ANNUAL REPORT AND ACCOUNTS 2009 CREATING THE UK’S BEST FINANCIAL SERVICES PROVIDER
The combined businesses balance sheet as at 31 December 2008 aggregates the Lloyds TSB Group and the HBOS Group balance sheets as at 31 December 2008, adjusted for the subsequent recapitalisation in January 2009 and reflects the fair value adjustments applied to the HBOS balance sheet at 16 January 2009.
Factors that could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by Lloyds Banking Group or on Lloyds Banking Group’s behalf include, but are not limited to, general economic conditions in the UK and internationally; inflation, deflation, interest rates, policies of the Bank of England and other G8 central banks, exchange rate, market and monetary fluctuations; changing demographic developments including mortality and changing customer behaviour including consumer spending, saving and borrowing habits, borrower credit quality, technological changes, natural and other disasters, adverse weather and similar contingencies outside the Group’s control; inadequate or failed internal or external processes, people and systems; terrorist acts and other acts of war or hostility and responses to those acts, geopolitical, pandemic or other such events; changes in laws, regulations, taxation, Government policies or accounting standards or practices and similar contingencies outside Lloyds Banking Group’s control; the ability to derive cost savings and other benefits as well as mitigate exposures from the acquisition and integration of HBOS; inadequate or failed internal or external processes, people and systems; exposure to regulatory scrutiny, legal proceedings or complaints; changes in competition and pricing environments; the inability to hedge certain risks economically; the adequacy of loss reserves; the ability to secure new customers and develop more business from existing customers; the degree of borrower credit quality; the ability to achieve value-creating mergers and/or acquisitions at the appropriate time and prices and the success of Lloyds Banking Group in managing the risks of the foregoing.
Lloyds Banking Group may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the US Securities and Exchange Commission, Lloyds Banking Group annual reviews, half-year announcements, proxy statements, offering circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of Lloyds Banking Group to third parties, including financial analysts. Except as required by any applicable law or regulation, the forward looking statements contained in this annual report are made as of the date hereof, and Lloyds Banking Group expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward looking statements contained in this annual report to reflect any change in Lloyds Banking Group’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
A detailed description of the corporate strategy which supports our vision. We aim to understand our customers and meet their needs, while building a high performance, efficient organisation that encourages and develops its staff.
– Utilising capital more effectively is increasingly important in the current environment and capital will be rigorously allocated across our portfolio of businesses to support business growth.
– The prudent Lloyds TSB ‘through the cycle’ approach to risk has been applied to the enlarged Group. Our conservative and prudent approach to risk is core to the business model and the ‘through the cycle’ approach means we will continue to support our customers throughout the economic cycle. The risk structures and frameworks that have been implemented are the foundation for good business management.
Total income, net of insurance claims, increased by 12 per cent to £23,964 million due to the absence of £3.4 billion of mark-to-market losses on the Group’s treasury asset portfolio and gains of £1.5 billion on capital transactions, which were partly offset by significant year-on-year margin pressures.
Robust capital position and strengthened funding profile. Core tier one capital at 8.1 per cent following the successful capital raising in December 2009. Wholesale funding maturing in more than one year increased from 44 per cent to 50 per cent.
In order to reflect the impact of the acquisition of HBOS, provide more relevant and meaningful comparatives and better present the underlying business performance, the results of the Group and divisions are presented on a combined businesses basis. The key principles adopted in the preparation of the combined businesses basis are described in the contents page. A full reconciliation of the combined businesses basis to the statutory basis is given in note 4 on page 151. Unless otherwise stated, the commentaries on pages 1 to 95 are on a combined businesses basis.
I am encouraged by what Lloyds Banking Group as an organisation has achieved this year. In particular, in November we launched the largest ever capital raising comprising a £9 billion debt exchange and a £13.5 billion rights issue. This capital raising programme could not have been completed so successfully without the strong support of the vast majority of our shareholders, debt holders and of course importantly the UK Government through UK Financial Investments. We remain immensely grateful to them for that support. In providing this market-based alternative to our intended participation in the Government Asset Protection Scheme, we believe we provided superior economic value to our shareholders. Both the rights issue and the liability management exercise are an important step towards meeting our, and the Government’s, objective for the Group to operate as a wholly privately owned self-supporting commercial enterprise. HM Treasury’s stake in the Group of 43.4 per cent at the year end has reduced to 41.3 per cent following the completion of the capital raising programme in February 2010.
PLACING AND COMPENSATORY OPEN OFFER A placing and compensatory open offer was successfully completed in June. The proceeds allowed the Group to repurchase the £4 billion of preference shares held by HM Treasury.
Whilst the capital raising activities took much of the external attention during 2009, the Group delivered a resilient core business performance and the integration of the two businesses is progressing ahead of schedule. Further detail on our performance is outlined in the group chief executive’s review.
The past year has been difficult for everyone and we are mindful of the uncertainty our colleagues have faced.
It is of course a privilege to have the opportunity to serve our customers. Given our scale, with that privilege comes obligations. That is why we are playing an active part in the UK’s economic recovery. I am pleased to note that we extended £70 billion of gross committed lending last year helping many households and businesses in the process. As the country’s largest private sector savings institution, we also played a commensurate part in encouraging people to rediscover the savings habit, an essential component of the economic recovery. More broadly we were, and continue to be, involved in all the Government schemes to encourage lending and to assist people or businesses in financial difficulties. Also, our Lloyds Development Capital activities provide vital equity and debt capital to smaller and medium-sized businesses that often are the most vulnerable, but at the same time, most growth orientated parts of the economy.
To the extent that banking institutions, including Lloyds Banking Group, meet their obligations of service and intermediation and are responsible and pro-active conduits of channelling savings into productive enterprises and households, we hope that trust in our institutions may be re-established. It will not happen overnight, but happen it must and it is up to us to ensure by our actions that it does.
It follows that it is right that there is thoughtful and considered debate on the shape and structure of our industry and not simply knee-jerk reaction by the industry. Accordingly, I believe that the combined efforts of a few of the major global financial institutions, perhaps with two or three of the respected industry bodies, should pro-actively help develop proposals which are acceptable to and can be broadly supported by regulatory authorities and governments. Such proposals could set the industry on the path towards an internationally agreed understanding, removing the uncertainty and scepticism hanging over the industry both of which factors act as a brake on progress, to the detriment of the broader economies.
2009 was another challenging year for the financial services industry, both in the UK and around the world, reflecting a continuation of many of the issues that arose in 2008. During the year, the UK experienced its sharpest contraction in gross domestic product (GDP) for many decades, with a sharp fall in the value of commercial property alongside rising company failures and higher unemployment levels. Despite the tough market conditions, our core businesses have performed well.
The management team implemented a number of programmes that have resulted in positive trends in margins, costs and impairments. Given the momentum we have already developed in these areas, and with the stabilising economy, we believe the Group is well positioned to deliver a strong financial performance in the coming years.
The continued development of our customer franchises has enabled us to offset the impact of the weak economy. In Retail, we opened nearly 2 million current accounts and nearly 5 million new savings accounts, which are important drivers for future profitable growth. We delivered an equally good performance in the Wholesale division. In our Commercial business, we opened approximately 100,000 new accounts and achieved a 23 per cent share of start-up businesses, and in Corporate we saw a 49 per cent improvement in cross-sales income from Lloyds TSB customers. Wealth and International, our new division, made a very encouraging start in 2009 with a strong growth in the number of relationship clients and a 13 per cent growth in the number of UK private banking customers. In Insurance, despite the more difficult market conditions, we made good progress in key product areas such as Open Ended Investment Companies (OEICs) and life assurance protection.
Following our recent successful capital raise, the Group’s year end core tier one ratio was 8.1 per cent and it rose by a further 30 basis points in February 2010. This reflects a number of successful actions during the year which included the £4 billion ordinary share placing and compensatory open offer in June, and the £22.5 billion equity raising and liability management exercises announced in November.
During 2009, the Group was required to work with HM Treasury to submit a restructuring plan to the European Commission in the context of a state aid review. During the last few months of 2009, the final terms of the restructuring plan were agreed by the European Commission College of Commissioners. The board approved the restructuring plan and is confident that it will not have a materially negative impact on the Group.
We have established positive trends in margin, costs and impairments. The management actions we have already taken in these areas, combined with the underlying business momentum, point towards significantly improved financial performance in the coming years.
We also believe there are significant opportunities for additional growth, potentially amounting to hundreds of millions of pounds in revenues. Over the last five years Lloyds TSB has delivered accelerating growth by focusing on acquiring, deepening and broadening customer relationships. We can see significant opportunity from sustaining this trend in the legacy Lloyds TSB franchise, and extending the model across the enlarged Group. As we realise this potential, we will add to our growth trajectory.
Going forward the Group is focused on delivering strategy and subsequently value to all our shareholders. The Government holding does not impact this management focus and we remain committed to operating as a wholly privately owned, self supporting, dividend paying, commercial enterprise over time.
As a result of HM Treasury’s investment in the Company in the context of the placing and open offer undertaken by the Company in November 2008 and the Group’s participation in the Credit Guarantee Scheme, the Group was required to work with HM Treasury to submit a restructuring plan to the European Commission in the context of a state aid review. This plan was required to contain measures to limit any competition distortions resulting from the state aid received by the Group.
Impairment losses, particularly from the heritage HBOS business, have also significantly impacted profits over the past two years. We outlined at the half-year that we believed Group impairment losses had peaked in the first half of 2009 and this was borne out in the full year numbers which showed a 21 per cent reduction in impairment in the second half of the year. The Group believes impairment losses will continue to fall going forward and though given the current economic environment such levels are still inflated we believe impairments will return to more normalised levels over the next couple of years. The significant reduction in expected impairments will evidently benefit profits.
% change in real GDP since the start of the recession
At the beginning of the year, most commentators would have expected such a sharp drop in GDP to result in much worse unemployment numbers than has been the case. In fact, employment has held up quite well given the severity of the decline in GDP (see chart 2). Similarly, the rate of company failures so far in this downturn has been lower than might have been expected given the severity of the GDP decline (see chart 3).
Meanwhile, property prices have also held up better than many forecasters had expected. At the beginning of the year, the average view was that house prices would fall by around 15 per cent during 2009, and decline further in 2010. In fact, the Halifax house price index ended the year higher than twelve months earlier, and other indices showed a similar picture. House prices fell during the early part of the year, but then started to recover in the second half and finished the year still above long term average levels relative to household incomes, albeit well down on their peak in 2007. The consensus view is now for modest further growth in 2010.
Commercial property prices showed a similar recovery. Having fallen sharply in late 2008 and early 2009, commercial property capital values have stabilised recently, despite continued falls in rental values, and many forecasts for 2009 and 2010 have been revised up. At the end of 2009, the consensus forecast was for modest growth in capital values this year and next, even as rental values decline further.
Looking forward, the most likely immediate economic scenario is one of slow and erratic growth. GDP is estimated to have begun to recover in Q4 2009, and may even have done so earlier once final revisions are made to earlier estimates for Q3. Survey evidence, including purchasing manager indices, were pointing to positive growth in manufacturing and services for most of the second half of 2009. Retail sales growth accelerated in late 2009, although some of this may have been spending brought forward to beat the restoration of VAT to 17.5 per cent. Unemployment appears to have levelled off, at least temporarily, and actually fell in late 2009. Financial market conditions have continued to normalise, in line with the improving economic outlook. The consensus forecast for 2010 has risen gradually, and by the end of 2009 was suggesting
Annual Report and Accounts 2009 2010 GDP growth of around 1.5 per cent, close to our own central scenario. This slow recovery is consistent with the sort of upturn seen after past financial crises. But even that below-trend growth relies mainly on a recovery in net external trade and an end to company destocking. Domestic demand growth is likely to be minimal in 2010.
It is possible that the economy will dip again if hit by some new shock – and what might start as a temporary setback to recovery could have longer lasting effects if it damages consumer, business or financial market confidence. Furthermore, uncertainties remain about how the economy will respond as and when the Bank of England begins to reverse quantitative easing and restore interest rates to more normal levels, and the Government begins to take action to reduce the large fiscal deficit.
2009 was a year of weakening growth in most of our markets. On the retail side, net new market mortgage lending (ie new lending minus repayments) was very low throughout 2009, as a result of which growth in outstanding balances slowed to around 1 per cent by year end. Net new market unsecured consumer lending was very weak in the first half of the year, and turned negative in the second half.
Businesses also appear to have used 2009 to strengthen their financial position where possible. Sharp cutbacks in investment spending, and in stocks, have enabled businesses in aggregate to remain in financial surplus and reduce their reliance on external credit – from banks, trade creditors and others. Large companies have also taken advantage of the recovery in financial markets to increase capital market borrowing thereby further reducing bank credit demand. As a result, the outstanding stock of bank and building society lending to private non-financial businesses declined in 2009, and corporate deposits returned to positive growth despite the weakness of demand in many companies’ markets. Strengthened corporate finances were probably a major factor limiting the growth in company failures in 2009. Indeed, as chart 3 shows, the rate of company failures reduced in the second half of 2009.
Total assets decreased by 9 per cent to £1,027 billion, with a 7 per cent decrease in loans and advances to customers reflecting the impact of reductions in non-relationship lending portfolios. Customer deposits decreased by 1 per cent to £407 billion, as growth in Retail was offset by the planned reduction in higher interest paying term deposits elsewhere.
Following the acquisition of HBOS in January 2009, the Group has recognised a gain of £11,173 million in respect of negative goodwill. This arises because the consideration paid to acquire HBOS, in January 2009, was considerably less than the fair value of the net assets acquired, reflecting the unique circumstances surrounding the transaction.
The UK Government has published draft legislation which, when enacted, will introduce a bank payroll tax of 50 per cent applicable to discretionary bonuses and other amounts over £25,000 awarded to bank employees in the period 9 December 2009 to 5 April 2010. The legislation has yet to be finalised and there remain significant uncertainties over aspects of its detailed application and the Group continues to asses its ultimate liability in respect of all of its schemes. However, in accordance with the requirements of International Accounting Standard (IAS) 19 ‘Employee Benefits’ the Group has provided in full for the estimated cost of the bank payroll tax; the amount is not significant.
Following the introduction of a prescribed stress test by the Financial Services Authority in January 2009 the Group undertook a significant exercise which stress tested the Group’s capital base to withstand the impact of a significant economic deterioration in the UK, resulting in a requirement to increase the Group’s capital position. As a result of this increased capital requirement, in March 2009, in what was clearly a difficult external market, the Group announced its intention to participate in the Government Asset Protection Scheme. This would have enabled the Group to substantially strengthen its capital position to meet the newly increased regulatory capital requirements, and reduce the risk profile of the enlarged Group’s balance sheet.
