A full version of our Annual Report and Accounts and information relating to Lloyds Banking Group is available at: www.lloydsbankinggroup.com
– Capital position strengthened: Core tier 1 capital ratio of 10.8 per cent, improved by 60 basis points
– Loan to deposit ratio substantially improved to 135 per cent (31 December 2010: 154 per cent)
Simplifying the Group: reducing costs and creating a new operational model
Remain confident that our medium-term financial targets, as set out in our June 2011 Strategic Review are achievable over time
– Continue to expect to deliver our balance sheet, cost and impairment targets in 2014, and in some cases sooner
– Full year banking net interest margin to be below 2 per cent in 2012, falling year-on-year by approximately the same amount in 2012 as in 2011, primarily driven by continuing high wholesale funding costs
Effects of liability management, volatile items and asset sales1 (74) (93)
Other costs include FSCS costs and UK bank levy in 2011, and FSCS costs and impairment of tangible fixed assets in 2010.
Building customer relationships Customer relationships are key to our strategy and critical for all our businesses. The significant differences across the divisions means financial and non-financial strategic indicators for the development of customer relationships are generally tracked at a divisional level and commentary is included in the specific divisional commentaries.
To measure progress in our aim of becoming the best bank for customers we have introduced a new customer satisfaction measure and are publically committed to reducing complaints. Our colleagues are a key differentiator and we have also introduced a new engagement survey to assess individual motivation and organisational processes.
We have over 30 million customers, iconic brands, including Lloyds TSB, Halifax, Bank of Scotland and Scottish Widows, and high-quality, committed people. We are looking to create a simpler, more agile, efficient and responsive organisation with a real focus on operating sustainably and responsibly. Whilst focusing on core markets which offer strong returns and attractive growth, we will maintain a prudent approach to risk and further strengthen the Group’s balance sheet.
Insurance The Life, Pensions and Investments business is the leading bancassurance provider in the UK and has one of the largest intermediary channels in the industry. The general insurance business is a leading distributor of home insurance in the UK and also offers a range of other general insurance products.
Key product markets – Life assurance, pensions and investments – General Insurance 1 Excludes Group Operations, central items and insurance claims
The integrated platform is allowing us to target further simplification benefits, as announced in June’s Strategic Review, and re-invest in the Group. Through redesigning our operations and processes, to reduce bottlenecks and errors, streamlining our product suite and using a breadth of distribution channels, optimising our sourcing and delayering our management structure we will be able to quickly and efficiently react to external pressures and provide improved services to customers. An element of the savings produced from simplification will enable us to invest further in the group, creating long lasting value, improving our strategic outlook and positioning us to deliver strong and sustainable returns.
Strong customer relationships Over the years we have developed long lasting and strong relationships with our customers. By listening to our customers and acting accordingly we will continue to build upon these relationships and become the best bank for customers.
A yeAr of chAnge And encourAging ProgreSS Overview 2011 was a year of low economic growth and challenging markets in many parts of the world, which resulted in a difficult year for the banking industry as a whole. The UK sector in particular was affected by a weakening UK economic environment, continuing regulatory uncertainty and the impact of the Euro crisis.
Despite this environment, we made progress against our objective of being the best bank for customers and on the key actions we are taking to deliver strong, stable and sustainable returns for shareholders over time. We created a new management team, presented our new strategy and are refocusing the business to meet our customers’ needs. We also delivered a resilient performance in the core business, and made good progress on the reduction of non-core assets.
Regulation The level of regulatory scrutiny across all areas of the business remains high, but there is some expectation that in 2012 we will start to see more clarity in a number of the key areas which will shape the industry’s future. I believe robust and stable regulation of the sector is an important component in rebuilding confidence and creating a healthy and sound financial system. Changes to the regulatory framework are necessary in the wake of the financial crisis. The reforms proposed by the Vickers Commission in its Independent Commission on Banking (ICB) report are an important step towards a safer and stronger sector. Further clarity is still required on some of the specific detail, and implementation will have many challenges. However I remain hopeful that the proposed changes will strengthen the banking sector and safeguard the interests of individuals and institutions. At the same time we forget at our peril the importance of financial services in all parts of the UK to our economy.
Sir Julian Horn-Smith, Independent Director since 2005 will not be standing for re-election at the annual general meeting. His counsel and advice on aspects of technology, marketing and customers will be much missed.
The Board has appointed Anthony Watson as Senior Independent Director and David Roberts as Deputy Chairman with effect from the annual general meeting.
More generally, I would like to thank them for their commitment and loyalty in what were challenging circumstances and in a climate of unfavourable public commentary on their work and livelihood. We are all determined to demonstrate the utility and usefulness of banking, specifically our type of banking, concentrated as it is on the UK and within that on retail and commercial banking.
It remains our intention over time to operate as a wholly privately owned, self-supporting, dividend paying, commercial enterprise. I believe our approach of focusing on customers in the UK whilst capitalising on our strong relationships, on our iconic and distinct brands, on our broad multi-channel distribution and on the clear operating model we have created is the right one. We saw the early benefits of this approach in 2011 through the resilient performance of our core business and the good progress in reducing our non-core assets.
During 2011 we have continued to be mindful of the need to exercise restraint as part of the effective governance of executive pay and as a result a number of actions have been taken, including not increasing fixed pay for Directors.
As a result, in 2011, we delivered a resilient performance and made good progress against the key elements of our strategic plan to become the best bank for our customers, despite a weakening UK economy, ongoing financial market volatility, continued high levels of regulatory scrutiny and competitive markets. We are now better positioned to adapt to the changing economic environment and to realise over time the full potential of our franchise, brands and capabilities, and therefore to deliver strong, stable and sustainable returns for our shareholders.
The Group reported a combined businesses profit before tax of £2,685 million in 2011 (2010: £2,212 million), and excluding the effects of liability management, volatile items and asset sales, profit before tax was £2,022 million (2010: £1,651 million). The core business delivered a resilient performance, with profit before tax of £6,349 million (2010: £6,152 million), and excluding volatile items, liability management effects and asset sales profit before tax was £5,746 million (2010: £6,101 million). On a statutory basis, the Group reported a loss before tax of £3,542 million in the year, which includes the PPI related provision.
Our strategy and action plan to deliver for customers and shareholders Our strategy, which we set out on 30 June 2011 following an extensive and detailed review of the business, is focused on the UK, where we have distinctive assets and capabilities including our valuable customer franchise and market position, and multiple strong brands.
While our focus is on restoring the Group to sustainable profitability and delivering returns for all shareholders, we expect the delivery of our strategic targets to provide, over time, an opportunity for the UK Government to dispose of its shareholding in the Group in an orderly manner, and deliver value for taxpayers.
David joined Halifax in 1995, and has over 25 years experience in Retail financial services. Having developed his career inside the Group, he now has responsibility for the Halifax Community Bank. He is also a director of Sainsburys’ bank and Chairman of the ‘Your Tomorrow’ pension fund trustees.
Tim joined the Group in 2006 as Deputy Group Finance Director, before being appointed acting Group Finance Director in April 2008. Appointed to the Board in October 2008 as Group Finance Director. Tim left the Group on 24 February 2012.
The four elements of our action plan to deliver our strategy are to: Strengthen our balance sheet and liquidity position
Reshape our business portfolio to fit our assets, capabilities and risk appetite
Invest to be the best bank for our customers and to grow our core customer businesses
Good progress against strategic initiatives We are already making good progress against the key initiatives set out in our strategy.
In reshaping our business portfolio, we have fully embedded across the business a conservative approach to, and prudent appetite for, risk. We have in place rigorous controls over the risk profile of all new business, as evidenced, for example, in the Retail mortgage book where we have seen impaired loans decreasing but where our coverage ratio has increased, and are managing and successfully reducing our non-core assets in a disciplined manner and broadly in line with book value. In the core business, the improving quality of our portfolios and their decreasing risk profile, has been reflected in a 7 per cent decrease in risk-weighted assets. We have also reviewed our existing portfolios and confirmed them as adequately provisioned.
Management team changes On 1 February 2012, we announced changes to the Group’s senior management team to ensure we have the right organisational structure to deliver on our strategy and move to the next phase of the Group’s transformation. As a result, five business lines, Retail, Wholesale, Commercial, Wealth and International, and Insurance, now report directly to me and, further to the centralisation of all control functions as part of the Strategic Review, five control and support functions also report to me, namely Group Corporate Functions (into which Human Resources, Legal and Secretariat and Group Audit report), Risk, Finance, Operations, and Corporate Affairs.
I am pleased to report that during 2011, despite the challenging economic climate, the Group exceeded its full year contribution to the ‘Merlin’ lending commitments which were agreed in February with the UK Government, both for SMEs and in total. In the full year we provided £45 billion of committed gross lending to UK businesses, of which £12.5 billion was to SMEs. In the same period, the Group supported the start-up of 124,000 new SME businesses. For 2012, we have relaunched our SME Charter in which we have pledged to make at least £12 billion of gross new lending available to SMEs.
For our Retail customers, the Group completed £28 billion of new mortgage business in 2011, achieving a market share of approximately 20 per cent of gross new residential mortgage lending. We are committed to supporting the UK housing market and first-time buyers in particular. We advanced more than £5.6 billion of new lending to first-time buyers in 2011, helping over 52,000 customers own their first homes. Our market share of new first-time buyer business was approximately 24 per cent by value in 2011. In total, we advanced more than £15.5 billion of new mortgages to over 124,000 customers buying their home in the UK in 2011. Our Halifax brand is a leading lender in the affordable housing sector, with a dedicated product range designed for borrowers seeking shared equity or shared ownership schemes.
Looking forward, as part of our commitment to customers, we will keep the same net number of branches in our network for the next three years, excluding Verde, and we will not close a branch if it is the last one in a community.
We also received a number of external awards recognising the quality and consistency of delivery to our customers. Within Wholesale, our Corporate Markets area won the Best Bank of the Year award for the seventh consecutive year at the Real FD/CBI Excellence awards, while in Retail we were named ‘Best Overall Mortgage Lender’ for the tenth year running in the Your Mortgage Magazine Awards and in Insurance we were named as Britain’s most popular home insurance provider by the independent market researchers GFK NOP for the tenth year in a row. In responding to our customers’ need for access through multiple channels, in Retail, we launched a suite of Mobile Banking apps, and have now recorded one and a half million downloads.
On competition, we are pleased that the Verde sale is seen as creating an effective new challenger in our market, and that our proposals, developed with the Payments Council, to make it quicker and simpler for customers to switch accounts, were recommended by the ICB and backed by the Government.
Outlook and financial guidance We expect the external environment to remain challenging in 2012, with a subdued economy, continued high levels of regulatory scrutiny and political uncertainty relating to the banking sector, and the continued potential for downside effects from financial market volatility and instability in the Eurozone.
Other financial information 86 Core and non-core business analysis 86 Volatility arising in insurance businesses 94 Liability management gains 95 Integration costs and benefits 96 Simplification costs and benefits 96 Banking net interest margin 97
The stark difference is due to the high levels of indebtedness that many developed economies accumulated prior to 2008, which are holding back economic growth through deleveraging of initially the private sector, but now governments too. In the Eurozone, countries with particularly high government debt or deficit levels have lost market confidence as they struggled to achieve the necessary fiscal tightening to bring their public finances onto a sustainable trajectory without damaging economic growth prospects too severely. Ireland, Portugal and Greece have received further IMF and EU financial support in return for accepting even more stringent austerity programmes, and at the time of writing it looks likely that private creditors will suffer effective haircuts of significantly more than 50 per cent on their Greek debt. Italy and Spain have also tightened public budgets further, and given their much greater size this is dragging down Eurozone economic growth more significantly. In the US, public finance concerns are less immediate, but the unsustainable long term trajectory of debt on current policies has led to political stalemate, raising the risk of sudden fiscal tightening as previous loosening measures expire, and in turn hurting businesses’ and consumers’ confidence. Global growth was also hampered in 2011 by natural disasters, including the floods in Australia and the earthquake and tsunami in Japan, the latter causing significant disruption to global manufacturing supply chains.
The current consensus view for 2012 UK GDP growth is not yet that weak, at 0.4 per cent. The low level of imbalances in the economy relative to the 2008 position suggest that weak growth should not deteriorate into significant recession provided the Eurozone moves quickly towards a solution to the sovereign debt crisis. Bank Rate is likely to stay at or close to current low levels for some time, and property prices are expected to be broadly stable. Unemployment is likely to rise further, however, as estimates of public sector job cuts have increased. The current consensus view for 2012 Irish GDP growth is broadly flat, and the unemployment rate there is expected to be stable. Property prices are expected to fall further, but by less than in 2011.
The impact on our markets The weak economic recovery has kept growth in our markets subdued. With the economy expected to grow weakly at best in 2012, our central expectation is that growth in our markets will remain weak in 2012.
Similarly, companies have been focused on paying down existing debt, for the third successive year in 2011. Non-financial companies made net repayments of 3.7 per cent of sterling lending from banks and building societies in 2011, after repayments of 3.5 per cent in 2010 and 2.2 per cent in 2009. Company deposits with UK banks rose by 1.1 per cent in 2011, slower than the 1.8 per cent rise in 2010 and the 4.5 per cent increase in 2009. Although companies have held back investment spending and prioritised cashflow, much of this has fed into lower borrowing rather than higher deposits.
Regulatory environment: Uncertainty remains over key elements of the ICB reforms, particularly recovery and resolution mechanisms and retail ring fencing, and future capital and liquidity requirements arising from CRD IV remain unclear.
We have over 30 million customers and customer leadership driven by superior customer insight, tailored products, better service and relationship focus is the overriding priority. We want to meet all the financial needs of our customers and help them succeed financially. Only by successfully focusing on the needs of customers can we deliver sustainable value to our shareholders.
Though the UK financial services market remains one of the largest in the world our business model and strategy has been formulated in the context of a cautious outlook for the UK economy.
Fundamentally we remain a more conservative, through the cycle, relationship focused business and with a stronger balance sheet, a simpler and more efficient structure and the renewed customer focus we believe we can deliver strong, stable and sustainable returns for shareholders.
Aim We will focus on attractive UK customer segments and their product needs, to target a sustainable statutory return on equity of between 12.5 and 14.5 per cent.
Continued reduction in non-core assets In 2011 we have continued to make good progress in reducing the level of non-core assets, which now stand at £141 billion, down £53 billion in the year.
Channels and products: We intend to create a highly efficient distribution platform whilst providing customers with greater choice and convenience. We will streamline our product suite and migrate products to digital distribution channels, encompassing the internet, mobile applications and telephony.
Our integration programme was substantially completed in 2011, delivering a single banking platform and a run-rate of £2 billion per annum in cost synergies and other operating efficiencies.
We are targeting £1.7 billion of cost savings in 2014 through a series of simplification initiatives and have delivered £0.2 billion in 2011.
Priorities for 2012 Creation of a more efficient and agile organisational structure
Increased focus on sourcing and further reducing the number of supplier relationships
Bancassurance is a core part of our proposition Bancassurance will be a core part of our proposition, through our multi-brand retail strategy. There is a growing need for advice relating to investment and protection and we are well placed to address this through our bancassurance model.
Priorities for 2012 Further revitalisation of Halifax as a challenger brand
We expect other operating income (net of insurance claims) to increase to approximately 50 per cent of total income built on deepening customer relationships and our focus on less capital intensive products.
We expect to invest approximately £500 million annually by 2014, equivalent to approximately one-third of savings from our simplification initiatives, to grow our core income in addition to our business as usual investment programme.
Key initiatives and progress in 2011 We have made great progress in strengthening the Group’s balance sheet in 2011. In addition to the continued strengthening of our capital ratios, we have continued to make excellent progress in our wholesale funding and continued to reduce the level of government and central bank funding. Though much progress has been made in the last few years in this area, it is clear, given the current economic and regulatory environment that further strengthening is required and we will continue to target improvement in four main areas: capital position, liquidity, funding and loan to deposit ratio.
Further reductions in the loan to deposit ratio stRenGthen the Group’s balance sheet and liquidity position.
Aim We will continue to strengthen the Group’s balance sheet and liquidity position to ensure a robust core tier 1 capital ratio and stable funding base by: Targeting a robust core tier 1 capital ratio, prudently in excess of 10 per cent Exceeding regulatory liquidity requirements Maintaining a stable funding base Improving the Group loan to deposit ratio to 130 per cent or below
We have made good progress in reducing our loan-to-deposit ratio and though we initially targeted a loan-to-deposit ratio of <130 per cent by the end of 2014, we now expect to attain this in 2012.
We have continued to improve our core tier 1 ratio, which now stands at 10.8 per cent on a Basel II basis. We continue to target a core tier 1 ratio prudently in excess of 10 per cent from 1 January 2013 when the transition period to Basel III commences.
Building valuaBle relationships the successful delivery of our strategy will be driven by the relationships we develop with our customers.
investing in communities lloyds banking Group is the biggest corporate investor in UK communities, investing over £85 million last year in financial inclusion and financial capability, higher education and sports for young people and almost £30 million to support grassroots charities working with disadvantaged communities.
An appropriate risk appetite ensuring the business has the strength in funding and capital to meet the most challenging of headwinds.
Continue to improve our complaint handling performance reducing FSA reportable banking complaints per 1,000 accounts to 1.3 by the end of 2012
Through our simplification programme and continued focus on becoming the best bank for customers, our FSA reportable banking complaints continued to fall.
