services are offered through a number of well recognised brands including lloyds TsB, Halifax, Bank of scotland, and scottish Widows, and a range of distribution channels. This includes the largest branch network in the uK and a comprehensive digital, telephony and mobile proposition.
Group Executive committee 80 directors’ report 82 corporate governance report 86 directors’ remuneration report 98
Confident in capital position; balance sheet further de-risked; funding position transformed q strong underlying capital generation with core tier 1 capital ratio increased to 12.0 per cent; on a pro forma fully loaded cRd iV basis the ratio is estimated at 8.1 per cent, including 0.3 per cent from expected cRd iV resolutions q continued capital-accretive non-core asset reduction of £42.3 billion, benefiting capital ratios, and exceeding initial 2012 guidance by £17 billion. non-core portfolio now less than £100 billion, at £98.4 billion q deposit growth of 4 per cent; core loan to deposit ratio of 101 per cent, in line with long-term target of 100 per cent; Group loan to deposit ratio of 121 per cent, achieving target two years in advance q Total wholesale funding reduced by £81.6 billion to £169.6 billion; maturity profile further improved with less than 30 per cent (2011: 45 per cent) of total wholesale funding with a maturity of less than one year
Further improving products and services to support customers and the UK economic recovery q uK’s largest lender to first time buyers, helping over 55,000 customers, and exceeding £5 billion lending target for 2012 q sME net lending growth of 4 per cent, against a shrinking market; exceeded 2012 sME net lending commitment of £13 billion and three year target of assisting 300,000 new start-ups by the end of 2012 q First participant in Funding for lending scheme, further enabling us to support the uK economy; £11 billion committed q increased net Promoter score in all three brands and a further reduction in FsA reportable banking complaints (excluding PPi) to 1.1 per 1,000, more than halving complaints in two years
Effects of asset sales, volatile items and liability management 1,570 841
in order to reflect the impact of the acquisition of HBOs, the amortisation of purchased intangible assets has been excluded; and the unwind of acquisition-related fair value adjustments is shown as one line in the management basis income statement, other than unwind related to asset sales which is included within the effects of asset sales, volatile items and liability management.
We have made good progress in reducing our loan to deposit ratio with the core loan to deposit ratio now at 101 per cent, very close to our core long-term target of 100 per cent, thereby strengthening our balance sheet.
We have developed a comprehensive customer experience programme measuring customer service at key touch points and their likelihood to recommend us. This is measured through the cross industry net promoter score metric where we have seen continued progress.
q underlying profit increased by 16 per cent, and core underlying profit by 21 per cent, driven by strong cost control and a significant reduction in impairment.
q Retail continues to support local communities through its contribution to Group programmes and through direct commitments by Retail colleagues. in 2012 over 8,500 colleagues in Retail used their ‘day to Make a difference’ in local communities, including supporting national school sports Week.
commercial Banking provides support to corporate clients through the provision of core banking products, such as lending, deposits and transaction banking services whilst also offering clients expertise in capital markets (private placements, bonds and syndicated loans), financial markets (foreign exchange, interest rate management, money market and credit) and private equity. This enables us to meet the varying and sometimes complex needs of corporate clients whilst ensuring capital efficiency.
Key brands include: 2012 highlights q commercial Banking was created in the fourth quarter of 2012 bringing small and Medium-sized Enterprises (sME) together with larger corporate uK and global clients to ensure consistent and effective client coverage. The former Wholesale division has been combined with the Australian and European corporate businesses previously reported in the international segment of Wealth, international and Asset Finance.
q underlying loss reduced by 60 per cent due to a 30 per cent reduction in impairments, which more than offset the reduction in total underlying income.
Asset Finance consists of a number of leasing and speciality lending businesses in the uK including lex Autolease and Black Horse Motor and Personal Finance along with our leasing and speciality lending businesses in Australia and our European online deposit business.
Contribution towards total Group income1 Performance indicators Underlying profit before tax
Dividends We strengthened our capital position during 2012 despite provisions and charges for regulatory issues. As we stated in 2011, we remain committed to restarting dividend payments as soon as we are able, and fully understand the difficulties that their absence is causing our shareholders. Once regulatory requirements have been clearly defined and we have prudently met them, and the financial position of the Group and market conditions permits, it is our intention to recommence dividend payments.
Management and Staff The Board is committed to achieving long-term success for the Group and generating strong, stable and sustainable returns for shareholders, and this is underpinned by our high standards of corporate governance. We have a strong executive management team, with deep experience and broad understanding of our business challenges. The team’s aim is to be the best bank for customers, while acting as ambassadors in leading cultural change in the organisation. in this way i feel confident we will deliver the value which our shareholders expect and deserve.
We also announced Timothy Ryan will retire from the Board in April 2013. Tim, too has made a substantial contribution to the Board over the last three years with his deep knowledge and understanding of the global financial services sector and the wider regulatory impact on our business.
Making a difference in communities by supporting education, employability and enterprise is central to the vision of the type of bank we want to be, a uK focused retail and commercial bank that exists to serve the needs of its customers. if we continue to focus on our Group values: putting customers first, keeping it simple and making a difference together we will build a strong and profitable Group, with a culture which reinforces these behavioural standards.
Following our strategic Review in 2011 we are committed to keeping our charitable and community investment at £85 million for the period of the strategic plan. This has meant thousands of colleagues have been able to volunteer in local community activities through our staff giving days. i am pleased that we raised over £3.6 million in charitable donations over the two years duration of our partnership with save the children as our ‘charity of the Year’. We are already actively supporting our new charity of the Year: the Alzheimer’s society and Alzheimer scotland, who have launched the Live Well Campaign, the first uK-wide dementia carers’ programme. We also continue to run a number of charitable programmes using our business capabilities to support local communities, including our recognised Lloyds Scholars programme, Money for Life our financial capability programme, and Business in the Community of which we have been a supporter of for over 20 years.
Remuneration The Remuneration committee undertook a further review of remuneration and executive remuneration in 2011. Anthony Watson, the chairman of the Remuneration committee, provides his usual review of our approach elsewhere in the report but due to the importance of remuneration to our stakeholders and the Group, as chairman, i also want to provide some context to the decisions we have taken.
We have therefore focused on the need to manage aggregate variable pay and the overall size of the bonus pool. The total bonus pool has been reduced by approximately 3 per cent to £365 million with the greater impact being applied to more senior staff and managed in the context of business and individual performance. As we are primarily a retail and commercial bank the awards under our Group bonus scheme remain a very small percentage of revenues at approximately 2 per cent, and represent approximately 7 per cent of pre-bonus management profit before tax, compared to 12.5 per cent in 2011. cash bonuses are capped at £2,000 with additional amounts paid in shares and subject to deferral and performance adjustment. The average value of bonuses paid per employee, will remain similar to 2011 at less than £3,900.
“�Significantly�improved� Group performance with core business increasingly well positioned for growth.”
We made substantial progress in reshaping the Group and strengthening the balance sheet. We have proactively managed the run-down of our non-core assets, reducing the portfolio by almost a third in 12 months to £98.4 billion, ahead of plan, and we have continued to do so in a capital-accretive way. We have transformed our funding structure with our use of wholesale funding reduced by £81.6 billion in the year, and the average maturity profile of the remaining wholesale funding further improved, with less than 30 per cent now having a maturity of under one year. The non-core reduction, together with above market deposit growth of 4 per cent, resulted in the Group’s loan to deposit ratio reducing to 121 per cent, with the core loan to deposit ratio at 101 per cent, in line with our core long-term target of 100 per cent.
We further strengthened our capital ratios in 2012, with the Group core tier 1 capital ratio increasing by 1.2 per cent to 12.0 per cent and our total capital ratio increasing by 1.7 per cent to 17.3 per cent, which is already in excess of the icB’s primary loss-absorbing capacity (PlAc) recommendations. On an estimated pro forma cRd iV fully loaded basis the Group’s common equity tier 1 capital ratio would have been 8.1 per cent, including the successful resolution of two cRd iV items now likely to happen. Given our strongly capital generative core business and continued progress in simultaneously releasing capital and reducing risk through non-core asset disposals, we continue to be confident in our capital position.
The substantial progress we are delivering in reducing risk and delivering on our strategic initiatives was reflected in the outcome of Moody’s investor service rating review of 114 financial institutions, where we received only a single notch downgrade on lloyds TsB Bank plc’s longer-term senior debt and deposit ratings, and retained our short-term Prime-1 rating in June 2012.
As we reshaped our business portfolio, we delivered improving credit quality trends in all divisions thanks to the rigorous application of risk controls on all new business and the further de-risking of existing portfolios. As a result, we achieved a further reduction in the Group impairment charge of 42 per cent to £5,697 million, significantly ahead of our expectation at the beginning of 2012. The improving quality of our portfolios and their decreasing risk profile was also reflected in a 12 per cent decrease in risk-weighted assets when compared to december 2011, principally driven by the reduction in non-core assets.
As part of being the best bank for customers, and reflecting the fact that the re-focusing of our sME business on delivery for customers is well under way, we announced the creation of our ‘commercial Banking’ division which brings together the Group’s sME clients together with larger corporate uK and global clients under the leadership of Andrew Bester who joined us in June 2012. The changes will allow us to transfer best practices from sMEs into mid-sized corporates and to deliver operational synergies between the different segments in order to become the best bank for our corporate and sME customers.
Within the Wealth business we have continued to leverage our expertise to deepen customer insight and to invest in products and services that are tailored to meet the needs of our clients. in preparation for the implementation of the Retail distribution Review (RdR) we invested in training our advisers to ensure that they are fully-qualified and best-positioned to continue to advise clients, and ensured that our systems and processes comply with new standards. in 2012, we also launched our private banking client centre which improved the ‘onboarding ’ experience for our uK Wealth clients, whilst making the referral process simpler for colleagues. We have a strong market position in Asset Finance and have continued to invest in our technology platform in 2012 to provide an improved, cost-effective customer experience.
in 2012, and over the past five years, we have supported many of our customers in their involvement in, and initiatives relating to, london 2012. Through our partnership with the Olympic and Paralympic Games, we supported 1 in 3 of the 2,000 companies that won london 2012 contracts, and played our role in the unprecedented success of the Games for the uK.
We agree with the Financial Policy committee that banks need to focus on strengthening their balance sheets in order to become increasingly resilient and to support the economy, and this is entirely consistent with the Group’s strategy and the progress we continue to deliver. Greater clarification from both the uK regulator and the European union on rules surrounding capital, funding and liquidity is expected to be received in 2013.
Dividends We remain committed to recommencing dividend payments when the financial position of the Group and market conditions permit and after regulatory capital requirements are clearly defined and prudently met. Although we made considerable progress in 2012, given regulatory uncertainty and the statutory loss in the year, a dividend payment has not been recommended this year.
eC mandated business disposal (Project verde) We continue to make good progress in the creation of Verde as a stand-alone bank which, as contemplated from the start of the process, will allow the Group to divest the business either through a sale or an initial Public Offering. From the summer 2013, Verde will be operating as a separate business within the lloyds Banking Group under the TsB brand. We reached an agreement on non-binding Heads of Terms with The co-operative Group plc in July 2012 and continue to make progress with these discussions towards signing a binding sales purchase agreement. Our aim remains to obtain best value for our shareholders as well as certainty, also for our customers and colleagues, while complying with the Ec requirement to divest the business by the end of november 2013.
The results of our colleague survey shows strong levels of engagement in some areas, such as using customer feedback to improve processes. However work still remains to ensure that lloyds Banking Group is a great place to work. The current economic climate, and the constant focus on the financial services sector has undoubtedly affected colleague engagement, but we now have a real opportunity, through visible action, to improve engagement across the Group which in turn will continue to support the delivery of our strategy.
We expect to reduce the non-core asset portfolio at least by a further £20 billion in 2013, and we therefore remain on track to achieve a non-core asset portfolio of £70 billion or less by the end of 2014, with more than half of this amount in retail assets.
The response to the sovereign debt crisis in the Eurozone has improved since the middle of 2012. Decisive support from the European Central Bank to struggling sovereigns, a slightly softer stance on further austerity and agreement on steps towards a banking union have together reversed the trend of spiralling sovereign yields. At the same time banks’ funding costs have been reduced and the outlook for their capital positions improved by stronger liquidity and the declining risk of Eurozone break-up, helping to limit the need for more bank recapitalisations which would be a further burden on governments. Some concerns remain over continued pressure for further austerity in weak countries, and over the detail of banking union which at this stage doesn’t appear to sever the link between banks and sovereigns. But the sign of increased willingness and ability of Eurozone authorities to deal with crisis development has already raised financial market confidence and is key to the future improvements in consumer and business confidence necessary to secure sustained economic recovery.
The current consensus view for 2013 uK GdP growth is better at 1.0 per cent. The low level of imbalances in the economy relative to the 2008 position suggests that recent weakness should not deteriorate into significant recession provided the Eurozone continues to move towards a solution to the sovereign debt crisis. indeed, the recent abatement of the inflation squeeze on consumers should help growth improve. But with growth expected to pick up only gradually, held back by fiscal tightening and weak export markets, the Bank Rate is expected to stay at current low levels through 2013 and most probably longer, and property prices are expected to be broadly stable. The recent improvement in unemployment is expected to moderate. The recent loss of the uK’s AAA rating is not assumed to have a material impact on the outlook since it had been largely expected by financial markets.
For the market as a whole, net new mortgage lending has amounted to just 0.6 per cent of outstanding balances during 2012, very similar to the previous two years. consumers’ use of unsecured credit has begun to improve slightly – consumers made net borrowings of 0.9 per cent of outstanding balances in 2012 after 3 years of making net repayments. Household deposits rose by 5.7 per cent in 2012, however, well above the 2-3 per cent growth rates of the previous 3 years, although still a third below the pre-crisis rate.
Customer drivers, including competition q Want simplicity and transparency q demand a quality, multi-channel customer service experience q increasingly demand better value for their money in the competitive open markets in which we operate, customers benefit from an increasing range of products and services from a growing choice of providers. The expectations and demands of customers continue to rise.
Key opportunities q economic environment: significant progress in reducing the Group’s risk profile and strengthening the balance sheet in recent years along with strategic actions taken in the last couple of years means we are better positioned to benefit as the economy recovers.
Our business model lloyds Banking Group is a leading financial services group with a simple, lower risk, customer focused, uK retail and commercial banking business model.
We provide a range of banking and financial services, primarily in the uK, to personal, commercial and corporate customers and have designed our business model around our distinctive assets and capabilities in serving customers effectively. By really focusing on the needs of customers, and operating sustainably and responsibly, we believe we will help Britain prosper and create value for shareholders.
The uK financial services market remains one of the largest in the world and although our business model and strategy have been formulated in the context of a cautious outlook for the uK economy it remains appropriate for all stages of the economic cycle. Whilst providing real differentiation and positioning us well for future regulatory reform.
Our strategy The Group’s strategy is built on being the best bank for customers, and creating value by investing where we can make a real difference for them. customer leadership driven by superior customer insight, simple tailored products, better service and relationship focus is the overriding priority. The customer is at the heart of everything we do, whether that be in our branches, our brands or our people. This commitment is supported by the Group values of putting customers first, keeping it simple and making a difference together.
Our customer focus remains the key driver for strategy and business decision making and substantial customer related investment is planned. Our strategy reflects our customers’ needs for product simplicity and transparency, access to credit, demands for access through multiple channels, value for money products and services and the importance of our staff in managing customer relationships.
We expect to meet the requirements for our liquidity coverage Ratio and our net stable Funding Ratio to be in advance of regulatory time table which has yet to be confirmed.
Priorities for 2013 q Maintained focus on sourcing and further reducing the number of supplier relationships q Further improving and streamlining our key operations and processes q increased utilisation and development of digital distribution channels
Key initiatives and progress in 2012 The simplification programme is central to the successful delivery of our strategy and we continue to make significant progress in driving further cost savings and efficiencies throughout the business whilst improving the customer experience. The success of this approach is evidenced by our achievement of run rate cost savings of £847 million at the end of 2012, which gives us confidence in reaching our run rate cost savings target of £1.9 billion by the end of 2014.
Channels and products We continue to streamline our product suite and migrate products to digital distribution channels, encompassing the internet, mobile applications and telephony. in 2012 we have seen continued growth of our internet and mobile channels. We intend to create a highly efficient distribution platform whilst providing customers with greater choice and convenience.
Priorities for 2013 q Further investment across our branch network including revitalisation of the lloyds Bank brand q continued support of the sME sector and commercial banking customers q Targeted investment transforming our Wealth offering and improving our insurance proposition
The life and Pensions business is being transformed and during the year, we continued to invest in our core systems, products and processes in advance of RdR and the launch of pension auto-enrolment, to enable us to support both retail and commercial customers through this period of change. We have taken the first steps towards launching an enhanced annuities proposition, with full implementation into this growing market expected in mid-2013.
When it comes to responsible banking, our customers don’t just think of the areas covered by a traditional ‘corporate responsibility’ programme. For them, taking responsibility more seriously means being a bank that: q is offering better service q looks after the financial interests of customers q responds to customer needs, e.g. offering longer opening hours in branches, enhancing access through a range of channels including the internet q provides clear communication q has policies in place on environmental protection q has policies in place on human rights and ethics q invests in communities
Operating responsibly whist improving customer service and helping Britain prosper are fundamental components of our group strategy. We can only achieve our customer focused strategy by building a sound reputation founded on the highest standards of corporate behaviour.
