View this report online A full version of our Annual Report and Accounts and information relating to Lloyds Banking Group is available at: www.lloydsbankinggroup.com
FORWARD LOOKING STATEMENTS This annual report includes certain forward looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995 with respect to the business, strategy and plans of Lloyds Banking Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Lloyds Banking Group or its directors’ and/or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ’will’, ‘would’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar future or conditional expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future.
Examples of such forward looking statements include, but are not limited to, projections or expectations of the Group’s future financial position including profit attributable to shareholders, provisions, economic profit, dividends, capital structure, expenditures or any other financial items or ratios; statements of plans, objectives or goals of the Group or its management including in respect of certain synergy targets; statements about the future business and economic environments in the United Kingdom (UK) and elsewhere including future trends in interest rates, foreign exchange rates, credit and equity market levels and demographic developments; statements about competition, regulation, disposals and consolidation or technological developments in the financial services industry; and statements of assumptions underlying such statements.
Factors that could cause actual business, strategy, plans and/or results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by the Group or on its behalf include, but are not limited to: general economic and business conditions in the UK and internationally; inflation, deflation, interest rates and policies of the Bank of England, the European Central Bank and other G8 central banks; fluctuations in exchange rates, stock markets and currencies; the ability to access sufficient funding to meet the Group’s liquidity needs; changes to the Group’s credit ratings; the ability to derive cost savings and other benefits as well as the ability to integrate successfully the acquisition of HBOS; changing demographic developments including mortality and changing customer behaviour including consumer spending, saving and borrowing habits; changes to borrower or counterparty credit quality; technological changes; natural and other disasters, adverse weather and similar contingencies outside the Group’s control; inadequate or failed internal or external processes, people and systems; terrorist acts and other acts of war or hostility and responses to those acts, geopolitical, pandemic or other such events; changes in laws, regulations, taxation, accounting standards or practices; regulatory capital or liquidity requirements and similar contingencies outside the Group’s control; the policies and actions of governmental or regulatory authorities in the UK, the European Union (EU), the US or elsewhere; the ability to attract and retain senior management and other employees; requirements or limitations imposed on the Group as a result of HM Treasury’s investment in the Group; the ability to complete satisfactorily the disposal of certain assets as part of the Group’s EU State Aid obligations; the extent of any future impairment charges or write-downs caused by depressed asset valuations; market related trends and developments; exposure to regulatory scrutiny, legal proceedings or complaints; changes in competition and pricing environments; the inability to hedge certain risks economically; the adequacy of loss reserves; the actions of competitors; and the success of the Group in managing the risks of the foregoing.
Lloyds Banking Group is quoted on both the London Stock Exchange and the New York Stock Exchange and is one of the largest companies within the FTSE 100.
Addressing the key issues An overview of the key issues currently affecting the Group.
There are four primary operating divisions within the Group: Retail, Wholesale, Wealth and International, and Insurance. The key product markets in which they participate and relative contribution to the Group’s total income are presented below and a more detailed analysis of their strategy, business and performance is outlined within the Business Review. All the divisions are focused on delivering the Group Strategy and offering an integrated professional service to customers.
RECONCILIATION OF COMBINED BUSINESSES PROFIT (LOSS) BEFORE TAX TO STATUTORY PROFIT BEFORE TAX Profit (loss) before tax – combined businesses 2,212 (6,300)
In order to reflect the impact of the acquisition of HBOS, the following adjustments have been made: – the 2009 results assume HBOS had been owned throughout the year; – the gain on acquisition of HBOS (in 2009) and amortisation of purchased intangible assets have been excluded; and – the unwind of acquisition-related fair value adjustments is shown as one line in the combined businesses income statement.
In order to better present the underlying business performance the following items, not related to acquisition accounting, have also been excluded: – integration costs; – insurance and policyholder interests volatility; – the Government Asset Protection Scheme (GAPS) fee paid in 2009; – goodwill impairment; – the curtailment gain in respect of the Group’s defined benefit pension schemes; – the customer goodwill payments provision; and – loss on disposal of businesses.
Further, to enable a better understanding of the Group’s core business trends and outlook, certain income statement and balance sheet information is analysed between core and non-core portfolios. Non-core portfolios consist of non-relationship assets and liabilities, together with assets and liabilities which are outside the Group’s current appetite. The EU mandated retail business disposal is not included in non-core portfolios.
Good progress on balance sheet reduction with cumulative non-core asset reduction of £105 billion
– Utilising capital more effectively is increasingly important in the current environment and capital will continue to be rigorously allocated across our portfolio of businesses to support core business growth.
Developing strong customer franchises that are based on deep customer relationships All our core businesses are focused on extending our customer relationships, whilst enhancing product capabilities to build competitive advantage. Ensuring we understand and effectively meet the needs of our customers from basic banking products to the more specialist services such as insurance, wealth management or corporate banking is at the heart of our business. It is also fundamental to ensuring we are developing long lasting customer relationships.
Managing our most valuable resource, our people Executing our strategy effectively will only be possible if we ensure deliverables are effectively aligned with our corporate strategy and we manage our most valuable resource, our people, well. Our people have the skills and capabilities to deliver the strategy but in driving performance it is important to ensure we encourage, manage and develop our staff whilst creating a great place to work.