For our Retail customers, the Group completed £28 billion of new mortgage business in 2011, achieving a market share of approximately 20 per cent of gross new residential mortgage lending. We are committed to supporting the UK housing market and first-time buyers in particular. We advanced more than £5.6 billion of new lending to first-time buyers in 2011, helping over 52,000 customers own their own homes. our market share of new first-time buyer business was approximately 24 per cent by value in 2011. in total, we advanced more than £15.5 billion of new mortgages to over 124,000 customers buying their home in the UK in 2011.
Supplier relationships having strong relationships with our suppliers is key to the delivery of our strategy and ensuring both the bank’s and our customers’ needs are effectively met. the Group looks to build and develop strong collaborative relationships and engage in regular dialogue, meaning we can better understand the environment in which we operate and help access and drive the continuous improvement and innovation in our value chain. through working with our suppliers, we also get the opportunity to leverage their unique specialist knowledge in order to drive increased value and proactively optimise our supply chain. We consider our suppliers’ social, ethical and environmental performance as a standard part of our procurement process. We are also a signatory to the prompt payment Code which requires us to provide clear guidance on payment procedures and encourage similar good practice amongst our suppliers and other businesses.
to make this happen our organisation aims to attract, retain and develop the best talent in the industry and embraces diversity. At lloyds banking Group, we are committed to making a significant investment in our people. life here is fast-moving and full of challenges; it’s also incredibly rewarding. our rewards and benefits packages, which go beyond salary and bonus, are designed to keep our employees motivated to deliver excellent customer service.
Priorities for 2012 Making our customer-facing teams more successful, by ensuring those colleagues who come into direct contact with our customers are equipped with the necessary skills and expertise to provide a positive customer experience
these values define what we stand for when we are at our best; individually and as a team. they will help shape decisions all colleagues make and the actions they take and are being woven in to the way we do business across the Group, to help make us the best bank for customers.
earlier this year we had our succession planning and execution independently assessed as strong and in many instances, industryleading when compared with other Ftse 100 businesses. succession to the Group executive Committee and divisional leadership teams has materially improved year-on-year with 92 per cent of roles having at least one identified successor.
We have brought greater focus to building strong talent pipelines at middle and junior leadership levels. A number of initiatives launched in 2011 include the MbA programme, lloyds scholars programme and a new development programme for emerging executives and middle managers.
in 2011 we recruited 167 people into the lloyds banking Group Graduate leadership programme. the strength of the programme has been externally acknowledged and the Group has been rated by the times as one of the top 30 UK organisations for graduate recruitment. in addition we have attracted 47 interns to the Group along with under privileged students aged 16-19 in our new 6 week career academies programme.
Performance and reward Managing performance plays a critical role in helping us to develop our colleagues to build long term partnerships with customers and strong relationships with each other. this year has seen clear steps taken to improve organisational performance.
Following the completion of the Group strategic Review in June, we started to simplify and further integrate our approach by aligning performance and reward for all colleagues. Reflecting the new regulatory environment, 2011 also saw a strengthening of executive performance management with the introduction of a new moderation process to assess risk stewardship by all our senior executives.
the Stonewall 2011 Top 100 Employers for lesbian, gay and bisexual people, ranked the Group as the top private sector employer in the UK and as top scottish employer by stonewall scotland.
Rainbow – the Group’s network for lesbian, gay, bisexual and transgender (lGbt) colleagues – this year reached 1000 members, making it one of the largest employee networks of its kind in the UK.
Rainbow helps to engage and support lGbt colleagues promoting a positive working environment across the organisation.
Community engagement lloyds banking Group is the UK’s biggest corporate investor in UK communities. last year, we invested over £85 million in communities, including support for financial capability, higher education, sports for young people and support to the Group’s charitable Foundations.
We are the biggest corporate investor in UK communities. Last year, we invested over £85 million to support financial inclusion and financial capability, higher education, sports for young people and grassroots charities.
Priorities for 2012 Explore opportunities to improve our management of environmental, social and governance risks and increase transparency around our management of these
in 2011, as in 2010, lloyds banking Group was the largest corporate participant in business in the Community’s Give & Gain day – the UK’s largest single day of volunteering. over 2,000 colleagues took part, undertaking a variety of activities including renovating playgrounds, clearing conservation areas and hosting employability skills sessions for schoolchildren. in 2011 we also announced that we are sponsoring Give & Gain day for the next three years.
lloyds scholars provides students with support for their academic and vocational development, offering a complete financial and support package. this includes bursaries to help with living costs and study materials; performance-related cash awards for good grades; hands-on work experience through paid summer internships with the Group; and access to advice and support from a dedicated mentor. in return for these benefits, we ask scholars to champion the scheme to future applicants and take part in at least 100 hours volunteering in their local communities each year.
in the 2011/2012 programme we have thirty students participating from the University of sheffield and University of bristol. We are expanding the programme to six universities and 120 students for the next intake of students.
As well as widening participation to higher education, we’re particularly pleased that this scheme seeks to deepen participation through volunteering at university, ensuring that students not only receive the appropriate support through their mentoring scheme but are given opportunities to get further involved in their free-time.”
last year, we launched our teach Me, teach others financial education training programme. We are providing 1,400 free places on the programme for colleges and community groups, to enable them to deliver quality financial education in their communities. in addition, 100 lloyds banking Group employees have taken the teach others course and are now volunteering in a wide variety of community organisations.
We are also encouraging businesses that bank with us to take action to address climate change. We have trained over 650 colleagues on our business & environment programme, to enable them to guide and support our customers in recognising environmental risks and seizing the opportunities. We are the only major UK bank to provide this kind of support to its business customers.
We are launching a partnership with the school for social entrepreneurs that will over five years provide a support package to 500 entrepreneurs to create new social enterprises and hundreds of jobs in communities across the UK. social entrepreneurs are people who use their entrepreneurial talent to address a social need or problem in their community. their businesses are playing an increasingly important role in the UK economy with an estimated annual turnover worth £25 billion and a workforce totalling one million. the programme will enable 100 entrepreneurs every year to go through the school’s unique action learning programme and receive grants ranging from £4,000 to £25,000.
Bringing the Games closer to communities With Lloyds TSB and Bank of Scotland branches on nearly every UK high street we are in a unique position to bring the inspiration and excitement of the Games closer to communities across the country, through programmes like National School Sport Week and our Local Heroes programme, supporting the future of Team GB and ParalympicsGB.
Scottish Widows is Pensions and Investment Provider of the London 2012 Olympic and Paralympic Games and in 2011 we gave customers the chance to be at the Games - more than 60,000 entered our exclusive competition.
Our vision for our partnership, delivered through Lloyds TSB, Bank of Scotland and Scottish Widows, is to bring the Games even closer to communities and millions of people across the UK. In 2011 we continued to realise this vision with a programme of inclusive, inspirational and engaging activities, resulting in us being seen as the sponsor doing the most to support the Games.
National School Sport Week – York High School York High School held a number of events to celebrate National School Sport Week 2011, promoting the Olympic and Paralympic Values, boosting participation in physical activity and providing young people with leadership opportunities.
We developed a free, step-by-step guide, to help businesses understand the various ways in which they can prepare for the Games and seize the business opportunities.
Our Pace & Power events brought together local business people with Olympians and Paralympians and Local Heroes, who shared their thoughts on sporting success and how this can be translated into the world of business.
2011 was the fourth year of the Local Heroes programme and we supported 324 athletes. Local Heroes also attended a variety of internal and customer-facing Group events and initiatives including sharing their experiences with young schoolchildren during National School Sport Week; attending events with Olympians and business customers on the parallels between high performance in business and sport; and visiting branches with the London 2012 Olympic Torch to engage with our colleagues, customers and their families.
Costs reduced 4 per cent, driven by Integration and Simplification related savings and lower bonus accruals, partially offset by inflationary pressures, the new UK bank levy and FSCS costs. The impairment charge reduced by 26 per cent, with lower charges seen across all divisions. These lower charges were principally supported by the continued application of our prudent risk appetite and strong risk management controls resulting in improved portfolio and new business quality, continued low interest rates, and broadly stable UK property prices, partly offset by weakening UK economic growth and rising unemployment.
Operating expenses and other costs in the core business fell by 2 per cent despite absorbing additional FSCS and bank levy costs. The core impairment charge reduced by 20 per cent, reflecting the general stabilisation of our portfolios, and our continued prudent risk appetite applied to new business. The 2011 core impairment charge as a percentage of average loans and advances to customers improved to 0.64 per cent. Core loans and advances to customers generated just 24 per cent of the Group’s impaired loans, with a coverage ratio of 39 per cent at 31 December 2011.
Non-core operating expenses and other costs reduced by 21 per cent, reflecting the elimination of certain costs of supporting the non-core portfolios. The non-core impairment charge reduced, principally as a result of material reductions in the Wholesale and International impairment charges.
Liability management gains Liability management gains of £1,295 million arose in 2011 on transactions undertaken as part of the Group’s management of capital, primarily on the exchange of certain debt securities for other debt instruments. The gain comprises £696 million recognised in statutory net interest income, reflecting a reduction in the carrying value of certain debt securities as a result of changes in expected cash flows, and £599 million recognised in statutory other operating income relating to the debt securities exchange. The comparable gain in 2010 was £423 million and was recognised in statutory other operating income.
Other operating income increased by 19 per cent when compared to the third quarter of 2011, reflecting a recovery from poor trading conditions seen in the third quarter, to a level of other income more comparable with that seen in the first half of the year.
Further reductions in the impairment charge The Group continued to see reductions in the impairment charge in 2011. The impairment charge of £9,787 million in 2011 was 26 per cent lower than the £13,181 million charge in 2010, with lower charges seen across all divisions. These lower charges were principally supported by the continued application of our prudent risk appetite and strong risk management controls resulting in improved portfolio and new business quality, continued low interest rates, and broadly stable UK retail and commercial property prices, partly offset by weakening UK economic growth and rising unemployment.
During 2011, Retail’s secured impairment charge was £463 million, in line with expectations, with the increase on 2010 largely reflecting a less certain outlook for house prices, and provisioning against existing credit risks which have longer emergence periods due to current low interest rates. These factors were partially offset by an improvement in the quality of the secured portfolio. This resulted in provisions as a percentage of impaired loans increasing from 23.5 per cent at 31 December 2010 to 25.6 per cent at 31 December 2011. Secured asset quality remained good and the number of customers entering arrears reduced through 2011 compared to 2010. The stock of properties in repossession remained stable and the sales prices of repossessed properties continued to be at expected values. The proportion of the mortgage portfolio with an indexed loan-to-value of greater than 100 per cent has decreased to 12 per cent benefitting from the regional mix of lending. The value of the portfolio with an indexed loan-to-value of greater than 100 per cent and more than three months in arrears has been stable at just over £3 billion.
Our core tier 1 capital ratio improved significantly to 10.8 per cent at 31 December 2011 (31 December 2010: 10.2 per cent). The impact of the statutory loss, and an increase in risk-weighted assets of approximately £7 billion from the implementation of CRD III which reduced core tier 1 capital ratio by approximately 20 basis points, were more than offset by a reduction in risk-weighted assets of £54.1 billion, principally from disposals of higher risk non-core assets. The total capital ratio improved to 15.6 per cent (31 December 2010: 15.2 per cent).
Risk-weighted assets reduced 13 per cent to £352.3 billion in 2011, driven by the run-down of our non-core asset portfolio, which accounted for 65 per cent of the reduction, and weak demand for new lending. Modelling changes had no material effect on risk-weighted assets.
In line with our strategy, the capital intensity of the balance sheet continues to reduce, with new lending being of better quality than existing portfolios, and thus having a lower average risk-weighting.
Total Group funded assets decreased to £587.7 billion from £655.0 billion at 31 December 2010, substantially driven by reductions in non-core portfolios across the banking divisions, continued customer deleveraging and de-risking and subdued demand in lending markets. We are pleased with the progress made on our balance sheet reduction plans in the period, given challenging market conditions. In 2011, we achieved a substantial reduction in the non-core portfolio of £53 billion, resulting in the portfolio at 31 December 2011 amounting to £141 billion. This reduction includes more than A2 billion of cash generated from repayments and disposals from the Irish portfolio.
The Group made excellent progress against its funding objectives in 2011 and further enhanced its general funding and liquidity position which is supported by a robust and stable customer deposit base. Customer deposits excluding repos increased by 6 per cent, reflecting good growth in relationship deposits, and now represent 62 per cent of our deposit and wholesale funding.
At 31 December 2011, the Group had £24 billion of issuance remaining under the UK Credit Guarantee Scheme. As previously outlined, we expect to repay the remaining facilities in line with their contractual maturity dates, £19 billion in the first half of 2012 and £5 billion in the second half of 2012.
Key balance sheet and other items 31 December 2011 £bn £bn £bn £bn £bn £bn £bn
Operating expenses excluding impairment of tangible fixed assets divided by total income net of insurance claims.
Impairment as a percentage of average advances 0.74% 2.23% 1.24% 8.90% 2.01%
Loans and advances to customers (excluding repos): Customer deposits (excluding repos): Total customer balances 599.9 599.3
Strategic focus Retail’s goal is to be the UK’s best bank for customers. This will be achieved by building deep and enduring relationships with our customers which will deliver real value to them, and, by continuing to support the UK economy. Developing our customer insight and having a deeper understanding of customers and their needs will enable us to better invest in products and services that customers will most value. In addition by simplifying the business and developing highly efficient and effective processes we will deliver an improved customer experience and increase the flexibility with which the business can respond to changes in the operating environment. Success for Retail will be reflected in an enhanced customer experience resulting in strong customer advocacy which in turn, we believe, will lead to lower customer acquisition costs, increased share of wallet and improved customer retention. Retail believes this strategy will drive sustainable long‑term value for all stakeholders.
2011 highlights Profit before tax decreased by 9 per cent to £3,636 million, driven by higher funding costs and muted demand for credit.
Operating expenses and other costs reduced by 4 per cent, benefiting from cost savings from both our integration and simplification programmes partially offset by inflation. We continue to invest in the Retail business to improve products and services for our customers including in both our digital platforms and our branches.
Fair value unwind decreased by 24 per cent, driven largely by the maturing balances of the pre‑acquisition portfolio.
Loans and advances to customers decreased by 3 per cent as customers continued to reduce their personal indebtedness particularly in unsecured lending, as non‑core balances reduced and as we maintained a conservative risk appetite. Risk‑weighted assets fell 6 per cent, principally reflecting reductions in unsecured balances.
Our support for households is vital to the strength of the UK economy. Through our community investment agenda we aim to make a lasting difference to the country, focusing on key themes such as financial capability and inclusion, and environmental responsibility.
Total income decreased by £1,061 million, or 10 per cent, to £9,194 million. This was driven by a reduction in net interest income of £1,151 million, while other income increased by £42 million. Core income trends were consistent with total income performance described below.
Credit performance across the business continued to be supported by our conservative approach to risk, a continued focus on existing customers and low interest rates. The impairment charge on loans and advances decreased by £777 million, or 28 per cent, to £1,970 million driven by reductions in the unsecured charge. The unsecured impairment charge reduced to £1,507 million from £2,455 million in 2010, reflecting the impact of our continued conservative approach to risk (resulting in improved new business quality), effective portfolio management and a reduction in unsecured balances. The secured impairment charge increased to £463 million from £292 million in 2010 largely reflecting a less certain outlook on house prices and appropriate provisioning against existing credit risks which have longer emergence periods due to current low interest rates. These factors were partially offset by underlying improvement in the quality of the secured portfolio.
The fair value unwind net credit was £839 million compared with £1,105 million in 2010. This reduction was driven largely by the maturing balances of the pre‑acquisition portfolio.
The division comprises Wholesale Banking and Markets (WBM) and our Asset Finance business. The Wholesale Banking and Markets business serves corporates with turnover above £15 million, and financial institutions with a range of relationship focused propositions, segmented according to customer need.
Coverage comprises Corporate Banking, Mid Markets and Sales. Corporate Banking is responsible for the overall management of relationships with major corporate and institutional customers principally in the UK. Similarly Mid Markets manages the relationships with mid market corporates, which operate on a pan-UK basis. Sales provide customers with tailor-made risk management solutions through liability, foreign exchange, commodity and interest rate management products.
In 2012, the focus will be on strengthening the franchise in those businesses that generate sustainable, predictable returns on equity at the level targeted by the Group Strategic Review while continuing to reduce non core assets in a capital efficient way.
Assets decreased by 18 per cent, (25 per cent excluding reverse repos), reflecting the targeted reduction in the non-core balance sheet by £35 billion. Although net lending to core customers (excluding reverse repos) reduced by £9 billion as a result of weak demand and continued customer deleveraging as credit facilities matured and were not renewed by customers, gross new committed lending to customers continues to meet our lending commitments. Risk-weighted assets reduced by 16 per cent, in line with the reduction in the balance sheet.
Awards In 2011, Wholesale’s focus on deepening customer relationships and continued commitment to core businesses was once again recognised by Finance Directors of commercial and corporate companies who voted Lloyds TSB as Bank of the Year in the CBI/Real FD awards for the seventh year running.
