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Becoming simpler and more efficient We are creating operational capability which is simpler and more efficient than today through further system enhancement and integration and are becoming more responsive to changing customer expectations while maintaining our cost leadership amongst UK high street banks. This cost leadership enables us to provide increased value to our customers and competitive differentiation.
IT resilience and digital transformation There is an ever increasing understanding of the criticality of technology in delivering customer service. During the year, the Board spent considerable time reviewing the delivery of the three-year IT resilience investment and digital transformation programmes. You can read more on page 65.
Read more on governance in the corporate governance report or online at www.lloydsbankinggroup.com
In terms of responsibilities, the Committee oversees: – the expression, measurement, communication and maintenance of our culture and values; – the design and development of the Responsible Business Plan and the Helping Britain Prosper Plan, the measurement of performance against such plans and their internal and external communication; – the development of policies relating to the responsible treatment of customers and their implementation, including measurement of trust, customer satisfaction and advocacy. This includes policies for access and inclusion and responsible lending including our customer vulnerability agenda; – our engagement with communities and charitable and philanthropic activities; – our approach to the control of our environmental impact, including measurement and internal and external reporting; – the policies relating to the responsible treatment of employees and their implementation, including inclusion and diversity, and our codes of responsibility; and – the engagement of employees in relation to the Group’s Responsible Business Plan.
More information on these changes as well as an overview of our approach to culture and values can be found in our corporate governance report on page 60.
In line with its broader aim of creating a safer and more stable UK banking sector, in December the Financial Policy Committee clarified its views on the future capital requirements for the industry. Importantly, these views for the industry as a whole are broadly consistent with the amount of capital we wish to retain to grow the business, meet regulatory requirements and cover uncertainties. This, in turn, supports the Group’s expectation to be able to distribute a significant proportion of the capital it generates going forward. Finally, we welcome the decision of the FCA to consult on a deadline for PPI complaints and the certainty that this will bring for both customers and shareholders.
Financial performance and balance sheet strength The Group has delivered another robust financial performance in the year, with underlying profit increasing by 5 per cent to £8,112 million, or by 10 per cent excluding TSB, leading to an improvement in our underlying return on required equity to 15.0 per cent. This improvement was driven by net interest income, reflecting the strengthening of our net interest margin, lower operating costs and a significant reduction in impairment charges, which more than offset the more subdued outturn for other income. Statutory profit before tax was 7 per cent lower at £1,644 million, after additional charges that we have taken for PPI.
During the year, we have continued to strengthen our balance sheet, with our strong capital generation enabling us to increase our common equity tier 1 (CET1) ratio to 13.0 per cent, after increased dividend payments. This and our other capital and leverage ratios remain among the strongest of our major banking peers worldwide, in turn positioning us well for evolving regulatory capital requirements. In addition, the Group’s liquidity position remains strong, with our total wholesale funding of £120 billion at the end of 2015 more than covered by our liquid assets of £123 billion.
In addition, the Board has recommended a special dividend of 0.5 pence per share, representing the distribution of surplus capital over and above the Board’s view of the current level of capital required to grow the business, meet regulatory requirements and cover uncertainties.
Helping Britain Prosper and delivering growth in our key customer segments As a customer-focused UK centric bank, our prospects are inextricably linked to the strength of the UK economy, which we continue to support through our strategic net lending targets in our key customer segments and the targets we have set through our Helping Britain Prosper Plan.
We continue to successfully deliver against our Helping Britain Prosper Plan targets to people, businesses and communities across the UK. Amongst these targets, in 2015 we donated £17 million to the Banks’ four independent charitable foundations to tackle disadvantage, while also providing more than £1 million of additional funding to support credit unions and more than 320,000 colleague volunteering hours to support community projects.
Building the best team We recognise the strategic importance of colleague engagement and the role that this plays in ensuring the continued delivery of our strategic priorities. The latest colleague survey results show that colleague engagement has continued to improve to the highest level to date and that our performance excellence score is above the UK ‘high performance norm’. We have also made good progress with our target for gender diversity in senior management, with women now representing 31 per cent of senior managers, up from 28 per cent two years ago. These encouraging results demonstrate the Group’s success in embedding a customer-focused culture and that our colleagues are committed to our aim of creating the best experience for our customers.
Outlook Our strong strategic progress and good financial performance position the Group well for future success, with our business model allowing us to respond effectively to the challenges of the lower for longer interest rate environment and the current market volatility. We remain committed to our financial targets for return on required equity and cost:income ratio, although in light of the implementation of the corporation tax surcharge for banks and the lower for longer interest rate environment, we now expect to deliver a return on required equity of 13.5 to 15.0 per cent in 2018 and a cost:income ratio of around 45 per cent as we exit 2019, with improvements every year. Our capital generation will remain strong and we are increasing our guidance for annual pre dividend CET1 capital generation to around 2 per cent. In 2016, we expect an increased net interest margin of around 2.70 per cent and, in light of our low risk approach, a full year asset quality ratio of around 20 basis points, significantly lower than our medium-term guidance.
Delivering for customers and shareholders Our key performance indicators have been considered by the Board and identify the most effective output measures for assessing financial performance and progress towards becoming the best bank for customers. KPIs for balance sheet reduction and strategic investment are no longer included as they were directly related to our previous strategic priorities which have now been superseded.
Underlying profit continued to increase in 2015, up 5 per cent.
Our net promoter score is the measure of customer service at key touch points and the likelihood of customers recommending us. It has continued to improve in the year.
Although customer complaints have increased in the year, levels remain significantly below most of our key competitors. 1 Excluding PPI. 2 The metric has changed from banking complaints to reportable complaints to reflect performance management measures.
Our score increased by 6 points in 2015. The index is the outcome of a survey of more than 68,000 of our employees which shows how strongly they believe we are committed to becoming the best bank for customers.
Operating responsibly A sustainable and responsible approach to doing business is integral to everything we do. It underpins our aim to become the best bank for customers and our purpose to help Britain prosper. It is central to our strategy and business model. Our Helping Britain Prosper Plan sets out our public targets to help Britain’s people, businesses and communities today, over and above our core business activities.
Our focus on doing business responsibly is recognised by our continued presence in the FTSE4Good index, our position in the CDP (Carbon Disclosure Project) and Euronext Vigeo UK 20 Index, as well as our ranking in the Business in the Community CR Index.
Helping Britain prosper People, businesses and communities are facing some challenging issues. We are using our scale, reach and influence to help address these, through our Helping Britain Prosper Plan We have always understood that when people, businesses and communities across Britain prosper, so do we. We help Britain prosper through our core products and services, but over and above these, through our Helping Britain Prosper Plan, which we launched in March 2014 and refreshed in 2015. The Plan was created in consultation with our stakeholders and external experts to ensure it is relevant and focused. It sets out clear targets to address social and economic issues prioritised by stakeholders which, as a bank, we are well placed to help address. These include: the shortage of affordable homes; supporting small businesses and the UK’s manufacturing base; helping people and organisations acquire the digital skills and capability they need; and tackling disadvantage in local communities in order that more people can share in the UK’s economic growth.
UK economic trends Resilience in the face of a fragile global economy Initial estimates indicate that the UK economy grew by 2.2 per cent in 2015, close to its 25-year average, at a time when global growth slowed. UK economic growth was the second strongest of the G7 countries, only marginally behind the US. Eurozone growth improved during 2015, back to its 25-year average, but at 1.5 per cent it remains significantly slower than the UK.
Leadership of global growth is shifting back to developed economies as they emerge from a period of private sector debt reduction, government cuts and tax increases. The slowdown in emerging markets as their credit cycle turns is pushing inflation down across the world as their currencies and commodity prices fall. UK inflation has hovered close to zero throughout 2015, and as a result, consumers’ inflation-adjusted incomes have increased, ending a seven year period in which they had been broadly flat. That has boosted consumer spending growth to an eight year high in 2015, and helped push unemployment down to pre-crisis levels.
There are, however, risks to those expectations, stemming from the deflationary impact of the slowdown in emerging markets, the associated recent volatility in financial markets that might weaken consumer and business confidence; and the referendum on UK membership of the EU which, if the vote is to leave, may create a period of uncertainty and impact companies’ investment plans. Crystallisation of any of these risks could impact the UK economy, which in turn would have a negative impact on the Group’s income, funding costs and impairment charges.
Ring-fencing and resolution regulation continues to be relevant for all European banks under the EU Bank Recovery and Resolution Directive and additionally for UK banks under the Financial Services (Banking Reform) Act. Final legislation and near-final rules have now been issued, enabling us to better plan for implementation. Given our UK retail and commercial focused business model, we continue to expect ring-fencing to be less onerous for us to implement than many of our UK peers as we anticipate the vast majority of our business will sit within the ring-fence.
We have seen an influx of new entrants to the market, with a variety of business models. Many of these new entrants have expertise and experience in digital product offerings, with strong funding positions, credible brands, and in some cases pre existing customer bases and branch networks. In addition, non banks such as technology firms and supermarkets are disrupting the banking industry.
Multi-channel approach: Operating in an integrated way through a range of distribution channels, including the largest branch network in the UK and a comprehensive digital proposition, ensures our customers can interact with us when they want and how they want.
Skilled and engaged people: Our colleagues provide real advantage. We continue to build a responsible culture where it is clear what is expected of them. Our Group Values of putting customers first, keeping it simple and making a difference together provide this clarity. We invest in skills and training while ensuring alignment to our customer focused strategy and commitment to build the best team.
By putting customers at the heart of everything we do, operating sustainably and responsibly and continuing to invest in our business strengths, we believe we will help Britain prosper and create value for our shareholders
Economic and political environment Our focus on the UK means our future is inextricably linked to the health of the UK economy, which has continued to perform resiliently.
Outcomes for our stakeholders Customers: Best bank for customers Doing the right thing for our customers by meeting their financial needs, helping them succeed, improving our service proposition and creating value for them, is fundamental to our business model and the long-term sustainability of the business.
Shareholders: Superior and sustainable returns The successful delivery of our business model and strategy should enable delivery of superior and sustainable returns for our shareholders.
Expected outcomes – Improved customer experience through enhanced digital offering – Retain convenience and reach of the leading branch network – Improvement in customer satisfaction and lower complaints
Expected outcomes – Increased automation of end-to-end customer journeys – More efficient change capability – Resilient systems and processes – Continuation of Simplification programme – Maintain cost leadership position
We are improving customer experience with our multi-brand, multi-channel approach, combining digital capabilities with face-to-face services. We are transforming our digital presence, providing simpler, seamless interactions across online and mobile while sustaining extensive customer reach through our leading branch network.
We are creating operational capability which is simpler and more efficient than today through further system enhancement and integration. We are becoming more responsive to changing customer expectations while maintaining our cost leadership amongst UK high street banks. This cost leadership enables us to provide increased value to our customers and competitive differentiation.
Expected outcomes – Net lending growth of >£1 billion annually in both SME and Mid Markets – Consumer Finance to increase UK customer assets by over £6 billion from 2015 to 2017 – Support our customers in retirement planning, increasing customer assets by over £10 billion
Initiatives – Create a great place to work that is focused on the customer – Build a high performance organisation – Build an inclusive workplace with a diverse workforce – Ensure reward structures are fair, transparent and understandable for colleagues
– An environment which supports agile working, a customer-centric mind-set and a culture of coaching and development – Enhanced benefits package with simplified pay ranges
– Growth in targeted areas: - SME lending growth of 5 per cent in a flat market - Consumer Finance customer asset growth of £3.2 billion - Execution of first external bulk annuity transaction – Maintain market leadership in key retail business lines: - Market leadership retained in current accounts and deposits - Mortgage growth below market due to focus on protecting margins
Read more about our Codes, Policies and our full Materiality Report at www.lloydsbankinggroup.com/RBDownloads
Tackling bribery and corruption We have established policies and procedures to ensure the Group complies with all applicable laws and regulations wherever it operates. Our Anti-Bribery Policy and principles apply to all Directors, colleagues, and anyone else acting on our behalf. The Policy prohibits the payment, offer, acceptance or request of any benefit (including cash) which could be construed as a bribe. All colleagues, including contractors, complete annual anti-bribery training and are encouraged to confidentially report any instances of suspected bribery via the Speak Up service or their line manager. Our suppliers are required to ensure that their employees are provided with appropriate training and awareness on a regular basis. Since 2014, the Group has been a member of Transparency International UK’s Business Integrity Forum, a network of major international companies committed to anti-corruption and high ethical standards in business practices.
We measure customer satisfaction using the industry standard Net Promoter Score. We also use internal customer dashboards, which provide monthly information about customers’ experience and views relating to our products and services. These data are discussed at the Group Executive Committee and the Board.
Responsible marketing and communications As a responsible business we must ensure that the way that we market our brands, products and services is fair, accurate, not misleading and ultimately easy for consumers to understand. The Group complies with voluntary and mandatory advertising and marketing standards. We are working to better understand customer behaviour and have used behavioural economic techniques to assess their preferences and improve our marketing materials as a result. This has made them more concise and clear. For example, we’ve simplified a savings maturity letter by introducing summary boxes and bullet points to highlight key information. This simple change has contributed to a reduction in complaints about the product maturity process by 80 per cent.
Tackling money laundering and terrorist financing We take steps to make sure our products are not used for criminal purposes, such as money laundering and terrorist financing, working closely with legislators and regulators to combat this. We complete appropriate and proportionate customer due diligence throughout the duration of the customer relationship, and we monitor unusual activity on all customer accounts and use advanced technology to detect potential criminal activity. If we spot anything suspicious we take immediate and appropriate action. In 2015 we made further revisions to our Anti-Money Laundering and Counter Terrorist Policy and launched specialist training across the Group to help colleagues understand what is required from them.
Serving vulnerable customers Ensuring our products and services are accessible and suitable to the individual needs of all our customers is at the heart of everything we do; consistently offering the best experience for all of our customers, providing products and services when our customers need our support. This includes improving our processes when customers are bereaved and reviewing our websites and mobile banking services to ensure they are accessible to all our disabled customers.
Help for businesses Our year-on-year net growth in lending to SMEs increased by 5 per cent in 2015. Our lending to SMEs has grown 25 per cent net since 2011, while it declined 13 per cent across the industry as a whole during the same period.
We can help our current and future customers to avoid financial difficulties by providing them with a better understanding of money matters. We have invested £10 million in our Money for Life programme for young people since it launched in 2009. We are reviewing this programme in 2016 following the launch of the UK Financial Capability Strategy published by the Money Advice Service and our own experience of delivering community based financial education. We are considering additional ways to support customers and colleagues with money management.
Explaining our wider economic contribution We contribute to the UK economy through our products and services, and through our commitments in our Helping Britain Prosper Plan. We also make a positive economic impact as a major employer and purchaser.
Learning and development Investing in learning and development is critical in supporting colleagues to carry out their roles to the best of their ability. In 2015 we launched our Line Manager Academy, a brand new programme aimed at increasing the capability of our line manager population, reinforcing how they apply our values and Codes of Responsibility in their day-to-day roles. Overall, Colleagues logged onto our online learning system, Discover Learning, more than 10 million times and more than 96 per cent of our colleagues undertook formal learning.
Colleagues who disclose they are lesbian, gay, bisexual or transgender 1 Colleague scope of reporting: UK payroll headcount includes established and fixed term contract colleagues. Excludes parental leavers, Non-Executive Directors, contractors, temp, agency and internationals.
2 2014 figures restated due to a change in HR system, and also to include International colleagues within the gender information, to be on a comparable basis with 2015 figures.
3 Diversity scope of reporting: UK & International payroll headcount includes parental leavers and excludes contractors. Gender information includes International colleagues. All other diversity information is UK payroll only.
Indicator is subject to limited ISAE 3000 (Revised) assurance by Deloitte LLP for the 2015 Annual Responsible Business Reporting. Deloitte LLP’s 2015 assurance statement and the 2015 Reporting Criteria are available online at www.lloydsbankinggroup.com/RBdownloads
We are committed to managing our direct environmental impact and reducing our greenhouse gas emissions. We do this through our Environmental Action Plan, which focuses on reducing risk and creating value through improved efficiency. More detail is included in our Environmental Statement, available online.
For more on emissions reporting and methodology, see the Directors’ report, page 109.
Support for the low carbon economy We provide finance to green industries and support for SMEs seeking to become more carbon and resource efficient.
Since 1985, we have given almost £600 million to tackle disadvantage in communities across the UK.
Independent Stakeholder Advisory Panel Our Independent Panel is in place to provide an external viewpoint on elements of our Responsible Business strategy. In 2015, they discussed broad topics including our Helping Britain Prosper Plan and Financial Inclusion Strategy and fed back their recommendations to the Responsible Business Committee. You can read more about the Panel online at www.lloydsbankinggroup.com/RB
Our approach to risk is founded on an effective control framework and a strong risk management culture which guides how our employees approach their work, the way they behave and the decisions they make. Risk appetite, defined as the amount and type of risk that we are prepared to seek, accept or tolerate, works in tandem with our strategy and is approved by the Board. Our risk appetite is then embedded within policies, authorities and limits across the Group.
Risk as a strategic differentiator Group strategy and risk appetite are developed together to ensure one informs the other and creates a strategy that delivers on becoming the best bank for our customers whilst helping Britain prosper and creating sustainable growth over time.
