The 2013 Annual Report and Accounts incorporates the Strategic Report and the consolidated financial statements, both of which have been approved by the Board of Directors.
+3% Our core loan book grew across all divisions -£35bn We reduced non-core assets by a third, or £35 billion, to £64 billion
The significant progress we have made in improving our profitability and our capital position is testament to the strength of our business model and the commitment of our people. António Horta-Osório Group Chief executive
Invest in product propositions and digital capabilities across our brands and divisions, to deliver the products our customers need through the channels they prefer, while improving efficiency and customer service
Apply in the second half of 2014 to restart dividend payments, and to move to a dividend payout ratio of at least 50 per cent of sustainable earnings in the medium term
Core loan book now growing in all divisions; returned mortgage lending to growth in the third quarter launched a rebranded, revitalised lloyds Bank and returned TSB to the high street in September
Further progress in reducing our international presence with exit from 21 countries since June 2011 now completed or announced; target for international presence of 10 countries or fewer in 2014 already achieved
Banking net interest margin increased 19 basis points to 2.12 per cent, and to 2.29 per cent in the fourth quarter
Tangible net asset value per share at 31 December 2013 of 48.5p (31 December 2012: 51.9p); includes loss on capital accretive non-core disposals, deferred tax write-offs, adverse reserve movements, and legacy charges
Run-off portfolio (non-core non-retail assets and certain non-core retail assets) expected to reduce to c.£23 billion and non-core non-retail assets to c.£15 billion by the end of 2014 expect, prior to any dividends, to generate fully loaded common equity tier 1 capital of around 2.5 percentage points over the next two years, and thereafter 1.5 – 2 percentage points per annum expect to apply to the PRA in the second half of 2014 to restart dividend payments, commencing at a modest level
We have more than 30 million customers and employ high quality, committed people across our iconic brands which include lloyds Bank, Halifax, Bank of Scotland, TSB and Scottish Widows. We are creating a simpler, more agile, efficient and responsive organisation with a focus on operating sustainably and responsibly. We are focused on our core uK market which has attractive growth prospects, and where we can earn strong returns while maintaining a prudent approach to risk and a strong balance sheet.
We have continued to make strong progress on the Simplification programme, which is a key driver of creating a lower cost, more efficient business.
We have made continued progress in enhancing customer satisfaction, as measured through the cross industry net promoter score metric. This measures customer service at key touch points and the likelihood of customers recommending us.
Regulation The regulation of the uK banking industry has changed significantly in my time as Chairman. Since the 2008 financial crisis, regulators have made great progress in enhancing the financial stability of the industry and the future regulatory framework is becoming clearer. However the challenge continues to be in striking the right balance between enhancing financial stability, and ensuring innovation, competition and growth.
Dividends We were pleased to announce earlier this year that given the progress the Group has made in substantially strengthening its capital position and improving its financial performance, that the PRA has now confirmed it will consider the Group’s applications to make dividend payments in line with its normal procedures for other banks. In the light of this, and subject to a return to sustainable profitability and there being no major unexpected changes in the Group’s business outlook or regulatory requirements, the Board expects that it will apply to the PRA in the second half of 2014 to restart dividend payments, commencing at a modest level. I fully understand the difficulties that the absence of dividends has caused our shareholders and I am particularly pleased we have now reached this position.
We were pleased to welcome Dyfrig John to the Board in January this year as an Independent non-executive Director. Dyfrig has significant banking experience in the uK and overseas, having served in a number of senior management and Board roles with HSBC and its subsidiaries, and given his position as the Chairman of Principality Building Society.
As a Board we believe that diversity helps to improve the quality of decision making and I am pleased that we maintained at least 25 per cent female representation on the Board ahead of the 2015 deadline mandated by the lord Davies report. I am confident that we will continue to promote diversity, both within the Board and the Group as a whole after my retirement.
Community and culture lloyds Banking Group has a presence in practically every community across the uK. We attach great importance to supporting these communities, both locally and nationally. This not only strengthens our business, but also helps to rebuild trust and confidence in the banking sector and underlines the positive role banks should play in society as a whole. Our commitment to these communities is demonstrated through a variety of initiatives which continue to focus on our values of putting customers first, keeping it simple and making a difference together.
We manage our business practices through our Responsible Business Committee (RBC), which reports to the Group executive Committee on a quarterly basis, and to the Board via the RBC’s Chair, Anita Frew, one of our non-executive Directors. In 2013, we continued to improve our governance structures, and now have all areas of the business represented on the RBC, to ensure effective management across the five pillars of our Codes of Responsible Business – customers, colleagues, communities, the environment, and relationships with our stakeholders. These developments will help to drive more positive outcomes, and move us closer to being the best bank for customers – which in turn will create sustainable value for shareholders.
The launch of our Helping Britain Prosper Plan in 2014 formalises our promise to make a difference in the areas where society’s needs overlap most closely with our core business services. Through seven commitments, backed by over 20 specific targets, I believe we can lead the industry in creating change in a meaningful and measurable way.
In 2012, despite improved underlying performance, we took the decision to reduce the bonus pool significantly below on-target levels. This reflected the views of our stakeholders, the uncertain economic outlook and the statutory loss for that year. For 2013, underlying performance was stronger, the economy is recovering, and the Group returned to pre-tax profit on a statutory basis. This improved performance, as shareholders are well aware, has been reflected in our share price, which rose 65 per cent in 2013, building on the 85 per cent increase in 2012.
Group bonus scheme awards remain a very small percentage of revenues at approximately 2 per cent, and represent approximately 6 per cent of pre-bonus underlying profit before tax, compared to 12 per cent in 2012. Cash bonuses are capped at £2,000 with additional amounts paid in shares and subject to deferral and performance adjustment. The average value of bonuses paid per employee remains below £4,500.
We are beginning to regain the trust of our customers and the Group is increasingly seen as a leader in the banking industry. Recent european legislation has introduced a cap on the variable element of remuneration at 100 per cent of fixed remuneration, rising to 200 per cent if shareholders provide their consent. To manage the impact of the legislation, we intend to make changes to our executive remuneration structure through the introduction of fixed share awards. The awards would be delivered over five years to support the alignment of executive and shareholder interests. These changes will be subject to appropriate shareholder approval at the 2014 AGM. There will be no increase to maximum remuneration at face value as a result of these changes.
The significant progress on our strategy is demonstrated by much improved financial results. However, we will always be mindful not to become complacent or let past success diminish our future efforts. In April I will hand over to lord Blackwell a strong bank that is well-placed competitively and looks to the future with a good deal of confidence, which I share. I wish the Group another successful year in 2014 and prosperity for many years ahead.
The Salz Review The Salz Review was published in April 2013. Whilst the review focused on issues and cultural behaviours that are specific to Barclays, it contains important lessons for all banks, and raises the expectation that all banks will consider whether selected issues exist in their own organisations. With that in mind the nomination & Governance Committee which is chaired by Sir Winfried Bischoff asked for a full analysis of the Group’s performance against the 34 Salz recommendations. The findings of this analysis are set out on page 90.
Summary In 2013 the Group delivered a strong performance, underpinned by the rapid progress we have made on our strategic objectives, many of which we have now delivered ahead of plan. Since we set these objectives in June 2011, we have substantially reduced costs and risk, strengthened our balance sheet and capital base and increased investment in our core franchise, creating a unique competitive position with a low cost of equity. We continue to be well placed to support our customers and the uK economic recovery and to deliver strong and sustainable returns to shareholders above our cost of equity. As a result of this progress, we have substantially improved our underlying performance, returned the Group to profitability in spite of additional legacy costs and in September the uK government began returning the Group to full private ownership. We have also confirmed that the Board expects that it will apply to the Prudential Regulatory Authority (PRA) in the second half of 2014 to restart dividend payments, commencing at a modest level.
Strengthening the balance sheet Over the course of 2013 we made further progress in strengthening the balance sheet and reducing risk, while continuing to manage down our wholesale funding.
We have reshaped, strengthened and simplified our business to create a low risk, efficient retail and commercial bank that is focused on our customers and on helping Britain prosper. António Horta-Osório Group Chief executive
In november 2013, we announced that we had agreed to sell our asset management business Scottish Widows Investment Partnership (SWIP) to Aberdeen Asset Management (Aberdeen) for a consideration valued at the time at up to £660 million. We also agreed to enter into a long-term strategic relationship with Aberdeen which is expected to result in a stronger asset management partner for the Group and its customers, combining Aberdeen’s and SWIP’s strengths across asset classes once the sale completes, which is expected in the first quarter of 2014.
Substantial further progress in our Simplification programme Our Simplification programme remains central to the successful delivery of our strategy, both in terms of realising further cost savings and efficiencies, and in improving the products and services we offer our customers. Through Simplification, we have made excellent progress in improving and rationalising processes, and reducing layers, suppliers and our non-branch property portfolio. The ongoing programme realised approximately £0.6 billion in further cost savings in 2013, generating a total of around £1.5 billion annual run-rate savings since inception and having identified further opportunities we are now increasing our target run-rate savings by a further £100 million to £2.0 billion by the end of 2014. The total spent on the programme to the end of 2013 was £1.7 billion.
Our strong portfolio of differentiated brands underlines our commitment to service and to helping our customers with the things that really matter – planning for the future, enabling them to purchase their home and protecting their families – as well as supporting uK business. Brand revitalisation is being reinforced by an extensive programme of branch refurbishment and investment in telephony and digital channels. We have so far refurbished over 1,500 branches since the Strategic Review, creating bright, modern environments incorporating screenless counters. We have also introduced active management of our banking halls, increased colleague training and extended opening hours at selected branches, enhancing the overall branch banking experience for our customers. In turn, this has resulted in a further 11 per cent improvement in net Promoter Scores and a fall in Group reportable banking complaints to 1.0 per 1,000 accounts (excluding PPI). This level of complaints represents the lowest of any major uK bank, with Halifax leading the way amongst our brands with 0.8 complaints per 1,000 accounts, and we expect to maintain this industry leading position.
In General Insurance, we have redesigned our claims process to make it more efficient and simpler and as a result, the majority of our Home Claims customers are receiving their settlements 30 per cent faster. Customers making a claim are now looked after by a dedicated advisor throughout the life of their claim and regular contact is maintained.
In Retail, we helped more than 80,000 new homeowners to purchase their first home, exceeding our target of 60,000 and advancing mortgages totalling over £9.7 billion. Through our participation in government schemes such as Help to Buy in the Halifax and Bank of Scotland brands (now also launched under the lloyds Bank brand in 2014), we are providing strong support for the recovery in the housing market, by facilitating access to mortgage financing for creditworthy home buyers at up to 95 per cent of property purchase values.
I am proud that, amongst many other accolades received during the year, we were named ‘Best Bank (uK)’ at the 2013 euromoney Awards and ‘Bank of the Year’ at The Banker’s 2013 Awards. These awards reflect the strong capabilities and diligence of our people who continue to support the delivery of our strategy.
Dividends In the second half of 2013, the Group commenced discussions with the PRA on the timetable and conditions for resuming dividend payments. Given the progress the Group has made in substantially strengthening its capital position and improving its financial performance, the PRA has now confirmed that it will consider the Group’s applications to make dividend payments in line with its normal procedures for other banks.
In the light of this, and subject to a return to sustainable profitability and there being no major unexpected changes in the Group’s business outlook or regulatory requirements, the Board expects that it will apply to the PRA in the second half of 2014 to restart dividend payments, commencing at a modest level. The Board expects thereafter to have a progressive dividend policy with the aim of moving, over the medium term, to a dividend payout ratio of at least 50 per cent of sustainable earnings.
unemployment, although still well above its pre-crisis level, fell relatively quickly through 2013 from 7.8 per cent at the end of 2012 to 7.2 per cent in the final quarter of 2013. low interest rates have helped to keep company failures subdued, falling to just 0.6 per cent of active companies in 2013, close to its pre-crisis low.
Risks to sustained recovery remain Risks to this outlook are more evenly balanced than in recent years. In the short-term, the rise in confidence and the renewed buoyancy in house prices could lead growth to accelerate by more than expected. However, downside risks also remain, mainly from outside the uK. The eurozone still doesn’t have in place the full cross-country risk sharing necessary to ensure the long term stability of the euro, so financial market turbulence remains a possibility if some countries’ governments or banks are revealed to be less robust than they currently appear. In the uS, the unsustainable long-term trajectory of government debt could still result in sharp spending cuts despite the recent bi-partisan agreement. Such scenarios would significantly impact the uK economy, which would, in turn, have a negative impact on the Group’s income, funding costs and impairment charges.
As the economic recovery continues, we expect demand for credit from households and small and medium-sized businesses to increase, but growth is likely to stay well below pre-crisis rates as the appetite to borrow remains constrained by recent experience. With Bank Rate not expected to rise until 2015, arrears are expected to continue to decline.
Financial Services (Banking Reform) Act 2013 The Financial Services (Banking Reform) Act gained Royal Assent on 18 December 2013. The Act implements the recommendations of the Independent Commission on Banking and the Parliamentary Commission on Banking Standards. It includes provisions for criminal sanctions and the new Senior Persons Regime. It also requires banks to ring-fence some retail and SMe activities from investment banking activities and conform to additional capital requirements beyond those required by Basel III. Importantly for the Group, given we are primarily a uK focused retail and commercial bank, the majority of our operations are likely to be within the ring-fence.
Access to convenient branches remains important for many customers, but demand for a quality multi-channel banking proposition is now more prevalent. More customers expect to be able to manage their finances whenever and wherever is most convenient for them, whether by telephone, online, or using smart phones. Service remains one of the key drivers of customer satisfaction and customers are less accepting of poor service given the competitive nature of the market.
There are some clear customer trends emerging, but we recognise that every customer, whether an individual or an organisation, has particular needs and we must engage with them accordingly. Fundamentally, every customer has a choice and will select the provider that can most effectively fulfil their personal needs.
Competition: it is likely that an increasingly competitive market for lending and deposits will require us to innovate and offer attractive new products.
We provide a range of services, primarily in the uK, to individuals and commercial customers and by focusing on the needs of customers and operating sustainably and responsibly, we believe we will help Britain prosper and create value for our shareholders.
The uK financial services market remains one of the largest in the world and, although our business model and strategy have been formulated in the context of a cautious outlook for the uK economy, they remain appropriate for all stages of the economic cycle, whilst providing real differentiation and positioning us well for future regulatory reform.
Our customer focus remains the key driver for strategy and business decision making and we are making substantial customer-related investment. Our strategy reflects our customers’ needs for product simplicity and transparency, access to credit, demands for access through multiple channels, value for money products and services and the importance of our staff in managing customer relationships.
Following the significant progress we have made against our original strategic plan, we expect to announce an update on our strategy in the second half of 2014 which will also incorporate the key elements of our new Helping Britain Prosper Plan.
Reshape our business portfolio to fit our assets, capabilities and risk appetite.
Aim We focus on attractive uK customer segments and their product needs to deliver a sustainable statutory return on equity of between 12.5 and 14.5 per cent. In order to reshape our business, we have been focusing on reducing non-core assets, improving our asset quality and reducing our international presence. We will invest in businesses which offer strong returns and attractive growth in line with our core customer strategy and within a conservative capital and liquidity framework.
Reshaping our international presence The strategic reshaping of our international footprint supports our ambition to help Britain prosper, as we focus on countries where we can service customers with ties to the uK. Following significant disposals in 2013 including Australia, we have now exited, or announced the exit from, 21 countries. In doing so, we have exceeded both our original target of less than 15 countries by the end of 2014 and our updated target of 10 countries or fewer by the end of 2014, more than a year ahead of plan, while retaining businesses that will benefit uK centric customers.
We continue to expect our strategy will deliver a statutory return on equity of between 12.5 and 14.5 per cent in the medium term.
Excellent progress continues to be made in reshaping the business through the reduction of our non-core assets which, having stood at £300 billion at the beginning of 2009, now stand at £64 billion.
Continue to optimise our liquidity position in light of evolving regulatory policy.
Strong capital position We have significantly strengthened the Group’s capital position and ratios during 2013, with the estimated pro forma fully loaded common equity tier 1 ratio improving by 2.2 per cent to 10.3 per cent.
Dividends totalling £2.2 billion paid by the insurance business to the Group
Maintaining a stable funding base The transformation of the Group’s funding position is now complete as we further improved our general funding, supported by a growing customer deposit base. The reduction in non-core assets, together with the continued growth in customer deposits this year, has reduced the Group’s wholesale funding requirement by £32.0 billion, to £137.6 billion and our core loan to deposit ratio target of 100 per cent has now been met.
Key initiatives and progress in 2013 The Simplification programme is central to the successful delivery of our strategy and we continue to make good progress in driving further cost savings and efficiencies across the business whilst improving the customer experience. The success of this approach is evidenced in our achievement of run rate cost savings of £1,457 million at the end of 2013 which have also enabled us to improve our cost:income ratio in the year to 51.2 per cent. We have a strong pipeline of further initiatives underway and, given previous Integration and Simplification experience, are confident that we can meet our enhanced £2.0 billion run rate costs savings target by the end of 2014.
