The Group is quoted on the London Stock Exchange and the New York Stock Exchange and is one of the largest companies in the FTSE 100 index of leading UK companies.
Growth in SME lending in 2014 Our share of mid-market banking relationships 1 in 4 £286bn Retail deposit balancesFirst-time buyers helped by us to buy their first home
In Asset Finance, Black Horse provides motor finance loans to over 200,000 customers through more than 5,000 dealers. Lex Autolease is the UK’s leading fleet management and fleet funding specialist with close to 300,000 vehicles under management.
I am confident that our low cost, low risk, customer focused, UK retail and commercial banking strategy is the right one in the current environment. It capitalises on the Group’s unique assets, including its franchise and capabilities, and is also consistent with our prudent risk appetite as well as our mission to ‘Help Britain Prosper’.
It is clear that regaining this trust, which is a business imperative rather than a ‘nice to have’, will take time. We are completely committed to achieving this by setting the highest possible standards of integrity to serve our customers and clients.
For more about corporate governance go to page 62 or visit www.lloydsbankinggroup.com
A responsible business Doing business fairly and responsibly is the best way to rebuild trust with Britain’s households, businesses and communities. It also rebuilds our colleagues’ pride in our Group. Our business model puts customers at the heart; based on traditional attributes such as prudence and a long-term view, whilst making the most of emerging digital channels. The best of the past combined with the best of the present and the future.
The Board recognises the importance of sustainable and growing dividends to our shareholders and is today announcing the resumption of dividend payments, with a recommended dividend payment of 0.75 pence per share in respect of 2014. This is a symbolic development that bears testament to our successful transformation and improved risk profile of the business.
Helping Britain prosper and delivering growth in our key customer segments As a UK centric retail and commercial bank, our future is inextricably linked to the health of the UK economy. In 2014 the UK economy continued to recover, with GDP growing robustly, unemployment falling, and both consumer and business confidence increasing. UK house prices have also continued to recover strongly, with an 8.4 per cent increase in the year. Against this, affordability measures remain good, with the recent calming of house price appreciation in London and the South East a welcome development.
In Consumer Finance, we achieved UK lending growth of 17 per cent to £16.0 billion, driven by 43 per cent growth in Asset Finance and a return to growth in our cards business following eight years of decline. New business growth was also strong, with a 48 per cent increase in Black Horse new business partly reflecting the launch of the Jaguar Land Rover partnership, and Cards benefiting from a 15 per cent increase in balance transfer volumes from new and existing customers as well as a 4 per cent increase in new consumer credit card accounts opened.
Being a low risk bank is also central to our strategy and business model, while supporting our aim of being best bank for our shareholders by reducing earnings volatility. This is illustrated by our credit default swap (CDS) spread reducing from over 300 basis points (bps) at the end of 2011 to less than 50 bps at the end of 2014, which is one of the best in the banking sector worldwide. We have significantly reduced risk in our lending business through careful portfolio management, the centralisation of the risk division and the implementation of tighter underwriting standards and controls. As a consequence, non-performing loans have reduced from over 10 per cent of lending balances in 2010 to less than 3 per cent in 2014. Over the same period, we have successfully reshaped the Group, reducing our non-core portfolio from £194 billion, or 25 per cent of customer loans, by £148 billion in a capital accretive way. As of December 2014, we now have a remaining Run-off portfolio of £16.9 billion, with lending assets of £14.4 billion within this total representing 3 per cent of customer loans.
RESHAPE our business portfolio to fit our assets, capabilities and risk appetite
– Simplification programme delivered £2 billion per annum of cost savings, £300 million ahead of original target
We have also identified a number of growth opportunities in segments and areas where we are currently underrepresented and will look to grow above the market, including business banking, financial planning and retirement, and unsecured consumer lending. Consequently, over the next three years we expect to grow net lending in our key customer segments by over £30 billion, comprising growth in line with the market in retail mortgages, coupled with increases in net lending of £3 billion in both our SME and Mid Markets segments, £4 billion growth in customer assets in Asset Finance and £2 billion in credit cards.
We also expect to grow customer assets by over £10 billion in our Insurance division over this timeframe through supporting our retail and corporate customers in making long-term preparations for retirement.
But as the deleveraging process is not yet complete, some aspects of the economy continue to look abnormal. Most obviously, the Bank of England’s Bank Rate (base rate) has remained at 0.5 per cent since 2009. The fiscal deficit remains large at over 5 per cent of GDP, and so requires a continued squeeze on public spending throughout the next Parliament after the May 2015 election. In addition, export growth remains subdued by weak demand in the Eurozone, the result of much less progress on private sector deleveraging and the rapid pace of fiscal tightening. The increasingly robust UK economic recovery has benefited our markets, although balance growth remains substantially lower than pre-crisis rates, as shown in the chart below.
As the economic recovery continues, we expect demand for credit from households and small and medium-sized businesses to rise, but growth is likely to stay well below pre-crisis rates as the appetite to borrow remains constrained by recent experience. With Bank Rate expected to rise only slowly, arrears are expected to remain low.
Given our UK focus, our financial performance is inextricably linked to the performance of the UK economy and its regulatory and competitive environment.
An ageing population is expected to affect the products and services that our customers require, with younger people requiring help with planning and providing for retirement, while the older generation is becoming increasingly interested in accessing their equity to support their retirement.
Our new strategy, which focuses on our multi-channel distribution model, simpler processes, broad product reach and expertise across insurance and banking, puts us in a unique position to respond to these market conditions and meet the needs of individual and corporate customers. Above all it recognises that we operate in a competitive market where additional challengers continue to emerge and the only way of ensuring success is by focusing on the ever-changing needs of our customers. Read more about our new strategic priorities on page 20.
In 2011 we outlined our strategy which was built upon being the best bank for customers by investing where we could make a real difference, while returning the Group to delivering strong, stable returns for our shareholders. The strategy contained four significant actions to take the Group forward: reshape, strengthen, simplify and invest.
Over the past three years, we have made significant progress in each of these areas, delivered a significant improvement in financial performance and built a strong track record of delivery. It was this strong progress that allowed the UK government to start selling down its stake in the Group, beginning the process of returning the company to full private ownership at a profit for the UK taxpayer.
Our key performance indicators have been considered by the Board and identify the most effective output measures for assessing progress towards becoming the best bank for customers and shareholders.
Variable remuneration including bonuses for all staff, including our Executive Directors, is based on the performance of the individual, the business area and the Group as a whole. Performance is assessed against a balanced scorecard of objectives and reviewed on a regular basis, across five areas (customer, building the business, risk, people and finance).
We have successfully reshaped the business by reducing our non-core assets from £300 billion at the beginning of 2009 to £17 billion in 2014.
Our common equity tier 1 ratio continued to improve, reaching 12.8 per cent in 2014; a strong position in absolute and relative terms compared to our peers.
Following the delivery of simplification benefits, we have increased strategic investment in the business and invested c.£465 million in addition to our business as usual investment performance in 2014.
Our aim is to be the best bank for customers while providing strong and sustainable returns for shareholders. Customers are at the heart of everything we do, whether that be through our distribution network, our brands or our people. This commitment is supported by our Group values of putting customers first, keeping it simple and making a difference together.
We create value for our customers through our distinctive strengths, in particular our range of iconic and distinct brands, our superior customer insight, high quality, committed colleagues and relationship focus.
The foundations for providing effective customer service are: our broad multi-channel distribution network, our financial strength, our efficient systems and processes, and our UK focus. We want to meet our customers’ financial needs, help them succeed and create value for them.
Over the next three years, we need to adapt to the changes in financial services brought about by technology, changing customer behaviour and increasing regulatory requirements, at a time when traditional competitors’ strategies converge and new entrants compete for customers. We aim to achieve this through three new strategic priorities which will be consistently applied across all divisions.
2. Becoming simpler and more efficient We will create operational capability which is simpler and more efficient than today through further system enhancement and integration and will become more responsive to changing customer expectations while maintaining our cost leadership amongst UK high street banks. This cost leadership enables us to provide increased value to our customers and competitive differentiation.
3. Delivering sustainable growth As the UK economy continues to recover, we will further develop Group-wide growth opportunities within our prudent risk appetite. We will maintain market leadership in our main retail businesses, making the most of our multi-brand, multi-channel strategy whilst also focusing on areas where we are currently underrepresented.
BEST CUSTOMER EXPERIENCE – top three for customer satisfaction – lowest reportable complaints ratio for peer group – maintain or grow share of branches
Governance We have a well-defined, robust Risk Management Framework and a number of Group Policies relating to responsible business. Our Group Ethics and Responsible Business Policy is underpinned by our Codes of Responsibility which outline our adherence to the principles of the United Nations declaration on Human Rights and support for the UN Guiding Principles on Business and Human Rights. We also adhere to the International Labour Organisation Fundamental Conventions.
The Helping Britain Prosper Plan complements our ambition to become the best bank for households, businesses and communities. It is fundamental in rebuilding trust with those we serve and also to make Lloyds Banking Group a business that colleagues are proud to work for.
2014 overview Reviewing the Plan as a whole, it’s clear that it has achieved a ‘first’ for the Group and for the UK banking sector: a framework that we can use to demonstrate to colleagues and external stakeholders the positive impact that our operations have across our seven commitments. We set some challenging targets in the Plan to push ourselves, and we know we need to do more work to meet some commitments in the future. The areas we need to focus on are: supporting colleagues; apprenticeships; and continuing to pay our suppliers on time.
We’ll better represent the diversity of our customer base and our communities at all levels of the Group 7.1 % of senior roles5 to be held by women 29% 29%
Reporting against this metric will commence in 2015 when the apprenticeship recruitment strategy and measurement approach advised in 2014 are fully embedded.
5.4 Undergraduates from low income families supported by the Lloyds Scholars programme
5.5 % of Lloyds Scholars (from low income families) who have secured a job within six months of graduating from University4 100% 90%
Fairer products We want to do the right thing in every single customer interaction. We’re making sure this happens in many different ways, including more than 200 different improvements for customers, including product-specific enhancements, such as better user tools on our digital services and greater flexibility for customers to switch between loan and saving products in search of the best option.
Customer complaints Providing an excellent service and getting it right for customers first time is the best way to prevent complaints. Excluding legacy complaints relating to PPI, the overall number of customer complaints we receive has fallen by 12 per cent compared with 2013 volumes. We also received fewer banking complaints per 1,000 accounts than our major peers during 2014. We’re determined to reduce complaint volumes even further in future by learning from and acting on customers’ feedback.
Branch access In our strategy update in October 2014 we confirmed that, alongside the digitisation of our business, branches will continue to play an important role in our multi-channel approach to meeting customer needs. To ensure our approach reflects customers’ changing behaviours, we stated that we intend to invest £1 billion in digital channels and that we will maintain or grow our share of branches over the next three years.
Financial inclusion and education As a bank that is committed to helping Britain prosper, we want to do more to champion financial inclusion, by focusing on five themes: accessible products and services that meet customers’ needs; improving people’s capability and confidence; working in partnership; investing in financial education; and supporting customers in financial difficulty that might be excluded from financial services.
COMMUNITY Through our high street brands, we’re an integral part of communities across Britain. We believe we can make our greatest contribution to society by helping Britain’s communities to prosper.
COLLEAGUES Our colleagues are at the heart of our business and are critical in ensuring we become the best bank for customers.
We always aim to appoint the best person available into any role, but also to attract talented people from diverse backgrounds and to be unbiased in the way we assess, select, appoint and promote them. We encourage job applications from those with a disability and run a work experience programme with Remploy to support people with disabilities wanting to enter the workplace. We offer a range of programmes to support disabled colleagues including the workplace adjustment programme, which provides physical and non-physical adjustments to support colleagues in their roles. Since 2002, 1,300 colleagues have participated in and benefited from our positive action career development and training programmes for disabled colleagues.
Disability: Percentage of colleagues who disclose they have a disability 1.3% 1.4%
Diversity scope of reporting: UK payroll headcount includes established and fixed term contract colleagues and parental leavers. Excludes Non-Executive Directors, contractors, temp, agency, internationals, TSB, SWIP and Sainsbury’s.
– Methodology We follow the principles of the Greenhouse Gas (GHG) Protocol Corporate Standard to calculate our Scope 1, 2 and 3 emissions from our worldwide operations.
– Intensity ratio An intensity ratio of GHG gases per £m of underlying income has been selected.
– Conservative approach to risk We have a fully embedded conservative approach to, and prudent appetite for, risk with risk culture and appetite driven from the top.
– Strong control framework This framework is the foundation for the delivery of effective risk management and ensures that the business units operate within approved parameters.
RISK GOVERNANCE Risk management strategy and risk appetite are developed and reviewed in tandem with Group strategy. The Group uses an enterprise-wide risk management framework to ensure a robust and consistent approach to risk management is applied across all business areas and all risk types in order to drive improvements in its risk profile in line with risk appetite.
Governance is maintained through delegation of authority from the Board, down through the management hierarchy to individuals, and is supported by a committee based structure designed to ensure that our risk appetite, policies, procedures, controls and reporting are fully in line with regulations, law, corporate governance and industry best practice.
Review risk appetite, frameworks and principles. to be recommended to the Board. Be exemplars of risk management
The material reduction reflects lower levels of new impairment as a result of effective risk management, improving economic conditions and the continued low interest rate environment, together with Run-off asset reductions.
– Board approved pensions risk appetite covering interest rate, credit spreads and equity risks. Credit assets are being purchased and equity holdings reduced in the pension schemes.
– Continue to effectively manage the DBPS to secure pensions provision to members and minimise Group impact.
– Continued engagement with government and regulatory authorities on forthcoming regulatory changes and market investigations and reviews.
Market risk Key market risks include interest rate risk across the Banking and Insurance businesses. However, our most significant market risk is from the Defined Benefit Pension Schemes (DBPS) where asset and liability movements impact on our capital position.
Capital risk Our future capital position is potentially at risk from a worsening macroeconomic environment. This could lead to adverse financial performance for the Group, which could deplete capital resources and/or increase capital requirements due to a deterioration in customers’ creditworthiness.
The Group’s risk‑weighted assets have fallen by 12 per cent to £239.7 billion reflecting the reduction in Run‑off assets, active portfolio management in Commercial Banking, and the improving economic conditions.
The Group’s liquidity position continues to improve with increased primary liquidity up £20.0 billion to £109.3 billion. In addition the Group has a further £99.2 billion of secondary liquid assets a proportion of which are expected to be eligible for the Liquidity Coverage Ratio (LCR). Based on the Group’s current understanding of the LCR standards due to be implemented in October 2015, the Group believes that it met the upcoming requirements as at 31 December 2014.
Total income of £18,368 million was 2 per cent lower than in 2013, with strong growth in net interest income offset by lower other income. Adjusting for St. James’s Place effects, total underlying income increased by 1 per cent.
Excluding income of £662 million and costs of £44 million relating to St. James’s Place in 2013.
Total costs of £9,412 million were 2 per cent lower than in 2013. The reduction was driven by incremental savings from the Simplification programme of £449 million and business disposals of £392 million, partly offset by pay and inflation of £116 million, and increased investment in the business. Total costs excluding TSB running costs in the year were £9,042 million (2013: £9,072 million). Costs in the fourth quarter included the Bank levy of £254 million (2013: £238 million).
The Simplification programme which began in 2011 is now delivering annual run‑rate savings of £2 billion, meeting the increased target announced with the 2013 results. In October the Group announced the next phase of the programme and is targeting a cost:income ratio excluding TSB and adjusting for operating lease depreciation of around 45 per cent by the end of 2017 with annual improvements in the ratio in the intervening years.
The impairment charge was £1,200 million, 60 per cent lower than in 2013 as a result of a significant reduction in run‑off business and improvements in all divisions. The improvement reflects lower levels of new impairment as a result of effective risk management, improving economic conditions and the continued low interest rate environment. The net charge has also benefited from significant provision releases but at lower levels than seen in 2013. The asset quality ratio in 2014 was 24 basis points. The impairment charge and asset quality ratio in the fourth quarter were £183 million and 15 basis points, respectively.
The volume of reactive PPI complaints in 2014 fell by 22 per cent compared with 2013 and by 12 per cent in the fourth quarter. During 2014 there has been a more sustained level of Claims Management Company (CMC) activity and as a result the Group is forecasting a slower decline in future volumes than previously expected. The provision remaining at 31 December 2014 assumes that we will receive a further 0.6 million complaints. This revised forecast of complaint volumes accounts for £1,080 million, approximately half of the additional provision taken in the year and of which £300 million in the fourth quarter. However, the provision remains sensitive to future trends; as an example, were reactive complaint levels in the first two quarters of 2015 to remain broadly in line with the fourth quarter of 2014 then the revised modelled total complaints and associated administration costs would increase the provision by approximately £700 million.
The Group has mailed the original Past Business Review (PBR) scope of 2.7 million policies as at 31 December 2014. During the year response rates to mailings have been slightly higher than expected, and some limited additional mailing has been added to the scope. This covers £300 million of the provision increase in the year and £45 million in the fourth quarter.
Other regulatory provisions During 2014 the Group has charged £925 million (2013: £405 million) in respect of other regulatory and conduct related matters of which £425 million was charged in the fourth quarter.
In July 2014, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rate) with the UK Financial Conduct Authority (FCA), the United States Commodity Futures Trading Commission and the United States Department of Justice regarding the manipulation several years ago of submissions to the British Bankers’ Association London Interbank Offered Rate and Sterling Repo Rate between May 2006 and 2009, as well as the associated systems and control failings. In addition to these regulatory settlements, the Group paid nearly £8 million to the Bank of England to compensate for fees that were underpaid as a direct consequence of the manipulation of the Sterling Repo Rate in 2008 and 2009. These costs were recognised in the first half.
