global recognition through the award of Credit Portfolio Manager of the Year at the 2016 Risk Awards. – Loans and advances to customers fell by 2 per cent to £100.4 billion. Above market growth in SME lending and increases in Mid Markets and Global Corporates offset by lower lending in Financial Institutions. – Deposits increased 1 per cent to £132.6 billion. Strong momentum in attracting high quality deposits with Global Transactional Banking balances up 10 per cent, further optimising the portfolio and strengthening the Group balance sheet.
Becoming simpler and more efficient – Launched a new digital service for employers, significantly reducing processing times for monthly corporate pension scheme management. – Introduced an online tool allowing customers to consolidate other workplace pensions assets into the Group. This builds on the existing ‘5 Steps to Retirement’ website, enabling customers to take control of their retirement plans.
Existing business income has decreased by £101 million, primarily driven by adverse economics.
Other non-banking net interest expense was £245 million (2015: net interest income £15 million). The change in the year was largely driven by a reduction in the net interest income reported by the non-banking businesses, the continued reduction in run-off non-banking assets together with a change to the funding cost charged to the remaining run-off non-banking assets to better reflect their maturity profile.
With a grant from the Bank of Scotland Foundation, the charity Fresh Start helps recently homeless people in Edinburgh to rebuild their lives in secure, well-equipped accommodation. Fresh Start is one of thousands of charities supported by our four Foundations and by colleagues who volunteer their expertise to help them.
The Board has agreed the following changes to our Board composition. Anthony Watson, our Senior Independent Director, will retire at the 2017 annual general meeting (AGM) after serving more than eight years on the Board. Anita Frew will succeed Anthony as Senior Independent Director. Anita will combine the role of Senior Independent Director with the role of Deputy Chairman, which she has held since May 2014. Anita’s significant board, financial and investment management experience, including as a Senior Independent Director, make her ideally suited to take on this role. Nick Luff, an independent Non-Executive Director, has notified the Board that in light of his other commitments he does not intend to seek re-election at the 2017 AGM. Nick will be succeeded as Chairman of the Audit Committee by Simon Henry. Simon has significant financial experience in the UK listed environment, retiring as Chief Financial Officer of Royal Dutch Shell plc in March 2017. His background and experience enable him to fulfil the role of Audit Committee Chairman and for SEC purposes the role of Audit Committee financial expert. Both Anthony and Nick leave with our thanks and best wishes for the future.
In September 2016 the Chairman and members of the Scottish Widows Board visited the Financial Planning & Retirement Lab in Edinburgh, to learn about innovative solutions for meeting the evolving needs of customers as they plan for retirement.
Managing extensive change while maintaining high levels of current performance and managing continually changing risks is an immensely challenging task. I would like to thank the Board and all our colleagues for their tremendous support and commitment throughout the year in meeting these challenges.
The Board and senior leaders have a vital role to play in shaping and embedding a healthy corporate culture, and this has been a major focus for the Board’s attention over the last year. As a Group we are clear that our Values of ‘putting customers first’, ‘keeping it simple’ and ‘making a difference together’, remain central to the next stage of our cultural evolution. Our Group Values are core to our strategy and are at the heart of what we do and how we work.
In 2017 we are embedding these behaviours in our key people processes, so our Values will be reinforced across all colleague experiences such as recruitment, performance management and career development. We want to ensure colleagues are empowered, inspired and incentivised to do the right thing for our customers. Our colleague surveys show continued strong engagement and commitment to helping us be the best bank for customers.
Skills and experience: Anita has significant board, financial and general management experience across a range of sectors, including banking, asset and investment management, manufacturing and utilities. She was previously Chairman of Victrex plc, the Senior Independent Director of Aberdeen Asset Management and IMI plc, an Executive Director of Abbott Mead Vickers, a Non-Executive Director of Northumbrian Water and has held various investment and marketing roles at Scottish Provident and the Royal Bank of Scotland. Her extensive board level, asset and investment management experience makes her a strong Deputy Chairman and Chairman of the Remuneration Committee. She has a BA (Hons) in International Business from the University of Strathclyde, a MRes in Humanities and Philosophy from the University of London and an Honorary DSc for contribution to industry and finance from the University of Cranfield.
External appointments: Chairman of Urban & Civic plc and a Governor of Motability.
External appointments: Chief Financial Officer and an Executive Director of Royal Dutch Shell plc with responsibility for Shell’s Finance, IT, Strategy and Planning functions (until 9 March 2017). Non-Executive Director of Rio Tinto plc and Rio Tinto Limited (from 1 July 2017). Chair of the European Round Table CFO Taskforce, Member of the Main Committee of the 100 Group of UK FTSE CFOs, the Advisory Panel of CIMA and of the Advisory Board of the Centre for European Reform.
Skills and experience: Deborah has an extensive executive background in managing technology, operations and new digital innovations across banking, payments and institutional investment. She broadens the Board’s diversity from a global market perspective. Deborah is a former Chief Executive Officer, Global Enterprise Payments and President, Personal Banking and Wealth Management at Citibank. She was previously President of Institutional Services at Charles Schwab Corporation and held executive roles at Engage Media Services Group, Visa International and Bank of America, where she held senior roles in Consumer Banking. She holds a BSc in Communications from the University of Montana.
External appointments: Member of the Supervisory Board of Fresenius Medical Care AG & Co. KGaA, Independent Director of Fluor Corporation and IHS Markit Ltd, a Trustee of the California Institute of Technology and of the Institute for Defense Analyses.
Skills and experience: Nick has significant financial services experience, particularly in insurance where he has served as Chief Executive of Lloyd’s of London and Prudential UK and Europe as well as Chairman of Brit Insurance. He is a former Non-Executive Director of the Prudential Regulation Authority and of Legal & General Group Plc as well as Chairman of the Financial Services Practitioner Panel. He has the knowledge and experience to provide valuable insight and contribute effectively as a Non-Executive Director and Member of the Audit Committee and Risk Committee as well as the governance experience and leadership qualities to chair Scottish Widows Group. Nick has a First Class Degree in Philosophy, Politics and Economics from Balliol College, University of Oxford.
External appointments: Member of the BBC Trust (until 31 March 2017), Chairman of the Britten-Pears Foundation, the Royal Northern College of Music and the Financial Conduct Authority's Financial Advice Working Group.
External Appointments: Non-Executive Director and Chair of the Risk Committee at Provident Financial plc; Senior Independent Director and Chair of Risk at QBE Insurance (Europe) Limited and Senior Independent Director and Chair of Risk at Swinton Group Limited.
12 George Culmer Executive Director and Chief Financial Officer Appointed: May 2012 (Board)
Skills and experience: Juan has significant banking and risk management experience, having spent 31 years working in these fields both internationally and in the UK. Juan is responsible for developing the Group’s risk framework, recommending its risk appetite and ensuring that all risks generated by the business are measured, reviewed and monitored on an ongoing basis. He was previously the Chief Risk Officer and an Executive Director of Santander’s UK business. Prior to this position, he held a number of senior risk, control and business management roles across the Corporate, Investment, Retail and Risk Divisions of the Santander Group. He has served as the Group’s Chief Risk Officer and as a member of the Group Executive Committee since January 2011. Juan has a BSc in Industrial Chemical Engineering from the Universidad Politécnica de Madrid, a Financial Management degree from ICADE School of Business and Economics and an MBA from the Institute de Empresa Business School.
Antonio joined the Group from Santander, where he had worked in a number of different leadership roles and jurisdictions since 1998. He was part of the management team that completed the take-overs of Abbey National in 2004 then Bradford & Bingley and Alliance & Leicester in 2008, and was Chief Financial Officer of Santander UK. Before Santander, Antonio spent over nine years at Arthur Andersen.
01 António Horta-Osório Executive Director and Group Chief Executive António joined the Board in January 2011 as an Executive Director and became Group Chief Executive in March 2011. Full biography on page 57.
04 Andrew Bester Group Director and CEO, Commercial Banking Andrew joined the Group in 2012 from Standard Chartered Bank where he held a variety of senior roles including Global COO and, later, Chief Financial Officer of Consumer Banking. Previously, Andrew worked at Xchanging Plc and Deutsche Bank and trained as a Chartered Accountant. Andrew sits on the Board of the Global Financial Markets Association (GFMA) and the Advisory Board of the University of Cambridge Programme for Sustainability Leadership and is a member of The Prince of Wales’s UK Corporate Leaders’ Group. Andrew is Executive Sponsor for Inclusion & Diversity and the Group’s Ambassador’s programme.
10 David Oldfield Group Director, Retail and Consumer Finance David was appointed in June 2015 as Group Director for the Retail division responsible for the retail branch network across Lloyds, Halifax and Bank of Scotland brands, along with UK Wealth and Business Banking. Additionally, in February 2016, David assumed responsibility for the Consumer Finance division. David started his career with Lloyds Bank 32 years ago on the graduate entrant programme and has held a number of key leadership roles across all divisions of the Group since that time. Immediately prior to this role he was appointed to the Group Executive Committee in May 2014 as Group Director, Operations. David is a Fellow of the Chartered Institute of Bankers. He is also Group Executive Sponsor for Disability.
12 Matthew Young Group Corporate Affairs Director Matt joined the Group as Corporate Affairs Director in 2011. Prior to Lloyds, he was Communications Director at Santander during a period when the bank made a successful entry into the UK market following the acquisition and subsequent rebranding of Abbey National, Alliance & Leicester, and Bradford & Bingley. Matt joined Santander from NatWest in 1999 where he held a number of senior communications roles. Matt has a degree in Political Science and a postgraduate certificate in Education. He is a Board member of the British Bankers Association, a member of the PR Guild, and a former trustee of the Prince of Wales sponsored charity, In Kind Direct.
This report sets out our approach to governance in practice, the work of the Board and its committees and explains how the Group applied the principles of the UK Corporate Governance Code (the Code) during 2016
LEADERSHIP The Board The Group is led by an effective, committed and unitary Board, which is collectively responsible for the long-term success of the Company. The Board comprises a Chairman (who was independent on appointment), independent Non-Executive Directors and Executive Directors. The names and biographies of current Directors are set out on pages 54 to 57.
Chairman Lord Blackwell Lord Blackwell leads the Board and promotes the highest standards of corporate governance. He sets the Board’s agenda and builds an effective and complementary Board. The Chairman leads Board succession planning and ensures effective communication with shareholders.
Group Chief Executive António Horta-Osório António Horta-Osório manages the Group on a day-to-day basis and makes decisions on matters affecting the operation, performance and strategy of the Group’s business. He delegates aspects of his own authority, as permitted under the Corporate Governance Framework, to members of the Group Executive Committee (GEC). He provides leadership and direction to senior management and coordinates all activities to implement the strategy and for managing the business in accordance with the Group’s risk appetite and business plan set by the Board.
Executive Directors Juan Colombás, George Culmer Under the leadership of the Group Chief Executive, the Executive Directors make and implement decisions in all matters affecting operations, performance and strategy. They provide specialist knowledge and experience to the Board. They are responsible for the successful leadership and management of the Risk and Finance divisions respectively. The Executive Directors design, develop and implement strategic plans and deal with day-to-day operations of the Group.
Board Committees The Board is supported by its Committees which make recommendations on matters delegated to them under the Corporate Governance Framework, in particular in relation to internal control, risk, financial reporting, governance and remuneration matters.
The Board recognises that governance must be dynamic and evolve to meet current and future demands. Therefore, in 2016 two further sub-committees of the Board Risk Committee were established to focus on Financial Markets and IT Resilience & Cyber, in addition to an existing Stress Testing & Recovery Planning sub-committee. The sub-committees were constituted to enable members of the Board Risk Committee to dedicate additional time and resource to better understand and to enable fuller review and challenge of the risks associated with the topic of the sub-committee. Current direct Board level oversight of these activities through regular updates and annual review continues unchanged.
Additionally, a Cyber Security Advisory Panel was established to bring an industry perspective and allow for discussion of the key cyber related activities and threats.
Dyfrig John5 4 4 1 The attendance of Directors at Committee meetings is displayed within the individual Committee reports found on pages 69 to 80 and for the Remuneration Committee on page 113. Whilst all Non-Executive Directors are, where appropriate, invited to and regularly attend other Committee meetings, only their attendance at Committees of which they are members is recorded.
The Group has a comprehensive and continuous agenda setting and escalation process in place for ensuring the Board has the right information at the right time and in the right format to enable the Directors to make the right decisions. The Chairman leads the process, assisted by the Group Chief Executive and Company Secretary. The process ensures that sufficient time is being set aside for strategic discussions and business critical items.
The process of escalating issues and agenda setting is reviewed at least annually as part of the Board Effectiveness Review with enhancements made to the process, where necessary, to ensure it remains effective.
Time allocated at each GEC meeting to consider whether any matters require escalation
– Ring-fencing and resolution – SM&CR updates – Regulatory updates – Whistleblowing updates
Regular agenda items – Group performance report from the Group Chief Executive – Report on financial performance, including budgets, forecasts and capital position from the Chief Financial Officer – Risk report from the Chief Risk Officer – Chairman’s activities report – Reports from Committee Chairmen
In 2016 ‘deep dive’ sessions were held on the following topics: – Commercial Banking
Board strategy offsite The Board sets aside time each year outside of the annual Board calendar to hold a strategy offsite giving the Directors the opportunity to solely focus on strategic issues.
This year the Board and the GEC held a two day offsite in June to discuss the strategic challenges and opportunities the Group faces in the future, based on four scenarios for how banking could evolve over the next ten years. The offsite enabled the Board to take a view of the longer-term outlook for the Group. The Board debated the transformation required to be ‘Bank of the Future’ in order to underpin continued competitive success. This will provide the backdrop to the next phase of strategic development, on which the Group will report later in 2017.
