– Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available interest rate cap, interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more complex option products, the Group calibrates its models using observable at‑the‑money data; where necessary, the Group adjusts for out‑of‑the‑money positions using a market standard consensus pricing service.
Transfers out of the level 3 portfolio (738) (296) (66) (1,100)
Transfers out of the level 3 portfolio (128) (384) (48) (560)
Losses recognised in other comprehensive income relating to those assets held at 31 December 2011 – (132) – (132)
Lead manager or broker quote/ consensus pricing from market data provider
The valuation techniques used for unlisted equities and venture capital investments vary depending on the nature of the investment, as described in the valuation methodology section above. Reasonably possible alternative valuations for these investments have been calculated by reference to the relevant approach taken as appropriate to the business sector and investment circumstances and as such the following inputs have been considered: – for valuations derived from earnings multiples, consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting an appropriate multiple; – the discount rates used in discounted cash flow valuations; and
Derivative valuation adjustments Derivative financial instruments which are carried in the balance sheet at fair value are adjusted where appropriate to reflect credit risk, market liquidity and other risks.
(ii) Uncollateralised derivative valuation adjustments – monoline counterparties The Group has no significant derivative exposures remaining against monoline counterparties as shown in note 56 Credit risk.
(iii) Market liquidity The Group includes mid to bid‑offer valuation adjustments against the expected cost of closing out the net market risk in the Group’s trading positions within a timeframe that is consistent with historical trading activity and spreads that the trading desks have accessed historically during the ordinary course of business in normal market conditions.
At 31 December 2011, the own credit adjustment arising from the fair valuation of £5,339 million (31 December 2010: £6,665 million) of the Group’s debt securities in issue designated at fair value through profit or loss resulted in a gain of £194 million (2010: no gain or loss).
Repurchase and securities lending transactions The Group enters into repurchase and securities lending transactions in the normal course of business that do not result in derecognition of the financial assets concerned. The carrying value of financial assets transferred under such arrangements, that did not qualify for derecognition, and their associated liabilities are as follows: Carrying value of transferred assets £m
Debt securities classified as loans and receivables 5,045 4,326 1,386 1,043
Securitisations and covered bonds Details about the Group’s securitisation and covered bond programmes, which may also result in financial assets not being derecognised in full, are provided in note 22.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; liquidity risk; capital risk; and insurance risk. Information about the Group’s exposure to each of the above risks and capital can be found on pages 99 to 170. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.
The Group establishes 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 mortgage portfolio.
At 31 December 2011 the aggregate notional principal of interest rate swaps designated as fair value hedges was £93,215 million (2010: £75,831 million) with a net fair value asset of £5,484 million (2010: asset of £3,166 million) (note 19). The gains on the hedging instruments were £1,982 million (2010: gains of £280 million). The losses on the hedged items attributable to the hedged risk were £1,999 million (2010: losses of £452 million).
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using currency borrowings and cross currency derivatives. At 31 December 2011 the aggregate notional principal of these currency borrowings was £2,245 million; the aggregate notional principal of the cross currency derivatives was £49 million (2010: cross currency derivatives £86 million) with a fair value liability of £1 million (2010: asset of £2 million) and they were designated on an after‑tax basis as hedges of net investments in foreign operations. In 2011, an ineffectiveness gain of £23 million before tax and £17 million after tax (2010: ineffectiveness loss of £28 million before tax and £20 million after tax) was recognised in the income statement arising from net investment hedges.