Other provisions also included £120 million recognised in the fourth quarter given the emerging experience relative to expectations for claims relating to policies issued by Clerical Medical Investment Group Limited in Germany, bringing the total provision to £520 million of which £199 million was unutilised at 31 December 2014.
Taxation The tax charge for the year to 31 December 2014 was £263 million, representing an effective tax rate of 15 per cent.
The effective tax rate was lower than the UK corporation tax rate largely as a result of tax exempt gains on sales of businesses in the first half and a lower deferred tax liability in respect of the value of in‑force assets for the life business partially offset by the effect of non‑deductible expenses.
Statutory return on required equity is calculated as the statutory profit after tax less the post tax profit attributable to other equity holders divided by the average required equity in the year. An adjustment is also made to reflect the notional earnings on any excess or shortfall in equity.
Both return measures have improved significantly in the year reflecting the strong growth in underlying profit and the return to statutory profit. The Group has a target statutory return on required equity of between 13.5 per cent and 15 per cent by the end of 2017.
The Group continued to strengthen its capital position, with the common equity tier 1 (CET1) ratio increasing to 12.8 per cent (31 December 2013: 10.3 per cent pro forma). The improvement was driven by a combination of underlying profit, further dividends from the Insurance business, changes to and improved valuations of the Group’s defined benefit pension arrangements, and a reduction in risk‑weighted assets. The positive effect of these items was partly offset by charges relating to legacy issues which reduced the CET1 ratio by 1.5 per cent, the ECN exchange and tender offers which reduced the ratio by 0.5 per cent and the recommended dividend which reduced the ratio by 0.2 per cent.
The Group’s leverage ratio increased to 4.9 per cent from 3.8 per cent (pro forma) in December 2013, with the AT1 issuance in the first half, where the Group repurchased the equivalent of £5 billion nominal (£4 billion regulatory value) of ECNs and issued £5.3 billion of new AT1 securities, accounting for 0.5 per cent of the increase.
Excludes repos of £nil (31 December 2013: £3.0 billion). Deposits comparative restated, see note 1, page 188.
The Group increased its net lending in key customer segments by 1 per cent with growth of 2 per cent in mortgages (excluding books closed to new business), growth of 5 per cent and 2 per cent in SME and Mid Markets respectively and 17 per cent in the UK consumer finance business. Overall, loans and advances to customers have fallen by 3 per cent to £477.6 billion as the growth in key segments has been more than offset by a reduction in Run‑off loans and advances. The Group reduced total Run‑off assets by 49 per cent to £16.9 billion.
Dividend The Board has recommended a dividend of 0.75 pence per ordinary share in respect of 2014, amounting to £535 million. The Group’s aim is to have a progressive dividend policy, with dividends starting at a modest level and increasing over the medium term to a dividend payout ratio of at least 50 per cent of sustainable earnings. The intention is to pay an interim and final dividend for 2015, subject to performance.
31 December 2013 comparatives are reported on a pro forma basis that includes the benefit of the sales of Heidelberger Leben, Scottish Widows Investment Partnership and the Group’s 50 per cent stake in Sainsbury’s Bank.
Progress against strategic initiatives – Continued development of its digital capability, with the launch of its new App and the optimisation of browser sites for mobile users. The online user base has increased to over 10.4 million customers, including more than 5 million active mobile users, an increase of 29 per cent from 2013. – Increased Net Promoter Scores across all channels in 2014.
31 December 2013 comparatives reflect CRD IV rules as implemented by the PRA at 1 January 2014.
Financial performance – Underlying profit increased by 5 per cent to £1,010 million driven by significant reductions in impairment charges across the portfolio and income growth in Asset Finance, partially offset by a fall in income in Credit Cards and investing for future growth in the businesses. – Net interest margin reduced by 45 basis points to 6.49 per cent, resulting in a 3 per cent fall in net interest income to £1,290 million. Strong new business growth and deposit repricing have been offset by a change in mix towards higher quality, lower margin lending to the new vehicle market and the impact of the current year’s strategic focus on growing the volume of new credit cards. Consistent with the strategy of acquiring high quality new business, the asset quality ratio improved by 71 basis points. – Other income increased slightly as a result of the growth strategy.
Capital – Remitted £1.0 billion of dividends to the Group in 2014 (2013: £2.2 billion), including the £0.3 billion of Heidelberger Leben sale proceeds, whilst maintaining a strong capital base. – Estimated capital surplus for Pillar 1 is £2.3 billion (Scottish Widows plc, £2.7 billion in 2013) and for Insurance Groups Directive is £3.0 billion (Insurance Group, £2.9 billion in 2013) with the decrease in Pillar 1 reflecting the dividends paid over the period.
Retirement assumption changes and experience variances include the benefit of acquiring, from Commercial Banking, £1.7 billion of loans during 2014; bringing total social housing, infrastructure and education acquired loans to £3.9 billion.
Assumption changes and experience variances include, within Protection and retirement, the benefits arising from the acquisition of attractive higher yielding assets to match long duration annuity liabilities and benefits from assumption changes. This has been offset by assumption changes within the existing Pensions and investments book including actions being taken to prepare for the structural changes arising from the DWP’s announcement, which introduced a cap on pension charges. These changes to corporate pensions will ensure that future new business is less capital intensive.
Banking net interest margin Banking net interest margin is calculated by dividing banking net interest income by average interest‑earning banking assets. A reconciliation of banking net interest income to Group net interest income showing the items that are excluded in determining banking net interest income follows: 2014 £m 2013 £m
In 2014 the Group’s statutory result before tax included positive insurance and policyholder interests volatility totalling £228 million compared to positive volatility of £668 million in 2013.
A review of investment strategy in the Group’s Insurance business has resulted in investment being made in a wider range of assets. Expected investment returns include appropriate returns for these assets.
The negative insurance volatility during 2014 of £219 million primarily reflects an adverse performance on equity and cash investments in the period relative to expected return.
In 2014, the statutory results before tax included a credit to other income which relates to policyholder interests volatility totalling £17 million (2013: £564 million) relating to offsetting movements in equity, bond and gilt returns.
On the Lloyds Banking Group reporting basis, all product transfers to TSB are assumed to have occurred on 1 January 2013.
Other relates mainly to risk‑weighted assets that result from TSB’s standalone capital calculations, for example threshold adjustments and exposures with other businesses in the Lloyds Banking Group.
Skills and experience: Significant financial services experience, particularly in insurance. External appointments: Member of the BBC Trust, Chairman of the Britten-Pears Foundation and Chairman of the Royal Northern College of Music. Former appointments: Non-Executive Director of the Prudential Regulation Authority, Chairman of Brit Insurance, Non-Executive Director of Legal and General Plc, Chief Executive of Prudential UK and Europe, Director of the Prudential plc Board, Chairman of the Financial Services Practitioner Panel, Chief Executive of Lloyd’s of London and a member of the Lloyd’s Council.
Andrew sits on the Board of the Global Financial Markets Association and the Advisory Board of the University of Cambridge Programme for Sustainability Leadership and is a member of The Prince of Wales’s UK Corporate Leaders’ Group. Andrew is also the Executive Sponsor for the Group’s Diversity & Inclusion programme.
Delivering our vision Managing a more agile organisation The Group benefits from the depth and diversity of experience within the management team. The team’s complementary skill sets strengthen the Group’s ability to effectively adjust to changing market environments, deliver on our strategic plan and become the best bank for customers.
Antonio joined the Group in 2011 as head of the Wealth and International division and Group Corporate Development. He took on his current role as head of Consumer Finance and Group Corporate Development in 2013. Antonio joined the Group from Santander where he had worked in a number of different finance and business roles since 1998. He was part of the management team that completed the take-over of Abbey National in 2004 and was Chief Financial Officer of Santander UK. Before Santander, Antonio spent over nine years at Arthur Andersen. Antonio has more than 25 years of experience in the financial services industry.
Vim joined the Group in 2011. He has responsibility for personal products and Group Marketing. Previously, Vim worked at Santander UK and Abbey National. He was appointed to our Group Executive Committee in 2013 and is a Scottish Widows and VISA Europe Board Director.
David is a Non-Executive Director for Motability Operations Plc and is also on the Group Insurance Boards and a Fellow of the Chartered Institute of Bankers.
Matt joined the Group in 2011 and has responsibility for internal and external communications, public policy and government relations, competition and community investment. Prior to this, he was Communications Director at Santander UK and he has also held senior positions with Abbey National and NatWest.
Before Aviva, Toby worked in a variety of senior positions at McKinsey, where he specialised in financial services and technology; JS & P (now Towry) as Chief Executive and Charcol, as Managing Director. Toby has been a Trustee of Macmillan Cancer Support since April 2013.
2014 has been another significant year for Lloyds Banking Group. The Board has taken a number of important decisions as we work towards the goal of becoming the ‘best bank for customers’. I am pleased to report that during the year the Board and its Committees met their key objectives and carried out their responsibilities effectively.
TSB In June and July 2014, as part of the divestment mandated by the European Commission, the Group completed an initial public offering of 38.5 per cent of the ordinary shares in TSB Banking Group plc (TSB). A further 11.5 per cent was placed with institutional investors in September, reducing the Group’s interest in TSB to approximately 50 per cent. The significant investor demand for shares in TSB, reflected confidence in the prospects for the business.
Stress tests Lloyds Banking Group plc, together with seven other financial institutions in the UK, was subject to the 2014 stress test conducted by the Prudential Regulation Authority (PRA) to assess resilience to adverse market developments and overall systemic risk in the UK financial system. The key assumptions in the stress test included the UK house price index falling 35 per cent and unemployment peaking at 11.8 per cent, resulting in a material impact on those UK banks which are significantly exposed to the UK housing market.
The Group exceeded the capital threshold set out for the purpose of the stress test and was not required to take any action as a result of this test. It will continue to ensure that its robust capital position is maintained.
Similarly, the Group had been subject to the 2014 EU-wide stress test conducted by the European Banking Authority (EBA) to assess overall systemic risk in the EU financial system. Again, the Group met all the capital benchmarks set out for the purpose of the stress test.
Both the appointment and removal of the Company Secretary is a matter for the Board as a whole. Malcolm Wood was appointed as Company Secretary in November 2014.
Access to advice The Group also provides access, at its expense, to the services of independent professional advisers in order to assist Directors in their role. Board Committees are also provided with sufficient resources to undertake their duties.
– coordinates all activities to implement the strategy and for managing the business in accordance with the Group’s risk appetite and business plan set by the Board.
AUTHORITY AND DELEGATION Corporate governance framework The Group’s corporate governance framework, which is reviewed annually by the Board, comprises the board authority and the delegated executive authority.
The approval of the remuneration policy, risk appetite and risk management framework is also reserved to the Board. The board authority delegates responsibility for day-to-day management of the business to the Group Chief Executive and sets out the basis for delegation of authorities from the Board to Board Committees.
Delegated executive authority The Group Chief Executive, through the delegated executive authority, delegates aspects of his own authority, as permitted, to members of the Group Executive Committee (GEC). The GEC meets weekly to scrutinise items of key business.
Transactions and contingency planning The Board: – approved strategic proposals, including the IPO of TSB Bank; and
Structure and capital The Board: – approved material changes to the capital structure of HBOS and Bank of Scotland; – considered the basis for allocation of capital, investments, acquisitions, mergers or disposals; and
– approved large transactions, including the sale of portfolios of UK and European real estate loans and tender offers for Enhanced Capital Notes (ECNs).
The role of the Board Committees The Board is supported by its Committees which make recommendations to the Board on matters delegated to them, in particular in relation to internal control, risk, financial reporting, governance and remuneration matters. This enables the Board to spend a greater proportion of its time on strategic, forward looking agenda items. Each Committee comprises Non-Executive Directors only and is chaired by an experienced Chairman. The Committee Chairs report to the Board on the activities of the Committee at each Board meeting. Information on the membership, role and activities of the Nomination & Governance, the Audit and the Risk Committees can be found on pages 73 to 81. Information on the Remuneration Committee can be found in the Directors’ remuneration report on pages 82 to 103. Terms of Reference for each of the Board Committees can be found on the website at www.lloydsbankinggroup.com
Subsidiary governance The Group conducts the majority of its business through a number of subsidiary entities. The Boards of the four main companies, Lloyds Banking Group plc, Lloyds Bank plc, HBOS plc and Bank of
In addition the Group has an insurance subsidiary, Scottish Widows Group Limited, which itself also has a number of separate operating subsidiaries. The Board of Scottish Widows Group Limited, which also sits as the Board of its major subsidiaries, is chaired by a non-executive member of the Lloyds Banking Group Board and contains a balance of independent non-executive directors, Group executives and Insurance Division executives. This composition supports its legal and regulatory requirements for independent decision making within the overall framework of Group policies and controls.
To help manage the legal, regulatory and reputational risks associated with the Group’s subsidiary entities, the Group requires that subsidiary boards and their directors meet minimum governance standards, as laid down in the legal entity management standards and directors’ handbook.
GROUP EXECUTIVE MEMBERS’ COMMITTEES These include the Group Executive Committee Please see pages 114 and 115 for a list of the Executive Committees and their purpose
ANTÓNIO HORTA-OSÓRIO Responsible for managing the business of the Group, in accordance with the strategy and long-term objectives approved by the Board.
Recommends an overall remuneration policy and philosophy that is aligned with the long-term interests of the Group, business objectives, risk appetite and values
Board strategy review During the year, the Board spent considerable time in a number of meetings, including two days off-site, to debate and devise its strategy for the next three years, building on the Group’s strong foundations of having become a low cost, low risk, UK focused retail and commercial bank.
Board appointments The chart opposite sets out the changes to Board membership in 2014. The appointment of new directors to the Board follows a formal, rigorous and transparent procedure. More information on Board and Committee composition and the appointment process is set out in the Nomination & Governance Committee report. The Directors’ biographies are set out on pages 58 and 59.
Board response Over the last four years, the Group has fundamentally overhauled systems and controls across the bank including the separation of key control functions such as Risk, Finance and Compliance from the business divisions in order to remove potential conflicts and provide clear independence. The Audit function has been strengthened and given an expanded remit through oversight of financial risks and controls and greater prominence with the Group Audit Director attending the Group Executive Committee meetings. The Group’s culture and values have changed; systems and processes were improved and more effective controls were implemented.
The Board regards the actions of these individuals between 2006 and 2009 as completely unacceptable. Their behaviour involved a gross breach of trust and we condemn it without reservation.
The individuals involved have either left the Group, been dismissed, been suspended or are subject to disciplinary proceedings. Bonuses totalling £3 million have been clawed back from those involved.
If any potential conflict arises, the articles of association permit the Board to authorise the conflict, subject to such conditions or limitations as the Board may determine.
Time commitments Non-Executive Directors are required to devote such time as is necessary for the effective discharge of their duties. On average, this equates to at least 35 to 40 days per annum (including attendance at Committee meetings). For Committee Chairs, this increases to at least 45 to 50 days with the Senior Independent Director and Deputy Chairman spending considerably more than 50 days on the Group’s business. Non-Executive Directors may be expected to relinquish other appointments to ensure that they can meet the time commitments of their role.
On being appointed Deputy Chairman and interim Risk Committee Chairman, Anita Frew attended numerous meetings with the relevant business executives, including the Chief Risk Officer, and shadowed the previous incumbent closely in the handover period. In particular, Ms Frew received dedicated training from business executives on stress testing to support her role as Chairman of the Stress Testing Sub-Committee of the Board Risk Committee.
These sessions also allow the Executive Directors an opportunity to consider business areas outside their direct responsibilities.
In addition, the Board hosted a series of ‘deep dives’ in 2014 to which all Directors were invited, and which provided an in-depth review of the operations of each of the business divisions and of the latest accounting standards and operating methodologies. The Board Risk Committee also received reviews from each division. All of the Directors attend the Board Risk Committee meetings.
BOARD AGENDA AND ATTENDANCE Setting the Board agenda The Chairman is responsible for setting the Board agenda, assisted by the Group Chief Executive and Company Secretary. A yearly planner is prepared by the Company Secretary to map out the flow of key items of business to the Board and to ensure that sufficient time is being set aside for strategic discussions.
The annual evaluation provides an opportunity to consider ways of identifying greater efficiencies, maximising strengths and highlighting areas for further development.
At the time of the 2015 AGM Anthony Watson will have been on the Board for more than six years. Therefore, in compliance with the Code, his review was particularly rigorous.
The outcome of the effectiveness review has been discussed by the Board and each of the Committees. The outcome of the evaluation of the Chairman was discussed by the Non-Executive Directors in the absence of the Chairman. If Directors have concerns about the Company or a proposed action which cannot be resolved, it is recorded in the Board minutes. Also on resignation, Non-Executive Directors are encouraged to provide a written statement of any concerns to the Chairman, for circulation to the Board. No such concerns were raised in 2014.
The process for escalation of matters to the Board and its Committees
Quality and timeliness of Board papers Actions taken previously had reduced volume, but more was required to improve quality and timeliness of papers.
Targeted training was rolled out to senior managers to ensure papers focus on the areas that are most likely to lead to discussion.
The Audit Committee took the decision in April 2014 to invite three firms to tender for the audit of the Group with effect from the 2016 year end. It was the Audit Committee’s intention to complete this process during the first half of 2014.