The delivery of cost synergies from the integration programme is ahead of schedule and we remain on track to deliver a run rate of more than £2 billion per annum of cost synergies and other operating efficiencies by the end of 2011.
The Group continues to actively support our customers and the UK economy by lending to UK households and businesses. Under the terms of our lending commitments to the UK Government we agreed to make available gross new lending of £67 billion in the 12 months to 28 February 2011 and we remain on track to deliver this having extended £63 billion of qualifying lending by the end of December 2010.
Banks have a central role in promoting and fuelling the economic recovery. We will continue to play our part in supporting UK growth by extending a significant amount of new lending to businesses and households. We have provided nearly £80 billion of gross lending to UK homeowners and businesses in 2010 and, as part of our SME charter, the Group is committed to helping 300,000 new start-up businesses by the end of 2012. We have already helped over 100,000 such enterprises during 2010. For the year ended 28 February 2011 we will exceed the mortgage and business lending commitments made by the Group to the UK Government.
In working diligently to create long term sustainable shareholder value we aim to restore our ability to pay dividends on ordinary shares as soon as market conditions and the financial performance of the Group permit. As you know this intention is subject to the expiry in 2012 of the restrictions arising from the European Commission’s remedies.
I have enjoyed meeting many colleagues in various visits to our operations all over the country over the past year. Gaining an on-the-spot insight into how they work to serve our stakeholders by building long term relationships with our customers and by supporting businesses has been invaluable. I must tell you that I have been impressed by their desire to work together to ensure the success of our integration, by their discipline and focus and by their commitment to their customers. It is clear that in our large and occasionally complex Group, teamwork combined with commitment, professionalism and hard work is the key to realising our promises to stakeholders.
Following on from the unprecedented turmoil across the sector in 2008 and 2009, the increased focus on remuneration has continued into 2010. In the context of the evolving economic environment and regulatory changes, the Remuneration Committee undertook a further review of executive remuneration in 2010. We firmly believe that remuneration policy needs to incentivise executives to continue strong, sustainable growth and delivery of value to shareholders, in light of one of the biggest integrations ever undertaken in the sector. The Committee equally however is mindful of the continued heightened awareness in the public domain around executive remuneration. Both these considerations informed the Committee’s decisions on remuneration this year and that for António Horta-Osório, our new Group Chief Executive.
In addition to the changes previously outlined during the year we have continued to strengthen the Board both in terms of in-depth banking experience and broader business perspectives. On 1 March 2010, two new Non-Executive Directors were appointed, Glen Moreno and David Roberts, and Anita Frew joined the Board on 1 December 2010.
Dr Wolfgang Berndt retired at the annual general meeting in May 2010, having joined the Board in 2003. I would like to thank him for his significant contribution to the Group.
The full particulars and background of all our Directors are set out on pages 110 and 111.
We have a great platform for the future and have established a strong financial and operational trajectory. I am confident that we will be able to grow the business further over the coming years with António Horta-Osório at the helm leading our 112,000 colleagues – a dedicated workforce and an experienced management team.
In Retail, our strategy is to develop deep and enduring customer relationships through offering a broad range of products addressing customers’ needs, alongside superior service and advice. We opened 1.9 million current accounts, and over 5 million new savings accounts, and increased customer deposits by 5 per cent in the year.
“ We achieved a step change in our financial performance despite slow economic growth, returning the Group to profitability while absorbing the substantial costs of reducing risk in the business.”
We also provided £49 billion of committed gross lending to UK businesses in 2010, of which £11 billion was for SMEs. As part of our SME Charter, the Group has committed to helping 300,000 new start-up businesses by the end of 2012, and has already helped in excess of 100,000 such enterprises during 2010. We continue to approve over 80 per cent of lending applications from SME customers. Despite the uncertain economic environment, the Group has successfully grown net lending to its core SME customers by 2.1 per cent, which compares favourably with the industry-wide reduction in SME lending reported in the latest available market statistics.
As a result of our focus, we will exceed the mortgage and business lending commitments made by the Group to the UK government for the year ended 28 February 2011.
We made excellent progress in enhancing our funding and liquidity position in 2010, thereby further reducing the Group’s risk, albeit at some incremental cost.
We operate in a demanding and evolving regulatory environment, and have continued to engage actively with our regulators during the year on a number of proposed reforms, ensuring we have a strong and stable banking system, which will also be able to support and serve its customers and the wider economy.
It has been a tremendous honour and a privilege to lead our many talented and dedicated people over the last eight years, and I would like to thank my colleagues and the Board for their support over this time. I am grateful to have been given the opportunity to create the new Group. The significant progress we have made in 2010 positions the Group well for the future to meet our objective of becoming the best bank for all our stakeholders, including our customers, shareholders and employees.
During the year, the Group extended £30 billion of gross mortgage lending (including remortgages) to UK homeowners (including £5 billion in new lending to firsttime buyers) and £49 billion of committed gross lending to UK businesses (of which £11 billion was for SMEs). As part of our SME Charter, the Group has committed to helping 300,000 start-ups by 2012, and has already helped in excess of 100,000 new start up businesses during 2010. We continue to approve over 80 per cent of lending applications from SME customers.