Chairman’s engagement programme The Chairman undertakes an extensive engagement programme each year representing the Group at industry events, acting as a spokesperson for the Group and meeting with clients, regulators, investors, the media, the Foundations and their beneficiaries.
The programme includes visits to regional offices, branches, IT and operations centres, where the Chairman meets local management and colleagues through meetings, floor walks, team talks and Town Hall sessions.
Showing support for customers and the community In September, Lord Blackwell spent two days in Aberdeen where he met with more than 100 business customers. During his visit, he delivered the keynote speech at a dinner for customers and local influencers, emphasising the Group's vital role in helping Britain prosper and the importance of building long-term customer relationships. At a breakfast for Mid Markets clients and local business leaders, he outlined his views on the economy and the importance of supporting local businesses.
Lord Blackwell also found time to host a Town Hall and Q&A session for colleagues at the Group's Albyn Place office. His final stop was an inspiring visit to Fly Cup Catering in Inverurie, a charity funded by the Bank of Scotland Foundation which provides catering training, employment experience and placements for adults with learning difficulties.
Speaking about the visit, he said: ‘I came away enthused by the commitment and enthusiasm of everyone I met, and by the general sense of cautious optimism from our commercial clients and relationship managers. It is extremely helpful to me to hear these perspectives first hand and to meet more of our tremendous colleagues.’
Time commitments Non-Executive Directors are required to devote such time as is necessary for the effective discharge of their duties. The estimated minimum time commitment set out in the terms of appointment is 35-40 days per annum including attendance at Committee meetings. For Committee Chairmen and the Senior Independent Director, this increases to a minimum of 45 to 50 days. As described elsewhere , the time devoted on the Group’s business by the Non-Executive Directors is in reality considerably more than the minimum requirements.
Directors have a continuing duty to notify the Chairman and Company Secretary as soon as they become aware of actual or potential conflict situations. Changes to the 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.
– Strategic and corporate induction – Governance and Director responsibilities – Senior Managers and
Briefing and reading materials Briefing and reading materials are made available on the Board portal.
2016 evaluation of the Board’s performance The 2016 evaluation was conducted internally between November 2016 and December 2016 by the Company Secretary, and was overseen by the Nomination and Governance Committee.
Many Directors commented favourably on the performance of the Board as a whole, describing it as hardworking, collegiate, questioning and highly engaged. Developments during 2016, including the continued use of deep dives, the establishment of sub-committees of the Board Risk Committee and the Cyber Security Advisory Panel have generally been welcomed and Directors have commented on the high quality of debate within the Board. Highlights mentioned by several Directors were the strategy offsite in June and governance of the acquisition of the MBNA UK consumer credit card business, where the Board was highly engaged in oversight and challenge of the acquisition process. Directors also spoke highly of the work done by the Chairman and the Chairs of the Committees in structuring agendas and ensuring that business is covered at the meetings.
– 2016 strategy offsite focused on reviewing future environment and business model – Regular Board deep dives and discussion topics related to digital disruption and strategic development held during the year
Step 5 Discussion of the Company Secretary’s report and draft conclusions and actions agreed
Chairman’s evaluation The Senior Independent Director carried out the evaluation of the Chairman’s performance using a questionnaire and individual meetings with Directors other than the Chairman. The outcome of the evaluation of the Chairman‘s performance was discussed by the Directors in the absence of the Chairman.
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 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.
Conclusion Our Controls Frameworks are continuously improved and enhanced, addressing known issues and keeping pace with the dynamic environment. Progress continues to be made in IT, Cyber, and Financial Crime. The 2016 CER assessment provides reasonable assurance that the Group's controls are effective or that where control weaknesses are identified, they are subject to management oversight and action plans. The Audit Committee, in conjunction with the Board Risk Committee, concluded that the assessment process was effective and recommended them to the Board for approval.
The British Bankers’ Association Code for Financial Reporting Disclosure - The Group has adopted the British Bankers’ Association’s Code for Financial Reporting Disclosure and its 2016 financial statements have been prepared in compliance with its principles.
SHAREHOLDER RELATIONSHIPS The Board recognises and values greatly the need to deliver a programme of engagement that offers all shareholders the opportunity to receive Company communications and to share their views with the Board.
In addition to this direct shareholder engagement, Investor Relations provides regular reports to the executive team and Board on key market issues and shareholder concerns.
Corporate governance meeting with institutional shareholders In October 2016, the Chairman hosted a meeting with a number of large institutional shareholders focused on the Group’s corporate governance arrangements. Following an overview from the Chairman on the Group’s strategy and culture and Board governance, the shareholders heard from each of the Chairmen of the Audit, Board Risk, Remuneration and Responsible Business Committees and the Senior Independent Director. The meeting was also attended by the Company Secretary and the Group Investor Relations Director. The meeting was structured to allow for an open dialogue and discussion on the matters of importance to institutional shareholders. Those in attendance were especially interested in hearing about the Group’s approach to becoming a more responsible business.
Governance and executive remuneration Lord Blackwell (Chairman and Chairman of the Nomination and Governance Committee) and Anita Frew (Deputy Chairman and Chairman of the Remuneration Committee) participated in meetings and discussions with investors and other stakeholders, including the Group’s regulators, regarding governance and the strategic direction of the Group. They also engaged with proxy advisors, regulators and shareholders on issues relating specifically to executive remuneration.
Mailing of Annual Report and Accounts, which includes an update from the Group Chief Executive
Director, make her ideally suited to take on this role. On the Committee’s recommendation, the Board has appointed Simon Henry to succeed Nick as Chairman of the Audit Committee. Simon has been a member of the Audit Committee since June 2014 and his background and experience enable him to fulfil the role of Audit Committee Chairman and for SEC purposes the role of Audit Committee financial expert.
The Committee will continue to keep under review the structure, size and composition of the Board and its Committees and to make appropriate recommendations to the Board.
Another important role for the Committee is ensuring the adequacy of succession planning, including contingency arrangements, both for Board appointments and key senior management roles. An in-depth review was conducted during the year of the Group’s talent management approach and succession pipeline and this will continue to be a focus during 2017.
Annual effectiveness review During the year, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.
Matters considered by the Committee During the year the Committee considered a number of issues relating to the Group’s governance arrangements, both internal and external. It assisted the Chairman in keeping the composition of the Board and its Committees under review and to lead the appointment process for nominations to the Board.
In assessing independence, the Committee did not rely solely on the Code criteria but considered whether, in fact, the Non-Executive Director was demonstrably independent and free of relationships and other circumstances that could affect their judgement. It did this with reference to the individual performance and conduct in reaching decisions. It also took account of any relationships that had been disclosed and authorised by the Board.
How did the induction programme help you prepare for your role on the Board?
How will you reflect on your first year on the Board?
I have extensive experience in managing IT operations and digital innovations. I was therefore delighted to be asked to join the new sub-committee of the Board Risk Committee, solely focusing on IT resilience and cyber security, bringing an independence of judgement and challenge to Board discussions.
Board and Committee meetings are open, fact-based and collegiate in the best sense: on any given topic there will typically be both experts and generalists. The Board culture works to draw all Directors into the subject, allowing for appropriate consideration and challenge from many angles, which enables an appropriate decision to be reached.
It is the Audit Committee’s job to review the integrity of the financial statements and the effectiveness of the internal and external auditor. The Audit Committee has delivered on its responsibilities
Based on the outcome of the annual board effectiveness review in 2015 additional training for Committee members has been introduced. Targeted training on risk weighted assets, derivative accounting, IFRS9 and insurance accounting has been provided. This year’s annual effectiveness review confirmed the Committee met its key objectives and carried out its responsibilities effectively.
Whilst the Committee’s membership comprises the Non-Executive Directors noted above, all Non-Executive Directors may attend meetings as agreed with the Chairman of the Committee. The Interim Group Audit Director, the external auditor, the Group Chief Executive, the Chief Financial Officer and the Chief Risk Officer also attend meetings of the Committee as appropriate.
How the Audit Committee spent its time in 2016 Financial reporting During the year, the Committee considered the following significant financial issues in relation to the Group’s financial statements and disclosures, with input from management, Group Audit and the external auditor: KEY ISSUES COMMITTEE REVIEW AND CONCLUSION
– The Committee continued to challenge the assumptions made by management to determine the provision for PPI redress and administration costs. The Committee oversaw continued use of sensitivities reflecting the uncertainty that remains around the ultimate cost of PPI redress. – The Committee also reviewed management’s assessment of the potential impact of a consultation paper by the Financial Conduct Authority which set a proposed deadline of June 2019 for consumers to make their PPI complaints and on the potential impact of the Plevin case. – Group Audit undertook periodic agreed upon procedures over the process used by management to calculate the PPI provision. Procedures undertaken were designed to identify the use of reasonable, consistent and supportable assumptions and inputs. No items were raised by exception for consideration by the Committee. – The Committee concluded that the provision for PPI redress and the Group’s external disclosures were appropriate.
– The Committee challenged the level of provisions made and the assumptions used to calculate the impairment provisions held by the Group. – Group Audit has provided assurance to the Audit Committee that the impairment governance processes are effective. – The Committee was satisfied that the impairment provisions were appropriate. The disclosures relating to impairment provisions are set out in note 52: ‘Financial risk management’ on page 261 of the financial statements.
– The Committee considered the recognition of deferred tax assets, in particular the forecast taxable profits based on the Group’s operating plan, the split of these forecasts by legal entity and the Group’s long-term financial and strategic plans. – 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 37: ‘Deferred tax’ on page 228 of the financial statements.
– 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 48: ‘Contingent liabilities and commitments’ on page 242 of the financial statements.
– The Committee challenged the economic and non-economic actuarial assumptions made by management which underpin the calculation of the VIF asset and the insurance liabilities. The Committee also reviewed the movements in the key assumptions since 31 December 2015.
– During the year, the Group reclassified approximately £20 billion of gilts within the liquidity portfolio as ‘available-for-sale’; the gilts were previously classified as ‘held-to-maturity’. – The Committee considered and was satisfied with management’s assessment of the circumstances which support the reclassification of the gilts, the appropriateness of the accounting treatment and related disclosure. – The disclosure is set out in note 49: ‘Financial instruments’ on page 245 of the financial statements.
– The sale of Visa Europe is one example of one-off transactions considered by the Audit Committee during the year. – The Committee was satisfied that the accounting treatment of the sale was appropriate.
The Directors are required to confirm whether they have a reasonable expectation that the Company and the Group will be able to continue to operate and meet their liabilities as they fall due for a specified period. The viability statement must also disclose the basis for Directors’ conclusions and explain why the period chosen is appropriate.
Speak Up (the Group’s whistleblowing service) The Committee received and considered reports from management on the Group’s whistleblowing arrangements including summaries of cases and ongoing reviews of the Whistleblowing Governance Structure. On consideration of the reports submitted, the Committee was satisfied with the actions which had been taken, the report first having been considered and approved by the Board’s Whistleblowing Champion, Anita Frew.
Auditor independence and remuneration Both the Board and the external auditor have safeguards in place to protect the independence and objectivity of the external auditor. In 2016 the Audit Committee approved an amended policy to regulate the use of the auditor for non-audit services to ensure compliance with the revised Ethical Standards for Auditors from the Financial Reporting Council (FRC).
Dear Shareholder I am pleased to report on how the Board Risk Committee has discharged its responsibilities throughout 2016.
The Committee has continued to build upon the progress reported last year around furthering the understanding of complex risks and seeking to enhance risk management. I am pleased to report that good progress continued to be made throughout 2016 in reducing risks across the Group’s material lending portfolios within both the Mortgage and Commercial businesses. The Committee will continue to review progress and developments during 2017.
Conclusion: Regular monitoring continues to assist the Committee in its assessment of the portfolios, with management continuing to take action to mitigate potential risks associated with the EU exit decision. Key credit risks continue to be well managed through strong, effective risk management and risk appetite, including early identification and management of potential concern customers.
The assessment included a review of the resilience of the Group, including specific areas of focus such as credit risk as well as impacts on the Group’s capital and liquidity positions. An assessment of the impact on dividends and mitigating actions proposed by management in each scenario was also undertaken.
The programme attracts a diverse array of applicants, ranging from an artisan bakery providing employment opportunities for young adults with learning difficulties to an artists' space dedicated to tackling problems of isolation through arts and creativity.
Corporate governance statement The corporate governance report found on pages 52 to 80 together with this report of which it forms part, fulfils the requirements of the Corporate Governance Statement for the purpose of the Financial Conduct Authority’s Disclosure Guidance and Transparency Rules (DTR).
No Directors have been appointed to the Board since the 2016 AGM. In the interests of good governance and in accordance with the provisions of the UK Corporate Governance Code, all Directors will however retire, and those wishing to serve again, will submit themselves for re-election at the forthcoming AGM. Anthony Watson, Senior Independent Director, will retire at the 2017 AGM after serving more than eight years on the Board and Nick Luff, an independent Non-Executive Director, has notified the Board that he does not intend to seek re-election at the 2017 AGM.
Directors’ and Officers’ liability insurance Throughout 2016 the Group had appropriate insurance cover in place to protect Directors, including the former Director who retired during the year, from liabilities that may arise against them personally in connection with the performance of their role. As well as insurance cover, the Group agrees to indemnify the Directors to the maximum extent permitted by law. Further information on the Group’s indemnity arrangements is provided below. No Director or former Director sought to recover costs or expenses under their indemnity in 2016.
