View our Annual Report and Accounts and other information about Lloyds Banking Group at lloydsbankinggroup.com
On behalf of the Board Lord Blackwell Chairman Lloyds Banking Group
Find out more about our Helping Britain Prosper Plan on page 20 visit lloydsbankinggroup.com/ prosperplan
Building capability and digital skills >700,000 of individuals, SMEs and charities trained in digital skills
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 03
Directors We review the Board composition and diversity regularly and are committed to ensuring we have the right balance of skills and experience within the Board. During the year we have announced a number of Board changes, as outlined below.
In February 2019, the Group was pleased to announce that William Chalmers will succeed George Culmer as Executive Director and Chief Financial Officer. I look forward to welcoming him to the executive team and the Board.
Payments £15 trillion of payments processed in 2018 = 7 x UK GDP
Strategic progress In February 2018, we launched the third stage of our strategic plan with an increased strategic investment of more than £3 billion over the three year plan period, building on our unique competitive advantages, to transform the Group to succeed in a digital world.
During 2018 we lent over £12 billion to first time buyers and increased lending to SME and Mid Market businesses by £3 billion to Help Britain Prosper and have committed to lending up to £18 billion in 2019 to businesses as part of our continued support for the UK economy. We have also provided digital skills training for more than 700,000 individuals, SMEs and charities, and supported over 3,000 charities through our independent charitable Foundations.
Summary Framed by our purpose to Help Britain Prosper, the Group has again delivered a strong customer experience and financial performance in 2018 whilst making significant progress in building new capabilities to transform the Group to succeed in a digital world. While the year ahead will bring its own challenges, given the ongoing economic and political uncertainty, I continue to believe that our simple, low risk business model is the right one. Our current strategic plan for 2018 to 2020, with continued strong investment, will further improve customer propositions and grow our leading digital bank as part of our multi-channel strategy, while continuing to provide leading and sustainable returns to our shareholders.
Our cost:income ratio, including remediation, further improved to 49.3 per cent and remains the lowest of our major UK banking peers.
Overall FCA reportable complaints excluding PPI and claims management companies have continued to reduce in 2018.
The FCA changed the approach to complaint reporting in June 2016 and historic data is presented since this date.
Link to strategic priorities Maximising the Group's capabilities Leading customer experience
Link to strategic priorities Leading customer experience 1 Restated to reflect changes in measurement approach.
Helping Britain Prosper Plan targets achieved 20/25 27/28 20/24 21/22 20/22
Our low risk business model and focus on efficiency positions us well irrespective of macro conditions, but if the UK economy sees significant sustained deterioration this is likely to impact Group performance
The UK financial services sector is expected to remain highly regulated
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 09
Our multi-channel offering, including the largest branch network and digital bank in the UK, enables customers to interact with us in whichever way they prefer. In addition, our customer data provides the Group with a wealth of information that we are now using to facilitate greater personalisation, while ensuring we meet all of our customers evolving banking and insurance needs.
Changes to customer expectations and behaviour, demographics and life patterns mean that we cannot be complacent.
The pace of digital adoption continues to surpass expectations and is likely to increase further in the coming years
Cyber security and the protection of customer data are increasingly important factors in retaining customer trust
Our response With customers becoming more empowered as a result of greater choice than ever before, we must continue to be responsive to their changing expectations and ensure that we continue to offer products and services they value. These expectations are likely to be increasingly influenced by non-traditional competitors in other industries as they continue to raise the bar for innovation.
As a large, UK focused financial services provider we face several external and internal challenges
Prudent, low risk participation choices with strong capital position Being low risk is fundamental to our business model. Our low risk appetite is reflected through the low level of non-performing loans and run-off assets, as well as our relative credit default swap spread. Our financial strength has been transformed in recent years with our capital position amongst the strongest in the sector worldwide.
Multi-brand, multi-channel customer proposition with data driven customer experience Operating in an integrated way through a range of distribution channels ensures our customers can interact with us when and how they want.
Ensuring IT systems are effective and resilient and that we are prepared for the threat of cyber risk pages 16 to 18
Maximising the Group’s capabilities Aligning the Group’s capabilities as the UK's sole integrated financial services provider to deepen customer relationships and grow in targeted segments.
Progress in 2018 In 2018 we have made significant progress in enhancing our digital propositions and branch network to reflect changing customer preferences, while also increasing personalisation.
We were the first large UK bank to meet the regulatory deadline for Open Banking. We have built on this success, launching our API-enabled aggregation functionality in the fourth quarter. Through this customers are now able to view their current accounts with us alongside those held outside of the Group.
Our Remote Advice Video Interviewing service is an important element of how we are improving the customer experience, providing our customers with greater flexibility and convenience in how they can discuss and meet their complex needs. In 2018, this service has gone from strength to strength, with an initial focus on our customers’ mortgage needs. Approximately 38,000 customers have already taken the opportunity to discuss their mortgage needs in one of our 270 branch locations that currently offer this service or from the comfort of their own home through our home to hub offering.
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Delivering for our customers The launch of our Open Banking aggregation capability and multiple functionality developments throughout the year were made possible by the replatforming of our mobile app during 2018. This replatforming placed our Lloyds, Halifax and Bank of Scotland banking brands on the same platform and has enabled us to react faster to change, doubling the frequency of new releases to the market. This supported the roll out of a number of new features for customers including push notifications and virtual assistants, both of which have been positively received by customers to date, with strong satisfaction and adoption rates.
When you first hear of being a Digital Champion, you assume that you have to be a computer whizz but, in reality, it’s just doing the things we all do every day, without realising.
In addition, we have brought our teams closer together, improving productivity and bringing further benefits to our colleagues’ working experience. Over 32 per cent of colleagues are now located in modern, collaborative working environments, as we continue to move to six strategic hubs across the UK.
Embracing new ways of working We are embracing new ways of working and transforming the way in which change is delivered. In particular, 15 per cent of change is now delivered using Agile, with 6,600 colleagues trained in these methodologies. This allows us to build cross functional teams and increase collaboration, efficiency and expertise in our decisions and, through this, deliver products and services that our customers really want, at a pace that ensures these remain relevant and timely. The ongoing improvement in the capabilities of our people and the methods in which we work will drive a continued cultural shift across the organisation and will help us deliver our significant strategic transformation. In addition, this will improve satisfaction and make it easier to do business, while also delivering a leading customer experience.
To enable this and ensure stakeholder considerations are at the heart of all corporate decision making, various papers relating to different stakeholder groups are presented regularly at Board. In addition all Board papers submitted are required to consider the impact of proposals on key stakeholder groups.
We aim to treat our customers fairly, making it easy for them to find, understand and access products that are right for them, whatever their circumstances.
The Group also looks to benchmark performance among customers and uses this insight from a range of internal and external research, including net promoter scores (NPS) and the GFK customer index, to improve services
To ensure Board members truly understand the needs of customers, a series of branch visits and customer events were undertaken during 2018 enabling direct feedback
We recognise the importance to customers of both their data and their money being safe, and we use advanced technology to protect them, including systems that prevent fraud and detect fraudulent payments in real time. We are continuously improving our cyber defences and also educate customers to improve their own security by championing public awareness campaigns, including Take Five. Colleagues also receive appropriate, ongoing training and support, such as anti-bribery training to help them protect our customers
The Group has the largest shareholder base in the UK and we undertake a comprehensive shareholder engagement programme with regular feedback to management and the Board.
Various members of the Board have engaged with shareholders through the year, including the Chairman, the Senior Independent Director and the Remuneration Committee Chair. The Remuneration Committee Chair, in particular, held numerous meetings with investors to gain feedback following the remuneration resolution outcome at the 2018 Annual General Meeting (AGM)
Our colleagues take pride in working for an inclusive and diverse bank and with their support we are building a culture in which everyone feels included, empowered and inspired to do the right thing for customers.
During the year we communicated directly with colleagues detailing the Group's performance, changes in the economic and regulatory environment and updates on our key strategic initiatives. We also hosted regular Ask Me Anything sessions providing the opportunity for colleagues and contingent workers to ask questions and receive real time responses directly from members of the Board and senior colleagues across all departments
The AGM is an opportunity for shareholders to hear directly from the Board on the Group’s performance and strategic direction, and importantly, to ask questions. In 2018
All institutional shareholder letters are discussed at the Board Nomination and Governance Committee to ensure Board members are aware of investor sentiment and concerns
The Group has a significant retail shareholder base and a team dedicated to engaging with retail shareholders who, with support from the Company’s registrar Equiniti Limited, deliver the Group’s shareholder service strategy, including the AGM. Further work is progressing to enhance engagement with retail shareholders in 2019. Group Secretariat provide feedback to the Board and appropriate Committees to ensure the views of retail shareholders are received and considered
We hosted regular breakfasts and informal dinners with the Chairman and Group Chief Executive. These took place in various hub locations and invitations were extended to contingent workers and suppliers working within these locations
Lloyds Banking Group colleague 4,000 colleagues attended Helping Britain Prosper LIVE with around 14,000 watching remotely
Our supply chain is crucial to the way we serve our customers, and through it our reach is considerable. We use a multi brand approach to deliver specific products and services. We work with around 3,500 suppliers of varying sizes, most in professional services sectors such as IT, cyber, operations, management consultancy, legal, HR, marketing and communication. In 2018 our supplier expenditure was £5.8 billion with 95 per cent of our direct suppliers located in the UK
The Responsible Business Committee is also responsible for overseeing the Group’s approach to responding to global issues of environmental sustainability, including measurement and reporting. Following a 2018 Board review of our sustainability approach we have developed a new sustainability strategy, read more on page 24 and 25
Read more on Responsible Business, our Helping Britain Prosper Plan targets and how we have supported the UK on page 20
We have a good relationship with our regulators and other government authorities and liaise regularly.
During 2018 we had regular meetings with our various regulators at different levels of the organisation from Board to senior management
Our ambition is to take a leading role in supporting the UK’s transition to a sustainable low carbon economy
We can only help with the unprecedented levels of change in Britain today by staying true to our purpose of Helping Britain Prosper. Operating responsibly is fundamental to everything we do, from lending to first time buyers to tackling disadvantage in areas such as mental health. Every colleague has a part to play, and every part of the Group has its own action plan for supporting customers, while involving colleagues in our work in communities.
We are in the early stages of this exciting collaboration between Lloyds Banking Group and the University of Birmingham. Moving from an initial idea, to challenge-centred research and engagement, exploring how businesses can be ‘rewired responsibly’ to inform, shape and energise Responsible Business. It’s a unique opportunity to explore best practice, and inform the evolution of responsible business decision making, underpinning Lloyds Banking Group’s pioneering initiative, ‘Helping Britain Prosper’. It has been some journey so far, laying down the foundations for future success.
Professor Ian Thomson, Director Lloyds Banking Group Centre for Responsible Business
Supporting businesses to start up and grow Increased amount of net lending to start-up, SME and Mid Market businesses £3bn £5bn2 £6bn 17 ICONS: BLACK/WHITE VERSION
RESPONSIBLE CONSUMPTION A N D P R O D U C T I O N
Percentage of roles held by Black, Asian and Minority Ethnic colleagues
The white icon should be contained by its defined colour, or black background.
As a UK focused retail and commercial financial services company, we recognise our responsibility to help address the economic, social and environmental challenges that the UK faces. We remain fully committed to Helping Britain Prosper.
Helping Britain get a home As the largest lender to the UK housing sector, we are committed to supporting home ownership across the UK and are working to make it an affordable reality for millions of people, lending £12.4 billion to first time buyers in 2018.
Helping people save for the future We recognise the importance of savings to build financial resilience and help to tackle disadvantage, so we’re making saving for the future as easy as possible by improving choice, flexibility and control. In 2018 we grew the assets we hold on behalf of customers in retirement and investment products by £7.4 billion.
More than 250 Lloyds Bank customers have been supported through our partnership with the Manufacturing Technology Centre (MTC), with around 70 of them undertaking a bespoke programme to improve efficiency and productivity or adopt new technology.
Partnering for progress In 2018 we led a consultation on the new Essential Digital Skills Framework for the Department for Education as their sole evaluation provider. This work provided the business case for the Government’s Digital Skills Entitlement; free digital skills training for all adults from 2020. We are a leading member of the UK Government’s Digital Skills Partnership, advisors to the Secretary of State for Digital, and chair the Department for Digital, Culture, Media and Sport’s Digital Enterprise Delivery Group. We have played a central role in implementing a Charity Digital Code of Practice, with local authorities now adopting our Digital Champions model. We have also worked closely with national and local governments like Greater Manchester Combined Authority and Welsh Assembly to drive change.
Lloyds Bank Academy In November we launched the Lloyds Bank Academy. Initially piloted in Manchester, the Academy provides basic and workplace skills through online and face-to-face courses. Developed with our charitable Foundations, academia, industry and Government, the Academy will scale nationally in 2019 and our existing initiatives will be closely aligned to extend our reach and impact.
We are building digital talent through our #ReDiscover initiative. Launched in July 2018 #ReDiscover brings a new digital edge to learning, helping children aged 11 to 14 to think and explore, meet digital professionals, undertake work placements, and build future digital needs into their studies. By holding school events and cocreating lesson plans we have inspired over 800 students to date.
In addition to funding, we support the Foundations through volunteering, and more than 370 colleagues are also active as mentors to charities supported by each of the Foundations. This year, we ran a pilot with the Lloyds Bank Foundation for England and Wales to recruit some of our senior leaders as charity trustees and launched a Community Forum through which colleagues support charities. Through these initiatives, our Foundations help us better understand some of the social issues people may be facing and we use these insights to help shape effective responses.
For more information about Gender Pay see pages 82 to 104
Supporting people with disabilities Traditionally, employment of people with disabilities has focused on making changes to physical infrastructure or working practices. We are moving the debate from accommodating disabilities to developing talent and careers. We offer bespoke training, career development programmes
In partnership with our independent charitable Foundations, we’re providing more than just traditional funding. Our Foundations are helping us work with charities they support to develop a deeper understanding of the challenges faced by customers affected by complex and sensitive issues.
I know I still have a way to go, but thanks to Mental Health and Money Advice I have improved my confidence and built up some skills to better manage my situation.
The Mental Health and Money Advice Service and recruitment process adjustments for colleagues and applicants with disabilities, including those who have become disabled while employed. Training includes courses run with external disability consultants, which have been described as life changing by attendees. We give full and fair consideration to applications from all candidates, offering guaranteed interviews for candidates declaring a disability, and meeting minimum role requirements. We are unbiased in our assessment, selection, appointment, training and promotion of people. In 2018 we retained our Business Disability Forum (BDF) Gold Standard, and hold Disability Confident Leader status with the Department for Work and Pensions. The BDF considers our workplace adjustment process for disabled colleagues to be ground breaking, creating a best practice case study that they have shared with around 400 other BDF member organisations. We are set to achieve Autism Friendly Bank and Employer accreditation from the National Autistic Society in mid-2019.
4 Percentage disclosure for disability has reduced due to the implementation of a new HR system in Nov 2018, with differing categories. Not all disability data could be directly mapped across into the new system.
This strategy supports the Task Force on Climate Related Financial Disclosures (TCFD) recommendations and incorporates an implementation plan to address them and achieve full disclosure within five years. The strategy maps to the key headings used in the TCFD framework.
Governance We have established a dedicated governance process to provide oversight and ownership of the sustainability strategy. This includes the Responsible Business Committee (RBC), a sub-committee of the Board, which meets quarterly and provides Board level oversight. This committee is chaired by Sara Weller, Group Non-Executive Director and includes the Chairman, Lord Blackwell as a member. At Executive level, we have established a Group Executive Sustainability Committee (GESC), which is a sub-committee of our Group Executive Committee (GEC) and provides oversight and recommends decisions to the GEC. The RBC, GEC and GESC have all been informed on key climate related issues by external industry experts.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 25
Total Scope 2 (location-based) 130,916 162,598 202,319 1 Restated 2017/2016 and 2016/2015 emissions data to improve the accuracy of reporting, using actual data to replace estimates.
This section of the strategic report constitutes Lloyds Banking Group's Non-Financial Information Statement, produced to comply with sections 414CA and 414CB of the Companies Act. The information listed is incorporated by cross-reference.
Environmental matters Environmental statement Reflecting the needs of our stakeholders: Communities and environment, page 18
Helping the transition to a sustainable low carbon economy, pages 24 to 25
Description of principal risks and impact of business activity Helping the transition to a sustainable low carbon economy: Risk management, page 25
2. The policies mentioned above form part of the Group’s Policy Framework which is founded on key risk management principles. The policies which underpin the principles define mandatory requirements for risk management. Robust processes and controls to identify and report policy outcomes are in place and were followed in 2018.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 27
Digitising the Group Rolled out Voice ID technology to make banking quicker and easier for customers, whilst providing added protection. Since launch, over 770,000 registered customers have used this functionality, completing 4 million verifications Continued to improve mobile banking experience, giving customers greater control and choice: – First UK bank to use location based payment tracking, enabling customers to identify fraudulent transactions
Transforming ways of working Delivered around 25,000 training hours to Group Customer Services colleagues, enabling them to better support vulnerable customers
At the heart of the branch, the Halifax Home Hub will help customers with all aspects of the home buying and moving process, with colleagues available without appointment. In the travel zone, customers will be able to order and exchange over 50 currencies and get advice on saving for their next trip, or how to pay for things while they are away. In the kids’ savings zone, children can learn about good savings habits, using the coin counting machine to see how much they have saved up. On the lower ground floor, a state-of-the-art safe deposit facility using biometric fingerprint technology will store customers’ possessions securely.
Green Loans In 2016 Commercial Banking announced the first green loans designed to help global corporate commercial real estate clients improve the energy efficiency of their estates. By the end of 2017, more than £500m had been lent under the initiative, improving over five million square feet of real estate. We have committed to a further one million square feet in 2018, and five million square feet by 2020.