In light of this, it was felt that by undertaking a tender process in the first half of the year the Group could avoid overlapping their tender process with other UK banks, which might be of benefit to the Group as it would ensure that the participating firms could put forward their strongest available team.
Outcome As was confirmed in the Group’s 2014 half-year results news release, after careful consideration of the strength of each proposal, the Board accepted the recommendation from the Audit Committee to retain the services of PwC. Accordingly, subject to shareholders’ approval, PwC will be reappointed as auditor. There will be a mandatory rotation for the 2021 year-end audit.
Investor Relations is also responsible for delivering the Group’s financial results which includes presentations to the market and publication of formal results and announcements, as well as hosting regular national and international roadshows and meetings for current and potential institutional equity and debt investors in the Company.
Company Secretary and retail shareholders Group Secretariat has a dedicated team responsible for managing services and communications for and with retail shareholders.
Usually, in excess of 70 per cent of total voting rights is voted by shareholders. The results are a key indicator of how shareholders support the Board. At the AGM in 2014, the ‘in favour’ vote range across all resolutions was 87.25 per cent to 99.98 per cent.
INTERNAL CONTROL The Board is responsible for the Group’s risk management systems and internal controls, which are designed to facilitate effective and efficient operations and to ensure the quality of internal and external reporting and compliance with applicable laws and regulations. The Directors and senior management are committed to maintaining a robust control framework as the foundation for the delivery of effective risk management. The Directors acknowledge their responsibilities in relation to the Group’s systems of risk management and internal control and for reviewing their effectiveness.
At Group level, a consolidated risk report and risk appetite dashboard are reviewed and regularly debated by the Group Risk Committee, Board Risk Committee and the Board to ensure they are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The report and dashboard provide a monthly view of the Group’s overall risk profile, key risks and management actions, together with performance against risk appetite and an assessment of emerging risks which could affect the Group’s performance over the life of the operating plan. Information regarding the main features of the internal control and risk management systems in relation to the financial reporting process is provided in the risk management report on pages 107 to 170.
The Group’s risk management and internal control systems are regularly reviewed by the Board and are consistent with the Guidance on Risk Management, Internal Control and Related Financial and Business Reporting issued by the Financial Reporting Council and compliant with the requirements of the Capital Requirements Directive IV (CRD IV). They have been in place for the year under review and up to the date of the approval of the annual report.
In September 2014 the Financial Reporting Council published an updated version of the UK Corporate Governance Code. This applies to the 2015 financial year and the Group will report on its application of the 2014 Code in the 2015 annual report.
Further information about the work of the Remuneration Committee is included in the Directors’ remuneration report on pages 82 to 103.
During the year the Committee also recommended the appointment of Anita Frew (a director since 2010) as Deputy Chairman and interim Risk Committee Chairman, following the retirement of David Roberts and the appointment of Alan Dickinson as Risk Committee Chairman in place of Anita Frew from January 2015.
Committee purpose and responsibilities The purpose of the Nomination & Governance Committee is to keep the Board’s governance, composition, skills, experience, knowledge, independence and succession arrangements under review and to make appropriate recommendations to the Board to ensure the Company’s arrangements are consistent with the highest corporate governance standards. A full list of the Committee’s responsibilities is detailed in its terms of reference, which can be found on our website at www.lloydsbankinggroup.com.
Effectiveness and succession planning The Committee: – oversaw the annual evaluation of the performance of the Board and its Committees, and recommended actions to address the findings. Full details of this action plan, and the 2014 effectiveness review and outcomes are set out on pages 69 and 70; – recommended the appointment of Anita Frew as Deputy Chairman in place of David Roberts. Ms Frew was also appointed as interim Board Risk Committee Chairman until 1 January 2015 when she was succeeded by Alan Dickinson; – oversaw the Board’s arrangements for the longer-term succession of Board and Committee members. Non-Executive succession planning is addressed as part of the ongoing review of Board composition and takes account of the need to regularly refresh the intake of Non-Executives to bring new, diverse perspectives to the Board and its deliberations, to ensure appropriate representation on each of the Board’s Committees and to plan for longer-term succession; and – considered the adequacy of succession arrangements for Executive Directors, members of the Group Executive Committee and their direct reports. The Chairman is responsible for developing and maintaining a succession plan in relation to the Group Chief Executive who is in turn, primarily responsible for developing and maintaining a succession plan for key leadership positions in the senior executive team.
Nick Prettejohn has significant financial services experience, particularly in insurance. He replaced Lord Blackwell as chair of the Group’s insurance business, Scottish Widows.
For further information on the Directors’ experience, please see their biographies on pages 58 and 59 or on the website at www.lloydsbankinggroup.com
After careful consideration of the strength of each proposal, the Board accepted the recommendation from the Audit Committee to retain the services of PwC. Accordingly, subject to shareholders’ approval, PwC will be reappointed as Auditor. There will be a mandatory rotation for the 2021 year-end audit.
In recognition of the ongoing level of uncertainty of the ultimate level of redress payments and other costs relating to Payment Protection Insurance (PPI), the Committee continued to spend considerable time each quarter reviewing the assumptions on which the cost provisions are based. In addition, given the scale of the residential mortgage book for the Group, the Committee focused on impairment provisions for mortgages.
HOW THE AUDIT COMMITTEE SPENT ITS TIME IN 2014 Financial reporting As might be expected a key responsibility of the Committee is to review the content of the Annual Report and Accounts, half yearly report and interim management statements. In doing so the Committee: – reviewed the Annual Report and Accounts to ensure that taken as a whole, based on the information supplied to and challenged by the Committee and on their judgement it is fair, balanced and understandable and advised the Board to that effect; – reviewed and challenged the going concern assessment undertaken by management; – reviewed and challenged, where necessary, the actions, estimates and judgements of management, in relation to the interim and annual financial statements. This was undertaken through regular reporting on ongoing litigation, conduct and regulatory matters affecting the Group, detailed portfolio impairment reviews and a review of the approach to PPI; and – monitored, on an ongoing basis, the integrity of the financial statements of the Group and reviewed the critical accounting policies, receiving regular reports on the detailed disclosure obligations and changes in accounting requirements.
Whistleblowing The Committee received and considered reports from management on the Group’s whistleblowing arrangements including the line activity, summaries of cases and ongoing reviews of the Whistleblowing Governance Structure.
Auditor tenure PwC has been the auditor of Lloyds Banking Group since 1995 and prior to that PwC and its predecessor firms were also auditors to certain of the Group’s predecessor companies. After careful consideration the Committee undertook a full tender exercise for the external audit of the Group during the year and, in doing so, reviewed the qualifications, expertise and resources of the tendering firms – further details of the tender are set out as a case study on page 70. The process culminated in a recommendation to reappoint PwC. In accordance with regulations the lead audit partner is subject to rotation with the next rotation due in 2016.
Auditor independence and remuneration Both the Board and the external auditor have safeguards in place to protect the independence and objectivity of the external auditor. The Audit Committee has a comprehensive policy to regulate the use of the auditor for non-audit services. This policy sets out the nature of work that the external auditor may not undertake and guidance on the hiring of former external audit staff.
Financial reporting During the year, the Committee considered the following significant financial issues/judgements in relation to the Group’s financial statements and disclosures, with input from management, Group Audit and the external auditor: KEY ISSUES/JUDGEMENTS IN FINANCIAL REPORTING
– The Audit Committee spent time understanding and assessing the adequacy of provision for other conduct related matters. – For derivatives mis-sold to SMEs, the Audit Committee understood the basis for determining forecast average redress payments based on experience to date, and the adequacy of provisions made for operational costs for the expected duration of the programme. – More broadly, the Audit Committee challenged management on their processes and controls for ensuring that all conduct related matters were identified and that exposures and associated provisions were appropriately quantified where necessary. – Group Audit independently reviewed and challenged the key estimates and assumptions of the Management in respect of the conduct provisions and confirmed that the methodology adopted for each provision and the individual processes were reasonable. – The Audit Committee was satisfied that the provisions for other conduct matters were appropriate. The disclosures relating to other conduct provisions are set out in note 40: ‘Other provisions’ on page 248 of the financial statements.
Allowance for impairment losses on loans and receivables Determining the appropriateness of impairment losses is judgemental and requires the Group to make a number of assumptions.
– The Audit Committee has discussed this matter previously and is satisfied that the disclosures set out in note 51(3)(C) to the financial statements on page 283 are appropriate.
Chairman’s overview I am pleased to report the Board Risk Committee fulfilled its responsibilities and met its key objectives, whilst the annual Board effectiveness review concluded the Committee continued to operate effectively. The Committee maintains an appropriate balance of its scheduled review of key risks, whilst maintaining a dynamic approach so that emerging risks are appropriately escalated and considered and management actions and plans are constructively challenged. For example, through 2014 the Committee reviewed the Group’s conduct strategy and reviewed the oversight and governance of the Group’s approach to the capital and stress testing work.
The continued embedding of a suitable ‘risk culture’ is a critical component of effective risk management and the Committee will continue to oversee management’s efforts in this regard.
Whilst the UK economy continued to recover in 2014, there remain continued external challenges, for example lack of economic growth in the Eurozone and volatility such as oil prices.
Risk Division In overseeing the risk function within the Group the Committee: – reviewed the adequacy of the Risk Division’s resources, its authorities and standing within the Company. The review scrutinised the Risk Division’s annual plan, which sets out how the Risk Division will achieve clear outcomes from individual teams in a structured and measurable manner; and – concluded that the Risk Division is adequately resourced and continues to have sufficient authority and standing within the Group. This outcome further reflects the importance of risk management in the Group.
Divisional risk profiles The Committee considered the risk profiles of the divisions of the Group and in doing so: – reviewed the divisional risk enterprise wide risk management reviews across the principle business areas; and – considered the Insurance Divisional risk appetite to ensure that it was specifically relevant to the Insurance Division, its separate prudential needs, and the separate categories of risks that are relevant to the insurance business.
The Committee was also heavily involved in the oversight and governance of the Group’s approach to the capital and stress testing required by both the PRA and the EBA.
Credit The Committee received regular updates through the consolidated risk report and divisional updates. The Committee considered the Group’s exposure to credit markets and the structural quality of new lending. In addition, the Committee considered more detailed reports on focussed areas, including the Mortgage and Commercial portfolios.
Background Stress testing is conducted to assess the Group’s risk profile against risk appetite and acts as a basis for discussion with the regulator for the setting of the capital planning buffer. The Board ensures that there is continued direct Board level oversight of the Group’s assumptions and results of the principal internal and regulatory stress testing exercises.
The Sub-Committee also commissioned an independent external review of the Group’s approach to stress testing to identify enhancements. Recommendations for the short and medium term have been appropriately actioned or incorporated into future plans.
On behalf of the Board and as Chairman of the Group’s Remuneration Committee, I am pleased to present the Directors’ remuneration report for the year ended 31 December 2014, which is split into two parts: – A summary of the Directors’ Remuneration Policy. This section contains a summary of the remuneration policy approved at the 2014 Annual General Meeting (AGM) and is for information only. No changes have been made to the policy this year. – The Directors’ Remuneration Implementation Report, which outlines how policy was implemented in 2014 and how the Directors’ Remuneration Policy is intended to apply in 2015.
As a result of this review, we have enhanced our governance relating to performance adjustment through the formation of the Independent Performance Adjustment Committee which supports the Remuneration Committee in its decision making relating to adjustments and through greater alignment between the Board Risk Committee and Remuneration Committee in assessing risk matters.
Remuneration outcomes for 2014 We have performed strongly in 2014, delivering substantial improvements in profitability while at the same time continuing to address historical legacy issues
As outlined elsewhere in the annual report, in terms of financial performance, our underlying profit increased by 26 per cent, driven by an increase in net interest income, further reduced costs and lower impairments. We have also delivered strongly against many of our key strategic goals, with continued delivery of simplification cost savings, reduction in risk and the successful completion of the TSB IPO during the year.
For the Executive Directors, performance against the financial measures of the annual bonus significantly exceeded the maximum targets, and performance against balanced scorecard objectives was also strong. However, taking into account the legacy issues noted above, the Committee determined that bonus awards of between 54 per cent and 69 per cent of maximum opportunity should be made to Executive Directors.
Consideration of stakeholders’ views We remain committed to maintaining regular dialogue with our key stakeholders and take careful consideration of their views when making our decisions.
The Committee reviews annually a report from the Group HR Director on the operation of the remuneration policy and its effectiveness. In 2014, the report concluded that effective systems and controls are in place for all requirements of the policy and that it delivers outcomes in line with the Group’s values, reward principles and the PRA Remuneration Code.
The remuneration policy tables for Executive and Non-Executive Directors are included below for ease of reference. They have been reproduced as approved with the exception of minor, inconsequential deletions. In particular, where 2014 examples were provided in the 2013 Annual Report, these have been removed. Information on how the Policy will be implemented in 2015 is included in the Directors’ remuneration report. The full policy is available at www.lloydsbankinggroup.com/investors/shareholder-info/shareholder-meetings.
The policy is based on principles which are applicable to all employees within the Group and in particular the principle that the reward package should support the delivery of our strategic goal to be the ‘Best Bank for Customers’. It embeds a performance-driven and meritocratic culture, encourages effective risk disciplines and is in line with relevant regulations and codes of best practice. There is no significant difference between the policy for Executive Directors and that for other senior employees. If a significant difference for any individual were proposed, this would be subject to approval by the Remuneration Committee (within regulatory requirements).
– Maximum potential The Committee will make no increase which it believes is inconsistent with the two parameters above. Increases will normally be in line with the increase awarded to the overall employee population. However, a greater salary increase may be appropriate in certain circumstances, such as a new appointment made on a salary below a market competitive level, where phased increases are planned, or where there has been an increase in the responsibilities of an individual.
– Operation The Fixed Share Award will be delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award.
– Maximum potential The maximum allowance for the GCE is 50 per cent of reference salary less any flexible benefit allowance.
– Maximum potential The Committee will make no increase in the benefits currently provided which it believes is inconsistent with the two parameters above. The Group’s flexible benefits allowance is capped at 4 per cent of base salary.
– Operation Executive Directors may participate in these plans in line with HMRC guidelines currently prevailing (where relevant), on the same basis as other eligible employees.
– Maximum potential Participation levels may be increased up to HMRC limits as amended from time to time. With effect from April 2014, the monthly savings limits for Save As You Earn (SAYE) is £500. The maximum value of shares that may be purchased under the Share Incentive Plan (SIP) in any year is £1,800 with a two for one match (although currently a one for one match is operated) and the maximum value of free shares that may be awarded in any year is £3,600.
– Maximum potential The maximum annual bonus opportunities are 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors.
At least 50 per cent of the awards are weighted towards financial measures, with the balance on strategic objectives. All assessments of performance are ultimately subject to the Committee’s judgement, but no award will be made if threshold performance is not met for financial measures and the individual is rated ‘Developing performer’ or below. The expected value of the bonus is 30 per cent of maximum opportunity.
At least 60 per cent of awards are weighted towards typical market (e.g. Total Shareholder Return (TSR)) and/or financial measures (e.g. economic profit), with the balance on strategic measures.
– Shareholding guidelines Executive Directors are required to build up a holding of a value of 200 per cent of base salary and fixed share award for the GCE and 150 per cent for other Executive Directors. Details of holding are shown in the Implementation Report.
– Operation The Committee is responsible for evaluating and making recommendations to the Board with regards to the Chairman’s fees. The Chairman does not participate in these discussions.
DIRECTORS’ REMUNERATION IMPLEMENTATION REPORT CONSIDERATION OF MATTERS RELATING TO DIRECTORS’ REMUNERATION The Remuneration Committee has responsibility for setting remuneration for all Executive Directors and the Chairman, including pension rights and any compensation payments. The Committee also recommends and monitors the level and structure of remuneration for senior management and material risk takers.
During 2014, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review. The Committee met 11 times and considered the following principal matters: – Review of remuneration arrangements for senior executives – Determination of the appropriate remuneration packages for a number of senior new hires – Determination of bonus pools based on Group performance and adjustment for risk – Performance conditions for the Long-Term Incentive Plan – Bonus and salary awards for Executive Directors and key senior managers – Approval of remuneration and terms of service that fall within the Committee’s terms of reference, including new hires – Feedback from the Committee Chairman on his meetings with the PRA and shareholders – Oversight and approval of revised bonus and performance adjustment methodology and process – Consideration of remuneration governance in light of regulatory changes
António Horta-Osório (Group Chief Executive), Rupert McNeil (Group HR Director), Paul Hucknall (HR Director, Performance & Reward) and Chris Evans (Director, Performance and Reward Governance) provided guidance to the Committee (other than for their own remuneration). Juan Colombás (Chief Risk Officer) and George Culmer (Chief Financial Officer) also attended the Committee to advise as and when necessary on risk and financial matters.
STATEMENT OF VOTING AT ANNUAL GENERAL MEETING The proposals on the Group’s remuneration policy and the remuneration offered to our Executive Directors in 2014 were detailed within the Directors’ remuneration report for 2013 and were voted on at the 2014 AGM. The shareholder votes submitted at the meeting, either directly, by mail or by proxy, were as follows: Votes cast in favour Votes cast against Votes withheld
As mentioned in the Chairman’s statement, we are committed to an ongoing dialogue with our shareholders. Shareholders have different views, notably on incentive scheme design and whilst we do take all comments into consideration, there will inevitably be some diverging views.
In line with the Group’s drive for providing greater transparency where appropriate, this report provides as much detail as possible unless deemed to be commercially sensitive.
Shares will be released in equal tranches over a five year period.
The CRO’s benefits in respect of relocation ended in January 2014.