The Company has also granted deeds of indemnity by deed poll and by way of entering into individual deeds, which constitute ‘qualifying third party indemnity provisions’ to the Directors of the Group’s subsidiary companies, including to former Directors who retired during the year and since the year end. Such deeds were in force during the financial year ended 31 December 2016 and remain in force as at the date of this report.
Share capital and control Share capital and restrictions on the transfer of shares or voting rights – note to the accounts Special rights with regard to the control of the Company – note to the accounts
O ther info rm atio n Lloyds Banking Group Annual Report and Accounts 2016
As at 31 December 2016, 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
The Solicitor for the Affairs of Her Majesty’s Treasury 4,943,698,4902 6.93%
1 Percentage provided was correct at the date of notification. 2 A direct holding. The Solicitor for the Affairs of Her Majesty’s Treasury notified the
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 30 and pages 154 to 158 and capital position on pages 159 to 166 and additionally have considered projections for the Group’s capital and funding position. Accordingly, the Directors conclude that it is appropriate to continue to adopt the going concern basis in preparing the accounts over the next 12 months, from the date of approval of the financial statements.
Greenhouse gas emissions The Group has voluntarily reported greenhouse gas emissions and environmental performance since 2009, and since 2013 this has been reported in line with the requirements of the Companies Act 2006. Our total emissions, in tonnes of CO2 equivalent, are reported in the strategic report on page 25.
The reporting period is 1 October 2015 to 30 September 2016, which is different to that of our Directors’ report (January 2016 – December 2016). This is in line with Regulations in that the majority of the emissions reporting year falls within the period of the Directors’ report. Emissions are reported based on an operational boundary. The scope of reporting is in line with the GHG Protocol and covers Scope 1, Scope 2 and Scope 3 emissions. Reported Scope 1 emissions cover emissions generated from gas and oil used in buildings, emissions from UK company-owned vehicles used for business travel and emissions from the use of air conditioning and chiller/refrigerant plant. Reported Scope 2 emissions cover emissions generated from the use of electricity, calculated using the location based methodology. Reported Scope 3 emissions relate to business travel undertaken by colleagues and emissions associated with the extraction and distribution of each of our energy sources – electricity, gas and oil. A detailed definition of these emissions can be found in our 2016 Reporting Criteria online at www.lloydsbankinggroup.com/rbdownloads
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 54 to 57 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.
Outcomes of the remuneration review The Committee conducted a full review of the Group’s remuneration arrangements in 2016. The main focus of this review was to ensure the remuneration arrangements support our purpose of helping Britain prosper and align to the Group’s aim of becoming the best bank for customers whilst delivering superior and sustainable returns for shareholders. With this in mind, the Committee simplified and updated the Reward Principles that apply across the Group to ensure they support the strategic priorities, as set out below: Strategic priorities Reward principle
2017 Annual General Meeting Approval for the Directors’ remuneration policy will be sought at the AGM on 11 May 2017; if approved, it will take effect from that date. I hope you will support the resolutions relating to remuneration.
– Helping Britain Prosper Plan – Best Bank for Customers index – Digital active customer base
The new variable remuneration arrangements have been designed to reinforce the simplified reward principles and maintain a separate short-term and long-term model. Remuneration remains weighted towards the long-term and the design closely aligns to the Group’s strategic priorities. There have not been any changes to the maximum potential under either plan.
Simplifying the approach to short-term variable remuneration: Group Performance Share The Group Performance Share plan provides Executive Directors and colleagues with a reward for delivery against the Group’s short-term financial and strategic priorities. The annual performance share outcome is based on a percentage of the Group’s underlying profit, adjusted by a strategic multiplier based on the Group’s Balanced Scorecard (BSC) metrics and risk matters. This approach replaces the more complex methodology used in recent years where the Group’s total bonus outcome was driven by the aggregate divisional and functional bonus outcomes and provides a clear line of sight for Executive Directors, colleagues and shareholders.
In order to ensure that the opportunity under the Group Performance Share plan is not increased when compared to the previous annual bonus plan, the Committee has included threshold and maximum payout levels. The maximum for 2017 is 20 per cent above the underlying profit target and a ‘Top’ rating against Balanced Scorecard objectives. This is consistent with prior years. The threshold is set at 20 per cent below the Group’s underlying profit target.
Long-term variable remuneration: Group Ownership Share From 2017, the long-term incentive plan will be known as the Group Ownership Share plan to reinforce its link to the Group’s strategic priorities and provide greater shareholder alignment. The Group Ownership Share plan ensures Executive Directors and senior colleagues build an ownership interest in the Group and are motivated by delivering long-term superior and sustainable returns for shareholders. Vesting is subject to future three-year performance with a clear link between measures and key strategic priorities.
The annual bonus outcome is driven by a combination of Group underlying profit and Balanced Scorecard performance. The long-term incentive plan measures Group performance over a three-year period, using a range of financial and strategic measures.
Total Shareholder Return (TSR) Per annum for the three years ended 31 December (5%) 16.6%
26.3% of underlying profit 4.8% of underlying profit 23.5% of underlying profit 4.2% of underlying profit
DIRECTORS’ REMUNERATION POLICY Approval for this remuneration policy will be sought at the AGM on 11 May 2017 and, if approved, will take effect from that date.
The policy is based on principles which are applicable to all employees within the Group and, in particular, the principle that the reward package should support the delivery of the Group's purpose of helping Britain prosper and the strategic aim of becoming the best bank for customers whilst delivering long-term superior and sustainable returns to shareholders. It fosters a performance-driven and meritocratic culture, encourages effective risk disciplines and is in line with relevant regulations and codes of best practice. There is no significant difference between the policy for Executive Directors and that for other senior employees. If a significant difference for any individual were proposed, this would be subject to approval by the Remuneration Committee (within regulatory requirements). The table below summarises how the policy applies across the Group.
Consideration of shareholders’ and employees’ views The Group is committed to regular dialogue with stakeholders. In formulating the policy, the Remuneration Committee has consulted extensively with a number of shareholders and key stakeholders, such as the Group’s main regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The following topics were discussed: – Alignment of variable remuneration to Group strategic priorities – Structure of variable remuneration – Latest regulatory requirements – Latest shareholder guidelines
Changes Previously, the Group Chief Executive (GCE) had a reference salary of £1.22 million which was used to calculate certain elements of long-term remuneration and the pension allowance. Due to the GCE’s base salary being increased to his reference salary (effective from 1 January 2017), the concept of reference salary is being removed. Elements of long-term remuneration and the pension allowance which were previously calculated with regard to reference salary will be calculated with regard to the GCE’s base salary.
Changes No change to policy for existing Executive Directors. All future appointments as Executive Directors will attract a maximum allowance of 25 per cent of base salary.
Operation Measures and targets are set annually and awards are determined by the Committee after the year end based on performance against the targets set. The Group Performance Share may be delivered partly in cash, shares, notes or other debt instruments including contingent convertible bonds. Where all or part of any award is deferred, the Committee may adjust these deferred awards in the event of any variation of share capital, demerger, special dividend or distribution or amend the terms of the plan in accordance with the plan rules.
Measures consist of both financial and non-financial measures and the weighting of these measures will be determined annually by the Committee. The weightings of the performance measures for the 2017 financial year are set out on page 99. 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.
Changes The deferral period has been extended to comply with new regulatory requirements.
Legacy awards and restrictions on payments The Committee reserves the right to make any remuneration payments/awards and any payments/awards for loss of office, notwithstanding that they are not in line with the policy set out above where the terms of the payment/award were agreed (i) before the Directors’ remuneration policy approved by shareholders on 15 May 2014 (the ‘2014 policy’) came into effect; (ii) pursuant to the 2014 policy; or (iii) at a time when the relevant individual was not a Director of the Group and, in the opinion of the Committee, the payment/award was not in consideration for the individual becoming a Director of the Group. Such payments/awards will have been set out in the annual report on remuneration for the relevant year. They include awards and payments made under previous approved remuneration policy and payments in relation to deferred bonus awards and long-term incentive awards granted in 2012 and 2013.
Approach to recruitment and appointment to the Board In determining appropriate remuneration arrangements on hiring a new Executive Director, the Committee will take into account all relevant factors. This may include the experience and calibre of the individual, local market practice, the existing remuneration arrangements for other executives and the business circumstances. The Committee will seek to ensure that arrangements are in the best interests of both the Group and its shareholders and will seek not to pay more than is necessary.
The maximum level of variable remuneration (excluding buy-out awards) that may be awarded to new Executive Directors is equal to 200 per cent of fixed remuneration, including any discount permitted by the European Banking Authority for Group Ownership Share awards. In making any such remuneration decisions, the Committee will apply any appropriate performance measures in line with those applied to other Executive Directors.
A full explanation will be provided of any buy-out award or discretionary payment.
Lord Blackwell 6 months 31 March 2014 António Horta-Osório 12 months 3 November 2010 George Culmer 12 months 1 March 2012 Juan Colombás 12 months 30 November 2010
Resignation Unvested deferred Group Performance Share awards are forfeited and in-year Group Performance Share awards are accrued until the date of termination (or the commencement of garden leave if earlier) unless the Committee determines otherwise in exceptional circumstances.
In-year Group Performance Share accrued up until date of change of control or merger (current year). Where there is a Corporate Event, deferred Group Performance Share awards vest to the extent and timing determined by the Committee in its absolute discretion.
1 If any Group Performance Share is to be paid to the Executive Director for the current year, this will be determined on the basis of performance for the period of actual service, rather than the full notice period (and so excluding any period of leave required by the Group).
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. – An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective sizing methodologies. – Fees and benefits for comparable roles in comparable publicly listed financial services groups of a similar size.
The service contracts and letters of appointments are available for inspection at the Company’s registered office.
For 2017, the benefits provided to Executive Directors include a car allowance, transportation, private medical insurance, life assurance and other benefits selected through the flexible benefits allowance which is currently capped at 4 per cent of base salary (unchanged from 2016).
The Committee considers the targets that apply to these measures to be commercially sensitive but will provide information on the level of payout relative to the performance achieved in next year’s annual report on remuneration. The Committee applies its judgement to determine the payout level commensurate with Group, business and/or individual performance. Performance adjustment is determined by the Remuneration Committee and/or Board Risk Committee and may result in a reduction of up to 100 per cent of the bonus opportunity for the relevant period. It can be applied on a collective or individual basis. When considering collective adjustment, the Senior Independent Performance Adjustment and Conduct Committee (SIPACC) submits a report to the Remuneration Committee and Board Risk Committee regarding any adjustments required to BSCs or the overall bonus outcome to reflect in-year or prior year risk matters. The application of malus will generally be considered when: – there is reasonable evidence of employee misbehaviour or material error or that they participated in conduct which resulted in losses for the Group or failed to meet appropriate standards of fitness and propriety; – there is material failure of risk management at a Group, business area, division and/or business unit level; – the Committee determines that the financial results for a given year do not support the level of variable remuneration awarded; and/or – any other circumstances where the Committee consider adjustments should be made.
Performance measures and targets 2017 awards will be subject to a three-year performance period with vesting between the third and seventh anniversary of award, on a pro-rata basis. Any shares released are subject to a further holding period in line with regulatory requirements and market practice. During 2016 and early 2017, the Committee consulted widely with shareholders on appropriate performance measures, particularly the link between performance measures and the Group’s strategic priorities. The awards made in 2017 will vest based on the Group’s performance against the following key financial and strategic measures: – Absolute Total Shareholder Return (30 per cent) – Economic profit (25 per cent) – Cost:income ratio (10 per cent) – Strategic measures (35 per cent))
Digital active customer base Set relative to 2019 targets Threshold: 14.3m Maximum: 14.9m
The annual Non-Executive Director fees were reviewed and as result of this review some of the fees were increased, as follows, to reflect market practice in financial services groups of a similar size. These changes took effect from 1 January 2017.
2 Including payments to Chairmen of other Committees who are members. 3 Where individual was not Chairman of another Committee. 4 During 2016, the fee for Chairmanship of the Responsible Business Committee increased from £30,000 to £40,000.
Remuneration outcome for 2016 Executive directors (audited) The following table summarises the total remuneration delivered during 2016 in relation to service as an Executive Director.
Total remuneration less 1 2016 base salary increase: 6 per cent (2 per cent in cash and the remainder in shares, held until the government has sold its shareholding in the Group). 2 Other remuneration payments comprise income from all employee share plans, which arises through employer matching or discounting of employee purchases. 3 The LTIP vesting and dividend equivalents awarded in shares were confirmed by the Remuneration Committee at its meeting on 15 February 2017. The average share price between 1 October 2016 and 31 December 2016 (58.30 pence) has been used to indicate the value. The shares were awarded in 2014 based on a share price of 78.878 pence. LTIP and dividend equivalent figures for 2015 have been adjusted for the share price on the date of vesting (72.75 pence).
5 In June 2015, the Group reached a settlement with the Financial Conduct Authority (FCA) with regard to aspects of its Payment Protection Insurance (PPI) complaint handling process during the period March 2012 to May 2013. As a result, the Committee decided to make performance adjustments in respect of bonuses awarded in 2012 and 2013 to the Group Executive Committee and some other senior executives given their ultimate oversight of the PPI operations. The number of shares adjusted was 409,039 for the Group Chief Executive (GCE), 109,464 for the Chief Financial Officer (CFO) and 376,055 for the Chief Risk Officer (CRO) (pro-rated in the above table to reflect his appointment to Executive Director on 29 November 2013). The share price used for the valuation was the market price for a share in the Group at the award dates, 49.29 pence and 78.878 pence, respectively.