Income Wholesale’s income performance was significantly impacted by lower asset balances, losses on asset disposals in the year to strengthen the balance sheet and net derivative valuation adjustments. Net derivative valuation adjustments of £718 million were driven primarily by a large fall in long term sterling interest rates and significantly higher market credit spreads. Losses on disposal of £697 million were realised from the disposal of assets and were offset by a related fair value unwind. Net of these effects, income reduced by £1,347 million or 20 per cent, primarily as a consequence of economic and market conditions, which resulted in customer deleveraging, higher funding costs, and lower trading revenues.
Total income net of volatile items and asset sales 5,474 6,821 (20)
The net banking margin decreased by three basis points to 1.56 per cent. This principally reflects increased wholesale funding costs, partly offset by customer re-pricing and increased deposit margins and volumes. Asset margins decreased as the benefit of higher customer rates was more than offset by funding costs, whilst liability margins improved.
The core impairment charge was £741 million, compared to £576 million in 2010. The increase is attributable to a few specific large cases reflecting the nature of impairments in a Wholesale portfolio. The non-core impairment charge decreased by £1,328 million, or 38 per cent, to £2,160 million in 2011. This was primarily due to lower impairment from non-core corporate real estate and real estate related asset portfolios, reflecting a stabilisation of commercial property prices in 2011. Non-core impairments in 2010 were significant as a result of the scale and pace of deterioration in the property sector and poorer quality heritage HBOS lending.
The share of results from joint ventures and associates, which are all non-core, comprised a small profit of £14 million, an improvement of £109 million, due to the non-recurrence of losses and impairments taken in 2010.
Loans and advances to customers excluding reverse repos reduced by £18.2 billion, or 13 per cent, to £123.3 billion as demand for new corporate lending and refinancing of existing facilities was more than offset by maturities, reflecting a continued trend of subdued corporate demand for lending, customer deleveraging and asset sales in non-core sectors. Non-core lending accounted for 51 per cent, of this reduction. Available-for-sale financial assets balances reduced by £16.9 billion, or 57 per cent, to £12.6 billion and debt securities by £13.3 billion, or 52 per cent, to £12.5 billion. This was driven by the reduction in the non-core balance sheet through treasury and other asset sales or not replenishing holdings after amortisations and maturities. The non-core proportion of these reductions was £12.7 billion, or 75 per cent, in the case of available-for-sale assets, and £13.1 billion, or 98 per cent, in the case of debt securities. Loans and advances to banks reduced by £4.0 billion, or 32 per cent, to £8.4 billion.
Of which reverse repos represent £16.8 billion (31 December 2010: £3.1 billion).
Net interest income decreased by £647 million, or 27 per cent, to £1,783 million. The decrease reflects lower interest-earning asset balances in line with the continued focus on balance sheet reduction and strengthening, mainly in loans and advances to customers, debt securities and available-for-sale positions. Net interest income was also adversely affected by higher wholesale funding costs, which was partially offset by an increase in the liability margin resulting from the increased market value of deposits.
Supporting start-ups Through our Relationship Manager network an innovative company has been able to research and launch their range of umbrellas, where the material changes colour when wet. SquidLondon umbrellas are stocked in places such as the Conran Store and the TATE.
Flexible monthly price plan Lloyds TSB was the first UK bank to offer a range of flexible Monthly PricePlans, which simplify charges and improve transparency for business banking customers. This innovative approach offers customers choice, flexibility and gives them greater control of their banking.
Operating expenses reduced by 4 per cent, primarily as a result of integration cost savings including lower back office staffing requirements.
Risk-weighted assets decreased by 5 per cent, reflecting the improved mix and risk profile of the portfolio.
Risk-weighted assets have reduced in the context of increased lending, reflecting the improvement in risk profiles as well as the higher mix of secured lending in the book.
The customer benefits arising from simplification are important with significant progress being made on the re-engineering of the lending process. A successful pilot of the new process has halved the time taken to fulfil lending to customers. This will be fully rolled out by the end of 2012. The product range has also been simplified for customers with the launch of the UK’s first range of Monthly Price Plans providing certainty and control over bank charges to SME customers; over 30,000 customers have already signed up to this new product.
Customer deposits increased 3 per cent to £32.1 billion reflecting our ongoing success in attracting new customers, combined with targeted support in key customer segments such as the education and legal sectors.
Within the core business, profit before tax and fair value unwind increased by 20 per cent
Wealth demonstrated continued strength in client acquisition through the UK franchise with an 8 per cent increase in customer numbers
Best UK Private Bank At the Financial Times and Investors Chronicle Wealth Management Awards, Bank of Scotland Private Banking won Best UK Private Bank. Voted for by industry experts and readers of the FT, the award evidences the high quality service our private banking clients receive.
Operating expenses increased by 1 per cent, due to higher regulatory costs, investment in growth initiatives and the effect of stronger foreign currency rates, partly offset by benefits from cost saving initiatives across all businesses.
Net loans and advances to customers decreased by 21 per cent, largely driven by de-risking of the balance sheet through reducing non-core assets across both Wealth & International. Risk-weighted assets decreased by 19 per cent, reflecting lower asset balances and additional impairment provisions, particularly in International.
Against its strategic objectives, Wealth demonstrated continued strength in client acquisition through the UK franchise with an 8 per cent increase in customer numbers. To date the division has announced the exit from seven countries, and corporate lending has been refocused around selected customers aligned to UK product and sector plans and the Group’s international risk appetite. International is contributing to a strengthening of the Group’s balance sheet through a significant and managed run-down of non-core assets together with diversification of sources of funding through international deposits.
Progress against strategic initiatives As with the wider Group, Wealth and International’s strategic focus has been on: Reshaping the business to better fit the Group’s risk appetite Focus remains on maximising value and aligning with the Group’s risk appetite through close management of the lending portfolio, continuing disciplined reduction of non-core assets, diversifying sources of funding and rationalisation of our international presence.
Financial performance Loss before tax and fair value unwind reduced by 22 per cent to £4,130 million due to a lower impairment charge, predominantly in Ireland, more than offset by lower income and higher costs.
Operating expenses and other costs increased by 1 per cent, due to increased investment in the International deposit business, the impact of the stronger Australian dollar and Swiss franc and additional regulatory costs in Wealth. On a constant currency basis, operating expenses reduced by 1 per cent. Despite increased investment in International deposit gathering, the cost: income ratio overall improved by 3 per cent in our core business.
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Net interest income increased by 20 per cent, reflecting improving deposit margins across the Wealth business.
Risk-weighted assets decreased by £2.6 billion or 25 per cent, to £7.8 billion reflecting lower lending volumes and improved use of collateral.
Funds under management reduced by £10.0 billion to £182.0 billion. Net outflows of £19.9 billion reflect expected attrition on insurance funds within SWIP, the market backdrop in the second half of 2011 and fund outflows within Invista Real Estate reflecting both transfers to SWIP during the year and the wind down of Invista Real Estate business. SWIP’s inflows include £2.4 billion of funds previously managed by Invista Real Estate. Reductions in global equity values contributed towards investment return, expenses and commission of funds under management by £2.8 billion. This together with the general market backdrop contributed to a shift in customer investments in our Wealth businesses away from funds towards Wealth and Retail deposits.
Loss before tax and fair value unwind reduced by £1,223 million to £4,319 million mainly as a result of a lower impairment charge, reflecting a reduction of £1,077 million in Ireland and £328 million in Australia.
The impairment charge reduced by £1,432 million, or 24 per cent, to £4,510 million due to reduced impairment charges in Ireland and Australia.
Risk weighted assets decreased by £8.8 billion or 18 per cent, to £39.5 billion reflecting lower asset balances and further impairment provisions and foreign exchange rate movements. This is partly offset by an increase in risk weighted assets to cover further deterioration in the Irish housing market and other credit risk model changes which impact risk weighted assets.
Customer deposits increased by £8.8 billion to £14.8 billion driven by continued strong performance within our International on-line deposit business.
LP&I UK sales of £10,219 million (PVNBP) reduced by 1 per cent
Capital management initiatives in 2011 have resulted in £2.3 billion mitigation of the potential impact of CRD IV
Against its strategic objectives, Insurance has focused on removing duplication to simplify the business and is improving customer insight to support responsiveness to changing customer needs. LP&I (UK) has built upon successful sales force integration and single bancassurance proposition launch to deliver a number of further improvements to its operations and capability. General Insurance has improved customer experience by the introduction of a single telephony and e-commerce platform across all brands.
Capital management initiatives in 2011 have resulted in £2.3 billion mitigation of the potential impact of CRD IV. This includes capital restructuring within the business that occurred in July 2011 which reduced the Group’s estimated total core tier 1 impact of CRD IV by over £2 billion. Since 1 January 2010, the mitigation of the potential impact of CRD IV is estimated to be £4.6 billion in total.
In 2011 LP&I (UK) built upon the successful sales force integration and proposition launch to deliver a number of further improvements to its operational capability and cost effectiveness. These include in-sourcing life and pensions policies from a third party, the further consolidation of locations, delivery of new eCommerce capability for intermediaries and enhanced investment accounting capabilities through a single outsourced arrangement.
Within General Insurance significant improvements have been delivered in improving the customer experience through the delivery of combined claims and administration platforms.
In General Insurance, the strategy is focused around protecting and growing home insurance business whilst seeking to expand its role in other markets.
The strategy is to secure value in the existing business, building on the relationship with its key distributor.
Despite the reduction in sales total new business profit within LP&I UK increased by £64 million, or 24 per cent, to £331 million.
Within the intermediary channel the increase in sales of £981 million, or 17 per cent, mainly reflects strong sales of corporate pensions in LP&I UK. The increase in sales has been achieved whilst maintaining the new business margin on corporate pension business.
The key drivers of investment return are equity and gilt movements. In the year UK equity markets fell 3 per cent and European markets fell 15 per cent while gilt markets increased by 16 per cent. In 2010 both equities and gilts performed strongly, creating large investment gains.
Maturity profile of in-force business The table below shows the profile of the Value of In-Force (VIF) asset recognised on the IFRS balance sheet based on the date when the profit is expected to emerge.
incorporates the methodology changes outlined in the october 2011 announcement (new Allocation Methodologies for Funding Costs and Capital).
property: we will further consolidate the group’s property portfolio, enabled by the delivery of process and efficiency savings from the simplification programme.
net interest income 585 571 effects of liability management, volatile items and asset sales 1,293 150
total income increased by £1,181 million to £1,829 million primarily due to a £1,143 million increase in volatility and liability management effects. these included a £872 million increase in liability management gains. in addition, there was a £615 million reduction in the mark-to-market losses arising from the equity conversion feature of the Group’s enhanced capital notes, partly offset by a £344 million adverse movement on banking volatility, which is attributed to ineffectiveness in hedge accounting relationships and banking book derivatives not mitigated through hedge accounting.
liability management gains arose on transactions undertaken as part of the Group’s management of capital, largely the exchange of certain debt securities for other debt instruments or, for 2010 only, ordinary shares. these transactions resulted in a gain of £1,295 million in 2011, which comprises £696 million recognised in statutory net interest income, reflecting a reduction in the carrying value of certain debt securities as a result of changes in expected cash flows, and £599 million recognised in statutory other income relating to the exchange of existing securities into new securities. the gain in 2010 (£423 million) was recognised in statutory other income.
Fair value unwind decreased by £172 million to a charge of £1,274 million primarily due to deal maturities leading to reduced amortisation.
Total income, net of insurance claims 19,536 20,023 operating expenses (9,369) (9,838)
Non-core net interest income 1,317 2,398 effects of liability management, volatile items and asset sales (677) (144)
Profit before tax and fair value unwind 6,977 6,541 7 fair value unwind (628) (389) (61)
Profit before tax and fair value unwind 2,704 711 436 192 1,369 1,565 6,977 impairment as a % of average advances 0.54% 0.89% 1.09% 0.63% 0.64%
Profit before tax and fair value unwind 2,446 2,028 178 160 1,238 491 6,541 impairment as a % of average advances 0.77% 0.57% 1.34% 0.31% 0.75%
(Loss) before tax and fair value unwind (6,235) (7,447) 16 fair value unwind 2,571 3,507 (27)
Total income, net of insurance claims 272 500 23 656 136 – 1,587 costs: other costs – – – – – (55) (55)
Assets loans and advances to customers excl reverse repos 27.7 46.8 1.4 35.9 111.8 customer deposits excluding repos – 2.8 0.3 1.3 4.4
impairment as a % of average advances 0.37% 4.37% 0.05% 10.15% 5.56%
the expected sterling investment returns used to determine the normalised profit of the business, which are based on prevailing market rates and published research into historical investment return differentials, are set out below: corporate bonds in unit-linked and With Profit funds (gross) 3.08 4.59 5.05 fixed interest investments backing annuity liabilities (gross) 3.89 4.78 5.30 the impact on the results due to the actual return on these investments differing from the expected return (based upon economic assumptions made at the beginning of the year) is included within insurance volatility. changes in market variables also affect the realistic valuation of the guarantees and options embedded within the With Profits funds, the value of the in-force business and the value of shareholders’ funds.
Policyholder interests volatility the application of accounting standards results in the introduction of other sources of significant volatility into the pre-tax profits of the life, pensions and investments business. in order to provide a clearer representation of the performance of the business, and consistent with the way in which it is managed, adjustments are made to remove this volatility from underlying profits. the effect of these adjustments is separately disclosed as policyholder interests volatility; there is no impact upon profit attributable to equity shareholders over the long term.
Run-rate by market facing division £m cost synergies have been delivered through the integration of hBoS operations, processes and it systems. these synergies have arisen through procurement; property with 83 head office sites vacated; it cost savings and job reductions.
Total dividend for the year1 – – – 648 2,026 31 December 31 December 31 December 31 December 31 December
Post-tax return on average shareholders’ equity (6.2) (0.7) 8.8 7.0 28.1 31 December 31 December 31 December 31 December 31 December
Full analysis of risk drivers 112 Financial soundness 112 Credit risk 129 Market risk 164 Operational risk 167 Insurance risk 169 Business risk 170
– the interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by both the Board and senior management.
– the group has a conservative business model embodied by a risk culture founded on prudence and individual accountability, where the needs of customers are paramount.
Enterprise-Wide Risk Management – the group uses an enterprise-Wide Risk management framework for the identification, assessment, measurement and management of risk.
– the framework seeks to strengthen the group’s ability to identify and assess risks, aggregate and report group wide risks and refine risk appetite.
Priorities for 2012 Risk Division’s mission in 2012 is to support sustainable growth through: Strategy: Supporting the delivery of the Group’s strategic plan, within risk appetite
The Group has made good progress in reducing non-core assets and improving the asset quality ratio.
Excellent progress in de-risking the Retail books. Solid progress in Wholesale and good progress to tackle the issues in the international books.
Risk as a strategic differentiator the group’s strategy and risk appetite were developed together to ensure one informed the other in creating a strategy that delivered on becoming the best bank for our customers whilst creating sustainable growth over time.
Conservative Approach – the group has a fully embedded conservative approach to, and prudent appetite for risk.
– taking risks which are well understood, consistent with strategy and appropriately remunerated, is a key driver of shareholder return.
in 2011, there has been a significant improvement in our Balance sheet, capital and funding position.
the group achieved a significant reduction in it’s impairment charge in 2011, due primarily to lower corporate real estate charges in Wholesale and strong Retail performance. All divisions experienced a reduction in impairment charges of above 20 per cent from 2010.
Reflecting the importance the group places on risk management, risk is included as one of the five principle criteria within the group’s balanced scorecard on which business areas and individual staff performance and remuneration is judged.
the Risk Committee, which comprises non-executive Directors, oversees and challenges the development, implementation and maintenance of the group’s risk management framework, ensuring that its strategy, principles, policies and resources are aligned internally to its risk appetite as well as externally to regulation, corporate governance and industry best practice. the Risk Committee regularly reviews the group’s risk exposures across the primary risk drivers and the detailed risk types.
– the Group Stress Testing Committee is responsible for reviewing, challenging and recommending to group executive Committee the annual stress testing of the group’s operating plan based on internal and FsA recommended scenarios, annual european Banking Authority stress tests, and other group wide macroeconomic stress tests.
During 2011, the group’s risk committee framework has been reviewed in order to ensure more effective risk management, clearer accountabilities, and more efficient and simplified processes. A new risk committee framework has been implemented, whereby the group Risk Committee is supported by the following Committees: Annual Report and Accounts 2011102
– Credit Risk Committees, which are responsible for the development and effectiveness of the relevant credit risk management framework, clear description of the group’s credit risk appetite, setting of high-level group credit policy, and compliance with regulatory credit requirements. Risk Committees monitor and review the group’s aggregate credit risk exposures and concentrations of risk on behalf of the group Risk Committee.
– the Group Market Risk Committee, which on behalf of the group Asset and Liability Committee, monitors and reviews the group’s aggregate market risk exposures and concentrations and provides a proactive and robust challenge around business activities giving rise to market risks.
– the Group Operational Risk Committee, which is responsible for identifying significant current and emerging operational risks or accumulation of risks and control deficiencies across the group and reviewing associated oversight plans to ensure pre-emptive risk management action. the Committee also seeks to ensure that adequate business area engagement occurs to develop, implement and maintain the group’s operational risk management framework.
– the Group Compliance and Conduct Risk Committee is responsible for forming a group wide view of the group’s compliance and conduct risk profile, reviewing the effectiveness of compliance and conduct risk frameworks and reviewing relevant polices and engagement with regulators.