Digitising the Group Launched a digital eligibility and pricing tool, enabling SME clients to understand instantly how likely they are to be approved for a loan or overdraft of up to £25,000 before they apply Expanded the online servicing functionality available to SME customers, including the ability for sole traders to digitally add or remove a party onto their business account in less than 24 hours
Transforming ways of working Restructured our Commercial Banking operations teams to align processing activity with the changing ways that customers consume our services Over 94,000 colleague training hours completed, helping us to develop the skills and capabilities of the future
The Scottish Widows pensions bus travelled around the country in 2018, helping members of the public with their retirement plans and visiting 25 employers that have their workplace pensions with Scottish Widows.
Starting in Edinburgh, the bus finished the first week on National Pensions Awareness Day at London Kings Cross Station before travelling the length of the country once more helping people understand their Scottish Widows workplace pension. The Group left a trail of happy customers behind them.
Transforming ways of working Involved customers and colleagues in developing and launching a new simple to understand protection product
Strong open book AUA customer net inflows £bn >0.6m new pension customers increased new business income £927m Underlying profit increased by 3%
Our approach to risk As a Group, managing risk effectively is fundamental to our strategy and future success. We are a simple, low risk, UK-focused financial services provider with a culture founded on strong risk management and a prudent through the cycle risk appetite. These are at the heart of everything we do, and ensure constructive challenge takes place across the business and underpins sustainable growth.
Supporting a consistent approach to Group-wide behaviour and risk decision-making. Consistency is delivered through the policy framework and risk committee structures
Digitising the Group Deploying new technology to make banking simpler and safer for customers is a key priority for the Group.
There has been a strong reduction in fraud losses over the last five years; while some of this is due to investment in systems, we place great reliance on having well trained, engaged and motivated teams.
EU exit Given the vast majority of our business is in the UK, the direct impact on the Group from leaving the EU is relatively small and we are well prepared to ensure continuity of our limited EU business activities. Given our UK focus, our performance is inextricably linked to the health of the UK economy. Economic performance has remained resilient in recent years and whilst the near term outlook for the UK economy remains unclear given the ongoing EU withdrawal negotiations, we have contingency plans in place. We have also taken a prudent approach to our balance sheet, increasing the amount of liquidity held and pre funding some issuance.
Irrespective of the outcome, our customer focused strategy remains the right one. We will continue to support our personal and business customers and have already announced that we will lend up to £18 billion to UK businesses in 2019, reaffirming our support for the UK economy. Guided by the overriding principle of Helping Britain Prosper, we will seek to minimise the impact on our customers. We have also been working hard to ensure we are well prepared to provide customers with effective and timely support.
Data Our Group is trusted with large volumes of data, which must be protected, whilst providing customers with ease of access through our multi-channel model. Data is our most valuable asset and so we must ensure that the information we hold is accurate, secure and managed appropriately. We meet the requirements of the General Data Protection Regulation (GDPR) that came into force in May 2018. The Group has taken this opportunity to implement new governance structures and demonstrate increased levels of accountability and transparency, as establishing trust is critical to our vision of being the best bank for customers. We have created a Group Data Protection Office (GDPO) to independently oversee compliance, reporting on this to Group and Board Risk Committees.
Extensive and thorough credit processes and controls to ensure effective risk identification, management and oversight
Early identification of signs of stress leading to prompt engagement with the customer
Regulatory and legal The risk that the Group is exposed to financial loss, fines, censure, or legal or enforcement action; or to civil or criminal proceedings in the courts (or equivalent) and/or the Group is unable to enforce its rights due to failing to comply with applicable laws (including codes of practice which could have legal implications), regulations, codes of conduct or legal obligations, or a failure to adequately manage actual or threatened litigation, including criminal proceedings.
Continued investment in people, processes, training and IT to help meet our legal and regulatory commitments
Ongoing horizon scanning to identify changes in regulatory and legal requirements
We respond as appropriate to impending legislation, regulation and associated consultations and participate in industry bodies. We continue to be proactive in responding to significant ongoing and new legislation, regulation and court proceedings.
There remains continued uncertainty around both the UK and global political and macroeconomic environment. The potential impacts of external factors have been considered in all principal risks to ensure any material uncertainties continue to be monitored and are appropriately mitigated.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 33
Clear customer accountabilities for colleagues, with rewards driven by customercentric metrics
Significant investment in compliance with General Data Protection Regulation and Basel Committee on Banking Supervision standards
Inability to attract or retain colleagues with key skills could impact the achievement of business objectives
The availability and resilience of IT systems remains a key strategic priority and the Cyber programme continues to focus on enhancing cyber security controls. Internal programmes ensure that data is used correctly, and the control environment is regularly assessed through both internal and third-party testing.
Capital The risk that we have a sub-optimal quantity or quality of capital or that capital is inefficiently deployed across the Group.
A worsening macroeconomic environment could lead to adverse financial performance, which could deplete capital resources and/or increase capital requirements due to a deterioration in customers’ creditworthiness
Close monitoring of capital and leverage ratios to ensure we meet regulatory requirements and risk appetite
Non-compliance with, or breaches of SM&CR requirements could result in lack of clear accountability, and legal and regulatory consequences
A dedicated programme is in place to assess and address the potential impacts of EU exit on the Group’s operations in Europe. The Group is in close and regular contact with regulators to develop and deploy our planned operating and legal structure to mitigate the potential impacts of EU exit
Market The risk that our capital or earnings profile is affected by adverse market rates, in particular interest rates and credit spreads in the banking business, equity and credit spreads in the Insurance business, and credit spreads in the Group’s defined benefit pension schemes.
Structural hedge programmes implemented to manage liability margins and margin compression
Principles regarding the requirements of data integrity, development, validation, implementation and ongoing maintenance
Helping students to aim high c.900 young people have benefited from our Lloyds Scholars programme
Lloyds Banking Group Annual Report and Accounts 2018 37 Strateg ic rep ort
1 Net of profits on disposal of operating lease assets of £60 million (2017: £32 million).
Net income of £17,768 million was 2 per cent higher than in 2017, with an increase in net interest income partly offset by slightly lower other income, while operating lease depreciation reduced by 9 per cent.
Operating costs of £8,165 million were slightly lower than 2017, with business as usual costs down 4 per cent offset by expected higher investment expensed and depreciation which together increased by 10 per cent. During 2018 the Group capitalised £1.5 billion of investment spend, equivalent to c.60 per cent of above the line investment, in line with 2017. Capitalised investment spend of £1.0 billion, or 67 per cent, related to intangible assets, a similar proportion to 2017.
Remediation charges were 31 per cent lower at £600 million and included additional charges of £234 million in the fourth quarter relating to a number of small items across existing programmes. The Group expects remediation charges to reduce significantly in 2019.
Stage 2 gross loans and advances to customers as a % of total 7.8 11.3 (3.5)pp
Stage 2 ECL2 allowances as a % of Stage 2 drawn balances 4.1 3.5 0.6pp
Stage 3 gross loans and advances to customers as a % of total 1.9 1.9 –
Stage 3 ECL2 allowances as a % of Stage 3 drawn balances 24.3 24.0 0.3pp
Further information on the reconciliation of underlying to statutory results is included on page 193.
Market volatility and asset sales of £50 million included negative insurance volatility of £103 million, with £236 million of negative insurance volatility in the fourth quarter reflecting weaker equity markets and wider credit spreads, compared to positive insurance volatility of £286 million in 2017. Market volatility
ther inform ation also included a £105 million loss on sale of the Irish mortgage portfolio and an adjustment to past service pension liabilities, both of which were recognised in the first half of 2018.
4 Excludes balances relating to margins of £3.8 billion (1 January 2018: £2.1 billion; 31 December 2017: £2.1 billion) and settlement accounts of £1.2 billion (1 January 2018: £1.5 billion; 31 December 2017: £1.5 billion).
Pro forma transitional total capital ratio3 23.1% 21.5% 1.6pp 21.5% 1.6pp
The Board’s view of the level of CET1 capital required for the Group remains around 13 per cent, plus a management buffer of around 1 per cent.
The transitional total capital ratio increased to 23.1 per cent on a pro forma basis (31 December 2017: 21.5 per cent) and the Group remains well positioned to meet its MREL requirement from 2020 with a pro forma transitional MREL ratio of 32.6 per cent (31 December 2017: 26.0 per cent). The leverage ratio on a pro forma basis increased to 5.6 per cent (31 December 2017: 5.4 per cent).
Dividend and share buyback The Group has a progressive and sustainable ordinary dividend policy whilst maintaining the flexibility to return surplus capital through buybacks or special dividends. The Board’s view of the current level of capital required to grow the business, meet regulatory requirements and cover uncertainties remains around 13 per cent plus a management buffer of around 1 per cent.
Given the strong business performance in 2018 the Board has recommended a final ordinary dividend of 2.14 pence per share. This is in addition to the interim ordinary dividend of 1.07 pence per share that was announced in the 2018 half year results. The total ordinary dividend per share for 2018 of 3.21 pence per share has increased by 5 per cent from 3.05 pence per share in 2017.
The Group is planning on the basis of an orderly EU withdrawal and, given the resilience of the UK economy, intends to implement a share buyback of up to £1.75 billion (2017: £1 billion) which will commence in March 2019 and is expected to be completed by 31 December 2019.
Given the total ordinary dividend of 3.21 pence per share and the intended share buyback, equivalent to up to 2.46 pence per ordinary share, the total capital return for 2018 will be up to 5.67 pence per share, an increase of 27 per cent on the prior year, equivalent to £4.0 billion.
Lloyds Banking Group Annual Report and Accounts 2018 41 Strateg ic rep ort
4 Capital build is reported on a pro forma basis before ordinary dividends and share buyback.
Lloyds Banking Group Annual Report and Accounts 2018 43 Strateg ic rep ort
5 Prior period restated to show European deposits as tactical balances.
Lloyds Banking Group Annual Report and Accounts 2018 45 Strateg ic rep ort
Volatility arising in insurance businesses Volatility included in the Group’s statutory results before tax comprises the following: £m
Less profit attributable to non-controlling interests and other equity holders (£m) (425) (403)
Share buyback During 2018, the Group completed a £1 billion share buyback programme with an average price paid of 63.4 pence per share. Through a reduction in the weighted average number of ordinary shares in issue, share buybacks have the effect of increasing earnings per share and, depending on the average price paid per share, can either increase or decrease the tangible net assets per share. The 2018 share buyback had the effect of increasing the earnings per share by 0.1 pence and decreasing the tangible net assets per share by 0.2 pence.
Total number of employees 64,928 67,905 1 2017 figures restated to reflect the Group’s current structure.
Chairman’s letter This Corporate Governance Report details our approach to governance in practice, how the Board operates and the key activities of the Board during the year, together with information on the annual Board evaluation process. It also includes the reports from each of the Board’s principal Committees. Strong Board oversight is vitally important alongside the executive governance framework. A major focus over the last year has been the implementation of our strategic transformation programme, following extensive Board engagement in the conception and design of the strategy to deliver the ‘Bank of the Future’. This transformation programme is managed through multiple workstreams and initiatives, and the scale and pace of change is highly demanding. It has involved a significant shift in organisational decision-making and controls from business and functional lines to cross divisional workstreams. It has also required a substantial investment in colleague skills and culture to support the re-shaping of roles around the new ways of working. The Board has devoted considerable time to reviewing the way this is being implemented, with particular attention to the management of the risks arising from the implementation of new technologies, the new ways of working and the overall pace of change.
Strategy The Board has been engaged with the Group’s strategy through multiple touchpoints throughout the year. These have included: the annual cycle of two offsite meetings to debate priorities and agree implementation plans; a suite of formal Board metrics and qualitative reporting to monitor progress and risks; ‘Deep dive’ sessions on key areas (see page 56 for more information); ‘Gallery Walk’ sessions with workstream teams in the Lab environment (more information can be found on page 17); and a wide range of informal interactions to ‘feel the pulse’.
3. Alan Dickinson Independent Director Appointed: September 2014 Skills and experience: Highly regarded retail and commercial banker Strong strategic, risk and core banking experience Regulatory and public policy experience Alan has 37 years’ experience with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK. More recently, Alan was a Non-Executive Director of Willis Limited and Chairman of its Risk Committee. He was formerly Chairman of Brown, Shipley & Co. Limited, a Non-Executive Director of Nationwide Building Society where he was Chairman of its Risk Committee and a Governor of Motability. External appointments: Chairman of Urban&Civic plc.
Lord Lupton was Deputy Chairman of Baring Brothers, co-founded the London office of Greenhill & Co., and was Chairman of Greenhill Europe. He was previously Chairman of Trustees of Dulwich Picture Gallery, a Trustee of the British Museum, Governor of Downe House School and a member of the International Advisory Board of Global Leadership Foundation. He became a Life Peer in October 2015 and is a former Treasurer of the Conservative Party. He served on the House of Lords Select Committee on Charities. External appointments: Senior Advisor to Greenhill Europe and Chairman of the Trustees of the Lovington Foundation.
8. Stuart Sinclair Independent Director Appointed: January 2016 Skills and experience: Extensive experience in retail banking, insurance and consumer finance Governance and regulatory experience
Significant experience in strategic planning and implementation Experience in consumer analysis, marketing and distribution Stuart is a former Non-Executive Director of TSB Banking Group plc, TSB Bank plc, LV Group, Virgin Direct and Vitality Health (formerly Prudential Health). Until recently he was the Interim Chairman of Provident Financial plc. He was also a former Senior Independent Director of Swinton Group Limited. In his executive career, he was President and Chief Operating Officer of Aspen Insurance after spending nine years with General Electric as Chief Executive Officer of the UK Consumer Finance business then President of GE Capital China. Before that he was Chief Executive Officer of Tesco Personal Finance and Director of UK Retail Banking at the Royal Bank of Scotland. He was a Council member of The Royal Institute for International Affairs (Chatham House). External appointments: Senior Independent Director and Chair of the Risk & Capital Committee at QBE UK Limited (formerly QBE Insurance (Europe) Limited).
9. Sara Weller CBE Independent Director Appointed: February 2012 Skills and experience: Background in retail and associated sectors, including financial services Strong board governance experience, including investor relations and remuneration Passionate advocate of customers, the community, financial inclusion and the development of digital skills Considerable experience of boards at both executive and non-executive level Sara’s previous appointments include Managing Director of Argos, various senior positions at J Sainsbury including Deputy Managing Director, Chairman of the Planning Inspectorate, Lead Non-Executive Director at the Department of Communities and Local Government, a Board member at the Higher Education Funding Council, a Non-Executive Director of Mitchells & Butlers as well as a number of senior management roles for Abbey National and Mars Confectionery. External appointments: Non-Executive Director of United Utilities Group and Chair of their Remuneration Committee and a member of their Nomination Committee, Lead Non-Executive Director at the Department for Work and Pensions, a Governing Council Member of Cambridge University and Trustee of Lloyds Bank Foundation for England and Wales.
10. António Horta-Osório Executive Director and Group Chief Executive Appointed: January 2011 (Board), March 2011 (Group Chief Executive) Skills and experience: Extensive experience in, and understanding of, both retail and commercial banking built over a period of more than 30 years, working both internationally and in the UK Drive, enthusiasm and commitment to customers Proven ability to build and lead strong management teams António previously worked for Citibank, Goldman Sachs and held various senior management positions at Grupo Santander before becoming its Executive Vice President and member of the Group’s Management Committee. He was a Non-Executive Director of Santander UK and subsequently its Chief Executive. He is also a former Non-Executive Director of the Court of the Bank of England. External appointments: Non-Executive Director of EXOR N.V., Fundação Champalimaud and Sociedade Francisco Manuel dos Santos in Portugal, a member of the Board of Stichting INPAR Management/ Enable and Chairman of the Wallace Collection.
11. George Culmer Executive Director and Chief Financial Officer Appointed: May 2012 (Board) Skills and experience: Extensive operational and financial expertise including strategic and financial planning and control Worked in financial services in the UK and overseas for over 25 years George was an Executive Director and Chief Financial Officer of RSA Insurance Group, the former Head of Capital Management of Zurich Financial Services and Chief Financial Officer of its UK operations as well as holding various senior management positions at Prudential. He is a Non-Executive Director of Scottish Widows. External appointments: None.
Group Executive Committee Delivering our vision and managing a more agile organisation 1. Carla Antunes Da Silva Group Strategy, Corporate Ventures and Investor Relations Director (GEC attendee)
António joined the Board as an Executive Director in January 2011 and became Group Chief Executive in March 2011. Read his full biography on page 53.
Skills and experience: Jakob was appointed Group Director, Community Banking in September 2017. From 2015 to 2017 he was Chief Operating Officer for the Retail Bank and prior to this he was Managing Director of Asset Finance. Other previous roles include Chief Operating Officer for Wealth & International, Managing Director International Retail and International Banking and Wholesale Banking Operations Director.
Skills and experience: Malcolm joined the Group as Company Secretary in November 2014. Read his full biography on page 53.
3 Stuart Sinclair succeeded Anita Frew as the Chair of the Remuneration Committee on 1 September 2018.
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‘Deep dive’ on people and ways of working in April, and an additional deep dive in October
Board appointments and Executive succession plans 1 Further details regarding stakeholder engagement can be found on pages 16 to 18.
(iii) the appointment of Schroders as the active investment manager of approximately £80 billion of the Scottish Widows and Lloyds Banking Group insurance and wealth related assets.
This strategic partnership will combine the Group’s significant client base, multi-channel distribution and digital capabilities with Schroders’ investment and wealth management expertise and technology capabilities.
The Group, led by the Nomination and Governance Committee, has worked closely with the Regulators to ensure that there is in place a Group structure and governance arrangements which are appropriate for the Group, and meet regulatory requirements. Lloyds Bank plc and Bank of Scotland plc have been identified as the banks which have been included within the ring-fence (together, the ‘Ring-Fenced Banks’). Broadly, there are three key PRA principles that underpin the governance structure for the Ring-Fenced Banks.