Defined benefit pension arrangements (audited) The GCE has a conditional unfunded pension commitment, subject to share price performance. This was a partial buy-out of a pension forfeited on joining from Santander Group. It is an Employer-Financed Retirement Benefits Scheme (EFRBS). The EFRBS provides benefits on a defined benefit basis at a normal retirement age of 65. The EFRBS applies for a maximum of six years following the commencement of employment and the maximum allowance over that period is 26.5 per cent of the higher of the GCE’s base salary or reference salary in the 12 months before retirement or leaving, subject to performance conditions. No additional benefit is due in the event of early retirement. The rate of pension accrual in each year depends on share price conditions being met. Accrual at 31 December 2016 is a pension of 6 per cent of the reference salary or £73,200. No new pension entitlement was accrued in 2016.
António Horta-Osório 4,640,077 55% 2,552,042 58.30 pence £1,487,840 £95,940 £1,583,780 1 For details of the performance outcome please refer to section ‘Long-term awards made in March 2014 vesting for the period ended on 31 December 2016‘.
The individual on-target award is then adjusted for the Group annual bonus outcome and for individual performance outcomes. Awards are approved by the Committee, which has discretion to adjust outcomes for any reason.
Annual bonus outcome for 2016 (audited) The target bonus outcome for 2016 (£397.1 million) was adjusted for: (1) Group underlying profit performance A target of £7,572 million was approved by the Board. In line with regulatory requirements, the underlying profit of £7,867 million has been adjusted by the incremental movement in Prudential Valuation Adjustment (PVA) from year-end 2015 to year-end 2016. The adjustment of £126 million reduces the underlying profit figure to £7,741 million, resulting in a modifier of 1.22.
The Group continued to make good progress in growing market share in areas where it is under represented, growing lending to SME clients and in consumer finance.
Lower risk bank Continued efforts to de-risk the bank, combined with sustained improvements in core prudential risks (capital, credit, funding) and a customer centric culture are delivering a lower risk bank. From a credit perspective, asset quality remained strong with no deterioration in the underlying portfolio. Prudent risk appetite and robust risk management framework reflected in lower impaired loans and an improved impaired loan ratio.
Awards are approved by the Committee, which has discretion to adjust outcomes for any reason.
Following the Committee’s assessment of performance against the underlying profit target and Group BSC objectives, and taking into account the collective performance adjustment of 19 per cent and the improvement to the individual rating of Strong plus, the Committee determined a 2016 bonus award for the GCE of £1,219,537 (108 per cent of salary and 77 per cent of maximum).
Successful outcome of ECN (‘enhanced capital notes’) court case – enabling the Group to improve the efficiency of its balance sheet and reduce funding costs.
Expected outcome as % of salary 0% 0% 30% 65% 100%
Juan Colombás The Chief Risk Officer’s (CRO) personal performance assessment for 2016, as confirmed by the Committee, reflected a number of considerations including: Strong risk management framework
The Group remains comfortably within risk appetite set by the Board, with strengthened processes and controls, aligning to the Group’s objective of being a low risk bank.
5% Share of first-time buyer market 20% 25% 5% Actual: 25.5%
Percentage change in remuneration of the Group Chief Executive versus the wider employee population Figures for ‘All Employees’ are calculated using figures for UK-based colleagues subject to the Group Annual Bonus Plan. This population is considered to be the most appropriate group of employees for these purposes because its remuneration structure is consistent with that of the GCE. For 2016, 46,963 colleagues were included in this category.
Committee. 3 As Deputy Chairman, Anita Frew does not receive any fee for membership of the Responsible Business Committee. 4 Nomination and Governance Committee. 5 Responsible Business Committee.
For the purposes of assessing the additional shareholding requirement related to the fixed share award, Executive Directors had up to three years from 1 January 2014 to build up the additional shareholding created by the addition of the fixed share award. As at 31 December 2016, all Executive Directors significantly exceeded the requirements.
Executive Directors are required to retain any shares vesting from 2014 LTIP awards onwards for a further two years post vesting (although vested shares count towards the shareholding requirement immediately after vesting).
Sara Weller 340,000 – – – – 340,000 n/a6 n/a 1 Including holdings of connected persons.
5 In addition, Nick Prettejohn held 400 6.475% preference shares at 1 January 2016 and 31 December 2016. 6 The changes in beneficial interests for António Horta-Osório (595 shares), George Culmer (519 shares) and Juan Colombás (519 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2016 and 21 February 2017. There have been no other changes up to 21 February 2017.
A summary of transactions undertaken in the year, including share plan awards vested plus open market purchases and sales made by Directors, is shown on page 111.
Share buy-out award (share options) 235,499 – – 235,499 – – 6, 7
6 Share buy-out award granted on 30 March 2011 for the loss of deferred share awards forfeited on leaving the Santander Group. Awards are consistent with those forfeited and have a nil option price.
7 Options exercised on 8 March 2016. The closing market price of the Group’s ordinary shares on that date was 70.63 pence. 8 Options exercised on 6 June 2016. The closing market price of the Group’s ordinary shares on that date was 69.64 pence. 9 Options exercised on 1 June 2016. The closing market price of the Group’s ordinary shares on that date was 71.34 pence. 10 Sharesave options granted on 10 October 2016.
Directors’ interests – summary of awards vested, purchases and sales made by directors in 2016 (unaudited)
16/03/2016 282,898 Exercise of Share buy out 16/03/2016 95,924 Fixed Share Award 17/06/2016 101,784 Fixed Share Award 30/06/2016 50,000 Share purchase 19/09/2016 44,355 Release of 2012 Deferred Bonus 19/09/2016 277,981 Release of 2013 Deferred Bonus 19/09/2016 116,080 Fixed Share Award 14/12/2016 104,370 Fixed Share Award
Share purchase Share purchase 1 After the settlement of tax and National Insurance contributions, where applicable. 2 Part of António Horta-Osório's 2016 salary increase was delivered in shares. 3 Shares held as at date of retirement.
Dyfrig John3 3 3 1 Joined the Committee on 4 January 2016. 2 Anthony Watson was unable to attend the Committee meeting in May 2016 due to a prior commitment. 3 Retired on 11 May 2016.
Statement of voting at Annual General Meeting The Group’s remuneration policy, which was effective during 2016, was detailed within the Directors’ remuneration report for 2013 and voted on at the 2014 AGM. The remuneration awarded to the Executive Directors in 2015 was disclosed in last year’s annual report on remuneration and was voted on at the 2016 AGM. The shareholder votes submitted at the meetings, either directly, by mail or by proxy, were as follows: Votes cast in favour Votes cast against Votes withheld
Annual report on remuneration (2016 vote) 48,674 97.67% 1,163 2.33% 176
AMA Home is one of many smaller construction businesses benefiting from our Housing Growth Partnership with the Government. We have invested more than £30 million through the Partnership and have a target to reach 1,500 homes by 2017.
Further information on risk management can be found: Risk overview 26
The risk overview (pages 26 to 31) provides a summary of risk management within the Group. It highlights the important role of risk as a strategic differentiator, risk achievements in 2016 along with a brief overview of the Group’s risk governance structure and the principal risks faced by the Group and key mitigating actions.
Each risk driver is described and managed using the following standard headings: definition, exposures, measurement, mitigation and monitoring.
Risk appetite is embedded within principles, policies, authorities and limits across the Group and continues to evolve to reflect external market developments and composition of the Group.
The Group’s strategy operates in tandem with the Board Risk Appetite and business planning is undertaken with a view to meeting the requirements of the Board Risk Appetite.
Performance is optimised by allowing business units to operate within approved risk appetite and limits.
Regulatory and legal: The industry continues to witness increased government and regulatory intervention in the financial sector with increasing regulatory rules and laws from both the UK and overseas affecting the Group’s operation.
Response to market changes (agility): As technology and customer needs change, the typical banking model is evolving and as such, operational complexity has the potential to restrict our speed of response.
– Early engagement with investors; capitalising on our name in the market, and spread issuance over the time window available.
Geopolitical shocks: Current uncertainties could further impede the global economic recovery. Events in China, Russia, the Middle-East, as well as terrorist activity, have the potential to worsen economic outlook and funding conditions.
CAPITAL STRESS TESTING Overview Stress testing is recognised as a key risk management tool within the Group by the Board, senior management, the businesses and the Risk and Finance functions. It is fully embedded in the planning process of the Group as a key activity in medium term planning and senior management is actively involved in stress testing activities via a strict governance process.
HOW RISK IS MANAGED IN LLOYDS BANKING GROUP The Group’s Risk Management Framework (RMF) (see risk overview, page 27) is structured around the following nine components which meet and align with the industry-accepted internal control framework issued by the Committee of Sponsoring Organisations of the Treadway Commission.
Responsible for the strategic management of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. It is also responsible for the risk management framework for market risk, liquidity risk, capital risk and earnings volatility.
Credit risk also arises from debt securities and derivatives. The total notional principal amount of interest rate, exchange rate, credit derivative and other contracts outstanding at 31 December 2016 is shown on page 131. 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 261.
The investments held in the Group’s defined benefit pension schemes also expose the Group to credit risk. Note 36 on page 222 provides further information on the defined benefit pension schemes’ assets and liabilities.
The obligor quality measurement of both retail and commercial counterparties is largely based on the outcomes of credit risk (probability of default PD) models. The Group operates a number of different regulatory rating models, typically developed internally using statistical analysis and management judgement – retail models rely more on the former, commercial models include more of the latter, especially in the larger corporate and more specialised lending portfolios. Internal data is supplemented with external data in model development, where appropriate.
In the principal retail portfolios, exposure at default and loss given default models are in use. For regulatory reporting purposes, counterparties are segmented into a number of rating grades, each representing a defined range of default probabilities and exposures migrate between rating grades if the assessment of the counterparty probability of default changes. The Retail Master scale comprises 13 non-default ratings and one default rating.
Limitations on concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite as well as individual, customer and bank limit guidelines. Credit policies and appetite statements are aligned to the Group’s risk appetite and restrict exposure to higher risk countries and more vulnerable sectors and asset classes. Note 18 on page 208 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 large exposures are detailed to the Board and reported in accordance with regulatory reporting requirements.
Robust country risk management: The Board sets country risk appetite. Within this, country limits are authorised by the Group Country Risk Appetite Committee, taking into account economic, financial, political and social factors. Group policies stipulate that these limits must be consistent with, and support, the approved business and strategic plans of the Group.
Additional mitigation for Commercial customers Individual credit assessment and independent sanction of customer and bank limits: With the exception of small exposures to SME customers where relationship managers have limited delegated sanctioning authority, credit risk in commercial customer portfolios is subject to sanction by the independent Risk Division, which considers the strengths and weaknesses of individual transactions, the balance of risk and reward, and how credit risk aligns to the Group’s risk appetite. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and limit guidelines. Approval requirements for each decision are based on a number of factors including, but not limited to, the transaction amount, the customer’s aggregate facilities, credit policy/risk appetite, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty and customer underwriting is generally the same as that for assets intended to be held to maturity. All hard underwriting must be sanctioned via credit limits and a pre-approved credit matrix may be used for Best Efforts underwriting.
The performance of all rating models is monitored on a regular basis, in order to seek to ensure that models provide appropriate risk differentiation capability, the generated ratings remain as accurate and robust as practical, and the models assign appropriate risk estimates to grades/pools. All models are monitored against a series of agreed key performance indicators. In the event that the monitoring identifies material exceptions or deviations from expected outcomes, these will be escalated in accordance with the governance framework set by the Group Model Governance Committee.
The Group’s treatment of loan renegotiations is included in the impairment policy in note 2(H) on page 189. Income statement information set out in the credit risk tables is on an underlying basis (see page 37).
Recovery can sometimes be through improvement in market or economic conditions, or the customer may benefit from access to alternative sources of liquidity, such as an equity injection. These can be especially relevant in real estate or other asset backed transactions where a fire sale of assets in a weak market may be unattractive.
All reviews performed in the good book, BSU within Commercial Banking or in the Run-off Division include analysis of latest financial information, a consideration of the market and sector the customer operates in, performance against plan and revised terms and conditions granted as part of any forbearance concession that may have been provided.
Exit from forbearance A customer where forbearance has been granted will remain treated and recorded as forborne until it evidences acceptable performance over a period of time. This period will depend on a number of factors such as whether the customer is trading in line with its revised plan, it is operating within the new terms and conditions (including observation to revised covenants and contractual payments), its financial performance is stable or improving and there are no undue concerns over its future performance. As a minimum, this cure period is currently expected to be at least 12 months following a forbearance event. Customers curing are managed according to their overriding Credit Risk Classification categorisation; this could be in BSU, Run-off or in mainstream Good Book.
The Group credit risk portfolio in 2016 Overview – Asset quality remains strong with portfolios continuing to benefit from the Group’s pro-active approach to risk management, continued low interest rates and a resilient UK economic environment. – The impairment charge increased by 14 per cent to £645 million in 2016 compared to £568 million in 2015. Gross charges remained broadly flat with the increase in net charges largely due to lower levels of releases and write-backs. – The asset quality ratio for 2016 was 15 basis points compared to 14 basis points during 2015 and the gross asset quality ratio (excluding releases and write-backs) was stable at 28 basis points. – Looking forward the 2017 full year asset quality ratio is expected to increase to around 25 basis points primarily reflecting lower releases and write-backs. – Impaired loans as a percentage of closing loans and advances reduced to 1.8 per cent at 31 December 2016, from 2.1 per cent at 31 December 2015, with impaired loans reducing by £1,095 million to £8,495 million during the period, due to further reductions in the Commercial Banking, Consumer Finance and Run-off portfolios.
