Shareholder information 191 index to annual report 192 pREsEntAtiOn Of infORMAtiOn in order to provide a more comparable representation of underlying business performance in certain commentaries in the overview and Business review, insurance and policyholder interests volatility have been separately analysed for the Group’s insurance businesses. further information on these items is shown on pages 34 and 35. in addition, a provision in respect of certain historic uS dollar payments, a provision in respect of the financial Services Compensation Scheme levy and goodwill impairment in 2008, and the profit on the sale of businesses, the results of discontinued businesses and the settlement of overdraft claims in 2007 have been separately analysed in the Group’s results. A reconciliation of this continuing businesses basis of presentation to the statutory profit is shown on page 1. Certain commentaries also separately analyse the impact of market dislocation from the results for both years.
fORwARd lOOking stAtEMEnts This annual report includes certain forward looking statements within the meaning of the uS private Securities litigation reform Act of 1995 with respect to the business, strategy and plans of lloyds Banking Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about lloyds Banking Group’s or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ’will’, ‘would’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar future or conditional expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future.
factors that could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by lloyds Banking Group or on lloyds Banking Group’s behalf include, but are not limited to, general economic conditions in the uK and internationally; inflation, deflation, policies of the Bank of england and other G7 central banks and interest rate, exchange rate, market and monetary fluctuations; changing demographic developments including consumer spending, saving and borrowing habits, technological changes, natural and other disasters, adverse weather, terrorist acts and other acts of war or hostility and responses to those acts; changes in laws, regulations, taxation, Government policies or accounting standards or practices and similar contingencies outside lloyds Banking Group’s control; the ability to derive cost savings and other benefits as well as mitigate exposures from the acquisition and integration of HBoS; inadequate or failed internal or external processes, people and systems; exposure to regulatory scrutiny, legal proceedings or complaints; changes in competition and pricing environments; the inability to hedge certain risks economically; the adequacy of loss reserves; the ability to secure new customers and develop more business from existing customers; the degree of borrower credit quality; the ability to achieve value-creating mergers and/or acquisitions at the appropriate time and prices and the success of lloyds Banking Group in managing the risks of the foregoing.
lloyds Banking Group may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the uS Securities and exchange Commission, lloyds Banking Group annual review, half-year announcement, proxy statements, offering circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of lloyds Banking Group to third parties, including financial analysts. The forward looking statements contained in this annual report are made as of the date hereof, and lloyds Banking Group undertakes no obligation to update any of its forward looking statements.
Annual report and Accounts 2008 2008 highlights statutory profit before tax reduced by 80 per cent to £807 million. A resilient underlying business performance was offset by the impact of market dislocation and adverse volatility relating to the Group’s insurance businesses.
A resilient business performance. profit before tax, on a continuing businesses basis, totalled £2,426 million, a decrease of 35 per cent which reflected the impact of £1,270 million of market dislocation and higher impairment levels.
Discontinued businesses – 162 profit on sale of businesses – 657 provision in respect of certain historic uS dollar payments (180) –
in purchasing HBoS we acquired £17.9 billion of net asset value for £7.7 billion so, as a board, we remain very much convinced that this is the right transaction for your company. The short-term outlook is indeed difficult. Your board believes, however, that the earnings potential of lloyds Banking Group will be significant in the longer term.
A great deal has been said in recent months about the nature of the Government’s involvement with the banking sector. We believe that most of the Government’s initiatives have been positive and well considered. in particular, we very much welcome the Government’s interventions to stabilise the banking system, provide liquidity and to encourage more lending. The dramatic unfolding of events across the world following the collapse of lehman’s meant that the Government needed to take swift and decisive action. it did so. That is why, despite lloyds TSB’s relative strength, in october 2008 we, together with other uK banks, were required by the uK Government to strengthen capital ratios as part of an industry wide initiative to reduce the systemic risk in the uK banking system. This led to us raising an additional £5.5 billion in capital, (£4.5 billion in ordinary shares and £1 billion in preference shares). HBoS were also required under the recapitalisation scheme to raise £11.5 billion, (£8.5 billion in ordinary shares and £3 billion in preference shares). The uK Government, as part of the capital raising process, has now become a 43.4 per cent shareholder in the Group.
2008 was a very difficult and challenging year for the banking industry, both in the uK and overseas. Asset values fell significantly in many developed markets. Wholesale funding contracted in a dramatic fashion as the expansionary credit conditions that had prevailed for some time ended abruptly. The uK Government had to intervene in the banking system by providing capital and liquidity where the markets had failed. in short, markets and economies behaved in ways which, i think it is fair to say, we have not seen in living memory.
We are committed to ensuring that the Group has a robust governance structure in place. Good corporate governance matters even more now than ever before. As we integrate HBoS we are now moving quickly to common governance standards. i believe this is important as there is a clear link between high quality governance and shareholder value creation.
During the year, we have continued the board’s renewal process with the appointment of three new non-executive directors, each of whom brings a wealth of experience to the board. They are Carolyn McCall, Sir David Manning and Martin Scicluna and brief biographical details can be found on pages 66 and 67. in addition, Tim ryan and Tony Watson will join us on 1 March and 2 April 2009, respectively. These appointments ensure that your board has a broad range of skills and senior experience, qualities which i believe are even more important now than they might have been before the economic turmoil began.
in october, Tim Tookey was appointed our new group finance director following Helen Weir’s move from this role to become group executive director, uK retail Banking after Terri Dial’s decision to leave the Group. Mike fairey, deputy group chief executive, retired in June following a 17 year career with the Group. on behalf of the board, i would like to thank Mike for his invaluable contribution to the Group over such a long period of time and wish Terri well in her new career.
Throughout the year, it became clear that there were a number of institutions facing significant challenges, both here in the uK and overseas. During the summer months there was a further collapse in confidence in the wholesale markets and, for all but the strongest, the pressures of funding reached crisis proportions. lloyds TSB had pursued a very successful relationship-focused strategy that had delivered good results for all our stakeholders, and we were continuing to perform relatively well. However, as the financial crisis gathered pace and a number of competitors recognised that they could not survive on a standalone basis, it became clear that the industry would begin to consolidate around a smaller number of larger players. it was against this backdrop that we decided to revisit our earlier strategic thinking regarding HBoS.
This has been an extraordinary year, by any measure and, as many commentators have observed, we are in the most severe global downturn since the 1930s. it was triggered by problems in the uS housing market, spread to the financial services industry and has now moved on to the broader economy. The uK has been profoundly impacted by the crisis and, as a bank that primarily does its business in the uK, lloyds TSB has felt the impact. in a year when many financial institutions declared losses, lloyds TSB did deliver profits, albeit lower than in previous years and i am very aware that, as with the rest of the industry, there has been a sharp reduction in our share price. The year also brought opportunities, and we began the process to acquire the HBoS business, which is probably the most far reaching event in our 243 year history.
Annual report and Accounts 2008 where we are adjusting the risk policies to reflect the current environment and those that will require significant change to meet our return hurdles and risk appetite. This is allowing us to focus on developing and growing those core business areas that fit with our relationship-based, lower-risk model, whilst we squarely address the issues that affect the higher-risk portfolios.
in line with our plans, we have completed substantial further work to analyse the portfolios. We understand the challenges faced by these portfolios and are taking the necessary actions; for instance, we have reviewed the major exposures in key lines, identified the significant concentrations, revised the credit criteria for key products and withdrawn from certain business lines.
our results for the year show a decline in earnings, and on a statutory basis the Group’s profit before tax fell by 80 per cent to £807 million. However, i believe a more appropriate way to view the results is to look at our performance on a continuing business basis, and taking this approach the Group profit before tax was £2,426 million, a reduction of 35 per cent.
Against a backdrop of recession and an ongoing global financial crisis, we expect 2009 to be another challenging year. our revenues will be less impacted than many other institutions, as we have a much lower reliance on transactional income, but we will nevertheless be affected by factors such as lower margins driven by lower interest rates and the accounting impact of replacing our single premium payment protection insurance product with a new monthly premium product, as well as the general slowdown in the economy.
lloyds Banking Group has not been immune from the market dislocation as even the safest banks like lloyds TSB with strong capital bases and limited exposure to risky assets have been impacted. like many other financial institutions the lloyds TSB Corporate Markets business has been significantly affected by the market dislocation; however the relationship focus of our strategy has meant that the impact on the Group’s profit before tax was comparatively limited at £1,270 million in 2008. Although significant in absolute terms, this remains relatively low compared to many of our global peers.
importantly in the current turbulent markets, the enlarged Group has a robust capital position, continues to fund at competitive prices and has diverse funding capabilities. The Group continues to offer security through its relative credit strength and our strong credit ratings are representative of this position. The board remains convinced that the combination of lloyds TSB and HBoS will bring long-term benefits for our shareholders.
The acquisition of HBoS provides a unique strategic opportunity to create the best financial services business in the united Kingdom. The combination of lloyds TSB and HBoS creates a new stronger organisation and helps support the stability of the uK financial system. We are bringing together two of the most efficient customer franchises in the country and providing an unrivalled distribution network for our customers. The information advantage from the large customer base is a real differentiating edge, and the size of our operations gives us a clear opportunity for better productivity. We are targeting benefits in excess of £1.5 billion per annum through cost synergies, or some 14 per cent of the enlarged Group’s cost base, by 2011. The enlarged Group has the capital strength and diverse funding capabilities which will enable us better to meet the current industry challenges and continue to lend to and support our customers. Despite our relative strength, the shape of the financial services markets is changing all the time and we will continue to operate in highly vibrant and competitive markets.
We believe we have a great case for value creation in the long-term, through building the largest financial services company in the uK, with the attendant benefits of a strong market position and large scale. All in, we believe this is a unique opportunity to create the uK’s leading financial services company.
We remained open for business last year and grew our lending prudently. lending to SMes grew by 20 per cent at lloyds TSB in 2008 and over 100,000 small businesses chose to bank with lloyds TSB last year. Both lloyds TSB and HBoS also launched charters setting out the practical steps they will take to support small businesses through the economic downturn. in addition, on the retail side, we are the biggest mortgage provider in the first time buyer market and more basic banking customers bank with lloyds Banking Group than any other bank.
Muted global inflation enabled central banks everywhere, including in the uK, to meet inflation objectives whilst maintaining interest rates at very low levels by historical standards. in this environment, uK real household incomes had grown strongly, as had corporate profits, and asset markets had boomed, notably housing. As in the uS economy, low interest rates, low inflation, a booming housing market and high real income growth encouraged sustained high levels of consumer spending. Savings rates had fallen to very low levels and household debt had grown faster than income.
We had anticipated that this benign environment was unlikely to last, and had as a result positioned our business to avoid riskier parts of the lending market and to focus on the likely longer-term rebound of savings. However, it was unclear what the trigger might be for the change in the economic environment and the readjustment by consumers towards lower borrowing and higher savings.
The initial cause of the readjustment was a gradual rise in interest rates globally as the extremely rapid growth of the newly industrialising economies greatly increased demand for raw materials and sharply higher commodity prices caused inflation to surge. The current financial crisis started in August 2007, with growing evidence that weakness in uS sub-prime lending due to higher interest rates was affecting the value of securitised assets held on the balance sheets of financial institutions globally. But by the start of 2008 this had not affected the global economy materially. However, the outlook for the global, and uK, economy deteriorated significantly during last year.