Clear and effective governance at both Ring-Fenced Bank and Lloyds Banking Group plc level – including second and third lines of defence in respect of risk management.
In order to meet ring-fencing requirements a major governance and legal entity programme has been implemented across the Group, which has included the following aspects: Reorganisation The reorganisation of the subsidiaries of the Group, which have now been restructured into four sub-groups under Lloyds Banking Group plc: the ‘Ring-Fenced Bank sub-group’ containing Lloyds Bank plc and Bank of Scotland plc (which includes the Halifax business and MBNA); the ‘LBCM sub-group’ under Lloyds Bank Corporate Markets plc, which now holds the Group’s subsidiaries and branches in the Crown Dependencies, Singapore and the US. A number of client agreements were also transferred from Lloyds Bank plc and Bank of Scotland plc to Lloyds Bank Corporate Markets plc in order to comply with the ringfencing regulatory requirements which took effect on 1 January 2019; the ‘Insurance sub-group’ under Scottish Widows Group Limited (including Scottish Widows Limited); and the ‘Equity sub-group’ under a new equity holding company, LBG Equity Investments Limited, under which the principal subsidiary is Lloyds Development Capital Limited.
The first is to review the environment in which the Group is operating – factors such as the economic and geopolitical climate for example – and recommend for Board approval how much risk the Group should take – the ‘Risk Appetite’. This will usually be a maximum level of risk in any one area – such as how large a proportion of new mortgage loans should be represented by high loan to value loans, typically to first time buyers.
The second is to ensure that the ways in which the risk that is taken are effective and efficient, for example setting out policies and procedures to be followed and checks and balances to make sure that the right actions happen. This is the Risk Management Framework which is reviewed regularly by the Board Risk Committee to give comfort that it is still guiding the Group to do those things right.
The third responsibility is to continually assess the ways in which Group colleagues have risk in mind when doing their jobs – what I would call the ‘Risk Culture’. The role of the Board and its Risk Committee is to set the ‘tone from the top’ – to set an example as to what risks to take and how to manage those risks.
A: The Committee pays a great deal of attention to these issues. Whilst PPI mis-selling is by far the most costly and well known issue, there remain many smaller issues which have been identified over the years since the financial crisis. The Group has established very considerable resources to address these potential redress requirements and has made material progress over the last 12 months in resolving these matters. In very many cases our customers may have been unaware of their potential claim. The Board Risk Committee has placed great emphasis on clearing up these issues and achieving resolution as rapidly as possible and reviews progress at each and every meeting.
Q: What are the biggest risk factors to our industry and what steps are we taking to address them?
As economic cycles mature, it is important to be mindful of the impact of the money supply upon asset prices and to gauge the impact of a sudden reversal of asset price growth on investor sentiment, markets and the real economy. We are always wary of asset price bubbles and the potential impact upon an ever more closely linked global economy of a sudden reversal.
The Board held joint discussions with Scottish Widows Group Limited in April, and Lloyds Bank Corporate Markets plc in September. These meetings are important in respect of both governance and the sharing of best practice. They also provide the opportunity for in-depth focus on both insurance and corporate markets matters. Performance and business updates are also provided, and, in the case of Lloyds Bank Corporate Markets plc, updates on key milestones in respect of the development of this new bank.
The right processes in place to deliver on our strategy During the year, there were eight scheduled Board meetings, with details of attendance shown on page 56. In addition to formal meetings, the Board meets as necessary to consider matters of a time-sensitive nature. The Chairman and the Chairmen of each Committee ensure Board and Committee meetings are structured to facilitate open discussion, debate and challenge.
The Executive Directors make decisions within clearly defined parameters which are documented within the Corporate Governance Framework. However, where appropriate, any activities outside the ordinary course of business are brought to the full Board for their consideration, even if the matters fall within the agreed parameters. The Corporate Governance Framework helps to ensure that decisions are made by management with the correct authority.
In the rare event of a Director being unable to attend a meeting, the Chairmen of the respective meetings discuss the matters proposed with the Director concerned wherever possible, seeking their support and feedback accordingly. The Chairman subsequently represents those views at the meeting.
The Group has a comprehensive and continuous agenda setting and escalation process in place to ensure that the Board has the right information at the right time and in the right format to enable the Directors to make the right decisions. The Chairman leads the process, assisted by the Group Chief Executive and Company Secretary. The process ensures that sufficient time is being set aside for strategic discussions and business critical items.
The process of escalating issues and agenda setting is reviewed at least annually as part of the Board Effectiveness Review with enhancements made to the process, where necessary, to ensure it remains effective. Details of the meeting process are provided on the next page.
Regarding the Board as a whole, I act as a trusted intermediary for the other NonExecutive Directors where this is required to help them to challenge and contribute effectively; and take the initiative in discussion with the Chairman or other Board members if it should seem that the Board is not functioning effectively.
A: The role of the Senior Independent Director has grown enormously in the past few years, and I believe stakeholders really value this alternative contact within the Board, providing a highly versatile intermediary with the Board and senior management. This is supported by me having a close relationship with the stakeholders to reinforce the trust and confidence needed to perform the role effectively. The majority of my role is undertaken during normal business circumstances, but recognising that I will need to step in when any issues arise. The relationships fostered during times of normal business provide a strong basis to deal with any such issues effectively and independently.
As one of his regular site visits, Lord Blackwell was in Cardiff in September meeting colleagues from St. William House, local branches and Lloyds Bank Foundation charity, Women Connect First.
Templates and guidelines are included within targeted training for authors of papers to ensure consistency and high quality of information.
People The Chairman: – has focused on building an independentlyminded, diverse Board, and has laid the foundations for an open Board culture; – invests considerable one-on-one time with Non-Executive Directors, which provides a platform for timely, two-way feedback, and helps the new Non-Executive Directors build confidence and a sense of belonging.
Questionnaires were sent to the Directors ahead of the one-to-one interviews with each Director. Egon Zehnder also attended the November Board meeting. This enabled Egon Zehnder to witness and evaluate the Board’s processes and behaviours.
Findings were reviewed with the Company Secretary. The summary findings were then shared and discussed with the Chairman and feedback on each of the Committees was shared with the relevant principal Committees. The final summary was presented to the Board in January at a meeting facilitated by Egon Zehnder. Feedback on individual Directors is shared with the Chairman.
This is a well functioning Board underpinned by a shared purpose, strong team dynamics and robust processes.2
Instructions have been given to all those who produce Board papers to avoid repetition between presentations and briefing papers. Bespoke training has also been provided by the Company Secretary.
The Group’s brokers attended the Board meeting in April to provide investor feedback on the results and strategy announcements.
Senior Manager and Certification Regime (SMCR) has also been included as an additional theme for all Non-Executive Directors.
In establishing and reviewing the risk management and internal control systems, the Directors carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity, the likelihood of a risk event occurring and the costs of control. The process for identification, evaluation and management of the principal risks faced by the Group is integrated into the Group’s overall framework for risk governance. The Group is forward-looking in its risk identification processes to ensure emerging risks are identified. The risk identification, evaluation and management process also identifies whether the controls in place result in an acceptable level of risk.
For details of Board engagement with colleagues during 2018, please see page 17.
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The Group has adopted the UK Finance Code for Financial Reporting Disclosure and its 2018 financial statements have been prepared in compliance with its principles.
A1. The Board’s Role The Group is led by an effective, committed unitary Board, which is collectively responsible for the long-term success of the Group. The Group’s Corporate Governance Framework, which is reviewed annually by the Board, sets out a number of key decisions and matters that are reserved for the Board’s approval. Further details can be found online at www.lloydsbankinggroup.com and on page 60.
The Non-Executive Directors challenge management constructively and help develop and set the Group’s strategy. They actively participate in Board decision-making and scrutinise management performance. The Non-Executive Directors satisfy themselves on the integrity of financial information and review the Group’s risk exposures and controls. The Non-Executive Directors, through the Remuneration Committee, determine the remuneration of Executive Directors.
A3. Role of the Chairman The Chairman has overall responsibility for the leadership of the Board and for ensuring its effectiveness. The responsibilities of the Chairman and his fellow Directors are set out above.
A4. Role of the Non-Executive Directors The Senior Independent Director (‘SID’), Anita Frew, acts as a sounding board for the Chairman and Group Chief Executive. She can be contacted by shareholders and other Directors as required.
Meetings are held between the Non-Executive Directors in the absence of the Executive Directors, and at least once a year in the absence of the Chairman.
More information on the annual Board effectiveness review can be found on pages 62 to 63 and information on the Board Diversity Policy can be found on page 69.
Ample opportunities, support and resources for learning are provided through a comprehensive programme, which is in place throughout the year and comprises both formal and informal training and information sessions.
The Group provides access, at its expense, to the services of independent professional advisers in order to assist Directors in their role.
C1. Financial and business reporting The Code requirement that the Annual Report is fair, balanced and understandable is considered throughout the drafting and reviewing process and the Board has concluded that the 2018 Annual Report is fair balanced and understandable. The Directors’ and Auditors’ Statements of Responsibility can be found on pages 81 and 161 respectively. Information on the Company’s business model and strategy can be found on pages 1 to 35.
E1. Shareholder engagement The Board actively engages with all stakeholders including shareholders and more information on our approach to relations with shareholders can be found on pages 16 to 17.
UK Corporate Governance Code The Financial Reporting Council published in July an amended UK Corporate Governance Code (the ‘New Code’), which is applicable from 1 January 2019, with requirements relating to the annual report applicable to the report and accounts for the year ending 31 December 2019. The Group will be reporting against this New Code in next year’s annual report, but the requirements have been considered by the Committee and the Board during the year under review and work has been done to implement changes to procedures, governance, culture and practice in line with the New Code.
Establishing the GEC characteristics and identifying and supporting potential successors into GEC-level roles
This included updating the ongoing development plans for potential successors into Executive Director roles, including Group Chief Executive.
The Board considered and approved the adoption of a public goal to increase ethnic diversity in the senior management population, a first for a FTSE-100 company. This has now been incorporated into the Board Diversity Policy which was approved by the Board in January 2019. The Board Diversity Policy is available at www.lloydsbankinggroup.com. Please see pages 22 to 23 and 69 for further information regarding diversity.
In recommending Directors for re-election the Committee reviews the performance of each Non-Executive Director and their ability to continue meeting the time commitments required. It also takes account of any relationships that had been disclosed. Details of conflicts of interest can be found on page 79. A particularly rigorous review of Lord Blackwell, Anita Frew and Sara Weller was undertaken as a result of having held the position of Non-Executive Director for longer than six years. Based on its assessment for 2018, the Committee is satisfied that, throughout the year, all Non-Executive Directors remained independent2 as to both character and judgement. All Directors were considered to have appropriate roles, including capabilities and time commitments.
1 Aside from assisting with senior recruitment and benchmarking, Russell Reynolds Associates have no other connection to the Company.
The Board places great emphasis on ensuring that its membership reflects diversity in its broadest sense. A combination of demographics, skills, experience, race, age, gender, educational and professional background and cognitive and personal strengths on the Board is important in providing a range of perspectives, insights and challenge needed to support good decision making. New appointments are made on merit, taking account of the specific skills and experience, independence and knowledge needed to ensure a rounded Board and the diversity benefits each candidate can bring to the overall Board composition. Amanda Mackenzie was the only Director to be appointed to Lloyds Banking Group plc during the year, and as part of her appointment diversity was considered in its broadest sense. Amanda brings experience of customer focus and leadership of Business in the Community, which will be a major asset in supporting our mission of Helping Britain Prosper. Objectives for achieving Board diversity may be set on a regular basis. On gender diversity the Board has a specific objective to maintain at least three female Board members and, recognising the target referred to in the Hampton-Alexander Review for FTSE companies to move towards 33 per cent female representation by 2020, to take opportunities to increase the number of female Board Members over time where that is consistent with other skills and diversity requirements. Female representation on the Board is currently 25 per cent (based on three female Directors and nine male Directors). The Board also places high emphasis on ensuring the development of diversity in the senior management roles within the Group and supports and oversees the Group’s objectives of achieving 40 per cent of senior roles held by female executives by 2020, and of 8 per cent of senior roles being held by Black, Asian and Minority Ethnic (BAME) executives by 2020. This is underpinned by a range of policies within the Group to help provide mentoring and development opportunities for female and BAME executives and to ensure unbiased career progression opportunities. Progress on this objective is monitored by the Board and built into its assessment of executive performance. A copy of the Policy is available on our website at www.lloydsbankinggroup.com/responsible-business and information on Board diversity can be found on pages 22, 23 and 56.
Regulatory applications were made to the PRA and the FCA in respect of the relevant Directors, and approval was obtained.
Dear Shareholder The past year has been another busy one for the Audit Committee (the ‘Committee’). In addition to continuing focus on issues relevant to the Company’s financial reporting and its internal control framework, considerable time has been spent on other key areas, including implementation of IFRS 9 and oversight of the process for the selection of a new external auditor.
Whilst the regulator has confirmed a 2019 deadline for claims relating to payment protection insurance (PPI), provisioning for other conduct matters in addition to PPI has continued to form part of the Committee’s focus. Preparations for the implementation of the ring-fencing regime have also been an important area of consideration, with the Committee reviewing the control and accounting aspects of the establishment of the Group’s non ring-fenced bank, which was successfully made operational during the second half of 2018. The Committee has in addition considered other key areas of judgement and complexity relevant to the financial statements, including review of significant one-off transactions, assisting in determining the appropriate accounting treatment in the sale of the Company’s c.3 per cent stake in Standard Life Aberdeen, and the sale of c.£4 billion of Irish mortgage assets.
Committee will continue to pay close attention to how the underlying models perform in potentially volatile economic scenarios.
All members of the Committee are independent Non-Executive Directors with competence in the financial sector and their biographies can be found on pages 52 to 53. Simon Henry is a Chartered Global Management Accountant and has extensive knowledge of financial markets, treasury, risk management and international accounting standards. He is a member having recent and relevant financial experience for the purposes of the UK Corporate Governance Code and is the Audit Committee financial expert for SEC purposes.
During the course of the year, the Committee held separate sessions with the internal and external audit teams, without members of the executive management present. For details of how the Committee was run, see page 60.
Whilst the Committee’s membership comprises the Non-Executive Directors noted on page 56, all Non-Executive Directors may attend meetings as agreed with the Chairman of the Committee. The Group Financial Controller, Chief Internal Auditor, the external auditor, the Group Chief Executive, the Chief Financial Officer, the Chief Risk Officer and the Chief Operating Officer also attend meetings of the Committee as appropriate. Details of Committee membership and meeting attendance can be found on page 56.
Lloyds Banking Group Annual Report and Accounts 2018 71 Strateg ic rep ort
Management judgement is used to determine the assumptions used to calculate the Group’s PPI provision. The principal assumptions used in the calculation are the number of future complaints, the extent to which they will be upheld, the average redress to be paid and expected future administration costs.
The Committee reviewed management’s assessment of future customer claims volumes considering, inter alia, the potential impact of regulatory changes; the FCA media campaign; claims management company and customer activity; and the additional remediation arising from the continual improvement of the Group’s operational practices.
The Committee has monitored developments on the Group’s secured and unsecured arrears handling activities, including the impact of the Group’s enhanced data capabilities and the risks emerging around operational costs.
Throughout 2018, the Committee challenged both the level of provision held by the Group, and the judgements and estimates used to calculate the provision. It reviewed on a regular basis the Group’s analysis by stage of its drawn and undrawn balances and its coverage ratios for the Group’s lending portfolios. The Committee was satisfied that the impairment provisions, and associated disclosures, were appropriate.
Management has designed its disclosures so that they comply with the requirements of the accounting standard, provide relevant information to users to gain an understanding of the new concepts and include sensitivities of assumptions where appropriate.
The Committee was satisfied that the control framework established by management to mitigate the financial control risks associated with the transfers was adequate and that the judgements used to determine the accounting for the transfers were appropriate.
The Committee has reviewed management’s assessment of forecast taxable profits based on the Group’s operating plan, the split of these forecasts by legal entity and the Group’s long-term financial and strategic plans. Management’s forecasts included estimates of the impact of the changes in the Group’s structure made to comply with ring-fencing requirements.
The Committee received a paper from the Group’s Insurance Audit Committee summarising its activities, which included a review of the economic and non-economic assumptions made by management to determine the Group’s VIF asset and insurance liabilities. The Committee reviewed this paper and discussed the assumptions made by management.
The Committee was satisfied with the Group’s disclosure included in its ‘Future accounting developments’ note to the financial statements setting out the impact of accounting standards that were not effective for the Group at 31 December 2018.
Lloyds Banking Group Annual Report and Accounts 2018 73 Strateg ic rep ort
External auditor The Committee oversees the relationship with the external auditor (PwC) including its terms of engagement and remuneration, and monitors its independence and objectivity. Mark Hannam has been PwC’s senior statutory audit partner for the Group and the Company since the beginning of 2016, and attends all meetings of the Committee. During 2018, the Committee reviewed PwC’s audit plan, including the underlying methodology, and PwC’s risk identification processes. In its assessment of PwC’s performance and effectiveness, the Committee has considered: PwC’s interactions with the Committee; the responses to a questionnaire issued to the Group’s businesses, Finance, Risk and Internal Audit; and the FRC’s Audit Quality Inspection Report published in June 2018. In addition, the FRC’s Audit Quality Review team reviewed PwC’s audit of the Group’s 2017 financial statements as part of its latest annual inspection of audit firms. The Chairman and the Committee received a copy of the findings and discussed them with PwC. Whilst there were no significant findings, some areas of PwC’s audit procedures were identified as needing limited improvements only. The Committee concluded that it was satisfied with the auditor’s performance and recommended to the Board a proposal for the re-appointment of the auditor at the Company’s AGM.