The Commission will also have regard to the Government’s wider goals of financial stability and creating an efficient, open, robust and diverse banking sector, with specific attention paid to the potential impact of its recommendations on: – Financial stability; – Lending to UK consumers and businesses and the pace of economic recovery; – Consumer choice; – The competitiveness of the UK financial and professional services sectors and the wider UK economy; and
Migration of 3,700 Halifax and Bank of Scotland ATMs to the Lloyds TSB platform – completes April 2011.
Following a review of the business, we completed our strategic exit from Ireland by the end of 2010, including the closure of 44 Bank of Scotland Ireland branches.
Completion of the legal transfer of our businesses in Spain to form one integrated business serving both local and international communities.
First estimates suggest that the UK economy grew by 1.4 per cent in 2010, below the long term average of 2.25 per cent. Growth peaked in the first half due to the initial boost from companies beginning to rebuild stocks, and has slowed during the second half. Consumer confidence has fallen back and house prices have recently reversed some of their 2009 rise. Nevertheless, employment has held up relatively well, falling by much less than in previous recessions and beginning to rise much earlier, although the recent trend is broadly flat. UK corporate liquidations have been on a gradually falling trend since Q3 2009, much earlier than in previous recoveries, and are now almost back to the level at the start of the recession. Related to that, commercial property prices have now risen by 16 per cent from the trough reached in July 2009. Even though house price rises have fallen back slightly recently, average prices are still 6 per cent above their trough of April 2009.
Our customer data shows that a combination of low interest rates and declining indebtedness is beginning to strengthen households’ cashflow. This is positive news for both impairments’ and the near-term general economic outlook. Nevertheless, we expect that a continuation of weak economic recovery will be accompanied by a sustained period of weak growth in our markets. Consumers and businesses will continue to deleverage slowly. Deposit growth will be limited by the pressure on consumers’ disposable incomes from wage growth below inflation and cuts in welfare benefits, and from rising investment spend by companies. Arrears trends should continue to improve, but less quickly in the coming year than the experience through 2010.
Customer relationship deposits increased by 3 per cent reflecting good growth in Retail and in Wealth and International.
Statutory profit before tax was £281 million in 2010. While this was a reduction from £1,042 million in 2009, the 2009 result had benefited from an £11,173 million credit from the gain arising on the HBOS acquisition (negative goodwill). In 2010, statutory profit included a charge for integration costs of £1,653 million (2009: £1,096 million), a provision of £500 million for customer goodwill payments, and a loss on disposal of businesses (acquired from a previous lending relationship) of £365 million; these items were partially offset by a £910 million pension curtailment gain and positive insurance volatility of £306 million. After a taxation charge of £539 million (see note 16 on page 181 and 182) and a charge for profit attributable to non-controlling interests of £62 million, loss attributable to equity shareholders was £320 million and loss per share amounted to 0.5 pence.
Note on presentation of results To enable meaningful comparisons to be made with prior periods, and in line with previous results announcements, the income statement commentaries below are on a combined businesses basis (see ‘basis of presentation’ – page 153). Certain commentaries also exclude the unwind of fair value adjustments.
margin pressures, and modest additional costs reflecting the successful increase in term issuance compared to our initial expectations.
In 2011, we see limited scope to increase asset pricing, with any gains likely to be offset by elevated wholesale funding costs, while liability margins will remain under pressure as a result of competitive markets and low base rates. Given these factors and the margin expansion since 2009, which we have achieved earlier than expected, we do not expect further progression in our net interest margin in 2011 compared to 2010 as a whole.
Core business income growth was primarily driven by a strong performance in Retail, where net interest income benefited from an increase in asset margins, the majority of which occurred in the first half of the year. This increase was partially offset however by lower savings margins. Mortgage margins reflected a continued increase in the proportion of mortgages on standard variable rates (now representing 48 per cent of outstanding balances), lower LIBOR to base rate spreads, and higher new business margins as assets were priced to appropriately reflect risk and changes in funding costs. The Group achieved a 22.1 per cent share of gross mortgage lending (2009: 24.1 per cent), in markets which remained generally subdued. Unsecured lending balances were lower, continuing the recent trend and reflecting lower customer demand and continuing customer deleveraging. During the year, we continued to build our current account and savings customer franchises in what remains a competitive market for customer deposits, and reduced the proportion of more expensive term deposits while maintaining good overall deposit growth of 5 per cent.
We have already made significant progress in capturing savings from the integration programme with annual run-rate savings totalling £1,379 million achieved as at 31 December 2010. The Group is on track to deliver a run-rate of £2 billion per annum of cost synergies and other operating efficiencies by the end of 2011.
Impaired loans increased by 10 per cent to £64,606 million, representing 10.3 per cent of closing advances, driven by an increase in impaired loans in International, partially offset by decreases in Retail and Wholesale facilitated by improving economic conditions and, in Wholesale, also as a result of write-offs of irrecoverable assets and the sale of previously impaired assets. The Group’s coverage ratio increased by 1.7 per cent to 45.9 per cent, primarily as a result of an increase in provisions in International, predominantly in Ireland. Non-core loans and advances to customers generated approximately 70 per cent of the Group’s impaired loans reflecting their higher risk profile, with a coverage ratio of around 50 per cent at 31 December 2010. The coverage ratio of the Group’s impaired core loans and advances to customers was approximately 37 per cent.
