lloyds Banking Group is quoted on both the london stock Exchange and the new York stock Exchange and is one of the largest companies within the FTsE 100.
Risk overview 42 summary of Group results 44 divisional results Retail 52 commercial Banking 55 Wealth, Asset Finance and international 59 insurance 63 Group Operations & central items 67
Parent company financial statements 345 notes to the parent company financial statements 348
q statutory loss of £570 million primarily due to PPi provisions of £3,575 million (including £1,500 million in the fourth quarter of 2012), and including £3,207 million of gains from sales of government securities
Presentation of information in order to provide a more meaningful view of underlying business pursuance, the results of the Group and divisions are presented on a management basis. The key principles adopted in the preparation of the management basis of reporting are described below.
MEAsuRinG sTRATEGic PERFORMAncE Our strategy lloyds Banking Group operates a simple, lower risk, customer focused uK retail and commercial banking business model. Our strategy is built around becoming the best bank for customers and creating value by investing in areas that make a real difference to these customers. customer leadership driven by superior customer insight, tailored products, better service and relationship focus is the overriding priority. By leveraging these capabilities and our strategic assets we believe we can help Britain prosper and deliver strong, stable and sustainable returns for shareholders.
How we measure performance We track our progress against our strategy to become the best bank for customers using a range of performance measures. Our progress in these areas is measured against a number of key financial indicators which are shown here.
PeRFORMAnCe MeASUReS Unlocking the Group’s potential We are reshaping our business portfolio to fit our assets, capabilities and risk appetite, strengthening the Group’s balance sheet and liquidity position, simplifying the Group to improve agility and efficiency and investing to be the best bank for customers. A comprehensive set of Key Performance indicators (KPis) has been developed to track progress in each of these areas and is outlined in the strategy section.
The Simplification programme has been running for 18 months and has maintained strong progress throughout the year, with over 200 initiatives underway across the Group.
As Simplification benefits materialise we are looking to increase the investment in the business and have committed to invest £500 million pa by 2014 in addition to our business as usual investment programme.
q Return on risk-weighted assets increased to 3.21 per cent from 2.56 per cent in 2011, driven primarily by the increase in profits.
q Retail has made continued progress in improving its customer service scores and saw a reduction in customer complaints (excluding PPi) of 28 per cent during 2012, both key indicators of customer advocacy. This has supported the strengthening of brand consideration to market leading levels.
The international business comprises the Group’s non-core banking business outside the uK, with the exception of corporate business written through the commercial Banking division. This primarily comprises ireland, Retail Europe and Asia.
Contribution towards total Group income1 Performance indicators Underlying loss before tax £m
Key brands include: 2012 highlights q in 2012 we combined our uK life Pensions and investments and General insurance businesses and restructured our operation to enable greater customer and market focus which contributed to an 8 per cent decrease in costs and leaves us well placed to realise benefits from risk diversification.
Overview 2012 was a momentous year for the united Kingdom. We celebrated the diamond Jubilee and the london 2012 Olympic and Paralympic Games. lloyds Banking Group was appointed a national Partner to the Games in 2007, and in this role we helped fund emerging athletes, supply volunteers and, crucially, support local businesses to enable them to take full advantage of the available commercial opportunities. We are proud of the significant role the Group played and of our part in creating a lasting legacy.
Directors We have strengthened and further diversified the knowledge and experience on our Board. On 31 May 2012, two new non-Executive directors were appointed, carolyn Fairbairn and lord Blackwell. carolyn’s background in strategy, public policy and regulation complements the experience of lord Blackwell in banking, consulting and life insurance. These appointments add to the existing combination of skills, and banking and life insurance perspectives, already present on our Board and will contribute to the quality of decision making.
i am pleased that we achieved our commitment of 25 per cent female representation on the Board three years ahead of the 2015 timeline mandated by the lord davies report. We believe that diversity in background and experience helps to enhance the quality of deliberations and decision making, and we will continue to promote it within the Board as an example to our entire organisation.
Within lloyds Banking Group we recognise the value of diversity in our colleagues from a broad and representative mix of backgrounds and experiences: different perspectives allow us to see and develop new opportunities. We promote internal initiatives to support diversity and inclusion within the Group and i was pleased to see our achievements also being recognised at the Business disability Forum. We can only achieve our customer-focused strategy by building a sound reputation founded on the highest standards of responsible behaviour. in 2012 we launched the codes of Responsibility to guide our decision making and help us put into practice our commitment to strive always to do the right thing.
Our Board The Board has seen a number of changes this year, and in line with the provisions of the uK corporate Governance code and the interests of good corporate governance, all directors are required to submit themselves for re-election on an annual basis. We are committed to ensuring we have the right balance of skills and experience within the Board, and we annually review its composition, and the diversity of backgrounds of its members.
Additionally the Board is committed to maintaining alignment between our senior executives and shareholders and we continue to operate a stringent deferral policy to ensure individual reward is aligned with the Group’s performance, the interests of its shareholders, and a prudent approach to risk management allowing where necessary for appropriate adjustment of incentive compensation to reflect malus. in March 2012, the Group announced that it had applied a performance adjustment to the deferred bonuses of certain directors and senior managers in relation to PPi. The long Term incentive Plan remains a core element of our reward package, although this did not pay out for four years to 2012.
Summary in 2012, we accelerated the delivery of our strategic initiatives and are now ahead of our plan to transform the Group, despite the challenging economic environment and continued regulatory uncertainty. As a result of our actions, the Group is now in a far stronger position, with capital ratios further improved, our funding position transformed, a significant and capital-accretive reduction in non-core assets achieved, costs reduced in absolute terms and asset quality further improved. While legacy issues, notably payment protection insurance (PPi), resulted in the Group still reporting a loss at the statutory level, our achievements resulted in a significant improvement in both Group underlying and statutory performance, and continued strong returns, above our cost of equity, being delivered in our core business.
The core business continues to deliver strong and stable returns above our cost of equity, with a return on risk-weighted assets of 2.56 per cent achieved in 2012, an increase of 10 basis points when compared to 2011 despite the challenging environment, with a small reduction in underlying profit of £42 million to £6,154 million being more than offset by a reduction of £6.1 billion in core risk-weighted assets. We continued to reduce costs in the core business, where they fell 5 per cent to £9,212 million, while the continued application of our conservative risk appetite meant that asset quality remained good, and the core impairment charge reduced by £968 million to £1,919 million.
Reinvesting a proportion of the savings from the simplification programme into our core franchise allows us to provide even greater levels of support and service to our customers.
Across commercial Banking, as part of our programme to enhance our capabilities in capital efficient products, we have continued to invest in the Transaction Banking platform, delivering new product propositions in card Payments & Acceptance, currencies and international cash Management. We also continued to invest in enhancing our online capabilities, with the number of clients migrating to our foreign exchange and money market e-portal ‘Arena’ tripling in 2012. We also launched specialised products, including a deposit account tailored to the needs of businesses in the agricultural sector. We were voted ‘Business Bank of the Year’ for the eighth consecutive year at the Real Fd/cBi Excellence awards, a testament to our support for British businesses.
£98.4 billion non-core assets We have proactively managed the run-down of our non-core assets by almost a third in the year.
lloyds Banking Group is an important institution for the prosperity and growth of the uK and we are committed to nurturing uK business. The lloyds TsB Enterprise Awards, now in their second year, celebrate innovation, drive and dedication within uK businesses and provided a number of winners with business support and a cash prize to invest in their business in 2012.
Our customers must be the focus of everything we do, and getting customer service right is at the heart of our strategy. The further substantial improvement in our net Promoter scores in 2012 shows the progress we have made in rebuilding trust with our customers. We also delivered a substantial reduction in FsA reportable banking complaints, excluding PPi, ending 2012 with one of the best performances of uK banks with just 1.1 complaints per 1,000 accounts. We have now brought forward the 2014 complaint reduction target of 1.0 complaint per 1,000 accounts to 2013.
Addressing legacy issues including payment protection insurance The Group continues to address legacy issues, and remains committed to resolving them and treating our customers fairly. The Group has had further experience of PPi complaint volumes, uphold rates and operational and redress costs since our third quarter 2012 interim Management statement. As a consequence, we have made a further provision of £1,500 million in the fourth quarter, which brings the amount provided for PPi in 2012 to £3,575 million, and the total amount provided to £6,775 million. Total costs incurred to the end of 2012 were £4,344 million, including approximately £700 million of related administration costs.
Our commitment to colleagues The progress we continue to deliver and our achievements in 2012 are a product of the commitment, drive and performance of our colleagues, and we see a real opportunity to improve engagement across all parts of the Group.
Remuneration continues to be an important topic for the Group and for our stakeholders. We are actively working to ensure continued alignment between performance and reward, and that colleagues are appropriately incentivised, with variable pay reflecting effective risk controls and the best outcome for customers. Bonus awards are subject to deferral and adjustment, and in 2012 total discretionary awards were approximately 3 per cent lower than last year. salary rewards have been limited, and frozen at more senior levels for the second year running, to reflect the continuing challenging economic environment.
Lloyds Banking Group Annual Report and Accounts 201218 business review Marketplace trends 19
Future economic developments in the UK and Ireland continue to be highly contingent on (i) how successful political leaders are at maintaining progress against the Eurozone crisis and enacting a tough but gradual fiscal tightening in the US, (ii) the extent to which the UK private sector can offset the effect of a shrinking public sector, and (iii) how the implementation of new regulation on banks impacts their ability to supply credit. With consensus forecasts for 2013 having stabilised in recent months, the most likely outlook for the Eurozone is another broadly flat year (Chart 2).
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The current consensus view for 2013 irish GdP growth is 0.9 per cent, and the unemployment rate there is expected to improve only very gradually. House prices are expected to continue their recent rise, but the overall pace of increase is likely to be very slow.
The weak economic recovery has kept growth in our markets subdued. With the economy expected to grow slowly in 2013, our central expectation is that growth in our markets will also remain weak.
it is not yet clear how the new resolution powers such as ‘bail-in’ will work in practice. Further uncertainty surrounds how the Recovery & Resolution directive interacts with other European legislative proposals such as the deposit Guarantee scheme and the work on Banking union.
We are supportive of the new ‘twin peaks’ model of regulation and believe it will help enhance stability in the sector.
Access to convenient branches remains important for many customers, but demand for a quality multi-channel banking proposition is now more prevalent. More customers expect to be able to manage their finances whenever and wherever is most convenient for them, whether by telephone, online, or using smartphones. service remains one of the key drivers of customer satisfaction and customers are less accepting of poor service given the competitive nature of the market.
The Verde business will have the capability to be a strong and effective challenger in what is already a highly competitive sector. We are seeing a number of new or expanding players including Virgin Money and Metro Bank looking to make inroads into the sector and an enhanced industry-wide switching service will be launched in september 2013, giving customers increased confidence to change provider when dissatisfied or offered a better deal elsewhere.
Our strategy, as outlined on the next few pages, reflects the market conditions and the changing needs of customers. Above all it recognises that we operate in a competitive market where additional challengers continue to emerge and the only way of ensuring success is by focusing on the ever-changing needs of our customers.
q Competition: increasingly competitive market for lending and deposits creates margin pressure.
Our iconic and distinct brands, our broad multi channel distribution network, our financial strength, conservative approach to risk management and our high quality, committed colleagues are the foundation for providing customers with effective service. Through distinctive strengths, in particular superior customer insight, simpler tailored products and relationship focus we want to meet the financial needs of our customers, whether that be through banking, insurance, investment, debt financing or risk management products, and help them succeed financially.
We also deliver value through a focus on increasing the efficiency of operations and processes across the value chain, simplifying the organisation and reducing costs. creating a lower risk, more agile, efficient organisation enables us to more effectively address customer needs whilst reducing the cost base.
REsHAPE our business portfolio to fit our assets, capabilities and risk appetite.
Priorities for 2013 q continue to reduce our non-core assets in a capital accretive manner q continue to improve our asset quality ratio q continue to reduce our international presence
Continued reduction in non-core assets in 2012 we delivered a further substantial reduction in non-core assets of £42 billion exceeding initial 2012 guidance by £17 billion. The amount of non-core assets now stands at £98 billion with nearly 90 per cent of our original target for non-core reduction already achieved. As a result we have now increased the target and are looking to reduce non-core assets to less than £70 billion by the end of 2014.
We have continued to take a disciplined approach to the management and reduction of our non-core assets and the 2012 reductions have been capital accretive.
The continued reduction of non-core assets and the prudent management of risk should result in an improvement in the Group’s asset quality ratio to 50-60 basis points by the end of 2014, with the core business expected to be at the bottom end of this range. in 2012 we have made excellent progress, with our asset quality ratio dropping from 162 to 107 basis points.
The Group continues to deliver on its strategy to strengthen the balance sheet and given our strongly capital generative core business and the ongoing capital accretive non-core asset reduction, we remain confident in the capital position.
Continue to exceed regulatory liquidity requirements The Group continues to maintain a strong liquidity position. Our primary liquid asset portfolio at the year end was £88 billion, which represents approximately three times our money market funding and approximately one and half times our aggregate wholesale funding with a maturity of less than a year, thus providing a substantial buffer in the event of market dislocation. in addition the Group has secondary liquidity holdings of more than £117 billion.
Maintaining a stable funding base The Group has completed the transformation of its funding profile, with customer deposit growth and non-core reduction driving a reduction in our wholesale funding requirement to £170 billion, a 32 per cent reduction in the year. At the same time the maturity profile of our wholesale funding further improved with only 30 per cent of total wholesale funding now having a maturity of less than one year.
The benefits of the simplification programme extend far beyond cost reductions. customers and staff are already benefiting from faster, more automated and less complex processes, for example: in commercial Banking we improved the lending process allowing businesses to receive their funds in half the time; while mobile and voice recognition technologies combined with simpler, faster processes in Retail; and a quicker claims process in insurance are further examples of how our actions are contributing to increased customer advocacy.
Sourcing We continue to optimise our demand management and are further strengthening our supplier relationships. By reducing the number of suppliers to the Group to under 10,000, and further focusing on a core group of lead suppliers, we will achieve approximately a 15 per cent saving in addressable spend. in 2012 we made progress towards this goal by reducing supplier numbers by 4,700 to around 10,500 and have further concentrated our expenditure within our top tier of suppliers.
More agile organisation We have already made good progress in creating a more agile organisation through delayering our management structure and centralising control functions. Our focus will continue to be on reduction in middle management, bringing our top team closer to the customers and front-line staff.
Although the cost:income ratio increased again in 2012 we continue to believe the cost savings we are already delivering and investment initiatives will deliver a cost:income ratio of 42- 44 per cent over time.
Aim We intend to invest approximately £500 million annually by 2014, equivalent to approximately one-third of the savings from our simplification initiatives, to grow our core income. This will result in an incremental investment of approximately £2 billion between 2011 and 2014. Our investment is subject to disciplined tests, including financial returns, fit to our risk appetite and alignment with our strategy to be the best bank for customers. The investment will primarily be focused on becoming the best bank for personal customers, becoming the best partner for our business customers and enhancing our insurance proposition.
We have also continued to revitalise the Halifax brand to be a challenger to the uK’s retail banks focusing on delivering a simple, efficient and fair customer experience, alongside innovative products and services such as our savers Prize draw and switching incentives.
investing in the insurance proposition significant progress has been made in repositioning insurance as a core part of our proposition. We combined our uK life Pensions and investments and General insurance businesses in 2012, helping us optimise the opportunities arising from the industry wide regulatory changes.
Meeting customers needs by developing appropriate products can only be achieved through the commitment and applied skills of our colleagues. Equally, we recognise the role our people play in helping communities to thrive through the services and advice we give to uK business, and through the programmes that promote financial capability and inclusion.
The full research findings for the ipsos MORi research are available at www.ipsos-mori.com1
Corporate Responsibility Ensuring the business is run sustainably and responsibly is a priority for the Group. Our responsible business strategy, focused around working with households, businesses and communities, is aligned to our overall business strategy and our aim to help Britain prosper.
Our approach to Corporate Responsibility, along with current priorities is developed by our Responsible Business Steering Group (RBSG), which reports directly to the Group Board. The RBSG develops principles and priorities from a top-level perspective and ensures they are embedded throughout our operations. The RBSG is chaired by Anita Frew, Nonexecutive Director of Lloyds Banking Group, and includes senior representation from across Lloyds Banking Group.
In addition to this internal committee we have also established a high-level experts group, an external stakeholder panel and have created a colleague focus group to ensure the views of our stakeholders are considered and effectively addressed in our reporting and communications.
In line with the Group’s values of putting customers first, keeping it simple, and making a difference together we are looking to build a strong and profitable Group, with a culture which reinforces stringent behavioural standards and ensures we are operating sustainably and responsibly, both inside and outside of the organisation.
Aim Our aim is to be the best bank for customers. Becoming the best bank for customers means being the best bank for families, for businesses and for our communities. We will achieve this by focusing on: q UK customers and those connected to the UK
London 2012 This year saw the culmination of our partnership with the London 2012 Olympic and Paralympic Games, following five years of activity aimed at bringing the Games closer to customers, communities and colleagues across the UK. Some of the highlights of the community benefits include; £1 billion of lending to help businesses benefit from London 2012 opportunities, 1,000 local heroes supported in communities across the UK, 24,000 schools taking part in National School Sport Week, inspiring over 9 million children to try sporting activities, 1,497 Olympic and Paralympic torchbearers selected by Lloyds Banking Group, and 3,000 customers were taken to the Games. The Games were just the beginning, highlighting and reinforcing the positive impact we can have on our communities. This is why we are delighted to be building on the legacy of the Games by developing both National School Sport Week and Local Heroes. These two programmes underpinned our partnership and had significant impact, opening doors to millions of children and communities up and down the country, encouraging them to play more sport.
