View our report OnlinE Our annual report and accounts and information relating to lloyds Banking Group is also available at: www.lloydsbankinggroup.com
Financial statements Report of the independent auditors on the consolidated financial statements 204 consolidated financial statements 206 notes to the consolidated financial statements 214
WE ARE cREATinG A siMPlER, MORE AGilE And REsPOnsiVE ORGAnisATiOn And ARE MAKinG A BiG inVEsTMEnT in PROducTs And sERVicEs. BY BEcOMinG THE BEsT BAnK FOR cusTOMERs WE BEliEVE WE cAn HElP BRiTAin PROsPER And dEliVER sTROnG, sTABlE And susTAinABlE RETuRns FOR OuR sHAREHOldERs.
Significantly improved Group performance; continue to work through legacy issues q substantial increase in Group underlying profit from £638 million to £2,607 million q Full year Group net interest margin of 1.93 per cent, in line with our guidance at the 2011 full year results q costs further reduced by 5 per cent to £10.1 billion, in line with strategic review target two years ahead of plan; simplification run rate savings increased to £847 million q credit quality continues to improve; 42 per cent impairment reduction to £5.7 billion, significantly ahead of original guidance of £7.2 billion; impairment charge as a percentage of average advances improved to 1.02 per cent (2011: 1.62 per cent)
q core net interest margin of 2.32 per cent; stable throughout 2012 q 5 per cent reduction in core costs to £9,212 million; 34 per cent reduction in core impairments to £1,919 million
Introduction 1 Group performance 2 Group key performance indicators 4 Divisional overview and KPIs 6 Chairman’s statement 10 Group Chief Executive’s review 14
Management profit 4,827 2,685 simplification, Ec mandated retail business disposal costs and integration costs (1,246) (1,452)
in order to better present business performance the effects of liability management, volatile items and asset sales are shown on a separate lines in the management basis income statement and ‘underlying profit’ is profit before taking into account these items and fair value unwind. comparatives have been restated accordingly. The following items, not related to acquisition accounting, have also been excluded: – simplification, Ec mandated retail business disposal costs and integration costs; – payment protection insurance provision; – other regulatory provisions; – certain past service pension credits in respect of the Group’s defined benefit pension schemes; – amortisation of purchased intangibles; – volatility arising in insurance businesses; and
Alignment of remuneration with performance To help ensure individuals are acting in the best interest of customers and shareholders, remuneration at all levels of the organisation across the business is aligned to the strategic development and financial performance of the business. All staff, including Executive directors, have a balanced scorecard which measures performance across five areas (customer, building the business, risk, people and finance) which is aligned to the Group’s strategic priorities and reviewed on a regular basis. Executive remuneration, in particular bonuses and incentive plans, is also assessed against balanced scorecard measures which incorporate Group financial performance measures, notably profit before tax, economic profit, earnings per share and total shareholder return.
Building customer relationships customer relationships are key to our strategy and critical for all our businesses. The significant differences across the divisions means financial and non-financial strategic indicators for the development of customer relationships are generally tracked at a divisional level and commentary is included in the specific divisional commentaries.
Excellent progress continues to be made in reshaping the business through the reduction of our non-core assets which now stand at £98 billion.
RETAil The Retail division operates the largest retail bank in the UK and is a leading provider of current accounts, savings, personal loans, credit cards and mortgages. The division is focused on improving customer service and advocacy and becoming the best bank for customers. With its strong stable of brands including lloyds TsB, Halifax, Bank of scotland and cheltenham & Gloucester, it serves over 30 million customers through one of the largest branch and fee free ATM networks in the uK and a comprehensive digital, telephony and mobile proposition.
Key brands include: 2012 highlights q in 2012, Retail further increased its profits and returns, and made substantial progress towards its goal of being the best bank for customers.
Lloyds Banking Group Annual Report and Accounts 20126 cOMMERciAl BAnKinG The Commercial Banking division supports our business clients from small businesses to large corporates. The division operates a client-centric approach, primarily focused on uK businesses and businesses with strong links to the uK, with coverage comprising sMEs, Mid Markets, Global corporates and Financial institutions. strong local knowledge, a real client focus and a comprehensive product range enables us to quickly provide clients with tailored solutions and an effective service.
Key brands include: 2012 highlights q in 2012 we achieved strong profitable growth in our Wealth and Asset Finance businesses while simultaneously making progress in strengthening our balance sheet, simplifying our international operating model and investing in building capability for the future.
q The balance sheet has been further strengthened through 24 per cent growth in customer deposits and a reduction in non-core assets of a further 20 per cent, including a £3.7 billion reduction in our irish portfolio.
q We achieved cost savings of 5 per cent through further progress on simplification initiatives which in turn enabled further investment in the core businesses to improve the customer experience.
q Total underlying profit reduced by 24 per cent and core underlying profit by 21 per cent, primarily reflecting a reduction in total underlying income, largely due to the subdued economic climate and increased weather related claims, partly offset by an 8 per cent decrease in costs.
q Our focus on putting customers first has led us to improve our home insurance claims management processes which has enabled us to get our customers back into their homes more quickly following the extreme weather events throughout 2012, helping improve customer satisfaction and contain claims costs.
“ Another year of progress for the Group against a still challenging economic and regulatory backdrop.”
£3.6 million Charity of the year during the two years of our partnership with save the children this sum was raised to support the work of the charity.
Board representation Three years ahead of the mandated timeline we have 25 per cent female representation.
With regard to executive remuneration we feel it is appropriate that the fixed elements of directors’ pay should remain unchanged for a further year, recognising the continued economic climate and the need to evidence sustained returns for shareholders. Our 2012 bonus awards have been determined conservatively against robust financial performance measures, and these awards will continue to be deferred into shares, until at least 2015.
in recognition of the Group’s performance in 2012, the Remuneration committee has decided to make an annual performance award to António Horta-Osório of £1,485,000 deferred in shares. The deferral period for this award will be extended to five years, and so will not be released until 2018, and will be subject to additional conditions related to the share price at which the uK Government invested. António has led the Group through a strong year that has put us ahead in the implementation of our strategic plan. i believe this, in part, is a reason for the Group being the best performing stock in the FTsE 100 in 2012.
With respect to the long-Term incentive Plan (lTiP), as key targets for the 2010 lTiP were not met awards made under this plan will not be paid. This means that lTiP awards have not been made for Executive directors in any of the last four years. The lTiP however remains a core part of our reward strategy and we hope that the performance conditions attached to the plan which ensure alignment with the Group’s strategic objectives and timeline of our medium term plan, will be met in 2013.
“We remain committed to operating as a privately owned Group, which is profitable, self supporting and dividend paying.”
We are a uK focused retail and commercial bank, and our aim, as defined in our strategic Review in June 2011 is to build a strong competitive advantage in terms of operational efficiency and risk premium, that will allow us to become the best bank for customers.
At the same time as achieving this further absolute reduction in costs, we have re-invested a third of our simplification savings and we are continuing to strengthen our core business by directing this investment to products and channels which better meet the needs of our customers. The provision of simpler and more transparent products and services to our customers, built around their needs and delivered efficiently, is a key part of regaining their trust. The speed of our progression towards becoming the best bank for customers is clearly demonstrated by increasing customer advocacy and steadily falling levels of banking complaints (excluding PPi).
in line with our uK-focused strategy, we have made further progress in reducing our international presence, and have now completed or announced our exit from twelve countries or overseas branches, as well as announcing a reduced presence in a further four locations.
The benefits of the simplification programme extend far beyond cost reductions. customers and staff are already benefiting from faster, more automated and less complex processes: for example, in commercial Banking we improved the lending process allowing businesses to receive their funds in almost half the time, while mobile and voice recognition technologies and simpler, faster processes in Retail and a quicker claims process in insurance are further examples of how our actions are contributing to increased customer advocacy.
Lloyds Banking Group Annual Report and Accounts 201216 in insurance, we continued to invest in our core systems, products and processes in advance of RdR and the launch of pension auto-enrolment, to enable us to support both retail and commercial customers through this period of change. We have taken the first steps towards launching an enhanced annuities proposition, with full implementation into this growing market expected in mid-2013. We are pleased with the further progress in enhancing our proposition, with scottish Widows being recognised for its products, service and quality, receiving a number of industry awards including ‘Best Group Pension Provider’ in the corporate Adviser Awards 2012.
Further supporting our customers and the UK economy Our future and that of the uK economy are inextricably linked, and as the largest uK retail and commercial bank we are aware of the importance of our role in helping Britain prosper and the mutual benefit of doing so. Our utilisation of the uK Government’s Funding for lending scheme (Fls) underlined our support in 2012 for the uK economic recovery. We were the first bank to participate in the scheme and have committed in excess of £11 billion in gross funds to customers through the scheme since its launch in september, having only drawn £3 billion from the scheme so far. We are committed to passing the financial benefit of this low-cost funding on to our customers and to the areas that can be of the most economic benefit to the uK, including sMEs and first time home buyers.
sMEs play a key part in uK economic growth and we continued to actively support them in 2012. We exceeded our sME charter lending commitment of £13 billion, having increased the original £12 billion target during the year, while also committing to lend an extra £1 billion to uK manufacturing businesses. in addition, we beat our three year target of assisting 300,000 new start-ups by the end of 2012, helping to stimulate economic output and improve business confidence. This support for uK sME customers is underlined by our net sME lending growth of 4 per cent in the year, for the second year running, compared to the market which saw a reduction in net lending to sMEs of 4 per cent.
For our uK Retail customers, we provided £26.2 billion of gross new mortgage lending in 2012. This included supporting over 55,000 customers in buying their first home, equivalent to one in every four first time buyers. We also launched a number of innovative shared equity and shared ownership mortgage offers as well as supporting the local lend a Hand scheme which has helped over 900 first time buyers to become homeowners.
Mortgages We provided £26.2 billion of gross new mortgage lending in 2012. This included supporting over 55,000 customers in buying their first home, equivalent to one in every four first time buyers.
We aim to ensure that all of our colleagues uphold the highest ethical standards and have the right tools to do their jobs, and in part this will be achieved by creating a positive working environment. As part of this, we have continued to develop our internal programmes supporting diversity, enhancing our ability to retain and attract talent across the Group. in september 2012 we launched our codes of Responsibility which define how we aspire to do business and which provide all our stakeholders – colleagues, customers, communities and suppliers – with clarity and transparency about what we stand for, helping us to rebuild our culture and reinforce our values.
in this context, and with continuing successful delivery against our strategic initiatives, we are targeting core loan growth in the second half of 2013 and an increase in the Group net interest margin to around 1.98 per cent for the full year. We anticipate a further improvement in asset quality, driving an expected substantial reduction in the 2013 impairment charge, with the correspondent increase in underlying profit before tax, while we also expect costs will continue to decrease with Group total costs reduced to around £9.8 billion in 2013. We also remain confident in meeting our medium-term guidance.
Conclusion We have delivered a substantial transformation of lloyds Banking Group in the first 18 months of delivery on our strategy, despite a challenging environment and the need to address legacy issues. We are now ahead of plan in creating a competitive advantage through a reduced risk premium and best-in-class efficiency. We are making significant investments in our simple, lower-risk, customer-focused uK retail and commercial banking model, thereby continuing to support our customers and helping Britain to prosper. We expect this to enable us to return to profitability and to grow our core business, to realise our full potential to deliver strong, stable and sustainable returns to shareholders, and to allow uK taxpayers’ investment in the Group to be repaid.
The external macro economic and regulatory environment in which we operate remains uncertain. We have outlined below some of the key regulatory, economic and social factors impacting our markets.
Early estimates suggest output of the UK economy grew only marginally by 0.2 per cent in 2012 from 2011. The unemployment rate, however, is estimated to have fallen from 8.4 per cent in the last quarter of 2011 to 7.8 per cent in the three months to December 2012, a direction and scale of change that would normally only be associated with healthy economic growth. Some of the rise in employment is likely to have been a temporary boost from the Olympics but it also appears that productivity has fallen since pre-crisis, boosting growth in companies’ unit wage costs and being a likely contributor to inflation remaining higher than expected. Company failures have also continued to decline, down from 4,294 in England and Wales in the final quarter of 2011 to 3,834 by the final quarter of 2012, and the failure rate has improved from 0.8 per cent to 0.7 per cent of companies, close to its pre-recession trough. House prices appear to have turned upwards during the final two months of the year, ending the year 2.3 per cent up on end 2011, but commercial property prices fell on average by 4.2 per cent.
Based on data for the first three quarters of 2012, the Irish economy appears to have grown weakly after having expanded in 2011 for the first time since 2007. The unemployment rate is estimated to have started to fall around mid-year, and at 14.6 per cent at the end of 2012 was lower than 14.8 per cent at the end of 2011. Strict austerity measures in recent years, targeted at improving international competitiveness, are beginning to pay off – falling domestic demand is now being more than offset by increasing net exports. The huge correction in property markets also appears to be nearing completion. CRE prices fell by 6.5 per cent in 2012, the smallest fall since the decline started in 2008 and house prices ended 2012 4.5 per cent lower than at the end of 2011, but with a trend of monthly increases since May.
Regulation Greater clarity is now emerging over the shape of the regulatory landscape but significant uncertainty remains and a number of key regulatory changes will impact our markets: Financial Services (Banking Reform) Bill On 12 October 2012 the Government published the draft Financial services (Banking Reform) Bill to implement the recommendations of the independent commission on Banking. The draft Bill would require banks to ring-fence some retail and sME activities from investment banking activities, conform to additional capital requirements beyond those required by Basel iii and implement a 7-day current account switching service. importantly for the Group, given we are primarily a uK-focused retail and commercial bank, the vast majority of our operations are likely to be within the ring-fence.
The Bill is being scrutinised by the commission on Banking standards prior to its introduction into Parliament. The commission released an interim report in december 2012 that called for the Bill to be amended to give the regulator powers to force a bank to implement full separation if there is thought to be ‘significant risk’ to the ring-fence. The commission will continue to take evidence on the Bill throughout the first quarter of 2013 on questions that remain open such as which services banks can place within the ring-fence. it is expected to produce its final report in the second quarter of 2013. uncertainty therefore remains over what the commission will ultimately recommend and whether the Government will accept the amendments that it proposes.
Other regulatory reforms The amount of regulatory change continues to rise. Other examples that could have significant impact on the Group include changes to accounting standards, the dodd-Frank Act, Eu Market infrastructure Regulation, FATcA, the Markets in Financial instruments directive Review, the OFT Personal current Account Market Review and solvency ii.
There are some clear customer trends emerging, but we recognize that every customer, whether an individual or an organisation, has particular needs and must be treated accordingly. Every customer has a choice and will select the provider that can most effectively service their personal needs.
Key challenges q economic environment: a weak, outlook for the uK economy, along with continuing economic uncertainty in the Eurozone .
q Regulatory environment: uncertainty remains over key elements of the independent commission on Banking reforms, particularly recovery and resolution mechanisms and retail ring fencing, and future capital and liquidity requirements arising from cRd iV remain unclear.
ultimately as a simple, lower risk, customer focused uK retail and commercial bank, we can rebuild the trust of our customers and other stakeholders, help Britain prosper and deliver strong, stable and sustainable returns for shareholders.
Our strategy is being delivered though a clear action plan focused on reshaping our business portfolio to fit our assets capabilities and risk appetite, strengthening the Group’s balance sheet and liquidity position, simplifying the Group to improve agility and efficiency and investing to be the best bank for customers. Our progress against this plan and the key priorities for 2013, is described on the next few pages.
Aim We continue to focus on attractive uK customer segments and their product needs to target a sustainable statutory return on equity of between 12.5 and 14.5 per cent. We will invest behind core areas which offer strong returns and attractive growth: these are businesses which are capital and liquidity efficient, with sustainable competitive advantage, and which are central to our core customer strategy. in reshaping our business, our focus will be on reducing non-core assets, improving our asset quality and reducing our international presence.
Key initiatives and progress in 2012 We continued to make significant progress in reshaping our business to become a simpler, customer focused organisation supported by better quality assets.
Asset quality ratio continues to improve towards our 50-60 basis points target.
We will further streamline our international presence and expect to exit or announce exit from at least 15 countries by 2014.
Priorities for 2013 q continue to build on our strong capital position with further improvements to our capital ratios q Maintaining the Group’s core loan to deposit ratio close to our long term target of 100 per cent q continued reduction in wholesale funding requirements
Key initiatives and progress in 2012 We continued to make good progress in strengthening the Group’s balance sheet in 2012. in addition to further improving our core tier 1 capital ratio, we have further improved our funding profile and position. We have been continuing to ensure we maintain strong liquidity, funding and capital positions and an appropriate loan to deposit ratio.
in the last quarter of 2012 we also repaid the remaining liquidity support received from the uK Government.
improved Group’s loan to deposit ratios With a substantial reduction in our non-core assets, and further growth in our relationship customer deposits, we have already achieved our initial Group loan to deposit ratio target of 130 per cent or below, reaching 121 per cent in 2012, two years ahead of our original target. Our core loan to deposit ratio of 101 per cent is already in line with our long term target of 100 per cent.
We have continued to improve our core tier 1 ratio, which now stands at 12.0 per cent on a Basel II basis. We continue to target a core tier 1 ratio prudently in excess of 10 per cent on a transitional basis.