The unsecured impairment charge decreased by 29 per cent, reflecting continued improving portfolio trends resulting from the Group’s prudent risk appetite, management actions taken over the past two years, and stable unemployment. Unsecured impaired loans decreased by £0.8 billion to £3.0 billion as a result of fewer cases going into arrears, improved quality of new business and increased write off of impaired loans. Impairment provisions as a percentage of impaired loans decreased to 50.6 per cent from 55.3 per cent, driven largely by relatively highly provided assets being written off combined with more stringent criteria for unsecured collections repayment plans.
In Wealth and International, impairment charges totalled £5,988 million, up 47 per cent on £4,078 million in 2009, reflecting increasing impairment charges in corporate and real estate in Ireland and Australia. The majority of the increase was in the non-core portfolio. The level of losses continues to be dominated by the economic environment in Ireland, and to a lesser extent has also been influenced by the performance of specific areas of the Australian economy.
Outlook – impairment Overall, and based on our current economic assumptions for the UK and Ireland, including unemployment and property valuations, we expect to see further reductions in impairment losses in 2011 and beyond. We continue to target an improvement in the overall Group impairment charge as a percentage of average loans and advances to customers towards an expected 50-60 basis points by around 2014, as economic conditions improve.
In Wholesale, depending upon UK economic conditions, notably consumer spending, future commercial real estate price stability, the continuation of low interest rates, and the performance of individually large exposures, we would expect to see a further modest reduction in 2011 as a whole, although the timing of the trend is inherently hard to predict. As previously guided, we expect the overall net impairment charge in our traditional lending businesses (especially in the trading and manufacturing sectors) to increase in 2011, driven in part by lower write backs on asset disposals compared to 2010 and the effect of the UK government austerity measures on the wider economy. However, we also expect our impairment charges in corporate real estate and real estate related sectors to be lower than 2010 as a result of a continuing stabilisation of the existing portfolio. We remain vigilant in monitoring changes in economic conditions and to individual lending positions and we continue to invest heavily in expert resource to work with customers to restructure their businesses on to sustainable bases, thus protecting employment where possible.
Despite the worsening trend during 2010, we expect to see a reduction in the Wealth and International impairment charge in 2011, although we anticipate that conditions will remain difficult, and we will therefore continue to monitor international markets closely.
Based on our economic outlook, we continue to target returns on equity of more than 15 per cent over the medium to longer term. However, there continue to be material uncertainties as to future capital requirements and therefore we cannot be more specific at this stage.
Rightsizing the balance sheet Total Group funded assets decreased to £655.0 billion from £715.1 billion at 31 December 2009, substantially driven by reductions in non-core lending portfolios across the three 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, particularly in the latter part of 2010.
Integration costs One-off integration costs of £1,653 million were incurred in 2010, bringing the total integration costs since the HBOS acquisition to £2,749 million. The integration costs relate to severance, IT and business costs of implementation.
Volatility arising in insurance businesses A large proportion of the funds held by the Group’s insurance businesses are invested in assets which are expected to be held on a long-term basis and which are inherently subject to short-term investment market fluctuations. Whilst it is expected that these investments will provide enhanced returns over the longer term, the short-term effect of investment market volatility can be significant. In 2010, higher equity market returns compared to our long-term assumptions have contributed to positive insurance and policyholder volatility totalling £306 million.
Customer goodwill payments provision On 21 February, 2011, we announced that we had reached a voluntary agreement with the Financial Services Authority (FSA) to initiate a customer review and contact programme regarding outstanding concerns relating to the variation of limits on some Retail mortgage contracts. These specifically related to some Halifax standard variable rate mortgage customers, where the wording in the mortgage offer documents received by these customers had the potential to cause confusion. Under the contact programme, goodwill payments will be made to affected customers.
There has been extensive scrutiny of the Payment Protection Insurance market in recent years, and the Financial Services Authority issued its final Policy Statement on PPI complaints handling in August 2010. The application of this Policy Statement could in extremis have a material impact on the Group’s financial position. In October 2010, an application for judicial review was issued by the British Bankers’ Association challenging the FSA’s new standards for PPI complaints handling and the Financial Ombudsman Service’s approach to such complaints. The hearing was held in late January 2011, and the judgement (which may be subject to appeal) is expected shortly. Further detail is given in note 54 on page 237.
The UK Government has appointed an Independent Commission on Banking (ICB) to review structural measures to reform the banking system and promote stability and competition. The ICB is not expected to publish its final report until September 2011 and it is too early to quantify any possible effect on the Group.
In February 2010, we announced that we would close our retail and intermediary business in the Republic of Ireland, and in August 2010 we announced that we would transfer, subject to the necessary approvals, the Bank of Scotland (Ireland) Limited (BOSI) business to Bank of Scotland plc. The business was transferred to Bank of Scotland plc on 31 December 2010, including all of the strategic management and decision making activities, at which point BOSI ceased to exist. As a result the Group no longer has any regulated banking business in the Republic of Ireland. Bank of Scotland plc will utilise its extensive operational and management capability, including general and credit management, oversight and control, within the UK in relation to the Irish portfolio, aiding the efficient run-down of the existing lending portfolio.