At the start of 2008, the consensus view was that the uK economy would grow by around 1.8 per cent on 2007. But as consumers’ spending power was squeezed by higher inflation and interest rates, and as consumer and business confidence collapsed, the consensus forecast gradually drifted downwards. The first full year figures for 2008 Gross Domestic product (GDp) growth, released in late January 2009 showed a final outcome of 0.7 per cent, with the second half showing negative growth. The last quarter of 2008 was particularly weak, due in large part to sharply lower manufacturing output, both in the uK and globally, as consumers cut spending on non-essentials, businesses cancelled investments and retailers reduced stocks. So far the slowdown owes more to lower business investment and weaker manufacturing and construction than it does to the consumer. Whilst spending had been strong in the preceding period, and savings rates had fallen to very low levels, there was not such an obvious consumer boom as had been the case prior to the 1990s recession.
By the end of last year, house prices were down 16 per cent on a year earlier, using the Halifax measure. That decline had improved affordability, with the ratio of house prices to average earnings having fallen from a peak of 5.8 in July 2007 to an estimated 4.4 by December 2008, but still above its long term average of 4.0.
Central banks have also responded – by sharply lowering the interest rates they control and by expanding their balance sheets to support financial markets. As a result, by early 2009, spreads in many financial markets had started to shrink, though remaining well above pre-crisis levels.
During the long upturn that preceded the recession, consumer and corporate borrowing had grown at a strong pace, boosted by booming asset prices and seemingly low levels of risk. Savings growth had been modest by comparison. The recession will see a significant change in that pattern, as households and businesses adjust to the new world. The first signs of that change are evident already.
The slowdown in both mortgages and unsecured lending is due to both demand and supply factors. A worsening economic outlook and falling house prices have depressed consumer confidence and curbed demand for both secured and unsecured borrowing. on the supply side, weak capital and funding positions have caused the withdrawal of some lenders from the market. Combined with increased perception of risk and falling asset values, this has restricted the aggregate supply of credit. However, the relative strength of lloyds TSB’s capital and funding position, and our relationship-based approach, has enabled us to continue to grow our lending, thereby increasing our share of new lending.
Statutory profit before tax reduced by 80 per cent to £807 million. A resilient underlying business performance was offset by the impact of market dislocation and adverse volatility relating to the Group’s insurance businesses.
In a difficult economic environment, asset quality remains satisfactory. Impairment losses increased by 68 per cent to £3,012 million, reflecting the impact of market dislocation, the slowdown in the UK economic environment and the impact of the falling house price index.
Robust capital ratios. Adjusting the year end capital ratios for the Government’s recapitalisation of UK banks, completed in January 2009, and the estimated impact of the acquisition of HBOS, the enlarged Lloyds Banking Group’s pro forma core tier 1 capital ratio stands at 6.4 per cent, the tier 1 ratio at 9.8 per cent and the total capital ratio at 12.5 per cent.
During 2008 there were three primary operating divisions: UK Retail Banking; Insurance and Investments; and Wholesale and International Banking. The key product markets in which they participate and relative contribution to the Group is presented below and a more detailed analysis of their strategy, business and performance is outlined within the Business Review. Following the acquisition of HBOS these divisions will be restructured with elements from some existing businesses coming together to form another division. The new Wealth and International division has been created to focus on Wealth Management, Asset Management and International Banking.
Provision in respect of certain historic US dollar payments, provision for Financial Services Compensation Scheme levy and goodwill Impairment (402) –
During 2008, the Group delivered a resilient core business performance against the backdrop of significant turbulence in global financial markets and a marked slowdown in the UK economic environment. Statutory profit attributable to equity shareholders however decreased by 75 per cent to £819 million and earnings per share decreased by 75 per cent to 14.3p, reflecting the impact of market dislocation, insurance volatility, caused by lower equity markets and wider credit spreads in fixed income markets, and a significant increase in impairment levels. Profit before tax fell by 80 per cent to £807 million.
Like many other financial institutions, the Group’s Corporate Markets business has been significantly affected by the ongoing impact of market dislocation; however, the relationship focus of our strategy and conservative risk management approach has meant that the impact on the Group’s profit before tax was limited to £1,270 million during 2008 (£925 million reduction in income; £345 million increase in impairment). In the extremely challenging and turbulent operating environment in global financial markets, this compares favourably to the impact on many other major financial services companies. The market dislocation largely reflects the impact of continuing mark-to-market adjustments in certain legacy trading portfolios, resulting from the marketwide repricing of liquidity and credit, together with the write-down of a number of Asset Backed Securities. Notably, even after fully absorbing this impact, the Wholesale and International Banking division delivered profit before tax of £274 million.
The net interest margin from our banking businesses was unchanged at 2.78 per cent, as improved product margins offset an adverse mix effect. Overall product margins were 12 basis points higher, reflecting stronger new business product margins in the mortgage and corporate businesses. Stronger growth in finer margin corporate and mortgage lending than in the wider margin unsecured consumer lending contributed to the negative mix effect which offset the increase in product margins.
Other income, net of insurance claims and excluding insurance grossing, decreased by £1,290 million, or 25 per cent, to £3,952 million, largely reflecting the impact of market dislocation. In the retail bank, higher fees and commissions receivable as a result of good growth in added value current accounts and card services were offset by lower creditor insurance commissions and the impact of changes in product design leading to a greater proportion of earnings being recognised as net interest income rather than fee income. In addition, good levels of growth were achieved in fee based product sales to commercial banking customers.
The Group continues to invest in improving processing efficiency, resulting in continued tight control over day-to-day operating costs. During 2008, operating expenses increased by five per cent to £5,582 million excluding the insurance grossing adjustment. Over the last 12 months, staff numbers increased by 678 (one per cent) to 58,756, as investment in higher levels of customer facing staff more than offset further efficiency improvements in back-office processing centres. These improvements in operational effectiveness have resulted in a further reduction in the Group cost:income ratio, excluding market dislocation, from 48.1 per cent to 47.0 per cent. The Group’s programme of productivity initiatives has continued to deliver significant benefits, improving underlying cost efficiency and creating greater headroom for further investment in the business. During 2008, the Group exceeded its expected net cost benefits target of £250 million in 2008 by delivering a total of £311 million net cost benefits from the programme.
The Wholesale and International Banking charge for impairment losses increased significantly by £936 million to £1,508 million, including a £345 million impairment charge relating to the impact of market dislocation during 2008. The remaining charge reflects an increase in the level of impairments as a result of the economic slowdown in the UK and the impact of a number of high profile financial services company collapses.
Excluding volatility, a provision in respect of certain historic US dollar payments, the Financial Services Compensation Scheme levy and goodwill impairment.
Excluding volatility, results of discontinued businesses, profit on sale of businesses and the settlement of overdraft claims.
Segmental analyses for 2007 have been restated as explained in note 4 on page 114.
Improved net interest margin, nine basis points higher than in 2007, reflecting improved key product margins, particularly in unsecured personal lending and new mortgages.
The new ‘Retail’ division operates a multi brand strategy with a range of highly recognised and well regarded brands including Lloyds TSB, Halifax, Bank of Scotland and Cheltenham & Gloucester.
SUCCeSSfUL yeAR foR SAvInGS And PeRSonAL LoAnS 2008 was the most successful year ever for savings and personal loans. Savings balances grew by £5 billion with over two million accounts opened, 28 per cent higher than 2007. A really impressive performance given the market uncertainty and low interest rate environment. Lloyds TSB continues to be the number one provider of personal loans (CACI data).
The Group’s market share of gross new mortgage lending increased to 10.8 per cent (2007: 8.1 per cent), as the Group continued to maintain its substantial presence in the UK mortgage market. Overall, new lending in the UK mortgage market fell by 29 per cent to £258 billion (2007: £363 billion) however the Group’s gross new mortgage lending in 2008 fell by only five per cent to £27.8 billion (2007: £29.4 billion). The higher market share of gross mortgage lending, in conjunction with a reduction in the Group’s share of mortgage redemptions, has led to a significant increase in our market share of net new lending to 27.5 per cent, which partly reflects the withdrawal of a number of competitors from the UK mortgage market. Group mortgage balances outstanding increased by 11 per cent to £112.9 billion.
Strong profit performance. Profit before tax increased by 22 per cent to £911 million.
Our business The Insurance and Investments division offered life assurance, pensions and investment products, general insurance and fund management services during 2008. These products were delivered through a number of brands including Scottish Widows, Lloyds TSB General Insurance and Scottish Widows Investment Partnership.
The strategic priorities for the new ‘Insurance’ division are: – Delivering profitable, market-led product propositions
The capital position of Scottish Widows has remained robust despite recent market turbulence. Scottish Widows’ approach to capital management, including its investments and hedging strategy, has been successful in mitigating the impact of market shocks on its current capital base. Additionally, Scottish Widows’ capital management strategy is designed to generate sufficient free cash flow to fund new business and maintain dividend flow to the Group. Accordingly, Scottish Widows continues to focus on improving the capital efficiency of its products and identifying further opportunities to improve its capital position. The post-tax return on embedded value, on an EEV basis, increased to 11.4 per cent, partly reflecting a lower value of in-force business resulting from recent falls in investment markets. During 2008, £0.2 billion of capital was paid to the Group via the regular annual dividend payment, giving a total capital repatriation of over £3.8 billion since the beginning of 2005.
In addition to reporting under IFRS, the Group, as in previous reporting periods, provides supplementary financial reporting for Scottish Widows on an EEV basis.
Expected return on shareholders’ net assets 146 187 profit before tax, excluding volatility and other items* 818 818 total (loss) profit before tax (298) 589
For 2008, the risk-free rate assumed in valuing the non-annuity in-force business is the 15 year UK gilt yield. The risk free rate assumed in valuing the in-force asset for the annuity business is presented as a single risk-free rate to allow easier comparison to the rate used for other business. That single risk-free rate has been derived to give the equivalent value to the annuity book, had that book been valued using the UK gilt yield curve increased to reflect the illiquidity premium described above. The risk-free rate used in valuing financial options and guarantees is defined as the spot yield derived from the UK gilt yield curve, in line with Scottish Widows’ FSA realistic balance sheet assumptions. The table below shows the range of resulting yields and other key assumptions.
This sensitivity shows the impact of reducing mortality rates on non-annuity business to 95 per cent of the expected rate.
Profit before tax from our general insurance operations increased by £124 million, to £234 million, reflecting a £109 million reduction in claims due to the absence of the severe weather related claims experienced in 2007 and the continued benefits from ongoing investment in our claims processes.
Net operating income increased by £22 million, reflecting good increases in new and renewal home insurance premium income. New business premium income increased by nine per cent and continued investment in our pricing and business retention capabilities delivered four per cent growth in renewal earned premiums.
Claims were £109 million lower, principally reflecting the absence of severe weather related claims experienced last year, which more than offset an increase of £15 million in payment protection insurance unemployment claims. Adjusting for the severe weather related claims, the claims ratio improved from 31 per cent to 30 per cent, reflecting continued benefits from ongoing investment in our claims processes and further efficiencies from improved process management.