Channels and products We continue to streamline and simplify our product suite, and migrate products and features to our digital and telephony distribution channels. We are the largest provider of digital banking services in the uK and saw a continued increase in internet and mobile customers during 2013.
The cost:income ratio improved in 2013 and we continue to believe the cost savings we are already delivering along with investment initiatives will further reduce this ratio over time.
Investing to be the best bank for personal customers Retail continued to invest in customer initiatives, in particular product proposition and distribution channels. We relaunched the lloyds Bank brand and continued to upgrade our branch networks, with over 1,500 refurbishments since the strategic review and our customers are also benefitting from extended opening hours and the installation of WiFi and tablets in a number of lloyds Bank and Halifax branches.
At the same time, we are continuing to transform our digital proposition in line with customers’ growing appetite and to support delivery of services to smart phones. Our Money Manager and International Payments services provide improved access and control for online users, whilst mobile banking enhancements have enabled over four million customers to regularly use these services. Our online customer base increased to over 10.5 million, with internet users initiating over 1.2 billion log ons in 2013.
In our Wealth business, we rolled out a new point of sale system and introduced a pilot of the improved Customer Relationship Management technology, while continuing to invest in products and propositions in the Asset Finance business, including new website functionality which allows customers to obtain car finance quotes online.
From 2014, our Wealth business will move into the Retail division, ensuring we can better service the needs of our wealthier Retail customers. Retail Business Banking will also transfer to the Retail division as we work to be the Group’s small business champion, by leveraging the Retail infrastructure. At the same time, Credit Cards will move out of the Retail division into the new Consumer Finance division to support this growth area.
Strategy Retail’s goal is to be the best bank for customers in the uK. We will do this by building deep and enduring relationships that deliver real value to our customers; by delivering greater choice and flexibility through our multiple brands and channels; by increasing our agility which will enable us to respond more quickly and better align our products and services to our customers’ needs; and by continuing to improve customer service and reducing customer complaints. This will increase customer advocacy and deliver lower customer acquisition costs and improved customer retention.
Ongoing development of our multi-channel offering. Our active online customer base has increased to over 10.5 million and mobile users to over four million.
Total underlying income 8,946 8,657 3 2013 financial highlights underlying profit increased 18 per cent to £3,749 million, driven by improved margins, reduced costs and favourable impairments.
loans and advances to customers were broadly in line with 2012 at £341.9 billion and gross new mortgage lending increased to £36.9 billion.
Simplified our geographic footprint by exiting Spain and Australia and improved service delivery to frontline staff and end-to-end client support by streamlining infrastructure and processes.
Played a prominent role in supporting the uK economy: net growth in SMe lending of 6 per cent against market contraction of 3 per cent; 80 per cent acceptances on SMe loan and overdraft applications; supported approximately 120,000 business start-ups; committed over £36 billion through Funding for lending; and committed over £1.3 billion to uK manufacturing in the year to end September 2013.
Core underlying profit up by 25 per cent to £2,193 million due to increased income and lower impairment charges. Core return on risk-weighted assets increased by 38 basis points to 1.74 per cent.
Core lending increased by 7 per cent driven by strong performance in SMe, Mid Markets and Global Corporates.
Strategy The uK Wealth business provides strong growth opportunities for the Group. Its goal is to be recognised as the wealth advisor of choice to appropriate Retail and Commercial Banking customers alongside targeted customer acquisition. We aim to grow the customer deposits and funds under management that we manage on behalf of franchise customers, whilst improving margins and operating efficiency. In Asset Finance, we have been refocusing the business into sectors which fit our risk appetite and are looking to deliver focused, profitable growth while completing the run-down or disposal of portfolios which are closed to new business. The addition of the credit card business to the new Consumer Finance division will provide significant growth opportunities.
Reinforced the focus on our banking businesses through the announced sale of Scottish Widows Investment Partnership and the sales of St. James’s Place.
non-core assets reduced by 37 per cent following the sale of our Australian Asset Finance and Spanish retail businesses, and other reductions in our non-core portfolio mainly within Ireland.
The Insurance division is one of the uK’s largest insurers and provides long-term savings, protection and investment products and general insurance products to customers in the uK and europe. The uK life, Pensions and Investments business (uK lP&I) provides long-term savings, protection and investment products distributed through the bancassurance, intermediary and direct channels of the lloyds Bank, Halifax, Bank of Scotland, TSB and Scottish Widows brands.
The General Insurance business is a leading distributor of home insurance in the uK, with products sold through the branch network, direct channels and strategic corporate partners. It operates primarily under the lloyds Bank, Halifax, Bank of Scotland and TSB brands.
Strategy The uK population is under protected and not saving enough for the future. Our Insurance division is focused on helping our customers to protect themselves today whilst preparing for a secure financial future. Our objective is to be the best insurance and retirement savings business for customers; providing simple, trusted, value for money products accessible through multiple channels.
In Home Insurance, we invested to improve customer focus. For instance, we introduced a dedicated claims advisor to each claimant resulting in significantly faster claims settlement.
Our Codes of Responsibility underpin our Group ethics Policy and set out clear guidelines for responsible behaviour across our business. We adhere to the principles of the united nations Declaration of Human Rights and support the un Guiding Principles on Business and Human Rights, and the
5 We’ll help businesses and individuals succeed with expert mentoring and training 5.1 number of colleagues trained to mentor SMes & social entrepreneurs through the Business Finance Taskforce accredited scheme and the lloyds Bank and Bank of Scotland Social entrepreneurs programme 5.2 number of new lloyds Banking Group Apprenticeship positions created with permanent employment 5.3 % of lloyds Banking Group Apprenticeships taken up by external candidates from the uK’s most disadvantaged areas 5.4 number of undergraduates from low income families supported by the lloyds Scholars programme 5.5 % of lloyds Scholars (from low income families) who have secured a job within 6 months of graduating from university3 1,000 (cumulative)
7 We’ll better represent the diversity of our customer base and our communities at all levels of the Group 7.1 % of senior roles4 to be held by women 7.2 We will consistently increase the engagement levels of ethnic minority colleagues in all roles 7.3 We will consistently increase the engagement levels of disabled colleagues in all roles 7.4 We will consistently increase the engagement levels of lGBT colleagues in all roles 66 (Colleague Survey score)
Aim Our aim is to be the best bank for customers. This means being the best bank for households, for businesses and for communities. We will achieve this by focusing on uK customers and those connected to the uK; delivering customer expectations; simplifying processes, policies and systems; investing in growth initiatives; maintaining an appropriate risk appetite that protects our customers; and ensuring the business has the strength of funding and capital to continue to make progress and to face challenges.
Help more customers get on the housing ladder and more customers climb up it, including supporting more than 80,000 first-time buyers.
A 6 per cent year-on-year net increase in loans to SMes compared with an industry net reduction of 3 per cent.
We have developed a comprehensive customer experience programme measuring customer service and their likelihood to recommend us. This is measured through the cross industry net promoter score metric where we have seen continued progress.
Supporting SMEs This year we’ve increased lending to SMes by 6 per cent compared with 2012 (despite an industry-wide reduction in funding of 3 per cent). We’ve greatly simplified the lending process and reduced the time it takes SMes to secure funds. This year we approved eight out of 10 business loan and overdraft requests, comparable with pre-2008 levels. We have committed to deliver £1.6 billion of new net lending to SMes in 2014. We are a signatory to the lending Code; a voluntary code covering dealings with consumers, micro-enterprises and charities with an income of less than £1 million.
Making a difference together In addition to the Funding for lending Scheme, we participate in several other joint schemes designed to help businesses access finance. These include the enterprise Finance Guarantee Scheme (eFG), through which we have offered almost 6,000 loans to customers, worth a total of £480 million and 25 per cent of all eFG loans to date. We are providing £100 million to SMes through the Regional Growth Fund and made significant investments in the Business Growth Fund, Scottish Investment Bank and Big Society Capital.
Leading our industry to help customers with Dementia This year we worked with the Alzheimer’s Society to create their Dementia-Friendly Financial Services Charter. We co-launched the Charter with the Alzheimer’s Society on 30 October 2013. We led a steering group of 24 other financial services organisations, who have committed to improve dementia awareness amongst their employees. We have already started to implement some of its recommendations, including the creation of ‘Dementia-Friends’, in branches.
Dealing with complaints more effectively We have worked hard to improve the way we deal with customer complaints. We invested in our successful phone-a-friend service, providing 40,000 branch and call centre colleagues with instant access to a dedicated specialist advice team. We now resolve more than 90 per cent of all complaints at first contact and faster than ever before thanks to our 24 hour, seven days a week complaints handling service.
Combating financial crime and money laundering We can identify unusual activity related to customers’ accounts and have processes in place to check customers’ identities. We have invested in advanced transaction monitoring technologies as part of our Group-wide Global Anti-Money laundering Programme and have refreshed our Group-wide Fraud Prevention training module, rolling out an interactive version for all colleagues.
Offered 1,000 apprenticeship places to young people, building on the success of our 2012 national Apprenticeship pilot.
Engaging colleagues with our values We ask colleagues to work in line with our three values: putting customers first, keeping it simple and making a difference together.
Colleague survey This year we received the highest response rate to date, with 76 per cent of colleagues participating, compared to 74 per cent in 2012.
In addition to these improved scores, the survey shows that participating colleagues’ confidence and trust in our organisation and leadership improved by 22 percentage points compared with 2012, reaching 70 per cent which is 8 percentage points above the uK average.
Mobilising colleagues to build a diverse, inclusive business We want to build a colleague team that truly reflects 21st century Britain, in which differences are welcomed and everyone is treated fairly and with dignity and respect.
Data source: HR system (HRIS). Apart from gender data, all diversity information is based on colleagues’ voluntary self-declaration. As a result this data is not fully representative; our systems do not record any diversity data for the proportion of colleagues who have not declared this information.
Flexible working We are committed to building a culture that encourages innovative agile working policies and practices.
Empowering colleagues to do their very best All colleagues can identify the training they need and access it through a new, more effective learning management system called Discover learning, which we launched in July 2013.
Reported accidents in 2013 We worked hard to improve safety across the Group and for the third year running achieved a reduction in the number of accidents. In 2013, accidents reduced by 10 per cent compared with 2012.
Rewarding and incentivising colleagues We try to achieve the right balance on remuneration: recognising the need to manage the Group’s finances prudently, but also to incentivise colleagues. We continue to evolve our reward structures, making them fairer for all colleagues and linked more directly with performance for customers.
Donated £29 million to the lloyds Bank, lloyds TSB and Bank of Scotland Foundations.
Our Community Investment total includes support for financial inclusion, community initiatives, leveraged colleague fundraising, sponsorship and support for grass roots charities.
Our Foundations In 2013 we donated more than £29 million to the lloyds Bank, lloyds TSB and Bank of Scotland Foundations, enabling them to make grants to local, regional and national charities across the uK.
Community Fund We support local organisations through our Community Fund. In 2013, colleagues nominated over 4,600 good causes for the Community Fund, from which, they shortlisted 1,568 organisations in 392 communities across Britain. Over 2.7 million votes were cast for local good causes – online, by SMS or in our lloyds Bank and Bank of Scotland branches – with grants of either £300 or £3,000 awarded to those that received the most votes. More than 450,000 people across Britain will benefit as a consequence of the Community Fund awards.
Giving Extra Awards This year we launched the Halifax Giving extra Awards, to recognise and reward people who give extra in their local communities. We awarded vouchers, worth £250 to £5,000 to 67 winners. They can donate these vouchers to the good cause of their choice.
Great Scottish Run and Cardiff Half Marathon This year, colleagues participating in the 2013 Bank of Scotland Great Scottish Run and lloyds Bank Cardiff Half Marathon raised over £44,000 for our Charity of the Year. More than 600 colleagues ran alongside thousands of other runners.
We can’t succeed without the trust and support of our stakeholders who include central and local government, suppliers, investors and non-governmental organisations (nGOs).
Aim The Group is committed to working responsibly and acting professionally with all our external stakeholders. Our approach to stakeholders is set out in our Code of Business Responsibility.
Achievements in 2013 Shared our views on culture, ethics and standards with the Parliamentary Commission on Banking Standards.
Worked closely with our unions as we implement our ongoing change programmes.
Continue to work with the uK government in its efforts to improve standards in the banking sector.
Our Group Sourcing team has committed to make responsible business practices integral to our sourcing activities by the end of 2014. This year we’ve made significant progress towards achieving this goal, developing a coherent plan that covers all aspects of our sourcing activities. The plan, which evolves and expands our current approach, was approved by the Responsible Business Committee in June 2013. It addresses sourcing activities across the Group, using our existing Group Sourcing Policy as a starting point, along with supplier standards through the creation of a new Supplier Code of Conduct. This new Code will set minimum standards across six key dimensions: human rights, ethical standards, environmental standards, governance, health and safety, and community.
Investors and rating agencies We regularly interact with our equity and debt investors through presentations, one-to-one and general meetings and undertook more than 650 investor meetings in 2013. We also manage relationships with the main rating agencies: Standard & Poor’s, Fitch & Moody’s.
Aim We aim to manage our own environmental impacts and support the drive towards a low carbon, more resource efficient economy.
Diverted 95 per cent of our operational waste from landfill – beating our 2020 target of 92 per cent.
Using scarce resources more efficiently During 2013, we’ve made progress against our eAP targets.
* Target excludes IT data centres and the use of oil as a fuel.
We work with SMes to help them to understand and maximise the commercial benefits of sustainable business practices. early in 2013, lloyds Bank and Bank of Scotland both launched versions of our new online tool, ReDuCe – a free resource that enables SMes to create and implement their own sustainable business plan.
Effective risk management, governance and control Managing risk effectively is important for any bank and fundamental to our strategy. We are now a more efficient, low risk, uK focused retail and commercial bank. This has been achieved by maintaining a conservative business model which embodies a risk culture founded on a prudent appetite for risk.
Conservative approach to risk We have a fully embedded conservative approach to, and prudent appetite for, risk with risk culture and appetite driven from the top.
Effective risk analysis, management and reporting This identifies opportunities as well as risks and ensures risks are managed appropriately and consistently with strategy. Our principal risks and performance against risk appetite are monitored and reported regularly to senior management using quantitative and qualitative analysis and are subject to relevant stress testing. This enables us to understand the risk in the business at both an individual risk type and aggregate portfolio level.
Improved capital position Our common equity tier 1 (CeT1) capital position has continued to build to 10.3 per cent on a pro forma fully loaded CRD IV basis, increasing by 2.2 per cent in the year, in line with our capital generative strategy.
State aid HM Treasury currently holds 32.7 per cent of the Group’s share capital. We continue to operate without government interference in day-to-day management decisions, however there is a risk that a change in government priorities could result in the current framework agreement being replaced, leading to interference in the operations of the Group. Failure to meet the eu State aid commitments arising from this government support could lead to sanctions.
Clearly defined levels of authority ensure we lend appropriately and responsibly with separation of origination and sanctioning activities.
Operational risk We face a number of key operational risks including fraud losses and failings in our customer processes. The availability, resilience and security of our core IT systems is the most significant.
We can accumulate additional capital in a variety of ways including raising equity via a rights issue or debt exchange and by raising tier 1 and tier 2 capital.
Regulatory risk Due to the nature of the industry we operate in we have to comply with a complex and demanding regulatory change agenda. Regulatory initiatives we have been working on in 2013 include CRD IV, Mortgage Market Review, Dodd-Frank and Foreign Account Tax Compliance Act 2010. The sanctions for failing to comply far outweigh the costs of implementation.
Commentary We are continuing our journey to embed the conduct strategy and be the industry leader for complaints performance.
Availability of core systems Commentary Through effective control activities interruptions to customer service and operational losses for 2013 have remained within the Board approved appetite limits.
The Group is now in a position where the core loan book is fully funded by core deposits.
Commentary We continue to build constructive relationships with our regulators in order to effectively manage the regulatory change agenda.
Overview In 2013, we significantly improved the Group’s profitability and further strengthened our capital position, while improving margins, and reducing costs and non-core assets as we simplified and de-risked the business. Income grew as funding costs fell, core lending increased and we benefited from gains on the sales of shares in St. James’s Place. This growth in income, combined with lower operating costs and impairments resulted in an increase in core underlying profits to £7.6 billion. The Group also returned its lending to core corporate customers to growth in the first half of 2013, and to mortgage customers in the second half, while non-core asset reductions continued to be capital accretive overall, with underlying losses from the non-core portfolio declined significantly.
Core costs decreased by 1 per cent, driven by further savings from the Simplification programme and the deconsolidation of St. James’s Place, partially offset by additional staff related costs and inflation. The core impairment charge decreased 21 per cent to £1,521 million with the reduction primarily attributable to Commercial Banking impairments, which reduced by 40 per cent year-on-year reflecting better quality new business and lower defaults due to the low interest rate environment.
non-core losses reduced by 60 per cent to £1,408 million year-on-year, largely as a result of the reduction in non-core assets which was also the primary driver of the 61 per cent reduction in the impairment charge to £1,483 million.