Prudent approach to risk Implementing a prudent approach to risk appetite across the Group, aligned to the embedding of a strong risk culture, driven both from the top and across the wider business, ensures we operate within risk appetite.
Strong control framework The Group’s Risk Management Framework (RMF) acts as the foundation for the delivery of effective risk control and ensures that the Group risk appetite is adhered to.
Business focus and accountability Effective risk management is a key focus and is included in key performance measures against which individual business units are assessed. The business areas in the first line are accountable for risk but with oversight from a strong and importantly, independent, Second Line Risk Division.
Achievements in 2015 We have continued our strategic journey and created a foundation to deliver our objectives, through reacting to changing customer behaviour, maintaining our strong capital position and increasing dividend payments, whilst continuing to adapt to the ever changing regulatory environment. Close and collaborative working across the Group within risk culture and appetite has supported key risk-related deliverables in the year. These included: Conduct Deploying a consistent and relentless approach under the Group conduct strategy to ensure we deliver customer needs with an open and transparent culture.
Review risk appetite, frameworks and principles to be recommended to the Board. Be exemplars of risk management
Risk-specific needs defined in detail for implementation by each business Primary risk drivers
This year we have added two new principal risks: – Insurance risk, reflecting that we are increasing our exposure to longevity risk, following our entry into the bulk annuity market in 2015; and – Governance risk, given increasing societal and regulatory focus on governance arrangements.
– Credit policy, incorporating prudent lending criteria, aligned with Board approved risk appetite, to effectively manage risk. – Robust risk assessment and credit sanctioning, with clearly defined levels of authority to ensure we lend appropriately and responsibly. – Extensive and thorough credit processes and controls to ensure effective risk identification, management and oversight. – Effective, well-established governance process supported by independent credit risk assurance. – Early identification of signs of stress leading to prompt action in engaging the customer.
Example: – Whilst we have a deep understanding of credit risks across our commercial, mortgage and other portfolios; a changing economic environment, e.g. interest rate rises, can impact on customer affordability and therefore our performance.
Credit risk decisions are consistent, fair and responsible, taking account of customers’ circumstances.
Operational risk We face significant operational risks which may result in financial loss, disruption or damage to our reputation. These include the availability, resilience and security of our core IT systems and the potential for failings in our customer processes.
People risk Key people risks include the risk that we fail to lead responsibly in an increasing competitive marketplace, particularly with the introduction of the SM&CR in 2016. This may dissuade capable individuals from taking up senior positions within the industry.
Insurance risk Key insurance risks within the Insurance business are longevity, persistency and property insurance. Longevity risk is expected to increase with the 2015 entry into the bulk annuity market. Longevity is also the key insurance risk in the Group’s Defined Benefit Pension Schemes.
Examples: – Increases in life expectancy (longevity) beyond current assumptions will increase the cost of annuities and pension scheme benefits. – Uncertain property insurance claims impact Insurance earnings and capital, e.g. extreme weather conditions, such as flooding, can result in high property damage claims.
– Insurance processes on underwriting, claims management, pricing and product design seek to control exposure to these risks. A team of longevity and bulk pricing experts has been built to support the new bulk annuity proposition. – The merits of longevity risk transfer and hedging solutions are regularly reviewed for both the Insurance business and the Group’s Defined Benefit Pension Schemes. – Property insurance exposure to accumulations of risk and possible catastrophes is mitigated by a broad reinsurance programme.
Loan to deposit ratio 3 Individual liquidity adequacy standards eligible primary liquid assets.
Resolution requirements are aimed at reducing the probability of failure and its impact on customers should we fail through continuity of critical banking services, helping rebuild trust in the financial services sector.
Market risk The risk that our capital or earnings profile is affected by adverse market rates, in particular interest rates and credit spreads in the Banking business and equity and credit spreads in the Insurance business and the Group’s Defined Benefit Pension Schemes. Examples: – Earnings are impacted by our ability to forecast and model customer behaviour accurately and establish appropriate hedging strategies. – The Insurance business is exposed indirectly to equity and credit markets through the value of future management charges on policyholder funds. Credit spread risk within the Insurance business primarily arises from bonds and loans used to back annuities. Credit spreads affect the value of the Group’s Defined Benefit Pension Schemes’ liabilities.
Pension surplus Delivering sustainable growth We manage our exposure to movements in market rates throughout the year, leading us to promote low volatility earnings and offer a comprehensive customer proposition with market risk hedging strategies to support strategic aims, including delivering sustainable growth.
PRINCIPAL RISKS KEY MITIGATING ACTIONS KEY RISK INDICATORS ALIGNMENT TO STRATEGIC PRIORITIES AND FUTURE FOCUS
Example: – Our funding and liquidity position is supported by a significant and stable customer deposit base. A deterioration in either the Group’s or the UK’s credit rating, or a sudden and significant withdrawal of customer deposits, would adversely impact our funding and liquidity position.
Governance risk Against a background of increased regulatory focus on governance and risk management, the most significant challenges arise from the SM&CR in force from March 2016 and the requirement to improve the resolvability of the Group and to ring-fence core UK financial services and activities from January 2019. Example: – Non-compliance with or breaches of ring-fencing, resolution and SM&CR requirements will result in legal and regulatory consequences.
– Our response to the SM&CR is managed through a programme with work streams addressing each of the major components. – A programme is in place to address the requirements of ring-fencing and resolution and we are in close and regular contact with regulators to develop plans for our anticipated operating and legal structures. – Our aim is to ensure that evolving risk and governance arrangements continue to be appropriate across the range of business in the Group in order to comply with regulatory objectives.
Overview: robust financial performance with increased underlying profits and returns; strong balance sheet The Group’s underlying profit increased by 5 per cent in the year to £8,112 million, driven by a 1 per cent increase in total income, lower operating costs despite increased investment in the business and a 48 per cent improvement in impairments. Statutory profit before tax was £1,644 million (2014: £1,762 million) after provisions for PPI of £4,000 million (2014: £2,200 million) including an additional £2,100 million charged in the fourth quarter. Statutory profit after tax was £956 million compared to £1,499 million in 2014.
The combination of good underlying profitability and continued reduction in risk-weighted assets resulted in an improvement in the Group’s common equity tier 1 ratio on a pro forma basis to 13.9 per cent before taking account of dividends in respect of 2015 and 13.0 per cent after dividends (31 December 2014: 12.8 per cent). The pro forma leverage ratio was 4.8 per cent (31 December 2014: 4.9 per cent).
Other income was 5 per cent lower at £6,155 million largely as a result of the reduction in run-off business. Excluding run-off, other income was in line with 2014. Fees and commissions were lower than 2014 mainly due to a reduction in current account and credit card transaction related net income, and the impact of changes in the regulatory environment. This was partly offset by income generated by the Insurance business from its entry into the bulk annuity market and the increase in operating lease income. As expected, other income recovered in the fourth quarter, and at £1,528 million, was 11 per cent ahead of the third quarter and 1 per cent higher than in the same period last year, despite insurance claims as a result of December’s floods and storms of £58 million.
1 Run-rate savings achieved from phase II of the Simplification programme.
Impaired loans as a % of closing advances 2.1% 2.9% (0.8)pp
Other items of £342 million related to the amortisation of intangible assets. The credit of £374 million in 2014 included a gain of £710 million relating to changes made to the Group’s defined benefit pension schemes.
Simplification Simplification costs in 2015 were £170 million and relate to redundancy costs incurred to deliver phase II of the Simplification programme. The costs of £966 million in 2014 primarily related to redundancy, IT and other business costs of implementation relating to phase I.
Assuming current FCA proposals are implemented and an average of approximately 10,000 complaints per week, including those related to Plevin, the outstanding provision should be sufficient to cover all future PPI related complaints and associated administration costs through to mid-2018.
Underlying return on required equity has improved in the year reflecting the improvement in underlying profit together with a reduction in the required equity which has been driven by the fall in risk-weighted assets. The statutory return was lower, largely as a result of higher conduct related provisions and the restriction on their tax deductibility.
At the time of the strategic update in October 2014, we anticipated achieving a sustainable return on required equity, of around 13.5 to 15.0 per cent by the end of 2017. Since this time, the expected level of interest rates over the plan period has reduced significantly, required equity has increased to 12 per cent and the new bank tax surcharge of 8 per cent will come into effect from 1 January 2016. We continue to target 13.5 to 15.0 per cent but, based on current interest rate assumptions, we now expect to deliver this in 2018.
Total deposits were £418 billion compared with £423 billion (excluding TSB) at 31 December 2014, largely due to a planned reduction in tactical deposits.
Wholesale funding was £120 billion, of which £38 billion, or 32 per cent, had a maturity of less than one year (31 December 2014: £41 billion, representing 35 per cent).
In addition to the internal stress testing activity undertaken in 2015, the Group participated in the UK-wide concurrent stress testing run by the Bank of England, comfortably exceeding both the capital and leverage minimum thresholds.
Risk-weighted assets reduced by 7 per cent, or £17 billion to £223 billion (31 December 2014: £240 billion), primarily driven by the sale of TSB, other disposals in the run-off business and continued improvements in credit quality, partly offset by targeted lending growth.
The Group’s pro forma leverage ratio, after taking account of dividends relating to 2015, reduced to 4.8 per cent (31 December 2014: 4.9 per cent) reflecting the reduction in tier 1 capital offset by the reduction in balance sheet assets arising, in part, from the sale of TSB.
Dividend The Board has recommended a final ordinary dividend of 1.5 pence per share, together with a capital distribution in the form of a special dividend of 0.5 pence per share. This is in addition to the interim ordinary dividend of 0.75 pence per share (2014: nil) that was announced at our 2015 half-year results.
Underlying profit (loss) excl. TSB 3,228 2,206 1,010 922 (68) 7,298
4 Including Insurance dividend relating to 2015, paid in 2016. Excluding the Insurance dividend the leverage ratio was the same at 4.8 per cent.
Consumer Finance provides a range of products including motor finance, credit cards, and European mortgages and deposit taking, aiming to deliver sustainable growth within risk appetite. Motor Finance seeks to achieve this through improving customer service by building digital capability and continuing to create innovative propositions. Credit Cards aims to attract customers through better use of Group customer relationships and insight, underpinned by improvements to customer experience.
– Increased Corporate Pensions funds under management by £1.4 billion to £28.4 billion through supporting a further 1,600 employers and 30,000 employees into auto-enrolment. – Helped 215,000 customers to understand their additional retirement choices introduced by Pensions Freedoms in April through our dedicated retirement planning website and customer hub. Around 27,000 of these customers benefited from a personalised appointment. – Launched a new non-advised pension drawdown product to support customers through the additional retirement choices introduced by Pensions Freedoms in April. – Successfully delivered our first external bulk annuity transaction with a £0.4 billion deal in the fourth quarter, building on the £2.4 billion Scottish Widows With-Profits deal earlier in the year. – Secured a further £1.4 billion of high yielding long-dated assets to improve investment returns for assets backing annuity liabilities, with over £5 billion acquired in the past four years through collaboration with the Commercial Banking Division. – Launched a protection proposition into the Independent Financial Adviser (IFA) channel, complementing the protection offering to customers of the Bank, which is now available online through a quick and easy digital journey. – Continued to grow Home Insurance sales through online channels, whilst developing an enhanced, more flexible, digitally enabled product expected to launch in the first half of 2016. – Helped more than 5,000 customers who were impacted by the floods and storms in December 2015. – Received approval from the PRA for our Solvency II internal model, on which ongoing capital requirements will be based. – Completed, through a Part VII transfer, the consolidation of eight UK Life companies into a single combined entity, significantly simplifying the business.
General Insurance income net of claims − − − 323 − 323 418 1 ‘Other’ is primarily income from return on free assets, interest expense plus certain provisions.
– Central items include income and expenditure not recharged to divisions, including the costs of certain central and head office functions.
Average interest-earning banking assets are gross of impairment allowances and comprise solely of customer and product balances in the banking businesses on which interest is earned or paid. Non-banking assets largely relate to fee based loans and advances within Commercial Banking and loans sold by Commercial Banking and Retail to Insurance to back annuitant liabilities. Other non-banking includes pooling arrangements where interest is received from or paid to customers based on the net of their lending and deposit balances but these balances cannot be netted on the Group balance sheet.
Non-banking items: Fee based loans and advances (10.1) (8.0) (7.2) (6.4)
The expected gross investment returns used to determine the underlying profit of the business are based on prevailing market rates and published research into historical investment return differentials for the range of assets held. Where appropriate, rates are updated throughout the year to reflect changing market conditions and changes in the asset mix. In 2015 the basis for calculating these expected returns has been enhanced to reflect an average of the 15 year swap rate over the preceding 12 months and rates were updated throughout the year to reflect changing market conditions. The negative insurance volatility during 2015 of £303 million primarily reflects lower equity returns than expected, widening credit spreads and low returns on cash investments.
Policyholder interests volatility 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 expected 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. In 2015, the statutory results before tax included a credit to other income which relates to policyholder interests volatility totalling £87 million (2014: £17 million) reflecting offsetting movements in equity, bond and gilt returns.
Basic earnings (loss) per ordinary share 0.8p 1.7p (1.2)p (2.1)p (4.3)p
Diluted earnings (loss) per ordinary share 0.8p 1.6p (1.2)p (2.1)p (4.3)p
Skills and experience: Lord Blackwell has deep financial services knowledge as well as extensive insurance, banking, regulatory and public policy experience gained from senior positions in a wide range of industries. His breadth of experience, credibility with key stakeholders and strong leadership qualities make him an effective Chairman. He was previously the Chairman of Scottish Widows Group, a former Senior Independent Director of Standard Life and also chaired their UK Life and Pensions Board. His other former Non-Executive Directorships have included Halma plc, Dixons Group and SEGRO. He was also a member of the Board of the Centre for Policy Studies, a Non-Executive Board Member of Ofcom and of the Office of Fair Trading, a Partner of McKinsey & Co. and a Director of Group Development at NatWest Group. He was Head of the Prime Minister’s Policy Unit from 1995 to 1997 and was appointed a Life Peer in 1997. External appointments: Chairman of Interserve plc (until 29 February 2016).
Skills and experience: Juan has significant banking and risk management experience, having spent 30 years working in these fields both internationally and in the UK. Juan is responsible for developing the Group’s risk framework, recommending its risk appetite and ensuring that all risks generated by the business are measured, reviewed and monitored on an ongoing basis. He was previously the Chief Risk Officer and Executive Director of Santander’s UK business. Prior to this position, he held a number of senior risk, control and business management roles across the Corporate, Investment, Retail and Risk Divisions of the Santander Group. He has served as the Group’s Chief Risk Officer and as a member of the Group Executive Committee since January 2011. External appointments: Vice Chairman of the International Financial Risk Institute.
Skills and experience: With a background in retail and associated sectors, including financial services, Sara brings a broad perspective to the Board. She is a strong advocate of customers and of the application of new technology, both of which directly support Lloyds Banking Group’s strategy. Sara has considerable experience of boards at both executive and non-executive level. Her previous appointments include Managing Director of Argos, various senior positions at J Sainsbury including Deputy Managing Director, Lead Non-Executive Director at the Department of Communities and Local Government, a Non-Executive Director of Mitchells & Butler as well as a number of senior management roles for Abbey National and Mars Confectionery. External appointments: Non-Executive Director of United Utilities Group and Chair of their Remuneration Committee, a Governing Council Member of Cambridge University, Chairman of the Planning Inspectorate and Board member at the Higher Education Funding Council.
George joined the Board as an Executive Director in May 2012.
Andrew sits on the Board of the Global Financial Markets Association and the Advisory Board of the University of Cambridge Programme for Sustainability Leadership and is a member of The Prince of Wales’s UK Corporate Leaders’ Group. Andrew is Executive Sponsor for Inclusion & Diversity and the Group’s Ambassador’s programme.
Vim joined the Group in 2011. He has responsibility for Retail Customer Products and Group Marketing. Previously, Vim worked at Santander UK and Abbey National. He was appointed to our Group Executive Committee in 2013 and is a Non-Executive Director of Scottish Widows and a VISA Europe Board Director.
Vim holds an Economics degree from the London School of Economics and is a member of the Institute of Chartered Accountants.
Matt joined the Group as Corporate Affairs Director in 2011 as part of a new management team brought in to bring the bank back to health following the financial crisis and return it private ownership. Prior to Lloyds, he was Communications Director at Santander during a period when the bank made a successful entry into the UK market following the acquisition and subsequent rebranding of Abbey National, Alliance & Leicester, and Bradford & Bingley. Matt joined Santander from NatWest in 1999 where he held a number of senior communications roles.
Matt has a degree in Political Science and a postgraduate certificate in Education. He is a Board member of the British Bankers Association, a member of the PR Guild, and a former trustee of the Prince of Wales sponsored charity, In Kind Direct.
Dear Shareholders As Chairman of the Board I believe that the highest standards of corporate governance are critical to the success of our business today. Good governance underpins the delivery of our strategy to become the best bank for customers and generate sustainable returns for shareholders. Our Board is committed to ensuring good governance is embedded in the thinking and processes of the business.