Looking ahead, other areas of focus will include continued improvements in the Group’s treatment of customers in financial difficulty, and consumer indebtedness more generally, operational resilience and ever evolving cyber risks, together with risks associated with delivery of the Group’s overall strategy and change portfolio. Uncertainties, particularly around the EU Exit, inevitably continue to provide challenges and potential impacts for the Group’s risk profile; the Committee continues to closely monitor developments in these areas.
In seeking to achieve this, the Committee assumes responsibility for monitoring the Group’s Risk Management Framework, which embraces risk principles, policies, methodologies, systems, processes, procedures and people. It also includes the review of new, or material amendments to risk principles and policies, and overseeing any action resulting from material breaches of such policy.
In 2018 the Committee considered reports on the progress of resolution of conduct issues affecting customers in financial difficulty. Key focus areas included pace and quality of remediation and analysis of lessons learned to prevent similar issues from arising in the future. The Committee also considered the progress made in transforming our approach to helping customers in financial difficulty and improving customer outcomes. Conclusion: Whilst good progress had been made, ongoing improvement in the Group’s treatment of customers in financial difficulty will continue to be an area of focus.
Consideration was given to the appropriateness of the Group’s credit risk appetite for new mortgage lending, risks inherent in the portfolio and comparative benchmarks of business mix and performance. The Committee noted the credit quality of new business and reductions in the level of arrears across the portfolio. In line with our ‘Helping Britain Prosper Plan’, the Group participates more fully in lending to first time buyers and the buy-to-let market than our peer group. The Committee reviewed the additional credit controls that have been introduced to further reduce exposure to more marginal customers in these segments. The Committee also reviewed plans to address the risks associated with maturing interest only mortgages and noted progress made. Conclusion: The Committee was satisfied that appropriate credit controls were in place to support continued market participation in line with the Group’s risk appetite limits, and that progress has been made on controls to address the risk of interest only lending.
Stress testing The Committee continues to review the key vulnerabilities of the Group to adverse changes in the economic environment, ensuring that there are adequate financial resources in the event of a severe yet plausible downturn.
The Committee has reviewed the stress testing outputs from both the internal and regulatory exercises. This year, PRA stress testing included the impact of IFRS 9 for the first time, which requires us to recognise expected lifetime losses rather than reflecting incurred losses and accelerates loss recognition. This was a key area of focus and challenge at the Committee, which reviewed the evolution of balances through IFRS 9 stages under stress, and associated impairment impact. In addition the Committee assessed the usage and governance of models in the stress testing process to ensure the results were satisfactorily produced.
Conclusion: The Group continues to heighten the controls required to manage data risk. In 2019 data risk has been classified as a primary risk type.
Conclusion: The Committee provides oversight of People risk, which will remain a key focus as the Group delivers simplified colleague processes and maximises colleague skills and capability to achieve the workforce of the future.
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Managing regulatory risk continues to be a key focus within the Group due to the significant amount of highly complex and interdependent regulatory reform that we have managed in 2018, and will continue to manage in 2019.
Model risk The Committee continues to recognise the importance of the Group Executive and the Board holding a strong understanding of the Group’s models, their associated risks and performance.
The Committee continues to focus on ensuring the Group has an effective framework for managing complaints including root cause analysis to establish lessons learned and help prevent similar issues in the future. Consideration has been given to complaint metric performance and quality as measured by the Financial Ombudsman Service.
Details of committee membership and meeting attendance can be found on page 56.
Dear Shareholder I am pleased to report on the activity of the Responsible Business Committee (the Committee) in 2018.
The Committee agreed that its approach should focus on three material areas aligned to the Bank of the Future with the aim of enabling people, businesses and communities to be ready for the future.
Doing business in a responsible way is key to the successful delivery of our purpose to Help Britain Prosper
Lloyds Banking Group Annual Report and Accounts 2018 79 Strateg ic rep ort
Corporate governance statement The Corporate Governance report found on pages 50 to 78 together with this Directors’ report of which it forms part, fulfils the requirements of the Corporate Governance Statement for the purpose of the Financial Conduct Authority’s Disclosure Guidance and Transparency Rules (DTR).
The final dividend in respect of 2017 of 2.05 pence per ordinary share was paid to shareholders on 29 May 2018, and an interim dividend for 2018 of 1.07 pence per ordinary share was paid on 26 September 2018; these dividends totalled £2.24 billion. Further information on dividends is shown in note 44 on page 234 and is incorporated by reference.
Future developments Greenhouse gas emissions (additional information) Supporting people with disabilities Engaging colleagues
The planning process is also underpinned by a robust capital and funding stress testing framework. This framework allows the Group to assess compliance of the operating plan with the Group’s risk appetite. The scenarios used for stress testing are designed to be severe but plausible, and take account of the availability and likely effectiveness of mitigating actions that could be taken by management to avoid or reduce the impact or occurrence of the underlying risks. In considering the likely effectiveness of such actions, the conclusions of the Board’s regular monitoring and review of risk and internal control systems, as discussed on page 64, is taken into account. Further information on stress testing and reverse stress testing is provided on page 110.
The Directors consider that the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy. The Directors have also separately reviewed and approved the strategic report. On behalf of the Board
The Committee is particularly mindful of its obligation to ensure that reward for Executive Directors is clear and transparent, is encouraging strong and sustainable performance, and that the variable components of remuneration are truly variable.
remuneration report. It became clear in these discussions that, while disclosure levels were generally considered good, the way we determined bonus awards for Executive Directors was perceived to be too complex, and we could make clearer both how the annual awards were calculated and where judgement or discretion had been applied by the Committee. This report has been designed in part to respond to that feedback and I believe we have listened to, and addressed, the concerns raised. I have summarised the key changes below.
We are not seeking to make any changes to the Directors’ Remuneration Policy for 2019, however we will consult widely on policy changes ahead of the Annual General Meeting in 2020.
Our performance and remuneration philosophy We continue to operate four core reward principles: Customer alignment
Minimum full time salary for all colleagues now exceeds National Living Wage by 7 per cent
Financial and strategic performance in 2018 delivered a Group Balanced Scorecard outcome of 83 per cent of maximum
The Committee is also mindful of the changes to corporate governance and reporting regulations which take effect from next year and has begun to prepare for their formal introduction and reporting.
In this report we have published details of our CEO pay ratio, which can be found on page 95. We have also provided an overview of activity that the Board will undertake with regard to understanding the views of the wider workforce on page 64. We anticipate that the role of the Committee will evolve and develop during 2019 and intend to provide full details in 2020. Other aspects the Committee intends to focus on in 2019 include post employment shareholding and pension contributions of Executive Directors relative to the majority of the workforce.
From April 2019, all full-time colleagues in the Group will be paid a minimum salary of £17,510, 7 per cent above the National Living Wage, and where eligible will receive a minimum pay increase of £600 in 2019. This reflects the Group’s commitment to offering colleagues a competitive reward package, which aims to reward all colleagues fairly for their contribution. The Group has been recognised as a Living Wage employer since 2015.
Variable remuneration for Executive Directors and other senior colleagues is weighted heavily toward long-term performance, ensuring our colleagues build an ownership interest in the Group and are motivated by delivering superior and sustainable returns for shareholders.
The approach to determining awards for Executive Directors is as follows: Evaluation of performance: The Committee reviews financial and non-financial performance against the Balanced Scorecard objectives. Judgement may then be used to ensure that mechanical scorecard outcomes are aligned to individual contribution, including how Executive Directors have performed.
How we have performed over three years (2016 LTIP measures) – see page 89.
The 2018 Group Balanced Scorecard is as follows: Performance Range/Outcome Objective Measure Minimum: 1 Maximum: 5 Score
The Committee set a funding level to award at target which is 30 per cent of max opportunity for EDs, as per policy, and 50 per cent for all other colleagues.
The Group modifier is applied to all colleague awards to take into account Group Performance against target. For 2018 an adjustment of 4 per cent.
The Chief Financial Officer’s individual performance assessment for 2018 reflected the Finance division’s objectives, assessed as Strong. The individual block ratings and assessment are shown above.
Continued improvement in the Group’s cost:income ratio to 46 per cent (49.3 per cent including remediation).
Exemplary leadership of delivery of the latest strategic plan, transforming the Group for success in a digital world.
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Weighting Measure Threshold Maximum Actual Vesting 30% Absolute total shareholder return (TSR) 8% p.a. 16% p.a. (4.8%) 0%
1 2018: Ordinary dividend in respect of the financial year ended 31 December 2018, partly paid in 2018 and partly to be paid in 2019 and intended share buyback. 2017: Ordinary dividend in respect of the financial year ended 31 December 2017, partly paid in 2017 and partly to be paid in 2018 and intended share buyback.
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25 per cent of the proportion of the award attributable to each performance measure will vest at threshold performance.
Digital net promoter score Set relative to 2020 targets Threshold: 64 Maximum: 67
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The level of pension allowances for 2019 are: GCE: 33 per cent of base salary CFO: 25 per cent of base salary COO: 25 per cent of base salary
The Committee considers the specific measures and targets that apply to 2019 to be commercially sensitive but will provide information on the level of payout relative to the performance achieved in next year’s annual report on remuneration.
1 Remuneration for the CFO Designate will take effect from commencement of employment.
Judgement on individual performance adjustment is informed by taking into account the severity of the issue, the individual’s proximity to the issue and the individual’s behaviour in relation to the issue. Individual adjustment may be applied through adjustments to balanced scorecard assessments and/or through reducing the GPS and/or GOS outcome.
Nomination and Governance Committee membership2 £15,600 £15,300 1 New members only.
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The 2018 total remuneration for the colleagues identified at P25, P50 and P75 are as follows: £26,490, £37,058, £67,225.
Due to operational constraints, the calculation of the colleague Pension Input Figure excludes the adjustment to uprate the opening value for defined benefit plans specified in section 229 of the Finance Act 2004. The omission of this factor does not materially affect the outcome of the ratio and/or distort the validity of the valuation. All other data has been calculated in line with the methodology for the single total figure of remuneration for the Group Chief Executive.
Gender pay We reduced our gender pay gap by 1.3 per cent in 2018 The Group is committed to offering all colleagues a reward package that is competitive, performance-driven and fair.
We recognise that supporting gender equality and diversity more broadly supports the success of the UK as a whole. We regularly review our pay levels to ensure that men and women are paid equally for doing equivalent roles across the Group and the Group is committed to increasing the number of women in senior roles. As a result of progress made in hiring female talent into senior positions and targeting greater pay awards for lower graded colleagues (where there is a majority of female colleagues), we have reduced our gender pay gap by 1.3 per cent. An increase in part time working at lower grades and a reduction in the number of female colleagues at the most senior grades, offset the progress made in female colleagues taking on more senior positions in the Group. As a result the mean bonus gap increased by 1.2 per cent from 2017 to 2018. Further information is available at: lloydsbankinggroup.com/globalassets/ourgroup /responsible-business/reporting-centre/ gender-pay-gap-report-2017-18-final.pdf.
The Committee comprises Non-Executive Directors from a wide background to provide a balanced and independent view on remuneration matters. During the year Anita Frew stepped down as Chair of the Committee and was replaced by Stuart Sinclair with effect from 1 September 2018. Stuart has been a member of the Committee since January 2016 and Anita remains a member of the Committee.
The purpose of the Committee is to set the remuneration for all Executive Directors and the Chairman, including pension rights and any compensation payments. It recommends and monitors the level and structure of remuneration for senior management and material risk takers. It also considers, agrees and recommends to the Board an overall remuneration policy and philosophy for the Group that is aligned with its long-term business strategy, its business objectives, its risk appetite, values and the long-term interests of the Group that recognises the interests of relevant stakeholders, including the wider workforce.
Share methodology including performance measures included within the Group Balanced Scorecard 2018 Colleague Group Ownership Share 2018 Sharesave offer
António Horta-Osório (Group Chief Executive), Juan Colombás (Chief Operating Officer), Jen Tippin (Group People and Productivity Director), Matt Sinnott (Group Reward Director), Stuart Woodward (Reward Regulation, Governance and Variable Reward Director) and Letitia Smith (Group Director, Conduct, Compliance & Operational Risk) provided guidance to the Committee (other than for their own remuneration). Stephen Shelley (Chief Risk Officer) and George Culmer (Chief Financial Officer) also attended the Committee to advise as and when necessary on risk, financial and other operational matters.
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Maximum potential The maximum allowance for the GCE is 50 per cent of base salary less any flexible benefits allowance.
When determining and reviewing the level of benefits provided, the Committee ensures that decisions are made within the following two parameters: An objective assessment of the individual’s responsibilities and the size and scope of their role, using objective jobsizing methodologies.
Purpose and link to strategy Executive Directors are eligible to participate in HMRCapproved share plans which promote share ownership by giving employees an opportunity to invest in Group shares.
The maximum value of free shares that may be awarded in any year is £3,600.
Where an award or a deferred award is in shares or other sharelinked instrument, the number of shares to be awarded may be calculated using a fair value or based on discount to market value, as appropriate.
Maximum potential The maximum Group Performance Share opportunities are 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors.
The Chairman receives an all-inclusive fee, which is reviewed periodically plus benefits including life insurance, car allowance, medical insurance and transportation. The Committee retains the right to provide additional benefits depending on individual circumstances. NEDs are paid a basic fee plus additional fees for the chairmanship/membership of committees and for membership of Group companies/boards/ non-board level committees.
This section discloses the remuneration awards made by the Group to Material Risk Takers (MRTs) in respect of the 2018 performance year. Additional information summarising the Group’s remuneration policies, structure and governance is also provided. These disclosures should be read in conjunction with the disclosures for Executive Directors contained in the Directors’ Remuneration Report (DRR) on pages 82 to 99, and together comply with the requirements of Article 450 of the Capital Requirements Regulation (EU) No. 575/2013 (CRR). The remuneration principles and practices detailed in the DRR apply to MRTs and non-MRTs in the same way as to Executive Directors (other than where stated in this disclosure).
The fixed share award, made annually, delivers Lloyds Banking Group shares over a period of five years. Its purpose is to ensure that total fixed remuneration is commensurate with the role, responsibilities and experience of the individual; provides a competitive reward package; and is appropriately balanced with variable remuneration, in line with regulatory requirements. The fixed share award can be amended or withdrawn in the following circumstances: to reflect a change in role; to reflect a Group leave policy (e.g. parental leave or sickness absence); termination of employment with the Group; if the award would be inconsistent with any applicable legal, regulatory or tax requirements or market practice.
Collective and discretionary adjustments to reflect risk matters and/or other factors.
Further information on deferral, vesting and performance adjustment can be found in the DRR on pages 94 and 99.
The Group’s approach to risk The Group operates a prudent approach to risk with rigorous management controls to support sustainable business growth and minimise losses. Through a strong and independent risk function (Risk division), a robust control framework is maintained to identify and escalate current and emerging risks, support sustainable growth within Group risk appetite, and to drive and inform good risk reward decision-making.
To meet ring-fencing requirements from 1 January 2019, core UK retail financial services and ancillary retail activities have been ring-fenced from other activities of the Group. The Group Risk Management Framework and Group Risk Appetite apply across the Group and are supplemented by risk management frameworks and risk appetites for the sub-groups to meet sub-group specific needs. In each case these are aligned to the Group position. The Group’s Corporate Governance Framework applies across Lloyds Banking Group plc, Lloyds Bank plc, Bank of Scotland plc and HBOS plc. It is tailored where needed to meet the entity specific needs of Lloyds Bank plc and Bank of Scotland plc, and supplementary Corporate Governance Frameworks are in place to address sub-group specific requirements of the other sub-groups (LBCM, Insurance and LBG Equity Investments). See our revised Group governance arrangements and Group restructure to comply with ring-fencing on page 58.
Governance and control The Group’s approach to risk is founded on a robust control framework and a strong risk management culture which are the foundation for the delivery of effective risk management and guide the way all employees approach their work, behave and make decisions.
The Group has a Disclosure Committee which assists the Group Chief Executive and Chief Financial Officer in fulfilling their disclosure responsibilities under relevant listing and other regulatory and legal requirements. In addition, the Audit Committee reviews the quality and acceptability of the Group’s financial disclosures. For further information on the Audit Committee’s responsibilities relating to financial reporting see pages 70 to 73.
– Counterparty credit risk3 – 4.7 – 2.5 7.2 1 As a separate regulated business, Insurance (excluding Wealth) maintains its own regulatory solvency requirements, including appropriate management buffers, and reports directly to the Insurance Board. Insurance does not hold any RWAs, as its assets are removed from the Banking Group’s regulatory capital calculations. However, in accordance with Capital Requirements Directive and Regulation (CRD IV) rules, part of the Group’s investment in Insurance is included in the calculation of threshold RWAs, while the remainder is taken as a capital deduction.
– Continued investment and priority focus on the Group’s Cyber Programme to ensure confidentiality and integrity of data and availability of systems. Key areas of focus relate to access controls, network security, disruptive technology, and denial of service capability. – Embedding of Group Cyber control framework aligned to industry recognised cyber security framework (NIST: National Institute of Standards and Technology). – Three year cyber strategy to deliver an industry-leading approach across the Group and to embed innovation in our approach to cyber. – Increased business and colleague engagement through education and awareness, phishing testing and security culture initiatives. Cyber risk is governed through all key risk committees and there are quarterly reviews of all cyber risks.
– The Group’s strategy is to introduce advanced data management practices, based on Group-wide standards, data-first culture and modern enterprise data platforms, supported by a simplified modern IT architecture. – The Group has implemented Open Banking and actively monitors implications for our customers, including protection from fraud. – We are making a significant investment to improve data privacy, including the security of data and oversight of third-parties.
Macroeconomic headwinds: The UK economic outlook is uncertain. Business investment is lower than historical averages with early signs of pressure in Retail and high street sectors. High levels of credit market liquidity have reduced spreads and weakened terms in some sectors, creating a potential under-pricing of risk and heightened risk of a market correction. These factors could lead to downward pressure on credit quality.
