Shareholder complaints The Group and two former members of the Group’s Board of Directors have been named as defendants in a purported securities class action pending in the United States District Court for the Southern District of New York. The complaint, dated 23 November 2011, asserts claims under the Securities Exchange Act of 1934 in connection with alleged material omissions from statements made in 2008 in connection with the acquisition of HBOS. No quantum is specified.
Items in the course of collection from banks – – – – – 1,408 – 1,408
Trading and other financial liabilities at fair value through profit or loss – 19,616 5,339 – – – – 24,955
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 78,991 78,991
Items in the course of collection from banks – – – – – 1,368 – 1,368
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 80,729 80,729
Unallocated surplus within insurance businesses – – – – – – 643 643
In 2010 the Group reviewed its approach to managing a portfolio of government securities held as a separately identifiable component of the Group’s liquidity portfolio. Given the long‑term nature of this portfolio, the Group concluded that certain of these securities will be able to be held until they reach maturity. Consequently, on 1 November 2010, government securities with a fair value of £3,601 million were reclassified from available‑for‑sale financial assets to held‑to‑maturity investments reflecting the Group’s positive intent and ability to hold them until maturity.
In 2008, in accordance with the amendment to IAS39 that became applicable during that year, the Group reviewed the categorisation of its financial assets classified as held for trading and available‑for‑sale. On the basis that there was no longer an active market for some of those assets, which are therefore more appropriately managed as loans, with effect from 1 July 2008, the Group transferred £2,993 million of assets previously classified as held for trading into loans and receivables. With effect from 1 November 2008, the Group transferred £437 million of assets previously classified as available‑for‑sale financial assets into loans and receivables. At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity. As at the date of reclassification, the weighted average effective interest rate of the assets transferred was 6.3 per cent with the estimated recoverable cash flows of £3,524 million.
Carrying value and fair value of reclassified assets The table below sets out the carrying value and fair value of reclassified financial assets.
From available‑for‑sale financial assets to loans and receivables 217 219 313 340 394 422 454 402
During the year ended 31 December 2011, the carrying value of assets reclassified to loans and receivables decreased by £779 million due to sales and maturities of £734 million and foreign exchange and other movements of £58 million less accretion of discount of £13 million.
The table below shows the additional gains (losses) that would have been recognised in other comprehensive income if the reclassifications had not occurred.
Fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets, such as the value of the Group’s branch network, the long‑term relationships with depositors and credit card relationships; premises and equipment; and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.
Valuation control framework The key elements of the control framework for the valuation of financial instruments include model validation, product implementation review and independent price verification. These functions are carried out by appropriately skilled risk and finance teams, independent of the business area responsible for the products.
Held‑to‑maturity investments The fair values of government securities are based on market prices.
Level 3 portfolios Level 3 portfolios are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Such instruments would include the Group’s venture capital and unlisted equity investments which are valued using various valuation techniques that require significant management judgement in determining appropriate assumptions, including earnings multiples and estimated future cash flows. Certain of the Group’s asset‑backed securities and derivatives, principally where there is no trading activity in such securities, are also classified as level 3.
Total trading and other financial assets at fair value through profit or loss 101,844 34,725 2,941 139,510
Total trading and other financial liabilities at fair value through profit or loss 3,168 21,787 – 24,955
Total trading and other financial assets at fair value through profit or loss 113,242 40,113 2,836 156,191
– A number of earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before interest, tax, depreciation and amortisation. The particular multiple selected being appropriate for the type of business being valued and is derived by reference to the current market‑based multiple. Consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple.
– Credit derivatives are valued using standard models with observable inputs, except for the items classified as level 3, which are valued using publicly available yield and credit default swap (CDS) curves.
Asset-backed securities Reasonably possible alternative valuations have been calculated for asset‑backed securities by using alternative pricing sources and calculating an absolute difference. The pricing difference is defined as the absolute difference between the actual price used and the closest, alternative price available.
The CVA is sensitive to: – the current size of the mark‑to‑market position on the uncollateralised asset; – expectations of future market volatility of the underlying asset; and
In circumstances where exposures to a counterparty become impaired, any associated derivative valuation adjustment is transferred and assessed for specific loss alongside other non‑derivative assets and liabilities that the counterparty may have with the Group.
At 31 December 2011, the Group’s derivative trading business held mid to bid‑offer valuation adjustments of £85 million (31 December 2010: £66 million).
(iv) Libor/Overnight Index Swap basis The Group’s derivative trading business applies £74 million (31 December 2010: £70 million) of valuation adjustments against the changing market approach to valuing derivatives that are subject to daily collateral margin, where standard market practice is to pay interest on an Overnight Index Swap basis rather than a Libor rate.