Combining the respective strengths of some 3,000 people in Corporate Banking and Products & Markets, Corporate Markets plays an integral role in leveraging and expanding the customer franchise and building deep, long-lasting relationships with around 26,000 corporate customers and was awarded jointly with Commercial Banking the ‘Real Finance/CBI FDs’ Excellence Awards - Bank of the year’ for the fourth year running.
Commercial Banking is a growing business with some 6,000 people serving nearly one million customers across the UK from one-person start-ups to large, established enterprises. Lloyds TSB has increased its lending to SMEs by nearly 20 per cent in 2008.
†The 2007 figures have been restated (see page 17). The 2006 figures are as originally published. *Before impact of market dislocation.
Profit before tax in Asset Finance decreased by 95 per cent to £2 million reflecting the significant combined impacts of higher impairments and lower residual values in response to the deteriorating economic conditions. Income increased by £62 million, or nine per cent, as a result of continued margin improvement across the Black horse consumer businesses and growth in Autolease, our contract hire fleet business. Costs increased by £57 million, or 13 per cent, largely reflecting the impact of higher operating lease depreciation on the enlarged Contract hire Fleet and exceptional residual value losses, but were otherwise flat year-on-year reflecting tight cost management and discipline. The impairment charge increased by £42 million to £270 million reflecting the impact of the economic slowdown in the UK.
Profit before tax in International Banking grew by eight per cent to £149 million reflecting strong income growth from meeting the needs of our customers, as the Group has increased its focus on growing its customer franchise in the increasingly global mobile affluent and high net worth wealth management market. Total income grew to £446 million, up 17 per cent (10 per cent excluding the impact of exchange rate movements), reflecting strong customer franchise growth, improved lending volumes at increased margins and strong growth in customer deposits. Costs increased by 19 per cent (nine per cent excluding the impact of exchange rate movements) reflecting increased investment in our target Private Banking and Expatriate Banking markets, and the trading surplus increased by 14 per cent.
The Group’s insurance businesses have 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 Insurance and Investments division, management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to the actual return. The difference between the actual return on these investments and the expected return based upon economic assumptions made at the beginning of the year is included within insurance volatility.
Changes in market variables also affect the realistic valuation of the guarantees and options embedded within products written in the Scottish Widows With Profits Fund, the value of the in-force business and the value of shareholders’ funds. Fluctuations in these values caused by changes in market variables, including corporate bond spreads, are also included within insurance volatility.
The most significant of these additional sources of volatility is policyholder tax. Accounting standards require that tax on policyholder investment returns should be included in the Group’s tax charge rather than being offset against the related income. The impact is, therefore, to either increase or decrease profit before tax with a corresponding change in the tax charge. Other sources of volatility include the
On 1 July 2008, the Financial Ombudsman Service referred concerns regarding the handling of PPI complaints to the Financial Services Authority (FSA) as an issue of wider implication. The Group and other industry members and trade associations have made submissions to the FSA regarding this referral. The matter was considered at the FSA Board meeting on 25 September 2008. The Group is working with industry members and trade associations in preparing an industry response to address regulatory concerns regarding the handling of PPI complaints.
On 30 September 2008, the FSA published a statement arising from its ongoing thematic review of PPI sales. In the statement, which was directed at the industry generally, the FSA highlighted certain concerns and indicated that it was escalating its regulatory intervention and considering appropriate action to deal with ongoing non-compliant sales practices and to remedy non-compliant past sales. The FSA plans to publish an update on the third phase of the thematic work in the first quarter of 2009.
The UK Office of Fair Trading (OFT) is carrying out an investigation into certain current account charges which are also subject to a legal test case (see note 48). In addition, on 16 July 2008, the OFT published a market study report on personal current accounts. This was followed by a period of consultation until 31 October 2008, and the OFT is expected to release a summary of the responses received, and is aiming to publish a further report in 2009 which will contain recommendations for the banking industry.
The OFT is continuing its investigation into interchange fees set by card networks and paid to card issuers. This investigation is in parallel with the European Commission’s own investigation into Visa cross-border interchange fees, the European Commission having issued its decision ordering MasterCard to set its cross-border interchange rate to zero by June 2008. This decision is now being appealed to the European Court of First Instance. Lloyds TSB Bank plc along with a number of other UK and European banks will intervene in the appeal supporting the MasterCard position.
At the same time the FSA, The Bank of England and her Majesty’s Treasury (hMT) are considering UK financial stability and depositor protection proposals. The Banking Act 2009 (the Act) came into force on 22 February 2009. The Act introduces a statutory objective of promoting financial stability for the Bank of England, working with hMT and the FSA. The Act also introduces a special resolution regime (SRR) in advance of a potential bank insoivency, which consists of three stabilisation tools: (i) private sector transfer; (ii) transfer to a ‘bridge bank’ established by the Bank of England; and (iii) temporary public ownership (nationalisation).
For several years, we have adopted the European Foundation for Quality Management’s Corporate Responsibility Framework to help us align corporate responsibility with business strategy and also with individual balanced scorecard priorities. As part of the process we have a network of senior managers across all business divisions, through whom we conduct an annual self-assessment of our performance with independent oversight and assurance. This allows us to identify strengths and areas for improvement and to prioritise objectives and actions. It also provides a benchmark against which we can compare our performance both internally and externally.
During 2008, Lloyds Banking Group has led a European Commissionsponsored working group along with a number of other major European businesses, business schools, consultancies and non-governmental organisations, in developing a framework for improved communication of non-financial performance between business and investors.
2012 local Heroes Local Heroes is Lloyds TSB’s first initiative to deliver its London 2012 vision of inspiring and supporting young people, businesses and communities across Britain. The programme recognises young sporting talent and provides funding support as they start out on their journey in performance sport with optimism and determination. Identifying 250 emerging young sportspeople each year in the run up to 2012 and beyond, Lloyds TSB Local Heroes is being delivered in partnership with SportsAid, a registered charity.
We are committed to being a responsible lender. It is in our interest to help customers borrow only those amounts they can afford to repay. We have a responsible lending programme with internal management reporting and accountability. This approach is reflected in our mortgage lending where we have maintained a significant share of net new mortgage lending, whilst continuing to focus on the prime mortgage market with a prudent average loan to value.
A series of 120 advice seminars with Lloyds Banking Group specialists and independent experts, providing practical advice and support will take place around the UK in 2009. These will help forge closer relationships between our business customers and accountants and business support agencies. The Group also extended the opportunity for customers without adequate capital to borrow under the Government’s Small Firms Loans Guarantee Scheme.
The majority of Lloyds Banking Group’s charitable giving is channelled through the four Lloyds TSB Foundations, which cover England and Wales, Scotland, Northern Ireland and the Channel Islands. Their mission is to improve the lives of disadvantaged people in local communities.
Our Charity of the Year relationship with Barnardo’s was extended to 18 months and ended on 30 June 2008. Over £1.8 million was raised for the Lloyds TSB and Barnardo’s ‘Securing Futures’ partnership far exceeding the £1 million target. The money raised will provide thousands of vocational training and education places for some of the most vulnerable and disadvantaged young people across the UK to help them have a better start in life and a brighter future.
As the first Partner of the London 2012 Olympic Games and Paralympic Games, we are delighted at the record breaking successes of Team GB and Paralympics GB in Beijing. Our Partnership however, is not just about focusing on elite sport, and the action that will take place for 17 days in 2012.
There are currently 250 Local Heroes, representing aspiring Olympians and Paralympians from all walks of life, from all sporting disciplines, from all over Great Britain. The funding we provide helps them on their journey in a variety of ways, from travel costs and new equipment, to competition entry fees and nutritional support.
Climate change has been described by the UK Government as the greatest long-term challenge facing the world today. We recognise that businesses have a role to play in helping to address the risks of climate change. Measures to tackle climate change will have potential implications for regulation, taxation and public policy. As well as physical, financial and market risks posed by climate change, there are also significant potential opportunities.
In 2007, we set a stretching target to reduce our CO2 emissions by 30 per cent by 2012 based on 2002 levels. We are very pleased to report that by the end of 2008 we have achieved a 31 per cent reduction in CO2, meeting our target four years ahead of schedule. We identified specific projects and prioritised investment to deliver significant CO2 reductions. We have also purchased renewable electricity and electricity from combined heat and power (CHP) sources, which have a lower carbon footprint than standard grid electricity.
During 2008, we have improved our systems for collecting car mileage information and energy consumption data. Using actual mileage and engine sizes rather than fleet averages gives a more accurate travel total. This, allied to a 40 per cent increase in teleconferencing to 422,000 meetings, has significantly reduced our travel related CO2 emissions.
In 2008 DEFRA introduced changes to the conversion factors to be used for calculating CO2 emissions from energy consumption and travel. In addition, they introduced new guidelines for the treatment of ‘renewable energy’ in calculating total CO2 emissions. The total CO2 emissions reported above have been calculated using the old conversion factors to provide a more accurate like-for-like comparison against the baseline. Using the new guidelines, our total emissions for 2008 would increase to 245,385 tonnes. In 2009, a priority for Lloyds Banking Group will be to baseline our environmental impacts across the combined Group.
In creating a great place to work in this way, we believe we will attract the highest performing people to join us and secure the commitment of those who are the strongest performers and have the highest potential to stay.
During 2009, we will undertake a full review of our approach to total reward as part of the integration of Lloyds TSB and HBOS.
reCognition While our emphasis is on providing recognition through line management, we also formally recognise those who have exceeded expectations and pushed boundaries in areas such as colleague support, customer service and building community profile. One example of this is through our ‘Making a Difference’ awards, which in 2008 recognised the contribution of over 180 colleagues who made exceptional contributions to the business and the community last year.
We remain committed to investing in the development of our colleagues so that they can deliver great customer service and results. Our learning and development focuses on the capability and skills needed for current roles as well as those we will need to be successful in the future.
Our line managers play a critical role in creating a positive learning environment, managing and supporting our colleagues to maximise development opportunities and embed learning to drive results. Developing and strengthening management capabilities remains a priority, along with personal learning plans built around the specific learning and future needs of our colleagues. Our business-focused learning programmes include critical business capabilities such as financial, risk and relationship management which enable us to support our customers effectively.
The maintenance of a strong control framework remains a priority and is the foundation for the delivery of effective risk management. Risk analysis and reporting capabilities support the identification of opportunities as well as risks and provide an aggregate view of the overall risk portfolio. Risk mitigation strategies clearly aligned with responsibilities and timescales are monitored at group and divisional level. Risk continues to be a key component of routine management information reporting.
During 2008, the global dislocation in financial markets has resulted in exceptional instability and volatility impacting upon market and investor confidence which has been characterised by a marked reduction in liquidity. This crisis in the financial markets led the UK Government to inject liquidity into the financial system and to require (and participate in) recapitalisation of the banking sector to restore confidence to the market.
This board-level engagement, coupled with the direct involvement of senior management in group-wide risk issues at group executive committee level, ensures that issues are escalated on a timely basis and appropriate remediation plans are put in place. The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by senior management. Key decisions are always taken by more than one person. Within Lloyds TSB there is a strong culture of command and control from the centre with short lines of communication between divisions and functions.