Customer complaint handling (total FCA reportable complaints per 1,000 accounts)1 and
Digital active customer growth Set relative to 2017 targets Threshold: 12.7m active users Maximum: 13.3m active users
The annual Non-Executive Director fees were last reviewed in 2013 and have remained unchanged since 1 July 2013: Basic fee £65,000 £65,000
Conditional pension buy-out5 712 732 – – – – 712 732
Other remuneration payments comprise contractual cash payments to George Culmer as part of the buyout of benefits from his previous employer and income from all employee share plans, which arises through employer matching or discounting of employee purchases up to a maximum of £960 per annum.
Amounts shown for 2013 reflect the period from 29 November 2013 when Juan Colombás was appointed as an Executive Director. Total remuneration for 2013 was £3,193,000. Under terms agreed when joining the Group, the CRO is entitled to a conditional lump sum benefit of £718,996 either (i) on reaching normal retirement age unless the CRO voluntarily resigns or is dismissed for cause, or (ii) on leaving due to long term sickness or health.
The Remuneration Committee reviewed performance in depth to determine ratings for the Group and each division, including consideration of risk matters arising in 2014. The overall rating for the Group was ‘Strong’: StrongGood TopDeveloping
To ensure fairness for our shareholders, the total bonus outcome is subject to a limit of 10 per cent of pre-bonus underlying profit. For 2014, the bonus outcome of £369.5 million is significantly below the limit of £813 million.
António Horta-Osório The Group Chief Executive’s individual performance assessment for 2014, as confirmed by the Committee, reflected a number of considerations including: – Strong financial performance: underlying profit increased by 26 per cent to £7,756 million in 2014 and statutory profit increased from £415 million to £1,762 million. – Successful completion of the TSB IPO in June 2014 and further successful sell down of the government’s holding to below 25 per cent. – Successful development of new 2015-2017 strategic plan for the Group.
Based on a full assessment of performance, the Committee agreed an individual rating for 2014 of ‘Strong’ for the Group Chief Executive.
Based on a full assessment of performance, the Committee agreed an individual rating for 2014 of ‘Strong’ for the Chief Financial Officer.
Juan Colombás The Chief Risk Officer’s personal performance assessment for 2014, as confirmed by the Committee, reflected a number of considerations including: – Good progress across the Board Risk Appetite, although legacy issues continue to present challenges. – Maintaining high level of responsiveness to our regulators with whom we strive for a strong working relationship. – Improvements in mitigating operational risks and regulatory breaches. – Driving progress in conduct strategy. – Leading remediation of legacy issues.
Based on a full assessment of performance, the Committee agreed an individual rating for 2014 of ‘Strong’ for the Chief Risk Officer.
The introduction of the Fixed Share Awards in 2014 resulted in a reduction in the annual bonus opportunity for the Chief Risk Officer (the maximum award reduced from 200 per cent to 100 per cent of base salary). Expected outcomes are based on individual performance, before taking into account a modifier based on underlying profit and the Risk division’s balanced scorecard, as follows: Rating Under Developing Good Strong Top
As with the bonus outcome determination for the wider Group, the Committee retains the discretion to adjust for other factors when determining individual awards, such as market relativity, year-on-year performance, stakeholder views, the statutory profit and the Group’s capital position. For 2014, the Committee exercised discretion by applying a reduction to the award for the Group Chief Executive.
If either condition is met earlier than the third anniversary of grant, vesting will still only occur on the third anniversary. The award will be subject to a further holding period following vesting such that, in any event, the award will release no earlier than five years after grant. If neither of the conditions has been met by the fifth anniversary of the award, the award will lapse entirely.
The Committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if it deems appropriate.
Short-term funding as a percentage of total funding 10% of award 20% 15% 25% 100% 7.0% 10.0%
Net simplification benefits 10% of award £1.5bn £1.8bn 25% 100% £2.0bn 10.0%
Dyfrig John (appointed January 2014) 105 – – – 105 –
Nick Prettejohn (appointed June 2014) 182 – – – 182 –
Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec 2013
Awards subject to performance under the Long-Term Incentive Plan had an expected value of 50 per cent of face value at grant (using current accounting assumptions). Values are based on the 31 December 2014 closing price of 75.82 pence. Full face value of awards are £25,111,769 for António Horta-Osório, £14,775,594 for George Culmer and £12,001,946 for Juan Colombás.
A summary of transactions undertaken in the year, including share plan awards vested plus open market purchases and sales made by Directors, is shown on page 103.
The performance conditions attached to these awards are set out in the table below. The performance period ends on 31 December 2016. Category Measure Basis of payout range Metric Weighting
– SAYE interests awarded in 2014 The Executive Directors are eligible to participate in the Group’s ‘sharesave’ and ‘sharematch’ plans. In 2014, the GCE and CFO were each granted SAYE options over 14,995 shares and the CRO was granted SAYE options over 29,990 shares (with an exercise price of 60.02 pence per share and a face value of £11,276 and £22,552 respectively). The share price used to calculate the face value is the price on grant (2 October 2014), which was 75.2 pence.
António Horta-Osório 1,452,401 – 1,452,401 – – – – – 1,4
Executive share award granted on 6 August 2012 for the loss of deferred share awards forfeited on leaving RSA Insurance Group plc.
Options exercised on 28 March 2014. The closing market price of the Group’s ordinary shares on that date was 74.34 pence.
None of the other directors at 31 December 2014 had options to acquire shares in Lloyds Banking Group plc or its subsidiaries.
Lloyds Banking Group long-term incentive plan (audited) The following table shows conditional shares awarded under the plan. Further information regarding this plan can be found on pages 90 and 100.
The shares awarded in March 2011 vested on 7 March 2014. The closing market price of the Group’s ordinary shares on that date was 81.35 pence.
The following table sets out the emoluments of the eight highest paid senior executives (excluding Executive Directors) in respect of the 2014 performance year.
Includes members of the Group Executive Committee and Senior Executive level colleagues.
Juan Colombás 1,409,048 07/03/14 231,604 Release of 2010, 2011 and 2012 Deferred Bonus 07/03/14 881,940 Release of 2011 LTIP
Going concern The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the foreseeable future, the Directors have considered a number of key dependencies which are set out in the risk management section under principal risks and uncertainties: funding and liquidity on page 32 and pages 146 to 152 and capital position on pages 153 to 165 and additionally have considered projections for the Group’s capital and funding position. Having consulted on these, the Directors conclude that it is appropriate to continue to adopt the going concern basis in preparing the accounts.
Alan Dickinson, Simon Henry and Nick Prettejohn have been appointed to the Board since the 2014 annual general meeting and will therefore stand for election at the forthcoming annual general meeting. In the interests of good governance and in accordance with the provisions of the UK Corporate Governance Code, all of the other Directors will retire and those wishing to serve again will submit themselves for re-election at the forthcoming annual general meeting.
Branches and financial risk management objectives and policies The Group provides a wide range of banking and financial services through branches and offices in the UK and overseas. Information about internal control and financial risk management systems in relation to financial reporting and financial risk management objectives and policies in relation to the use of financial instruments can be found in the following sections of the annual report, which are incorporated into this report by reference: Pages
Internal control and financial risk management systems in relation to financial reporting 107 to 170 and 71 to 72
RISK MANAGEMENT All narrative and quantitative tables are unaudited unless otherwise stated. The audited information is required to comply with the requirements of relevant International Financial Reporting Standards.
Further information on risk management can be found: Risk overview 30
THE GROUP’S APPROACH TO RISK The Group operates a prudent approach to risk with rigorous management controls to keep the Group safe, support sustainable business growth and minimise losses within risk appetite. The Group has a strong and independent risk function (Risk Division) with a mission to maintain a robust control framework, identify and escalate emerging risks and support sustainable business growth within risk appetite through good risk reward decisioning.
The Group has a conservative business model embodied by a risk culture founded on a prudent approach to managing risk. The Group refreshed its Codes of Business and Personal Responsibility in 2014 reinforcing its approach where colleagues are accountable for the risks they take and the needs of customers are paramount.
RISK APPETITE – The Group defines risk appetite as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate.’ – The Group’s strategy operates in tandem with its high level risk appetite which is supported by more detailed metrics and limits. An updated Risk Appetite Statement was approved by the Board in 2014. This incorporated recommendations from the Non-Executive Directors and is fully aligned with Group strategy. – Risk appetite is embedded within principles, policies, authorities and limits across the Group. – Risk appetite will continue to evolve to reflect external market developments and the composition of the Group.
Table 1.1: Exposure to risk arising from the business activities of the Group The table below provides a high level guide to the how the Group’s business activities are reflected in its risk measures and balance sheet.
The Commercial Banking division supports business clients from small businesses to large corporates to financial institutions, with a range of propositions fully segmented according to client needs
The Consumer Finance division comprises the Group’s consumer and corporate credit card businesses, along with Black Horse motor financing and Lex Autolease car leasing businesses in Asset Finance
TSB is a standalone multi-channel retail banking business. It serves retail and small business customers; providing a full range of retail banking products
Leveraging data Increasing regulatory scrutiny under EU Data Protection Regulation could have material commercial impact on the Group’s strategy as currently proposed.
– Assessment of the possible impacts of this legislation is ongoing and the Group expects to deliver enhanced systems to fulfil related regulatory requirements.
UK political uncertainty and risk of United Kingdom leaving the European Union The outcome of the 2015 General Election, and the likelihood of a referendum on British membership of the EU, remain unclear.
The Group uses scenario stress testing to: – Provide an assessment of strategic plans under adverse circumstances, against Board risk appetite to ensure the Group is managed within risk appetite. – Drive the development of potential actions and contingency plans to mitigate the impacts of adverse scenarios. Stress testing also links directly to the Group’s Recovery Planning process. – Support the Internal Capital Adequacy Assessment Process (ICAAP) and setting of Individual Capital Guidance (ICG). – Meet the standards required and information needs of internal and external stakeholders, including regulators.
During 2014, the Group was subject to stress testing exercises carried out by the European Banking Authority (EBA) and the PRA. As announced in October and December, the Group exceeded the capital thresholds set for both these tests and was not required to take any action as a result of these exercises.
The Group’s stress testing programme also involves undertaking assessment of operational risk scenarios, liquidity scenarios, market risk sensitivities, business specific scenarios (see relevant risk section for further information on risk specific level stress testing) and reverse stress testing. This provides a comprehensive view of the potential impacts arising from the risks to which the Group is exposed and reflects the nature, scale and complexity of the Group.
METHODOLOGY The Chief Economist’s Office develops the macroeconomic scenarios to be used by the Group. Internal scenarios are developed based on key uncertainties for the economic outlook. A wide set of economic parameter assumptions is constructed, with over 150 metrics provided such as Gross Domestic Product, Base Rate, unemployment, Property Indices, Insolvencies and Corporate Failures to facilitate modelling of scenarios across the Group. Where an external scenario is provided as was the case with the EBA and the UK-wide PRA stress exercises, the Chief Economist’s Office broadens the externally supplied parameters to the level of detail required by the Group. These are then sent back to the regulator who ensures consistent application of assumptions across banks.
The methodologies and modelling approach used for stress testing ensures that a clear link is shown between the macroeconomic scenarios, the business drivers for each area and the resultant stress testing outputs. All material assumptions used in modelling are documented and justified, with a clearly communicated review and sign off process. Modelling is supported by expert judgement and is subject to the Group Model Risk Governance Policy.
GOVERNANCE Clear accountabilities and responsibilities for stress testing are assigned to senior management and the risk and finance functions throughout the Group. This is formalised through the Business Planning and Stress Testing Policy and Procedures, which are reviewed at least annually.
The main economic assumptions developed by the Chief Economist’s Office are reviewed and challenged at Group Risk Committee (GRC)/ Group Executive Committee (GEC) and Board Risk Committee (BRC), and approved by the Board before being cascaded across the Group.
This approach provides the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also seeks to facilitate effective communication on these matters across the Group.
Role of the Board and senior management – key responsibilities of the Board and senior management include: – setting risk appetite and approval of the RMF; – approval of Group-wide risk principles and policies; – the cascade of delegated authority (e.g. to Board sub-committees and the Group Chief Executive); and – effective oversight over risk management consistent with the risk appetite.
Risk appetite is defined within the Group as the amount and type of risk that the Group is prepared to seek, accept or tolerate. Risk appetite is documented in a Risk Appetite Statement reviewed and approved annually by the Board. The Board risk appetite is aligned to the Risk Appetite Framework, and in turn the Risk Management Framework and Group Risk Principles.
As a separate regulated entity with its own Board, the Insurance business maintains its own Risk Appetite Framework, aligned to the Group risk appetite. Where deemed material and relevant, Insurance business metrics are included in the Group Board Risk Appetite Statement.
Group Chief Risk Officer: – Develops the Board Risk Appetite Statement in collaboration with the Group Chief Executive and other GEC members. – Obtains the Board’s support and approval of the Board Risk Appetite Statement. – Oversees that the metrics are fully embedded by the business and reported on a monthly basis. – Ensures breaches are identified, escalated and appropriate mitigating action is taken by the business.
Risk appetite is embedded across the Group in the following ways: – Communication – Board Risk Appetite Metrics developed and agreed with business and operational teams. In addition Board Risk Appetite cascaded down into more detailed metrics and limits within Functional and Divisional Sub-Board Risk Appetite Statements along with additional supporting metrics which should be used to drive local decision making and behaviours. – Policies – Group Policies updated to ensure they are aligned with Risk Appetite Statement. – Reporting – Performance against Board Risk Appetite metrics reported to Divisional, Functional, and Group Risk Committees and the BRC and Board. – Performance Management – Group and Divisional Scorecards include adherence to risk appetite as a general measure and include more detailed risk appetite measures which are pertinent for that area of the Group. – Key Decision Making – Strategy operates in tandem with risk appetite and the Group’s annual Operating Plan is developed within the boundaries set by risk appetite.
Governance frameworks – the Board-approved frameworks set out key principles for the overall management of risk in the organisation, aligned with Group strategy and risk appetite; based on a current and comprehensive risk profile that identifies all material risks to the organisation. These Governance Frameworks are underpinned by a hierarchy of policies that is coherent, consistent, and accessible.
– Business lines (first line) have primary responsibility for risk decisions, identifying, measuring, monitoring and controlling risks within their areas of accountability. They are required to establish effective governance, and control frameworks for their business compliant with Group Policy requirements, to maintain appropriate risk management skills, mechanisms and toolkits, and to act within Group risk appetite parameters set and approved by the Board. – Risk Division (second line) is a centralised function providing oversight and independent challenge to the effectiveness of risk decisions taken by business management, providing advice and guidance, reviewing challenging and reporting on the risk profile of the Group and ensuring that mitigating actions are appropriate. – Group Audit (third line) provides independent, objective assurance and consulting activity designed to add value and improve the organisation’s operations. It helps the Group accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.
Seco nd line o f d efence – risk o versig ht
(Insurance Group is a separate regulated entity with its own Board, governance structure and Divisional Risk Officer)
Provides strategic and senior oversight over design, launch and management of products including new product approval, periodic product reviews and management of risk in the back book.
Group Financial Crime Committee Reviews and challenges the management of financial crime risk including the overall strategy and performance and engagement with financial crime authorities. The committee is accountable for ensuring that, at Group level, financial crime risks are effectively identified and managed within risk appetite and that strategies for financial crime prevention are effectively co-ordinated and implemented across the Group.
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Risk appetite Credit risk appetite is described and reported on a monthly basis through a suite of Board metrics derived from a combination of accounting and credit portfolio performance measures, which include the use of credit risk rating systems as inputs. The Board metrics are supported by more detailed sub-Board appetite metrics at divisional and business level and by a comprehensive suite of credit risk appetite statements, credit policies, sector caps, and product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite. The metrics cover but are not limited to geographic concentration, single name customer concentration, mortgage exposure, Loan to Value ratios (LTVs), higher risk sector concentration, limit utilisation, leveraged exposure, equity exposure, affordability and the quality of new lending.
Mitigation The Group uses a range of approaches to mitigate credit risk.
Stress testing and scenario analysis: The Group’s credit portfolios are also subjected to regular stress testing, with stress scenario assessments run at various levels of the organisation. Exercises focused on individual divisions and portfolios are performed in addition to the Group led and regulatory stress tests. For further information on the stress testing process, methodology and governance refer to page 111.
Additional mitigation for Retail and Consumer Finance customers The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using information held by credit reference agencies (CRA). The Group also assesses the affordability of the borrower under a stressed interest rate scenario. In addition, the Group has in place quantitative limits such as product maximum limits, the level of borrowing to income and the ratio of borrowing to collateral. Some of these limits relate to internal approval levels and others are hard limits above which the Group will reject the application. The Group also has certain criteria that are applicable to specific products such as for applications for a mortgage on a property that is to be let by the applicant.
In 2014 the Group updated its policy for high-value mortgage lending, to restrict UK mortgage applications for greater than £500,000 to a maximum income multiple of four. This was a targeted policy change primarily designed to address specific inflationary pressures in the London housing market.
For UK mortgages, the Group’s policy is to reject all standard applications with a LTV greater than 90 per cent. Applications with a LTV up to 95 per cent are permitted for certain schemes, for example the UK government’s Help to Buy scheme. For mainstream mortgages the Group has maximum per cent LTV limits which depend upon the loan size. These limits are currently: Table 1.4: UK mainstream loan to value analysis Loan size From To Maximum LTV
Those customers deemed higher risk where there is cause for concern over future repayment capability or where there is a risk of impairment will lead to the customer being transferred to the Business Support Unit (BSU) at an early stage. In addition, any forbearance concession requested by a customer is reviewed and must be approved by the independent Risk Division. If approved and Risk Division determines that the customer is in financial difficulty and the concession is outside of the Group’s appetite, then the customer will be transferred to BSU. The over-arching aim of the BSU is to provide support and work with each customer to try and resolve the issues, to restore the business to a financially viable position and thereby bring about a business turnaround. This may involve a combination of debt restructuring, work out strategies and other types of forbearance.