Priorities for 2013 q Continue to simplify systems, processes and products by making it easier and more convenient for customers to do business with us, thereby improving the overall experience q Continue to improve our complaint handling performance reducing FSA reportable banking complaints per 1,000 accounts to 1.0 by the end of 2013 q Maximise the use of our customer relationships and insight to enable us to engage more effectively with our customers and become more responsive to customer needs. This will enable us to deliver against their expectations at key customer touch points to improve our customers’ current and future experience
Our Retail division continued to develop their savings product offering. The Halifax savers Prize draw has been very popular, with over 1 million customers subscribing, supporting strong increases in customer advocacy. They also continued to develop the isA Promise that resonated with customers and helped to support a record new isA performance in 2012. in addition, they developed new ways to support our customer’s savings requirements including the recently launched Junior isA that allows young people to start to build a tax free savings pot.
We continue to be recognised with external awards. Our corporate and commercial businesses won the Best Bank of the Year award for the eighth consecutive year at the Real Fd/cBi excellence awards, and in our insurance division we were named as Britain’s Most Popular Home insurance Provider by the independent market researchers GFK nOP for the eleventh year in a row.
Retail division also provides current accounts to one in three people in the uK and are the uK’s biggest provider of basic bank accounts, making a significant investment in helping to bring people into the financial system. We currently provide over 3 million such accounts and in 2012 opened around 225,000 new accounts. in conjunction with the national Offender Management service, we offer more basic banking facilities to prisoners than any other bank. Almost as importantly, we can help our customers move to a full facility current account. in 2012 over 100,000 customers who previously had a basic bank account either upgraded to or opened a mainstream bank account. We have recently made a number of improvements to make it easier for basic bank account customers to upgrade.
Lloyds Banking Group Annual Report and Accounts 201234 cOllEAGuEs Our colleagues will deliver the service that makes us the best bank for customers.
An important sign that we are doing the right thing, is the proportion of appointments that we can fill internally. during 2012 we have been successful in filling 78 per cent of executive roles with internal talent. We also focused on building rounded general management experience by moving some of our highest potential executives across our different businesses and in 2013 we will continue our work to validate and improve internal succession.
The Group wide Academies have now been fully implemented, providing a clear learning standard and a clear way to plan their careers for all colleagues.
Performance and Reward Managing performance plays a critical role in helping us to develop our colleagues to build long term partnerships supporting customers and strong relationships with each other.
Encouraging colleague share ownership in lloyds Banking Group is important. The first save-As-You-Earn plan in 3 years has been announced, commencing in 2013, as well as the continued promotion of our sharematch scheme. Our Flex programme, which offers a range of benefit choices, continues to be popular with colleagues. We also began Pensions Auto-Enrolment from 1 January 2013 for those colleagues who do not participate in one of our existing Pension plans.
Growing great leaders The Group has continued to provide leadership programmes with success; highlighted by the fact that 78% of our executive roles in 2012 were filled with internal talent. The Group has also increased focus on our Emerging Talent shown through the launch of the Apprenticeship scheme and the Future Executives Programme.
Our sexual orientation programme continues to be recognised as amongst the best. in the stonewall 2012 Top 100 Employers index the Group was placed in the top 20 organisations and was named Top Welsh Private sector Employer and 2nd best scottish Employer. Our Rainbow network was also given ‘star performer’ status. We are also leading the way for customers with both lloyds TsB and Halifax featuring gay couples in product advertising.
These activities are showing positive outcomes, with higher engagement scores for female and ethnic minority colleagues, and some steady progress in closing the gap for lesbian, gay and bisexual colleagues. We will continue to build upon our progress during 2013 to ensure we reflect the diverse needs of our customers, colleagues and communities.
Diversity networks The Group has four diversity networks, which were formed by groups of colleagues to help focus on the specific challenges and barriers that they face at work. They do this through connecting their members (virtually and face to face), focusing on development and playing an active role in supporting the development of the diversity strategy.
Our 2013/14 Charity of the Year is supporting Alzheimer’s Society and Alzheimer Scotland’s Live Well Campaign.
Aim The aim of our community strategy is to help the uK’s most disadvantaged communities prosper as a result of our financial and colleagues’ commitment. during 2012 we continued to develop our community strategy around the themes of Education, Employability and Enterprise.
The Money for life Qualifications programme provides accredited training to enable organisations ranging from citizens Advice Bureaus to Housing Associations, charities and colleges to embed money management skills at a local level. We trained 1,400 people to run money management sessions in communities in 2012.
The Money for life challenge is a national competition that provides £500 grants to empower teams of 16-24 year olds to develop innovative money management projects that impact their communities. We awarded 110 grants in 2012.
Priorities for 2013 q continuing our level of investment in uK communities aligned with our strategy themed around Education, Employability and Enterprise and support of the uK charity sector through our Foundations q continuation of our plan to strengthen our responsible business governance, including our reporting assurance and verification process q develop a set of measures that will help us to understand the extent to which we help Britain prosper. From the outputs of the measures we will look to create associated robust KPis and targets q launch a Financial inclusion steering Group and set priorities in 2013
In 2012, the Group supported over 32,000 colleagues’ volunteering for charities and community groups. The Foundations also provided Matched Giving to some of these organisations for colleagues’ time spent volunteering outside of working hours.
scholars receive a unique combination of financial support, a lloyds Banking Group mentor, sessions to develop their skills and the opportunity to gain valuable work experience through paid internships. in return we ask that they volunteer for local causes, enabling them to enhance their cV whilst giving back to the community. We accept students from nearly all disciplines and all have the opportunity, but no obligation, to join our Graduate leadership Programme after university.
Community volunteering Our Day to Make a Difference volunteering programme enables colleagues to spend one day a year volunteering for a charity or community project of their choice. Over 32,000 of our colleagues registered to use their day to volunteer in 2012. This compares with 7,300 colleagues in 2010 and 16,000 colleagues in 2011.
Give & Gain Day We are the largest participant in Business in the community’s Give & Gain day – the uK’s single biggest day of volunteering. in 2012 more than 4,500 colleagues took part, doubling the engagement seen in 2011. We have committed to sponsor Give & Gain day until 2014.
The funds raised will help over 12,000 children in our local communities through the Families & schools Together (FAsT) programme. FAsT provides support to parents by engaging them in their children’s education. The programme aims to reinforce family bonds and create a supportive network between parents, children, schools and communities. Teachers have reported a 5 per cent improvement in reading, writing and maths amongst children enrolled in FAsT after just eight weeks.
Reducing our environmental impact As a responsible business, we are working to reduce our own environmental footprint and support the uK Governments targets to move towards a low-carbon economy.
Our Environmental Action Plan incorporates programmes to reduce our impacts in the areas of energy, paper, business travel, waste and water. specific initiatives include ‘no travel’ weeks, embedding an enhanced dry mixed recycling process and optimisation of our building controls to reduce the energy we use.
As well as benefitting the environment, making fewer journeys means our colleagues are away from home less, improving their health and well being.
The Group reports those energy emissions arising from its own direct business activities where it holds the title to the energy supply contract directly with the energy supplier.
We have improved the accuracy of energy data for the 2011 reporting period, replacing estimates with actual data. We have also applied the latest dEFRA conversion factors to both reporting periods. Our reporting periods are from the 1 October to the 30 september each year.
Priorities for 2013 q continue to support delivery of the Group’s customer focused strategic plan within risk appetite q continue programme of investment in the Group’s risk systems q Maintain and strengthen the Group’s strong risk culture by managing performance to ensure risk based behaviours q deliver against new regulatory requirements q continue to attract, retain and develop high quality people
q Strong control framework: The Group has a strong risk control framework which is the foundation for the delivery of effective risk management. This framework ensures appropriate engagement in developing risk appetite whilst also ensuring business units operate within approved parameters.
Conduct risk conduct risk and how the Group manages its customer relationships affect all aspects of the Group’s operations and our management of this risk is closely aligned with achievement of the Group’s strategic vision to be the best bank for customers. As a provider of a wide range of financial services products across different brands and distribution channels to an extremely broad and varied customer base, and as a participant in market activities, the Group faces significant conduct risks, which could result in selling products to customers which do not meet their needs; failure to deal with a customer’s complaint effectively where the Group has got it wrong and not met customer expectations; and behaviours which do not meet market standards.
A further reduction in FsA reportable banking complaints (excluding PPi) to 1.1 per 1,000 accounts, a strong performance relative to our peers.
non-core assets reduced by £42.3 billion and our international presence was reduced in line with the
charges relating to simplification amounted to £676 million, while costs relating to the Ec mandated retail business disposal (Verde) totalled £570 million.
The non-core asset reduction and further deposit growth of 4 per cent (excluding repos) also allowed us to further transform our funding position in 2012, with the core loan to deposit ratio of 101 per cent at the end of 2012 now very close to our long-term target of 100 per cent. The total amount of Group wholesale funding reduced by 32 per cent to £169.6 billion at the end of 2012 from £251.2 billion at the end of 2011, and its maturity profile was further improved, with wholesale funding with a maturity of less than one year reduced to less than 30 per cent of total wholesale funding at the end of 2012, down from 45 per cent at the end of 2011.
As at 31 december 2012, we had realised annual run rate savings of £847 million from our initiatives to simplify the Group, an increase of £605 million since 31 december 2011, with the simplification programme contributing in year cost savings of £774 million in 2012.
since the start of the programme 18 months ago, we have made strong progress in our simplification programme, with over 200 improvements delivered. We continue to simplify our business operations through streamlining and improving customer processes, reducing management layers and increasing spans of control as well as restructuring business units. The latter includes consolidation of back office operations sites, optimisation of our model for delivery of iT and outsourcing of our property facilities and asset management services. These improvements are also contributing to improved customer service and significant reductions in customer complaints (excluding PPi).
The Group’s management profit has been affected by our active management of the balance sheet position in response to the low interest rate environment and the reduction in wholesale funding spreads seen in 2012.
The net volume of PPi complaints and costs of contact and redress continue to trend downwards. complaints received in the fourth quarter of 2012 were approximately 20 per cent lower than the preceding quarter, and around 30 per cent lower than the second quarter of 2012. The average monthly spend for the fourth quarter of 2012 was approximately £200 million, a reduction of approximately 25 per cent on the third quarter. While uncertainty remains, we expect the average monthly spend to reduce further in the first half of 2013, by broadly 20 per cent when compared to the fourth quarter of 2012, before further reducing in the second half of the year.
Other regulatory matters in June 2012, a number of banks, including lloyds Banking Group, reached agreement with the Financial services Authority (FsA) to carry out a thorough assessment of iRHP sales made since 1 december 2001 to certain small and medium sized businesses. The Group agreed that, on conclusion of this review, it would provide redress to any of these customers where appropriate. At that time the total cost was not expected to be material.
The 33 per cent fall in non-core risk-weighted assets over the last year is in line with the 30 per cent of asset reductions achieved and reflects the substantial decrease in risk we have achieved over this period. We continue to expect our non-core assets to reduce to £70 billion or less by the end of 2014, at which point we expect more than 50 per cent to be retail assets.
The substantial reduction we have achieved in our non-core portfolio means we have now met our Ec asset reduction commitment of £181 billion and we will now seek formal release from this commitment, substantially ahead of the deadline of 31 december 2014.
We delivered customer deposit growth of 4 per cent, with good growth in both our Retail and Wealth, Asset Finance and international divisions.
Wholesale funding has reduced by 32 per cent since 31 december 2011 to £169.6 billion. Our short-term money-market funding reduced further by 55 per cent to £31.0 billion (2011: £69.1 billion). We have also improved the maturity profile of wholesale funding, with less than 30 per cent of wholesale funding having a maturity of less than one year at 31 december 2012, compared to 45 per cent at 31 december 2011.
in January 2013, to promote short-term resilience of bank liquidity risk profiles, the Basel committee amended the calculation of the liquidity coverage Ratio. This requirement has been relaxed to allow a wider pool of asset classes to be deemed to be liquid, and to lengthen the implementation timeframe and assumed cash outflows have been reduced. We await the FsA’s interpretation as it applies to uK banks before we can assess the impact to our liquidity position.
Conclusion in 2012 we delivered a significantly improved underlying performance with key metrics in line with or ahead of expectations and guidance. The core business continues to deliver strong and stable returns, above the cost of equity. in a challenging economic and regulatory environment we have further derisked the balance sheet, strengthened the capital position and transformed our funding profile, and as a result, we are now increasingly well positioned for growth.
Total underlying income, net of insurance claims 8,657 5,138 2,842 1,851 (102) 18,386
Total underlying income, net of insurance claims 9,157 5,998 3,233 2,277 381 21,046 liability management – – – – 1,295 1,295
impairment charge as a percentage of average advances 0.54% 2.32% 6.48% 1.62%
Strategic focus Retail’s goal is to be the best bank for customers in the uK. We are working towards this by building deep and enduring relationships with our customers that deliver real value to them, and by continuing to support the uK economy. We are increasing engagement with our customers by delivering greater choice and flexibility through our multiple brands and channels. At the same time we are simplifying the business to increase our agility and enable us to respond more quickly to customers’ needs, and improve customer experience. We are particularly focused on continuing to improve customer service and actively reduce customer complaints. in addition, by further developing our customer insight and gaining a deeper understanding of our customers, we are better aligning our products and services to our customers’ requirements. This is increasing customer advocacy which ultimately delivers lower customer acquisition costs, greater share of their business and improved customer retention.
Progress against strategic initiatives Retail has continued to make excellent progress towards being the best bank for customers during 2012. This progress is demonstrated by an increase in customer advocacy, reflected in our customer service scores which have risen by 13 per cent during 2012. This improvement is being supported by the strong focus within Retail on reducing customer complaints, which have decreased by 28 per cent (excluding PPi). Over 2012, based on performance across Branch, Telephone and internet Banking, lloyds TsB has been the leading High street bank for customer service1.
We are continuing to successfully simplify the bank. We have implemented further automation, and improved the functionality of current account and isA savings switching services to improve customer experience. These processes also require significantly fewer manual interventions, contributing to reduced costs and customer complaints. We have also continued to develop our telephony services for customers and have introduced ‘say Anything’ interactive Voice Response technology, which guides customer calls accurately and promptly to the right service.
Total costs fell by 5 per cent, largely as a result of the simplification programme. As part of this programme we have delivered end-to-end process enhancements, migration of customers to self-service channels, and implemented further improvements in purchasing arrangements across Retail. We have also delivered other day-to-day cost benefits, which, when combined with our work on simplification, more than offset on-going cost inflation and increased investment spend.
q We continued to deepen our relationships with core clients through our investment in new products and capabilities to drive capital efficiency and through our lending commitments to support the uK economy and sMEs, including our involvement in the uK Government’s national loan Guarantee and the Funding for lending scheme (Fls).
q core underlying profit increased by 1 per cent to £1,748 million, driven by reduced impairments and improved other income from resilient performances in capital Markets, Financial Markets and ldc. This was offset by lower net interest income. Return on risk-weighted assets increased to 1.36 per cent from 1.32 per cent.
Restated to reflect transfers from Wealth, Asset Finance and international and transfer of Asset Finance to Wealth, Asset Finance and international.1
in 2012, we made good progress in simplifying the business through a series of initiatives to streamline operational processes and improve client experience and service. We have already delivered benefits through de-layering the organisation and removing inefficiencies and will continue to benefit as we deliver synergies from bringing the legacy divisions together. Within sME, significant progress has been made in simplifying the lending process and the time taken to complete lending transactions to clients has almost halved from the end of 2011 compared to the end of 2012. The reshaping and simplifying of the business is leading to a more effective and agile organisation.
in 2012, we supported our Global corporate clients in raising £12.8 billion of financing through the debt capital Markets, enabling them to finance and grow their businesses. We have made good progress in creating solutions for our clients, attaining a top five position in investment Grade corporate sterling debt issuance, and were awarded the 2012 Greenwich Quality leader award for large corporate Banking in the uK, recognising our strong client experience.
As a testament to our client-centric approach, commercial Banking was awarded for the eighth year in a row the Business Bank of the Year at the Fd’s Excellence Awards (in association with the institute of chartered Accountants in England and Wales, supported by the cBi).
Other income increased by £126 million, reflecting higher client activity in Financial Markets and debt capital Markets despite difficult market conditions, and a resilient performance in ldc benefiting from a strong vintage.
commercial Banking costs decreased by 3 per cent, with continued focus on cost management, savings attributable to the simplification programme and the savings arising from the reduction in non-core assets. The benefits of these cost savings initiatives enabled further investment in Wholesale product capabilities in Financial Markets, capital Markets and Transaction Banking.