Table 1.1 sets out the role of the second line of defence and in particular that of the risk oversight committee and its interaction with the chief risk officer, the group risk directors and the divisional risk officers. This structure which has been in place for a number of years, has evolved with the risk oversight committee reviewing regular reports on the Group’s risk exposures as well as taking a keen interest in the adequacy and capability of resources within the risk functions.
Lloyds TSB has a conservative business model and risk culture. The focus has been and remains on building and maintaining long-term relationships with customers. This involves taking a ‘through the cycle’ view whereby the sustainability of a relationship through good and bad economic times is taken into account. The approach is supported by a ‘through the cycle’ approach to risk with strong central control and monitoring.
The board, assisted by its committees, the risk oversight committee, the group executive committee, and the group audit committee, approves the Group’s overall risk management framework. The board also reviews the Group’s aggregate risk exposures and concentrations of risk to seek to ensure that these are consistent with the board’s appetite for risk. The role of the board, audit committee and risk oversight committee are shown in the corporate governance section on pages 70 to 72, and further key risk oversight roles are described below.
The group executive committee, assisted by the group business risk committee and the group asset and liability 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, whilst also reviewing the Group’s aggregate risk exposures and concentrations of risk. The group executive committee’s duties are described in greater detail on page 71. The group executive committee members are also members of the group business risk committee and the group asset and liability committee, both of which are chaired by the group chief executive. The group business risk committee is supported by the following: The group compliance and operational risk committee is responsible for proactively identifying current and emerging significant compliance and 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 divisional engagement occurs to develop, implement and maintain the Group’s compliance and operational risk management framework.
The group asset and liability committee is supported by the senior asset and liability committee, which is responsible for the review and escalation of issues of group level significance to the group asset and liability committee relating to the strategic management of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. It is also responsible for the risk management framework for market risk, liquidity risk, capital risk and earnings volatility.
Group executive directors have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are required to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within the parameters set by the board, group executive committee and group risk. Compliance with policies and parameters is overseen by the risk oversight committee, the group business risk committee, the group asset and liability committee, group risk and the divisional risk offi cers.
Reporting line Functional reporting line from BU risk officer or function to divisional risk officers Functional reporting line to support the committees
risk reporting is standardised through the use of standard definitions when reporting, to enable risk aggregation. Divisions monitor their risk levels against their risk appetite, seeking to ensure effective mitigating action is being taken where appropriate. Divisional risk reports are reviewed by divisional executive committees to ensure that respective senior management are satisfied with the overall risk profile, risk accountabilities and progress on any necessary mitigating actions. Reporting, including that of performance against relevant limits or policies, is in place to provide a level of detail appropriate to the exposures concerned and regular information is provided to group risk for review and aggregate reporting. Any significant issues identified in the monitoring process are appropriately reported, and an escalation process is in place to report significant losses to appropriate levels of management. Group risk reports on risk exposures and material issues quarterly to the group asset and liability committee, group business risk committee, group executive committee, risk oversight committee and the board.
The Group’s risk language is designed to capture the Group’s principal risks referred to as the ‘primary risk drivers’. A description of each risk, including definition, appetite, control and exposures, is included below. These are further broken down into 28 more granular risk types to enable more detailed review and facilitate appropriate reporting and monitoring, as set out in Table 1.3.
At present the most significant risks faced by the Group are: People risk: the Group’s recent improvement to its people risk exposure, driven by leadership development and succession planning strategies, is now challenged by integration events and market disruption. External pressure on incentivisation in the banking industry increases the risk of losing specialist resources. The Group is addressing these pressures and taking the necessary steps to retain resources.
– Wholesale, where companies are facing increasingly difficult conditions, resulting in corporate default levels rising and leading to increases in corporate impairment.
integration risk: A further risk arises as a result of the acquisition of HBOS plc by Lloyds TSB Group plc reflecting the risk that Lloyds Banking Group may fail to realise the business growth opportunities, revenue benefits, cost synergies, operational efficiencies and other benefits anticipated from, or may incur unanticipated costs and losses associated with, the acquisition of HBOS plc. As a consequence Lloyds Banking Group results may suffer as a result of operational, financial, management and other integration risks. The Group has created an integration committee as a sub-committee to the group executive committee to oversee the integration process.
A common approach is applied across the Group to assess the creation of shareholder value. This is measured by economic profit (the profit attributable to shareholders, less a notional charge for the equity invested in the business). The focus on economic profit allows the Group to compare the returns being made on capital employed in each business on a consistent basis. During the year, as a result of the market dislocation and banking crisis, economic profit fell by £994 million to £731 million.
As part of the annual business planning process, the group develops a set of management actions to prevent or mitigate the impact on earnings in the event that business risks materialise. Additionally, business risk monitoring, through regular reports and oversight, results in corrective actions to plans and reductions in exposures where necessary.
Credit risk appetite is expressed both in terms of credit risk economic equity and in terms of the impact of credit risk on earnings volatility.
In terms of loans and advances, credit risk arises both from amounts lent and commitments to extend credit to a customer as required. These commitments can take the form of loans and overdrafts, or credit instruments such as guarantees and standby, documentary and commercial letters of credit. With respect to commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail commitments to extend credit can be cancelled and the credit worthiness of customers is monitored frequently. In addition, most wholesale commitments to extend credit are contingent upon customers maintaining specific credit standards, which are regularly monitored.
– Credit scoring: In its principal retail portfolios, the Group uses statistically-based decisioning techniques (primarily credit scoring). Divisional risk departments review scorecard effectiveness and approve changes, with material changes to scorecards that form part of a probability of default rating system subject to group risk approval.
– Cross-border and cross-currency exposures: Country limits are authorised by Country Limits Panel and managed by a dedicated unit taking into account economic and political factors.
– Daily settlement limits: Settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day.
– Surplus assets are held primarily in three portfolios: the surplus in the non-profit fund within the long term fund of Scottish Widows plc, assets in shareholder funds of life assurance companies and an investment portfolio within the general insurance business.
The Group’s defined benefit staff pension schemes are exposed to significant risks from the constituent parts of their assets and from the present value of their liabilities, primarily equity and real interest rate risk. For further information on pension scheme assets and liabilities please refer to note 37.
Lloyds Banking Group Annual Report and Accounts 2008 taBle 1.5: Banking – non-trading £m £m
Current and potential future insurance risk exposures are assessed and aggregated using risk measures based on 1-in-20 year stresses and other supporting measures where appropriate, for example those set out in Note 33.
Insurance risk is primarily controlled via the following processes: – Underwriting (the process to ensure that new insurance proposals are properly assessed) – Pricing-to-risk (new insurance proposals would usually be priced in accordance with the underwriting assessment) – Claims management – Product design – Policy wording – Product management – The use of reinsurance or other risk mitigation techniques.
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 our chosen reinsurers.
Ongoing monitoring is in place to track the progression of insurance risks. This normally involves monitoring relevant experiences against expectations (for example claims experience, option take up rates, persistency experience, expenses, non-disclosure at the point of sale), as well as evaluating the effectiveness of controls put in place to manage insurance risk.
The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from inadequate or failed internal processes and systems, people-related events and deficiencies in the performance of external suppliers/service providers.
The risk of reductions in earnings and/or value, through financial or reputational loss, associated with financial crime and failure to comply with related legal and regulatory obligations, these losses may include censure, fines or the cost of litigation.
The risk of reductions in earnings and/or value, through financial or reputational loss, from change initiatives failing to deliver to requirements, budget or timescale or failing to implement change effectively or realise the desired benefits.
The Group has developed an impact on earnings approach to operational risk appetite. This involves looking at how much the Group could lose due to operational risk losses at various levels of certainty.
The main sources of operational risk within the Group relate to uncertainties created by the changing business, in particular the legal and regulatory environment in which financial firms operate both in the UK and overseas. As a result the most significant operational risk exposures are legal and regulatory.
Legal and regulatory exposure is driven by the significant volume of current legislation and regulation with which the Group has to comply, along with new legislation and regulation which needs to be reviewed, assessed and embedded into day-to-day operational and business practices across the Group as a whole. Further uncertainties arise where regulations are principles-based without the regulator defining supporting minimum standards either for the benefit of the consumer or firms. This gives rise to both the risk of retrospection from any one regulator and also to the risk of differing interpretation by individual regulators.
Business unit risk exposure is aggregated at divisional level and reported to group risk where a group-wide report is prepared. The report is discussed at the monthly group compliance and operational risk committee. This committee can escalate matters to the chief risk officer, or higher committees if appropriate.
The Group has adopted a formal approach to operational risk event escalation. This involves the identification of an event, an assessment of the materiality of the event in accordance with a risk event impact matrix and appropriate escalation.
Financial soundness risk has three key risk components covering liquidity and funding risk; capital risk; and financial & prudential regulatory reporting, disclosure and tax risk.
A series of measures are used across the Group to monitor both short and long term liquidity including: ratios, cash outflow triggers, and stress test survival period triggers. Strict criteria and limits are in place to ensure marketable securities are available as part of the portfolio of highly liquid assets.
The Group’s funding and liquidity position is underpinned by its significant retail deposit base, accompanied by appropriate funding from the wholesale markets. A substantial proportion of the retail deposit base is made up of customers’ current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to raise inter-bank deposits and to issue certificates of deposit and commercial paper to meet short-term obligations. The Group’s short-term money market funding is based on a qualitative analysis of the market’s capacity for the Group’s credit. The Group has developed strong relationships with certain wholesale market segments, and also has access to central banks and corporate customers, to supplement its retail deposit base.
Liquidity is actively monitored at business unit and Group level at an appropriate frequency. Routine reporting is in place to senior management and through the Group’s committee structure, in particular the group asset and liability committee and the senior asset and liability committee which meet monthly. In a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event. Liquidity policies and procedures are subject to independent oversight.
Daily monitoring and control processes are in place to address both statutory and prudential liquidity requirements. In addition, the framework has two other important components: – Firstly, Lloyds Banking Group stress tests its potential cash flow mismatch position under various scenarios on an ongoing basis. The cash flow mismatch position considers on-balance sheet cash flows, commitments received and granted, and material derivative cash flows. Specifically, commitments granted include the pipeline of new business awaiting completion as well as other standby or revolving credit facilities. Behavioural adjustments are developed, evaluating how the cash flow position might change under each stress scenario to derive a stressed cash flow position. Scenarios cover both Lloyds Banking Group name specific and systemic difficulties. The scenarios and the assumptions are reviewed at least annually to gain assurance they continue to be relevant to the nature of the business.
The information reviewed by the group executive committee, group asset and liability committee and senior asset and liability committee includes analysis set out in table 1.7.
Also a key input into the FSA’s ICG setting process (which addresses the requirements of Pillar 2 of the Basel II framework) is each bank’s Internal Capital Adequacy Assessment Process. The FSA’s approach is to monitor the available capital resources in relation to the ICG requirement. The Group has been given an ICG by the FSA and the board has also agreed a formal buffer to be maintained in addition to this requirement. Any breaches of the formal buffer must be notified to the FSA, together with proposed remedial action. No such notification has been made in 2008. The FSA has made it clear that each ICG remains a confidential matter between each bank and the FSA.