To ensure the highest standards of corporate behaviour in 2012 we launched the new Codes of Responsibility to guide our decision making. These Codes, governed by the RBSG, specifically outline the way we aspire to do business as individuals and as a corporation, and are based on five pillars of responsible business which include customers, colleagues and communities.
CUSTOMERS Only by focusing on customers’ needs and addressing those needs can we expect to deliver benefit to our stakeholders.
Customer focus The Group’s strategy is built on being the best bank for customers, and creating value by investing where we can make a real difference for customers. The customer is at the heart of everything we do, whether that be in our branches, our brands or our people. This commitment is supported by the Group values of putting customers first, keeping it simple and making a difference together.
We are committed to supporting the UK housing market and first time buyers in particular, writing 1 in 4 of all first time buyer mortgage loans completed in the UK. We advanced more than £6 billion of new lending to first time buyers in 2012, helping over 55,000 customers own their own homes. We have committed publicly to lending £6.5 billion to 60,000 first time buyers in 2013, an increase of 30 per cent on our £5.0 billion commitment in 2012, and the UK’s biggest-ever commitment to support first time buyers. Our gross new residential mortgage lending totalled £26.2 billion in the UK in 2012 across all customer segments.
We have developed a comprehensive customer experience programme measuring customer service at key touch points and their likelihood to recommend us. This is measured through the cross industry Net Promoter Score metric where we have seen continued progress.
Complaint handling As part of our strategy to become the best bank for customers we publicly committed to reduce the level of FsA reportable banking complaints, excluding PPi, we receive by 20 per cent year on year. We achieved a reduction from 1.5 complaints per 1,000 accounts in the second half of 2011, to 1.1 in the second half of 2012. We aim to reduce this further in 2013 to 1.0 complaint per 1,000 accounts. The progress to date has been accomplished through the ongoing success of our phone-a-friend service, a dedicated team which branch and call centre staff can refer to for specialist support with complaint handling, and the training we provide to our c. 40,000 front line colleagues. We are the first financial services organisation to roll out an externally accredited complaint handling qualification to all our complaint handling staff. As a result of these and other initiatives, we are now resolving over 90 per cent of complaints at first touch. in addition, we offer a 24 hours a day, 7 days a week service, helping colleagues to resolve complaints around the clock, ensuring customers get the right outcome faster. We have also made a significant improvement to our online complaint handling form, meaning we are now able to respond to these complaints within 6 hours.
Our Group wide Root cause Analysis team, who conduct detailed analysis and research into the source of customer complaints, reduced complaints further this year. They achieved a reduction of approximately 39,000 per month by continuing to listen to customers to understand the cause of their complaints, and by making improvements to fix these issues to prevent repeat occurrences. For example, changes to customers’ pending funds information has enabled telephone banking advisors to provide a much clearer breakdown of current account transactions to customers, resulting in a reduction of approximately 2,500 complaints per month. These improvements have been driven by listening to our customers and acting directly on their feedback.
Simple, tailored products and services Our strategy recognises our customers’ needs for product simplicity and transparency, access through multiple channels and value for money products and services. We have worked hard to ensure we are offering products and services that respond to customers evolving needs, and as a result, a number of new and innovative products have been launched in 2012. We also built on our disability principles for product and process design; these involve adhering to our legal duty to make reasonable adjustments to anticipate the needs of customers with disabilities and prevent discrimination and also to make reasonable adjustments to stop less favourable treatment if it is occurring.
in meeting the needs of our customers, we also made strong progress this year on improving the products and services we offer customers with disabilities. The progress to date has been accomplished through many initiatives including the launch of the disability services support Team, a specialised team set up to help front line colleagues with queries or complaints, our ongoing work under the Prime Ministers’ challenge on dementia, the introduction of a comprehensive colleague guide, working with disability Rights uK to hold customer focus groups to understand how we capture and action customers’ appropriate service needs and the introduction of an online accessibility feedback form so we get greater understanding of our customers’ requirements. The Business disability Forum ranked lloyds Banking Group joint second in the disability standard 2011/12 and this activity will continue into 2013 with the introduction of additional services to improve our accessibility to customers with a wide range of disabilities.
Customer service and Simplification in line with our strategy to become the best bank for customers, customer needs remain at the heart of how we reshape our businesses. Through our simplification programme we have continued to enhance and streamline customer processes, with a number of significant improvements having been made during the year. These include the re-design of our account switching and closure processes, improvements to our cash isA transfer process, enhancements to our end-to-end bereavement process and the streamlining of our commercial lending process. We have also introduced advanced interactive Voice Response technology, bringing a new and more flexible approach to the way customers undertake their telephone banking.
Online sign language service The Group was the first financial services provider in the uK to introduce sign Video – a sign language communication service for deaf customers. This technology enables customers to communicate in their first or preferred language of British sign language.
Lloyds Banking Group Annual Report and Accounts 201234 cOllEAGuEs WHO PuT cusTOMERs FiRsT… With colleagues who put customers first, keep it simple and make a difference together, we will deliver the service that makes us the best bank for customers.
Colleague engagement Our annual colleague Engagement survey is an important way for us to find out how we are working together and how well we are building a high performance culture. More than 77,000 colleagues took part in this year’s colleague survey, giving us the clearest insight yet into how colleagues feel about working for lloyds Banking Group. The survey also gives each colleague an opportunity to add their own individual comments and around 40,000 colleagues took time to do this.
Priorities for 2013 q Ensuring colleagues live our values q Building colleague pride and trust in the Group and our future q Helping colleagues fulfil their potential through learning and development q Managing all aspects of performance q Building a diverse and inclusive workforce
Thanks to colleague feedback and the strategic input from the Group’s leaders, in 2013 we are focusing on three key areas: – fostering authentic and credible leaders who, through their actions, engender trust and understanding and personify the Group Values; – demonstrating that there is a promising future for colleagues with attractive opportunities for learning and development and a compelling reward offering; and
We have continued to deliver Group wide leadership programmes to accelerate the development of the most effective leaders and to strengthen our leadership capability overall. Embedded in these programmes is a focus on building a high-performance culture and putting customers at the heart of everything we do. This year, we have worked with the Open university to launch our new core curriculum of leadership training to equip a wider range of colleagues with the knowledge and skills required to improve performance in their roles. Overall, 3,000 of our leaders have experienced leadership training in 2012.
Our gender programme has made strong progress throughout the year. in 2011 lord davies’ Review recommended that organisations have a target of 25 per cent female representation on the board by 2015. The Group committed to meet this goal and we are proud to have exceeded this during 2012 – two years ahead of target with 27 per cent female representation. We also launched a role model programme across the Group. Footprints in the snow showcases the career paths of the Group’s most senior women, providing footprints and stepping stones for other women to follow, be inspired by and succeed. This has proved to be one of our most successful programmes to date with positive feedback from the women who have attended sessions. Role model programmes for ethnic minority, disabled, and lesbian, gay, transgender and bisexual colleagues are now being developed to launch during 2013.
To ensure that we continue to provide one of the best packages for working parents in the uK we introduced a number of improvements, which included, better advice and guidance for colleagues and line managers, e-learning modules to support new parents, and a Parents forum where colleagues can connect and share experiences around working parent issues.
London 2012 Partnership colleagues were an integral part of the successful delivery of the london 2012 Partnership. A key objective for the Partnership was to ensure that all colleagues within the Group were proud of the Partnership. We also wanted to provide a platform for colleague participation and community engagement and give colleagues the opportunity to build customer relationships.
HOW WE ARE DOING MORE… We recognise that if we are to be the best bank for our customers, we must also aim to be the best bank for communities. By doing more to be a responsible business we are able to make a sustainable contribution to help Britain prosper.
Money for Life Challenge The Money for life challenge is a national competition that provides £500 grants to empower teams of 16-24 year olds to develop innovative money management projects that impact their communities. We awarded 110 grants in 2012.
Lloyds Scholars lloyds scholars, our social mobility programme aimed at uK students, was established in 2011. in partnership with six leading universities across the uK we offer students from lower income households a complete support package, helping them manage the financial strain of university whilst improving their employability.
Business connectors was developed in the wake of the uK riots in 2011, and in particular the devastating effect these events had on the sense of community in some of the uK’s most disadvantaged neighbourhoods. The programme was therefore designed to tackle these issues head on by harnessing expertise from business to tackle local needs.
Empowering our people to participate in activities, during work time, that benefit their local communities, helps to build pride in the bank. As well as the benefits that our people’s skills bring to communities, which equate to millions of pounds of in-kind support for organisations, it also gives them the opportunity to develop skills which are valuable to our business. community activity also helps us to work alongside our customers, visibly demonstrating that we are committed to the same things as they are.
national School Sport Week Our vision for london 2012 was to inspire and support young people, communities and business all over Britain on their journey to the Games and beyond. Part of this vision was running national school sport Week, a week long sporting celebration for schools. Over 2,500 volunteered, helping to bring the excitement of london 2012 to their local communities.
Funding grassroots charities Much of the our charitable giving is through the Lloyds TSB and Bank of Scotland Foundations. during 2012 the Group donated more than £29 million to the Foundations enabling them to make grants to local, regional and national charities across the uK. Many charities working in the uK’s most deprived areas have received support, making a significant difference to the communities that need it most. in addition to making grants, the Foundations encourage our colleagues to become active in their community by providing Matched Giving for charities they support. Each colleague can claim up to £1,000 per year for their charitable fundraising efforts and time given to charities.
These programmes have contributed to the Group’s reportable cO2 emissions reducing by around 9 per cent from the previous period.
Colleague volunteering We are the largest participant in Business in the community’s Give & Gain day – the uK’s single biggest day of volunteering. in 2012 more than 4,500 colleagues took part, doubling the engagement seen in 2011
We have also continued to invest, with our Risk Transformation having delivered improved analytics and enhanced customer support for our retail customers as well as simplified processes for rating the risk of commercial customers. This investment has also driven reductions in the Group’s impairments and risk-weighted assets. Further investment during 2012 has allowed us to keep pace with the growing range of regulatory demands, and prepare for future changes required under the Banking Reform Bill including Ring Fencing and Recovery and Resolution planning.
Risk as a strategic differentiator The Group strategy and risk appetite were developed together to ensure one informed the other in creating a strategy that delivers on becoming the best bank for our customers whilst helping Britain prosper and creating sustainable growth over time.
Credit risk Arising in the Retail, commercial Banking, and Wealth, Asset Finance and international divisions, reflecting the risks inherent in the Group’s lending activities and, to a lesser extent in the insurance division in respect of investment holdings and exposures to reinsurers. Adverse changes in the credit quality of the Group’s uK and/or international borrowers and counterparties, or in their behaviour, would be expected to reduce the value of the Group’s assets and materially increase the Group’s allowances for impairment losses.
People risk The Group has a strategic aim to be the best bank for customers. it is committed to addressing issues within the business that could contribute to customers receiving unfair outcomes. The Group believes the quality, values and engagement of its people are fundamental to successful delivery of this strategy. This belief coincides with our regulators‘ increasing focus on the culture which underpins the performance and behaviour of employees in the development and delivery of fair outcomes to customers.
insurance risk The major sources of insurance risk are within the insurance business and the Group’s defined benefit pension schemes. insurance risk is inherent in the insurance business and can be affected by demographic trends and customer behaviour. insurance risks accepted relate primarily to mortality, longevity, morbidity, persistency, property and unemployment. The primary insurance risk of the Group’s defined benefit pension schemes is related to longevity. insurance risk has the potential to significantly impact the earnings and capital position of the insurance business of the Group. For the Group’s defined benefit pension schemes, insurance risk could significantly increase the cost of pension provision and impact the balance sheet of the Group.
More on the Group’s principal risks and uncertainties, including mitigating actions
Significantly improved Group underlying profitability We reported a Group underlying profit before tax of £2,607 million, an increase of £1,969 million, with another strong performance from the core business at £6,154 million (2011: £6,196 million) and a reduction of £2,011 million in non-core losses to £3,547 million. This was driven by continued improvement in asset quality and further progress on our simplification programme, which resulted in, respectively, a substantial improvement in the impairment charge, down 42 per cent to £5,697 million, and a further reduction in total costs of 5 per cent to £10,082 million. These improvements more than offset an expected reduction in underlying income, down 13 per cent to £18,386 million, due mainly to a decline in net interest margin, further non-core asset reductions and continued subdued demand for lending and customer deleveraging.
We continue to simplify our reporting and this is the last time we will report management profit as a separate item. Going forward our reporting will focus on underlying and statutory profit. in addition, impairment charges directly related to asset sales are now included in the asset sales line.
A reduction in other income of 8 per cent to £8,416 million was mainly driven by lower expected returns in the insurance business and low customer confidence affecting sales of insurance products. in addition, fee income in Asset Finance and international was lower, while managed reduction in the balance sheet also reduced fees and commissions.
Lloyds Banking Group Annual Report and Accounts 201246 core total costs reduced by 5 per cent driven by the benefits of our simplification programme, partly offset by inflationary pressures and increased investment in the business, while in the non-core business, the reduction of 7 per cent was mainly a result of a smaller non-core portfolio.
impairment impairment charge impairment charge as a % of average advances
We continue to improve asset quality through the ongoing application of our conservative credit risk appetite, strong risk management controls and de-risking of our portfolios. This resulted in a reduction in the Group impairment charge of 42 per cent to £5,697 million. The overall performance of the portfolio continues to improve and benefits from low interest rates and broadly stable uK residential property prices, partly offset by the subdued uK economy, the weak commercial real estate market, and high, although reducing, unemployment.
non-core loans and advances to customers accounted for 72 per cent of the Group’s impaired loans and had a coverage ratio of 51 per cent at 31 december 2012 (31 december 2011: 48 per cent).
simplification, Ec mandated retail business disposal and integration costs (1,246) (1,452)
Payment protection insurance provision The Group has had further experience of PPi complaint volumes, uphold rates and operational and redress costs since the announcement of our third quarter 2012 interim Management statement. As a consequence, we have made a further provision of £1,500 million in the fourth quarter, which brings the amount provided for PPi in 2012 to £3,575 million, and the total amount provided to £6,775 million. Total costs incurred to the end of 2012 were £4,344 million, including approximately £700 million of related administration costs.
The Group has also taken a provision of £100 million for potential redress and other costs relating to uK Retail and other legacy conduct of business issues.
Past service pensions credit As previously disclosed at the 2012 Half-Year Results, following a review of policy in respect of discretionary pension increases in relation to the Group’s defined benefit pension schemes, increases in certain schemes are now linked to the consumer Price index rather than the Retail Price index. The effect of this change is a reduction in the Group’s defined benefit obligation of £250 million, the benefit of which has been recognised in the Group’s income statement in 2012.
Confident in Group’s capital position: capital ratios further improved and substantial further progress on balance sheet reduction We have a strong capital position, and increased our core tier 1 capital ratio to 12.0 per cent at the end of december 2012 (31 december 2011: 10.8 per cent). This increase was principally driven by a reduction in risk-weighted assets of £42.0 billion, mainly driven by the non-core reduction, and the contribution from management profit, partly offset by statutory items and tax costs. The total capital ratio at 31 december 2012 improved to 17.3 per cent (31 december 2011: 15.6 per cent), which is already in excess of the independent commission Banking’s (icB) primary loss-absorbing capacity (PlAc) recommendations.
Pro forma fully loaded cRd iV core tier 1 capital ratio 8.1% 7.1% 1.0pp
The Financial Policy committee (FPc) published its Financial stability Report on 29 november 2012 recommending that the Financial services Authority (FsA) takes action to ensure that the capital of uK banks and building societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights. The Group has made significant progress and continues to deliver on its strategy of strengthening the balance sheet, including its capital position, to improve the resilience of the Group.
The Group has strong governance, processes and controls which, combined with the Group’s proactive management of risk, result in an appropriate level of capital. This includes: – Rigorous stress testing exercises where the results are shared with the FsA; and
Banking net interest margin 2.08% 2.09% (1)bp impairment charge as a % of average advances 0.36% 0.54% (18)bp
Key balance sheet items loans and advances to customers excluding reverse repos 343.3 352.8 (3)
net interest margin was stable at 2.08 per cent in 2012. The net interest margin in the second half of the year particularly benefited from rate changes we made to the lending portfolio, but continues to be affected by higher funding costs and the impact of portfolio de-risking.
compared to the other major High street Banks (defined as Barclays, Halifax, HsBc, natWest and santander), using a composite weighted score of main current account holder’s satisfaction with branch, telephone and internet services (among those using those channels in the last month). © GfK nOP Financial Research survey (FRs), 12 months ended december 2012 approximately 45,000 adults surveyed.
credit performance across the business continued to be strong considering the subdued economic environment. This was supported by our sustainable approach to risk, a continued focus on lending to existing customers and low interest rates. The unsecured impairment charge reduced to £893 million from £1,507 million in 2011, reflecting the impact of our sustainable approach to risk (resulting in improved new business quality), effective portfolio management and a reduction in unsecured balances. The secured impairment charge decreased to £377 million from £463 million in 2011, reflecting further reductions in impaired loans in the secured portfolio.
Risk-weighted assets decreased by £7.7 billion during 2012. This was the result of lower lending balances, effective portfolio management and prior de-risking of the balance sheet.