Total structural foreign currency exposures, after net investment hedges 167 (742)
Loans and receivables: Loans and advances to banks, net1 32,606 30,272
Past due but not impaired – 13,215 1,289 3,427 17,931 –
Impaired – no provision required – 2,189 433 5,313 7,935 –
The table below sets out the reconciliation of the allowance for impairment losses of £18,732 million (31 December 2010: £18,373 million) shown in note 25 to the allowance for impairment losses on a combined businesses basis of £27,718 million (31 December 2010: £29,635 million) shown above: 2011 £m
Asset‑backed securities: Corporate and other debt securities 163 164 459 106 166 758 1,816
Trading assets: Bank and building society certificates of deposit – 1,147 1,574 142 – – 2,863
Total other assets held at fair value through profit or loss 22,504 3,881 8,286 6,395 1,907 2,620 45,593
Debt securities, treasury and other bills held at fair value through profit or loss Trading assets: Bank and building society certificates of deposit – 3,086 506 100 – – 3,692
Total debt securities held as trading assets 2,047 5,816 2,541 367 13 470 11,254
Asset‑backed securities: Corporate and other debt securities 3,870 1,619 4,397 3,269 1,275 1,760 16,190
Total held at fair value through profit or loss 28,032 9,165 8,367 4,078 1,364 2,421 53,427
Derivative assets An analysis of derivative assets is given in note 19. 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 Group's maximum credit risk relating to derivative assets of £19,395 million (2010: £19,037 million), cash collateral of £5,269 million (2010: £1,429 million) was held and a further £7,875 million was due from OECD banks (2010: £8,385 million).
Loans and advances to banks The Group may require collateral before entering into a credit commitment with another bank, depending on the type of financial product and the counterparty involved, and netting arrangements are obtained whenever possible and to the extent that such agreements are legally enforceable. Collateral is held as part of reverse repurchase or securities borrowing transactions.
The majority of non‑mortgage retail lending is unsecured. At 31 December 2011, total non‑mortgage lending amounted to £47,085 million (2010: £51,929 million), against which the Group held an impairment allowance of £1,848 million (2010: £2,587 million). Gross impaired non‑mortgage lending amounted to £4,544 million (2010: £5,582 million). The fair value of the collateral held in respect of this lending was £43 million (2010: £40 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation and the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over‑collateralisation and to provide a clearer representation of the Group’s exposure.
The Group credit risk disclosures for unimpaired non‑mortgage retail lending report assets gross of collateral and therefore disclose the maximum loss exposure. The Group believes that this approach is appropriate. The value of collateral is reassessed if there is observable evidence of distress of the borrower. Unimpaired non‑mortgage retail lending, including any associated collateral, is managed on a customer‑by‑customer basis rather than a portfolio basis. No aggregated collateral information for the entire unimpaired non‑mortgage retail lending portfolio is provided to key management personnel.
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 £19,395 million (2010: £19,037 million), cash collateral of £5,269 million (2010: £1,429 million) was held.
The fair value of collateral pledged in respect of repurchase transactions, accounted for as secured borrowings, where the secured party is permitted by contract or custom to repledge was £39,679 million (2010: £53,781 million). In addition, the following financial assets on the balance sheet have been pledged as collateral as part of securities lending transactions: Assets pledged £m £m
The Group operates a number of schemes to assist borrowers who are experiencing financial difficulties. Details of the material elements of these schemes are set out below and in the Risk Management report on pages 132 to 134.
– 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.
Treatments offered to Irish retail secured customers in financial difficulty While the treatments offered to mortgage customers in financial difficulty in the UK and in Ireland are broadly similar, the current period of economic distress in Ireland and resultant regulatory Code of Conduct on Mortgage Arrears have resulted in an environment of ongoing assistance to customers, with greater flexibility within policy as to the duration and frequency of treatments. Care is taken to keep customers informed of their position and their circumstances are regularly reviewed; at least every six months.
The performance of such models is monitored and challenged on an ongoing basis, in line with the Group’s model governance policies. The models are also regularly recalibrated to reflect up to date customer behaviour and market conditions. Specifically, regular detailed analysis of modelled provision outputs is undertaken to demonstrate that the risk of forbearance or other similar activities is recognised, that the outcome period adequately captures the risk and that the underlying risk is appropriately reflected. Where this is not the case, additional provisions are applied to capture the risk.
Covenant resets and breach of covenant waivers This consists of an agreement by the Group either to amend a clause in a loan agreement (or similar document) or to waive a breach of a clause, which will typically relate to a financial commitment linked to the credit quality of the customer. The identification of a covenant breach will usually occur through one of the following: – the processing of audited or management accounts; – contact from the customer during preparation of their compliance certificate; – the receipt of customer information from which covenant compliance is calculated; or
Prior to allowing the transfer, the Group undertakes a full financial review to confirm the customer’s financial difficulty and ability to maintain the revised level of repayment. The aim of this activity is to manage customers through their temporary financial distress, and accordingly, on expiry of the break, the customer is transferred back onto capital and interest repayment terms, with the outstanding balance recovered across the remaining term of the original loan.
and interest) burden on the borrower, to encourage early repayment of outstanding loans to the Group, to protect the value of the residual debt provided, and/or to benefit from any future growth in value of the borrower. Debt for equity swaps are typically used as a last resort.