At 31 December 2009, the Group’s overall funding support from governmental and central bank sources totalled £157 billion, with a significant proportion (predominantly Special Liquidity Scheme (SLS) and Credit Guarantee Scheme (CGS) funding) maturing over the course of the next two years. The Group’s balance sheet reduction plans will avoid the necessity to refinance much of this funding. The current cost to the Group of participating in these schemes is currently approximately 50 basis points over LIBOR for the SLS and approximately 130 basis points over LIBOR for CGS. Overall, based on expected spreads and balance sheet mix, we believe the increased cost of wholesale funding over the next few years is expected to negatively impact the Groups net interest margin by less than 10 basis points, and this cost is expected to be more than offset by the impact of improved product pricing.
The deterioration in the UK economic environment, particularly in the first half of 2009, created an extremely challenging operating background against which to integrate two large banking organisations. As expected, against this backdrop, the significant increase in corporate impairments has led the Group to report a loss before the credit for negative goodwill arising on the acquisition of HBOS. The Group has a strong risk management culture and is well-placed to manage through the near-term challenges and benefit from what we expect to be a slow but steady UK economic recovery during 2010 and beyond.
Impairment as a percentage of average advances3 1.11% 5.92% 6.04% 3.25%
Report of the independent auditors on the consolidated financial statements 126
Share of results of joint ventures and associates 7 (944) (21) 2 4 (952)
Fair value unwind represents the impact on the consolidated and divisional income statements of the acquisition related balance sheet adjustments. These adjustments principally reflect the application of market based credit spreads to HBOS’s lending portfolios and own debt. The net fair value unwind in 2009 is mainly attributable to a reduction in the impairment charge of £6,859 million, as losses reflected in the opening balance sheet valuation of the lending portfolios have been incurred, offset by a charge to net interest income of £2,166 million as the value of HBOS’s own debt accretes to par.
Retail is the largest retail bank in the UK and the leading provider of current accounts, savings, personal loans, credit cards and mortgages. With its strong stable of brands including Lloyds TSB, Halifax, Bank of Scotland and Cheltenham & Gloucester, it serves over 30 million customers through one of the largest branch and fee free ATM networks in the UK.
Impairment losses have increased by 14 per cent to £4,227 million, reflecting the effect of increased UK unemployment during 2009 on the unsecured charge, partly offset by a lower secured impairment charge as house prices stabilised.
Continued good new lending quality, reflecting continued strong credit criteria with the average loan-to-value ratio on new mortgage lending at 59 per cent, compared to 63 per cent for 2008.
DEEP AND ENDURING CUSTOMER RELATIONSHIPS A key goal of Retail is to build deeper and enduring relationships with customers and, in particular to help its customers build a more secure financial future. Retail has continued to maintain momentum in its key businesses and is making good progress in implementing its relationship strategy. In 2009 the number of customers with their main current account with Retail (those paying in more than £1,000 a month) increased by 4 per cent. In addition, almost 5 million new savings accounts and almost 2 million new current accounts were opened.
IMPROVING PRODUCTIVITY AND CONTINUALLY IMPROVING CUSTOMER SERVICE Productivity in both branch networks has increased during 2009. The Lloyds TSB network has continued to realise the benefits of the investments made in 2008 in developing branch staff as well as increasing the number of branches opening on a Saturday. Consequently in 2009, sales of personal core banking products by personal bankers increased by 20 per cent. Productivity in the Halifax branch network has grown steadily, with the introduction of the Lloyds TSB leads system to support the more effective cross-selling of products. The sharing of best practice with the Halifax financial advisors has seen their number of monthly sales of protection products increase by over 200 per cent during 2009.
Following a period of strong growth in the use of internet banking, a significant percentage of Retail’s customer enquiries and transactions now occur online. There are 6.8 million active users of Retail internet services logging on 52 million times a month. There has been an 18 per cent growth in online account transfers and online payments to third parties. In addition, customers are making increasing use of electronic statements, with more than 6 million accounts now having statements delivered electronically rather than in paper format.
Profit before tax and fair value unwind decreased by £1,567 million to £975 million. This decrease was driven by higher impairment losses and lower income, partly offset by a reduction in operating expenses.
Lending to customers in 2009 has fallen by 2 per cent reflecting the impact of customers reducing their personal indebtedness and not taking on new financial commitments in the current difficult economic environment. Risk-weighted assets increased by 8 per cent reflecting the impact of the weak economic environment on credit quality.
Customer deposits have increased by 4 per cent over the last 12 months despite the high level of term deposits maturing during the period, as a result of Halifax and Bank of Scotland deposit gathering activities in the first half of 2008. Deposit growth accelerated through 2009 reversing the trend of declining deposit balances in the second half of 2008. Deposit growth in the second half of 2009 was particularly strong at £5.6 billion, or 3 per cent. Current account balances have increased by 15 per cent in the year resulting from growth in the number of current accounts and the low interest rate environment.
Impairment losses on loans and advances have increased by £532 million, or 14 per cent, to £4,227 million in 2009. Impairment losses as a percentage of average advances were 1.11 per cent in 2009 compared to 0.97 per cent in 2008. Higher unemployment and the weak economy drove a significant increase in unsecured impairments which was partly offset by a lower secured impairment charge as house prices stabilised. Unsecured impairment losses are sensitive to economic conditions, particularly unemployment levels; consequently the 2009 impairment charge increased by £1,038 million to £3,438 million. The stabilisation of the housing market, in combination with lower interest rates and prudent risk management, has resulted in the secured impairment charge decreasing in 2009 by £506 million to £789 million. Total impaired loans, as a percentage of closing advances to customers, decreased during the second half of the year to 2.9 per cent compared to 3.0 per cent at 30 June 2009 and 2.6 per cent at 31 December 2008.
THE ‘THROUGH THE CYCLE’ RELATIONSHIP FOCUSED STRATEGY MEANS WHOLESALE WILL SUPPORT CUSTOMERS THROUGHOUT THE ECONOMIC CYCLE
Loss before tax and fair value unwind amounted to £11,600 million, an increase of £1,121 million on 2008 due to higher levels of impairment, partly offset by an increase in other operating income and a decrease in operating expenses.
Total income has increased by 63 per cent to £8,909 million, particularly reflecting the lower impact of market dislocation and continued strength in sales and trading activity.
Share of results of joint ventures and associates (720) (944) 24
Impairment losses as a % of average advances 5.92% 3.32% As at 31 December 2009 2008 Change £bn £bn %
Loans and receivables: Loans and advances to customers 191.8 234.6 (18)
The share of losses from joint ventures and associates reduced by £224 million to a loss of £720 million. There were fewer write-offs in 2009 as the majority of the book is now valued at nil, with a remaining portfolio conservative carrying value of approximately £190 million.
Wholesale Markets net interest income was approximately 34 per cent lower primarily reflecting the higher cost of funding. Other operating income increased by £4,472 million, primarily due to the absence of prior year investment write downs associated with the dislocated markets and some valuation recoveries in 2009.
Corporate Real Estate net interest income decreased overall due to the increased funding costs and falling levels of income from impaired assets, partly offset by increased margins from asset re-pricing.
Cost:income ratio 23.9% 34.0% As at 31 December 2009 2008 Change £bn £bn %
The reduction in available-for-sale financial assets is a result of the decision to sell the majority of these assets, which were held for liquidity purposes, and increase deposits with the Bank of England, thereby improving the quality of the liquid asset portfolio.
Loss before tax and fair value unwind increased by £216 million to £459 million due to higher impairment losses, partially offset by a decrease in operating expenses.
Total income decreased by £154 million, or 8 per cent, to £1,830 million from lower business volumes on assets held under operating leases, lower insurance income in the Personal Finance business due to the move to a monthly premium product, as well as reduced new business volumes. This was offset in part by margin improvement across the consumer finance businesses.
The International business comprises the Groups other international banking businesses outside of the UK, with the exception of the corporate business in North America which is managed through the Group’s Wholesale division. These largely comprise corporate, commercial and asset finance businesses in Australia, Ireland and Continental Europe and retail businesses in Ireland, Germany and the Netherlands.
Total income has decreased by 6 per cent to £2,345 million, reflecting lower net interest margins, and the impact of lower global stock markets particularly in the first half of the year, partly offset by favourable foreign exchange movements.
Net interest income has decreased by 7 per cent to £1,217 million, the banking net interest margin decline of 35 basis points reflects higher wholesale funding costs and lower deposit margins in the low base rate environment, partly offset by the impact of strong portfolio management in International, leading to an underlying gross asset reduction of 7 per cent, and higher asset pricing leading to higher margins.
On 9 February 2010 the Group announced its intention to reshape the Irish business to reflect the continuing difficult economic environment and secure a viable future. The Group intends to close both the Halifax retail business in the Republic of Ireland and the Bank of Scotland (Ireland) intermediary business and refocus the Irish business on its established strengths and long standing ICC Bank heritage of corporate and commercial banking. The resulting closure of 44 Halifax retail branches and the majority of the associated job losses are planned to take place by the end of July 2010.
Profit before tax and fair value unwind decreased by 46 per cent to £198 million primarily due to lower income.
Excluding adverse foreign exchange movements of approximately £40 million, operating expenses increased by 10 per cent to £425 million driven by additional costs associated with the transitional services following the disposal by HBOS of BankWest and St. Andrews Australia in December 2008, the development of International’s deposit taking operation in Germany and increased risk management resources to manage impaired asset portfolios in Ireland and Australia.
Customer deposits fell by 22 per cent to £5.8 billion, principally in Ireland reflecting aggressive pricing from competitors who have also benefited from the Irish Government deposit guarantee. This was partly offset by a strong performance in Bank of Scotland Germany, which raised over €1 billion of deposits since its launch in January 2009.
DEVELOPING STRONG AND ENDURING CUSTOMER RELATIONSHIPS AND DELIVERING SUSTAINABLE PROFITABLE GROWTH REMAIN KEY AREAS OF FOCUS
Total income net of insurance claims has decreased by £647 million to £2,020 million, due to the non-recurrence of £334 million of HBOS legacy one-off benefits, a £156 million increase in insurance claims and the impact of challenging economic conditions driving lower sales and returns, partially offset by significantly lower charges for policyholder lapses.
Life, Pensions and Investments UK sales of £12,973 million (PVNBP) reduced by 26 per cent. In addition to the general contraction in the market, sales were significantly impacted as the intermediary sales forces were integrated and a number of HBOS legacy products with poor returns were withdrawn. These factors led to sales through the intermediary channel reducing by 35 per cent. Bancassurance sales, excluding payment protection, were resilient given the challenging market conditions with a reduction of 11 per cent from 2008. Sales of OEIC products delivered strong growth of 12 per cent.
Good progress was made in integrating the legacy Lloyds TSB and HBOS Insurance businesses. Insurance division integration synergies of £55 million for 2009 were ahead of expectations.
Leveraging distribution and asset management For Life, Pensions and Investments work is well progressed in developing an integrated bancassurance proposition, planned to be launched mid 2010. In conjunction with Scottish Widows Investment Partnership, during 2009 Life, Pensions and Investments UK also made good progress in further developing its OEIC proposition, leading to strong sales of its new capital protected fund OEIC.
Profit before tax, before experience variances and assumption changes 828 1,258 (34)
The 2008 comparative results include the results of the HBOS Life, Pensions and Investments business as if it had been acquired on 1 January 2008. The 2008 results for the HBOS Life, Pensions and Investments business have been restated from those previously published including use of the market consistent economic assumptions as adopted by Scottish Widows, but excluding the impact of any acquisition-related fair value adjustments. From 1 January 2009 the results reflect additional alignment with Scottish Widows in respect of accounting practices and non-economic assumptions.
This sensitivity shows the impact of a 10 basis point increase in the allowance for illiquidity premium. It assumes that the overall corporate bond spreads are unchanged and hence market values are unchanged. Government bond yields and the non-annuity risk-free rate are both assumed to be unchanged. The increased illiquidity premium increases the annuity risk-free rate.
Claims paid on insurance contracts (net of reinsurance) (637) (481) (32)
Analysed by business function, IT costs decreased by £82 million, or 6 per cent, to £1,265 million, driven by the early realisation of synergy savings due to the consolidation of IT operations across the Group in addition to lower investment spend as project activity was rationalised and replaced by integration activity. Within Operations, costs were broadly flat, increasing by only £13 million to £555 million. Activity during 2009 has focused on centralising and then rationalising the Group’s operational activities.
Share of results of joint ventures and associates 3 4 (25)
Central items profit before tax and fair value unwind amounted to £670 million, compared to a loss of £517 million in 2008. Total income increased by £1,401 million to £965 million primarily as a result of gains arising when the Group exchanged certain existing subordinated debt securities for new securities. These exchanges resulted in a gain on extinguishment of the existing liability of £1,498 million (of which £1,468 million is reflected in central items), being the difference between the carrying amount of the security extinguished and the fair value of the new security together with related fees and costs.
During 2009, the Group’s statutory profit before tax included positive insurance and policyholder interests volatility of £478 million compared to negative volatility of £2,349 million in 2008 primarily reflecting the more favourable financial markets in 2009.
The impact on the results due to the actual return on these investments differing from the expected return (based upon economic assumptions made at the beginning of the year) is included within insurance volatility. Changes in market variables also affect the realistic valuation of the guarantees and options embedded within the With Profits Funds, the value of the in-force business and the value of shareholders’ funds.
The liabilities in respect of the Group’s annuity business are matched by a portfolio of fixed interest securities, which includes a large proportion of corporate bonds. In accordance with the approach adopted in 2008, the value of in-force business for the annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of these corporate bond holdings. The illiquidity premium is estimated to have reduced to 75 basis points as at 31 December 2009 (31 December 2008: 154 basis points) which has offset the gains on assets backing the annuity liabilities reducing the volatility of the results. Overall, the positive volatility in 2009 in the Insurance division of £237 million, reflected a partial recovery in financial markets. During 2009, equities have recovered by 22 per cent and corporate bond spreads have narrowed, offset by a reduction in gilts reflecting an increase in yields and a reduction in property values of 6.6 per cent. This contrasts with 2008 where a 33 per cent reduction in equities was the main driver of the £1,425 million negative volatility in 2008.
Annualised cost savings from synergies and other operating efficiencies of £2 billion are now targeted by the end of 2011, an increase from the previously forecast cost savings in excess of £1.5 billion. The increase arises in the main from further efficiency gains leading to role reductions and, to a lesser extent, property and procurement benefits which are now more certain following the application of the Lloyds TSB approach to HBOS.
Total cost reductions from synergies of £534 million are ahead of the target £450 million. They are analysed by division in the table below and included in the Group’s combined businesses basis loss before tax for the year to 31 December 2009. These benefits relate primarily to reductions in staff numbers and procurement savings.
One-off integration costs of £1,096 million were incurred in the year which have been excluded from the combined businesses basis loss before tax. The integration costs relate to severance, IT and business costs of implementation. The severance provisions are for over 15,000 role reductions announced in the year, of which more than 11,500 relate to 2009, the balance being delivered in 2010. The overwhelming majority of role reductions in 2009 were achieved through redeployment, natural turnover and voluntary redundancy.