Wholesale sub-segment – financial performance Total Core £m change £m 20111 £m change
Key balance sheet items at 31 December £bn change £bn change loans and advances to customers excluding reverse repos 105.1 126.9 (17) 73.5 79.3 (7)
Restated to reflect transfers from Wealth, Asset Finance and international and transfers of Asset Finance to Wealth, Asset Finance and international.1
Key balance sheet items at 31 December 2012 £bn 2012 £bn loans and advances to customers excluding reverse repos 29.6 28.8 3 28.5 27.4 4
Total underlying profit increased £42 million, with core underlying profit increasing by £36 million due to the significant reduction in impairments and costs, partially offset by reduced underlying income.
Total customer deposits excluding repos increased £2.0 billion reflecting the ongoing success in attracting new customers.
q We achieved cost savings of 5 per cent through further progress on simplification initiatives, which in turn enabled further investment in the core businesses to improve the customer experience.
in the international businesses, the priority is to maximise value in the medium-term. The immediate focus is on close management of the balance sheet where we are contributing to a strengthening of the Group’s balance sheet through a significant and managed run-down of non-core assets. At the same time, we continue progress on rationalising our international footprint delivering operational efficiencies and reducing the cost base to fit the reshaped business models.
We remain confident that by delivering our strategy to be a simple, customer-focused uK and international business we can increase the trust of both customers and stakeholders. in Wealth this has resulted in an improvement of client service accessibility. This is demonstrated by the faster access to advice and support that customers are now receiving as a result of a new Private Banking client centre. The new centre is making the referral process from Retail to our Wealth business simpler and swifter, and will be fully rolled out across the lloyds TsB and the Halifax networks by the end of 2013.
in the uK, lex Autolease delivered strong new business performance with a year on year increase in deliveries of 11 per cent. lex Autolease is a market leader in the uK and already in the top five car leasing firms in Europe, with a strong customer proposition and deep insights and capabilities in the contract hire market.
in line with our strategy to grow the motor and direct business, the Australian asset finance business achieved new business growth of 16 per cent in 2012. The business also began a strategic investment to automate and simplify end to end systems with the objective of delivering an improved, cost effective customer experience.
net interest income decreased by 20 per cent. core net interest income grew by 6 per cent due to strong deposit inflows within the Wealth and on-line deposit businesses. non-core net interest income reduced by 31 per cent driven by a 20 per cent fall in non-core assets, higher funding costs and the increased level of impaired assets in ireland.
The impairment charge reduced by 59 per cent to £1,480 million, largely as a result of lower charges in the irish business where the charge amounted to £1,245 million (2011: £3,187 million). The rate of increase in newly impaired loans in ireland has slowed through 2012 from £4.1 billion to £1.6 billion.
Our Wealth and on-line deposit businesses continued to grow strongly with balances as at december 2012 of £51 billion, an increase of £11 billion in 2012. Overall, the Wealth, Asset Finance and international businesses have become a significant contributor to the Group’s funding with an £18 billion excess of deposits over customer advances.
Other Wealth: st James’s Place 34.8 28.5 invista Real Estate – 0.8
Funds under management increased by £7.1 billion to £189.1 billion primarily driven by improved investment markets. inflows have increased in the year primarily in st James’s Place. However this was largely offset by a reduced level of inflows in sWiP, where we have also seen an increase in the level of outflows in the year, in part reflecting a lack of consumer confidence in investment products across the industry. Outflows in sWiP also consist of attrition within the insurance funds and strategic asset allocation decisions.
q We have invested in extending our life insurance proposition with a new earnings protection offer which has simpler application and claims processes.
Our focus is on investing to build profit streams in areas where we have market scale and competitive advantage, leveraging Group synergies. Roughly one third of new business income and the majority of our General insurance income comes from insurance sales (home and life protection) to retail bank customers, building on strong linkages to our banking and mortgage businesses under the lloyds TsB, Halifax and Bank of scotland brands. The rest of our business is focused on retirement savings, both the provision of annuities and pensions sold externally through intermediary and direct channels under the iconic scottish Widows brand. in 2012 we were the market leaders in corporate pensions. Whilst we also have a strong stream of ongoing profits from our legacy back book, including £24 billion invested in our With Profits funds, we are streamlining and reshaping the business including exiting the offshore bonds market.
We have developed a deep understanding of the protection and savings needs of our customers through our annual Protection, Pension and savings reports. The centre for the Modern Family, which aims to improve understanding of families’ needs in the uK, was launched in december 2011 as part of our commitment to better understanding our customers’ needs and Helping Britain Prosper. The benefits of this insight are reflected in the strength of our customer propositions which have won several industry awards including; ‘Best stakeholder Pension provider’ for the third year running at the Moneywise 2012 Pension Awards, ‘Best Group Pension Provider’ in the corporate Adviser awards and ‘Best Personal Pensions Provider’ in the Professional Adviser awards.
Financial performance and balance sheet progress LP&i General insurance Total new business income: new intermediary and direct income 357 321 – – 357 321
There has been strong growth in the intermediary channel, particularly in corporate pensions where sales were 23 per cent higher than 2011 ahead of to the introduction of RdR. This reflects the underlying strength of our proposition and the quality of service provided to customers. initiatives such as MyMoneyWorks and our market leading auto enrolment engine, combined with a continuing focus on our strong relationships, ensure that we are well placed to take advantage of the changing market-place as a result of RdR. individual pensions sales have increased by 3 per cent, driven by sales of our flagship Retirement Account product.
Total net recharges to divisions 2,723 2,836 4 2011 comparative figures have also been amended to reflect the effect of the continuing consolidation of operations across the Group. To ensure a fair comparison of 2012 performance, 2011 direct costs have been restated with an equivalent offsetting increase in recharges to divisions.
Restated for transfers between Wealth, Asset Finance and international, and commercial Banking.
Total underlying income, net of insurance claims 8,609 4,684 2,276 1,793 (76) 17,285
impairment charge as a % of average advances 0.54% 0.95% 0.60% 0.64%
impairment charge as a % of average advances 0.29% 4.28% 3.42% 3.08%
Key balance sheet items at 31 December 2012 £bn £bn £bn £bn £bn £bn 2011 £m £m £m £m £m £m insurance claims – – – – – –
impairment charge as a % of average advances 0.58% 4.60% 7.11% 4.60%
insurance hedging arrangements (20) 2 includes volatility relating to the Group’s interest in st James’s Place.
net asset value per ordinary share 62p 67p 68p 68p 155p loans and advances to customers 517,225 565,638 592,597 626,969 240,344
Total dividend per ordinary share2 – – – – 11.4p number of ordinary shares in issue (millions)3 70,343 68,727 68,074 63,775 5,973
Annual dividends comprise both interim and estimated final dividend payments. under iFRs, the total dividend for the year represents the interim dividend paid during the year and the final dividend which will be paid and accounted for during the following year.
Former appointments: sir Winfried was appointed chairman of citigroup Europe in 2000. He became the acting chief Executive Officer of citigroup inc. in 2007 and was subsequently appointed as chairman in the same year until his retirement in February 2009. Prior to this, he was the Group chief Executive and then chairman of schroders.
Skills and experience: david has many years experience at board and executive management level in retail and commercial banking in the uK and internationally. As chair of the Risk committee, he has a deep understanding of risk management, underpinned by recent, in-depth knowledge of all aspects of banking operations. david’s valuable contributions to the deliberations of the Board and committee meetings, combined with natural leadership qualities, make david an effective deputy chairman.
Skills and experience: lord Blackwell has in-depth insurance, banking, regulatory and public policy experience gained from senior positions in a wide range of industries. He has the knowledge and experience to contribute effectively as a non-Executive director and lead the Board of scottish Widows Group.
Skills and experience: carolyn has extensive digital and on-line, Government and regulatory experience gained across a range of sectors including media and financial services. With her broad experience and strong analytical mind, carolyn plays an active part in reviewing the strategy of the Board and contributing to the debate at Board and committee meetings.
Former appointments: Anita was an Executive director of Abbott Mead Vickers, director of corporate development at WPP Group and a non-Executive director of northumbrian Water. she has held various investment and marketing roles at scottish Provident and the Royal Bank of scotland.
Skills and experience: nick has significant financial experience in the uK listed environment having served in a number of senior finance positions within a range of sectors. His background and experience enables him to fulfil the role of Audit committee chair and for sEc purposes the role of Audit committee Financial Expert.
David Roberts deputy chairman independent director chairman of the Risk committee. Member of the Audit committee, the Remuneration committee and the nomination & Governance committee
Anita Frew independent director Member of the Audit committee and the Risk committee
Board of Directors 78 Group Executive Committee 80 Directors’ report 82 Corporate governance report 86 Directors’ remuneration report 98 Other remuneration disclosures 114
Former appointments: George was an Executive director and chief Financial Officer of RsA insurance Group. He is also the former Head of capital Management of Zurich Financial services and chief Financial Officer of its uK operations. George previously held various senior management positions at Prudential.
Anthony Watson, CBe senior independent director chairman of the Remuneration committee. Member of the Audit committee, the Risk committee and the nomination & Governance committee
George Culmer Group Finance director Joined the Board on 16 May 2012
The Group benefits from the depth and diversity of experience within the management team. The complementary skill sets across the team strengthens the Group’s ability to effectively adjust to changing market environments, deliver on our strategic plan and become the best bank for customers. Brief biographies of the management team are outlined below: dEliVERinG OuR VisiOn MAnAGinG A MORE AGilE ORGAnisATiOn
Andrew , cEO commercial Banking, was appointed as a Group director on 1 July 2012. He is also the chairman of lloyds development capital. Prior to joining lloyds Banking Group, Andrew worked at standard chartered Bank in a variety of senior roles including Global cOO of consumer Banking, chief Financial Officer of consumer Banking and co-Head of Wholesale Banking for Greater china and before that the same role for the Africa region. Before joining standard chartered, Andrew was the Group Finance director for Xchanging, a leading European outsourcing firm. Prior to this, he worked at deutsche Bank in Europe.
Andrew qualified as a chartered Accountant with deloitte & Touche. He is a member of the south African institute of chartered Accountants, the chartered institute of Management Accountants and is a chartered Global Management Accountant. He is also a member of the Association of corporate Treasurers, Association of Financial Markets in Europe and Global Financial Markets Association.
Juan was appointed as the Group’s chief Risk Officer on 24 January 2011. A member of the Group Executive committee, he is responsible for effective risk management across the bank. His team is represented across all the divisions and the extended Risk community includes some 7,000 colleagues.
Antonio joined lloyds Banking Group in March 2011. He is a Group director with responsibility for Wealth, Asset Finance, international & Group corporate development. since joining the Group, Antonio’s highlight has been leading the Group strategic Review. His division has since been fundamental in supporting the Group’s agenda to both reshape its international presence and strengthen the balance sheet through significant non-core reduction and double-digit deposit growth.
Antonio Lorenzo Group director, Wealth, Asset Finance & international and Group corporate development david is Group director of the Halifax community Bank. He has specific responsibility for the Halifax branch network and its 10,500 colleagues. Halifax is playing a key role in the Group’s strategy as a challenger brand, with a focus on making customers better off.
Matt is a member of the Board of Trustees at in Kind direct, one of the Prince’s charities, and founded by HRH Prince of Wales in 1996. He is a member of the city uK’s strategic Advisory committee and of the chartered institute of Public Relations.
Mark joined lloyds Banking Group as the director of Group Operations in March 2009. in september 2009 his responsibilities expanded to include Group integration director. Mark became the chairman of lloyds TsB scotland in december 2009 and is also the Group’s Executive sponsor for disability.
Principal activities The company is a holding company and its subsidiary undertakings provide a wide range of banking and financial services through branches and offices in the uK and overseas.
Business review and future developments 10 to 76 and 115 to 202
Directors Biographical details of directors are shown on pages 78 and 79. Particulars of their emoluments and interests in shares in the company are given on pages 98 to 114. changes to the composition of the Board since 1 January 2012 up to the date of this report are shown in the table below: Joined the Board Retired from the Board lord leitch 29 February 2012 sir Julian Horn-smith 17 May 2012
Directors’ conflicts of interest The Board, as permitted by the company’s articles of association, has authorised all potential conflicts of interest that have been declared by individual directors. decisions regarding these conflicts of interest could be and were only taken by directors who had no interest in the matter. in taking the decision, the directors acted in a way they considered, in good faith, would be most likely to promote the company’s success. The directors have the ability to impose conditions, if thought appropriate, when granting authorisation. Any authorities given are reviewed periodically, and as considered appropriate, and at least every 15 months. no director is permitted to vote on any resolution or matter where he or she has an actual or potential conflict of interest. The Board confirms that no material conflicts were reported to it during the year.
Corporate governance report The corporate governance report can be found on pages 86 to 97 and, together with this directors’ report of which it forms part, fulfils the requirements of the corporate Governance statement for the purpose of the Financial service Authority’s disclosure and Transparency Rules (dTR).
Dividends The directors do not propose to pay a final dividend in respect of the year ended 31 december 2012. Further information on ordinary dividends is shown in note 50 on page 290 and is incorporated into this report by reference.
The company is party to a deed of covenant with each of the four lloyds TsB Foundations (the Foundations) which hold limited voting shares in the company (the limited voting shares are further described in note 46 on page 286). under the terms of the deeds of covenant, the company makes an annual payment to each of the Foundations. in the event of a successful offer for more than 50 per cent of the issued ordinary share capital of the company, each limited voting share would convert to an ordinary share under the terms of the company’s articles of association. The payment obligation under the deeds of covenant would come to an end one year following the conversion of the limited voting shares.
lloyds Banking Group is committed to providing employees with comprehensive coverage of the economic and financial issues affecting the Group. We have established a full suite of communication channels, including an extensive face-to-face briefing programme, which allows us to update our employees on our performance and any financial issues throughout the year.
The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the company’s transactions and disclose with reasonable accuracy at any time the financial position of the company and the Group and enable them to ensure that the financial statements and the directors’ remuneration report comply with the companies Act 2006 and, as regards the Group financial statements, Article 4 of the iAs Regulation. They are also responsible for safeguarding the assets of the company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Each of the current directors, who are in office and whose names and functions are listed on pages 78 and 79 of this annual report, confirm that, to the best of his or her knowledge: – the Group financial statements, which have been prepared in accordance with iFRss as adopted by the European union, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and Group; and
The Board is committed to achieving long term success for the company by being the best bank for customers and generating stable and sustainable returns for shareholders. Fundamental to the Board’s strategy are high standards of corporate governance designed to ensure rigour in the Board’s discussions and decision making. This report explains how our corporate governance standards, in particular, those laid down in the 2010 edition of the Financial Reporting council (FRc)’s uK corporate Governance code (the code), apply in practice to ensure that the Board and management work together for the long term benefit of the company and its shareholders. The code can be accessed at www.frc.org.uk. in 2012, the code was reviewed by the FRc and amendments were introduced that will apply to financial periods commencing after 1 October 2012 (the new code). Wherever appropriate, the Board has sought in 2012 to apply the provisions of the new code.
To assist the Board in carrying out its functions and to provide independent oversight of the internal control and risk management framework, a substantial part of the Board’s responsibilities are delegated to the Board’s committees. Each of the committees is chaired by an experienced chairman and comprises independent non-Executive Members only. All non-Executive directors serve on at least two committees. The Board is kept up to date on the activities of the committees through reports from the committee chairmen at each board meeting. Terms of Reference for each of the committees can be found on our website at www.lloydsbankinggroup.com and information on the membership, role and activities of each of the committees can be found on pages 94 to 97.
in addition to the standing committees, the Board also established ad hoc committees during the year to oversee management’s response to the industry investigation into liBOR and the FsA investigation into HBOs. Both committees were set up as sub-committees of the Risk committee and are chaired by david Roberts, chair of the Risk committee.
The Executive Governance Framework is the means by which the Group chief Executive delegates responsibilities at executive level to assist him in carrying out his duties. The Group chief Executive reserves certain matters to himself and, subject to financial limits, delegates responsibilities to the Executive directors, his direct reports and other senior executives who collectively make up the Group Executive committee. The Executive Governance Framework provides for delegation to individuals and not to committees.
Skills and experience The primary consideration when determining effectiveness is to ensure that the Board represents a mix of backgrounds and experience that will enhance the quality of its deliberations and decisions.
As part of the ongoing review of composition, specific skills required by the Board are identified with reference to the overall skills of the Board at the time, the need to address longer term succession and current business priorities. All directors are required to have good – and in most cases have deep – experience and understanding of the banking and financial services sector. The complexity of the Group means that broader skills are also required. Maintaining the right balance is an ongoing priority. More information on the background and experience of our directors is set out on pages 78 and 79.
Whilst gender diversity is improving at the Board level, the Board recognises that more needs to done to improve the representation of women in senior management roles. The following table details the percentage of women employed at various levels of seniority within the Group at 31 december 2012 compared with statistics at the same date in 2011.
non-Executive director succession planning is addressed as part of the ongoing review of Board composition. The policy takes account of the need regularly to refresh the intake of non-Executives to bring new, diverse perspectives to the Board and its deliberations, to ensure appropriate representation on each of the Board’s committees and to plan for longer term succession. The average tenure of the non-Executive directors is approximately two and a half years. Following the move to annual re-election of directors, non-Executive directors are appointed on a rolling 12 month basis.
The findings of the 2012 review stressed the progress made under the chairman’s leadership with strong support from experienced committee chairmen. it identified a number of key strengths including: a high calibre and committed Board with a wide range of skills; a high degree of trust between Executive and non-Executive directors; extensive contact between the non-Executive directors and management at various levels; and a clear programme to strengthen the Board’s governance and oversight of the insurance business. inevitably, it also identified areas for further efficiencies and effectiveness.