I am responsible for leading the Board and ensuring its effectiveness. I am pleased to report that further to the actions identified by the Company Secretary in his review and in the 2014 Board Effectiveness Review, changes were introduced and actions implemented which have led to improvements in a number of areas. Details of the 2015 Board Effectiveness Review, together with information about our progress against the 2014 review actions are on pages 67 and 68.
Looking forward to 2016, our corporate governance priorities will be continuing to deliver and oversee the implementation of the Group’s strategy, implementing the actions from the 2015 Board Effectiveness Review and the introduction of the Senior Managers and Certification Regime (SM&CR).
Corporate Governance Framework Our Corporate Governance Framework is reviewed at least annually by the Board to ensure it remains effective. This year the framework was subject to an additional end-to-end review by the Company Secretary.
LEADERSHIP The Board The Group is led by an effective, committed and unitary Board, which is collectively responsible for the long-term success of the Company. The Board comprises a Chairman (who was independent on appointment), independent Non-Executive Directors and Executive Directors. The names and biographies of current Directors are set out on pages 56 and 57.
The Corporate Governance Framework sets out a number of key decisions and matters that are reserved for the Board’s approval. The Board sets the strategy, oversees its delivery and establishes the culture, values and standards of the Group. The Board ensures that the Group manages risk effectively, monitors financial performance and reporting and ensures that appropriate and effective succession planning arrangements and remuneration policies are in place. It provides and encourages entrepreneurial leadership across the Group within this framework.
Board Committees The Board is supported by its Committees which make recommendations on matters delegated to them under the Corporate Governance Framework, in particular in relation to internal control, risk, financial reporting, governance and remuneration matters. This enables the Board to spend a greater proportion of its time on strategic, forward looking agenda items. Each Committee comprises Non-Executive Directors only and is chaired by an experienced Chairman. The Committee Chairmen report to the Board on the activities of the Committee at each Board meeting. A structure chart of the Board Committees can be found on page 62.
Subsidiary governance The Boards of the four main companies, Lloyds Banking Group plc, Lloyds Bank plc, HBOS plc and Bank of Scotland plc, comprise the same Directors, with Board meetings for these companies being held concurrently. The agenda is split between the companies, allowing decisions to be taken and scrutinised by the appropriate Board.
Changes in Board Committees During 2015, the Nomination & Governance Committee continued to keep under review succession planning and the effectiveness of the Board and its Committees. To ensure the Group’s corporate governance is consistent with best practice, in addition to the annual Board Effectiveness Review, a Corporate Governance Review was carried out by the Company Secretary during the year. The following changes to Committees were made: – The Group established a Responsible Business Committee (RBC) of the Board. The RBC is chaired by Sara Weller CBE and includes as members Lord Blackwell, Chairman, and Anita Frew, Deputy Chairman. The RBC oversees the measurement and communication of the Group’s customer-centric culture and values, as well as the development of the Helping Britain Prosper Plan. The creation of a board-level RBC underlines the Group’s commitment to being a responsible business. A report on the activities of the RBC can be found on page 81; – Anita Frew, Deputy Chairman, succeeded Anthony Watson, Senior Independent Director, as Chairman of the Remuneration Committee, effective 1 October 2015. The change reflected best governance on the separation of the role of the Senior Independent Director and the Chairman of the Remuneration Committee. Mr Watson served as Chairman of the Remuneration Committee since May 2010 and remains a member of the Remuneration Committee; – Alan Dickinson, an independent Non-Executive Director and Chairman of the Board Risk Committee, was appointed as a member of the Remuneration and Nomination & Governance Committees, effective 17 July 2015; – Carolyn Fairbairn, an independent Non-Executive Director, retired from the Board and as a member of the Audit and Remuneration Committees on 31 October 2015; – Deborah McWhinney joined the Board as an independent Non-Executive Director on 1 December 2015 and was appointed as a member of the Audit and Risk Committees; and – Stuart Sinclair joined the Board as an independent Non-Executive Director on 4 January 2016 and was appointed as a member of the Risk and Remuneration Committees.
The Board in 2015 The Directors who served during the year and their attendance at Board meetings is set out in the table below. The attendance of Directors at Committee meetings is displayed within the individual Committee reports found on pages 72 to 81 and for the Remuneration Committee on page 91. Whilst all Non-Executive Directors are, where appropriate, invited to and regularly attend other Committee meetings, only their attendance at Committees of which they are members is recorded.
2 Mr Henry was unable to join the July Board meeting due to the third quarter 2015 results announcement for Royal Dutch Shell plc, of which he is Chief Financial Officer, being presented on the same day.
The process of escalating issues and agenda setting was a key focus of the 2014 Board Effectiveness Review and the Company
Effective use of the Board’s time To ensure that there is sufficient time for the Board to discuss matters of a material nature, Board dinners and/or breakfast meetings are held prior to each scheduled Board meeting. This allows the Directors greater time to discuss their views ahead of the meeting. Some of these pre meetings are for Non-Executive Directors only, some also include the Group Chief Executive and others the full Board. At least once a year, a meeting is held without the Chairman in attendance. Additionally, ‘deep dive’ sessions into specific topics are delivered either at the end of Board meetings or at additional sessions held between Board meetings.
– Investor Relations updates – AGM briefing – Dividend reinvestment programme
In addition to the annual schedule of Board and Committee meetings, the Board held eight ‘deep dives’, a two-day strategy offsite meeting and a strategy meeting at the Group’s Bristol site reviewing the operating plan. Further details are given opposite.
The Board meets annually prior to the AGM in Scotland followed by a joint discussion with the Board of Scottish Widows Group Limited allowing in-depth focus on insurance matters.
Chairman’s activities The Chairman undertakes an extensive engagement programme each year representing the Group at industry events, acting as a spokesperson for the Group and meeting with clients, regulators, investors, the media, our Foundations and their beneficiaries. The programme includes visits to regional offices, branches, IT and operations centres, where the Chairman meets local management and colleagues through meetings, floor walks, team talks and Town Hall sessions. The Town Hall sessions are an opportunity for colleagues to hear from the Chairman on the Group’s performance and strategic direction, and importantly, to ask questions. These events are very popular and are always well attended.
The Board spends considerable time reviewing the delivery of the three-year IT resilience investment and digital transformation programmes. IT resilience and cyber security are regularly monitored through the risk dashboard in the reports from the Group Chief Executive and Group Risk Officer and through the work of the Board Risk Committee of which all Non-Executive Directors are members. Additionally, the Board received a detailed progress update at its strategy offsite meeting in November and presentations from senior management on the delivery of the programmes at ‘deep dive’ sessions held during the year.
Information on the progress being made on the delivery of digital capability can be found in the strategic report and on IT resilience and cyber security in the report from the Board Risk Committee.
Board changes In June 2015, Carolyn Fairbairn, an independent Non-Executive Director, informed the Board of her intention to retire from the Board on 31 October 2015 to take up the position of Director-General of the Confederation of British Industry in November 2015. Ms Fairbairn had been a member of the Board since June 2012. Dyfrig John, an independent Non-Executive Director, has notified the Board that he wishes to reduce his workload and therefore does not intend to seek re-election at the 2016 AGM. Mr John has been a member of the Board since January 2014. Deborah McWhinney and Stuart Sinclair joined the Board as independent Non-Executive Directors on 1 December 2015 and 4 January 2016 respectively. The Board is not looking actively to appoint any further Non-Executive Directors at this stage.
Developing diversity The Board recognises that senior management is a group from which future directors may be selected. To promote diversity the Group has a variety of colleague networks which include: Breakthrough, a women’s network; the Group Ethnic Minority network; the Access network which aims to provide support for colleagues with disabilities; and Rainbow, an inclusive Groupwide network for lesbian, gay, bisexual and transgender colleagues. More information on the Group’s diversity programmes, including details of the Group’s commitment to raise the percentage of women employed in senior management roles to 40 per cent by 2020, is provided in the Responsible Business section of our website at www.lloydsbankinggroup.com/ our-group/responsible-business
Board induction The Group appreciates the importance of a well-focused induction plan to help a new Director get up to speed as quickly as possible and enable them to contribute fully to Board deliberations. The Chairman personally ensures that on appointment each Director receives a full, formal and tailored induction. The emphasis is on ensuring the induction brings the business and its issues alive for the new Director, taking account of the specific role they have been appointed to fulfil and the skills/experience of the Director to date. The plan is informed by the recruitment and resourcing process, with input from other key internal stakeholders and from the Directors themselves. At its core is a comprehensive programme of one-to-one briefings with key senior executives across the Group. Committee Chairmen receive additional dedicated training from relevant business executives to support them in their role and the Chairman of Scottish Widows Group Limited receives further briefings on the insurance business. Non-Executive Directors are encouraged to identify any further information needs and to request any additional meetings or visits to help familiarise themselves with the business. In practice, some of the areas covered by the induction plan are likely to have been covered as part of the Director’s own research prior to taking on the role. However, the plan aims to provide a more in-depth review of the issues and, facilitated by the Company Secretary, is delivered as soon as possible after the date of appointment. Directors who take on or change roles during the year attend induction meetings in respect of those new roles.
One-to-one briefings – Chairman – Company Secretary – Executive Directors – GEC members – Group Audit Director – Senior executives from across the Group
Professional development and training Continuing professional development is an important aspect of every professional’s working life, including Directors. Skills and knowledge need to be kept up-to-date to ensure the efficiency of the Board as a whole and the ability of every single Director to contribute to the highest standards.
The Board also receives regular refresher training and information sessions throughout the year to address current business or emerging issues such as the SM&CR, ring-fencing and resolution and stress testing.
Management meetings and one-to-one meetings with key executives from across the Group’s operations complete the picture. The Company Secretary maintains a training and development log for each Director.
2015 evaluation of the Board’s performance In accordance with the three year cycle, the 2015 evaluation was facilitated externally by JCA Group between October 2015 and January 2016. The review was commissioned by the Chairman, assisted by the Company Secretary and overseen by the Nomination & Governance Committee. JCA Group has provided certain Board and senior management level recruitment services to the Group from time to time but not in relation to the searches for the Group Board Non-Executive Directors during 2015. Otherwise, JCA Group has no other connection with the Group.
– Corporate Governance Framework amended to impose clear responsibility on GEC members to escalate matters – Time allocated at each GEC meeting to consider whether any matters require escalation – Briefings to other senior executives on the obligation to escalate matters – Quarterly reviews of topics for Board presentations and deep dives introduced involving the Chairman, the Company Secretary, the Chief Risk Officer and the Group Chief Executive or his Chief of Staff, who assists the Group Chief Executive and runs his executive office. The quarterly reviews are also attended by the Group Audit Director and the Group Director, Conduct, Compliance and Operational Risk – Improved 2015 effectiveness review scores
If Directors have concerns about the Company or a proposed action which cannot be resolved, it is recorded in the Board minutes. Also on resignation, Non-Executive Directors are encouraged to provide a written statement of any concerns to the Chairman, for circulation to the Board. No such concerns were raised in 2015 and up to the date of this report.
Non-Executive Directors may be expected to relinquish other appointments to ensure that they can meet the time commitments of their role. Fees paid to Non-Executive Directors reflect the time commitment and responsibilities of the role. Non-Executive Directors do not receive share options or other performance related pay. Executive Directors are restricted to taking no more than one non-executive director role in a FTSE 100 company nor the chairmanship of such a company. The Chairman is required to commit to this being his primary role, limiting his other commitments to ensure he can spend as much time as the role requires. The Chairman will step down as Chairman of Interserve plc on 29 February 2016. The Chairman’s biography can be found on page 56.
The review found the governance of the Group by the Board and its Committees to be generally effective and the Secretariat and the Insurance Secretariat to be generally effective in supporting the governance of the Group. Recommendations included: – quarterly reviews of topics for Board presentations and deep dives involving the Chairman, the Company Secretary, the Chief Risk Officer and the Group Chief Executive or his Chief of Staff, who assists the Group Chief Executive and runs his executive office. The quarterly reviews are also attended by the Group Audit Director and the Group Director, Conduct, Compliance and Operational Risk; – Board and Committee papers to be standardised using the adoption of a new Board template; – the Board calendar should avoid more than two Board Committee meetings taking place on the same day; – Chairmen should maintain an appropriate balance between presentations and time allocated to discussion; and – Secretariat should recruit additional senior capability in order to take a more pro-active role in maintaining high governance standards throughout the Group.
The Nomination & Governance Committee considered the review in January 2016 prior to a report on the conclusions to the Board. The Board reviewed and approved the proposed changes, which were part of a wider range of initiatives undertaken to prepare the Group for the introduction of SM&CR and SIMR.
EFFECTIVENESS continued Conflicts of interest All Directors of the Company and its subsidiaries must avoid any situation which might give rise to a conflict between their personal interests and those of the Group. Prior to appointment, potential conflicts of interest are disclosed and assessed to ensure that there are no matters which would prevent that person from taking on the role.
Stuart Sinclair is a Non-Executive Director of Provident Financial Plc, a supplier of personal credit products to the non-standard lending market, and Senior Independent Director at both QBE Insurance (Europe) Limited, a general insurance and reinsurance company, and Swinton Group Limited, an insurance broker for home and motor insurance. The Board has recognised that potential conflicts may arise in relation to his position at QBE Insurance and in relation to Swinton Group. The Board has authorised the potential conflicts and requires Mr Sinclair to recuse himself from discussions, should the need arise.
Prior to Carolyn Fairbairn’s retirement from the Board, she was also a Non-Executive Director of the Competition and Markets Authority (CMA). During the period she served on the Board, she recused herself from all discussions at the CMA on their investigation into banking competition.
In establishing and reviewing during the year the systems of risk management and internal control, the Directors confirm that they carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity, the likelihood of a risk event occurring and the costs of control. The process for identification, evaluation and management of the principal risks faced by the Group is integrated into the Group’s overall framework for risk governance. The Group is forward-looking in its risk identification processes to ensure emerging risks are identified. The risk identification, evaluation and management process also identifies whether the controls in place result in an acceptable level of risk. At Group level, a consolidated risk report and risk appetite dashboard are reviewed and regularly debated by the Group Risk Committee, Board Risk Committee and the Board to ensure that they are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The report and dashboard provide a monthly view of the Group’s overall risk profile, key risks and management actions, together with performance against risk appetite and an assessment of emerging risks which could affect the Group’s performance over the life of the operating plan. Information regarding the main features of the risk management and internal control systems in relation to the financial reporting process is provided within the risk management report on pages 112 to 169.
Shareholders are engaged using a rolling programme of communications. By way of example, when the Group resumed dividend payments in February 2015 a mailing was sent to shareholders informing them of the choices available based on existing payment instructions held.
Key facts at 31 December 2015 – The Group has 2.6 million shareholders, the largest number of ordinary shareholders in the UK. Retail shareholders represent approximately 99.1 per cent of the total number of shareholders. – Institutional shareholders hold approximately 95.6 per cent of the issued share capital on the share register including approximately 7 per cent held on behalf of retail shareholders in private nominee arrangements.
Relationships with institutional investors Investor Relations has primary responsibility for managing and developing the Group’s external relationships with existing and potential institutional equity investors. Supported by the Group Chief Executive, Chief Financial Officer, other members of the senior management team and Non-Executive Board members where appropriate, they achieve this through a combination of briefings to analysts and institutional investors (both at results briefings and throughout the year), as well as individual discussions with institutional investors.
During 2015, Investor Relations held over 1,250 meetings with and gave presentations to institutional debt and equity investors. Discussions included the Group’s financial and operational performance, the dividend payment and associated policy, the Group’s capital management policy and progress in the Group’s strategy to be the best bank for customers.
Good succession planning contributes to the delivery of the Group’s strategy by ensuring the desired mix of skills and experience of Board members now and in the future.
The Committee considered progress against the actions from the 2014 Board Effectiveness Review and I am pleased to report that the changes introduced and actions arising from the review have led to concrete improvements in a number of areas. Details of our progress against the 2014 review actions and the findings and recommendations from the externally facilitated 2015 review can be found on page 68. I and the other Board members find the annual review process valuable and insightful.
Just as importantly, talent needs to be recognised and nurtured within executive and management levels and across the Group as a whole. The Group’s Annual Talent Review allows the Group to identify talent and have the right succession plans and development programmes in place to ensure the Group creates opportunities for current and future leaders.
Process The Committee supports the Chairman in keeping the composition of the Board and its Committees under regular review and in leading the appointment process for nominations to the Board.
In the 2015 full year results, an additional provision of £4,000 million was made for expected PPI costs. To 31 December 2015, the Group has provided a total of £16,025 million in respect of PPI mis-selling redress and administration costs.
– For Packaged Bank Accounts, the Committee understood the basis for determining expected complaints levels, the range of potential redress payments and the adequacy of provisions made for operational costs for the expected duration of the programme. – Group Audit has undertaken a review of the process that has been established and maintained by management to calculate the extent of conduct related provisions; and has provided assurance to the Committee that the process uses reasonable, consistent, supportable assumptions and inputs. – The Committee was satisfied that the provisions for other conduct matters were appropriate. The disclosures relating to other conduct provisions are set out in note 39: ‘Other provisions’ on page 234 of the financial statements.