Savings to date have been driven largely from role reductions resulting from deployment of the new Group organisational design adopting the Lloyds TSB approach. The overwhelming majority of role reductions in 2009 were achieved through redeployment, natural turnover and voluntary redundancy. Only a small proportion left via compulsory redundancy. In addition the Group has ceased occupancy of 83 properties during 2009, well ahead of the start of year target of 50.
In the circular to shareholders regarding the acquisition of HBOS, it was stated that annual cost savings of £1.5 billion (run-rate) were expected to be achieved by the end of 2011 at a cost of approximately 140 per cent. The Group is now expecting £2 billion of savings at an implementation cost to synergy ratio of around 155 per cent. The increase in the ratio of implementation costs to annualised cost savings has been driven principally by a recognition of the relative complexity of the HBOS systems and processes.
The synergies achieved in the year of £534 million include a number of one-off savings, which have been excluded from the sustainable run-rate benefits. There has also been an increase in the rate of savings in the year resulting in a sustainable run-rate benefit of £766 million. The target run-rate of £750 million announced in November 2009 has therefore been surpassed, a key factor in determining the increase to the overall run-rate target to £2 billion.
Creating a great place to work is a core priority to enable the Group to be recognised, both within the financial services sector, but also more generally in the UK employment market, as the best organisation to work for.
In creating a great place to work, we believe we will attract and retain talented and high performing people. We offer excellent learning and development opportunities so that our colleagues can build fulfilling careers within the organisation.
The focus has been on enabling the business to integrate, while also building foundations for the future to ensure the organisation can attract, retain and develop the best talent. People have been at the heart of the change programme, and a robust communications process has been followed to ensure that colleagues are aware of the changes before they happen. We have four recognised Unions who have been consulted about all proposed changes.
We believe that to create a high commitment, high performance organisation, we need high levels of colleague engagement. The Group uses a comprehensive, confidential online engagement survey that all colleagues can access, to help us measure and assess current levels of colleague engagement across the organisation. The results are reviewed on a quarterly basis so the outcomes can be analysed and action plans developed.
Through twice yearly formal reviews and regular feedback, all our people understand how their performance impacts on colleagues, customers and our overall business success. Together, these act as effective processes for differentiating high performance and addressing and managing underperformance.
We are committed to ensuring that all colleagues have the technical, management and leadership skills that will enable Lloyds Banking Group to deliver the high performance needed to be recognised as the best financial services company.
In 2009 Lloyds TSB was named by the charity Working Families as one of the UK’s Top 20 Employers for working parents, and we will continue to focus on ensuring all colleagues can achieve a good balance between their work and their lives outside.
This has been a challenge for the industry as a whole and has required us to operate within a framework of interest from an increasing number of stakeholders, including organisations such as the FSA and UKFI.
Our objective is to be recognised as the best financial services company in the UK by customers, colleagues and shareholders. We will do this by building deep, lasting customer relationships which help our customers achieve what is important to them. We want to be recognised and recommended as a trusted brand by customers, a good employer by colleagues and a valued contributor in the community.
– Building deep, lasting customer relationships; exceeding their expectations whenever they touch one of our brands
We assess our progress against these objectives on an ongoing basis. Our active approach to corporate responsibility ensures that the Group makes a positive contribution to communities all over the UK. This helps us achieve a competitive advantage and deliver business success, despite a difficult economic environment. The Group contributed more than £29 million in 2009 to local charities and community organisations through our charitable Foundations.
In 2009, the former Lloyds TSB Group Code of Conduct was adopted across all of our operations. The Code of Conduct sets out the core values and standards that govern the way we conduct our business. The Code is underpinned by individual corporate responsibility policies which set minimum requirements for all our business activities. A rolling review process is also underway, benchmarking our corporate responsibility policies against best practice. In 2009, for example, we issued a revised Environmental Policy.
CUSTOMER ADVOCACY During 2009, we implemented consistent customer advocacy metrics across the new Group. The Net Promoter Score was introduced as a measure of customer advocacy in Lloyds TSB in 2008. It was then rolled out in our Halifax and Bank of Scotland brands in the second half of 2009. This metric measures customer recommendation of our products and services, rather than customer satisfaction, and, as a result, will give us a better insight into the service we deliver.
Four thousand customers across the three brands are interviewed each month, in addition to surveys conducted with customers through specific channels or products, to establish the likelihood that they would recommend one of our brands to friends or colleagues. This gives us good insight on how we are doing. It also informs what we need to address to improve customer advocacy.
The Group has also extended the opportunity for customers without adequate capital to borrow under the Government’s Enterprise Finance Guarantee Scheme. We are one of the most active participants in the Scheme, offering almost a third of the total loans made under the Scheme.
Lloyds TSB, Halifax and Bank of Scotland have dedicated Customer Support and Money Management units to provide specialist help to customers who are worried about their financial situation. We have an ongoing programme to train customer-facing colleagues to provide advice and support to customers on managing their borrowing. We proactively contact customers that are showing signs of pressure on their finances. We help them find an appropriate solution, either through more effective budgeting, or by rescheduling their borrowing with us. In 2009 we handled over a million calls with customers in difficulty. We also support independent money advice networks, including the Money Advice Trust and the Consumer Credit Counselling Service. In 2009 we contributed more than £6 million to the financial advice sector.
The Foundations currently fund a number of financial inclusion and financial capability projects, including grants for Citizens Advice Bureaux (CAB) in England, Wales, Scotland and the Channel Islands, to support their work in providing advice and information to disadvantaged people. The Lloyds TSB Foundation for England and Wales recently announced a grant for Calderdale’s Citizen’s Advice Bureau worth £50,000 to support the salary of a volunteer co-ordinator to enable the recruitment and support of an additional 30 volunteer advisors to respond to the increasing demand for its services.
Working with teachers, schools and young ambassadors nationwide, it aims to support the Government’s objective of offering young people the opportunity to participate in five hours of sport and physical activity a week, as well as encourage links to sports clubs in the wider community. Young people are encouraged to try a new Olympic or Paralympic sport and live the Olympic and Paralympic values. Sporting and PE achievements are celebrated and profiled as part of the programme to help maximise its impact and value for children, teachers and parents.
The Group’s Sustainability Network holds events and runs awareness campaigns to encourage colleagues to play their part. Travel reduction was one of the Network’s key themes in 2009, inspiring colleagues to take steps to reduce their travel footprints.
ENVIRONMENTAL RISK MANAGEMENT We have introduced policies and procedures to reduce the environmental impact of our lending activities. We aim to reduce environmental impacts through effective risk management. In 2009 we implemented an integrated Groupwide Environmental Risk Policy to manage these risks. The Policy requires transactions to be assessed for material risks as part of the credit sanctioning process.
During 2009 we implemented a harmonised groupwide approach to monitoring and reporting Equator Principles transactions, and training colleagues on the Equator Principles. An Equator Principles Review Group has been formed, comprising experts from both Risk and Project Finance teams, and supported by external environmental consultants. This Group is responsible for reviewing all new Equator Principle transactions, to ensure that each transaction is compliant and is consistent with the Group Environmental Risk Policy, prior to being sanctioned.
Equator Principles reporting January to December 2009: DEALS Equator Principle risk category
The Group has rolled out the heritage Lloyds TSB approach to risk appetite, policies, delegations and risk committee structure and has continued to embed these across all risk disciplines and into the business. Having achieved alignment of all high level group principles and appetites on the date of acquisition, the Group has continued to embed these at all levels.
– The group model governance and approvals committee, which is responsible for setting the control framework and standards for models across the Group, including establishing appropriate levels of delegated authority, the approval of models that are considered to be material to the Group (including credit risk rating systems), and the principles underlying the Group’s economic capital framework.
– The group insurance risk committee, which is responsible for the development and effectiveness of the Group’s insurance risk management framework, clear articulation of the Group’s insurance risk appetite, setting of high level insurance risk policy, and ensuring compliance with regulatory insurance requirements. On behalf of the group business risk committee, the group insurance risk committee monitors and reviews the Group’s aggregate insurance risk exposures and provides proactive and robust challenge around insurance risk and business activities giving rise to insurance risk.
– During the year, the Group has created divisional financial control committees to provide governance over financial statements. The meetings provide review and challenge as to the veracity of the results, press release and supporting analyst information addressing the processes that have been followed in drawing them up. Items of focus are key assumptions and areas of subjectivity in the results and ensuring proper remediation of control issues that impact internal controls over financial reporting, the Group’s auditors also report findings from their audit work.
The group risk directors and divisional risk officers meet on a regular basis under the chairmanship of the chief risk officer to review and challenge the risk profile of the Group and seek to ensure that mitigating actions are appropriate. Aggregate risk reports are reviewed by this group before submission to group business risk committees and then to risk oversight committee.
RISK MANAGEMENT OVERSIGHT The chief risk officer, oversees and promotes the development and implementation of a consistent group-wide risk management framework. The chief risk officer, supported by the group risk directors and the divisional risk officers, provides objective challenge to the Group’s senior management. The group executive committee and the board receive regular briefings and guidance from the chief risk officer to ensure awareness of the overarching risk management framework and a clear understanding of their accountabilities for risk and internal control.
Divisional risk officers provide oversight of risk management activity for all risks within each of the Group’s divisions. Reporting directly to the group executive directors responsible for the divisions and to the chief risk officer, their day-to-day contact with business management, business operations and risk initiatives seeks to provide an effective risk oversight mechanism.
RISK MANAGEMENT IN THE BUSINESS Line management are directly accountable for the management of risks arising in their individual businesses. A key objective is to ensure that business decisions strike an appropriate balance between risk and reward, consistent with the Group’s risk appetite.
Risk management in the business forms part of a tiered risk management model, as shown above, with the divisional risk officers and group risk providing oversight and challenge, as described above, and the chief risk officer and group committees establishing the group-wide perspective.
High level group policy – policy statements for each of the main risk types aligned to the risk drivers
Execution of the Group’s risk management framework is dependent upon a clear and consistent risk identifi cation using a common language to defi ne risks and to categorise them (see table 1.3 below).
Arising in the Retail, Wholesale and Wealth and International divisions, refl ecting the risks inherent in the Group’s lending activities and in the Insurance division in respect of investment of own funds. Over the last two years the deteriorating economic outlook, both in the UK and overseas, brought about by the banking crisis has impacted the fi nancial services industry resulting in further high profi le losses and writedowns. The Group is impacted by the economic downturn and a further worsening of the business environment could adversely impact earnings.
At group level, a consolidated risk report is produced which is reviewed and debated by the group business risk committee, group executive committee, audit committee, risk oversight committee and the board to ensure that they are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The consolidated risk report provides a regular assessment of the aggregate residual risk for the primary risk drivers, comparing the assessment with the previous quarter and providing a forecast for the next 12 months.
Legal and regulatory: The risk of regulatory action leading to fine and/or public censure and/or successful legal action being taken against the Group as a result of failure to meet one or more legal and/or regulatory requirements either in the UK or overseas.
The industry is currently subject to a wide range of international and UK consultations on proposals to change the regulatory requirements. For example the Basel Committee on Banking Supervision has issued proposals with respect to capital and liquidity requirements for banks (‘Strengthening the resilience of the banking sector’ and ‘International framework for liquidity risk measurement, standards and monitoring’) and draft proposals have also been issued for new capital requirements for insurers (Solvency II). In the UK we have seen the Turner review and more recently, proposals have been issued for governance, recovery and resolution (‘Living Wills’) arrangements and also, potentially conduct of business requirements, which could have significant implications for past business as well as future product offerings for customers. There is a high level of uncertainty both as to the financial outcome in terms of specific requirements and the speed of implementation in the UK and internationally.
Arising in the banking business of the Group and impacting the Retail, Wholesale and Wealth and International divisions reflecting the risk that the Group is unable to attract and retain either retail, wholesale or corporate deposits or issue debt securities. Like all major banks, the Group is dependent on confidence in the short and longer term wholesale funding markets; should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding and provide liquidity when necessary, it could impact its ability to fund its financial obligations.
Integration: The risk that Lloyds Banking Group fails to realise the business growth opportunities, revenue benefits, cost synergies, operational efficiencies and other benefits anticipated from, or incurs unanticipated costs and losses associated with, the acquisition of HBOS plc.
The integration of the two legacy organisations presents one of the largest integration challenges that has been seen in the UK financial services industry. There is a risk that the Group may fail to realise the business growth opportunities, revenue benefits, cost synergies, operational efficiencies and other benefits anticipated from the acquisition of HBOS plc by Lloyds TSB Group plc, or may incur unanticipated costs and losses associated as a result. As a consequence, the Group results may suffer as a result of operational, financial management and other integration risks. The risk of failure to deliver synergy benefits or to meet publicly stated targets could potentially result in a loss of shareholder or market confidence with negative perceptions of the Group’s integration strategy. As the Group goes through the integration process there is a danger of losing key staff potentially impacting upon integration plans.
MEASUREMENT An annual business planning process is conducted at group, divisional and business unit level which includes a quantitative and qualitative assessment of the risks that could impact the Group’s plans. Within the planning round, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams. Stress testing and scenario analysis are fully embedded in the Group’s risk management practice. The Group assesses a wide array of scenarios including economic recessions, regulatory action and scenarios specific to the operations of each part of the business.
APPROACH The Group has adapted the heritage Lloyds TSB business risk approach which includes stress testing the medium term plan to changes in economic assumptions. The output of this stress testing is used to determine investment decisions.
RISK APPETITE Credit risk appetite is set by the board and is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio performance measures which in turn use the various credit risk rating systems as inputs. These metrics are supported by a comprehensive suite of policies, sector caps, product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite.
– Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures
– Specialist expertise: Credit quality is maintained by specialist units providing, for example: intensive management and control; security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector-specific expertise; and legal services applicable to the particular market place and product range offered by the business.
It is the Group’s policy that collateral should always be realistically valued by an appropriately qualified source, independent of the customer, at the time of borrowing. Collateral is reviewed on a regular basis in accordance with business unit credit policy, which will vary according to the type of lending and collateral involved. In order to minimise the credit loss, the Group may seek additional collateral from the counterparty as soon as impairment indicators are identified for the relevant individual loans and advances.
APPROACH The Group has largely adopted the heritage Lloyds TSB credit risk approach, including governance structure, sanctioning processes and risk appetite controls and framework. Integrated, prudent through the cycle credit policies and procedures have mostly all been established and implemented across the Group, supported by robust early warning indicators and triggers.
To support UK Retail customers who are encountering financial difficulties the Group has launched a cross-channel support programme. Lloyds TSB branches and telephony units have at least one trained Financial Health Specialist providing customers with budgeting and money management advice. In the Group’s Halifax and Bank of Scotland businesses, customers have a dedicated telephone support line with trained specialists able to guide them through any financial difficulties. Support is also available for all customers online, and via a specially developed support brochure. 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 where they have multiple credit facilities that require restructuring.