The total notional principle amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2014 is shown in the table above. The notional principle amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 54 on page 293.
Recoveries assets are written down to the present value of future expected cash flows on these assets.
– The average indexed loan to value (LTV) on the mortgage portfolio at 31 December 2014 decreased to 49.2 per cent compared with 53.3 per cent at 31 December 2013. The percentage of closing loans and advances with an indexed LTV in excess of 100 per cent decreased to 2.2 per cent at 31 December 2014, compared with 5.4 per cent at 31 December 2013. – The average LTV for new mortgages and further advances written in 2014 was 64.8 per cent compared with 64.0 per cent for 2013 reflecting the Group’s participation in the UK government’s Help to Buy scheme.
Table 1.16: Analysis of residential interest-only mortgages maturities, excluding Buy-to-let mortgages £bn 1 Year 2-5 Years 6-10 Years > 11 Years
Value of loans as at 31 December 20141 1.8 9.2 14.6 52.7
Includes collective unimpaired provisions of £338 million (31 December 2013: £436 million).
Ireland – The most significant contribution to impaired loans is the Commercial Real Estate portfolio. 92.3 per cent of the portfolio is impaired. The impairment coverage ratio has increased to 83.5 per cent from 74.2 per cent at 31 December 2013 reflecting additional impairments on already impaired connections as well as the impact of deleveraging activities. Net lending in Ireland Commercial Real Estate has reduced to £0.4 billion (31 December 2013: £1.7 billion). – Total impaired loans within the Irish retail mortgage portfolio decreased by 88.2 per cent (£878 million) to £118 million compared with £996 million at 31 December 2013. The reduction was driven by the disposal of the majority of impaired assets in the second half of 2014. – In the Irish retail mortgage portfolio the average indexed loan to value (LTV) at 31 December 2014 decreased to 88.5 per cent compared with 102.3 per cent at 31 December 2013. The percentage of closing loans and advances with an indexed LTV in excess of 100 per cent decreased to 38.9 per cent at 31 December 2014, compared with 54.0 per cent at 31 December 2013.
Ireland Commercial real estate Net lending in Ireland Commercial real estate has reduced to £0.4 billion (31 December 2013: £1.7 billion). Table 1.25 details the loan to value breakdown based on gross lending of £1.8 billion (31 December 2013: £5.5 billion).
Table 1.26: Run-off UK Direct Real Estate LTV analysis At 31 December 2014 At 31 December 2013
Identified indirect exposure information, where available is also taken into account when setting limits and determining credit risk appetite for individual counterparties. This forms part of the Group’s credit analysis undertaken at least annually for counterparty and sector reviews, with interim updates performed as necessary. Interim updates would usually be triggered by specific credit events such as rating downgrades, sovereign events or other developments such as spread widening. Examples of indirect risk which have been identified, where information is available, are: European Banking groups with lending and other exposures to certain Eurozone Countries; corporate customers with operations or significant trade in certain European jurisdictions; major travel operators known to operate in certain Eurozone Countries; and international banks with custodian operations based in certain European locations.
The gross IFRS reported values for the exposures to Eurozone countries are detailed in the following tables. However, derivative balances are included within exposures to financial institutions or corporates, as appropriate, at fair value adjusted for master netting agreements at obligor level and net of cash collateral in line with legal agreements. Exposures in respect of reverse repurchase agreements are included on a gross IFRS basis and are disclosed based on the counterparty rather than the collateral (repos and stock lending are excluded); reverse repurchase exposures are not, therefore, reduced as a result of collateral held. Reverse repurchase exposures to Institutional funds secured by UK Gilts are excluded from all Eurozone exposures as detailed in the footnotes. Exposures to central clearing counterparties are shown net.
Excludes reverse repurchase exposure to Institutional funds secured by UK gilts of £1,455 million (2013: £1,559 million) on a gross basis.
The Group has been a signatory to the Equator Principles since 2006 and has adopted and applied the expanded scope of Equator Principles III. The Equator Principles support the Group’s approach to assessing and managing environmental and social issues in Project Finance, Project-Related Corporate loans and Bridge loans. Further information is contained within the Group’s Responsible Business Report.
The appetite is reviewed and approved annually by the Board. To stay within appetite, the Group has policies, processes and standards which provide the framework for businesses and colleagues to operate in accordance with the laws, regulations and voluntary codes which apply to the Group and its activities.
This includes: – Conduct risk appetite established at Group and business area level; – Customer needs explicitly considered within business and product level planning and strategy; – Cultural transformation, supported by strong direction and tone from senior executives and the Board. This is underpinned by the Group’s values and Codes of Responsibility, to deliver the best bank for customers; – Enhanced product governance framework to ensure products continue to offer customers fair value, and meet the needs of the relevant target market throughout their life cycle; – Sales processes and governance framework to deliver consistently fair outcomes; – Effective root cause analysis which enables issues to be rectified at an earlier stage; – Enhanced recruitment and training, and a focus on how the Group manages colleagues’ performance with clearer customer accountabilities; and – Application of the conduct strategy to third parties involved in serving the Group’s customers.
Risk appetite The Group’s Risk Management Framework articulates accountabilities for the management of market risk across the Group, and how this is discharged through a robust governance structure against sanctioned risk appetite. Market risk exposures are measured and controlled through a combination of scenario/stress analysis, percentile based measures and sensitivity analysis.
The Group ensures that it has adequate cash and balances at central banks and stocks of high quality liquid assets (e.g. Gilts or US Treasury Securities) that can be converted easily into cash to meet liquidity requirements. The majority of these assets are held as Available-for-Sale with the remainder held as financial assets at fair value through profit and loss. Further information on these balances can be found under the Risk Management section – Funding and Liquidity risk. Interest rate risk in the asset portfolios is swapped into floating.
The table below shows the key market risks for the Group’s defined benefit pension schemes and trading, banking and Insurance activities.
Margin compression risk also arises from the current low rate environment, which may restrict the ability to change interest rates applying to customers in response to changes in interbank and central bank rates.
Equity Risk arises from different sources: – The Group’s equity holdings in Banco Sabadell and Aberdeen; – Exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and – The Group’s private equity investments.
In addition: – A trigger on the pension scheme deficit is used in respect of defined benefit pensions which has a material impact on capital resources; – Profit and loss triggers are used in the trading books in order to ensure that mitigating action is considered if profit and loss becomes volatile; – Interest rate repricing gaps, earnings sensitivity analysis, and open foreign exchange positions are used for banking book activity; and – Stress testing and scenario analysis are also used in certain portfolios and at Group level, to simulate the impact of extreme conditions and to understand more fully the interdependence of different parts of the balance sheet.
Although an important market standard measure of risk, VaR has limitations. These arise from the use of limited historical data which may not encompass all potential events, particularly those which describe extreme market conditions, defined holding periods which assume the risk can be liquidated or hedged within that period and the exposure level at the confidence interval does not convey any information about potential losses which may occur if this level is exceeded. The Group recognises these limitations and supplements the use of VaR with a variety of other measurements which reflect the nature of the business activity. These include detailed sensitivity analysis, position reporting and stress testing analysis.
The Group holds securities within its trading books mainly under the Credit Trading, Gilts and Repo Trading businesses within Financial Markets for funding and to meet customer requirements. The outright interest rate risk exposure, after hedging, is small relative to the Group.
Low interest income sensitivity continues to reflect structural hedging against margin compression, with small year on year variances reflecting changes in operational flows.
Defined benefit pension schemes The Group takes an active involvement in agreeing risk management and mitigation strategies with the Trustees of the schemes through whom any such activity must be conducted. An interest rate and inflation hedging programme is in place to reduce liability risk. The schemes have also reduced equity allocation and are investing the proceeds in credit assets as part of a programme to de-risk the portfolio.
As defined within the scope of the Group Interest Rate Risk in the banking book Policy, all hedgeable interest rate risk in the non-traded book should be transferred to GCT via the Interest Rate Risk Transfer Pricing (ITP) framework. GCT is responsible for managing centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of Group Asset and Liability Committee (GALCO) within the Board risk appetite. The Group centrally manages the overall interest rate structure of the balance sheet giving consideration to both the stability of net interest income and protection of shareholder value from changes in market interest rates. A structural hedging programme is in place to manage rate insensitive balances through investing in longer term fixed rate assets or interest rate swaps, subject to the authorisation and mandate of Group Asset and liability Committee within the Board risk appetite. Derivative desks in Financial Markets will then externalise the hedges to the market. However, certain residual interest rate risks may remain outside the centre due to differences in basis and profile mismatches, largely arising from customer behaviour. Whilst the bank faces margin decompression in the current low rate environment, its exposure to pipeline and prepayment risk are not considered material, and are appropriately monitored and controlled through Divisional ALCOs.
Defined benefit pension schemes In addition to the wider risk management framework, governance of the schemes includes two specialist pensions committees (one Group executive sub-committee and a supporting management committee).
Risk appetite The Group’s Operational risk appetite is designed to safeguard the interests of customers, internal and external stakeholders, and shareholders. Appetite is expressed through six high level statements summarised below, each of which are defined with limits and triggers approved by the Board, and are regularly monitored by executive and Board risk committees: – Customer: The Group builds trust and does not expect its customers to be impacted negatively.
The risks below also have potential to negatively impact customers and the Group’s future results: – Terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events and responses to those acts/events may create economic and political uncertainties, which could have a material adverse effect on UK and international macroeconomic conditions generally, and more specifically on the Group’s results of operations, financial condition or prospects in ways that cannot necessarily be predicted. – Systems and procedures are implemented and maintained by the Group to comply with increasingly complex and detailed anti-money laundering and anti-terrorism laws and regulations. However, these may not always be fully effective in preventing third parties from using the Group as a conduit for money laundering and other illegal or prohibited activities. Should the Group be associated with money laundering or breaches of financial crime regulations and prohibitions, its reputation could suffer and/or it could become subject to fines, sanctions and legal enforcement; any one of which could have a material adverse effect upon operating results, financial condition and prospects.
The table overleaf shows high level loss and event trends for the Group using Basel II categories.
Exposure Liquidity exposure represents the amount of potential stressed outflows in any future period less expected inflows. Liquidity is considered from both an internal and a regulatory perspective.
Mitigation The Group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through short-term liquidity management and over the life of the funding plan. Short-term liquidity management is considered from two perspectives; business as usual and stressed conditions, in the less than one year time horizon. The Group manages its risk appetite and liquidity position as a coverage ratio (proportion of stressed outflows covered by eligible liquid assets) corresponding with the PRA and CRD IV liquidity requirements. Longer term funding is used to manage the Group’s strategic liquidity profile, determined by the Group’s balance sheet structure. Longer term is defined as having an original maturity of more than one year.
Intra-day liquidity Liquidity required for clearing and payment systems under stressed conditions
Funding concentration risk Segmentation by instrument, product, currency, counterparty and term structure
Following the recent UK implementation of the EU Bank Recovery and Resolution Directive, ratings agencies may review their ratings to reassess the likelihood of UK extraordinary government support. On 3 February 2015 Standard & Poor’s lowered the long term ratings on the two holding companies Lloyds Banking Group plc and HBOS plc by two notches to the BBB level. The operating companies Lloyds Bank plc and Bank of Scotland plc continue to have long term ratings of A but have been placed on CreditWatch with negative implications. At the same time Standard & Poor’s announced that the holding companies of the Group have a positive outlook as they could revise upward the unsupported Group Credit Profile of Lloyds Banking Group. Lloyds Bank plc is currently rated A1 by Moody’s and A by Fitch, however it is likely that they may review these ratings later in the year, taking into account regulatory changes, particularly relating to Recovery and Resolution. The effects of a downgrade from all three rating agencies are included in the Group liquidity stress testing.
The Liquidity Coverage Ratio (LCR) is due to become the Pillar 1 standard for liquidity in the UK from October 2015. The Group continues to monitor the requirements, has a robust and well governed reporting framework in place and expects to meet the minimum requirements following finalisation from the PRA. Based on the Group’s current knowledge of the LCR standards due in October 2015, it believes that it met the upcoming requirements as at 31 December 2014.
Excludes £21.3 billion (31 December 2013: £20.1 billion) of loans and advances to banks within the Insurance business and £1.9 billion (31 December 2013: £0.2 billion) of reverse repurchase agreements.
Other assets and other liabilities primarily include balances in the Group’s Insurance business and the fair value of derivative assets and liabilities.
Table 1.40: Analysis of 2014 total wholesale funding by residual maturity (audited)
The Group has analysed its balance sheet between unencumbered and encumbered assets.
Unencumbered – Cannot be used: Assets that have not been pledged but which the Group has assessed could not be pledged and therefore could not be used to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements.
The minimum amount of total capital, under Pillar 1 of the regulatory framework, is determined as 8 per cent of the aggregate risk-weighted assets calculated in respect of credit risk, counterparty credit risk, operational risk and market risk. At least 4 per cent of risk-weighted assets were required to be covered by Common Equity Tier 1 (CET1) capital in 2014, increasing to 4.5 per cent from 1 January 2015.
In addition to the risk-based capital framework described above, the Group is also subject to minimum capital requirements under the leverage ratio framework. The leverage ratio is calculated by dividing tier 1 capital resources by a defined measure of on-balance sheet assets and off-balance sheet items.
The Group’s leverage ratio currently exceeds the aggregate minimum levels proposed by the FPC which require major domestic banks to meet a minimum ratio of 3 per cent, a supplementary systemic risk based buffer of up to 1.05 per cent (to apply from 2016 for globally systemically important banks (G-SIBs) and from 2019 for major domestic banks) and a time-varying countercyclical leverage buffer of up to 0.9 per cent (currently set at zero per cent). At least 75 per cent of the minimum 3 per cent and the entirety of any buffers must be met by CET1 capital. It is expected that the proposals will be implemented during 2015.
The Group continues to monitor these developments very closely, analysing the potential capital impacts to ensure the Group continues to maintain a strong capital position that exceeds the minimum regulatory requirements and the Group’s risk appetite and is consistent with market expectations.
The Group intends to have a progressive dividend policy with dividends starting at a modest level and increasing over the medium term to a dividend payout ratio of at least 50 per cent of sustainable earnings. The ability of the Group to pay a dividend is subject to a number of constraints. Under the Companies Act 2006, dividends may only be paid out of ‘profits available for distribution’, which are determined by reference to a company’s separate financial statements. Lloyds Banking Group plc acts a holding company which also raises debt to fund the activities of the Group. The profitability of the Company is therefore dependent upon the receipt of dividends from its subsidiaries and consequently its ability to sustain dividend payments is in turn largely dependent on the ability of its subsidiaries to continue making dividend payments.
As the Insurance business is excluded from the scope of the Group’s regulatory capital consolidation, profits made by Insurance are removed from CET1 capital. Dividends paid to the Group by Insurance, however, are recognised through CET1 Capital and for the period include £400 million paid in March 2014 and £300 million paid in December 2014. In addition, the sale of Heidelberger Leben resulted in the payment of an additional dividend by Insurance to the Group of £295 million.
As a result of the offers launched in the first half of the year, the Group has met its AT1 requirement under the CRD IV capital framework. Through the exchange and tender offers, the Group repurchased the equivalent of £5 billion nominal (£4 billion regulatory value) of ECNs and issued £5.3 billion of new AT1 securities. In addition to delivering the Group’s AT1 requirement, the exchange and tender offers also increased the Group’s leverage ratios by approximately 50 basis points, improved the Group’s rating agency metrics, and has benefited the Group’s net interest margin in 2014 by approximately 7 basis points. Coupon payments on the new AT1 securities are accounted for as distributions from reserves. The exchanges resulted in a net accounting charge of approximately £1.1 billion, which has reduced the Group’s fully loaded CET1 capital ratio by approximately 50 basis points.
CRD IV rules as implemented by the PRA at 1 January 2014.
Credit risk includes movements in contributions to the default fund of central counterparties and counterparty credit risk includes the movements in credit valuation adjustments.
The risk-weighted asset movements table provides an analysis of the movement in risk-weighted assets in the year and an insight in to the key drivers of the movements. The analysis is compiled on a monthly basis through the identification and categorisation of risk-weighted asset movements and is subject to management judgement.
Model and methodology changes include the movement in risk-weighted assets arising from new model implementation, model enhancement and changes in credit risk approach applied to certain portfolios. Model and methodology changes reduced risk-weighted assets by £5.6 billion, primarily due to the removal of a temporary capital buffer applied to the Group’s internal market risk models on completion of specific market risk infrastructure projects. Reductions in credit risk arise from a number of small methodology refinements in Commercial Banking, partially offset by risk-weighted asset increases arising from updates to mortgage models and refinement of risk models for unsecured products in Retail and Consumer Finance.
31 December 2013 comparatives are reported on the same basis of calculation as the current year.
Key movements The 1.1 per cent increase in the Group’s fully loaded leverage ratio from 3.8 per cent (pro forma) to 4.9 per cent predominantly reflects the increase in the Group’s tier 1 capital position over the period, including the issuance of £5.3 billion of CRD IV compliant AT1 instruments and the growth in CET1 capital, as discussed on page 154.