- Total UK Direct Real Estate gross lending across the Group was £19.9 billion (31 December 2015: £19.7 billion). This mainly includes Commercial Banking lending of £18.5 billion, £0.5 billion booked in the Islands Commercial business and £0.2 billion within Retail Business Banking (within Retail Division) with the Group continuing to write new business within conservative risk appetite parameters. The Group’s significantly reduced legacy run-off direct real estate portfolio has continued to fall to £0.7 billion at 31 December 2016 (31 December 2015: £1.1 billion), and now represents a very modest element of the total UK Direct Real Estate lending portfolio.
Transferred to not impaired during the year (800) (112) (81) (54) (1,047) (1,358)
Total Group 455,175 1 Impairment provisions include collective unidentified impairment provisions.
– The impairment charge increased by £6 million to £104 million in 2016 (31 December 2015: £98 million). – Loans and advances reduced by 2.6 per cent on the Secured book to £295 billion, with reductions in both the Mainstream and buy-to-let portfolios. The closed Specialist portfolio has continued to run-off, reducing by 10.0 per cent to £18 billion. – Impaired loans increased by £286 million to £4,104 million in 2016 and the value of mortgages greater than three months in arrears (excluding repossessions) increased by £128 million to £6,033 million at 31 December 2016 (31 December 2015: £5,905 million). These are both principally due to delayed litigation while changes were made to legal processes. New business quality remained stable and flows into arrears improved. – Impairment provisions as a percentage of impaired loans was 36.6 per cent (31 December 2015: 37.5 per cent).
Total Secured 294,503 302,413 1 Specialist lending has been closed to new business since 2009.
Table 1.12: Period end and average LTVs across the Retail mortgage portfolios Mainstream
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 2016, interest only balances as a proportion of total owner occupier balances had reduced to 31.3 per cent (31 December 2015: 33.9 per cent). The average indexed loan to value improved to 43.8 per cent (31 December: 46.6 per cent).
Maturity profile (£m)2: Past term interest only balances (£m)3 1,361 1,140
Average loan to value (%) 31.5 32.5 1 In addition the Group has buy-to-let interest only balances of £48,575 million (2015: £49,751 million) and certain other interest only balances of £3,703 million (2015: £3,705 million).
2 December 2015 values have been restated to now include the interest only elements of mortgage accounts which consist of partial interest only and partial capital repayment.
Permanent treatments 1 Includes customers who had an arrangement to pay less than the contractual amount at 31 December or where an arrangement ended within the previous three months.
SME – The SME Banking portfolio continues to grow within prudent credit risk appetite parameters. – Portfolio credit quality has remained stable or improved across all key metrics. – SME continues to benefit from write-backs/releases. There was a net impairment release of £7 million in 2016 compared to a net release of £22 million during 2015.
Table 1.18: LTV – UK Direct Real Estate At 31 December 20161 At 31 December 20151
2 Predominantly investment grade corporate CRE lending where the Group is relying on the corporate covenant.
Classified as impaired during the year: Transferred to unimpaired: Exposures >£5m but still reported as forborne – (15)
Consumer Finance – UK Loans and advances increased during 2016, driven by strong growth ahead of the market in the UK Motor Finance portfolio, and continued growth in line with the market in the Credit Cards portfolio.
Forborne loans At 31 December 2016, total loans and advances currently or recently subject to forbearance as a percentage of total loans and advances had reduced across the major Consumer Finance portfolios with decreases in Consumer Credit Cards and Loans offset by an increase in UK Motor Finance. (31 December 2016: 1.4 per cent; 31 December 2015: 1.6 per cent).
Corporate real estate and other corporate 1,873 1,410 75.3 745 52.8
Run-off Corporate real estate, other corporate and Specialist Finance At 31 December 2016 £998 million (31 December 2015 £1,780 million) of total loans and advances were forborne of which £995 million (31 December 2015: £1,771 million) were impaired. Impairment provisions as a percentage of forborne loans and advances decreased from 52.5 per cent at 31 December 2015 to 51.1 per cent at 31 December 2016.
In addition to the exposures detailed above, the Group has exposures in the following Eurozone countries: Table 1.31: Other Eurozone exposures Sovereign debt Financial institutions
Trading and other financial liabilities at fair value through profit or loss 54,504 45,079 9,425 – Interest rate, foreign exchange
Derivative assets and liabilities are held by the Group for three main purposes; to provide risk management solutions for clients, to manage portfolio risks arising from client business and to manage and hedge the Group’s own risks. The majority of derivatives exposure arises within Financial Markets. Insurance business assets and liabilities relate to policyholder funds, as well as shareholder invested assets, including annuity funds. The Group recognises the value of in-force business in respect of Insurance’s long-term life assurance contracts as an asset in the balance sheet (see note 24, page 213).
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 148).
Insurance portfolios1 l – – l l – Trading portfolios2 – – – – – –
The Board risk appetite is cascaded first to the Group Asset and Liability Committee (GALCO), chaired by the Chief Financial Officer, where risk appetite is approved and monitored by risk type, and then to Group Market Risk Committee (GMRC) where risk appetite is sub allocated by Division. These metrics are reviewed regularly by senior management to inform effective decision making.
Interest rate risk Interest rate risk in the Group’s divisional portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.36) and off balance sheet positions. Behavioural assumptions are applied to (i) embedded optionality within products; (ii) the duration of balances that are contractually repayable on demand, such as current accounts and overdrafts, together with net free reserves of the group; and (iii) to the re-pricing behaviour of managed rate liabilities namely variable rate savings.
Basis risk arises from the possible changes in spreads, for example where the bank lends with reference to a central bank rate but funds with reference to LIBOR and the spread between these two rates widens or tightens.
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; and (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.
The Group has an integrated Asset and Liability Management (ALM) system which supports non traded asset and liability management of the Group. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. The Group is aware that any assumptions based model is open to challenge. A full behavioural review is performed annually to ensure the assumptions remain appropriate.
Table 1.36 below shows supplementary value sensitivity to a steepening and flattening in the yield curve. This ensures there are no unintended consequences to managing risk to parallel shifts in rates.
Table 1.36: Banking activities: market value sensitivity to a steepening and flattening of the yield curve
Monitoring The appropriate limits and triggers are monitored by senior executive Committees within the Banking divisions. Banking assets, liabilities and associated hedging are actively monitored and if necessary rebalanced to be within agreed tolerances.
For further information on defined benefit pension scheme assets and liabilities please refer to note 36 on page 222.
Mitigation The Group takes an active involvement in agreeing risk management and mitigation strategies with the schemes’ Trustees. An interest rate and inflation hedging programme is in place to reduce liability risk. In recent years the schemes have also reduced equity allocation and invested the proceeds in credit assets as part of a programme to de-risk the portfolio.
Table 1.38: Insurance business: profit before tax sensitivities Increase (reduction) in profit before tax 2016 £m 20151 £m
Monitoring Market risks in the Insurance business are monitored by Insurance senior executive committees and ultimately the Insurance Board. Monitoring includes the progression of market risk capital against risk appetite limits, as well as the sensitivity of profit before tax to combined market risk stress scenarios and in year market movements. Asset/liability matching positions and hedges in place are actively monitored and if necessary rebalanced to be within agreed tolerances. In addition market risk is controlled via approved investment policies and mandates.
A number of these risks also apply where there is a reliance on third party suppliers to provide services to the Group or its customers.
Measurement Operational risk is managed within a Board approved framework and risk appetite. A variety of measures are used such as: scoring of potential risks, using impact and likelihood, with impact thresholds aligned to risk appetite statements; assessment of the effectiveness of controls; monitoring of events and losses by size, business unit and internal risk categories.
Operational risk scenario assessments and actual losses are used by the Group to calculate the appropriate holding of operational risk regulatory capital under the Internal Capital Adequacy Assessment Process (ICAAP). The Group calculates its minimum (Pillar I) operational risk capital requirements using The Standardised Approach (TSA), which the Basel Committee has stated as being appropriate for an ‘internationally active’ bank.
– The Group adopts a risk based approach to mitigate the internal and external fraud risks it faces, reflecting the current and emerging fraud risks within the market. Fraud Risk Appetite metrics have been defined, holistically covering the impacts of fraud in term of losses to the Group, costs of fraud systems and operations, and customer experience of actual and attempted fraud. Oversight of the appropriateness and performance of these metrics is undertaken regularly through business area and Group-level committees. This approach drives a continual programme of prioritised enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Group-wide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group’s fraud awareness programme remains a key component of its fraud control environment, and awareness of fraud risk is supported by mandatory training for all colleagues. – The Group has adopted policies and procedures designed to detect and prevent the use of its banking network for money laundering, terrorist financing, bribery and activities prohibited by legal and regulatory sanctions. The Group regularly reviews and assesses these policies to keep them current, effective and consistent across markets and jurisdictions, against a background of increasingly complex and detailed laws and regulations. The Group requires mandatory training on these topics for all employees. Specifically, the anti-money laundering procedures include ‘know-yourcustomer ’ requirements, transaction monitoring technologies and reporting of suspicions of money laundering or terrorist financing to the applicable regulatory authorities and the Anti-Bribery Policy prohibits the payment, offer, acceptance or request of a bribe, including ‘facilitation payments’ by any employee or agent and provides a confidential reporting service for anonymous reporting for suspected or actual bribery activity. The Sanctions and Related Prohibitions Policy sets out a framework of controls for compliance with legal and regulatory sanctions. – The Group remediates issues that are identified in its customer processes, addressing root cause and rectifying customers as required. Enhancing the overall servicing environment remains a focus of dedicated Group programmes such as Customer Journey Transformation. – Following the successful divestment of TSB the Group retains responsibility for the ongoing provision of key services which are managed via robust service and change management processes. There are separate governance arrangements and additional controls in place to ensure contractual commitments are met.
– Operational resilience measures and recovery planning defined in the Group’s Resilience & Continuity (including Incident Management) policy ensure an appropriate and consistent approach to the management of continuity risks, including potential interruptions from a range of internal and external incidents or threats including environmental and climatic issues, terrorism, cyber, economic instability, pandemic planning and operational incidents.
The Group maintains a Contingency Funding Plan which is designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing. Contingency Funding Plan invocation and escalation processes are based on analysis of five major quantitative and qualitative components, comprising assessment of: early warning indicators, prudential and regulatory liquidity risk limits and triggers, stress testing results, event and systemic indicators and market intelligence.
Total funded assets reduced by £5.8 billion to £465.4 billion during 2016. Loans and advances to customers, excluding reverse repos, reduced by £5.5 billion. Growth in Consumer Finance was strong at 11 per cent and SME lending growth was 3 per cent, both outperforming the market. This was offset by a reduction in mortgage balances as the Group continues to balance risk and margin considerations versus volumes in a competitive low growth market. Total customer deposits fell by £5.3 billion to £413.0 billion at 31 December 2016, largely due to lower Retail and Consumer Finance tactical balances.
7 Excludes £2.5 billion (31 December 2015: £nil) of repurchase agreements.
Debt securities in issue: Of which issued by Lloyds Banking Group plc3 – – – – – – 1.7 5.7 7.4 3.4 1 Medium-term notes include funding from the National Loan Guarantee Scheme (31 December 2016: £1.4 billion; 31 December 2015: £1.4 billion).
Gross term issuance for 2016 totalled £10.4 billion. The Group maintained a diversified approach to funding markets with trades in public and private format, secured and unsecured products and a wide range of currencies and markets. In 2016, the Group drew down £1.0 billion under the Funding for Lending Scheme (FLS), taking peak usage to £33.1 billion, with £3.0 billion of maturities during the year. A further £4.5 billion was drawn under the Bank of England’s Term Funding Scheme (TFS), underlining the Group’s support to the UK economy. The maturities for the FLS and TFS are fully factored into the Group’s funding plan.
Liquidity portfolio At 31 December 2016, the Banking business had £120.8 billion of highly liquid unencumbered LCR eligible assets, of which £120.3 billion is LCR level 1 eligible and £0.5 billion is LCR level 2 eligible. These assets are available to meet cash and collateral outflows and PRA regulatory requirements. A separate liquidity portfolio to mitigate any insurance liquidity risk is managed within the Insurance business. LCR eligible liquid assets represent over 8 times the Group’s money market funding less than one year maturity (excluding derivative collateral margins and settlement accounts) and exceed total wholesale funding, and thus provides a substantial buffer in the event of continued market dislocation.
High quality government/MDB/agency bonds2 75.3 65.8 14 72.4 63.0 1 Average for 2015 includes fourth quarter 2015 only.
Table 1.48: On balance sheet encumbered and unencumbered assets Encumbered with counterparties other than central banks Prepositioned and encumbered assets held with central banks £m
Loans and advances to customers 14,542 30,883 7,305 52,730 153,482 7,032 152,997 91,717 251,746 457,958
Derivative financial instruments – – – – – – – 29,467 29,467 29,467
CAPITAL RISK Definition Capital risk is defined as the risk that the Group has a sub-optimal quantity or quality of capital or that capital is inefficiently deployed across the Group.
There are three systemic buffers in the Capital Requirements Directive: – The G-SII buffer is applied to global systemically important institutions. The Group has not been classified as a G-SII. – The O-SII buffer may be applied to other systemically important institutions. The Group has been classified as an O-SII by the PRA, but the O-SII buffer is set to zero in the UK. – The Systemic Risk Buffer (SRB) will be applied to ring-fenced banks from 1 January 2019. In July 2016 the FPC published their methodology for quantifying the buffer for each ring-fenced bank and in December 2016 the PRA published their statement of policy on their approach for implementing the SRB. The size of buffer applied to the Group’s ring-fenced bank (RFB) sub-group in 2019 will be dependent upon the total assets of the sub-group. The largest buffer the FPC anticipates applying to any ring-fenced bank is 2.5 per cent.