Risk Division, headed by the Chief Risk Officer, consists of eleven Risk Directors and their specialist teams. these teams provide oversight and independent challenge to business management and support the senior executive and the Board with independent reporting on risks and opportunities. Risk Directors, responsible for each risk type, meet on a regular basis under the Chairmanship of the Chief Risk Officer to review and challenge the risk profile of the group and to ensure that mitigating actions are appropriate.
Business Unit managing Directors/executives have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are required to establish control frameworks for their businesses that are consistent with the group’s policies and are within the parameters set by the Board, group executive Committee and Risk Division. Compliance with policies and parameters is overseen by the Risk Committee, the group Risk Committee, the group Asset and Liability Committee, and Risk Division, and independently challenged by group Audit.
Risk Directors, who report directly to the Chief Risk Officer, are allocated responsibility for specific risk types and are responsible for ensuring the adequacy of the framework for their risk types as well as the oversight of the risk profile across the group. Risk Directors also support specific business areas to provide an enterprise-wide risk management perspective.
All business areas complete a control effectiveness review annually (see page 186), reviewing the effectiveness of their internal controls and putting in place a programme of enhancements where appropriate. executives of each business area and each group executive Committee member certify the accuracy of their assessment.
Risk management in the business forms part of a tiered risk management model, as shown above, with Risk Division providing oversight and challenge, and the Chief Risk Officer and group committees establishing the group wide perspective.
the principal elements of the framework are shown in table 1.2. these map to the components of the internal control framework issued by the Committee of sponsoring Organisations of the treadway Commission.
the risk appetite is executed through Policy Framework and Accountabilities, comprising the following levels of policy: – Principles: Board-level statements of principle for the six primary risk drivers
All policies are reviewed annually to ensure they remain fit for purpose.
Colleagues are expected to be aware of and to comply with the policies and procedures which apply to them and their work. Line management in each business area has primary responsibility for ensuring that they do so.
the outcomes of independent reviews (including internal and external audit and regulatory reviews) are reflected in risk management activities and action plans.
the combination of right-sizing the balance sheet and continued development of the retail deposit base has seen the group’s wholesale funding requirement reduce in the past year. the progress the group has made to date in diversifying its funding sources has further strengthened its funding base. During the first half of 2011 the group accelerated term funding initiatives and the run down of certain non-core asset portfolios allowing a further reduction in total government and central bank facilities. the group repaid its remaining drawings under the Bank of england sLs scheme in full during 2011. Outstandings under the Credit guarantee scheme reduced in line with their contractual maturities, with £23.5 billion remaining at end December. the outstanding amount matures during 2012.
Risk Definition Liquidity risk is defined as the risk that the group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost.
Funding risk is defined as the risk that the group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.
Liquidity and funding (continued) Mitigating Actions the group takes many mitigating actions with respect to this principle risk, key examples include: the group has maintained its liquidity levels in excess of the iLg regulatory minimum (FsA’s individual Liquidity Adequacy standards) at all times. Funding projections show the group will achieve the proposed Basel iii liquidity and funding metrics in advance of expected implementation dates. the Liquidity Coverage Ratio (LCR) is due to be implemented on 1 January 2015 and the net stable Funding Ratio (nsFR) has a 1 January 2018 implementation date. the european Commission released its proposal for implementing Basel iii into europe (CRD iV) in July 2011 and we note that discussions over the final detail are ongoing.
the group carries out monthly stress testing of its liquidity position against a range of scenarios, including those prescribed by the FsA. the group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
term wholesale funding issuance for the year totalled £35 billion, in excess of plan, representing £2 billion pre-funding of the requirement for 2012.
Credit Principal Risks Arising in the Retail, Wholesale, Commercial, and Wealth and international divisions, reflecting the risks inherent in the group’s lending activities and, to a much lesser extent in the insurance division in respect of investment of own funds. Adverse changes in the credit quality of the group’s Uk and/or international borrowers and counterparties, or in their behaviour, would be expected to reduce the value of the group’s assets and materially increase the group’s write-downs and allowances for impairment losses. Credit risk can be affected by a range of factors, including, inter alia, increased unemployment, reduced asset values, lower consumer spending, increased personal or corporate insolvency levels, reduced corporate profits, increased interest rates or higher tenant defaults. Over the last four years, the global banking crisis and economic downturn has driven cyclically high bad debt charges. these have arisen from the group’s lending to: – Wholesale customers (including those in Wealth and international): where companies continue to face difficult business conditions. impairment levels have reduced materially since the peak of the economic downturn and more aggressive risk appetite in the HBOs businesses when elevated corporate default levels and illiquid commercial property markets resulted in heightened impairment charges. the Uk economy remains fragile. Consumer and business confidence is low, consumer spending has been falling over the past year, the reduction in public sector spending is deepening and exports are failing to offset domestic weakness. the possibility of further economic weakness remains. Financial market instability represents an additional downside risk. the group has exposure in both the Uk and internationally, including europe, ireland, UsA and Australia, particularly in commercial real estate lending, where we have a high level of lending secured on secondary and tertiary assets.
in addition, the european Banking Authority, the european insurance and Occupational Pensions Authority and the european securities and markets Authority as new eU supervisory Authorities are likely to have greater influence on regulatory matters across the eU.
– the main equity market risks arise in the life assurance companies and staff pension schemes.
Mitigating Actions the group takes many mitigating actions with respect to this principal risk, key examples include: market risk is managed within a Board approved framework using a range of metrics to monitor the group’s profile against its stated appetite and potential market conditions.
People Principal Risks the quality and effectiveness of the group’s people are fundamental to its success. Consequently, the group’s management of material people risks is critical to its capacity to deliver against its long-term strategic objectives. Over the next year the group’s ability to manage people risks successfully may be affected by the following key drivers: – the group’s continuing structural consolidation and the sale of part of our branch network under Project Verde may result in disruption to our ability to lead and manage our people effectively.
– the continually changing, more rigorous regulatory environment may impact our people strategy, remuneration practices and retention.
– macroeconomic conditions and negative media attention on the banking sector may impact retention, colleague sentiment and engagement.
insurance risk is controlled by robust processes including underwriting, pricing-to-risk, claims management, reinsurance and other risk mitigation techniques.
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Risk drivers the group’s risk language is designed to capture the group’s ‘primary risk drivers’. A description of each ‘primary risk driver’, including definition, appetite, control and exposures, is included below. these are further sub-divided into 33 more granular risk types to enable more detailed review and facilitate appropriate reporting and monitoring, as set out in table 1.3.
measurement A series of measures are used across the group to monitor both short and long-term liquidity including: ratios, cash outflow triggers, wholesale funding maturity profile, early warning indicators and stress test survival period triggers. the Board approved liquidity risk appetite links a number of these measures to balance sheet progression set out in the group funding plan, with regular reporting to the group Asset and Liability Committee and the Board. strict criteria and limits are in place to ensure highly liquid marketable securities are available as part of the portfolio of liquid assets.
Details of contractual maturities for assets and liabilities form an important source of information for the management of liquidity risk. note 56 to the financial statements on page 337 sets out an analysis of assets and liabilities by relevant maturity grouping. in order to reflect more accurately the expected behaviour of the group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. this forms the foundation of the group’s liquidity controls.
mitigation the group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through both short-term liquidity management and long-term funding strategy. short-term liquidity management is considered from two perspectives; Risk mAnAgement
Daily monitoring and control processes are in place to address both statutory and prudential liquidity requirements. in addition, the framework has two other important components: – Firstly, the group stress tests its potential cash flow mismatch position under various scenarios on an ongoing basis. the cash flow mismatch position considers on-balance sheet cash flows, commitments received and granted, and material derivative cash flows. specifically, commitments granted include the pipeline of new business awaiting completion as well as other standby or revolving credit facilities. Behavioural adjustments are developed, evaluating how the cash flow position might change under each stress scenario to derive a stressed cash flow position. scenarios cover both Lloyds Banking group name specific and systemic difficulties. the scenarios and the assumptions are reviewed at least annually to gain assurance they continue to be relevant to the nature of the business.
the combination of right-sizing the balance sheet and continued development of the retail deposit base has seen the group’s wholesale funding requirement reduce materially in the past two years. the progress the group has made to date in diversifying its funding sources has further strengthened its funding base.
Sterling US Dollar Euro Other currencies Total £bn £bn £bn £bn £bn
the wholesale funding position includes debt issued under the legacy government Credit guarantee scheme, for which the last maturity will occur in October 2012.
Available-for-sale financial assets – primary 25.4 17.3 47 trading and fair value through profit or loss7 (3.5) –
Other assets and other liabilities primarily include balances in the group’s insurance businesses and the fair value of derivative assets and liabilities.
encumbered assets the group remains a consistent issuer in a number of secured funding markets, in particular RmBs and covered bonds (see table 1.6).
Liquidity management Liquidity is managed at the aggregate group level, with active monitoring at both business unit and group level. monitoring and control processes are in place to address both internal and regulatory requirements. in a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event.
the group carries out stress testing of its liquidity position against a range of scenarios, including those prescribed by the FsA. the group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
the payments on those of the hybrid capital securities that are not cash-cumulative and which are expected, subject to their terms and conditions, to be paid in 2012 are estimated to amount to approximately £170 million. in the context of recent macro prudential policy discussions, the Board of Lloyds Banking group has decided to issue new Lloyds Banking group ordinary shares to raise this amount. the group has entered into an agreement with a third-party financial institution in connection with the issue of these new ordinary shares. such ordinary shares are expected to be issued, subject to market conditions, by the end of April 2012 at a price determined by reference to the volume weighted average price of our ordinary shares in a period prior to their date of issue.
Definition Capital risk is defined as the risk of the group having a sub-optimal amount or quality of capital or that capital is inefficiently deployed across the group.
the minimum total capital required under pillar 1 of the Basel ii framework is the Capital Resources Requirement (CRR) calculated as 8 per cent of risk weighted assets. in addition to the minimum requirements for total capital, the FsA has made statements to explain it also operates a framework of targets and expected buffers for core tier 1 and tier 1 capital.
During the course of 2011 the eBA undertook two european wide exercises to assess the capital strength of the larger banks within the sector.
During the course of the year there have been a number of significant regulatory reform developments: – ‘CRD iii’ came into force on 31 December 2011 resulting in increased risk weighted assets for market and credit risk.
– the group is aware that there is currently a review of the endorsed ratings that may be used in internal Ratings Based (iRB) models and the group is working on the assumption that no material changes to our modelling approaches will result from the review.
mitigation the group has developed procedures to ensure that compliance with both current and potential future requirements are understood and that policies are aligned to its risk appetite.
Core tier 1 shareholders’ equity per balance sheet 45,920 46,061 non-controlling interests per balance sheet 674 841
Risk type analysis of risk-weighted assets market and counterparty risk 19,521 15,782
Risk-weighted assets reduced by £54,031 million to £352,341 million, a decrease of 13 per cent. this reflects risk weighted asset reductions across all banking divisions driven by balance sheet reductions of non-core assets, lower core lending balances and stronger management of risk.
the determination of realistic liabilities of the With Profit Funds includes the value of internal transfers expected to be made from each With Profit Fund to the non Profit Fund held within the same life insurance entity. these internal transfers may include charges on policies where the associated costs are borne by the non Profit Fund. the With Profit insurance Capital Component may be reduced by the value, calculated in the stress test scenario, of these internal transfers, but only to the extent that credit has not been taken for the value of these charges in deriving actuarial reserves for the relevant non Profit Fund.
Adjustments onto a regulatory basis: Unallocated surplus within insurance business 242 58 – – – 300
Other differences between iFRs and regulatory valuation of assets and liabilities – – 107 (163) 124 68 estimated share of ‘realistic’ liabilities consistent with the FsA reporting treatment (341) (58) – – – (399)
Other differences between iFRs and regulatory valuation of assets and liabilities – – 625 (919) 111 (183)
Qualifying loan capital – – – 1,991 – 1,991 support arrangement assets 344 – (344) – – –
Further Support Account: the Further support Account is an extra tier of capital support for the with-profits policies in existence at the date of demutualisation. the scheme requires that assets can only be transferred from the non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the support Account and Further support Account. Unlike the support Account test, the economic value used for this test includes both admissible assets and the present value of future profits of business written in the non-Participating Fund or by any subsidiaries of that fund. the balance of the Further support Account is expected to reduce to nil by the year 2030. At 31 December 2011, the estimated net economic value of the non-Participating Fund and its subsidiaries for the purposes of this test was £5,494 million (31 December 2010: £4,322 million) and the estimated combined value of the support Account and Further support Account was £2,291 million (31 December 2010: £2,446 million).
Uk non Profit Funds Available capital in the Uk non Profit Funds has decreased from £2,138 million at 31 December 2010 to an estimated £1,024 million at 31 December 2011. the main cause of the decrease was the impact of capital transactions supporting the purchase of Clerical medical by scottish Widows in July 2011. this was partially offset by increases in available capital from changes in assumptions. it should be noted that the decrease in the non Profit Fund from the purchase of Clerical medical is largely compensated for by an increase in the available capital in the shareholder Funds.
Other long-term funds Outside the With Profit Funds, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are broadly matched. the most critical non-economic assumptions are mortality rates in respect of annuity business written (lower
For those policies written in scottish Widows pre-demutualisation containing potentially valuable options and guarantees, under the terms of the scheme a separate memorandum account was set up within the With Profit Fund of scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. the Additional Account had a value at 31 December 2011 of £2.0 billion (2010: £1.8 billion). the eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. the ultimate cost will therefore not be known for many years.
As noted above, under the realistic capital regime of the FsA, the liabilities of both the Clerical medical and scottish Widows With Profit Funds are valued using a market-consistent stochastic simulation model. this model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
the most significant economic assumptions included in the model are: – Risk-free yield. the risk-free yield is defined as spot yields derived from the Uk gilt yield curve.
mitigation the group maintains a system of internal controls, which is designed to: – ensure that accounting policies are consistently applied, transactions are recorded and undertaken in accordance with delegated authorities, that assets are safeguarded and liabilities are properly recorded; – enable the calculation, preparation and reporting of financial, prudential regulatory and tax outcomes in accordance with applicable international Financial Reporting standards, statutory and regulatory requirements; – ensure that disclosures are made on a timely basis in accordance with statutory and regulatory requirements and as far as possible are consistent with best practice and in compliance with the British Bankers’ Association Code for Financial Reporting Disclosure.
Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers. A significant proportion of the investments are held in unit-linked and with-profits funds where the shareholder risk is limited, subject to any guarantees given.
note 2(H) to the financial statements on page 221 provides details of the group’s approach to the impairment of financial assets.
the group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of counterparty. in its principal retail portfolios exposure at default and loss given default models are also in use. they have been developed internally and use statistical analysis, combined, where appropriate, with external data and subject matter expert judgement. each rating model is subject to a validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. the most material rating models are approved by the group Risk Committee. Responsibility for the approval of the remaining material rating models, and the governance framework in place around all Lloyds Banking group models, is delegated to the group model governance Committee.
the models vary, inter alia, in the extent to which they are point in time versus through the cycle. the models are subject to rigorous validation and oversight/governance, including where appropriate, benchmarking to external information.
Mitigation the group uses a range of approaches to mitigate credit risk.
For mainstream mortgages greater than £5,000,000 the maximum LtV is 50 per cent. Buy-to-let mortgages are limited to a maximum of £1,000,000 and 75 per cent LtV. All mortgage applications above £500,000 are subject to manual underwriting.
individual credit assessment and sanction: Credit risk in wholesale portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward. exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. the group’s credit risk appetite criteria for counterparty underwriting is generally the same as that for assets intended to be held over the period to maturity.
stress testing and scenario analysis: the credit portfolio is also subjected to stress testing and scenario analysis, to simulate outcomes and calculate their associated impact. events are modelled at a group wide level, at divisional and business unit level and by rating model and portfolio, for example, within a specific industry sector.
specialist expertise: Credit quality is maintained by specialist units providing, for example: intensive management and control (see intensive Care section); security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector specific expertise; and legal services applicable to the particular market place and product range offered by the business.
Daily settlement limits: settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of all settlement risk arising from the group’s market transactions on any single day.
Credit risk assurance and review: Risk oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes, and test the adequacy of credit risk infrastructure and governance processes throughout the group. this includes tracking portfolio performance against an agreed set of key risk indicators. group Credit Risk Assurance, a group level function comprising experienced credit professionals, is also in place. in conjunction with Risk senior management, this team carries out independent risk based credit reviews, providing individual business unit assessment of the effectiveness of risk management practices and adherence to risk controls across the diverse range of the group’s wholesale businesses and activities, facilitating a wide range of audit, assurance and review work. these include cyclical (‘standard’) credit reviews, non-standard reviews, project reviews, credit risk rating model reviews and bespoke assignments, including impairment reviews as required. the work of group Credit Risk Assurance continues to provide executive and senior management with assurance and guidance on credit quality, effectiveness of credit risk controls and accuracy of impairments.
the determination of cash flows for cases in the Business support Units (BsU) is undertaken by a specialist risk team who gather a range of information from various sources including the customer, professional advisers and the group’s own credit teams to fully understand and appraise the customer’s business and circumstances. A more detailed assessment is undertaken to assist in reducing risk exposure and highlighting potential strategic options. this often involves the group, in addition to using its own internal experts, engaging professional advisers to perform independent Business Reviews (iBRs) and, where relevant, independently value collateral held. in more complex cases, such as those involving work-out strategies, the review may also involve: – critically assessing customer’s ability to successfully manage the business effectively in a distressed situation where turnaround is required; – analysis of market sector factors, i.e. products, customers, suppliers, pricing and margin issues; – performance review of operational areas that should be considered in terms of current effectiveness and efficiency and scope for improvements; – financial analysis to model plans and factor in potential sensitivities, vulnerabilities and upsides; and
the specific tools available to assist customers vary by territory and product and the customer’s status. in defining the treatments offered to customers who have experienced financial distress, the group distinguishes between the following three categories: – Forbearance – a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original contractual payments such as a temporary capital payment break.