Share of results of joint ventures and associates 17 (95) (8) (10) 5 (91)
Profit (loss) before tax and fair value unwind 3,611 127 (5,196) 1,145 (593) (906)
Key balance sheet and other items 31 December 2009 £bn £bn £bn £bn £bn £bn
Impairment on loans and advances to customers divided by average loans and advances to customers, excluding reverse repo transactions, gross of allowance for impairment losses.
Profit before tax and fair value unwind increased to £3,611 million, a strong increase of £2,636 million compared to 2009, driven by good income growth, tight cost control and a significantly lower impairment charge.
Loans and advances to customers decreased by £7.4 billion, or 2 per cent to £363.7 billion, as customers continued to reduce their personal indebtedness, particularly unsecured debt. While mortgage balances declined by £3.8 billion, Retail continued to support first time buyers and home movers with gross mortgage lending of £30 billion.
Deep and enduring customer relationships The Retail strategy is to build deep and enduring relationships so that customers choose Retail’s relationship brands (Lloyds TSB, Halifax and Bank of Scotland) for more of their financial needs. This is being achieved through offering a broad range of products that address customer needs, alongside superior customer service and advice. Retail also continues to work to ensure customers are the focus of business development including instituting a number of programmes to ensure key customer needs underpin ongoing product and service development.
Retail has also continued to develop its current account switching facility, which plays a key role in building a strong relationship with new customers, by making it easy for customers to switch. Experience has shown that after customers use the current account switching facility, they are over 70 per cent more likely to transfer their primary current account.
Retail is committed to supporting the housing market and working with customers to find solutions to their changing situations. An example of this is the recently launched Equity Support Scheme that enables customers with low or negative equity to move home. This scheme recognises that there are significant numbers of customers who are making payments on their mortgage and have a desire to move but due to lack of equity have been unable to do so. Retail has also extended its popular first time buyer ‘Lend a Hand’ mortgage to all home movers. This product helps customers through allowing friends and family to contribute to a savings account supporting a mortgage.
Retail continues to work to deliver products and services that address customer needs. An example of this is the recently launched Halifax
Cash ISA Promise. In the month following the launch in October 2010 the ISA business performed significantly ahead of expectations with 44,000 accounts transferred, despite the launch being outside of the traditional ISA season. This industry leading promise addresses the poor transfer times between ISA providers, by promising to pay interest on new cash ISAs from the completed application date rather than when funds are transferred into the account, often weeks later. The other parts of the promise are increased information on cash ISA interest rates and an assurance that all cash ISAs are open to both new and existing customers.
Retail has been implementing new sales and customer service technology for mortgages and bancassurance across the network. These are being delivered to improve the quality of customer advice and increase the speed of decision making. The Mortgage Sales Platform offers customers a more comprehensive interview experience, a faster mortgage decision and ‘one best way’ of selling mortgages across its brands. In the bancassurance business a new platform has been rolled out to advisors, with tools which better identify customer’s needs. This innovative platform also brings portfolio modelling tools to the Retail market.
Retail has made good progress with integration, delivering significant cost savings and increased productivity as well as optimising performance across the business. The division has delivered run-rate synergies of £529 million at the end of 2010 and is on track to achieve run-rate synergies of £867 million by the end of 2011.
In 2010, Retail commenced the roll-out of a single counter system across all its branches providing a strong and efficient platform with increased functionality to further improve customer service. This is being supported by a ‘one best way’ programme that ensures there is a single efficient and effective approach to all major processes.
Profit before tax and fair value unwind increased to £3,611 million, a significant improvement compared to £975 million in 2009. This increase in profit was driven by strong income growth, tight cost control and a significant reduction in the impairment charge in the context of a stabilising economy.
Operating expenses remained well controlled and increased by 2 per cent, against an increase in total income of 12 per cent, reflecting ongoing cost control and synergies from the integration. The cost:income ratio for the year improved to 42.3 per cent compared to 46.7 per cent in 2009.
The UK mortgage market for both house purchase and re-mortgaging was slightly lower in 2010, with gross market lending of £136.1 billion compared to £143.3 billion in 2009. Retail’s gross mortgage lending (including remortgages) was £30 billion in 2010. This lending included full delivery on agreed lending commitments. New mortgage lending continued to be focused on supporting the housing market with more than 70 per cent of the lending being for house purchase rather than re-mortgaging. Retail remains the largest lender to first time buyers in the market helping over 50,000 customers buy their first home. It also continues to be an industry leader in its support for shared equity and shared ownership schemes.
Risk-weighted assets decreased by £19.3 billion, or 15 per cent, to £109.3 billion in 2010. This reduction was driven by lower lending balances, recalibrated downturn loss given default rates and the lower risk mix of the loan portfolio with reduced exposure to unsecured lending.
Non-core operations consist of specialist mortgages (self-certified and sub-prime), selected third-party branded loans and selected third-party branded credit cards. As at 31 December 2010, these operations included loans and advances to customers of £30.6 billion (31 December 2009: £33.5 billion) and risk weighted assets of £11.2 billion (31 December 2009: £13.2 billion). In 2010 they also contributed income of £591 million (compared to £388 million in 2009) and an impairment charge of £124 million (compared to £253 million in 2009). In addition to the non-core assets, Retail continues to progress plans to divest other retail assets and liabilities in line with the state aid obligations.