At 31 December 2008, the principal subsidiary involved in the Group’s life assurance operations was Scottish Widows plc (Scottish Widows), which holds the only large With Profit Fund managed by Lloyds Banking Group.
Assets attributable to the shareholder held outside the long-term funds – – – 862 862
Adjustment to include estimated ‘realistic’ liabilities payable to the shareholder (406) – (406) – (406)
further support account: The Further Support Account is an extra tier of capital support for the with-profits policies in existence at the date of demutualisation. The Scheme requires that assets can only be transferred from the Non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the Support Account and Further Support Account. Unlike the Support Account test, the economic value used for this test includes both admissible assets and the present value of future profits of business written in the Non-Participating Fund or by any subsidiaries of that fund. The balance of the Further Support Account is expected to reduce to nil by the year 2030. At 31 December 2008, the estimated net economic value of the Non-Participating Fund and its subsidiaries for the purposes of this test was £3,603 million (31 December 2007: £4,026 million) and the estimated combined value of the Support Account and Further Support Account was £2,584 million (31 December 2007: £2,834 million).
The comparative position as at 31 December 2007 was as follows (again, relating to Scottish Widows plc only): Non- Total With Profit Participating Long Term Shareholder
Fund Fund Fund Fund Total £m £m £m £m £m as at 31 december 2007
Assets attributable to the shareholder held outside the long-term funds – – – 956 956
Adjustment to include estimated ‘realistic’ liabilities payable to the shareholder (634) – (634) – (634)
The estimated financial position of the With Profit Fund of Scottish Widows at 31 December 2008, calculated on a ‘realistic’ basis, is given in the following table, in the form reported to the FSA. As a result of the capital support arrangements, it is considered appropriate to also disclose the estimated ‘realistic’ financial position of the Long Term Fund of Scottish Widows as a whole, which consists of both the With Profit Fund and the Non-Participating Fund.
The movements in Scottish Widows plc’s available capital resources can be analysed as follows: Non- Total With Profit Participating Long Term Shareholder
Changes in assumptions used to measure life assurance liabilities 15 (29) (14) – (14)
With Profit Fund Other (in accordance long-term Total life with FRS 27) funds business £m £m £m as at 31 december 2007
Number of ordinary shares in issue (millions)2 5,973 5,648 5,638 5,603 5,596 financial ratios (%)3
Joined the board in 2004 as group finance director. Appointed as group executive director, UK retail banking in April 2008. Group finance director of Kingfisher from 2000 to 2004. Previously finance director of B&Q from 1997, having joined that company in 1995, and held a senior position at McKinsey & Co from 1990 to 1995. Began her career at Unilever in 1983. A non-executive director of Royal Mail Holdings. A member of the Said Business School Advisory Board and a former member of the Accounting Standards Board. Aged 46
Joined the Group in 2003 as managing director, corporate banking before being appointed to the board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was president and chief executive officer of eCharge Corporation from 1999 to 2001 and co-founder and vice chairman of the board of Chase Cost Management Inc from 1996 to 2003. A non-executive director of BritishAmerican Business Inc. A member of the fund-raising board of the National Society for the Prevention of Cruelty to Children, a director of Business in the Community and a director and trustee of In Kind Direct. Aged 58
GROUP STRUCTURE On 16 January 2009, Lloyds TSB Group plc changed its name to Lloyds Banking Group plc, following the acquisition of HBOS plc.
DIRECTORS’ RESPONSIBILITy STATEMENT Each of the current directors, whose names and functions are shown on pages 66 and 67 of this annual report, confirms that, to the best of his or her knowledge: – the financial statements, prepared in accordance with International Financial Reporting Standards as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and Group; and
The committee exercises specific powers delegated to it by the board from time to time.
The risk oversight committee comprises Sir Victor Blank (chairman), Mr Brown, Mr du Plessis, Sir Julian Horn-Smith, Lord Leitch, Sir David Manning, Mr Ryan (from 1 March 2009) and Mr Scicluna. All non-executive directors are also invited to attend meetings if they wish. The risk oversight committee’s duties include overseeing the development, implementation and maintenance of the Group’s overall risk management framework, and its risk appetite, strategy, principles and policies, to ensure they are in line with emerging regulatory, corporate governance and industry best practice. The committee also oversees the Group’s risk exposures; facilitates the involvement of non-executive directors in risk issues and aids their understanding of these issues; oversees adherence to Group risk policies and standards and considers any material amendments to them; and reviews the work of the group risk division.
The attendance of directors at board meetings and at meetings of the audit, nomination, remuneration and risk oversight committees during 2008 were as follows: Audit Nomination Remuneration Risk Oversight Board Committee Committee Committee Committee
Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have prepared the consolidated and parent company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. The financial statements are required by law to give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss of the Group for that period. The directors consider that in preparing the financial statements on pages 97 to 190 the Company and the Group have used appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider applicable have been followed.
We have used targets in our incentive plans that encourage the prudent management of risk. The economic profit measure that we use takes account of the capital we need to generate our profits, and the risk of the business we are undertaking. For a given level of profit, higher risk will result in lower levels of annual incentive payout for our executives. Economic profit is measured on the performance of our business (and in particular default rates on loans) through an entire economic cycle. This discourages management from taking short-term risks that will have adverse long-term consequences. As a result we have been able to avoid the riskier types of lending or the less prudent funding strategies that were the downfall of some other UK banks.
Our past approach to remuneration has been well received by shareholders and a key focus for the committee and the management team is to maintain that positive relationship. We have therefore consulted extensively with shareholders in relation to all of our 2008 and 2009 remuneration decisions.
The remuneration committee reviews the remuneration policy for the top management group. The committee’s role is to ensure that members of the executive management are provided with appropriate incentives to encourage them to enhance the performance of the Group and that they are rewarded for their individual contribution to the success of the organisation.
During 2008, Alithos Limited continued to provide information on behalf of the committee for the testing of the total shareholder return (TSR) (calculated by reference to both dividends and growth in share price) performance conditions for the Group’s long-term incentive schemes.
Mr Daniels, Mrs Risley (Group Human Resources Director), Mr Farley (Reward & Employment Policy Director) and Ms Kemp (HR Director, Total Reward) provided guidance to the committee (other than for their own remuneration).
As a result of this review, and discussions with the FSA, we have identified some areas of governance where we will be implementing changes for the future, as part of our plan for integrating the Lloyds TSB and HBOS businesses:
For the 2009 incentive we have increased the alignment to long-term prudent risk management by introducing deferral. For executive directors and other senior executives, any cash incentive earned will be deferred and paid-out over three years. If the performance that led to the incentive is found to be unsustainable, then this deferred portion may be forfeited.
When deciding the approach to take for remuneration in 2009, the remuneration committee considered a range of factors. In forming the Lloyds Banking Group, our senior executive team will be managing a combined business twice the size of Lloyds TSB, at the same time as integrating two highly complex businesses, one of which had a flawed business model. The balance sheet alone will be among the largest balance sheets in the world. There will be significant increases in workload and responsibilities. Shareholders, customers and tax-payers will want to ensure that the right team is in place, appropriately motivated and incentivised to take this bank forward, put appropriate risk management frameworks into HBOS, and deliver the value from the takeover. The terms on which senior executives have recently been appointed within the banking sector shows that shareholders remain convinced of the need to offer competitive compensation packages.
Basic salaries are reviewed annually, usually in December, taking into account individual performance and market information (which is provided by Towers Perrin) and then adjusted from 1 January of the following year. The remuneration committee confirmed during the 2008 review that the FTSE 20 was the most appropriate comparator group to use to benchmark overall competitiveness of the remuneration package whilst taking particular account of the remuneration practice of our direct competitors, namely the major UK banks. The FTSE 20 is regarded as providing a realistic and relevant comparison in terms of company size and complexity, as well as being a key market for talent.
However, in recognition of the current operating environment and in common with many of our peers, base salaries for 2009 remain unchanged from the salaries set for 2008. Basic salary increases for other employees across the Group will remain in line with any market movement, but will, in general be significantly lower than in previous years.
In reviewing measures, the remuneration committee has aimed to build on existing aspects of the remuneration policy that have been successful, with a focus on long-term performance, taking appropriate account of risk. At the same time, the committee has sought to develop arrangements that motivate executives to meet the near-term objectives of integrating the two businesses.
EARNINGS PER SHARE (APPLyING TO AWARD OF 60 PER CENT OF SALARy, BEING HALF THE REGULAR LTIP AWARD)
Earnings per share continues to be an important measure of our profitability and ability to generate cash at a point in time. The committee has therefore decided to retain this well-recognised measure in our incentive system.
Economic profit has been used as a performance measure within Lloyds TSB for a number of years. It has been very successful at introducing a long-term, risk-based approach to managing our business. Given the increasing focus now being placed on risk-adjusted measures by shareholders and regulators, adoption of this established measure into the LTIP is felt by the committee to be a further enhancement of the alignment between our remuneration and business strategy. Our economic profit measure is a through-the-cycle measure, which encourages prudent risk management of our portfolio, considering the impact of decisions over an entire economic cycle.
The committee is aware that some shareholders favour relative TSR as a measure, and so will further consider its role for long-term incentive awards in 2010 and beyond during the review to be carried out later in 2009. However, it is the view of the committee that an economic profit measure is better aligned with the Financial Services Authority’s draft Code of Practice criteria.
The Integration Award naturally includes a component relating to the achievement of our £1.5 billion synergy goal by the end of 2011. However, in order to demonstrate the credibility of our integration to the market, it is important that the trajectory of achieving the synergies, and the cost of achievement, are well balanced. Therefore, the synergy element will include targets for synergy savings in 2009 and 2010 (although awards will not ultimately vest until the end of 2011, and will be subject to an assessment by the remuneration committee at that point that the synergies have been achieved on a sustainable basis).
The executive directors and the chairman are also eligible to participate in the Group’s ‘sharesave’ scheme and the Group’s ‘shareplan’. These are ‘all-employee’ share schemes.
It is the Group’s policy that where compensation on early termination is due, it should be paid on a phased basis, mitigated in the event that alternative employment is secured, and that bonus payments should relate to the period of actual service, rather than the full notice period, and will be determined on the basis of performance.
Independent non-executive directors do not have service agreements and their appointment may be terminated, in accordance with the articles of association, at any time without compensation.
Ms Dial elected to become a member of the pension scheme for life cover only.
The changes in beneficial interests between 31 December 2008 and 26 February 2009 related to applications made under the Placing and Open Offer, the Scheme of Arrangement relating to the acquisition of HBOS plc and ‘partnership’ and ‘matching’ shares acquired under the Lloyds TSB Group Shareplan.
March 2005 – August 2005 That the Company’s ranking based on TSR over the relevant period against a comparator group (15 companies including Lloyds TSB) must be at least eighth, when 30 per cent of the option will be exercisable. If the Company is ranked first to fourth position in the group, then 100 per cent of the option will be exercisable and if ranked ninth or below, the performance condition is not met.