The Group continues to be in a strong position to deliver further simplification initiatives and, given previous integration and simplification experience, we are confident our £1.9 billion target can be completed as planned.
The main initiatives now being progressed are: Operations and processes We continue to make significant progress re-engineering our end to end processes. We have implemented process automation across the business including isA and account transfers, account closures, and mortgage surveyor and valuation services. We are also materially reducing the number of iT applications and modernising our iT infrastructure estate. This will improve the customer experience, increase productivity and reduce risk, errors, complexity and costs.
We are targeting £1.9 billion of run rate cost savings by the end of 2014 through a series of Simplification initiatives and are well on track having already delivered £0.8 billion of run rate cost savings by the end of 2012.
Lloyds Banking Group Annual Report and Accounts 201226 siMPliFY the Group to improve agility and efficiency.
Aim Our simplification programme continues to focus on creating a more efficient, agile organisation, reducing costs in the business whilst improving the customer and colleague experience. As announced last year, we are now targeting £1.9 billion of run rate cost savings by the end of 2014 through a series of simplification initiatives. savings will be realised by focusing on: operations and processes, channels and products, sourcing and creating a more agile organisation.
in general insurance we have further enhanced our processes including our claims management process helping improve customer satisfaction and contain claims costs.
As Simplification benefits materialise we are looking to increase the investment in the business and have committed to invest £500 million per annum by 2014.
BuildinG VAluABlE RElATiOnsHiPs THE succEssFul dEliVERY OF OuR sTRATEGY And FOcus On HElPinG BRiTAin PROsPER Will BE dRiVEn BY THE RElATiOnsHiPs WE dEVElOP
Alongside these findings, ipsos MORi’s issues index shows that the state of the uK economy remained the primary concern of the British public throughout 2012.
Relationships and responsibility The Group considers the three stakeholder groups of customers, colleagues and communities as key – crucially recognising their interdependence as we realise our vision of being the best bank for customers.
We aspire to conduct business in a way that values and respects the human rights of our colleagues, customers and those of the communities in which we operate. We adhere to the principles of the United Nations Declaration of Human Rights, International Labour Organisation Fundamental Conventions and are signatories to the Equator Principles (see page 167). Our Codes of Responsibility set standards of ethical behaviour for our colleagues. We also take into account social, ethical and environmental issues in our investment, lending and service operations.
During 2012 we underlined our commitment to SME and Mid Markets lending by successfully participating in both the National Loans Guarantee Scheme (NLGS), and the government’s Funding for Lending (FLS) initiative. We issued our full funding allocation of £1.4 billion under NLGS, as well as becoming the first bank to participate in the Funding for Lending scheme and have committed in excess of £11 billion in gross funds to customers through the scheme since its launch in September.
Through our Simplification programme and continued focus on becoming the best bank for customers, our FSA reportable banking complaints continued to fall.
We have enhanced our internet banking offering to enable our retail customers to do more online. This has helped to drive large increases in the number of customers who use both traditional online services and mobile banking with customers increasing to 9.5 million and 3.3 million respectively. in addition we have become one of the founding partners of Go On, a nationwide campaign which aims to help improve digital capability for all, with a particular focus on sMEs.
Listening to our customers We have made some great improvements to our isA processes. We have simplified the isA account opening process and made it easier to transfer funds in, enhanced our systems and removed administration hurdles, instated ‘savings champions’ in branch to deal with isA customer queries and improved interest rate visibility.
customer satisfaction is assessed through the net Promoter score (nPs), which measures the likelihood of customers recommending us to others. Our high street brands made significant headway in 2012, achieving their highest ever nPs scores, with the Group wide score rising from 44 in 2011 to 49 at the end of 2012.
Treating customers fairly central to our aim of building deep and lasting customer relationships is our determination to treat customers fairly and ensure we are transparent in dealings with them. We conduct regular monitoring to check that we are complying with our robust customer treatment policies and are achieving fair outcomes for customers. customer outcomes are an important component in colleague reward and remuneration. Our approach to fair customer treatment takes into consideration product, sales and after sales: – Products: we have strengthened our framework for developing and managing our product range, including the introduction of new product governance processes and a comprehensive risk assessment tool that centres on fair customer treatment.
Financial inclusion We aim to lead the banking sector in reaching those who are financially excluded and equip them with the confidence and capability to manage their money effectively.
Supplier relationships Having strong relationships with our suppliers is key to the delivery of our strategy and ensuring both the bank’s and our customers’ needs are effectively met. The Group looks to build and develop strong collaborative relationships and engage in regular dialogue, meaning we can better understand the environment in which we operate and help access and drive the continuous improvement and innovation in our value chain. Through working with our suppliers, we also get the opportunity to leverage their unique specialist knowledge in order to drive increased value and proactively optimise our supply chain. We consider our suppliers’ social, ethical and environmental performance as a standard part of our procurement process. We are also a signatory to the Prompt Payment code which requires us to provide clear guidance on payment procedures and encourage similar good practice amongst our suppliers and other businesses.
Aim Our ambition is to be a bank where our colleagues give their best and want to build their career. Our people are at the heart of our business and are critical in ensuring that we deliver our strategy to be the best bank for customers and through this, help Britain prosper.
Each colleague should have access to the training and development opportunities that enable them to do their role well. This should also ensure that we are able to grow talent internally, to drive our business in a sustainable way.
Having a diverse workforce is also a priority for us. At lloyds Banking Group, we want the diversity of our employee base to reflect the population of the uK and who our customers are: the better we reflect our marketplace, the better we can serve it.
We also encourage our colleagues to work closely with the community to build lasting relationships that are the foundation for our business in the future.
Living through our values To unlock the great potential in our business, we ask all colleagues to focus on our three values: putting customers first, keeping it simple and making a difference together.
Putting customers first means thinking about what’s best for customers in everything we do. That means understanding and anticipating customers’ needs, delivering on our promises to customers and each other and taking ownership to get things right for every customer. We need to ensure that what we are doing enables our customers to get the most from their money; living this value will enable colleagues to deliver our strategy to be the best bank for customers.
Colleagues received an average of 6.9 days formal learning in 2012 reflecting ongoing commitment to learning and development.
– creating a solid platform to share and reinforce our strategic vision and help colleagues understand the role they play in helping us to be Best Bank for customers.
Learning and Development learning and development supports our colleagues to be the best they can be to help us be the best bank for customers.
significant progress has been made on improving both the efficiency and effectiveness of the learning offered to colleagues. We moved more classroom training to e-learning, and increased the average amount of training received to a level above industry benchmarks.
Diversity and inclusion A key element of achieving our vision is having a diverse and inclusive workforce; and we have made progress during 2012. With a footprint that touches nearly every community and household in the uK, understanding and meeting those diverse needs, as well as our workforce reflecting the communities we serve, will support our goal of being the best bank for customers.
in 2012 our disability programme was ranked joint 2nd, achieving ‘Gold standard’ and named ‘Best Private sector Employer’ by the Business disability Forum, the world’s leading employers’ organisation on disability and business. Our end-to-end Workplace adjustment programme is industry leading and, to date, almost 10,000 cases have been managed through this process.
We continued to focus on developing our talented ethnic minority colleagues throughout 2012. Ten career development Programme courses were delivered to over 120 colleagues. The programme is aimed at colleagues who are looking to achieve their first management or senior management position and supports participants in achieving their full potential. The course receives outstanding feedback from delegates and has produced excellent results with improved promotion rates, improved performance ratings and increased engagement.
last year the Group invested £85 million in a range of flagship programmes and initiatives. despite the challenging economic environment the Group committed to keep our investment at this level for the period of its strategic plan.
education Personal money management is a fundamental life skill. in recent years there has been a huge groundswell of support to introduce compulsory financial education in schools, but there remains a lost generation of adults who have passed through the education system without acquiring these skills.
Money for life was awarded a Big Tick and was highly commended in Business in the community’s Awards for Excellence 2012.
lloyds scholars was named corporate Responsibility Project of the year at the 2012 charity Times Award.
Fundraising Through a range of engaging fundraising initiatives and personal commitment, colleagues from across the Group have raised over £3.6 million, including Matched Funding, for our 2011/12 charity of the Year save the children. This has by far exceeded our fundraising target of £2.5 million.
Our 2013/14 charity of the Year, chosen by colleagues, is supporting Alzheimer’s society and Alzheimer scotland’s live Well campaign, the first uK-wide dementia carers programme.
Measuring our performance in order to measure and manage our overall community investment in a systematic way, we use the industry standard london Benchmarking Group model. The model records cash, colleague time, in-kind donations and management time, as well as the outputs and longer-term community and business impacts of our projects.
As an example our ‘no Travel Week’ policy has changed the Group’s business travel culture since its introduction in June 2011. By promoting viable technology alternatives travel bookings have decreased by 130,000 during this period. We have also met the World Wildlife Fund 1 in 5 challenge and made significant progress against our target to reduce business travel by 20 per cent by 2020.
The complaints process has been simplified and as a result we have seen a further reduction in FsA reportable banking complaints to 1.1 per 1,000 accounts, the lowest level of any major uK bank. This is aligned to our customer focused strategy and reduced conduct risk.
Aim Managing risk effectively is important for any bank and fundamental to our strategy. We are looking to create a more efficient, lower risk, uK focused retail and commercial bank. in doing this we maintain a conservative business model embodied by a risk culture founded on a prudent appetite for risk.
q effective risk analysis, management and reporting: Effective risk analysis ensures the identification of opportunities as well as risks and ensures risks are managed appropriately and consistently with strategy. The Group’s key 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 ensures we fully understand the risk in the business at both an individual risk type and aggregate portfolio level. The key risks to the Group are outlined on the next page.
Liquidity and funding risk liquidity and funding continue to remain a key area of focus for the Group and the industry as a whole. like all major banks, the Group is dependent on confidence in the short and long term wholesale funding markets and deposit markets. should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding, its ability to fund its financial obligations and meet its commitments as they fall due could be impacted.
State Funding and State Aid On behalf of HM Treasury the Treasury solicitor holds 39.2 per cent of the Group’s share capital. HM Treasury’s shareholding continues to be managed without interference in day to day management decisions however there is a risk that a change in Government priorities could result in the framework agreement currently in place being replaced leading to interference in the operations of the Group. The Group also continues to make good progress in meeting its Eu state Aid commitments arising from the original provision of Government support although failure to meet Eu state Aid commitments could lead to sanctions.
Returns increased in the core business in our core business, the return on risk-weighted assets improved 10 basis points to 2.56 per cent, and underlying profit was broadly stable at £6,154 million (2011: £6,196 million). core total costs reduced 5 per cent to £9,212 million as a result of further simplification savings, and the impairment charge decreased 34 per cent to £1,919 million driven primarily by continued improvement in the quality of our portfolios. These effects broadly offset a reduction of 8 per cent in underlying income which reflected expected continued subdued lending demand and customer deleveraging, as well as a decline in core net interest margin of 10 basis points year-on-year. This decline was mainly a result of higher wholesale funding costs, but was mitigated throughout the year by the benefit of repricing certain lending portfolios and further improvements to the funding mix.
Management and statutory results Management profit, which includes the effects of asset sales, liability management, volatile items and fair value unwind was £4,827 million, an increase of £2,142 million or 80 per cent compared to 2011. This included a profit on government bond sales of £3,207 million (2011: £196 million) as a result of our active management of our balance sheet in response to the low interest rate environment, and a positive fair value unwind of £650 million, partly offset by a loss on asset sales of £660 million, charges for own debt volatility of £270 million, and other volatility of £478 million.
The statutory loss before tax of £570 million included provisions of £3,575 million in relation to legacy PPi business and £400 million in relation to iRHP sales to small and medium sized business. charges relating to simplification amounted to £676 million, while costs relating to the Ec mandated retail business disposal (Verde) totalled £570 million. The loss after tax was £1,343 million, with a tax charge of £773 million. This tax charge reflects a policyholder tax charge arising from the revaluation of policyholder tax credits in the light of current economic forecasts and recent changes to the taxation of life insurance companies and the impact of the announced reduction in uK corporation tax rate to 23 per cent on the net deferred tax asset.
Balance sheet further strengthened; remain confident in our capital position We continue to make good progress in strengthening our balance sheet, further improving our core tier 1 capital ratio by 1.2 per cent to 12.0 per cent by the end of 2012. The total capital ratio improved from 15.6 per cent at the end of 2011 to 17.3 per cent, which already exceeds the independent commission on Banking’s (icB) primary loss-absorbing capacity (PlAc) recommendations. Our fully loaded core tier 1 ratio increased by 1 per cent to 8.1 per cent. We continued to reduce risk in the balance sheet, achieving a significant non-core asset reduction and completing the transformation of our funding position. We remain confident in our capital position given our strongly capital generative core business and the capital accretive non-core asset reduction achieved in the year.
Our liquidity position remains strong, with a primary liquid asset portfolio of £87.6 billion. The total liquid asset portfolio of £205 billion represents approximately four times our wholesale funding with a maturity of less than one year at the end of 2012, providing a substantial buffer in the event of market dislocation.
in the first half of 2012 the Asset Finance business, previously reported within Wholesale, was transferred to the Wealth, Asset Finance and international division. in the fourth quarter of 2012, the Group’s Wholesale and commercial divisions were combined to form the new commercial Banking division. The Group’s European and Australian wholesale business has also been transferred from Wealth, Asset Finance and international to commercial Banking.
Given the good progress we have made in the delivery of the simplification programme in restructuring, simplifying and improving processes, we remain on track to meet our increased run rate target of £1.9 billion by the end of 2014. This compares with the original target of £1.7 billion announced in June 2011 as part of our strategic Review. We are now also targeting a reduction in Group total costs to around £9.8 billion in 2013.
non-core impairment The non-core impairment charge of £3,778 million was 45 per cent lower than the charge in 2011, driven by material reductions of 29 per cent to £2,242 million in the commercial Banking charge, and of 60 per cent to £1,321 million in the international charge. in commercial Banking, non-core impairments decreased, particularly in the Australasian and Acquisition Finance portfolios, partly offset by further deterioration in the shipping portfolio as a result of a weak market. in international, the impairment charge reduction was largely as a result of lower charges in the irish business.
Management profit Management profit was £4,827 million in 2012, an increase of £2,142 million when compared to 2011. This incorporates the effects of asset sales, liability management, volatile items and fair value unwind.
The profit from asset sales of £2,547 million primarily relates to £3,207 million gains from sales of Government securities, as the Group has taken the opportunity afforded by the continuing low yields on these securities to rebalance and reduce the level of these holdings. Also included are losses from asset disposals of £1,349 million, principally relating to the run-down of the non-core portfolios, partially offset by a related fair value unwind of £689 million.
Own debt volatility of £270 million is primarily driven by a charge relating to the change in fair value of the small proportion of the Group’s wholesale funding which was designated at fair value at inception, and which reflects the tightening in credit spreads in the second half of 2012. This was partly offset by a positive impact relating to the change in fair value of the equity conversion feature of the Enhanced capital notes.
Other volatile items include the change in fair value of interest rate derivatives and foreign exchange hedges in the banking book not mitigated through hedge accounting, reflecting the volatile market conditions in the period, and a positive net derivative valuation adjustment.
Simplification and eC mandated retail business disposal costs The costs of the simplification programme were £676 million in 2012, with a total of £861 million spent to date. These costs related to severance, iT and business costs of implementation. FTE role reductions of 4,892 were announced in 2012 taking the total to 6,990 since the start of the programme. simplification of our business operations continues through reduction in management layers and increasing spans of control as well as restructuring business units. The latter includes consolidation of back office operations sites, optimisation of our iT delivery model and outsourcing of our property facilities and asset management services. costs relating to the Ec mandated business disposal in 2012 were £570 million and from inception to date total £782 million (costs in the year ended 31 december 2011: £170 million).
Given the agreement with the FsA reached on 30 January 2013 following the outcome of a pilot review of iRHP sales to small and medium-sized businesses, the Group now believes it is appropriate to increase its provision for iRHP by £310 million, based on revised estimates of redress and related administration costs. The provision in relation to iRHP now totals £300 million for the cost of redress and £100 million for related administration costs, all of which was accounted for in 2012. At the end of 2012, only £20 million of the original provision had been utilised.
volatility arising in insurance businesses The Group’s statutory result before tax is affected by insurance volatility, caused by movements in financial markets, and policyholder interests volatility, which primarily reflects the gross up of policyholder tax included in the Group tax charge. in 2012 the Group’s statutory result before tax included positive insurance and policyholder interests volatility totalling £306 million compared to negative volatility of £838 million in 2011. Further detail is given on pages 74 and 75.
Taxation The tax charge for 2012 was £773 million. This represents a greater tax burden than that implied by the uK statutory rate. This is primarily due to a policyholder tax charge of £583 million arising from the revaluation of policyholder tax credits in the light of current economic forecasts and recent changes to the taxation of life insurance companies. An additional £308 million of the tax charge results from the impact of the announced reduction in uK corporation tax rate to 23 per cent on the net deferred tax asset.
– Prudent internal models, based on empirical data, that meet regulatory and stringent internal requirements in the context of on-going macro prudential policy discussions the Board has decided to issue new lloyds Banking Group ordinary shares to fund discretionary payments on tier 1 hybrid capital securities to be made during 2013. such discretionary payments are estimated to amount to approximately £350 million and will be made subject to the terms and conditions of the tier 1 hybrid capital securities. Further detail is included on page 184.