The exposure to monolines arising from negative basis trades is calculated as the mark‑to‑market of the CDS protection purchased from the monoline insurer after credit valuation adjustments. The exposure to monolines on wrapped loans and receivables and bonds is the internal assessment of amounts that will be recovered on interest and principal shortfalls.
Mortgage‑backed securities: US residential mortgage‑backed securities: Sub‑prime – – – – – – – –
Collateralised debt obligations: Federal family education loan programme 3,526 3,419 107 – – – – –
Liquidity risk Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost. The Group carries out monthly stress testing of its liquidity position against a range of scenarios, including those prescribed by the FSA. The Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
Loans and advances to banks 22,520 2,754 2,550 1,529 919 30,272
Trading and other financial liabilities at fair value through profit or loss 11,293 2,218 5,125 5,544 3,632 27,812
The majority of the Group’s non‑participating investment contract liabilities are unit‑linked. These unit‑linked products are invested in accordance with unit fund mandates. Clauses are included in policyholder contracts to permit the deferral of sales, where necessary, so that linked assets can be realised without being a forced seller.
Included within cash and cash equivalents at 31 December 2011 is £21,601 million (2010: £14,694 million; 2009:£13,323 million) held within the Group’s life funds, which is not immediately available for use in the business.
Acquisition of and additional investment in joint ventures (10) (65) (215)
This report, including the opinions, has been prepared for and only for the Company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
– have been prepared in accordance with the requirements of the Companies Act 2006.
Opinion on other matters prescribed by the Companies Act 2006 In our opinion: – the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and
Matters on which we are required to report by exception We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: – adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or
Cash and cash equivalents at beginning of year 375 2,837 1,201
Cash and cash equivalents at end of year 1,105 375 2,837
The accounting policies of the Company are the same as those of the Group which are set out in note 2 to the consolidated financial statements, except that it has no policy in respect of consolidation and investments in subsidiaries are carried at historical cost, less any provisions for impairment.
Note 5: Other reserves The merger reserve comprises the premium on shares issued on 13 January 2009 under the placing and open offer and shares issued on 16 January 2009 on the acquisition of HBOS plc.
Note 7: Subordinated liabilities These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer. Any repayments of subordinated liabilities require the consent of the Financial Services Authority.
7.875% Non-Cumulative Preference Shares callable 2013 (US$1,250 million) a 170 119 7.875% Non-Cumulative Preference Shares callable 2013 (e500 million) a 83 57 6.0884% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2015 (£745 million) a 10 9 5.92% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2015 (US$750 million) a 124 110 6.267% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2016 (US$1,000 million) a 306 279 6.3673% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2019 (£335 million) a 2 2 6.475% Non-Cumulative Preference Shares callable 2024 (£186 million) a 38 34 6.413% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2035 (US$750 million) a 114 98 6.657% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2037 (US$750 million) a 131 115 9.25% Non-Cumulative Irredeemable Preference Shares (£300 million) a 266 239 9.75% Non-Cumulative Irredeemable Preference Shares (£100 million) a 54 49
Total subordinated liabilities 4,308 4,074 a Further information regarding these issues can be found in note 46 to the consolidated financial statements.
In addition the Company carried out banking activities through its subsidiary, Lloyds TSB Bank plc. At 31 December 2011, the Company held deposits of £1,105 million with Lloyds TSB Bank plc (2010: £375 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. Included within subordinated liabilities is £2,287 million (2010: £2,073 million) and within other liabilities is £10,261 million (2010: £7,988 million) due to subsidiary undertakings. In addition, at 31 December 2011 the Company had interest rate and currency swaps with Lloyds TSB Bank plc with an aggregate notional principal amount of £2,338 million and a net positive fair value of £1,660 million (2010: notional principal amount of £2,504 million and a net positive fair value of £1,664 million), of which contracts with an aggregate notional principal amount of £1,349 million and a net positive fair value of £314 million (2010: notional principal amount of £1,754 million and a net positive fair value of £330 million) were designated as fair value hedges to manage the Company’s issuance of subordinated liabilities and debt securities in issue.