Strategic focus commercial Banking’s strategy is to be the best bank for our clients. We have put clients at the centre of our business model and will lead our business through four coverage segments: small and Medium-sized Enterprises (sME), Mid Markets, Global corporates and Financial institutions. We will meet our clients’ needs with a suite of core banking products from lending and Transaction Banking to Financial Markets and capital Markets, delivering the full capability of the bank to our clients and serving their needs as they move up the value chain. Our strategy is driven by three guiding principles; to be client centric, uK focused and capital efficient with a rigorous focus on executing our plans according to these core principles. Our business will be delivered through the formation of a simpler leaner organisation, sharper prioritisation of resources to support our core clients and focused investment in product capability to better serve our clients’ needs. All of this will contribute to the delivery of strong and sustainable commercial Banking returns over time.
We continued to invest in product capability in 2012 and are positioning ourselves to benefit from eventual economic recovery. As part of our programme to enhance our capabilities in capital efficient products, we have continued to invest in the Transaction Banking platform delivering product capabilities in card Payments & Acceptance, currencies and international cash Management. Meanwhile, we processed all ticket payments and provided merchant support at all of the principal london 2012 Olympic sites. in Foreign Exchange, client volumes increased by 19 per cent compared to 2011 through investments in electronic channels and improved pricing and risk management capabilities. More specifically on client connectivity we are making good progress in Foreign Exchange service to provide our clients with a seamless 24 hour service globally in 2013.
in Project Finance, we provided in excess of £750 million of lending to uK infrastructure initiatives and achieved the top uK Bookrunner position in 2012. We received the PPP deal of the Year award in 2012 from Project Finance international, highlighting our commitment and the key role we are playing in supporting uK infrastructure projects that are vital for stimulating economic growth.
impairment charges decreased by £1,264 million, due to a 29 per cent reduction in non-core impairments driven by the Australasian and the Acquisition Finance portfolio, partly offset by further deterioration in the shipping portfolio. core impairments decreased by 33 per cent including in Mid Markets, corporate and sME. in Mid Markets and corporate there were specific large impairments in 2011 which were not repeated in 2012.
Risk-weighted assets decreased by £27.7 billion primarily reflecting repayments, the impact of subdued corporate lending and balance sheet disposals; core risk-weighted assets remained broadly flat due to the impact of regulatory treatments and rule changes. non-core risk-weighted assets represented £27.0 billion of this reduction and was driven by non-core disposals.
net interest income decreased by £914 million. core net interest income decreased by £545 million due to average lending volumes decreasing by £6.1 billion as a result of subdued global corporate client demand, continuing the current market trend of deleveraging, and lower margins.
Total impairments decreased £61 million reflecting the continued benefits from the application of a prudent risk appetite and the low interest rate environment, helping to maintain defaults at a lower level.
WEAlTH, AssET FinAncE And inTERnATiOnAl 2012 highlights q in 2012 we achieved strong profitable growth in our Wealth and Asset Finance businesses while simultaneously making progress in strengthening our balance sheet, simplifying our international operating model and investing in building capability for the future.
q divisional performance improved in 2012 with losses reducing by 67 per cent to £929 million primarily driven by lower impairments, mainly in ireland. Profits in the core business increased by 27 per cent to £459 million, driven by strong performance in the Wealth and Asset Finance businesses.
q The balance sheet has been further strengthened through a 24 per cent growth in customer deposits and a reduction in non-core assets of a further 20 per cent, including a £3.7 billion reduction in our irish portfolio.
Key balance sheet items loans and advances to customers excluding reverse repos 33.4 40.2 (17)
Strategic focus The business segments of the division have been aligned this year to reflect the operating model: – Wealth – our uK and international Wealth businesses, scottish Widows investment Partnership and st James’s Place.
Progress against strategic initiatives The significant progress we have made in strengthening the balance sheet positions us for focused, profitable growth in our core business. Alongside this we will continue to grow total customer balances (including deposits and funds under management) in the Wealth businesses where over time we expect customer appetite to shift from deposits to investment products.
We are in the process of reshaping the business, realising additional efficiencies and cost savings through initiatives to consolidate the Wealth businesses and create a shared support infrastructure, develop a single customer platform and to automate core systems and processes for efficiency and improved customer experience in both Wealth and Asset Finance. The division has also made good progress towards reducing its international presence with a further five exits announced in the year bringing the total to twelve, representing over a one third reduction in our international presence over the last two years.
We have further reduced non-core loans by £7.0 billion in 2012 through a mixture of repayments and selected asset disposals. This includes the impact of a £2.6 billion (gross) asset reduction in ireland in respect of a successful disposal of a portfolio of wholesale assets. Within Asset Finance, the non-strategic portfolio in run-off now represents only 10 per cent of the total business.
Financial performance underlying loss reduced by 67 per cent to £929 million primarily due to a £2,124 million reduction in impairments and lower costs, partially offset by a fall in non-core income as a result of the balance sheet reduction.
underlying non-core loss reduced by 56 per cent to £1,388 million driven by a continued reduction in impairments in ireland.
q Our recent enhanced annuities pilot has been an important step towards further strengthening our overall retirement savings business.
Total underlying income net of insurance claims 1,279 1,585 572 692 1,851 2,277 lP&i existing business profit 380 637 lP&i new business profit 318 331 underlying profit reduced by £358 million to £1,107 million in 2012, with a 19 per cent reduction in total underlying income, largely due to the subdued economic climate and increased property claims, being partially offset by an 8 per cent decrease in costs.
costs reduced by 8 per cent reflecting a continued strong focus on cost management across the business and the ongoing delivery of simplification cost saving initiatives.
Present value of new Business Premiums (PvnBP) An analysis of the present value of new life business premiums for business written by the insurance division, split between the uK and European life, Pensions and investments Businesses is given below: UK £m europe £m
The reduction in European sales reflects an expected reduction in new business due to the strategy of focusing on the relationship with our key distributors and securing value in the existing book of business.
during 2012, direct costs have fallen by £130 million (4 per cent) driven by simplification savings and the continued focus on cost management which more than offset inflationary rises and incremental costs from Group investment projects. Group Operations continues to play a major part in leading the delivery of the programme as well as through initiatives to improve sourcing, re-engineer end-to-end process, and consolidate and rationalise property and iT.
We are continuing to optimise our demand management, simplify specifications and strengthen our supplier relationships. We have reduced the number of suppliers to the Group from just over 18,000 at the start of the programme to around 10,500; while further concentrating our expenditure within our top tier of suppliers. We have also introduced a number of efficiencies across our iT estate including the rationalisation of servers and storage devices and the optimisation of licence arrangements, with iT costs falling by 2 per cent after absorbing increased costs from delivering Group strategic initiatives which deliver income and cost benefits in other divisions. Operations costs decreased by 9 per cent through the continuing rationalisation of our major Operations functions.
The basis of preparation of the core and non-core income statements is set out on the inside front cover.
Effects of asset sales, volatile items and liability management (647) 60
loans and advances to customers (excluding reverse repos) 425.3 437.0 (3)
Other assets: Trading and other financial assets at fair value through profit and loss 154.0 138.8 11
Key balance sheet items at 31 december 2011 £bn £bn £bn £bn £bn £bn loans and advances to customers excl reverse repos 325.1 106.7 5.1 0.1 437.0
Key balance sheet items at 31 december 2011 £bn £bn £bn £bn £bn £bn
Lloyds Banking Group Annual Report and Accounts 201274 volatility arising in insurance businesses The Group’s statutory result before tax is affected by insurance volatility, caused by movements in financial markets, and policyholder interests volatility, which primarily reflects the gross up of policyholder tax included in the Group tax charge.
The impact on the results due to the actual return on these investments differing from the expected return (based upon economic assumptions made at the beginning of the year) is included within insurance volatility. changes in market variables also affect the realistic valuation of the guarantees and options embedded within the With Profits Funds, the value of the in-force business and the value of shareholders’ funds.
The positive insurance volatility during 2012 in the insurance division was £183 million, primarily reflecting the benefits of an increase in equity market values relative to the expected return and a reduction in gilt yields and a narrowing of corporate bond spreads. This has been partially offset by lower cash returns compared to the long-term expectation.
Lloyds Banking Group Annual Report and Accounts 201274 volatility arising in insurance businesses (continued)
The most significant of these additional sources of volatility is policyholder tax. Accounting standards require that tax on policyholder investment returns should be included in the Group’s tax charge rather than being offset against the related income. The result is, therefore, to either increase or decrease profit before tax with a related change in the tax charge. Timing and measurement differences exist between provisions for tax and charges made to policyholders. consistent with the normalised approach taken in respect of insurance volatility, differences in the expected levels of the policyholder tax provision and policyholder charges are adjusted through policyholder interests volatility.
The statutory financial information set out in the table below has been derived from the annual report and accounts of lloyds Banking Group plc for each of the past five years.
Total income, net of insurance claims1 20,510 20,802 24,868 22,526 9,872
Lord Blackwell independent director Member of the Audit committee and the Risk committee chairman of scottish Widows Group
Former appointments: Tim was the President and chief Executive of the securities industry and Financial Markets Association and a director in the Office of Thrift supervision, us department of the Treasury. He is a former director of Koram Bank, the international Foundation of Election systems and the us-Japan Foundation. He held a number of senior appointments in JP Morgan chase including Vice chairman, Financial institutions and Governments. Tim was also a member of the Global Markets Advisory committee for the national intelligence council.
Former appointments: Martin was a member of the Board of Partners of deloitte uK from 1991 to 2007 and served as its chairman from 1995. He joined the firm in 1973 and was a partner from 1982 until he retired in 2008. Martin was a member of the Board of directors of deloitte Touche Tohmatsu from 1999 to 2007.
Skills and experience: António brings extensive experience in, and understanding of, both retail and commercial banking. This has been built over a period of more than 25 years, working both internationally as well as in the uK. António’s drive, enthusiasm and commitment to customers, along with his proven ability to build and lead strong management teams, brings significant value to all stakeholders of lloyds Banking Group.
external appointments: António is a non-Executive director of Fundação champalimaud and sociedade Francisco Manuel dos santos in Portugal and a Governor of the london Business school.
Alison attended university in scotland and the usA and has an MBA from cambridge university’s Judge institute.
Results The consolidated income statement shows a loss for the year ended 31 december 2012 of £1,343 million.
Business review, future developments and financial risk management objectives and policies The information that fulfils the requirements of the business review, future developments and financial risk management objectives and policies can be found in the following sections of the annual report, which are incorporated into this report by reference: Pages
G R Moreno 17 May 2012 lord Blackwell 1 June 2012 c J Fairbairn 1 June 2012
The company did not repurchase any of its shares during the year (2011: none).
As at the date of this report, the company had been notified under Rule 5 of the dTR that The solicitor for the Affairs of Her Majesty’s Treasury had a direct interest of 39.76 per cent in the issued share capital with rights to vote in all circumstances at general meetings. no other notification has been received that anyone has an interest of 3 per cent or more in the issued ordinary share capital. The actual direct interest in the issued share capital of the company held by The solicitor for the Affairs of Her Majesty’s Treasury as at the date of this report is 39.25 per cent.
Change of control The company is not party to any significant contracts that are subject to change of control provisions in the event of a takeover bid.
essential business contracts There are no persons with whom the Group has contractual or other arrangements that are considered essential to the business of the Group.
Lloyds Banking Group Annual Report and Accounts 201284 independent auditors and audit information Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no relevant audit information of which the company’s auditors are unaware and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of the companies Act 2006.
Claire A Davies company secretary 1 March 2013 company number sc95000
The Board believes that the committees are operating effectively. The 2012 Board Effectiveness Review carried out by independent Audit summarised the performance of the committees as follows: “A distinctive characteristic of the Board governance at Lloyds Banking Group is that much of the Board’s work is done in the Committees ...The Committees themselves are very highly regarded by management and Non-Executive Directors alike, we think entirely justifiably. Their high performance contributes a very large element of the overall positive picture.”
A summary of the Board Governance Framework is available in the Governance section of our website at www.lloydsbanking.com.
Through the adoption of consistent and proportionate standards, the Group subsidiaries Manual helps the Group to manage the legal, regulatory and reputational risks associated with its subsidiary entities by providing guidance on the required governance structures and controls having regard to the nature and risk profile of the entity.
The Group chief Executive is responsible for: – managing the business of the Group in accordance with the strategy and long term objectives approved by the Board; – incurring capital and revenue expenditure, as appropriate, to meet the objectives set by the Board; and
The chairman is responsible for developing and maintaining a succession plan in relation to the Group chief Executive and for reviewing the plan with the nomination & Governance committee at least annually. A detailed exercise was undertaken in 2012 to identify potential internal and external successors to the Group chief Executive both for contingency purposes and on a longer term development basis.
The company will report on the progress of the above action plan in the 2013 annual report.
On 28 February 2013, the Group announced that nick luff would join the Board on 5 March 2013 as a non-Executive director and, in due course, successor to Martin scicluna as chair of the Audit committee. nick, who has over 10 years experience as a finance director, has recent and relevant financial expertise and a sound understanding of internal reporting and controls.
The nomination & Governance committee is currently conducting the search for Tim Ryan’s successor.
in August 2012, claire davies succeeded Harry Baines as company secretary. Harry is thanked for his dedication and wise counsel.
Time commitment As in recent years, the time commitment demanded of non-Executive directors in 2012 remained substantially in excess of the time envisaged within the terms of their appointment. However, the Board timetable returned to largely scheduled meetings as the need for ad hoc meetings declined. The average expected time commitment for non-Executive directors (including attendance at committee meetings) is between 30 – 35 days. For committee chairs, this increases to 40 – 50 days with the senior independent director and deputy chairman spending considerably more than 50 days on the company’s business. All of these expected time commitments were significantly exceeded in 2012.
Former Directors who served during 2012 number of meetings held during the period that the director held office.
The directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of published policies and procedures and regular management briefings. A requirement to comply with internal control risk policies is a key component of individual staff objectives expressed in the balanced scorecard. Key business risks are identified, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. in addition, there is an annual evaluation review exercise whereby the key businesses and head office functions review specific controls and attest to the accuracy of their assessments. The review covers all enterprise-wide risk management categories and is in accordance with the principles of the code. As in previous years, this exercise was completed for the year ended 31 december 2012. All returns have been satisfactorily completed and appropriately certified.
Auditor independence and remuneration Both the Board and the external auditors have safeguards in place to protect the independence and objectivity of the external auditors. The Audit committee has a comprehensive policy to regulate the use of auditors for non-audit services. This policy sets out the nature of work the external auditors may not undertake, which includes work which will ultimately be subject to external audit, internal audit services and secondments to senior management positions in the Group that involve decision-making. it also includes the Group’s policy on hiring former external audit staff. For those services that are deemed appropriate for the auditors to carry out, the policy sets out the approval process that must be followed for each type of assignment. The chairman of the Audit committee must be consulted regarding potential instructions in respect of allowable non-audit services with a value above defined fee limits.
Conclusion in conclusion, the Group confirms its compliance with all provisions of the code throughout the year ending 31 december 2012. in addition, the Group has voluntarily applied certain new code provisions, in particular the board diversity and evaluation provisions.
Financial Statements and Reporting of the Group – monitors the integrity of the financial statements of the Group relating to the Group’s financial performance, reviewing significant financial reporting issues and the judgements which they contain; – provides advice to the Board on whether 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 performance, business model and strategy; – reviews and challenges where necessary, the actions, estimates and judgements of management in relation to the financial statements; – reviews any significant adjustments to financial reporting resulting from the audit and resolves any disagreements between management and the external auditors regarding financial reporting; and
Retirement benefit obligations considered the assumptions underlying the calculation of defined benefit liabilities and were satisfied that they were appropriate.
considered the assumptions made by management in determining the provision for PPi redress, and were content that the assumptions were appropriate, although they will be considered periodically against actual claims experience.
– reviews the work and resources of the Group Risk division.
– reviewed and enhanced the Group’s risk appetite framework, policies and principles; – at each meeting, reviewed the Group’s consolidated risk profile, key risks and management actions, together with performance against risk appetite. details of the Group’s principal risks are set out in the risk management section on pages 118 to 124; – reviewed conduct risk at each meeting, including product governance and conduct strategy, complaints, outcome testing and mitigating actions; – reviewed the Group’s capital and funding plan under the Group and FsA stress testing scenarios, including scenarios developed by the Risk committee; – reviewed the internal capital Adequacy Assessment Process report; – received reports on the economic outlook, international regulatory relationships, pension and hedging risks, longevity risk within insurance, anti-money laundering and financial crime and iT resilience and cyber security; and
Based on role, market competitiveness, and performance (based on actual value)
in my previous statements i have highlighted the importance of our long-Term incentive Plan in aligning our reward strategy to the performance of the business. Through the application of carefully considered, stretching target measures, we are able to ensure that awards are forfeited or restricted where performance does not meet the desired level. We also require executives to retain the net shares (ie.after the deduction of tax) awarded under the lTiP for a minimum period following receipt. This directly connects the financial reward for the executive and senior management team with the growth and prosperity of the company and motivates them to demonstrate appropriate behaviours across all areas of the business.
in general, the committee retains discretion over all remuneration plans and consideration is given to the exercise of such discretion both at the point of award and subsequently when assessing performance under the lTiP.
The Group has complied throughout the period with the requirements of the uK corporate Governance code (previously known as the combined code) in relation to directors’ remuneration. in addition, the report has been prepared in accordance with the large and Medium sized companies and Groups (Accounts and Reports) Regulations 2008.