Uncertainty remains over UK monetary policy, and tightening US monetary policy is pressuring some emerging markets with potential spill over effects on growth and asset prices in other markets.
Policy tightening in the US and China has weakened global growth prospects; this is likely to bring a pause to US policy normalisation and Chinese deleveraging of its high debt levels, in turn weakening crisis management tools.
Further, there is an emerging risk of unintended consequences within decision-making undertaken by machine learning which could occur on a large scale in a short period of time, creating new operational risks that affect financial and non-financial outcomes, for example credit portfolio anomalies or conduct impacts. This is relevant for the Group at present as the delivery of GSR3 utilises new technologies.
There is increased focus on these risks by key stakeholders including businesses, clients and investors, and the regulatory landscape is evolving to reflect these risks.
There is uncertainty across the whole UK Banking sector as to the impact such discontinuation or changes may have and they may adversely affect a broad array of financial products, including any LIBOR-based securities, loans and derivatives.
Any discontinuation or changes could have important implications for both the Group and our customers, for example: necessitating amendments to existing documents and contracts; changes to systems and infrastructures; and the possibility of disputes.
– The Group is working closely with the Bank of England initiated Working Group on Sterling Risk-Free Reference Rates on the transition away from LIBOR in the UK. – Maintain close engagement with the FCA on potential impacts.
Capital stress testing Overview Stress testing is recognised as a key risk management tool by the Boards, senior management, the businesses and the Risk and Finance functions of all parts of the Group and its legal entities. It is fully embedded in the planning process of the Group and its legal entities as a key activity in medium-term planning, and senior management is actively involved in stress testing activities via a strict governance process.
Risk Appetite: Assess the results of the stress test against the risk appetite of all parts of the Group to ensure the Group and its legal entities are managed within their risk parameters.
The Group Financial Risk Committee (GFRC), chaired by the Chief Risk Officer and attended by the Chief Financial Officer and other senior Risk and Finance colleagues, is the committee that has primary responsibility for overseeing the development and execution of the Group’s stress tests. Lloyds Bank Corporate Markets (LBCM) Risk Committee performs a similar function within the scope of LBCM.
Role of the Board and senior management Key responsibilities of the Board and senior management include: setting risk appetite and approval of the RMF; approval of Group-wide risk principles and policies; the cascade of delegated authority (for example to Board sub-committees and the Group Chief Executive); and effective oversight of risk management consistent with risk appetite.
Governance frameworks The policy framework is founded on Board-approved key principles for the overall management of risk in the organisation. These are aligned with Group strategy and risk appetite and based on a current and comprehensive risk profile that identifies all material risks to the organisation. The principles are underpinned by a hierarchy of policies which define mandatory requirements for risk management and control. These are consistently implemented across the Group.
Three lines of defence model The RMF is implemented through a ‘three lines of defence’ model which defines clear responsibilities and accountabilities and ensures effective independent oversight and assurance activities take place covering key decisions.
It also has a key role in promoting the implementation of a strategic approach to risk management reflecting the risk appetite and RMF agreed by the Board that encompasses: oversighting embedding of effective risk management processes; transparent, focused risk monitoring and reporting; provision of expert and high quality advice and guidance to the Board, executives and management on strategic issues and horizon scanning, including pending regulatory changes; and a constructive dialogue with the first line through provision of advice, development of common methodologies, understanding, education, training, and development of new risk management tools.
Risk culture Supporting the formal frameworks of the RMF is the underlying culture, or shared behaviours and values, which sets out in clear terms what constitutes good behaviour and good practice. In order to effectively manage risk across the organisation, the functions encompassed within the three lines of defence have a clear understanding of risk appetite, business strategy and an understanding of (and commitment to) the role they play in delivering it. A number of levers are used to reinforce the risk culture, including tone from the top, clear accountabilities, effective communication and challenge and an appropriately aligned performance incentive.
Board, Executive and Risk Committees The Group’s risk governance structure (see table 1.2) strengthens risk evaluation and management, while also positioning the Group to manage the changing regulatory environment in an efficient and effective manner.
Group Executive Committee (GEC) Assists the Group Chief Executive in exercising his authority in relation to material matters having strategic, cross-business area or Group-wide implications.
Group Model Governance Committee Responsible for setting the model governance framework, the associated policy and related principles and procedures; reviewing and approving models, model changes, model extensions and capital post model adjustments; recommending approval to Group Risk Committee (GRC) of those models which require GRC approval; monitoring summary of model performance, approving any appropriate corrective actions; and monitoring performance against risk appetite and escalating as required.
As part of the ‘three lines of defence’ model, Risk division is the second line of defence providing oversight and independent challenge to key risk decisions taken by business management. Risk division also tests the effectiveness of credit risk management and internal credit risk controls. This includes ensuring that the control and monitoring of higher risk and vulnerable portfolios/sectors is appropriate and confirming that appropriate loss allowances for impairment are in place. Output from these reviews help to inform credit risk appetite and credit policy.
Following the introduction of IFRS 9, underlying processes and key controls have been updated with additional management information produced to assist in monitoring portfolio quality and provision coverage. Group governance and oversight of impairments remains largely unchanged.
Frequent and robust credit risk oversight and assurance: oversight and assurance of credit risk is undertaken by independent credit risk oversight functions operating within Retail credit risk and Commercial banking risk which are part of the Group’s second line of defence. Their primary objective is to provide reasonable and independent oversight that credit risk is being effectively managed and to ensure that appropriate controls are in place and being adhered to. Group Internal Audit also provides assurance to the Board Audit Committee on the effectiveness of credit risk management controls across the Group’s activities.
Collateral values are assessed at the time of loan origination. The Group requires collateral to be realistically valued by an appropriately qualified source, independent of both the credit decision process and the customer, at the time of borrowing. In certain circumstances, for Retail residential mortgages this may include the use of automated valuation models based on market data, subject to accuracy criteria and LTV limits. Where third-parties are used for collateral valuations, they are subject to regular monitoring and review. Collateral values are subject to review, which will vary according to the type of lending, collateral involved and account performance. Such reviews are undertaken to confirm that the value recorded remains appropriate and whether revaluation is required, considering for example, account performance, market conditions and any information available that may indicate that the value of the collateral has materially declined. In such instances, the Group may seek additional collateral and/or other amendments to the terms of the facility. The Group adjusts estimated market values to take account of the costs of realisation and any discount associated with the realisation of the collateral when estimating credit losses.
The Group seeks to avoid correlation or wrong-way risk where possible. Under the Group’s repurchase (repo) policy, the issuer of the collateral and the repo counterparty should be neither the same nor connected. The same rule applies for derivatives. Risk division has the necessary discretion to extend this rule to other cases where there is significant correlation. Countries with a rating equivalent to AA- or better may be considered to have no adverse correlation between the counterparty domiciled in that country and the country of risk (issuer of securities).
For UK mortgages, the Group’s policy permits owner occupier applications with a maximum LTV of 95 per cent. Applications with an LTV above 90 per cent are subject to enhanced underwriting criteria, including higher scorecard cut-offs and loan size restrictions.
Buy-to-let mortgages within Retail are limited to a maximum loan size of £1,000,000 and 75 per cent LTV. Buy-to-let applications must pass a minimum rental cover ratio of 125 per cent under stressed interest rates, after applicable tax liabilities. Portfolio Landlords (customers with four or more mortgaged buy-to-let properties) are subject to additional controls including evaluation of overall portfolio resilience.
Additional mitigation for Commercial customers Individual credit assessment and independent sanction of customer and bank limits: with the exception of small exposures to SME customers where certain relationship managers have limited delegated sanctioning authority, credit risk in commercial customer portfolios is subject to sanction by the independent Risk division, which considers the strengths and weaknesses of individual transactions, the balance of risk and reward, and how credit risk aligns to the Group and Divisional risk appetite. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and risk based recommended maximum limit parameters. Approval requirements for each decision are based on a number of factors including, but not limited to, the transaction amount, the customer’s aggregate facilities, credit policy, risk appetite, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty and customer underwriting is generally the same as that for assets intended to be held to maturity. All hard underwriting must be sanctioned by Risk division. A pre-approved credit matrix may be used for ‘best efforts’ underwriting.
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 relevant counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day.
Master netting agreements It is credit policy that a Group approved master netting agreement must be used for all derivative and traded product transactions and must be in place prior to trading. This requirement extends to trades with clients and the counterparties used for the Bank’s own hedging activities, which may also include clearing trades with Central Counterparties (CCPs). Any exceptions must be approved by the appropriate credit sanctioner. Master netting agreements do not generally result in an offset of balance sheet assets and liabilities for accounting purposes, as transactions are usually settled on a gross basis. However, within relevant jurisdictions and for appropriate counterparty types master netting agreements do reduce the credit risk to the extent that, if an event of default occurs, all trades with the counterparty may be 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 this is the net position of all trades under the master netting agreement.
The Group classifies accounts as forborne at the time a customer in financial difficulty is granted a concession. Accounts are classified as forborne for a minimum of two or three years, dependent on whether the exposure is performing or non-performing when the concession is applied.
The Group’s treatment of loan renegotiations is included in the impairment policy in note 2(H) on page 180.
Credit quality remains strong with no deterioration in credit risk. Flow to arrears remains stable at low levels. The Group’s loan portfolios continue to be well positioned, reflecting the Group’s continued prudent, through the cycle approach to credit risk and benefiting from continued low interest rates and a resilient UK economy
Stage 2 loans as a proportion of total loans and advances to customers have reduced to 7.8 per cent (1 January 2018: 11.3 per cent), with Stage 2 loans and advances down by £14.3 billion to £38.3 billion, driven by the sale of the Irish mortgage portfolio, model refinements to the Stage 2 transfer approach for Secured and portfolio improvements. Coverage of Stage 2 drawn balances increased to 4.1 per cent (1 January 2018: 3.5 per cent)
Stage 3 assets have either defaulted or are otherwise considered to be credit impaired. These assets carry a lifetime ECL.
In the following statutory basis tables, POCI assets relate to a fixed pool of mortgages that were purchased as part of the HBOS acquisition at a deep discount to face value reflecting credit losses incurred from the point of origination to the date of acquisition totalling £1,002 million at 31 December 2018. The residual ECL allowance and resulting low coverage ratio reflects further deterioration in the creditworthiness from the date of acquisition. Over time, the POCI assets will run off as the loans redeem, pay down or losses are crystallised.
The Group uses the underlying basis to monitor the creditworthiness of the lending portfolio and related ECL allowances because it provides a better indication of the credit performance of the POCI assets. The underlying basis assumes that the lending assets acquired as part of a business combination was originated by the Group and is classified as either Stage 1, 2 or 3 according to the change in credit risk over the period since origination. Underlying ECL allowances have been calculated accordingly.
2 Total and Stage 3 expected credit loss allowances as a percentage of drawn balances are calculated excluding loans in recoveries for Retail (31 December 2018: £250 million; 1 January 2018: £291 million).
Table 1.6b: Reconciliation between statutory and underlying basis of Group gross loans and advances to customers
Total ECL allowances 4,448 4,774 3,498 1 Prior period comparatives are on an IAS 39 basis.
Purchased or originated credit-impaired assets – – (553) (598) 1,151 1 ECL allowances are stated on an IFRS 9 basis.
The table below shows the ECL calculated under each scenario on both an underlying and a statutory basis.
Loans and advances remained flat during the period at £343 billion as of 31 December 2018.
ECL allowances (drawn and undrawn) as a percentage of gross lending (%) 0.5 0.2 2.8 22.0 1 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA acquisition related adjustments.
4 Total and Stage 3 ECL allowances as a percentage of drawn balances are calculated excluding loans in recoveries for Unsecured (31 December 2018: £233 million; 1 January 2018: £277 million) and Business Banking within Other (31 December 2018: £17 million; 1 January 2018: £14 million).
At 1 January 20181,4 1 Gross lending and ECL allowances on drawn balances are stated on an IFRS 9 basis; the balances include the impact of the HBOS and MBNA related acquisition adjustments.
4 Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
Other loans and advances increased by £1.4 billion to £10.4 billion driven by a transfer of largely Stage 1 assets from SME into Business Banking. The impairment charge increased by £5 million to £28 million in the year due to the non-repeat of one-off write-backs in 2017 relating to a closed portfolio. Coverage remained flat at 1.2 per cent.
Table 1.16: Analysis of owner occupier interest only mortgages (statutory basis)
2 The balances include the impact of HBOS related acquisition adjustments.
Expected credit losses as a % of total loans and advances which are forborne1
2 The balances exclude the impact of HBOS related acquisition adjustments.
Table 1.20: Commercial Banking expected credit loss allowances (drawn and undrawn) as a percentage of loans and advances to customers
Table 1.21: Commercial Banking Stage 2 loans and advances to customers
At 1 January 20181 1 Certain balances have been reallocated between segments. This includes the incorporation of International Wealth into Commercial Banking and the allocation of Run-off across Retail and Commercial Banking.
Portfolios The SME and Mid Markets portfolios are domestically focused and reflect both our prudent credit risk appetite and the underlying performance of the UK economy. Whilst certain sectors of the market are showing some emerging signs of stress, the overall credit quality of the portfolios has remained broadly stable with levels of impairment remaining low.
The commercial real estate business within the Group’s Mid Markets and Global Corporates portfolio is focused on clients operating in the UK commercial property market ranging in size from medium-sized private real estate entities up to publicly listed property companies. Credit quality remains good with minimal impairments/stressed loans. Recognising this is a cyclical sector, appropriate caps are in place to control exposure and business propositions continue to be written in line with a prudent, through the cycle risk appetite with conservative LTVs, strong quality of income and proven management teams.
Commercial Banking UK Direct Real Estate LTV analysis The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities, such as hotels, care homes and housebuilders). Exposures to social housing providers are also excluded.
Development lending is subject to specific credit risk appetite criteria, including maximum loan to gross development value and maximum loan to cost, with funding typically only released against completed works as confirmed by the Group's monitoring quantity surveyor.
2 Excludes Islands Commercial UK Direct Real Estate of £0.45 billion (31 December 2017: £0.45bn).
3 Prior period comparatives are on an IAS 39 basis. Includes run-off, previously excluded.
Eurozone exposures The Group manages its exposures to individual countries, both within and without the Eurozone, through authorised country limits which take into account economic, financial, political and social factors. In addition, the Group manages its direct risks to the selected Eurozone countries Ireland, Spain, Italy and Greece by establishing and monitoring risk limits for individual banks, financial institutions, corporates and individuals.
The Group has been a signatory to the Equator Principles since 2008 and has adopted and applied the expanded scope of Equator Principles III. The Equator Principles support the Group’s approach to assessing and managing environmental and social issues in Project Finance, ProjectRelated Corporate loans and Bridge loans. The Group has also been a signatory to the UN Principles for Responsible Investment (UNPRI) since 2012, which incorporate ESG (environmental, social and governance risk) considerations in asset management. Scottish Widows is responsible for the annual UNPRI reporting process.
Risk conducts thematic reviews of regulatory compliance and provides oversight of regulatory compliance assessments across businesses and divisions where appropriate.
Due to the level of enhanced focus relating to conduct, there is a risk that certain aspects of the Group’s current or legacy business may be determined by the Financial Conduct Authority, other regulatory bodies or the courts as not being conducted in accordance with applicable laws or regulations, or in a manner that fails to deliver fair and reasonable customer treatment.
Monitoring and testing of customer outcomes to ensure the Group delivers fair outcomes for customers whilst making continuous improvements to products, services and processes.
Internal and/or external fraud or financial crime; Failure to ensure compliance with increasingly complex and detailed regulation including anti-money laundering, anti-bribery, counterterrorist financing, and financial sanctions and prohibitions laws and regulations; and
Operational risk is managed across the Group through an operational risk framework and operational risk policies. The operational risk framework includes a risk and control self-assessment process, risk impact likelihood matrix, key risk and control indicators, risk appetite, a robust operational event management and escalation process, scenario analysis and an operational losses process.
Table 1.26 below shows high level loss and event trends for the Group using Basel II categories. Based on data captured on the Group’s Operational Risk System, in 2018 the highest frequency of events occurred in external fraud (59.83 per cent) and execution, delivery and process management (25.52 per cent). Clients, products and business practices accounted for 63.18 per cent of losses by value, driven by legacy issues where impacts materialised in 2018 (excluding PPI).
The Group continues to optimise its approach to IT and operational resilience by investing in technology improvements and enhancing the resilience of systems that support the Group’s critical business processes, primarily through the Technology Resilience Programme, with independent verification of progress on an annual basis. The Board recognises the role that resilient technology plays in achieving the Group’s strategy of becoming the best bank for customers and in maintaining banking services across the wider industry. As such, the Board dedicates considerable time and focus to this subject at both the Board and the Board Risk Committee, and continues to sponsor key investment programmes that enhance resilience.
138 Lloyds Banking Group Annual Report and Accounts 2018 arrangements to keep them current, effective and consistent across markets and jurisdictions. The Group requires mandatory training on these topics for all employees. Specifically, the anti-money laundering procedures include ‘know-your-customer’ requirements, transaction monitoring technologies, reporting of suspicions of money laundering or terrorist financing to the applicable regulatory authorities, and interaction between the Group’s Financial Intelligence Unit and external agencies and other financial institutions. The Anti-Bribery Policy prohibits the payment, offer, acceptance or request of a bribe, including ‘facilitation payments’ by any employee or agent and provides a confidential reporting service for anonymous reporting of suspected or actual bribery activity. The Sanctions and the Related Prohibitions Policy sets out a framework of controls for compliance with legal and regulatory sanctions.
Colleague engagement may continue to be challenged by ongoing media attention on banking sector culture, conduct and ethical considerations.