Financial assets: Cash and cash equivalents – – – 375 375
Credit risk The majority of the Company’s credit risk arises from amounts due from its wholly owned subsidiary, Lloyds TSB Bank plc, and subsidiaries of that company.
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £303 million (2010: £302 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years.
Note 11: Approval of the financial statements and other information The parent company financial statements were approved by the directors of Lloyds Banking Group plc on 27 February 2012.
Shareholder enquiries The Company’s share register and the Lloyds Banking Group Shareholder Account are maintained by Equiniti Limited. Contact them using the details below if you have enquiries about your shareholding, including: – Change of name or address
Equiniti Limited Aspect House Spencer Road Lancing West Sussex BN99 6DA
Calls to 0871 numbers are charged at 8p per minute from a BT landline. The price of calls from mobiles and other networks may vary. Calls from outside the United Kingdom are charged at applicable international rates. The call prices we have quoted were correct in February 2012.
Internet services are available 24/7 and telephone services are available between 8.00am and 9.15pm, Monday to Friday, and 9.00am to 1.00pm, Saturday. To open a Halifax Share Dealing Account you must be 18 years of age or over and be resident in the UK, Jersey, Guernsey or the Isle of Man.
Shareholders in the Lloyds Banking Group Shareholder Account can only trade by telephone through the Halifax Share Dealing Service.
Basel III The capital reforms and introduction of a global liquidity standard proposed by the Basel Committee on Banking Supervision in 2010 and due to be phased in from 1 January 2013 onwards.
Commercial Mortgage-Backed Securities are securities that represent interests in a pool of commercial mortgages. Investors in these securities have the right to cash received from mortgage repayments of interest and principal. Further information on the Group’s investment in CMBS is given in note 56.
Conduits A financial vehicle that holds asset-backed securities which are financed with short-term deposits (generally commercial paper) that use the asset-backed securities as collateral. The conduit will often have a liquidity line provided by a bank that it can draw down on in the event that it is unable to issue funding to the market. The Group sponsors three asset-backed conduits, Argento, Cancara and Grampian. Further details are provided in note 23.
Core tier 1 capital As defined by the FSA mainly comprising shareholders’ equity and equity non-controlling interests after deducting goodwill, other intangible assets and other regulatory deductions. Further details are given in the Capital Risk section on page 118.
Core tier 1 ratio Core tier 1 capital as a percentage of risk weighted assets.
Exposure at Default An estimate of the amount expected to be owed by a customer at the time of the customer’s default.
Guaranteed mortgages Mortgages for which there is a guarantor to provide the lender a certain level of financial security in the event of default of the borrower.
Impairment is measured individually for assets that are individually significant, and collectively where a portfolio comprises homogenous assets and where appropriate statistical techniques are available.
Credit enhancement facilities are used to enhance the creditworthiness of financial obligations and cover losses due to asset default. Two general types of credit enhancement are third-party loan guarantees (such as guaranteed mortgages) and self-enhancement through overcollateralisation (in the case of covered mortgage bonds). Liquidity enhancement makes funds available if required, for other reasons than asset default, eg to ensure timely repayment of maturing commercial paper.
Medium Term Notes Medium term notes are a form of corporate borrowing covering maturity periods ranging from nine months to 30 years. Details of the notes issued under the Group’s medium term notes programmes are given in note 37.
Shareholders' equity divided by the number of ordinary shares and limited voting ordinary shares in issue, adjusted to exclude shares held under certain employee share ownership plans.
Student loan related assets Assets which are referenced to underlying student loans (see note 56).
Subordinated liabilities Liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer. Details of the Group’s subordinated liabilities are set out in note 46.
Sub-Prime Sub-prime is defined as loans to borrowers typically having weakened credit histories that include payment delinquencies and potentially more severe problems such as court judgements and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, high debt-to-income ratios, or other criteria indicating heightened risk of default.
Tier 2 capital A component of regulatory capital defined by the FSA, mainly comprising qualifying subordinated loan capital, certain non-controlling interests and eligible collective impairment allowances. Further details are given in the Capital Risk section on page 118.