This takes into account, amongst other things: – the Pillar 2A Individual Capital Guidance (ICG) set by the PRA, reflecting their point in time estimate, which may change over time, of the amount of capital that is needed in relation to risks not covered by Pillar 1. During the year the PRA updated the Group’s ICG representing a reduction from 4.6 per cent to 4.5 per cent of risk-weighted assets at 31 December 2016, of which 2.5 per cent has to be covered by CET1 capital. – the PRA Buffer, which they set taking into account the results of the PRA stress tests and other information, as well as outputs from our internal stress tests and other information. In November 2016 the PRA published the results of its 2016 stress tests which showed the Group’s capital depletion to be 2.5 per cent after management actions compared to 3.3 per cent in the 2015 PRA stress tests and 4.8 per cent in the 2014 PRA stress tests. The PRA requires the PRA buffer to remain confidential between the Group and the PRA. – future regulatory developments, including the introduction of the Systemic Risk Buffer in 2019.
The CET1 ratio on a pro forma basis reflects the prudent retention of circa 0.8 per cent of capital, above the current target level, to cover the estimated capital impact of the MBNA acquisition that was announced in December 2016.
Over the year the Group generated around 1.9 per cent of CET1 capital on a pro forma basis, pre dividend, primarily as a result of the following: – Strong underlying capital generation of 2.2 per cent, largely driven by underlying profits; – The dividend paid by the Insurance business in February 2017 in relation to its 2016 earnings of 0.2 per cent; – Impact of conduct charges of (1.0) per cent; – Impact of market movements, netting to 0.2 per cent. This included 0.8 per cent from the impact of the accounting reclassification of c.£20 billion of gilts within the liquidity portfolio from ‘held-to-maturity’ to ‘available-for-sale’, offset by a number of market related movements, including an adverse impact of movements in the defined benefit pension schemes of (0.4) per cent; – Other items largely representing a reduction in risk-weighted assets, most notably in the fourth quarter, largely relating to active portfolio management, disposals, an improvement in credit quality and capital efficient securitisation activity, partially offset by model updates related to UK mortgage portfolios and the impact of the redemption of the remaining series of Enhanced Capital Notes in the first quarter.
3 The common equity tier 1 ratio is 13.8 per cent on a pro forma basis upon recognition of the dividend paid by the Insurance business in February 2017 in relation to its 2016 earnings (31 December 2015: 13.0 per cent pro forma).
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.
3 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.
Credit risk-weighted assets reductions of £5.4 billion were driven by the following key movements: – Asset size movements. Credit risk-weighted assets decreased by £4.9 billion, primarily due to active portfolio management, partially offset by continued growth in targeted customer segments. – Disposals of the Group’s interest in strategic equity investments and other targeted disposals reduced credit risk-weighted assets by £3.8 billion. – Model update increases of £4.4 billion were mainly related to the Mainstream and buy-to-let UK mortgage portfolios. – Methodology and policy reductions of £2.4 billion are principally due to securitisation activity.
Operational risk-weighted assets reduced by £0.8 billion due to the annual update of the income based TSA operational risk calculation.
The derivatives exposure measure, representing derivative financial instruments per the balance sheet net of deconsolidation and derivatives adjustments, reduced marginally with market movements and trading activity broadly offset through netting and cash collateral inflows.
The average leverage ratio of 4.9 per cent over the quarter reflected a strengthening tier 1 capital position prior to the accrual for the announced full year special dividend and the reduction in balance sheet assets during the quarter, largely reflecting the reduction in liquid asset holdings.
Modified UK leverage ratio The Group’s leverage ratio on a modified basis, excluding qualifying central bank claims from the leverage exposure measure, is 5.2 per cent. This follows the rule modification applied to the UK Leverage Ratio Framework by the PRA in August 2016 as a result of recommendations made by the Financial Policy Committee.
The Financial Policy Committee has indicated that it intends to recalibrate the UK framework in 2017 in order to adjust for the impact of the rule modification, thereby ensuring that levels of capital currently required to meet leverage ratio minimums are maintained. The modified UK leverage ratio should therefore be considered in the context of the proposed recalibration.
Insurance businesses The business transacted by the insurance companies within the Group comprises both life insurance business and general insurance business. Life insurance business comprises unit-linked business, non-profit business and with-profits business.
State aid commitments In 2015 we satisfied all material structural and behavioural commitments following the successful carve-out and disposal of TSB with respect to the State Aid commitments agreed with the European Commission under the State Aid regime in 2009. We are therefore no longer subject to restrictive behavioural commitments including the constraint on acquisitions, but continue to be bound by two remaining limited ancillary commitments which means that we remain subject to supervision by the European Commission with respect to these commitments until they cease to have effect on or before June 2017.
Monitoring Insurance risks in the Insurance business are monitored by Insurance senior executive Committees and ultimately the Insurance Board. Governance of the Group’s defined benefit pension schemes includes two specialist pension committees. Significant risks from the Insurance business and the defined benefit pension schemes are reviewed by the Group Executive and Group Risk Committees and/or Board.
Insurance risk exposures within the Insurance business are monitored against risk appetite. The Insurance business monitors experiences against expectations, for example business volumes and mix, claims and persistency experience. The effectiveness of controls put in place to manage insurance risk is evaluated and significant divergences from experience or movements in risk exposures are investigated and remedial action taken.
Mitigation The Group takes many mitigating actions with respect to people risk. Key areas of focus include: – Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning; – Continued focus on the Group’s culture by developing and delivering initiatives that reinforce the appropriate behaviours which generate the best possible long-term outcomes for customers and colleagues; – Managing organisational capability and capacity through divisional people strategies to ensure there are the right skills and resources to meet our customers’ needs and deliver our strategic plan; – Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations; – Ensuring compliance with legal and regulatory requirements related to SM&CR, embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities; and – Ongoing consultation with the Group’s recognised unions on changes which impact their members.
Monitoring People risks from across the Group are monitored and reported through Board and Group Governance Committees in accordance with the Group’s Risk Management Framework and People Risk sub-framework. Risk exposures are discussed monthly via the Group People Risk Committee with upwards reporting to Group Risk and Executive Committees. In addition oversight, challenge and reporting is completed at Risk Division level and combined with Risk Assurance reviews, assesses the effectiveness of controls, recommending follow up remedial action if relevant. All material People Risk events are escalated in accordance with the formal Group Operational Risk Policy and People Policies to the respective Divisional Managing Directors and the Group Director, Conduct, Compliance and Operational Risk.
For further information on Corporate Governance see pages 60 to 80.
These items were initially discussed with the Audit Committee as part of our audit plan. There were no modifications to this initial assessment and these were the key matters for discussion at the conclusion of our audit.
Independent auditors’ report to the members of Lloyds Banking Group plc REPORT ON THE FINANCIAL STATEMENTS Our opinion In our opinion: – Lloyds Banking Group plc’s consolidated financial statements and parent company financial statements (the ‘financial statements’) give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2016 and of the Group’s profit and the Group’s and the parent company’s cash flows for the year then ended; – the consolidated financial statements have been properly prepared in accordance with International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union; – the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and – the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the consolidated financial statements, Article 4 of the IAS Regulation.
What we have audited The financial statements, included within the Annual Report and Accounts (the ‘Annual Report’), comprise: – the consolidated and parent company balance sheets as at 31 December 2016; – the consolidated income statement and the consolidated statement of comprehensive income for the year then ended; – the consolidated and parent company cash flow statements for the year then ended; – the consolidated and parent company statements of changes in equity for the year then ended; and – the notes to the financial statements, which include a summary of accounting policies and other explanatory information.
Independent auditors’ report to the members of Lloyds Banking Group plc continued us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. With respect to the Strategic Report and Directors’ Report, we consider whether those reports include the disclosures required by applicable legal requirements.
Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: Overall Group materiality £325 million (2015: £300 million).
Any reporting units which were considered individually financially significant in the context of the Group’s consolidated financial statements were considered full scope components. We then considered the individual financial significance of other reporting units in relation to primary statement account balances. In doing this we also considered the presence of any significant audit risks and other qualitative factors (including history of misstatements through fraud or error). Any reporting unit which was not already included as a full scope audit component but was identified as being individually financially significant in respect of one of more primary statement account balances was subject to specific audit procedures over those account balances. Inconsequential components (defined as reporting units which did not represent a reasonable possibility of a risk of material misstatement either individually or in aggregate) were eliminated from further consideration for specific audit procedures although they were subject to Group level analytical review procedures. All remaining reporting units which were neither inconsequential nor individually financially significant were within our audit scope, with the risk of material misstatement mitigated through audit procedures including testing of entity level controls and Group and component level analytical review procedures.
We also focused on the calculation of required impairment provisions, including the use of models, and in particular the critical assumptions used in those models and calculations.
Management also applies adjustments, or overlays, where they believe the data driven parameters and calculations are not appropriate, either due to emerging trends or models not capturing the risks in the loan portfolio. An example of this is an overlay for the current low interest rates which management apply on top of the impairment model output in Retail. These overlays require significant judgement and are therefore a main area of focus.
We found these key controls were designed, implemented and operated effectively, and therefore we determined that we could place reliance on these key controls for the purposes of our audit.
We understood and critically assessed the models used. Modelling assumptions and parameters, such as probability of default, are based on historic data. We challenged whether historic experience was representative of current circumstances and of the recent losses incurred in the portfolios. Where changes had been made in model parameters and assumptions, we understood the reasons why changes had taken place and used our industry knowledge and experience to evaluate the appropriateness of such changes. We performed sensitivity analysis, and for certain portfolios, re-performed the provision calculation using our own independent models. We understood and corroborated any material differences identified. We also performed testing to obtain evidence over the existence and valuation of collateral.
Based on the evidence obtained we found that the impairment model assumptions, data used within the models and overlays to modelled outputs are reasonable and therefore concluded that provisions are appropriate.
For the collective unidentified impaired provision, which reflects losses incurred but not yet identified, we tested the completeness and accuracy of the underlying loan information used in the impairment models by agreeing details to the Group’s source systems as well as re-performing the calculation of the modelled provision. For the key inputs and assumptions in the model, we obtained and tested objective evidence that supported their appropriateness. For overlays to the modelled output, we challenged management to provide objective evidence that the overlays were appropriate.
We also considered whether certain recent events and macro-economic factors (e.g. continued volatility and uncertainty around commodity prices, sterling exchange rate movements and further reduction in interest rates) had been appropriately considered and captured.
In relation to known issues, the measurement of provisions is highly judgemental and involves the use of several management assumptions including volume of future complaints and related redress costs.
Furthermore, there is a risk that these known and emerging issues are not appropriately disclosed in the financial statements.
We found these key controls were designed, implemented and operated effectively and therefore we determined that we could place reliance on these key controls for the purposes of our audit.
Refer to page 72 (Audit Committee Report), page 186 (Accounting Policies) and pages 213, 217 and 221 (Notes 24, 32, 33 and Critical Accounting Estimates and Judgements).
We engaged our actuarial specialists to assess the actuarial assumptions, including the consideration and challenge of management’s rationale for the judgements applied and any reliance placed on industry information.
For credit risk and illiquidity premium we assessed the appropriateness of the methodology, including modifications made, against our knowledge and experience of the regulatory requirements and of the industry. We assessed the assumptions with reference to wider market practice and prevailing economic conditions. We challenged whether the actual asset mix remained an appropriate proxy to a market consistent portfolio by comparing the proportion of illiquid assets held to those held by other similar companies; this comparison was based on our understanding of the market and the most recent public information for other similar companies. We performed testing to confirm that the assumptions approved were those applied.
Refer to page 72 (Audit Committee Report), page 186 (Accounting Policies), and page 261 (Note 52).
The allocation of forecast profits is also judgemental when considering the utilisation of the deferred tax assets in the separate legal entities where the assets reside. Furthermore, there have recently been changes to legislation in relation to the level of profits which banking entities may offset with brought forward tax losses.
We examined and challenged the analyses performed by management which set out the basis for their judgements in respect of the material tax exposures identified, together with relevant supporting evidence such as correspondence with tax authorities and legal opinions obtained. We used our understanding of the business and also read correspondence with tax authorities to challenge the completeness of identified exposures and the need for provisions.
The Group has entered into a number of significant one-off transactions where a high level of complexity and/or judgement is involved in determining the accounting treatment resulting in an increased risk of management bias. (e.g. the redemption of ECN’s and the reclassification of gilts from held-to-maturity to available-for-sale).
We understood and tested key controls which require that one-off transactions are referred to Group Financial Reporting and an accounting paper prepared. We found the key controls were designed, implemented and operated effectively.
We made our own assessment as to the most appropriate accounting treatment for each individual significant transaction, using this as a basis to challenge the key judgements made by management, including the assessment of any potential management bias.
We assessed whether the extent of the disclosures made, in relation to significant transactions was appropriate.
Going concern Under the Listing Rules we are required to review the directors’ statement, set out on page 82, in relation to going concern. We have nothing to report having performed our review.
– the section of the Annual Report on page 72, as required by provision C.3.8 of the Code, describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee.
Independent auditors’ report to the members of Lloyds Banking Group plc continued Directors’ remuneration Directors’ remuneration report - Companies Act 2006 opinion In our opinion, the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006.