Key balance sheet and other items Loans and advances to customers 173.2 191.8 (10) Loans and advances to banks 12.4 18.9 (34)
The focus for 2011 remains on the planning and execution of the remaining 40 migrations and strengthening risk systems, whilst ensuring that we continue to deliver our high levels of customer service. The division achieved run-rate synergies of £359 million at the end of 2010 and is on track to deliver run-rate synergies of £532 million by the end of 2011.
Prioritising businesses In 2009, Wholesale systematically reviewed its assets, portfolios and businesses to identify those that would add most value to its relationship-focused strategic vision. In 2010, Wholesale ensured that investment in product and service capability was directed towards these core growth areas, and explored divestment opportunities for the remaining non-core assets.
Total income decreased by £347 million, or 4 per cent to £8,562 million mainly driven by a 6 per cent decrease in net interest income.
The decline in net interest income primarily reflects lower interest earning asset balances across loans and receivables in line with the Group’s targeted balance sheet reduction, mainly in loans and advances to customers, debt securities and available for-sale-positions. Income was affected by higher funding costs and lower lending volumes, although this was partly offset by higher customer margins on new business and from re-pricing on renewals.
Operating expenses decreased by £362 million, or 9 per cent, to £3,744 million primarily from a further reduction in the level of operating lease depreciation in Asset Finance and a continued focus on cost management including savings attributable to the integration programme. This was partially offset by additional costs in the Business Support Unit and continued investment in customer facing resource and systems.
Total income decreased by £54 million, or 3 per cent, to £1,776 million as a result of lower business volumes on assets held under operating leases. The lower business volumes are in-line with a targeted reduction in this asset class and were partly offset by stronger margins.
The impairment charge decreased by £564 million to £264 million, reflecting a stabilising economic environment and an improvement in market conditions for both the retail and non-retail consumer finance businesses. The lower impairment charge has been driven by a reduction in new cases entering arrears, the reduced book size and a better mix in the credit quality of new business being written over the last two years.
The International business comprises the Group’s other international banking businesses outside the UK, with the exception of corporate business in North America which is managed through the Group’s Wholesale division. These largely comprise corporate, commercial and asset finance business in Australia, Ireland and Continental Europe and retail businesses in Germany and the Netherlands.
2010 HIGHLIGHTS Loss before tax increased to £4,824 million compared to £2,356 million in 2009.
Maximising value in the short to medium term In International, the focus remains on managing the impaired asset portfolio and continued strengthening of the control environment. Redeployment of resource from front line activity and the wider Group to manage arrears and collections is now complete and business support units are fully operational. The business aims to de-risk and reduce the balance sheet where possible, with net repayments in the International portfolio contributing £4.1 billion to the reduction in underlying local currency customer advances.
In order to retain local administrative capability, historic knowledge and continuity of customer relationships, Bank of Scotland plc has entered into an agreement with an independent service company which will perform various administrative functions relating to the Irish business. Under this proposal the majority of BOSI employees have transferred to the service company.
The impairment charge decreased by 35 per cent reflecting strong credit management and improved collections and recoveries processes in 2010.
Includes Insight Investment’s external fund management business up to disposal on 2 November 2009.
Total income increased by 1 per cent, but was 7 per cent lower in constant currency. This reflects lower interest earning assets and the increased strain of higher impaired assets, partly offset by additional income on the £7 billion European loan portfolio transferred from Wholesale division in the second half of 2009.
Operating expenses increased by 15 per cent, partially due to foreign exchange movements. In constant currency, operating expenses increased by 12 per cent reflecting the development of International’s deposit taking operation in Germany, increased risk management resources to manage impaired asset portfolios in Ireland and Australia and costs associated with the closure of the Irish business.
The impairment charge and loans and advances to customers are summarised by key geography in the following table.
Other income decreased 4 per cent to £2,814 million largely resulting from the decrease in PPi income as a result of the Group’s decision to cease writing payment protection business, partially off-set by improved new business income and the higher than expected return from improved investment markets.
Lp&I uk sales of £10,316 million (pVnBp) reduced by 20 per cent. the reduction in sales is largely due to the withdrawal of certain lower return HBos legacy products in the second half of 2009 as the business continued to focus on value over volume and a change in mix towards protection products which, although more profitable, result in relatively lower PvnBP. An improvement in investment market conditions resulted in a reduction in sales of capital protected products.
Profit before tax and fair value unwind – before impact of PPI new business closure 1,215 1,024 19
Life, Pensions and Investments: Before impact of PPI new business closure 753 617 22
The Insurance division continues to focus on cost reduction with costs decreasing by 12 per cent in 2010. Efficiencies have been achieved without compromising the quality of customer service and customer satisfaction scores have remained robust across the division.
Leveraging distribution and asset management An integrated Life, Pensions and Investments UK bancassurance proposition was launched in June 2010. The proposition draws on product design and customer service expertise from the two heritages in order to establish a consistent base from which to further leverage the scale of the Group’s bancassurance operation.
Profit before tax and fair value unwind – before impact of PPI new business closure 753 617 22
Total profit before tax, before volatility and other items, increased by £86 million, or 9 per cent, to £1,052 million. Excluding the impact of experience variances and assumption changes, the profit before tax increased by £84 million or 10 per cent to £912 million.