Exposure limits by risk type are assessed through the business planning process and used as a control mechanism to ensure risks are taken within risk appetite.
The capital conservation buffer (CCB) is a standard buffer of 2.5 per cent of risk-weighted assets designed to provide for losses in the event of stress. The CCB has been phased in over a number of years – during 2018 it was 1.875 per cent and it increased to the full 2.5 per cent on 1 January 2019.
The countercyclical capital buffer (CCYB) is time-varying and is designed to require banks to hold additional capital to remove or reduce the build-up of systemic risk in times of credit boom, providing additional loss absorbing capacity and acting as an incentive for banks to constrain further credit growth. The amount of the buffer is determined by reference to buffer rates set by the FPC for the individual countries where the Group has relevant credit exposures. The CCYB rate for the UK is currently set at 1.0 per cent. The FPC regularly considers the adequacy of the UK CCYB rate in light of the evolution of the overall risk environment. As at 31 December 2018 non-zero buffer rates also currently apply for Norway, Sweden, Hong Kong, Iceland, Slovakia, Czech Republic, and Lithuania. During 2019 France, Bulgaria, Denmark and Ireland will implement non-zero buffer rates. The Group’s overall countercyclical capital buffer at 31 December 2018 was 0.9 per cent of risk-weighted assets, having increased significantly during the year (from 0.002 per cent at 31 December 2017) as a result of the increase in the UK rate from nil to 1.0 per cent, the Group’s relevant credit exposures being predominantly UK based.
In addition to the risk-based capital framework outlined above, the Group is also subject to minimum capital requirements under the UK Leverage Ratio Framework. The leverage ratio is calculated by dividing fully loaded tier 1 capital resources by a defined measure of on-balance sheet assets and off-balance sheet items.
Monitoring Capital is actively managed and monitoring capital ratios is a key factor in the Group’s planning processes and stress testing, which separately cover the RFB sub-group and key individual banking entities. Multi-year forecasts of the Group’s capital position, based upon the Group’s operating plan, are produced at least annually to inform the Group’s capital plan whilst shorter term forecasts are more frequently undertaken to understand and respond to variations of the Group’s actual performance against the plan. The capital plans are tested for capital adequacy using a range of stress scenarios covering adverse economic conditions as well as other adverse factors that could impact the Group and the Group maintains a recovery plan which sets out a range of potential mitigating actions that could be taken in response to a stress.
The Group notes that the UK regulatory authorities have previously announced, via the Financial Policy Committee (FPC) of the Bank of England, that the change in accounting standard will not change the cumulative losses banks incur during any given stress period (the losses will however be provided for at an earlier point in the stress) and that the FPC will take steps to ensure that the interaction of IFRS 9 accounting with its annual stress test does not result in de facto increases in capital requirements. In the short term the IFRS 9 transitional arrangements for capital, which the Group has adopted, will provide some stability in capital requirements against the increased provisioning, measurement uncertainty and volatility introduced by IFRS 9.
Regular reporting of actual and projected ratios for Group, the RFB sub-group and key legal entities, including those in stressed scenarios, is undertaken, including submissions to the Group Capital Risk Committee (GCRC), Group Financial Risk Committee (GFRC), Group Asset and Liability Committee (GALCO), Group Risk Committee (GRC), Board Risk Committee (BRC) and the Board. Capital policies and procedures are well established and subject to independent oversight.
the Group’s current countercyclical capital buffer (CCYB) requirement of 0.9 per cent of risk-weighted assets.
Minimum requirement for own funds and eligible liabilities (MREL) The purpose of the minimum requirement for own funds and eligible liabilities (MREL) is to require firms to maintain sufficient equity and liabilities that are capable of credibly bearing losses in resolution. MREL can be satisfied by a combination of regulatory capital and certain unsecured liabilities (which must be subordinate to a firm’s operating liabilities).
The completion of the sale of the Irish mortgage portfolio in the second half of the year which resulted in a 0.25 per cent increase
Other movements, resulting in a net increase of 0.03 per cent, included the impact of structural changes arising from transfers between Insurance and the ring-fenced bank, risk-weighted asset reductions, market movements and additional pension contributions
The implementation of IFRS 9 on 1 January 2018 resulted in an initial reduction in CET1 capital of 0.30 per cent which, following the application of transitional relief, reduced to 0.01 per cent. No additional relief has been recognised at 31 December 2018 as Stage 1 and Stage 2 expected credit losses (ECLs), net of regulatory expected losses, have not increased beyond the position at 1 January 2018.
Overall the Group’s CET1 ratio has strengthened to 16.0 per cent on a pro forma basis before ordinary dividends and the share buyback. After ordinary dividends the Group’s CET1 ratio reduces to 14.8 per cent on a pro forma basis. In addition the Board intends to implement a share buyback programme of up to £1.75 billion, equivalent to 2.46 pence per share. The buyback will impact the Group’s capital position in 2019 and is expected to reduce CET1 capital by c. 0.9 per cent. Allowing for this at 31 December 2018 the pro forma CET1 ratio would be 13.9 per cent after ordinary dividends (31 December 2017: 13.9 per cent pro forma, after ordinary dividends and the share buyback).
Deconsolidation of instruments issued by insurance entities1 (1,767) (1,786) (1,767) (1,786)
2 Preference shares, preferred securities and other subordinated liabilities are categorised as subordinated liabilities in the balance sheet.
Dividends paid out on ordinary shares during the year (2,240) – – (2,240)
AT1 capital resources have increased by £690 million in the period, primarily reflecting the issuance of a new AT1 capital instrument during the year, partially offset by the annual reduction in the transitional limit applied to grandfathered AT1 capital instruments.
3 Counterparty credit risk includes movements in contributions to the default funds of central counterparties and movements in credit valuation adjustment risk.
Model update increases of £1.5 billion were driven by model refinements, principally within Retail portfolios
Methodology and policy reductions of £0.8 billion were driven by further capital efficient securitisation activity
Acquisitions and disposals reduction of £5.9 billion reflects the sale of the Irish mortgage portfolio and certain strategic equity holdings
Market risk, risk-weighted assets reductions of £1.0 billion were largely due to a reduction in underlying positions and refinements to internal models, partly offset by migrations to Lloyds Bank Corporate Markets.
On a pro forma basis the UK leverage ratio increased to 5.6 per cent from 5.4 per cent pro forma at 31 December 2017, reflecting the increase in the pro forma fully loaded tier 1 capital position, partially offset by the increase in the exposure measure.
4 Calculated in accordance with CRD IV rules which include central bank claims within the leverage exposure measure.
5 The UK leverage ratio is 5.6 per cent on a pro forma basis reflecting the dividend paid by the Insurance business in February 2019 in relation to its 2018 earnings (31 December 2017: 5.4 per cent pro forma).
Table 1.33 : Application of IFRS 9 on a full impact basis for capital and leverage
Further details on the Group’s adoption of the transitional arrangements for IFRS 9 can be found in the Group publication entitled IFRS 9 Financial Instruments Transition, published in March 2018 and located on the Group’s website at
The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and is supported by strong relationships across customer segments. The Group has consistently observed that in aggregate the retail deposit base provides a stable source of funding. Funding concentration by counterparty, currency and tenor is monitored on an ongoing basis and where concentrations do exist, these are managed as part of the planning process and limited by internal risk appetite, with analysis regularly provided to senior management.
Monitoring Daily monitoring and control processes are in place to address internal and regulatory liquidity requirements. In order to meet ring-fencing requirements from 1 January 2019, the shape and scale of liquidity reporting has increased with additional monitoring and reporting requirements for the Ring-Fenced Bank (RFB) sub-group and non-ringfenced banking entities. The Group monitors a range of market and internal early warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group. This captures regulatory metrics as well as metrics the Group considers relevant for its liquidity profile. These are a mixture of quantitative and qualitative measures, including: daily variation of customer balances; changes in maturity profiles; funding concentrations; changes in LCR outflows; credit default swap (CDS) spreads; and basis risks.
The Group carries out internal stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longerterm horizons against a range of scenarios forming an important part of the internal risk appetite. The scenarios and assumptions are reviewed at least annually to ensure that they continue to be relevant to the nature of the
During 2018, the Group repaid £12 billion of its FLS drawings, which has reduced the amount outstanding to £13.1 billion at 31 December 2018. The balance of Term Funding Scheme drawings remains at £19.9 billion as at 31 December 2018.
7 Excludes repos of £1.8 billion (1 January 2018: £2.6 billion; 31 December 2017: £2.6 billion).
Table 1.35: Reconciliation of Group funding to the balance sheet (audited)
Debt securities in issue: Of which issued by Lloyds Banking Group plc2 – – – – – – 9.9 10.4 20.3 15.4 1 The Group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities and subordinated liabilities.
Financial assets at fair value through other comprehensive income – – 7,278 7,278 – 17,114 – 423 17,537 24,815
Loans and receivables: Loans and advances to banks – – – – – 213 1,417 4,981 6,611 6,611
3 The following assets are classified as unencumbered – cannot be used: assets held within the Group’s Insurance businesses which are generally held to either back liabilities to policyholders or to support the solvency of the Insurance subsidiaries; assets held within consolidated limited liability partnerships which provide security for the Group’s obligations to its pension schemes; assets segregated in order to meet the Financial Resilience requirements of the PRA’s Supervisory Statement 9/16 ‘Operational Continuity in Resolution’; assets pledged to facilitate the use of intra-day payment and settlement systems; and reverse repos and derivatives balance sheet ledger items.
The above table sets out the carrying value of the Group’s encumbered and unencumbered assets, separately identifying those that are available to support the Group’s funding needs. The table does not include collateral received by the Group (i.e. from reverse repos) that is not recognised on its balance sheet, the vast majority of which the Group is permitted to repledge.
Supporting a consistent approach to Group-wide behaviour and risk decision-making through a Group policy framework which helps everyone understand their responsibilities by clearly articulating and communicating rules, standards, boundaries and risk appetite measures which can be controlled, enforced and monitored.
Financial assets at fair value through profit or loss 158,529 35,246 6,380 116,903
Loans and advances to customers 484,858 – 484,818 40 Interest rate
Financial assets at fair value through other comprehensive income 24,815 – 24,815 – Interest rate, foreign exchange, credit spread
Financial liabilities at fair value through profit or loss 30,547 23,451 7,085 11
Derivative financial instruments 21,373 10,827 8,406 2,140 Interest rate, foreign exchange, credit spread
The Group ensures that it has adequate cash and balances at central banks and stocks of high quality liquid assets (e.g. gilts or US Treasury securities) that can be converted easily into cash to meet liquidity requirements. The majority of these assets are held as financial assets at fair value through other comprehensive income with the remainder held as financial assets at fair value through profit and loss. Further information on these balances can be found under Funding and liquidity risk on page 149. Interest rate risk in the asset portfolios is swapped into a floating rate.
Profit before tax Loss Gain > £500m £250m – £500m £50m – £250m
Equity risk Equity risk arises primarily from three different sources; (i) the Group’s strategic equity holdings e.g. Visa Europe, now held in the Equities subgroup; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital within the Equities sub-group.
The surplus or deficit in the schemes is tracked on a monthly basis along with various single factor and scenario stresses which consider the assets and liabilities holistically. Key metrics are monitored monthly including the Group’s capital resources of the scheme, the performance against risk appetite triggers, and the performance of the hedged asset and liability matching positions.
Inflation exposure arises from a combination of inflation linked policyholder benefits and inflation assumptions used to project future expenses.
One of the consequences of preparations for the formation of the Ring-Fenced Bank was to reduce the impact of some stresses within the Insurance business, though Group exposures may not have materially changed. Examples of this include centralisation of defined benefit pension schemes, and the transfer of specific hedging programmes from the corporate centre to the business unit where the exposure emanated.
Mitigation Equity and credit spread risks are closely monitored and, where appropriate, asset liability matching is undertaken to mitigate risk. Hedging strategies are in place to reduce exposure from unit-linked funds and the with-profit funds.
The risk of loss measured by the VaR model is the minimum expected loss in earnings given the 95 per cent confidence. The total and average trading VaR numbers reported below have been obtained after the application of the diversification benefits across the five risk types, but does not reflect any diversification between Lloyds Bank Corporate Markets and any other entities. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported at Group level.
As a result of the wide scope and breadth of coverage, there is exposure to model risk across a number of the Group’s primary risk categories.
Mitigation The model risk management framework, established by and with continued oversight from an independent team in the Risk division, provides the foundation for managing and mitigating model risk within the Group. Accountability is cascaded from the Board and senior management via the Group Risk Management Framework.
Notes to the consolidated financial statements 177 1. Basis of preparation 2. Accounting policies 3. Critical accounting judgements and estimates 4. Segmental analysis 5. Net interest income 6. Net fee and commission income 7. Net trading income 8. Insurance premium income 9. Other operating income 10. Insurance claims 11. Operating expenses 12 Auditors’ remuneration 14. Taxation 15. Earnings per share 16. Financial assets at fair value through profit or loss 17. Derivative financial instruments 18. Financial assets at amortised cost 19. Finance lease receivables 20. Allowance for impairment losses on loans and receivables 21. Financial assets at fair value through other comprehensive income 22. Available-for-sale financial assets 23. Goodwill 24. Value of in-force business 25. Other intangible assets 26. Property, plant and equipment 27. Other assets 28. Financial liabilities at fair value through profit or loss 29. Debt securities in issue 30. Securitisations and covered bonds 31. Liabilities arising from insurance contracts and participating investment contracts 32. Life insurance sensitivity analysis 33. Liabilities arising from non-participating investment contracts 34. Other liabilities 35. Retirement benefit obligations 36. Deferred tax 37. Other provisions 38. Subordinated liabilities 39. Share capital 40. Share premium account 41. Other reserves 42. Retained profits 43. Other equity instruments 44. Dividends on ordinary shares 45. Share-based payments 46. Related party transactions 47. Contingent liabilities and commitments 48. Structured entities 49. Financial instruments 50. Transfers of financial assets 51. Offsetting of financial assets and liabilities 52. Financial risk management 53. Consolidated cash flow statement 54. Adoption of IFRS 9 and IFRS 15 55. Future accounting developments
Our opinion is consistent with our reporting to the Audit Committee.
Our audit approach Overview – Overall Group materiality: £360 million (2017: £350 million), based on 5 per cent of profit adjusted to remove the effects of certain items which were considered to have a disproportionate impact. – Overall parent company materiality: £360 million (2017: £350 million), based on 1 per cent of total assets. – The scope of our audit and the nature, timing and extent of audit procedures performed were determined by our risk assessment, the financial significance of components and other qualitative factors (including history of misstatement through fraud or error). – We performed audit procedures over components considered financially significant in the context of the Group (full scope audit) or in the context of individual primary statement account balances (audit of specific account balances). We performed other procedures including testing entity level controls, information technology general controls and analytical review procedures to mitigate the risk of material misstatement in the residual components.
Independent auditors’ report to the members of Lloyds Banking Group plc
There are inherent limitations in the audit procedures described above and the further removed non‑compliance with laws and regulations is from the events and transactions reflected in the financial statements, the less likely we would become aware of it. Also, the risk of not detecting a material misstatement due to fraud is higher than the risk of not detecting one resulting from error, as fraud may involve deliberate concealment by, for example, forgery or intentional misrepresentations, or through collusion.
We have selected total assets as an appropriate benchmark for parent company materiality. Profit based benchmarks are not considered appropriate for parent company materiality as the Group is not required to disclose a parent company profit & loss. Where the calculated parent company materiality from total assets exceeds the Group overall materiality level, the parent company overall materiality has been restricted to equal the Group overall materiality level.
Certain account balances were audited centrally by the Group engagement team.
Commercial Banking Expected credit loss allowances relating to credit impaired loans and advances (referred to herein also as being in Stage 3) in the Commercial Banking division are primarily estimated on an individual basis. Judgement is required to determine when a loan is considered to be credit impaired, and then to estimate the expected future cash flows related to that loan under multiple weighted scenario outcomes. An expected credit loss allowance is determined on Commercial Banking loans and advances which are not classified as being credit impaired at the reporting date (referred to as being in Stages 1 and 2) using impairment models based on key assumptions including probability of default and loss given default. Management apply overlays to the modelled output to address risks not captured by the model.
We understood and assessed the appropriateness of the impairment models developed and used by management. This included assessing and challenging the appropriateness of key modelling judgements (e.g. the transfer criteria used to determine significant increase in credit risk) and quantifying the impact of the use of proxies and simplifications, assessing whether these were appropriate. We also created our own independent models covering certain parts of the model calculation and for selected portfolios this enabled us to re‑perform management’s calculation and challenge their outputs.
– Re‑performed management’s allowance calculation, testing key inputs including expected future cash flows, discount rates, valuations of collateral held and the weightings applied to scenario outcomes.
We understood and tested the key controls around the identification of matters which require provision, the estimation and review of provisions, including governance processes, challenge of key assumptions and approval of provisions.
Based on the procedures performed and evidence obtained, we found management’s assumptions to be appropriate.
Some of the economic and non‑economic actuarial assumptions used in valuing the insurance contract liabilities and the value of in‑force business asset are highly judgemental in nature, in particular persistency (the retention of policies over time), longevity (the expectation of how long an annuity policyholder will live and how that might change over time), maintenance expenses (future expenses incurred to maintain existing policies to maturity), credit default and illiquidity premium (adjustments made to the discount rate).
Based on the evidence obtained, we found that the methodologies, modelled assumptions, data used within the models and overlays to modelled outputs to be appropriate.
Based on the evidence obtained, we determined that the methodologies, inputs and assumptions are appropriate.
Defined benefit obligation Group Refer to page 70 (Audit Committee Report), page 177 (Accounting Policies) and page 219 (Note 35 and Critical Accounting Estimates and Judgements). The valuation of the retirement benefit schemes in the Group are determined with reference to various actuarial assumptions including discount rate, rate of inflation and mortality rates. Due to the size of these schemes, small changes in these assumptions can have a material impact on the estimated defined benefit obligation.