At Awarded Lapsed At during the year during the year year of vesting Notes
In addition we report to you if, in our opinion, we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and other transactions is not disclosed.
opinion In our opinion: – the consolidated financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union, of the state of the Group’s affairs as at 31 December 2008 and of its profit and cash flows for the year then ended; – the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation; and
Trading and other financial assets at fair value through profit or loss 16 45,064 57,911
Movement in cash flow hedges, net of tax – (15) – (15) – (15)
– transferred to income statement in respect of disposals – (19) – (19) – (19)
Movement in cash flow hedges, net of tax – (12) – (12) – (12)
Employee share option schemes: – value of employee services – – (4) (4) – (4)
In the context of this continued turbulence and uncertainty in the financial markets, combined with a deteriorating global economic outlook, the Group has also taken steps to strengthen its capital position (see note 52 for details of the preference and ordinary share capital issued by the Group in January 2009) in order to provide a buffer against further shocks arising from the financial systems and to ensure that it remains competitive.
2 accounTing poLicies The consolidated financial statements 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 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 financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, availablefor -sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts.
The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include all entities over which the Group has the power to govern the financial and operating policies which generally accompanies a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. Group undertakings are fully consolidated from the date on which control is transferred to the Group; they are de-consolidated from the date that control ceases. Open Ended Investment Companies (OEICs) where the Group, through the Group’s life funds, has a controlling interest are consolidated; the unitholders’ interest is reported in other liabilities. Intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
The Group applies a policy of treating transactions with minority interests as transactions with parties external to the Group. Disposals to minority interests result in gains and losses for the Group that are recorded in the income statement. Purchases from minority interests result in goodwill, being the difference between any consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary.
Purchases and sales of securities and other financial assets and liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset. Trading securities and other financial assets and liabilities at fair value through profit or loss are initially recognised at fair value. Available-for-sale financial assets are initially recognised at fair value inclusive of transaction costs. These financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all risks and rewards of ownership.
All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and options pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 3 (Critical accounting estimates and judgements: Valuation of financial instruments) and note 49 (Financial risk management: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
If there is no objective evidence of individual impairment the asset is included in a group of financial assets with similar credit risk characteristics and collectively assessed for impairment. Segmentation takes into account such factors as the type of asset, industry, geographical location, collateral type, past-due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated. Future cash flows are estimated on the basis of the contractual cash flows of the assets in the Group and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.
Loans that are either subject to collective impairment assessment or individually significant and whose terms have been renegotiated are no longer considered to be past due but are treated as new loans. In subsequent years, the asset is considered to be past due and disclosed only if further renegotiated.
Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): – Freehold/long and short leasehold premises: shorter of 50 years or the remaining period of the lease – Leasehold improvements: shorter of 10 years or, if lease renewal is not likely, the remaining period of the lease
Equipment: – Fixtures and furnishings: 10-20 years – Other equipment and motor vehicles: 2-8 years
The Group’s income statement includes the current service cost of providing pension benefits, the expected return on the schemes’ assets, net of expected administration costs, and the interest cost on the schemes’ liabilities. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are not recognised unless the cumulative unrecognised gain or loss at the end of the previous reporting period exceeds the greater of 10 per cent of the scheme assets or liabilities (‘the corridor approach’). In these circumstances the excess is charged or 2 accounTing poLicies continued
Premiums received in respect of insurance and participating investment contracts are recognised as revenue when due, except as detailed below in respect of unit-linked contracts.
– insurance or participating investment contracts which are not unit-linked or in the group’s With profit fund
A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by estimating the future cash flows over the duration of in-force policies and discounting them back to the valuation date allowing for probabilities of occurrence. The liability will vary with movements in interest rates and with the cost of life assurance and annuity benefits where future mortality is uncertain.
The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into sterling at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on the translation of a foreign operation are recognised directly in equity and included in profit or loss on its disposal.
At 31 December 2008 gross loans and advances to customers and banks totalled £287,220 million (2007: £247,067 million) against which impairment allowances of £3,727 million (2007: £2,408 million) had been made.
Assumptions used in calculating provisions for loan impairment have been updated to reflect market conditions, including those in respect of house price inflation, forced sale discount and probability of borrower default. If average house prices were 12.5 per cent lower than those in place as at 31 December 2008, the house price index related impact on the impairment charge would be an increase of approximately £85 million.
The fair values of the Group’s financial assets and liabilities are disclosed within note 49 on pages 175 to 177 together with an indication of the valuation technique used for each major asset or liability category, the inputs into valuation models that have the potential to significantly impact the value determined, the assumptions, if any, used for those inputs and the effects of applying reasonably possible alternative assumptions or, in the case of ABS within available-for-sale financial assets, a shift in credit spreads.
The net liability recognised in the balance sheet at 31 December 2008 in respect of the Group’s retirement benefit obligations was £1,771 million (2007: £2,144 million) of which £1,657 million (2007: £2,033 million) related to defined benefit pension schemes. This liability excludes actuarial losses of £267 million (2007: gains of £1,350 million) which the Group is permitted to leave unrecognised. The defined benefit pension schemes’ gross deficit totalled £1,924 million (2007: £683 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
Two important assumptions are the rate of inflation and the expected lifetime of the schemes’ members. The assumed rate of inflation affects the rate at which salaries are projected to grow and therefore the size of the pension that employees receive upon retirement and also the rate at which pensions in payment increase. Over the longer term rates of inflation can vary significantly; at 31 December 2008 it was assumed that the rate of inflation would be 3.0 per cent per annum (2007: 3.3 per cent), although if this was increased by 0.2 per cent the overall deficit would increase by approximately £451 million and the annual cost by approximately £17 million. A reduction of 0.2 per cent would reduce the overall deficit by approximately £437 million and the annual cost by approximately £16 million.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 4 segmenTaL anaLysis The Group is a leading financial services group, whose businesses provide a wide range of banking and financial services predominantly in the UK.
wholesale Life, pensions insurance and uk retail general and asset and international central inter-segment banking insurance management investments banking group items eliminations Total £m £m £m £m £m £m £m £m year ended 31 december 2008
Securities and other (losses) gains comprise net gains arising on assets and liabilities held at fair value through profit or loss and for trading as follows: £m £m
Fees payable for the audit of the Company’s current year annual report 7.1 6.8
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 2.5 2.5
Audits of the unconsolidated Open Ended Investment Companies managed by the Group 0.5 0.4
other non-audit fees: This category includes due diligence relating to corporate finance, including venture capital transactions and other assurance and advisory services.
The Group has procedures that are designed to ensure auditor independence, including that fees for audit and non-audit services are approved in advance. This approval can be obtained either on an individual engagement basis or, for certain types of non-audit services, particularly those of a recurring nature, through the approval of a fee cap covering all engagements of that type provided the fee is below that cap. All statutory audit work as well as non-audit assignments where the fee is expected to exceed the relevant fee cap must be pre-approved by the audit committee on an individual engagement basis. On a quarterly basis, the audit committee receives a report detailing all pre-approved services and amounts paid to the auditors for such pre-approved services.
Total impairment charged to the income statement 3,012 1,796 13 profiT on saLe of businesses £m £m
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 16 Trading and oTher financiaL asseTs aT fair vaLue Through profiT or Loss £m £m
(iii) certain private equity investments 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.
The maximum exposure to credit risk at 31 December 2008 of the loans and advances to banks and customers designated at fair value through profit or loss was £325 million (2007: £404 million); the Group does not hold any credit derivatives or other instruments in mitigation of this risk. There was no significant movement in the fair value of these loans attributable to changes in credit risk; this is determined by reference to the publicly available credit ratings of the instruments involved.
The Group’s Corporate Markets business has no direct exposure to US sub-prime ABS and limited indirect exposure through asset-backed security collateralised debt obligations (ABS CDOs). During 2008, the market value of Corporate Markets’ holdings in ABS CDOs reduced and, as a result, there has been an income statement charge of £92 million (2007: £114 million). The Group’s Corporate Markets business has no exposure to mezzanine ABS CDOs. In addition, there are £1,867 million (2007: £1,861 million) of ABS CDOs which remain fully cash collateralised by major global financial institutions.
Financial calendar 2009 195 16 Trading and oTher financiaL asseTs aT fair vaLue Through profiT or Loss continued
At 31 December 2008, fair values of £956 million (2007: £1,570 million) of the Group’s trading and other financial assets classified as fair value through profit or loss, held within the Corporate Markets business, were valued using unobservable inputs. These assets largely represent the Group’s venture capital investments, for which values are determined using valuation techniques which follow British Venture Capital Association (BVCA) guidelines. In respect of these assets, during the year to 31 December 2008, a credit of £111 million (2007: credit of £51 million) was recognised in the income statement relating to the change in their fair values.
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. As discussed in note 19, the Group also uses credit default swaps to securitise, in combination with external funding, £8,360 million (2007: £4,325 million) of corporate and commercial banking loans.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued contract/notional fair value fair value amount assets liabilities £m £m £m
Derivatives designated as fair value hedges: Interest rate swaps (including swap options) 37,243 434 1,665
Total recognised derivative assets/liabilities 8,659 7,582 18 Loans and advances To banks £m £m
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 19 Loans and advances To cusTomers £m £m
At 31 December 2008 the total amount of residential mortgages subject to securitisation was £34,293 million (2007: £46,284 million) in respect of which external funding at the year end amounted to £9,824 million (2007: £12,403 million); external funding is shown in debt securities in issue (see note 31). The Group participates in the securitisation through the provision of administration and other services, the provision of interest rate and currency swaps and in the form of unsecured loan financing which is subordinate to the interests of the floating rate note holders.
In addition the Group has entered into a number of securitisations of elements of its corporate and commercial loan portfolio. The total value of loans so securitised was £8,360 million (2007: £4,325 million), utilising a combination of external funding totalling £226 million (2007: £98 million) and credit default swaps.
Loans and advances to customers Loans and Retail – Retail – advances to mortgages other Wholesale Total banks Total £m £m £m £m £m £m
Recoveries of advances written off in previous years 1 111 – 112 – 112
Equity shares: Treasury bills and other bills: Treasury bills and similar securities – 2,402 2,402 – 1,608 1,608
Cancara is the Group’s hybrid Asset Backed Commercial Paper conduit. Total exposures in Cancara were £12,615 million (31 December 2007: £12,469 million) comprising the £6,273 million (31 December 2007: £8,268 million) of debt securities detailed above and £6,342 million (31 December 2007: £4,201 million) of loans and advances to customers (see note 19). Cancara, which is fully consolidated in the Group’s accounts, is managed in a very conservative manner, which is demonstrated by the quality and ratings stability of its underlying asset portfolio. At 31 December 2008, the asset-backed securities in Cancara were 91.8 and 94.2 per cent (31 December 2007: 100 per cent) Aaa/AAA rated by Moody’s and Standard & Poor’s respectively, and there was no exposure either directly or indirectly to sub-prime US mortgages within Cancara’s debt security portfolio. At 31 December 2008 loans and advances included no US sub-prime mortgage exposure (31 December 2007: £115 million).
The investment properties are valued at least annually at open-market value, by independent, professionally qualified valuers, who have recent experience in the location and categories of the investment properties being valued.