The net impact of experience variances is not significant, with the reduction from the prior year reflecting the non-recurrence of benefits in 2009. Assumption changes in 2010 are predominantly driven by benefits in the European business and lower assumed investment management costs in the UK business, partly offset by a charge from aligning future maintenance expense assumptions within the Clerical Medical business to reflect the heritage Lloyds TSB approach.
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds. The value of the in-force business asset for annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of these corporate bond holdings.
This sensitivity shows the impact of reducing new business, maintenance expenses and investment expenses to 90 per cent of the expected rate.
This sensitivity shows the impact of reducing mortality and morbidity rates on non-annuity business to 95 per cent of the expected rate.
In sensitivities 4 to 7 and 9 assumptions have been flexed on the basis used to calculate the value of in-force business and the realistic and statutory reserving bases. A change in risk discount rates is not relevant as the risk discount rate is not an input to a market consistent valuation.
Underwriting income for home insurance showed modest growth of 3 per cent to £922 million. Home commission payable was adversely affected by the alignment of commission arrangements between the legacy businesses during the year.
PPI underwriting income decreased by £187 million, or 26 per cent, to £544 million reflecting the continued impact on new business volumes from the market wide move to monthly premiums in 2009 and the Group’s withdrawal from the payment protection market on 23 July 2010. Changes in commission payable reflect lower volumes of PPI written during the year.
Loss before tax (63) (149) 58 2009 comparative figures have been amended to reflect the effect of centralising operations across the Group as part of the integration programme. To ensure a fair comparison of the 2010 performance, 2009 direct costs have been increased with an equivalent offsetting increase in recharges to divisions.
Total income decreased by £1,390 million to £(425) million primarily due to a £1,045 million reduction in liability management gains, together with a £193 million increase in the mark-to-market losses arising from the equity conversion feature of the Group’s Enhanced Capital Notes and a £131 million reduction in the gain on other derivatives which cannot be mitigated through hedge accounting.
Liability management gains arose on transactions undertaken in both 2009 and 2010 as part of the Group’s management of capital which exchanged certain debt securities for ordinary shares or other debt instruments. These transactions resulted in a gain of £423 million in 2010 compared to a gain of £1,498 million in 2009 (of which £1,468 million is reflected in Central items). The fair value of the equity conversion feature of the Group’s Enhanced Capital Notes decreased by £620 million in 2010 compared to a decrease of £427 million in 2009.
The Group’s statutory profit before tax is affected by insurance volatility, caused by movements in financial markets, and policyholder interests volatility, which primarily reflects the gross up of policyholder tax included in the Group tax charge.
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) 4.59 5.05 4.34
The most significant of these additional sources of volatility is policyholder tax. Accounting standards require that tax on policyholder investment returns should be included in the Group’s tax charge rather than being offset against the related income. The impact is, therefore, to either increase or decrease profit before tax with a corresponding change in the tax charge. Over the longer term the charges levied to policyholders to cover policyholder tax on investment returns and the related tax provisions are expected to offset. In practice timing and measurement differences exist between provisions for tax and charges made to policyholders. Consistent with the normalised approach taken in respect of insurance volatility, differences in the expected levels of the policyholder tax provision and policyholder charges are adjusted through policyholder interests volatility. Other sources of volatility include the minorities’ share of the profits earned by investment vehicles which are not wholly owned by the long-term assurance funds.
Product and channel systems are being integrated and harmonised where required and this will continue through the first half of 2011 in parallel with a detailed and rigorous programme of testing in preparation for customer data migration from HBOS systems to the single IT platform by the end of 2011.
Loans and advances to customers Risk weighted assets Customer deposits £m £m £bn £bn £bn
Total non-core assets at 31 December 2009 have been reduced by £3.9 billion from the previously presented figure of £240 billion following a reclassification between core and non-core.
Annual dividends comprise both interim and estimated final dividend payments. Under IFRS, the total dividend for the year represents the interim dividend paid during the year and the final dividend which will be paid and accounted for during the following year.
This figure excludes 81 million (2006 to 2008: 79 million) limited voting ordinary shares.
Capital ratios are in accordance with Basel II requirements; other than the ratios for 2007 and 2006 which reflect Basel I.
Although 2010 has been a period of considerable change, we are proud of our continuously high levels of colleague engagement. This is vital in creating a high commitment, high performance organisation.
In 2010 we introduced a cap on our Defined Benefit pension schemes that will help us to manage the significant long-term cost inherent in the scheme and continue to meet our obligations to all members in future years. Alongside this we introduced a new Defined Contribution pension scheme that gives considerable flexibility to employees to plan for retirement.
In 2010 we have continued to invest in the development of our colleagues across the organisation providing an average of 5.4 days formal learning per full time equivalent.
Leadership and management capability Leaders throughout the organisation play a critical role in bringing our values to life for colleagues. The Group has continued its focus on developing and strengthening leadership and management skills with the launch of new Group wide Executive Development and Leadership and Management programmes. Using a shared Leadership language these have placed a particular emphasis on Performance Management and leading during a period of sustained rapid change.
During 2010, we have continued to make strong progress in all areas of Diversity & Inclusion. With a broad strategy, significant focus has come through the appointment of five Executive Director level sponsors who cover gender and work life balance, ethnic diversity, sexual orientation, disability and generational diversity.