Under the Listing Rules we are required to review the part of the corporate governance statement relating to ten further provisions of the Code. We have nothing to report having performed our review.
(a) The maintenance and integrity of the Lloyds Banking Group plc website is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website.
Total comprehensive income attributable to other equity holders 412 394 287
Post-retirement defined benefit scheme remeasurements, net of tax – – (1,028) (1,028) – – (1,028)
Distributions on other equity instruments, net of tax – – (321) (321) – – (321)
Distributions on other equity instruments, net of tax – – (225) (225) – – (225)
Post-retirement defined benefit scheme remeasurements, net of tax – – (215) (215) – – (215)
Total other comprehensive income – (825) (215) (1,040) – – (1,040)
Value of employee services: Share option schemes – – 107 107 – – 107
Proceeds from sale and maturity of financial assets 6,335 22,000 4,668
Disposal of businesses, net of cash disposed 53(E) 5 (4,071) 543
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. 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.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2016 and which have not been applied in preparing these financial statements are given in note 55.
(A) Consolidation The assets, liabilities and results of Group undertakings (including structured entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures. Details of the Group’s subsidiaries and related undertakings are given on pages 293 to 300.
The treatment of transactions with non‑controlling interests depends on whether, as a result of the transaction, the Group loses control of the subsidiary. Changes in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions; any difference between the amount by which the non‑controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent entity. Where the Group loses control of the subsidiary, at the date when control is lost the amount of any non‑controlling interest in that former subsidiary is derecognised and any investment retained in the former subsidiary is remeasured to its fair value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.
(D) Revenue recognition Interest income and expense are recognised in the income statement for all interest-bearing financial instruments using the effective interest method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability, including early redemption fees, and related penalties; and premiums and discounts that are an integral part of the overall return. Direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument are also taken into account.
Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided. Loan commitment fees for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an adjustment to the effective interest rate on the loan once drawn. Where it is unlikely that loan commitments will be drawn, loan commitment fees are recognised over the life of the facility.
Held for trading: Trading securities are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short-term gains. Such securities are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.
NOTE 2: ACCOUNTING POLICIES continued The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a fair value by using valuation techniques. Refer to note 49(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.
The Group is permitted to transfer a financial asset from the available-for-sale category to the loans and receivables category where that asset would otherwise have met the definition of loans and receivables at the time of reclassification and where there is both the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a financial asset from the available-for-sale category to the held-to-maturity category is permitted when the Group has the ability and intent to hold that financial asset to maturity. Reclassifications are made at fair value as of the reclassification date. Fair value becomes the new cost or amortised cost as applicable. Effective interest rates for financial assets reclassified to the loans and receivables and held-to-maturity categories are determined at the reclassification date. Any previous gain or loss on a transferred asset that has been recognised in equity is amortised to profit or loss over the remaining life of the investment using the effective interest method or until the asset becomes impaired. Any difference between the new amortised cost and the expected cash flows is also amortised over the remaining life of the asset using the effective interest method.
(4) Held-to-maturity investments Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group’s management has the positive intention and ability to hold to maturity other than: those that the Group designates upon initial recognition as at fair value through profit or loss; those that the Group designates as available-for-sale; and those that meet the definition of loans and receivables.
The method of recognising the movements in the fair value of derivatives depends on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item, the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.
Products sold by the life insurance business are classified into three categories: – Insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance risk as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. These contracts may or may not include discretionary participation features. – Investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional
Financial statements discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets. – Non-participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
(2) General insurance business The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included in insurance premium income, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods are deferred in the balance sheet within liabilities arising from insurance contracts and participating investment contracts on a basis that reflects the length of time for which contracts have been in force and the projected incidence of risk over the term of the contract and only credited to the income statement when earned. Broking commission is recognised when the underwriter accepts the risk of providing insurance cover to the customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience.
The segmental results and comparatives are presented on an underlying basis, the basis reviewed by the chief operating decision maker. The effects of the following are excluded in arriving at underlying profit: – losses on redemption of the Enhanced Capital Notes and the volatility in the value of the embedded equity conversion feature; – market volatility and other items, which includes the effects of certain asset sales, the volatility relating to the Group’s own debt and hedging arrangements as well as that arising in the insurance businesses, insurance gross up, the unwind of acquisition-related fair value adjustments and the amortisation of purchased intangible assets; – restructuring costs, (which in 2015 and 2016 comprised severance related costs relating to the Simplification programme announced in October 2014 and in 2014 included severance, IT and business costs relating to the programme started in 2011) and the costs of implementing regulatory reform and ring-fencing; – TSB build and dual running costs and the loss relating to the TSB sale in 2015; – payment protection insurance and other conduct provisions; and – certain past service pension credits or charges.
Other includes certain assets previously reported as outside of the Group’s risk appetite and the results of businesses disposed. Other also includes income and expenditure not recharged to divisions, including the costs of certain central and head office functions and the costs of managing the Group’s technology platforms, branch and head office property estate, operations (including payments, banking operations and collections) and sourcing, the costs of which are predominantly recharged to the other divisions. It also reflects other items not recharged to the divisions.
Segment underlying income, net of insurance claims 7,550 4,722 3,279 1,609 340 17,500
Total underlying income, net of insurance claims 7,779 4,648 3,313 1,664 233 17,637
Total underlying income, net of insurance claims 7,472 4,504 3,405 1,594 467 17,442
Other segment items: Investments in joint ventures and associates at end of year 1 – 9 – 64 74 1 Restated – see page 194. 2 Net of profits on disposal of operating lease assets of £67 million.
Other income, net of insurance claims 5,739 1,482 (140) (614) – – 6,467
3 Net of profits on disposal of operating lease assets of £58 million (2015: £66 million; 2014: £67 million).
Interest and similar income: Loans and advances to customers 3.32 3.50 3.53 15,190 16,256 17,806
Loans and advances to banks 0.46 0.42 0.52 381 397 406
Customer deposits, excluding liabilities under sale and repurchase transactions 0.69 0.87 1.15 (2,520) (3,299) (4,781)
Interest payable on liabilities held at amortised cost 1.07 1.19 1.45 (5,289) (6,053) (7,949)
Amounts payable to unitholders in consolidated open-ended investment vehicles 10.85 1.16 3.23 (2,057) (244) (602)
Included within interest and similar income is £205 million (2015: £248 million; 2014: £407 million) in respect of impaired financial assets. Net interest income also includes a credit of £557 million (2015: credit of £956 million; 2014: credit of £1,153 million) transferred from the cash flow hedging reserve (see note 42).
Total net gains arising on assets and liabilities held at fair value through profit or loss 17,151 2,849 8,546
Gains less losses on disposal of available-for-sale financial assets (note 42) 575 51 131
Share of results of joint ventures and associates (1) (3) 32
Depreciation and amortisation: Depreciation of property, plant and equipment (note 26) 1,761 1,534 1,391
Performance-based awards expensed in 2016 include cash awards amounting to £116 million (2015: £96 million; 2014: £104 million).
Total fees payable to the Company’s auditors by the Group 24.3 24.3 32.1
All statutory audit work as well as non-audit assignments where the fee is expected to exceed the relevant fee cap must be pre-approved by the Audit Committee on an individual engagement basis. On a quarterly basis, the Audit Committee receives and reviews a report detailing all pre-approved services and amounts paid to the auditors for such pre-approved services.
Audits of the unconsolidated Open Ended Investment Companies managed by the Group 0.4 0.4 0.4
Reviews of the financial position of corporate and other borrowers 1.2 3.1 5.0
Impairment losses on loans and receivables: Loans and advances to customers 592 443 735
UK corporation tax: Current tax on profit for the year (1,010) (485) (162)
Effect of results of joint ventures and associates (1) (1) 7
Weighted average number of ordinary shares in issue – basic 71,234 71,272 71,350
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 140 million (2015: 101 million; 2014: 22 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
Loans and advances to banks 2,606 – 2,606 3,065 – 3,065
(ii) private equity investments of £2,245 million (2015: £2,415 million) that are managed, and evaluated, on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis.
NOTE 16: DERIVATIVE FINANCIAL INSTRUMENTS The fair values and notional amounts of derivative instruments are set out in the following table: Contract/ notional amount £m
Total derivative assets/liabilities – trading and other 3,394,500 33,426 32,960 4,083,962 26,781 23,864
Derivatives designated as fair value hedges: Options purchased – – – – – –
The Group holds derivatives as part of the following strategies: – Customer driven, where derivatives are held as part of the provision of risk management products to Group customers; – To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by the Group is to utilise a combination of fair value and cash flow hedge approaches as described in note 52; and – Derivatives held in policyholder funds as permitted by the investment strategies of those funds.
Total loans and advances to customers before allowance for impairment losses 460,370 458,208
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 31.
In addition, the collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been separately identified at the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. Risk drivers for secured retail lending include the current indexed loan‑to‑value, previous mortgage arrears, internal cross‑product delinquency data and external credit bureau data; for unsecured retail lending they include whether the account is up‑to‑date and, if not, the number of payments that have been missed; and for commercial lending they include factors such as observed default rates and loss given default. An assessment is made of the likelihood of assets being impaired at the balance sheet date and being identified subsequently; the length of time taken to identify that an impairment event has occurred is known as the loss emergence period. The loss emergence period is determined by local management for each portfolio and the Group has a range of loss emergence periods which are dependent upon the characteristics of the portfolios. Loss emergence periods are reviewed regularly and updated when appropriate. In general the periods used across the Group vary between one month and 12 months based on historical experience. Unsecured portfolios tend to have shorter loss emergence periods than secured portfolios. This provision is sensitive to changes in the loss emergence period. Management use a significant level of judgement when determining the collective unidentified impairment provision, including the assessment of the level of overall risk existing within particular sectors and the impact of the low interest rate environment on loss emergence periods. In the Commercial Banking division, an increase of one month in the loss emergence period in respect of the loan portfolio assessed for collective unidentified impairment provisions would result in an increase in the collective unidentified impairment provision of approximately £33 million (2015: £36 million).
NOTE 21: ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES continued
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,016 million (2015: £2,016 million), £1,836 million, or 91 per cent of the total (2015: £1,836 million, 91 per cent of the total) has been allocated to Scottish Widows in the Group’s Insurance division and £170 million, or 8 per cent of the total (2015: £170 million, 8 per cent of the total) to Motor Finance in the Group’s Consumer Finance division.
The recoverable amount of the goodwill relating to Scottish Widows has been based on a value-in-use calculation. The calculation uses pre-tax projections of future cash flows based upon budgets and plans approved by management covering a five-year period, the related run-off of existing business in force and a discount rate of 10 per cent. The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. New business cash flows beyond the five-year period have been extrapolated using a steady 3 per cent growth rate which does not exceed the long-term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds and illiquid loan assets. The value of the in-force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of corporate bond holdings and relevant illiquid loan assets. In determining the market premium for illiquidity, we consider a range of inputs which reflect actual asset allocation and relevant observable market data. The illiquidity premium is estimated to be 138 basis points at 31 December 2016 (2015: range of 85 to 144 basis points).
Risk-free rate (value of in-force annuity business)1 1.38 to 5.58 0.85 to 5.64
Expenditure on investment properties (see below) 344 – – – 344
Accumulated depreciation and impairment: Exchange and other adjustments – 9 (2) 7 14
Capital expenditure in respect of investment properties which had been contracted for but not recognised in the financial statements was £65 million (2015: £37 million).
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2015 and 2016 no contingent rentals in respect of operating leases were recognised in the income statement.
Liabilities in respect of securities sold under repurchase agreements 2,462 –
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2016 was £16,079 million, which was £6,656 million higher than the balance sheet carrying value (2015: £12,034 million, which was £4,156 million higher than the balance sheet carrying value). At 31 December 2016 there was a cumulative £95 million increase 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 an increase of £28 million arose in 2016 and a decrease of £114 million arose in 2015.
With-profit fund realistic liabilities (i) Business description Scottish Widows Limited has the only with-profit funds within the Group. The primary purpose of the conventional and unitised business written in the with-profit funds is to provide a smoothed investment vehicle to policyholders, protecting them against short-term market fluctuations. Payouts may be subject to a guaranteed minimum payout if certain policy conditions are met. With-profit policyholders are entitled to at least 90 per cent of the distributed profits, with the shareholders receiving the balance. The policyholders are also usually insured against death and the policy may carry a guaranteed annuity option at retirement.
Investment volatility The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical volatility where it is not possible to observe meaningful prices.
For those policies written in Scottish Widows pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up, within the With-Profit Fund originally held in Scottish Widows plc and subsequently transferred into Scottish Widows Limited, called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2016 of £2.7 billion (2015: £2.5 billion). The eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
The most significant economic assumptions included in the model are risk-free yield and investment volatility.
(iv) Options and guarantees outside the With-Profit Funds A number of typical guarantees are provided outside the With-Profit Funds such as guaranteed payments on death (e.g. term assurance) or guaranteed income for life (e.g. annuities). In addition, certain personal pension policyholders in Scottish Widows, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £82 million (2015: £68 million) in respect of those guarantees.
The movements in non-life insurance contract liabilities and reinsurance assets over the year have been as follows: £m £m
Guaranteed annuity option take up6 5% addition (12) (10) 2 2
5 This sensitivity shows the impact on the value of in-force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk-free rate by 25 basis points.
1 On 11 March 2014 the Group announced a change to its defined benefit pension schemes, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This was partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business.