Capital expenditure contracted for at the balance sheet date but not recognised in the financial statements 82 111 23 goodwiLL
The recoverable amount of Asset Finance has also been based on a value in use calculation using cash flow projections based on financial budgets and plans approved by management covering a five-year period and a discount rate of 15 per cent (gross of tax). The discount rate has been set at a premium over the Group’s weighted average cost of capital to take into account the specific risk profile of the Asset Finance business. The cash flows for each of the businesses of Asset Finance beyond the five-year period are extrapolated using steady growth rates, in each case not exceeding 2.5 per cent nor the long-term average growth rates for the markets in which the respective businesses of Asset Finance participate.
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 the risk-free rate and all cash flows are discounted at the risk-free rate.
Future mortality, morbidity, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and represent management’s best estimate of likely future experience.
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2008 and 2007 no contingent rentals in respect of operating leases were recognised in the income statement.
At 31 December 2008 £1,833 million (2007: £1,781 million) of other assets had a contractual residual maturity of greater than one year.
28 deposiTs from banks The breakdown of deposits from banks between the domestic and international offices of the Group is set out below: £m £m
Included in deposits from banks were deposits of £2,574 million (2007: £1,509 million) held as collateral, principally in relation to derivative contracts. The fair value of those deposits approximates the carrying amount.
At 31 December 2008 £2,499 million (2007: £1,949 million) of customer accounts had a contractual residual maturity of greater than one year.
Included in customer accounts were deposits of £1,002 million (2007: £777 million) held as collateral, principally in relation to derivative contracts. The fair value of those deposits approximates the carrying amount.
30 Trading and oTher LiabiLiTies aT fair vaLue Through profiT or Loss £m £m
At 31 December 2008 £6,525 million (2007: £2,032 million) of trading and other liabilities at fair value through profit or loss had a contractual residual maturity of greater than one year.
Non-life insurance (see (2) below): Reinsurance balances receivable are reported within other assets (note 27).
The Group’s With Profit Fund contains life insurance contracts and participating investment contracts. The calculation of With Profit Fund 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 24. The persistency rates used for the realistic valuation of the With Profit Fund liabilities make an allowance for potential changes in future experience as the guarantees and options within with-profits contracts become more valuable under adverse market conditions.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 34 LiabiLiTies arising from non-parTicipaTing invesTmenT conTracTs The movement in liabilities arising from non-participating investment contracts may be analysed as follows: Gross Reinsurance Net £m £m £m
Defined contribution pension schemes 71 63 £m £m amounts recognised in the balance sheet
The latest full valuations of the two main schemes are being carried out as at 30 June 2008. The provisional results have been updated to 31 December 2008 by qualified independent actuaries. The last full valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2008 by qualified independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows.
An analysis of the impact of a reasonable change in these assumptions is provided in note 3.
During the year ended 31 December 2008 the charge to the income statement in respect of these schemes was £71 million (2007: £63 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 30 June 2007; this valuation has been updated to 31 December 2008 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 7.50 per cent (2007: 7.43 per cent).
Charge for the year 7 17 38 deferred Tax The movement in the net deferred tax balance is as follows: £m £m
Lloyds Banking Group Annual Report and Accounts 2008 39 other provisions provisions for vacant contingent Customer leasehold liabilities and remediation property commitments provisions and other total £m £m £m £m
Charge for the year 6 – 35 41 provisions for Contingent liabilities and Commitments
The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales, in those cases where the original sales processes have been found to be deficient. During 2008 management has reviewed the adequacy of the provisions held having regard to current complaint volumes and the level of payments being made and are satisfied that no additional charge is required. At 31 December 2008 the remaining provisions held relate to past sales of a number of products, including mortgage endowment policies, sold through the branch networks of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester and underwritten by life assurance companies within the Group and also by third parties. The principal assumptions that are made in the assessment of the adequacy of the provision relate to the number of cases that are likely to require redress, taking into account any time barring, and the estimated average cost per case. The ultimate cost and timing of the payments remains highly uncertain and will be influenced by external factors beyond the control of management, such as regulatory actions, media interest and the performance of the financial markets. However, it is expected that the majority of the remaining expenditure will be incurred within the next five years.
b) Dividends will accrue at a rate of 6.369 per cent per annum up to 24 August 2015, and, unless redeemed, at a rate reset quarterly equal to 1.28 per cent per annum above the London interbank offered rate for three-month sterling deposits thereafter. These preference shares can be redeemed at the option of the Company on 25 August 2015 or quarterly thereafter.
d) In certain circumstances, these notes, bonds and securities would acquire the characteristics of preference share capital. Any repayments of undated subordinated liabilities would require prior notification to the financial Services Authority. They are accounted for as liabilities since coupon payments are mandatory as a consequence of the terms of the 6 per cent non-cumulative Redeemable Preference Shares.
f) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds Banking Group plc can declare or pay a dividend until payments have been resumed. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares.
g) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds Banking Group plc can declare or pay a dividend until payments are resumed. Any deferred payments will be made good on redemption of the securities. The securities can be redeemed at par at the option of Lloyds TSB Bank plc on any coupon date.
m) These securities constitute limited partnership interests in Lloyds TSB Capital 1 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. non-cumulative income distributions accrue at a fixed rate of 7.375 per cent per annum up to 7 february 2012; thereafter they will accrue at a margin of 2.33 per cent over EURIBoR. This issue was made under the limited subordinated guarantee of Lloyds TSB Bank plc. In certain circumstances these preferred securities will be mandatorily exchanged for preference shares in Lloyds Banking Group plc. Lloyds Banking Group plc has entered into an agreement whereby dividends may only be paid on its ordinary shares if sufficient distributable profits are available for distributions due in the financial year on these preferred securities.
n) These securities constitute limited partnership interests in Lloyds TSB Capital 2 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. non-cumulative income distributions accrue at a fixed rate of 7.834 per cent per annum up to 7 february 2015; thereafter they will accrue at a margin of 3.50 per cent over a rate based on the yield of specified UK Government stock. This issue was made under the limited subordinated guarantee of Lloyds TSB Bank plc. In certain circumstances these preferred securities will be mandatorily exchanged for preference shares in Lloyds Banking Group plc. Lloyds Banking Group plc has entered into an agreement whereby dividends may only be paid on its ordinary shares if sufficient distributable profits are available for distributions due in the financial year on these preferred securities.
Japanese yen: ¥m ¥m 50 million Preference shares of ¥25 each 1,250 1,250 number of shares number of shares £m £m issued and fully paid ordinary shares ordinary shares of 25p each
Information regarding significant direct or indirect holdings of shares in the Company can be found on page 191.
ordinary shares The holders of ordinary shares (excluding the limited voting ordinary shares), who held 98.7 per cent of the total share capital as at 31 December 2008, are entitled to receive the Company’s report and accounts, attend, speak and vote at general meetings and appoint proxies to exercise voting rights. Holders of ordinary shares (excluding the limited voting ordinary shares) may also receive a dividend (subject to the provisions of the Company’s articles of association) and on a winding up may share in the assets of the Company.
Any repayment of the fixed/floating rate non-cumulative callable preference shares would require prior notification to the fSA. The sterling fixed/floating rate non-cumulative callable preference shares can be redeemed at the option of the Company on or after 25 August 2015; at this call date, dividends will be reset at a margin of 1.28 per cent over 3 month LIBoR. The US dollar fixed/floating rate non-cumulative callable preference shares can be redeemed at the option of the Company on or after 14 november 2016; at this call date, dividends will be reset at a margin of 1.035 per cent over 3 month LIBoR. In certain circumstances, the fixed/floating rate non-cumulative callable preference shares may be mandatorily exchanged for qualifying non-innovative tier 1 securities and in certain circumstances and subject to compliance with certain requirements, the fixed/floating rate non-cumulative callable preference shares may be redeemed by the Company at certain times in the event that the fSA makes a decision that the preference shares can no longer qualify as non-innovative tier 1 capital. The Company may declare no dividend or a partial dividend on these preference shares; notwithstanding this discretion, in certain circumstances, the dividends on the fixed/floating rate non-cumulative callable preference shares will be mandatorily payable if the preference shares cease to be eligible to qualify as regulatory capital and the Company is in
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued compliance with relevant fSA regulations regarding capital adequacy. Dividends may be reduced if the distributable profits of the Company are insufficient to cover the payment in full of the dividends and also the payment in full of all other dividends on shares issued by the Company. These securities were issued during 2006 primarily to finance the development and expansion of the business of the Group.
At 1 January and 31 December 343 343 £m £m revaluation reserve in respect of available-for-sale financial assets
45 ordinary dividends pence per share Pence per share £m £m final dividend for previous year paid during the current year 24.7 23.5 1,394 1,325
Growth in earnings per share which is equal to the aggregate percentage change in the Retail Price Index plus two percentage points for each complete year of the relevant period together with a further condition that Lloyds Banking Group plc’s ranking based on total shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be in the top fifty companies of the fTSE 100.
The performance condition is linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 17 companies including Lloyds Banking Group plc.
The same conditions apply as for grants made up to August 2004, except that: – the performance condition is linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 15 companies including Lloyds Banking Group plc; – if the performance condition has not been met at the end of the third subsequent year, the options will lapse; and – the full grant of options becomes exercisable only if the Group is ranked in the top four places of the comparator group. A sliding scale applies between fourth and eighth positions. If Lloyds Banking Group is ranked below the median (ninth or below) the options will not be exercisable and will lapse.
The weighted average share price at the time that the options were exercised during 2008 was 370.29 pence (2007: 552.20 pence). The weighted average remaining contractual life of options outstanding at the end of the year was 3.4 years (2007: 1.7 years).
Exercised (117,236) nil (203,170) nil forfeited (15,802) nil (59,679) nil outstanding at 31 December 857,611 nil 308,718 nil
The weighted average remaining contractual life of options outstanding at the end of 2007 was 0.9 years.
(ii) for the other 50 per cent of the award (the ‘TSR Award’) – the performance condition is as described for may 2006 with the relevant performance period commencing on 8 march 2007 (the date of the first award) and ending on 7 march 2010.
The fair value of the share awards granted in 2008 was £2.28 (2007: £3.13).
An award of shares may be made annually to employees based on a percentage of each employee’s salary in the preceding year up to a maximum of £3,000. The percentage is normally announced concurrently with the Group’s annual results and the price of the shares awarded is announced at the time of award. The shares awarded are held in trust for a mandatory period of three years on the employee’s behalf. The award is subject to a non-market based condition: if an employee leaves the Group within this three year period for other than a ‘good’ reason, all of the shares awarded will be forfeited (for awards made up to April 2005, only a portion of the shares would be forfeited: 75 per cent within one year of the award, 50 per cent within two years and 25 per cent within three years).
The number of shares awarded relating to free shares in 2008 was 8,862,823 (2007: 6,784,201), with an average fair value of £4.38 (2007: £5.82), based on the market price at the date of award.
In addition, mr fairey retired as at 30 June 2008 and received his non approved benefit entitlement in the form of a lump sum in accordance with the scheme rules. A tax free amount of £4,523,000 was paid from the fURBS, with a further taxable amount of £2,446,000 made by the Group from provisions set aside. The total amount of £6,969,000 covered the Group’s liability to provide benefits in respect of salary in excess of the earnings cap.