Lower risk, stronger balance sheet with core loan growth and a substantially enhanced capital position We have now substantially completed our work to transform the balance sheet, by strengthening our funding, liquidity and capital position, and reducing non-core assets, and we returned core corporate and mortgage lending to growth in 2013.
We reduced non-core assets by £34.9 billion to £63.5 billion during the year, with non-retail non-core assets reduced to £24.7 billion. non-core asset reductions continue to be capital accretive overall and, together with core underlying profit generation and management actions, resulted in a considerable strengthening of our capital ratios. The Group’s pro forma fully loaded CRD IV common equity tier 1 ratio improved to 10.3 per cent from 8.1 per cent at 31 December 2012, in spite of the additional legacy charges, changes to pension accounting following the implementation of IAS 19R and other statutory items.
Group underlying income increased by 2 per cent to £18,805 million and, excluding St. James’s Place effects, was broadly unchanged at £18,143 million, with strong growth in net interest income offsetting the reduction in other income. The growth in core income more than offset the decline in non-core income which resulted from the continued reduction of non-core assets.
net interest income (excluding St. James’s Place effects) increased by 5 per cent to £10,884 million in 2013, and grew for the fourth successive quarter. The growth reflected increased core lending and the improved net interest margin, partly offset by reduced net interest income from the smaller non-core asset portfolio.
Core net interest income increased 8 per cent principally as a result of the significant improvement in margin.
At 31 December 2013, we had achieved annual run-rate cost savings of £1,457 million from our initiatives to simplify the Group, an increase of £610 million since 31 December 2012. We have now increased our expectations for annual run-rate cost savings from the Simplification programme at the end of 2014 from £1.9 billion to £2.0 billion.
Impaired loans as a % of closing advances: Provisions as a % of impaired loans: The impairment charge reduced by 47 per cent to £3,004 million reflecting the improved credit quality of the core portfolio, continued prudent management of impaired loans and a further reduction in non-core assets. The asset quality ratio improved by 45 basis points to 0.57 per cent, and is now within the target range for the Group set out in our Strategic Review of 50 to 60 basis points. The core asset quality ratio remains low at 0.35 per cent.
The 21 per cent decrease in the core impairment charge to £1,521 million was primarily driven by lower impairment in Commercial Banking, which was down 40 per cent compared to 2012 given the improvement in the economic environment together with higher releases in 2013 compared to the same period in 2012. The significant improvement in the non-core impairment charge of 61 per cent compared to 2012 reflected reductions in the Corporate Real estate and Irish portfolios following asset disposals.
The Group’s statutory profit before tax is affected by insurance volatility caused by movements in financial markets generating a variance against expected returns, and policyholder interests volatility which primarily reflects the gross up of policyholder tax included in the Group tax charge. The statutory result included £668 million of positive insurance and policyholder interests volatility (2012: positive volatility of £312 million), reflecting the rise in equity markets in the period.
A revision of our forecasts for uphold rates and response rates to proactive mailings together account for approximately £0.4 billion of the increased provision, and reflect forecast rates above our recent experience. The Group has also increased its estimates for remediation costs, which principally relate to the re-review of previously defended complaints, and this accounts for approximately £0.3 billion of the increased provision.
Other provisions also included an additional £75 million recognised in the first half of 2013 for claims relating to policies issued by Clerical Medical Insurance Group limited in Germany, bringing the total provision to £400 million, of which £246 million remains unutilised at 31 December 2013.
Taxation The tax charge for 2013 was £1,217 million. This reflected a higher effective tax rate than the uK statutory rate primarily due to an additional tax charge arising from the impact on the net deferred tax asset of the reductions in uK corporation tax rate to 21 per cent from 1 April 2014 and 20 per cent from 1 April 2015; the write-down of a deferred tax asset in respect of Australian trading losses following the sale of our Australian operations; and policyholder taxes. We expect the effective tax rate in future periods will be in the range of 20-25 per cent, subject to policyholder tax and any possible effect from disposals such as Verde.
The non-core portfolio now poses substantially less risk to the Group. As a result, approximately £31 billion of retail non-core assets including our uK and Dutch mortgage portfolios and the majority of the uK Asset Finance business will be reabsorbed into the core business, with the remaining non-core assets managed in a separate run-off unit. We will no longer report on a core/non-core basis in 2014, but will continue to report separately on those assets that remain in run-off.
Conclusion The Group has delivered improvements in underlying profits and core returns with growth in core lending, underlying income and net interest margin, and further reductions in costs and impairments. The continued progress in reducing balance sheet risk and the strengthening of the Group’s capital ratios leaves us well positioned to continue growing our core business as we support the uK economic recovery.
The financial statements have been restated following the implementation of IAS 19R employee Benefits and IFRS 10 Consolidated Financial Statements with effect from 1 January 2013.
Performance summary £m 20121 £m Change net interest income 2,426 2,206 10
Wealth, Asset Finance and International 2013 financial highlights losses reduced by 95 per cent to £42 million driven by lower impairments in non-core, mainly in Ireland, and strong profitable growth in the core business.
Core margin improved by 301 basis points from 5.90 per cent to 8.91 per cent driven by deposit pricing.
excludes reverse repos on loans and advances and excluding repos on deposits.
Generated £692 million of operating cash net of £285 million of cash invested in writing new business.
IFRS new business margin reduced to 2.6 per cent due to changes in the basis of taxation of life protection business.
Performance summary £m 20121 £m Change net interest income (103) (78) (32)
Lloyds Banking Group Annual Report and Accounts 201362 new business income reduced by £88 million to £431 million driven by reduced protection and annuities new business income following changes to the basis of taxation on the life protection business in January 2013. Pensions and investments new business income increased slightly with a strong performance in corporate pensions being largely offset by reduced investments volumes following the Group’s decision to stop providing investment advice to retail customers with savings below £100,000.
The Insurance business generated £692 million of cash in 2013, £157 million lower than the prior year. The reduction was due to the change in intra group commission arrangements, the run-off of the legacy creditor book, and a slight increase in cash invested in new business, largely due to lower protection new business income.
– Group Operations supports the Group by providing high quality services and delivering investment project capability through Information Technology (IT), Operations (including Customer Service and Global Payments) as well as Property and Sourcing. Achieving excellent service availability and high standards is a key part of our strategy to be the best bank for customers.
– Operations costs increased slightly from 2012 to 2013 with enhancements to our customer services processes and regulatory and compliance activities, in areas such as Global Payments, offset by Simplification savings. This includes delivering Industry Accounts Switchers, Global Anti Money laundering and Foreign Account Tax Compliance Act projects serving the rest of the Group.
The impact on the results due to the actual return on these investments differing from the expected return (based upon economic assumptions made at the beginning of the year, adjusted for significant changes in asset mix) is included within insurance volatility. Changes in market variables also affect the realistic valuation of the guarantees and options embedded within the with-profits funds, the value of the in-force business and the value of shareholders’ funds.
The most significant of these additional sources of volatility is policyholder tax. Accounting standards require that tax on policyholder investment returns should be included in the Group’s tax charge rather than being offset against the related income. The result is, therefore, to either increase or decrease profit before tax with a related change in the tax charge. Timing and measurement differences exist between provisions for tax and charges made to policyholders. Consistent with the normalised approach taken in respect of insurance volatility, differences in the expected levels of the policyholder tax provision and policyholder charges are adjusted through policyholder interests volatility.
Insurance hedging arrangements To protect against deterioration in equity market conditions and the consequent negative impact on the value of in-force business on the Group balance sheet, the Group purchased put option contracts in 2012 financed by selling some upside potential from equity market movements. These expired in 2013 and the charge booked in 2013 on these contracts was £9 million. new protection was acquired in 2013 to replace the expired contracts. On a mark-to-market valuation basis a loss of £105 million was recognised in relation to the new contracts in 2013.
The financial statements for each of the years presented have been audited by PricewaterhouseCoopers llP, independent auditors.
Post-tax return on average shareholders’ equity (2.0) (3.3) (6.7) (0.8) 9.0 31 December 31 December 31 December 31 December 31 December
Former appointments: Carolyn was a non-executive Director of the Financial Services Authority and chaired their Risk Committee, a Director of Group Development and Strategy at ITV plc and Director of Strategy and a member of the executive Board at the BBC. She is a former partner of McKinsey & Co. and was a policy adviser in the Prime Minister’s Policy unit. Carolyn began her career as an economist at the World Bank.
Dyfrig John, CBE Independent Director Joined the Board on 1 January 2014
Marc joined the Group in February 2010. He is a qualified Company Secretary and solicitor with 20 years of experience in a broad range of listed entities within the financial services, retail and telecommunications sectors and with professional service firms.
Chairman of the Risk Committee Member of the Audit Committee, the Remuneration Committee and the nomination & Governance Committee
Skills and experience: Carolyn has extensive digital and on-line, government and regulatory experience gained across a range of sectors including media and financial services. With her broad experience and strong analytical mind, Carolyn plays an active part in reviewing the strategy of the Board and contributing to the debate at Board and Committee meetings. Carolyn has a BA in economics from the university of Cambridge, an MA in International Relations from the university of Pennsylvania and an MBA from InSeAD.
External appointments: Carolyn is a non-executive Director of The Vitec Group and is the Chairman of its Remuneration Committee. She is a trustee of Marie Curie and a non-executive Director of the Competition and Markets Authority and the uK Statistics Authority.
Anthony Watson, CBE Senior Independent Director Joined the Board in April 2009
External appointments: Tony is a non-executive Director of Vodafone Group, Senior Independent Director of Hammerson and Witan Investment Trust, Chairman of the lincoln’s Inn Investment Committee and a member of the norges Bank Investment Management Corporate Governance Advisory Board.
Former appointments: Former Chief executive of Hermes Pensions Management and formerly Chairman of the Asian Infrastructure Fund, MePC and of the Strategic Investment Board (northern Ireland). Former Member of the Financial Reporting Council and the Marks & Spencer Pension Trustees.
Former appointments: George was an executive Director and Chief Financial Officer of RSA Insurance Group. He is also the former Head of Capital Management of Zurich Financial Services and Chief Financial Officer of its uK operations. George previously held various senior management positions at Prudential.
Skills and experience: Juan has significant banking and risk management experience, having spent 28 years working in these fields both internationally and in the uK. He has served as the Group’s Chief Risk Officer and as a member of the Group executive Committee since January 2011. 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. 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.
Alison Brittain Group Director, Retail Alison joined lloyds Banking Group in September 2011 as Group Director for the Retail Division. She has responsibility for the lloyds Bank, Halifax and Bank of Scotland retail branch networks, remote channels and products, in addition to the Retail Business Banking and uK Wealth businesses. Alison is also a member of the FCA’s Practitioner Panel and a non-executive Director for Marks and Spencer Group plc.
Mark Fisher Director, Group Operations Mark joined lloyds Banking Group as the Director of Group Operations in March 2009. In September 2009 his responsibilities expanded to include Group Integration Director. Mark became the Chairman of lloyds TSB Scotland in December 2009 and is also the Group’s executive Sponsor for disability.
Mark is a career banker having joined natWest in 1981. He was Retail Finance Director and later Chief Operating Officer before natWest was bought by RBS.
Antonio Lorenzo Group Director, Consumer Finance and Group Corporate Development Antonio joined lloyds Banking Group in March 2011. He is a Group Director with responsibility for Consumer Finance and Group Corporate Development. until recently, Antonio led the Wealth, Asset Finance and International division, which has been fundamental in supporting the Group’s agenda to both reshape its international presence and strengthen the balance sheet through significant non-core reduction and double digit deposit growth. Antonio also led the Group Strategic Review.
Directors’ indemnities The Directors of the Company, including the former Directors who retired during the year and since the year end, have entered into individual deeds of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ for the purposes of the Companies Act 2006. The deeds indemnify the Directors to the maximum extent permitted by law and remain in force for the duration of a Director’s period of office. The deeds were in force during the whole of the financial year or from the date of appointment in respect of the Directors appointed in 2013 and 2014. Deeds for existing Directors are available for inspection at the Company’s registered office. In addition, the Group had appropriate Directors and Officers liability Insurance cover in place throughout 2013.
Share capital and control Information about share capital, restrictions on the transfer of shares or voting rights and special rights with regard to control of the Company is shown in note 45 on pages 289 and 290 and is incorporated into this report by reference.
Emissions reporting The Group has voluntarily reported on its carbon dioxide (CO2) emissions in its annual Responsible Business Report and Annual Report and Accounts since 2009, but new regulations introduced through an amendment to the Companies Act 2006 require changes to the scope of disclosure compared to previous years. Previously, reported scope 1 emissions covered only the emissions generated from the gas and oil in uK buildings where the Group holds the supply contract direct with the utilities supplier along with emissions generated from companyowned vehicles used for business travel; and reported scope 2 emissions covered only the emissions generated from the use of electricity in uK buildings where the Group hold the supply contract direct with the electricity supplier. This year, additional emissions included in the scope of 2013 reporting relate to: uK sites where the Group does not hold the supply contract directly with the energy supplier (shadow sites); energy consumed in international locations (non-uK sites); and gas emissions arising from the use of air-conditioning and chiller/refrigerant plant (fugitive emissions). In addition the Group is now reporting emissions in terms of CO2 equivalent tonnes (CO2e).
Scope of disclosure The Group reports emissions based on an operational boundary. Reported scope 1 emissions cover: emissions generated from the gas and oil used in all the buildings the Group operates business from (uK and International); emissions generated from uK company-owned vehicles used for business travel; and fugitive emissions arising from the use of air-conditioning and chiller/refrigerant plant to service the Group’s uK property portfolio. Reported scope 2 emissions cover emissions generated from the use of electricity in all the buildings the Group operates business from. Reported scope 3 emissions relate to business travel undertaken by colleagues based in the uK using rail, privately owned vehicles, hired vehicles and air travel. emissions associated with joint ventures and investments are not included in the emissions disclosure as they fall outside the scope of our operational boundary.
Fugitive emissions – Fugitive emissions for lloyds Banking Group arise from the use of air-conditioning and chiller/refrigerant plant to service our uK property portfolio. Actual data relating to fugitive emissions is not currently collated centrally by the Group. Therefore, for the 2013 reporting period these emissions have been estimated based on a register of assets used by its Facilities Management partner to maintain and service the Group’s estate. leakage rates and emissions factors from the 2012 Guidelines to Defra/Department of energy and Climate Change (DeCC’s) GHG Conversion Factors have been applied to each asset on the register according to the gas type used within the asset.
2 Scope 2 – emissions generated from the energy billed for electricity for sites where the Group does not hold the supply contract directly with the energy supplier (shadow sites) and emissions generated from non-uK sites.
each of the current Directors, who are in office and whose names and functions are listed on pages 70 and 71 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
Independent auditor and audit information each person who is a Director at the date of approval of this report confirms that, so far as the Director is aware, there is no relevant audit information of which the Company’s auditor is unaware and each Director has taken all the steps that he or she ought to have taken as a Director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of the Companies Act 2006.
Chairman succession – Following the announcement of my intention to retire before the 2014 annual general meeting, a committee of the Board was established to oversee the search and selection of my successor. I am delighted that lord Blackwell has been chosen to succeed me as Chairman of lloyds Banking Group. Over the past four years, the Group has made significant progress in its goal to become a strong, efficient, uK-focused retail and commercial bank. Whilst clearly some challenges remain, the performance of the Group is well on track. This gives me great confidence in its future and I wish norman every success as he leads the Group at this important time. The appointment of lord Blackwell as Chairman received unanimous Board approval. Full details of the selection process are outlined on page 82.
Board effectiveness – The Board carries out an annual evaluation of its effectiveness. In 2013, this was conducted internally. The review was overseen by the nomination & Governance Committee and considered the Board’s performance principally by reference to the balance of skills, experience, independence and knowledge of the Board, its diversity, including gender, and how the Directors work together as a unit. The review also considered my effectiveness as Chairman of the Board, the effectiveness of the Committees, the Committee Chairmen, the Senior Independent Director and the Deputy Chairman. The results of the review are set out on page 86.
The Board and its members Purpose and responsibilities The Group is led by a Board comprising a non-executive Chairman, independent non-executive Directors and executive Directors. The Board is collectively responsible for the long term success of the Company. It achieves this by setting the strategy and overseeing delivery against it, establishing the culture, values and standards of the Group, ensuring that the Group manages risk effectively, monitoring financial performance and reporting and ensuring that appropriate and effective succession planning arrangements and remuneration policies are in place.
Access to advice The Group also provides access, at its expense, to the services of independent professional advisers in order to assist Directors in their role, especially non-executive Directors, wherever this is deemed necessary. Board Committees are also provided with sufficient resources to undertake their duties.
Chairman Overall responsibility for the leadership of the Board and the promotion of the highest standards of corporate governance.