Overall, given our strongly capital generative core business and the ongoing capital accretive non-core asset reduction, we remain confident in the Group’s capital position.
We have also fully repaid all debt issued under the uK Government’s credit Guarantee scheme, achieving a reduction of £23.5 billion in 2012.
in the first quarter of 2012, we drew €13.5 billion (the sterling equivalent at the date of drawdown was £11.2 billion) under the European central Bank’s long-Term Refinancing Operation for an initial term of three years, to part fund a pool of non-core euro denominated assets. since the year-end, the Group has repaid over £8 billion of these, a decision which demonstrates the Group’s balance sheet strength and strong liquidity position. We will retain the remaining funds as a currency hedge against our European portfolio.
Given the improvements we have made to the strength of our balance sheet, we have significantly greater balance sheet flexibility with a strong liquidity position and reduced funding requirements. We re-purchased over £15 billion of term wholesale funding in 2012, including £8.5 billion through two public tenders for senior funding. These tenders were undertaken to more effectively manage our overall wholesale funding profile and optimise our future interest expense, whilst maintaining a prudent approach to liquidity.
impairment charge as a percentage of average advances 0.36% 1.85% 3.12% 1.02%
Key balance sheet items at 31 December 2012 £bn £bn £bn £bn £bn £bn loans and advances to customers excluding reverse repos 343.3 134.7 33.4 0.7 512.1 2011 £m £m £m £m £m £m insurance claims – – – (343) – (343)
q We continued to support the first time buyer mortgage market, lending to one in four first time buyers. We also increased our commitment for lending to first time buyers during 2013. in addition, we continue to deliver strong growth in customer deposit balances attracting funds from almost one in every four savers.
By investing in customers and growth, we are positioning ourselves for an improvement in market conditions. We have maintained our position as the uK’s largest lender to first time buyers and in 2012 helped one in every four buy their first home. This achievement has been supported by the development of new propositions for first time and new-build property buyers. We have continued to deliver net inflows from switching current accounts as well as attracting deposits from almost one in every four savers. This has supported strong growth in customer deposit balances and contributed to our strengthened balance sheet. in addition, we have supported over half a million customers to buy their cars, improve their homes and manage their finances through unsecured consumer loans.
Other income decreased by 12 per cent largely as a result of lower bancassurance income that reflected the subdued investment and protection market environment.
Balance sheet progress loans and advances to customers decreased by 3 per cent. This was driven by a number of factors, including reduced customer demand for new credit, existing customers continuing to reduce their personal indebtedness, non-core lending run-off and Retail maintaining a sustainable approach to risk. The reduction in lending to customers was in part due to the repayment of unsecured debt where balances reduced by £1.7 billion to £22.0 billion, or 7 per cent. secured balances reduced by £7.8 billion, to £321.3 billion, of which £1.4 billion was a reduction in non-core mortgage balances.
customer deposits increased by 6 per cent in 2012. This reflects the success of our multi-brand customer propositions and the agile pricing strategy that Retail has developed. Retail continued to deliver sustained growth in the savings market despite the high levels of competition. Our strong stable of savings brands continues to provide customers with a market leading range of products to meet their savings needs.
q underlying loss in the former Wholesale business reduced by 36 per cent due to a 31 per cent reduction in impairments and improved other income. This more than offset lower net interest income, resulting from our strategic non-core asset reduction and increased wholesale funding costs.
q underlying profit in the former commercial business increased by 10 per cent, driven by reduced impairments and costs partly offset by lower underlying income. core net lending grew by 4 per cent against market contraction of 4 per cent and we assisted in excess of 120,000 sMEs to start up in 2012.
in Mid Markets we grew share of lending in a declining market and will invest in additional capacity to support our clients in 2013. in social Housing, within Mid Markets, we topped the Housing Association Bond league table in 2012 with 10 Bookrunner mandates for 10 separate housing associations, highlighting our support for clients and contributing to the availability of housing stock in the uK.
in ldc, our private equity arm, we continued to invest equity through the cycle in support of clients across sME and Mid Markets. during 2012, 96 per cent of our investment was focused on the uK with over £300 million invested in new portfolio companies.
Banking net interest margin decreased by 28 basis points to 1.58 per cent, primarily reflecting margin compression from increased wholesale funding costs and competition for customer deposits. core net interest margin decreased by 32 basis points to 2.22 per cent as there was limited opportunity for asset repricing to offset higher funding costs. non-core net interest margin decreased by 48 basis points to 0.35 per cent, reflecting higher wholesale funding costs.
Balance sheet progress commercial Banking continues to focus on de-risking the balance sheet by reducing non-core assets whilst strengthening its relationships with core customers. net lending in the former commercial division increased by £0.8 billion, whilst core client deleveraging, and the non-core asset reduction in the former Wholesale division, more than offset this increase. non-core assets decreased £33.2 billion mainly driven by a reduction of treasury assets of £14.5 billion and loans and advances to customers, excluding reverse repos.
Banking net interest margin 0.96% 1.35% (39)bp 1.40% 1.83% (43)bp impairment charge as a % of average advances 2.10% 2.56% (46)bp 0.59% 0.90% (31)bp
Banking net interest margin decreased by 39 basis points to 0.96 per cent, primarily reflecting margin compression from increased wholesale funding costs and competition for customer deposits. core net interest margin decreased by 43 basis points to 1.40 per cent following limited opportunity for asset repricing to offset higher funding costs.
Other income increased by £133 million, with core other income increasing by £214 million, reflecting higher client activity in Financial Markets and debt capital Markets despite difficult market conditions, and a resilient performance in ldc benefiting from strong vintage.
Banking net interest margin 3.96% 4.21% (25)bp 4.11% 4.37% (26)bp impairment charge as a % of average advances 0.81% 1.06% (25)bp 0.89% 1.09% (20)bp
core net lending increased £1.1 billion despite the sME market contracting 4 per cent. core net interest income decreased £59 million primarily due to compressed margins from higher wholesale funding costs and increased competition for customer deposits. This is reflected in the core net interest margin reduction of 26 basis points.
We continue to focus on simplifying operations and processes, delayering management structures, consolidating supplier relationships and increasing the efficiency of distribution channels.
We are investing in our Wealth business to grow market share in what is viewed as a key growth opportunity for the Group. The investment is geared towards developing compelling propositions for mass affluent and affluent customers within the uK and channel islands and also those with uK connections in anglophile territories. during 2012, we created one single Wealth business with the aim of generating synergies across the international and uK businesses.
We are focused on ways to leverage the strength of our core banking franchise which holds a number of significant customers who are ‘wealth eligible’. investment has already been made in customer experience and plans are underway for significant technology and product development. during 2012 there have been approximately 115,000 referrals into the Wealth business from other areas of the Group.
in Asset Finance we have strong market positions in the uK and Australia and a strong funding base through our online deposit business. We have refocused the businesses and have made substantial progress in exiting portfolios which do not fit our risk appetite while positioning the motor leasing and finance businesses for growth.
The Blackhorse Motor Finance business grew new business by 11 per cent reflecting its return to a growth strategy. The business has a strong established market position and a broad customer franchise. Our focus is on further upgrading our market leading technology platform and using it to launch new customer propositions.
core underlying profit increased by 27 per cent to £459 million, largely driven by the strong performance in our Wealth and Asset Finance motor and contract hire businesses where core underlying profit increased by 25 and 13 per cent, respectively, together with improved profitability in our on-line deposit businesses. core income was flat mainly as a result of lower income from funds under management as investment markets in 2012 remained subdued. core costs reduced by 5 per cent to £1,795 million reflecting the progress we have made in simplifying and consolidating our Wealth business as part of the simplification programme. This enabled us to make significant investment within the Wealth business in the year.
net interest margin fell to 1.65 per cent from 1.72 per cent in 2011 despite margins in our core business increasing to 5.90 per cent in 2012, up from 5.04 per cent in 2011. The year on year reduction in divisional margin was driven by our non-core business where margins fell from 1.35 per cent in 2011 to 1.13 per cent in 2012 as a result of significant non-core asset run-off in the year together with increased levels of impaired assets, mainly in ireland.
Total costs decreased by 5 per cent despite a 4 per cent increase in total customer balances and funds under management. This reflected our continued focus on simplifying our business model and reducing our international footprint.
Return on risk-weighted assets 6.38% 4.15% 2.71% 2.03% (7.32)% (13.04)% (2.31)% (5.82)%
The focus in Wealth has been to grow market share in uK and international Wealth through increasing deposits and funds managed on behalf of franchise customers, whilst improving margins and operating efficiency. customer deposits increased by £4.6 billion or 18 per cent to £30.8 billion reflecting continued growth in our core Wealth businesses whilst funds under management grew by 4 per cent reflecting a shift of customer appetite away from investment products towards deposits.
in Asset Finance, underlying profit increased by 10 per cent, despite an 8 per cent reduction in loans and operating lease assets as we completed the refocusing of the business to fit our risk appetite. This resulted in improving margins in our motor finance and lending business, together with a 46 per cent growth in on-line deposits.
Balance sheet progress net loans and advances to customers decreased by £6.8 billion to £33.4 billion with continued management focus continued on de-risking the balance sheet. This reflects net repayments and asset sales of £7.5 billion, additional impairment provisions of £1.4 billion mainly within the international businesses, and foreign exchange movements of £0.7 billion.
Opening funds under management 182.0 192.0 inflows: Outflows: sWiP – internal (7.7) (4.5)
q We have further enhanced our corporate Pensions proposition, with the addition of AssistMe, an auto-enrolment tool that complements our MyMoneyWorks corporate pension platform. The strength of our proposition, combined with strong activity in the run up to implementation of the Retail distribution Review (RdR), has driven 23 per cent growth in corporate pensions.
EEV new business margin 3.8% 4.0% (0.2)pp life, Pensions and investments sales (PVnBP) 10,364 10,662 (3)
We see strong potential in the bancassurance channel. Whilst we withdrew investment advisors following a review of the implications of RdR, we continue to maintain a strong advisor force within branches to service insurance needs of customers. We have expanded our life insurance proposition with a new earnings protection product with simple application and claims processes. We are investing to improve customer experience in our market leading home insurance business: for example, improving our claims function to settle claims faster and get customers back in their homes more quickly. This will enable us to protect and grow the business, leverage sales opportunities linked to online banking services and make more effective use of the deep understanding we have of our customers. We will use this experience to expand in other core customer insurance needs such as commercial insurance.
We continue to focus on retention of customers within our legacy lP&i books, including opportunities to migrate customers with maturing products into new investment propositions. These customers provide 34 per cent of our total underlying profit. Whilst we have invested in the systems and processes to help independent Financial Advisers through RdR, we anticipate exits from the market and the direct channel will be increasingly important for the ‘orphan’ customers created.
lP&i existing business profit reduced by £257 million to £380 million in 2012. More than £200 million of this reduction is attributable to the subdued economic environment. For lP&i insurance contracts, returns on existing business reflect long-term economic assumptions for these policies. The subdued economic environment has resulted in the rate of return used in calculating the 2012 results being significantly lower than the comparable rate in the prior year and this was the main driver of the reduction in existing business profit. Existing business profits in our European business were impacted by the non-recurrence of net positive prior year assumption changes.
lP&i total new business profit also decreased by 4 per cent to £318 million, primarily reflecting a 3 per cent reduction in PVnBP driven by lower bancassurance volumes, reflecting the impact of the economic environment on customers’ desire to invest and the decision to only offer investment advice for customers with savings above £100,000 ahead of RdR. High volumes of corporate pension sales through the intermediary channel have partially offset this; however, this change in business mix has resulted in a slight decrease in EEV new business margin which remains strong at 3.8 per cent.
General insurance other income reduced by £98 million primarily reflecting the run-off of the PPi book and lower investment returns. Home insurance income was broadly in line with last year and reflects the maturity and competitiveness of the market. increased claims of £22 million, 6 per cent higher than the prior year, were mainly driven by adverse property claims following weather events that have impacted during the year, with 2012 being the second wettest year on record. Weather related claims totalled £110 million which is £95 million higher than such claims in 2011. This was partly offset by lower underlying home claims reflecting our improved claims management processes which improved customer experience and reduced average claims costs as well as lower claims as a result of the reduction in the size of the PPi book. despite the impact of weather related claims our combined ratio remains strong at 72 per cent.
The capital position of the insurance group remains robust. The estimated insurance Groups directive (iGd) capital surplus was £3.7 billion (£3.7 billion at 31 december 2011). A dividend of £0.6 billion was paid to the Group further mitigating the potential impact of cRd iV on the Group.
Total sales (PVnBP) have decreased by 3 per cent to £10,364 million primarily reflecting lower investments and protection volumes partially offset by strong sales of corporate and individual pensions in lP&i uK.
The direct channel continues to perform well and is being developed for future growth. This channel will become even more important to our business with the introduction of RdR.
Group Property costs decreased by 3 per cent as we continued to consolidate the Group’s property portfolio; as well as having set up a number of specialist operations centres of excellence and successfully outsourced our property facilities and asset management services.
Total underlying income largely reflects the net impact of items not recharged by the Group’s corporate Treasury to the divisions. The reduction in income in 2012 is partly due to the retention in the centre of expense items relating to certain risk and balance sheet management actions, including the run-off of prior year actions. Total costs include the costs of certain central and head office functions and corporate costs such as the Financial services compensation scheme charge and the Bank levy.
non-core portfolios consist of non-relationship assets and liabilities together with assets and liabilities which are outside the Group’s current risk appetite.
Wealth, Asset Finance and international 2,276 (22) 5.3 9.6 51.0 non-core portfolios
Wealth, Asset Finance and international2 2,278 (33) 5.1 9.8 40.4 insurance 2,141 – – – –
Banking net interest margin 2.32% 2.42% (10)bp impairment charge as a % of average advances 0.44% 0.64% (20)bp
Total core assets 826.1 829.8 customer deposits (excluding repos) 419.0 401.5 4
Total underlying income, net of insurance claims 8,884 5,081 2,278 2,141 381 18,765 liability management – – – – 1,295 1,295
Banking net interest margin 0.55% 1.01% (46)bp impairment charge as a % of average advances 3.08% 4.60% (1.52)pp
Total underlying income, net of insurance claims 48 454 566 58 (25) 1,101
Total underlying income, net of insurance claims 273 917 955 136 – 2,281
insurance volatility The Group’s insurance business has liability products that are supported by substantial holdings of investments, including equities, property and fixed interest investments, all of which are subject to variations in their value. The value of the liabilities does not move exactly in line with changes in the value of the investments, yet iFRs requires that the changes in both the value of the liabilities and investments be reflected within the income statement. As these investments are substantial and movements in their value can have a significant impact on the profitability of the Group, management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to results based on the actual return.
Property return (gross) 5.48 6.99 corporate bonds in unit-linked and With Profit Funds (gross) 3.08 4.59
Group hedging arrangements To protect against further 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 2011, financed by selling some upside potential from equity market movements. These expired in 2012 and the charge booked in 2012 on these contracts was £3 million. new protection was acquired in 2012 to replace the expired contracts. There was no initial cost associated with these hedging arrangements. On a mark-to-market valuation basis a loss of £17 million was recognised in relation to the new contracts in 2012.
Average interest-earning banking assets, which are calculated gross of related impairment allowances, and average interest-bearing banking liabilities relate solely to customer and product balances in the banking businesses on which interest is earned or paid. Funding and capital balances including debt securities in issue, subordinated debt, repos and shareholders’ equity are excluded from the calculation of average interest-bearing banking liabilities. However, the cost of funding these balances allocated to the banking businesses is included in banking net interest income.
Policyholder interests volatility The application of accounting standards results in the introduction of other sources of significant volatility into the pre-tax profits of the life, pensions and investments business. in order to provide a clearer representation of the performance of the business, and consistent with the way in which it is managed, adjustments are made to remove this volatility from underlying profits. The effect of these adjustments is separately disclosed as policyholder interests volatility.
Basic earnings per ordinary share (2.0)p (4.1) p (0.5)p 7.5p 6.7p diluted earnings per ordinary share (2.0)p (4.1) p (0.5)p 7.5p 6.6p
This figure excludes 81 million (2008: 79 million) limited voting ordinary shares.
Restated in 2009 for iFRs 2 (Revised) and to separate the share of results of joint ventures and associates from total income.
Skills and experience: sir Winfried has substantial experience of leading complex international boards in the uK, Asia and the us. His background spans a range of sectors, including banking and capital markets, finance and government regulation and public policy. sir Winfried is a highly respected leader with the proven experience and judgement to lead the Board of lloyds Banking Group.
external appointments: sir Winfried is a non-Executive director of Eli lilly and company and The McGraw Hill companies inc. He is chairman of the Advisory council of ThecityuK and a Member of the Akbank international Advisory Board.