The 2012 review was conducted following a period of significant transformation of the Board, with a substantial change in its membership. The period was marked by a discernible shift from crisis management towards building a sustainable business. This move towards recovery provides an opportunity to refocus the Board’s attention. The 2013 action plan centres around the following key themes: – Refocusing of the Board Agenda. As the business continues to stabilise, the Board will look to spend an increasing proportion of its time on forward looking matters, reducing the time it spends on operational and business critical matters. A refocusing of the agenda is planned to allow more time for strategic discussion and debate. The content of board packs will also be reviewed to ensure that directors receive the information they need including more routine reporting of strategic matters centred around customers, competitors, colleagues and culture.
Appointments in 2012, as part of its longer term succession planning, the Board identified the need for a number of new directors. The nomination & Governance committee, supported by executive search firms JcA Group and Egon Zehnder respectively, conducted the search for the following appointments which were made during 2012: – sara Weller, non-Executive director, who was nominated for her strong customer advocacy and technology experience in February 2012; – George culmer, Executive director, who was appointed Group Finance director in May 2012; – lord Blackwell, non-Executive director and chair of the insurance Board, who was appointed for his insurance, banking and consulting expertise in June 2012; and
election and re-election All directors appointed to the Board since the annual general meeting in 2012 will stand for election at the 2013 annual general meeting. All other directors will retire and those willing to serve again will submit themselves for re-election at the annual general meeting. Biographies of all current directors are set out on pages 78 and 79. details of the directors seeking election or re-election at the annual general meeting are set out in the notice of Meeting.
Attended Held1 Attended Held1 Attended Held1,2 Attended Held1 Attended Held1 Attended Held1
There is an ongoing process for identifying, evaluating and managing the significant risks faced by the company. This process has been in place for the year under review and up to the date of the approval of the annual report and is regularly reviewed by the Board. information regarding the main features of the internal control and risk management systems in relation to the financial reporting process is given within the Risk Management Report on pages 115 to 202.
An overview of the Remuneration committee is set out on page 96. The work of the Remuneration committee is explained in the directors’ Remuneration Report on pages 98 to 114.
external Auditors – recommends the external auditors’ appointment, re-appointment and removal; – approves the external auditors’ terms of engagement and remuneration; – assesses the external auditors’ effectiveness, independence and objectivity; – approves the provision of non audit services by the external auditor and related remuneration; – agree with the Board a policy on the employment of former employees of the Group’s auditors and monitoring the implementation of this policy; – reviews reports from the auditors on audit planning and their findings, significant issues and judgements on accounting and internal control systems; and
Significant Accounting Matters during the year, the committee considered the following significant accounting issues, matters and judgements in relation to the Group’s financial statements and disclosures: issue Approach
To keep the Board’s governance arrangements under review and make appropriate recommendations to the Board to ensure that the company’s arrangements are consistent with best practice corporate governance standards; and to assist the chairman in keeping the composition of the Board under review and to lead the appointments process for nominations to the Board.
– oversees the process for appointments of new non-Executive directors and makes recommendations to the Board.
ReMUneRATiOn To set the principles and parameters of remuneration policy for the Group, and to oversee remuneration policy and outcomes for those colleagues specified in the terms of reference
Statement by the Chairman of the Remuneration Committee As chairman of the Group’s Remuneration committee, i am pleased to introduce the directors’ Remuneration Report for 2012 and to provide context around the key reward decisions taken in respect of the past year and our future plans.
in setting our reward policy we endeavour to keep the structure as simple as possible and to clearly communicate the aims of the policy to our colleagues and our shareholders. We believe that transparency around our policy and the basis for our performance measures is critical to rebuilding trust with our employees and our numerous stakeholders. This has been evident in the annual disclosures we make to explain our policy approach to remuneration and the actions we undertake to implement this. We support the new proposals made by the department for Business, innovation and skills (Bis) to codify and standardise additional reporting expectations in this area. We are also heartened to note that many elements of the draft regulations published to date are already incorporated in our annual reporting.
shareholders will also note that revised shareholding guidelines have been introduced from 2012 (as detailed on page 103) which we are considering extending to a broader population in the future.
Our commitment to managing executive reward through the strict application of challenging lTiP performance measures is demonstrated through the confirmation that, as key targets for the 2010 lTiP have not been met, awards made under this plan will not vest. Moreover, for the anticipated 2013 lTiP awards we have once again set challenging targets for delivery of core financial measures (Economic Profit and Absolute Total shareholder Return) alongside operational measures aligned to the strategic business plan, all underpinned by a clear consideration of the risk impact of our activities.
The committee has striven to ensure that the remuneration policies and practices detailed in this Report are appropriate to supporting the delivery of the company’s current and future strategy. This Report will be tabled for shareholder approval at the AGM, which i hope you will support.
The committee recognises the attention which Bank remuneration receives and is very aware both of the importance of getting the right balance between the linkage of rewards to performance and the competitive process; recruiting, retaining and motivating staff as well as a more widely perceived concept of fairness for all involved.
Our objective is to align individual reward with the Group’s performance, the interests of its shareholders, and a prudent approach to risk management. in this way we balance the requirements of our various stakeholders: our customers, shareholders, employees, and regulators. This approach is in line with the Association of British insurers best practice code on remuneration and the FsA Remuneration code of Practice, as the policy seeks to reward long-term value creation whilst not encouraging excessive risk taking.
For example, in good times, when default rates on loans are low, we adjust the economic profit measure downwards based on a higher average expected default experience over the economic cycle. This encourages us to avoid business and funding strategies that are only profitable during boom times but turn bad in a recession. Economic profit plays a prominent role in our incentive plans for executives, with its inclusion in both the annual and lTiP performance measures.
For the 2012 annual incentive plan we continue to align the award to long-term prudent risk management by deferring 100 per cent of the award for Executive directors, which is subject to malus. Executive directors are also required to retain any shares vesting from lTiP awards from 2010 onwards for a further 2 years, after allowing for tax and national insurance requirements. For other employees, the immediate cash bonus award is limited to £2,000 with a percentage of larger bonuses being subject to deferral and malus. if the performance is unsustainable during the deferral period some or all of the award may be forfeited.
We aim to ensure that the totality of remuneration for Executive directors is competitive against our benchmark groups. These groups are other major uK banks and the top 20 companies in the FTsE 100, reflecting practices in large uK companies across all sectors. We aim to be competitively but conservatively positioned against the market.
The remuneration package offered to our Executive directors and other senior managers within the business is fundamentally based on the same components as are provided to other employees, including the eligibility to participate in all-employee share plans. However, the ratio of fixed to variable income is adjusted such that more than half of total reward for this group is put at risk by linking earnings (through delivery of the annual incentive plan and lTiP) to challenging company, individual and share price performance. This weighting towards variable pay is intended to promote behaviours focused on the success of the business.
Annual awards of up to 300 per cent of salary for the Group chief Executive and Executive directors. Vesting based on financial measures comprising Absolute Total shareholder Return, Economic Profit and strategic financial objectives. details of the performance conditions are provided below.
These targets apply differently for the Executive directors, reflecting differing strategic priorities. The non-financial measures include key performance indicators relating to risk management, sME lending, process efficiency, service quality and employee engagement.
The committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if they deem this appropriate. in this respect, the committee has recommended to the Board that it should exercise its discretion to adjust the value of certain 2010 bonus awards, on a basis equivalent to that applied in the previous year.
The key achievements of the Group are set out in the Group chief Executive’s review on pages 14 to 17 of this annual report.
The calculation of the annual incentive plan outcomes for Executive directors, based on the achievement of performance against targets in respect of 2012, has been vigorously discussed by the Remuneration committee. The bonuses awarded are shown in the table below: name A Horta-Osório M G Culmer
The award for Mr A Horta-Osório will be delivered in the form of a conditional share award. This will be subject to the normal performance adjustment policy and will only vest if a share price of 73.6p has been reached for a given period of time or the Government has sold at least 33 per cent of its shareholding at prices above 61p. This award will not be released before the fifth anniversary of award and will be forfeited if neither of the conditions has been met by that date. The Board believes that these conditions are in the interests of all shareholders and support our common aim of repaying the taxpayer. The award for Mr M G culmer reflects his contribution for 2012 as a whole and is not based on strict time apportionment.
Long-term incentive award The current lTiP rules allow for awards to be made of up to 400 per cent of base salary. under normal circumstances, awards can be made of up to 300 per cent of salary with the additional 100 per cent available for circumstances that the Remuneration committee deems to be exceptional. Awards in 2013 have been set at 300 per cent for the Group chief Executive and 275 per cent for Executive directors and the Group Executive committee.
Payout range set relative to 2015 targets Threshold: £37 billion Maximum: £28 billion sME lending Payout range set relative to performance against market lending to sMEs over 3 year period to 2015
Pension Executive directors may participate in the Group’s defined contribution scheme (under which their pension entitlement will be based upon both employer and employee contributions). company contributions are 25 per cent of salary, with the exception of António Horta-Osório who is eligible for 50 per cent of reference salary, including his flexible benefit allowance. These can be taken as cash or pension contributions, or a mixture of each.
Shareholding guidelines Executive directors are required to build up a holding in lloyds Banking Group shares of value equal to 1.5 times gross salary (2 times gross salary for the Group chief Executive) and are expected to achieve these targets within 3 years from the later of 1 January 2012 and their date of joining the Board. They are required to retain any shares vesting from lTiP awards from 2010 onwards for a further two years post vesting. The Group chief Executive is making significant progress in reaching this target. The Group shareholding requirements policy in respect of Executive directors was restated in May 2012 and was extended to cover all members of the Group Executive committee at 1 times gross salary.
Service agreements The Group’s policy is for Executive directors to have service agreements with notice periods of no more than one year. All current Executive directors are entitled to receive 12 months’ notice from the Group, but would be required to give at least six months’ notice.
Termination 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. Where it is appropriate to make a bonus payment to the individual, this should relate to the period of actual service, rather than the full notice period, will be determined on the basis of performance as for all continuing employees and will remain subject to malus. in the event of redundancy, the individual may receive a payment in line with statutory entitlements at that time.
Governance and Risk Management An essential component of our approach to remuneration is the governance process that underpins it. This ensures that our policy is robustly applied and risk is managed appropriately.
The committee works closely with the Risk committee in ensuring the bonus pool is moderated. The two committees meet together every year to determine whether the proposed bonus pool and performance assessments adequately reflected the risk appetite and framework of the Group; whether it took account of current and future risks; and whether any further adjustment is required or merited. We are also determined to ensure that the aggregate of the variable remuneration for all our colleagues is appropriate and balanced with the interests of shareholders and all other stakeholders.
The committee monitors the application of the authority delegated to the Group chief Executive who in turn delegates to the Group Executive committee, the Executive compensation committee and the divisional Remuneration committees, to ensure that policies and principles are being fairly and consistently applied. The committee liaises closely with the Risk committee and the Group’s risk function in relation to risk-adjusted performance measures, including consideration of both current and future risk. Together the management of remuneration and risk form an integral part of the Board’s determination of Group corporate strategy.
during 2012, the committee met 10 times and considered the following principal matters: – Review of remuneration arrangements for senior executives
– Bonus and salary awards for Executive directors and key senior managers
We thank all committee members for their commitment during the last year and attendance at meetings.
Performance graph The graph below illustrates the performance of the Group measured by TsR against a ‘broad equity market index’ over the past five years. The Group has been a constituent of the FTsE 100 index throughout this five year period.
António Horta-Osório 1,061 549 171 54 59 1,485 3,379 1,765 non-executive Directors lord Blackwell (from 1 June 2012) 101 101 –
The award for Mr M G culmer will be subject to 100 per cent deferral into shares until at least 2015.
Former Directors who served during 2012 a share buy out award granted on 30 March 2011 for the loss of deferred share awards forfeited on leaving the santander Group. Awards are consistent with those forfeited and have a nil option price.
j Exercisable for a period of six months from date of leaving.
March 2004 – August 2004 That the company’s ranking based on TsR over the relevant period against a comparator group (17 uK and international financial services companies including lloyds Banking Group) must be at least ninth, when 14 per cent of the option would be exercisable. if the company was ranked first in the group, then 100 per cent of the option would be exercisable and if ranked tenth or below the performance condition would not be met.
The following table contains information on the performance conditions for awards made under the long-term incentive plan. The Remuneration committee chose the relevant performance conditions because they were felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
April 2009 ePS: The release of 50 per cent of the shares was dependent on the extent to which growth in EPs achieved cumulative EPs targets over the three year period from January 2009 to december 2011.
Absolute Share Price: Relevant to 28 per cent of the award. Performance to be measured based on the Absolute share Price on 26 March 2013, being the third anniversary of the award date.
Absolute Total Shareholder Return: Relevant to 30 per cent of the award. Performance will be measured against the annualised return over the three year period ending 31 december 2014.
Short-term funding as a percentage of total funding: Relevant to 10 per cent of the award. Performance will be measured relative to 2014 targets.
At 1 January 2012 (or later date of appointment) At 31 December
Principal risks and uncertainties have been identified through the Group’s risk management processes. A brief overview of the Group’s principal risks and how these are mitigated can be found on page 118.
The mission of Risk division is to maintain a robust control framework, identify and escalate emerging risks and support sustainable business growth within risk appetite through good risk reward decisioning.
q Risk infrastructure: continue programme of investment in the Group’s risk systems.
q People agenda: continue to attract, retain and develop high quality people.
The Group has zero appetite for systemic unfair customer outcomes arising from product design, sales or after-sales processes.
The Group’s risk culture is embedded within the Group’s risk appetites, policies, procedures, controls and reporting. For example: – The Group’s risk culture is embedded within its approach to conduct risk, and is supported by frameworks to help it deliver the right outcomes for customers, and implemented through policies and standards in key areas such as product governance, responsible lending, claims and complaints handling.
– Risk appetite will continue to evolve in tandem with Group strategy.
– Board-level engagement, coupled with the direct involvement of senior management in Group wide risk issues at Group Executive committee level, ensures that issues are promptly escalated and remediation plans are initiated where required.
CReDiT RiSK Definition credit risk is defined as the risk that parties with whom the Group has contracted fail to meet their obligations (both on or off balance sheet).
COnDUCT RiSK Definition conduct risk is defined as the risk of customer detriment or censure and/or a reduction in earnings/value, through financial or reputational loss, from inappropriate or poor customer treatment or business conduct.
The Group takes many mitigating actions with respect to this principal risk; key examples include: – The Group’s conduct strategy and supporting framework have been designed to support its vision and strategic aim to put the customer at the heart of everything it does. The Group has developed and implemented a framework to enable it to deliver the right outcomes for its customers, which is supported by policies and standards in key areas, including product governance, customer treatment, sales, responsible lending, customers in financial difficulties, claims and complaints handling.
– The Group actively engages with regulatory bodies and other stakeholders in developing its understanding of current customer treatment concerns. The Group develops colleagues’ awareness of these and other expected standards of conduct through these and other policies and standards and codes of responsibility. it also undertakes root cause analysis of complaints and makes use of technology and metrics to facilitate earlier detection and mitigation of conduct issues.
– credit spread risk: This risk arises when the market perception of the creditworthiness of a particular counterparty changes. The main credit spread exposure arises in the insurance business, defined benefit pension schemes and banking businesses.
A variety of risk measures are used such as: – sensitivity based measures (e.g. sensitivity to 1 basis point move in interest rates)
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
The Group adopts a risk based approach to external fraud management, reflecting the current and emerging external fraud risks within the market. This approach drives an annual programme of enhancements to the Group’s technology, process and people related controls; with emphasis on preventative controls, supported by real time detective controls – wherever feasible. The Group has developed a mature and robust fraud operating model with centralised accountability established, discharged via Group wide policies and operational control frameworks. The Group’s fraud awareness programme is a key component of its fraud control environment; in 2012 a Group wide awareness campaign was launched specifically addressing the emerging ‘cyber’ threats and the role that the Group’s colleagues play in helping to keep its customers safe and secure.
– Ensuring compliance with legal and regulatory requirements related to Approved Persons and the Remuneration code, and embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities.
Principal risks liquidity and funding continues to remain a key area of focus for the Group and the industry as a whole. like all major banks, the Group is dependent on confidence in the short and long-term wholesale funding markets. should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding, its ability to fund its financial obligations could be impacted. The key dependencies on successfully funding the Group’s balance sheet include: – continued functioning of the money and capital markets.
– The Group has a contingency funding plan embedded within the Group liquidity Policy which has been designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing.
The Group has received no indications that the Government intends to change the existing operating arrangements with regard to the role of uKFi and engagement with the Group.
On 19 July 2012 the Group announced that it had agreed non-binding heads of terms with The co-operative Group (the co-operative) for the disposal of the Verde business. The Group continues to work with the co-operative to agree a sale and purchase agreement, with completion of the divestment expected by the end of november 2013. The Group has also undertaken planning for an initial Public Offering (iPO) of the Verde business, should this be required as a fallback option. The Verde business will be rebranded and operating on a standalone basis within lloyds Banking Group during 2013 and available for sale to another third party as a further fallback option.
Macroeconomic environment The operating plan is challenging, with a focus on improving earnings while achieving the required regulatory improvements on capital and liquidity. Any adverse movement in interest rates or deterioration in macroeconomic environment beyond the Group’s assumptions would delay improvement of the earnings and return profile.