Acts as a sounding board for the Chairman and Group Chief executive on Board and shareholder matters.
Delegated executive authority The Group Chief executive, through the delegated executive authority, delegates aspects of his own authority, as permitted, to members of the Group executive Committee. The Group executive Committee meets weekly to scrutinise items of key business. The Group Audit Director, Group HR Director and the Company Secretary attend the weekly Group executive Committee meetings to ensure that there is appropriate internal audit oversight, employee interests and people strategy matters are considered and that the highest standards of corporate governance are maintained.
The Group Chief executive outlined his Group strategy in 2011 including a simplification target of reducing the number of legal entities in the Group from 1,685 to fewer than 1,000 by the end of 2014. As at 31 December 2013, the number of Group entities had reduced to 929, achieving the target one year ahead of schedule.
Strategy and budget Approves the Group’s strategy and long-term objectives, the Medium Term Plan and the annual budget and reviews delivery against plan.
Approves the governance principles, corporate governance framework, Board Committee terms of reference and key Group policies.
Structure, capital and transactions Approves material changes to the Group’s corporate and organisational structure and changes to capital structure.
Following initial public offering Once TSB Bank is listed on the london Stock exchange, its independence will be prescribed in a relationship agreement between itself and lloyds Banking Group. Any transactions between the Group and TSB Bank will be at arms length through a transitional service agreement and long term service agreement.
Board composition Board size The Board should be of sufficient size to reflect a broad range of views and perspectives whilst allowing all Directors to participate effectively in meetings. The Board currently comprises three executive Directors, eight independent non-executive Directors and the Chairman who was independent on appointment. The size of the Board is within the optimal range set by the nomination & Governance Committee. Further details on independence are set out in the nomination & Governance Committee Report.
Appointments In 2013, the Board identified the need for a number of new Directors to supplement the banking, finance and risk experience on the Board. The following Board appointments were made: – On 5 March 2013, nick luff was appointed as a non-executive Director and replaced Martin Scicluna as Chairman of the Audit Committee on 31 March 2013; and
The nomination & Governance Committee is currently conducting a search for additional directors with relevant banking, finance and risk experience. A search is also being conducted for a new chairman of Scottish Widows Group limited in place of lord Blackwell.
It was clear from Board feedback that lord Blackwell was considered by his fellow Directors to be a suitable candidate to succeed Sir Winfried as Chairman and at the request of the Board, he made himself available for consideration for the role. He did not take part in any of the discussions on Chairman succession following his decision to apply for the role.
– the Group Disability Programme, providing equal opportunity for colleagues with disabilities.
Conflicts of interest All Directors of the Group and its subsidiaries must avoid any situation which might give rise to a conflict between their personal interests and those of the Group. Prior to appointment, potential conflicts of interest are disclosed and assessed to ensure that there are no matters which would prevent that person from taking on the appointment.
In preparation for his role as Chairman of lloyds Banking Group, lord Blackwell has undertaken an intensive induction and continuing business awareness programme. Since his appointment was approved, he has also joined Sir Winfried Bischoff in attending important internal and external meetings.
Board agenda and attendance Setting the Board agenda The Chairman is responsible for setting the Board agenda, assisted by the Group Chief executive and Company Secretary. A yearly planner is prepared by the Company Secretary to map out the flow of key items of business to the Board and to ensure that sufficient time is being set aside for strategic discussions.
Attendance at meetings In 2013, a total of 10 Board meetings were held, eight of which were scheduled and two of which were ad hoc meetings. Ad hoc Board meetings are called at short notice to discuss a matter that cannot wait until the next scheduled Board meeting. Where a Director is unable to attend a meeting, the Chairman discusses the matter with the Director and seeks their support for the proposed recommendation. He also represents their views at the meeting. each of the two ad hoc meetings held in 2013 concerned matters that had been previously approved in principle by the full Board. Board members also attended the annual general meeting held in edinburgh.
The mix of skills and experience on the Board. The focus of the Board’s agenda.
Actions taken previously have reduced the volume of papers received by the Board, but further improvements are required.
With the pending retirement of Sir Winfried Bischoff, the Board would benefit from additional banking, finance and risk expertise.
The effectiveness of the internal control system 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.
Shareholder relationships The Board recognises the importance of promoting mutual understanding between the Company and its shareholders through greater engagement. In 2013, there was regular dialogue with investors with more than 450 equity investor meetings and approximately 200 debt investor meetings undertaken during the year. Many of these meetings were undertaken by senior management (primarily the Group Chief executive and Chief Financial Officer) or other Board or GeC members. The Chairman has also attended a number of meetings to discuss governance and the Group’s strategic direction. Anthony Watson, the Chairman of the Remuneration Committee and the Senior Independent Director, regularly meets the larger shareholders to listen to their views and discuss executive remuneration.
UK Corporate Governance Code The Group confirms that is has applied the main principles and complied with all provisions of the Code throughout the year ending 31 December 2013.
Martin Scicluna 1/1 1 number of meetings held during the period the member held office.
Corporate Governance The Committee oversaw the Board’s governance arrangements to ensure that they reflected best practice and remain fit for purpose. In 2013, the Committee received regular corporate governance updates from the Company Secretary. The reports detailed the impact emerging regulation would have on the Board and its corporate governance practices. The Committee considered these matters and made recommendations to the Board on how best to respond. The corporate governance framework, comprising the board authority and the delegated executive authority sets out the responsibilities of the Board and its Committees and details the authorities delegated to management. In 2013, the Committee recommended changes to the framework to reflect changes to the organisational design, best practice and regulatory requirements.
Board and Committee composition The nomination & Governance Committee assists the Chairman in his assessment of the skills, experience, knowledge, composition and diversity of the Board and its Committees. During 2013, the Committee identified the need to appoint a number of directors. In March 2013, nick luff joined the Board as a non-executive Director and, in due course, succeeded Martin Scicluna as Chairman of the Audit Committee. Mr luff, who has over 10 years experience as a finance director, has recent and relevant financial expertise and a sound understanding of internal reporting and controls.
Dyfrig John, who joined the Board in January 2014, has significant uK retail banking experience, having served in various senior management roles throughout his career, most notably for HSBC Bank Plc as its Deputy Chairman and Chief executive Officer, uK and europe.
Independence The nomination & Governance Committee is responsible for the ongoing assessment of the independence of non-executive Directors. 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 as well as relevant external factors. 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. Based on its assessment for 2013, the nomination & Governance Committee is satisfied that, throughout the year, all non-executive Directors remained independent as to both character and judgement.
under the Committee’s oversight, significant progress was made during 2013 in improving the effectiveness of Group Audit. A new charter for Group Audit was adopted, the Committee reviewed the audit plan in greater depth, and the formal reporting line for the Group Audit Director was changed such that the reporting line is to the Chairman of the Audit Committee. Group Audit provided strong support for the Committee’s work during the year, in relation to both financial reporting, and internal control and risk management.
Reviews the content of the annual report and accounts and interim management statements and advises the Board on whether, taken as a whole, it is fair, balanced and understandable.
Considers the major findings of any internal investigations into control weaknesses, fraud or misconduct and management’s response.
Reviews the findings of audits with the external auditor, considering management’s responsiveness to the auditor’s findings and recommendations.
Internal audit Monitors the effectiveness of the Group’s internal audit function and the internal audit programme.
Reviews the adequacy of the Group Audit’s resources, its internal audit programme and standing within the Company.
In the 2013 full year results, an additional provision of £3.1 billion was reflected for expected PPI costs. The provision brought the total amount set aside by the Group to cover PPI costs to £9.8 billion.
The Audit Committee considered and challenged the calculation of the value of expected future net cash flows from currently in-force insurance contracts and the liabilities arising from those contracts.
Internal control and risk management Details of the internal control and risk management systems in relation to the financial reporting process is given within the risk management report on page 123. Specific matters that the Audit Committee considered during 2013 included: – the scope of the work being undertaken as part of the Finance Transformation programme, in particular the implementation of a new consolidation system for the Group; – the extent of work being performed by the Finance teams across the Group and considering the adequacy of resources in place to ensure that the control environment continued to operate effectively; and
Whistleblowing Throughout 2013 the Committee received reports from management on the Group’s Whistleblowing line activity, a summary of key cases and the effectiveness of the Whistleblowing Governance Structure. The Committee oversaw the following key developments in 2013: – Independent Call Handling: the existing whistleblower hotline was replaced in 2013 by a 24 hour, multilingual service, managed externally by an independent service provider; – Mandatory Training: Group-wide mandatory Whistleblowing training was developed and rolled out across the Group, raising awareness of the regime; and
Oversees adherence to Group risk principles, policies and standards and any action taken resulting from material policy breaches.
Committee composition, skills and experience The Chair of the Board Risk Committee, David Roberts, has a deep understanding of risk management, underpinned by in-depth knowledge of all aspects of banking operations, having spent his career in banking. David is supported on the Committee by non executive Director members who have a variety of industry backgrounds, including banking, financial services and retail, who bring scrutiny and fresh perspective to the risk management framework of the Group. The Committee composition therefore includes core banking and risk knowledge, together with the breadth that brings wider knowledge from other sectors and a clear awareness of customer needs. As a reflection of the degree of importance attached to risk in the Group, all Directors attend the Board Risk Committee meetings, including those Directors who are not members. The Group Audit Director and the external auditor also attend Board Risk Committee meetings.
Key matters considered by the Committee Set out below are some of the key matters considered in 2013.
Regulatory developments The Committee received regular updates from management on regulatory developments and assessed the impact of those developments on the Group’s risk profile.
TSB Bank plc is required to operate within the Group’s risk appetite. The Committee considered TSB Bank’s risk appetite and metrics on two occasions during the year and reported to the Board that TSB Bank’s risk appetite was appropriate.
Insurance risk The Board Risk Committee reviewed the insurance divisional risk appetite to ensure that it was specifically relevant to the Insurance Division, its separate prudential needs, and the separate categories of risks that are relevant to the insurance business. The insurance business has its own separate board and risk committee.
Conduct risk The Board Risk Committee received a presentation from management on conduct risk at each of its meetings. The presentations during the year included: reviews of prior conduct issues and regulatory investigations to identify lessons learnt; the review of conduct issues under management; reviews of the Group’s conduct strategy and its embedded status including reports from Group Audit; sales processes and product governance, including the progress of annual product risk assessments, the results of outcome testing including mystery shopping results and complaint metrics; rewards and incentives; and specific deep dives, including reviews of certain products prior to and following their launch.
Timothy Ryan 7/7 1 number of meetings held during the period the member held office.
Reviews and approves the remuneration of all senior officers in the risk management and compliance functions.
Remuneration reporting Reports annually to the Board the substance of the Company’s remuneration policy and proposes any substantive changes.
Monitors the application of the authority delegated to the Group Chief executive and the Divisional/ Business Area Remuneration Committees.
Recommends the approval by shareholders of the design of any longer term performance related pay schemes, and any significant changes to existing schemes.
Determines the eligibility and targets for any longer term performance related pay schemes, and subsequently reviews performance against these targets and proposes any awards.
Gender remuneration review The Group is committed to the principle of equal pay and intends that all colleagues should be paid fairly regardless of their age, gender, race, disability or other personal characteristics. To test this principle, the Committee commissioned a review into the differences in base pay between genders in senior executive roles, where bias was most likely to arise.
The review concluded that the average position to market does not show gender bias in any division, function or grade. Although no definitive bias was identified in this study, the Committee now receives annual reports on the topic to ensure there are no adverse changes.
Changes to the remuneration reporting regime The Committee dedicated significant time in 2013 to assessing the impact of changes to the remuneration reporting regime on the Group’s approach to executive remuneration.
The Group’s remuneration policy report sets out the parameters of the directors’ remuneration package. The remuneration policy was developed by the Committee having considered the ways in which the Group can strengthen and simplify the alignment of remuneration with its business performance and relative to shareholder returns. The policy is subject to a binding shareholder vote at the 2014 annual general meeting and requires that a majority of shareholders vote in favour of the policy before it can be implemented.
The governance policy is designed to achieve compliance with european Commission regulation and the PRA Remuneration Code and supports consistent and effective risk management that accepts risk-taking only within the tolerated risk appetite of the Group and in line with our business strategy, objectives, values and long-term interests.
– The Directors’ Remuneration Implementation Report, which outlines how policy was implemented in 2013 and how the Directors’ Remuneration Policy is intended to apply in 2014, and which will be subject to an advisory vote.
– long-term incentive plan, which is designed to support value creation for shareholders by measuring financial targets (currently economic Profit and Total Shareholder Return) and strategic targets, which ensure a focus on strategic objectives, in particular those related to our customers. Performance is measured over three years and executive Directors are required to hold the shares which vest for a further two years, thereby maintaining a link with shareholder experience after the award has vested.
We are, therefore, seeking separate approval to allow us to award variable remuneration up to a maximum of 200 per cent of fixed remuneration. These changes have also led the Committee to review the remuneration package for directors and for staff under the scope of the regulation.
– Shareholding requirement: the existing requirements (200 per cent of salary for the Group Chief executive, 150 per cent for other executive Directors and 100 per cent for other members of the Group executive Committee) will remain, but will also be applied to the fixed share award so the total requirement will increase. In addition, deferred bonus awards will no longer be included in the calculation so individuals will need to hold more than before.
Board changes The appointment of Juan Colombás to the Board on 29 november 2013 highlights the importance of risk management in the Group. Juan previously attended at least two meetings of the Remuneration Committee annually, but will now attend all meetings to support the consideration of risk in the Committee’s decision making, other than any part of a meeting which discusses his own remuneration.
Consideration of shareholders’ and employees’ views We are committed to regular dialogue with stakeholders. During the year, the Remuneration Committee has consulted extensively with uK Financial Investments (uKFI) and a number of other shareholders and key stakeholders, such as the Group’s main regulators, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
Base salaries as at January 2014 are detailed below in the Implementation Report on page 111.
Maximum potential The Committee will make no increase which it believes is inconsistent with the two parameters above. Increases will normally be in line with the increase awarded to the overall employee population. However, a greater salary increase may be appropriate in certain circumstances, such as a new appointment made on a salary below a market competitive level, where phased increases are planned, or where there has been an increase in the responsibilities of an individual.
Maximum potential The maximum allowance for the GCe is 50 per cent of reference salary less any flexible benefit allowance.
Incentivise and reward the achievement of the Group’s longer-term objectives, to align executive interests with those of shareholders and to retain key individuals.
Vesting will be subject to the achievement of performance conditions measured over a period of three years, or such longer period, as determined by the Committee.
At least 60 per cent of awards are weighted towards typical market (e.g. Total Shareholder Return (TSR)) and/or financial measures (e.g. economic Profit), with the balance on strategic measures.
2. The expected value of remuneration for performance midway between threshold and maximum, assuming 30 per cent of maximum annual bonus opportunity and 50 per cent vesting under the long-term incentive plan.
The package will normally be aligned with the remuneration policy as described in the table above. However, the Committee retains the discretion to make appropriate remuneration decisions outside the standard policy to facilitate the recruitment of an individual of the calibre required and in exceptional cases.
This may, for example, include the following circumstances: – An interim recruit, appointed to fill an executive Director role on a short-term basis.
– In the event of long-term incapacity, if the executive Director does not perform their duties for a period of at least 26 weeks (in aggregate over a 12 month period), the Group shall be entitled to terminate the executive’s employment by giving three months’ notice.
– At any time, at its absolute discretion, the Group may elect to terminate the individual’s employment by paying to the executive Director, in lieu of the notice period, an amount equivalent to base salary, subject to mitigation as described more fully in the termination payments section of this report, below.
Paid until date of termination (including any period of leave required by the Group). In respect of the balance of any notice period, base salary will be paid in monthly instalments, offset by earnings from new employment during this period.
Paid until date of retirement/death. For ill health, injury, permanent disability, paid for the applicable notice period (including any period of leave required by the Group).
unvested award lapses on date of leaving (or on notice of leaving) unless the Committee determines otherwise in exceptional circumstances.
Reference to change of control or merger includes a compromise or arrangement under section 899 of the Companies Act 2006 or equivalent. Fixed share awards may also be released/exchanged in the event of a resolution for the voluntary winding up of the Company; a demerger, delisting, distribution (other than an ordinary dividend) or other transaction, which, in the opinion of the Committee, might affect the current or future value of any award; or a reverse takeover, merger by way of a dual listed company or other significant corporate event, as determined by the Committee. In the event of a demerger, special dividend or other transaction which would in the Committee’s opinion affect the value of awards, the Committee may allow a long-term incentive award to vest to the extent relevant performance conditions are met to that date and if the Committee so determined, on a time pro-rated basis to reflect the number of months of the performance period worked.
The GCe and the Chairman are responsible for evaluating and making recommendations to the Board in relation to the fees of the neDs.
Fees and benefits as at January 2014 are detailed below in the Implementation Report on page 112.
Letters of appointment The Group’s policy is for independent neDs to have letters of appointment, not service agreements. non-executive appointments may be terminated, in accordance with the Articles of Association, at any time.