– Whilst the path of the economic recovery remains uncertain, the Group continues to expect the 2010 charge to be significantly lower than the total 2009 charge.
– The Group has largely adopted the heritage Lloyds TSB’s credit risk approach and is implementing prudent, ‘through the cycle’ credit policies and procedures across the Group.
TABLE 1.5: ASSET QUALITY BY DIVISION As at 31 December 2009
LEVERAGE FINANCE LENDING Leverage finance exposures arise in Wholesale and in Wealth and International. The Group defines leverage as that business booked within Lloyds Acquisition Finance in Wholesale and the equivalent business in Lloyds International. The portfolio is well spread by sector with the majority of the exposures being UK focused.
– New lending quality has remained strong, with lower arrears evident.
TABLE 1.7: IMPAIRMENTS ON RETAIL LOANS AND ADVANCES As at 31 December 2009
Secured impairment losses were £789 million in 2009, a reduction of £506 million compared with 2008. The main drivers of the reduction are internal activities (risk and collections policies) and better than anticipated external factors (interest rates, house prices and unemployment). The combination of these factors has resulted in a reduction in impaired loans in the second half of the year. As a percentage of average gross loans and advances to customers, secured impairment losses decreased to 0.23 per cent in 2009 from 0.38 per cent in 2008.
Although impaired loans in the year increased to £7,196 million, Retail has seen a steady reduction in the second half of the year from £7,612 million at June 2009. Impaired secured loans, as a percentage of closing advances, increased to 2.1 per cent at 31 December 2009 from 1.4 per cent in 2008.
TABLE 1.9: MORTGAGES GREATER THAN THREE MONTHS IN ARREARS (EXCLUDING POSSESSIONS) As at 31 December
Average loan to value: Stock of residential mortgages 51.0 75.2 72.3 54.8
Average loan to value: Stock of residential mortgages 52.2 77.0 71.7 54.9
The impairment charge for unsecured lending was £3,438 million in 2009, an increase of £1,037 million on 2008 which reflects the higher unemployment levels seen in the year. Consistent with the Group’s statements at the half-year, Retail’s impairment losses on unsecured lending were higher in the second half of the year, largely driven by the standardisation of the treatment for concessionary repayment plans; if this charge was excluded, impairment losses were stable.
Bank accounts: Impaired loans decreased to 13.6 per cent of closing advances (31 December 2008: 17.0 per cent) and provisions, as a percentage of closing advances, decreased to 8.9 per cent (31 December 2008: 10.6 per cent).
– Significant resources deployed into the Business Support Units focused on key asset classes.
TABLE 1.11: IMPAIRMENTS ON WHOLESALE LOANS AND ADVANCES As at 31 December 2009
Wholesale has invested heavily in implementing the required infrastructure to deal with the stress which has been experienced in the portfolio to date and is satisfied that impairment levels are prudent, with the impairment charge for the second half reducing from the peak evidenced in the first half. Refinancing risk is an emerging issue with significant maturities due in the next few years. Against the Group’s economic assumptions, 2010 is expected to continue to be difficult. However the Group has made significant strides during 2009 in putting in place robust and prudent lending policies and processes with the expectation that, in tandem with a market which is evidencing signs of recovery, Wholesale will see an improving risk profile across the portfolio together with continued reduction in impairments.
During the first half of 2009, as a result of significant market volatility, the value of the portfolio materially reduced. In the second half of the year, the main share indices have evidenced an upward movement and this has largely offset continued pressure on earnings across the investment portfolio, together contributing to a relatively flat position across the total portfolio. While some positive signs are evident, value recovery going forward continues to be treated with caution.
WHOLESALE MARKETS Wholesale Markets encompasses the securitisation conduits (Cancara, Grampian and Landale), a portfolio of Structured Credit Investments and Structured Corporate Finance (which covers shipping, rail, aviation, corporate asset finance and infrastructure finance). Global shipping markets, especially the dry bulk and container sectors, experienced considerable pressure during 2009, leading to higher impairment levels; while the Group expects continued sector pressure in 2010, it has forecast a lower rate of new problem cases.
The Asset Finance retail portfolio has come under significant stress in 2009 in line with the broader difficult economic conditions. The rise in the impairments and expected loss has been driven by a combination of increased unemployment, falling house prices and fall in motor values although these have stabilised in 2009 following a large fall in 2008. Retail second lien secured lending has been impacted by a combination of stressed factors including the fall in house prices, since the loans were provided reducing the equity in the property, the restriction in the retail credit market limiting the ability to refinance and an increase in the number of defaults due to the stressed economy resulting in larger than anticipated increases in impairments.
– Impairment charges considered to have peaked in Wealth and International in 2009 given the Group’s economic assumptions although uncertainty remains over Ireland and the impact of the continued economic decline on Bank of Scotland (Ireland) impairment levels.
EXPOSURES The Group’s banking activities expose it to the risk of adverse movements in interest rates, credit spreads, exchange rates and equity prices, with little or no exposure to commodity risk. The volatility of market values can be affected by both the transparency of prices and the amount of liquidity in the market for the relevant asset.
The Group’s defined benefit staff pension schemes are exposed to significant risks from the constituent parts of their assets and from the present value of their liabilities, primarily equity and real interest rate risk. For further information on pension scheme assets and liabilities please refer to note 41.
For this table the average, minimum and maximum positions reflect the period from 19 January 2009 to 31 December 2009.
The measure, however, is simplified in that it assumes all interest rates, for all currencies and maturities, move at the same time and by the same amount.
Pension schemes Management of the assets of the Group’s defined benefit pension schemes is the responsibility of the Scheme Trustees, who also appoint the Scheme Actuaries to perform the triennial valuations. The Group monitors its pensions exposure holistically using a variety of metrics including accounting and economic deficits and contribution rates. These and other measures are regularly reviewed by the Pensions Strategy Committee and used in discussions with the Trustees, through whom any risk management and mitigation activity must be conducted.
Insurance portfolios The Group’s market risk exposure in respect of insurance activities described above is measured using EEV as a proxy for economic value. The pre-tax sensitivity of EEV to standardised stresses is shown below for the years ended 31 December 2009 and 2008. The 2008 comparatives are based on a post acquisition basis assuming the legacy businesses were combined at the year end and are unaudited. During 2009, the credit spread sensitivity was changed from a 25 basis point increase to a 30 per cent widening of the spread between corporate bonds and the swap curve, including an allowance for the assumed change in the illiquidity premium. Therefore no 2008 comparative is available. Foreign exchange risk arises predominantly from overseas holdings of equities. Impacts have only been shown in one direction but can be assumed to be reasonably symmetrical. Opening and closing numbers only have been provided as this data is not volatile and consequently is not tracked on a daily basis.
Interest rate risk (impact of 25 basis point reduction pre-tax) 64.0 59.7
Market risk in the Group’s retail portfolios and in the Group’s capital and funding activities is managed within limits defined in the detailed Group policy for interest rate risk in the banking book, which is reviewed and approved annually.
The Group’s overall appetite for insurance risk is reviewed and approved annually by the board.
Current and potential future insurance risk exposures are assessed and aggregated using risk measures based on 1-in-20 year stresses and other supporting measures where appropriate, for example those set out in Note 37.
In respect of insurance risks in the staff pension schemes, the Group ensures that effective communication mechanisms are in place for consultation with the trustees to assist with the management of risk in line with the Group’s risk appetite.
Insurance risk exposures are reported and monitored regularly by the group executive committee.
Legal and regulatory exposure is driven by the significant volume of current legislation and regulation with which the Group has to comply, along with new legislation and regulation which needs to be reviewed, assessed and embedded into day-to-day operational and business practices across the Group as a whole. Following the financial crisis, the pace and extent of regulatory reform proposals both in the UK and internationally have increased significantly, and can be expected to remain at high levels. Future changes in regulation, fiscal or other policies are unpredictable and beyond the control of the Group. Future changes in regulation, fiscal or other policies are unpredictable and beyond the control of the Group, but could for instance affect the Group’s future business strategy, structure or approach to funding. Further uncertainties arise where regulations are principles-based without the regulator defining supporting minimum standards either for the benefit of the consumer or firms. This gives rise to both the risk of retrospection from any one regulator and also to the risk of differing interpretation by individual regulators.
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 both short-term liquidity management and long-term funding strategy. Short-term liquidity management is considered from two perspectives; business as usual and liquidity under stressed conditions, both of which relate to funding in the less than one year time horizon. Longer term funding is used to manage the Group’s strategic liquidity profile which is 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 business unit and Group level at an appropriate frequency. Routine reporting is in place to senior management and through the Group’s committee structure, in particular the group asset and liability committee and the senior asset and liability committee which meet 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 oversight.
The Group has invested considerable resource to ensure that it will satisfy the governance, reporting and stress testing requirements of the FSA’s new ILAS liquidity regime. This work will continue in 2010 as further parts of the ILAS regime take effect. The Group has noted the industry move towards strategic balance sheet measures of the funding profile and has started to monitor the market’s net stable funding ratio and the FSA’s structural funding ratio. The Group is aware that the regulatory
LIQUIDITY AND FUNDING MANAGEMENT IN 2009 To understand the trends in liquidity and funding the comparatives have been provided for 2008 for the combined businesses. Consequently, pages 83 to 85 covering liquidity and funding management in 2009 are unaudited.
Wholesale assets comprise balances arising from banking businesses and includes cash and balances at central banks, loans and advances to banks, debt securities and available-for-sale financial assets.
Lloyds Banking Group has continued to extend the term of its wholesale funding. The following significant capital market transactions were undertaken in 2009: – £13.5 billion rights issue
The following tables reconcile figures reported on page 84 with those in the balance sheet.
TABLE 1.21: RECONCILIATION OF WHOLESALE FUNDING FIGURE FROM TABLE 1.18 TO THE BALANCE SHEET As at 31 December 2009
Movement in tier 1 securities relating to ECNs exchange offer – (5,447)
DEFINITION The risk of reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies, ineffective controls over financial, prudential regulatory and tax reporting, failure to manage the associated risks of changes in taxation rates, law, ownership or corporate structure and the failure to disclose information about the Group on a timely basis.
REGULATORY CAPITAL REQUIREMENTS Each life insurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FSA; the basis of calculating the regulatory capital requirement is given below. Except for Scottish Widows and Clerical Medical, the regulatory capital requirement is a combination of amounts held in respect of actuarial reserves, sums at risk and maintenance expenses (the Long-Term Insurance Capital Requirement) and amounts required to cover various stress tests. The regulatory capital requirement is deducted from the available capital resources to give ‘statutory excess capital’.
CAPITAL STATEMENT The following table provides more detail regarding the capital resources available to meet regulatory capital requirements in the life insurance businesses. The figures quoted are based on management’s current expectations pending completion of the annual financial returns to the FSA. The figures allow for a transfer of £261 million and an anticipated transfer of £147 million from long-term funds to the UK life shareholder funds as at 31 December 2009.
Held within the long-term funds – – 8,011 – 405 8,416
Available capital resources for with-profit funds are presented in the table on a ‘realistic’ basis.
Requirement to maintain a Support Account: The Scheme requires the maintenance of a ‘Support Account’ within the Non-Participating Fund. The quantum of the Support Account is calculated with reference to the value of assets backing current with-profits policies which also existed at the date of demutualisation and must be maintained until the value of these assets reaches a minimum level. Assets can only be transferred from the Non-Participating Fund if the value of the remaining assets in the fund exceeds the value of the Support Account. Scottish Widows has obtained from the FSA permission to include the value of the Support Account (or,if greater, the excess of realistic liabilities for business written before demutualisation over the relevant assets) in assessing the realistic value of assets available to the With Profit Fund. At 31 December 2009, the estimated value of surplus admissible assets in the Non-Participating Fund was £1,627 million (31 December 2008: £1,523 million) and the estimated value of the Support Account was £222 million (31 December 2008: £200 million).
Adjustments onto a regulatory basis: Unallocated surplus within insurance business 293 – – – 293
UK LIFE SHAREHOLDER FUNDS Available capital in the UK life shareholder funds has increased from £1,152 million at 31 December 2008 to an estimated £2,059 million at 31 December 2009. The acquisition of Clerical Medical resulted in a £1,342 million increase. Redemption of subordinated debt (shown within dividends and capital transfers) has been partly offset by actual and proposed transfers from the long term funds.
Changes in estimations and in demographic assumptions used to measure life assurance liabilities – 19 (208) 43 36 (110)
Unit-linked business (excluding that accounted for as non-participating investment contracts) – 11,480 11,480
The Group has sold insurance products that contain options and guarantees, both within the with-profit funds and in other funds.
As noted above, under the realistic capital regime of the FSA, the liabilities of the with-profit funds are valued using a market-consistent stochastic simulation model. This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
The most significant economic assumptions included in the model are: – Risk-free yield. The risk-free yield is defined as spot yields derived from the UK gilt yield curve.
This figure excludes 81 million (2005 to 2008: 79 million) limited voting ordinary shares.
Joined the board in 2005 and was appointed deputy chairman in May 2009. Appointed chairman of Scottish Widows in 2007. Held a number of senior and general management appointments in Allied Dunbar, Eagle Star and Threadneedle Asset Management before the merger of Zurich Group and British American Tobacco’s fi nancial services businesses in 1998. Subsequently served as chairman and chief executive offi cer of Zurich Financial Services United Kingdom, Ireland, Southern Africa and Asia Pacifi c, until his retirement in 2004. Chairman of the Government’s Review of Skills (published in December 2006) and deputy chairman of the Commonwealth Education Fund. Chairman of BUPA and Intrinsic Financial Services and a non-executive director of Paternoster. Former chairman of the National Employment Panel. Aged 62.
Chairman of the audit committee and a member of the risk oversight committee
Member of the nomination and governance committee and chairman of the remuneration committee
Joined the board on 2 April 2009. Previously chief executive of Hermes Pensions Management. Held a number of senior appointments in AMP Asset Management from 1991 to 1998. A non-executive director of Hammerson, Vodafone and Witan Investment Trust, a member of the Norges Bank Investment Management advisory board and chairman of Marks and Spencer Pension Trust, Asian Infrastructure Fund and Lincoln’s Inn investment committee. A former chairman of MEPC and of the Strategic Investment Board (Northern Ireland) and a former member of the Financial Reporting Council. Aged 64.
Member of the nomination and governance, remuneration and risk oversight committees
Joined the board in 2004 as group fi nance director. Appointed as group executive director, UK retail banking in April 2008. Group fi nance director of Kingfi sher from 2000 to 2004. Previously fi nance director of B&Q, having joined that company in 1995 from McKinsey & Co where she was a senior manager. Began her career at Unilever. Member of the Financial Services Practitioner Panel and the Said Business School Advisory Board. Chair of the British Bankers’ Association Retail Committee. A former member of the Accounting Standards Board. Fellow of the Chartered Institute of Management Accountants. Aged 47.