Recoverability of the deferred tax asset A deferred tax asset can be recognised only to the extent that it is recoverable. Where a deferred tax asset arises from carry forward losses, the future levels of taxable profit in the Group must be assessed.
Uncertain tax positions The Group has open tax matters which require it to make judgements about the most likely outcome for the purposes of calculating its tax position.
Auditor independence and remuneration Both the Board and the external auditor have safeguards in place to protect the independence and objectivity of the external auditor. The Audit Committee has a comprehensive policy to regulate the use of the auditor for non-audit services.
PwC have been auditor to the company and the Group since 1995, having previously been auditor to certain of the Group’s constituent companies. PwC were re-appointed as auditor with effect from 1 January 2016 as part of a tendering process conducted during 2014.
The Committee continues to set the tone from the top on risk management and embedding risk culture.
Committee composition, skills and experience Alan Dickinson became Chair of the Board Risk Committee on 1 January 2015, taking over responsibility from Anita Frew. Alan is a highly regarded Retail and Commercial banker, having spent 37 years with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK, overseeing the group’s Retail and Commercial operations in the UK. The Committee is composed of independent Non-Executive Directors, who provide core banking and risk knowledge, together with breadth of experience which brings knowledge from other sectors, and a clear awareness of the importance of putting the customer at the centre of all that the Group does.
IT resilience and cyber security The risks posed in respect of cyber security and the overall resilience of the IT systems has been a central area of focus for the Committee, acknowledging the increased threat posed to the Group’s business by online crime.
The adequacy of arrangements for IT operational resilience were considered in detail, including the levels of complexity and automation in the Group’s IT systems, with emphasis on processes which underpinned services critical to day to day operations, in particular those with immediate customer impact. In respect of cyber security, consideration was given to areas including possibilities for malicious access and removal of information from systems, and the ability of the Group to detect such attacks.
Conclusion: Whilst much has been achieved in respect of IT resilience and cyber security initiatives, including enhancements delivered to increase resilience to cyber threats, and evidence of a more unified approach to IT resilience, work in respect IT resilience and cyber security will remain an important area for the Group in 2016, and will continue to be reviewed by the Committee.
The stress testing scenarios considered by the Committee were diverse, including internally modelled scenarios involving factors such as material economic downturns and large scale cyber-attack, with further consideration of stress testing against a number of external scenarios, including those set by the PRA.
Detailed comparisons of the approach to the management of risk within each division were also considered, including any significant differences in approach, and any instances of potential best practice which could be implemented across the Group. Common and emerging trends were also highlighted.
Emerging risks Achieving the Group’s ‘low risk’ ambitions requires review of the material risks emerging, in particular in relation to the Group’s operating plan, assessing their likely impact and agreeing appropriate mitigants.
The constantly evolving regulatory and economic landscapes in which the Group operates, both within the UK and overseas, have been important factors in assessing emerging risk, and agreeing mitigating actions where material change is anticipated.
A number of initiatives are in course across the organisation to implement the provisions of the Financial Services (Banking Reform) Act (the ‘Act’), including projects to enable the implementation of the Senior Managers and Certification Regime, and also the requirements of ring-fenced banking.
I am delighted to present the first report from the Responsible Business Committee, formed in July 2015, to provide oversight, challenge and guidance on the Group’s approach to becoming a more responsible business.
The Committee’s remit includes: – the establishment, measurement and review of plans to strengthen the Group’s culture and values; – the Group‘s approach to: building trust with customers; communities; environment; employees; ethical business; stakeholder engagement and reputation; – the design and development of the Responsible Business plan and Helping Britain Prosper Plan (HBPP) and the measurement of performance against these plans.
The establishment of a Board Committee to oversee our responsible business activities demonstrates our commitment to doing business in the right way as we work to help Britain prosper.
The Committee’s activities in 2015 During 2015, the Committee has: – received updates on the development of a framework for assessing and measuring stakeholder trust, including customers and shareholders; – worked with the executive team to develop the HBPP with a focused suite of metrics; – considered reports from the Chairman of the Group Customer First Committee (see update on page 22) and GEC members on the development of the Group’s culture framework; and – discussed responsible business activities in the Group with colleagues in business areas, including Group Sourcing.
Introduction On behalf of the Board and as Chair of the Group’s Remuneration Committee, I am pleased to present the Directors’ remuneration report for the year ended 31 December 2015. I am extremely grateful for the overall strong support and positive feedback received from shareholders during 2015. I look forward to working together during 2016.
This report is split into three parts: – Remuneration at a glance - a summary of the key aspects of remuneration outcomes for 2015. – Directors’ remuneration policy – Annual report on remuneration - how the policy was implemented in 2015 and is intended to apply in 2016.
Underpinning the Group’s strategic focus is the ‘building the best team’ agenda, a key component of which is the Group’s desire to offer fair reward to all colleagues. In considering employee reward, the Committee seeks to balance the importance of dealing with legacy conduct-related matters, investment for our customers, returning value to shareholders and providing support to the communities in which we operate. The Committee has placed a great deal of emphasis on ensuring that reward outcomes are aligned to the long term sustainable success of the business, the Group’s commitment to rebuilding trust and changing our culture to ensure that colleagues are empowered, inspired and incentivised to do the right thing for customers, particularly when it comes to dealing with, and learning from, mistakes of the past.
The Group has continued to embed the revised methodology for calculating the risk-adjusted bonus outcome implemented in 2014. The Committee believes it is important that all colleagues are rewarded in a way that recognises the very highest of expectations in respect of conduct and customer treatment and the links between performance, risk management and reward are clear in the way that the Group sets expectations and communicates them with colleagues. When there are failures in risk management, or when material errors occur, it is equally important that accountability is taken collectively for those issues and, where appropriate, at an individual level as well. During 2015, a number of risk and conduct-related matters had an impact on both the Group’s financial performance and its reputation with the public, shareholders and regulatory bodies, such as PPI, as well as the risk management failure which led to regulatory settlement on PPI complaint handling.
The approach to determine bonus awards for the Executive Directors is consistent with other colleagues across the Group. The Committee determined that bonus awards of between 57 per cent and 63 per cent of maximum opportunity should be made to Executive Directors. In addition, we applied reductions to the 2012 and 2013 deferred bonus awards for each of the Executive Directors, in line with other senior managers, to reflect the Group’s handling of PPI complaints.
23.5% of underlying profit 4.2% of underlying profit 6.6% of underlying profit 4.5% of underlying profit
Annual bonus plan outcome Despite the better results in 2015, the decision has been taken to reduce the Group’s total bonus outcome by approximately 26 per cent. Material adjustments have been made to the outcome in 2015 (as in 2014) to reflect the impacts of legacy items.
Executive Director remuneration outcomes The charts below summarise the Executive Directors’ remuneration for the years ended 31 December 2014 and 2015.
Purpose and link to strategy Base salary reflects the role of the individual taking account of responsibilities and experience, and pay in the Group as a whole. It helps to recruit and retain Executive Directors and forms the basis of a competitive remuneration package.
Maximum potential The maximum award is 100 per cent of base salary.
Maximum potential The maximum annual bonus opportunities are 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors.
Long-term incentive plan (LTIP) Purpose and link to strategy Incentivise and reward the achievement of the Group’s longer-term objectives, to align executive interests with those of shareholders and to retain key individuals.
At least 60 per cent of awards are weighted towards typical market (e.g. Total Shareholder Return) and/or financial measures (e.g. economic profit), with the balance on strategic measures.
For future awards, the Committee will disclose in the annual report on remuneration for the relevant year historic measure and target information, together with how the Group has performed against those targets, unless this information is deemed to be commercially sensitive.
When determining fee levels, the following are considered: – The individual’s skills and experience. – Comparable fees at FTSE companies of a similar size to Lloyds Banking Group, including the major UK banks.
The Chairman receives an all inclusive fee, which is reviewed periodically plus benefits including life insurance, car allowance, medical insurance and transportation. The Committee retains the right to provide additional benefits depending on individual circumstances.
Matters considered by the Committee The Committee met 11 times during 2015, including four ad hoc meetings called at short notice, to consider the following principal matters: – Review of remuneration arrangements for senior executives; – Determination of bonus outcome based on divisional and functional performance and adjustment for risk; – Review of the use of new balanced scorecards for the determination of bonuses in divisions and functions; – Performance conditions for the long-term incentive plan (LTIP) and the deferred bonus plan, including a review of clawback provisions; – Bonus and salary awards for Executive Directors and key senior managers; – Performance adjustments in respect of staff, and in particular in relation to staff accountable for PPI or LIBOR infractions; – Feedback from the Committee Chairman on his/her meetings respectively with the PRA and shareholders; – Results of the Remuneration Committee effectiveness review and the suggestions for improvement; – Approval of the 2014 and 2015 Directors’ remuneration report for publication within the annual report and Form 20-F; and – Remuneration governance in the light of regulatory changes.
António Horta-Osório (Group Chief Executive), Rupert McNeil (Group HR Director until 16 October 2015), Paul Hucknall (HR Director, Performance & Reward), Chris Evans (Director, Performance and Variable Reward) and Matthew Elderfield (Group Director, Conduct, Compliance and Organisational Risk) provided guidance to the Committee (other than for their own remuneration).
The 2015 annual bonus outcome for the Group (excluding TSB) was determined by adjusting the Group’s target bonus outcome (£415.4 million in 2015) according to: – Group underlying profit performance: a target of £7,536 million was approved by the Board, with threshold and maximum set at 20 per cent above and below target. The outcome for 2015 was as follows: Below threshold (0%) Threshold (55%) On-Target (100%) Maximum (145%)
– Growth in the key customer segments – net lending to SMEs increased by 5 per cent and there has been continued development of the Group’s digital capability.
– An increased ordinary dividend of 2.25 pence per share in 2015, in line with its progressive and sustainable dividend policy.
Divisional/functional performance modifier (weighted average of all divisions/functions) Modified total outcome £479.5m Collective performance adjustment (approx.) 26%
António Horta-Osório The Group Chief Executive’s (GCE) individual performance assessment for 2015, as confirmed by the Committee, reflected a number of considerations including: – Underlying profit increased by 5 per cent to £8,112 million, leading to an improvement in underlying return on required equity to 15 per cent. – Improved financial strength with the pro forma common equity tier 1 (CET1) ratio at 13.0 per cent after dividend payments and improved credit rating.
– Continued support for ‘helping Britain prosper’ plan, maintaining record of above market growth in SME lending.
– Continued growth in digital channels and service capabilities for personal customers.
– Gained shareholder support for credible and sustainable dividend policy. 2015 ordinary dividends 2.25 pence per share, with an additional special dividend of 0.5 pence per share recommended.
Following the Committee’s assessment of performance against the underlying profit target and Group BSC objectives, and taking into account the collective performance adjustment of 26 per cent and the individual rating of Strong, the Committee determined a 2015 bonus award to the GCE of £849,649 (57 per cent of maximum). As disclosed previously, the mechanical bonus outcome for the GCE’s bonus in 2014 was £978,882. This award was reduced to £800,000 to reflect the external environment at the time. The GCE’s 2015 bonus of £849,649 is 13 per cent lower than the 2014 mechanical bonus outcome.
– Cost leadership, with continued reductions in cost:income ratio to 49.3 per cent.
Long-term awards made in March 2013 vesting for the period ended on 31 December 2015 (audited) The Group has performed strongly over the performance period of the 2013 Long Term Incentive Plan (LTIP) awards, continuing to transform the business for the benefit of its shareholders. During the performance period of the plan (from 1 January 2013 to 31 December 2015), the Group’s share price increased by 47 per cent from 49.69 pence to 73.07 pence.
Relative spend on pay (£m) The graph below illustrates the relative importance of spend on pay (total remuneration of all Group employees) compared with distributions to shareholders. Distributions to shareholders are ordinary and special dividends.
2 Awards subject to performance under the LTIP had an expected value of 50 per cent of face value at grant (using current accounting assumptions). Values are based on the 31 December 2015 closing price of 73.07 pence. Full face value of awards are £24,991,833 for António Horta-Osório, £13,055,725 for George Culmer and £10,058,995 for Juan Colombás.
3 The changes in beneficial interests for António Horta-Osório (613 shares), George Culmer (534 shares) and Juan Colombás (534 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2015 and 24 February 2016. There have been no other changes up to 24 February 2016.
Customer complaint handling (total FCA reportable complaints per 1,000 accounts)1 and Financial Ombudsman Service (FOS) uphold rate
1 Measure excludes PPI complaints and any complaints received via Claims Management Companies (CMC), but includes Banking, Home Finance, General Insurance, Life, Pensions and Investment complaints. The Group’s performance is heavily influenced by CMC volumes which are automatically reportable if defended. However, only 2 per cent of complaints received via CMCs are currently upheld by the Financial Ombudsman Service (FOS). Accordingly, the Committee has determined that complaints received via CMCs should be excluded from this measure.
The targets referred to in the table relate to the Group’s strategic plan, as approved by the Board. Further details have not been provided for reasons of commercial sensitivity, but will be disclosed after vesting.
Deferred bonus awarded in 2015 Bonus is deferred into shares. The face value of the share awards in respect of bonuses granted in March 2015 was £800,000 (1,000,875 shares) for the GCE; £496,000 (620,542 shares) for the CFO; and £467,892 (585,376 shares) for the CRO. The share price used to calculate the face value is the average price over the five days prior to grant (6 March to 11 March 2015), which was 79.93 pence.
Lloyds Banking Group long-term incentive plan (audited) The following table shows conditional shares awarded under the plan. Further information regarding this plan can be found on pages 100 and 105.
António Horta-Osório 9,644,684 – 9,316,764 327,920 – 31/12/2014 – 1 1 The shares awarded in March 2012 vested on 12 March 2015. The closing market price of the Group’s ordinary shares on that date was 79.2 pence.
Values are based on the 31 December 2015 closing price of 73.07 pence.
27/03/15 149,642 Fixed Share Award 19/05/15 56 Dividend reinvestment 25/06/15 136,880 Fixed Share Award 29/09/15 162,262 Fixed Share Award 21/12/15 166,993 Fixed Share Award
For the first time since 2011, a base salary increase is proposed for the GCE. The GCE was hired on the basis that upon the Government shareholding falling in the range of 15-20 per cent or less, the Committee would consider his remuneration being increased in line with market conditions. With the Government’s shareholding now being around 9 per cent and given the recovery of the Group’s financial strength, the Committee has decided it should now begin to adjust the GCE’s salary towards the reference salary. After discussion with shareholders, the Committee has decided to stage this adjustment over two years. For 2016, this will consist of an increase in base salary of 2 per cent, in line with the other Executive Directors, and an additional increase of 4 per cent to reflect the arrangements above, taking his total salary to £1,125,000. The GCE has suggested, and the Board has approved, that for 2016 the 4 per cent increase be delivered in shares and held until the Government has sold its shareholding in the Group. After this increase, the GCE’s salary remains conservative compared to peers.
The GCE is also entitled to the provision of an Employer-Financed Retirement Benefits Scheme (EFRBS), subject to performance conditions, as described further in the annual report on remuneration.
Performance adjustment is determined by the Remuneration Committee and Board Risk Committee and may result in a reduction of up to 100 per cent of the bonus opportunity. The Independent Performance Adjustment Committee (IPAC) reviews the BSC outcomes and submits a report to the Remuneration Committee and Board Risk Committee to assist in this process.
Individual performance adjustment is informed using a matrix-based approach taking into account the severity of the issue, the individual’s proximity to the issue and the individual’s behaviour in relation to the issue.
In addition, the annual bonus may be subject to clawback for a period of up to seven years after the date of award. This period may be extended to ten years where there is an ongoing internal or regulatory investigation.
During 2015 and early 2016, the Committee consulted widely with various shareholders on appropriate performance measures and, in particular, on how management can be incentivised through the LTIP to successfully deliver the objectives set out in the Group Strategic Review.
Nomination & Governance Committee membership2 £5,000 £5,000 1 New members only. 2 Where individual is not already Chairman of another Committee.
Corporate governance statement The corporate governance report found on pages 56 to 81 together with this report of which it forms part, fulfils the requirements of the Corporate Governance Statement for the purpose of the Financial Conduct Authority’s Disclosure and Transparency Rules (DTR).
The Company has also granted a deed of indemnity through deed poll which constituted ‘qualifying third party indemnity provisions’ to the Directors of the Group’s subsidiary companies, including to former Directors who retired during the year and since the year end.
Share capital and control Share capital and restrictions on the transfer of shares or voting rights – note to the accounts
Post balance sheet events Other than as stated in note 56 (which is incorporated into this report by reference), there have been no other material post balance sheet events.
Group, divisional and business unit operating plans are produced and subject to regulatory and internal stress testing scenarios on an annual basis. The planning process takes account of the Group’s business objectives, the risks taken to seek to meet those objectives and the controls in place to mitigate those risks to remain within the Group’s overall risk appetite.