Consideration of matters relating to directors’ remuneration The members of the Committee during 2013 were: – Anthony Watson (chairman)
– Determination of the appropriate remuneration packages for a number of senior new hires
– Bonus and salary awards for executive Directors and key senior managers
António Horta-Osório (Group Chief executive), Rupert Mcneil (Group HR Director) and Paul Hucknall (HR Director, Performance & Reward) provided guidance to the Committee (other than for their own remuneration). Juan Colombás (Chief Risk Officer) and George Culmer (Chief Financial Officer) also attended the Committee to advise as and when necessary on risk and financial matters.
Statement of voting at general meeting The proposals on the remuneration offered to our executive Directors in 2013 were detailed within the Directors’ Remuneration Report for 2012 and were voted on at the 2013 Annual General Meeting. The shareholder votes submitted at the meeting, either directly, by mail or by proxy, were as follows: Votes cast (number of shares
As mentioned in the Chairman’s statement, we are committed to an ongoing dialogue with our shareholders. Shareholders have different views, notably on incentive scheme design and whilst we do take all comments into consideration, there will inevitably be some diverging views, notably on the structure of such schemes and on the choice of performance measures.
Fixed Share Award As stated in the Chairman’s letter, we have introduced an additional element in the package in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for executive Directors, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements.
Pension In line with the remuneration policy, executive Directors are entitled to a cash allowance in lieu of pension contributions. The level of allowances has not been increased for 2014.
Benefits For 2014, the benefits provided to executive Directors include a car allowance, transportation, private medical insurance, life assurance and other benefits selected through the flexible benefit allowance which is capped at 4 per cent of base salary.
– Balanced scorecard (BSC) objectives comprising five categories (finance, building the business, customer, risk and people) – 50 per cent
Financial economic Profit Set relative to 2016 targets Threshold: £2,154m Maximum: £3,231m
SMe lending Set relative to targets for SMe lending growth over 3 year period
Chairman and Non-Executive Director fees in 2014 The annual fee for the Chairman is unchanged at £700,000.
For 2014, the benefits provided to the Chairman include a car allowance, medical insurance, life assurance and transportation.
– Balanced scorecard objectives (50 per cent): reflecting the strategic priorities specific to the executive Director, but based on consistent categories: – Financial
Detailed performance assessments are prepared annually in respect of the Group and each of the divisions and presented for review by the Committee. The assessments are also reviewed by the Risk Committee. For the Group’s senior ‘Code Staff’, including the executive Directors, a further review is undertaken to ensure that adequate consideration has been given to risk factors. Based on the financial and balanced scorecard assessment, the Committee applies its judgement in determining the bonus outcomes. It takes into consideration any other factors, particularly in relation to legacy issues, such as the additional provision for PPI and the substantial fine levied by the Financial Conduct Authority in respect of controls around Bancassurance incentives arrangements.
– Substantially improved financial performance: underlying profit increased by 140 per cent to £6,166 million in 2013.
– The Group’s share price in 2013 increased by 65 per cent, making it the second best performing among the world’s top 50 banks and well above the FTSe100 increase of 14 per cent.
George Culmer The maximum bonus opportunity of the Chief Financial Officer (CFO) was 200 per cent of basic salary. For 2013, the Group outperformed the financial targets as shown above. The balanced scorecard used to inform the decisions of the Committee is the overall scorecard for the Finance function. The CFO’s balanced scorecard assessment for 2013, as confirmed by the Committee on 23 January 2014, reflected a number of considerations in 2013, including: – excellent management of Group Capital, Funding and liquidity in a challenging environment.
– Core impairment charge decreased 21 per cent to £1,521 million with the reduction primarily attributable to Commercial Banking impairments, which reduced by 40 per cent year-on-year reflecting better quality new business and lower defaults due to the low interest rate environment.
– Maintained focus on cost control and efficiency, resulted in total costs falling by 5 per cent to £9,635 million.
The Committee agreed a balanced scorecard rating for 2013 of ‘Strong plus’ for the CFO.
– non-core assets reduced by 35 per cent from £98.4 billion to £63.5 billion; reductions continue to be capital accretive overall, contributing to the release of approximately £2.6 billion of capital in the year.
– Close control over the management of the Risk Appetite and the understanding of the control environment.
The Committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if they deem appropriate.
Long-term awards made in March 2011 vesting for the period ended on December 2013 At the end of the performance period, it has been assessed that awards will vest at 54 per cent of maximum.
Historical TSR performance The chart below shows the historical TSR of lloyds Banking Group plc compared with the FTSe 100 as requested by the regulations, rebased as at 1 January 2008. The FTSe 100 index has been chosen as it is a widely recognised equity index of which lloyds Banking Group plc has been a constituent throughout this period.
Shareholding guidelines executive Directors are required to build up a holding in lloyds Banking Group plc shares of value equal to 150 per cent of gross salary (200 per cent of gross salary for the Group Chief executive) and are expected to achieve these targets within three years from the later of 1 January 2012 and their date of joining the Board. They are required to retain any shares vesting from lTIP awards granted from 2012 onwards for a further two years post vesting (although vested shares would count towards the shareholding requirement). Members of the executive Committee are required to build up a shareholding of 100 per cent of their gross salary. As at 31 December 2013, all executive Directors significantly exceeded the requirements.
David Roberts 968,641 – – – – 968,641 n/a n/a nick luff 80,000 – – – – 80,000 n/a n/a
Absolute TSR Growth in share price including dividends Threshold: 8% pa Maximum: 16% pa
Total costs (adjusted) Payout range set relative to 2015 targets Threshold: <=£9,323m Maximum: <=£8,973m non-core assets at end of 2015 (excluding uK Retail)
George Culmer 2,216,187 – – – 2,216,187 – 1/4/2013 31/3/2018 b, c
The market price for a share in the Group at 1 January 2013 and 31 December 2013 was 47.92 pence and 78.88 pence, respectively. The range of prices between 1 January 2013 and 31 December 2013 was 46.305 pence to 80.37 pence.
each risk driver is described and managed using the following standard headings: definition, appetite, exposure, measurement, mitigation and monitoring.
– The Group’s strategy operates in tandem with its high level risk appetite which is supported by more detailed metrics and limits. An updated Risk Appetite Statement was approved by the Board in 2013. This incorporated recommendations from the non-executive Directors and is fully aligned with Group strategy.
– Risk appetite is embedded within principles, policies, authorities and limits across the Group.
– Risk appetite will continue to evolve to reflect external market developments and the composition of the Group.
– Board-level engagement, coupled with the direct involvement of senior management in Group-wide risk issues at Group executive Committee level, ensures that issues are promptly escalated and remediation plans are initiated where required.
– The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by both the Board and senior management.
– The Chief Risk Officer regularly informs the Board Risk Committee (BRC) of the aggregate risk profile and has direct access to the Chairman and members of the Board Risk Committee. The Chief Risk Officer was appointed to the Board on 29 november 2013.
Group Operations provides high quality services and delivers investment project capability through IT, Operations, Property and Sourcing
Evolution of conduct expectations The Consumer Credit regulatory regime is in a period of transition and will be transferred from the Office of Fair Trading (OFT) to the FCA in April 2014 to complement its current mandate. It is possible that the FCA will adopt a different approach and apply a wide range of enforcement powers. Key mitigating actions – Rigorous implementation of Conduct Strategy across the Group.
Technology Internet and mobile technologies are changing customer behaviour, leading to changes in the banking model. Major changes in payments are also expected over next two to five years. The cyber risk landscape has continued to evolve over the last 18 months. Key mitigating actions – Increased focus on digital, demonstrated by the creation of the ‘Digital, Marketing and Customer Development’ function. – IT resilience improvement programme following the 2013 review. – Development of customer focused IT risk appetite and refreshed cyber strategy with refined risk appetite.
– Continuing work to embed a strong, customer-centric and robust risk culture, alongside wider Group Cultural Transformation activities. – engagement in Chartered Banker: Professional Standards Board and roll out of the Foundation Standards and planning for the leadership Standards. – Assessment of Group actions against the findings of the Barclays Salz Review and response to the various components of the Banking Reform Act.
Overview Stress testing is recognised as an essential risk management tool within the Group by the Board, senior management, the businesses and the risk and finance functions. Stress testing is embedded in the planning process of the Group and is applied to the base case plan. This allows senior management and Board to assess the base case plan in adverse circumstances and to adjust strategies/propose mitigating actions if the plan does not meet risk appetite in a stressed scenario. A rigorous review and challenge process ensures that senior management are actively involved in stress testing.
The Group Capital and Regulatory Reporting team, supported by Group Corporate Treasury, reviews all capital related stress outputs, including the calculation of indicative capital ratios. The Group Corporate Treasury team also reviews the stress outputs from divisions and evaluates the impact upon the Group’s Capital and Funding Plan.
The Insurance Division, as a separate regulated entity, has its own Board and governance structure. The Insurance Board, assisted by a Risk Oversight Committee and Audit Committee, approves the governance, risk and control frameworks for insurance and insurance risk appetite, ensuring it aligns with the Group’s framework and risk appetite.
Group Financial Risk Committee Responsible for reviewing, challenging and recommending to GeC, the Group Individual liquidity Adequacy Assessment and Internal Capital Adequacy Assessment Process submissions, the Group Recovery Plan, and the annual stress testing of the Group’s operating plan based on internal and PRA recommended scenarios, annual european Banking Authority stress tests, and other Group-wide macroeconomic stress tests.
Risk Management Framework (RMF) The RMF (see Risk Overview, page 41) is structured around nine components which meet and align with the industry-accepted internal control framework issued by the Committee of Sponsoring Organisations of the Treadway Commission (COSO).
– Risk Division (second line) is a centralised function providing oversight and independent challenge to the effectiveness of risk decisions taken by business management, providing advice and guidance reviewing, challenging and reporting on the risk profile of the Group and ensuring that mitigating actions are appropriate.
– provision of a constructive working environment in which Risk Division is trusted and respected, and promotes a constructive dialogue with the first line through advice, development of common methodologies, understanding, education, training, and development of new tools.
The Chief Risk Officer is accountable for developing and leading an industry-wide recognised Risk function that adds value to the Group by: – providing a regular comprehensive view of the Group’s risk profile, key risks both current and emerging, and management actions; – (with input from the business areas and Risk Division) proposing Group Risk Appetite to the Board for approval, and oversighting performance of the Group against Risk Appetite; – developing an effective RMF meeting regulatory requirements for approval by the Board, and oversighting execution and compliance; and
– challenging management on emerging risks and providing expert risk and control advice to help management maintain an effective risk and control framework.
Risk appetite Credit risk appetite is set at Board level and is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio performance measures, which may include the use of various credit risk rating systems as inputs. These metrics are supported by more detailed appetite metrics at divisional and business level and by a comprehensive suite of policies, sector caps, product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite.
Credit risk can also arise from debt securities, private equity investments, derivatives and foreign exchange activities. The total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2013 is shown on page 246. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 54 on page 327.
Credit risk exposure also arises in the Group’s defined benefit pension schemes from holding investments. note 41 on page 271 provides further information on the defined benefit schemes’ assets and liabilities.
For regulatory capital purposes the Group’s rating systems assess probability of default and if appropriate, exposure at default and loss given default, in order to derive an expected loss. If not appropriate, regulatory prescribed exposure at default and loss given default values are used in order to derive an expected loss. In contrast, impairment allowances are recognised for financial reporting purposes only for loss events that have occurred at the balance sheet date, based on objective evidence of impairment. Due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements differs from the amount determined from the expected loss models that are used for internal operational management and banking regulation purposes. note 2(H) on page 217 provides details of the Group’s approach to the impairment of financial assets.
The quality definition of both retail and commercial counterparties/exposures is largely based on the outcomes of credit risk (probability of default – PD) models. The Group operates a significant number of different rating models, typically developed internally using statistical analysis and management judgement – retail models rely more on the former, commercial models include more of the latter, especially in the larger corporate and more specialised lending portfolios. Internal data is supplemented with external data in model development, where appropriate.
each rating model is subject to a validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. The most material rating models are approved by the Group Risk Committee. Responsibility for the approval of the remaining material rating models, and the governance framework in place around all Group models, is delegated to the Group Model Governance Committee.
Credit risk assurance and review: A specialist team within Group Audit, comprising experienced credit professionals, is in place to perform credit risk assurance. This team carries out independent risk based internal control audits and credit quality reviews, providing an assessment of the effectiveness of internal controls, risk management practices, credit risk classification, as well as the accuracy of impairment provisions. These audits and reviews cover the diverse range of the Group’s businesses and activities, and include both ‘standard’ risk based audits and reviews as well as bespoke assignments to respond to any emerging risks or regulatory requirement. The work of Group Audit therefore continues to provide executive and senior management (and Audit Committee) with assurance and guidance on credit quality, effectiveness of credit risk controls and Business Support unit (BSu) work out strategies, as well as accuracy of impairments.
For uK mortgages, the Group’s policy is to reject all standard applications with a lTV greater than 90 per cent. Applications with a lTV up to 95 per cent are permitted for certain schemes, for example Help to Buy and lend a Hand. For mainstream mortgages the Group has maximum per cent lTV limits which depend upon the loan size. These limits are currently: Table 1.4: Loan to value analysis
Monitoring In conjunction with Risk Division, businesses identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Risk Division in turn produces an aggregated review of credit risk throughout the Group, including reports on significant credit exposures, which are presented to the GRC and the BRC.
Retail customers The Group’s aim in offering forbearance and other assistance to retail customers in financial distress is to benefit both the customer and the Group by discharging the Group’s regulatory and social responsibilities to support its customers and act in their best long-term interests and by bringing customer facilities back into a sustainable position which, for residential mortgages, also means keeping customers in their homes. The Group offers a range of tools and assistance to support retail customers who are encountering financial difficulties. Cases are managed on an individual basis, with the circumstances of each customer considered separately and the action taken judged as being affordable and sustainable for the customer. Operationally, the provision and review of such assistance is controlled through the application of an appropriate policy framework, controls around the execution of policy, regular review of the different treatments to confirm that they remain appropriate, monitoring of customers’ performance and the level of payments received, and management visibility of the nature and extent of assistance provided and the associated risk.
– Term extensions: a permanent account change for customers in financial distress where the overall term of the mortgage is extended, resulting in a lower contractual monthly payment.
To assist customers in financial distress, the Group also participates in, or benefits from, the following uK government sponsored programmes for households: – Income Support for Mortgage Interest – This is a government medium-term initiative that provides certain defined categories of customers, principally those who are unemployed, access to a benefit scheme, paid for by the government, which covers all or part of the interest on the mortgage. Qualifying customers are able to claim for mortgage interest on up to £200,000 of the mortgage. All decisions regarding an individual’s eligibility and any amounts payable under the scheme rest solely with the government. Payments are made directly to the Group by the appropriate government department.
The Group credit risk portfolio in 2013 Overview – Impairment charge decreased by 47 per cent to £3,004 million in the year to 31 December 2013, continuing the improvement seen in 2012. The impairment charge has decreased across all divisions.
– The impairment charge as a percentage of average loans and advances to customers improved to 0.57 per cent compared to 1.02 per cent at 31 December 2012.
Core impairment charge as a % of average advances 0.35% 0.44% (9)bp
Table 1.6: Total impairment charge loans and advances to customers 2,988 5,654 47
The fair value of derivatives not settled by central counterparties was £2,344 million, comprising assets of £28,808 million and liabilities of £26,464 million.
– The overall value of assets entering arrears in 2013 was lower in both unsecured and secured lending compared to 2012.
Core impairment charge as a % of average advances 0.33% 0.37% (4)bp non-core impairment charge as a % of average advances 0.17% 0.29% (12)bp
Total core 317,323 non-core unsecured: Total non-core gross lending 26,502 1,627 6.1 378 24.5
The Retail division’s loans and advances to customers are analysed in the following table: Table 1.12: Retail loans and advances to customers
Impairment The impairment charge decreased by £124 million, to £253 million compared with 2012. The annualised impairment charge as a percentage of average loans and advances to customers was 0.08 per cent at 31 December 2013 compared to 0.12 per cent in 2012. Impairment provisions were £1,472 million at 31 December 2013 compared to £1,616 million at 31 December 2012. Impaired loans have fallen for four consecutive years and were £5,641 million at 31 December 2013 compared to £6,321 million at 31 December 2012. As a result of this continued trend in 2013, impairment provisions as a percentage of impaired loans increased to 26.1 per cent from 25.6 per cent at 31 December 2012.
Number of cases Total mortgage accounts % Value of loans1 Total mortgage balances %
Value of loans represents total book value of mortgages more than three months in arrears.
The percentage of closing loans and advances with an indexed lTV in excess of 100 per cent decreased to 5.2 per cent at 31 December 2013, compared with 11.7 per cent at 31 December 2012.
Average loan to value is calculated as total loans and advances as a percentage of the total collateral of these loans and advances.