The Group manages 105 (2007: 107) open Ended Investment Companies (oEICs), and of these 47 (2007: 40) are consolidated. The Group invested £455 million (2007: £1,961 million) and redeemed £343 million (2007: £1,526 million) in the unconsolidated oEICs during the year and had investments, at fair value, of £2,661 million (2007: £2,233 million) at 31 December. The Group earned fees of £206 million from the unconsolidated oEICs (2007: £200 million). The Company held no investments in oEICs at any time during 2007 or 2008.
A further hearing was held on 7 to 9 July 2008 to consider whether those financial institutions’ historic terms and conditions are capable of being penalties, and to consider whether their historic terms are assessable for fairness. on 21 January 2009, the court confirmed that the relevant charges under Lloyds TSB Bank plc’s historic terms and conditions are not capable of being penalties but are assessable for fairness, to the extent that the bank’s contracts with customers included the applicable charging terms. The issue of whether the charges are actually fair will be determined at subsequent hearings. If various appeals are pursued, the proceedings may take a number of years to conclude.
Cases before the financial ombudsman Service and the County Courts are currently stayed pending the outcome of the legal proceedings initiated by the ofT. Lloyds Banking Group intends to continue to defend its position strongly. Accordingly, no provision in relation to the outcome of this litigation has been made. Depending on the High Court’s determinations, a range of outcomes is possible, some of which could have a significant financial impact on the Group. The ultimate impact of the litigation on the Group can only be known at its conclusion.
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued £m £m
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: mortgage offers made 3,056 4,639 1 year or over original maturity 31,761 32,165 of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £46,890 million (2007: £53,036 million) was irrevocable.
at fair value derivatives through profit or loss designated designated held at as hedging held for upon initial available- loans and amortised insurance instruments trading recognition for-sale receivables cost contracts total £m £m £m £m £m £m £m £m as at 31 december 2008 financial assets
Items in course of transmission to banks – – – – – 508 – 508
Cash and balances at central banks – – – – – 4,330 – 4,330
Liabilities arising from non-participating investment contracts – – – – – – 18,197 18,197
Subordinated liabilities – – – – – 11,958 – 11,958 reClassifiCation of finanCial assets
Since their reclassification to loans and receivables, a net credit of £31 million has been recognised in the income statement for the six months to 31 December 2008 within net interest income and a charge of £158 million within impairment. The weighted average effective interest rate of the assets transferred was 6.3 per cent with expected recoverable cash flows of £3,524 million.
Since their reclassification to loans and receivables, an amount of £3 million has been recognised in the income statement for the two months to 31 December 2008 within interest income and a further £23 million within impairment. The weighted average effective interest rate of the assets transferred was 10.9 per cent with expected recoverable cash flows of £837 million.
foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the Group’s overseas operations.
The Group’s main overseas operations are in the Americas, Asia and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows: 49 finanCial risK management continued
The Group’s credit risk exposure arises predominantly in the United Kingdom and the European Union.
Irrevocable loan commitments and other credit-related contingencies2 51,659 56,600 maximum credit risk exposure 436,824 356,860 maximum credit risk exposure before offset items 452,259 366,353
loans and advances to banks – the Group may require collateral before entering into a credit commitment with another bank, depending on the type of the financial product and the counterparty involved, and netting agreements are obtained whenever possible and to the extent that such agreements are legally enforceable.
assets arising from reinsurance contracts held – of the assets arising from reinsurance contracts held at 31 December 2008 of £385 million (2007: £350 million), £380 million (2007: £341 million) were due from insurers with a credit rating of AA or above.
The analysis of lending between retail and wholesale has been prepared based upon the type of exposure and not the business segment in which the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within wholesale are exposures to corporate customers and other large institutions.
Collateral held against retail mortgage lending is principally comprised of residential properties; their fair value has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house prices, after making allowance for indexation error and dilapidations. The resulting valuation has been limited to the principal amount of the outstanding advance in order to provide a clearer representation of the Group’s credit exposure.
Analysis by loan to value ratio of the Group’s residential mortgage lending which is neither past due nor impaired: Less than 70 per cent 55,040 66,716 70 per cent to 80 per cent 15,812 15,690 80 per cent to 90 per cent 15,954 12,102
Debt securities, treasury and other bills – analysis by credit rating: rated bb aaa aa a bbb or lower not rated total £m £m £m £m £m £m £m as at 31 december 2008 debt securities held at fair value through profit or loss
Bank and building society certificates of deposit – 9,418 166 – 18 – 9,602
Rated BB AAA AA A BBB or lower not rated Total £m £m £m £m £m £m £m as at 31 december 2007 debt securities held at fair value through profit or loss
Total held as trading assets 330 1,311 1,502 149 62 524 3,878 other assets held at fair value through profit or loss: Bank and building society certificates of deposit 42 548 53 – – 168 811 mortgage backed securities 61 – – – – 9 70
1 month months months years years Total £m £m £m £m £m £m as at 31 december 2008
further information on the Group’s liquidity exposures is provided on pages 55 and 56.
Index to annual report 192 financial calendar 2009 195 within 1-3 3-5 over 5 1 year years years years total £m £m £m £m £m
The valuation technique for each major category of financial instrument and, where valuation models are used, significant inputs into valuation models, are discussed below.
The fair value movement on assets and liabilities held at fair value through profit or loss and gains in respect of instruments held for trading are disclosed in note 7.
An analysis of derivatives including fair values by contract type is given in note 17.
At 31 December 2008, the Group had a senior synthetic position in a structured corporate collateralised debt obligation (CDo) that is valued in part using assumptions around recovery levels. The effect of using reasonably possible alternative favourable or adverse assumptions for recovery levels would increase or reduce net trading income by up to £80 million respectively.
The fair value of short-term debt securities in issue is approximately equal to their carrying value. fair value for other debt securities and for subordinated liabilities is estimated using quoted market prices.
Trading and other liabilities at fair value through profit or loss 6,754 3,206 6,754 3,206
Liabilities arising from non-participating investment contracts 14,243 18,197 14,243 18,197 50 Consolidated Cash flow statement
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss 22,565 3,840
(d) analysis of Cash and Cash equivalents as shown in the balanCe sheet £m £m
Total cash and cash equivalents 32,760 31,891 mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-day operations.
Included within cash and cash equivalents at 31 December 2008 is £8,255 million (2007: £7,426 million) held within the Group’s life funds, which is not immediately available for use in the business.
Trading and other financial assets at fair value through profit or loss – 10,999
IfRS 8 operating Segments Replaces IAS 14 Segment Reporting and requires reporting of financial and descriptive information about operating segments which are based on how financial information is reported and evaluated internally.
Requires the effects of all transactions with non-controlling interests to be recorded in equity if there is no change in control; any remaining interest in an investee is re-measured to fair value in determining the gain or loss recognised in profit or loss where control over the investee is lost.
Amendment to IAS 39 financial Instruments: Recognition and measurement – Eligible Hedged Items1, 2
on 13 January 2009, the Group issued 2,596,653,203 ordinary shares at 173.3p, largely subscribed for by Hm Treasury, raising a total of £4,500 million.
aCquisition on 16 January 2009, the Group acquired 100 per cent of the ordinary share capital of HBoS plc, which together with its subsidiaries undertakes banking, insurance and other financial services related activities. Under the terms of the acquisition, HBoS shareholders received 0.605 Lloyds Banking Group shares for every 1 HBoS share.
Capitalisation issue on 19 november 2008, the Company’s shareholders approved, subject to certain conditions, a resolution authorising the board to capitalise an amount out of the Company’s reserves and to apply such amount in paying up new Company shares. on 26 february 2009, the board approved a capitalisation issue of one for forty ordinary shares held.
name Change on 19 november 2008, the Company’s shareholders approved, subject to certain conditions, a resolution changing the name of the Company to Lloyds Banking Group plc. These conditions were met and the Company changed its name on 16 January 2009.
We report to you our opinion as to whether the parent company financial statements give a true and fair view and whether the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985. We also report to you whether, in our opinion, the information given in the directors’ report is consistent with the parent company financial statements. The information given in the directors’ report includes that specific information presented in the overview and the Business Review that is cross referred from the principal activities, business review, future developments and financial risk management objectives and policies section of the directors’ report.
We read other information contained in the annual report and consider whether it is consistent with the audited parent company financial statements. The other information comprises only the chairman’s statement, the group chief executive’s review, the Business Review, the directors’ report, the corporate governance disclosures, the unaudited part of the directors’ remuneration report, the shareholder information and all other information listed on the contents page . We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the parent company financial statements. our responsibilities do not extend to any other information.
opinion In our opinion: – the parent company financial statements give a true and fair view, in accordance with IfRSs as adopted by the European Union as applied in accordance with the provisions of the Companies Act 1985, of the state of the parent company’s affairs as at 31 December 2008 and cash flows for the year then ended; – the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985; and – the information given in the directors’ report is consistent with the parent company financial statements.
sir victor blank J eric daniels tim J w tookey Chairman Group Chief Executive Group finance Director
2 deferred tax assets The movement in the net deferred tax assets is as follows: £m £m
In certain circumstances, these bonds would acquire the characteristics of preference share capital. Any repayments of undated loan capital would require the prior consent of the financial Services Authority. They are accounted for as liabilities as coupon payments are mandatory as a consequence of the terms of certain preference shares. At the callable date the coupon on these bonds will be reset by reference to the applicable five year benchmark gilt rate.
The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of Lloyds Banking Group plc, are: Percentage of equity
Lloyds TSB Asset finance Division Limited England 100%† Consumer credit, leasing and related services
none of the parent company’s subsidiaries has experienced any significant restrictions in paying dividends or repaying loans and advances. All regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may impact those subsidiaries’ ability to make distributions.
Total financial liabilities 29 – – 4,089 4,118 interest rate risK and CurrenCy risK
Debt securities in issue 2,644 1,744 2,644 1,744 10 post balanCe sheet events Details of the Company’s post balance sheet events are set out in note 52 to the consolidated financial statements.
11 approval of the finanCial statements and other information The parent company financial statements were approved by the directors of Lloyds Banking Group plc on 26 february 2009.
Parent company financial statements 183 notes to the parent company financial statements 186 shareholder information shareholder information 191
Lloyds Banking Group shares are traded in the USA through an nYSE-listed sponsored ADR facility, with The Bank of new York mellon as the depositary. The ADRs are traded on the new York Stock Exchange under the symbol LYG. The CUSIP number is 539439109 and the ratio of ADRs to ordinary shares is 1:4.
Computershare Investor Services continue to maintain the register of Lloyds Banking Group shareholder account holders (formerly the HBoS shareholder account). If you have any queries please either write to Computershare Investor Services PLC, Po Box 1910, Bristol BS99 7DS or call 0870 702 0102 or visit www.computershare.com
Directors’ pensions 84, 87 notes to the consolidated financial statements 142 post balanCe sheet events 181 prinCipal subsidiaries 188 presentation of information contents page provisions
Accounting policy 110 notes to the group accounts 148 regulation 35 related party transaCtions 161 risK management frameworK