Mitigating actions Actions to respond to the proposals on ring fencing are being taken forward alongside planning for recovery and resolution as part of a programme of work with senior executive sponsorship and robust governance arrangements.
Mitigating actions Prudent provisioning policy – provisions for legacy conduct issues represent management’s best estimate of the anticipated costs of related customer contact and/or redress, including administration expenses.
Responsible for the strategic management of the Group’s assets and liabilities and the profit and loss implications of balance sheet management actions. it is also responsible for the risk management framework for market risk, liquidity risk, capital risk and earnings volatility.
Group incident Executive sets the strategic direction for the Group’s response to significant incidents which could affect its ability to continue to operate, and instigates any tactical initiatives required.
The Group Risk Committee is supported by the following committees to ensure more effective risk management, clearer accountabilities and more efficient and simplified processes.
credit Risk committees Responsible for the development and effectiveness of the relevant credit risk management framework, clear description of the Group’s credit risk appetite, setting of credit policy, and compliance with regulatory credit requirements.
Group Market Risk committee Monitors and reviews the Group’s aggregate market risk exposures and concentrations and provides a proactive and robust challenge around business activities giving rise to market risks.
Reviews and challenges the management of financial crime risk including the overall strategy and performance and engagement with financial crime authorities. The committee is accountable for ensuring that, at Group level, financial crime risks are effectively identified and managed within risk appetite and that strategies for financial crime prevention are effectively co-ordinated and implemented across the Group.
– Business unit Managing directors/Executives (the first line of defence) have primary responsibility for identifying, 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 policies and are within the parameters set by the Board, Group Executive committee and Risk division.
– Group Audit (the third line of defence) provides independent, objective assurance across all areas of the Group focusing on the effectiveness of risk management, control and governance processes in line with ERM principles.
The Chief Risk Officer – oversees and promotes the development and implementation of consistent Group wide governance risk and control frameworks; – provides objective challenge to the Group’s senior management with the support of the Risk directors; – provides regular briefings and guidance to the Group Executive committee and the Board ensuring awareness of the Group’s risk profile and the overarching risk management framework with a clear understanding of their accountabilities for risk and internal control.
Risk directors – report directly to the chief Risk Officer; – have allocated responsibility for specific risk types; – are responsible for ensuring the adequacy of the framework for their risk types as well as the oversight of the associated risk profile across the Group; and
independent Challenge Group Audit provides independent assurance to the Audit committee and the Board that risks within the Group are recognised, monitored and managed within acceptable parameters. Group Audit is fully independent of Risk, seeking to ensure objective challenge to the effectiveness of the risk governance framework.
A key component of the ERM Framework is the common risk language, which categorises the risks to which the Group is exposed into eleven categories which are used consistently to support risk aggregation and standardised reporting. The Framework (table 1.3) outlines the key risk management activities undertaken consistently across the Group for all types of risk. These activities map to the components of the internal control framework issued by the committee of sponsoring Organisations of the Treadway commission.
un di ng ri sk in su ra nc e ris k1
Risk response – actions to mitigate each risk are aligned to the Group’s risk appetite and tolerances, managing future uncertainty and responding in a manner which reduces the likelihood of downside outcomes and increases the upside.
The Group policy framework has four component parts: – Group Principles – statements aligned to the Group’s risk drivers which set the foundation for the Group’s behaviours and decision making; – Group Policies – documents which translate a specific component of risk appetite into mandatory requirements, key measures and controls; – Group Procedures – operational standards required to implement Policy across the Group; and
– Business Processes – activity, or set of activities, which detail how local businesses will comply with Group Policies and Procedures.
credit risk can also arise from debt securities, private equity investments, derivatives and foreign exchange activities. note 18 on page 247 shows the total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 december 2012. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. such amounts are reflected in note 55 on page 319.
Our prudent credit risk appetite and strong risk management controls have supported a lower impairment charge in 2012, and the continued improvement in the credit quality of our portfolios.
controls over rating systems: The Group has established an independent team in the Risk division that sets common minimum standards, designed to ensure risk models and associated rating systems are developed consistently, and are of sufficient quality to support business decisions and meet regulatory requirements. internal rating systems are developed and owned by the Risk division. line management takes responsibility for ensuring the validation of the rating systems, supported and challenged by an independent specialist group function.
specialist expertise: credit quality is maintained by specialist units providing, for example: intensive management and control (see intensive care of customers in financial difficulty); security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector specific expertise; and legal services applicable to the particular market place and product range offered by the business.
stress testing and scenario analysis: The credit portfolio is also subjected to stress testing and scenario analysis. Events are modelled at a Group wide level, at divisional and business unit level and by rating model and portfolio.
Retail Assets (lending to individuals in Retail and Wealth, Asset Finance and international divisions) The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using information held by credit reference agencies (cRA). The Group also assesses the affordability of the borrowings to the borrower under stressed scenarios including increased interest rates. in addition, the Group has in place quantitative limits such as product maximum limits, the level of borrowing to income and the ratio of borrowing to collateral. some of these limits relate to internal approval levels and others are hard limits above which the Group will
Lloyds Banking Group Annual Report and Accounts 2012134 reject the application. The Group also has certain criteria that are applicable to specific products such as for applications for a mortgage on a property that is to be let by the applicant.
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.
collateral held as security for financial assets other than loans and advances is determined by the nature of the instrument. debt securities, treasury and other eligible bills are generally unsecured, with the exception of asset-backed securities and similar instruments, which are secured by portfolios of financial assets. collateral is generally not held against loans and advances to financial institutions, except where securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement. derivative transactions with wholesale counterparties are typically collateralised under a credit support Annex in conjunction with the isdA Master Agreement.
Master netting agreements Where it is appropriate and likely to be effective, the Group seeks to enter into master netting agreements. Although master netting agreements do not generally result in an offset of balance sheet assets and liabilities, as transactions are usually settled on a gross basis, they do reduce the credit risk to the extent that, if an event of default occurs, all amounts with the counterparty are terminated and settled on a net basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting agreements can change substantially within a short period, since it is affected by each transaction subject to the agreement.
Monitoring in conjunction with Risk, businesses identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by senior management. Risk division in turn produces an aggregated review of credit risk throughout the Group, including reports on significant credit exposures, which are presented to the Group Risk committee and the Board Risk committee.
Assistance is provided through trained colleagues in branches and dedicated telephony units, and via online guidance material. For those customers requiring more intensive help, assistance is provided through dedicated support units where tailored repayment programmes can be agreed. customers are actively supported and referred to free money advice agencies when they have multiple credit facilities, including those at other lenders, that require restructuring. Within the collections and Recoveries functions, the sharing of best practice and alignment of policies across the Group has helped to drive more effective customer outcomes and achieve operational efficiencies.
Commercial Customers Wholesale credit facilities are reviewed on a regular basis and more frequently where required. When financial stress is exhibited, the customer would be transferred at an early stage to one of the Group’s specialist Bsus or customer support teams.
customer support provides intensive care and support to smaller commercial small and medium-sized enterprises (sME) customers in difficulty. Whilst the customer relationship remains with the Relationship Manager, they are supported by a customer support Manager to oversee and manage identified risk.
it is Group policy that where forbearance has been granted for a commercial customer it must be managed either within the Group’s good book watchlist credit Risk classification framework or within a Bsu. Whilst the Group treats all impaired assets to commercial customers as having been granted some form of forbearance in the past, granting forbearance does not necessarily mean that it is expected that future cashflows will fall, or that the asset is impaired. depending on circumstances and within robust parameters and controls, the Group believes forbearance can help support the customer in the medium term.
Following a forbearance event, should the customer show a sustained period of stabilisation on their new terms and conditions or where the forbearance has reversed or cured, the customer would likely be returned to the mainstream good classification, at which point they may no longer be considered forborne. such a decision can be made only by the independent Risk division.
The Group’s accounting policy for loan renegotiations and forbearance is set out in note 2(H) on page 219.
£m £m change loans and advances to customers 5,654 9,712 42 debt securities classified as loans and receivables 15 49 69
The fair value adjustments relating to loans and advances were those required to reflect the HBOs assets in the Group’s consolidated financial records at their fair value and took into account both the expected future impairment losses and market liquidity at the date of acquisition. The unwind relating to future impairment losses requires significant management judgement to determine its timing which includes an assessment of whether the losses incurred in the current period were expected at the date of the acquisition and assessing whether the remaining losses expected at the date of the acquisition will still be incurred. The element relating to market liquidity unwinds to the income statement over the estimated useful lives of the related assets (until 2014 for wholesale loans and 2018 for retail loans) although if an asset is written off or suffers previously unexpected impairment then this element of the fair value will no longer be considered a timing difference (liquidity) but permanent (impairment). The fair value unwind in respect of impairment losses incurred was £868 million for 2012 (2011: £1,693 million). The fair value unwind in respect of loans and advances is expected to continue to decrease in future years as fixed-rate periods on mortgages expire, loans are repaid or written off, and will reduce to zero over time.
Provisions as a percentage of impaired loans are calculated excluding Retail unsecured loans in recoveries (2012: £1,047 million; 2011: £1,054 million).
Provisions as a percentage of impaired loans are calculated excluding Retail unsecured loans in recoveries (2012: £82 million; 2011: £83 million).2
– The Retail impairment charge, as an annualised percentage of average loans and advances to customers decreased to 0.36 per cent in 2012 from 0.54 per cent in 2011.
– The overall value of assets entering arrears in 2012 was lower in both unsecured and secured lending compared to 2011.
– non-core represents 8 per cent of total Retail assets at 31 december 2012 and is primarily specialist mortgages which is closed to new business and has been in run-off since 2009.
core impairment charge as a % of average advances 0.37% 0.54% (17)bp non-core impairment charge as a % of average advances 0.29% 0.59% (30)bp impairment charge as a % of average advances 0.36% 0.54% (18)bp
Lloyds Banking Group Annual Report and Accounts 2012142 impaired loans and provisions Retail impaired loans decreased by £502 million to £8,320 million compared with 31 december 2011 and, as a percentage of closing loans and advances to customers, decreased to 2.4 per cent from 2.5 per cent at 31 december 2011. impairment provisions as a percentage of impaired loans (excluding unsecured loans in recoveries) decreased to 32.5 per cent from 35.4 per cent at 31 december 2011 driven by the reduction in unsecured impaired loans.
2012 £m secured: Buy to let 49,568 48,276 unsecured: Bank accounts 2,710 2,602
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions1 impairment provisions as a % of impaired loans3 unsecured: impairment provisions (1,957)
The number of customers entering into arrears was 7 per cent lower in 2012 in comparison with 2011.
Table 1.17: Mortgages greater than three months in arrears (excluding repossessions) (unaudited)
Lloyds Banking Group Annual Report and Accounts 2012144 secured loan to value analysis The average indexed loan to value (lTV) on the mortgage portfolio at 31 december 2012 increased to 56.4 per cent compared with 55.9 per cent at 31 december 2011. The average lTV for new mortgages and further advances written in 2012 was 62.6 per cent compared with 62.1 per cent for 2011.
Table 1.18: Actual and average LTvs across the Retail mortgage portfolios (audited)
Average loan to value:2 stock of residential mortgages 52.2 74.0 72.6 55.9 new residential lending 61.4 65.8 n/a 62.1 specialist lending is closed to new business and is in run-off.
impaired loans decreased by £371 million since 31 december 2011 to £1,999 million at 31 december 2012 which represented 8.8 per cent of closing loans and advances to customers, compared with 9.6 per cent at 31 december 2011. The reduction in impaired loans is a result of the Group’s sustainable risk appetite and ongoing effective portfolio management. Retail’s exposure to revolving credit products has been actively managed to ensure that it is appropriate to customers’ changing financial circumstances.
impairment provisions decreased by £348 million, compared with 31 december 2011. This reduction was driven by fewer assets entering arrears and recoveries assets being written down to the present value of future expected cash flows. impairment provisions as a percentage of impaired loans in collections decreased to 82.6 per cent at 31 december 2012 from 86.5 per cent at 31 december 2011.
core impairment charge as a % of average advances 0.67% 0.95% (28)bp non-core impairment charge as a % of average advances 4.28% 4.60% (32)bp impairment charge as a % of average advances 1.85% 2.32% (47)bp impairment charges have decreased 30 per cent compared with 2011 driven by lower charges in Australasia and leveraged lending in Acquisition Finance, which was partly offset by further deterioration in the shipping portfolio as a result of weak markets. The low interest rate environment is helping to maintain defaults at a lower level.
core impairments in 2012 were 33 per cent lower compared to 2011. This is primarily attributable to lower impairments in some core portfolios, including in Mid Markets, corporate and sME. in Mid Markets and corporate, there were specific large impairments in 2011, which were not repeated in 2012.
As a result, core impairment charges as an annualised percentage of average loans and advances to customers reduced to 0.67 per cent compared to 2011 (0.95 per cent).
non-core impairments were also lower, driven mainly by lower charges on non-core Acquisition Finance and Australasian exposures, partially offset by further deterioration in the shipping portfolio due to a weak market. There was a significant deterioration in the leveraged market during the first half of 2011 which has not been repeated during 2012. A significant portion of the Australasian impaired portfolio was disposed of in 2011 and 2012, and the residual portfolio is considered better quality.
impaired loans and provisions The overall quality of the commercial Banking portfolio continues to improve. despite a reducing portfolio, as a percentage of closing loans and advances to customers, impaired loans decreased to 16.6 per cent from 19.5 per cent at 31 december 2011.
non-core impairment provisions as a percentage of non-core impaired assets are lower than core, mainly a factor of the asset mix, where the non-core portfolios are heavily weighted towards real estate and real estate related portfolios with higher collateral levels against lending.
Total core 107,088 loans and advances to banks 7,132 debt securities 536
Total core 123,410 loans and advances to banks 8,161 debt securities 190
Total non-core 49,029 loans and advances to banks 300 debt securities 12,300
Commercial The commercial portfolio credit quality remains stable and impairment charges have fallen over the last 12 months to £252 million in 2012 from £296 million in 2011. The decrease reflects the continued benefits of the low interest rate environment, which has helped to maintain defaults at a lower level, and the continued application of the Group’s prudent risk appetite and through the cycle credit policy that has proven itself appropriate for both customers and the Group.
Sales and Trading – Acts as the link between the wholesale markets and the Group’s balance sheet management activities providing pricing and risk management solutions to both internal and external clients. The portfolio comprises £5.8 billion of loans and advances to banks, £1.7 billion of available-for-sale debt securities and £2.8 billion of loans and advances to customers (excluding reverse repos). sales and Trading actively manages the government bond portfolio which is now almost solely AAA/AA rated. Exposure to the weaker Eurozone sovereigns has been managed down to a de minimis level given continued concerns over market conditions across the Eurozone.
The majority of sales and Trading’s funding and risk management activity is transacted with investment grade counterparties including sovereign central banks and much of it is on a collateralised basis, such as repos facing a central counterparty (ccP). derivative transactions with Fi counterparties are typically collateralised under a credit support annex in conjunction with the international swaps and derivatives Association Master Agreement. during 2012 the Group continued to consolidate its counterparty risk via ccPs as part of an ongoing move to reduce counterparty risk by clearing standardised derivative contracts.
The portfolio remains regionally focused with real estate asset quality that is largely secondary and tertiary in nature. However, these assets have been the subject of significant and frequent review, and have been impaired to appropriate levels.
The profile of the Group’s portfolio allows the Group flexibility to consider asset disposal, loan sales or repayments through the now embedded property asset management platforms and has allowed the Group to attract liquidity from different counterparties in a demanding environment. Over the last three years corporate Real Estate Bsu has reduced non-core gross loan exposure by approximately £21 billion. in 2012, disposals outside london accounted for over 70 per cent of corporate Real Estate Bsu’s disposals by value and over 90 per cent by number. This is higher than the general market experience.
secured loan to value analysis for uK direct Real Estate lending in commercial Banking The Group classifies direct Real Estate as exposure which is directly supported by cashflows from property activities, as opposed to trading activities (such as hotels, care homes and housebuilders). The Group manages its exposures to direct Real Estate in a number of different business units.
loan to value ratios (indexed or actual if within last 12 months) for the Group’s largest transactions (over £5 million) are detailed in the table below. The Group considers this portfolio to be appropriately provided for after taking into account the provisions held for each transaction and the value of the collateral held. in the case of impaired uK direct Real Estate exposures (over £5 million) there is a net property collateral shortfall of approximately £0.2 billion. This figure excludes benefits of credit mitigants such as cross collateralisation and cross guarantees. For the good book, unsecured and over 100 per cent lTV lending mainly comprises lending supported by either the strength of the obligors’ balance sheet or a strong parent. The Group makes use of a variety of methodologies to assess the value of property collateral, where external valuations are not available. These include use of market indexes, models and subject matter expert judgement.
– in the irish wholesale portfolio, 85.2 per cent (2011: 84.3 per cent) is now impaired with a coverage ratio of 68.0 per cent (2011: 61.1 per cent), primarily reflecting continued deterioration in the irish commercial property market. net exposure in ireland wholesale has reduced to £5.4 billion (2011: £8.6 billion).
core impairment charge as a % of average advances 0.45% 0.60% (15)bp
non-core impairment charge 1,458 3,571 59 non-core impairment charge as a % of average advances 3.42% 7.11% (3.69)pp
Wealth Total impaired loans increased by £53 million to £284 million compared with £231 million at 31 december 2011. impairment provisions as a percentage of closing loans and advances decreased to 25.7 per cent from 32.0 per cent at 31 december 2011. The impairment charge for 2012 was £23 million. The impairment charge, as an annualised percentage of average loans and advances to customers, decreased to 0.51 per cent compared with 0.67 per cent in 2011.