In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. Note 19 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2011 was £152,314 million (2010: £112,507 million) with a net fair value liability of £358 million (2010: liability of £843 million) (note 19). In 2011, ineffectiveness recognised in the income statement that arises from cash flow hedges was a loss of £13 million (2010: gain of £160 million).
The Group’s main overseas operations are in the Americas, Asia, Australasia and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows: Functional currency of Group operations £m £m
Deposit amounts available for offset and amounts available for offset under master netting arrangements do not meet the criteria under IAS 32 to enable loans and advances and derivative assets respectively to be presented net of these balances in the financial statements.
Includes assets within the Group’s unit‑linked funds for which credit risk is borne by the policyholders and assets within the Group’s With Profits funds for which credit risk is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back related contract liabilities.
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(H). All impaired loans which exceed certain thresholds, principally within the Group’s Wholesale division, are individually assessed for impairment by reviewing expected future cash flows including those that could arise from the realisation of security. Included in loans and receivables are advances which are individually determined to be impaired with a gross amount before impairment allowances of £48,142 million (31 December 2010: £51,608 million).
Allowance for impairment losses on loans and advances to customers on a combined businesses basis 27,718 29,635
Total loans and advances which are past due but not impaired 15 12,742 1,093 2,509 16,344 –
Total held as available‑for‑sale financial assets 24,470 6,581 7,937 1,250 129 333 40,700
Debt securities, treasury and other bills held at fair value through profit or loss An analysis of the Group’s trading and other financial assets at fair value through profit or loss is included in note 18. The credit quality of the Group’s debt securities, treasury and other bills held at fair value through profit or loss is set out below: AAA £m
Asset‑backed securities: Other asset‑backed securities 19 151 52 – – – 222
Corporate and other debt securities 1,205 1,209 1,839 183 13 470 4,919
Other assets held at fair value through profit or loss: Bank and building society certificates of deposit 52 107 447 – – – 606
Unimpaired non‑mortgage retail lending amounted to £42,541 million (2010: £46,347 million). Lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the time of loan origination and are thereafter monitored in accordance with business unit credit policy.
There were reverse repurchase agreements which are accounted for as collateralised loans with a carrying value of £16,835 million (2010: £3,096 million), against which the Group held collateral with a fair value of £16,936 million (2010: £2,987 million), all of which the Group is able to repledge. Included in these amounts are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £34 million (2010: £42 million). These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.
At 31 December 2011, total wholesale lending amounted to £196,824 million (2010: £213,945 million), against which the Group held an impairment allowance of £23,139 million (2010: £24,975 million). Gross impaired wholesale lending amounted to £47,660 million (2010: £51,244 million). The fair value of the collateral held in respect of impaired wholesale lending which is secured was £13,977 million (2010: £14,520 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation. For the purposes of determining the total collateral held by the Group in respect of impaired secured wholesale lending, the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over‑collateralisation and to provide a clearer representation of the Group’s exposure.
Wholesale unimpaired lending amounted to £149,164 million (2010: £162,701 million). Wholesale lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the time of loan origination. The types of collateral taken and the frequency with which collateral is required at origination is dependent upon the size and structure of the borrower. For exposures to corporate customers and other large institutions, the Group will often require the collateral to include a first charge over land and buildings owned and occupied by the business, a mortgagee debenture over the company’s undertaking and one or more of its assets, and keyman insurance. The Group maintains policies setting out acceptable collateral, maximum loan‑to‑value ratios and other criteria to be considered when reviewing a loan application. The decision as to whether or not collateral is required will be based upon the nature of the transaction and the credit worthiness of the customer. Other than for project finance, object finance and income producing real estate where charges over the subject assets are a basic requirement, the provision of collateral will not determine the outcome of a credit application. The fundamental business proposition must evidence the ability of the business to generate funds from normal business sources to repay debt.
Lending decisions in respect of irrevocable loan commitments are based on the obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. For wholesale commitments, it is the Group’s practice to request collateral whose value is commensurate with the nature of the commitment. For retail mortgage commitments, the majority are for mortgages with a loan ‑to‑value ratio of less than 100 per cent. Aggregated collateral information covering the entire balance of irrevocable loan commitments over which security will be taken is not provided to key management personnel.
Retail customers The Group classifies the treatments offered to customers who have experienced financial difficulty into the following categories: – Forbearance: a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original contractual payments, for example capital payment breaks and payment assistance breaks. Any arrears existing at the commencement of the arrangement are retained.
– Repair: an account change used to repair a customer’s position when they have emerged from financial difficulty, for example capitalisation of arrears.