Hedge accounting Group Refer to page 70 (Audit Committee Report), page 177 (Accounting Policies), and page 255 (Note 52). The Group enters into derivative contracts in order to manage and economically hedge risks such as interest and foreign exchange rate risk. These arrangements create accounting mismatches which are addressed through designating instruments into fair value or cash flow hedge accounting relationships.
We understood and tested key controls over the designation and ongoing management of hedge accounting relationships, including testing of hedge effectiveness as well as the controls around the preparation and review of hedging strategy and related documentation prior to the implementation of new hedges.
Privileged access to IT systems Group and parent company Refer to page 70 (Audit Committee Report). The Group’s financial reporting processes are reliant on automated processes, controls and data managed by IT systems.
Strategic Report and Directors’ Report In our opinion, based on the work undertaken in the course of the audit, the information given in the Strategic Report and Directors’ Report for the year ended 31 December 2018 is consistent with the financial statements and has been prepared in accordance with applicable legal requirements. (CA06)
We have nothing to report having performed a review of the directors’ statement that they have carried out a robust assessment of the principal risks facing the Group and statement in relation to the longer‑term viability of the Group. Our review was substantially less in scope than an audit and only consisted of making inquiries and considering the directors’ process supporting their statements; checking that the statements are in alignment with the relevant provisions of the UK Corporate Governance Code (the ‘Code‘); and considering whether the statements are consistent with the knowledge and understanding of the Group and parent company and their environment obtained in the course of the audit. (Listing Rules)
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 169
Gains and losses attributable to own credit risk: Gains (losses) before tax 533 (55) –
Total comprehensive income attributable to other equity holders 433 415 412
Items in the course of collection from banks 647 755 755
Financial assets at fair value through profit or loss 16 158,529 176,008 162,878
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 173
Total equity and liabilities 797,598 811,182 812,109 1 See note 54.
Movements in revaluation reserve in respect of financial assets held at fair value through other comprehensive income, net of tax: Gains and losses attributable to own credit risk, net of tax
Movement in treasury shares – – 40 40 – – 40
Further details of movements in the Group’s share capital, reserves and other equity instruments are provided in notes 39, 40, 41, 42 and 43.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 175
Profit for the year – – 2,413 2,413 – 101 2,514
Other employee award schemes – – 168 168 – – 168
Changes in non‑controlling interests – – – – – (23) (23)
Gains and losses attributable to own credit risk, net of tax
Movement in treasury shares – – (411) (411) – – (411)
Proceeds from sale and maturity of financial assets 26,806 18,675 6,335
Acquisition of businesses, net of cash acquired 53(E) (49) (1,923) (20)
Disposal of businesses, net of cash disposed 53(F) 1 129 5
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 177
(1) Subsidiaries Subsidiaries are entities controlled by the Group. The Group controls an entity when it has power over the entity, is exposed to, or has rights to, variable returns from its involvement with the entity, and has the ability to affect those returns through the exercise of its power. This generally accompanies a shareholding of more than one half of the voting rights although in certain circumstances a holding of less than one half of the voting rights may still result in the ability of the Group to exercise control. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. The Group reassesses whether or not it controls an entity if facts and circumstances indicate that there are changes to any of the above elements. Subsidiaries are fully consolidated from the date on which control is transferred to the Group; they are de‑consolidated from the date that control ceases.
The acquisition method of accounting is used to account for business combinations by the Group. The consideration for the acquisition of a subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interests issued by the Group. The consideration includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred except those relating to the issuance of debt instruments (see (E)(5) below) or share capital (see (P) below). Identifiable assets acquired and liabilities assumed in a business combination are measured initially at their fair value at the acquisition date.
(D) Revenue recognition (1) Net interest income 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 to the gross carrying amount of the financial asset (before adjusting for expected credit losses) or to the amortised cost of the financial liability, including early redemption fees, and related penalties, and premiums and discounts that are an integral part of the overall return. Direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument are also taken into account. Interest income from non‑credit impaired financial assets is recognised by applying the effective interest rate to the gross carrying amount of the asset; for credit impaired financial assets, the effective interest rate is applied to the net carrying amount after deducting the allowance for expected credit losses. Impairment policies are set out in (H) below.
Revenue recognition policies specific to trading income are set out in E(3) below, life insurance and general insurance business are detailed below (see (M) below); those relating to leases are set out in (J)(2) below.
Note 2: Accounting policies continued (E) Financial assets and liabilities On initial recognition, financial assets are classified as measured at amortised cost, fair value through other comprehensive income or fair value through profit or loss, depending on the Group’s business model for managing the financial assets and whether the cash flows represent solely payments of principal and interest. The Group assesses its business models at a portfolio level based on its objectives for the relevant portfolio, how the performance of the portfolio is managed and reported, and the frequency of asset sales. Financial assets with embedded derivatives are considered in their entirety when considering their cash flow characteristics. The Group reclassifies financial assets when and only when its business model for managing those assets changes. A reclassification will only take place when the change is significant to the Group’s operations and will occur at a portfolio level and not for individual instruments; reclassifications are expected to be rare. Equity investments are measured at fair value through profit or loss unless the Group elects at initial recognition to account for the instruments at fair value through other comprehensive income. For these instruments, principally strategic investments, dividends are recognised in profit or loss but fair value gains and losses are not subsequently reclassified to profit or loss following derecognition of the investment.
The Group initially recognises loans and advances, deposits, debt securities in issue and subordinated liabilities when the Group becomes a party to the contractual provisions of the instrument. Regular way purchases and sales of securities and other financial assets and trading liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.
(2) Financial assets measured at fair value through other comprehensive income Financial assets that are held to collect contractual cash flows and for subsequent sale, where the assets’ cash flows represent solely payments of principal and interest, are recognised in the balance sheet at their fair value, inclusive of transaction costs. Interest calculated using the effective interest method and foreign exchange gains and losses on assets denominated in foreign currencies are recognised in the income statement. All other gains and losses arising from changes in fair value are recognised directly in other comprehensive income, until the financial asset is either sold or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement other than in respect of equity shares, for which the cumulative revaluation amount is transferred directly to retained profits. The Group recognises a charge for expected credit losses in the income statement (see (H) below). As the asset is measured at fair value, the charge does not adjust the carrying value of the asset, it is reflected in other comprehensive income.
The assets backing the insurance and investment contracts issued by the Group do not meet the criteria to be measured at amortised cost or fair value through other comprehensive income as they are managed on a fair value basis and accordingly are measured at fair value through profit or loss. Similarly, trading securities, which are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short‑term gains, do not meet these criteria and are also measured at fair value through profit or loss. Financial assets measured at fair value through profit or loss are recognised in the balance sheet at their fair value. Fair value gains and losses together with interest coupons and dividend income are recognised in the income statement within net trading income.
(G) Offset Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set‑off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. Cash collateral on exchange traded derivative transactions is presented gross unless the collateral cash flows are always settled net with the derivative cash flows. In certain situations, even though master netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 181
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. In the latter circumstances, the loan will remain classified as either Stage 2 or Stage 3 until the credit risk has improved such that it no longer represents a significant increase since origination (for a return to Stage 1), or the loan is no longer credit impaired (for a return to Stage 2). Renegotiation may also lead to the loan and associated allowance being derecognised and a new loan being recognised initially at fair value.
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 continuing attempts to recover are no longer appropriate. For commercial 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.
(K) Employee benefits Short‑term employee benefits, such as salaries, paid absences, performance‑based cash awards and social security costs are recognised over the period in which the employees provide the related services.
(L) Taxation Tax expense comprises current and deferred tax. Current and deferred tax are charged or credited in the income statement except to the extent that the tax arises from a transaction or event which is recognised, in the same or a different period, outside the income statement (either in other comprehensive income, directly in equity, or through a business combination), in which case the tax appears in the same statement as the transaction that gave rise to it.
Deferred tax assets and liabilities are not recognised in respect of temporary differences that arise on initial recognition of assets and liabilities acquired other than in a business combination. Deferred tax is not discounted.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 183
– Non‑participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
Note 3: Critical accounting judgements and estimates 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 significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty in these financial statements, which together are deemed critical to the Group’s results and financial position, are as follows: Allowance for impairment losses At 31 December 2018 the Group’s expected credit loss allowance was £3,362 million (1 January 2018: £3,533 million), of which £3,169 million (1 January 2018: £3,260 million) was in respect of drawn balances.
Definition of default The probability of default (PD) of an exposure, both over a 12 month period and over its lifetime, is a key input to the measurement of the ECL allowance. Default has occurred when there is evidence that the customer is experiencing significant financial difficulty which is likely to affect the ability to repay amounts due. The definition of default adopted by the Group is described in note 2(H) Impairment of financial assets. The Group has rebutted the presumption in IFRS 9 that default occurs no later than when a payment is 90 days past due for UK mortgages. As a result, approximately £0.6 billion of UK mortgages were classified as Stage 2 rather than Stage 3 at 31 December 2018; the impact on the Group’s ECL allowance was not material.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 187
Note 3: Critical accounting judgements and estimates continued The table below shows the extent to which a higher ECL allowance has been recognised to take account of forward looking information from the weighted multiple economic scenarios.
The table below shows the Group’s ECL for the upside and downside scenarios using a 100 per cent weighting compared to the base case scenario; both stage allocation and the ECL are based on the single scenario only. All non‑modelled provisions, including management judgement, remain unchanged.
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 32.
Under current law there is no expiry date for UK trading losses not yet utilised, although (since Finance Act 2016) banking losses that arose before 1 April 2015 can only be used against 25 per cent of taxable profits arising after 1 April 2016, and they cannot be used to reduce the surcharge on banking profits. This restriction in utilisation means that the value of the deferred tax asset is only expected to be fully recovered by 2033. It is possible that future tax law changes could materially affect the value of these losses ultimately realised by the Group.
The valuation techniques for level 2 and, particularly, level 3 financial instruments involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information. In addition, in line with market practice, the Group applies credit, debit and funding valuation adjustments in determining the fair value of its uncollateralised derivative positions. A description of these adjustments is set out in note 49. Further details of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair value are also set out in note 49. Details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the risk management section on page 154.
The segmental results and comparatives are presented on an underlying basis, the basis reviewed by the chief operating decision maker. The effects of the following are excluded in arriving at underlying profit: – losses on redemption of the Enhanced Capital Notes in 2016 and the volatility in the value of the embedded equity conversion feature; – market volatility and asset sales, which includes the effects of certain asset sales, the volatility relating to the Group’s own debt and hedging arrangements and that arising in the insurance businesses and insurance gross up; – the unwind of acquisition‑related fair value adjustments and the amortisation of purchased intangible assets; – restructuring costs, comprising costs relating to the Simplification programme and the costs of implementing regulatory reform and ring‑fencing, the rationalisation of the non‑branch property portfolio and the integration of MBNA; and – payment protection insurance.
In 2018 charges in relation to other conduct provisions (referred to as remediation) have been reclassified so that they are now included in underlying profit. In addition, results in relation to certain assets which are outside the Group's risk appetite, previously reported as part of run‑off within Other, have been reclassified into Retail and Commercial. Comparative figures have been restated accordingly.
For the majority of those derivative contracts entered into by business units for risk management purposes, the business unit recognises the net interest income or expense on an accrual accounting basis and transfers the remainder of the movement in the fair value of the derivative to the central group segment where the resulting accounting volatility is managed where possible through the establishment of hedge accounting relationships. Any change in fair value of the hedged instrument attributable to the hedged risk is also recorded within the central group segment. This allocation of the fair value of the derivative and change in fair value of the hedged instrument attributable to the hedged risk avoids accounting asymmetry in segmental results and leads to accounting volatility, which is managed centrally and reported within Other.
Gains less losses on disposal of financial assets at fair value through other comprehensive income – – – 275 275
Other segment items reflected in income statement above: Decrease in value of in‑force business – – (55) – (55)
Other segment items: Investments in joint ventures and associates at end of year 4 6 – 81 91 1 Net of profits on disposal of operating lease assets of £60 million.
Other income, net of insurance claims 2,221 1,798 1,846 340 6,205
Other income, net of insurance claims 2,165 1,875 1,878 86 6,004
Other segment items reflected in income statement above: Decrease in value of in‑force business – – 472 – 472
Other income, net of insurance claims 5,230 107 673 – 6,010
1 In the year ended 31 December 2018 this comprises the effects of asset sales (loss of £145 million); volatility and other items (gains of £95 million); the amortisation of purchased intangibles (£108 million); restructuring (£879 million, comprising severance related costs, the rationalisation of the non‑branch property portfolio, the work on implementing the ring‑fencing requirements and the integration of MBNA and Zurich’s UK workplace pensions and savings business); and the fair value unwind and other items (losses of £319 million).
Interest and similar income: Loans and advances to customers 3.17 3.16 3.32 15,078 14,712 15,190
Customer deposits, excluding liabilities under sale and repurchase transactions 0.53 0.49 0.69 (1,813) (1,722) (2,520)
Note 7: Net trading income 2018 £m 2017 £m 2016 £m
Net income arising on assets and liabilities mandatorily held at fair value through profit or loss: Financial instruments held for trading (8) 404 (428)
Net (expense) income arising on assets and liabilities designated at fair value through profit or loss (156) (144) (154)
Note 8: Insurance premium income 2018 £m 2017 £m 2016 £m
Note 9: Other operating income 2018 £m 2017 £m 2016 £m
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 197
Life insurance and participating investment contracts gross claims and surrenders can also be analysed as follows: Total life insurance gross claims and surrenders (8,735) (8,898) (8,617)
Pensions and other post‑retirement benefit schemes (note 35) 705 625 555
Regulatory provisions: Payment protection insurance provision (note 37) 750 1,650 1,000
Performance‑based awards expensed in 2018 include cash awards amounting to £137 million (2017: £102 million; 2016: £116 million).
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 19.1 18.6 14.7
Note 12: Auditors’ remuneration continued The Group has procedures that are designed to ensure auditor independence, including prohibiting certain non‑audit services. All statutory audit work as well as most non‑audit assignments must be pre‑approved by the audit committee on an individual engagement basis; for certain types of non‑audit engagements where the fee is ‘de minimis’ the audit committee has pre‑approved all assignments subject to confirmation by management. On a quarterly basis, the audit committee receives and reviews a report detailing all pre‑approved services and amounts paid to the auditors for such pre‑approved services.
Audits of the unconsolidated Open Ended Investment Companies managed by the Group 0.3 0.3 0.4
Financial assets at fair value through other comprehensive income (14) – – – (14)
Additions (repayments) Expected loss allowances are recognised on origination of new loans or further drawdowns of existing facilities. Repayments relate to the reduction of loss allowances as a result of repayments of outstanding balances.
Movements in the Group‘s impairment allowances are shown in note 20.
UK corporation tax: Current tax on profit for the year (1,386) (1,342) (1,010)
Remeasurement of deferred tax due to rate changes 32 (9) (201)
Note 15: Earnings per share 2018 £m 2017 £m 2016 £m
Weighted average number of ordinary shares in issue – diluted 72,279 72,393 72,024
There were no anti‑dilutive share options and awards excluded from the calculation of diluted earnings per share (2017: none; 2016: weighted‑average of 0.3 million).
Loans and advances to banks 848 2,178 3,026 1,614 2,582 4,196 1,614 – 1,614
Debt securities: Bank and building society certificates of deposit – 1,105 1,105 – 222 222 – 222 222
Exchange rate contracts: Interest rate contracts: Total derivative assets/liabilities – trading and other 5,464,658 22,032 20,265 2,905,020 23,953 24,511
Central bank balances5 (16) 30 20 1 Included within Loans and advances to customers 2 Included within Debt securities in issue 3 Included within Financial assets at fair value through other comprehensive income 4 Included within Customer deposits 5 Included within Cash and balances at central banks
Total loans and advances to banks 6,280 3 – – 6,283
Total financial assets at amortised cost 452,524 24,354 4,188 15,313 496,379
Gross investment in finance leases, receivable: Not later than 1 year 458 680
Analysis of movement in the allowance for impairment losses by Stage
Provisions in relation to loan commitments and financial guarantees 123 64 6 – 193
Net increase and decrease in balances comprise the movements in the expected credit loss as a result of new loans originated and repayments of outstanding balances throughout the reporting period. Loans which are written off in the period are first transferred to Stage 3 before acquiring a full allowance and subsequent write‑off. Consequently, recoveries on assets previously written‑off also occur in Stage 3 only.
Recoveries of advances written off in previous years 482 – 482
Of the total allowance in respect of loans and advances to customers at 31 December 2017 £1,772 million related to lending that had been determined to be impaired (either individually or on a collective basis) at that reporting date.
Note 21: Financial assets at fair value through other comprehensive income £m £m
1 For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.
Risk‑free rate (value of in‑force non‑annuity business) 1 0.00 to 4.05 0.00 to 4.20
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 211
The acquired value of in‑force non‑participating investment contracts includes £167 million (2017: £185 million) in relation to OEIC business.
Movement in the value of in‑force business (note 9) (55) (165)
This breakdown shows the movement in the value of in‑force business only, and does not represent the full contribution that each item in the breakdown makes to profit before tax. This will also contain changes in the other assets and liabilities, including the effects of changes in assumptions used to value the liabilities, of the relevant businesses. The presentation of economic variance includes the impact of financial market conditions being different at the end of the year from those included in assumptions used to calculate new and existing business returns.
Accumulated amortisation: Balance sheet amount at 31 December 2018 380 – 591 – 2,376 3,347
Expenditure on investment properties (see below) 143 – – – 143
Rental income of £197 million (2017: £213 million) and direct operating expenses arising from properties that generate rental income of £23 million (2017: £24 million) have been recognised in the income statement.
Capital expenditure in respect of investment properties which had been contracted for but not recognised in the financial statements was £33 million (2017: £21 million).