We operate tough contract provisions relative to market practice, whereby no executive has an entitlement to more than 12 months’ notice (not taking into account recruitment provisions), pay in lieu of notice is limited to basic salary, is paid monthly over 12 months and is mitigated if the executive gets another job. This approach avoids the risk of payment for failure.
We have a robust governance framework with an independent Remuneration committee reviewing all compensation decisions for senior executives. This approach to governance and review is cascaded through the organisation. We also ensure that all control function employees are assessed and their remuneration determined jointly by the relevant business director and the control function director. The remuneration of senior risk and compliance officers is also reviewed by the Remuneration committee.
There were again no increases to base salaries for Executive directors
Based on Group financial targets relating to Profit Before Tax and Economic Profit as well as Balanced scorecard measures covering divisional financial targets, customers (e.g. sME lending), people, risk and building the business subject to deferral and malus in line with FsA requirements
incentive awards for Executive directors are based upon individual contribution and overall corporate results. incentive opportunity is driven equally by i) corporate performance based on profit before tax and economic profit, and ii) divisional achievement and individual performance. individual targets relevant to improving overall business performance are contained in a Balanced scorecard and are grouped under the following headings: – Financial
Lloyds Banking Group Annual Report and Accounts 2012102 during 2012, the committee has consulted widely with shareholders on the topic of performance measures and sharing the growth in the company appropriately between shareholders and management. The committee believes that the performance measures for the 2013 lTiP award for the Executive committee should be Economic Profit, Absolute Total shareholder Return and strategic non-financial measures. These measures capture risk management, profit growth and shareholder experience and align shareholder experience and management reward.
Economic Profit Payout range set relative to 2015 targets Threshold: £1,254 million Maximum: £1,881 million
Absolute TsR Growth in share price including dividends Threshold: 8% per annum Maximum: 16% per annum customer satisfaction (FsA reportable complaints per 1,000 customers over 3 years)
Any entitlements under the pension scheme or equity plans will be in accordance with the scheme rules on leaving.
M G culmer 12 months 16 May 2012 independent non-Executive directors do not have service agreements and their appointment may be terminated, in accordance with the articles of association, at any time without compensation.
external appointments The Group recognises that Executive directors may be invited to become non-Executive directors of other companies and that these appointments may broaden their knowledge and experience, to the benefit of the Group. Fees are normally retained by the individual directors as the post entails personal responsibility.
The committee determines the pensions policy for the Group and advises on other major changes to employee benefits schemes. it also agrees the policy for authorising claims for expenses from the Group chief Executive and the chairman. it has delegated power for settling remuneration for the chairman, the Group Executive directors, the company secretary and any group employee whose salary and annual bonus exceeds a specified amount, currently £750,000. To ensure compliance with the FsA code of Practice, the committee approves remuneration for code staff and that of senior risk and compliance officers.
The committee’s terms of reference are available from the company secretary and are displayed on the Group’s website, www.lloydsbankinggroup.com. These terms were last updated in April 2012 to ensure continued compliance with the FsA code.
– determination of the appropriate remuneration packages for a number of senior new hires
– Approval of remuneration and terms of service that fall within the committee’s terms of reference, including new appointments
– Feedback from the Remuneration committee chairman on his meetings with the FsA and shareholders
All plans (10% of the issued ordinary share capital of the Group in any consecutive 10 years)
Dec 2008 Dec 2007 Dec 2009 Dec 2011Dec 2010 Dec 2012
Following changes to the amount of tax relief available on pension contributions in each year, directors may elect to receive some or all of their allowances as cash. contributions into the pension scheme shown on page 108 are commensurately reduced.
One-off payments comprise a contractual cash payment to António Horta-Osório as part of the buyout of his benefits from his previous employer and an allowance to Tim Tookey to reflect his additional responsibilities as interim Group chief Executive.
Defined contribution scheme members during the year to 31 december 2012 the Group has made the following contributions to the defined contribution scheme: António Horta-Osório 18
none of the other directors at 31 december 2012 had options to acquire shares in lloyds Banking Group plc or its subsidiaries.
The market price for a share in the company at 1 January 2012 and 31 december 2012 was 25.91p and 47.92p, respectively. The range of prices between 1 January 2012 and 31 december 2012 was 25.295p to 49.25p.
Options granted in 2004 became exercisable as the performance condition was met on the re-test. The performance condition vested at 24 per cent for Truett Tate’s March option and at 14 per cent for all other options granted to Executive directors during 2004.
Options granted in 2005 became exercisable as the performance condition was met when tested. Grants vested at 82.5 per cent for all options granted to Executive directors.
b The Absolute share Price element of this award has an end of performance period date of 26 March 2013.
At the end of the performance period, it has been assessed that none of the performance conditions has been met and therefore the Awards will not vest.
The targets are: ePS vesting % Absolute improvement in adjusted ePS
economic profit vesting % Compound annual growth rate of adjusted eP
Vesting between threshold and maximum will be on a straight line basis, provided that shares comprised in the Absolute share Price element of the award may only be released if both the EPs and Economic Profit performance measures have been satisfied at the threshold level or above.
economic Profit: Relevant to 331/3 per cent of the award. The performance target is based on 2013 adjusted Economic Profit.
March 2012 and september 2012 economic Profit: Relevant to 30 per cent of the award. The performance target is based on 2014 adjusted Economic Profit.
net Simplification benefits: Relevant to 10 per cent of the award. Performance will be measured by reference to the run rate achieved by end of 2014.
Directors’ interests (audited) The beneficial interests of those who were directors at 31 december 2012 in ordinary shares of lloyds Banking Group were: number of shares
The register of directors’ interests, which is open to inspection, contains full particulars of directors’ shareholdings and options to acquire shares in lloyds Banking Group.
The analysis of Risk drivers details how all risks are managed across the Group. Each risk driver section includes a definition; a risk appetite statement; exposures associated with the risk that the Group faces; and how the risk is measured, mitigated and monitored.
The Group has a conservative business model embodied by a risk culture founded on a prudent approach to managing risk. The Group refreshed its codes of Business and Personal Responsibility in 2012 reinforcing its approach; colleagues are accountable for the risks they take and the needs of customers are paramount.
Achievements in 2012 q Robust risk governance framework and conservative risk appetite further embedded across the Group.
q implementation of conduct strategy to ensure legacy issues of the past are not repeated.
Risk appetite – The Group defines risk appetite as ‘the amount and type of risk that our organisation is prepared to seek, accept or tolerate.’
Governance and control – Governance is maintained through delegation of authority from the Board, Board Risk committee and Audit committee, down through the management hierarchy supported by a committee-based structure designed to ensure that the Group’s risk appetite, policies, procedures, controls and reporting are fully in line with regulations, law, corporate governance and industry good-practice.
– A strong control framework remains a priority for the Group and is the foundation for the delivery of effective risk management.
– The Group optimises performance by allowing business units to operate within approved parameters.
Risk decision making and reporting – Taking risks which are well understood, consistent with strategy with appropriate margin is a key driver of shareholder value.
– An aggregate view of the Group’s overall risk profile, key risks and management actions, together with performance against risk appetite are reported to and discussed monthly at the Group Risk committee and Group Asset and liability committee with regular reporting to the Board Risk committee and the Board.
– Rigorous stress testing exercises are carried out to assess the impact of a range of adverse scenarios with different probabilities and severities to inform strategic planning.
Principal risks and uncertainties At present the most significant risks faced by the Group are detailed below. These risks could impact on the success of delivering against the Group’s long-term strategic objectives and are aligned to the Group’s Risk drivers.
Over the last five years, the global banking crisis and economic downturn has driven cyclically high bad debt charges, especially in the Group’s legacy HBOs portfolios, arising from the Group’s lending to both retail (including those in Wealth, Asset Finance and international division) and commercial customers (including those in Wealth, Asset Finance and international division). Group portfolios will remain strongly linked to the economic environment, with inter alia house price falls, unemployment increases, consumer over-indebtedness and rising interest rates being possible impacts to the Group’s exposures. The Group has exposure to commercial customers in both the uK and internationally, including Europe and ireland, particularly related to commercial real estate lending, where the Group has a high level of lending secured on secondary and tertiary assets. The possibility of further economic downside risk remains.
The Group takes many mitigating actions with respect to this principal risk. The Group manages its credit risk in a variety of ways such as: – through prudent and through the cycle credit risk appetite and policies; – clearly defined levels of authority (including, independently sanctioned and controlled credit limits for commercial customers and counterparties, sound credit scoring models and credit policies for retail customers); – robust credit processes and controls; and
– well-established Group and divisional committees that ensure distressed and impaired loans are identified, considered, controlled and appropriately escalated and appropriately impaired (taking account of the Group’s latest view of current and expected market conditions, as well as refinancing risk).
There remains a high level of scrutiny regarding financial institutions’ treatment of customers and business conduct from regulatory bodies, the media and politicians. The FsA in particular continues to drive focus on conduct of business activities through its supervision activity.
Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market-implied inflation rates, credit spreads and prices for bonds, foreign exchange rates, equity, property and commodity prices and other instruments), lead to reductions in earnings and/or value.
– Equity and credit spread risk: The Group continues to liaise with defined benefit pension scheme Trustees with regard to appropriately de-risking the pension scheme portfolio.
– information security: The risk of information leakage, loss or theft. The threat profile is rapidly changing; in particular increasingly sophisticated attacks by cybercrime groups.
– negative political and media attention on banking sector culture, sales practices and ethical conduct may impact colleague engagement, investor sentiment and the Group’s cost base.
The Group takes many mitigating actions with respect to people risk. Key examples include: – Focusing on strengthening the risk-based culture amongst colleagues by developing and delivering a number of initiatives that reinforce risk-based behaviours to generate the best possible outcomes for customers and colleagues; – continuing to ensure strong management of the impact of organisational change and consolidation on colleagues; – Embedding our codes of Personal and Business Responsibility across the Group; – Reviewing and developing incentives continually to ensure they promote colleagues’ behaviours that meet customer needs and regulatory expectations; – Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning; – Maintaining focus on people risk management across the Group; and
The major sources of insurance risk are within the insurance business and the Group’s defined benefit pension schemes. insurance risk is inherent in the insurance business and can be affected by customer behaviour. insurance risks accepted relate primarily to mortality, longevity, morbidity, persistency, expenses, property and unemployment. The primary insurance risk of the Group’s defined benefit pension schemes is related to longevity.
The Group continues to work closely with the FsA, Eu commission, HM Treasury and the Monitoring Trustee appointed by the Eu commission to ensure the successful implementation of the restructuring plan and mitigate customer impact.
Compliance and conduct significant legacy costs beyond current provisioning could have significant impact on capital ratios and credit ratings with consequent impact on liquidity risk. There is inherent uncertainty in making estimates of provisions required.
The Risk Governance structure below is integral to implementing ERM across the Group and by ensuring Risk is appropriately represented on key committees ensures that risk management is discussed in these meetings. This structure outlines the flow and escalation of risk information and reporting from business areas and the Risk division to the Group Executive committee (GEc) and Board. conversely, strategic direction and guidance is cascaded down from the Board and GEc.
The Board, assisted by the Board Risk and Audit committees, approves the Group’s overall governance, risk and control frameworks and risk appetite. The risk focus of these committees, together with other committees are described below: The roles of the Board, Board Risk and Audit committees are further described in the corporate Governance section on pages 86 to 97.
The Group executive is supported by the: Group Risk committee Reviews and recommends the Group’s risk appetite and governance, risk and control frameworks, high-level Group policies and the allocation of risk appetite. The committee also regularly reviews risk exposures and risk/ reward returns.
Provides strategic and senior oversight over design, launch and management of products, including new product approval, annual product reviews and management of risk in the back book.
Responsible for monitoring and challenging the Group’s compliance and conduct risk management framework, aggregated compliance and conduct risk profile, and its alignment with agreed risk appetite.
Responsible for setting the framework and standards for model governance across the Group, including establishing appropriate levels of delegated authority and principles underlying the Group’s risk modelling framework, specifically regarding consistency of approach across business units and risk types. it approves risk models other than a small number defined as highly material to the Group, which are approved by the Group Risk committee. This also meets FsA BiPRu requirements regarding the governance and approval for internal Ratings Based models, including internal Assessment models, Market Risk VaR and Advanced Measurement approach models.
Risk management framework Risk management strategy and risk appetite are developed and reviewed in tandem with Group strategy. The Group uses an Enterprise Risk Management (ERM) framework to ensure a robust and consistent approach to risk management is applied across all business areas and all risk types in order to drive improvements in its risk profile in line with risk appetite.
Objective setting – the Group’s high level risk appetite is derived from its business strategy of achieving strong, stable and sustainable growth. The risk management strategy and objectives are set to support the business in operating in line with the agreed risk appetite.
internal environment – the Group’s risk culture ensures that colleague capability is developed, individual accountabilities and limits are understood, and policies and procedures are adhered to. colleagues are expected to be aware of, and to comply with, the policies and procedures which apply to them and their work. line management in each business area has primary responsibility for ensuring that they do so.
information and communication – risk reporting consolidates and escalates key risks and management information internally through the Group’s committee structure and reports these externally to regulators. Risk reporting is reviewed by the business executive sitting as a risk committee, to ensure that senior management is satisfied with the overall risk profile, risk accountabilities and progress on any necessary action plans and tracking. information is provided to Risk division for review and aggregation to feed into regular reporting on risk exposures and material issues.
This statement of the Group’s overall appetite for credit risk is reviewed and approved annually. With the support of the Group Risk committee, the Group chief Executive allocates this risk appetite across the Group.
note 2(H) on page 219 provides details of the Group’s approach to the impairment of financial assets.
Measurement in measuring the credit risk of loans and advances to customers and to banks at a counterparty level, the Group reflects three components: (i) the ‘probability of default’ by the counterparty on its contractual obligations; (ii) current exposures to the counterparty and their likely future development, from which the Group derives the ‘exposure at default’; and (iii) the likely loss ratio on the defaulted obligations (the ‘loss given default’).
For regulatory capital purposes the Group’s rating systems assess probability of default and if permitted, exposure at default and loss given default, in order to derive an expected loss. if not permitted, regulatory prescribed exposure at default and loss given default values are used in order to derive an expected loss. in contrast, impairment allowances are recognised for financial reporting purposes only for loss events that have occurred at the balance sheet date, based on objective evidence of impairment. due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements differs from the amount determined from the expected loss models that are used for internal operational management and banking regulation purposes.
The Group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of counterparty. in its principal retail portfolios exposure at default and loss given default models are also in use. They have been developed internally and use statistical analysis, combined, where appropriate, with external data and subject matter expert judgement. Each rating model is subject to a validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. The most material rating models are approved by the Group Risk committee. Responsibility for the approval of the remaining material rating models, and the governance framework in place around all Group models, is delegated to the Group Model Governance committee.
Each probability of default model segments counterparties into a number of rating grades, each representing a defined range of default probabilities (details of these rating scales are published in the Group’s Pillar iii disclosure). Exposures migrate between rating grades if the assessment of the counterparty probability of default changes. Each rating system is required to map to a master scale, which supports the consolidation of credit risk information across portfolios through the adoption of a common rating scale. Given the differing risk profiles and credit rating considerations, the underlying risk reporting has been split into two distinct master scales, a retail master scale and a wholesale master scale (note 55 on page 320 provides an analysis of the portfolio and page 137 provides details of our credit risk portfolio).
The models vary, inter alia, in the extent to which they are point in time versus through the cycle. The models are subject to rigorous validation and oversight/governance, including where appropriate, benchmarking to external information.
in retail, for reporting purposes, counterparties are also segmented into a number of rating grades, each representing a defined range of default probabilities and exposures migrate between rating grades if the assessment of the counterparty probability of default changes.
For uK mortgages, the Group’s policy is to reject all standard applications with a loan-to-value (lTV) greater than 90 per cent. For mainstream mortgages the Group has maximum per cent lTV limits which depend upon the loan size. These limits are currently: Table 1.4: Loan to value analysis (unaudited)
credit scoring: in its principal retail portfolios, the Group uses statistically based decisioning techniques (primarily credit scoring models). The Risk division reviews model effectiveness, while new models and model changes are referred by them to the appropriate Model Governance committees for approval. The most material changes are approved in accordance with the governance framework set by the Group Model Governance committee.
commercial customers individual credit assessment and sanction with the exception of smaller sME names: credit risk in commercial customers portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and limit guidelines. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty underwriting is generally the same as that for assets intended to be held over the period to maturity.
counterparty limits: limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market movements. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.
Lloyds Banking Group Annual Report and Accounts 2012134 it is the Group’s policy that collateral should always be realistically valued by an appropriately qualified source, independent of both the credit decision process and the customer, at the time of borrowing. collateral is reviewed on a regular basis in accordance with business unit credit policy, which will vary according to the type of lending and collateral involved. For residential mortgages, the Group adjusts open market property values to take account of the costs of realisation and any discount associated with the realisation of the collateral. in order to minimise the credit loss, the Group may seek additional collateral from the counterparty as soon as impairment indicators are identified for the relevant individual loans and advances.