Ireland Total impaired loans decreased by £3,859 million, or 24 per cent to £12,501 million compared with £16,360 million at 31 december 2011. The reduction is driven primarily by commercial Real Estate and corporate loans. impaired loans as a percentage of closing loans and advances decreased to 64.0 per cent from 66.0 per cent at 31 december 2011. continuing weakness in the irish real estate markets resulted in a further increase in ireland wholesale coverage in 2012 to 68.0 per cent from 61.1 per cent.
The Group continued to reduce its exposure to ireland. Gross loans and advances reduced by £5,242 million during 2012 mainly due to write-offs of £2.5 billion, disposals of £1.4 billion and net repayments of £0.7 billion.
Lloyds Banking Group Annual Report and Accounts 2012156 secured loan to value analysis for commercial Real Estate lending in ireland Wholesale loan to value ratios (indexed or actual if within last 18 months) for the Group’s largest transactions (over A5 million) are detailed in the table below. The Group considers this portfolio to be appropriately provided for after taking into account the provisions held for each transaction and the value of the collateral held. in the case of impaired ireland commercial real estate exposures (over €5 million) there is a net property collateral shortfall of approximately £0.3 billion. This figure excludes benefits of credit mitigants such as cross collateralisation and cross guarantees. As a result of the market environment, market-based information on valuations is limited. The Group therefore makes use of a variety of methodologies to assess the value of property collateral. These include use of market indexes, models and subject matter expert judgement.
identified indirect exposure information is also taken into account when setting limits and determining credit risk appetite for individual counterparties. This forms part of the Group’s credit analysis undertaken at least annually for counterparty and sector reviews, with interim updates performed as necessary. interim updates would usually be triggered by specific credit events such as rating downgrades, sovereign events or other developments such as spread widening. Examples of indirect risk which have been identified are: European banking groups with lending and other exposures to certain Eurozone countries; corporate customers with operations or significant trade in certain European jurisdictions; major travel operators known to operate in certain Eurozone countries; and international banks with custodian operations based in certain European locations.
For multi-country asset backed securities exposures, the Group has reported exposures based on the largest country exposure. The country of exposure for asset backed securities is based on the location of the underlying assets, which are predominantly residential mortgages, not on the domicile of the issuer.
Exposures to ireland, spain, Portugal, Greece and italy The Group continues to have minimal exposure, in aggregate, which could be considered to be direct recourse to the sovereign risk of the selected countries.
Financial institutions – banks: net trading assets 7 – 7 – – –
The Group has exposures to a structured vehicle incorporated in ireland. in accordance with the reporting protocol outlined above, the exposures classified as Bonds have been reported on the basis of the underlying country of risk, while other exposures have been reported against the country of registration of the structured vehicle.
Carrying value £m netting £m net £m carrying value £m netting £m net £m sovereign debt: Financial institutions – banks: Financial institutions – other: Asset backed securities: corporate: Personal: The Group held impairment provisions of £112 million (2011: £149 million) against corporate amortised cost exposures and £105 million (2011: £70 million) against personal amortised cost exposures. £220 million (2011: £349 million) was included in reserves in respect of available-for-sale securities included in the table above.
Personal exposures within spain are predominantly secured residential mortgages, where about half of the borrowers are expatriates. impaired lending represented 7 per cent (2011: 6 per cent) of the portfolio, with a coverage ratio of 90 per cent (2011: 64 per cent).
Financial institutions – other: net trading assets – – – 8 – 8
Asset backed securities: Available-for-sale – – – 23 – 23 corporate: Personal – – – – – –
The Group held impairment provisions of £40 million (2011: £43 million) against corporate amortised cost exposures. in 2011, £21 million was included in reserves in respect of available-for-sale securities included in the table above.
Financial institutions – other: net trading assets – – – 17 – 17
The Group held impairment provisions of £2 million (2011: £1 million) against corporate amortised cost exposures. £nil (2011: £17 million) was included in reserves in respect of available-for-sale securities included in the table above.
Eurozone redenomination risk Redenomination risk arises from the uncertainty over how an exiting member state would deal with pre-incurred euro contractual liabilities and, in particular, whether it (or a competent European body) legislates to re-denominate such liabilities into a post-euro currency. it is generally expected that an exiting member state would introduce a new national currency and determine an opening rate of exchange, which would then change when trading commences in the new currency, exposing the holders of the new currency to the risk of changes in the value of the new currency against the Euro. Although considered less likely, multiple member exits may also take place, and in the case of a total dissolution of the Eurozone, the Euro may cease to be a valid currency, with the possibility of all states re-introducing their own currencies.
– The introduction of one or more new currencies would be likely to lead to significant operational issues for clearing and payment systems. The Group continues to work actively with central banks, regulators and with the main clearing and payment systems to better understand and mitigate the impact of these risks on the Group and its customers.
The Group has a robust, Group wide approach to assess, monitor and report Equator Principle transactions. it also provides ongoing training for lending officers and more in-depth training for colleagues working in project finance is offered.
since 2011, the Group has participated in the Equator Principles strategic Review process (‘Equator Principles iii’) which is examining the scope of application, transparency, implementation and governance of the Principles. The process is nearing completion, and it is envisaged that the final version of Equator Principles iii will be published in 2013. The Group is currently reviewing its approach to the Equator Principles to ensure that it fully complies with the new requirements once introduced.
A B C Total in progress – 3 – 3 not completed – – – –
exposures conduct risk affects all aspects of the Group’s operations, all types of customers and other stakeholders. There is currently a high level of scrutiny regarding conduct risk and treatment of customers by financial institutions from the press, politicians and regulatory bodies. The Group has been actively managing conduct issues as part of its conduct strategy and has undertaken a range of actions in respect of both front and back book of business. Work continues to close back book issues such as payment protection insurance and drive down complaint volumes. An ongoing focus on the delivery of fair outcomes, business standards and the implementation of the conduct strategy, which will make greater use of technology and metrics to determine inherent conduct risks, will facilitate earlier detection and mitigation of conduct issues.
Measurement conduct risks are measured against a set of risk appetite measures, with appropriate limits and triggers, which have been approved by the Board. Metrics include assessments of products, sales, aftersales and fair outcomes for customers.
These appetites and metrics are tracked within the Group’s three lines of defence control framework. Business areas track and report the conduct risks in their business. These reports are challenged by Risk division and contribute to reporting on conduct risk provided to the Group compliance and conduct committee, the Group Risk committee and the Board Risk committee.
– senior business leaders monitor the progress of these assessments and mitigations.
Risk appetite The Group’s overall appetite for market risk is reviewed and approved annually by the Board. With the support of the Group Asset and liability committee, the Group chief Executive allocates this risk appetite across the Group. individual members of the Group Executive committee ensure that market risk appetite is further cascaded to an appropriate level within their areas of responsibility.
Market risk in the Group’s retail portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets and liabilities. interest rate risk arises predominantly from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets.
Foreign currency risk also arises from the Group’s investment in its overseas operations. net investment exposures are disclosed (see note 55 on page 319) and it is Group policy to hedge non-functional currency exposures.
– unit-linked liabilities are matched with the same assets that are used to define the liability but future fee income is dependent upon the performance of those assets. (This forms part of the Value of in-force business, see note 29 on page 256).
– surplus assets are held primarily in four portfolios: (a) in the long-term funds within the life insurance companies; (b) in the corresponding shareholder funds; (c) in investment portfolios within the general insurance business; and (d) within the main fund of Heidelberger lebensversicherung AG.
in addition, profit and loss triggers are used in the Trading Books in order to ensure that mitigating action is considered if profit and loss becomes volatile. Both VaR and standard stress measures are used in setting divisional market risk appetite limits and triggers.
Although an important market standard measure of risk, VaR has limitations. These arise from the use of limited historical data, an assumed distribution, defined holding periods, set confidence intervals and frequency of calculation. The exposure level at the confidence interval does not convey any information about potential losses which may arise if this level is exceeded. A 95 per cent confidence interval with a 1-day holding period is equivalent to an expected 1 in 20 day loss.
Table 1.44: Trading portfolios: vaR 1-day 95 per cent confidence level (audited) Most of the Group’s trading activity is undertaken to meet the requirements of wholesale and retail customers for foreign exchange and interest rate products.
Banking activities Market risk in non-trading books consists almost entirely of exposure to changes in interest rates including the margin between interbank and central bank rates. This is the potential impact on earnings and value that could occur when, if rates fall, liabilities cannot be re-priced as quickly or by as much as assets; or when, if rates rise, assets cannot be re-priced as quickly or by as much as liabilities.
The following table shows, split by material currency, the Group’s sensitivities at 31 december 2012 to an immediate up and down 25 basis points change to all interest rates.
defined benefit pension schemes Management of the assets of the Group’s defined benefit pension schemes is the responsibility of the scheme Trustees, who also appoint the scheme Actuaries to perform the triennial valuations. The Group monitors its defined benefit pension exposure holistically using a variety of metrics including accounting and economic deficits and contribution rates. These and other measures are regularly reviewed by the Group Asset and liability committee and the Group Market Risk committee and used in discussions with the Trustees, through whom any risk management and mitigation activity must be conducted.
Monitoring The Group Asset and liability committee and the Group Market Risk committee regularly review high level market risk exposure, as part of the wider risk management framework. They also make recommendations to the Group chief Executive concerning overall market risk appetite and market risk policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. levels of exposures compared to approved limits and triggers are monitored by Risk division and where appropriate, escalation procedures are in place.
Trading portfolios and Banking activities Trading is restricted to a number of specialist centres, the most important centre being the treasury and trading business in london. These centres also manage market risk in the wholesale non-trading portfolios, both in the uK and internationally. The level of exposure is strictly controlled and monitored within approved limits. Active management of the wholesale portfolios is necessary to meet customer requirements and changing market circumstances.
iT Systems and resilience – The risk of reductions in earnings and/or value through financial or reputational loss resulting from the failure to develop, deliver or maintain effective iT solutions. This includes the resilience of the Group’s iT infrastructure and systems, rigorous change control processes to minimise the risk of incidents impacting their availability, and formal business continuity and recovery arrangements which are designed and tested to evidence the recoverability of key services within prescribed timescales. significant business-wide incidents are managed via an incident management process, which is subject to frequent testing.
The continuing structural consolidation and the sale of part of the branch network under Project Verde may result in disruption of senior management’s ability to lead and manage the Group effectively. The level and impact of change is managed via robust change management governance and a consolidated strategic change Plan. There are separate Governance arrangements in place in Project Verde to oversee the impacts of the divestment on the retained business customers, operations and controls.
The Group’s businesses are dependent on processing and reporting accurately and efficiently a high volume of complex transactions across numerous and diverse products and services, in different currencies and subject to a number of different legal and regulatory regimes. The complexity of these operations presents potential risks. in addition, any breach in security of the Group’s systems could disrupt its business, result in the disclosure of confidential information and create significant financial and legal exposure.
Measurement The Group manages its operational risks via a risk framework which includes definition, monitoring and measurement against appetite targets and thresholds. Appetites are defined with limits and triggers which are approved by the Board and which are regularly reviewed and monitored by the Group Operational Risk committee. The Group monitors events and losses by size, business unit and internal risk categories. The table below shows high level loss and event trends using Basel ii categories.
The operational risk profile of the Group as a whole and of individual business areas is regularly reviewed within the overarching three lines of defence control framework. Business area reports are reviewed and challenged at Risk division level, whilst audit and assurance teams ensure that all levels of reporting are subject to rigorous scrutiny.
– increased regulatory scrutiny of incentive and remuneration practices, and Approved Persons following recent changes to domestic and international regulatory structures.
– The Group continues to develop colleagues’ awareness of their responsibilities in managing risk in their role through the embedding of codes of Personal and Business Responsibility which ensure a strong focus on fair customer outcomes and support the effective management of the Group’s overall risk profile.
The ability to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of high grade marketable debt securities as set out in Table 1.48 which can be sold to provide, or used to secure, additional short term funding should the need arise from either market counterparties or central bank facilities (Bank of England, European central Bank, Federal Reserve and Reserve Bank of Australia).
We have significantly strengthened our liquidity and funding position, leaving the Group well positioned for growth.
intra-day liquidity liquidity required for clearing and payment systems under stressed conditions.
Lloyds Banking Group Annual Report and Accounts 2012178 during the first half of 2012 the Group accelerated term funding initiatives and the run down of certain non-core asset portfolios allowing a further reduction in money market funding and total government and central bank facilities. This has significantly reduced exposure to wholesale outflows and rating agency downgrades. The Group repaid its remaining drawings under the Government’s credit Guarantee scheme in full, in line with its contractual maturities.
The combination of right-sizing the balance sheet and continued development of the customer deposit base has seen the Group’s wholesale funding requirement reduce materially in recent years. The progress the Group has made to date in diversifying its funding sources has further strengthened its funding base. Funding concentration is not considered significant by the Group but where such concentrations do exist (at the customer or industry level) they are not deemed material at Group level.
Sterling US Dollar euro Other currencies Total £bn £bn £bn £bn £bn
At 31 December 2012 debt securities in issue 120.4 – (3.0) 117.4
At 31 december 2011 debt securities in issue 189.9 – (4.8) 185.1
Liquidity Portfolio At 31 december 2012, the Group had £87.6 billion (2011: £94.8 billion) of highly liquid unencumbered assets in its primary liquidity portfolio which are available to meet cash and collateral outflows, as illustrated in the table below. in addition the Group had £117.1 billion (2011: £107.4 billion) of secondary liquidity covering a range of ratings but all investment grade and central bank eligible. This liquidity is managed as a single pool in the centre under the control of the function charged with managing the liquidity of the Group. it is available for deployment at immediate notice, subject to complying with regulatory requirements, and is a key component of the Group’s liquidity management process.
Table 1.54: Liquidity portfolio: currency (unaudited) Sterling US Dollar euro Other currencies Total £bn £bn £bn £bn £bn
Primary liquid assets of £87.6 billion represent approximately 260 per cent (133 per cent at 31 december 2011) of the Group’s money market funding positions and are approximately 173 per cent (84 per cent at 31 december 2011) of all wholesale funding with a maturity of less than one year, and thus provides substantial buffer in the event of continued market dislocation.
The Group uses secured transactions to manage short-term cash and collateral needs. At 31 december 2012, the fair value of collateral pledged as security in repo transactions was £48.1 billion (2011: £39.7 billion). internally held notes encumbered through repo activity or assets pledged are included in these disclosure amounts. note 55 on page 329 sets out further information on assets pledged as security. Within asset-backed commercial paper (ABcP) conduits, assets pledged as security for ABcP investors totalled £6.4 billion (2011: £8.8 billion). note 22 on page 253 sets out the assets held within the ABcP conduits.
Risk appetite insurance risk appetite is defined with regard to the quantum and composition of insurance risk that exists currently in the Group and the Group’s risk preferences. it takes account of the need for each entity in the Group to maintain solvency in excess of the minimum level required by the entity’s jurisdictional legal or regulatory requirements. The Group’s appetite for insurance solvency and earnings is reviewed and approved annually by the Board.
exposures The major sources of insurance risk within the Group are the insurance business and the Group’s defined benefit pension schemes. The nature of insurance business involves the accepting of insurance risks which relate primarily to mortality, longevity, morbidity, persistency, expenses, property and unemployment. The prime insurance risk of the Group’s defined benefit pension schemes is related to longevity.
Mitigation A key element of the control framework is the consideration of insurance risk by an appropriate combination of high level committees and Boards. For the insurance business the ultimate control body is the Board of scottish Widows Group limited with significant risks also reviewed by the Group Executive and Group Risk committees and/or Board. All Group defined benefit pension schemes issues are covered by the Group Asset and liability committee and the Group Risk committee.
The most significant insurance risks within the insurance business are longevity risk, persistency risk and expenses. The merits of longevity risk transfer and hedging solutions are regularly reviewed. it is not possible to hedge persistency risk.
The Group is able to accumulate additional capital through profit retention, by raising equity via, for example, a rights issue or debt exchange and by raising tier 1 and tier 2 capital by issuing subordinated liabilities, taking account of the potential capital eligibility requirements under cRd iV. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time.
We have made significant progress and continue to deliver on our strategy of strengthening the balance sheet to improve the resilience of the Group.
capital policies and procedures are subject to independent oversight. Regular reporting of actual and projected ratios, including those that could occur under cRd iV and in stressed scenarios, is submitted to the senior Asset and liability committee (a sub-committee of the Group Asset and liability committee), the Group Asset and liability committee, the Group Risk committee and the Board.
– in november the Financial stability Board published an updated list of Global systemically important Banks (G-siBs) which no longer included the Group. The Group remains, however, a domestic systemically important Bank (d-siB) within the uK.
capital position at 31 december 2012 The Group’s capital position, at 31 december 2012 and applying the existing regulatory framework, is set out in the following section. Additionally, estimated pro forma information about the Group’s capital position on a cRd iV basis is set out on page 192.