1 Percentage provided was correct at the date of notification. 2 A direct holding. 3 The most recent notification provided by BlackRock, Inc. under Rule 5 of the DTR identifies (i) an indirect holding of 3,599,451,380 shares in the Company representing 5.04 per cent of the voting rights in the Company, and (ii) a holding of 69,305,385 in other financial instruments in respect of the Company representing 0.09 per cent of the voting rights of the Company. BlackRock, Inc.’s holding most recently notified to the Company under Rule 5 of the DTR varies from the holding disclosed in BlackRock, Inc.’s Schedule 13-G filing with the US Securities and Exchange Commission dated 9 February 2016, which identifies beneficial ownership of 4,847,496,882 shares in the Company representing 6.8 per cent of the issued share capital in the Company. This variance is attributable to different notification and disclosure requirements between these regulatory regimes.
Information relevant to the assessment can be found in the following sections of the annual report and accounts: – The Group’s principal activities, business and operating models and strategic direction are described in the strategic report; – Emerging risks are disclosed on page 114; – The principal risks, including the Group’s objectives, policies and processes for managing credit, capital, liquidity and funding, are provided in the Risk Management section on pages 112 to 169; and – The Group’s approach to stress testing and reverse stress testing, including both regulatory and internal stresses, is described on page 115.
Based upon this assessment, the Directors have a reasonable expectation that the Company and the Group will be able to continue in operation and meet its liabilities as they fall due over the next three years to 31 December 2018.
Inclusion and diversity We aim to appoint the best person available into any role and to attract talented people from diverse backgrounds. We encourage and give full and fair consideration to job applications from people with a disability and are unbiased in the way we assess, select, appoint, train and promote people. We encourage job applications from those with a disability and continue to run a work experience programme with Remploy to support people with disabilities wanting to enter the workplace. All colleagues, including disabled colleagues, are provided with training and development opportunities so that they can carry out their role to the best of their ability. All line managers completed inclusion and diversity capability training in 2015, and an additional 200 colleagues were trained to deliver disability awareness sessions with customers.
Statement of directors’ responsibilities The Directors are responsible for preparing the annual report, the Directors’ remuneration report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law, the Directors have prepared the Group and parent Company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. Under company law, the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the Company and of the profit or loss of the Company and Group for that period. In preparing these financial statements, the Directors are required to: select suitable accounting policies and then apply them consistently; make judgements and accounting estimates that are reasonable and prudent; and state whether applicable IFRSs as adopted by the European Union have been followed.
Risk decision making and reporting – Taking risks which are well understood, consistent with strategy and with appropriate return is a key driver of shareholder value. – Risk analysis and reporting supports the identification of opportunities as well as risks. – An aggregate view of the Group’s overall risk profile, key risks and management actions, and performance against risk appetite, is reported to and discussed monthly at the Group Risk Committee (and a subset at the 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. – The Chief Risk Officer regularly informs the Board Risk Committee (BRC) of the aggregate risk profile and as a member of the Board, has direct access to the Chairman and members of BRC.
The risk overview (pages 28 to 33) provides a summary of risk management within the Group. It highlights the important role of risk as a strategic differentiator, risk achievements in 2015 and priorities for 2016 along with a brief overview of the Group’s risk governance structure and the principal risks faced by the Group and key mitigating actions.
Table 1.1: Exposure to risk arising from the business activities of the Group The table below provides a high level guide to how the Group’s business activities are reflected in its risk measures and balance sheet. Details of the business activities for each division are provided in the Divisional Results on pages 42 to 51.
– Continue to implement our conduct strategy ensuring the customer is at the heart of our business planning whilst working closely with regulatory authorities and industry bodies to ensure that the Group can identify and respond to the evolving regulatory landscape. – Programmes in place to deliver SM&CR by March 2016 implementation and ring-fencing and resolution by January 2019.
– Regular reviews and updates to strategic milestones provide opportunity to reposition and reprioritise to minimise and negate potential impacts.
Conduct risk: In a low growth environment we cannot compromise on our Conduct Strategy for revenue growth. Further provisions for legacy issues may be required if issues emerge which require remediation.
Market liquidity: Financial markets continue to exhibit signs of a lack of liquidity and potential impacts include the speed at which structural hedging can be undertaken and relevant asset portfolio liquidated.
Ring-fencing and resolution: UK ring-fencing legislation, regulation and rules impact the Group’s business and operating model and could impact the ability to, and cost of, serving customers effectively to a greater extent than current assumptions, with potential changes in the competitive landscape and changes to customer and market behaviour.
– Assessment of the possible impacts of legislation is ongoing and the Group expects to deliver enhanced systems to fulfil related regulatory requirements. – Chief Data Officer reviewing Groupwide operating model and aligning the Group’s appetite appropriately.
Geopolitical shocks: Current uncertainties could further impede the global economic recovery and adjustment from a period of ultra-accommodative monetary policy. Events in China, Russia and the Middle-East, as well as terrorist activity, have the potential to trigger changes in market risk pricing which could lead to rising funding costs.
– Current risk appetite criteria limits single counterparty bank and non-bank exposures complemented by a UK-focused strategy. – The Group’s Financial Stability Forum is in place to develop and maintain the Group’s Stability Response Plan, whilst also acting as a Rapid Reaction Group, meeting when external crises occur.
The Chief Economist’s Office develops the internal macroeconomic scenarios used by the Group, based on key uncertainties for the Group’s economic outlook. A wide set of economic parameter assumptions is constructed, with over 150 metrics provided such as Gross Domestic Product, Base Rate, unemployment, property indices, insolvencies and corporate failures to facilitate modelling of scenarios across the Group. Where an external scenario is provided, as was the case with the UK-wide concurrent Bank of England stress exercise, the Chief Economist’s Office broadens the externally supplied parameters to the level of detail required by the Group.
The Group Financial Risk Committee (GFRC), chaired by the Chief Risk Officer and attended by the Chief Finance Officer and other senior Risk and Finance colleagues, is the Committee that has primary responsibility for overseeing the development and execution of the Group’s stress tests.
CAPITAL STRESS TESTING Overview Stress testing is recognised as a key risk management tool within the Group by the Board, senior management, the businesses and the Risk and Finance functions. Stress testing is fully embedded in the planning process of the Group as a key activity in medium term planning. Senior management is actively involved in stress testing activities via a strict governance process.
Regulatory stress tests During 2015, the Group was subject to the UK-wide concurrent stress test run by the Bank of England. As announced in December, the Group comfortably exceeded the capital thresholds set by the regulator and was not required to take any action as a result of this test.
Internal stress tests At least on an annual basis, the Group conducts a detailed macroeconomic stress test of the operating plan, which is supplemented with higher-level refreshes if necessary. The exercise aims to highlight the key vulnerabilities of the Group to adverse changes in the economic environment, and to ensure that there are adequate financial resources in the event of a downturn. The internal stress test includes different economic scenarios, both in terms of severity and focus (for example exploring the impacts of both low and high interest rate environments).
– The Board Risk Committee is responsible for overseeing the development, implementation and maintenance of the Group’s overall risk management framework and its risk appetite, to ensure they are in line with emerging regulatory, corporate governance and industry best practice.
All business areas complete a Control Effectiveness Review annually, reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. Executives from each business area and each GEC member challenge and certify the accuracy of their assessment. This key process is overseen and independently challenged by Policy Owners, Risk Division and Group Audit, and reported to the Board.
Culture – supporting the formal frameworks of the RMF is the underlying culture, or shared behaviours and values, which sets out in clear terms what constitutes good behaviour and good practice. In order to effectively manage risk across the organisation, the functions encompassed within the Three Lines of Defence have a clear understanding of risk appetite, business strategy and an understanding of (and commitment to) the role they play in delivering it. A number of levers are used to reinforce the risk culture, including tone from the top, clear accountabilities, effective communication and challenge and an appropriately aligned performance incentive and structure.
Resources and capabilities – appropriate mechanisms are in place to avoid over-reliance on key personnel or system/ technical expertise within the Group. Adequate resources are in place to serve customers both under normal working conditions and in times of stress, and monitoring procedures are in place to ensure that the level of available resource can be increased if required. Colleagues undertake appropriate training to ensure they have the skills and knowledge necessary to enable them to deliver fair outcomes for customers, being mindful of the Group’s Conduct Strategy, Customer Treatment Policy/ Standards and Financial Conduct Authority requirements.
– Risk Division (second line) is a centralised function providing oversight and independent constructive challenge to the effectiveness of risk decisions taken by business management, providing proactive advice and guidance, reviewing challenging and reporting on the risk profile of the Group and ensuring that mitigating actions are appropriate. – Group Audit (third line) provides independent, objective assurance and consulting activity designed to add value and improve the organisation’s operations. It helps the Group accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. Group Audit provides independent assurance to the Audit Committee and the Board that risks within the Group are recognised, monitored and managed within acceptable parameters. Group Audit is fully independent of the Risk Division and the business, and seeks to ensure objective challenge to the effectiveness of the risk governance framework.
Company Secretariat support senior and Board level committees, and support the Chairs in agenda planning. This gives a further line of escalation outside the Three Lines of Defence.
Page 121 Page 143 Page 144 Page 151 Page 153 Page 160 Page 166 Page 166 Page 167 Page 168 Page 169 1 The Group considers these to be principal risks. See risk overview pages 28 to 33 for further details.
In terms of loans and advances, (for example loans and overdrafts) and contingent liabilities (for example credit instruments such as guarantees and standby, documentary and commercial letters of credit), credit risk arises both from amounts advanced and commitments to extend credit to a customer or bank as required within documentation. With respect to commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail commitments to extend credit can be cancelled without notice and the creditworthiness of customers is monitored regularly. Most commercial term commitments to extend credit are contingent upon customers maintaining specific credit standards, which together with the creditworthiness of customers are monitored regularly.
The obligor quality measurement of both retail and commercial counterparties is largely based on the outcomes of credit risk (probability of default – PD) models. The Group operates a number of different regulatory rating models, typically developed internally using statistical analysis and management judgement – retail models rely more on the former, commercial models include more of the latter, especially in the larger corporate and more specialised lending portfolios. Internal data is supplemented with external data in model development, where appropriate.
Group Audit performs the third line of credit risk assurance. A specialist team within Group Audit, comprising experienced credit professionals, is in place to carry out independent risk based internal control audits, providing an assessment of the effectiveness of internal credit controls, credit risk classification and the raising of impairment provisions. These audits cover the diverse range of the Group’s businesses and activities, and include both ‘standard’ risk based audits and reviews as well as bespoke assignments to respond to any emerging risks or regulatory requirement. The work of Group Audit therefore continues to provide executive, senior management and Board Audit Committee with assurance on effectiveness of credit risk controls, as well as appropriateness of impairments.
It is policy that commercial lending decisions must be based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. The types of collateral taken and the requirement for which collateral is required at origination is dependent upon the credit quality, size and structure of the borrower. For non-retail exposures, the Group will often require the collateral to include a first charge over land and buildings owned and occupied by the business, a mortgage debenture over the company’s undertaking and one or more of its assets, and key man insurance. The Group maintains policies setting out acceptable collateral, maximum LTV ratios and other criteria to be considered when reviewing an application. The decision as to whether or not collateral is required will be based upon the nature of the transaction and the credit worthiness of the customer/counterparty. Other than for project finance, object finance and income producing real estate where charges over the subject assets are a basic requirement, the provision of collateral will not determine the outcome of an application. Notwithstanding this, the fundamental business proposition must evidence the ability of the business to generate funds from normal business sources to repay a customer/counterparty’s financial commitment.
Credit policies are in place to avoid correlation or wrong way risk. Under the repo policies, the issuer of the collateral and the repo counterparty should be neither the same nor connected. The same rule applies for derivatives under collateral policies. The Risk Division has the necessary discretion to extend this rule to other cases where there is significant correlation. Countries with a rating equivalent to AA- and above may be considered to have no adverse correlation between the counterparty domiciled in the country and that country of risk (issuer of securities).
Master netting agreements Where it is appropriate and likely to be effective, the Group seeks to enter into master netting agreements. Although master netting agreements do not generally result in an offset of balance sheet assets and liabilities for accounting purposes, as transactions are usually settled on a gross basis, they do
Other credit risk transfers The Group also undertakes asset sales, credit derivative based transactions and securitisations as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.
Assistance is provided through trained colleagues in branches and dedicated telephony units, and via online guidance material. For those customers requiring more intensive help, assistance is provided through dedicated support units where tailored repayment programmes can be agreed. Customers are actively supported and referred to free money advice agencies when they have multiple credit facilities, including those at other lenders that require restructuring. Within the Collections and Recoveries functions, the sharing of best practice and alignment of policies across the Group has helped to drive more effective customer outcomes and achieve operational efficiencies.
The specific tools available to assist customers vary by product and the customer’s status. In defining the treatments offered to customers who have experienced financial distress, the Group distinguishes between the following categories: – Reduced payment arrangements: a temporary arrangement for customers in financial distress where arrears accrue at the contractual payment, for example short-term arrangements to pay. – Term extensions: a permanent account change for customers in financial distress where the overall term of the mortgage is extended, resulting in a lower contractual monthly payment. – Repair: a permanent account change used to repair a customer’s position when they have emerged from financial difficulty, for example capitalisation of arrears.
The Income Support for Mortgage Interest scheme remains the most successful of the government backed schemes. It is the longest-running, is the most widely known and provides both the customer and the Group with an assurance as to the maintenance of at least two years’ worth of interest payments. The Group estimates that customers representing approximately £2.2 billion of its mortgage exposures are receiving this benefit. This includes those who are also receiving other treatments for financial difficulty.
Commercial customers Early identification, control and monitoring are key in order to support the customer and protect the Group. With the exception of small exposures in SME all non-retail exposures in the Commercial Banking and Run-off divisions are reviewed at least annually by the independent Risk Division (and more frequently where required). As part of the Group’s established Credit Risk Classification system, every exposure in the good book is categorised as either ‘good’ or ‘watchlist’. This complements the Group’s risk rating tools and is designed to identify and highlight portfolio levels of asset quality as well as individual problem credits. All watchlist names are reviewed by the business and Risk Division regularly, and the classification is updated if required. This process seeks to ensure that relationship managers act promptly to identify, and highlight to senior management those customers who have the possibility to become higher risk in the future.
BSU case officers manage non-retail distressed assets in Commercial Banking and Run-off divisions, and are part of the independent Risk Division. They are highly experienced and operate in a closely controlled and monitored environment, including regular oversight and close scrutiny by senior management.
The main types of forbearance concessions to commercial customers in financial difficulty are set out below: – Covenants: This includes temporary and permanent waivers, amendment or resetting of non-payment contractual covenants (including LTV and interest cover). The granting of this type of concession in itself would not result in the loan being classified as impaired and the customer is kept under review in the event that further forbearance is necessary; – Extensions/Alterations: This includes extension and/or 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; amendments to an interest rate to a level considered outside of market or the Group’s risk appetite, or other amendments such as changes to capital and/or interest servicing arrangements including capital repayment holidays or conversion to interest only terms; and – Multiple type of forbearance (a combination of the above two).
Any event that causes concern over future payments is likely to result in the customer being assessed for impairment and, if required, an impairment allowance recognised. If impairment is identified, the customer is immediately transferred to BSU (if not already managed there) and the lending will be treated as impaired.
All reviews performed in the good book, BSU within Commercial Banking or in the Run-off division include analysis of latest financial information, a consideration of the market and sector the customer operates in, performance against plan and revised terms and conditions granted as part of the forbearance concession.
The exception to this 12 month minimum period is where a permanent structural cure is made (for example, an injection of new collateral security or a partial repayment of debt to restore an LTV back to within a covenant). In this case, the customer may exit forbearance once the permanent cure has been made.
However, notwithstanding this, the overriding requirement for exit from forbearance in all cases is that the customer is not impaired and the reason for the forbearance event is no longer present.
– The reduction reflects lower levels of new impairment as a result of effective risk management, a favourable credit environment, improving UK economic conditions and continued low interest rates. – The asset quality ratio (impairment charge as a percentage of average loans and advances to customers) improved to 0.14 per cent compared to 0.23 per cent during 2014. – At the Group Strategic Update in October 2014, we outlined that although it would be lower between 2015 to 2017, we expect the Group asset quality ratio to be c.40 basis points through the economic cycle. – In 2016, the Group expects to benefit from its continued disciplined approach to the management of credit and the resilient UK economy. Write-backs and provision releases, however, are expected to be at a lower level and as a result, the Group expects the asset quality ratio for the 2016 full year to be around 20 basis points. – Impaired loans as a percentage of closing loans and advances reduced to 2.1 per cent at 31 December 2015, from 2.9 per cent at 31 December 2014 driven by reductions within the continuing and run-off portfolios, including the sale of Irish commercial loans during the third quarter. Provisions as a percentage of impaired loans reduced from 56.4 per cent to 46.1 per cent reflecting the disposal of highly covered assets during the year. – Retail division impairment provisions as a percentage of impaired loans have increased to 40.4 per cent from 38.8 per cent at 31 December 2014, with Secured increasing by 0.5 percentage points to 37.5 per cent. Consumer Finance division impairment provisions as a percentage of impaired loans have increased to 72.8 per cent from 70.5 per cent at 31 December 2014, with Credit Cards increasing by 5.3 percentage points to 81.8 per cent and Asset Finance UK decreasing by 2.8 percentage points to 67.2 per cent.
The stock of repossessions decreased to 654 cases at 31 December 2015 compared to 1,740 cases at 31 December 2014.