– Repair – an account change used to repair a customer’s position when they have emerged from financial difficulty, such as capitalisation of arrears when a payment track record has been re-established.
Wholesale credit facilities are reviewed on a regular basis and more frequently where required. When financial stress is exhibited, the customer would be transferred at an early stage to our specialist BsU and Customer support teams.
– the finance application checklist: Details of the type of information we may ask customers to provide in order to support their lending application.
– Business mentoring: Businesses may benefit from the support of a business mentor. www.mentorsme.co.uk is a free online service that enables businesses to locate local independent mentoring organisations that suit their specific business needs.
– these lower charges were principally supported by the continued application of our prudent risk appetite and strong risk management controls resulting in improved portfolio and new business quality, continued low interest rates, and broadly stable Uk property prices, partly offset by weakening Uk economic growth and rising unemployment.
– the group’s overall core impairment charge during 2011 was materially lower compared to 2010, due primarily to strong Retail performance offset by higher core impairments in Wholesale due to a few specific cases.
the fair value adjustments relating to loans and advances were those required to reflect the HBOs assets in the Company’s consolidated financial records at their fair value and took into account both the expected future impairment losses and market liquidity at the date of acquisition. the unwind relating to future impairment losses requires significant management judgement to determine its timing which includes an assessment of whether the losses incurred in the current period were expected at the date of the acquisition and assessing whether the remaining losses expected at the date of the acquisition will still be incurred. the element relating to market liquidity unwinds to the income statement over the estimated useful lives of the related assets (until 2014 for wholesale loans and 2018 for retail loans) although if an asset is written off or suffers previously unexpected impairment then this element of the fair value will no longer be considered a timing difference (liquidity) but permanent (impairment). in 2011, a net credit of £1,943 million (2010: £3,118 million) relates to the unwind of HBOs acquisition fair value adjustments. Of that amount, £1,693 million (2010: £2,229 million) relates to impairment losses incurred which were expected at the date of acquisition. the fair value unwind in respect of loans and advances is expected to continue to decrease in future years as fixed-rate periods on mortgages expire, loans are repaid or written off, and will reduce to zero over time.
Outlook – group the Uk economy is fragile with a weak short-term economic outlook generally expected. Consumer and business confidence remains low, relatively high inflation has reduced consumer spending power and exports are falling.
– the overall value of assets entering arrears in 2011 were lower in both unsecured and secured lending compared to 2010.
the Retail division’s loans and advances to customers are analysed in the following table: table 1.28: Retail loans and advances to customers (audited)
impairment provisions held against secured assets reflect the group’s view of appropriate allowance for incurred losses. the group holds appropriate impairment provisions for customers who are experiencing financial difficulty, either on a forbearance arrangement or who may be able to maintain their repayments whilst interest rates remain low. At December 2011, 1.2 per cent of loan balances were on a forbearance arrangement, compared to 1.3 per cent at 31 December 2010.
Average loan-to-value:2 stock of residential mortgages 52.2 74.0 72.6 55.9 new residential lending 61.4 65.8 n/a 62.1
Average loan-to-value:2 specialist lending is closed to new business and is in run-off.
Average loan-to-value is calculated as total loans and advances as a percentage of the total collateral assigned to these loans and advances.
A combination of the group’s risk appetite, reduced demand from customers for new unsecured borrowing and existing customers continuing to reduce their personal indebtedness contributed to loans and advances to customers reducing by £3.1 billion to £24.8 billion at 31 December 2011.
the impairment charge as a percentage of average loans and advances to customers decreased to 5.66 per cent in 2011 from 8.11 per cent in 2010, with the impairment charge reducing at a greater rate than the reduction in average loans and advances in 2011.
impaired loans decreased by £0.6 billion to £2.4 billion which represented 9.6 per cent of closing loans and advances to customers at 31 December 2011, compared with 10.7 per cent at 31 December 2010. the reduction in impaired loans is a result of tightening credit policy across the credit lifecycle, including stronger controls on customer affordability. Retail’s exposure to revolving credit products has been actively managed to ensure that it is appropriate to customers’ changing financial circumstances. the portfolios show a level of early arrears for accounts acquired since 2009 which are at pre-recession levels, highlighting an underlying improvement in the risk profile of the business.
impairment provisions decreased by £0.4 billion, compared with 31 December 2010, to £1.1 billion. this reduction was primarily a result of the movement of assets from Collections to Recoveries, at which point they are written down to the present value of future expected cash flows. the proportion of impaired loans that have been written down to the present value of future expected cash flows on these assets has increased to 48.0 per cent at 31 December 2011 from 38.7 per cent at 31 December 2010. impairment provisions as a percentage of impaired loans in collections increased to 86.5 per cent at 31 December 2011 from 82.5 per cent at 31 December 2010.
Overview – impairment losses for 2011 decreased significantly to £2,901 million, from £4,064 million for 2010.
– the group has proactively managed down sovereign as well as banking and trading book exposures to selected european countries. Divestment strategy was focused on balance sheet reduction and disposing of higher risk positions.
Wholesale’s impairment charge decreased £1,163 million, or 29 per cent, compared to £4,064 million during 2010. Despite a subdued Uk economic environment in 2011, impairment charges have decreased substantially compared with 2010 due to robust proactive risk management, an appropriately impaired portfolio (against our current economic assumptions) and a low interest rate environment helping to maintain defaults at a lower level. impairment charges as an annualised percentage of average loans and advances to customers reduced to 1.95 per cent from 2.23 per cent in 2010.
impaired loans and provisions – core Core impaired loans reduced by £526 million to £3,904 million compared with 31 December 2010. the reduction is primarily due to the restructuring of assets. these restructured assets had a lower impairment coverage resulting in core impairment provisions as a percentage of core impaired loans increasing to 59.4 per cent from 52.4 per cent at 31 December 2010. As a percentage of closing core advances, core impaired loans remained unchanged compared 31 December 2010 at 5.0 per cent.
At 31 December 2010 treasury and trading 1,050 – – – –
Of which Wholesale markets is £21,279 million, Wholesale equity £2,109 million, treasury and trading £6,011 million and Corporate £59 million.
Financial Institutions – Continuing concerns over sovereign fiscal deficits and public sector debt levels have necessitated increased scrutiny and risk reduction to the european banking sector, in particular banks domiciled in the weaker eurozone countries. trading exposures are in large part either short term and/or collateralised and inter bank lending activity is mainly very short term with strong investment grade counterparties.
the management of the portfolio has focussed on continuing to support its long-term customers and at the same time reduce the exposure to real estate through managed sales, which has resulted in a realisation of over £4.8 billion of cash receipts in 2011 despite the worsening transactional market. in addition there has been over £5 billion of restructurings undertaken with longer term facilities put in place to support our customer base.
Wholesale equity the Wholesale equity portfolio (assets representing ‘equity Risk’ including ordinary equity, preference shares and debt securities) totals £4.9 billion (split £3.8 billion on balance sheet commitments and £1.1 billion as yet undrawn, the majority of which relates to Lloyds Development Capital and the Funds investment business).
the overall size of the portfolio has shown a downward trend in the second half of 2011, in the main due to significant disposals of a number of assets from the Project Finance business. Continuing concerns around sovereign debt in the eurozone and disappointing economic data from the major economies has resulted in ongoing volatility in equity markets.
Wholesale markets Loans and advances to customers of £35.8 billion largely comprise balances in the structured Corporate Finance portfolio, which includes Acquisition Finance (leveraged lending), Project Finance and Asset Based Finance (ship Finance, Aircraft Finance, Rail Capital and Corporate Asset finance). the dampened effect of Uk economic conditions has been felt in the Acquisition Finance portfolio resulting in a higher impairment charge on leveraged exposures during 2011 compared to 2010. However, a number of sectors remain vulnerable, especially retail, leisure and healthcare, and refinancing risk is also an issue, with significant loan maturities due in the next few years. in ship Finance, the outlook for the container, tanker and dry bulk sectors is challenging.
treasury and trading treasury and trading acts as the link between the wholesale markets and the group’s balance sheet management activities and provides pricing and risk management solutions to both internal and external clients.
the majority of treasury and trading’s funding and risk management activity is transacted with investment grade counterparties including sovereign central banks and much of it is on a secured basis, such as repos facing a Central Counterparty (“CCP”). Derivative transactions with wholesale counterparties are typically collateralised under a Credit support Annex in conjunction with the isDA master Agreement. During the year Lloyds Banking group became a member of LCH swapClear as part of a move to reduce counterparty risk by clearing standardised derivative contracts through a CCP. treasury and trading has reduced the government bond portfolio in response to growing concern over market conditions in the eurozone resulting in minimal exposure to weaker eurozone sovereigns. the credit quality of the government bond portfolio is almost solely AAA/AA rated sovereign debt.
– the decrease reflects the continued application of our prudent credit risk appetite approach and the benefits of the low interest rate environment which has helped maintain defaults at a lower level.
– Portfolio metrics including delinquencies and assets under close monitoring have generally remained steady or improved.
Loans and advances to customers 28,554 impairment provisions include collective unimpaired provisions.
Loans and advances to customers 2,015 impairment provisions include collective unimpaired provisions.
– On the irish Wholesale portfolio, 84 per cent of the portfolio is now impaired at a coverage ratio of 61 per cent.
– On the irish Retail portfolio, impairment provisions as a percentage of impaired loans has increased to 73 per cent against a backdrop of falling house prices and an increase in borrowers falling into arrears.
Wealth and international’s impairment charge in 2011 almost entirely related to non-core portfolios. the impairment charge decreased by £1,378 million to £4,610 million compared with 2010. impairment charges as an annualised percentage of average loans and advances to customers decreased to 7.37 per cent from 8.9 per cent in 2010.
table 1.45: Impairments on Wealth and International loans and advances – core (unaudited)
table 1.46: Impairments on Wealth and International loans and advances – non-core (unaudited)
Continuing weakness in the irish real estate markets resulted in a further increase in impaired wholesale loans and coverage in 2011. the majority of irish retail provisions relate to a residential mortgage portfolio where impairment charges have increased in relation to 2010 due to a continued decline in residential property prices and higher arrears levels, including customers on a forbearance arrangement.
Australasia total impaired loans decreased by £1,407 million, or 34 per cent to £2,780 million compared with £4,187 million at 31 December 2010. the decrease in impaired loans in the period is as a result of impaired asset disposals and write offs partially offset by further migration of cases to impaired status. total impaired loans as a percentage of closing loans and advances decreased to 28.5 per cent from 28.7 per cent at 31 December 2010.
impairment on the group’s Commercial Real estate portfolio in Australasia was the main contributor to the full year charge. this portfolio is exposed to Australian non-metropolitan real estate markets where market conditions and asset valuations in 2011 have remained weak. the group has significantly reduced its remaining exposure to these markets following the successful disposal of a £1 billion portfolio of loans during the last quarter of 2011 in our two most challenging markets (gold Coast and new Zealand). A specific charge of £70 million was also incurred in the period as a result of losses arising from the earthquake in new Zealand.
Wholesale europe total impaired loans decreased by £29 million, or 3 per cent to £978 million compared with £1,007 million at 31 December 2010 and as a percentage of closing loans and advances increased to 15.4 per cent from 13.8 per cent at 31 December 2010. impairment charges decreased by £5 million to £204 million compared to 2010. impairment charges as an annualised percentage of average loans and advances to customers increased to 2.9 per cent compared to 2.8 per cent in 2010. Commercial real estate was the primary driver of the impairment charge in Wholesale europe reflecting provisions on a small number of specific transactions.
Exposures to selected Eurozone countries the following section summarises the group’s direct exposure to certain european countries which have been identified on the basis of a standard & Poor’s rating of A or less, as at 31 December 2011. the exposures are shown at their balance sheet carrying values and are based on the country of domicile of the counterparty, unless otherwise indicated.
Available for sale: Derivatives – net CDs assets and liabilities – – – – – –
Derivative balances are shown at fair value adjusted where master netting agreements exist and net of cash collateral of £155 million. there are credit default swap positions referenced to banking groups domiciled in italy (net long of £1 million and net short of £4 million) and spain (net short of £10 million).
Other Corporate balances within individual countries comprise: greece – the exposures in greece principally relate to shipping loans to greek shipping companies where the assets are generally secured and the vessels operate in international waters; repayment is mainly dependent on international trade and the industry is less sensitive to the greek economy.
Amortised cost: Off balance sheet exposures – – – – 34 34
Utilities Total throughout 2011, the group continued to provide finance for a wide range of projects within the renewables, energy & utilities and infrastructure sectors that have the capability to deliver positive social and environmental outcomes. this year saw a 56 per cent increase in the value of renewables projects that the group provided finance for compared to 2010. When completed, renewable projects within the Uk funded during 2011 will provide over 540,000 homes with renewable energy, avoiding tens of thousands of tonnes of CO2 emissions each year.
Risk appetite market risk appetite is defined with regard to the quantum and composition of market risk that currently exists in the group and the group’s risk preferences.
this statement of the group’s overall appetite for market risk is reviewed and approved annually by the Board. With the support of the group Asset and Liability Committee, the group Chief executive allocates this risk appetite across the group. individual members of the group executive Committee ensure that market risk appetite is further delegated to an appropriate level within their areas of responsibility.
– standard stresses: interest Rates 25bp; equities 10 per cent; Credit spreads relative 30 per cent widening
the schemes’ main exposures are to equity risk, real rate risk and credit spread risk. Accounting for the pension schemes under international Accounting standard (iAs)19 spreads any adverse impacts of these risks over time.
interest rate risk (impact of 25 basis point reduction pre-tax) 59.2 82.1
Mitigation Various mitigation activities are undertaken across the group to manage portfolios and seek to ensure they remain within approved limits.
Banking activities trading is restricted to a number of specialist centres, the most important centre being the treasury and trading business in London. these centres also manage market risk in the wholesale non-trading portfolios, both in the Uk and internationally. the level of exposure is strictly controlled and monitored within approved limits. Active management of the wholesale portfolios is necessary to meet customer requirements and changing market circumstances.
– the investment strategy for other insurance liabilities is determined by the term and nature of the underlying liabilities and asset/liability matching positions are actively monitored. Actuarial tools are used to project and match the cash flows.
Customer treatment the risk of regulatory censure and/or a reduction in earnings/value through financial or reputational loss, from inappropriate or poor customer treatment.
Financial crime the risk of reductions in earnings and/or value, through financial or reputational loss, associated with financial crime and failure to comply with related regulatory obligations, these losses may include censure, fines or the cost of litigation. this includes risks associated with fraud and bribery.
security the risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft of or damage to the group’s assets, the loss, corruption, misuse or theft of the group’s information assets or threats or actual harm to the group’s people. this also includes risks relating to terrorist acts, other acts of war, geopolitical, pandemic or other such events.
the group continues to face risks relating to its ability to attract, retain, and develop high calibre talent, as a result of challenges arising from ongoing regulatory and public interest in remuneration practices. in addition there is uncertainty from eU state aid requirements and independent Commission on Banking proposals on banking reform.
– Control assessment, evaluating the effectiveness of the control framework covering each of the key risks to which the business area is exposed.
Measurement insurance risks are measured using a variety of techniques including stress and scenario testing; and, where appropriate, stochastic modelling.
insurance risk is primarily controlled via the following processes: – Underwriting (the process to ensure that new insurance proposals are properly assessed)
Measurement An annual business planning process is conducted at group, divisional and business unit level which includes a quantitative and qualitative assessment of the risks that could impact the group’s plans. Within the planning round, the group conducts both scenario analysis and stress tests to assess risks to future earning streams. stress testing and scenario analysis are fully embedded in the group’s risk management practice. the group assesses a wide array of scenarios including economic recessions, regulatory action scenarios, scenarios specific to the operations of each part of the business, as well as reverse stress tests.
Joined the Board in December 2010. Chairman of Victrex, the FTSE 250 global manufacturer of high performance polymers, having previously been the Senior Independent Director. Since 2000, she has held a portfolio of Non-Executive Directorships, currently holding positions as Senior Non-Executive Director of Aberdeen Asset Management and as Non-Executive Director of IMI. Prior to this she was Executive Director of Abbott Mead Vickers, Director of Corporate Development at WPP Group and a Non-Executive Director of Northumbrian Water and has held various investment and marketing roles at Scottish Provident and the Royal Bank of Scotland. Aged 54.
Audit Committee To monitor and review the formal arrangements established by the Board in respect of the financial statements and reporting of the Group; internal controls and the risk management framework; internal audit; and the Group’s relationship with its external auditors.
Risk Committee To review and report its conclusions to the Board on the Group’s risk appetite and risk management framework. The Committee has a forward looking perspective, anticipating changes in business conditions.