Chairman of the risk oversight committee and a member of the remuneration committee
Six directors stood down from the board during the year, as follows: Mr J P du Plessis (17 April), Mr Ewan Brown (5 June), Sir Victor Blank (15 September), Mr P N Green (23 October), Sir David Manning (2 November) and Ms C J McCall (31 December).
Mr T T Ryan and Mr Anthony Watson joined the board on 1 March 2009 and 2 April 2009, respectively.
Sir Winfried Bischoff joined the board on 15 September 2009 and Mr G R Moreno and Mr D L Roberts have been appointed directors from 1 March 2010. In accordance with the articles of association, they offer themselves for election at the annual general meeting.
Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no relevant audit information of which the Company’s auditors are unaware and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of the Companies Act 2006.
The board considers that it is of an appropriate size to oversee the Group’s businesses, with a suitable diversity of backgrounds and mix of experience and expertise to maximise its effectiveness. The composition of the board is kept under continuous review by the chairman, with the support of the nomination and governance committee, to ensure the right balance of skills and experience. All director appointments are subject to detailed due diligence which includes a robust search and selection process overseen by the nominations and governance committee. On 11 February 2010, the Company announced the appointments of Mr Moreno and Mr Roberts to take effect on 1 March 2010. Their details are included in the biographies on pages 96 and 97.
The current induction and training programmes are being reviewed and enhanced to ensure that they meet the requirement for a ‘substantive and personalised’ programme as recommended by the Walker Review of Corporate Governance of UK Banking Industry published in November 2009.
The chairman has endorsed the effectiveness and commitment of all directors standing for election or re-election at the AGM, and the senior independent director has given a similar endorsement in respect of the chairman’s election.
The company secretary oversees communications with private shareholders. Shareholders are encouraged to attend and participate in the Group’s AGM.
CHAIRMAN’S COMMITTEE The chairman’s committee, comprising the chairman, deputy chairman and the group chief executive, meets to assist the chairman in ensuring the effectiveness and efficiency of board meetings. The committee exercises specific powers delegated to it by the board from time to time.
The nomination and governance committee is chaired by Sir Winfried Bischoff. Lord Leitch, Dr Berndt and Sir Julian Horn-Smith are members. The committee reviews the structure, size and composition of the board; oversees the selection process for prospective directors; makes recommendations to the board on potential appointments and re-appointments of directors at the end of their specified term; and considers board succession. Following expansion of its terms of reference, it also reviews the board’s governance arrangements and oversees the Company’s implementation of governance requirements eg under the Walker Review and Combined Code.
GROUP EXECUTIVE COMMITTEE The group executive committee, comprising the group chief executive, all the group executive directors (as shown on page 97), together with the chief risk officer, the group human resources director and the director of group operations, meets to assist the group chief executive in performing his duties. Specifically, the committee considers the development and implementation of strategy, operational plans, policies and budgets; the monitoring of operating and financial performance; the assessment and control of risk; the prioritisation and allocation of resources; and the monitoring of competitive forces in each area of operation. The committee, assisted by its sub-committees, the group business risk and group asset and liability committees, also supports the group chief executive in endeavouring to ensure the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, and in reviewing the Group’s aggregate risk exposures and concentrations of risk.
Anthony Watson4 7 11 18 (max 20) 3 (max 3) 2 (max 2)
Ewan Brown6 4 6 10 (max 12) 4 (max 5) 2 (max 2)
Sir David Manning9 7 15 22 (max 26) 1 (max 1) 12 (max 12) 4)
Appointed to the board on 2 April 2009. Appointed to the audit and risk oversight committees on 6 May 2009.
The directors have responsibility for ensuring that the Company and the Group keep proper accounting records which disclose with reasonable accuracy the financial position of the Company and the Group and which enable them to ensure that the financial statements and the directors’ remuneration report comply with the Companies Act 2006 and, as regards the consolidated financial statements, Article 4 of the IAS Regulation. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and the Group and to prevent and detect fraud and other irregularities.
The directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of published policies and procedures and regular management briefings. A requirement to comply with internal control risk policies is a key component of individual staff objectives expressed in the balanced scorecard. Key business risks are identified, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. In addition, there is an annual control self assessment exercise whereby the key businesses and head office functions review specific controls and attest to the accuracy of their assessments. The assessment covers all enterprise-wide risk management categories and is in accordance with the principles of the Combined Code. As in previous years, this exercise was completed for the year ended 31 December 2009. All returns have been satisfactorily completed and appropriately certified.
The effectiveness of the internal control system is reviewed regularly by the board and the audit committee, which also receives reports of reviews undertaken around Lloyds Banking Group by group risk and group audit. The audit committee receives reports from the Company’s auditors, PricewaterhouseCoopers LLP (which include details of significant internal control matters that they have identified), and has a discussion with the auditors at least once a year without executives present, to ensure that there are no unresolved issues of concern.
This is a report made by the board of Lloyds Banking Group plc, on the recommendation of the remuneration committee. It covers the current and proposed components of the remuneration policy and details the remuneration for each serving director during 2009.
INTRODUCTION This last year has been one of the most challenging for remuneration in banking, following on from 2008 which was a year of unprecedented change and turmoil across the sector. The committee is also aware that remuneration is a sensitive issue for society as well. At the same time, the Group has been faced with the immense task of integrating the Lloyds TSB and HBOS businesses - one of the biggest integrations ever undertaken in the sector and where considerable progress has been made during the first year of the three year programme, as described elsewhere in this report. In making decisions on remuneration, the remuneration committee has continually had to balance the current operating environment and the fact that the Group is in a loss making position with the need to motivate the executives to run the business in a way to maximise the returns for the shareholder, including the tax payer. The committee has sought to strike this balance by maintaining the prudent approach to reward overall that it has adopted in previous years, whilst ensuring that the right incentives are in place to reward future performance. At the same time the committee has during 2009 built on the work of 2008 to ensure that the Group’s remuneration policy and arrangements comply with the FSA Code of Practice on Remuneration.
CONCLUSION Our approach to remuneration has been developed with extensive input and consultation from both our shareholders and regulators during 2009 and the early part of 2010. The remuneration committee believes that this approach strikes the best balance possible given the unique circumstances that exist for the Group at this time and the need to continue to motivate and retain the management team. The committee does have concerns that by continuing to hold base pay levels at 2008 levels, remuneration for the executive directors is likely to become uncompetitive versus our peer group. However, by adding the share price related element to the 2010 LTIP it is hoped that this will go some way to addressing this. But this is an area that will be kept under close and continuous review by the committee and one where we will continue to engage with shareholders during 2010 as their views are essential in this debate. The committee believes that the approach this year achieves an appropriate balance between recognition of the sensitivity of the current environment and this longer term policy objective.
In 2010, our remuneration package will continue to have the same main elements as for 2009: – Base salary
In addition, executive directors participate in pension arrangements and receive benefits such as life assurance and medical insurance.
– At his own request the group chief executive waived his award under the annual incentive plan for 2009
The approximate make-up of the main components of our new package for executive directors on an expected value basis is shown below: Based on a combination of performance targets comprising earnings per share, economic profit and the achievement of stretching share price targets 40% Paid in shares after three years
– A combination of financial and non-financial measures encourages a long-term focus
The committee met on 13 occasions during 2009, and the members were as follows: – Dr Wolfgang Berndt (chairman)
– Ms Carolyn McCall (from 23 January 2009 until 31 December 2009)
In addition to their advice on executive remuneration, during 2009 Towers Perrin also provided market remuneration data as well as other remuneration consulting services to the Group, Hewitt New Bridge Street provided pension consulting services.
The key developments in the committee’s terms of reference are: – Extension of its direct responsibilities to include all those colleagues who perform significant influence functions for the Group and those who could have a material impact on the Group’s risk profile; – Formalising the periodic review of the adequacy and effectiveness of the Group’s remuneration policy; – Formalising annual reporting to the board on the substance of the Group’s remuneration policy and propose any substantive changes. This report will be supported by independent commentary from the chief risk officer in the context of the Group’s risk appetite and by positive assurance from each group executive director that all remuneration arrangements within their division/function reflect fully the Group’s overall approach to remuneration; and
We aim to choose incentive plan targets that are directly linked to the business strategy and priorities. This not only ensures alignment with company performance, but also means that the targets are meaningful to executives and therefore motivating. This ensures that incentive packages are valued by executives and are cost effective.
Annual incentive 200 per cent of salary maximum (225 per cent for group chief executive), as for 2009
Based 50 per cent on balanced scorecard covering, customers, people, risk and build franchise
From April 2012, executive directors with final salary pensions will move to a defined contribution pension arrangement, with no compensation
GENERAL CONSIDERATIONS When deciding the approach to take for remuneration in 2010, the remuneration committee considered a range of factors. The environment for remuneration in the banking sector remains very sensitive and the committee is aware of this. Consistent with best practice, shareholders were fully consulted during the process and their views have been taken into account in the decisions the committee has made. At the same time, the ongoing challenges of the HBOS integration to create the UK’s leading consumer bank were also considered by the committee as is the need to retain and motivate the management team to build on the outstanding start made to this process in 2009.
However, in recognition of the current operating environment base salaries for 2010 remain unchanged from the salaries set for 2008. Base salary increases for other employees across the Group will remain in line with any market movement, but will, in general be significantly lower than in previous years.
Consistent with the aim of ensuring that short-term financial results are only achievable sustainably, the committee has decided that the incentive will be deferred and released in tranches over a three year period. The deferred incentive will be subject to 100 per cent clawback if the performance that generated the incentive is found to be unsustainable.
The details of the targets for the proposed measures are set out below: Earnings per share (applying to award of 100 per cent of salary) Earnings per share continues to be an important measure of our profitability and ability to generate cash. The committee has therefore decided to retain this well-recognised measure in our incentive system.
Economic profit (applying to award of 100 per cent of salary) The use of economic profit has been very successful in introducing a long-term, risk-based approach to managing our business. Economic profit is calculated on a through-the-cycle basis, considering the impact of decisions over an entire economic cycle, encouraging prudent risk management of our portfolio.
For the economic profit element of the award, performance will be based on the compound annual growth rate (CAGR) from the 2009 base over a three year period.
There will be an underpin to the absolute share price element of the award such that shares making up that element may only be released if both the EPS and the economic profit element have achieved a threshold level of vesting as above.
PENSION As stated last year, in April 2012, all executive directors will transition to defined contribution pension arrangements with contributions of 25 per cent of base salary for the group chief executive and other executive directors, with no compensation for ceasing final salary accrual.
REMUNERATION FOR 2009 2009 ANNUAL INCENTIVE SCHEME The annual incentive scheme for executive directors is designed to reflect specific goals linked to the performance of the business.
The maximum annual incentive opportunity is 200 per cent (225 per cent for the group chief executive) of basic salary for the achievement of exceptional performance targets. The maximum payment under the corporate half of the annual incentive is only available if exceptional performance is achieved against the stretching corporate target. An amount equal to 50 per cent of this element of the incentive is available on the achievement of the stretching corporate target. Failure to achieve at least 90 per cent of the stretching target would result in no payment under the corporate half of the incentive.
Any payments under the plan are deferred 100 per cent in shares until June 2012 and subject to claw back.
Details of the plan, including the specific performance conditions, can be found on page 124.
During 2009, Mr Daniels and Mrs Weir received fees of £75,000 and £30,208 respectively, which were retained by them, for serving as non-executive directors of other companies.
Rebased to 100 on 31 December 2004 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec 31 Dec
Sir Victor Blank4 (until 14 September 2009) 640 5 38 683 669
The cash column under ‘other benefits’ includes flexible benefits payments (4 per cent of basic salary), the tax planning allowance for Mr Daniels, payments to certain directors who elect to take cash rather than a company car under the car scheme and the cash balance of a pension allowance for Mrs Weir. Sir Winfried Bischoff has elected to take cash rather than a company car.
The non cash column includes amounts relating to the use of a company car, use of a company driver and private medical insurance and the cost of home security in respect of Sir Victor Blank. It also includes the value of any matching shares which are received under the terms of Shareplan, through which employees have the opportunity to purchase shares up to a maximum of £125 per month and receive matching shares on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share.
Column (d) is the equivalent transfer value, but calculated as at 31 December 2008 on the assumption that the director left service at that date.
The changes in beneficial interests between 31 December 2009 and 25 February 2010 related to ‘partnership’ and ‘matching’ shares acquired under the Lloyds TSB Group Shareplan. 1
T J W Tookey 35,305 – 35,305 – – (see page 125) 20/4/2009 19/10/2009 j
f Exercisable to the extent at which the performance condition vested.
i Option lapsed as not exercised by 10th anniversary of date of grant.
j Mr Tookey exercised his option on 8 May 2009. Market price on day of exercise was 100.70p.
Sir Victor Blank retired as chairman on 14 September 2009 but remained employed by the Group until 31 January 2010.
The market price for a share in the Company at 1 January 2009 and 31 December 2009 was 126p and 50.69p, respectively. The range of prices between 1 January 2009 and 31 December 2009 was 40.30p to 140.70p.
As the performance condition had not been met, the options lapsed in 2009.
March 2004 – August 2004 That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international fi nancial services companies including Lloyds Banking Group) must be at least ninth, when 14 per cent of the option will be exercisable. If the Company is ranked fi rst in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met.
March 2005 – August 2005 That the Company’s ranking based on TSR over the relevant period against a comparator group (15 companies including Lloyds Banking Group) must be at least eighth, when 30 per cent of the option will be exercisable. If the Company is ranked fi rst to fourth position in the group, then 100 per cent of the option will be exercisable and if ranked ninth or below, the performance condition is not met.
LLOYDS TSB PERFORMANCE SHARE PLAN Under the plan, executive directors were required to defer 50 per cent of their bonus awards in 2006 into shares in the Company, known as bonus shares. The number of bonus shares awarded was calculated after the deduction of income tax and national insurance from the deferred element of the bonus.
The following table details the number of bonus and performance shares released in respect of their 2005 bonus.
LLOYDS TSB LONG-TERM INCENTIVE PLAN The following are conditional share awards available under the plan. Further information regarding this plan can be found on pages 124 and 125.
May 2006 For 50 per cent of the award (the ‘EPS Award’) – the percentage increase in earnings per share of the Group (on a compound annualised basis) over the relevant period must be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the retail price index over the same period. If it is less than 3 per cent per annum, the EPS Award will lapse. If the increase is more than 3 per cent but less than 6 per cent per annum, then the proportion of shares released will be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
When tested at the end of the relevant performance period, neither the EPS nor the TSR performance conditions were met and all awards made in 2006 lapsed.