New residential lending 65.3 62.7 n/a 64.8 1 Average loan to value is calculated as total loans and advances as a percentage of the indexed total collateral of these loans and advances.
Retail has reduced its exposure to owner occupier interest only mortgages throughout 2015. New owner occupier interest only mortgages are limited to a maximum loan to value of 75 per cent, with a verifiable repayment vehicle sufficient to repay the loan. Interest only mortgages represented 0.1 per cent of new residential mortgages in 2015 (0.1 per cent in 2014).
Average loan to value (%) 46.6 51.0 1 In addition the Group has Buy-to-let interest only balances of £49,751 million (2014: £47,761 million) and certain other interest only balances of £3,705 million (2014: £4,153 million).
2 Includes temporary interest-only arrangements and short-term payment holidays granted in collections where the customer is currently benefiting from the treatment and where the concession has ended within the previous six months (temporary interest-only) and previous 12 months (short-term payment holidays).
Commercial Banking forbearance At 31 December 2015, £3,514 million (31 December 2014: £5,137 million) of total loans and advances were forborne of which £2,528 million (31 December 2014: £3,241 million) were impaired. Impairment provisions as a percentage of forborne loans and advances decreased marginally from 31.0 per cent at 31 December 2014 to 30.9 per cent at 31 December 2015.
Impaired loans and advances The movements in Commercial Banking impaired forborne loans and advances were as follows: Table 1.22: Movement in Commercial Banking impaired forborne loans and advances (audited)
Unimpaired loans and advances Unimpaired forborne loans and advances were £986 million at 31 December 2015 (31 December 2014: £1,896 million).
Impairment charge as a % of average advances 0.68% 1.05% (37) bps
2 Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the last six months. Permanent changes which commenced during the last 24 months for existing customers as at 31 December are also included.
Impairment charge as a % of average advances1 0.20% 0.64% (44)bps 1 In respect of loans and advances to customers.
Classified as impaired during the year: Transferred to unimpaired but still reported as forborne during the year: Asset disposal/sales of impaired assets (763) (4,363)
Run-off Ireland commercial real estate and corporate All loans and advances (whether impaired or unimpaired) are treated as forborne. At 31 December 2015, £37 million (31 December 2014: £3,436 million) of total loans and advances were forborne of which £5 million (31 December 2014: £3,052 million) were impaired. Impairment provisions as a percentage of forborne loans and advances decreased from 72.2 per cent at 31 December 2014 to nil at 31 December 2015.
Eurozone exposures The following section summarises the Group’s direct exposure to Eurozone countries at 31 December 2015. The exposures comprise on-balance sheet exposures based on their balance sheet carrying values and off-balance sheet exposures, and are based on the country of domicile of the counterparty unless otherwise indicated.
At 31 December 2014 1 Excludes reverse repurchase exposure to Institutional funds domiciled in Ireland secured by UK gilts of £11,267 million (2014: £10,456 million) on a gross basis.
The Group provides colleague training in environmental risk management as part of the standard suite of credit risk courses. Supporting this training, a range of online resource is available to colleagues and includes environmental risk theory, procedural guidance, and information on environmental legislation and sector-specific environmental impacts.
The Group’s leadership team is committed to embedding the Conduct Strategy within the business following its approved transition into business as usual to support the development of the right customer centric culture. The Board and Group Risk Committee receive regular reports and metrics to track progress on how the Group is meeting customer needs and minimising conduct risk.
All Group business areas have continued to apply significant resources to the Conduct Strategy to achieve the target of transition to business as usual and to continue delivering improved outcomes for customers.
The Group actively engages with regulatory bodies and other stakeholders in developing its understanding of current customer treatment concerns, and those relating to the fairness and effectiveness of markets, to ensure that the implementation of the Group’s conduct strategy meets evolving stakeholder expectations.
Cash and balances at central banks 58,417 – 58,417 – Interest rate
Items in course of transmission to banks 717 – 717 – Interest rate
Trading and other financial liabilities at fair value through profit or loss 51,863 43,984 7,879 – Interest rate, foreign exchange
Liabilities arising from insurance and investment contracts 103,071 – – 103,071 Credit spread
Table 1.37: Key market risks for the Group by individual business activity (profit before tax impact measured against Group single stress scenarios)
Interest rate risk Interest rate risk in the Group’s divisional portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.36) and off balance sheet positions of the Group. Behavioural assumptions are applied to (i) embedded optionality within products; (ii) the duration of balances that are contractually repayable on demand, such as current accounts and overdrafts, together with net free reserves of the group; and (iii) to the re-pricing behaviour of managed rate liabilities namely variable rate savings.
Equity risk Equity risk arises primarily from three different sources; (i) the Group’s strategic equity holdings in Banco Sabadell, Aberdeen, and Visa Europe; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital.
(iii) Market Value notional limit: this caps the amount of conventional and inflation-linked government bonds held by the Group for liquidity purposes.
(iv) Structural hedge limits; these metrics enhance understanding of assumption and duration risk taken within the behaviouralisation of this portfolio.
Basis risk, foreign exchange, equity, and credit spread risks are measured primarily through scenario analysis by assessing the impact on profit before tax over a 12 month horizon arising from a change in market rates, and reported within the Board Risk Appetite on a monthly basis. Supplementary measures such as sensitivity and exposure limits are applied where they provide greater insight into risk positions. Frequency of reporting supplementary measures varies from daily to quarterly appropriate to each asset class.
Net investment foreign exchange exposures are managed centrally by GCT, by hedging non GBP asset values with currency borrowing. Economic foreign exchange exposures arising from non-functional currency flows are identified by divisions and transferred and managed centrally. The Group also has a policy of forward hedging its forecasted currency profit and loss to year end.
Defined benefit pension schemes Exposures The Group’s defined benefit pension schemes are exposed to significant risks from both their assets and from the present value of their liabilities, primarily real interest rate, credit spread, equity, and alternative asset risks. The liability discount rate provides exposure to interest rate risk and credit spread risk, which are partially offset by fixed interest assets (such as gilts and corporate bonds) and swaps. Equity and alternative asset risk arises from direct asset holdings.
Monitoring In addition to the wider risk management framework, governance of the schemes includes two specialist pensions committees (one Group executive sub-committee and a supporting management committee).
Monitoring Market risks in the Insurance business are monitored by Insurance senior executive Committees and ultimately the Insurance Board. Monitoring includes the progression of market risk capital against risk appetite limits, as well as the sensitivity of profit before tax to combined market risk stress scenarios and in year market movements. Asset/liability matching positions and hedges in place are actively monitored and if necessary rebalanced to be within agreed tolerances. In addition market risk is controlled via approved investment policies and mandates.
Table 1.42: Trading portfolios: VaR (1-day 95 per cent confidence level) (audited) At 31 December 2015 At 31 December 2014
Although it is an important market standard measure of risk, VaR has limitations. One of them is the use of limited historical data sample which influences the output by the implicit assumption that future market behaviour will not differ greatly from the historically observed period. Another known limitation is the use of defined holding periods which assumes that the risk can be liquidated or hedged within that holding period. Also calculating the VaR at the chosen confidence interval does not give enough information about potential losses which may occur if this level is exceeded. The Group fully recognises these limitations and supplements the use of VaR with a variety of other measurements which reflect the nature of the business activity. These include detailed sensitivity analysis, position reporting and a stress testing programme.
Trading book VaR (1-day 99 per cent) is compared daily against both hypothetical and clean profit and loss. 1-day 99 per cent VaR charts for Lloyds Bank, HBOS and Lloyds Banking Group models can be found in the Group’s Pillar 3 Report.
Execution, delivery and process management 15.81 20.30 11.08 14.12 1 During the year, the Group undertook a review of the internal classification of operational risk events to improve alignment to the Basel categories. As a result of this review, the Group has changed the classification categories for a number of events. 2014 has been revised to reflect the new categorisations.
Mitigation The Group continues to review and invest in its control environment to ensure it addresses the inherent risks faced. Risks are reported and discussed at local governance forums and escalated to executive management as appropriate. This ensures the correct level of visibility and engagement. The Group employs a range of risk management strategies, including: avoidance, mitigation, transfer (which would also include insurance) and acceptance. Contingency plans are maintained for a range of potential scenarios, with regular disaster recovery and scenario testing scheduled to test and challenge the readiness of the Group to respond in the event of an incident.
– The Group continues to mature its approach to operational resilience. The IT Resilience Programme is making significant progress in addressing the observations and associated resilience risks raised in the Independent IT Resilience Review performed by PwC (2013). The Board recognises the role that resilient technology plays in achieving the Group’s strategy of becoming the best bank for customers and in maintaining banking services across the wider industry. As such, the Board dedicates considerable time and focus to this subject at both the Board and the Board Risk Committee, and continues to sponsor key investment programmes that enhance our resilience. – The threat landscape associated with cyber risk has continued to evolve alongside increasing Regulatory attention. The Board has defined a Cyber Risk Appetite and is supporting investment to help mitigate this risk. – In addition to initiatives that protect the Group against a malicious cyber-attack the Group continues to invest in enhanced protection of customer information, including limiting access to key systems and enhancing the security, durability and accessibility of critical information. – The Group adopts a risk based approach to mitigate the external fraud risks it faces, reflecting the current and emerging external fraud risks within the market. This approach drives an annual programme of enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Groupwide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group’s fraud awareness programme remains a key component of its fraud control environment. – The Group remediates issues that are identified in its customer processes, addressing root cause and rectifying customers as required. Enhancing the overall servicing environment remains a focus of dedicated Group programmes such as Simplification. – Following the successful divestment of TSB the Group retains responsibility for the ongoing provision of key services which are managed via robust change management governance and a consolidated strategic change plan. There are separate governance arrangements in place to oversee the impacts of the divestment on the retained business customers, operations and controls. – Operational resilience measures and recovery planning defined in the Group’s Business Continuity Management policy ensure an appropriate and consistent approach to the management of continuity risks, including potential interruptions from a range of internal and external incidents or threats including environmental and climatic issues, terrorism, cyber, economic instability, pandemic planning and operational incidents. – The Group has adopted policies and procedures designed to detect and prevent the use of its banking network for money laundering, terrorist financing, bribery and activities prohibited by legal and regulatory sanctions. The Group regularly reviews and assesses these policies to keep them current, effective and consistent across markets. The Group requires mandatory training on these topics for all employees. Specifically, the anti-money laundering procedures include ‘know-your-customer’ requirements, transaction monitoring technologies and reporting of suspicions of money laundering or terrorist financing to the applicable regulatory authorities and the Anti-Bribery Policy prohibits the payment, offer, acceptance or request of a bribe, including ‘facilitation payments’ by any employee or agent and provides a confidential reporting service for anonymous reporting for suspected or actual bribery activity. The Sanctions and the Related Prohibitions Policy sets out a framework of controls for compliance with legal and regulatory sanctions.
Mitigation The Group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through short term liquidity management and over the life of the funding plan, combining business as usual and stressed conditions. The Group manages its risk appetite and liquidity position as a coverage ratio (proportion of stressed outflows covered by eligible liquid assets) corresponding with the PRA and CRD IV liquidity requirements. Longer term funding is used to manage the Group’s strategic liquidity profile, determined by the Group’s balance sheet structure. Longer term is defined as having an original maturity of more than one year.
Monitoring Liquidity is actively monitored at Group level. Routine reporting is in place to senior management and through the Group’s committee structure, in particular GALCO which meets monthly. In a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event. Liquidity policies and procedures are subject to independent internal oversight.
In addition, the monitoring framework has two other important components. Firstly, the Group carries out stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longer term (up to three months) horizons against a range of scenarios reflecting possible future liquidity risks. The scenarios and the assumptions are reviewed at least annually to gain assurance that they continue to be relevant to the nature of the business. For further information on the Group’s 2015 liquidity stress testing results refer to page 158. In addition to the liquidity stress testing framework, the Group funding plan is stressed against a range of macroeconomic scenarios, including those prescribed by the PRA. The Group also applies its own macroeconomic stress scenarios, including a one in 20 year recession. Liquidity Risk Appetite and regulatory metrics are calculated and monitored over the life the plan under base and stress conditions.
Funding and liquidity management in 2015 During 2015 the Group has maintained its strong funding and liquidity position, with a loan to deposit ratio of 109 per cent, LCR eligible liquid assets broadly equal to total wholesale funding and over five times money market funding less than one year to maturity at 31 December 2015. The Group has a diverse funding platform which comprises a strong customer deposit base along with wholesale funding comprising of a range of secured and unsecured funding products.
Total customer deposits fell by £28.8 billion to £418.3 billion at 31 December 2015, largely due to the sale of TSB and the planned reduction in tactical deposits.
Wholesale funding has increased by £3.4 billion to £119.9 billion; the amount with a residual maturity less than one year falling to £37.9 billion (£41.1 billion at 31 December 2014). The Group’s term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total wholesale funding) increased to 68 per cent (65 per cent at 31 December 2014). In 2015 the Group’s term issuance costs were lower than 2014 and significantly lower than previous years.
The combination of a strong balance sheet and access to a wide range of funding markets, including government and central bank schemes, provides the Group with a broad range of options with respect to funding the balance sheet.
Loan to deposit ratio (%) 108.8 106.8 2 LCR eligible liquid assets/money market funding less than one year maturity1 5.7 5.8 (2)
2 Excludes £20.8 billion (31 December 2014: £21.3 billion) of loans and advances to banks within the Insurance business and £0.9 billion (31 December 2014: £1.9 billion) of reverse repurchase agreements.
Stress testing results Internal stress testing results at 31 December 2015 showed that the Banking business had liquidity resources representing 163 per cent of modelled outflows from all wholesale funding sources, retail and corporate deposits, intraday requirements and rating dependent contracts under the Group’s most severe liquidity stress scenario (the three month PRA combined scenario).
Other realisable assets Cannot be used Total £m £m £m £m £m £m £m £m £m £m
Trading and other financial assets at fair value through profit or loss – – 6,922 6,922 – 7,459 17 126,138 133,614 140,536
Held-to-maturity investments – – – – – 19,808 – – 19,808 19,808
Trading and other financial assets at fair value through profit or loss – – 13,389 13,389 – 5,149 2,259 131,134 138,542 151,931
Available-for-sale financial assets 119 – 18,321 18,440 – 37,711 30 312 38,053 56,493
Held-to-maturity investments – – – – – – – – – –
The Group is also required to maintain a number of regulatory capital buffers which are required to be met with CET1 capital.
The countercyclical capital buffer is time-varying and is designed to require banks to hold additional capital to remove or reduce the build up of systemic risk in times of credit boom, providing additional loss absorbing capacity and acting as an incentive for banks to constrain further credit growth. The amount of the buffer is determined by reference to buffer rates set by the FPC for the individual countries where the Group has credit risk exposures. The current requirement for the Group is negligible.
The proposed leverage ratio framework does not currently give rise to higher capital requirements for the Group than the risk-based capital framework.
Lloyds Banking Group plc acts as a holding company which also issues capital and other securities to capitalise and fund the activities of the Group. The profitability of the holding company, and consequently its ability to sustain dividend payments, is therefore dependent upon the continued receipt of dividends from its subsidiaries (representing both banking and Insurance). A number of Group subsidiaries, principally those with banking and insurance activities, are also subject to regulatory capital requirements. These require entities to maintain minimum amounts of capital related to their size and risk. The principal operating subsidiary is Lloyds Bank plc which, at 31 December 2015, had a consolidated CET1 capital ratio of 15.2 per cent (31 December 2014: 15.1 per cent). The Group actively manages the capital of its subsidiaries, which includes monitoring the regulatory capital ratios for its banking and insurance subsidiaries against approved risk appetite limits. It operates a formal capital management policy which requires all subsidiary entities to remit any surplus capital to their parent companies.
During 2014 and 2015 the Group has undertaken significant capital management actions in order to simplify the Group’s internal capital structure and to ensure that profits generated by subsidiary entities can be more easily remitted to the Company. These activities relate to a number of subsidiary entities, and include the court approved capital reductions by HBOS plc and Bank of Scotland plc, the part VII transfers within insurance businesses and obtaining PRA approval for our internal model, which will support the Solvency II capital regime for the Insurance subsidiaries with effect from 1 January 2016.
The key differences between the transitional capital calculation as at 31 December 2015 and the fully loaded equivalent are as follows: – Capital securities that previously qualified as tier 1 or tier 2 capital, but do not fully qualify under CRD IV, can be included in tier 1 or tier 2 capital (as applicable) up to specified limits which reduce by 10 per cent per annum until 2022. – The significant investment deduction from additional tier 1 (AT1) will gradually transition to tier 2.
Tier 2 capital resources have reduced by £1,790 million in the year largely reflecting calls and redemptions, amortisation of dated instruments, foreign exchange movements and an increase in the significant investments deduction, partly offset by the issuance of new tier 2 instruments.
2 Threshold risk-weighted assets reflect the element of significant investments and deferred tax assets that are permitted to be risk-weighted instead of deducted from CET1 capital. Significant investments primarily arise from the investment in the Group’s Insurance business.