In addition the Group has Buy to let interest only balances of £47,261 million (2012: £44,585 million) and certain other interest only balances of £4,750 million (2012: £6,046 million).
– The overall quality of the core Commercial Banking portfolio remains good with the Group’s prudent through the cycle approach to risk appetite, and the continuing low interest rate environment helping to maintain defaults at a relatively low level. new business is of good quality and better than the back book average.
Core impaired loans decreased by £776 million to £5,131 million compared with £5,907 million at 31 December 2012, and as a percentage of closing loans and advances to customers decreased to 4.6 per cent from 5.6 per cent at 31 December 2012. The core impairment charge has reduced to £424 million in 2013 compared to £704 million in 2012, reflecting better quality origination and higher releases, with the low interest rate environment helping to maintain defaults at a relatively lower level.
non-core impaired loans decreased by £8,475 million to £9,583 million compared with £18,058 million at 31 December 2012 and as a percentage of closing loans and advances to customers increased to 46.3 per cent from 45.3 per cent at 31 December 2012. The non-core impairment charge has reduced to £743 million in 2013 compared to £2,242 million in 2012, reflecting the continued deleveraging.
Includes collective unimpaired provisions of £523 million; core: £446 million; non-core: £77 million.
Includes the Corporate Real estate BSu portfolio which is now managed with other Corporate (including non-core good book Corporate Real estate) assets which were previously disclosed in Other.
Lloyds Banking Group Annual Report and Accounts 2013152 loans and advances to customers Impaired loans
Financial Institutions Commercial Banking maintains relationships with a number of major uK and International Finance Institutions, which are predominantly investment grade rated. These relationships are either client focused or held to support the Group’s funding, liquidity and general hedging requirements. The impairment charge in Financial Institutions remained low at £4 million.
Non-core Corporate Real Estate and other Corporate loans and advances to customers include the non-core Corporate Real estate Business Support unit (BSu) portfolio. Following successful asset reduction progress, this portfolio is now managed together with european assets and other Corporate assets previously disclosed as Other non-core.
The portfolio has reduced significantly ahead of expectations primarily due to the momentum on various deleveraging strategies including consensual asset sales by customers, loan sales and asset disposals which totalled £7.4 billion (net book value) in the year. The non-core Corporate Real estate BSu element of the portfolio reduced from £15.7 billion to £8.9 billion during 2013 and there was considerable progress on the european exposure within this portfolio where loan balances fell from £3.7 billion to £0.7 billion.
Non-core UK Direct Real Estate The Group considers this portfolio to be appropriately provided for after taking into account the value of the collateral held. In the case of impaired uK Direct Real estate exposures (over £5 million) there is a net property collateral shortfall of approximately £0.1 billion. This figure excludes benefits of credit mitigants such as cross collateralisation and cross guarantees. The Group makes use of a variety of methodologies to assess the value of property collateral, where external valuations are not available. These include use of market indexes, models and subject matter expert judgement. loan to value ratios (indexed or actual if within last 12 months) for the Group’s largest transactions (over £5 million) are detailed in the table below.
Impairment provisions as a percentage of impaired loans increased to 69.9 per cent from 67.5 per cent at 31 December 2012. This increase was driven by the International portfolios.
R is k m an ag em en t The Group’s approach to risk 124 Emerging risks 126 Stress testing 127 Risk governance 129 Full analysis of risk drivers 133
Total impaired loans decreased by £3,177 million, or 25 per cent to £9,324 million compared with £12,501 million at 31 December 2012. The reduction was driven primarily by commercial real estate and corporate loans. Impaired loans as a percentage of closing loans and advances decreased to 60.6 per cent compared to 64.0 per cent at December 2012. Continuing weakness in the Irish real estate markets resulted in a further increase in Ireland wholesale coverage in 2013 to 73.1 per cent.
Impairment charges decreased by £637 million to £608 million compared to 2012. The impairment charge as an annualised percentage of average loans and advances to customers improved to 3.28 per cent from 5.53 per cent in 2012.
Commercial Real estate lending in Ireland: secured loan to value analysis loan to value ratios (indexed or actual if within last 18 months) for the Group’s largest transactions (over A5 million) are detailed in the table below. The Group considers this portfolio to be appropriately provided for after taking into account the provisions held for each transaction and the value of the collateral held. In the case of impaired Ireland commercial real estate exposures (over A5 million) there is a net property collateral shortfall of approximately £0.2 billion. This figure excludes benefits of credit mitigants such as cross collateralisation and cross guarantees. The Group makes use of a variety of methodologies to assess the value of property collateral where external valuations are not available. These include use of market indexes, models and subject matter expert judgement.
Asset Finance united Kingdom: the impairment charge reduced by 53 per cent to £57 million (of which £43 million related to non-core assets) compared with £121 million in 2012, driven by continued strong credit management and further improved credit quality. The retail portfolio saw fewer customers failing to meet their payment arrangements resulting in a lower proportion of people falling into arrears. The retail impairments also benefited from debt sale activity during the course of the year. The number of defaults in all areas of the commercial and corporate lending book was low relative to the last three years, reflecting effective previous and ongoing credit risk management actions.
Australia: the portfolio was fully disposed of in the second half of 2013.
Lloyds Banking Group Annual Report and Accounts 2013160 exposures to selected eurozone countries The Group continues to have minimal exposure, in aggregate, which could be considered to be direct recourse to the sovereign risk of the selected countries.
At 31 December 2012 excludes reverse repurchase exposure to institutional funds domiciled in luxembourg secured by uK Gilts of £1,559 million (2012: £82 million) on a gross basis.
Total balances with other eurozone countries have decreased from £59,475 million to £35,208 million. This is primarily due to a decrease in Dutch central bank balances. Derivatives with sovereigns and sovereign referenced credit default swaps are insignificant.
The Group has been a signatory to the equator Principles since 2006 and has adopted and applied the expanded scope of equator Principles III. The equator Principles support the Group’s approach to assessing and managing environmental and social issues in Project Finance Project-Related Corporate loans and Bridge loans. Further information is contained within the Group’s Responsible Business Report.
These market reforms are intended to encourage investment of around £200 billion by 2020 in projects designed to provide clean, secure, affordable energy. Clearly, uK and eu policy have impacts on the Group’s customers. It influences the decisions they take about whether or not to invest in sustainable projects or initiatives. However, the Group’s focus is on promoting the commercial benefits of sustainability to its customers. The Group is working with them and the uK government to help meet Britain’s renewable energy objectives.
This includes: – enhanced approach to business planning and strategy with customers at the heart; – Cultural transformation, linked to the Group’s values and Codes of Responsibility, to deliver the best bank for customers; – enhanced product governance framework to ensure products continue to offer customers value for money, and meet the needs of the relevant target market; – Sales processes and governance framework to deliver consistently fair outcomes; – CRAMs to identify where the Group may be operating outside its risk appetite; – Continuing the journey to become the industry leader for complaints performance; and
Definition Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market-implied inflation rates, credit spreads and bond prices, foreign exchange rates, equity, property and commodity prices and other instruments), lead to reductions in earnings and/or value.
For further information on defined benefit pension scheme assets and liabilities please refer to note 41 on page 271.
Table 1.26 above shows relevant balance sheet items relating to banking and trading activities. The trading book VaR sensitivity inputs are separately identified.
Foreign currency risk arises from: (a) translational exposure: the Group’s investment in its overseas operations. net investment exposures are disclosed (see note 54 on page 327) and it is Group policy to hedge non-functional currency exposures; and
Insurance portfolios The Group’s insurance activities expose it to market risk (encompassing equity, credit spread, interest rate, exchange rate and property risk): – With-profits funds are managed with the aim of generating smoothed returns consistent with policyholders’ expectations. exposure arises where the value of the underlying funds are insufficient to meet the obligations, termed burnthrough.
– unit-linked funds where policyholders select their investments. exposure arises as future fee income is dependent upon the performance of those assets. This fee income forms part of the Value of in-force business, see note 28 on page 257.
– The majority of Insurance’s equity risk exposure relates to unit-linked funds, through the value of future fee income, and with-profits funds, through burnthrough. Credit spread risk exposure largely results from holding fixed income assets in the annuity portfolio with the aim of providing additional returns.
Internal market risk models for trading book activities comprise VaR, Stressed VaR and Incremental Risk Charge and these are explained in detail in the Group’s Market Risk section of the Pillar III Disclosures.
In addition: – Capital impact and deficit triggers are used in respect of defined benefit pensions which have a material impact on capital resources.
– Interest rate repricing gaps, earnings sensitivity analysis, and open foreign exchange positions are used for banking book activity, and
– Stress testing and scenario analysis are also used in certain portfolios and at Group level, to simulate the impact of extreme conditions and to understand more fully the interdependence of different parts of the balance sheet.
Table 1.28: Trading portfolios: VaR 1-day 95 per cent confidence level (audited)
Banking activities Market risk in non-trading books consists of exposure to changes in interest rates including basis risk. This is the potential impact on earnings and value that occurs due to mismatches in the timing of repricing assets and liabilities.
(d) Market Value notional limit: this caps the amount of conventional and inflation-linked government bonds held by the Group for liquidity purposes.
Table 1.30 below shows the banking book income sensitivity to an instantaneous parallel up and down 25 basis points change to all interest rates.
Defined benefit pension schemes The Group takes an active involvement in agreeing risk management and mitigation strategies with the Trustees of the schemes through whom any such activity must be conducted. An interest rate hedging programme is in place to reduce liability risk. The schemes are also reducing equity allocation and investing the proceeds in credit assets as part of a programme to appropriately de-risk the portfolio.
As defined within the scope of the Group IRRBB Policy, all hedgeable interest rate risk in the non-traded book should be transferred to GCT via the Interest Rate Risk Transfer Pricing (ITP) framework. GCT is responsible for managing centralised risk (both traded and non-traded) and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of Group Asset and liability Committee within the Board Risk Appetite. Derivative desks in Financial Markets will then externalise the hedges to the market. However, certain residual interest rate risks may remain outside the centre due to differences in basis and profile mismatches, largely arising from customer behaviour.
– Risk culture: All colleagues are responsible for risk within their individual roles. The Group sets a strong tone from the top and embraces a risk culture across the business which is aligned to its strategy, vision, values and codes of responsibility. The Group encourages an open dialogue and rapid escalation of potential threats and events.
– Systems and procedures in place to comply with increasingly complex and detailed anti-money laundering and anti-terrorism laws and regulations may not always be fully effective in preventing third parties from using the Group as a conduit for money laundering. Should the Group be associated with money laundering, its reputation could suffer and/or it could become subject to fines, sanctions and legal enforcement; any one of which could have a material adverse effect on operating results, financial condition and prospects.
– The Group has, and will continue to, invest in enhanced protection of customer information, including access to key systems and the security, durability and accessibility of critical records.
The Group maintains a formal approach to operational risk event escalation, whereby material events are identified, captured and escalated. Root causes of events are determined and action plans put in place to ensure an optimum level of control to keep customers and the business safe, reduce costs, and improve efficiency.
Details of contractual maturities for assets and liabilities form an important source of information for the management of liquidity risk. note 54 on page 327 sets out an analysis of assets and liabilities by relevant maturity grouping. In order to reflect more accurately the expected behaviour of the Group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. Divisional teams form a view of customer behaviour based on quantitative and qualitative analysis and these assumptions are subject to governance via divisional asset and liability committees. This also forms the foundation of the Group’s liquidity Transfer Pricing (lTP) and the liquidity risk stress testing framework on which the Group’s liquidity controls are based.
Off balance sheet Stressed cash outflows from commitments granted. Specifically, commitments granted include the pipeline of new business awaiting completion as well as other standby or revolving credit facilities
Franchise viability Actions that need to be taken to maintain the Group’s core business franchise and reputation
During the year, the individual entities within the Group, and the Group, complied with all of the external regulatory liquidity and funding requirements to which they are subject and expects to meet all future liquidity regulatory requirements as implemented by the PRA.
The combination of a strong balance sheet and access to a wide range of funding markets, including government schemes, provides the Group with a broad range of options with respect to funding the balance sheet in the future.
Group funding sources Total funded assets reduced by £28.5 billion to £510.2 billion. This reduction enabled the Group to make changes in wholesale funding which reduced by £32.0 billion to £137.6 billion, with the volume with a residual maturity less than one year reducing to £44.2 billion (£50.6 billion at 31 December 2012). The Group’s term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total wholesale funding) reduced to 68 per cent (70 per cent at 31 December 2012) as expected in line with maturities of wholesale term funding and limited term wholesale issuance in 2013.
excludes £20.1 billion (31 December 2012: £19.6 billion) of loans and advances to banks within the Insurance business and £0.2 billion (31 December 2012: £0.7 billion) of reverse repurchase agreements.
Term issuance for 2013 totalled £4.3 billion with the majority across medium-term notes and private placements. utilisation of the uK government’s Funding for lending Scheme (FlS) has further underlined the Group’s support to the uK economic recovery, and the Group remains committed to passing the benefits of this low cost funding on to its customers. The Group drew down £3.0 billion in 2012 and £5.0 billion in 2013 under the FlS scheme. A further £2.2 billion was drawn in January 2014, which under FlS rules, counts as funding from the 2013 scheme capacity.
Primary liquid assets of £89.3 billion represent approximately 4.2 times (3.5 times at 31 December 2012) the Group’s money market funding less than one year maturity (excluding derivative collateral margins and settlement accounts) and are approximately 2.0 times (1.7 times at 31 December 2012) all wholesale funding less than one year maturity, and thus provides a substantial buffer in the event of continued market dislocation.
In addition to primary liquidity holdings the Group has significant secondary liquidity holdings providing access to liquidity facilities at a number of central banks which the Group routinely makes use of as part of its normal liquidity management practices. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of primary and secondary liquid assets and expects to see some transition from primary to secondary assets over the course of 2014.
Definition Capital risk is defined as the risk that the Group has a sub-optimal amount or quality of capital or that capital is inefficiently deployed across the Group.
Exposure A capital exposure arises where the Group has insufficient capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures while optimising value for shareholders.
The regulatory minimum amounts of capital, under Pillar I of the Basel framework, are determined as percentages of the aggregate risk-weighted assets calculated in respect of credit risk, counterparty credit risk, operational risk and market risk (Trading Book), which are predominantly calculated using internal models that are prudently calibrated based on internal loss experience. The models are subject to a number of internal controls and external scrutiny from the PRA.
The Group is able to accumulate additional capital through profit retention, by raising equity via, for example, a rights issue or debt exchange and by raising tier 1 and tier 2 capital by issuing subordinated liabilities. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time. The Group is also able to manage the demand for capital through management actions including adjusting its lending strategy, risk hedging strategies and through business disposals. If necessary, this can include limiting new business.
– Pro forma fully loaded CRD IV leverage ratio including tier 1 instruments was 4.1 per cent and was 3.4 per cent when including only CeT1 capital resources. excluding the pro forma impacts, the fully loaded ratio including tier 1 instruments was 4.0 per cent and 3.4 per cent when including only CeT1 capital resources.
Less: deductions from tier 2 50 per cent excess of expected losses over impairment provisions (373) (636)
Tier 1 and tier 2 capital resources have reduced primarily due to the reallocation of unconsolidated investments in life and General Insurance businesses, which were previously deducted as supervisory deductions from total capital, to become deductions from tier 1 capital (50 per cent of the total) and tier 2 capital (also 50 per cent).
Retail risk-weighted assets reduced by £9.8 billion in the year primarily due to improvements in credit quality due to effective portfolio management and the impact of positive macroeconomic factors including favourable movements in uK house prices.
The reduction in Standardised approach risk-weighted assets is largely due to the roll-out of new IRB approaches, predominantly the implementation of slotting models in the uK and Ireland, and non-core disposals.
Counterparty credit risk-weighted assets reduced from £12.8 billion to £7.8 billion. Contributing to this reduction are mark-to-market changes, management actions and migration of portfolios to the Foundation IRB approach.
– external economic factors captures movements driven by changes in the economic environment. The reduction in risk-weighted assets of £15.4 billion is mainly due to changes in underlying credit quality, favourable house price movements and non-core exposures moving into default under the Foundation IRB approach.
– Regulatory policy changes represent changes required by regulatory authorities. Substantially all of the £5.4 billion reduction is due to the implementation of slotting models relating to Commercial Real estate and other exposures in the uK and Ireland.
CRD IV capital and leverage information The data in the following tables represents estimates reflecting the Group’s interpretation of the CRD IV rules published on 27 June 2013 via the Official Journal of the european union (including amendments made to the Regulation via the Corrigenda published on 30 november 2013) and the PRA policy statement PS7/13, issued on 19 December 2013. The actual capital ratios under CRD IV may differ as the final rules are assessed in their entirety, related technical standards are finalised and other guidance is issued by the relevant regulatory bodies.
Capital position on a CRD IV basis The Group’s capital position at 31 December 2013 is shown in the table below calculated on the following three bases; firstly the current prevailing regulatory framework; secondly applying the CRD IV rules including the transitional arrangements that have been in place from 1 January 2014; and thirdly on a fully loaded basis.