Former appointments: david joined Barclays in 1983 and held various senior management positions culminating in Executive director, member of the Group Executive committee and chief Executive, international Retail and commercial Banking, a position which he held until december 2006. He is a former non-Executive director of BAA and Absa Group and was chairman and chief Executive of BAWAG P.s.K. AG.
external appointments: carolyn is a non-Executive director of The Vitec Group and a member of its Audit, nominations and Remuneration committees. in January 2012, she was appointed a trustee of Marie curie cancer care.
external appointments: Anita is the chairman of Victrex plc, having previously been its senior independent director, and is the senior independent director of Aberdeen Asset Management. she is a non-Executive director of iMi.
Carolyn Fairbairn independent director Member of the Audit committee and the Remuneration committee
external appointments: Tim is the Global Head of Regulatory strategy and Policy at JP Morgan. He is a director of the Great-West life insurance co., Power corporation of canada and Power Financial corp.
Skills and experience: Martin has significant finance experience. He was with deloitte for 34 years including 26 years as an Audit Partner serving a number of FTsE100 companies. His background and experience enables him to fulfil the role of Audit committee chair and for sEc purposes the role of Audit committee Financial Expert.
Skills and experience: Tony has over 40 years’ experience in the investment management industry and related sectors. As senior independent director and chair of the Remuneration committee, he ensures close and regular dialogue with shareholders with the aim of better aligning executive reward with shareholder interests. His former experience as chief Executive of Hermes Pensions Management places him in an ideal position to carry out these roles.
António Horta-Osório Group chief Executive Appointed Group chief Executive in March 2011
Juan has over 25 years of experience in banking having completed a range of Risk, control and Business Management roles across the corporate, investment, Retail and Risk divisions of the santander Group. He has lived in the uK since 2006 when he joined the santander uK business as the chief Risk Officer.
david has over 25 years experience in retail financial services. He is chairman of the ‘Your Tomorrow’ pension fund trustees and is a member of the institute of Financial services school of Finance Board of Governors. He is also community ambassador for Yorkshire and Humberside.
Financial risk management objectives and internal control policies in relation to the use of financial instruments 115 to 202 (and in note 55 on pages 318 to 338)
M A scicluna and T T Ryan, Jr will retire from the Board on 31 March 2013 and 18 April 2013, respectively.
n l luff will be appointed to the Board on 5 March 2013.
lord Blackwell, c J Fairbairn and n l luff were, or will be, appointed to the Board since the annual general meeting held in 2012 and will therefore stand for election at the forthcoming annual general meeting.
The powers of the directors are determined by the companies Act 2006 and the company’s articles of association. The directors were granted authority at the 2012 annual general meeting to issue and allot shares and to repurchase its own shares. Renewal authorities will be sought at the 2013 annual general meeting.
Substantial shareholders information provided to the company by substantial shareholders pursuant to the dTR is published via a Regulatory information service and is available on the company’s website.
Research and development activities during the ordinary course of business the Group develops new products and services within the business units.
Lloyds Banking Group Annual Report and Accounts 201284 employees lloyds Banking Group is committed to providing employment practices and policies which recognise the diversity of our workforce. We will not unfairly discriminate in our recruitment or employment practices on the basis of any factor which is not relevant to individuals’ performance including sex, race, disability, age, sexual orientation or religious belief. We work hard to ensure lloyds Banking Group is inclusive for all our colleagues.
To support us in this aim, lloyds Banking Group belongs to a number of major uK employment equality campaign groups, including the Business disability Forum, The Age and Employment network, stonewall and Race for Opportunity. Our involvement with these organisations enables us to identify and implement best practice for our staff. lloyds Banking Group has a range of programmes to support colleagues who become disabled or acquire a long-term health condition. These include a workplace adjustment programme to provide physical equipment or changes to the way a job is done. The Group also runs residential Personal and career development Programmes to help colleagues deal positively with the impact of a disability and the colleague disability network, Access, provides peer support.
schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement in lloyds Banking Group.
Further information on employees can be found on pages 34 to 37.
Role of the Board 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 through the approval and monitoring of the Group’s risk appetite and a robust risk management framework; – monitoring financial performance and reporting, including the approval of the Group’s annual report and accounts; and
delegation of specialist matters to the committees allows a degree of rigour and scrutiny that would not be possible by the Board acting alone. Matters of particular importance such as funding and liquidity, the internal capital Adequacy Assessment Process, provisioning and risk appetite are debated thoroughly by the relevant committee but need to be approved by the Board as a whole.
Authority and delegation The Board operates through a Governance Framework which is reviewed at least annually to ensure that it remains fit for purpose. The Governance Framework comprises the Board Governance Framework, the Executive Governance Framework and the Group subsidiaries Manual, each of which are explained below.
Roles of the Chairman and Chief executive There is a clear division of responsibilities at the head of the company. The chairman has overall responsibility for the leadership of the Board while the Group chief Executive manages and leads the business.
The responsibilities of the chairman are set out in the Board Governance Framework and include: – leadership of the Board; – promoting the highest standards of corporate governance; – oversight of the content of the Board meeting agendas to ensure that the Board devotes its time and attention to the right matters. Agendas are finalised at Board Agenda Review meetings involving the chairman, Group chief Executive and company secretary. The deputy chairman and senior independent director also attend; – effective communication with shareholders and development of understanding of the views of shareholders; – leading and, with the assistance of the company secretary, attending to the identification and provision of induction, training and development needs for directors and the Board generally; – ensuring, with the support of the company secretary, that directors receive timely and relevant information and are kept advised of key developments, both during and between formal meetings; – encouraging open dialogue between directors and to this end, he meets regularly with the non-Executive directors in the absence of Executive directors in private sessions; and
– building an effective and complementary Board and, in conjunction with the nomination & Governance committee, planning succession in Board appointments.
Following a period of absence in 2011, the details of which were explained in last year’s report, the Group chief Executive, António Horta-Osório, returned to work in January 2012. The Board has been impressed with his energy and commitment to the role as evidenced by the demonstrable progress made in delivering the strategy. The Board through the chairman continues to monitor his progress and is confident that he has fully recovered.
Board composition The nomination & Governance committee is responsible for assisting the chairman in reviewing the overall composition of the Board, including its size, structure, independence and diversity. To ensure transparency and consistency, the Board has established principles that underpin its approach to 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. At year end, the Board comprised 11 directors, down from 12 in 2011. The size of the Board is within the optimal range set by the nomination & Governance committee.
The Board recognises that senior management is the feeder group from which future directors may eventually be selected. To improve the representation of women in these roles, the Group has implemented a variety of initiatives. These include: the Breakthrough Women’s network, which boasts a talent pool in excess of 4,000 members; and Footprints in the snow, a female role model programme that showcases the career paths of the Group’s most senior women, providing footprints and stepping stones for other women to follow, be inspired by and succeed. in addition, the Group has a leading suite of policies to support working parents to achieve a sustainable work life balance. These efforts have been recognised by our positive placing in the Times Top 50 Employers for Women and through the Breaking the Mould awards. More information on the Group’s commitment to diversity can be found on page 37.
Succession planning The nomination & Governance committee oversees the Board’s arrangements for the longer term succession of Board and committee members.
Board effectiveness review The annual evaluation of the Board’s effectiveness provides an opportunity to consider ways of identifying greater efficiencies, maximising strengths and highlighting areas for further development.
After conducting external reviews in 2009 and 2010, we conducted an internal review in 2011. Key actions arising from that review included the need for increased focus on executive succession and improving the quality and timeliness of board papers. Both of these have been addressed in 2012 to the Board’s satisfaction. As explained below, further improving the information provided to the Board to reflect the refocusing of the agenda will remain a priority for 2013.
– Working together. Given the relative ‘newness’ of the Board, further opportunities will be sought for directors, particularly non-Executive directors, to meet outside formal meetings to assist them in coming together as a team. The cycle of Board meetings and events will be reviewed to allow greater opportunity for directors to spend time together outside the boardroom.
– carolyn Fairbairn, non Executive director, who was appointed for her digital and on-line, strategy, public policy and regulatory knowledge in June 2012.
There has been no increase to non-Executive director fees since January 2008.
– a bespoke induction programme tailored by the chairman to the individual needs of the director having regard to their specific role on the Board and their skills and experience to date.
All directors, including non-Executive directors, have access to the services of the company secretary in relation to discharging their duties as a director, or as a member of any Board committee. The appointment, and removal, of the company secretary is a matter reserved for the Board as a whole. in addition, the Group provides access, at its expense, to the services of external advisers in order to assist directors in their role, wherever this is deemed necessary.
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 Risk division and internal audit. The Audit committee receives reports from the company’s auditors, Pricewaterhousecoopers llP (which include details of significant internal control matters that they have identified), and has a discussion with the auditors at least once a year without executives present, to ensure that there are no unresolved issues of concern.
Each year the Audit committee establishes a limit on the fees that can be paid to the external auditors in respect of non-audit services and monitors quarterly the amounts paid to the auditors in this regard. The external auditors also report regularly to the Audit committee on the actions that they have taken to comply with professional and regulatory requirements and current best practice in order to maintain their independence. This includes the rotation of key members of the audit team. Total auditor remuneration analysed between audit and other services is shown in note 11 to the financial statements on pages 241 and 242.
Remuneration The Remuneration committee, chaired by Anthony Watson, is responsible for overseeing the Group’s remuneration arrangements and compliance with the FsA’s Remuneration code. The Remuneration committee’s terms of reference are available on the website at www.lloydsbankinggroup.com.
investor Relations has primary responsibility for managing day-to-day communications with institutional shareholders. supported by the Group chief Executive and Group Finance director, they achieve this through a combination of briefings to analysts and institutional shareholders (both at results briefings and throughout the year), as well as site visits and individual discussions with institutional shareholders.
Compliance with the British Bankers’ Association Code for Financial Reporting Disclosure in september 2010, the British Bankers’ Association published a code for Financial Reporting disclosure (the ‘disclosure code’). The disclosure code sets out five disclosure principles together with supporting guidance. The principles are that uK banks: commit to providing high quality, meaningful and decision-useful disclosures; commit to ongoing review of, and enhancement to, their financial instrument disclosures for key areas of interest; will assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of such guidance; will seek to enhance the comparability of financial statement disclosures across the uK banking sector; and will clearly differentiate in their annual reports between information that is audited and information that is unaudited.
– reviews the quality and acceptability of the related accounting policies, practices and financial reporting disclosures.
internal Controls and the Risk Management Framework – reviews the effectiveness of the systems for internal control, risk management and compliance with financial services legislation and regulations; – reviews the Group’s procedures for detecting financial reporting fraud; – reviews the Group’s procedures for handling of complaints or concerns regarding accounting or auditing matters; and
internal Audit – reviews and monitors the effectiveness of the Group’s internal audit function and activities, in the context of the Group’s overall risk management system; – approve the appointment or removal of the Group Audit director as head of the internal audit function; – review the internal audit programme and ensure that the internal audit function is adequately resourced and has appropriate access to information; and
– consider the major findings of any significant internal audit escalated to the committee by the Group Audit director and consider managements responses.
Other Matters – undertake similar duties for all subsidiary companies where a legal or regulatory provision requires audit committee involvement except where the subsidiary company’s board has appointed a separate audit committee.
– reviewed, challenged and recommended to the Board the Group annual and interim reports and accounts; – reviewed significant accounting issues, matters and judgements as discussed with the auditors (see table below); – reviewed the Group’s position as a going concern; – reviewed the effectiveness of the external auditor, recommended their re-appointment and determined their remuneration; – attended four half day ‘deep dive’ sessions with each of the divisions; – reviewed litigation and regulatory risks; – received reports from the divisional Financial control committees and the Group Risk committee; – received a report from the Group secretariat on corporate Governance changes relevant to the Audit committee; – reviewed internal controls across the Group, including through participating in ‘deep dive’ meetings on each of the main divisions within the Group and receiving reports from the internal audit department on items such as sOX reporting; – reviewed the Group’s key finance programmes; – considered the appointment of the Group Audit director; – reviewed details of the Group’s whistle blowing procedures and incidents; and
Fair value of financial instruments Reviewed the appropriateness of the judgements made by management in valuing certain portfolios of assets and liabilities and were satisfied that these judgements were appropriate.
Recoverability of deferred tax assets considered the recognition of deferred tax assets and agreed with management’s judgement that the deferred tax assets were appropriately supported by forecast taxable profits.
Other regulatory provisions considered the assumptions made by management to redress provision for several regulatory matters. These matters included litigation in relation to our insurance branch business in Germany and sales of interest rate hedging products to certain small and medium-sized businesses.
– oversees the Board’s governance arrangements; – oversees the Group’s implementation of governance requirements in particular reviewing the Governance Frameworks; – reviews the overall composition of the Board including its size, diversity, independence and structure; – considers Board succession; – oversees the selection process for prospective directors; – makes recommendations to the Board on potential appointments and reappointments of directors at the end of their specified term, including the ongoing review of independence; – review of membership of Board committees; – oversees the annual evaluation of the performance of the Board; and
– reviewed Board composition including the Group’s continued response to the davies Review and diversity targets; – oversaw the search and selection process for new non-Executive directors; – oversaw the Board Evaluation process including formulation of the actions arising from the outcomes of the evaluation; – reviewed the Governance Framework to ensure consistency with organisational changes and emerging developments; – regularly reviewed developments in the regulatory environment around corporate governance; and
– information about the Remuneration committee’s activities during 2012 is given in the directors’ remuneration report on pages 98 to 114.
– four deep dives (in conjunction with the Audit committee) on risk arising from each of the divisions and including the critical iT infrastructure and systems operated by the Group.
central to the Bis proposals is the active engagement of shareholders to approve the remuneration policy applied by the company. We maintain an open and transparent exchange of information and feedback with our shareholders and acknowledge the weight of their judgment in setting our policies. in line with the Bis proposals, we have therefore included dedicated commentary on these interactions and the outcome of the shareholder vote on our reward policy in the body of the Report.
The introduction of a binding shareholder vote on policy will promote consistency by requiring strict adherence to policy for a three-year period from approval, permitting exception only by agreement through a further shareholder vote. Whilst, in certain individual circumstances this may require us to revert directly to shareholders within the three year period, the commitment to an approved policy will promote upfront transparency with shareholders and will ensure rigour is embedded into policy design and adherence, firmly underpinning the responsibility and accountability that we as a committee have to fulfil.
The package delivered to our Executive directors and our Group Executive committee remains broadly consistent with that provided in previous years. The composition of the package is approximately as follows: Long-term incentive
Our executives’ annual incentives are based on stretching performance objectives and targets in the Group Balanced scorecard. This Balanced scorecard is derived from the Medium Term Plan which defines the financial and non-financial targets within our agreed risk appetite over a three year period.
Any annual bonus for Executive directors is deferred into shares and released over time, helping to increase alignment with shareholders. These deferrals are subject to malus in the event of unsustainable performance.
Policy objective How achieved cost effective packages to attract and retain executives
We select incentive plan targets that are directly linked to the business strategy and priorities, ensuring alignment with company performance, targets that are meaningful to executives and incentive packages that are both valued by executives and cost effective.
Moreover, the assessment of performance against target measures is moderated by the Group Risk function to ensure that the performance is sustainable in the long term and does not merely produce a positive short-term result. The committee places great weight on this assessment and holds the Executive directors to a more stringent standard in this regard.
in all executive remuneration discussions the committee considers the approach towards establishing pay levels elsewhere in the Group. When setting remuneration levels for Executive directors, the committee refers to benchmark data from comparable organisations across the FTsE and industry sector to ensure that remuneration is positioned competitively but conservatively against the market.
Annual incentive 200 per cent of salary maximum (225 per cent for the Group chief Executive)
Alignment with Group performance Motivation of executives Pay for performance Alignment with sound risk management long-term incentive plan
Annual incentive plan The annual incentive scheme for Executive directors is designed to reflect specific goals linked to the successful performance of the business.
Chairman’s remuneration The chairman’s remuneration comprises salary and benefits. He does not participate in the annual bonus and long-term incentive arrangements, nor is he entitled to pension benefits. The chairman’s fee was last reviewed in 2012 and is currently £700,000 per annum.
The annual fees were reviewed in 2012 and remain unchanged as listed below.
non-Executive director – base fee £65,000 deputy chairman £100,000 senior independent director £60,000
independent non-Executive directors who serve on the Boards of subsidiary companies may also receive fees from the subsidiaries.
notice to be given by the Company Date of service agreement/letter of appointment sir Winfried Bischoff 6 months 27 July 2009
Helen Weir left the company in March 2012 under a redundancy agreement entered into on 7 April 2011. in addition to the contractual salary payments made during the 12-month notice period, she received a payment of £4,200 in respect of her statutory redundancy entitlement. no further non-contractual payments were made in respect of the cessation of employment, in keeping with our policy for handling terminations.
The overarching purpose of the Remuneration committee is to consider, agree and recommend to the board an overall remuneration policy and philosophy for the Group that is defined by, supports and is closely aligned to its long-term business strategy, business objectives, risk appetite and values and recognises the interests of relevant stakeholders. The Group has a conservative business model characterised by a risk culture founded on prudence and accountability. The remuneration policy and philosophy covers the whole Group, but the committee pays particular attention to the top management population, including the highest paid employees in each division, those colleagues who perform significant influence functions for the Group and those who could have a material impact on the Group’s risk profile. The committee’s role is to ensure that these colleagues are provided with appropriate incentives and reward to encourage them to enhance the performance of the Group and that they are recognised for their individual contribution to the success of the organisation, whilst ensuring that there is no reward for excessive risk taking.