Results The consolidated income statement shows a loss attributable to equity shareholders for the year ended 31 December 2011 of £2,714 million.
Principal activities The Company is a holding company and its subsidiary undertakings provide a wide range of banking and financial services through branches and offices in the UK and overseas.
Post balance sheet events There have been no material post balance sheet events.
In the interests of good corporate governance and in accordance with the provisions of the UK Corporate Governance Code, the Board has decided that all of the other directors will retire voluntarily and those willing to serve again will submit themselves for re-election at the annual general meeting.
Directors’ indemnities The directors of the Company, including the former directors who retired during the year and since the year end, have entered into individual deeds of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ for the purposes of the Companies Act 2006. In addition, the Company has granted a deed of indemnity through deed poll which constituted ‘third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ to the directors of the Group’s subsidiary companies, including to former directors who retired during the year and since the year end. The deeds were in force during the whole of the financial year or from the date of appointment in respect of the directors who joined the boards in 2011 and 2012. The indemnities remain in force for the duration of a director’s period of office. The deeds indemnify the directors to the maximum extent permitted by law. Deeds for existing directors are available for inspection at the Company’s registered office.
Share capital Information about share capital and dividends is shown in notes 47 and 51 on pages 290 to 292 and page 295 and is incorporated into this report by reference. The Company did not repurchase any ordinary shares of 10p each during the year.
The Company is party to a deed of covenant with each of the four Lloyds TSB Foundations (the Foundations) which hold limited voting shares in the Company (the limited voting shares are further described in note 47 on page 292). Under the terms of the deeds of covenant, the Company makes an annual payment to each of the Foundations. In the event of a successful offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting share would convert to an ordinary share under the terms of the Company’s articles of association. The payment obligation under the deeds of covenant would come to an end one year following the conversion of the limited voting shares.
Donations The income statement includes a charge for charitable donations totalling £32,972,000 in 2011 (2010: £30,750,000), including £28,228,000 (2010: £28,228,000) which will be paid under the deeds of covenant to the four Lloyds TSB Foundations during 2012 and £2,000,000 paid to the Bank of Scotland Foundation during 2011.
Significant contracts Details of related party transactions are set out in note 53 on pages 302 to 305.
The Board is collectively responsible for the long term success of the Company including setting the strategy and establishing the values and standards of the Group. The Group Strategic Review, initiated by António Horta-Osório in March 2011, has been a key area of focus for the Board during 2011 and all Directors participated fully in its formulation. An internal project team supported by McKinsey & Co, was established under the direction of the Group Chief Executive. Detailed plans and proposals were developed by the executive between March and June 2011. During that period, the Board met a number of times to consider, evaluate and challenge the proposals. Additional meetings took place with the Non-Executive Directors individually. The final challenge process took place during a two day Board Strategy session in June 2011. This meeting was held offsite to allow Directors to fully consider and evaluate the strategic options before they were put to the Board for approval. The offsite meeting also provided an opportunity to foster closer working relationships between Board members and the new senior team.
Open dialogue is encouraged between Directors. To this end, the Chairman meets regularly with the Non-Executive Directors in the absence of Executive Directors either in private sessions held following regular Board or Committee meetings or in separately arranged meetings. The Executive Directors are aware of such meetings through the Board calendar. Non-Executive Directors meet at least once a year without the Chairman being present to discuss his performance. Such meetings are led by the Senior Independent Director. All Non-Executive Directors have ready access to the Group Chief Executive and other senior executives.
In 2011, a total of sixteen Board meetings were held of which nine were scheduled at the start of the year. The number of meetings held reflects the continuing challenging environment in which the Group operates and the emphasis placed on keeping the Board informed of developments on a timely basis. Details of attendance at meetings are set out on page 182.
To assist the Board in carrying out its functions and to provide independent oversight of internal control and risk management, certain responsibilities are delegated to the Board’s Committees. The Board is kept up to date on the activities of the Committees through reports from each of the Committee Chairmen. Terms of reference for each of the Committees are available on the website at www.lloydsbankinggroup.com. Information on the membership, role and activities of each of the Committees can be found on pages 183 to 185.
– The Group Subsidiaries Manual. Lloyds Banking Group conducts its business through a large number of subsidiary entities. To help manage the legal, regulatory and reputational risks associated with these entities, the Group requires its subsidiaries to adopt consistent, proportionate and appropriate standards. The Group Subsidiaries Manual provides guidance on the required governance structures and controls having regard to the nature and risk profile of the entity. The Group Subsidiaries Manual was introduced in April 2011 and was updated in the second half of the year to reflect changes made to the overall Governance Framework in response to the Group Strategic Review.
Board composition The Nomination & Governance Committee is responsible for reviewing the composition of the Board, including size and structure. During 2011, it oversaw the search and selection process for new directors, including Sara Weller, who was appointed as a Non-Executive Director on 1 February 2012, and the new Group Finance Director. In reviewing Board composition, the Committee has regard to a range of factors, including: Skills and experience In reviewing composition, the Board aims to ensure that its membership represents a mix of backgrounds and experience that will enhance the quality of its deliberations and decisions. As part of the ongoing review of composition, specific skills required by the Board are identified with reference to the overall skills of the Board at the time, the need to address longer term succession and current business priorities. All Directors are required to have good – and in most cases have deep – experience and understanding of the banking and financial services sector. The complexity of the Group means that broader skills are also required. Maintaining the right balance is an ongoing priority.
Diversity The Board continues to place emphasis on ensuring that its membership reflects diversity in the broadest sense including diversity of gender, ethnicity and background. The Group welcomes and publicly supports the Davies Review. The Board has committed to show demonstrable progress towards the goal of achieving at least 25 per cent (and ultimately 30 per cent) female representation on the Board by 2013 and expects to meet this by 2015. As a founder member of the 30% Club, which encourages UK companies to aim for at least 30 per cent female representation on their boards by 2015, Sir Winfried Bischoff takes an active interest in promoting diversity within the Group and in business more generally. The Nomination & Governance Committee currently utilises the services of an Executive search firm which has signed up to the 30% Club's voluntary Code of Conduct for Executive Search firms.
Independence The Board’s preference is to ensure a strong majority of independent directors. At year end, our Board comprised three Executive Directors, eight independent Non-Executive Directors and the Chairman. The Code requirement that at least half the Board should be independent Non-Executive Directors has been met throughout the year.
The Nomination & Governance Committee is responsible for assessing the independence of Non-Executive Directors on appointment and annually thereafter. Based on its 2011 assessment, it is satisfied that throughout the year, all Non-Executive Directors were independent as to both character and judgement.
The detailed process leading to the appointment of António Horta-Osório was explained in the 2010 Corporate Governance Report. He joined the Board as an Executive Director on 17 January 2011. This allowed him time to get to know the business and to complete an orderly handover before assuming the role of Group Chief Executive on 1 March 2011.
Succession planning The Nomination & Governance Committee oversees the Board’s arrangements for the longer term succession of Board and Committee members.
Non-Executive succession planning Non-executive director succession planning is addressed as part of the ongoing review of Board composition. The policy takes account of the need regularly to refresh the intake of Non-Executives to bring new perspectives, to ensure appropriate representation on each of the Board’s Committees and to plan for longer term succession. The average tenure of the Non-Executive Directors is just over two years. Following the move to annual re-election of directors, non-executive directors are appointed on a rolling 12 months basis.
The Chairman is responsible for developing and maintaining a succession plan in relation to the Group Chief Executive and for reviewing the plan with the Nomination & Governance Committee at least annually. During 2011, emphasis was also placed on contingency arrangements during the Group Chief Executive's leave of absence.
The 2011 Board evaluation process was overseen by the Nomination & Governance Committee and took the form of: – a detailed questionnaire, drafted by Group Secretariat in conjunction with the Chairman, to assess the effectiveness of the Board, its Committees and individual Directors; – individual follow up interviews with the Chairman; and
The Company Secretary oversees communications with private shareholders. The Group’s annual general meeting provides an opportunity to meet the Group’s Directors and to hear more about the strategy of the Group. Shareholders are encouraged to attend the annual general meeting and to raise any questions at the meeting or in advance, using the email address shown in the pack which will be sent to shareholders in March 2012.
Conclusion In conclusion, the Group confirms its compliance with all relevant provisions of the Code throughout the year ending 31 December 2011.
Appointed to the Board on 17 January 2011. On leave of absence from 2 November 2011 to 8 January 2012 and was therefore absent from meetings between these dates. See page 179 for details.
Audit To monitor and review the formal arrangements established by the Board in respect of: (a) the financial statements and reporting of the Group; (b) internal controls and the risk management framework; (c) internal audit; and
– reviews the structure, size and composition of the Board; – oversees the selection process for prospective directors; – makes recommendations to the Board on potential appointments and reappointments of Directors at the end of their specified term; – considers Board succession; – oversees the annual evaluation of the performance of the Board; – reviews the Board’s governance arrangements; – oversees the Group’s implementation of governance requirements; and
– oversees the process for appointments of new Non-Executive Directors and makes recommendations to the Board.
Information about the Remuneration Committee’s responsibilities is given in the Directors’ remuneration report on pages 187 to 204.
(b) the Group’s risk management framework, taking a forward looking perspective and anticipating changes in business conditions.
– reviewed the Group consolidated risk report and received an update from the Chief Risk Officer at each meeting; – reviewed the risk and control frameworks; – reviewed the Internal Capital Adequacy Assessment Process report; – reviewed the Group’s funding plan and stress testing process; – participated in deep dives in conjunction with each division and with members of the group risk team; – reviewed the Group’s risk appetite framework; and
The approximate make-up of the main components of our package for Executive Directors on an expected value basis is shown below: Based on a combination of performance targets comprising economic profit, absolute total shareholder return and strategic financial objectives 20% Paid in shares after three years
Based on financial measures and on a balanced scorecard of non-financial measures35% Deferred into shares until at least March 2014, subject to malus
Salary increases have also been restricted. Salaries as part of the annual review will increase by less than 2.5 per cent, with lower or zero increases at more senior levels.
In the same way, for leavers we are conscious of the importance of mitigating the Company’s costs and not paying more than is appropriate through previously agreed exit terms. Other than in exceptional circumstances we pay only that required under contractual entitlements.
This is a report made by the Board of Lloyds Banking Group plc, on the recommendation of the Remuneration Committee. It covers the current and proposed components of the remuneration policy and details the remuneration for each serving Director during 2011.
The overarching purpose of the Remuneration Committee is to consider, agree and recommend to the board an overall remuneration policy and philosophy for the Group that is defined by, supports and is closely aligned to its long-term business strategy, business objectives, risk appetite and values and recognises the interests of relevant stakeholders. The Group has a conservative business model characterised by a risk culture founded on prudence and accountability. The remuneration policy and philosophy covers the whole Group, but the Committee pays particular attention to the top management population, including the highest paid employees in each division, those colleagues who perform significant influence functions for the Group and those who could have a material impact on the Group’s risk profile. The Committee’s role is to ensure that these colleagues are provided with appropriate incentives and reward to encourage them to enhance the performance of the Group and that they are recognised for their individual contribution to the success of the organisation, whilst ensuring that there is no reward for excessive risk taking. The Committee works closely with the Risk Committee in ensuring the bonus pool is moderated. The two Committees meet every year to determine whether the proposed bonus pool and performance assessments adequately reflected the risk appetite and framework of the Group; whether it took account of current and future risks; and whether any further adjustment is required or merited. We are also determined to ensure that the aggregate of the variable remuneration for all our colleagues is appropriate and balanced with the interests of shareholders and all other stakeholders.
During 2011, the Committee met 12 times and considered the following principal matters: – Review of remuneration arrangements for senior executives
– Determination of bonus pools based on Group performance and adjustment for risk
Eric Daniels (until 28 February 2011), António Horta-Osório (from 1 March 2011), Angie Risley (Group HR Director) and Liz Jackson (HR Director, Reward) provided guidance to the Committee (other than for their own remuneration). Juan Colombás (Chief Risk Officer) and Tim Tookey (Group Finance Director) also attended the Committee to advise as and when necessary on risk and financial matters.
Any annual bonus for Executive Directors is deferred into shares and released over time, helping to increase alignment with shareholders. These deferrals are subject to malus in the event of unsustainable performance.
Executives are also aligned with shareholders through the LTIP, which pays out in shares based on performance against Group financial targets over a three year period. In addition to purely financial metrics of Economic Profit and Total Shareholder Return, the performance conditions for the 2012 LTIP will comprise measures linked to the Strategic Review that reflect the wider Group objectives. These measures are short-term funding as a percentage of total funding, noncore assets at the end of 2014, run-rate simplification benefits achieved at the end of 2014 and customer satisfaction.
The key achievements of the Group are set out in the Group Chief Executive’s review on pages 14 to 19 of this Annual Report.
The calculation of the annual incentive plan outcomes for Executive Directors, based on the achievement of performance against targets in respect of performance in 2011, has been vigorously discussed by the Remuneration Committee. Mr Horta-Osório advised the Board that he did not wish to be considered for a bonus in respect of the 2011 performance year. The bonuses awarded to directors are shown in the table below: Name A Horta-Osório G T Tate T J W Tookey
Long-term incentive performance measures During 2011, the Committee has consulted widely with shareholders on the topic of performance measures and sharing the growth in the Company appropriately between shareholders and management. The Committee believes that the performance measures for the 2012 LTIP award for the Executive Committee should be Economic Profit, Absolute Total Shareholder Return and strategic financial measures. These measures capture risk measurement, profit growth and shareholder experience and align shareholder experience and management reward.
Pension Executive directors may participate in the Group’s defined contribution scheme (under which their pension entitlement will be based upon both employer and employee contributions). Company contributions are 25 per cent of salary, with the exception of António Horta-Osório who is eligible for 50 per cent of reference salary, including his flexible benefit allowance. These can be taken as cash or pension contributions, or a mixture of each.
Chairman’s remuneration The Chairman’s remuneration comprises salary and benefits. He does not participate in the annual bonus and long-term incentive arrangements, nor is he entitled to pension benefits.
Independent Non-Executive Directors who serve on the Boards of subsidiary companies may also receive fees from the subsidiaries.
During 2011, Eric Daniels received fees of £76,000 which was retained by him, for serving as Non-Executive Director of BT plc. Truett Tate received fees of £30,000 as chairman of Arora Holdings Ltd and £20,000 as a Director of Towergate Partnership Ltd. These fees were retained by him.
Bonus awards made to Executive Directors in respect of 2010 were amended in February 2012 by reducing the amounts awarded in Deferred Shares. The reduction amounted to 40 per cent of the award in respect of Mr Daniels and 25 per cent of the awards in respect of Mr Kane, Mr Tate, Mr Tookey and Mrs Weir. The Board’s decision is based on the fact that had the outcome of the Judicial Review into Payment Protection Insurance (PPI) in April 2011 been known, and had the consequential provision made been effected at the time of the award of the 2010 bonus in February 2011, the bonus pool would have been lower and individual bonus awards would also have been lower.
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2011 and 2010, respectively. For Mr Daniels the 2011 figure is the pension put into payment upon retirement on 30 September 2011. For Mr Kane, the 2011 figure is the deferred pension entitlement as at the date of opting-out of the pension scheme on 15 June 2011.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2011 based on factors supplied by the actuary of the pension scheme.
At 1 January 2011 (or later date of appointment) At 31 December
António Horta-Osório – 342,265 342,265 – – – – – j, k
The Remuneration Committee chose the relevant performance conditions because they were felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
March 2001 Growth in earnings per share which is equal to the aggregate percentage change in the retail price index plus three percentage points for each complete year of the relevant period plus a further condition that the Company’s ranking based on TSR over the relevant period should be in the top 50 companies of the FTSE 100.
As the performance conditions for those options granted in March 2001 were not met, the options lapsed in March 2011.
Economic Profit: Relevant to 331/3 per cent of the award. The performance target is based on 2013 adjusted Economic Profit.
Vesting between threshold and maximum will be on a straight line basis, provided that shares comprised in the Absolute Share Price element of the award may only be released if both the EPS and Economic Profit performance measures have been satisfied at the threshold level or above.
António Horta-Osório 100,000 1/3/11 Purchase on appointment 30/3/11 167,099 March 2011 Share Buy Out award 5/8/11 200,000 Purchase
REPORT OF THE INDEPENDENT AUDITORS ON THE CONSOLIDATED FINANCIAL STATEMENTS Independent auditors’ report to the members of Lloyds Banking Group plc We have audited the group financial statements of Lloyds Banking Group plc for the year ended 31 December 2011 which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated statement of changes in equity, the consolidated cash flow statement and the related notes. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union.
Opinion on other matters prescribed by the Companies Act 2006 In our opinion: – the information given in the Directors’ Report for the financial year for which the group financial statements are prepared is consistent with the group financial statements; and
Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion: – certain disclosures of directors’ remuneration specified by law are not made; or
Under the Listing Rules we are required to review: – the directors’ statement, on page 174, in relation to going concern; – the part of the Corporate Governance Report relating to the company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review; and
Movements in revaluation reserve in respect of available-for-sale financial assets: Change in fair value 2,603 1,231 2,035
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income 916 (1,048) (530)
Liabilities arising from insurance contracts and participating investment contracts 38 78,991 80,729
Value of employee services: Share option schemes – – 125 125 – 125
Further details of movements in the Group’s share capital and reserves are provided in notes 47, 48, 49 and 50.