The movements in the transitional CRD IV common equity tier 1, tier 1, tier 2 and total capital positions in the period are shown below: Table 1.46: Movements in capital
In line with previous reporting periods, the PRA has asked the Group to publish a leverage ratio on a fully loaded CRD IV basis, with the exposure measure adjusted to reflect the basis of the original December 2010 Basel III leverage ratio framework, as interpreted through guidance released in July 2012.
exposure value for derivatives 24,598 24,598 24,598 exposure value for securities and financing transactions 6,700 6,700 6,700
For Scottish Widows and Clerical Medical, no Resilience Capital Requirement is required. However, a further test is required in respect of the With-Profit Funds. This involves comparing the statutory basis of assessment with a realistic basis of assessment as described below.
Realistic basis: The PRA requires each life insurance company which contains a With-Profit Fund in excess of £500 million to also carry out a realistic valuation of that fund. The Group has two such funds; one within Scottish Widows and one within Clerical Medical. The word realistic in this context reflects the fact that assumptions are best-estimate as opposed to prudent. This realistic valuation is an assessment of the financial position of a With-Profit Fund calculated under a methodology prescribed by the PRA.
The valuation of with-profits assets in a With-Profit Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-profit business written therein, it includes the present value of the anticipated future release of the prudent margins for adverse deviation. In addition, the realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above. The realistic valuation of liabilities differs from the statutory basis in including an allowance for future bonuses whilst the value of options and guarantees are assessed using a stochastic simulation model which values these liabilities on a basis consistent with tradable market option contracts (a market-consistent basis). In calculating the realistic liabilities, the model also takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given in the section entitled Options and guarantees on page 191.
Capital statement The following table provides more detail regarding the capital resources available to meet regulatory capital requirements in the life insurance businesses. The figures quoted are based on management’s current expectations pending completion of the annual financial returns to the PRA.
Other differences between IFRS and regulatory valuation of assets and liabilities – – (430) (2,659) (23) (3,112)
estimated share of realistic liabilities consistent with the PRA reporting treatment (389) (55) – – – (444)
Other differences between IFRS and regulatory valuation of assets and liabilities – – 101 (175) 152 78 estimated share of realistic liabilities consistent with the PRA reporting treatment (305) (62) – – – (367)
The surplus held in the Clerical Medical With-Profit Fund can only be applied to meet the requirements of the fund itself or distributed according to the prescribed rules of the fund. Shareholders are entitled to an amount not exceeding one ninth of the amount distributed to policyholders in the form of bonuses on traditional with-profits business. The use of capital within the fund is also subject to the terms of the Scheme of Demutualisation effected in 1996 and the conditions contained in the Principles and Practices of Financial Management of the fund. In extreme circumstances capital within the Clerical Medical non-Profit Fund may be made available to support the With-Profit Fund.
Other life insurance businesses except as described above capital held in uK non-Profit Funds is potentially transferable to other parts of the Group, subject to meeting the regulatory requirements of these businesses. There are no prior arrangements in place to allow capital to move freely between life insurance entities or other parts of the Group.
Overseas life business includes several life companies outside the uK, including Germany and Ireland. In all cases the available capital resources are subject to local regulatory requirements, and transfer to other parts of the Group is subject to additional complexity surrounding the transfer of capital from one country to another.
Changes in estimations and in demographic assumptions used to measure life assurance liabilities 2 6 101 – 11 120
With-Profit Funds Available capital in the Scottish Widows With-Profit Fund has increased from £90 million at 31 December 2012 to an estimated £157 million at 31 December 2013 mainly due to a decrease in the liabilities of the non-transferred business (caused by model changes and positive investment returns). Available capital in the Clerical Medical With-Profit Fund is estimated to be zero at 31 December 2013 (no change from 31 December 2012). This is because the fund is in the process of distributing the free estate and all surplus will ultimately be distributed to policyholders.
uK non-Profit Funds Available capital in the uK non-Profit Funds has increased from £1,120 million at 31 December 2012 to an estimated £1,382 million at 31 December 2013. This is mainly due to income on existing business offset by the impact of writing new business, positive investment returns, one-off transfers and an increase in provisions.
Insurance and participating investment contract liabilities 13,539 7,427 57,012 4,064 82,042 non-participating investment contract liabilities – – 26,722 868 27,590
Insurance and participating investment contract liabilities 13,779 8,248 51,681 8,431 82,139 non-participating investment contract liabilities – – 49,929 4,443 54,372
Shareholders’ funds Shareholders’ funds outside the long-term business fund are invested in readily tradable assets (e.g. equities and fixed interest securities), cash and a range of less liquid fixed interest instruments, at levels consistent with the liquidity risk appetite of the Insurance business.
The most critical non-economic assumptions are the level of take-up of options inherent in the contracts (higher take-up rates are more onerous), mortality rates (lower mortality rates are generally more onerous) and lapses prior to dates at which a guarantee would apply (lower lapse rates are generally more onerous where guarantees are in the money). The sensitivity of the capital position and capital requirements of the With-Profit Funds is partly mitigated by the actions that can be taken by management.
Assets held in excess of those backing reserves are invested in readily tradable assets (e.g. equities and fixed interest securities), cash and a range of less liquid fixed interest instruments, at levels consistent with the risk appetite of the Insurance business.
Options and guarantees The Group has sold insurance products that contain options and guarantees, both within the With-Profit Funds and in other funds.
For those policies written in Scottish Widows pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up within the With-Profit Fund of Scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2013 of £2.2 billion (2012: £2.1 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.
Definition Insurance risk is defined as the risk of adverse developments in the timing, frequency and severity of claims for insured/underwritten events and in customer behaviour, leading to reductions in earnings and/or value.
Risk appetite Insurance risk appetite is defined with regard to the quantum and composition of insurance risk that exists currently in the Group and the Group’s risk preferences. Insurance risk appetite in the Insurance business is set by the Insurance Board and includes maximum earnings exposures to longevity and persistency risk in defined stresses. Insurance risk appetite for longevity in the defined benefit pension schemes is set by the Board using two key metrics: a one year increase to life expectancy and a combined market and longevity stress.
Exposures The major sources of insurance risk within the Group are the Insurance business and the Group’s defined benefit pension schemes. The nature of Insurance business involves the accepting of insurance risks which relate primarily to mortality, longevity, morbidity, persistency and expenses for the life and pension business, and property and unemployment for the general insurance business. The prime insurance risk of the Group’s defined benefit pension schemes is related to longevity. As with any business, the Group is exposed to a number of insurance events, some of which are covered by bespoke corporate insurance policies.
In addition, exposure limits by risk type are assessed through the business planning process and used as a control mechanism to ensure risks are taken within risk appetite.
The most significant insurance risks within the Insurance business are longevity risk, persistency risk and expenses. The merits of longevity risk transfer and hedging solutions are regularly reviewed. It is not possible to hedge persistency risk. General insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses with significant mortality risk and morbidity risk being transferred to the Group’s chosen reinsurers. The most significant insurance risk in the defined benefit pension schemes is longevity risk. The merits of longevity risk transfer and hedging solutions are regularly reviewed.
Risk appetite The Group’s people risk appetite and corresponding measures are reviewed and approved annually by the Board to enable the Group to lead responsibly and proficiently, manage people resource effectively, support and develop colleague talent, and meet legal and regulatory obligations related to its people.
To achieve this, the Group has developed and implemented policies and processes that provide a framework where the Group’s businesses and colleagues can operate in accordance with the laws, regulations and voluntary codes that apply to the Group and its activities.
Exposures The Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives and to be the best bank for customers. Over the coming year the Group anticipates the following key people risk exposures: – Retention of colleague talent within key populations in the context of a more active employment market; – The Group’s reward scheme compliance and talent attraction may be impacted by regulatory changes to remuneration governance and the Approved Persons regime; and
– Colleague engagement may be challenged by ongoing media attention on banking sector culture, sales practices and ethical conduct.
Definition Financial reporting risk is defined as the risk that the Group suffers reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies, ineffective controls over financial reporting, failure to manage the associated risks of changes in taxation rates, law, ownership or corporate structure and the failure to disclose accurate and timely information.
Risk appetite The risk appetite is set by the Board and reviewed on an annual basis or more frequently. It includes complying with statutory and regulatory reporting requirements and compliance with tax legislation in the jurisdictions in which the Group operates.
Monitoring Financial reporting risk is actively monitored at business unit and Group levels. There are specific programmes of work undertaken across the Group to support: – annual assessments of (1) the effectiveness of internal controls over financial reporting; and (2) the effectiveness of the Group’s disclosure controls and procedures, both in accordance with the requirements of the uS Sarbanes Oxley Act; – annual certifications by the Senior Accounting Officer with respect to the maintenance of appropriate tax accounting arrangements, in accordance with the requirements of the 2009 Finance Act.
Risk appetite Governance risk appetite is defined and embedded through the Group’s Governance Principle and Policy which are reviewed and approved by the Board on an annual basis. The Group has governance arrangements that support the effective long-term operation of the business, maximise shareholder value and meet regulatory and social expectations.
Mitigation The Group’s Risk Management Framework establishes robust arrangements for risk governance, in particular by: – defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a Three lines of Defence model which supports the discharge of responsibilities to customers, shareholders and regulators; – outlining governance arrangements which articulate the enterprise-wide approach to risk management; and
In addition, in 2013 the Group undertook a review of the findings of the Barclays Salz Review to ensure the Salz recommendations were factored into the Group’s current approach to governance and ongoing initiatives. A further review will be undertaken in 2014.
What we have audited The Group financial statements and Parent Company financial statements (the ‘financial statements’), which are prepared by lloyds Banking Group plc (the ‘Parent Company’), comprise: – the Consolidated and Parent Company balance sheets as at 31 December 2013; – the Consolidated income statement and the Consolidated statement of comprehensive income for the year then ended; – the Consolidated and Parent Company statements of changes in equity and cash flow statements for the year then ended; and
Overview of the scope of our audit The Group is structured into four divisions being Retail Banking, Commercial Banking, Insurance, and Wealth, Asset Finance and International, as well as the Group’s centralised functions (Group Operations and Central Items). each of the divisions and the centralised functions comprises a number of business reporting units. The Group financial statements are a consolidation of these business reporting units.
In establishing the overall approach to the Group audit, we determined the type of work that needed to be performed at the reporting units by us, as the Group engagement team, or component auditors within PwC uK and from other PwC network firms operating under our instruction. Where the work was performed by component auditors, we determined the level of involvement we needed to have in the audit work at those reporting units to be able to conclude whether sufficient appropriate audit evidence had been obtained as a basis for our opinion on the Group financial statements as a whole.
Where impairment is calculated collectively for portfolios of loans in Retail Banking, Commercial Banking, and Wealth, Asset Finance and International, we understood and assessed the provisioning models and underlying assumptions used. In examining the models and assumptions, we considered whether all relevant risks were reflected in the modelled provision, and where not, whether model overlays appropriately reflected those risks.
Given the judgemental nature of all of these provisions, we assessed critically the disclosures made in the financial statements. We particularly focused on assessing whether the disclosures made sufficiently clear the significant uncertainties that exist around determining the provisions and the sensitivity of the provisions to changes in the underlying assumptions.
We assessed critically the specified actuarial assumptions, including consideration of management’s rationale for the judgements applied and, where applicable, verifying back to underlying policyholder and industry benchmark data. We also tested controls over the experience and expense analysis.
For longevity, persistency and expenses we considered recent experience and the appropriateness of the judgements on how future experience will evolve.
For credit risk and illiquidity premium we have assessed the appropriateness of the methodology and any modifications made. We assessed the underlying assumptions with reference to wider market practice and prevailing economic conditions.
For judgemental balances, which could include management bias, we considered the risk in planning our audit approach and reflected this in the audit work we performed, specifically in respect of impairment, conduct provisions, insurance liabilities and financial instruments held at fair value.
We assessed and tested the effectiveness of company-wide controls, and performed our own analytical and substantive procedures on balances in the consolidated income statement and balance sheet. We also tested controls and performed substantive procedures over the new consolidation system.
– the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.
Items that will not subsequently be reclassified to profit or loss: Post-retirement defined benefit scheme remeasurements: Remeasurements before taxation (136) (2,136) 624
Items that may subsequently be reclassified to profit or loss: Movements in revaluation reserve in respect of available-for-sale financial assets: Adjustment on transfers from held-to-maturity portfolio – 1,168 –
Trading and other financial liabilities at fair value through profit or loss 34 43,625 33,392 22,357 notes in circulation 1,176 1,198 1,145
Sir Winfried Bischoff António Horta-Osório George Culmer Chairman Group Chief executive Chief Financial Officer note £ million £ million £ million
(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.
(1) Subsidiaries Subsidiaries are entities controlled by the Group. The Group controls an entity when it has power over the entity, is exposed to, or has rights to, variable returns from its involvement with the entity, and has the ability to affect those returns through the exercise of its power. This generally accompanies a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. The Group reassesses whether or not it controls an entity if facts and circumstances indicate that there are changes to any of the above elements. Subsidiaries are fully consolidated from the date on which control is transferred to the Group; they are de-consolidated from the date that control ceases. Details of the principal subsidiaries are given in note 9 to the parent company financial statements.
(B) Goodwill Goodwill arises on business combinations, including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and associates; goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities acquired. Where the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities of the acquired entity is greater than the cost of acquisition, the excess is recognised immediately in the income statement.
(C) Other intangible assets Other intangible assets include brands, core deposit intangible, purchased credit card relationships, customer-related intangibles and both internally and externally generated capitalised software enhancements. Intangible assets which have been determined to have a finite useful life are amortised on a straight line basis over their estimated useful life as follows: Capitalised software enhancements up to 7 years
(E) Financial assets and liabilities On initial recognition, financial assets are classified into fair value through profit or loss, available-for-sale financial assets, held-to-maturity investments or loans and receivables. Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are held at fair value. The Group initially recognises loans
– if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available-for-sale financial assets in ‘rare circumstances’.
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 have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been designated as available-for-sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a
(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
(F) Derivative financial instruments and hedge accounting All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and option pricing models, as appropriate. Derivatives are
(G) Offset Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. In certain situations, even though master netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.
Debt for equity exchanges equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity securities, held as available-for-sale. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.
(2) Available-for-sale financial assets The Group assesses, at each balance sheet date, whether there is objective evidence that an available-for-sale financial asset is impaired. In addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and future prospects of the issuer, assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. If an impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the income statement; any excess is taken to other comprehensive income. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.
(I) Investment property Investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital appreciation or both. The Group’s investment property primarily relates to property held for long-term rental yields and capital appreciation within the life insurance funds. Investment property is carried in the balance sheet at fair value, being the open market value as determined in accordance with the guidance published by the Royal Institution of Chartered Surveyors. If this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices. These valuations are reviewed at least annually by an independent valuation expert. Investment property being redeveloped for continuing use as investment property, or for which the market has become less active, continues to be measured at fair value. Changes in fair value are recognised in the income statement as net trading income.
Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening years; these valuations are updated to 31 December each year by qualified independent actuaries. For the purposes of these annual updates scheme assets are included at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the balance sheet date on high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability.
Remeasurements, comprising actuarial gains and losses, the return on plan assets (excluding amounts included in net interest expense (income) and net of the cost of managing the plan assets), and the effect of changes to the asset ceiling (if applicable) are reflected immediately in the balance sheet with a charge or credit recognised in other comprehensive income in the period in which they occur. Remeasurements recognised in other comprehensive income are reflected immediately in retained profits and will not subsequently be reclassified to profit or loss.
(M) Share-based compensation The Group operates a number of equity-settled, share-based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model or a Monte Carlo simulation. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You earn plans are treated as non-vesting conditions and the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement.
Liabilities – Insurance and participating investment contracts in the Group’s with-profit funds liabilities of the Group’s with-profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Prudential Regulation Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below). Further details on the realistic capital regime are given on page 187. Changes in the value of these liabilities are recognised in the income statement through insurance claims.
(iii) Value of in-force business The Group recognises as an asset the value of in-force business in respect of insurance contracts and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date. This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency rates and includes allowances for both non-market risk and for the realistic value of financial options and guarantees. each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
(4) Reinsurance Contracts entered into by the Group with reinsurers under which the Group is compensated for benefits payable on one or more contracts issued by the Group are recognised as assets arising from reinsurance contracts held. Where the underlying contracts issued by the Group are classified as insurance contracts and the reinsurance contract transfers significant insurance risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as insurance contracts. Where the underlying contracts issued by the Group are classified as non-participating investment contracts and the reinsurance contract transfers financial risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as non-participating investment contracts.
Assets arising from reinsurance contracts held – Classified as insurance contracts Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured contracts and in accordance with the terms of each reinsurance contract and are regularly reviewed for impairment. Premiums payable for reinsurance contracts are recognised as an expense when due within insurance premium income. Changes in the reinsurance recoverable assets are recognised in the income statement through insurance claims.