G-SIB requirements Although the Group is not currently classified as a Global Systemically Important Bank (G-SIB), by virtue of the leverage exposure exceeding €200 billion, the Group is required to report G-SIB metrics to the PRA. The Group’s metrics used within the 2014 Basel G-SIBs annual exercise will be disclosed from April 2015, and the results are expected to be made available by the Basel Committee later this year.
Statutory basis: Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. If the market is not active, the Group establishes a fair value by using valuation techniques. Liabilities are calculated using a projection of future cash flows after making prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the PRA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for with-profits policies that are at the discretion of management, but does include a value for policyholder options likely to be exercised.
The realistic excess capital is calculated as the difference between realistic assets and realistic liabilities of the With-Profit Fund with a further deduction to cover various stress tests (the Risk Capital Margin). In circumstances where the realistic excess capital position is less than the statutory excess
ther inform ation capital, the company is required to hold additional capital to cover the shortfall. Any additional capital requirement under this test is referred to as the With-Profits Insurance Capital Component.
Estimated share of realistic liabilities consistent with the PRA reporting treatment (328) (53) – – – (381)
Adjustments onto a regulatory basis: Unallocated surplus within Insurance business 336 55 – – – 391
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. Under the Scheme 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 PRA 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 (subject to the Non-Participating Fund being able to cover this amount by its surplus admissible assets) in assessing the realistic value of assets available to the With-Profit Fund. At 31 December 2014 the estimated value of surplus admissible assets in the Non-Participating Fund was £796 million (2013: £1,902 million) and the estimated value of the Support Account was £nil (2013: £nil). However, at 31 December 2014, the excess of realistic liabilities of with-profits business written before demutualisation over the relevant assets was £39 million (2013: £54 million) which, in accordance with the PRA’s permission, has been used to assess the estimated value of realistic assets available to the With-Profit Fund (and has therefore reduced the value of the Non-Participating Fund’s surplus admissible assets by that amount).
Overseas life business includes several life companies outside the UK. In all cases the available capital resources are subject to local regulatory requirements, and transfer to other parts of the Group is subject to additional complexity surrounding the transfer of capital from one country to another.
UK Life Shareholder Funds Available capital in the UK Life Shareholder Funds has decreased from £2,314 million at 31 December 2013 to an estimated £2,283 million at 31 December 2014. The decrease mainly reflects the funding used to pay the dividend from Scottish Widows Group to Lloyds Bank and a tranche of subordinated debt due to be redeemed in 2015 which therefore no longer contributes to capital, partly offset by receipt of transfers from the Non-Profit Funds.
Measurement People risk is measured through a series of quantitative and qualitative indicators, aligned to key sources of people risk for the Group such as succession, retention and whistleblowing. In addition to risk appetite measures and limits, people risks and controls are monitored across individual Divisions and business units. Divisional metrics are calibrated against the Group’s risk appetite and monitored on a monthly basis via the Group’s risk governance framework and reporting structures.
The Group has a Disclosure Committee which assists the Group Chief Executive and Chief Financial Officer in fulfilling their disclosure responsibilities under relevant listing and other regulatory and legal requirements. In addition, the Audit Committee reviews the quality and acceptability of the Group’s financial disclosures. For further information on the Audit Committee’s responsibilities relating to financial reporting see pages 75 to 78.
Under the banner of the Risk Management Framework new training modules have been launched during 2014 to support all colleagues in understanding and fulfilling their risk responsibilities.
Monitoring A review of the Group’s Risk Management Framework, which includes the status of the Group’s Principles and Policy Framework, and the design and operational effectiveness of key governance committees, is undertaken on an annual basis and the findings are reported to the Group Risk Committee, Board Risk Committee and the Board.
This includes a review of the Group’s current approach to governance and ongoing initiatives in light of the latest regulatory guidance.
Notes to the consolidated financial statements 188 1. Basis of preparation 2. Accounting policies 3. Critical accounting estimates and judgements 4. Segmental analysis 5. Net interest income 6. Net fee and commission income 7. Net trading income 8. Insurance premium income 9. Other operating income 10. Insurance claims 11. Operating expenses 13. Taxation 14. Earnings per share 15. Trading and other financial assets at fair value through profit or loss 16. Derivative financial instruments 17. Loans and advances to banks 18. Loans and advances to customers 19. Securitisations and covered bonds 20. Structured entities 21. Allowance for impairment losses on loans and receivables 22. Available-for-sale financial assets 23. Investment properties 24. Goodwill 25. Value of in-force business 26. Other intangible assets 27. Tangible fixed assets 28. Other assets 29. Deposits from banks 30 Customer deposits 31. Trading and other financial liabilities at fair value through profit or loss 32. Debt securities in issue 33. Liabilities arising from insurance contracts and participating investment contracts 34. Life insurance sensitivity analysis 35. Liabilities arising from non-participating investment contracts 36. Unallocated surplus within insurance businesses 37. Other liabilities 38. Retirement benefit obligations 39. Deferred tax 40. Other provisions 41. Subordinated liabilities 42. Share capital 43. Share premium account 44. Other reserves 45. Retained profits 46. Other equity instruments 47. Ordinary dividends 48. Share-based payments 49. Related party transactions 50. Contingent liabilities and commitments 51. Financial instruments 52. Transfers of financial assets 53. Offsetting of financial assets and liabilities 54. Financial risk management 55. Consolidated cash flow statement 56. Disposal of a non-controlling interest in TSB Banking Group plc 57. Future accounting developments
Overall Group materiality We have determined overall Group materiality to be £268 million which represents 5 per cent of adjusted profit before tax. Profit before tax was adjusted for a number of non-recurring items.
Impairment is a highly subjective area due to the level of judgement applied by management in determining provisions.
We focused on the identification of impairment events, which differs based upon the type of lending product and customer. Judgement is required to determine whether a loss has been incurred.
In addition to testing the key controls, we have also performed the following procedures: Retail and Consumer Finance We understood management’s basis for determining whether a loan is impaired and assessed the reasonableness using our understanding of the Group’s lending portfolios and our broader industry knowledge. For Retail and Consumer Finance exposures, impairment is calculated using models. We therefore tested the completeness and accuracy of data from underlying systems and data warehouses that is used in those models.
We understood and critically assessed the models used. Where changes had been made in model parameters and assumptions, we understood the reasons why changes had taken place and used our industry knowledge and experience to evaluate the appropriateness of such changes. We performed a sensitivity analysis on the key assumptions as well as using our own models to estimate the impairment provision for a sample of loans.
In evaluating the models and assumptions, we also considered whether all relevant risks were reflected in the modelled provision, and where not, whether overlays to modelled calculations appropriately reflected those risks. We challenged management to provide objective evidence to support the overlay adjustments made to the modelled provision. Modelling assumptions and parameters, such as probability of default, are based on historic data. We challenged whether historic experience was representative of current circumstances and of the losses incurred in the portfolios. This included consideration of the improving economic conditions. We also considered if there was evidence of incurred losses which were not being identified from the historic data.
For the collective unimpaired provision, which reflects losses incurred but not yet identified, we tested the completeness and accuracy of the underlying loan information used in the impairment models by agreeing details to the Group’s source systems as well as re-performing the calculation of the modelled provision. For the key assumptions in the model, we challenged management who provide objective evidence that they were appropriate. Further, we used our industry experience and knowledge to consider the appropriateness of the provision.
Actuarial assumptions used in the valuation of insurance contracts (liabilities and assets representing the value of in-force business) Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), page 199 (Critical Accounting Estimates and Judgements) and page 227 (notes).
Persistency can be impacted by changes to regulation for products sold by the Group. In recent times the Group’s products have been affected by regulatory changes including the Retail Distribution Review, Pensions Auto-Enrolment and more recently the Finance Act 2014. We focused on whether management had made appropriate assumptions against this changing regulatory background.
Recognition of deferred tax assets Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), and page 247 (notes).
Pension valuations and obligations Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), page 199 (Critical Accounting Estimates and Judgements) and page 240 (notes).
The valuations of the pension obligations are calculated with reference to a number of actuarial assumptions and inputs including discount rate, rate of inflation and mortality rates.
The treatment of curtailments, settlements, past service costs and measurements and other amendments can significantly impact the balance sheet and results of the Group, as demonstrated by the curtailment gain recognised in the year.
We also read and assessed the disclosures made in the financial statements, including disclosures of the assumptions.
One-off transactions Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), and page 321 (notes).
One-off transactions were deemed to be an area of focus due to their nature and previous control deficiencies in relation to such transactions. The accounting for one-off transactions can often be judgemental and complex, and require transaction specific controls to be designed and operate effectively.
During the year, in response to control deficiencies identified in the prior year, management introduced a new key control for one-off transactions. We tested the design, implementation and operating effectiveness of the control, and determined that we could rely on this control for the purposes of our audit.
We met regularly with management throughout the year to understand any proposed large or unusual transactions and to discuss the accounting and disclosure implications.
Given the judgemental nature of the accounting for certain one-off transactions, we assessed the disclosures made in the financial statements to check they complied with the relevant accounting standards and other pronouncements on disclosures. We particularly focused on challenging management that the disclosures were complete and sufficiently clear in highlighting the nature, accounting treatment and financial statement impact of the one-off transactions.
We assessed the models used by management to calculate the fair value adjustments. As there have been no significant changes to the models over the year, we challenged management to demonstrate to us that the models and the underlying methodologies remain appropriate.
Business reporting units that are not subject to specific audit procedures are still subject to audit work on entity level controls and Group level analytical review procedures over their financial information.
ISAs (UK & Ireland) reporting Under ISAs (UK & Ireland) we are required to report to you if, in our opinion: – information in the Annual Report is: – materially inconsistent with the information in the audited financial statements; or – apparently materially incorrect based on, or materially inconsistent with, our knowledge of the Group and Parent Company acquired in the course of performing our audit; or – otherwise misleading.
– the section of the Annual Report on page 76, as required by provision C.3.8 of the Code, describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee.
Directors’ remuneration report - Companies Act 2006 opinion In our opinion, the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.
In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax – (1,014) – (1,014) – (1,014)
Movements in cash flow hedging reserve, net of tax – 25 – 25 – 25
In previous years the Group has separately reported, in the balance sheet, cash collateral balances and derivative positions with the same exchange; these cash collateral balances are now offset. The effect of this at 31 December 2014 has been to reduce both loans and advances to customers and derivative liabilities by £2,820 million and both customer deposits and derivative assets by £2,294 million. Comparative figures have been revised accordingly, the impact at 31 December 2013 being to reduce derivative assets by £2,321 million (31 December 2012: £923 million), loans and advances to customers by £2,329 million (31 December 2012: £461 million), customer deposits by £1,844 million (31 December 2012: £696 million) and derivative liabilities by £2,806 million (31 December 2012: £688 million).
(A) CONSOLIDATION The assets, liabilities and results of Group undertakings (including structured entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) including expected early redemption fees and related penalties and premiums and discounts that are an integral part of the overall return. Direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument are also taken into account in the calculation. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see (H) below).
Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided. Loan commitment fees for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an adjustment to the effective interest rate on the loan once drawn. Where it is unlikely that loan commitments will be drawn, loan commitment fees are recognised over the life of the facility. Loan syndication fees are recognised as revenue when the syndication has been completed and the Group retains no part of the loan package for itself or retains a part at the same effective interest rate for all interest‑bearing financial instruments, including loans and advances, as for the other participants.
Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has transferred its contractual right to receive the cash flows from the assets and either: – substantially all of the risks and rewards of ownership have been transferred; or – the Group has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.
Trading securities are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short‑term gains. Such securities are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.
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 assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, with management information also prepared on this basis. As noted in (A)(2) above certain of the Group’s investments are managed as venture capital investments and evaluated on the basis of their fair value and these assets are designated at fair value through profit or loss. – where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise need to be separately accounted for.
An exchange of financial liabilities on substantially different terms is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. The difference between the carrying amount of a financial liability extinguished and the new financial liability is recognised in profit or loss together with any related costs or fees incurred.
Impairment allowances are assessed individually for financial assets that are individually significant. Such individual assessment is used primarily for the Group’s commercial lending portfolios. Impairment allowances for portfolios of smaller balance homogenous loans such as most residential mortgages, personal loans and credit card balances in the Group’s retail portfolios in both the Retail and Consumer Finance divisions 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.
(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 and the remaining period of the lease. – Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease.
Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In the event that an asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately. The recoverable amount is the higher of the asset’s fair value less costs to sell and its value in use.
– Insurance and participating investment contracts which are unit-linked 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.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) (iii) Value of in-force business The Group recognises as an asset the value of in‑force business in respect of insurance contracts and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date. This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency rates and includes allowances for both non‑market risk and for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when recognised in other comprehensive income as qualifying cash flow or net investment hedges. Non‑monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was determined. Translation differences on equities and similar non‑monetary items held at fair value
(2) Dividends Dividends paid on the Group’s ordinary shares are recognised as a reduction in equity in the period in which they are paid.
In making this assessment account is taken of business plans, the five year board approved operating plan and the following future risk factors: – The expected future economic outlook as set out in the Group Chief Executive’s Review and Market Overview; – The retail banking business disposal as required by the European Commission; and – Future regulatory change.
The deferred tax asset is expected to be utilised over different time periods in each of the entities in which the losses arise. Under current UK tax law there is no expiry date for unused tax losses. The losses are still expected to be fully utilised by 2019.
In December 2014 the Chancellor of the Exchequer announced proposals to restrict to 50 per cent the amount of banks’ profits that can be offset by carried forward tax losses for the purposes of calculating corporation tax liabilities. These proposals are expected to be included in the Finance Bill 2015 and, if passed into law, will take effect in respect of profits arising after 1 April 2015. The Group estimates that these proposals will result in no change to the level of deferred tax recognition although it will increase the period over which it expects to fully utilise its tax losses from 2019 to 2025.
RETIREMENT BENEFIT OBLIGATIONS The net asset recognised in the balance sheet at 31 December 2014 in respect of the Group’s retirement benefit obligations was £694 million (comprising an asset of £1,147 million and a liability of £453 million) (2013: a net liability of £998 million comprising an asset of £98 million and a liability of £1,096 million) related to post‑retirement defined benefit schemes. The defined benefit pension schemes’ net accounting surplus totalled £890 million (2013: deficit of £787 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
VALUATION OF ASSETS AND LIABILITIES ARISING FROM LIFE INSURANCE BUSINESS At 31 December 2014, the Group recognised a value of in‑force business asset of £4,446 million (2013: £4,874 million) and an acquired value of in‑force business asset of £418 million (2013: £461 million). The value of in‑force business asset represents the present value of future profits expected to arise from the portfolio of in‑force life insurance and participating investment contracts. The acquired value of in‑force business asset represents the contractual rights to benefits from providing investment management services in relation to non‑participating investment contracts acquired in business combinations and portfolio transfers. The methodology used to value these assets is set out in note 25. The valuation or recoverability of these assets requires assumptions to be made about future economic and operating conditions which are inherently uncertain and changes could significantly affect the value attributed to these assets. The key assumptions that have been made in determining the carrying value of the value of in‑force business assets at 31 December 2014 are set out in note 25.
Consumer Finance comprises the Group’s consumer and corporate Credit Card businesses, along with the Black Horse motor financing and Lex Autolease car leasing businesses in Asset Finance. The Group’s European deposits and Dutch retail mortgage businesses are managed within Asset Finance.
Other segment items reflected in income statement above: (Decrease) increase in value of in‑force business – – – (428) – – (428)
Comprises the effects of asset sales (gain of £138 million), volatile items (gain of £286 million), liability management (loss of £1,386 million), Simplification costs related to severance, IT and business costs of implementation (£966 million), TSB build and dual running costs (£558 million), the past service pension credit of £710 million (which represents the curtailment credit of £843 million following the Group’s decision to reduce the cap on pensionable pay partly offset by the cost of other changes to the pay, benefits and reward offered to employees) and the amortisation of purchased intangibles (£336 million).
Included within interest and similar income is £407 million (2013: £901 million; 2012: £1,133 million) in respect of impaired financial assets. Net interest income also includes a credit of £1,153 million (2013: credit of £550 million; 2012: credit of £92 million) transferred from the cash flow hedging reserve (see note 44).
Securities and other gains comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows: 2014 £m 2013 £m 2012 £m
Gains less losses on disposal of available‑for‑sale financial assets (note 44) 131 629 3,547
OTHER On 31 March 2014 the Group completed the sale of Scottish Widows Investment Partnership, realising a gain of £128 million; this gain has been more than offset by losses on other asset sales.
Staff costs: Pensions and other post‑retirement benefit schemes (note 38): Past service charges (credits)1 (822) 104 (250)
Amortisation of acquired value of in‑force non‑participating investment contracts (note 25) 43 54 79
AVERAGE HEADCOUNT The average number of persons on a headcount basis employed by the Group during the year was as follows: FEES PAYABLE TO THE AUDITORS Fees payable to the Company’s auditors by the Group are as follows: 2014 £m 2013 £m 2012 £m
NOTE 11: OPERATING EXPENSES (CONTINUED) The following types of services are included in the categories listed above: Audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with regulatory filings. Other services supplied pursuant to legislation relate primarily to the costs associated with the Sarbanes‑Oxley Act audit requirements together with the cost of the audit of the Group’s Form 20‑F filing.