– determination of bonus pools based on Group performance and adjustment for risk
The committee appoints independent consultants to provide advice on specific matters according to their particular expertise. during the year, deloitte llP advised the committee. deloitte has voluntarily signed up to the Remuneration consultants’ code of conduct and are judged by the committee to be independent. deloitte’s fees for 2012 for advising the committee amounted to £336,000.
Lloyds Banking Group Annual Report and Accounts 2012106 deloitte also provided other consulting, tax and advisory services to lloyds Banking Group during the year, but did not provide advice on executive remuneration matters other than for the committee.
António Horta-Osório, cathy Turner (as chief Administrative Officer from 1 June 2012), Angie Risley (Group HR director until 31 August 2012), Rupert Mcneil (Group HR director from 1 september 2012), liz Jackson (HR director, Reward until 31 March 2012) and Paul Hucknall (HR director, Reward from 1 April 2012) provided guidance to the committee (other than for their own remuneration). Juan colombás (chief Risk Officer), Tim Tookey (Group Finance director until 24 February 2012) and George culmer (Group Finance director from 16 May 2012) also attended the committee to advise as and when necessary on risk and financial matters.
Lloyds Banking Group plc FTSE 100 index Rebased to 100 on 31 December 2007. Source: Deloitte
Former Directors who served during 2012 sir Julian Horn-smith (until 17 May 2012) 40 40 100
Other cash benefits include flexible benefits payments (4 per cent of basic salary) and payments to certain directors who elect to take cash rather than a company car under the car scheme.
The award for Mr A Horta-Osório will be delivered in the form of a conditional share award. This will be subject to the normal performance adjustment policy and will only vest if a share price of 73.6p has been reached for a given period of time or the Government has sold at least 33 per cent of its shareholding at prices above 61p. This award will not be released before the fifth anniversary of award and will be forfeited if neither of the conditions has been met by that date. The Board believes that these conditions are in the interests of all shareholders and support our common aim of repaying the taxpayer.
Directors’ pensions (audited) The Executive directors are members of the lloyds Banking Group defined contribution pension scheme. in previous years the Group also operated a defined benefit pension scheme, however there are now no directors accruing further pensionable service on a defined benefit basis.
T J W Tookey1 5 contributions were made for two months only.
b not exercisable as the option has not been held for the period required by the relevant scheme.
c Executive share award granted on 6 August 2012 for the loss of deferred share awards forfeited on leaving RsA insurance Group plc.
The following table contains information on the performance conditions for executive options granted since 2004. The Remuneration committee chose the relevant performance conditions because they were felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
March 2005 – August 2005 That the company’s ranking based on TsR over the relevant period against a comparator group (15 companies including lloyds Banking Group) must be at least eighth, when 30 per cent of the option would be exercisable. if the company was ranked first to fourth position in the group, then 100 per cent of the option would be exercisable and if ranked ninth or below, the performance condition would not be met.
economic profit: The release of the remaining 50 per cent of shares was dependent on the extent to which the Group achieved cumulative Economic Profit targets over the three year period from January 2009 to december 2011.
The performance conditions were met and the awards vested to participants in full. On 14 March 2012 it was determined that the Award would not be transferred or issued to the current and former Executive directors.
economic Profit: Relevant to 36 per cent of the award. Performance to be measured based on the compound annual growth rate of adjusted Economic Profit over the three financial years starting on 1 January 2010 relative to 2009 adjusted Economic Profit base.
Absolute Total Shareholder Return: Relevant to 331/3 per cent of the award. Performance will be measured against the annualised return over the three year period ending 31 december 2013.
non-core assets at the end of 2014: Relevant to 10 per cent of the award. Performance will be measured by reference to balance sheet core assets at 31 december 2014.
Maximum 100% 30% per annum Short-term funding as a percentage of total funding vesting % Target
António Horta-Osório1 1,067,099 1,407,780 1,408,3592 non-executive Directors sir Winfried Bischoff 1,100,000 1,300,000 lord Blackwell – 50,000 c J Fairbairn – –
The changes in beneficial interests for Mr A Horta-Osório and Mr M G culmer relate to 'partnership' and 'matching' shares acquired under the lloyds Banking Group share incentive Plan between 31 december 2012 and 1 March 2013.
OTHER REMunERATiOn disclOsuREs emoluments of the eight highest paid senior executives (unaudited) Emoluments of the eight highest paid senior executives can be found on the Group’s website at www.lloydsbankinggroup.com
The Group’s approach to risk The Group operates a strong and independent Risk division with rigorous management controls to keep the Group safe, support sustainable business growth and minimise losses within risk appetite.
Risk culture The Board ensures that senior management implements risk policies and risk appetites that either limit or, where appropriate, prohibit activities, relationships and situations that could be detrimental to the Group’s risk profile.
– Risk appetite is embedded within policies, authorities and limits across the Group.
– The chief Risk Officer regularly informs the Board Risk committee of the aggregate risk profile and has direct access to the chairman and members of the Board Risk committee.
Principal risks conduct risk and how the Group manages its customer relationships affect all aspects of the Group’s operations and are closely aligned with achievement of the Group’s strategic vision to be the best bank for customers. As a provider of a wide range of financial services products across different brands and numerous distribution channels to an extremely broad and varied customer base, and as a participant in market activities the Group faces significant conduct risks, such as: products or services not meeting the needs of its customers; sales processes which could result in selling products to customers which do not meet their needs; failure to deal with a customer’s complaint effectively where the Group has got it wrong and not met customer expectations; behaviours which do not meet market standards.
There is a risk that certain aspects of the Group’s business may be determined by the FsA, other regulatory bodies or the courts as not being conducted in accordance with applicable laws or regulations, or fair and reasonable treatment in their opinion. The Group may also be liable for damages to third parties harmed by the conduct of its business.
High level market risk exposure is reported regularly to appropriate committees for monitoring and oversight by senior management.
– External fraud: The risk of loss to the Group and/or its customers resulting from an act of deception or omission.
Material operational risks are reported regularly to appropriate committees, attracting senior management visibility, and are managed via a range of strategies – avoidance, mitigation, transfer (including insurance), and acceptance.
The Group has a strategic aim to be the best bank for customers; it is committed to addressing issues within the business that could contribute to customers receiving unfair outcomes. The Group believes the quality, effectiveness and engagement of its people are fundamental to its successful delivery of this strategy. This belief coincides with the increasing external focus on the culture which underpins the performance and behaviour of employees in the development and delivery of fair outcomes to customers.
– limited further deterioration in the uK’s and the Group’s credit rating. in June 2012 the Group experienced a one notch downgrade in its long-term rating from Moody’s, following the agency’s review of 114 European banks. The impact that the Group experienced following the downgrade was not material and was consistent with the modelled outcomes based on the stress testing framework. similarly, the internal stress testing framework indicates that Moody’s one notch downgrade of the uK’s credit rating, announced on 22 February 2013, will not have a material impact on the Group’s liquidity and funding positions; and
The Group takes many mitigating actions with respect to this principal risk, key examples include: – Actuarial assumptions are reviewed in line with experience and in-depth reviews are conducted regularly. longevity assumptions for the Group’s defined benefit pension schemes are reviewed annually together with other iFRs assumptions. Expert judgement is required; and
state Funding and state Aid is not considered as one of the Group’s Risk drivers; however the Group does consider state Funding and state Aid to be a Principal Risk.
HM Treasury currently holds 39.2 per cent of the Group’s ordinary share capital. united Kingdom Financial investments limited (uKFi), as manager of HM Treasury’s shareholding, continues to operate in line with the framework document between uKFi and HM Treasury, managing the investment in the Group on a commercial basis without interference in day-to-day management decisions. There is a risk that a change in Government priorities could result in the framework agreement currently in place being replaced leading to interference in the operations of the Group.
Lloyds Banking Group Annual Report and Accounts 2012124 emerging risks The Group considers the following to be risks that have the potential to increase in significance and affect the performance of the Group. These risks are considered alongside the Group’s five year operating plan.
Capital risk The Group has a strong capital position but remains exposed to the risks of lower than expected profitability, significant losses in a number of stress scenarios or volatility through accounting standards and regulatory changes.
Regulatory change The Parliamentary commission on Banking standards (PcBs) was asked to conduct pre-legislative scrutiny on the draft Banking Reform Bill. The PcBs published its initial report on 21 december 2012. The report contains the commission’s consideration of the Government’s draft legislation which gives effect to the recommendations of the independent commission on Banking. The PcBs looked at ‘Ring fencing’, one of the uK Government’s main proposals for increasing financial stability.
Accounting standards A number of potential changes to accounting standards are under consultation. These standards are currently scheduled for implementation between 2015 and 2018 and have the potential to add substantial volatility to the Group’s reported results and capital.
Board Assisted by Board Risk committee and Audit committee approves the Group’s overall governance, risk and control frameworks and risk appetite. The Board also reviews the Group’s aggregate risk exposures and concentrations of risk to ensure that these are consistent with the Board’s agreed appetite for risk.
Group Executive committee supports the Group chief Executive in ensuring the effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, while also reviewing the Group’s aggregate risk exposures and concentrations of risk.
Responsible for reviewing, challenging and recommending to Group Executive committee the annual stress testing of the Group’s operating plan based on internal and FsA recommended scenarios, annual European Banking Authority stress tests, and other Group wide macroeconomic stress tests.
Responsible for identifying significant current and emerging operational risks or accumulation of risks and control deficiencies across the Group and reviewing associated oversight plans to ensure pre-emptive risk management action. The committee also seeks to ensure that adequate business area engagement occurs to develop, implement and maintain the Group’s operational risk management framework.
How risk is managed in Lloyds Banking Group The Enterprise Risk Management framework is implemented through a ‘Three lines of defence’ model which defines clear responsibilities and accountabilities and ensures effective independent assurance activities take place covering key decisions.
All business areas complete a control effectiveness review annually (see page 130), reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. Executives of each business area and each Group Executive committee member certify the accuracy of their assessment.
This approach provides the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. it also seeks to facilitate effective communication on these matters across the Group.
– support specific business areas to provide an enterprise-wide risk management perspective.
The framework is designed to ensure that policies and controls can be adapted to reflect adjustments to business strategy and risk appetite which are made in response to changing market conditions. By providing a structured approach to identify and assess the impact of emerging risks, agree tolerances and develop mitigating strategies the framework also supports the Group’s aim of maximising shareholder value over time.
Pe op le ri sk li q ui di ty a nd F
Fi na nc ia l R ep or tin g ris k
event identification – incidents occurring internally or externally that could affect achievement of the Group’s objectives are identified, differentiating between risks and opportunities. Group wide risk tools and methodologies are used to help identify risks across the different risk types including external horizon scanning by Risk division.
The overall effectiveness of the risk management framework depends on the people undertaking these activities and the quality of the supporting systems and tools. The risk transformation programme is progressing significant investment in risk infrastructure to strengthen the Group’s risk management capability of which the Group policy framework is a key element.
All Policy Framework documents are actively managed and maintained to ensure that they remain effective and aligned to the Group’s risk appetite and changing business needs. Management of the Policy life cycle includes: – Policy setting – development and formal approval of Policy documents to address the Group’s material risk areas; – Policy embedding – ensuring all colleagues are aware of the Policies which impact them, and the required processes are in place in business units to implement the Policy requirements; – Policy assurance – monitoring and oversight activity to confirm adherence to Policy requirements and ensure any non-compliance is identified and managed; and
– Policy review – review of each Policy at least once a year in light of any changes to the internal or external environment in order to identify any amendments needed to ensure effective management of the risk within the Group’s appetite.
The Group considers these to be principal risks. see pages 118 to 124 for further details.
Credit risk Definition credit risk is defined as the risk that parties with whom the Group has contracted fail to meet their obligations (both on and off balance sheet).
exposures The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions, sovereigns and corporate clients. The credit risk exposures of the Group are set out in note 55 on page 319. credit risk exposures are categorised as ‘retail’, arising primarily in the Retail and Wealth, Asset Finance and international divisions, ‘commercial’ and ‘corporate’, ‘financial institutions’ or ‘sovereigns’ arising in the commercial Banking and Wealth, Asset Finance and international divisions.
credit risk exposures in the insurance business arise primarily from holding investments and from exposure to reinsurers. A significant proportion of the investments are held in unit-linked and with-profits funds where the shareholder risk is limited, subject to any guarantees given.
in non-retail portfolios the Pd models segment counterparties into a number of rating grades, with each grade representing a defined range of default probabilities, and there are a number of different model rating scales. counterparties/exposures migrate between rating grades if the assessment of the Pd changes. The modelled Pds ‘map’ to a (non-retail) master scale which enables the consolidation of credit risk information, and it is this that forms the basis for the iFRs credit quality characterisation.
internal control credit principles and policy: Risk division sets out the credit principles and policy according to which credit risk is managed. Principles and policies are reviewed at least annually, and any changes are subject to a review and approval process. Policies, where appropriate, include lending guidelines, which define the responsibilities of lending officers and provide a disciplined and focused benchmark for credit decisions. These policies and procedures define chosen target market and risk acceptance criteria. These have been and will continue to be fine-tuned as appropriate and include the use of early warning indicators to help anticipate future areas of concern and allow us to take early and proactive mitigating actions. Risk oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes, and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators.
Other credit risk transfers The Group also undertakes asset sales and credit derivative based transactions as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.
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 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.
The above assessment, monitoring and control processes continue throughout the period the case is managed within the Bsu. All the analysis performed around cash flows is used to determine appropriate impairment provisions.
One of the components of the approach to forbearance and early identification of issues used for commercial customers is the Group’s credit Risk classification Policy. This complements the Group’s risk rating tools and is designed to identify and highlight portfolio levels of asset quality as well as individual problem credits. This policy includes the Group’s good book/mainstream early warning watchlist process identifying ‘special Mention’ and ‘sub standard’ cases. This process seeks to ensure that Relationship Managers act promptly to identify, and highlight to senior management, customers that have the possibility to become higher risk in the future. customers classified as special Mention/ sub standard are subject to additional controls and regular monitoring routines, including oversight by Bsu and the independent Risk function.
– As part of its participation in the Funding for lending scheme, the Group will continue to offer interest rate reductions of 1 per cent on all approved business loan, commercial mortgage and hire purchase applications for the whole life of these loans. – The Group will do everything possible to support business customers that are facing financial difficulties through its customer support specialists.
The Group credit risk portfolio in 2012 Overview – The Group’s impairment charge decreased by 42 per cent to £5,697 million in 2012, due to significant reductions in both the core and non-core portfolios and an improving overall credit quality. – The lower charges were supported by the continued application of the Group’s prudent risk appetite and strong risk management controls. The portfolio also benefited from continued low interest rates, and broadly stable uK retail property prices, partly offset by subdued uK and global economic growth, high unemployment and a weak commercial real estate market. – The Group’s core impairment charge of £1,919 million in 2012 was 34 per cent lower compared to 2011, driven by better performance in all divisions. – The Group’s non-core impairment charge of £3,778 million in 2012 was 45 per cent lower compared to 2011. This is primarily driven by lower impairment from the non-core irish and Australasian portfolios as the Group works through legacy issues.
– The Group’s exposures which are higher risk are being successfully managed by the Business and customer support units in commercial Banking and ireland wholesale and collection and Recovery units in Retail.
Loans and advances to customers £m impaired loans £m impaired loans as a % of closing advances impairment provisions1 £m impairment provisions as a % of impaired loans2
Provisions as a percentage of impaired loans are calculated excluding Retail unsecured loans in recoveries (2012: £1,129 million; 2011: £1,137 million).
The Retail division’s loans and advances to customers are analysed in the following table: Table 1.14: Retail loans and advances to customers (audited)
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions1 impairment provisions as a % of impaired loans3 unsecured: impairment provisions (378)
A combination of reduced demand from customers for new unsecured borrowing and existing customers continuing to reduce their personal indebtedness contributed to loans and advances to customers reducing by £2,066 million since 31 december 2011 to £22,698 million at 31 december 2012.
Overview – impairment charges were £2,946 million in 2012, down from £4,210 million in 2011. The decrease in the underlying impairment charge was primarily driven by lower charges in Australasia and in Acquisition Finance. The reduction was partly offset by further deterioration in the shipping portfolio as a result of weak markets.
– core impairment charges as an annualised percentage of average loans and advances to customers reduced to 0.67 per cent compared to 0.95 per cent at 31 december 2011.
commercial Banking’s impaired loans reduced by £9,152 million to £23,965 million compared with 31 december 2011. The reduction is due to write-offs on irrecoverable assets, the sale of previously impaired assets, net repayments and transfers out of Business support unit more than offsetting the flow of newly impaired assets into Business support unit. Furthermore, the flow of assets into impaired status was lower during 2012 compared to 2011.