(iv) Amendment to IFRIC 14 Prepayments of a Minimum Funding Requirement. Applies when an entity is subject to minimum funding requirements and makes an early payment of contributions to cover those requirements and permits such an entity to treat the benefit of such an early payment as an asset.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2011 and which have not been applied in preparing these financial statements are given in note 58.
Investment vehicles, such as Open Ended Investment Companies (OEICs), where the Group has control are consolidated. Control arises when the Group manages the funds and also has a majority beneficial interest. In circumstances where the Group holds a majority beneficial interest, but is not the fund manager, the Group does not consolidate the entity as it does not have the fund manager’s decision‑making powers over the investment activities of the OEIC necessary to establish control. The interests of parties other than the Group are reported in other liabilities.
Special purpose entities (SPEs) are consolidated if, in substance, the Group controls the entity. A key indicator of such control, amongst others, is where the Group is exposed to the risks and benefits of the SPE.
Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of associates and joint ventures is included in the Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal except where it has been written off directly to reserves in the past.
(C) Other intangible assets Other intangible assets include brands, core deposit intangibles, purchased credit card relationships, customer‑related intangibles and both internally and externally generated capitalised software enhancements. Intangible assets which have been determined to have a finite useful life are amortised on a straight line basis over their estimated useful life as follows: Capitalised software enhancements up to 5 years
(D) Revenue recognition Interest income and expense are recognised in the income statement for all interest‑bearing financial instruments using the effective interest method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.
The Group is permitted to reclassify, at fair value at the date of transfer, non‑derivative financial assets (other than those designated at fair value through profit or loss by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or repurchased in the near term, as follows: – if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at initial recognition), they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the foreseeable future or until maturity; – if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available‑for‑sale financial assets in ‘rare circumstances’.
(3) Loans and receivables Loans and receivables include loans and advances to banks and customers and eligible assets including those transferred into this category out of the fair value through profit or loss or available‑for‑sale financial assets categories. Loans and receivables are initially recognised when cash is advanced to the borrowers at fair value inclusive of transaction costs or, for eligible assets transferred into this category, their fair value at the date of transfer. Financial assets classified as loans and receivables are accounted for at amortised cost using the effective interest method (see (D) above) less provision for impairment (see (H) below).
The method of recognising the movements in the fair value of derivatives depends on whether they are designated as hedging instruments and, if so, the nature of the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item and the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.
– Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease
When an operating lease is terminated before the end of the lease period, any payment made to the lessor by way of penalty is recognised as an expense in the period of termination.
Operating lease assets are included within tangible fixed assets at cost and depreciated over their estimated useful lives, which equates to the lives of the leases, after taking into account anticipated residual values. Operating lease rental income is recognised on a straight‑line basis over the life of the lease.
(M) Share-based compensation The Group operates a number of equity‑settled, share‑based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black‑Scholes option pricing model. The determination of fair values excludes the impact of any non‑market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting period, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated as non‑vesting conditions and in accordance with IFRS 2 (Revised) the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement over any remaining vesting period.
A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by estimating the future cash flows over the duration of in‑force policies and discounting them back to the valuation date allowing for probabilities of occurrence. The liability will vary with movements in interest rates and with the cost of life insurance and annuity benefits where future mortality is uncertain.
Foreign exchange differences arising on the translation of a foreign operation are recognised in other comprehensive income and accumulated in a separate component of equity together with exchange differences arising from the translation of borrowings and other currency instruments designated as hedges of such investments (see (F)(3) above). On disposal of a foreign operation, the cumulative amount of exchange differences relating to that foreign operation are reclassified from equity and included in determining the profit or loss arising on disposal.
Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the Retail portfolios. The collective impairment allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including the interdependency of house prices, unemployment rates, interest rates, borrowers’ behaviour, and consumer bankruptcy trends. It is, however, inherently difficult to estimate how changes in one or more of these factors might impact the collective impairment allowance.
Fair value of financial instruments In accordance with IFRS 7, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy. Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation techniques including discounted cash flow analysis and valuation models. These valuation techniques involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information.
As disclosed in note 44, deferred tax assets totalling £1,288 million (2010: £685 million) have not been recognised in respect of certain capital losses carried forward, trading losses carried forward (mainly in certain overseas companies) and unrelieved foreign tax credits as there are no predicted future capital or taxable profits against which these losses can be recognised.
Retirement benefit obligations The net asset recognised in the balance sheet at 31 December 2011 in respect of the Group’s retirement benefit obligations was £957 million (comprising an asset of £1,338 million and a liability of £381 million) (2010: a net asset of £313 million) of which an asset of £1,131 million (2010: £479 million) related to defined benefit pension schemes. As explained in note 2(L), the Group adopts the corridor approach to the recognition of actuarial gains and losses in respect of its pension schemes and as a consequence has not recognised actuarial losses of £539 million (2010: £959 million). After allowing for this, the defined benefit pension schemes’ net accounting surplus totalled £592 million (2010: deficit of £480 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 2011, the Group recognised a value in‑force business asset of £5,247 million (2010: £5,898 million) and an acquired value in‑force business asset of £1,391 million (2010: £1,469 million). The value 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 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 2(O)(1). 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 in‑force business assets at 31 December 2011 are set out in note 30.
At 31 December 2011, the Group carried liabilities arising from insurance contracts and participating investment contracts of £78,991 million (2010: £80,729 million). The methodology used to value these liabilities is described in note 2(O)(1). Elements of the liability valuations require assumptions to be made about future investment returns, future mortality rates and future policyholder behaviour and are subject to significant management judgement and estimation uncertainty. The key assumptions that have been made in determining the carrying value of these liabilities are set out in note 38.
Effects of liability management, volatile items and asset sales 48 (1,415) – – – 1,293 (74)
Other segment items reflected in income statement above: Increase (decrease) in value of in‑force business – – – 3 (625) – (622)
Other segment items reflected in income statement above: Increase in value of in‑force business – – – 2 787 – 789
Wealth and Reported basis Retail Wholesale Commercial International Insurance Other total £m £m £m £m £m £m £m
Other segment items reflected in income statement above: (Decrease) increase in value of in‑force business – – – (5) 1,097 – 1,092
Total income, net of insurance claims 20,771 – 838 (168) – (318) 21,123
Comprises the payment protection insurance provision (£3,200 million) and the provision in relation to German insurance business litigation (£175 million).
Total income, net of insurance claims 24,956 – (306) (246) – (960) 23,444
Costs: Impairment of tangible fixed assets (202) 52 – – – – (150)
Geographical areas The Group’s activities are focused in the UK and the analyses of income and assets below are based on the location of the branch or entity recording the income or assets.
Interest and similar income: Loans and advances to customers, excluding lease and hire purchase receivables 4.00 4.37 3.67 23,208 25,459 24,171
Debt securities held as loans and receivables 3.17 4.41 3.68 590 1,377 1,469
Interest receivable on loans and receivables 3.63 4.03 3.50 25,168 27,974 27,261
Interest and similar expense: Deposits from banks, excluding liabilities under sale and repurchase transactions 0.80 0.78 0.95 (222) (319) (883)
Net expense arising on liabilities held at fair value through profit or loss – debt securities in issue (230) (231) (125)
Net (losses) gains on financial instruments held for trading (1,065) 2,449 2,894
Change in provision for ceded unearned premiums (note 38(2)) – (9) 26
Change in non‑participating investment contract liabilities: Change in gross liabilities1 520 (5,449) (7,932)
Provision in relation to German insurance business litigation (note 45) 175 – –
Total operating expenses, excluding payment protection insurance provision and Government Asset Protection Scheme fee 13,050 13,270 13,484
£65 million (2010: £52 million; 2009: £nil) of the impairment of tangible fixed assets relates to integration activities.
Performance‑based awards expensed in 2011 include cash awards amounting to £160 million (2010: £163 million; 2009: £180 million).
Average headcount The average number of persons on a headcount basis employed by the Group during the year was as follows: Fees payable to the auditors Fees payable to the Company’s auditors by the Group are as follows: £m £m £m
Other non‑audit fees: Services relating to corporate finance transactions 6.3 1.9 0.3
Total fees payable to the Company’s auditors by the Group 36.3 40.4 40.7
Share of income statement amounts: Insurance claims – – (465) – – – – – (465)
Share of post-tax results 31 (39) (549) – (49) (203) 31 (88) (752)
During 2011, the Group recognised a net £8 million of losses of associates not previously recognised. The Group’s unrecognised share of losses of associates during 2010 was £8 million (2009: £64 million) and of joint ventures is £85 million in 2011 (2010: £180 million; 2009: £424 million). For entities making losses, subsequent profits earned are not recognised until previously unrecognised losses are extinguished. The Group’s unrecognised share of losses net of unrecognised profits on a cumulative basis of associates is £56 million (2010: £104 million; 2009: £64 million) and of joint ventures is £299 million (2010: £339 million; 2009: £424 million).
Note 15: Loss on disposal of businesses in 2010 During 2009, the Group acquired an oil drilling rig construction business through a previous lending relationship and consolidated the results and net assets of the business from the date it exercised control.
In the second half of 2010, the Group reached agreement to dispose of its interests in the two wholly‑owned subsidiary companies through which this business operates; the sale was completed in January 2011. These companies, which had gross assets of £860 million, were sold to Seadrill Limited; a loss of £365 million arose on disposal.
(A) Analysis of tax credit (charge) for the year £m £m £m
Foreign tax: Current tax on profit for the year (90) (82) (221)
Deferred tax (note 44): Origination and reversal of temporary differences 1,621 (393) 2,429
Tax credit (charge) thereon at UK corporation tax rate of 26.5 per cent (2010 and 2009: 28.0 per cent) 939 (79) (292)
Tax credit (charge) on (loss) profit on ordinary activities 828 (539) 1,911
In December 2009, as part of the Group’s recapitalisation and exit from the Government Asset Protection Scheme, the Group entered into an agreement with holders of certain existing liabilities to exchange these for ordinary shares or for cash on 18 February 2010. The weighted average number of anti‑dilutive shares arising from this transaction that have been excluded from the calculation of diluted earnings per share was 294 million at 31 December 2009. On 18 February 2010, the above exchange completed and 3,141 million new ordinary shares in Lloyds Banking Group plc were issued.
Debt securities: Other public sector securities – 1,183 1,183 – 919 919
Bank and building society certificates of deposit 2,863 385 3,248 3,692 606 4,298
The fair values and notional amounts of derivative instruments are set out in the following table: Contract/notional amount
Derivatives designated as cash flow hedges: Interest rate swaps 152,314 5,250 5,608
Total loans and advances to banks before allowance for impairment losses 32,620 30,292
Commitments for expenditure in respect of equipment to be leased (30) (21)
Later than 1 year and not later than 5 years 2,307 1,965
Later than 1 year and not later than 5 years 137 101
Cash deposits of £20,435 million (2010: £36,579 million) held by the Group are restricted in use to repayment of the debt securities issued by the SPEs, the term advances relating to covered bonds and other legal obligations.
Note 23: Special purpose entities In addition to the special purpose entities discussed in note 22, which are used for securitisation and covered bond programmes, the Group sponsors three asset‑backed conduits, Argento, Cancara and Grampian, which invest in debt securities and client receivables. All the external assets in these conduits are consolidated in the Group’s financial statements and are included in the credit market exposures set out in note 56. The total consolidated exposures in these conduits are set out in the table below: Argento £m
Debt securities classified as available‑for‑sale financial assets (note 26): Corporate and other debt securities 73 – – 73
Note 24: Debt securities classified as loans and receivables Debt securities accounted for as loans and receivables comprise: £m £m
Recoveries of advances written off in previous years 421 – 8 429
Asset‑backed securities: Corporate and other debt securities 73 5,172 5,245 463 11,669 12,132
Details of the Group’s asset‑backed conduits shown in the table above are included in note 23.
Direct operating expenses arising from investment properties that generate rental income 50 77
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in‑force business are set out below: Economic assumptions Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk‑free rate and all cash flows are discounted at a risk‑free rate.
Risk‑free rate (financial options and guarantees) 0.22 to 3.36 0.63 to 4.50
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.
Balance sheet amount at 31 December 2011 531 1,578 122 395 570 3,196
In addition, total future minimum sub‑lease income of £40 million at 31 December 2011 (£55 million at 31 December 2010) is expected to be received under non‑cancellable sub‑leases of the Group’s premises.
Assets arising from reinsurance contracts held (note 38 and note 40) 2,534 2,146
Costs deferred, net of amounts amortised to the income statement 92 69
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £7,987 million (2010: £11,112 million) and a fair value of £8,088 million (2010: £11,278 million).
Liabilities held at fair value through profit or loss (debt securities) 5,339 6,665
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements 12,378 14,612
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2011 was £5,487 million, which was £148 million higher than the balance sheet carrying value (31 December 2010: £6,607 million, which was £58 million lower than the balance sheet carrying value). At 31 December 2011 there was a cumulative £183 million decrease 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 TSB Bank plc, the issuing entity within the Group. Of the cumulative amount, a decrease of £194 million arose in 2011 and none arose in 2010.
Note 38: Liabilities arising from insurance contracts and participating investment contracts Insurance contract and participating investment contract liabilities are comprised as follows: Gross £m
Life insurance (see (1) below): Non‑life insurance contracts (see (2) below): Reinsurance balances are reported within other assets (note 33).1
(1) Life insurance The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows: Insurance contracts
The realistic assessment is carried out using a stochastic simulation model which values liabilities on a market consistent basis. The calculation of realistic liabilities uses best estimate assumptions for mortality, persistency rates and expenses. These are calculated in a similar manner to those used for the value of in‑force business as discussed in note 30.
(iii) Assumptions Key assumptions used in the calculation of with‑profit liabilities, and the processes for determining these, are: Investment returns and discount rates The realistic capital regime dictates that with‑profit fund liabilities are valued on a market‑consistent basis. This is achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with‑profit fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk‑free yield and all cash flows are discounted using the risk‑free yield. The risk‑free yield is defined as the spot yield derived from the relevant government bond yield curve. Further information on significant options and guarantees is given on page 127.
– Change in the assumption in respect of current and future mortality rates (£74 million decrease)
Change in liabilities charged to income statement (note 10) (186) 12 (174)
The liability of £386 million shown in the above table excludes £9 million of unallocated claims handling expenses.
Note 39: Life insurance sensitivity analysis The following table demonstrates the effect of changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in‑force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
This sensitivity shows the impact of a 25 basis point increase in credit default spreads on corporate bonds and the corresponding reduction in market values. Government bond yields, the risk‑free rate and illiquidity premia are all assumed to be unchanged.
Note 40: Liabilities arising from non-participating investment contracts The movement in liabilities arising from non‑participating investment contracts may be analysed as follows: Gross Reinsurance Net £m £m £m
Change in unallocated surplus recognised in the income statement (note 10) (340) (439)
The Group currently expects to pay contributions of approximately £650 million to its defined benefit schemes in 2012.
Assumptions The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 5.00 5.50
Sensitivity analysis The effect of changes in key assumptions on the pension charge in the Group’s income statement and on the net defined benefit pension scheme asset or liability is set out below: Increase (decrease) in the income statement charge
Expected life expectancy of members: Increase of one year 38 40 (655) (620)
Present value of defined benefit obligation (28,236) (26,862) (27,073) (15,617) (16,795) (17,378)
During the year ended 31 December 2011 the charge to the income statement in respect of defined contribution schemes was £202 million (2010: £173 million; 2009: £208 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
For the principal post‑retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 30 June 2008; this valuation has been updated to 31 December 2011 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 6.61 per cent (2010: 7.54 per cent).
Amount (charged) credited to equity: Available‑for‑sale financial assets (note 49) (574) (330)
Asset at 31 December 4,182 3,917 Asset at 31 December 4,182 3,917
Deferred tax assets of £384 million (31 December 2010: £396 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.
Payment protection insurance There has been extensive scrutiny of the Payment Protection Insurance (PPI) market in recent years.
In October 2010, the UK Competition Commission confirmed its decision to prohibit the active sale of PPI by a distributor to a customer within seven days of a sale of credit. This followed the completion of its formal investigation into the supply of PPI services (other than store card PPI) to non‑business customers in the UK in January 2009 and a referral of the proposed prohibition to the Competition Appeal Tribunal. The Competition Commission consulted on the wording of a draft Order to implement its findings from October 2010, and published the final Order on 24 March 2011 which became effective on 6 April 2011. Following an earlier decision to stop selling single premium PPI products, the Group ceased to offer PPI products to its customers in July 2010.
Customer goodwill payments Following discussions with the FSA regarding the application of an interest rate variation clause in certain Bank of Scotland plc variable rate mortgage contracts Bank of Scotland plc applied for a Voluntary Variation of Permission (VVOP) in February 2011 and agreed to initiate a customer review and contact programme and to make goodwill payments to affected customers. The Group made a provision of £500 million within its 2010 accounts in respect of this matter. Since that time further information has become available which has resulted in Bank of Scotland plc applying for, and being granted, an amended VVOP by the FSA in November 2011. No additional charge is required at this time.