Impairment losses on loans and receivables: Loans and advances to customers 735 2,725 5,125
NOTE 13: TAXATION (CONTINUED) (B) FACTORS AFFECTING THE TAX CHARGE FOR THE YEAR A reconciliation of the credit (charge) that would result from applying the standard UK corporation tax rate to the profit (loss) before tax to the actual tax charge for the year is given below: 2014 £m 2013 £m 2012 £m
Tax (charge) credit thereon at UK corporation tax rate of 21.5 per cent (2013: 23.25 per cent; 2012: 24.5 per cent) (379) (96) 148
Further factors affecting the life business1: Derecognition of deferred tax on policyholder tax credit – – (583)
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 22 million (2013: 18 million; 2012: 13 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares that arise in respect of share options and awards granted to employees. The number of shares that could have been acquired at the average annual share price of the Company’s shares based on the monetary value of the subscription rights attached to outstanding share options and awards is determined. This is deducted from the number of shares issuable under such options and awards to leave a residual bonus amount of shares which are added to the weighted‑average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.
NOTE 15: TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS These assets are comprised as follows: Trading assets £m
Debt securities: Bank and building society certificates of deposit 554 – 554 1,491 – 1,491
NOTE 15: TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS (CONTINUED) Other financial assets at fair value through profit or loss include the following assets designated into that category: (i) financial assets backing insurance contracts and investment contracts of £94,314 million (2013: £101,185 million) which are so designated because the related liabilities either have cash flows that are contractually based on the performance of the assets or are contracts whose measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise arise. Included within these assets are investments in unconsolidated structured entities of £27,590 million (2013: £24,552 million), see note 20; (ii) loans and advances to customers of £27 million at 31 December 2013 which were economically hedged by interest rate derivatives which were not in hedge accounting relationships and where significant measurement inconsistencies would otherwise have arisen if the related derivatives had not been treated as trading liabilities and the loans and advances had not been carried at amortised cost; and
The maximum exposure to credit risk at 31 December 2013 of the loans and advances to banks and customers designated at fair value through profit or loss at that date was £27 million; the Group did not hold any credit derivatives or other instruments in mitigation of this risk. There was no significant movement in the fair value of these loans attributable to changes in credit risk which was determined by reference to the publicly available credit ratings of the instruments involved.
Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS 39. Derivatives are held at fair value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 51.
The principal derivatives used by the Group are as follows: – Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a specified future date. – Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date. – Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre‑set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise, in combination with external funding, £611 million (2013: £828 million) of corporate and commercial banking loans. – Equity derivatives are also used by the Group as part of its equity‑based retail product activity to eliminate the Group’s exposure to fluctuations in various international stock exchange indices. Index‑linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.
The embedded equity conversion feature of £646 million (2013: £1,212 million) reflects the value of the equity conversion feature contained in the Enhanced Capital Notes issued by the Group in 2009; the gain of £401 million arising from the change in fair value over 2014 (2013: loss of £209 million; 2012: gain of £249 million) is included within net gains on financial instruments held for trading within net trading income (note 7). In addition, £967 million of the embedded derivative, being that portion of the embedded equity conversion feature related to ECNs derecognised pursuant to the Group’s exchange and retail tender transactions completed in April 2014 (see note 9), has been derecognised on completion of those transactions.
NOTE 16: DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) HEDGED CASH FLOWS For designated cash flow hedges the following table shows when the Group’s hedged cash flows are expected to occur and when they will affect income.
The Group has not voluntarily offered to repurchase assets from any of its public securitisation programmes during 2014 (2013: none). Such repurchases are made in order to ensure that the expected maturity dates of the notes issued from these programmes are met.
NOTE 20: STRUCTURED ENTITIES The Group’s interests in structured entities are both consolidated and unconsolidated. Detail of the Group’s interests in consolidated structured entities are set out in: note 19 for securitisations and covered bond vehicles, note 38 for structured entities associated with the Group’s pension schemes, and below in part (A) and (B). Details of the Group’s interests in unconsolidated structured entities are included below in part (C).
Debt securities: Bank and building society certificates of deposit – 298 298 – 208 208
In addition, the following amounts have been recognised in the income statement: £m £m
The investment properties are valued at least annually at open‑market value, by independent professionally qualified valuers, who have recent experience in the location and categories of the investment properties being valued.
Movement in the value of in‑force business taken to income statement (note 9) (428) 416
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 and illiquid loan assets. 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 corporate bond holdings and relevant illiquid loan assets. The determination of the market premium for illiquidity reflects actual asset allocation and relevant observable market data, and has been checked for consistency with the capital markets. The illiquidity premium is estimated to be 120 basis points at 31 December 2014 (2013: 91 basis points).
NON-MARKET RISK An allowance for non‑market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non‑market risk is required. However, in the case of operational risk, reinsurer default and the with‑profit funds these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.
Mortality and morbidity The mortality and morbidity assumptions, including allowances for improvements in longevity, are set with regard to the Group’s actual experience where this provides a reliable basis and relevant industry data otherwise.
Capitalised software enhancements principally comprise identifiable and directly associated internal staff and other costs.
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2014 and 2013 no contingent rentals in respect of operating leases were recognised in the income statement.
In addition, total future minimum sub‑lease income of £45 million at 31 December 2014 (£19 million at 31 December 2013) is expected to be received under non‑cancellable sub‑leases of the Group’s premises.
NOTE 31: TRADING AND OTHER FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS
Trading and other financial liabilities at fair value through profit or loss 62,102 43,625
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2014 was £10,112 million, which was £3,373 million higher than the balance sheet carrying value (2013: £6,625 million, which was £1,358 million higher than the balance sheet carrying value). At 31 December 2014 there was a cumulative £181 million increase in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount a decrease of £33 million arose in 2014 and a decrease of £40 million arose in 2013.
The primary purpose of the conventional and unitised business written in the with‑profit funds is to provide a smoothed investment vehicle to policyholders, protecting them against short‑term market fluctuations. Payouts may be subject to a guaranteed minimum payout if certain policy conditions are met. With‑profit policyholders are entitled to at least 90 per cent of the distributed profits, with the shareholders receiving the balance. The policyholders are also usually insured against death and the policy may carry a guaranteed annuity option at retirement.
NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS (CONTINUED) Mortality and morbidity The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this provides a reliable basis, and relevant industry data otherwise, and include a margin for adverse deviation.
Change in provision for unearned premiums charged to income statement (note 8) (18) 3 (15)
These provisions represent the liability for short‑term insurance contracts for which the Group’s obligations are not expired at the year end. Gross £m Reinsurance £m Net £m
Current estimate in respect of above claims 180 479 506 367 393 339 283 2,547
Liability recognised in the balance sheet 3 4 12 12 16 45 110 202
NOTE 35: LIABILITIES ARISING FROM NON-PARTICIPATING INVESTMENT CONTRACTS The movement in liabilities arising from non‑participating investment contracts may be analysed as follows: Gross £m
NOTE 38: RETIREMENT BENEFIT OBLIGATIONS (CONTINUED) During 2009, the Group made one‑off contributions to the Lloyds Bank Pension Scheme No 1 and Lloyds Bank Pension Scheme No 2 of approximately £1 billion in aggregate. These contributions took the form of interests in limited liability partnerships for each of the two schemes which contained assets of approximately £5.4 billion in aggregate entitling the schemes to annual payments of approximately £215 million in aggregate until 31 December 2014. As all scheduled distributions have now been made, the value of the partnership interests equates to a nominal amount and the limited liability partnerships will continue to hold assets to provide security for the Group’s obligations to the Lloyds Bank Pension Scheme No1 and Lloyds Bank Pension Scheme No 2. At 31 December 2014, the limited liability partnerships held assets of approximately £5.1 billion and cash payments of £215 million were made to the pension schemes during the year (2013: £215 million). The limited liability partnerships are consolidated fully in the Group’s balance sheet (see note 20).
NOTE 38: RETIREMENT BENEFIT OBLIGATIONS (CONTINUED) Composition of scheme assets: Quoted Unquoted Total Quoted Unquoted Total £m £m £m £m £m £m
Interest rate risk: The defined benefit obligation is determined using a discount rate derived from yields on AA‑rated corporate bonds. A decrease in corporate bond yields will increase plan liabilities although this will be partially offset by an increase in the value of bond holdings.
NOTE 38: RETIREMENT BENEFIT OBLIGATIONS (CONTINUED) The ultimate cost of the defined benefit obligations to the Group will depend upon actual future events rather than the assumptions made. The assumptions made are unlikely to be borne out in practice and as such the cost may be higher or lower than expected.
Sensitivity analysis The effect of reasonably possible changes in key assumptions on the value of scheme liabilities and the resulting pension charge in the Group’s income statement and on the net defined benefit pension scheme liability, for the Group’s three most significant schemes, is set out below. The sensitivities provided assume that all other assumptions and the value of the schemes’ assets remain unchanged, and are not intended to represent changes that are at the extremes of possibility. The calculations are approximate in nature and full detailed calculations could lead to a different result. It is unlikely that isolated changes to individual assumptions will be experienced in practice. Due to the correlation of assumptions, aggregating the effects of these isolated changes may not be a reasonable estimate of the actual effect of simultaneous changes in multiple assumptions.
Asset‑liability matching strategies The main schemes’ assets are invested in a diversified portfolio, consisting primarily of debt securities. The investment strategy is not static and will evolve to reflect the structure of liabilities within the schemes. Specific asset‑liability matching strategies for each pension plan are independently determined by the responsible governance body for each scheme and in consultation with the employer.
A significant goal of the asset‑liability matching strategies adopted by Group schemes is to reduce volatility caused by changes in market expectations of interest rates and inflation. In the main, this is achieved by investing scheme assets in bonds, primarily fixed interest gilts and index linked gilts, and by entering into interest rate and inflation swap arrangements. These investments are structured to take into account the profile of scheme liabilities, and actively managed to reflect both changing market conditions and changes to the liability profile.
Maturity analysis method and assumptions The projected benefit payments are based on the assumptions underlying the assessment of the obligations, including allowance for expected future inflation. They are shown in their undiscounted form and therefore appear large relative to the discounted assessment of the defined benefit obligations recognised in the Group’s balance sheet. They are in respect of benefits that have been accrued prior to the respective year‑end date only and make no allowance for any benefits that may have been accrued subsequently.
NOTE 39: DEFERRED TAX The movement in the net deferred tax balance is as follows: 2014 £m 2013 £m
Deferred tax assets of £190 million (2013: £168 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
NOTE 40: OTHER PROVISIONS (CONTINUED) PROVISIONS FOR COMMITMENTS Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s ability to meet its repayment obligations.
Re-review of previously handled cases Approximately 0.6 million cases were included within the scope of remediation at 31 December 2013. These largely related to previously defended complaints which are being reviewed again to ensure consistency with the current complaint handling policy, now in operation. This exercise has commenced and is expected to be substantially complete by the end of June 2015, albeit with payments made in the second half of 2015 for some cases. The Group expects to uphold more of these cases due to the recent increase in uphold rates. Further cases have also been added to the remediation scope and relate to previously upheld cases. These cases have previously received redress and may receive a top‑up payment. Given the increase in uphold rates and additional volumes to the scope, this has resulted in a further provision for the year of £250 million.
Sensitivity includes complaint handling costs, and has increased as a result of higher uphold rates and a shift towards older policies.
The percentage of complaints where the Group finds in favour of the customer. This is a blend of proactive and customer initiated complaints. The 85 per cent uphold rate is based on six months to December 2014. The lower uphold rate in the future reflects a lower proportion of PBR related cases which typically have a higher uphold rate, reflecting the higher risk nature of those policy sales.
The amount that is paid in redress in relation to a policy found to have been mis‑sold, comprising, where applicable, the refund of premium, compound interest charged and interest at 8 per cent per annum. Actuals are based on the six months to December 2014. The increase in future average redress is influenced by fewer PBR policies due to the maturity of the PBR mailing. The increase is also due to a shift in the reactive complaint mix towards older, and therefore more expensive, policies.
On LIBOR, the Group has reached settlements with the FCA in the United Kingdom, the United States Commodity Futures Trading Commission (CFTC) and the United States Department of Justice (DOJ) in relation to investigations into submissions between May 2006 and 2009 and related systems and controls failings.
The settlements in relation to LIBOR are part of an industry‑wide investigation into the setting of interbank offered rates across a range of currencies. Under the settlement, the Group has paid £35 million, £62 million and £50 million to the FCA, CFTC and DOJ respectively. As part of the settlement with the DOJ, the Group has also entered into a two‑year Deferred Prosecution Agreement in relation to one count of wire fraud relating to the setting of LIBOR.
In relation to the BBA Sterling Repo Rate, the Group has reached a settlement with the FCA regarding submissions made between April 2008 and September 2009. This issue involved four individuals who the FCA has concluded manipulated BBA Repo Rate submissions to reduce fees payable under the Special Liquidity Scheme (SLS). The issue was proactively brought to the FCA’s attention when it was identified by the Group as part of its internal investigation into the LIBOR issues.
The BBA Repo Rate was used by the Bank of England (BoE) to calculate the fees for the SLS. During the period that Lloyds TSB and HBOS used the SLS they paid £1,278 million in fees, just under half of all the fees payable by the industry under the Scheme. As a result of the actions of the four individuals involved, the Group has paid nearly £8 million to compensate the BoE for amounts underpaid (by Lloyds TSB and HBOS and the other banks that used the SLS).
During 2014, the Group has charged a further £150 million in respect of estimated redress costs, increasing the total amount provided for redress and related administration costs for in‑scope customers to £680 million (31 December 2013: £530 million). This increase relates to an extension in the timetable for customers being able to opt‑in to the review and the volume and complexity of claims. As at 31 December 2014, the Group has utilised £571 million (31 December 2013: £162 million), with £109 million (31 December 2013: £368 million) of the provision remaining.
Other legal actions and regulatory matters In the course of its business, the Group is engaged in discussions with the PRA, FCA and other UK and overseas regulators and other governmental authorities on a range of matters. The Group also receives complaints and claims from customers in connection with its past conduct and, where significant, provisions are held against the costs expected to be incurred as a result of the conclusions reached. In 2014 the provision was increased by a further £430 million, in respect of a number of matters affecting the Retail, Commercial Banking and Consumer Finance divisions, including potential claims and remediation in respect of products sold through the branch network and continuing investigation of matters highlighted through industry‑wide regulatory reviews, as well as legacy product sales and historical systems and controls such as those governing legacy incentive schemes. This brings the total amount charged to £730 million of which £209 million had been utilised at 31 December 2014. This increase reflected the Group’s assessment of a limited number of matters under discussion, none of which currently is individually considered financially material in the context of the Group.
VACANT LEASEHOLD PROPERTY Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub‑let income, compared to the head rent, and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biannual basis and will normally run off over the period of under‑recovery of the leases concerned, currently averaging four years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
OTHER 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.
Other provisions include those arising out of the insolvency of a third party insurer, which remains exposed to asbestos and pollution claims in the US. The ultimate cost and timing of payments are uncertain. The provision held of £28 million at 31 December 2014 represents management’s current best estimate of the cost after having regard to actuarial estimates of future losses.
Total preference shares 1,091 876 a Since 2004, the Company has had in issue 400 6 per cent non‑cumulative preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a fixed rate non‑cumulative preferential dividend of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company.
b The fixed rate on this security was reset from 8.117 per cent to 6.059 per cent with effect from 31 May 2010.
d The fixed rate on this security was reset from 6.35 per cent to 3 month Euribor plus 2.50 per cent with effect from 25 February 2013.
Undated subordinated liabilities 6.625% Undated Subordinated Step‑up Notes (£410 million) a, b 5 6
5.125% Step‑up Perpetual Subordinated Notes callable 2015 (£560 million) (Scottish Widows plc) 548 533 5.125% Undated Subordinated Fixed to Floating Notes (e750 million) 50 49 7.5% Undated Subordinated Step‑up Notes (£300 million) 4 5 5.125% Undated Subordinated Step‑up Notes callable 2016 (£500 million) 2 2 6.5% Undated Subordinated Step‑up Notes callable 2019 (£270 million) 1 1 8% Undated Subordinated Step‑up Notes callable 2023 (£200 million) – –
7.375% Undated Subordinated Guaranteed Bonds (£200 million) (Clerical Medical Finance plc) 41 44 5.625% Cumulative Callable Fixed to Floating Rate Undated Subordinated Notes callable 2019 (£500 million) – 5 12% Perpetual Subordinated Bonds (£100 million) 20 20 5.75% Undated Subordinated Step‑up Notes (£600 million) 2 3 8.75% Perpetual Subordinated Bonds (£100 million) 5 5 9.375% Perpetual Subordinated Bonds (£50 million) 14 14 5.75% Undated Subordinated Step‑up Notes (£500 million) 6 4 6.5% Undated Subordinated Step‑up Notes callable 2029 (£450 million) – –
6% Undated Subordinated Step‑up Guaranteed Bonds callable 2032 (£500 million) 10 10
Series 3 (US$600 million) a 231 218 13.625% Perpetual Subordinated Bonds (£75 million) 18 19 11.75% Perpetual Subordinated Bonds (£100 million) 102 102
b The fixed rate on this security was reset from 6.625 per cent to 4.64821 per cent with effect from 15 July 2010.
c The fixed rate on this security was reset from 6.05 per cent to 3 month Euribor plus 2.25 per cent with effect from 23 November 2011.
(1) AUTHORISED SHARE CAPITAL As permitted by the Companies Act 2006, the Company removed references to authorised share capital from its articles of association at the annual general meeting on 5 June 2009. This change took effect from 1 October 2009.
There were no movements in this reserve during 2014, 2013 or 2012.