Lloyds Banking Group Annual Report and Accounts 2012146 non-core impaired loans reduced by £8,345 million to £18,058 million compared with 31 december 2011. The reduction reflects write offs and asset sales of previously impaired assets partly offset by new to impaired loans, especially in corporate Real Estate Business support unit as a result of the Group’s proactive stance to ensure its secondary real estate portfolio is appropriately managed. non-core impairment provisions as a percentage of non-core impaired loans reduced marginally to 39.4 per cent from 39.8 per cent at 31 december 2011. A reduction was also seen in corporate Real Estate Bsu (36.7 per cent compared to 37.0 per cent at 31 december 2011), due to the high level of provision coverage on previously impaired assets which were either sold or written-off during 2012, and a lower impairment rate on newly impaired assets, although this was offset partially by additional charges on previously impaired assets. As a percentage of closing non-core advances, impaired loans increased to 45.3 per cent from 43.9 per cent at 31 december 2011. The increase was driven by corporate Real Estate Bsu, with weak market conditions resulting in existing corporate Real Estate Bsu managed unimpaired connections transferring to impaired status.
Loans and advances to customers £m impaired loans £m impaired loans as a % of closing advances impairment provisions1 £m impairment provisions as a % of impaired loans
Available-for-sale financial assets 3,154 includes collective unimpaired provisions of £545 million (31 december 2011: £637 million).1
Total non-core 32,654 loans and advances to banks 448 debt securities 4,725
Financial Institutions (FIs) – commercial Banking maintains relationships with many major financial institutions throughout the world. These relationships are either client focused or held to support the Group’s funding, liquidity and general hedging requirements. Trading exposures continue to be predominantly short-term and/or collateralised with inter bank activity mainly undertaken with strong investment grade counterparties. The Eurozone crisis continued during 2012 and continues to require very close portfolio scrutiny and oversight. detailed contingency plans are in place and continuously refined, whilst exposures to Fis domiciled in peripheral Eurozone countries in particular have been further reduced and are being managed within tight risk parameters.
Project Finance – Principally focuses on lending to large scale uK infrastructure. The good book accounts for over 95 per cent of the portfolio which is representative of the quasi government cashflow or monopolistic nature of the assets. Good book assets are performing well and have shown resilience to economic cyclicality.
UK Direct Real Estate in Business Support Units – The Group’s Business support unit portfolios consist of £12.7 billion gross (£8.8 billion net of impairment) of uK direct Real Estate loan exposure at 31 december 2012. This incorporates both core and non-core uK direct real estate exposure.
impairment provisions as a percentage of impaired loans increased to 67.5 per cent from 61.7 per cent at 31 december 2011. The increase was driven by the international portfolios.
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions1 impairment provisions as a % of impaired loans international – – –
Australia – impaired loans decreased by £56 million to £39 million compared with £95 million at 31 december 2011 and as a percentage of closing loans and advances decreased to 1.0 per cent from 2.3 per cent at 31 december 2011. The impairment charge has also reduced materially by 53 per cent to £15 million. The Asset Finance business continues to benefit from strong credit management and improving credit quality supported by a resilient Australian economy.
The Group manages its exposures to individual countries through authorised country limits which take into account economic, financial, political and social factors. in addition, the Group manages its direct risks to the selected countries by establishing and monitoring risk limits for individual banks, financial institutions, corporates and individuals.
The Group Financial stability Forum has been established in order to monitor developments within the Eurozone, carry out stress testing through detailed scenario analysis and complete appropriate due diligence on the Group’s exposures.
The Group Financial stability Forum has carried out a number of scenario analyses and rehearsals to test the Group’s resilience in the event of further instability in certain Eurozone countries. The Group has developed and refined pre-determined action plans that would be executed in such scenarios. The plans set out governance requirements and responsibilities for the key actions which would be carried out and cover risk areas such as payments, liquidity and capital, communications, suppliers and systems, legal, credit, delivery channels and products, employees and the impact on customers.
The Group has included certain amounts on a net basis to better reflect the overall risk to which the Group is exposed. The gross iFRs reported values for the exposures to ireland, spain, Portugal, Greece and italy are detailed in the following tables. derivative balances are included within exposures to financial institutions or corporates, as appropriate, at fair value adjusted for master netting agreements at obligor level and net of cash collateral in line with legal agreements. Exposures in respect of reverse repurchase agreements are included on a gross iFRs basis and are disclosed based on the counterparty rather than the collateral (repos and stock lending are excluded); reverse repurchase exposures are not, therefore, reduced as a result of collateral held. Exposures to central clearing counterparties are shown net.
Financial institutions Asset backed securities £m Corporate £m Personal £m insurance assets £m Total £m Banks £m Other £m derivatives with sovereigns and sovereign referenced credit default swaps are insignificant. included within exposures to banks, and treated as available-for-sale assets, are covered bonds of £1.1 billion (2011: £1.7 billion). The covered bonds are ultimately secured on a pool of mortgage assets in the countries concerned and benefit from over-collateralisation, with an overall weighted maturity of approximately four years. Exposures to other financial institutions relate primarily to balances held within insurance companies and funds. no impairments are held against these exposures.
The Group continued to reduce its exposure to these countries and exposures have been proactively managed down in line with its risk appetite. The Group’s total exposure has reduced 24 per cent from £24,614 million to £18,703 million.
Financial institutions – other: Asset backed securities: corporate: Personal: The Group held impairment provisions of £6,597 million (2011: £7,961 million) against corporate amortised cost exposures and £1,111 million (2011: £1,034 million) against personal amortised cost exposures. £34 million (2011: £170 million) was included in reserves in respect of available-for-sale securities included in the table above.
The corporate exposure in spain is mainly local lending (82 per cent of the total spanish exposures) comprising corporate loans and project finance facilities (86 per cent) and commercial real estate portfolio (14 per cent).
Financial institutions – banks: net trading assets 20 – 20 – – –
Asset backed securities: corporate: Personal: insurance assets – – – – – –
The Group held impairment provisions of £21 million (2011: £25 million) against corporate amortised cost exposures. £55 million (2011: £160 million) was included in reserves in respect of available-for-sale securities included in the table above.
The exposures in Greece principally relate to shipping loans to Greek shipping companies where the assets are generally secured and the vessels operate in international waters; repayment is mainly dependent on international trade and the industry is less sensitive to the Greek economy.
in addition to the above balances there are unutilised and uncommitted money market lines and repo facilities of approximately £0.2 billion (2011: £0.6 billion) predominantly in respect of italian banks. Bank limits have been closely monitored with amounts and tenors reduced where appropriate.
Lloyds Banking Group Annual Report and Accounts 2012166 environmental risk management The Group’s policies and procedures ensure it manages the environmental impact of its lending activities. The Group wide credit Risk Principles require all credit risk to be incurred with due regard to environmental legislation and the Group’s code of Business Responsibility.
since 2011, an electronic environmental risk screening system has been the primary mechanism for assessing environmental risk in commercial Banking. This provides real time screening of location specific and sector based risks that may be present in a transaction. Where a risk is identified, the transaction is referred to the Group’s expert in-house Environmental Risk team for further review and assessment, as outlined below. Additional support is provided by the Group’s panel of environmental consultants as required.
Monitoring Business unit risk exposure is reported to Risk division where it is aggregated and reported at Group level. The report forms the basis of challenge to the business at the monthly Group compliance and conduct Risk committee. This committee may escalate matters to the chief Risk Officer, or higher committees. The report also forms the basis of the regulatory sections in the Group’s consolidated risk reporting.
exposures Trading portfolios The Group’s trading activity is small relative to its peers and the Group does not have a programme of proprietary trading activities. The average 95 per cent 1-day trading Value at Risk (VaR) was £7.0 million for the year to 31 december 2012 (2011: £6 million). Most of the Group’s trading activity is undertaken to meet the requirements of wholesale and retail customers for foreign exchange and interest rate products.
Risk also arises from the margin of interbank rates over central bank rates. A further banking risk arises from competitive pressures on product terms in existing loans and deposits, which sometimes restricts the Group in its ability to change interest rates applying to customers in response to changes in interbank and central bank rates.
Measurement Market risk is managed within a Board approved framework and risk appetite. A variety of risk measures are used such as: – sensitivity based measures (e.g. sensitivity to 1 basis point move in interest rates).
The Group recognises these limitations and supplements the use of VaR with a variety of other techniques more suited to the nature of the business activity. These include interest rate repricing gaps, open exchange positions and sensitivity analysis. 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. These measures are reviewed regularly by senior management to inform effective decision making.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled within the trading risk appetite and any residual risk is hedged in the market.
insurance portfolios Market risk exposures from the insurance business are controlled via approved investment policies and triggers set with reference to the Group’s overall risk appetite and regularly reviewed by the Group Market Risk committee: – The With Profit Funds are managed in accordance with the relevant fund’s principles and practices of financial management and legal requirements.
Supplier Management – The risk of reductions in earnings and/or value through financial or reputational loss from services with outsourced partners or third-party suppliers.
in setting operational risk appetite, the Group looks at both impact on solvency and the Group’s reputation. Appetite is defined and monitored relative to a number of key indicators, including the size and numbers of material events, and the amounts of operational risk losses that have arisen.
Operational risk appetites and actual exposures are used by the Group to calculate the appropriate holding of operational risk regulatory capital under the internal capital Adequacy Assessment Process (icAAP). The Group calculates its operational risk capital requirements using the standardised Approach (TsA), which the Basel committee states as being appropriate for an “internationally active” bank.
Mitigation Operational risk is relevant to every aspect of the Group’s business and activities. The Group’s operational risk framework consists of the following key components: – identification and categorisation of the key operational risks facing a business area, including defining risk appetite; – Risk assessment, including impact assessment of financial and non-financial impacts (e.g. reputational risk) for each of the key risks to which the business area is exposed; – control assessment, evaluating the effectiveness of the control framework covering each of the key risks to which the business area is exposed; – loss and incident management, capturing actions to manage any losses facing a business area; – The development of key risk indicators for management reporting, including the monitoring of risk appetite; – Oversight and assurance of the risk management framework in businesses; and
– The Group places considerable emphasis on its responsibilities arising from the FsA’s Approved Persons regime, Remuneration code and other people-focused regulatory requirements; this includes dedicating resources across the Group, and the provision of training, guidance and oversight of senior management’s knowledge and delivery of their accountabilities.
Monitoring People risks from across the Group are reported through the first line of defence. Key people risks are then escalated to the relevant operational or regulatory oversight committees. Key people risks are assessed in the context of the Group’s wider risk profile, and tracked to remediation.
Definition liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost. Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.
Risk appetite liquidity and funding risk appetite for the banking businesses is set by the Board and this statement of the Group’s overall appetite for liquidity risk is reviewed and approved annually by the Board. With the support of the Group Asset and liability committee (GAlcO), the Group chief Executive allocates this risk appetite across the Group. Risk is reported against appetite through various metrics that enable the Group to manage liquidity and funding constraints. The Group chief Executive, assisted by GAlcO regularly reviews performance against risk appetite.
Marketable asset Haircut widening and repos assumed not to roll on contractual maturity.
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.
liquidity stress tests are applied to the Group’s funding plan to project possible future stressed positions. The funding plan is also stressed against a range of macroeconomic scenarios, including those prescribed by the FsA under the Pillar ii ‘anchor’ scenario. The Group applies its own macroeconomic stress scenarios, covering a stagnation and a recession.
– secondly, the Group has a contingency funding plan embedded within the Group liquidity Policy which has been designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing. contingency funding plan invocation and escalation processes are based on analysis of five major quantitative and qualitative components, comprising assessment of: early warning indicators, prudential and regulatory liquidity risk limits and triggers, stress testing results, event and systemic indicators and market intelligence.
despite difficult funding markets during much of 2012 as investor confidence was impacted by concerns over Eurozone sovereign debt levels, downgrades and possible defaults and the potential downside effects from financial market volatility, the Group continued to fund adequately, maintaining a broadly stable stock of primary liquid assets during the year and meeting its regulatory liquidity requirements at all times.
Group funding sources Total wholesale funding reduced by £81.6 billion to £169.6 billion, with the volume with a residual maturity less than one year falling £62.7 billion to £50.6 billion. The Group term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total wholesale funding) improved to 70 per cent (55 per cent at 31 december 2011) due to good progress in new term issuance and a significant reduction in short term money market funding (2012: £31 billion; 2011: £69.1 billion). Term wholesale issuance for the year totalled £20.1 billion.
Total wholesale funding by type and expected residual maturity is detailed below.
Table 1.48: Analysis of 2012 total wholesale funding by residual maturity (audited)
A reconciliation to the Group’s balance sheet is provided on page 182.
cash balances and balances at central banks – primary are combined in the Group’s balance sheet.
Table 1.52: Reconciliation of Group funding figure to the balance sheet (audited)
during 2012, the GAlcO mandated Group corporate Treasury to establish a new core liquidity and collateral asset portfolio. The portfolio is subject to defined risk appetite with tight controls over eligible assets, which must also be diversified across geography, currency, markets and tenor.
The Group’s stress testing assumes that further credit rating downgrades may reduce investor appetite for some of the Group’s liability classes and therefore funding capacity. in June 2012 the Group experienced a one notch downgrade in its long-term rating from Moody’s, following the agency’s review of 114 European banks. The impact that the Group experienced following the downgrade was not material and was consistent with the modelled outcomes based on the stress testing framework. A hypothetical idiosyncratic two notch downgrade of the Group’s current long-term debt rating and accompanying short-term downgrade, implemented instantaneously by all major rating agencies could result in an outflow of £11.5 billion of cash over a period of up to one year, £3.5 billion of collateral posting related to customer financial contracts and £18.0 billion of collateral posting associated with secured funding. The Group’s internal liquidity risk appetite includes such a stress scenario. The stress scenario modelling demonstrates the Group has available liquidity resources to manage such an event.
in addition the Group retained internally £26.3 billion (2011: £31.9 billion) of notes secured with £37.6 billion (2011: £42.4 billion) of assets. For details on the Group’s covered bond programme refer to note 21 on page 252.
The rating changes that the Group has experienced since the fourth quarter of 2011 did not significantly change its borrowing costs, reduce its issuance capacity or require significant collateral posting. in november 2012 standard & Poor’s revised its outlook on the Group’s long-term rating to negative from stable. However, even if a two notch long-term downgrade and a simultaneous short-term downgrade occurred, the Group would remain investment grade.
Hybrid capital securities coupon payments The discretionary payments on Tier 1 hybrid capital securities which are expected to be paid in 2013, subject to their terms and conditions, are estimated to amount to approximately £350 million. in the context of on-going macro prudential policy discussions, the Board of lloyds Banking Group has decided to issue new lloyds Banking Group ordinary shares to raise this amount. The Group has entered into an agreement with a third-party financial institution in connection with the issue of these new ordinary shares. such ordinary shares are expected to be issued, subject to market conditions, by the end of April 2013 at a price determined by reference to the volume weighted average price of our ordinary shares in a period prior to their date of issue.
Measurement insurance risks are measured using a variety of techniques including stress and scenario testing, and where appropriate, stochastic modelling. current and potential future insurance risk exposures are assessed and aggregated using risk measures based on 1-in-200 year stresses (Group defined benefit pension schemes utilise 1-in-20 year stresses) and other supporting measures where appropriate, including those set out in notes 37 and 38 to the financial statements.
insurance risk is mitigated through pooling and through diversification across large numbers of individuals, geographical areas, and different types of risk exposure. A number of processes are used to control insurance risk including: underwriting (the process to ensure that new insurance proposals are properly assessed); Pricing-to-risk (new insurance proposals are priced to cover the underlying risks inherent within the products); claims management; Product design and management; Policy wording; Reinsurance and cost controls and efficiencies.
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. At all times, close attention is paid to the adequacy of reserves, solvency management and regulatory requirements.
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.
There are a number of regulatory issues and challenges across the broader regulatory environment such as changes in the investment advice regulations when the Retail distribution Review (RdR) came into force on 1 January 2013; ongoing focus on changes in the anti-bribery and sanctions controls; and being dual regulated by two new regulators (the Prudential Regulation Authority and Financial conduct Authority). This is expected to happen from April 2013. At a European and us level, significant regulatory initiatives and new directives or changes to existing directives will impact the Group in the next 12 to 24 months. This includes the enactment of the dodd-Frank Act, a revised Markets in Financial instruments directive and development of the single supervisory Mechanism.
– Material risks and issues are escalated to Group-level bodies which challenge the business on its management of risks and issues.
– The Group takes very seriously its responsibilities for complying with legal and regulatory sanctions requirements in all the jurisdictions in which it operates. in order to assist adherence to relevant economic sanctions legislation, the Group has enhanced its internal compliance processes including those associated with customer and payment screening. The Group has continued the delivery of a programme of staff training regarding policies and procedures for detecting and preventing economic sanctions non-compliance.
Risk Appetite capital risk appetite is set by the Board, reflecting the Group’s strategic plans, regulatory capital constraints and market expectations, and includes a number of minimum capital ratios and target buffers. The Board and the Group chief Executive, assisted by the Group Asset and liability committee, regularly review performance against the 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 regulatory minimum amounts of capital, under Pillar i of the Basel framework, are determined as percentages of the aggregate risk-weighted assets calculated for credit risk, operational risk and market risk (Trading Book), which are predominately 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 FsA.
The FsA requires icG and cPB to remain confidential matters between a bank and the FsA.
Mitigation The Group has developed procedures to ensure that it complies with current requirements, is positioned to meet anticipated future requirements and that policies and risk appetite are aligned to them.
The Group has in issue, as part of tier 2 capital resources, Enhanced capital notes which will convert to core tier 1 capital in the event that the Group’s published core tier 1 ratio (as defined by the FsA in May 2009) falls below 5 per cent.