Commensurate with the aim of this activity (i.e. to manage customers through their temporary financial difficulty) during the capital payment break arrears accrue based on the temporary interest only contractual monthly payment. On expiry of the break, the customer is transferred back onto capital and interest repayment terms, with the outstanding balance recovered across the remaining term of the original loan.
Forbearance – Payment assistance break These agreements allow customers to suspend monthly payments for a limited period in order to address short‑term financial difficulties. This treatment is only available as a forbearance tool to customers who are less than one monthly payment in arrears and for a maximum period of three months during the term of the mortgage.
The contractual monthly payment is reset when the term extension is implemented and any subsequent arrears will accrue based on this revised payment.
The Group assesses whether a loan benefitting from a UK Government sponsored programme is impaired using the same accounting policies and practices as it does for loans not benefitting from such a programme. There is no direct impact on the impairment status of a loan benefitting from the Mortgage Rescue schemes, as these schemes involve the purchase, and eventual sale, of the property. The loans included within the Income Support for Mortgage Interest scheme and the Homeowner Mortgage Support scheme may be impaired, in accordance with the normal definition of impairment.
The Income Support for Mortgage Interest scheme remains the most successful of the Government backed schemes. It is the longest‑running, is the most widely known and provides both the customer and the Group with an assurance as to the maintenance of at least two years’ worth of interest payments. The Group estimates that around £3 billion of its mortgage exposures are receiving this benefit. This includes those who are also receiving other treatments for financial difficulty.
The Group’s own UK retail secured schemes have also shown signs of success with over 86 per cent of customers who have accepted capital payment breaks having maintained or improved their arrears position over the twelve months after transfer. The Group believes that its mortgage payment arrangements continue to be an effective way to manage short‑term affordability issues.
Impairment allowance as % of loans and advances receiving treatment £m £m
– the receipt of a compliance certificate from a customer or agent.
Debt for equity swaps This type of forbearance involves the Group writing off debt, either partially or in whole, in exchange for equity in the company, usually in the form of ordinary shares, warrants, options or other equity instruments. The primary goals of debt for equity swaps are to reduce the debt service (capital
Partial debt write off An agreement to write off part of a contractual financial obligation in order to facilitate survival of a corporate entity on a going concern basis. Partial debt write‑offs are typically used as a last resort.
Exposures to monolines At 31 December 2011, the Group had no direct exposure to sub‑investment grade monolines on credit default swap (CDS) contracts. Its exposure to investment grade monolines through CDS contracts was £14 million (gross exposure: £168 million) and through wrapped loans and receivables was £178 million (gross exposure: £274 million).
Cash and balances at central banks 60,420 296 6 – – 60,722
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 10,612 4,838 6,729 21,407 39,581 83,167
Debt securities held as loans and receivables 57 250 374 2,941 22,113 25,735
Liabilities arising from insurance and investment contracts 15,425 1,550 5,337 20,174 90,249 132,735
Liabilities arising from non‑participating investment contracts 27,429 – – – 22,207 49,636
Capital risk appetite is set by the Board and reported through various metrics that enable the Group to manage capital constraints and market expectations. The Group Chief Executive, assisted by the Group Asset and Liability Committee, regularly reviews performance against risk appetite. A key metric is the Group’s core tier 1 capital ratio which the Group currently aims to maintain prudently in excess of 10 per cent.
The Group maintains its own buffer to ensure that the regulatory minimum requirements and regulatory targets and buffers are met at all times.
Additionally an extensive series of stress analyses is undertaken during the year to determine the adequacy of the Group’s capital resources against the FSA minimum requirements in severe economic conditions.
Net charge (credit) in respect of defined benefit schemes 199 (455) 529
Less: amounts with a maturity of three months or more (6,369) (4,998) (7,937)
Note 58: Future accounting developments The following pronouncements may have a significant effect on the Group’s financial statements but are not applicable for the year ending 31 December 2011 and have not been applied in preparing these financial statements. Save as disclosed, the full impact of these accounting changes is being assessed by the Group.
Supersedes IAS 27 Consolidated and Separate Financial Statements and SIC‑12 Consolidation – Special Purpose Entities and establishes principles for the preparation of consolidated financial statements when an entity controls one or more entities.
Requires an entity to disclose information that enables users of financial statements to evaluate the nature of, and risks associated with, its interests in other entities and the effects of those interests on its financial position, financial performance and cash flows.
IFRS 13 Fair Value Measurement The standard defines fair value, sets out a framework for measuring fair value and requires disclosures about fair value measurements. It applies to IFRSs that require or permit fair value measurements or disclosures about fair value measurements.