Total capital resources 53,603 54,996 covered by grandfathering provisions issued by FsA.
Risk-weighted assets reduced by £42,042 million to £310,299 million, a decrease of 12 per cent. This reflects a combination of balance sheet reductions of non-core assets, lower core lending balances and strong management of risk.
Operational risk-weighted assets are determined under the standardised approach, which uses income as the basis of calculation. The decrease in the risk-weighted assets is a result of a reduction in three year rolling-average income.
The estimates of pro forma cRd iV risk-weighted assets shown are also based upon July 2011 draft rules updated to reflect the Group’s current view of the most likely application of the final rules.
The Group’s capital position may be different should alternative text be agreed. There are potential changes that could result in increases to risk-weighted assets including, for example, the application of a 90 day definition of default for retail assets and the Eu corporate exemption from the cVA not applying. conversely, if the FsA were to apply the more favourable treatment allowed in relation to insurance holdings (rather than the less favourable treatment that has been assumed will apply), this would increase the estimated fully loaded cET1 ratio by a further 1.0 per cent.
Remove accounting value of derivatives and securities finance transactions (76,731) (76,731) (76,731)
derivatives and securities financing transactions have been calculated by applying the accounting measure of exposure (plus, for derivatives, an add-on for potential future exposure) and the regulatory netting rules based on the Basel ii Framework.
The realistic valuation of liabilities includes an allowance for future bonuses. Options and guarantees are valued using a stochastic simulation model which values these liabilities on a basis consistent with tradable market option contracts (a market-consistent basis). The model takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given in the section entitled Options and guarantees on page 199.
Qualifying loan capital – – – 2,238 – 2,238 support arrangement assets 190 – (190) – – –
Adjustments onto a regulatory basis: unallocated surplus within insurance business 242 58 – – – 300
Qualifying loan capital – – – 1,997 – 1,997 support arrangement assets 184 – (184) – – –
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 2012, the estimated net economic value of the non-Participating Fund and its subsidiaries for the purposes of this test was £5,647 million (2011: £5,494 million) and the estimated combined value of the support Account and Further support Account was £2,171 million (2011: £2,291 million).
uK non-Profit Funds Available capital in the uK non-Profit Funds has increased from £1,024 million at 31 december 2011 to an estimated £1,120 million at 31 december 2012. This is mainly due to income on existing business offset by the impact of writing new business, positive investment returns, one-off transfers and an increase in provisions.
uK life shareholder Funds Available capital in the uK life shareholder Funds has increased from £3,677 million at 31 december 2011 to an estimated £3,854 million at 31 december 2012. The increase is mainly due to dividend receipts and transfers between funds offset by the issue of and payments on subordinated debt.
Other life insurance business – – 12,923 2 12,925 insurance and participating investment contract liabilities 13,779 8,248 51,681 8,431 82,139 non-participating investment contract liabilities – – 49,929 4,443 54,372
With-Profit Fund liabilities 13,651 9,300 4 – 22,955 unit-linked business (excluding that accounted for as non-participating investment contracts) – – 34,660 7,801 42,461
Options and guarantees outside the With-Profit Funds A number of typical guarantees are provided outside the With-Profit Funds such as guaranteed payments on death (e.g. term assurance) or guaranteed income for life (e.g. annuities). in addition, certain personal pension policyholders in scottish Widows, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £56 million (2011: £61 million) in respect of those guarantees. if future salary growth were 0.5 per cent per annum greater than assumed, the liability would increase by approximately £2 million. if yields were 0.5 per cent lower than assumed, the liability would increase by approximately £8 million.
Mitigation The Group maintains a system of internal controls, which is designed to: – ensure that accounting policies are consistently applied, transactions are recorded and undertaken in accordance with delegated authorities, that assets are safeguarded and liabilities are properly recorded; – enable the calculation, preparation and reporting of financial, prudential regulatory and tax outcomes in accordance with applicable international Financial Reporting standards, statutory and regulatory requirements; – ensure that disclosures are made on a timely basis in accordance with statutory and regulatory requirements and as far as possible are consistent with best practice and in compliance with the British Bankers’ Association code for Financial Reporting disclosure.
Through a system of internal controls we deliver meaningful, transparent and timely disclosures.
Mitigation The Group’s internal governance framework consists of the following key components: – clearly defined authorities and accountabilities delegated to business management, which ultimately derive from the Board; – core principles established to ensure consistent and effective internal governance and decision-making arrangements at business level; – a Group Policy framework which defines clear control requirements for the business and supports effective risk management; and
– a risk management model based on three lines of defence, with clear allocation of responsibilities for risk management, oversight and independent challenge.
Monitoring A review of the Group’s governance and internal control framework, including the status of the Group’s Principles and Policy Framework, and the design and operational effectiveness of key governance committees, is undertaken on an annual basis and the findings reported to the Group Risk committee, Board Risk committee and the Board.
Report of the independent auditors on the parent company financial statements 344
Respective responsibilities of directors and auditors As explained more fully in the statement of directors’ responsibilities on page 84, the directors are responsible for the preparation of the group financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the group financial statements in accordance with applicable law and international standards on Auditing (uK and ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical standards for Auditors.
– have been prepared in accordance with the requirements of the companies Act 2006 and Article 4 of the iAs Regulation.
Philip Rivett senior statutory Auditor for and on behalf of Pricewaterhousecoopers llP chartered Accountants and statutory Auditors london 1 March 2013
Annual Report and Accounts 2012206 cOnsOlidATEd incOME sTATEMEnT for the year ended 31 december note £ million £ million £ million interest and similar income 23,535 26,316 29,340 interest and similar expense (14,460) (13,618) (16,794)
Other comprehensive income for the year, net of tax (918) 2,242 278
Annual Report and Accounts 2012208 cOnsOlidATEd BAlAncE sHEET at 31 december note £ million £ million
Movements in cash flow hedging reserve, net of tax – 25 – 25 – 25 currency translation differences (tax: £nil) – (14) – (14) – (14)
Value of employee services: share option schemes – – 81 81 – 81
Transactions with owners issue of ordinary shares 316 – – 316 – 316
Value of employee services: share option schemes – – 154 154 – 154
Adjustments for: change in operating assets 56(A) 48,333 44,097 31,860 change in operating liabilities 56(B) (46,681) (19,187) (45,683)
Cash and cash equivalents at end of year 56(d) 101,058 85,889 62,300
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts. As stated on page 82, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements.
(ii) Deferred Tax: Recovery of Underlying Assets (Amendment to IAS 12). introduces a rebuttable presumption that investment property measured at fair value is recovered entirely through sale and that deferred tax in respect of such investment property is recognised on that basis.
investment vehicles, such as Open Ended investment companies (OEics), where the Group has control are consolidated. control arises when the Group manages the funds and also has a majority beneficial interest. in circumstances where the Group holds a majority beneficial interest, but is not the fund manager, the Group does not consolidate the entity as it does not have the fund manager’s decision-making powers over the investment activities of the OEic necessary to establish control. The interests of parties other than the Group are reported in other liabilities.
The treatment of transactions with non-controlling interests depends on whether, as a result of the transaction, the Group loses control of the subsidiary. changes in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions; any difference between the amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent entity. Where the group loses control of the subsidiary, at the date when control is lost the amount of any non-controlling interest in that former subsidiary is derecognised and any investment retained in the former subsidiary is remeasured to its fair value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.
(2) Joint ventures and associates Joint ventures are entities over which the Group has joint control under a contractual arrangement with other parties. Associates are entities over which the Group has significant influence, but not control or joint control, over the financial and operating policies. significant influence is the power to participate in the financial and operating policy decisions of the entity and is normally achieved through holding between 20 per cent and 50 per cent of the voting share capital of the entity.
The Group utilises the venture capital exemption for investments where significant influence or joint control is present and the business unit operates as a venture capital business. These investments are designated at initial recognition at fair value through profit or loss. Otherwise, the Group’s investments in joint ventures and associates are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Group’s share of the post-acquisition results of the joint venture or associate based on audited accounts which are coterminous with the Group or made up to a date which is not more than three months before the Group’s reporting date. The share of any losses is restricted to a level that reflects an obligation to fund such losses.
(D) Revenue recognition interest income and expense are recognised in the income statement for all interest-bearing financial instruments using the effective interest method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.
dividend income is recognised when the right to receive payment is established.
Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. such assets and liabilities are carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur. Financial assets and liabilities are designated at fair value through profit or loss on acquisition in the following circumstances: – it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on different bases. The main type of financial assets designated by the Group at fair value through profit or loss are assets backing insurance contracts and investment contracts issued by the Group’s life insurance businesses. Fair value designation allows changes in the fair value of these assets to be recorded in the income statement along with the changes in the value of the associated liabilities, thereby significantly reducing the measurement inconsistency had the assets been classified as available-for-sale financial assets.
– the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, with management information also prepared on this basis. As noted in (A)(2) above certain of the Group’s investments are managed as venture capital investments and evaluated on the basis of their fair value and these assets are designated at fair value through profit or loss.
(2) Available-for-sale financial assets debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss, held-to-maturity investments or as loans and receivables are classified as available-for-sale financial assets and are recognised in the balance sheet at their fair value, inclusive of transaction costs. Available-for-sale financial assets are those intended to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of investments classified as available-for-sale are recognised directly in other comprehensive income, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement. interest calculated using the effective interest method and foreign exchange gains and losses on debt securities denominated in foreign currencies are recognised in the income statement.
(3) Loans and receivables loans and receivables include loans and advances to banks and customers and eligible assets including those transferred into this category out of the fair value through profit or loss or available-for-sale financial assets categories. loans and receivables are initially recognised when cash is advanced to the borrowers at fair value inclusive of transaction costs or, for eligible assets transferred into this category, their fair value at the date of transfer. Financial assets classified as loans and receivables are accounted for at amortised cost using the effective interest method (see (d) above) less provision for impairment (see (H) below).
(6) Sale and repurchase agreements securities sold subject to repurchase agreements (repos) continue to be recognised on the balance sheet where substantially all of the risks and rewards are retained. Funds received under these arrangements are included in deposits from banks, customer deposits, or trading liabilities. conversely, securities purchased under agreements to resell (reverse repos), where the Group does not acquire substantially all of the risks and rewards of ownership, are recorded as loans and receivables or trading securities. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method.
securities lent to counterparties are retained in the financial statements. securities borrowed are not recognised in the financial statements, unless these are sold to third parties, in which case the obligation to return them is recorded at fair value as a trading liability.
changes in the fair value of any derivative instrument that is not part of a hedging relationship are recognised immediately in the income statement.
in respect of the Group’s secured mortgage portfolios, the impairment allowance is calculated based on a definition of impaired loans which are those six months or more in arrears (or certain cases where the borrower is bankrupt or is in possession). The estimated cash flows are calculated based on historical experience and are dependent on estimates of the expected value of collateral which takes into account expected future movements in house prices, less costs to sell.
loan renegotiations and forbearance in certain circumstances, the Group will renegotiate the original terms of a customer’s loan, either as part of an ongoing customer relationship or in response to adverse changes in the circumstances of the borrower. Where the renegotiated payments of interest and principal will not recover the original carrying value of the asset, the asset continues to be reported as past due and is considered impaired. Where the renegotiated payments of interest and principal will recover the original carrying value of the asset, the loan is no longer reported as past due or impaired provided that payments are made in accordance with the revised terms. Renegotiation may lead to the loan and associated provision being derecognised and a new loan being recognised initially at fair value.
Write offs A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery and the amount of the loss has been determined. subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement. For both secured and unsecured retail balances, the write-off takes place only once an extensive set of collections processes has been completed, or the status of the account reaches a point where policy dictates that forbearance is no longer appropriate. For wholesale lending, a write-off occurs if the loan facility with the customer is restructured, the asset is under administration and the only monies that can be received are the amounts estimated by the administrator, the underlying assets are disposed and a decision is made that no further settlement monies will be received, or external evidence (for example, third party valuations) is available that there has been an irreversible decline in expected cash flows.
(2) Available-for-sale financial assets The Group assesses, at each balance sheet date, whether there is objective evidence that an available-for-sale financial asset is impaired. in addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and future prospects of the issuer, assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. if an impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment. if, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the income statement; any excess is taken to other comprehensive income. impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.
Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. in the event that an asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately. The recoverable amount is the higher of the asset’s fair value less costs to sell and its value in use.
(2) As lessor Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee but not necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments, together with any unguaranteed residual value, is recognised as a receivable, net of provisions, within loans and advances to banks and customers. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance lease income. Finance lease income is recognised in interest income over the term of the lease using the net investment
method (before tax) so as to give a constant rate of return on the net investment in the leases. unguaranteed residual values are reviewed regularly to identify any impairment.
(n) Taxation current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised. income tax payable on profits is recognised as an expense in the period in which those profits arise. The tax effects of losses available for carry forward are recognised as an asset when it is probable that future taxable profits will be available against which these losses can be utilised. deferred and current tax related to gains and losses on the fair value re-measurement of available-for-sale investments and cash flow hedges, where these gains and losses are recognised in other comprehensive income, is also recognised in other comprehensive income. such tax is subsequently transferred to the income statement together with the gain or loss.
deferred and current tax assets and liabilities are offset when they arise in the same tax reporting group and where there is both a legal right of offset and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously.
Lloyds Banking Group Annual Report and Accounts 2012224 note 2: Accounting policies (continued)
costs which are directly attributable and incremental to securing new non-participating investment contracts are deferred. This asset is subsequently amortised over the period of the provision of investment management services and is reviewed for impairment in circumstances where its carrying amount may not be recoverable. if the asset is greater than its recoverable amount it is written down immediately through fee and commission expense in the income statement. All other costs are recognised as expenses when incurred.
(3) Liability adequacy test At each balance sheet date liability adequacy tests are performed to ensure the adequacy of insurance and participating investment contract liabilities net of related deferred cost assets and value of in-force business. in performing these tests current best estimates of discounted future contractual cash flows and claims handling and policy administration expenses, as well as investment income from the assets backing such liabilities, are used. Any deficiency is immediately charged to the income statement, initially by writing off the relevant assets and subsequently by establishing a provision for losses arising from liability adequacy tests.
contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of resources are uncertain or cannot be measured reliably. contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.
(2) Dividends dividends paid on the Group’s ordinary shares are recognised as a reduction in equity in the period in which they are paid.
Lloyds Banking Group Annual Report and Accounts 2012226 note 3: Critical accounting estimates and judgements The preparation of the Group’s financial statements in accordance with iFRs requires management to make judgements, estimates and assumptions in applying the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.
The allowance for impairment losses on loans and receivables is management’s best estimate of losses incurred in the portfolio at the balance sheet date. impairment allowances are made up of two components, those determined individually and those determined collectively.
collective impairment allowances are generally established for smaller balance homogenous portfolios such as the retail portfolios. The collective impairment allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including the interdependency of house prices, unemployment rates, interest rates, borrowers’ behaviour, and consumer bankruptcy trends. it is, however, inherently difficult to estimate how changes in one or more of these factors might impact the collective impairment allowance.
Lloyds Banking Group Annual Report and Accounts 2012228 note 3: Critical accounting estimates and judgements (continued)
The effect on the Group’s profit before tax and shareholders’ equity of changes in key assumptions used in determining the life insurance assets and liabilities is set out in note 38.
note 44 contains more detail on the nature of the assumptions that have been made and key sensitivities.
The Group Executive committee has been determined to be the chief operating decision maker for the Group. The Group’s operating segments reflect its organisational and management structures. The Group Executive committee reviews the Group’s internal reporting based around these segments in order to assess performance and allocate resources. This assessment includes a consideration of each segment’s net interest revenue and consequently the total interest income and expense for all reportable segments is presented on a net basis. The segments are differentiated by the type of products provided, by whether the customers are individuals or corporate entities and by the geographical location of the customer.
Wealth, Asset Finance and international gives increased focus and momentum to the Group’s private banking and asset management activities, closely co-ordinates the management of its international businesses and now also encompasses the Asset Finance business in the uK and Australia. Wealth comprises the Group’s private banking, wealth and asset management businesses in the uK and overseas. international comprises retail businesses, principally in continental Europe.
Lloyds Banking Group Annual Report and Accounts 2012230 note 4: Segmental analysis (continued)
Total underlying income, net of insurance claims 8,657 5,138 2,842 1,851 (102) 18,386 liability management – – – – (229) (229)
Other segment items reflected in income statement above: (decrease) increase in value of in-force business – – (4) 273 – 269
Other segment items: Additions to tangible fixed assets 143 67 1,732 378 683 3,003 investments in joint ventures and associates at end of year 185 113 6 – 9 313
Total underlying income, net of insurance claims 10,272 6,829 3,601 2,208 448 23,358 liability management – – – – 423 423
Lloyds Banking Group Annual Report and Accounts 2012234 note 4: Segmental analysis (continued)
There was no individual non-uK country contributing more than 5 per cent of total income or total assets.
net interest income 9,075 12,698 12,546 included within interest and similar income is £1,133 million (2011: £1,405 million; 2010: £1,288 million) in respect of impaired financial assets. net interest income also includes a credit of £92 million (2011: charge of £70 million; 2010: charge of £932 million) transferred from the cash flow hedging reserve (see note 48).
Lloyds Banking Group Annual Report and Accounts 2012236 note 6: net fee and commission income £m £m £m
As discussed in note 2, fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in note 5. Fees and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown in note 7.