March and April 2008 For 50 per cent of the award (the ‘EPS Award’) – the performance condition was as described for May 2006 with the relevant performance period commencing on 1 January 2008 and ending on 31 December 2010.
April 2009 EPS: The release of 50 per cent of the shares will be dependent on the extent to which the growth in EPS achieves cumulative EPS targets over the three year period.
The EPS and economic profit performance measures applying to this 2009 LTIP award were set on the basis that the Group would enter into GAPS. Now that the Group is not participating in GAPS, the remuneration committee has determined that these performance measures will be restated on a basis consistent with the EPS and economic profit measures used for the 2010 LTIP awards. This restatement will be undertaken in 2010.
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As explained more fully in the Directors’ Responsibilities Statement on page 99, the directors are responsible for the preparation of the group financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit the group financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
This report, including the opinions, has been prepared for and only for the company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Movements in revaluation reserve in respect of available-for-sale fi nancial assets, net of tax: Change in fair value 1,936 (2,031)
Trading and other financial liabilities at fair value through profit or loss 34 28,271 6,754
Liabilities arising from insurance contracts and participating investment contracts 36 76,179 33,792
Employee share option schemes: Value of employee services – – 43 – 43
Repayment of capital to minority shareholders – – – (3) (3)
Effects of exchange rate changes on cash and cash equivalents (210) 1,440
The consolidated financial statements of Lloyds Banking Group plc (prior to 16 January 2009 known as Lloyds TSB Group plc) have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union (EU). IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is no difference in application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.
(iv) IFRS 8 Operating Segments. This new standard replaces IAS 14 Segment Reporting and requires reporting of financial and descriptive information about operating segments which are based on how financial information is reported and evaluated internally. The segment information for the year ended 31 December 2009 and for the corresponding comparative period is presented in note 4. The application of this new standard, which affects disclosures only, has not had any impact for amounts recognised in these financial statements.
The application of the following IFRS pronouncements which all became effective in 2009 has had no material impact on these financial statements: – Amendments to IFRIC 9 Reassessment of Embedded Derivatives and IAS 39 Financial Instruments: Recognition and Measurement. This amendment clarifies that a reassessment of embedded derivatives is required whenever a financial asset has been reclassified out of the fair value through profit or loss category.
Revenue recognition policies specific to life insurance and general insurance business are detailed below (see accounting policy 2(O)).
(1) Financial instruments at fair value through profit or loss Financial instruments are classified at fair value through profit or loss where they are trading securities or where they are designated at fair value through profit or loss by management. Derivatives are carried at fair value (see accounting policy 2(F)).
Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. Such assets and liabilities are carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur. Financial assets and liabilities are designated at fair value through profit or loss on acquisition in the following circumstances: – it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or losses on different bases. The main type of financial assets designated by the Group at fair value through profit or loss are assets backing insurance contracts and investment contracts issued by the Group’s life insurance businesses. Fair value designation allows changes in the fair value of these assets to be recorded in the income statement along with the changes in the value of the associated liabilities, thereby significantly reducing the measurement inconsistency had the assets been classified as available-for-sale financial assets.
– the Group has neither retained nor transferred substantially all the risks and rewards, but has transferred control.
The method of recognising the movements in the fair value of the derivatives depends on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of the same. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item and the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.
(3) Net investment hedges Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in other comprehensive income, the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of. The hedging instrument in net investments hedges may include non-derivative liabilities as well as derivative financial instruments.
(J) TANGIBLE FIXED ASSETS Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): – Freehold/long and short leasehold premises: shorter of 50 years or the remaining period of the lease
Liabilities – Insurance and participating investment contracts in the Group’s with-profi t funds
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 Financial Services Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in unallocated surplus (see below). Further details on the realistic capital regime are given on page 89. Changes in the value of these liabilities are recognised through insurance claims.
Liabilities for unit-linked insurance contracts and participating investment contracts are stated at the bid value of units plus, an additional allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Changes in the value of the liability are recognised in the income statement through insurance claims. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
The benefits to which the Group is entitled under its reinsurance contracts held are recognised as reinsurance assets. These assets consist of short-term balances due from reinsurers as well as longer term receivables that are dependent on the expected claims and benefits arising under the related reinsured contracts. Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured contracts and in accordance with the terms of each reinsurance contract and are regularly reviewed for impairment. Premiums payable for reinsurance contracts are recognised as an expense when due within insurance premium income. Changes in the reinsurance recoverable assets are recognised in the income statement through insurance claims.
(Q) PROVISIONS Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the obligations and they can be reliably estimated.
The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty in these financial statements, which together are deemed critical to the Group’s results and financial position, are discussed below.
At 31 December 2009 gross loans and receivables totalled £710,362 million (2008: £287,220 million) against which impairment allowances of £15,380 million (2008: £3,727 million) had been made (see note 24). Impairment allowances are made up of two components, those determined individually and those determined collectively.
Individual component All impaired loans which exceed a certain threshold, principally within the Group’s Wholesale division, are individually assessed for impairment having regard to expected future cash flows including those that could arise from the realisation of security. The determination of these allowances often requires the exercise of considerable judgement by management involving matters such as local economic conditions and the resulting trading performance of the customer and the value of the security held, for which there may not be a readily accessible market. In particular, significant judgement is required by management in the current economic environment in assessing the borrower’s cash flows and debt servicing capability together with the realisable value of commercial real estate collateral. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.
Collective component Impairment allowances for portfolios of smaller balance homogenous loans, such as residential mortgages, personal loans and credit card balances that are below the individual assessment thresholds, and for loan losses that have been incurred but not separately identified at the balance sheet date, are determined on a collective basis. Collective impairment allowances are calculated on a portfolio basis using models which take into account factors such as historical experience of accounts progression through the various stages of delinquency, historical loss rates, the credit quality of the portfolio, and the value of any collateral held, which is estimated, where appropriate, using indices such as house price indices.
Given the relative size of the Group’s mortgage portfolio, a key variable is UK house prices which determine the collateral value supporting loans in such portfolios. The value of this collateral is estimated by applying changes in house price indices to the original assessed value of the property. If average house prices within the Group’s mortgage portfolio were 10 per cent lower than those estimated at 31 December 2009, the house price index related impact on the impairment charge would be an increase of approximately £350 million.
IMPAIRMENT OF AVAILABLE-FOR-SALE FINANCIAL ASSETS In determining whether an impairment loss has been incurred in respect of an available-for-sale financial asset, the Group performs an objective review of the current financial circumstances and future prospects of the issuer and, in the case of equity shares, considers whether there has been a significant or prolonged decline in the fair value of that asset below its cost. This consideration requires management judgement. Among factors considered by the Group is whether the decline in fair value is a result of a change in the quality of the asset or a downward movement in the market as a whole. An assessment is performed of the future cash flows expected to be realised from the asset, taking into account, where appropriate, the quality of underlying security and credit protection available. The increase in the fair value of available-for-sale financial assets during the year was £2,234 million (2008: reduction of £2,721 million). Impairment losses in respect of available-for-sale financial assets transferred from reserves to the income statement totalled £602 million (2008: £130 million).
Management judgement is required in determining the categorisation of the Group’s financial instruments that are carried at fair value. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is less judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models. These require management judgement and therefore contain significant estimation uncertainty (note 53).
The valuation techniques used are set out in note 53 on page 224. This provides details of the inputs into valuation models that have the potential to significantly impact the value determined, sets out the assumptions used for those inputs and provides the effects of applying reasonably possible alternative assumptions.
At 31 December 2009 the Group carried an asset for current tax recoverable of £680 million (2008: £300 million) and current tax liabilities of £51 million (2008: £nil). In determining the carrying value of these balances, management have taken account of tax issues that are subject to ongoing discussion with HM Revenue & Customs and other tax authorities. Inherent in this is management’s assessment of legal and professional advice, case law and other relevant guidance. The determination of the outcome of such matters requires significant management judgement in assessing the various risks and applying appropriate probability weightings in determining the carrying value of current and deferred tax balances.
The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Assumptions are made regarding the expected lifetime of scheme members based upon recent experience, however given the rate of advance in medical science and increasing levels of obesity, it is uncertain whether they will ultimately reflect actual experience. Assumptions used by management reflect recent longevity experience and extrapolate the improving trend. An increase of one year in the expected lifetime of scheme members would increase the overall deficit by approximately £590 million and the annual cost by approximately £79 million; a reduction of one year would reduce the overall deficit by approximately £603 million and the annual cost by approximately £76 million.
The size of the overall deficit is also sensitive to changes in the discount rate, which is affected by market conditions and therefore potentially subject to significant variations. At 31 December 2009 the discount rate used was 5.7 per cent (2008: 6.3 per cent); a reduction of 0.2 per cent would increase the overall deficit by approximately £985 million and the annual cost by approximately £82 million, while an increase of 0.2 per cent would reduce the net deficit by approximately £937 million and the annual cost by approximately £68 million.
The exercise to fair value the HBOS Group balance sheet was inherently highly subjective and required management to make a number of assumptions and estimates. The overall effect was to reduce the book value of the assets acquired by £11,975 million, after the recognition of brands 3 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS continued
The process for determining key assumptions that have been made for life insurance assets and liabilities at 31 December 2009 is detailed in notes 28 and 36. The impact on profit before tax of changes in key assumptions is detailed in note 37.
The Group is a leading financial services group, whose businesses provide a wide range of banking and financial services in the UK and in certain locations overseas.
During 2009, following the acquisition of HBOS, the Group’s activities were reorganised into four financial reporting segments: Retail, Wholesale, Wealth and International and Insurance. Consequently, the comparative information has been restated to be consistent with the reorganised structure of the Group. The segmental results and comparatives are presented on the basis reviewed by the chief operating decision maker in 2009 and therefore include the pre-acquisition results of HBOS for 2008 and for the period from 1 January 2009 to 16 January 2009.
Wealth and International was created to give increased focus and momentum to the Group’s private banking and asset management activities and to closely co-ordinate the management of its international businesses. Wealth comprises the Group’s private banking, wealth and asset management businesses in the UK and overseas. International comprises corporate, commercial, asset finance and retail businesses in Australia, Ireland and continental Europe.
Other segment items reflected in income statement above: Movement in value of in-force business – – (5) 1,097 – 1,092
Lloyds Removal of: Banking Group Pre-acquisition Acquisition Insurance Fair value Reported statutory results of HBOS related1 Volatility gross up unwind basis £m £m £m £m £m £m £m
Total income, net of insurance claims 23,278 469 – (468) (61) 746 23,964
Loss on disposal – (799) (46) 845 – – – –
As the activities of the Group were predominantly carried out in the UK prior to the acquisition of HBOS, no comparative geographical analysis is presented.
Interest and similar income: Loans and advances to customers 3.58 6.33 24,171 13,808
Debt securities held as loans and receivables 3.68 2.52 1,469 61
Net expense arising on liabilities held at fair value through profit or loss – debt securities in issue (125) (232)
Total net gains (losses) arising on assets and liabilities held at fair value through profit or loss 15,647 (7,053)
Net gains (losses) on financial instruments held for trading 2,894 (1,216)
Change in provision for ceded unearned premiums (note 36(2)) 26 –
Gains less losses on disposal of available-for-sale financial assets (note 47) 97 19
Claims and surrenders: Change in insurance and participating investment contract liabilities (note 36(1)): Change in gross liabilities (5,922) 4,332
Amortisation of acquired value of in-force non-participating investment contracts (note 28) 75 –
Impairment losses on loans and receivables: Loans and advances to banks (3) 135
Total impairment losses on loans and receivables (note 24) 16,028 2,876
Principal area of operations esure Holdings Limited (see below) Insurance Ordinary 70% 31 December UK
All of the interests in the joint ventures above are incorporated in the UK. All interests in joint ventures are held by subsidiaries. Where entities have statutory accounts drawn up to a date other than 31 December management accounts are used when accounting for them by the Group.
As the fair value of the identifiable net assets acquired was greater than the total consideration paid, negative goodwill arises on the acquisition. The negative goodwill is recognised as ‘Gain on acquisition’ in the income statement for the year ended 31 December 2009.
Consideration of acquisition costs: Issue of 7,776 million ordinary shares of 25p in Lloyds Banking Group plc2 (7,651)
The post acquisition loss before tax of HBOS plc covering the period from 17 January 2009 to 31 December 2009 which is included in the Group statutory consolidated income statement for the year to 31 December 2009 is £5,613 million.
UK corporation tax: Current tax on profi t for the year (227) (667)
The credit for tax on the profit for 2009 is based on a UK corporation tax rate of 28.0 per cent (2008: 28.5 per cent).
Transferred to income statement in respect of impairment 621 (168) 453
Other comprehensive income for the year 2,219 (480) 1,739 Before tax amount £m
Transferred to income statement in respect of disposals (19) – (19)
Effect of profit (loss) in joint ventures and associates (211) –
The weighted-average number of anti-dilutive share options and awards excluded from the calculation of diluted earnings per share was 393 million at 31 December 2009 (2008: 59 million).
Weighted-average number of ordinary shares in issue (basic) as published 5,742
Restated 11,660 17 TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS
Loans and advances to banks 4,702 635 5,337 – – –
Debt securities: Bank and building society certificates of deposit 2,034 – 2,034 – 433 433
The Group’s Wholesale division had exposure to negative basis asset-backed securities of £1,174 million (31 December 2008: £584 million) of which £970 million were protected by monoline financial guarantors (note 54).
Kelso1 Corporate loans and revolving credit facilities 595 7 1,158 3
Morse1 Corporate loans and revolving credit facilities – – 1,050 –
Debt securities: Classified as loans and receivables 437 – – 437
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 23 DEBT SECURITIES CLASSIFIED AS LOANS AND RECEIVABLES
Debt securities accounted for as loans and receivables comprise: £m £m
Bank and building society certificates of deposit – 1,014 1,014 – 9,602 9,602
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,016 million (31 December 2008: £2,256 million), £1,836 million (or 91 per cent of the total) has been allocated to Scottish Widows in the Group’s Insurance division and £170 million (or 8 per cent of the total) to Asset Finance in the Group’s Wholesale division.
A market consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. The risk-free rate used for the value of financial options and guarantees is defined as the spot yield derived from the relevant government bond yield curve in line with FSA realistic balance sheet assumptions.
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds. In accordance with the approach adopted in December 2008, the value of the in-force business asset for UK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of these corporate bond holdings. The illiquidity premium is estimated to be 75 basis points as at 31 December 2009 (31 December 2008: 154 basis points). The reduction in the illiquidity premium over 2009 has offset gains made on the assets backing the annuity liabilities, reducing the benefit within the results from the reduction in corporate bond spreads.
The table below shows the range of resulting yields and other key assumptions at 31 December for UK business: %
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 28 VALUE OF IN-FORCE BUSINESS continued
Balance sheet amount at 31 December 2009 575 2,377 242 640 253 4,087
Balance sheet amount at 31 December 2009 1,577 2,525 5,122 9,224
Balance sheet amount at 31 December 2008 727 940 1,298 2,965
Liabilities in respect of securities sold under repurchase agreements 27,558 24,888
Included in deposits from banks were deposits of £17,253 million (31 December 2008: £2,574 million) held as collateral. The fair value of those deposits approximates the carrying amount.