– the parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or
Other matter We have reported separately on the group financial statements of Lloyds Banking Group plc for the year ended 31 December 2011.
Philip Rivett Senior Statutory Auditor for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 27 February 2012
Capital redemption reserve Retained profits1 Total £ million £ million £ million £ million £ million
Value of employee services: Share option schemes – – – 74 74
Value of employee services: Share option schemes – – – 129 129
Costs incurred in respect of the acquisition of HBOS plc – – (138)
Note 4: Share capital and share premium Details of the Company’s share capital and share premium account are as set out in notes 47 and 48 to the consolidated financial statements.
Movements in other reserves were as follows: 2011 £m 2010 £m 2009 £m
Note 8: Debt securities in issue These comprise US$862.5 million 7.75% Public Income Notes due 2050 issued by the Company in July 2010.
The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of Lloyds Banking Group plc, are: Country of registration/ incorporation
Related party information in respect of other related party transactions is given in note 53 to the consolidated financial statements.
Measurement basis of financial assets and liabilities The accounting policies in note 2 to the consolidated financial statements describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the Company’s financial assets and liabilities by category and by balance sheet heading.
The derivative assets designated as hedging instruments represent level 2 portfolios. Of derivative assets classified as held for trading (not being designated as hedging instruments) shown above, £174 million (31 December 2010: £157 million) represents level 2 portfolios and £1,172 million (31 December 2010: £1,177 million) represents level 3 portfolios. The level 3 derivatives reflect the value of the equity conversion feature of the Enhanced Capital Notes issued in December 2009 as part of Lloyds Banking Group’s recapitalisation and exit from the Government Asset Protection Scheme.
The following reconciliation shows the movements in derivative financial instrument assets within level 3 portfolios: £m £m
Equiniti operates a web based enquiry and portfolio management service for you to receive shareholder communications electronically and to register your proxy appointments or voting instructions online. You can also change your address or bank details either by telephone or online. Visit www.shareview.co.uk for details.
Share price information Shareholders can access both the latest and historical share prices via our website, www.lloydsbankinggroup.com, as well as listings in most national newspapers. For a real time buying or selling price, you will need to contact a stockbroker, or you can contact the sharedealing providers detailed below.
American Depositary Receipts (ADRs) Lloyds Banking Group shares are traded in the USA through an NYSE-listed sponsored ADR facility, with The Bank of New York Mellon as the depositary. The ADRs are traded on the New York Stock Exchange under the symbol LYG. The CUSIP number is 539439109 and the ratio of ADRs to ordinary shares is 1:4.
For details contact: The Bank of New York Mellon, PO Box 358516, Pittsburgh, Pennsylvania 15252-8516. Telephone: 1-866-259-0336 (US toll free), international callers: +1 201-680-6825. Alternatively visit www.adrbnymellon.com or email shrrelations@bnymellon.com
Analysis of shareholders At 31 December 2011 Shareholders Number of ordinary shares
Share sale fraud Lloyds Banking Group have been made aware of an increasing number of share sale frauds being reported by listed companies. This involves bogus stockbrokers, usually based overseas, cold calling people to: – either pressure them into buying shares that promise high returns; or
– offer to buy their shares at an inflated price claiming that there is a ‘secret’ takeover or merger. This is followed by a request for an upfront cash bond to commit to the deal.
This annual report includes certain forward looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995 with respect to the business, strategy and plans of Lloyds Banking Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Lloyds Banking Group or its directors’ and/or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ’will’, ‘would’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar future or conditional expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future.
Bank levy The levy that applies to certain UK banks, UK building societies and the UK operations of foreign banks from 1 January 2011. The levy is payable based on a percentage of the chargeable equity and liabilities of the bank as at the balance sheet date.
Basel II The capital adequacy framework issued by the Basel Committee on Banking Supervision in June 2006 in the form of the ‘International Convergence of Capital Measurement and Capital Standards’.
Debt securities in issue These are unsubordinated debt securities issued by the Group. They include commercial paper, certificates of deposit, bonds and medium-term notes.
Expected loss This is the amount of loss that can be expected by the Group calculated in accordance with FSA rules. In broad terms it is calculated by multiplying the Default Frequency by the Loss Given Default by the Exposure at Default.
Net interest margin Net interest margin is net interest income as a percentage of average interest-earning assets. Details of the Group’s banking net interest margin are given on page 97.
Over the counter derivatives Over the counter derivatives are derivatives for which the terms and conditions can be freely negotiated by the counterparties involved, unlike exchange traded derivatives which have standardised terms.
Retail loans Money loaned to individuals rather than institutions. These include both secured and unsecured loans such as mortgages and credit card balances.
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