Floating Rate Undated Subordinated Notes (e500 million) a 45 42 4.25% Perpetual Fixed to Floating Rate Reset Subordinated Guaranteed Notes (e750 million) (Clerical Medical Finance plc) 231 215 10.25% Subordinated Undated Instruments (£100 million) a 1 1 5.125% Step‑up Perpetual Subordinated Notes callable 2015 (£560 million) (Scottish Widows plc) 554 550 5.125% Undated Subordinated Fixed to Floating Notes (e750 million) a 52 47 7.5% Undated Subordinated Step‑up Notes (£300 million) 5 3 5.125% Undated Subordinated Step‑up Notes callable 2016 (£500 million) a 2 –
c The fixed rate on this security was reset from 6.625 per cent to 4.64821 per cent with effect from 15 July 2010.
Dated subordinated liabilities 12% Guaranteed Subordinated Bonds 2011 (£100 million) a – 109 6.50% Notes 2011 (US$150 million) – 99 4.75% Subordinated Notes 2011 (e850 million) – 764 Subordinated Step‑up Floating Rate Notes 2016 (e500 million) b, c 179 432 Subordinated Step‑up Floating Rate Notes 2016 (£300 million) b, c 184 296 Callable Floating Rate Subordinated Notes 2016 (e500 million) b, c 88 401 Callable Floating Rate Subordinated Notes 2016 (e500 million) b, c 124 417 Subordinated Callable Notes 2016 (US$750 million) b, c 191 440 Subordinated Callable Notes 2017 callable 2012 (e1,000 million) c 219 758 6.75% Subordinated Callable Fixed to Floating Rate Instruments 2017 callable 2012 (Aus$200 million) c 5 127 Subordinated Callable Floating Rate Instruments 2017 callable 2012 (Aus$400 million) c 38 255 5.109% Callable Fixed to Floating Rate Notes 2017 callable 2012 (Can$500 million) c 8 305
c Following an exchange, on 1 December 2011, certain holders elected to exchange some or all of the notes they held for new dated subordinated liabilities issued by Lloyds TSB Bank plc.
Issued on redemption of preference shares and other subordinated liabilities in 2010 – 4,299,422,579 – – 429 –
Issued to the Lloyds TSB Foundations – – 107,740,591 – – 11
Subdivision of limited voting ordinary shares – – 80,921,051 – – 12
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 18 May 2011. The authority to issue shares and the authority to make market purchases of shares will expire at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
In November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received by the Group, the Group agreed to suspend the payment of coupons and dividends on certain of the Group’s preference shares and preferred securities for the two‑year period from 31 January 2010 to 31 January 2012. Consequently, the terms of these instruments prevented the Company from making dividend payments on ordinary shares during the year.
Limited voting ordinary shares The limited voting ordinary shares are held by the Lloyds TSB Foundations (the Foundations). The holders of the limited voting ordinary shares, who held 0.1 per cent of the total ordinary share capital as at 31 December 2011, are entitled to receive copies of every circular or other document sent out by the Company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary shares in all respects from the date of conversion.
Shares issued on redemption and exchange of preference shares and other subordinated liabilities1 – 1,808 –
During the year ended 31 December 2011 the Group operated the following share‑based payment schemes, all of which are equity settled.
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 April 2001 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. Prior to 18 April 2001, the normal limit was equal to one year’s remuneration and no performance multiplier was applied.
For options granted up to March 2001 The performance condition was that growth in earnings per share must be equal to the aggregate percentage change in the Retail Prices Index plus three percentage points for each complete year of the relevant period together with a further condition that Lloyds Banking Group plc’s ranking based on total shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be in the top fifty companies of the FTSE 100.
Lloyds Banking Group Share Buy Out Awards As part of arrangements to facilitate the recruitment of certain Executives, options have been granted by individual deed and, where appropriate, in accordance with the Listing Rules of the UK Listing Authority.
No options were exercised during 2011 or 2010. The options outstanding under the HBOS Share Option Plan and St James’s Place Share Option Plan at 31 December 2011 had exercise prices in the range of £0.5183 to £8.7189 (2010: £0.5183 to £8.7189) and a weighted average remaining contractual life of 2.0 years (2010: 3.0 years).
The performance conditions for awards made in April, May and September 2009 are as follows: (i) Earnings per share (EPS): relevant to 50 per cent of the award. Performance will be measured based on EPS growth over a three‑year period from the baseline EPS of 2008.
(ii) Economic Profit (EP): relevant to 50 per cent of the award. Performance will be measured based on the extent to which cumulative EP targets are achieved over the three‑year period.
The performance conditions for awards made in March and August 2010 are as follows: (i) EPS: relevant to 50 per cent of the award. Performance will be measured based on EPS growth over a three‑year period from the baseline EPS of 2009.
If the adjusted EPS reaches 6.4p, 25 per cent of this element of the award, being the threshold, will vest.
If adjusted EPS reaches 7.4p, 100 per cent of this element will vest.
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding for the option schemes were as follows: Executive schemes SAYE schemes Other share option plans
The number of shares awarded relating to matching shares in 2011 was 30,999,387 (2010: 17,411,651), with an average fair value of £0.42 (2010: £0.63), based on market prices at the date of award.
Key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the Lloyds Banking Group plc Group Executive Committee together with its Non‑Executive Directors.
Granted, including certain adjustments1 (includes entitlements of appointed directors) 20 4 –
Granted, including certain adjustments1 (includes entitlements of appointed directors) 35 39 17
Deposits placed by key management personnel attracted interest rates of up to 5 per cent (2010: 4.25 per cent; 2009: 6.50 per cent).
At 31 December 2011, the Group did not provide any guarantees in respect of key management personnel (2010 and 2009: none).
Since 31 December 2010, the Group has had the following significant transactions with the UK Government or UK Government‑related entities: Government and central bank facilities During the year ended 31 December 2011, 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.
As at 31 December 2011, the Group’s investment in the Business Growth Fund was £20 million.
Open Ended Investment Companies (OEICs) The Group manages 249 (2010: 402) OEICs, and of these 142 (2010: 111) are consolidated. The Group invested £1,283 million (2010: £1,460 million) and redeemed £884 million (2010: £982 million) in the unconsolidated OEICs during the year and had investments, at fair value, of £4,431 million (2010: £7,920 million) at 31 December. The Group earned fees of £318 million from the unconsolidated OEICs (2010: £271 million).
Interbank offered rate setting investigations Several government agencies in the UK, US and overseas, including the US Commodity Futures Trading Commission, the US SEC, the US Department of Justice and the FSA as well as the European Commission, are conducting investigations into submissions made by panel members to the bodies that set various interbank offered rates. The Group, and/or its subsidiaries, were (at the relevant time) and remain members of various panels that submit data to these bodies. The Group has received requests from some government agencies for information and is co‑operating with their investigations. In addition, recently the Group has been named in private lawsuits, including purported class action suits in the US with regard to the setting of London interbank offered rates (LIBOR). It is currently not possible to predict the scope and ultimate outcome of the various regulatory investigations or private lawsuits, including the timing and scale of the potential impact of any investigations and private lawsuits on the Group.
Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. The borrowings with HM Treasury, which total circa £20 billion, are on an interest‑only basis until 31 March 2012 and the FSCS and HM Treasury are currently discussing the terms for refinancing these borrowings to take effect from 1 April 2012. Each deposit‑taking institution contributes towards the management expenses levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March. In determining an appropriate accrual in respect of the management expenses levy, certain assumptions have been made including the proportion of total protected deposits held by the Group, the level and timing of repayments to be made by the FSCS to HM Treasury and the interest rate to be charged by HM Treasury. For the year ended 31 December 2011, the Group has charged £179 million (2010: £46 million; 2009: £73 million) to the income statement in respect of the costs of the FSCS.
Litigation in relation to insurance branch business in Germany Clerical Medical Investment Group Limited (CMIG) has received a number of claims in the German courts, relating to policies issued by CMIG but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. CMIG has won the majority of decisions to date, although a small number of regional district and appeal courts have found against CMIG on specific grounds. CMIG’s strategy includes defending claims robustly and appealing against adverse judgments. The ultimate financial effect, which could be significant, will only be known once all relevant claims have been resolved. However, consistent with this strategy, and having regard to the costs involved in managing these claims, and the inherent risks of litigation, the Group has recognised a provision of £175 million. Management believes this represents the most appropriate estimate of the financial impact, based upon a series of assumptions, including the number of claims received, the proportion upheld, and resulting legal and administration costs.
In addition, a UK‑based shareholder action group has threatened multi‑claimant claims on a similar basis against the Group and two former directors in the UK. No claim has yet been issued.
Other legal actions and regulatory matters In addition, during the ordinary course of business the Group is subject to other threatened and actual legal proceedings (which may include class action lawsuits brought on behalf of customers, shareholders or other third parties), regulatory investigations, regulatory challenges 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 to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed properly to assess the merits of the case and no provisions are held against 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.
Later than 1 year and not later than 5 years 1,187 1,120
Trading and other financial assets at fair value through profit or loss – 18,056 121,454 – – – – 139,510
Loans and receivables: Loans and advances to banks – – – – 32,606 – – 32,606
Loans and advances to customers – – – – 565,638 – – 565,638
Debt securities in issue – – – – – 185,059 – 185,059
Unallocated surplus within insurance businesses – – – – – – 300 300
Trading and other financial assets at fair value through profit or loss – 23,707 132,484 – – – – 156,191
Loans and receivables: Loans and advances to banks – – – – 30,272 – – 30,272
Loans and advances to customers – – – – 592,597 – – 592,597
Trading and other financial liabilities at fair value through profit or loss – 20,097 6,665 – – – – 26,762
(2) Reclassification of financial assets No financial assets were reclassified in 2011
From held for trading to loans and receivables 67 56 750 727 1,833 1,822 2,883 2,926
No financial assets were reclassified in accordance with paragraphs 50B, 50D or 50E of IAS 39 in 2011, 2010 and 2009; the following disclosures relate to those assets which were so reclassified in 2008.
From available‑for‑sale financial assets to loans and receivables (68) 69 161 (108)
b) Actual amounts recognised in respect of reclassified assets After reclassification the reclassified financial assets contributed the following amounts to the Group income statement.
Items in the course of collection from banks 1,408 1,408 1,368 1,368
Trading and other financial assets at fair value through profit or loss 139,510 139,510 156,191 156,191
Loans and receivables: Loans and advances to banks 32,606 32,554 30,272 30,236
Trading and other financial liabilities at fair value through profit or loss 24,955 24,955 26,762 26,762
Loans and receivables The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates. The carrying value of the variable rate loans and those relating to lease financing is assumed to be their fair value. For fixed rate lending, several different techniques are used to estimate fair value, as considered appropriate. These techniques also take account of expected credit losses and changes in interest rates and expected future cash flows in establishing fair value. For commercial and personal customers, fair value is principally estimated by discounting anticipated cash flows (including interest at contractual rates) at market rates for similar loans offered by the Group and other financial institutions. The fair value for corporate loans is estimated by discounting anticipated cash flows at a rate which reflects the effects of interest rate changes, adjusted for changes in credit risk. Certain loans secured on residential properties are made at a fixed rate for a limited period, typically two to five years, after which the loans revert to the relevant variable rate. The fair value of such loans is estimated by reference to the market rates for similar loans of maturity equal to the remaining fixed interest rate period. The fair values of asset‑backed securities and secondary loans, which were previously within assets held for trading and were reclassified to loans and receivables, are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data.
Notes in circulation The fair value of notes in circulation which are payable on demand is considered to be equal to their carrying value.
Total trading and other financial liabilities at fair value through profit or loss 864 25,898 – 26,762
Asset-backed securities Where there is no trading activity in asset‑backed securities, valuation models, consensus pricing information from third party pricing services and broker or lead manager quotes are used to determine an appropriate valuation. Asset‑backed securities are then classified as either level 2 or level 3 depending on whether there is more than one consistent independent source of data. If there is a single, uncorroborated market source for a significant valuation input or where there are materially inconsistent levels then the security is reported as level 3. Asset classes classified as level 3 mainly comprise certain collateralised loan obligations and collateralised debt obligations.
Equity investments (including venture capital) Unlisted equities and fund investments are accounted for as trading and other financial assets at fair value through profit or loss or as available‑ for‑sale financial assets. These investments are valued using different techniques as a result of the variety of investments across the portfolio in accordance with the Group’s valuation policy and are calculated using International Private Equity and Venture Capital Guidelines.
Unquoted equities and property partnerships in the life funds Third party valuations are used to obtain the fair value of unquoted investments. Management take account of any pertinent information, such as recent transactions and information received on particular investments, to adjust the third party valuations where necessary.
Movements in Level 3 Portfolio The table below analyses movements in the level 3 financial assets portfolio.
Trading and other financial assets at fair value through profit or loss Availablefor -sale Derivative assets Total financial assets £m £m £m £m
Gains (losses) recognised in the income statement relating to those assets held at 31 December 2010 151 (81) (667) (597)
Derivative financial instruments (i) 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.
(ii) In respect of credit default swaps written on level 3 negative basis asset‑backed securities, reasonably possible alternative valuations have been calculated by flexing the spread between the underlying asset and the credit default swap, or adjusting market yields, by a reasonable amount. The sensitivity is determined by applying a 60 bps increase/decrease in the spread between the asset and the credit default swap.
Venture capital and equity investments Third party valuers have been used to determine the value of unlisted equities and property partnerships included in the Group's life insurance funds.
– in line with International Private Equity and Venture Capital Guidelines, the values of underlying investments in fund investments portfolios.
The DVA is sensitive to: – the current size of the mark‑to‑market position on the uncollateralised liability; – expectations of future market volatility of the underlying liability; and
A one per cent rise in the CDS spread would lead to an increase in the DVA of £125 million to £618 million.
Note 56: Financial risk management As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.
Market risk The Group uses various market risk measures for risk reporting and setting risk appetite limits and triggers. These measures include Value at Risk and Stress Scenarios.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non‑structural foreign exchange exposures in the non‑trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 165.
Credit risk The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom, the European Union, Australia and the United States. Credit risk appetite is set at Board level and is described and reported through a suite of metrics devised from a combination of accounting and credit portfolio performance measures, which include the use of various credit risk rating systems as inputs. The Group uses a range of approaches to mitigate credit risk, including internal control policies, obtaining collateral, using master netting agreements and other credit risk transfers, such as asset sales and credit derivative based transactions.
Trading and other financial assets at fair value through profit or loss (excluding equity shares)3: Loans and advances 11,121 12,545
Loans and receivables The disclosures in the table below and those on pages 324 to 325 are produced under the combined businesses approach used for the Group’s segmental reporting. The Group believes that, for reporting periods immediately following a significant acquisition such as the acquisition of HBOS in 2009, this combined businesses 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.
Allowance for impairment losses on loans and advances to customers 18,732 18,373
Comprises an allowance held at 31 December 2008 of £10,693 million and a charge for the period from 1 January 2009 to 16 January 2009 of £454 million.
Total loans and advances which are neither past due nor impaired 30,259 339,509 45,058 159,274 543,841 12,545
Total loans and advances which are past due but not impaired – 13,215 1,289 3,427 17,931 –
Available‑for‑sale financial assets (excluding equity shares) An analysis of the Group’s available‑for‑sale financial assets is included in note 26. The credit quality of the Group’s available‑for‑sale financial assets (excluding equity shares) is set out below: AAA £m
Debt securities: Other public sector securities – – – – – 27 27
Total held as available-for-sale financial assets 23,483 8,002 3,054 597 193 139 35,468
Debt securities: Other public sector securities – – – – – 29 29
Treasury bills and other bills 4,439 – 1,629 – – – 6,068
Corporate and other debt securities 304 141 312 489 151 179 1,576
Total held as trading assets 2,266 5,824 2,541 367 13 470 11,481
Credit risk in respect of trading and other financial assets at fair value through profit or loss held within the Group’s unit‑linked funds is borne by the policyholders and credit risk in respect of With Profits funds is largely borne by the policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back those contract liabilities.
Assets arising from reinsurance contracts held Of the assets arising from reinsurance contracts held at 31 December 2011 of £2,534 million (2010: £2,146 million), £842 million (2010: £671 million) were due from insurers with a credit rating of AA or above.
Loans and receivables The disclosures below are produced under the combined businesses approach used for the Group’s segmental reporting. The Group believes that, for reporting periods immediately following a significant acquisition, such as the acquisition of HBOS in 2009, this combined businesses basis, which includes the allowance for loan losses at the acquisition on a gross basis, more fairly reflects the underlying provisioning status of the loans.
At 31 December 2010 70 per cent to 80 per cent 57,979 1,869 787 60,635 80 per cent to 90 per cent 53,732 2,381 1,138 57,251 90 per cent to 100 per cent 43,263 2,413 1,359 47,035
In addition, securities held as collateral in the form of stock borrowed amounted to £10,438 million (2010: £72,224 million). Of this amount, £5,308 million (2010: £52,393 million) had been resold or repledged as collateral for the Group’s own transactions.
Irrevocable loan commitments and other credit-related contingencies At 31 December 2011, the Group held irrevocable loan commitments and other credit‑related contingencies of £57,329 million (2010: £67,809 million). Collateral is held as security, in the event that lending is drawn down, on £13,279 million (2010: £13,011 million) of these balances.
In addition to the assets detailed above, the Group also holds assets that are encumbered through the Group’s asset‑backed conduits and its securitisation and covered bond programmes. Further details of these assets are provided in notes 22 and 23.