Note 28: Financial liabilities at fair value through profit or loss 2018 £m 2017 £m
Liabilities designated at fair value through profit or loss: Debt securities in issue 7,085 7,812
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements 21,595 41,378
Financial liabilities at fair value through profit or loss 30,547 50,877
Total securitisation and covered bond programmes 33,673 29,792 1 Includes £53 million (2017: £nil) of securitisation notes held at fair value through profit or loss.
Note 31: Liabilities arising from insurance contracts and participating investment contracts Insurance contract and participating investment contract liabilities are comprised as follows: Gross £m
2 Reinsurance balances are reported within other assets (note 27) .
Change in liabilities charged to the income statement (note 10) 9,082 (15) 9,067 108 9,175
(iv) Options and guarantees within the With-Profit Funds The most significant options and guarantees provided from within the With‑Profit Funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
Lapse rates (persistency) Lapse rates are allowed for on some non‑profit fund contracts. The process for setting these rates is as described for with‑profit liabilities, however a prudent scenario is assumed by the inclusion of a margin for adverse deviation within the non‑profit fund liabilities.
Increase/(decrease) in liabilities charged to the income statement 1 335 337
Guaranteed annuity option take up6 5% addition (3) (2) (6) (5)
2 This sensitivity shows the impact on the annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
Note 33: Liabilities arising from non-participating investment contracts The movement in liabilities arising from non‑participating investment contracts may be analysed as follows: 2018 £m 2017 £m
The balances above are shown gross of reinsurance. As at 31 December 2018, related reinsurance balances were £20 million (2017: £26 million); reinsurance balances are reported within other assets (note 27). Liabilities arising from non‑participating investment contracts are categorised as level 2. See note 49 for details of levels in the fair value hierarchy.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 219
Note 35: Retirement benefit obligations 2018 £m 2017 £m 2016 £m
Total charge to the income statement (note 11) 705 625 555 2018 £m 2017 £m
In July 2018 a decision was sought from the High Court in respect of the requirement to equalise the Guaranteed Minimum Pension (GMP) benefits accrued between 1990 and 1997 from contracting out of the State Earnings Related Pension Scheme. In its judgment handed down on 26 October 2018 the High Court confirmed the requirement to treat men and women equally with respect to these benefits and a range of methods that the Trustee is entitled to adopt to achieve equalisation. The Group continues to work with the Trustee on the detail of implementing this judgment and has recognised a past service cost of £108 million consistent with the principles outlined within the judgment. This is based on a number of assumptions and the actual impact may be different.
Corporate and other debt securities 8,813 – 8,813 6,903 – 6,903
1 Of the total debt instruments, £29,033 million (31 December 2017: £27,732 million) were investment grade (credit ratings equal to or better than ‘BBB’) .
The pension schemes’ pooled investment vehicles comprise: 2018 £m 2017 £m
Life expectancy for member aged 60, on the valuation date: Life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 at 31 December 2018 is assumed to live for, on average, 27.8 years for a male and 29.4 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years’ time at age 60.
Sensitivity analysis method and assumptions The sensitivity analysis above reflects the impact on the Group’s three most significant schemes which account for over 90 per cent of the Group’s defined benefit obligations. Whilst differences in the underlying liability profiles for the remainder of the Group’s pension arrangements mean they may exhibit slightly different sensitivities to variations in these assumptions, the sensitivities provided above are indicative of the impact across the Group as a whole.
Maturity analysis of benefits expected to be paid: In more than 45 years 4,270 5,219
Other post-retirement benefit schemes The Group operates a number of schemes which provide post‑retirement healthcare benefits and concessionary mortgages to certain employees, retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post‑retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future insurance premiums payable.
(Charge) credit to the income statement (256) (100) 64 (45) (6) (5) (348)
No deferred tax has been recognised in respect of foreign trade losses where it is not more likely than not that we will be able to utilise them in future periods. Of the asset not recognised, £36 million (2017: £35 million) relates to losses that will expire if not used within 20 years, and £53 million (2017: £56 million) relates to losses with no expiry date.
Provisions for financial commitments and guarantees Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s ability to meet its repayment obligations. See also note 20.
Payment protection insurance (excluding MBNA) The Group increased the provision for PPI costs by a further £750 million in the year ended 31 December 2018, bringing the total amount provided to £19,425 million.
The charge in 2018 related to a number of factors including higher expected complaint volumes, which increased to 13,000 per week, and associated administration costs, an increase in average redress per complaint, additional operational costs to deal with potential complaint volatility and continued improvements in data interrogation and the Group’s ability to identify valid complaints. The remaining provision is consistent with an average of approximately 13,000 complaints per week to the industry deadline of the end of August 2019.
Arrears handling related activities The Group has provided an additional £151 million in the year ended 31 December 2018 for the costs of identifying and rectifying certain arrears management fees and activities, taking the total provided to date to £793 million. The Group has put in place a number of actions to improve its handling of customers in these areas and has made good progress in reimbursing arrears fees to impacted customers.
The review follows the conclusion of a criminal trial in which a number of individuals, including two former HBOS employees, were convicted of conspiracy to corrupt, fraudulent trading and associated money laundering offences which occurred prior to the acquisition of HBOS by the Group in 2009. The Group has provided a further £15 million in the year ended 31 December 2018 for customer settlements, raising the total amount provided to £115 million and is now nearing the end of the process of paying compensation to the victims of the fraud, including ex‑gratia payments and re‑imbursements of legal fees.
Repurchases and redemptions during the year1 – (614) – (1,642) (2,256)
Ordinary shares The holders of ordinary shares, who held 100 per cent of the total ordinary share capital at 31 December 2018, 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 may also receive a dividend (subject to the provisions of the Company’s articles of association) and on a winding up may share in the assets of the Company.
Limited voting ordinary shares At the annual general meeting on 11 May 2017, the Company’s shareholders approved the redesignation of the 80,921,051 limited voting ordinary shares held by the Lloyds Bank Foundations as ordinary shares of 10 pence each. The redesignation took effect on 1 July 2017 and the redesignated shares now rank equally with the existing issued ordinary shares of the Company.
Note 40: Share premium account 2018 £m 2017 £m 2016 £m
The Group bought back and cancelled 1,578 million shares under the programme, for a total consideration, including expenses, of £1,005 million. Upon cancellation, £158 million being the nominal value of the shares repurchased was transferred to the capital redemption reserve.
Movements in other reserves were as follows: 2017 £m 2016 £m
Gains and losses attributable to own credit risk (net of tax) 2 389 (40) –
During the year ended 31 December 2018 the Group issued £1,136 million (US$1,500 million) of Additional Tier 1 (AT1) securities; issue costs of £5 million, net of tax, have been charged to retained profits.
The trustees of the following holdings of Lloyds Banking Group plc shares in relation to employee share schemes retain the right to receive dividends but have chosen to waive their entitlement to the dividends on those shares as indicated: the Lloyds Banking Group Share Incentive Plan (holding at 31 December 2018: 5,538,164 shares, 31 December 2017: 12,414,401 shares, waived rights to all dividends), the HBOS Share Incentive Plan Trust (holding at 31 December 2018: 445,625 shares, 31 December 2017: 445,625 shares, waived rights to all dividends), the Lloyds Banking Group Employee Share Ownership Trust (holding at 31 December 2018: 5,679,119 shares, 31 December 2017: 13,346,132 shares, on which it waived rights to all dividends) and Lloyds Group Holdings (Jersey) Limited (holding at 31 December 2018: 42,846 shares, 31 December 2017: 42,846 shares, waived rights to all but a nominal amount of one penny in total).
Group Performance Share plan The Group operates a Group Performance Share plan that is equity settled. Bonuses in respect of employee performance in 2018 have been recognised in the charge in line with the proportion of the deferral period completed.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 235
Other share option plans Lloyds Banking Group Executive Share Plan 2003 The Plan was adopted in December 2003 and under the Plan share options may be granted to senior employees. Options under this plan have been granted specifically to facilitate recruitment (to compensate new recruits for any lost share awards), and also to make grants to key individuals for retention purposes. In some instances, grants may be made subject to individual performance conditions.
The weighted average fair value of options granted in the year was £0.55 (2017: £0.62). 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 2018 was £0.65 (2017: £0.69). The weighted average remaining contractual life of options outstanding at the end of the year was 5.2 years (2017: 4.9 years).
On 10 May 2018, the Group made an award of £200 (2017: £200) of shares to all eligible employees. The number of shares awarded was 21,513,300 (2017: 21,566,047), with an average fair value of £0.67 (2017: £0.69) based on the market price at the date of award.
The number of shares awarded relating to matching shares in 2018 was 34,174,161 (2017: 32,025,497), with an average fair value of £0.63 (2017: £0.67), based on market prices at the date of award.
Fixed share awards Fixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for certain Lloyds Banking Group employees, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements. The fixed share awards are delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award. The number of shares purchased in 2018 was 8,965,562 (2017: 9,313,314).
Note 46: Related party transactions Key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the Lloyds Banking Group plc Group Executive Committee together with its Non‑Executive Directors.
Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £nil million (2017: £0.05 million; 2016: £0.1 million).
Advanced (includes loans of appointed key management personnel) 1 1 3
Placed (includes deposits of appointed key management personnel) 33 41 41
The Group provides banking and some investment management services to certain of its pension funds. At 31 December 2018, customer deposits of £225 million (2017: £337 million) and investment and insurance contract liabilities of £79 million (2017: £307 million) related to the Group’s pension funds.
Collective investment vehicles The Group manages 131 (2017: 134) collective investment vehicles, such as Open Ended Investment Companies (OEICs) and of these 82 (2017: 83) are consolidated. The Group invested £620 million (2017: £418 million) and redeemed £404 million (2017: £616 million) in the unconsolidated collective investment vehicles during the year and had investments, at fair value, of £2,513 million (2017: £2,328 million) at 31 December. The Group earned fees of £128 million from the unconsolidated collective investment vehicles during 2018 (2017: £133 million).
Joint ventures and associates At 31 December 2018 there were loans and advances to customers of £57 million (2017: £123 million) outstanding and balances within customer deposits of £2 million (2017: £9 million) relating to joint ventures and associates.
Note 47: Contingent liabilities and commitments Interchange fees With respect to multi‑lateral interchange fees (MIFs), the Group is not directly involved in the ongoing investigations and litigation (as described below) which involve card schemes such as Visa and Mastercard. However, the Group is a member/licensee of Visa and Mastercard and other card schemes: – The European Commission continues to pursue competition investigations against Mastercard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA; – Litigation brought by retailers continues in the English Courts against both Visa and Mastercard; – Any ultimate impact on the Group of the above investigations and litigation against Visa and Mastercard remains uncertain at this time.
Visa Inc completed its acquisition of Visa Europe on 21 June 2016. As part of this transaction, the Group and certain other UK banks also entered into a Loss Sharing Agreement (LSA) with Visa Inc, which clarifies the allocation of liabilities between the parties should the litigation referred to above result in Visa Inc being liable for damages payable by Visa Europe. The maximum amount of liability to which the Group may be subject under the LSA is capped at the cash consideration which was received by the Group at completion. Visa Inc may also have recourse to a general indemnity, previously in place under Visa Europe’s Operating Regulations, for damages claims concerning inter or intra‑regional MIF setting activities.
LIBOR and other trading rates In July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate. The Group continues to cooperate with various other government and regulatory authorities, including the Swiss Competition Commission, and a number of US State Attorneys General, in conjunction with their investigations into submissions made by panel members to the bodies that set LIBOR and various other interbank offered rates.
Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar, Japanese Yen and Sterling LIBOR and the Australian BBSW Reference Rate. Certain of the plaintiffs’ claims, have been dismissed by the US Federal Court for Southern District of New York (subject to appeals).
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 239
Note 48: Structured entities The Group’s interests in structured entities are both consolidated and unconsolidated. Detail of the Group’s interests in consolidated structured entities are set out in: note 30 for securitisations and covered bond vehicles, note 35 for structured entities associated with the Group’s pension schemes, and below in part (A) and (B). Details of the Group’s interests in unconsolidated structured entities are included below in part (C).
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 241
Note 49: Financial instruments (1) Measurement basis of financial assets and liabilities The accounting policies in note 2 describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet heading.
Deposits from banks – – – – – 30,320 – 30,320
Cash and balances at central banks – – – – 58,521 – 58,521
Items in the course of collection from banks – – – – 755 – 755
Liabilities arising from insurance contracts and participating investment contracts – – – – – 103,413 103,413
Wherever possible, fair values have been calculated using unadjusted quoted market prices in active markets for identical instruments held by the Group. Where quoted market prices are not available, or are unreliable because of poor liquidity, fair values have been determined using valuation techniques which, to the extent possible, use market observable inputs, but in some cases use non‑market observable inputs. Valuation techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics similar to those of the instruments held by the Group.
Bank and building society certificates of deposit – 222 – 222
Total financial assets carried at fair value, excluding derivatives 140,306 60,288 4,382 204,976
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 21,595 – 21,595
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 41,378 – 41,378
Note 49: Financial instruments continued The table below analyses movements in the level 3 financial liabilities portfolio, excluding derivatives.
Credit and Debit Valuation Adjustments (CVA and DVA) are applied to the Group’s over‑the‑counter derivative exposures with counterparties that are not subject to standard interbank collateral arrangements. These exposures largely relate to the provision of risk management solutions for corporate customers within the Commercial Banking division.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 249
The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise. A one per cent rise in interest rates would lead to a £108 million fall in the overall valuation adjustment to £222 million. The CVA model used by the Group does not assume any correlation between the level of interest rates and default rates.
Financial liabilities at fair value through profit or loss 11 – – – – –
Derivatives Reasonably possible alternative assumptions have been determined in respect of swaptions in the Group’s derivative portfolios which are priced using industry standard option pricing models. Such models require interest rate volatilities which may be unobservable at longer maturities. To derive reasonably possible alternative valuations these volatilities have been flexed within a range of 19 per cent to 80 per cent (2017: 9 per cent to 94 per cent).
Financial assets at amortised cost: Loans and advances to customers: unimpaired 467,670 467,276 – 16,832 450,444
Loans and advances to customers The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates due to their short term nature. The carrying value of the variable rate loans and those relating to lease financing is assumed to be their fair value.
(5) Reclassifications of financial assets Other than the reclassifications on adoption of IFRS 9 on 1 January 2018 (note 54), there have been no reclassifications of financial assets in 2017 or 2018.
Financial assets at fair value through other comprehensive income (2017: available‑for‑sale financial assets) 7,279 5,337 19,359 16,753
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 253
Financial assets at fair value through profit or loss: Loans and advances to banks: Loans and advances to customers: Available‑for‑sale financial assets 42,098 – 42,098 – (16,751) 25,347
3 The Group enters into derivatives and repurchase and reverse repurchase agreements with various counterparties which are governed by industry standard master netting agreements. The Group holds and provides cash and securities collateral in respective of derivative transactions covered by these agreements. The right to set off balances under these master netting agreements or to set off cash and securities collateral only arises in the event of non‑payment or default and, as a result, these arrangements do not qualify for offsetting under IAS 32.
The effects of over collateralisation have not been taken into account in the above table.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; liquidity risk; capital risk; and insurance risk. Information about the Group’s exposure to each of the above risks and capital can be found on pages 105 to 159. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.
The Group establishes hedge accounting relationships for interest rate risk using cash flow hedges and fair value hedges. The Group is exposed to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The derivatives used to manage the structural hedge may be designated into cash flow hedges to manage income statement volatility. The economic items related to the structural hedge, for example current accounts, are not suitable hedge items to be documented into accounting hedge relationships. The Group is exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The Group applies netting between similar risks before applying hedge accounting.
At 31 December 2018 the aggregate notional principal of interest rate swaps designated as fair value hedges was £150,971 million (2017: £109,670 million) with a net fair value asset of £760 million (2017: asset of £738 million) (note 17). The gains on the hedging instruments were £94 million (2017: losses of £420 million). The losses on the hedged items attributable to the hedged risk were £32 million (2017: gains of £484 million). The gains and losses relating to the fair value hedges are recorded in net trading income.
Total structural foreign currency exposures, after net investment hedges 112 59 60 32 374 32
Financial assets at amortised cost 496,379 (3,241) 493,138 482,752 (7,030) 475,722
Performance bonds and other transaction‑related contingencies 2,425 – 2,425 2,300 – 2,300 1 Amounts shown net of related impairment allowances.
O ther inform ation Lloyds Banking Group Annual Report and Accounts 2018 257
At 31 December 2018 the most significant concentrations of exposure were in mortgages (comprising 61 per cent of total loans and advances to customers) and to financial, business and other services (comprising 16 per cent of the total).
(C) Credit quality of assets Loans and advances The analysis of lending has been prepared based on the division in which the asset is held; with the business segment in which the exposure is recorded reflected in the ratings system applied. The internal credit ratings systems used by the Group differ between Retail and Commercial, reflecting the characteristics of these exposures and the way that they are managed internally; these credit ratings are set out below. All probabilities of default (PDs) include forward‑looking information and are based on 12 month values, with the exception of credit impaired.
Below standard, but not credit‑impaired – – 415 – – 415
Below standard, but not credit‑impaired – 42 207 7 – 256
Below standard, but not credit‑impaired – – 276 – – 276
Asset‑backed securities: Corporate and other debt securities 1,176 16 1,192 27 16 43
Note 52: Financial risk management continued Debt securities, treasury and other bills held at fair value through profit or loss An analysis of the Group’s financial assets at fair value through profit or loss is included in note 16. The credit quality of the Group’s debt securities, treasury and other bills held at fair value through profit or loss is set out below: Investment grade1 £m Other2 £m Total £m
Asset‑backed securities: Corporate and other debt securities 16,141 1,922 18,063 17,343 2,124 19,467
Treasury bills and other bills 20 – 20 18 – 18