(Q) Provisions and contingent liabilities Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the obligations and they can be reliably estimated.
The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty in these financial statements, which together are deemed critical to the Group’s results and financial position, are as follows.
and the resulting trading performance of the customer, and the value of the security held, for which there may not be a readily accessible market. In particular, significant judgement is required by management in the current economic environment in assessing the borrower’s cash flows and debt servicing capability together with the realisable value of collateral. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.
Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the retail portfolios. The collective impairment allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including the interdependency of house prices, unemployment rates, interest rates, borrowers’ behaviour, and consumer bankruptcy trends. It is, however, inherently difficult to estimate how changes in one or more of these factors might impact the collective impairment allowance.
In making this assessment account is taken of business plans, the five year board approved operating plan and the following future risk factors: – The expected future economic outlook as set out in the Group Chief executive’s Review and Market Overview; – The retail banking business disposal as required by the european Commission; and
The deferred tax asset is expected to be utilised over different time periods in each of the entities in which the losses arise. under current uK tax law there is no expiry date for unused tax losses. The losses are still expected to be fully utilised by 2019.
Retirement benefit obligations The net liability recognised in the balance sheet at 31 December 2013 in respect of the Group’s retirement benefit obligations was £998 million (comprising an asset of £98 million and a liability of £1,096 million) (2012: a net liability of £1,164 million comprising an asset of £741 million and a liability of £1,905 million) related to post-retirement defined benefit schemes. The defined benefit pension schemes’ net accounting deficit totalled £787 million (2012: deficit of £957 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
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 note 41.
Valuation of assets and liabilities arising from life insurance business At 31 December 2013, the Group recognised a value of in-force business asset of £4,874 million (2012: £5,488 million) and an acquired value of in-force business asset of £461 million (2012: £1,312 million). The value of in-force business asset represents the present value of future profits expected to arise from the portfolio of in-force life insurance and participating investment contracts. The acquired value of in-force business asset represents the contractual rights to benefits from providing investment management services in relation to non-participating investment contracts acquired in business combinations and portfolio transfers. The methodology used to value these assets is set out in note 28. The valuation or recoverability of these assets requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to these assets. The key assumptions that have been made in determining the carrying value of the value of in-force business assets at 31 December 2013 are set out in note 28.
Wealth, Asset Finance and International gives increased focus and momentum to the Group’s private banking and asset management activities, closely co-ordinates the management of its international businesses and also encompasses the Asset Finance business. Wealth comprises the Group’s private banking, wealth and asset management businesses in the uK and overseas. International comprises retail businesses, principally in Continental europe.
Inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the uK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.
Total underlying income, net of insurance claims 8,946 5,134 2,679 1,777 269 18,805
Investments in joint ventures and associates at end of year 185 113 6 – 9 313
Other segment items reflected in income statement above: Increase (decrease) in value of in-force business – – 3 (625) – (622)
Investments in joint ventures and associates at end of year 147 155 29 – 3 334
Other income, net of insurance claims 8,104 2 857 168 – (295) 8,836
Geographical areas Following the continuing reduction in the Group’s non-uK activities, an analysis between uK and non-uK activities is no longer provided.
Included within interest and similar income is £901 million (2012: £1,133 million; 2011: £1,405 million) in respect of impaired financial assets. net interest income also includes a credit of £550 million (2012: credit of £92 million; 2011: charge of £70 million) transferred from the cash flow hedging reserve (see note 47).
Securities and other gains (losses) comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows: £m £m £m net income (expense) arising on assets held at fair value through profit or loss: Debt securities, loans and advances 55 4,042 5,293
Total net earned premiums 8,197 8,284 8,170 life insurance gross premiums can be further analysed as follows: £m £m £m life and pensions 6,823 6,755 6,737 non-life insurance gross written premiums can be further analysed as follows: £m £m £m
Share of results of joint ventures and associates (note 13) 43 28 31
Claims and surrenders: Change in insurance and participating investment contracts (note 36(1)): Change in gross liabilities (5,184) (4,284) 1,383
Claims and claims paid: Change in liabilities (note 36(2)): Total non-life insurance (356) (365) (343)
Pensions and other post-retirement benefit schemes (note 41): Past service charges (credits)2 104 (250) –
Other regulatory provisions in 2013 include a fine of £28 million levied on the Group by the Financial Conduct Authority in relation to failings in control over sales incentive schemes in the Group’s branch network.
Performance-based compensation expense deferred until later years comprises: Awards made in respect of the year ended 31 December 47 37 43
Fees payable for the audit of the Company’s current year annual report 1.5 1.6 1.7
Share of balance sheet amounts: Share of net assets at 31 December 95 298 309 6 15 25 101 313 334
Movement in investments over the year: Share of post-tax results 7 34 31 36 (6) – 43 28 31
The Group’s unrecognised share of losses of associates for the year was £4 million (2012: recognised net loss of £10 million; 2011: recognised net loss of £8 million) and of joint ventures was £94 million in 2013 (2012: £126 million; 2011: £85 million). For entities making losses, subsequent profits earned are not recognised until previously unrecognised losses are extinguished. The Group’s unrecognised share of losses net of unrecognised profits on a cumulative basis of associates is £36 million (2012: £31 million; 2011: £56 million) and of joint ventures is £358 million (2012: £330 million; 2011: £299 million).
The Group’s principal joint venture investment at 31 December 2013 was in Sainsbury’s Bank plc; the Group owns 50 per cent of the ordinary share capital of Sainsbury’s Bank plc, whose business is banking and principal area of operation is the uK. Sainsbury’s Bank plc is incorporated in the uK and the Group’s interest is held by a subsidiary. In May 2013 the Group reached agreement to sell its interest in Sainsbury’s Bank plc to J Sainsbury plc; this transaction completed on 31 January 2014 and the Group’s investment at 31 December 2013 is included in disposal group assets (see note 16).
The charge for tax on the profit for 2013 is based on a uK corporation tax rate of 23.25 per cent (2012: 24.5 per cent; 2011: 26.5 per cent).
(B) Factors affecting the tax (charge) credit for the year A reconciliation of the credit (charge) that would result from applying the standard uK corporation tax rate to the profit (loss) before tax to the actual tax (charge) credit for the year is given below: £m £m £m
Taxation of certain insurance assets arising on transition to new tax regime – (221) –
The Finance Act 2012 introduced a new uK tax regime for the taxation of life insurance companies which takes effect from 1 January 2013. The new regime, combined with current economic forecasts, had a number of impacts on the tax charge in 2012.
Disposal groups classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. The Group has recognised an impairment of £382 million within other income relating to disposal groups classified as held for sale during 2013.
Disposal groups measured at fair value less costs to sell of £247 million (2012: liability of £20 million), which are non-recurring fair value measurements, are based on prices offered by third parties under binding sale and purchase agreements and are therefore classified within level 3 of the fair value hierarchy.
Note 17: Trading and other financial assets at fair value through profit or loss These assets are comprised as follows: Trading assets £m
The maximum exposure to credit risk at 31 December 2013 of the loans and advances to banks and customers designated at fair value through profit or loss was £27 million (2012: £34 million); the Group does not hold any credit derivatives or other instruments in mitigation of this risk. There was no significant movement in the fair value of these loans attributable to changes in credit risk which is determined by reference to the publicly available credit ratings of the instruments involved.
– exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date.
The principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 54 Credit risk.
loans and advances to customers include finance lease receivables, which may be analysed as follows: £m £m
The Group has a number of covered bond programmes, for which limited liability Partnerships have been established to ring-fence asset pools and guarantee the covered bonds issued by the Group. At the reporting date the Group had over-collateralised these programmes as set out in the table above to meet the terms of the programmes, to secure the rating of the covered bonds and to provide operational flexibility. From time-to-time, the obligations of the Group to provide collateral may increase due to the formal requirements of the programmes. The Group may also voluntarily contribute collateral to support the ratings of the covered bonds.
The assets and liabilities of the Insurance business held in consolidated collective investment vehicles, such as Open-ended Investment Companies and limited partnerships, are not directly available for use by the Group. However, the Group’s investment in the majority of these collective investment vehicles is readily realisable. As at 31 December 2013, the total carrying value of these consolidated collective investment vehicle assets and liabilities held by the Group was £55,934 million (2012: £68,644million).
The Group has no contractual arrangements (such as liquidity facilities) that would require it to provide financial or other support to the consolidated collective investment vehicles; the Group has not previously provided such support and has no current intentions to provide such support.
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 (2012: £2,016 million), £1,836 million, or 91 per cent of the total (2012: £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 (2012: £170 million, 8 per cent of the total) to Asset Finance in the Group’s Wealth, Asset Finance and International division.
The movement in the acquired value of in-force non-participating investment contracts over the year is as follows: 2013 £m 2012 £m
The acquired value of in-force non-participating investment contracts includes £277 million (2012: £303 million) in relation to OeIC business.
Movement in the value of in-force business taken to income statement (note 9) 416 269
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below:
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, since late 2012, 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. The determination of the market premium for illiquidity reflects actual asset allocation and relevant observable market data, and has been checked for consistency with the capital markets. The illiquidity premium is estimated to be 91 basis points at 31 December 2013 (2012: 73 basis points). Moving to the actual asset allocation in the calculation of the market premium for illiquidity combined with a change to the assumed level of illiquidity within the illiquid loan assets, has been to increase the value of in-force business by £118 million at 31 December 2013. This is included as an assumption change in the table above. The effect of this change on profit before tax, after also including the impacts of movements in liabilities, is given in note 36.
Included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting to £416 million (2012: £192 million).
Note 34: Trading and other financial liabilities at fair value through profit or loss £m £m liabilities held at fair value through profit or loss 5,306 5,700
Trading liabilities: liabilities in respect of securities sold under repurchase agreements 28,902 24,553
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.
Unit-linked business – This includes unit-linked pensions and unit-linked bonds, the primary purpose of which is to provide an investment vehicle where the policyholder is also insured against death.
– Change in the assumption in respect of current and future mortality rates (£114 million increase).
– Determination of illiquidity premium for annuity business based on actual asset allocation and change to assumed level of illiquidity within illiquid loan assets (£118 million increase).
Current estimate of cumulative claims 674 442 483 493 353 382 349 3,176
This sensitivity shows the impact of a flat 5 per cent addition to the expected rate.
Note 39: Unallocated surplus within insurance businesses The movement in the unallocated surplus within long-term insurance businesses over the year can be analysed as follows: £m £m
Change in unallocated surplus recognised in the income statement (note 10) 123 (31)
The terms of these arrangements require the Group to maintain assets in these vehicles to agreed minimum values in order to secure obligations owed to the relevant Group pension schemes. The Group has satisfied this requirement during 2013.
Net amount recognised in the balance sheet (787) (957) 2013 2012 £m £m
Composition of scheme assets: Quoted Unquoted Total Quoted unquoted Total £m £m £m £m £m £m
An analysis by credit rating of the pension schemes’ debt securities is provided below: AAA AA A BBB Rated
The pension schemes’ pooled investment vehicles comprise: £m £m uK equity investment funds 457 2,996 non-uK equity investment funds 2,177 2,265
Assumptions The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 4.60 4.60
Discount rate:2 expected life expectancy of members: Increase of one year 38 40 686 675
At 31 December 2013, the assumed discount rate is 4.6 per cent (2012: 4.60 per cent).
Defined contribution schemes The Group operates a number of defined contribution pension schemes in the uK and overseas, principally Your Tomorrow and the defined contribution sections of the lloyds Bank Pension Scheme no. 1.
During the year ended 31 December 2013 the charge to the income statement in respect of defined contribution schemes was £255 million (2012: £229 million; 2011: £202 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
Note 42: Deferred tax The movement in the net deferred tax balance is as follows: £m £m
Income statement (charge) credit (note 14): Due to change in uK corporation tax rate (594) (320)
The deferred tax (charge) credit in the income statement comprises the following temporary differences: £m £m £m
Deferred tax assets Deferred tax assets are recognised for tax losses carried forward to the extent that the realisation of the related tax benefit through future taxable profits is probable. Group companies have recognised deferred tax assets of £6,338 million (2012: £7,034 million) in relation to trading tax losses carried forward. After reviews of medium-term profit forecasts, the Group considers that there will be sufficient profits in the future against which these losses will be offset (see note 3).
Deferred tax assets of £168 million (2012: £330 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
– Uphold rates – average uphold rates per policy have increased from 61 per cent during the first half to 80 per cent for the last six months, with an average of 81 per cent in the fourth quarter. This reflects the impact of changes to the complaint handling policy, in part following consultation with the Financial Conduct Authority (FCA) and feedback from the FOS. In addition to this, there was a greater proportion of proactive mailing complaints received during the period for which uphold rates are higher. The provision assumes a slightly higher uphold rate going forward to allow for further embedding of complaint handling policy changes. The impact of higher uphold rates has resulted in a £335 million increase to the provision.
– Expenses – given the update to volume related assumptions, the Group has also increased its estimate for administrative expenses which comprise complaint handling costs and costs arising from cases subsequently referred to the FOS, by £780 million.
Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for approximately 40 per cent of the policies sold since 2000, covering both customer-initiated complaints and actual and expected proactive mailings undertaken by the Group. The total amount provided for PPI represents the Group’s best estimate of the likely future costs, albeit a number of risks and uncertainties remain, in particular complaint volumes, uphold rates, average redress paid, the scope and cost of proactive mailings and remediation, and the outcome of the FCA enforcement Team investigation. The cost of these factors could differ materially from the Group’s estimates and the assumptions underpinning them and could result in a further provision being required.
The percentage of cases reviewed by the Group that are subsequently referred to the FOS by the customer. A complaint is considered mature when six months have elapsed since initial decision. Actuals are based on decision made by the Group during January to June 2013 and subsequently referred to the FOS.
The percentage of complaints referred where the FOS arrive at a different decision to the Group. Actuals are based on six months to December 2013. The future overturn rate is expected to be lower due to changes in the case review process implemented during 2013 which has resulted in a higher uphold rate as noted above. In turn this reduces the number / percentage of cases likely to be overturned by the FOS.
However, there are still a number of uncertainties as to the full impact of the FCJ’s decisions, and the validity of any of the claims facing CMIG will turn upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will only be known once there is further clarity with respect to a range of legal issues and factual determinations involved in these claims and/or all relevant claims have been resolved.
The Group provided £400 million in its accounts for the year ended 31 December 2012 for the estimated cost of redress and related administration costs, based on a pilot review that had been conducted at the time. In the final quarter of 2013, a significant number of additional cases were reviewed, providing a larger and more representative sample from which to estimate the total cost of the review. As a result, an additional provision of £130 million has been recognised. During the same period, the Group confirmed it would pay any redress due to in-scope customers before any consequential loss claims had been outlined and agreed with them. At 31 December 2013, the total amount provided for the cost of redress and related administration costs is £530 million of which £162 million had been utilised. no provision has been recognised in relation to claims from customers which are not covered by the agreement with the FCA, or incremental claims from customers within the scope of the review. These will be monitored and future provisions will be recognised to the extent an obligation resulting in a probable outflow is identified.
Other Provisions are made for staff and other costs related to Group restructuring initiatives at the point at which the Group becomes irrevocably committed to the expenditure.
Note 44: Subordinated liabilities £m £m undated subordinated liabilities 1,916 1,927 enhanced Capital notes 8,938 8,947
These securities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated enhanced Capital notes (eCns) ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the year (2012: none). no repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Prudential Regulatory Authority.
The movement in subordinated liabilities during the year was as follows: £m £m
7.875% non-cumulative Preference Shares callable 2013 (uS$1,250 million) – 259 7.875% non-cumulative Preference Shares callable 2013 (e500 million) – 149 6.0884% non-cumulative Fixed to Floating Rate Preference Shares callable 2015 (£745 million) 10 10 5.92% non-cumulative Fixed to Floating Rate Preference Shares callable 2015 (uS$750 million) 127 125 6.267% non-cumulative Fixed to Floating Rate Preference Shares callable 2016 (uS$1,000 million) 274 280 6.3673% non-cumulative Fixed to Floating Rate Preference Shares callable 2019 (£335 million) 2 2 6.475% non-cumulative Preference Shares callable 2024 (£186 million) 39 39 6.413% non-cumulative Fixed to Floating Rate Preference Shares callable 2035 (uS$750 million) 51 104 6.657% non-cumulative Fixed to Floating Rate Preference Shares callable 2037 (uS$750 million) 16 14 9.25% non-cumulative Irredeemable Preference Shares (£300 million) 304 350 9.75% non-cumulative Irredeemable Preference Shares (£100 million) 53 53
e Following an exchange in February 2012, certain holders elected to exchange some notes into a new series of dated subordinated securities issued by lloyds Bank plc.
Undated subordinated liabilities 6.625% undated Subordinated Step-up notes (£410 million) a, b 6 6
c The fixed rate on this security was reset from 6.05 per cent to 3 month euribor plus 2.25 per cent with effect from 23 november 2011.