Total net gains arising on assets and liabilities held at fair value through profit or loss 13,139 146 12,394 net gains (losses) on financial instruments held for trading 344 (1,065) 2,449
Lloyds Banking Group Annual Report and Accounts 2012236 note 8: insurance premium income £m £m £m
Gross written premiums 1,081 1,198 1,332 ceded reinsurance premiums (31) (52) (104)
net written premiums 1,050 1,146 1,228 change in provision for unearned premiums (note 37(2)) 72 70 156 change in provision for ceded unearned premiums (note 37(2)) (7) – (9)
Lloyds Banking Group Annual Report and Accounts 2012238 note 9: Other operating income £m £m £m
Lloyds Banking Group Annual Report and Accounts 2012238 note 10: insurance claims insurance claims comprise: £m £m £m
Advertising and promotion 314 398 362 uK bank levy 179 189 –
Following changes by the Group to the terms of its defined benefit pension schemes in 2010, all future increases to pensionable salary will be capped each year at the lower of: Retail Prices index inflation; each employee’s actual percentage increase in pay; and 2 per cent of pensionable pay. in addition to this, during the second half of 2010 there was a change in commutation factors in certain defined benefit schemes. The combined effect of these changes was a reduction in the Group’s defined benefit obligation of £1,081 million and a reduction in the Group’s unrecognised actuarial losses of £171 million, resulting in a net curtailment gain of £910 million recognised in the income statement in 2010 and a reduction in the balance sheet liability.
Lloyds Banking Group Annual Report and Accounts 2012240 note 11: Operating expenses (continued)
Performance-based compensation expense deferred until later years comprises: Awards made in respect of the year ended 31 december 37 43 39
Performance-based awards expensed in 2012 include cash awards amounting to £128 million (2011: £160 million; 2010: £163 million).
Total fees payable to the Company’s auditors by the Group 27.0 36.3 40.4
Reviews of the financial position of corporate and other borrowers 5.4 11.0 17.2
loans and advances to customers 5,125 8,020 10,727 debt securities classified as loans and receivables (4) 49 57
Foreign tax: current tax on profit for the year (86) (90) (82)
The charge for tax on the profit for 2012 is based on a uK corporation tax rate of 24.5 per cent (2011: 26.5 per cent; 2010: 28.0 per cent).
Tax credit (charge) thereon at uK corporation tax rate of 24.5 per cent (2011: 26.5 per cent; 2010: 28.0 per cent) 140 939 (79)
Tax (charge) credit on (loss) profit on ordinary activities (773) 828 (539)
The Finance Act 2012 introduced a new uK tax regime for the taxation of life insurance companies which takes effect from 1 January 2013. The new regime, combined with current economic forecasts, has had a number of impacts on the tax charge.
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares, if any, that arise in respect of share options and awards granted to employees. The number of shares that could have been acquired at the average annual share price of the company’s shares based on the monetary value of the subscription rights attached to outstanding share options and awards is determined. This is deducted from the number of shares issuable under such options and awards to leave a residual bonus amount of shares which are added to the weighted-average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.
The weighted-average number of anti-dilutive share options and awards excluded from the calculation of diluted earnings per share was 37 million at 31 december 2012 (2011: 619 million; 2010: 92 million).
Lloyds Banking Group Annual Report and Accounts 2012246 note 17: Trading and other financial assets at fair value through profit or loss These assets are comprised as follows: Trading assets £m
Other financial assets at fair value through profit or loss £m Total £m loans and advances to customers 13,598 34 13,632 9,642 124 9,766 loans and advances to banks 919 – 919 1,355 – 1,355 debt securities: Other public sector securities – 1,056 1,056 – 1,183 1,183
The maximum exposure to credit risk at 31 december 2012 of the loans and advances to banks and customers designated at fair value through profit or loss was £34 million (2011: £124 million); the Group does not hold any credit derivatives or other instruments in mitigation of this risk. There was no significant movement in the fair value of these loans attributable to changes in credit risk which is determined by reference to the publicly available credit ratings of the instruments involved.
Total loans and advances to banks before allowance for impairment losses 29,420 32,620
Total loans and advances to customers before allowance for impairment losses 532,475 584,370
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. during 2012 and 2011 no contingent rentals in respect of finance leases were recognised in the income statement. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £33 million (2011: £92 million).
The unguaranteed residual values included in finance lease receivables were as follows: £m £m not later than 1 year 49 56 later than 1 year and not later than 5 years 126 137 later than 5 years 14 20
Securitisation programmes loans and advances to customers and debt securities classified as loans and receivables include loans securitised under the Group’s securitisation programmes, the majority of which have been sold by subsidiary companies to bankruptcy remote special purpose entities (sPEs). As the sPEs are funded by the issue of debt on terms whereby the majority of the risks and rewards of the portfolio are retained by the subsidiary, the sPEs are consolidated fully and all of these loans are retained on the Group’s balance sheet, with the related notes in issue included within debt securities in issue. in addition to the sPEs described below, the Group sponsors three conduit programmes, Argento, cancara and Grampian.
PFi/PPP and project finance loans 688 104 767 110 less held by the Group (58,732) (86,637)
Lloyds Banking Group Annual Report and Accounts 2012252 note 22: Special purpose entities in addition to the special purpose entities discussed in note 21, which are used for securitisation and covered bond programmes, the Group sponsors three asset-backed conduits, Argento, cancara and Grampian, which invest in debt securities and client receivables. All the external assets in these conduits are consolidated in the Group’s financial statements and are included in the credit market exposures set out in note 55. The total consolidated exposures in these conduits are set out in the table below: Argento £m
charge (release) to the income statement (note 12) 5,125 – (4) 5,121
Of the total allowance in respect of loans and advances to customers, £3,309 million (2011: £3,832 million) was assessed on a collective basis.
Lloyds Banking Group Annual Report and Accounts 2012254 note 26: Held-to-maturity investments £m £m debt securities: government securities – 8,098 during 2012 the Group has reviewed its holding of government securities classified as held-to-maturity. since it is no longer the Group’s intention to hold these to maturity, they have been reclassified as available-for-sale (note 25). details of the impact of this reclassification are provided in note 54.
Maintenance expenses Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs. Explicit allowance is made for future expense inflation. For German business appropriate cost assumptions have been set in accordance with the rules of the local regulatory body.
Accumulated amortisation: Exchange and other adjustments – – – – 2 2
The core deposit intangible is the benefit derived from a large stable deposit base that has low interest rates, and the balance sheet amount at 31 december 2012 shown above will be amortised, in accordance with the Group’s accounting policy, on a straight line basis over its remaining useful life of four years (see note 2(c)).
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. during 2012 and 2011 no contingent rentals in respect of operating leases were recognised in the income statement.
in addition, total future minimum sub-lease income of £30 million at 31 december 2012 (£40 million at 31 december 2011) is expected to be received under non-cancellable sub-leases of the Group’s premises.
note 33: Deposits from banks £m £m liabilities in respect of securities sold under repurchase agreements 23,368 14,389
liabilities designated at fair value through profit or loss represent debt securities in issue which either contain substantive embedded derivatives which would otherwise need to be recognised and measured at fair value separately from the related debt securities, or which are accounted for at fair value to significantly reduce an accounting mismatch.
Reinsurance1 £m net £m life insurance (see (1) below): non-life insurance contracts (see (2) below): Reinsurance balances are reported within other assets (note 32).1
change in liabilities charged to the income statement (note 10) 3,425 859 4,284 186 4,470 liabilities for insurance contracts and participating investment contracts can be split into with-profit fund liabilities, accounted for using the FsA’s realistic capital regime (realistic liabilities) and non-profit fund liabilities, accounted for using a prospective actuarial discounted cash flow methodology, as follows: With-profit fund £m non-profit fund £m
Guaranteed annuity option take-up rates certain pension contracts contain guaranteed annuity options that allow the policyholder to take an annuity benefit on retirement at annuity rates that were guaranteed at the outset of the contract. For contracts that contain such options, key assumptions in determining the cost of options are economic conditions in which the option has value, mortality rates and take up rates of other options. The financial impact is dependent on the value of corresponding investments, interest rates and longevity at the time of the claim.
The most recent experience is considered along with the results of previous analyses and management’s views on future experience, taking into consideration potential changes in future experience that may result from guarantees and options becoming more valuable under adverse market conditions, in order to determine a ‘best estimate’ view of what persistency will be. in determining this best estimate view a number of factors are considered, including the credibility of the results (which will be affected by the volume of data available), any exceptional events that have occurred during the period under consideration, any known or expected trends in underlying data and relevant published market data.
Life insurance – The policyholder is insured against death or permanent disability, usually for predetermined amounts. such business includes whole of life and term assurance and long-term creditor policies.
– inclusion of illiquid loan assets in the valuation of the annuity portfolio (£44 million increase).
– Reduction of assumed future bonus rate and move to yield curve valuation of annuities (£19 million increase).
claims outstanding comprise those claims that have been notified and those that have been incurred but not reported. claims incurred but not reported are determined based on the historical emergence of claims and their average cost. The notified claims element represents the best estimate of the cost of claims reported using projections and estimates based on historical experience.
change in liabilities charged to income statement (note 10) (186) 12 (174)
increase (decrease) in liabilities: Arising from current year claims 492 – 492
change in liabilities charged to income statement (note 10) (74) 1 (73)
increase in illiquidity premia9 0.10% addition 93 72 change in variable increase (reduction) in profit before tax £m increase (reduction) in equity £m
Lloyds Banking Group Annual Report and Accounts 2012270 note 42: Retirement benefit obligations £m £m £m
The total amount recognised in the balance sheet relates to: £m £m defined benefit pension schemes 1,748 1,131
The Group currently expects to pay contributions of approximately £1,025 million to its defined benefit schemes in 2013.
Assumptions The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: discount rate 4.60 5.00
Expected life expectancy of members: increase of one year 74 38 (697) (655)
Present value of defined benefit obligation (31,324) (28,236) (26,862) (27,073) (15,617) (16,795) (17,378)
Fair value of scheme assets 30,367 28,828 26,382 23,518 13,693 16,112 15,279
Defined contribution schemes The Group operates a number of defined contribution pension schemes in the uK and overseas, principally Your Tomorrow and the defined contribution sections of the lloyds TsB Group Pension scheme no. 1.
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 30 June 2008; this valuation has been updated to 31 december 2012 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 6.50 per cent (2011: 6.61 per cent).
Amount credited (charged) to equity: Available-for-sale financial assets (note 48) 344 (574)
Asset at 31 December 3,958 4,182 Asset at 31 December 3,958 4,182
Lloyds Banking Group Annual Report and Accounts 2012276 note 43: Deferred tax (continued)
On 21 March 2012, the Government announced that the corporation tax rate applicable from 1 April 2012 would be 24 per cent. This change passed into legislation on 26 March 2012. in addition, the Finance Act 2012, which was substantively enacted on 3 July 2012, included legislation to reduce the main rate of corporation tax from 24 per cent to 23 per cent with effect from 1 April 2013. The change in the main rate of corporation tax from 25 per cent to 23 per cent has resulted in a reduction in the Group’s net deferred tax asset at 31 december 2012 of £286 million, comprising the £308 million charge included in the income statement and a £22 million credit included in equity.
interest rate hedging products in June 2012, a number of banks, including the Group, reached agreement with the FsA to carry out a thorough assessment of sales made since 1 december 2001 of interest rate hedging products (iRHP) to certain small and medium-sized businesses. The Group agreed that on conclusion of this review it would provide redress to any of these customers where appropriate.
These securities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated Enhanced capital notes ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the year (2011: none). no repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Financial services Authority.
Foreign exchange and other movements (268) 576 during February 2012, the Group completed the exchange of part of a series of preferred debt securities issued by the HBOs group for a new series of dated subordinated securities issued by lloyds TsB Bank plc. This exchange resulted in a gain on the extinguishment of the existing securities of £59 million being the difference between the carrying amount of the securities extinguished and the fair value of the new securities issued together with related fees and costs.
b in november 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to 31 January 2012.
e Following an exchange in February 2012, certain holders elected to exchange some notes into a new series of dated subordinated securities issued by lloyds TsB Bank plc.
Total preferred securities 4,394 4,893 a in november 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to 31 January 2012.
Primary capital undated Floating Rate notes: series 1 (us$750 million) a, b 165 175 series 2 (us$500 million) a, b 173 183 series 3 (us$600 million) a, b 223 235 13.625% Perpetual subordinated Bonds (£75 million) a 19 16 11.75% Perpetual subordinated Bonds (£100 million) 102 102
With the exception of the two series identified in footnote b below, the Ecns were issued in lower tier 2 format and are convertible into ordinary shares on the breach of a defined trigger. The trigger is if the published core tier 1 ratio of the Group (as defined by the Financial services Authority in May 2009) falls below 5 per cent.
note £m £m enhanced Capital notes 7.625% Enhanced capital notes due 2019 (£151 million) 144 142 8.125% Enhanced capital notes due 2019 (£4 million) 4 4 9% Enhanced capital notes due 2019 (£97 million) 98 98 7.8673% Enhanced capital notes due 2019 (£331 million) 332 330 15% Enhanced capital notes due 2019 (£775 million) 1,093 1,120 15% Enhanced capital notes due 2019 (e487 million) 571 601 8.875% Enhanced capital notes due 2020 (e125 million) 113 107 9.334% Enhanced capital notes due 2020 (£208 million) 230 232 7.375% Enhanced capital notes due 2020 (e95 million) 78 79
Lloyds Banking Group Annual Report and Accounts 2012284 note 45: Subordinated liabilities (continued)
f The interest rate payable on this security was reset from 6.305 per cent fixed to 3-month libor plus 1.2 per cent with effect from 18 October 2012.
Ordinary shares of 10p (formerly 25p) each issued on redemption of preference shares and other subordinated liabilities in 2010 – – 4,299,422,579 – – 429 issued in relation to the payment of coupons on certain hybrid capital securities 479,297,215 – – 47 – –
Share issuances in 2012 the Group issued 479 million new ordinary shares in relation to payment of coupons in the year on certain hybrid capital securities that are non-cumulative; the remaining 1,137 million shares issued in 2012 were in respect of employee share schemes.
The shares issued in 2011 were in respect of employee share schemes.
in addition, the company is not aware of any agreements between shareholders that may result in restrictions on the transfer of securities and/ or voting rights.
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 17 May 2012. The authority to issue shares and the authority to make market purchases of shares will expire at the annual general meeting. shareholders will be asked, at the annual general meeting, to give similar authorities.
Ordinary shares The holders of ordinary shares (excluding the limited voting ordinary shares), who held 99.9 per cent of the total ordinary share capital at 31 december 2012, 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 the restrictions noted below) and on a winding up may share in the assets of the company.
in november 2009, as part of the restructuring plan that was a requirement for European commission approval of state aid received by the Group, the Group agreed to suspend the payment of coupons and dividends on certain of the Group’s preference shares and preferred securities for the two-year period from 31 January 2010 to 31 January 2012. consequently, the terms of these instruments prevented the company from making dividend payments on ordinary shares during that period.
Preference shares The company has in issue various classes of preference shares which are all classified as liabilities under iFRs and details of which are shown in note 45.
Lloyds Banking Group Annual Report and Accounts 2012286 note 47: Share premium account £m £m £m issued in relation to the settlement of coupons on certain hybrid capital securities1 123 – –
shares issued on redemption and exchange of preference shares and other subordinated liabilities2 – – 1,808
Redemption of preference shares3 – – 11 during the year the Group issued new ordinary shares for a consideration of £170 million in relation to payment of coupons in 2012 on certain hybrid capital securities that are non-cumulative.
On 18 February 2010, the company issued 3,141 million ordinary shares as consideration for the redemption of certain preference shares and preferred securities; and during May and June 2010, the company issued a further 1,158 million ordinary shares in relation to three separate exchanges for preference shares and other subordinated liabilities issued by the Group. A total share premium of £1,808 million was recorded in respect of these transactions.
in January 2010, the company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital redemption reserve and a transfer of £11 million from the merger reserve to the share premium account.
Foreign currency gains (losses) on net investment hedges (tax: £nil) 55 (26) (162)
Retained profits are stated after deducting £158 million (2011: £33 million; 2010: £47 million) representing 301 million (2011: 58 million; 2010: 49 million) treasury shares held.
Charge to the income statement The charge to the income statement is set out below: £m £m £m deferred bonus plan 248 221 355
Lloyds Banking Group Annual Report and Accounts 2012290 note 51: Share-based payments (continued)
The performance condition was measured over a three year period which commenced at the end of the financial year preceding the grant of the option and continued until the end of the third subsequent year. if the performance condition was not then met, it was measured at the end of the fourth financial year. if the condition was not then met, the options would lapse.
Lloyds Banking Group Annual Report and Accounts 2012292 note 51: Share-based payments (continued)
The weighted average fair value of options granted in the year was £0.30 (2011: £0.46). The fair values of options granted have been determined using a standard Black-scholes model. The weighted average share price at the time that the options were exercised during 2012 was £0.33 (2011: £0.51). The weighted average remaining contractual life of options outstanding at the end of the year was 3.7 years (2011: 2.1 years).
The fair values of the majority of options granted have been determined using a standard Black-scholes model. The fair values of the remaining options have been determined by Monte carlo simulation.