The specific tools available to assist customers vary by territory and product and the customer’s status. in defining the treatments offered to customers who have experienced financial distress, the Group distinguishes between the following three categories: – Reduced contractual monthly payment – a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original contractual payments, for example capital payment breaks and payment assistance breaks. Any arrears existing at the commencement of the arrangement are retained; – Financial distress assistance – an arrangement for customers in financial distress where arrears accrue at the contractual payment, for example short-term arrangements to pay and term extensions; and – Repair – an account change used to repair a customer’s position when they have emerged from financial difficulty, for example capitalisation of arrears.
To assist customers in financial distress, the Group also participates in, or benefits from, the following uK Government sponsored programmes for households:
The determination of cash flows for cases in the Bsus is undertaken by a specialist risk team who gather a range of information from various sources including the customer, professional advisers and the Group’s own credit teams to fully understand and appraise the customer’s business and circumstances. A more detailed assessment is undertaken to assist in reducing risk exposure and highlighting potential strategic options. This often involves the Group, in addition to using its own internal experts, engaging professional advisers to perform independent Business Reviews and, where relevant, independently value collateral held. in more complex cases, such as those involving work-out strategies, the review may also involve: – critically assessing customer’s ability to successfully manage the business effectively in a distressed situation where turnaround is required; – analysis of market sector factors, i.e. products, customers, suppliers, pricing and margin issues; – performance review of operational areas that should be considered in terms of current effectiveness and efficiency and scope for improvements; – financial analysis to model plans and factor in potential sensitivities, vulnerabilities and upsides; and
Multiple types of forbearance concessions may occur and each case is treated depending on its own specific circumstances, as the Group’s strategy and offer of forbearance is largely dependent on the individual situation. Early identification, control and monitoring are key in order to support the customer and protect the Group.
The Group’s forbearance actions for its commercial customers experiencing financial difficulties fall into the following three main categories: – Amendments – Waiver or amendment of covenants or interest rate to a level considered outside of market or the Group’s risk appetite; – Extensions – Extension/alteration of repayment terms to a level outside of market or the Group’s risk appetite due to the customer’s inability to make existing contractual repayment terms; and – Forgiveness – debt for equity swaps or partial debt forgiveness. This type of forbearance will always give rise to impairment.
concessions granted under forbearance would be classified in the Group’s credit Risk classification system according to the severity of the customer’s financial distress. Management information is produced which gives a high level view of asset quality, with clearly defined parameters and features. Trends and warning signs are reported and advised to senior management promptly, which include issues not yet identified by rating models. A robust review and challenge process is applied to each credit if asset quality declines, initiating an appropriate and measured response. As the financial stress of a credit deteriorates the credit Risk classification helps to determine the route and management of the customer. Repeat transgressions of forbearance would be reflected in the strategy to manage the customer and an objective reassessment of any impairment will be undertaken on a regular basis. This is subject to independent review and sanctioning.
– The Group’s divestment strategy remains focused on reducing non-core assets and on the disposal of higher risk positions.
Wealth, Asset Finance and international 22 33 33 impairment charge as a % of average advances 0.44% 0.64% (20)pp
Table 1.15: impairments on Retail loans and advances – core (unaudited)
At 31 December number of cases Total mortgage accounts % value of debt1 Total mortgage balances %
The stock of repossessions decreased to 2,438 cases at 31 december 2012 compared to 3,054 cases at 31 december 2011.
The percentage of closing loans and advances with an indexed lTV in excess of 100 per cent decreased to 11.7 per cent (£37,811 million) at 31 december 2012, compared with 12.0 per cent (£39,729 million) at 31 december 2011. The tables below show lTVs across the principal mortgage portfolios.
– The fall in the impairment charge reflects generally stable obligor credit quality overall, with the low interest rate environment helping to maintain defaults at a lower level, despite weaker consumer confidence in a number of sectors. The credit risk appetite approach is through the cycle helping to ensure that new business written is of good quality.
impairment provisions as a percentage of impaired loans increased to 41.7 per cent from 41.3 per cent at 31 december 2011 as Business support unit was successful in selling a number of impaired assets which generally had lower coverage levels. The Business support unit portfolio continues to reduce as a result of robust and proactive risk management.
Available-for-sale financial assets 12,554 includes collective unimpaired provisions of £894 million (2011: £1,213 million).1
Wholesale Overall obligor quality remains stable, and impairment charges reduced over the last 12 months to £452 million in 2012 from £759 million in 2011.
The £75,510 million of gross loans and advances to customers in the Wholesale core portfolio is structured across a number of different coverage segments delivered via a suite of core banking products from lending and Transaction Banking to Financial Markets and capital Markets. These include: Mid Markets – The businesses are predominantly uK focused and several sectors have continued to face challenging trading conditions in the face of domestic economic performance, weak consumer sentiment and public sector austerity measures. The Retail, leisure, construction and care sectors have shown the most evident stress, although there is wide disparity between the performance of the stronger and weaker businesses in each of these areas. The Group’s through the cycle risk appetite has helped ensure that the portfolio quality has remained relatively stable.
Over 75 per cent of the non-core corporate Real Estate Bsu portfolio consists of distressed or sub standard direct real estate loans. The remainder relates to loans to other real estate related sectors, supported by trading activities (such as housebuilders, hotels and care homes), with assets managed by specialist teams.
The non-core Acquisition Finance portfolio is approximately 75 per cent managed in Business support unit reflecting its relatively high risk parameters, with significant loan maturities due in the next few years. in ship Finance, the tankers, dry bulk and containers sectors remained challenging in 2012. The ship Finance portfolio is non-core and as such projects have been successfully completed to accelerate exits when deemed in the best interest of the Group with further planning at an advanced stage to facilitate early exits where opportunities arise during 2013. in december 2012, the Group sold its Rail Finance rolling stock operating lease businesses and made a managed disposal of some of its us aircraft exposure. These reduced the Group’s non-core assets and eliminated the operational and residual value risk related to these assets.
specialised lending also includes a small non-core equity business and a significantly reduced Treasury Assets portfolio. Following a number of material disposals during 2012, the non-core drawn assets representing equity risk now only totals £0.7 billion. The Treasury Asset legacy investment portfolio mainly encompasses a portfolio of asset-backed securities and financial institution covered Bond positions. This portfolio size continues to be actively reduced through asset sales and from bond maturities. Further details of commercial Banking’s asset-backed securities portfolio is provided in note 55 on page 334.
Lloyds Banking Group Annual Report and Accounts 2012154 impaired loans and provisions Total impaired loans decreased by £4,322 million to £14,008 million compared with £18,330 million at 31 december 2011 and as a percentage of closing loans and advances to customers decreased to 32.6 per cent from 35.6 per cent at 31 december 2011. This is primarily driven by reductions in ireland wholesale.
Loans and advances to customers £m impaired loans £m impaired loans as a % of closing advances
impairment provisions1 £m impairment provisions as a % of impaired loans
international: latin America and Middle East 612 211 34.5 144 68.2
impairment charges decreased by £1,942 million to £1,245 million compared to 2011 as the rate of increase in newly impaired loans fell during 2012. impairment charges as an annualised percentage of average loans and advances to customers decreased to 5.53 per cent from 11.93 per cent in 2011.
Assets held by the insurance business are shareholder assets and are held outside the with-profits and unit-linked funds. Approximately £106 million (2011: £127 million) of these exposures relate to direct investments where the issuer is resident in ireland, spain, Portugal, Greece or italy and the credit rating is consistent with the tight credit criteria defined under the appropriate investment mandate. The remaining exposures relate to interests in two funds domiciled in ireland and administered by scottish Widows investment Partnership (the Global liquidity Fund and the short-Term Fund) where in line with the investment mandates, cash is invested in the money markets. For these funds, the exposure is analysed on a look through basis to the underlying assets held and the insurance business’ pro rata share of these assets rather than treating all the holding in the fund as exposure to ireland. Within the above exposures there are no sovereign exposures.
Carrying value netting net carrying value netting net £m £m £m £m £m £m sovereign debt – – – – – –
The movement in the period within exposures to financial institutions is primarily due to reverse repurchase transactions secured primarily on uK gilts.
see page 153 for further details on irish corporate and personal exposures. The off-balance sheet exposures to corporates are principally undrawn facilities.
included within exposures to banks, and treated as available-for-sale assets are covered bonds of £1.1 billion (2011: £1.4 billion), which are ultimately secured on a pool of mortgage assets in the countries concerned and benefit from over-collateralisation and have an overall weighted maturity of approximately four years. The Group has credit default swap positions referenced to banking groups domiciled in spain (net short of £4.1 million), which are included in the balances detailed above, and unutilised and uncommitted money market lines and repo facilities of approximately £1.0 billion (2011: £1.1 billion) in respect of spanish banks. Bank limits have been closely monitored with amounts and tenors reduced where appropriate.
Exposures comprise lending to corporates, including a small amount of commercial real estate exposure.
Carrying value £m netting £m net £m carrying value £m netting £m net £m sovereign debt – – – – – –
Asset backed securities: corporate: Personal – – – – – –
At 31 December 2012 slovakia – – – – – – – – –
– The Group has undertaken actions to mitigate redenomination risk for both assets and liabilities where possible, but it is not clear that such mitigation will be effective in the event of a member exit.
Table 1.39: Environmental risk management approach colleagues are trained in environmental risk management as part of the Group’s standard credit risk training course, and bespoke training can be provided upon request. supporting this training, a range of documents are provided to all colleagues online including environmental risk theory, procedural guidance, and information on environmental legislation and sector-specific environmental impacts.
Project Finance: Equator Principles The Group has been a signatory to the Equator Principles since 2006. The Equator Principles support the Group’s approach to assessing and managing environmental and social issues in project finance. Project finance is often used to fund the development and construction of major infrastructure and industrial projects. The Equator Principles are applicable to project finance transactions above us$10 million and provide a framework to support responsible decision making.
lending officers are responsible for undertaking initial classification of transactions that qualify under the Equator Principles. Their assessments are subject to further review by the in-house Environmental Risk team and retained consultant, and for higher risk transactions by the Equator Principles Review Group, comprising experts from both the Risk and Project Finance teams. This ensures that each transaction is compliant and is consistent with the Group’s environmental risk policy. A range of training and support materials are provided to risk and transactional colleagues to ensure that they are familiar with the requirements of the Principles.
Risk appetite The Group has zero risk appetite for systemic unfair customer outcomes arising from product design, sales or other after sales processes. This appetite is reviewed and approved annually by the Board. To achieve this, the Group has policies, processes and standards which provide the framework for businesses and colleagues to operate in accordance with the laws, regulations and voluntary codes which apply to the Group and its activities.
Banking activities The Group’s banking activities expose it to the risk of adverse movements in interest rates, credit spreads, exchange rates and equity prices, with little or no exposure to commodity risk. The volatility of market values can be affected by both the transparency of prices and the amount of liquidity in the market for the relevant asset.
insurance portfolios The Group’s insurance activities also expose it to market risk, encompassing interest rate, exchange rate, property, credit spreads and equity risk: – With Profit Funds are managed with the aim of generating rates of return consistent with policyholders’ expectations and this involves the mismatch of assets and liabilities.
The Group’s trading activity is small relative to its peers and the Group does not have a programme of proprietary trading activities.
The risk of loss measured by the VaR model is the potential loss in earnings given the confidence level and assumptions noted above. The total and average trading VaR does not assume any diversification benefit across the five risk types, which now include inflation. 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 as a whole. The Group internally uses VaR as the primary measure for all trading book positions arising from short term market facing activity. Trading book VaR (1-day 99 per cent) is compared daily against both forecast and actual profit and loss.
Open market risk for the trading operations continues to be low with respect to the size of the Group and similar institutions, reflecting the fact that the Group’s trading operations are customer-centric, focusing on hedging and recycling client risks.
Risk exposure is monitored monthly using, primarily, market value sensitivity. This methodology considers all re-pricing mismatches in the current balance sheet and calculates the change in market value that would result from a set of defined interest rate shocks. Where re-pricing maturity is based on assumptions about customer behaviour these assumptions are also reviewed monthly. A limit structure exists to ensure that risks stemming from residual and temporary positions or from changes in assumptions about customer behaviour remain within the Group’s risk appetite.
Base case market value is calculated on the basis of the Group’s balance sheet with re-pricing dates adjusted according to behavioural assumptions. The above sensitivities show how this projected market value would change in response to an immediate parallel shift to all relevant interest rates – market and administered.
The schemes’ main exposures are to equity risk, real rate risk and credit spread risk. Accounting for the defined benefit pension schemes under international Accounting standard (iAs) 19 spreads any adverse impacts of these risks over time.
– The investment strategy for other insurance liabilities is determined by the term and nature of the underlying liabilities and asset/liability matching positions are actively monitored. Actuarial tools are used to project and match the cash flows.
The Group has implemented an Operational Risk Framework which embraces the risk life-cycle of identification; measurement and assessment; management via appropriate mitigants and controls; and monitoring and reporting. To ensure the rigour of the Operational Risk Framework, the Group defines operational risks in the form of a number of discrete categories, the principal ones being: Customer Processes – The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from poor externally facing business processes. customer process risk includes customer transaction and processing errors due to incorrect capturing of customer information and/or system failure.
Security – The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft of or damage to the Group’s assets, the loss, corruption, misuse or theft of the Group’s information assets or threats or actual harm to the Group’s people. This also includes risks relating to terrorist acts, other acts of war, geopolitical, pandemic or other such events.
Risk Appetite The Group has developed an impact on earnings approach to operational risk appetite. This involves looking at how much the Group could lose due to operational risk losses at various levels of certainty.
The Group continues to operate a robust control environment with regular review and investment.
Risk appetite The Group’s appetite for people risk is reviewed and approved annually by the Board. The high level appetite is described as: The Group leads responsibly and proficiently, manages people resource effectively, supports and develops colleague talent, and meets legal and regulatory obligations related to its people.
Mitigation The Group undertakes a variety of programmes which aim to manage its people risks; there are currently four key areas of activity; – The Group focuses on leadership and colleague retention, including initiatives and strategies to attract, develop and retain high-calibre colleagues and that cross-Group succession planning is well implemented.
details of contractual maturities for assets and liabilities form an important source of information for the management of liquidity risk. note 55 on page 336 sets out an analysis of assets and liabilities by relevant maturity grouping. in order to reflect more accurately the expected behaviour of the Group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. divisional teams form a view of customer behaviour based on quantitative and qualitative analysis and these assumptions are subject to governance via divisional asset and liability committees. This also forms the foundation of the Group’s stress testing framework on which the Group’s liquidity controls are based.
The Group’s funding and liquidity position is underpinned by its significant customer deposit base, and has been supported by stable funding from the wholesale markets with a reduced dependence on short-term wholesale funding. A substantial proportion of the retail deposit base is made up of customers’ current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to raise interbank deposits and to issue certificates of deposit and commercial paper to meet short-term obligations. The Group’s appetite for short-term money market funding is based on a qualitative analysis of the market’s capacity for the Group’s credit. The Group has developed strong relationships with certain wholesale market segments, and also has access to corporate customers to supplement its retail deposit base.
The Group actively manages its balance sheet and contingent liabilities by ensuring that the internal pricing mechanism for funds within the Group fully incorporates liquidity costs. This transfer pricing mechanism ensures that liquidity risk is reflected in product pricing and supports the overall Group balance sheet strategy and that the correct behaviours and decisions are rewarded.
The planned introduction of the liquidity coverage Ratio (lcR – minimum requirement will begin at 60 per cent in January 2015 rising in equal annual steps of 10 per cent to reach 100 per cent in January 2019) and the introduction of the net stable Funding Ratio (nsFR – January 2018) contained within cRd iV are intended to raise the resilience of banks to potential liquidity shocks and provide the basis for a harmonised approach to liquidity risk management. The guidance issued by the Basel committee is still subject to final ratification by the Eu and the methodology is likely to be refined on the basis of feedback from banks and regulators during the observation period. The Group has invested considerable resource to ensure that it satisfies the governance, reporting and stress testing requirements of the FsA’s individual liquidity Adequacy standards liquidity regime and will satisfy the agreed final nsFR and lcR requirements. The Group monitors and forecasts the Group’s nsFR and lcR. The actions already announced to right size the balance sheet are expected to ensure compliance with the future minimum standards. These standards are expected to be 100 per cent for both ratios by their respective effective dates.
during the year, the individual entities within the Group, and the Group, complied with all of the external regulatory liquidity and funding requirements to which they are subject.
Liquidity and funding management in 2012 liquidity and funding continues to remain a key area of focus for the Group and the industry as a whole. like all major banks, the Group is dependent on confidence in the short and long-term wholesale funding markets. should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding, its ability to fund its financial obligations could be impacted.
The table below summarises the Group’s wholesale term issuance during 2012. The Group’s 2012 issuance plan was successfully completed in the first half of 2012 through the ability of the Group to access a diverse range of markets and currencies, both in unsecured and secured form.
secondary liquidity assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
Primary liquidity assets are FsA eligible liquid assets including uK Gilts, us Treasuries, Euro AAA government debt and unencumbered cash balances held at central banks.
Following the introduction of the FsA’s individual liquidity guidance under ilAs, the Group now manages its liquidity position as a coverage ratio (proportion of stressed outflows covered by primary liquid assets) rather than by reference to a quantum of liquid assets; the liquidity position reflects a buffer over the regulatory minimum.
in addition to primary liquidity holdings the Group has significant secondary liquidity holdings providing access to open market operations at a number of central banks which the Group routinely makes use of as part of its normal liquidity management practices. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.