Pension schemes Defined benefit schemes Critical accounting estimates and judgements The value of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The discount rate is required to be set with reference to market yields at the end of the reporting period on high quality corporate bonds in the currency and with a term consistent with the defined benefit pension schemes’ obligations. The average duration of the schemes’ obligations is approximately 20 years. The market for bonds with a similar duration is illiquid and, as a result, significant management judgement is required to determine an appropriate yield curve on which to base the discount rate. The cost of the benefits payable by the schemes will also depend upon the life expectancy of the members. The Group considers latest market practice and actual experience in determining the appropriate assumptions for both current mortality expectations and the rate of future mortality improvement. Given the advances in medical science in recent years, it is uncertain whether this rate of improvement will be sustained going forward and, as a result, actual experience may differ from current expectations. The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptions is set out in (iii) below.
(i) Characteristics of and risks associated with the Group’s schemes The Group has established a number of defined benefit pension schemes in the UK and overseas. All significant schemes are based in the UK, with the three most significant being the defined benefit sections of the Lloyds Bank Pension Schemes No’s 1 and 2 and the HBOS Final Salary Pension Scheme. These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2016 is generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
Weighted-average rate of increase for pensions in payment 2.74 2.58 2016 Years 2015 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 liability 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.
Expected life expectancy of members: Increase of one year 42 43 1,213 952
1 At 31 December 2016, the assumed rate of RPI inflation is 3.23 per cent and CPI inflation 2.18 per cent (2015: RPI 2.99 per cent and CPI 1.99 per cent).
Maturity profile of defined benefit obligation The following table provides information on the weighted average duration of the defined benefit pension obligations and the distribution and timing of benefit payments: Years
The Group’s total deferred tax asset includes £4,298 million (2015: £4,890 million) in respect of trading losses carried forward. The tax losses have arisen in individual legal entities and will be used as future taxable profits arise in those legal entities, though substantially all of the unused tax losses for which a deferred tax asset has been recognised arise in Bank of Scotland plc and Lloyds Bank plc.
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 in particular with respect to future 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 significant uncertainty around the impact of the proposed regulatory changes, FCA media campaign and Claims Management Companies and customer activity.
Average redress per upheld policy2 £1,700 £1,470 £100 = £125m 1 Sensitivity includes complaint handling costs.
Arrears handling related activities Following a review of the Group’s secured and unsecured arrears handling activities, the Group has put in place a number of actions to further improve its handling of customers in these areas. As a result, the Group has provided an additional £261 million in the year ended 31 December 2016 (bringing the total provision to £397 million), for the costs of identifying and rectifying certain arrears management fees and activities. As at 31 December 2016, the unutilised provision was £383 million (31 December 2015: £136 million).
Other 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 and claims from customers in connection with its past conduct and, where significant, provisions are held against the costs expected to be incurred as a result of the conclusions reached. In the year ended 31 December 2016, the Group charged an additional £450 million in respect of matters across all divisions. At 31 December 2016, the Group held unutilised provisions totalling £573 million for these other legal actions and regulatory matters.
Vacant leasehold property Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biannual basis and will normally run off over the period of under-recovery of the leases concerned, currently averaging 3 years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
7.286% Perpetual Regulatory Tier One Securities (Series A) – (150) – – – (150)
13% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 – – – – (244) (244)
11.875% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 – – – – (960) (960)
8.117% Non-cumulative Perpetual Preferred Securities (Class A) – (250) – – – (250)
6.05% Fixed to Floating Rate Undated Subordinated Notes – – (18) – – (18)
5.125% Undated Subordinated Fixed to Floating Rate Notes – – (50) – – (50)
6.305% Subordinated Callable Fixed to Floating Notes 2017 – – – – (35) (35)
These securities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated Enhanced Capital Notes (ECNs) ranked equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during 2016 (2015: none).
(3) Share capital and control There are no restrictions on the transfer of shares in the Company other than as set out in the articles of association and: – certain restrictions which may from time to time be imposed by law and regulations (for example, insider trading laws); – where directors and certain employees of the Company require the approval of the Company to deal in the Company’s shares; and – pursuant to the rules of some of the Company’s employee share plans where certain restrictions may apply while the shares are subject to the plans.
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 12 May 2016. The authority to issue shares and the authority to make market purchases of shares will expire at the next annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
1 During the year ended 31 December 2016, the Company redeemed all of its outstanding 6.267% Non-cumulative Fixed to Floating Rate Callable US Dollar Preference Shares at their combined sterling equivalent par value of £210 million. These preference shares had been accounted for as subordinated liabilities. On redemption an amount of £210 million was transferred from the distributable merger reserve to the share premium account (2015: £131 million in respect of the redemption of the outstanding 6.0884% Non-cumulative Fixed to Floating Rate Preference Shares and 5.92% Non-cumulative Fixed to Floating Rate Preference Shares).
Revaluation reserve in respect of available-for-sale financial assets 759 (438) (67)
1 There were no movements in this reserve during 2014, 2015 or 2016.
The revaluation reserve in respect of available-for-sale financial assets represents the cumulative after tax unrealised change in the fair value of financial assets classified as available-for-sale since initial recognition; in the case of available-for-sale financial assets obtained on acquisitions of businesses, since the date of acquisition; and in the case of transferred assets that were previously held at amortised cost, by reference to that amortised cost.
1 Net of a credit in respect of unclaimed dividends written-back in accordance with the Company’s Articles of Association.
Additional Tier 1 securities issued in the year: Sterling notes (£3,725 million nominal) – – 3,725
NOTE 45: DIVIDENDS ON ORDINARY SHARES The directors have recommended a final dividend, which is subject to approval by the shareholders at the Annual General Meeting, of 1.7 pence per share (2015: 1.5 pence per share; 2014: 0.75 pence per share) representing a total dividend of £1,212 million (2015: £1,070 million; 2014: £535 million), which will be paid on 16 May 2017. The directors have also recommended a special dividend of 0.5 pence per share (2015: 0.5 pence per share; 2014: nil) representing a total dividend of £356 million (2015: £357 million; 2014: nil). These financial statements do not reflect these recommended dividends.
Recommended by directors at previous year end: Special dividend 0.50 – – 357 – –
Deferred bonus plans The Group operates a number of deferred bonus plans that are equity settled. Bonuses in respect of employee performance in 2016 have been recognised in the charge in line with the proportion of the deferral period completed.
Participants may be entitled to any dividends paid during the vesting period if the performance conditions are met. An amount equal in value to any dividends paid between the award date and the date the Remuneration Committee determine that the performance conditions were met may be paid, based on the number of shares that vest. The Remuneration Committee will determine if any dividends are to be paid in cash or in shares. Details of the performance conditions for the plan are provided in the Directors’ remuneration report.
At the end of the performance period for the 2013 grant, the targets had not been fully met and therefore these awards vested in 2016 at a rate of 94.18 per cent.
Awards in respect of the 2014 grant will vest in 2017 at a rate of 55 per cent.
The fair value calculations at 31 December 2016 for grants made in the year, using Black-Scholes models and Monte Carlo simulation, are based on the following assumptions: Save-As-YouEarn
Fixed share awards Fixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for certain Lloyds Banking Group employees, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements. The fixed share awards are delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award. The number of shares purchased in 2016 was 10,031,272 (2015: 8,237,469).
Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £0.1 million (2015: £0.1 million; 2014: £0.1 million).
Granted, including certain adjustments (includes entitlements of appointed key management personnel) 3 3 –
Advanced (includes loans of appointed key management personnel) 3 4 2
At 31 December 2016, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £0.4 million with five directors and two connected persons (2015: £1 million with four directors and six connected persons; 2014: £1 million with six directors and six connected persons).
Collective investment vehicles The Group manages 139 (2015: 168) collective investment vehicles, such as Open Ended Investment Companies (OEICs) and of these 83 (2015: 95) are consolidated. The Group invested £265 million (2015: £818 million) and redeemed £826 million (2015: £616 million) in the unconsolidated collective investment vehicles during the year and had investments, at fair value, of £2,405 million (2015: £2,129 million) at 31 December. The Group earned fees of £192 million from the unconsolidated collective investment vehicles during 2016 (2015: £187 million).
In addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2016, these companies had total assets of approximately £4,712 million (2015: £3,911 million), total liabilities of approximately £5,033 million (2015: £4,104 million) and for the year ended 31 December 2016 had turnover of approximately £4,401 million (2015: £4,660 million) and made a loss of approximately £27 million (2015: net loss of £181 million). In addition, the Group has provided £1,550 million (2015: £1,710 million) of financing to these companies on which it received £127 million (2015: £125 million) of interest income in the year.
NOTE 48: CONTINGENT LIABILITIES AND COMMITMENTS Interchange fees With respect to multi-lateral interchange fees (MIFs), the Group is not directly involved in the ongoing investigations and litigation (as described below) which involve card schemes such as Visa and MasterCard. However, the Group is a member of Visa and MasterCard and other card schemes.
Financial Services Compensation Scheme The Financial Services Compensation Scheme (FSCS) is the UK’s independent statutory compensation fund of last resort for customers of authorised financial services firms and pays compensation if a firm is unable or likely to be unable to pay claims against it. The FSCS is funded by levies on the authorised financial services industry. Each deposit-taking institution contributes towards the FSCS levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March.
Mortgage arrears handling activities On 26 May 2016, the Group was informed that an enforcement team at the FCA had commenced an investigation in connection with the Group’s mortgage arrears handling activities. This investigation is ongoing and it is currently not possible to make a reliable assessment of the liability, if any, that may result from the investigation.
Other legal actions and regulatory matters In addition, during the ordinary course of business the Group is subject to other complaints and threatened or actual legal proceedings (including class or group action claims) brought by or on behalf of current or former employees, customers, investors or other third parties, as well as legal and regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: Mortgage offers made 10,749 9,995
Capital commitments Excluding commitments in respect of investment property (note 26), capital expenditure contracted but not provided for at 31 December 2016 amounted to £543 million (2015: £388 million). Of this amount, £541 million (2015: £380 million) related to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
Cash and balances at central banks – – – – – 47,452 – 47,452
Items in course of transmission to banks – – – – – 548 – 548
Cash and balances at central banks – – – – – 58,417 – 58,417
Available-for-sale financial assets – – – 33,032 – – – 33,032
Deposits from banks – – – – – 16,925 – 16,925
Derivative financial instruments 2,437 23,864 – – – – – 26,301
Notes in circulation – – – – – 1,112 – 1,112
Liabilities arising from non-participating investment contracts – – – – – – 22,777 22,777
Unallocated surplus within insurance businesses – – – – – – 257 257
NOTE 49: FINANCIAL INSTRUMENTS continued (3) Financial assets and liabilities carried at fair value Critical accounting estimates and judgements The valuation techniques for level 2 and, particularly, level 3 financial instruments involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information. In addition, in line with market practice, the Group applies credit, debit and funding valuation adjustments in determining the fair value of its uncollateralised derivative positions. A description of these adjustments is set out in this note on page 253. Further details of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair value are set out below. Details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the risk management section on page 146.
Debt securities: Bank and building society certificates of deposit – 186 – 186
Total financial assets carried at fair value, excluding derivatives 104,759 63,009 5,800 173,568
Gains recognised in the income statement within other income 437 – 437 192 – 192
Gains recognised in other comprehensive income within the revaluation reserve in respect of available-for-sale financial assets – 312 312 – 302 302
Gains recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December 642 – 642 34 – 34
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 42,067 – 42,067
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 38,431 – 38,431
Total financial liabilities carried at fair value, excluding derivatives 4,153 47,709 1 51,863
Loans and advances to customers: impaired 7,165 6,989 – – 6,989
Loans and advances to banks The carrying value of short dated loans and advances to banks is assumed to be their fair value. The fair value of loans and advances to banks is estimated by discounting the anticipated cash flows at a market discount rate adjusted for the credit spread of the obligor or, where not observable, the credit spread of borrowers of similar credit quality.
Repos included in above amounts: Deposits from banks 7,061 7,061 – 7,061 –
Debt securities in issue The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities is calculated based on quoted market prices where available. Where quoted market prices are not available, fair value is estimated using discounted cash flow techniques at a rate which reflects market rates of interest and the Group’s own credit spread.
NOTE 50: TRANSFERS OF FINANCIAL ASSETS There were no significant transferred financial assets which were derecognised in their entirety, but with ongoing exposure. Details of transferred financial assets that continue to be recognised in full are as follows.
Market risk Interest rate risk Interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. The rates on the remaining deposits are contractually fixed for their term to maturity.
In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the commercial business. Note 16 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2016 was £384,182 million (2015: £460,829 million) with a net fair value liability of £352 million (2015: liability of £718 million) (note 16). In 2016, ineffectiveness recognised in the income statement that arises from cash flow hedges was a gain of £24 million (2015: gain of £3 million).
At 31 December 2016 the most significant concentrations of exposure were in mortgages (comprising 67 per cent of total loans and advances to customers) and to financial, business and other services (comprising 11 per cent of the total). For further information on concentrations of the Group’s loans, refer to note 18.
Allowance for impairment losses on loans and advances to customers on an underlying basis 3,532 4,172 1 Comprises an allowance held at 31 December 2008 of £10,693 million and a charge for the period from 1 January 2009 to 16 January 2009 of £454 million.
The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and commercial are not the same, reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Commercial lending has been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models. Further information about the Group’s internal probabilities of default rating models can be found on page 124.
Asset-backed securities: Corporate and other debt securities 29 65 94 417 109 526
Total debt securities classified as loans and receivables 3,397 4,191 1 Credit ratings equal to or better than ‘BBB’.
Total held as trading assets 12,165 3 12,168 9,452 30 9,482