Liabilities held at fair value through profit or loss (debt securities) 6,160 6,748
At 31 December 2009 £44,441 million (31 December 2008: £29,967 million) of liabilities arising from insurance contracts and participating investment contracts had a contractual residual maturity of greater than one year.
Change in liabilities charged to the income statement (note 10) (1,177) (3,155) (4,332) (40) (4,372)
The realistic assessment is carried out using a stochastic simulation model which values liabilities on a market consistent basis. The calculation of realistic liabilities uses best estimate assumptions for mortality, persistency rates and expenses. These are calculated in a similar manner to those used for the value of in-force business as discussed in note 28.
(iii) Assumptions Key assumptions used in the calculation of with-profit liabilities, and the processes for determining these, are: INVESTMENT RETURNS AND DISCOUNT RATES The realistic capital regime dictates that with-profit fund liabilities are valued on a market-consistent basis. This is achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with-profit fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk-free yield and all cash flows are discounted using the risk-free yield. The risk-free yield is defined as the spot yield derived from the relevant government bond yield curve.
(iii) Assumptions Generally, assumptions used to value non-profit fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the measurement of non-profit fund liabilities are: INTEREST RATES The rates used are derived in accordance with the guidelines set by local regulatory bodies. These limit the rates of interest that can be used by reference to a number of factors including the redemption yields on fixed interest assets at the valuation date.
36 LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued
Change in provision for unearned premiums charged to income statement (note 8) 16 – 16
Incurred but not reported 23 – 23 36 LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued
Current estimate in respect of above claims 201 204 299 199 639 1,542
Current estimate of claims relating to general insurance business acquired during the year 283 321 391 270 1,265
The following table demonstrates the effect of changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 39 UNALLOCATED SURPLUS WITHIN INSURANCE BUSINESSES
The movement in the unallocated surplus within long-term insurance business over the year can be analysed as follows: £m £m
Defined benefit schemes The Group has established a number of defined benefit pension schemes in the UK and overseas, the three most significant being the defined benefit sections of the Lloyds TSB Group Pension Schemes No’s 1 and 2 and the HBOS Final Salary Pension Scheme (HFSPS). These schemes provide retirement benefits calculated as a percentage of final salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2009 was 50.
The Group currently expects to pay contributions of at least £500 million to its defined benefit schemes in 2010.
Rate of increase for pensions in payment 3.20 2.80 Years Years
Money market instruments, cash and other assets and liabilities 3,904 669
Experience gains (losses) on scheme liabilities 31 (39) (185) (50) (69)
The deferred tax credit in the income statement comprises the following temporary differences: £m £m
In addition, deferred tax assets have not been recognised in respect of unrelieved foreign tax carried forward as at 31 December 2009 of £53 million (31 December 2008: £60 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised. These tax credits can be carried forward indefinitely.
43 OTHER PROVISIONS Provisions for contingent Customer Vacant liabilities and remediation Restructuring leasehold commitments provisions provisions property Other Total £m £m £m £m £m £m
Charge (release) for the year 43 (130) 101 40 17 71
RESTRUCTURING Provisions are made for staff and other costs related to Group restructuring initiatives at the point at which the Group becomes irrevocably committed to the expenditure.
As part of the Group’s recapitalisation and agreement not to enter GAPS which included a £13.1 billion rights issue (net of costs) (note 45), on 1 December, 10 December and 15 December 2009, the Group issued a total of £8,554 million of enhanced capital notes in exchange for certain existing preference shares, preferred securities and undated subordinated liabilities.
The ECNs contain an equity conversion feature (based on a fixed definition as defined by the Financial Services Authority in May 2009) that requires them to convert into ordinary shares if the consolidated core tier 1 ratio of the Group falls below 5 per cent. The conversion feature meets the definition of an embedded derivative and has been recorded separately as a derivative asset (note 18). The ECNs are guaranteed by either the Company or Lloyds TSB Bank plc. These guarantees are subordinated to the claims of senior creditors, rank equally with the claims of the holders of dated subordinated liabilities and are senior to the claims of holders of undated subordinated liabilities, preferred securities and shareholders of the respective guarantor.
The securities in this note 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 preferred shares and 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 enhanced capital notes ranks equally with that of the dated subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the year (2008: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the Financial Services Authority.
6.475% fi xed rate non-cumulative callable preference shares (£186 million) b, c, e 45 –
13% Euro Step-up Perpetual Capital Securities callable 2019 (€532 million) e 47 –
13% Sterling Step-up Perpetual Capital Securities callable 2029 (£700 million) e 666 –
5.625% Cumulative Callable Fixed to Floating Rate Undated Subordinated Notes (£500 million) b, c, d, e 1 –
Floating Rate Undated Subordinated Notes (€500 million) b, c, d, e 41 –
5.75% Undated Subordinated Step-up Notes (£600 million) b, c, d, e 2 –
7.5% Undated Subordinated Step-up Notes (£300 million) b, c, d, e 4 –
5.75% Undated Subordinated Step-up Notes (£500 million) b, c, d, e 3 –
Subordinated Step-up Floating Rate Notes 2016 callable 2011 (£300 million) 296 300 Subordinated Step-up Floating Rate Notes 2016 callable 2011 (€500 million) 445 480 Callable Floating Rate Subordinated Notes 2016 (€500 million) b 374 – Subordinated Notes 2016 (€500 million) b 389 – Notes 2016 (US$750 million) b 367 – Subordinated Lower Tier II Notes 2017 (€1,000 million) b 704 – Subordinated Callable Notes 2017 (US$1,000 million) b 464 – Subordinated Callable Floating Rate Instruments 2017 (Aus$400 million) b 209 – 6.75% Subordinated Callable Fixed/Floating Rate Instruments 2017 (Aus$200 million) b 101 – 5.109% Callable Fixed to Floating Rate Notes 2017 (Can$500 million) b 263 – Lower Tier II Subordinated Notes 2017 (£500 million) b 474 – 5.625% Subordinated Fixed to Floating Rate Notes due 2018 callable 2013 (€1,000 million) 979 992 6.75% Subordinated Fixed Rate Notes 2018 (US$2,000 million) b 917 –
SHARE SUBDIVISION At the general meeting held on 26 November 2009 the Company’s shareholders approved the subdivision of the ordinary shares with each ordinary share of 25 pence subdivided into one ordinary share of 10 pence and a deferred share of 15 pence. In addition, the shareholders approved the subdivision of the limited voting ordinary shares with each share of 25 pence subdivided into one limited voting ordinary share of 10 pence and a deferred share of 15 pence.
In December 2009, the Company issued 36,505 million shares in a rights issue at an issue price of 37 pence per new share as part of its recapitalisation and exit from the Government Asset Protection Scheme. This raised £13,112 million (net of £395 million of issue costs). This issue resulted in an increase of £3,651 million in share capital and an increase of £9,461 million in the share premium account.
DEFERRED SHARES The share subdivision noted above created 27,243 million deferred shares of 15 pence each. These shares carry no voting or dividend rights and on a return of capital on a winding up of the Company will have the right to receive the paid up amount only after ordinary shareholders have received in aggregate any amounts paid up plus £10 million per ordinary share.
Where, under an employee share plan operated by the Company, participants are the benefi cial owners of shares but not the registered owners, the voting rights are normally exercised by the registered owner at the direction of the participant. Outstanding awards and options would normally vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions at that time.
Under the terms of the state aid remedies referred to in note 9, the Company is prevented from making discretionary coupon and dividend payments on certain capital instruments from 31 January 2010 until 31 January 2012. Consequently, the terms of these instruments prevent the Company from making dividend payments on ordinary shares. 45 SHARE CAPITAL
LIMITED VOTING ORDINARY SHARES The limited voting ordinary shares are held by the Lloyds TSB Foundations (the Foundations). The holders of the limited voting ordinary shares, who held 1.3 per cent of the total ordinary shares as at 31 December 2009, are entitled to receive copies of every circular or other document sent out by the Company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary shares in all respects from the date of conversion.
Premium arising on Placing and Compensatory Open Offer of ordinary shares 1,303 –
Value of employee services includes a credit of £111 million (2008: £59 million) reflecting the income statement charge in respect of SAYE and executive options, together with a related tax credit of £5 million (2008: tax charge £16 million). Purchase/sale of treasury shares includes a credit of £128 million (2008: £31 million) relating to the cost of other share scheme awards.
Executive and SAYE schemes: Options granted in the year 13 28
SHARE BASED PAYMENT SCHEME DETAILS During the year ended 31 December 2009 the Group operated the following share based payment schemes, all of which are equity settled.
Options granted in 2004 became exercisable as the performance condition was met on the re-test. The performance condition vested at 14 per cent for executive directors, 24 per cent for managing directors, and 100 per cent for all other executives.
Movements in the number of share options outstanding under the executive share option schemes during 2008 and 2009 are set out below: Weighted average Weighted average Number of exercise price Number of exercise price options (pence) options (pence)
The weighted average fair value of options granted in the year was £0.68 (2008: £2.92). The weighted average share price at the time that the options were exercised during 2009 was £0.71 (2008: £2.91). The weighted average remaining contractual life of options outstanding at the end of the year was 3.0 years (2008: 2.5 years).
Outstanding at 16 January, date of acquisition of HBOS 13,040,430 670.01
Lloyds TSB Long-Term Incentive Plan The Long-Term Incentive Plan (‘LTIP’) introduced in 2006 is aimed at delivering shareholder value by linking the receipt of shares to an improvement in the performance of the Group over a three year period. Awards are made within limits set by the rules of the plan, with the limits determining the maximum number of shares that can be awarded equating to three times annual salary. In exceptional circumstances this may increase to four times annual salary.
(ii) For the other 50 per cent of the award (the ‘TSR Award’) – it will be necessary for the Group’s total shareholder return (calculated by reference to both dividends and growth in share price) to exceed the median of a comparator group (14 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award will vest where the Group’s total shareholder return is equal to median and vesting will occur on a straight line basis in between these points. Where the Group’s total shareholder return is below the median of the comparator group, the TSR Award will lapse. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
(ii) For the other 50 per cent of the award (the TSR Award) – the performance condition is as described for May 2006, except that the comparator group comprises of 13 companies, with the relevant performance period commencing on 6 March 2008 (the date of the first award) and ending on 5 March 2011.
In addition in 2009 an additional discretionary award was made in April, May and September 2009. The performance conditions for those awards are as follows: (i) Synergy savings: The release of 50 per cent of the shares will be dependent on the achievement of target run-rate synergy savings in 2009 and 2010 as well as the achievement of sustainable synergy savings of at least £1.5 billion by the end of 2011. The award will be broken down into three equally weighted annual tranches. Performance will be assessed at the end of each year against annual performance targets based on a trajectory to meet the 2011 target. The extent to which targets have been achieved will determine the proportion of shares to be banked each year. Any release of shares will be subject to the remuneration committee judging the overall success of the delivery of the integration programme.
No free shares were awarded in 2009 (2008: 8,862,823 shares, with an average fair value of £4.38 based on the market price at the date of award).
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 Lloyds Banking Group plc group executive committee together with its non-executive directors.
Aggregate contributions in respect of key management personnel to defi ned contribution pension schemes were £0.4 million (2008: £0.2 million).
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 1.28 per cent and 24.90 per cent in 2009 (2008: 2.14 per cent and 34.01 per cent).
At 31 December 2009, the Group did not provide any guarantees in respect of key management personnel (2008: none).
At 31 December 2009, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £2 million with seven directors and four connected persons (2008: £3 million with eight directors and six connected persons).
On 16 January 2009, the Company acquired 100 per cent of the ordinary share capital of HBOS plc. From this date, HBOS plc and its subsidiaries became controlled entities. In accordance with IAS 27, transactions and balances with subsidiaries have been eliminated on consolidation.
In June 2009 the Company issued 10,408 million new ordinary shares as part of a placing and compensatory open offer; HM Treasury subscribed for approximately 4,521 million of these new ordinary shares at a price of 38.43 pence per share. As placees were procured for all the new ordinary shares for which valid acceptances were not received under the placing and compensatory open offer, HM Treasury’s shareholding remained at 43.4 per cent. The Company used the proceeds from this placing and compensatory open offer to redeem the £4,000 million preference shares issued by the Company to HM Treasury described above at 101 per cent of their issue price (in accordance with the terms agreed with HM Treasury) together with accrued dividends thereon.
In December 2009 the Company issued 36,505 million new ordinary shares in respect of a rights issue as part of an alternative to the Group’s proposed participation in GAPS (together with a liability management exercise). The Company entered into an Undertaking to Subscribe agreement with HM Treasury whereby HM Treasury undertook, amongst other things, to take up its rights to subscribe for all of the new shares to which it was entitled under the rights issue. HM Treasury subscribed for approximately 15,854 million new shares at a price of 37 pence per share. As subscribers were procured for all the new ordinary shares for which valid acceptances were not received under the rights issue, HM Treasury’s shareholding remained at 43.4 per cent. In addition, the Group paid HM Treasury a commission payment of approximately £132 million in consideration, inter alia, of HM Treasury’s pre-launch commitment to participate in full in respect of its entitlements under the rights issue.
Material related party agreements in connection with capital transactions In connection with the placing and compensatory open offer, an Open Offer Agreement dated 7 March 2009 was entered into between the Company and HM Treasury (as amended and restated, amongst other things, to include certain other parties) pursuant to which, amongst other things, HM Treasury agreed that, to the extent not placed or taken up under the compensatory open offer and subject to the terms and conditions set out in the Open Offer Agreement, HM Treasury would subscribe for the open offer shares itself at the issue price. In consideration of the provision of its services under the Open Offer Agreement, the Company agreed to pay to HM Treasury (i) a commission of 0.5 per cent of the aggregate value of the open offer shares at the issue price; and (ii) a further commission of 1 per cent of the aggregate value of the open offer shares subscribed for by HM Treasury or by placees (including HM Treasury) at the issue price.
Pursuant to its obligations under the open offer agreement entered into by the Company with effect from 13 October 2008, the Company entered into a Registration Rights Agreement with HM Treasury on 12 January 2009, granting customary demand and ‘piggyback’ registration rights in the United States under the United States Securities Act of 1933, as amended, to HM Treasury with respect to any ordinary shares of the Group held by HM Treasury.
There were no other material transactions between the Group and HM Treasury during the period between 13 January 2009 and 31 December 2009 that were not made in the ordinary course of business or that are unusual in their nature or conditions.