Stress testing results internal stress testing results at 31 december 2012 show that the Group has liquidity resources representing 128 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intra-day requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario (the three month combined (market wide and Group specific) scenario).
encumbered assets during 2012 the Group was a consistent issuer in a number of secured funding markets, in particular residential mortgage-backed securities and covered bonds. The table below summarises the assets encumbered through the Group’s external issuance transactions.
At 31 december 2011 in addition the Group retained internally £58.7 billion (2011: £86.6 billion) of notes secured with £78.2 billion (2011: £114.6 billion) of assets. For details on the Group’s securitisation programme refer to note 21 on page 252.
Group borrowing costs The Group’s borrowing costs and issuance in the capital markets are dependent on a number of factors, and increased cost or reduction of capacity could materially adversely affect the Group’s results of operations, financial condition and prospects. in particular, reduction in the credit rating of the Group or deterioration in the capital markets’ perception of the Group’s financial resilience could significantly increase its borrowing costs and limit its issuance capacity in the capital markets. As an indicator over the last 12 months the spread between an index of A rated long term senior unsecured bank debt and an index of similar BBB rated bank debt, both of which are publicly available, averaged 134 basis points. The applicability to and implications for the Group’s funding cost would depend on the type of issuance, and prevailing market conditions. The impact on the Group’s funding cost is subject to a number of assumptions and uncertainties and is therefore impossible to quantify precisely.
in respect of insurance risks in the defined benefit pension schemes, the Group ensures that effective communication mechanisms are in place for consultation with the trustees to assist with the management of risk in line with the Group’s risk appetite.
– Oversight and assurance of the regulatory risks within the business.
Monitoring Business unit risk exposure is reported to Risk division where it is aggregated at Group level and a report prepared. The report forms the basis of challenge to the business at the monthly Group compliance and conduct Risk committee. This committee may escalate matters to the chief Risk Officer, or higher committees. The report also forms the basis of the regulatory sections in the Group’s consolidated risk reporting.
Maintaining an effective relationship with our regulators remains a key focus for the Group.
Definition capital risk is defined as the risk that the Group has a sub-optimal amount or quality of capital or that capital is inefficiently deployed across the Group.
The minimum requirement for total capital is supplemented, under Pillar ii of the framework, through the issuance of bank specific individual capital Guidance (icG) which adjusts the Pillar i minimum for those risks not covered or not fully covered under Pillar i. A key input into the FsA’s icG setting process is a bank’s own assessment of the amount of capital it needs, a process known as the internal capital Adequacy Assessment Process. The Group has been set an icG by the FsA and maintains capital at a level which exceeds this requirement.
– The implementation of cRd iV has been delayed beyond the original proposed date of 1 January 2013 to an as yet unknown implementation date while certain parts of the draft directive and regulation continue to be refined.
Generally, the reforms are developed and phased in over long periods which allows time for the Group to further strengthen its capital position as necessary through business performance and mitigating actions.
The movements in core tier 1, tier 1, tier 2 and total capital in the period are shown below: Table 1.58: Movements in capital (unaudited)
Tier 1 capital Tier 1 capital has decreased in the period by £445 million mainly as a result of a debt exchange undertaken in February 2012 and foreign exchange movements.
Tier 2 capital Tier 2 capital has decreased in the period by £1,884 million largely arising from a decrease in dated subordinated debt, principally due to amortisation, foreign exchange movements and fair value movements in Enhanced capital notes. unrealised gains on available-for-sale equity investments have also decreased in the year.
supervisory deductions supervisory deductions principally consist of investments in subsidiary undertakings that are not within the banking group for regulatory purposes. These investments are primarily the scottish Widows and clerical Medical life and pensions businesses together with the Group’s general insurance business and the investment in st. James’s Place.
At 31 december 2012, on a pro forma cRd iV transitional basis the Group’s estimated common equity tier 1 (cET1-cRd iV equivalent of core tier 1) ratio would have been 11.6 per cent, and on a pro forma cRd iV fully loaded basis it would have been 8.1 per cent.
The pro forma fully loaded cRd iV cET1 ratio of 8.1 per cent comfortably exceeds the 4.5 per cent minimum and the additional 2.5 per cent conservation buffer that are required under the draft rules from 2019. nevertheless, the Group will continue to monitor closely the emergence of the final rules and their impact upon its ratios. Moreover, through transition to the new rules, the Group is aiming to build the ratio to an amount prudently in excess of 10 per cent by continuing to run down its non-core portfolios and by profit generation.
– The ‘cRd iV fully loaded with ineligible tier 1 instruments grandfathered’ basis uses the tier 1 capital calculated by applying the rules laid out in the July 2011 draft publication of cRd iV, without transition, with the exception that tier 1 instruments which will be ineligible once the transitional phase has elapsed are counted in full.
To ensure that the capital and exposure components of the ratio are measured consistently, the assets of the insurance entities included in the accounting consolidation have been excluded from the exposure measure in proportion to the capital that is excluded in tier 1.
Realistic basis: The FsA requires each life insurance company which contains a With-Profit Fund in excess of £500 million to also carry out a realistic valuation of that fund. The Group has two such funds; one within scottish Widows and one within clerical Medical. The word realistic in this context reflects the fact that assumptions are best-estimate as opposed to prudent. This realistic valuation is an assessment of the financial position of a With-Profit Fund calculated under a methodology prescribed by the FsA.
The valuation of with-profits assets in a With-Profit Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-profit business written therein, it includes the present value of the anticipated future release of the prudent margins for adverse deviation. in addition, the realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above.
The determination of realistic liabilities of the With-Profit Funds includes the value of internal transfers expected to be made from each With-Profit Fund to the non-Profit Fund held within the same life insurance entity. These internal transfers may include charges on policies where the associated costs are borne by the non-Profit Fund.
Estimated share of realistic liabilities consistent with the FsA reporting treatment (305) (62) – – – (367)
Estimated share of realistic liabilities consistent with the FsA reporting treatment (341) (58) – – – (399)
Other restrictions in the Non-Participating Fund: in addition to the policies which existed at the date of demutualisation, the With-Profit Fund includes policies which have been written since that date. As a result of statements made to policyholders that investment policy will usually be the same for both types of business, there is an implicit requirement to hold additional regulatory assets in respect of the business written after demutualisation. The estimated amount required to provide such support at 31 december 2012 is £128 million (2011: £117 million). scottish Widows has obtained from the FsA permission to include the value of this support in assessing the realistic value of assets available to the With-Profit Fund. There is a further test requiring that no amounts can be transferred from the non-Participating Fund of scottish Widows unless there are sufficient assets within the long-Term Fund to meet both policyholders’ reasonable expectations in light of liabilities in force at a year-end and the new business expected to be written over the following year.
Overseas life business includes several life companies outside the uK, including Germany and ireland. in all cases the available capital resources are subject to local regulatory requirements, and transfer to other parts of the Group is subject to additional complexity surrounding the transfer of capital from one country to another.
At 31 December 2012 unit-linked business (excluding that accounted for as non-participating investment contracts) – – 38,756 8,429 47,185
Assets held in excess of those backing reserves are invested in readily tradable assets (e.g. equities and fixed interest securities), cash and a range of less liquid fixed interest instruments, at levels consistent with the risk appetite of the insurance business.
Monitoring Financial reporting risk is actively monitored at business unit and Group levels. There are specific programmes of work undertaken across the Group to support: – annual assessments of (1) the effectiveness of internal controls over financial reporting; and (2) the effectiveness of the Group’s disclosure controls and procedures, both in accordance with the requirements of the us sarbanes Oxley Act; – annual certifications by the senior Accounting Officer with respect to the maintenance of appropriate tax accounting arrangements, in accordance with the requirements of the 2009 Finance Act.
Definition Governance risk is defined as the risk that the Group’s organisational infrastructure fails to provide robust oversight of decision making and the control mechanisms to ensure strategies and management instructions are implemented effectively.
Risk Appetite Governance risk appetite is defined and embedded through the Group’s Governance Policy which is reviewed and approved by the Board on an annual basis.
exposure The internal governance arrangements of major financial institutions are currently subject to a high level of regulatory and public scrutiny. The Group’s exposure to governance risk is also reflective of the significant volume of existing and proposed legislation and regulation within the uK and overseas with which it must comply.
Report of the independent auditors on the consolidated financial statements 204
REPORT OF THE indEPEndEnT AudiTORs On THE cOnsOlidATEd FinAnciAl sTATEMEnTs independent auditors’ report to the members of Lloyds Banking Group plc We have audited the group financial statements of lloyds Banking Group plc for the year ended 31 december 2012 which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes. The financial reporting framework that has been applied in their preparation is applicable law and international Financial Reporting standards (iFRss) as adopted by the European union.
Scope of the audit of the financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. in addition, we read all the financial and non-financial information in the Annual Report and Accounts to identify material inconsistencies with the audited financial statements. if we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
– certain elements of the report to shareholders by the Board on directors’ remuneration.
Report of the independent auditors on the consolidated financial statements 204 Consolidated financial statements 206 Notes to the consolidated financial statements 214 Report of the independent auditors on the parent company financial statements 344 Parent company financial statements 345 Notes to the parent company financial statements 348 cOnsOlidATEd sTATEMEnT OF cOMPREHEnsiVE incOME for the year ended 31 december
Lloyds Banking Group Annual Report and Accounts 2012206 £ million £ million £ million
net income statement transfers (92) 70 932 currency translation differences (tax: nil) (14) (84) (129)
Assets cash and balances at central banks 80,298 60,722 items in the course of collection from banks 1,256 1,408
Tangible fixed assets 31 7,342 7,673 current tax recoverable 354 434 deferred tax assets 43 4,285 4,496
Retirement benefit obligations 42 300 381 current tax liabilities 138 103 deferred tax liabilities 43 327 314
Total liabilities 879,868 923,952 equity share premium account 47 16,872 16,541
The directors approved the consolidated financial statements on 1 March 2013.
Further details of movements in the Group’s share capital and reserves are provided in notes 46, 47, 48 and 49.
(loss) profit for the year – – (2,787) (2,787) 73 (2,714)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax – 1,611 – 1,611 (1) 1,610
Movements in cash flow hedging reserve, net of tax – 716 – 716 – 716 currency translation differences (tax: nil) – (84) – (84) – (84)
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax – 498 – 498 (5) 493
Acquisition of businesses, net of cash acquired 56(E) (11) (13) (73)
disposal of businesses, net of cash disposed 56(F) 37 298 428 net cash provided by (used in) investing activities 15,232 6,932 (2,398)
cash and cash equivalents at beginning of year 85,889 62,300 65,690
The Group has reviewed its holding of government securities classified as held-to-maturity; since it is no longer the Group’s intention to hold these to maturity, they have been reclassified as available-for-sale. in addition, as the Group’s share of results of joint ventures and associates is no longer significant, this is now included within other operating income and the related asset reported within other assets; comparatives have been re-presented on a consistent basis.
(i) Disclosures – Transfers of Financial Assets (Amendments to IFRS 7). Requires disclosures in respect of all transferred financial assets that are not derecognised in their entirety and transferred assets that are derecognised in their entirety but with which there is continuing involvement. disclosures in connection with such transfers can be found in note 54.
(1) Subsidiaries subsidiaries include entities over which the Group has the power to govern the financial and operating policies which generally accompanies a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. 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. details of the principal subsidiaries are given in note 9 to the parent company financial statements.
intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
Goodwill is recognised as an asset at cost and is tested at least annually for impairment. if an impairment is identified the carrying value of the goodwill is written down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of associates and joint ventures is included in the Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal except where it has been written off directly to reserves in the past.
The effective interest rate is calculated on initial recognition of the financial asset or liability by estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts expected to be paid or received by the Group including expected 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 in the calculation. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see (H) below).
Trading securities 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. such securities are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. if the market is not active the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Refer to note 3 (critical accounting estimates and judgements: Fair value of financial instruments) and note 54(3) (Financial instruments: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
The Group has entered into securitisation and similar transactions to finance certain loans and advances to customers. in cases where the securitisation vehicles are funded by the issue of debt, on terms whereby the majority of the risks and rewards of the portfolio of securitised
When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between the original carrying value of the liability and the fair value of the new equity is recognised in the profit or loss together with any related costs or fees incurred.
The Group designates certain derivatives as either: (1) hedges of the fair value of the particular risks inherent in recognised assets or liabilities (fair value hedges); (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges of net investments in foreign operations (net investment hedges). These are accounted for as follows:
(1) Fair value hedges changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk; this also applies if the hedged asset is classified as an available-for-sale financial asset. if the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the income statement. The cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using the effective interest method over the period to maturity.
subsequent to the recognition of an impairment loss on a financial asset or a group of financial assets, interest income continues to be recognised on an effective interest rate basis, on the asset’s carrying value net of impairment provisions. if, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower’s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the income statement.
Homogenous groups of loans in respect of portfolios of smaller balance, homogenous loans, the asset is included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. segmentation takes into account factors such as the type of asset, industry sector, geographical location, collateral type, past-due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.
Incurred but not yet identified impairment The collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been separately identified at the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. Risk drivers for secured retail lending include the current indexed loan-to-value, previous mortgage arrears, internal cross-product delinquency data and external credit bureau data; for unsecured retail lending they include whether the account is up-to-date and, if not, the number of payments that have been missed; and for wholesale lending they include factors such as observed default rates and loss given default. An assessment is made of the likelihood of each account becoming recognised as impaired within the loss emergence period, with the economic loss that each portfolio is likely to generate were it to become impaired. The loss emergence period is determined by local management for each portfolio and the Group has a range of loss emergence periods which are dependent upon the characteristics of the portfolios. loss emergence periods are reviewed regularly and updated when appropriate. in general the periods used across the Group vary between one month and twelve months based on historical experience. unsecured portfolios tend to have shorter loss emergence periods than secured portfolios.
debt for equity exchanges Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity securities, held as available-for-sale. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.
(i) investment property investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital appreciation or both. The Group’s investment property primarily relates to property held for long-term rental yields and capital appreciation within the life insurance funds. investment property is carried in the balance sheet at fair value, being the open market value as determined in accordance with the guidance published by the Royal institution of chartered surveyors. if this information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices. These valuations are reviewed at least annually by an independent valuation expert. investment property being redeveloped for continuing use as investment property, or for which the market has become less active, continues to be measured at fair value. changes in fair value are recognised in the income statement as net trading income.
– leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease.
(L) Pensions and other post-retirement benefits The Group operates a number of post-retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation to pay further contributions.
– investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets.
(ii) Accounting for non-participating investment contracts The Group’s non-participating investment contracts are primarily unit-linked. These contracts are accounted for as financial liabilities whose value is contractually linked to the fair values of financial assets within the Group’s unitised investment funds. The value of the unit-linked financial liabilities is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet date. Their value is never less than the amount payable on surrender, discounted for the required notice period where applicable. investment returns (including movements in fair value and investment income) allocated to those contracts are recognised in the income statement through insurance claims.
Assets arising from reinsurance contracts held – Classified as non-participating investment contracts These contracts are accounted for as financial assets whose value is contractually linked to the fair values of financial assets within the reinsurers’ investment funds. investment returns (including movements in fair value and investment income) allocated to these contracts are recognised in insurance claims. deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the assets arising from reinsurance contracts held.
(P) Foreign currency translation items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the functional currency). The consolidated financial statements are presented in sterling, which is the company’s functional and presentation currency.
(3) Treasury shares Where the company or any member of the Group purchases the company’s share capital, the consideration paid is deducted from shareholders’ equity as treasury shares until they are cancelled. Where such shares are subsequently sold or reissued, any consideration received is included in shareholders’ equity.
individual impairment allowances are generally established against the Group’s wholesale lending portfolios. The determination of individual impairment allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions and the resulting trading performance of the customer, and the value of the security held, for which there may not be a readily accessible market. in particular, significant judgement is required by management in the current economic environment in assessing the borrower’s cash flows and debt servicing capability together with the realisable value of collateral. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.
Given the relative size of the mortgage portfolio, a key variable is house prices which determine the collateral value supporting loans in such portfolios. The value of this collateral is estimated by applying changes in house price indices to the original assessed value of the property. if average house prices were ten per cent lower than those estimated at 31 december 2012, the impairment charge would increase by approximately £330 million in respect of uK mortgages and a further £55 million in respect of irish mortgages.
The Group’s total deferred tax asset includes £7,034 million (2011: £5,862 million) in respect of trading losses carried forward. The tax losses have arisen in individual legal entities and will be used as future taxable profits arise in those legal entities, though substantially all of the unused tax losses for which a deferred tax asset has been recognised arise in Bank of scotland plc and lloyds TsB Bank plc.
The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptions is set out in note 42.
Lloyds Banking Group Annual Report and Accounts 2012228 note 4: Segmental analysis lloyds Banking Group provides a wide range of banking and financial services in the uK and in certain locations overseas.
The segmental results and comparatives are presented on a management basis, the basis reviewed by the chief operating decision maker. Previously the results of the Group’s segments had been reviewed on a combined businesses basis and the Group’s segmental analysis was presented accordingly. Profit on the management basis is equivalent to profit before tax on a combined businesses basis. However, the effects of asset sales, volatile items and liability management are shown on a separate line in the management basis income statements whereas they were previously included in the relevant line items on a combined businesses basis; in addition the results of asset sales are now reported net of the related fair value unwind whereas this was previously included on the separate fair value unwind line.