Additional measures to manage the Group’s capital position include seeking to strike an appropriate balance of capital held within its insurance and banking subsidiaries and through improving the quality of its capital through liability management exercises.
The regulatory framework within which the Group operates continues to be enhanced as part of the global banking reforms. The Group monitors these developments very closely, participates actively in the regulatory consultation processes and analyses the potential financial impacts, ensuring that the Group continues to have a strong loss absorption capacity exceeding regulatory requirements.
Over the course of 2012 some of the key developments were: – in October, the uK Government published the draft Financial services (Banking Reform) Bill which will give effect to the recommendations of the independent commission on Banking covering banking structural reforms (‘ring-fencing’ of retail banking activities), bail-in of senior debt and depositor preference. in december, the Parliamentary commission on Banking standards published its first report commenting upon the draft Bill.
Capital management in 2012 The Group actively manages its capital position, closely monitoring the changing market and regulatory environments. The Group further strengthened its capital ratios in 2012. This was principally driven by management profit and a reduction in risk-weighted assets, reflecting asset reductions and the substantial decrease in risk, partly offset by statutory items and tax costs. The core business remains strongly capital generative and there is continued progress in simultaneously reducing risk and creating capital through the disposal of non-core assets.
undated subordinated debt 1,828 1,859 dated subordinated debt 19,886 21,229 unrealised gains on available-for-sale equity investments 56 386
Less: deductions from tier 2 50% excess of expected losses over impairment provisions (unaudited) (636) (720)
Lloyds Banking Group Annual Report and Accounts 2012190 core tier 1 capital core tier 1 capital has reduced by £798 million during 2012 primarily due to the attributable loss for the period and the deduction of the increase to the pension scheme asset balances, which have been partially offset by a decrease in the deductions of intangibles, the adjustment for own credit, the excess of expected losses over impairment provisions and share issuance.
Risk-weighted assets within Wealth, Asset Finance and international have reduced by £7,426 million as a result of the run down of non-core asset portfolios and foreign exchange movements.
Pro forma CRD iv capital and leverage information cRd iV capital and leverage estimates will be incorporated in the Group’s Pillar iii report in detailed templates. The data in the following tables represent a summary of the information that will be published as part of the Group’s Pillar iii report. These estimates reflect the Group’s current interpretation of the draft rules. The actual impact of cRd iV on capital ratios may be materially different as the requirements and related technical standards have not yet been finalised. The actual impact will also be dependent on required regulatory approvals and the extent to which further management action is taken prior to implementation.
capital position on cRd iV basis The Group’s capital position at 31 december 2012 calculated on current regulatory rules and also estimated on a pro forma basis, applying the cRd iV rules and assuming existing FsA waivers still apply, is shown in the table below.
The pro forma cRd iV capital resources shown reflect estimates of the impact of the rules laid out in the draft of cRd iV published by the European commission in July 2011 (July 2011 draft) on both a transitional basis as if 2012 had been the first year of transition and on a fully loaded basis (referred to as cRd iV ‘end-point definition’ in FsA documentation). The transitional position shown is consistent with FsA’s statement ‘cRd iV transitional provisions on capital resources’ published on 26 October 2012 on the FsA website.
The key impacts on capital resources of the transitional rules are that: – The deductions for goodwill and other intangible assets and excess of expected losses over impairment provisions that are made from core tier 1 under the current rules are made from additional tier 1; – A part of the deduction that would otherwise be made for significant investments is risk-weighted instead. The residual deduction is made 50 per cent from tier 1 and 50 per cent from tier 2 rather than from total capital; – The deduction made for securitisations is made fully from cET1 rather than 50 per cent from core tier 1 and 50 per cent from tier 2 capital as under the current rules; – A proportion of the deferred tax asset is deducted from cET1; – A proportion of the additional tier 1 and tier 2 instruments become ineligible under the grandfathering rules; – Eligible provisions are nil as collectively assessed impairment provisions for the standardised portfolios can no longer be included under tier 2 capital (instead a corresponding reduction is made to standardised risk-weighted assets); and
The impact of the fully loaded rules on capital resources is that: – non-controlling interests are no longer eligible for inclusion; – The amount of unrealised reserves on available for sale assets are included in full rather than being deducted; – Excess of expected losses over impairment provisions and the deduction made for securitisations are deducted fully from cET1 instead of 50 per cent from core tier 1 and 50 per cent from tier 2 under the current rules; – The amount of significant investments that is not risk-weighted is fully deducted following a corresponding deduction approach; – deferred tax assets are deducted from cET1; – Existing additional tier 1 and a proportion of tier 2 instruments become ineligible and are excluded. The Group would expect to accumulate additional tier 1 and tier 2 capital as required through the issuance of subordinated liabilities, taking account of the potential capital eligibility requirements under cRd iV. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time; – Eligible provisions are nil as collectively assessed impairment provisions for the standardised portfolios can no longer be included under tier 2 capital (instead a corresponding reduction is made to standardised risk-weighted assets); and
The Group’s approach to risk 116 Principal risks and uncertainties 118 State Funding and State Aid 124 Emerging risks 125 Risk governance 126 Full analysis of risk drivers 131
Life insurance businesses The business transacted by the life insurance companies within the Group comprises unit-linked business, non-profit business and with-profits business. several companies transact either unit-linked and/or non-profit business, but scottish Widows plc (scottish Widows) and clerical Medical investment Group limited (clerical Medical) hold the only large With-Profit Funds managed by the Group.
Regulatory capital requirements Each life insurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FsA; the basis of calculating the regulatory capital requirement is given below. Except for scottish Widows and clerical Medical, the regulatory capital requirement is a combination of amounts held in respect of actuarial reserves, sums at risk and maintenance expenses (the long-Term insurance capital Requirement) and amounts required to cover various stress tests (the Resilience capital Requirement). The regulatory capital requirement is deducted from the available capital resources to give statutory excess capital.
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 FsA.
shareholders’ funds: Held outside the long-term funds – – 6 1,791 562 2,359
Formal intra-group capital arrangements scottish Widows has a formal arrangement with one of its subsidiary undertakings, scottish Widows unit Funds limited, whereby the subsidiary company can draw down capital from scottish Widows to finance new business which is reinsured from the parent to its subsidiary. scottish Widows has also provided subordinated loans to its fellow group undertaking scottish Widows Bank plc. no such arrangement exists for clerical Medical.
Requirement to maintain a Support Account: The scheme requires the maintenance of a support Account within the non-Participating Fund. The quantum of the support Account is calculated with reference to the value of assets backing current with-profits policies which also existed at the date of demutualisation. under the scheme assets can only be transferred from the non-Participating Fund if the value of the remaining assets in the fund exceeds the value of the support Account. scottish Widows has obtained from the FsA permission to include the value of the support Account or, if greater, the excess of realistic liabilities for business written before demutualisation over the relevant assets (subject to the non-Participating Fund being able to cover this amount by its surplus admissible assets) in assessing the realistic value of assets available to the With-Profit Fund. At 31 december 2012 the estimated value of surplus admissible assets in the non-Participating Fund was £1,430 million (2011: £1,198 million) and the estimated value of the support Account was £nil (2011: £nil). However, at 31 december 2012, the excess of realistic liabilities of with-profits business written before demutualisation over the relevant assets was £62 million (2011: £67 million) which, in accordance with the FsA’s permission, has been used to assess the estimated value of realistic assets available to the With-Profit Fund (and has therefore reduced the value of the non-Participating Fund’s surplus admissible assets by that amount).
Movements in regulatory capital The movements in the Group’s available capital resources in the life business can be analysed as follows: Table 1.63: Movements in available capital resources (unaudited)
Total Life Business £m changes in estimations and in demographic assumptions used to measure life assurance liabilities (11) 4 81 – (6) 68 change in support arrangements 6 – (6) – – –
With-Profit Funds Available capital in the scottish Widows With-Profit Fund has increased from £85 million at 31 december 2011 to an estimated £90 million at 31 december 2012. Available capital in the clerical Medical With-Profit Fund is estimated to be zero at 31 december 2012 (no change from 31 december 2011). This is because the fund is in the process of distributing the free estate and all surplus will ultimately be distributed to policyholders.
Other life insurance business – – 12,559 55 12,614 insurance and participating investment contract liabilities 13,651 9,300 47,223 7,856 78,030 non-participating investment contract liabilities – – 45,469 4,167 49,636
Capital sensitivities 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.
With-Profit Funds The with-profits realistic liabilities and the available capital for the With-Profit Funds are sensitive to both market conditions and changes to a number of non-economic assumptions that affect the valuation of the liabilities of the fund. The available capital resources (and capital requirements) are sensitive to the level of the stock market, with the position worsening at low stock market levels as a result of the guarantees to policyholders increasing in value. However, the exposure to guaranteed annuity options increases under rising stock market levels. An increase in the level of equity volatility implied by the market cost of equity put options also increases the market consistent value of the options given to policyholders and worsens the capital position. Various hedging strategies are used to manage these exposures.
Options and guarantees within the With-Profit Funds The most significant options and guarantees provided from within the With-Profit Funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
The most significant economic assumptions included in the model are: – Risk-free yield. The risk-free yield is defined as spot yields derived from the government bond yield curve.
– investment volatility. The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, at 31 december 2012, the 10 year equity-implied atthe -money assumption was set at 26.3 per cent (2011: 27.2 per cent). The assumption for property volatility was 15 per cent (2011: 15 per cent). The volatility of interest rates has been calibrated to the implied volatility of swaptions which was broadly 18 per cent (2011: 19 per cent).
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, compliance with tax legislation in the jurisdictions in which the Group operates.
exposure Exposure represents the sufficiency of the Group’s policies and procedures to maintain adequate systems, processes and controls to support statutory, prudential regulatory and tax reporting, to prevent and detect financial reporting fraud, to manage the Group’s tax position and to support market disclosures.
The Group has a disclosure committee which assists the Group chief Executive and Group Finance director in fulfilling their disclosure responsibilities under relevant listing requirements. in addition, the Audit committee reviews the quality and acceptability of the Group’s financial disclosures. For further information on the Audit committee’s responsibilities relating to financial reporting see page 94.
Measurement The Group’s governance arrangements are assessed against new or proposed legislation and regulation in order to identify any areas of enhancement required.
Opinion on financial statements in our opinion the group financial statements: – give a true and fair view of the state of the Group’s affairs at 31 december 2012 and of its loss and cash flows for the year then ended; – have been properly prepared in accordance with iFRss as adopted by the European union; and
Profit attributable to non-controlling interests 84 73 62 loss attributable to equity shareholders (1,427) (2,787) (320)
Basic earnings per share 16 (2.0)p (4.1)p (0.5)p diluted earnings per share 16 (2.0)p (4.1)p (0.5)p
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income 116 916 (1,048)
Lloyds Banking Group Annual Report and Accounts 2012208 equity and liabilities note £ million £ million
Liabilities deposits from banks 33 38,405 39,810 items in course of transmission to banks 996 844
Trading and other financial liabilities at fair value through profit or loss 35 35,972 24,955 derivative financial instruments 18 48,665 58,212 notes in circulation 1,198 1,145 debt securities in issue 36 117,369 185,059 liabilities arising from insurance contracts and participating investment contracts 37 82,953 78,991 liabilities arising from non-participating investment contracts 39 54,372 49,636 unallocated surplus within insurance businesses 40 267 300
Value of employee services: share option schemes – – 125 125 – 125
Cash flows from financing activities dividends paid to non-controlling interests (56) (50) (47)
change in non-controlling interests 23 8 2 net cash (used in) provided by financing activities (3,104) (3,242) 566
Annual Report and Accounts 2012214 nOTEs TO THE cOnsOlidATEd FinAnciAl sTATEMEnTs note 1: Basis of preparation The consolidated financial statements of lloyds Banking Group plc have been prepared in accordance with international Financial Reporting standards (iFRs) as adopted by the European union (Eu). iFRs comprises accounting standards prefixed iFRs issued by the international Accounting standards Board (iAsB) and those prefixed iAs issued by the iAsB’s predecessor body as well as interpretations issued by the international Financial Reporting interpretations committee (iFRic) and its predecessor body. The Eu endorsed version of iAs 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is no difference in application to the Group between iFRs as adopted by the Eu and iFRs as issued by the iAsB.
The Group has adopted the following amendments to standards which became effective for financial years beginning on or after 1 January 2012. neither of these amendments has had a material impact on these financial statements.
special purpose entities (sPEs) are consolidated if, in substance, the Group controls the entity. A key indicator of such control, amongst others, is where the Group is exposed to the risks and benefits of the sPE.
(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
Brands (which have been assessed as having finite lives) 10-15 years customer-related intangibles up to 10 years core deposit intangible up to 8 years
Purchased credit card relationships 5 years intangible assets with finite useful lives are reviewed at each reporting date to assess whether there is any indication that they are impaired. if any such indication exists the recoverable amount of the asset is determined and in the event that the asset’s carrying amount is greater than its recoverable amount, it is written down immediately. certain brands have been determined to have an indefinite useful life and are not amortised. such intangible assets are reassessed annually to reconfirm that an indefinite useful life remains appropriate. in the event that an indefinite life is inappropriate a finite life is determined and an impairment review is performed on the asset.
(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. Purchases and sales of securities and other financial assets and trading liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.
Lloyds Banking Group Annual Report and Accounts 2012216 note 2: Accounting policies (continued)
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 financial asset from the available-for-sale category to the held-to-maturity category is permitted when the Group has the ability and intent to hold that financial asset to maturity.
Lloyds Banking Group Annual Report and Accounts 2012218 note 2: Accounting policies (continued)
impairment allowances are assessed individually for financial assets that are individually significant. such individual assessment is used primarily for the Group’s wholesale lending portfolios in the commercial Banking and Wealth, Asset Finance and international divisions. impairment allowances for portfolios of smaller balance homogenous loans such as most residential mortgages, personal loans and credit card balances in the Group’s retail portfolios in both the Retail and Wealth, Asset Finance and international divisions that are below the individual assessment thresholds, and for loan losses that have been incurred but not separately identified at the balance sheet date, are determined on a collective basis.
individual assessment in respect of individually significant financial assets in the Group’s wholesale lending portfolios, assets are reviewed on a regular basis and those showing potential or actual vulnerability are placed on a watch list where greater monitoring is undertaken and any adverse or potentially adverse impact on ability to repay is used in assessing whether an asset should be transferred to a dedicated Business support unit. specific examples of trigger events that would lead to the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of additional impairment allowances) include (i) trading losses, loss of business or major customer of a borrower; (ii) material breaches of the terms and conditions of a loan facility, including non-payment of interest or principal, or a fall in the value of security such that it is no longer considered adequate; (iii) disappearance of an active market because of financial difficulties; or (iv) restructuring a facility with preferential terms to aid recovery of the lending (such as a debt for equity swap).
For impaired debt instruments which are held at amortised cost, 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.
collective assessment impairment is assessed on a collective basis for (1) homogenous groups of loans that are not considered individually impaired; and (2) to cover losses which have been incurred but have not yet been identified on loans subject to individual impairment.
Lloyds Banking Group Annual Report and Accounts 2012222 note 2: Accounting policies (continued)
The Group’s balance sheet includes the net surplus or deficit, being the difference between the fair value of scheme assets and the discounted value of scheme liabilities at the balance sheet date adjusted for any cumulative unrecognised actuarial gains or losses. surpluses are only recognised to the extent that they are recoverable through reduced contributions in the future or through refunds from the schemes.
Products sold by the life insurance business are classified into three categories: – insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance risk as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. These contracts may or may not include discretionary participation features.
Premiums and claims Premiums received in respect of insurance and participating investment contracts are recognised as revenue when due except for unit-linked contracts on which premiums are recognised as revenue when received. claims are recorded as an expense on the earlier of the maturity date or the date on which the claim is notified.
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 Financial services 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 195. changes in the value of these liabilities are recognised in the income statement through insurance claims.
changes in the value of these liabilities are recognised in the income statement through insurance claims.
– Insurance and participating investment contracts which are unit-linked liabilities for unit-linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. changes in the value of the liability are recognised in the income statement through insurance claims. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the non-participating investment contract liability.
(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.
(1) Share issue costs incremental costs directly attributable to the issue of new shares or options or to the acquisition of a business are shown in equity as a deduction, net of tax, from the proceeds.
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.
in addition, a collective unimpaired provision is made for loan losses that have been incurred but have not been separately identified at the balance sheet date. This provision is sensitive to changes in the time between the loss event and the date the impairment is specifically identified. This period is known as the loss emergence period. in the commercial Banking division, an increase of one month in the loss emergence period in respect of the loan portfolio assessed for collective unimpaired provisions would result in an increase in the collective unimpaired provision of approximately £130 million (at 31 december 2011, a one month increase in the loss emergence period would have increased the collective unimpaired provision by an estimated £181 million).
Lloyds Banking Group Annual Report and Accounts 2012226 note 3: Critical accounting estimates and judgements (continued)
Recoverability of deferred tax assets At 31 december 2012 the Group carried deferred tax assets on its balance sheet of £4,285 million (2011: £4,496 million) and deferred tax liabilities of £327 million (2011: £314 million) (note 43). This presentation takes into account the ability of the Group to net deferred tax assets and liabilities only where there is a legally enforceable right of offset. note 43 presents the Group’s deferred tax assets and liabilities by type. The largest category of deferred tax asset relates to tax losses carried forward.