PAYMENT PROTECTION INSURANCE In January 2009, the UK Competition Commission (the ‘Competition Commission’) completed its formal investigation into the supply of Payment Protection Insurance (PPI) services (except store card PPI) to non-business customers in the UK and published its fi nal report setting out its remedies. Prior to this the Group had made the commercial decision to sell only regular monthly premium PPI to its personal loan customers. The Competition Commission decided to adopt various remedies including a prohibition on the active sale of PPI by a distributor to a customer within seven days of the distributor’s sale of credit to that customer.
On 30 March 2009, Barclays Bank plc lodged an appeal in the UK Competition Appeal Tribunal (the ‘Competition Appeal Tribunal’) against the Competition Commission’s fi ndings. Lloyds Banking Group was granted permission by the Competition Appeal Tribunal to intervene in the appeal. The Competition Appeal Tribunal handed down its judgment on 16 October 2009 fi nding in favour of Barclays in respect of its challenge to the Competition Commission’s prohibition of distributors selling PPI at the credit point of sale but it did not uphold Barclays’ challenge to the Competition Commission’s fi ndings on market defi nition. The matter has now been referred back to the Competition Commission. This may or may not result in the Competition Commission ultimately reaching a different conclusion.
UNARRANGED OVERDRAFT CHARGES The Supreme Court published its judgment in respect of the fairness of unarranged overdraft charges on personal current accounts on 25 November 2009, fi nding in favour of the litigant banks. On 22 December 2009, the OFT announced that it will not continue its investigation into the fairness of these charges. The Group is working with the regulators to ensure that outstanding customer complaints are concluded as quickly as possible and anticipate that most cases in the county courts will be discontinued. The Group expects that some customers will argue that despite the test case ruling they are entitled to a refund of unarranged overdraft charges on the basis of other legal arguments or challenges. The Group would robustly defend any such complaints or claims and does not expect the outcome of any such complaints or claims to have a material adverse effect on its fi nancial position.
From available-for-sale fi nancial assets to loans and receivables 394 422 454 402
After reclassifi cation the reclassifi ed fi nancial assets contributed the following amounts to the Group income statement.
Trading and other fi nancial assets at fair value through profi t or loss 150,011 45,064 150,011 45,064
There were no signifi cant transfers between level 1 and level 2 during the year.
Equity investments Various valuation techniques Earnings, net asset value, underlying asset values, property prices, forecast cash fl ows 234 n/a
Asset-backed securities Lead manager or broker quote/ consensus pricing from market data provider
Prepayment rates, probability of default, loss given default and yield curves
– The earnings multiple methodology is described in the section on venture capital investments above.
CREDIT VALUATION ADJUSTMENT A Credit Valuation Adjustment (CVA) is applied to the Group’s over-the-counter corporate derivative exposures to adjust the counterparty credit risk-free derivative valuations provided by standard interbank lending interest rate curves. The Group uses a simulation model to develop expected future exposures and calculate a pricing reserve based on the relative credit spread of the counterparty compared to the Group. At 31 December 2009 the CVA balance was £663 million (31 December 2008 £203 million). This adjustment has been made to the valuation of over-the-counter derivative instruments classifi ed as level 2.
Observable CDS spreads and recovery rates are used to develop the probability of default for quoted clients. Observable sector CDS curves and recovery rates are used for unquoted clients. The Loss Given Default (LGD) is based on observable recovery rates and internal credit assessments. The combination of a one notch deterioration in credit rating of derivative counterparties and a 10 per cent increase in LGD increases the CVA charge by £181 million. Current market value is used to estimate the projected exposure for products not supported by the model. For these, CVA is calculated on an add-on basis (in total contributing 10 per cent of the overall CVA balance at 31 December 2009). A separate reserve of £43 million is held against features not supported by the current CVA model including rate/credit and wrong-way risk (where exposure to the counterparty is adversely correlated with the credit quality of the counterparty). A separate provision of £25 million is held against pricing risk on collateralised counterparties.
MOVEMENTS IN LEVEL 3 PORTFOLIO The table below analyses movements in the Level 3 fi nancial assets portfolio.
Gains (losses) recognised in the income statement (114) (452) (1,005) (1,571)
As a bancassurer, fi nancial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with fi nancial instruments represent a signifi cant component of the risks faced by the Group.
The primary risks affecting the Group through its use of fi nancial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk and the Group’s management of capital can be found on pages 56 to 94. The following additional disclosures, which provide quantitative information about the risks within fi nancial instruments held or issued by the Group, should be read in conjunction with that earlier information.
The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss is considered to be the balance sheet carrying amount or, for non-derivative off-balance sheet transactions and fi nancial guarantees, their contractual nominal amounts.
Trading and other fi nancial assets at fair value through profi t or loss (excluding equity shares) 65,861 21,790
Neither past due nor impaired 35,333 347,292 48,429 185,872 581,593 19,082
Past due but not impaired – 12,587 1,873 5,118 19,578 –
Past due but not impaired 17 3,134 1,146 555 4,835 –
Impaired – no provision required – 479 150 1,253 1,882 –
Debt securities held at fair value through profi t or loss
Total other assets held at fair value through profi t or loss 21,489 2,415 5,576 3,790 1,327 3,218 37,815
Bank and building society certifi cates of deposit 22 499 452 22 19 – 1,014
Trading assets: Government securities 38 – – – – – 38
Bank and building society certifi cates of deposit 96 337 – – – – 433
Total other assets held at fair value through profi t or loss 10,728 1,716 3,463 2,436 704 1,561 20,608
Bank and building society certifi cates of deposit – 9,418 166 – 18 – 9,602
Asset-backed securities: Corporate and other debt securities 18 1,204 1,663 114 – 532 3,531
CREDIT MARKET EXPOSURES The Group’s credit market exposures primarily relate to asset-backed securities exposures held in Wholesale division. These exposures are classified as loans and receivables (note 23), available-for-sale (note 25) and trading and other financial assets at fair value through profit or loss (note 17) depending on the nature of the investment.
Personal sector: Federal family education loan programme student loans 5,938 3,306 – 9,244 2,951
The table below sets out Wholesale division’s net exposure to US RMBS by vintage.
Credit ratings An analysis of external credit ratings as at 31 December 2009 of the Wholesale division’s asset-backed securities portfolio by asset class is provided below. These ratings are based on the lowest of Moody’s, Standard & Poor’s and Fitch.
(4) LIQUIDITY RISK The table below analyses assets and liabilities of the Group into relevant maturity groupings based on the remaining contractual period at the balance sheet date; balances with no fi xed maturity are included in the over 5 years category.
Trading and other fi nancial assets at fair value through profi t or loss 22,912 6,047 10,517 9,666 100,869 150,011
Loans and advances to banks 24,641 2,783 4,759 1,880 1,298 35,361
Loans and advances to customers 84,441 12,623 30,296 126,355 373,254 626,969
Debt securities held as loans and receivables 92 143 557 4,149 27,711 32,652
Liabilities arising from insurance and investment contracts 57,797 1,480 2,975 12,151 49,206 123,609
Loans and advances to banks 23,585 4,712 7,002 5,354 105 40,758
Liabilities arising from insurance and investment contracts 382 983 2,695 8,117 36,128 48,305 54 FINANCIAL RISK MANAGEMENT continued
The table below analyses fi nancial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an undiscounted future cash fl ow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fi xed maturity are included in the over 5 years category.
1 month months months years years Total £m £m £m £m £m £m
Total non-derivative fi nancial liabilities 453,254 96,048 94,908 166,425 67,973 878,608
Total derivative fi nancial liabilities 19,267 2,523 9,539 9,208 3,971 44,508
Total non-derivative fi nancial liabilities 268,921 50,026 26,205 30,517 28,525 404,194
Change in derivative fi nancial instruments, trading and other liabilities at fair value through profi t or loss (27,037) 22,565
(D) ANALYSIS OF CASH AND CASH EQUIVALENTS AS SHOWN IN THE BALANCE SHEET
Cash proceeds from issue of share capital: Private placement – 760
Repayment of capital to minority shareholders and extinguishment of minority interests (5,035) (3)
Cash and cash equivalents acquired, net of acquisition costs 16,341 –
Net cash infl ow arising from acquisition of HBOS 16,477 –
Requires the effects of all transactions with non-controlling interests to be recorded in equity if there is no change in control; any remaining interest in an investee is re-measured to fair value in determining the gain or loss recognised in profi t or loss where control over the investee is lost.
Clarifi es how the principles underlying hedge accounting should be applied in particular situations.
Clarifi es that an entity that receives goods or services in a share-based payment arrangement must account for those goods or services no matter which entity in the group settles the transaction, whether or not settled in shares or cash.
Clarifi es that when an entity renegotiates the terms of its debt with the result that the liability is extinguished by the debtor issuing its own equity instruments to the creditor, a gain or loss is recognised in profi t or loss representing the difference between the carrying value of the fi nancial liability and the fair value of the equity instruments issued; the fair value of the fi nancial liability is used to measure the gain or loss where the fair value of the equity instruments cannot be reliably measured.
On 18 February 2010, the exchange completed and 3,141 million ordinary shares in Lloyds Banking Group plc were issued as consideration for the redemption of preference shares and preferred securities. In accordance with the Group’s accounting policy in respect of debt for equity exchanges, a gain of £85 million was recognised on this exchange transaction.
The consolidated fi nancial statements were approved by the directors of Lloyds Banking Group plc on 25 February 2010.
SCOPE OF THE AUDIT OF THE FINANCIAL STATEMENTS An audit involves obtaining evidence about the amounts and disclosures in the fi nancial statements suffi cient to give reasonable assurance that the fi nancial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the parent company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of signifi cant accounting estimates made by the directors; and the overall presentation of the fi nancial statements.
The directors approved the parent company fi nancial statements on 25 February 2010.
Total comprehensive income comprises only the profi t for the year; no income statement has been shown for the parent company, as permitted by section 408 of the Companies Act 2006.
The application of the following IFRS pronouncement which became effective in 2009 has had no material impact on these fi nancial statements: – Amendment to IAS 27 Consolidated and Separate Financial Statements – Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate. This amendment removes the defi nition of the cost method and requires the presentation of dividends as income in the separate fi nancial statements of the investor.
Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2016 (US$1,000 million) a 327 824
6.3673% Non-Cumulative Fixed to Floating Rate Preference Shares (£335 million) a 2 –
As discussed in note 50 to the consolidated fi nancial statements, the Group provides share based compensation to employees through a number of schemes; these are all in relation to shares in the Company and the cost of providing those benefi ts is recharged to the employing companies in the Group on a cash basis.
Investment in HBOS plc: Acquisition of ordinary share capital 7,787 –
Country of share capital registration/ and voting incorporation rights held Nature of business
Lloyds TSB Bank plc England 100% Banking and fi nancial services
Bank of Scotland plc Scotland 100% Banking and fi nancial services
In November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received by the Group, Lloyds Banking Group agreed to suspend the payment of coupons and dividends on certain of the Group preference shares and preferred securities for the two year period from 31 January 2010 to 31 January 2012. The Group has agreed to temporarily suspend and/or waive dividend payments on certain preference shares which have been issued intra-group. Consequently, in accordance with the terms of some of these instruments, subsidiaries may be prevented from making dividend payments on ordinary shares during this period. In addition, certain subsidiary companies currently have insufficient distributable reserves to make dividend payments.
In addition the parent company carried out banking activities through its subsidiary, Lloyds TSB Bank plc (the Bank). At 31 December 2009, the parent company held deposits of £2,837 million with the Bank (2008: £1,201 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. Included within subordinated liabilities is £1,899 million (2008: £nil) and within other liabilities is £6,999 million (2008: £nil) due to subsidiary undertakings. In addition, at 31 December 2009 the parent company had interest rate and currency swaps with the Bank with an aggregate notional principal amount of £11,373 million and a net positive fair value of £2,260 million (2008: notional principal amount of £4,567 million and a net positive fair value of £1,297 million), of which contracts with an aggregate notional principal amount of £1,460 million and a net positive fair value of £343 million (2008: notional principal amount of £1,870 million and a net positive fair value of £501 million) were designated as fair value hedges to manage the Company’s issuance of subordinated liabilities and debt securities in issue.
Total fi nancial liabilities – – – 4,531 4,531 Derivatives designated as Held for hedging instruments, held trading at fair Held at at fair value through value through Loans and amortised profi t or loss profi t or loss receivables cost Total £m £m £m £m £m
Financial assets: Cash and cash equivalents – – – 1,201 1,201
Financial liabilities: Debt securities in issue – – – 2,644 2,644
CREDIT RISK The majority of the Company’s credit risk arises from amounts due from its wholly owned subsidiaries, Lloyds TSB Bank plc and HBOS plc, and subsidiaries of these companies.
Details of the Company’s post balance sheet events are set out in note 57 to the consolidated fi nancial statements.
INDIVIDUAL SAVINGS ACCOUNTS (ISAs) The Company provides a facility for investing in Lloyds Banking Group shares through an ISA. For details contact: Retail Investor Operations, Equiniti Limited, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA. Telephone 0871 384 2244.
– Dividend information, including loss of dividend warrant or tax voucher.
Calls to 09058 and 0871 numbers are charged at 55p and 8p per minute, respectively, from a BT landline. The price of calls from mobiles and other networks may vary. The call prices we have quoted were correct in February 2010.
Commercial Paper Commercial paper is an unsecured promissory note issued to fi nance short-term credit needs. It specifi es the face amount paid to investors on the maturity date. Commercial Paper can be issued as an unsecured obligation of the Group, or for example when issued by the Group’s conduits as an asset-backed obligation (in such case it is referred to as asset-backed commercial paper). Commercial Paper is usually issued for periods from as little as a week up to nine months.
First/Second Lien A fi rst lien gives the holder (usually the bank lending the funds) the fi rst right to collect compensation from the sale of the underlying collateral in the event of a default on the loan. A second lien may be issued against the same collateral but in the case of default, compensation for this debt will only be received after the fi rst lien has been repaid.
Home Loans A loan to purchase a residential property which is then used as collateral to guarantee repayment of the loan. The borrower gives the lender a lien against the property, and the lender can foreclose on the property if the borrower does not repay the loan per the agreed terms.
Loan-to-value ratio The loan-to-value ratio is a mathematical calculation which expresses the amount of a mortgage balance outstanding as a percentage of the total appraised value of the property. A high LTV indicates that there is less value to protect the lender against house price falls or increases in the loan if repayments are not made and interest is added to the outstanding balance of the loan.
Monolines A monoline insurer is defi ned as an entity which specialises in providing credit protection to the holders of debt instruments in the event of default by the debt security counterparty. This protection is typically provided in the form of derivatives such as credit default swaps referencing the underlying exposures held.
Student loan related assets Assets which are referenced to underlying student loans. (See note 54).
Sub-Prime Sub-prime is defi ned as loans to borrowers typically having weakened credit histories that include payment delinquencies and potentially more severe problems such as court judgements and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, high debt-to-income ratios, or other criteria indicating heightened risk of default.