Following a reorganisation during 2012, the Group’s activities are now organised into four financial reporting segments: Retail; commercial Banking; Wealth, Asset Finance and international; and insurance. The impact of this reorganisation was as follows: – The Group’s Wholesale and commercial divisions have been combined to form commercial Banking.
– The Asset Finance business unit, previously reported within Wholesale, is now reported within the Wealth, Asset Finance and international segment; the Asset Finance business recorded a management basis profit before tax of £319 million in the year ended 31 december 2012 (2011: £275 million; 2010: £380 million).
commercial Banking provides banking and related services for all uK and multinational business clients, from small and medium-sized enterprises to major corporate and financial institutions.
inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the uK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.
Other income (net of fee and commission expense) 1,462 2,932 2,043 2,294 (315) 8,416
Other income (net of fee and commission expense) 1,660 2,806 2,230 2,687 (204) 9,179 insurance claims – – – (343) – (343)
Reconciliation of reported basis to statutory results The reported basis is the basis on which financial information is presented to the chief operating decision maker which excludes certain items included in the statutory results. The table below reconciles the statutory results to the reported basis.
Fair value unwind – – – – 650 650 comprises the effects of asset sales (gain of £2,547 million), volatile items (loss of £748 million), liability management (loss of £229 million), simplification costs related to severance, iT and business costs of implementation (£676 million), Ec mandated retail business disposal costs (£570 million), the amortisation of purchased intangibles (£482 million) and the past service pensions credit (£250 million, see note 11).
comprises the effects of asset sales (gain of £284 million), volatile items (loss of £738 million), liability management (gain of £1,295 million), integration and simplification costs related to severance, iT and business costs of implementation (£1,282 million), Ec mandated retail business disposal costs (£170 million) and the amortisation of purchased intangibles (£562 million).
Fair value unwind – – – – 2,464 2,464 comprises the effects of asset sales (gain of £496 million), volatile items (loss of £270 million), liability management (gain of £423 million), the pension curtailment gain (£910 million, see note 11), integration costs related to severance, iT and business costs of implementation (£1,653 million) and the amortisation of purchased intangibles (£629 million).
Geographical areas The Group’s activities are focused in the uK and the analyses of income and assets below are based on the location of the branch or entity recording the income or assets.
2012 £m 2011 £m 2010 £m interest and similar income: loans and advances to customers, excluding lease and hire purchase receivables 3.91 4.00 4.37 20,928 23,208 25,459 loans and advances to banks 0.53 0.78 0.72 590 628 512 debt securities held as loans and receivables 4.77 3.17 4.41 433 590 1,377 lease and hire purchase receivables 5.35 5.13 6.74 672 742 626 interest receivable on loans and receivables 3.39 3.63 4.03 22,623 25,168 27,974
Total interest and similar expense 2.24 1.95 2.31 (14,460) (13,618) (16,794)
Gains less losses on disposal of available-for-sale financial assets (note 48) 3,547 343 399
Life insurance and participating investment contracts claims and surrenders: change in insurance and participating investment contracts (note 37(1)): change in gross liabilities (4,284) 1,383 (4,622)
non-life insurance claims and claims paid: change in liabilities (note 37(2)): Total non-life insurance (365) (343) (539)
life insurance and participating investment contracts gross claims can also be analysed as follows: Total life insurance gross claims (8,719) (8,622) (9,397)
A non-life insurance claims development table is included in note 37.
Pensions and other post-retirement benefit schemes (note 42): Past service credits and curtailment gains1 (250) – (910)
Amortisation of acquired value of in-force non-participating investment contracts (note 29) 79 78 76
Regulatory provisions: Payment protection insurance provision (note 44) 3,575 3,200 –
Performance-based compensation expense comprises: Awards made in respect of the year ended 31 december 362 363 505
Average headcount The average number of persons on a headcount basis employed by the Group during the year was as follows: Fees payable to the auditors Fees payable to the company’s auditors by the Group are as follows: £m £m £m
Fees payable for the audit of the company’s current year annual report 1.6 1.7 1.9
it is the Group’s policy to use the auditors on assignments in cases where their knowledge of the Group means that it is neither efficient nor cost effective to employ another firm of accountants. such assignments typically relate to the provision of advice on tax issues, assistance in transactions involving the acquisition and disposal of businesses and accounting advice.
The Group has procedures that are designed to ensure auditor independence, including that fees for audit and non-audit services are approved in advance. This approval can be obtained either on an individual engagement basis or, for certain types of non-audit services, particularly those of a recurring nature, through the approval of a fee cap covering all engagements of that type provided the fee is below that cap. All statutory audit work as well as non-audit assignments where the fee is expected to exceed the relevant fee cap must be pre-approved by the Audit committee on an individual engagement basis. On a quarterly basis, the Audit committee receives a report detailing all preapproved services and amounts paid to the auditors for such pre-approved services.
Audits of the unconsolidated Open Ended investment companies managed by the Group 0.8 0.6 0.8
Lloyds Banking Group Annual Report and Accounts 2012242 note 13: investments in joint ventures and associates The Group’s share of results of and investments in joint ventures and associates comprises: Joint ventures Associates Total 2012 £m 2011 £m 2010 £m 2012 £m 2011 £m 2010 £m 2012 £m 2011 £m 2010 £m share of income statement amounts: Share of post-tax results 34 31 (39) (6) – (49) 28 31 (88)
The Group’s principal joint venture investment at 31 december 2012 was in sainsbury’s Bank plc; the Group owns 50 per cent of the ordinary share capital of sainsbury’s Bank plc, whose business is banking and principal area of operation is the uK. sainsbury’s Bank plc is incorporated in the uK and the Group’s interest is held by a subsidiary.
Lloyds Banking Group Annual Report and Accounts 2012244 note 14: Loss on disposal of businesses in 2010 during 2009, the Group acquired an oil drilling rig construction business through a previous lending relationship and consolidated the results and net assets of the business from the date it exercised control.
The Group extended vendor financing, on normal commercial terms and negotiated on an arms length basis, to seadrill to facilitate the acquisition of the rig holding companies. The loan is not contingent on the performance of the oil rigs under construction. Accordingly, at 31 december 2010, the subsidiaries were derecognised.
Adjustments in respect of prior years 58 (146) 310 double taxation relief – – 1
deferred tax on tax losses not previously recognised – 332 –
Basic loss per share (2.0)p (4.1)p (0.5)p diluted loss per share (2.0)p (4.1)p (0.5)p
Other financial assets at fair value through profit or loss include the following assets designated into that category: (i) financial assets backing insurance contracts and investment contracts of £127,907 million (2011: £118,890 million) which are so designated because the related liabilities either have cash flows that are contractually based on the performance of the assets or are contracts whose measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise arise; (ii) loans and advances to customers of £34 million (2011: £124 million) which are economically hedged by interest rate derivatives which are not in hedge accounting relationships and where significant measurement inconsistencies would otherwise arise if the related derivatives were treated as trading liabilities and the loans and advances were carried at amortised cost; and
– Equity derivatives are also used by the Group as part of its equity-based retail product activity to eliminate the Group’s exposure to fluctuations in various international stock exchange indices. index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.
Lloyds Banking Group Annual Report and Accounts 2012248 note 18: Derivative financial instruments (continued)
The embedded equity conversion feature of £1,421 million (2011: £1,172 million) reflects the value of the equity conversion feature contained in the Enhanced capital notes issued by the Group in 2009; the gain of £249 million arising from the change in fair value over 2012 (2011: loss of £5 million; 2010: loss of £620 million) is included within net gains on financial instruments held for trading within net trading income (note 7).
Hedged forecast cash flows expected to occur: Hedged forecast cash flows affect profit or loss: There were no transactions for which cash flow hedge accounting had to be ceased in 2012 or 2011 as a result of the highly probable cash flows no longer being expected to occur.
note 19: Loans and advances to banks £m £m lending to banks 591 1,810
The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to these arrangements and the carrying value of the notes in issue at 31 december, are listed below. The notes in issue are reported in note 36.
cash deposits of £19,691 million (2011: £20,435 million) held by the Group are restricted in use to repayment of the debt securities issued by the sPEs, the term advances relating to covered bonds and other legal obligations.
Other special purpose entities during 2009, the Group established lloyds TsB Pension ABcs (no 1) llP and lloyds TsB Pension ABcs (no 2) llP and transferred approximately £5 billion of assets, primarily comprising notes in certain of the Group’s securitisation programmes, in aggregate to these entities. Further details are provided in note 42.
note 23: Debt securities classified as loans and receivables debt securities accounted for as loans and receivables comprise: £m £m
charge to the income statement (note 12) 8,020 – 49 8,069
Recoveries of advances written off in previous years 843 – 15 858 unwinding of discount (374) – – (374)
Total £m debt securities: Other public sector securities – – – – 27 27
Total available-for-sale financial assets 539 30,835 31,374 1,623 35,783 37,406 details of the Group’s asset-backed conduits shown in the table above are included in note 22.
in addition, the following amounts have been recognised in the income statement: £m £m
The acquired value of in-force non-participating investment contracts includes £303 million (2011: £329 million) in relation to OEic business.
Movement in the value of in-force business taken to income statement (note 9) 269 (622)
Lloyds Banking Group Annual Report and Accounts 2012258 note 29: value of in-force business (continued)
capitalised software enhancements principally comprise identifiable and directly associated internal staff and other costs.
Premises equipment Operating lease assets Total tangible fixed assets £m £m £m £m cost: Exchange and other adjustments – (45) (22) (67)
Balance sheet amount at 31 december 2011 1,357 1,809 4,507 7,673
At 31 december the future minimum rentals receivable under non-cancellable operating leases were as follows: £m £m
Assets arising from reinsurance contracts held (note 37 and note 39) 2,320 2,534 deferred acquisition and origination costs (see below) 774 693 settlement balances 1,332 1,193 corporate pension asset 6,353 3,873 investments in joint ventures and associates (note 13) 313 334
included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting to £192 million (2011: £323 million).
Lloyds Banking Group Annual Report and Accounts 2012262 note 35: Trading and other financial liabilities at fair value through profit or loss £m £m liabilities held at fair value through profit or loss (debt securities) 5,700 5,339
Trading liabilities: liabilities in respect of securities sold under repurchase agreements 24,553 12,378 short positions in securities 2,200 3,701
Medium-term notes issued 29,537 63,366 covered bonds (note 21) 40,673 38,196 certificates of deposit issued 11,087 27,994 securitisation notes (note 21) 28,059 37,412 commercial paper 8,013 18,091
(i) Business description The Group has with-profit funds within scottish Widows plc and clerical Medical investment Group limited containing both insurance contracts and participating investment contracts.
(i) Business description The Group principally writes the following types of life insurance contracts within its non-profit funds. shareholder profits on these types of business arise from management fees and other policy charges.
German insurance business is written through the Group’s subsidiary Heidelberger leben and comprises policies similar to the uK definitions above, except that there is participation by the policyholder in the investment, insurance and expense profits of Heidelberger leben. A minimum level of policyholder participation is prescribed by German law. The following types of life insurance contracts are written: – Traditional and unit linked endowment or pensions business; and
Provisions for unearned premiums increase in the year 1,082 (52) 1,030
change in provision for unearned premiums charged to income statement (note 8) (70) – (70)
Exchange and other adjustments 4 (1) 3 increase in the year 1,081 (31) 1,050
change in provision for unearned premiums charged to income statement (note 8) (72) 7 (65)
Lloyds Banking Group Annual Report and Accounts 2012266 note 37: Liabilities arising from insurance contracts and participating investment contracts (continued)
Claims outstanding incurred but not reported 164 (11) 153 cash paid for claims settled in the year (485) – (485)
incurred but not reported 40 (1) 39 incurred but not reported 82 (1) 81
Estimate of ultimate claims costs: At end of accident year 211 208 317 205 639 609 446 421 3,056
Five years later 201 203 286 six years later 201 202 seven years later 200 current estimate in respect of above claims 200 202 286 186 487 497 366 421 2,645 current estimate of claims relating to general insurance business acquired in 2009 272 315 388 256 – – – – 1,231 current estimate of cumulative claims 472 517 674 442 487 497 366 421 3,876
The liability of £296 million shown in the above table excludes £13 million of unallocated claims handling expenses and £11 million of unexpired risk reserve.
Change in variable increase (reduction) in profit before tax £m increase (reduction) in equity £m
Exchange and other adjustments 1 – 1 changes in existing business 526 12 538
note 40: Unallocated surplus within insurance businesses The movement in the unallocated surplus within long-term insurance businesses over the year can be analysed as follows: £m £m change in unallocated surplus recognised in the income statement (note 10) (31) (340)
note 41: Other liabilities £m £m settlement balances 2,006 1,937 unitholders’ interest in Open Ended investment companies 20,935 18,249
Movements in the defined benefit obligation current service cost (360) (380)
The expected return on scheme assets has been calculated using the following assumptions: Equities and alternative assets 7.3 8.3
Fixed interest gilts 3.0 4.0 index linked gilts 2.8 3.9 non-government bonds 4.9 4.9
Fixed interest gilts 771 995 index linked gilts 6,429 6,211 non-government bonds 5,014 4,250
The assets of all the funded schemes are held independently of the Group’s assets in separate trustee administered funds.
Report of the independent auditors on the consolidated financial statements 204 Consolidated financial statements 206 Notes to the consolidated financial statements 214 Report of the independent auditors on the parent company financial statements 344 Parent company financial statements 345 Notes to the parent company financial statements 348 note 42: Retirement benefit obligations (continued)
during the year ended 31 december 2012 the charge to the income statement in respect of defined contribution schemes was £229 million (2011: £202 million; 2010: £173 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
Deferred tax (charge) credit in the income statement (562) 1,121 (671)
The proposed further reduction in the rate of corporation tax by 2 per cent to 21 per cent by 1 April 2014 is expected to be enacted during 2013. The effect of this further change upon the Group’s deferred tax balances and leasing business cannot be reliably estimated at this stage.
(Release) charge for the year (9) 3,575 650 2 58 4,276
Other regulatory matters in the course of its business, the Group is engaged in discussions with the FsA or other regulators in relation to a range of matters. in 2012 a provision of £100 million was made in respect of certain uK retail and other matters; however, the ultimate impact on the Group of these discussions can only be known at the conclusion of such discussions.
vacant leasehold property Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biannual basis and will normally run off over the period of under-recovery of the leases concerned, currently averaging three years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
Lloyds Banking Group Annual Report and Accounts 2012280 note 45: Subordinated liabilities £m £m
The movement in subordinated liabilities during the year was as follows: £m £m issued during the year 128 2,302
Total preference shares 1,385 1,216 a since 2004, the company has had in issue 400 6 per cent non-cumulative preference shares of 25p each. The shares, which are redeemable at the option of the company at any time, carry the rights to a fixed rate non-cumulative preferential dividend of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. upon winding up, the shares rank equally with any other preference shares issued by the company. The holder of the shares waived its right to payment for the period from 1 March 2010 to 1 March 2012.
7.375% undated subordinated Guaranteed Bonds (£200 million) (clerical Medical Finance plc) 37 36 5.625% cumulative callable Fixed to Floating Rate undated subordinated notes callable 2019 (£500 million) a 1 –
Floating Rate Primary capital notes (us$250 million) a, b 111 118
Total undated subordinated liabilities 1,927 1,949 a in november 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to 31 January 2012.
Dated subordinated liabilities subordinated step-up Floating Rate notes 2016 (e500 million) a 172 179 subordinated step-up Floating Rate notes 2016 (£300 million) a 184 184 callable Floating Rate subordinated notes 2016 (e500 million) a 96 88 callable Floating Rate subordinated notes 2016 (e500 million) a 137 124 subordinated callable notes 2016 (us$750 million) a 198 191 subordinated callable notes 2017 (e1,000 million) b 243 219 6.75% subordinated callable Fixed to Floating Rate instruments 2017 (Aus$200 million) d 6 5 subordinated callable Floating Rate instruments 2017 (Aus$400 million) b 38 38 5.109% callable Fixed to Floating Rate notes 2017 (can$500 million) e 8 8 subordinated callable notes 2017 (us$1,000 million) b 198 192 6.305% subordinated callable Fixed to Floating Rate notes 2017 (£500 million) f 21 22 5.50% subordinated Fixed Rate notes 2012 (e750 million) – 640 5.625% subordinated Fixed to Floating Rate notes due 2018 callable 2013 (e1,000 million) 858 902 4.25% subordinated Guaranteed notes 2013 (us$1,000 million) 619 636 6.45% Fixed to Floating subordinated Guaranteed Bonds 2023 (e400 million) (clerical Medical Finance plc) 181 176 5.875% subordinated Guaranteed Bonds 2014 (e750 million) 669 713 4.375% callable Fixed to Floating Rate subordinated notes 2019 (e750 million) 604 621 6.9625% callable subordinated Fixed to Floating Rate notes 2020 callable 2015 (£750 million) 716 725 11.875% subordinated Fixed to Fixed Rate notes 2021 callable 2016 (e1,147 million) 977 977 10.75% subordinated Fixed to Fixed Rate notes 2021 callable 2016 (£466 million) 477 467 9.875% subordinated Fixed to Fixed Rate notes 2021 callable 2016 (us$568 million) 360 368 10.125% subordinated Fixed to Fixed Rate notes 2021 callable 2016 (can$387 million) 240 246 13% subordinated Fixed to Fixed Rate notes 2021 callable 2016 (Aus$417 million) 280 276 6.75% subordinated Fixed Rate notes 2018 (us$2,000 million) 1,146 1,205 10.375% subordinated Fixed to Fixed Rate notes 2024 callable 2019 (e154 million) c 143 –
d The interest rate payable on this security was reset from 6.75 per cent fixed to Bank Bill swap Rate plus 0.76 per cent with effect from 1 May 2012.