Leverage ratio In January 2015 the existing CRD IV rules on the calculation of the leverage ratio were amended to align with the European Commission’s interpretation of the revised Basel III leverage ratio framework. The Group’s leverage ratio has been calculated in accordance with the amended CRD IV rules on leverage.
The table on the next page summarises the component parts of the Group’s leverage ratio. Further analysis is provided in the Group’s Pillar 3 Report.
G-SIB requirements Although the Group is not currently classified as a Global Systemically Important Bank (G-SIB), by virtue of the leverage exposure exceeding €200 billion, the Group is required to report G-SIB metrics to the PRA. The Group’s metrics used within the 2015 Basel G-SIBs annual exercise will be disclosed from April 2016, and the results are expected to be made available by the Basel Committee later this year.
The minimum required capital must be maintained at all times throughout the year. These capital requirements and the capital available to meet them are regularly estimated in order to ensure that capital maintenance requirements are being met.
Measurement Regulatory and legal risks are measured against a set of risk appetite metrics, with appropriate thresholds, which are approved annually by the Board and which are regularly reviewed and monitored. Metrics include assessments of control and material regulatory rule breaches.
Longevity and persistency are key risks within the life and pensions business. Longevity risk arises from the annuity portfolios where policyholders’ future cashflows are guaranteed at retirement and increases in life expectancy, beyond current assumptions, will increase the cost of annuities. Longevity risk exposures are expected to increase following the 2015 entry into the bulk annuity market. Persistency assumptions are set to give a best estimate however, customer behaviour may result in increased cancellations or cessation of contributions.
The Group has a Disclosure Committee which assists the Group Chief Executive and Chief Financial Officer in fulfilling their disclosure responsibilities under relevant listing and other regulatory and legal requirements. In addition, the Audit Committee reviews the quality and acceptability of the Group’s financial disclosures. For further information on the Audit Committee’s responsibilities relating to financial reporting see pages 74 to 77.
Risk appetite Governance risk appetite is defined and embedded through the Group’s Governance Principle and Policy Framework which are reviewed and approved by the Board on an annual basis. The Group has governance arrangements that support the effective long-term operation of the business and the vision of being the best bank for customers, maximise shareholder value and meet regulatory and social expectations.
Exposures The internal and corporate governance arrangements of major financial institutions continue to be 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. Risk governance and risk culture are mutually reinforcing.
Under the banner of the RMF, training modules are in place to support all colleagues in understanding and fulfilling their risk responsibilities.
The Ethics and Responsible Business Policy and supporting Codes of Personal Responsibility and Business Responsibility embody the Group’s values and reflect its commitment to operating responsibly and ethically both at a business and an individual level. All colleagues are required to adhere to the Codes in all aspects of their roles.
The financial reporting framework that has been applied in the preparation of the financial statements is applicable law and IFRSs as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
Our audit approach Overview Set out below is an overview of our audit approach, highlighting key aspects including materiality level, scope and areas of focus of our audit. These are described in further detail later in this audit report.
We designed our audit by determining materiality and assessing the risks of material misstatement in the financial statements. In particular, we looked at where the directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. We also addressed the risk of management override of internal controls, including evaluating whether there was evidence of bias by the directors or management that represented a risk of material misstatement due to fraud.
What we have audited The financial statements, included within the Annual Report and Accounts (the ‘Annual Report’), comprise: – the consolidated and parent company balance sheets as at 31 December 2015; – the consolidated income statement and the consolidated statement of comprehensive income for the year then ended; – the consolidated and parent company cash flow statements for the year then ended; – the consolidated and parent company statements of changes in equity for the year then ended; and – the notes to the financial statements, which include a summary of accounting policies and other explanatory information.
Judgement is applied to determine appropriate parameters and assumptions used to calculate impairment. For example, the assumption of customers that will default, the valuation of collateral for secured lending and the future cash flows of commercial loan customers.
We understood and tested key controls and focused on: – the identification of impairment events; – the governance over the impairment processes, including the continuous re-assessment by management that impairment models are still calibrated in a way which is appropriate for the impairment risks in the Group’s loan portfolios; – the transfer of data between underlying source systems and the impairment models that the Group operates; and
We understood management’s basis for determining whether a loan is impaired and assessed the reasonableness using our understanding of the Group’s lending portfolios and our broader industry knowledge.
We understood and critically assessed the models used. Modelling assumptions and parameters, such as probability of default, are based on historic data. We challenged whether historic experience was representative of current circumstances and of the recent losses incurred in the portfolios. Where changes had been made in model parameters and assumptions, we understood the reasons why changes had taken place and used our industry knowledge and experience to evaluate the appropriateness of such changes. We also performed sensitivity analysis, and for certain portfolios, re-performed the provision calculation using our own independent models. We understood and corroborated any material differences identified.
In evaluating the models and assumptions, we also considered whether all relevant risks were reflected in the modelled provision, and where not, whether overlays to modelled calculations appropriately reflected those risks. We challenged management to provide objective evidence to support the overlay adjustments made to the modelled provision.
We assessed critically the criteria for determining whether an impairment event had occurred and therefore whether there was a requirement to calculate an impairment provision. We tested a sample of performing loans with characteristics that might imply an impairment event had occurred (for example a customer experiencing financial difficulty or approaching a refinancing deadline) to challenge whether all impairment events had been identified by management. We also haphazardly selected a sample of performing loans to further challenge whether all impairment events had been identified by management. We did not identify further impairment events.
The Group enters into a number of hedges to manage structural interest rate risk. These arrangements create accounting mismatches which are addressed through hedge accounting arrangements, predominantly fair value hedges or cash flow hedges. For example, one of the macro cash flow hedge models uses a portfolio of Base Rate mortgage assets which are designated into hedge relationships with LIBOR based swaps.
The application of hedge accounting and ensuring hedge effectiveness can be highly judgemental and requires close monitoring from management.
We tested key year-end reconciliations between underlying source systems and spreadsheets used to manage hedging models, including testing the calculation of hedge effectiveness adjustments.
We also tested a sample of manual adjustments posted to hedge reserves relating to hedge ineffectiveness arising in hedging models.
We assessed whether the extent of the disclosures made, in particular, in relation to contingent liabilities and judgements was appropriate.
We have evaluated the impact of recent tax law changes on the calculation of the Group's deferred tax balances, including confirming that the loss restriction rules, the banking surcharge and the restriction of deductions for certain compensation payments have been correctly applied.
The Group applies fair value adjustments to uncollateralised derivative positions, such as credit and debit valuation adjustments (CVA and DVA) and funding valuation adjustments (FVA).
The accounting for the sale and subsequent derecognition of TSB Banking Group plc in the consolidated financial statements has been judgmental and complex, and has required transaction specific controls to be designed and operate effectively.
We met with management prior to the sale of TSB Banking Group plc to discuss the accounting and disclosure implications.
Rationale for benchmark applied Our starting point was 5 per cent of profit before tax, a generally accepted auditing practice. However, profit before tax was adjusted to remove the disproportionate effect of certain, but not all, items excluded by management from underlying profit. The costs associated with the disposal of TSB Banking Group plc and conduct expenses and for which specific audit procedures were undertaken were excluded from profit before tax in 2015. In 2015 for the first time we used an average over 3 years (2013 to 2015) which reduces the potential for volatility and large increases in materiality year-on-year.
– the section of the Annual Report on page 75, as required by provision C.3.8 of the Code, describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee.
Philip Rivett (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 24 February 2016
Adjustment on sale of interest in TSB Banking Group plc (TSB, note 55) – – – – – (825) (825)
The directors approved the consolidated financial statements on 24 February 2016.
Further details of movements in the Group’s share capital, reserves and other equity instruments are provided in notes 41, 42, 43, 44 and 45.
Adjustment on sale of non-controlling interest in TSB – – (171) (171) – 805 634
Movements in cash flow hedging reserve, net of tax – (1,405) – (1,405) – (1,405)
Net cash provided by (used in) operating activities 16,372 10,353 (15,531)
Proceeds from sale and maturity of financial assets 22,000 4,668 21,552
Disposal of businesses, net of cash disposed 54(E) (4,071) 543 696
Effects of exchange rate changes on cash and cash equivalents 2 (6) (53)
Cash and cash equivalents at beginning of year 65,147 66,797 101,058
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2015 and which have not been applied in preparing these financial statements are given in note 57.
Financial statements to a date which is not more than three months before the Group’s reporting date. The share of any losses is restricted to a level that reflects an obligation to fund such losses.
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).
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 50(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.
The Group is permitted to reclassify, at fair value at the date of transfer, non-derivative financial assets (other than those designated at fair value through profit or loss by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or repurchased in the near term, as follows: – if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at initial recognition), they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the foreseeable future or until maturity; or – if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available-for-sale financial assets in ‘rare circumstances’.
(4) Held-to-maturity investments Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group’s management has the positive intention and ability to hold to maturity other than: – those that the Group designates upon initial recognition as at fair value through profit or loss; – those that the Group designates as available-for-sale; and – those that meet the definition of loans and receivables.
O ther info rm atio n current fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the income statement; any excess is taken to other comprehensive income. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.
(N) Insurance The Group undertakes both life insurance and general insurance business. Insurance and participating investment contracts are accounted for under IFRS 4 Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and participating investment contracts that applied prior to the adoption of IFRS. The Group, therefore, continues to account for these products using UK GAAP, including FRS 27 Life Assurance, and UK established practice.
Products sold by the life insurance business are classified into three categories: – Insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance risk as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur. These contracts may or may not include discretionary participation features. – 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. – Non-participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
Liabilities of the Group’s with-profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Prudential Regulation Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below). Changes in the value of these liabilities are recognised in the income statement through insurance claims.
Individual impairment allowances are generally established against the Group’s commercial 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. 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.
Note 39 contains more detail on the nature of the assumptions that have been made and key sensitivities.
Defined benefit pension scheme obligations The net asset recognised in the balance sheet at 31 December 2015 in respect of the Group’s defined benefit pension scheme obligations was £736 million (comprising an asset of £901 million and a liability of £165 million) (2014: a net asset of £890 million comprising an asset of £1,147 million and a liability of £257 million). The Group’s accounting policy for its defined benefit pension scheme obligations is set out in note 2(K).
The value of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The discount rate is required to be set with reference to market yields at the end of the reporting period on high quality corporate bonds with the currency and term of the corporate bonds consistent with the defined benefit pension schemes’ obligations. The average duration of the schemes’ obligations is approximately 20 years. The market for bonds with a 20 year duration is illiquid and, as a result, significant management judgement is required to determine an appropriate yield curve on which to base the discount rate. The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Following the completion of the latest triennial funding valuations, the Group has updated its demographic assumptions for both current mortality expectations and the rate of future mortality improvement. However, given the advances in medical science in recent years, it is uncertain whether this rate of improvement will be sustained going forward and, as a result, actual experience may differ from current expectations. 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 37.
In making this assessment account is taken of business plans, the board approved operating plan and the expected future economic outlook as set out in the Group Chief Executive’s Review and Market Overview, as well as the risks associated with future regulatory change.
The deferred tax asset is expected to be utilised over different time periods in each of the entities in which the losses arise. Under current UK tax law there is no expiry date for unused tax losses. Following the enactment of the Finance Act 2015, there is now a restriction imposed on the amount of banks’ profits that can be offset by certain carried forward tax losses for the purposes of calculating corporation tax liabilities. The losses are expected to be fully utilised by 2025.
Retail offers a broad range of financial service products, including current accounts, savings, personal loans and mortgages, to UK retail customers, incorporating wealth and small business customers. It is also a distributor of insurance, protection and credit cards and a range of long-term savings and investment products.
At 31 December 2015, the Group carried total liabilities arising from insurance contracts and participating investment contracts of £80,294 million (2014: £86,918 million). The methodology used to value these liabilities is described in note 33. Elements of the liability valuations require assumptions to be made about future investment returns, future mortality rates and future policyholder behaviour and are subject to significant management judgement and estimation uncertainty. The key assumptions that have been made in determining the carrying value of these liabilities are set out in note 33.
Total underlying income, net of insurance claims 8,519 4,576 2,645 1,664 233 17,637
Other segment items reflected in income statement above: (Decrease) increase in value of in-force business – – – (162) – (162)
Other segment items reflected in income statement above: (Decrease) increase in value of in-force business – – – (428) – (428)
Total underlying income, net of insurance claims 7,935 4,372 2,692 1,757 1,271 18,027
Other income, net of insurance claims 5,739 1,460 22 (140) (614) – 6,467
2 Comprises the payment protection insurance provision (£3,050 million) and other regulatory provisions (£405 million). 3 Comprises the underlying results of TSB, dual running and build costs.
Interest and similar income: Loans and advances to customers 3.50 3.53 3.84 16,256 17,806 19,928
Amounts payable to unitholders in consolidated open-ended investment vehicles 1.16 3.23 12.08 (244) (602) (3,091)
Securities and other gains comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows: 2015 £m 2014 £m 2013 £m
Net income arising on assets held at fair value through profit or loss: Debt securities, loans and advances 451 4,805 55
Net gains on financial instruments held for trading 194 851 136
Share of results of joint ventures and associates (3) 32 43
Liability management In April 2014, the Group completed concurrent Sterling, Euro and Dollar exchange offers with holders of certain series of its Enhanced Capital Notes (ECNs) to exchange the ECNs for new Additional Tier 1 (AT1) securities. In addition the Group completed a tender offer to eligible retail holders outside the United States to sell their Sterling-denominated ECNs for cash. The exchange offers completed with the equivalent of £5.0 billion of ECNs being exchanged for the equivalent of £5.35 billion of AT1 securities, before issue costs. The retail tender offer completed with approximately £58.5 million of ECNs being repurchased for cash. A loss of £1,362 million was recognised in relation to these exchange and tender transactions in the year ended 31 December 2014.
NOTE 10: INSURANCE CLAIMS Insurance claims comprise: 2015 £m 2014 £m 2013 £m
Fees payable for the audit of the Company’s current year annual report 1.2 1.4 1.5
Other non-audit fees: Services relating to corporate finance transactions 0.2 0.3 0.3
Total fees payable to the Company’s auditors by the Group 24.3 32.1 32.5
During the year, the auditors also earned fees payable by entities outside the consolidated Lloyds Banking Group in respect of the following: 2015 £m 2014 £m 2013 £m
Impairment losses on loans and receivables: Loans and advances to customers 443 735 2,725
Total impairment losses on loans and receivables (note 21) 441 737 2,726
Foreign tax: Current tax on profit for the year (24) (39) (60)
Deferred tax (note 38): Origination and reversal of temporary differences (185) (72) (434)
Debt securities: Other public sector securities – 2,039 2,039 – 2,170 2,170
The principal derivatives used by the Group are as follows: – Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a specified future date. – Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date. – Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise, in combination with external funding, £455 million (2014: £611 million) of corporate and commercial banking loans. – 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.
The Finance (No. 2) Act 2015 (the Act) was substantively enacted on 26 October 2015. The Act reduced the main rate of corporation tax to 19 per cent from 1 April 2017 and 18 per cent from 1 April 2020; however from 1 January 2016 banking profits will be subject to an additional surcharge of 8 per cent. The change in the main rate of corporation tax from 20 per cent to 18 per cent, and the additional surcharge of 8 per cent, have resulted in a movement in the Group’s net deferred tax asset at 31 December 2015 of £123 million, comprising the £27 million charge included in the income statement and a £96 million charge included in equity.
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 101 million (2014: 22 million; 2013: 18 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
(ii) private equity investments of £2,415 million (2014: £2,350 million) that are managed, and evaluated, on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis.
Derivatives designated as cash flow hedges: Total derivative assets/liabilities – hedging 745,854 2,686 2,437 804,796 4,233 3,616
The embedded equity conversion feature of £545 million (2014: £646 million) reflects the value of the equity conversion feature contained in the Enhanced Capital Notes issued by the Group in 2009; the loss of £101 million arising from the change in fair value over 2015 (2014: gain of £401 million; 2013: loss of £209 million) is included within net gains on financial instruments held for trading within net trading income (note 7).
For amounts included above which are subject to reverse repurchase agreements see note 53.
Later than 1 year and not later than 5 years 1,225 1,214
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 2015 and 2014 no contingent rentals in respect of finance leases were recognised in the income statement. There was no allowance for uncollectable finance lease receivables included in the allowance for impairment losses (2014: £1 million).
The Group earns fees from managing the investments of these funds. The investment management fees that the Group earned from these entities, including those in which the Group held no ownership interest at 31 December 2015, are reported in note 6.
The acquired value of in-force non-participating investment contracts includes £228 million (2014: £251 million) in relation to OEIC business.
NOTE 25: VALUE OF IN-FORCE BUSINESS continued The table below shows the resulting range of yields and other key assumptions at 31 December: %
Risk-free rate (financial options and guarantees)1 0.00 to 2.54 0.29 to 2.20
Change in fair value of investment properties (note 7) 513 – – – 513
Change in fair value of investment properties (note 7) 416 – – – 416
Life insurance The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows: Insurance contracts £m
Historical persistency experience is analysed using statistical techniques. As experience can vary considerably between different product types and for contracts that have been in force for different periods, the data is broken down into broadly homogenous groups for the purposes of this analysis.
– Change in the assumption in respect of current and future mortality rates (£224 million increase). – Change in expenses assumptions (£70 million increase).