The recoverability of the Group’s deferred tax assets in respect of carry forward losses is based on an assessment of future levels of taxable profit expected to arise that can be offset against these losses. The Group’s expectations as to the level of future taxable profits take into account the Group’s long-term financial and strategic plans, and anticipated future tax adjusting items.
As disclosed in note 43; deferred tax assets totalling £1,311 million (2011: £1,288 million) have not been recognised in respect of certain capital losses carried forward, trading losses carried forward and unrelieved foreign tax credits as there are no predicted future capital or taxable profits against which these losses can be recognised.
Retirement benefit obligations The net asset recognised in the balance sheet at 31 december 2012 in respect of the Group’s retirement benefit obligations was £1,567 million (comprising an asset of £1,867 million and a liability of £300 million) (2011: a net asset of £957 million) of which an asset of £1,748 million (2011: £1,131 million) related to defined benefit pension schemes. As explained in note 2(l), the Group adopts the corridor approach to the recognition of actuarial gains and losses in respect of its pension schemes and as a consequence has not recognised actuarial losses of £2,705 million (2011: £539 million). After allowing for this, the defined benefit pension schemes’ net accounting deficit totalled £957 million (2011: surplus of £592 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
Payment protection insurance and other regulatory provisions At 31 december 2012, the Group carried provisions of £3,366 million (2011: £2,499 million) against the cost of making redress payments to customers and the related administration costs in connection with historic regulatory breaches, principally the misselling of payment protection insurance. determining the amount of the provisions, which represent management’s best estimate of the cost of settling these issues, requires the exercise of significant judgement. it will often be necessary to form a view on matters which are inherently uncertain, such as the number of future complaints, the extent to which they will be upheld and the average cost of redress. consequently the continued appropriateness of the underlying assumptions is reviewed on a regular basis against actual experience and other relevant evidence and adjustments made to the provisions where appropriate.
in addition, asset sales now include sales of centrally held government bonds, following an increase in activity in the first half of 2012.
comparative figures have been restated accordingly for all of the above changes.
Total underlying income, net of insurance claims 9,157 5,998 3,233 2,277 381 21,046
Other segment items reflected in income statement above: increase (decrease) in value of in-force business – – 3 (625) – (622)
Lloyds Banking Group Annual Report and Accounts 2012232 note 4: Segmental analysis (continued)
Removal of: Acquisition related and other items1 £m volatility arising in insurance businesses £m insurance gross up £m
Lloyds Banking Group Annual Report and Accounts 2012234 note 5: net interest income
Total interest and similar income 3.32 3.58 3.95 23,535 26,316 29,340 interest and similar expense: deposits from banks, excluding liabilities under sale and repurchase transactions 1.14 0.80 0.78 (324) (222) (319)
liabilities under sale and repurchase agreements 1.47 1.39 1.18 (245) (335) (744)
Fee and commission income: credit and debit card fees 941 877 812
Total net income arising on assets held at fair value through profit or loss 13,715 376 12,625 net expense arising on liabilities held at fair value through profit or loss – debt securities in issue (576) (230) (231)
Movement in value of in-force business (note 29) 269 (622) 789 liability management (see below) (338) 599 423 share of results of joint ventures and associates (note 13) 28 31 (88)
during 2010, lloyds Banking Group plc issued ordinary shares in exchange for certain existing securities, resulting in total gains of £403 million. Also during 2010 the Group entered into a bilateral exchange in respect of certain Enhanced capital notes on which a profit of £20 million arose.
change in assets arising from reinsurance contracts held (186) 451 256 change in non-participating investment contracts: change in gross liabilities (5,058) 520 (5,449)
Lloyds Banking Group Annual Report and Accounts 2012240 note 11: Operating expenses £m £m £m staff costs: Performance-based compensation 395 361 533 social security costs 383 432 396
Financial services compensation scheme levy (note 53) 175 179 46 depreciation and amortisation: depreciation of tangible fixed assets (note 31) 1,431 1,434 1,635
Following a review of policy in respect of discretionary pension increases in relation to the Group’s defined benefit pension schemes, increases in certain schemes are now linked to the consumer Price index rather than the Retail Price index. The impact of this change is a reduction in the Group’s defined benefit obligation of £258 million, recognised in the Group’s income statement in 2012, net of a charge of £8 million resulting from a change to the commutation factors in one of the Group’s smaller schemes.
in addition, regulatory provisions of £50 million (2011: £nil; 2010: £nil) have been charged against income.
Fees payable for other services: Audit of the company’s subsidiaries pursuant to legislation 15.7 16.9 17.9
Other non-audit fees: services relating to corporate finance transactions 0.5 6.3 1.9
Lloyds Banking Group Annual Report and Accounts 2012242 note 11: Operating expenses (continued)
Services relating to taxation: This category includes tax compliance and tax advisory services. Other non-audit fees: This category includes due diligence relating to corporate finance, including venture capital transactions and other assurance and advisory services.
in the second half of 2010, the Group reached agreement to dispose of its interests in the two wholly-owned subsidiary companies through which this business operates; the sale was completed in January 2011. These companies, which had gross assets of £860 million, were sold to seadrill limited; a loss of £365 million arose on disposal.
Adjustments in respect of prior years (8) 36 49 current tax (charge) credit (211) (293) 132 deferred tax (note 43): Origination and reversal of temporary differences (339) 1,621 (393)
Factors affecting credit (charge): uK corporation tax rate change (308) (404) (137)
changes to the taxation of pension business: Policyholder tax cost (182) – –
Weighted average number of ordinary shares in issue – basic 69,841 68,470 67,117
Weighted average number of ordinary shares in issue – diluted 69,841 68,470 67,117
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 13 million (2011: 10 million; 2010: 8 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
Asset-backed securities: corporate and other debt securities 1,172 23,686 24,858 1,576 20,282 21,858
(iii) private equity investments of £2,110 million (2011: £1,850 million) that are managed, and evaluated, on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis.
For amounts included above which are subject to repurchase agreements see note 55.
Lloyds Banking Group Annual Report and Accounts 2012246 note 18: Derivative financial instruments The Group holds derivatives as part of the following strategies: – customer driven, where derivatives are held as part of the provision of risk management products to Group customers; – To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by the Group is to utilise a combination of fair value and cash flow hedge approaches as described in note 55; and
– credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise, in combination with external funding, £2,829 million (2011: £3,436 million) of corporate and commercial banking loans.
Hedging derivatives designated as fair value hedges: interest rate swaps 135,516 6,018 1,772
derivatives designated as cash flow hedges: interest rate swaps 86,190 4,653 4,438
Hedging derivatives designated as fair value hedges: Options written 657 – 9 derivatives designated as cash flow hedges: interest rate swaps 152,314 5,250 5,608
derivatives designated as net investment hedges: cross currency swaps 49 – 1
Total loans and advances to banks 29,417 32,606 included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £662 million (2011: £508 million). collateral is held with a fair value of £662 million (2011: £511 million), all of which the Group is able to repledge.
Total loans and advances to customers 517,225 565,638 included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £5,087 million (2011: £16,835 million). collateral is held with a fair value of £4,916 million (2011: £16,936 million), all of which the Group is able to repledge. included within this are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £2 million (2011: £34 million).
commitments for expenditure in respect of equipment to be leased (18) (30)
Lloyds Banking Group Annual Report and Accounts 2012252 note 20: Loans and advances to customers (continued)
Total unguaranteed residual values 189 213 note 21: Securitisations and covered bonds
Loans and advances securitised £m notes in issue £m loans and advances securitised £m notes in issue £m
Other asset-backed securities 1,150 5,030 corporate and other debt securities 402 537
Lloyds Banking Group Annual Report and Accounts 2012254 note 24: Allowance for impairment losses on loans and receivables
Of the total allowance in respect of loans and advances to customers, £13,936 million (2011: £17,021 million) related to lending that had been determined to be impaired (either individually or on a collective basis) at the reporting date.
Bank and building society certificates of deposit – 188 188 – 366 366
Asset-backed securities: corporate and other debt securities – 1,848 1,848 73 5,172 5,245
Total additions 928 1,399 changes in fair value (note 7) (264) (107)
The recoverable amount of scottish Widows has been based on a value-in-use calculation. The calculation uses post-tax projections of future cash flows based upon budgets and plans approved by management covering a five-year period, and a discount rate of 12 per cent (net of tax). The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. cash flows beyond the five-year period have been extrapolated using a steady 3 per cent growth rate which does not exceed the long-term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of scottish Widows to fall below its balance sheet carrying value.
The recoverable amount of Asset Finance has also been based on a value-in-use calculation using pre-tax cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 14 per cent (gross of tax). The cash flows beyond the five-year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long-term average growth rates for the markets in which Asset Finance participates. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Asset Finance to fall below the balance sheet carrying value.
The movement in the acquired value of in-force non-participating investment contracts over the year is as follows: 2012 £m 2011 £m
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: economic assumptions Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. in practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate.
A market-consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. The risk-free rate used for the value of financial options and guarantees is defined as the spot yield derived from the relevant government bond yield curve. Further information on options and guarantees can be found on page 199.
The table below shows the resulting range of yields and other key assumptions at 31 december for uK business: Risk-free rate (value of in-force non-annuity business) 2.32 2.48
Risk-free rate (financial options and guarantees) 0.22 to 3.56 0.22 to 3.36
non-economic assumptions Future mortality, morbidity, expenses, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and on management’s view of future experience.
Lapse (persistency) and paid-up rates lapse and paid up rates assumptions are reviewed each year. The most recent experience is considered along with the results of previous analyses and management’s views on future experience. in determining this best estimate view, a number of factors are considered, including the credibility of the results (which will be affected by the volume of data available), any exceptional events that have occurred during the period under consideration and any known or expected trends in underlying data.
These assumptions are intended to represent a best estimate of future experience, and further information about the effect of changes in key assumptions is given in note 38.
Lloyds Banking Group Annual Report and Accounts 2012258 note 30: Other intangible assets
Capitalised software enhancements Total £m £m £m £m £m £m cost: Exchange and other adjustments – – – – 5 5
Balance sheet amount at 31 December 2012 510 1,210 62 355 655 2,792
Balance sheet amount at 31 december 2011 531 1,578 122 395 570 3,196 included within brands above are assets of £380 million (31 december 2011: £380 million) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not have an indefinite useful life.
Lloyds Banking Group Annual Report and Accounts 2012260 note 31: Tangible fixed assets
Accumulated depreciation and impairment: Exchange and other adjustments – 17 18 35 impairment charged to the income statement – 65 – 65 depreciation charge for the year 137 411 886 1,434
Total other assets 18,308 14,762 deferred acquisition and origination costs: £m £m costs deferred, net of amounts amortised to the income statement 80 92
note 34: Customer deposits £m £m non-interest bearing current accounts 30,633 29,468 interest bearing current accounts 71,478 72,562 savings and investment accounts 261,573 238,132 liabilities in respect of securities sold under repurchase agreements 4,433 7,996
Customer deposits 426,912 413,906 included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £4,429 million (2011: £7,987 million) and a fair value of £4,552 million (2011: £8,088 million).
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 december 2012 was £6,553 million, which was £853 million higher than the balance sheet carrying value (2011: £5,487 million, which was £148 million higher than the balance sheet carrying value). At 31 december 2012 there was a cumulative £254 million increase in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of lloyds TsB Bank plc, the issuing entity within the Group. Of the cumulative amount an increase of £437 million arose in 2012 and a decrease of £194 million arose in 2011.
Total debt securities in issue 117,369 185,059 note 37: Liabilities arising from insurance contracts and participating investment contracts insurance contract and participating investment contract liabilities are comprised as follows: Gross £m
(ii) Method of calculation of liabilities With-profit liabilities are stated at their realistic value, the main components of which are: – With-profit benefit reserve, the total asset shares for with-profit policies; – cost of options and guarantees (including guaranteed annuity options); – deductions levied against asset shares; – Planned enhancements to with-profits benefits reserve; and
The realistic assessment is carried out using a stochastic simulation model which values liabilities on a market-consistent basis. The calculation of realistic liabilities uses best estimate assumptions for mortality, persistency rates and expenses. These are calculated in a similar manner to those used for the value of in-force business as discussed in note 29.
(iii) Assumptions Key assumptions used in the calculation of with-profit liabilities, and the processes for determining these, are: Investment returns and discount rates The realistic capital regime dictates that with-profit fund liabilities are valued on a market-consistent basis. This is achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with-profit fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk-free yield and all cash flows are discounted using the risk-free yield. The risk-free yield is defined as the spot yield derived from the relevant government bond yield curve. Further information on significant options and guarantees is given on page 199.
Key changes in assumptions A detailed review of the Group’s assumptions in 2012 resulted in the following key impacts on profit before tax: – change in persistency assumptions (£124 million decrease).
– Addition of an allowance for the time value cost of interest rate options on traditional with-profits business (£10 million decrease).
The movements in non-life insurance contract liabilities and reinsurance assets over the year have been as follows: Gross Reinsurance net £m £m £m
Lloyds Banking Group Annual Report and Accounts 2012268 note 38: Life insurance sensitivity analysis The following table demonstrates the effect of reasonably possible changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. in practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
Widening of credit default spreads on corporate bonds8 0.25% addition (164) (123)
in 2012, there was a net credit of £250 million following a decision to link discretionary pension increases in certain schemes to the consumer Price index; and in 2010, there was a credit of £910 million following the Group’s decision to cap all future increases to pensionable salary in its principal uK defined benefit pension schemes, together with a change in commutation factors in certain schemes (note 11).
Defined benefit schemes The Group has established a number of defined benefit pension schemes in the uK and overseas, the three most significant being the defined benefit sections of the lloyds TsB Group Pension schemes no’s 1 and 2 and the HBOs Final salary Pension scheme. These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 december 2012 was generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
The Group’s obligations in respect of its defined benefit schemes are funded.
during 2009, the Group made one-off contributions to the lloyds TsB Group Pension scheme no 1 and lloyds TsB Group Pension scheme no 2 of approximately £1 billion in aggregate. These contributions took the form of interests in limited liability partnerships for each of the two schemes which contained assets of approximately £5 billion in aggregate entitling the schemes to annual payments of approximately £215 million in aggregate until 31 december 2014. Thereafter, assuming that all distributions have been made, the value of the partnership interests will equate to a nominal amount. At 31 december 2012, the limited liability partnerships held assets of approximately £4.7 billion; cash payments of £215 million were made to the pension schemes during the year (2011: £215 million). The limited liability partnerships are fully consolidated in the Group’s balance sheet (see note 22).
Fair value of scheme assets 30,367 28,828 unrecognised actuarial losses 2,705 539 net amount recognised in the balance sheet 1,748 1,131 £m £m
Rate of inflation: Retail Prices index 2.90 3.00 consumer Price index 2.00 2.00
Rate of increase for pensions in payment 2.70 2.80 2012 years 2011 Years life expectancy for member aged 60, on the valuation date: life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 at 31 december 2012 is assumed to live for, on average, 27.4 years for a male and 29.7 years for a female. in practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. it is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
At 31 december 2012, the assumed discount rate is 4.60 per cent (2011: 5.00 per cent).
The expected return on scheme assets in 2013 will be calculated using the following assumptions: %
The expected return on scheme assets was determined by considering the expected returns available on the assets underlying the current investment policy. Expected yields on fixed interest investments are based on gross redemption yields at the balance sheet date at a term and credit rating broadly appropriate for the bonds held. Expected returns on equity and property investments are long-term rates based on the views of the plan’s independent investment consultants. The expected return on equities allows for the different expected returns from the private equity, infrastructure and hedge fund investments held by some of the funded schemes. some of the funded schemes also invest in certain money market instruments and the expected return on these investments has been assumed to be the same as cash.
Experience (losses) gains on scheme liabilities (501) (277) 496 31 (39) (185) (50)
Experience gains (losses) on scheme assets 442 926 1,624 886 (3,520) 139 314
Statutory position £m £m Tax disclosure £m £m deferred tax assets 4,285 4,496 deferred tax assets 8,726 7,995 deferred tax liabilities (327) (314) deferred tax liabilities (4,768) (3,813)
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 £7,034 million (2011: £5,862 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).
Total deferred tax assets 8,726 7,995 £m £m deferred tax liabilities: Accelerated capital allowances – (243)
deferred tax assets of £330 million (2011: £384 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.
Lloyds Banking Group Annual Report and Accounts 2012278 note 44: Other provisions
Payment protection insurance Following the unsuccessful legal challenge by the British Bankers’ Association against the FsA and the Financial Ombudsman service, the Group held discussions with the FsA with a view to seeking clarity around the detailed implementation of the FsA Policy statement which set out evidential provisions and guidance on the fair assessment of a complaint and the calculation of redress in respect of payment protection insurance (PPi) sales standards. As a result, the Group concluded that there are certain circumstances where customer redress will be appropriate. Accordingly the Group made a provision in its income statement for the year ended 31 december 2011 of £3,200 million in respect of the anticipated costs of such redress, including administration expenses.