(1) Authorised share capital As permitted by the companies Act 2006, the company removed references to authorised share capital from its articles of association at the annual general meeting on 5 June 2009. This change took effect from 1 October 2009.
(2) issued and fully paid share capital number of shares number of shares number of shares £m £m £m
Deferred shares of 15p each cancellation of deferred shares – – (27,242,603,417) – – (4,086)
On 5 november 2010 the company cancelled all of its deferred shares and an amount of £4,086 million was credited to the capital redemption reserve.
On 18 February 2010, the company issued 3,141 million ordinary shares as consideration for the redemption of certain preference shares and preferred securities. during May and June 2010, the company issued a further 1,158 million ordinary shares in relation to three separate exchanges for preference shares and other subordinated liabilities issued by the Group.
(3) Share capital and control There are no restrictions on the transfer of shares in the company other than as set out in the articles of association and: – certain restrictions which may from time to time be imposed by law and regulations (for example, insider trading laws); – pursuant to the uK listing Authority’s listing rules where directors and certain employees of the company require the approval of the company to deal in the company’s shares; and
Lloyds Banking Group Annual Report and Accounts 2012288 note 48: Other reserves £m £m £m
Revaluation reserve in respect of available-for-sale financial assets 399 1,326 (285)
Redemption of preference shares1 – – 3 in January 2010, the company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital redemption reserve and a transfer of £11 million from the merger reserve to the share premium account.
change in fair value of available-for-sale financial assets 779 2,603 1,231 income statement transfers: £m £m £m
Cash flow hedging reserve change in fair value of hedging derivatives 116 916 (1,048)
Total charge to the income statement 333 376 541 during the year ended 31 december 2012 the Group operated the following share-based payment schemes, all of which are equity settled.
Options granted to senior executives other than Executive directors were not so highly leveraged and, as a result, different performance multipliers were applied to their options. For the majority of executives, options were granted with the performance condition but with no performance multiplier.
– the full grant of options became exercisable only if the Group was ranked in the top four places of the comparator group. A sliding scale applied between fourth and eighth positions. if lloyds Banking Group was ranked below the median (ninth or below) the options would lapse.
Movements in the number of share options outstanding under the sAYE schemes are set out below: number of options
For the HBOs sharesave plan, no options were exercised during 2012 or 2011. The options outstanding at 31 december 2012 had an exercise price of £1.8066 (2011: £1.8066) and a weighted average remaining contractual life of 2.1 years (2011: 2.0 years).
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 and as such were not subject to any performance conditions. The Plan’s usage has now been extended to not only compensate new recruits for any lost share awards but also to make grants to key individuals for retention purposes with, in some instances, the grant being made subject to individual performance conditions.
HBOS share option plans The table below details the outstanding options for the HBOs share Option Plan and the st James’s Place share Option Plan. The final award under the HBOs share Option Plan was made in 2004. under this plan, options over shares, at market value with a face value equal to 20 per cent of salary, were granted to employees with the exception of certain senior executives. A separate option plan exists for some partners of st James’s Place, which granted options in respect of lloyds Banking Group plc shares. The final award under the st James’s Place share Option Plan was made in 2009. Movements in the number of share options outstanding under these schemes are set out below: Participants are not entitled to any dividends paid during the vesting period.
(ii) economic Profit (eP): relevant to 50 per cent of the award. Performance was measured based on the extent to which cumulative EP targets were achieved over the three-year period.
The performance conditions were met and, as a consequence, the share awards vested in full in March 2012 for all participants, with the exception of current and former Executive directors.
The performance conditions for awards made in March and August 2010 were as follows: (i) ePS: relevant to 50 per cent of the award. Performance was measured based on EPs growth over a three-year period from the baseline EPs of 2009.
if the absolute improvement in adjusted EPs reached 158 per cent, 25 per cent of this element of the award, being the threshold, would vest. if absolute improvement in adjusted EPs reached 180 per cent, 100 per cent of this element would vest.
(ii) eP: relevant to 50 per cent of the award. Performance was measured based on the compound annual growth rate of adjusted EP over the three financial years starting on 1 January 2010 relative to an adjusted 2009 EP base.
if the adjusted EPs reaches 6.4p, 25 per cent of this element of the award, being the threshold, will vest.
For awards made to Executive directors, a third performance condition was set, relating to Absolute Total shareholder Return, relevant to one third of the award. Performance will be measured based on the annualised Absolute Total shareholder Return over the three year performance period. if the annualised Absolute Total shareholder Return at the end of the performance period is less than 8 per cent, none of this element of the award will vest. if the Absolute Total shareholder Return is 8 per cent, 25 per cent of this element of the award, being the threshold, will vest. if the Absolute Total shareholder Return is 14 per cent or higher, 100 per cent of this element will vest. Vesting between threshold and maximum will be on a straight line basis. The EPs and EP performance conditions will each relate to 33.3 per cent of the total award.
if the adjusted EP reaches £1,653 million, 100 per cent of this element will vest.
if non-core assets amount to £80 billion or less, 100 per cent of this element will vest.
if complaints per 1,000 customers average 1.3 per annum or less over three years, 100 per cent of this element will vest.
The weighted average fair value of the share awards granted in 2012 was £0.24 (2011: £0.54). The fair values of the majority of share awards granted have been determined using a standard Black-scholes model. The fair values of the remaining share awards have been determined by Monte carlo simulation.
The fair value of the share awards granted in 2012 was £0.27. The fair values of share awards granted have been determined using a standard Black-scholes model.
The fair value calculations at 31 december 2012 for grants made in the year, using Black-scholes models and Monte carlo simulation, are based on the following assumptions: executive Share Plan 2003 LTiP Share Buy
The number of shares awarded relating to matching shares in 2012 was 36,158,343 (2011: 30,999,387), with an average fair value of £0.34 (2011: £0.42), based on market prices at the date of award.
Granted, including certain adjustments1 (includes entitlements of appointed key management personnel) 8 20 4
Exercised/lapsed (includes entitlements of former key management personnel) (5) (4) –
Exercised/lapsed (includes entitlements of former key management personnel) (33) (33) (2)
2010 includes adjustments, using a standard HMRc formula, to negate the dilutionary impact of the Group’s 2009 capital raising activities.
Repayments (includes loans of former key management personnel) (4) (1) (1)
Placed (includes deposits of appointed key management personnel) 39 17 12
Credit guarantee scheme HM Treasury launched the credit Guarantee scheme in October 2008. The drawdown window for the credit Guarantee scheme closed for new issuance at the end of February 2010. At 31 december 2011, the Group had £23.5 billion of debt in issue under the credit Guarantee scheme but this was all repaid during 2012. during the year ended 31 december 2012, fees of £59 million paid to HM Treasury in respect of guaranteed funding were included in the Group’s income statement (2011: £291 million).
national Loan Guarantee Scheme The Group is participating in the uK Government’s national loan Guarantee scheme, which was launched on 20 March 2012. Through the scheme, the Group is providing eligible uK businesses with discounted funding, subject to continuation of the scheme and its financial benefits, and based on the Group’s existing lending criteria. Eligible businesses who take up the funding benefit from a 1 per cent discount on their funding rate for a certain period of time.
Business Growth Fund in May 2011 the Group agreed, together with The Royal Bank of scotland plc (and three other non-related parties), to commit up to £300 million of equity investment by subscribing for shares in the Business Growth Fund plc which is the company created to fulfil the role of the Business Growth Fund as set out in the British Bankers’ Association’s Business Taskforce Report of October 2010. At 31 december 2012, the Group had invested £50 million (2011: £20 million) in the Business Growth Fund and carried the investment at a fair value of £44 million (2011: £16 million).
in addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 december 2012, these companies had total assets of approximately £10,759 million (2011: £11,500 million), total liabilities of approximately £10,956 million (2011: £10,807 million) and for the year ended 31 december 2012 had turnover of approximately £8,169 million (2011: £7,376 million) and made a net loss of approximately £488 million (2011: net loss of £83 million). in addition, the Group has provided £5,146 million (2011: £5,767 million) of financing to these companies on which it received £208 million (2011: £106 million) of interest income in the year.
Lloyds Banking Group Annual Report and Accounts 2012302 note 53: Contingent liabilities and commitments (continued)
Trading and other financial liabilities at fair value through profit or loss – 30,272 5,700 – – – – 35,972 notes in circulation – – – – – 1,198 – 1,198 debt securities in issue – – – – – 117,369 – 117,369 liabilities arising from insurance contracts and participating investment contracts – – – – – – 82,953 82,953 liabilities arising from non-participating investment contracts – – – – – – 54,372 54,372 unallocated surplus within insurance businesses – – – – – – 267 267 subordinated liabilities – – – – – 34,092 – 34,092
Trading and other financial assets at fair value through profit or loss – 18,056 121,454 – – – – 139,510 derivative financial instruments 12,850 53,163 – – – – – 66,013 loans and receivables: loans and advances to banks – – – – 32,606 – – 32,606 loans and advances to customers – – – – 565,638 – – 565,638 debt securities – – – – 12,470 – – 12,470
Financial guarantees – – 49 – – – – 49 subordinated liabilities – – – – – 35,089 – 35,089
From available-for-sale financial assets to held-to-maturity investments – – 3,624 3,846 3,455 3,539 – – – –
Total carrying value and fair value 5,171 5,210 3,908 4,121 4,518 4,606 2,227 2,244 3,337 3,328 during the year ended 31 december 2012, the carrying value of assets reclassified to loans and receivables decreased by £111 million due to sales and maturities of £137 million and foreign exchange and other movements of £4 million less accretion of discount of £30 million.
no financial assets have been reclassified in accordance with paragraphs 50B, 50d or 50E of iAs 39 since 2008; the following disclosures relate to those assets which were so reclassified in 2008.
valuation methodology Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
Model validation covers both qualitative and quantitative elements relating to new models. in respect of new products, a product implementation review is conducted pre- and post-trading. Pre-trade testing ensures that the new model is integrated into the Group’s systems and that the profit and loss and risk reporting are consistent throughout the trade life cycle. Post-trade testing examines the explanatory power of the implemented model, actively monitoring model parameters and comparing in-house pricing to external sources. independent price verification procedures cover financial instruments carried at fair value. The frequency of the review is matched to the availability of independent data, monthly being the minimum. Valuation differences in breach of established thresholds are escalated to senior management. The results from independent pricing and valuation reserves are reviewed monthly by senior management.
Formal committees, consisting of senior risk, finance and business management, meet at least quarterly to discuss and approve valuations in more judgemental areas, in particular for unquoted equities, structured credit, over-the-counter options and the credit Valuation Adjustment (cVA) reserve.
Trading and other financial liabilities at fair value through profit or loss liabilities held at fair value through profit or loss (debt securities) – 5,700 – 5,700
Total trading and other financial liabilities at fair value through profit or loss 1,865 34,107 – 35,972
Total financial liabilities carried at fair value 1,901 82,193 591 84,685
Trading and other financial assets at fair value through profit or loss loans and advances to customers – 9,766 – 9,766 loans and advances to banks – 1,355 – 1,355 debt securities: Other public sector securities 375 808 – 1,183
Equity investments (including venture capital) unlisted equities and fund investments are accounted for as trading and other financial assets at fair value through profit or loss or as availablefor -sale financial assets. These investments are valued using different techniques as a result of the variety of investments across the portfolio in accordance with the Group’s valuation policy and are calculated using international Private Equity and Venture capital Guidelines.
– credit derivatives which are valued using standard models with observable inputs, except for the items classified as level 3, which are valued using publicly available yield and credit default swap (cds) curves.
Gains (losses) recognised in the income statement 166 (356) (335) (525)
Earnings, net asset value and earnings multiples, forecast cash flows unlisted equities and property partnerships in the life funds
Venture capital and equity investments Third party valuers have been used to determine the value of unlisted equities and property partnerships included in the Group’s life insurance funds.
– in line with international Private Equity and Venture capital Guidelines, the values of underlying investments in fund investments portfolios.
(i) Uncollateralised derivative valuation adjustments, excluding monoline counterparties The following table summarises the movement on this valuation adjustment account during 2012 and 2011: 2012 £m 2011 £m income statement (credit) charge (209) 718
Funding Valuation Adjustment 143 294 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.
A cVA is taken where the Group has a positive future uncollateralised exposure (asset). A dVA is taken where the Group has a negative future uncollateralised exposure (liability). These adjustments reflect interest rates and expectations of counterparty creditworthiness and the Group’s own credit spread respectively.
(iv) Libor/Overnight Index Swap basis The Group’s derivative trading business applies £74 million (31 december 2011: £74 million) of valuation adjustments against the changing market approach to valuing derivatives that are subject to daily collateral margin, where standard market practice is to pay interest on an Overnight index swap basis rather than a libor rate.
As set out in note 21, included within loans and receivables are loans securitised under the Group’s securitisation programmes. The Group retains all or a majority of the risks and rewards associated with these loans and they are retained on the Group’s balance sheet. Assets transferred into the Group’s securitisation programmes are not available to be used by the Group during the term of those arrangements.
Amount represents the carrying amount of the asset plus undrawn commitments of £30 million.
Market risk The Group uses various market risk measures for risk reporting and setting risk appetite limits and triggers. These measures include Value at Risk and stress scenarios.
The Group establishes two types of hedge accounting relationships for interest rate risk: fair value hedges and cash flow hedges. 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 majority of the Group’s hedge accounting relationships are fair value hedges where interest rate swaps are used to hedge the interest rate risk inherent in the fixed rate capital issuances.
At 31 december 2012 the aggregate notional principal of interest rate swaps designated as fair value hedges was £135,516 million (2011: £93,215 million) with a net fair value asset of £4,246 million (2011: asset of £5,484 million) (note 18). The gains on the hedging instruments were £572 million (2011: gains of £1,982 million). The losses on the hedged items attributable to the hedged risk were £560 million (2011: losses of £1,999 million).
in addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. note 18 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional principal of the interest rate swaps designated as cash flow hedges at 31 december 2012 was £86,190 million (2011: £152,314 million) with a net fair value asset of £215 million (2011: liability of £358 million) (note 18). in 2012, ineffectiveness recognised in the income statement that arises from cash flow hedges was a gain of £6 million (2011: loss of £13 million).
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in london. Associated VaR and the closing, average, maximum and minimum are disclosed on page 171.
Japanese yen: Gross exposure 19 20 net investment hedge (19) –
£m £m loans and receivables: loans and advances to banks, net1 29,417 32,606 loans and advances to customers, net1 517,225 565,638 debt securities, net1 5,273 12,470 deposit amounts available for offset2 (5,728) (4,174)
Lloyds Banking Group Annual Report and Accounts 2012320 note 55: Financial risk management (continued)
Lloyds Banking Group Annual Report and Accounts 2012322 note 55: Financial risk management (continued)
Asset-backed securities: corporate and other debt securities 150 – 67 – – 320 537
At 31 December 2012 debt securities: Other public sector securities – – – – – – –
At 31 december 2011 debt securities: Other public sector securities – – – – – 27 27
Bank and building society certificates of deposit 81 177 71 37 – – 366
Lloyds Banking Group Annual Report and Accounts 2012324 note 55: Financial risk management (continued)
Total debt securities held as trading assets 2,380 1,479 1,939 631 152 179 6,760
Asset-backed securities: corporate and other debt securities 3,415 2,111 6,197 5,195 1,199 2,165 20,282
unimpaired non-mortgage retail lending amounted to £42,145 million (2011: £42,541 million). lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. collateral values are rigorously assessed at the time of loan origination and are thereafter monitored in accordance with business unit credit policy.
For unimpaired secured wholesale lending, the Group reports assets gross of collateral and therefore discloses the maximum loss exposure. The Group believes that this approach is appropriate as collateral values at origination and during a period of good performance may not be representative of the value of collateral if the obligor enters a distressed state.
Trading and other financial assets at fair value through profit or loss (excluding equity shares) in respect of trading and other financial assets at fair value through profit or loss, the fair value of collateral accepted under reverse repurchase transactions which are accounted for as collateralised loans that the Group is permitted by contract or custom to sell or repledge was £19,629 million (2011: £15,765 million). Of this, £15,640 million was sold or repledged (2011: £3,740 million).
Derivative assets, after offsetting of amounts under master netting arrangements The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. in respect of the net derivative assets after offsetting of amounts under master netting arrangements of £18,392 million (2011: £19,395 million), cash collateral of £5,429 million (2011: £5,269 million) was held.
The Group operates a number of schemes to assist borrowers who are experiencing financial stress. The material elements of these schemes are described in the Risk Management report on pages 135 to 137 and further details relating to those cases where the Group has granted a concession, whether temporarily or permanently, are set out below.
Reduced contractual monthly payment – Payment assistance break These agreements allow customers to suspend monthly payments for a limited period in order to address short-term financial difficulties. This treatment is only available as a forbearance tool to customers who are less than one monthly payment in arrears and for a maximum period of three months during the term of the mortgage.