Issue costs of other equity instruments (net of tax) (note 46) (21) – –
A number of Group entities and sub‑groups, principally those with banking and insurance activities, are subject to various individual regulatory capital requirements. The payment of dividends by subsidiaries and the ability of members of the Group to lend money to other members of the Group may be subject to regulatory or legal restrictions, the availability of reserves and the financial and operating performance of the entity.
CHARGE TO THE INCOME STATEMENT The charge to the income statement is set out below: 2013 £m 2012 £m
Executive and SAYE plans: Options granted in the year 29 42 12
LLOYDS BANKING GROUP EXECUTIVE SHARE OPTION SCHEMES The executive share option schemes were long‑term incentive schemes available to certain senior executives of the Group, with grants usually made annually. Options were granted within limits set by the rules of the schemes relating to the number of shares under option and the price payable on the exercise of options. The last grant of executive options was made in August 2005. These options were granted without a performance multiplier and the maximum limit for the grant of options in normal circumstances was three times annual salary. Between March 2004 and August 2004, the aggregate value of the award based upon the market price at the date of grant could not exceed four times the executive’s annual remuneration and, normally, the limit for the grant of options to an executive in any one year would be equal to 1.5 times annual salary with a maximum performance multiplier of 3.5.
All options granted in 2004 lapsed on 18 March 2014 and 12 August 2014.
The weighted average fair value of options granted in the year was £0.72 (2013: £0.56). The fair values of options granted have been determined using a standard Black‑Scholes model. The weighted average share price at the time that the options were exercised during 2014 was £0.75 (2013: £0.55). The weighted average remaining contractual life of options outstanding at the end of the year was 7.0 years (2013: 3.6 years).
If the adjusted EP reaches £225 million, 25 per cent of this element of the award, being the threshold, will vest.
(ii) Absolute Total Shareholder Return (ATSR): relevant to 30 per cent of the award. Performance will be measured against the annualised return over the three year period ending 31 December 2014.
At the end of the performance period, it has been assessed that rewards will vest at 97 per cent of maximum.
The performance conditions for awards made in March and October 2013 are as follows: (i) EP: relevant to 35 per cent of the award. The performance target is based on 2015 adjusted EP outcome.
(ii) Absolute Total Shareholder Return (ATSR): relevant to 30 per cent of the award. Performance will be measured against the annualised return over the three year period ending 31 December 2015.
(iii) Adjusted total costs: relevant to 10 per cent of the award. The performance target is based on 2015 adjusted total costs.
If adjusted total costs are £9,323 million or less, 25 per cent of this element of the award, being the threshold, will vest.
NOTE 48: SHARE-BASED PAYMENTS (CONTINUED) (iv) Non-core assets excluding UK Retail at the end of 2015: relevant to 10 per cent of the award. Performance will be measured by reference to balance sheet non‑core assets at 31 December 2015.
(v) FCA reportable complaints: relevant to 10 per cent of the award. Performance will be measured by reference to the total number of FCA reportable complaints per 1,000 customers over the three year period to 31 December 2015.
If complaints per 1,000 customers average 0.95 per annum or less over three years, 100 per cent of this element will vest.
(vi) SME lending: relevant to 5 per cent of the award. Performance will be measured by reference to the movement in lending to SMEs relative to the market as reported by the Bank of England over the three year period ending 31 December 2015.
– 46.5 per cent, 100 per cent of this element will vest.
(v) Net Promoter Score: relevant to 10 per cent of the award. Performance will be measured against the Major Group Ranking position of Lloyds Banking Group, the position averaged over the final twelve months of the performance period.
Weighted average expected life 3.3 years 1.2 years 3.0 years 3.0 years
Deposits placed by key management personnel attracted interest rates of up to 4.7 per cent (2013: 2.9 per cent; 2012: 3.8 per cent).
SUBSIDIARIES Details of the principal subsidiaries are given in note 9 to the parent company financial statements. In accordance with IFRS 10 Consolidated financial statements, transactions and balances with subsidiaries have been eliminated on consolidation.
UK GOVERNMENT In January 2009, the UK Government through HM Treasury became a related party of the Company following its subscription for ordinary shares issued under a placing and open offer. At 31 December 2014, HM Treasury held more than 20 per cent of the Company’s ordinary share capital and consequently HM Treasury remained a related party of the Company during the year ended 31 December 2014.
NOTE 49: RELATED PARTY TRANSACTIONS (CONTINUED) In accordance with IAS 24, UK Government‑controlled entities became related parties of the Group. The Group regards the Bank of England and entities controlled by the UK Government, including The Royal Bank of Scotland Group plc, Northern Rock (Asset Management) plc and Bradford & Bingley plc, as related parties.
During the year ended 31 December 2014, the Group participated in a number of schemes operated by the UK Government and central banks and made available to eligible banks and building societies.
Big Society Capital In January 2012 the Group agreed, together with The Royal Bank of Scotland plc (and two other non‑related parties), to commit up to £50 million each of equity investment into the Big Society Capital Fund. The Fund, which was created as part of the Project Merlin arrangements, is a UK social investment fund. The Fund was officially launched on 3 April 2012 and the Group had invested £23 million in the Fund by 31 December 2013 and invested a further £8 million during the year ended 31 December 2014.
The Group carried out private banking operations in Switzerland with assets under management of approximately £7 billion. Those operations were sold in November 2013. Therefore, as a protective measure, in December 2013 the Group notified the DOJ of its intent to participate in the Programme. Having completed due diligence under the terms of the Programme, the Group has concluded that its further participation in the Programme is not warranted and it has communicated to the DOJ its decision to withdraw from the Programme.
RESIDENTIAL MORTGAGE REPOSSESSIONS In August 2014, the Northern Ireland High Court handed down judgment in favour of the borrowers in relation to three residential mortgage test cases, concerning certain aspects of the Group’s practice with respect to the recalculation of contractual monthly instalments of customers in arrears. The Group is reviewing the issues raised by the judgment and will respond as appropriate to any investigations or proceedings that may in due course be instigated as a result of these issues.
OTHER LEGAL ACTIONS AND REGULATORY MATTERS In addition, during the ordinary course of business the Group is subject to other complaints and threatened or actual legal proceedings (including class or group action claims) brought by or on behalf of employees, customers, investors or other third parties, as well as regulatory reviews, challenges, investigations and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required at the relevant balance sheet date. In some cases it will not be possible to form a view, for example because the facts are unclear or because further time is needed properly to assess the merits of the case, and no provisions are held in relation to such matters. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.
Other commitments 64,015 55,002 1 year or over original maturity 34,455 40,616
Cash and balances at central banks – – – – – 50,492 – 50,492
Items in course of transmission to banks – – – – – 979 – 979
Cash and balances at central banks – – – – – 49,915 – 49,915
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) (3) FINANCIAL ASSETS AND LIABILITIES CARRIED AT FAIR VALUE
Total trading and other financial assets at fair value through profit or loss 85,333 53,118 4,232 142,683
At 31 December 2014, the own credit adjustment arising from the fair valuation of £6,739 million (2013: £5,267 million) of the Group’s debt securities in issue designated at fair value through profit or loss resulted in a gain of £33 million (2013: gain of £40 million).
The Group’s level 3 derivative assets include £646 million (2013: £1,212 million) in respect of the value of the embedded equity conversion feature of the Enhanced Capital Notes issued in December 2009. The embedded equity conversion feature is valued by comparing the market price of the Enhanced Capital Notes with the market price of similar bonds without the conversion feature. The latter is calculated by discounting the expected Enhanced Capital Note cash flows in the absence of a conversion using prevailing market yields for similar capital securities without the conversion feature. The market price of the Enhanced Capital Notes was calculated with reference to multiple broker quotes.
At 31 December 2014, the Group’s derivative trading business held mid to bid‑offer valuation adjustments of £74 million (2013: £70 million).
Trading and other financial assets at fair value through profit or loss Debt securities Discounted cash flows Credit spreads (bps) n/a3
Ranges are shown where appropriate and represent the highest and lowest inputs used in the level 3 valuations.
Derivatives Reasonably possible alternative assumptions have been determined in respect of the Group’s derivative portfolios as follows: – In respect of the embedded equity conversion feature of the Enhanced Capital Notes, the sensitivity was based on the absolute difference between the actual price of the enhanced capital note and the closest, alternative broker quote available plus the impact of applying a 10 bps increase/decrease in the market yield used to derive a market price for similar bonds without the conversion feature. The effect of interdependency of the assumptions is not material to the effect of applying reasonably possible alternative assumptions to the valuations of derivative financial instruments. – Uncollateralised inflation swaps are valued using appropriate discount spreads for such transactions. These spreads are not generally observable for longer maturities. The reasonably possible alternative valuations reflect flexing of the spreads for the differing maturities to alternative values of between 3 bps and 167 bps (2013: 62 bps and 192 bps). – Swaptions are priced using industry standard option pricing models. Such models require interest rate volatilities which may be unobservable at longer maturities. To derive reasonably possible alternative valuations these volatilities have been flexed within a range of 4 per cent to 120 per cent (2013: 3 per cent and 112 per cent).
Reverse repos included in above amounts: Loans and advances to customers 120 – – 120
Valuation hierarchy The table below analyses the fair values of the financial liabilities of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 277).
Repos included in above amounts: Deposits from banks 2,112 – 2,112 –
(1) TRANSFERRED FINANCIAL ASSETS THAT CONTINUE TO BE RECOGNISED IN FULL The Group enters into repurchase and securities lending transactions in the normal course of business that do not result in derecognition of the financial assets covered as substantially all of the risks and rewards, including credit, interest rate, prepayment and other price risks are retained by the Group. In all cases, the transferee has the right to sell or repledge the assets concerned.
Loans and receivables: Loans and advances to customers 2,353 908 19,074 3,936
Excludes securitisation notes held by the Group of £38,149 million (31 December 2013: £38,288 million).
(2) TRANSFERRED FINANCIAL ASSETS DERECOGNISED IN THEIR ENTIRETY WITH ONGOING EXPOSURE Transferred financial assets which were derecognised in their entirety, but with ongoing exposure, consisted of £33 million of debt securities (2013: £78 million) with a fair value of £33 million (2013: £76 million) and a maximum exposure to loss of £33 million (2013: £78 million).
Trading and other financial assets at fair value through profit or loss: Loans and advances to banks: Loans and advances to customers: Available‑for‑sale financial assets 43,976 – 43,976 – (3,725) 40,251
At 31 December 2014 the aggregate notional principal of interest rate swaps designated as fair value hedges was £115,394 million (2013: £154,657 million) with a net fair value asset of £1,511 million (2013: asset of £1,618 million) (note 16). The losses on the hedging instruments were £2,866 million (2013: losses of £933 million). The gains on the hedged items attributable to the hedged risk were £2,720 million (2013: gains of £872 million).
A. Maximum credit exposure 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, which includes amounts held to cover unit‑linked and With Profits funds liabilities, is considered to be the balance sheet carrying amount or, for non‑derivative off‑balance sheet transactions and financial guarantees, their contractual nominal amounts.
Loans and advances to customers, net1 482,704 (4,094) 478,610 492,952 (6,811) 486,141
Debt securities, treasury and other bills 53,630 – 53,630 46,837 – 46,837
Includes assets within the Group’s unit‑linked funds for which credit risk is borne by the policyholders and assets within the Group’s With‑Profits funds for which credit risk is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back related contract liabilities.
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) B. Concentrations of exposure The Group’s management of concentration risk includes single name, industry sector and country limits as well as controls over the Group’s overall exposure to certain products. Further information on the Group’s management of this risk is included within Credit risk mitigation, Risk management on page 118.
Following the continuing reduction in the Group’s non‑UK activities, an analysis of credit risk exposures by geographical region has not been provided.
Loans and receivables The disclosures in the table below and those on pages 297 and 298 are produced under the underlying basis used for the Group’s segmental reporting. The Group believes that, for reporting periods following a significant acquisition such as the acquisition of HBOS in 2009, this underlying basis, which includes the allowance for loan losses at the acquisition date on a gross basis, more fairly reflects the underlying provisioning status of the loans. The remaining acquisition‑related fair value adjustments in respect of this lending are therefore identified separately in this table.
The table below sets out the reconciliation of the allowance for impairment losses of £6,414 million (2013: £11,966 million) shown in note 21 to the allowance for impairment losses on an underlying basis of £7,652 million (2013: £15,707 million) shown above: 2014 £m
Allowance for impairment losses on loans and advances to customers 6,414 11,966
Loans and advances which are neither past due nor impaired Loans and advances designated at fair value through profit or loss £m
Total loans and advances which are neither past due nor impaired 26,003 320,324 37,886 106,768 464,978 36,725
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Available-for-sale financial assets (excluding equity shares) An analysis of the Group’s available‑for‑sale financial assets is included in note 22. The credit quality of the Group’s available‑for‑sale financial assets (excluding equity shares) is set out below: Investment grade1 £m
Other assets held at fair value through profit or loss: Other public sector securities 2,170 – – 2,170
Total other assets held at fair value through profit or loss 39,351 583 1,927 41,861
Assets arising from reinsurance contracts held Of the assets arising from reinsurance contracts held at 31 December 2014 of £682 million (2013: £732 million), £363 million (2013: £383 million) were due from insurers with a credit rating of AA or above.
D. Collateral held as security for financial assets A general description of collateral held as security in respect of financial instruments is provided on page 119. The Group holds collateral against loans and receivables and irrevocable loan commitments; qualitative and, where appropriate, quantitative information is provided in respect of this collateral below. Collateral held as security for trading and other financial assets at fair value through profit or loss and for derivative assets is also shown below.
The extent to which collateral values are actively managed will depend on the credit quality and other circumstances of the obligor. Although lending decisions are predominantly based on expected cash flows, any collateral provided may impact the pricing and other terms of a loan or facility granted; this will have a financial impact on the amount of net interest income recognised and on internal loss‑given‑default estimates that contribute to the determination of asset quality.
Derivative assets, after offsetting of amounts under master netting arrangements The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the net derivative assets after offsetting of amounts under master netting arrangements of £14,199 million (2013: £11,325 million), cash collateral of £3,651 million (2013: £2,702 million) was held.
Trading and other financial liabilities at fair value through profit or loss The fair value of collateral pledged in respect of repurchase transactions, accounted for as secure borrowing, where the secured party is permitted by contract or custom to repledge was £56,696 million (2013: £37,999 million).
Trading and other financial assets at fair value through profit or loss 9,955 9,928
The Group assesses whether a loan benefiting from a UK Government sponsored programme is impaired using the same accounting policies and practices as it does for loans not benefiting from such a programme. There is no direct impact on the impairment status of a loan benefiting from the Mortgage Rescue schemes, as these schemes involve the purchase, and eventual sale, of the property. The loans included within the Income Support for Mortgage Interest scheme may be impaired, in accordance with the normal definition of impairment.
Unsecured Credit risk provisioning for the retail unsecured portfolio is undertaken on a purely collective basis. The approach used is based on segmented cash flow models, divided into two primary streams for loans judged to be impaired and those that are not. Accounts subject to repayment plans and collections refinance loans are among those considered to be impaired.
At 31 December 2014, unsecured retail loans and advances currently or recently subject to forbearance were 1.6 per cent (31 December 2013: 1.8 per cent) of total UK retail unsecured loans and advances.
Further analysis of the forborne loan balances is set out below: Total loans and advances which are currently or recently forborne
Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the previous six months. Permanent changes which commenced during the last 24 months for existing customers as at 31 December are also included.
Further analysis of the movements in UK retail lending forborne loans and advances during the year is as follows: Secured lending £m
Forbearance A key factor in determining whether the Group treats a commercial customer as forborne is the granting of a concession to a borrower who experiences, or is believed to be about to experience, financial difficulty and which is outside the Group’s current risk appetite. Where a concession is granted to a customer that is not in financial difficulty or the risk profile is considered within the Group’s current risk appetite, the concession would not be considered to be an act of forbearance. The Group does not believe forbearance reporting is appropriate for derivatives, available for sale assets and the trading book where assets are marked to market daily.
Whilst the material portfolios have been reviewed for forbearance, some non‑retail loans and advances in Commercial Banking and Run‑off divisions have not been reviewed on the basis that the level is relatively immaterial or because the concept of forbearance is not relevant.
Types of forbearance The Group’s strategy and offer of forbearance is largely dependent on the individual situation and early identification, control and monitoring are key to supporting the customer and protecting the Group. Concessions are often provided to help the customer with their day to day liquidity and working capital.
Exit from forbearance classification A customer where forbearance has been granted will remain treated and recorded as forborne until it evidences acceptable performance over a period of time. This period will depend on a number of factors such as whether the customer is trading in line with its revised plan, it is operating within the new terms and conditions (including observation to revised covenants and contractual payments), its financial performance is stable or improving, and there are no undue concerns over its future performance. As a minimum, this period is currently expected to be at least 12 months following a forbearance event. However, notwithstanding this, the overriding requirement is that the financial difficulty previously seen has been removed, and the performance has stabilised.
The exception to this 12 month minimum period is where a permanent structure cure is made (for example, an injection of new collateral security or a partial repayment of debt to restore an LTV back to within a covenant). In this case, the obligor may be removed from the forbearance category once the permanent cure has been made.
Impaired loans and advances The movements in Commercial Banking impaired forborne loans and advances were as follows: £m
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Unimpaired loans and advances The table below sets out the largest unimpaired forborne loans and advances to Commercial Banking customers (exposures over £5 million) as at 31 December 2014 by type of forbearance, together with a breakdown of exposures classified as Direct Real Estate: Direct Real Estate £m
The movements in UK Commercial Banking unimpaired forborne exposures over £5 million were: £m