Mortality and morbidity The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this provides a reliable basis, and relevant industry data otherwise, and include a margin for adverse deviation.
Widening of credit default spreads on corporate bonds8 0.25% addition (183) (151) (168) (132)
On 11 March 2014 the Group announced a change to its defined benefit pension schemes, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This was partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business. In 2013, the Group agreed certain changes to early retirement and commutation factors in two of its principal defined benefit pension schemes, resulting in a cost of £104 million recognised in the Group’s income statement in the year ended 31 December 2013.
The total amount recognised in the balance sheet relates to: 2015 £m 2014 £m
Pension schemes Defined benefit schemes (i) Characteristics of and risks associated with the Group’s schemes The Group has established a number of defined benefit pension schemes in the UK and overseas. All significant schemes are based in the UK, with the three most significant being the defined benefit sections of the Lloyds Bank Pension Schemes No’s 1 and 2 and the HBOS Final Salary Pension Scheme. These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2015 is generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
The Group operates a number of funded and unfunded pension arrangements, the majority, including the three most significant schemes, are funded schemes in the UK. All schemes are operated as separate legal entities under trust law by the trustees. All UK schemes are funded in compliance with the Pensions Act 2004. A valuation exercise is carried out for each scheme at least every three years, whereby scheme assets are measured at market value and liabilities (‘Technical Provisions’) are measured using prudent assumptions, if a deficit is identified a recovery plan is agreed and sent to the Pensions Regulator for review. The outcome of this valuation process, including agreement of any recovery plans, is agreed between the Group and the scheme Trustee. The Group has not provided for these deficit contributions as the future economic benefits arising from these contributions are expected to be available to the Group. The Group’s overseas defined benefit pension schemes are subject to local regulatory arrangements.
The Group has also established three private limited companies which hold assets to provide security for the Group’s obligations to the HBOS Final Salary Pension Scheme, a section of the Lloyds Bank Pension Scheme No 1 and the Lloyds Bank Offshore Pension Scheme. At 31 December 2015 these held assets of approximately £4.1 billion in aggregate; they do not make any distributions to the pension schemes. The private limited companies are consolidated fully in the Group’s balance sheet. The terms of these arrangements require the Group to maintain assets in these vehicles to agreed minimum values in order to secure obligations owed to the relevant Group pension schemes. The Group has satisfied this requirement during 2015.
Money market instruments, cash, derivatives and other assets and liabilities 525 (458) 67 1,179 (632) 547 1 Of the total debt instruments, £18,428 million (31 December 2014: £19,209 million) were investment grade (credit ratings equal to or better than ‘BBB’).
Weighted-average rate of increase for pensions in payment 2.58 2.59 2015 Years 2014 Years
The asset-liability matching strategy currently mitigates substantially all of the interest rate and inflation rate volatility of the liabilities.
During the year ended 31 December 2015 the charge to the income statement in respect of defined contribution schemes was £233 million (2014: £252 million; 2013: £255 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
NOTE 38: DEFERRED TAX The movement in the net deferred tax balance is as follows: 2015 £m 2014 £m
On 26 November 2015, the FCA published a consultation paper (CP15/39: Rules and guidance on payment protection insurance complaints) proposing (i) the introduction of a deadline by which consumers would need to make their PPI complaints including an FCA led communications campaign, and (ii) rules and guidance about how firms should handle PPI complaints in light of the Supreme Court’s decision in Plevin v Paragon Personal Finance Limited [2014] UKSC 61 (Plevin).
Based on recent trends, and in light of the proposals from the FCA, the Group now expects a higher level of complaints than previously assumed including those related to Plevin. As a result the Group has increased the total expected reactive complaint volumes to 4.7 million with approximately 1.3 million still expected to be received. This is equivalent to approximately 10,000 net complaints per week on average through to the proposed time bar of mid 2018.
The Group continues to progress the re-review of previously handled cases and expects this to be substantially complete by the end of the first quarter of 2016. During the year the scope has been extended by 0.5 million to 1.7 million cases relating largely to previously redressed cases, in addition to which, higher overturn rates and average redress have been experienced. At the end of January 2016, 77 per cent of cases had been reviewed and 77 per cent of all cash payments made.
Key metrics and sensitivities are highlighted in the table below: Sensitivities1 To date unless noted Future Sensitivity
Average redress per upheld policy4 £1,810 £1,400 £100 = £170m 1 All sensitivities exclude claims where no PPI policy was held.
3 The percentage of complaints where the Group finds in favour of the customer excluding PBR. The 76 per cent uphold rate per policy is based on the six months to 31 December 2015. Future uphold rate and sensitivities are influenced by a proportion of complaints falling under the Plevin rules and guidance which would otherwise be defended.
The validity of the claims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will only be known once all relevant claims have been resolved.
6.9625% Callable Subordinated Fixed to Floating Rate Notes 2020 callable 2015 – – – – (737) (737)
These securities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the dated Enhanced Capital Notes (ECNs) ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during 2015 (2014: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Prudential Regulation Authority.
Exchange offer in respect of Enhanced Capital Notes – – – (4,961) – (4,961)
4.875% Undated Subordinated Fixed to Floating Rate Instruments – – (78) – – (78)
NOTE 41: SHARE CAPITAL (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.
Issued in relation to the payment of coupons on certain hybrid capital securities – – 712,973,022 – – 71
– 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 – pursuant to the rules of some of the Company’s employee share plans where certain restrictions may apply while the shares are subject to the plans.
Preference shares The Company has in issue various classes of preference shares which are all classified as liabilities under IFRS and details of which are shown in note 40.
1 During the year ended 31 December 2015, the Company redeemed all of its outstanding 6.0884% Non-cumulative Fixed to Floating Rate Preference Shares and 5.92% Non-cumulative Fixed to Floating Rate Preference Shares at their combined par value of £131 million. These preference shares had been accounted for as subordinated liabilities. On redemption an amount of £131 million was transferred from the distributable merger reserve to the share premium account.
The payment of dividends by subsidiaries and the ability of members of the Group to lend money to other members of the Group may be subject to regulatory or legal restrictions, the availability of reserves and the financial and operating performance of the entity. Details of such restrictions and the methods adopted by the Group to manage the capital of its subsidiaries are provided under Capital Risk on page 162.
The principal terms of the AT1 securities are described below: – The securities rank behind the claims against Lloyds Banking Group plc of (a) unsubordinated creditors, (b) claims which are, or are expressed to be, subordinated to the claims of unsubordinated creditors of Lloyds Banking Group plc but not further or otherwise or (c) whose claims are, or are expressed to be, junior to the claims of other creditors of Lloyds Banking Group, whether subordinated or unsubordinated, other than those whose claims rank, or are expressed to rank, pari passu with, or junior to, the claims of the holders of the AT1 Securities in a winding-up occurring prior to the Conversion Trigger. – The securities bear a fixed rate of interest until the first call date. After the initial call date, in the event that they are not redeemed, the AT1 securities will bear interest at rates fixed periodically in advance for five year periods based on market rates. – Interest on the securities will be due and payable only at the sole discretion of Lloyds Banking Group plc, and Lloyds Banking Group plc may at any time elect to cancel any Interest Payment (or any part thereof) which would otherwise be payable on any Interest Payment Date. There are also certain restrictions on the payment of interest as specified in the terms. – The securities are undated and are repayable, at the option of Lloyds Banking Group plc, in whole at the first call date, or on any fifth anniversary after the first call date. In addition, the AT1 securities are repayable, at the option of Lloyds Banking Group plc, in whole for certain regulatory or tax reasons. Any repayments require the prior consent of the PRA. – The securities convert into ordinary shares of Lloyds Banking Group plc, at a pre-determined price, should the fully loaded Common Equity Tier 1 ratio of the Group fall below 7.0 per cent.
Deferred bonus plans The Group operates a number of deferred bonus plans that are equity settled. Bonuses in respect of employee performance in 2015 have been recognised in the charge in line with the proportion of the deferral period completed.
For the HBOS sharesave plan, no options were exercised during 2015 or 2014. The options outstanding at 31 December 2015 had an exercise price of £1.8066 (2014: £1.8066) and a weighted average remaining contractual life of 0.4 years (2014: 1.4 years).
The weighted average fair value of SAYE options granted during 2015 was £0.17 (2014: £0.22). The fair values of the SAYE options have been determined using a standard Black-Scholes model.
The weighted average fair value of options granted in the year was £0.75 (2014: £0.72). The fair values of options granted have been determined using a standard Black-Scholes model. The weighted average share price at the time that the options were exercised during 2015 was £0.83 (2014: £0.75). The weighted average remaining contractual life of options outstanding at the end of the year was 6.1 years (2014: 7.0 years).
The number of shares awarded relating to matching shares in 2015 was 18,001,413 (2014: 16,248,562), with an average fair value of £0.78 (2014: £0.78), based on market prices at the date of award.
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other transactions between the Group and its key management personnel: 2015 £m 2014 £m 2013 £m
NOTE 48: RELATED PARTY TRANSACTIONS Key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the Lloyds Banking Group plc Group Executive Committee together with its Non-Executive Directors.
During the year ended 31 December 2015, the Group participated in a number of schemes operated by the UK government and central banks and made available to eligible banks and building societies.
Other government-related entities Other than the transactions referred to above, there were no other significant transactions with the UK government and UK government-controlled entities (including UK government-controlled banks) during the period that were not made in the ordinary course of business or that were unusual in their nature or conditions.
It is currently not possible to predict the scope and ultimate outcome on the Group of the various outstanding regulatory investigations not encompassed by the settlements, any private lawsuits or any related challenges to the interpretation or validity of any of the Group’s contractual arrangements, including their timing and scale.
Collective investment vehicles The Group manages 168 (2014: 132) collective investment vehicles, such as Open Ended Investment Companies (OEICs) and of these 95 (2014: 80) are consolidated. The Group invested £818 million (2014: £811 million) and redeemed £616 million (2014: £984 million) in the unconsolidated collective investment vehicles during the year and had investments, at fair value, of £2,129 million (2014: £2,243 million) at 31 December. The Group earned fees of £187 million from the unconsolidated collective investment vehicles during 2015 (2014: £201 million).
Tax authorities The Group provides for potential tax liabilities that may arise on the basis of the amounts expected to be paid to tax authorities including open matters where Her Majesty’s Revenue and Customs (HMRC) adopt a different interpretation and application of tax law. The Group has an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary, which ceased trading on 31 December 2010. In 2013 HMRC informed the Group that their interpretation of the UK rules, permitting the offset of such losses, denies the claim; if HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £600 million and a reduction in the Group’s deferred tax asset of approximately £400 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due. There are a number of other open matters on which the Group is in discussion with HMRC; none of these is expected to have a material impact on the financial position of the Group.
Liabilities arising from insurance contracts and participating investment contracts – – – – – – 86,918 86,918
Liabilities arising from non-participating investment contracts – – – – – – 27,248 27,248
Loans and advances to customers – 30,109 – 30,109 Loans and advances to banks – 3,065 – 3,065 Debt securities: Other public sector securities – 759 1,280 2,039 Bank and building society certificates of deposit – 135 – 135 Asset-backed securities: Mortgage-backed securities – 1,295 63 1,358 Other asset-backed securities – 839 8 847
Corporate and other debt securities 38 18,241 2,037 20,316 20,919 22,504 3,389 46,812
Treasury and other bills – – – – Total available-for-sale financial assets 25,309 7,039 684 33,032 Total financial assets carried at fair value, excluding derivatives 104,759 63,009 5,800 173,568
Gains recognised in the income statement within other income 192 – 192 579 – 579
Transfers out of the level 3 portfolio (146) – (146) (385) (74) (459)
Gains recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December 34 – 34 547 – 547
At 31 December 2015 Trading and other financial liabilities at fair value through profit or loss
Total trading and other financial liabilities at fair value through profit or loss 4,153 47,709 1 51,863 Financial guarantees – – 48 48 Total financial liabilities carried at fair value, excluding derivatives 4,153 47,709 49 51,911 At 31 December 2014
Gains recognised in the income statement, within other income, relating to the change in fair value of those liabilities held at 31 December – 3 3 – 1 1
(C) Derivatives All of the Group’s derivative assets and liabilities are carried at fair value. At 31 December 2015, such assets totalled £29,467 million (31 December 2014: £36,128 million) and liabilities totalled £26,301 million (31 December 2014: £33,187 million). The table below analyses these derivative balances by valuation methodology (level 1, 2 or 3, as described on page 251). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and level 2 during the year.
Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include: – Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are developed from publicly quoted rates. – Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources. – 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. – 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.
Gains (losses) recognised in the income statement within other income (87) (36) 755 (375)
Derecognised pursuant to exchange and retail tender offers in respect of Enhanced Capital Notes – – (967) –
Transfers out of the level 3 portfolio (1,263) 819 (53) 4
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.
The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise. A one per cent rise in interest rates would lead to a £200 million fall in the overall valuation adjustment to £233 million. The CVA model used by the Group does not assume any correlation between the level of interest rates and default rates.
The Group has also recognised a Funding Valuation Adjustment to adjust for the net cost of funding uncollateralised derivative positions. This adjustment is calculated on the expected future exposure discounted at a suitable cost of funds. A ten basis points increase in the cost of funds will increase the funding valuation adjustment by approximately £30 million.
(D) Sensitivity of level 3 valuations At 31 December 2015 At 31 December 2014
Level 3 financial assets carried at fair value 7,269 8,145 Trading and other financial liabilities at fair value through profit or loss 1 – – 5 – – Derivative financial liabilities Interest rate derivatives
(2) Transferred financial assets derecognised in their entirety with ongoing exposure Transferred financial assets which were derecognised in their entirety, but with ongoing exposure, consisted of £9 million of debt securities (2014: £33 million) with a fair value of £9 million (2014: £33 million) and a maximum exposure to loss of £9 million (2014: £33 million).
Trading and other financial liabilities at fair value through profit or loss: 1 After impairment allowance.
NOTE 52: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES continued NOTE 53: FINANCIAL RISK MANAGEMENT As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.
In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the commercial business. Note 16 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 2015 was £460,829 million (2014: £518,746 million) with a net fair value liability of £718 million (2014: liability of £930 million) (note 16). In 2015, ineffectiveness recognised in the income statement that arises from cash flow hedges was a gain of £3 million (2014: gain of £56 million).
Credit risk The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom. Information about the Group’s exposure to credit risk, credit risk management, measurement and mitigation can be found on pages 121 to 143.
Loans and receivables: Loans and advances to banks, net1 25,117 – 25,117 26,155 – 26,155
Off-balance sheet items: Other items serving as direct credit substitutes 458 – 458 330 – 330
Performance bonds and other transaction-related contingencies 2,123 – 2,123 2,293 – 2,293 1 Amounts shown net of related impairment allowances.
B. Concentrations of exposure The Group’s management of concentration risk includes single name, industry sector and country limits as well as controls over the Group’s overall exposure to certain products. Further information on the Group’s management of this risk is included within Credit risk mitigation, Risk management on page 122.
Past due but not impaired 111 8,233 393 463 9,089 –
Allowance for impairment losses on loans and advances to customers on an underlying basis 4,172 7,652 1 Comprises an allowance held at 31 December 2008 of £10,693 million and a charge for the period from 1 January 2009 to 16 January 2009 of £454 million.
Available-for-sale financial assets (excluding equity shares) An analysis of the Group’s available-for-sale financial assets is included in note 22. The credit quality of the Group’s available-for-sale financial assets (excluding equity shares) is set out below: Investment grade1 £m Other2 £m Total £m
Debt securities: Bank and building society certificates of deposit 186 – 186 298 – 298
Treasury bills and other bills – – – 863 – 863
Held-to-maturity investments An analysis of the credit quality of the Group’s held-to-maturity investments at 31 December 2015 is set out below: Investment grade1 £m Other £m Total £m
Debt securities, treasury and other bills held at fair value through profit or loss An analysis of the Group’s trading and other financial assets at fair value through profit or loss is included in note 15. The credit quality of the Group’s debt securities, treasury and other bills held at fair value through profit or loss is set out below: Investment grade1 £m Other2 £m Total £m
Treasury bills and other bills – – – 1,437 – 1,437
Total held as trading assets 9,452 30 9,482 11,559 210 11,769
2 Other comprises sub-investment grade (2015: £1,418 million; 2014: £1,896 million) and not rated (2015: £632 million; 2014: £3,473 million).
Financial guarantees and irrevocable loan commitments Financial guarantees represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards.
Unimpaired secured commercial lending is predominantly managed on a cash flow basis. On occasion, it may include an assessment of underlying collateral, although, for impaired lending, this will not always involve assessing it on a fair value basis. No aggregated collateral information for the entire unimpaired secured commercial lending portfolio is provided to key management personnel.
Trading and other financial assets at fair value through profit or loss (excluding equity shares) Included in trading and other financial assets at fair value through profit or loss are reverse repurchase agreements treated as collateralised loans with a carrying value of £33,174 million (2014: £36,725 million). Collateral is held with a fair value of £36,493 million (2014: £42,858 million), all of which the Group is able to repledge. At 31 December 2015, £15,438 million had been repledged (2014: £10,319 million).