Through reviewing our resourcing, work life balance and leadership development practices, we have continued to ensure we are able to attract, recruit and retain talented colleagues from diverse backgrounds. With diversity and inclusion integrated into the organisation’s mainstream management development we are equipping our leaders to embrace inclusion and leverage the opportunities of diverse thinking. All colleagues have had the opportunity to learn more about our progress, to give their views and to participate through the Group’s first national Diversity & Inclusion Week, a campaign to be repeated on an annual basis.
Our ethnic diversity colleague network has also grown in numbers, with over 1500 colleagues participating. Alongside our internal activity, our external presence has grown through our sponsorship of the Runnymede Trust’s2 ‘Snowy Peaks’ report which researched ethnic minority success at senior management and executive levels.
We have created a team to lead on the development and delivery of a people risk strategy. The team will also support the establishment of people risk management across the Group. This will be achieved through effective support, challenge and oversight of risk management across Human Resources; managing and co-ordinating the Group’s regulatory relationship on Human Resource issues and through strategic people risk management.
Our business strategy is to be recognised as the UK’s best financial services company. We want to be recognised and recommended as a trusted brand by customers, a good employer by colleagues and an active, valued participant in our communities.
Responsible lending, advice and support As a responsible lender, we wish to ensure customers only borrow what they can afford to repay. We have a responsible lending programme with internal management reporting and accountability. Our customer-facing employees are trained to offer the necessary advice and support to help customers manage their borrowing.
Lloyds TSB, Halifax and Bank of Scotland all have dedicated Customer Support and Money Management units to provide specialist help to customers who are concerned about their financial situation. They are there to help customers who actively seek help with their finances, and proactively contact those who we believe are at the highest risk of missing repayments. We speak with more than 300,000 customers a month to assess their financial health and find ways in which we can help.
We also want to help our customers to protect themselves from financial crime. Our various brand websites contain information to help customers to understand how to protect against the risks of common types of internet fraud. We run regular financial crime awareness campaigns, support industry education initiatives and sponsor the charity Crimestoppers.
We are already one of the leading global financers of renewable energy (by debt underwriting capability). In 2010, Lloyds Banking Group was rated the top UK bank in the new FTSE CDP Carbon Strategy Index Series, recognising our performance in managing climate risks and grasping the emerging opportunities.
We have a presence in almost every community in the UK and touch many millions of lives. Our significant role in the financial services sector is a privilege, and one that comes with important obligations.
We have developed dedicated products and services that address financial exclusion. With over four million accounts, we are the biggest provider of social bank accounts in the UK. Social bank accounts – often known as basic bank accounts – are a simple form of current account that are open to anyone, regardless of credit rating, as long as they have not been convicted of fraud or are an un-discharged bankrupt. They enable customers to pay household bills by direct debit, which can save them money when compared with other methods of payment. We also are the only bank to offer social banking customers a bespoke Christmas savings account, the Halifax Christmas Saver. This is an important part of our work to help close the savings gap.
In 2010, our colleagues claimed £1.3 million in matched funding, raising £3.2 million for charities in the process.
Treating customers fairly Treating customers fairly, and ensuring that we are transparent in all our dealings with them, is central to our aim of building deep and lasting relationships with customers.
Halifax also launched a ‘No Fees’ First Time Buyer Mortgage early in 2011 – a first among mainstream lenders. The mortgage offers Halifax current account customers a 90 per cent loan-to-value mortgage at a two year fixed-rate of 5.79 per cent. It has been specifically designed to help first time buyers by paying the fees on their mortgage.
As part of our award winning 2012 SME Charter, we have pledged to support 300,000 new start-ups across the country by 2012. The Charter sets out a series of commitments that form a three year programme of support for SMEs to help them grow as the recovery gains momentum. We are running 200 business seminars every year for the next three years, providing expert guidance and support for up to 90,000 SMEs on starting up, employment, exporting, bidding for London 2012 Olympic and Paralympic Games contracts, finance and sustainability.
Looking ahead, we need to continue to engage in open conversations with our key stakeholders and demonstrate how we are listening to their needs. We realise that it will take time to rebuild trust and understanding in the sector and we are committed to leading the way. By listening to our stakeholders, and by acting in their best interests, we will support our strategic aim of being recognised by them as the UK’s best financial services organisation. Over time, we believe that this will enable us to deliver superior, more sustainable shareholder value.
The Group has a conservative business model embodied by a risk culture founded on prudence and accountability, where everyone understands that they are accountable for the risks they take and that the needs of customers are paramount. The focus has been and remains on building and sustaining long-term relationships with customers, through good and bad economic times. The approach is supported by a ‘through the cycle’ approach to risk with strong control and monitoring.
BOARD AND COMMITTEES The Board, assisted by its key Risk Committees (Risk Committee and Audit Committee), approves the Group’s overall risk management framework. The Board also reviews the Group’s aggregate risk exposures and concentrations of risk to ensure that these are consistent with the Board’s appetite for risk. The role of the Board, Audit Committee and Risk Committee are shown in the corporate governance section on pages 120 to 121, and further key risk oversight roles are described below.
The Group Business Risk Committee reviews and recommends the Group’s risk appetite and risk management framework, high-level group policies and the allocation of risk appetite. Group Business Risk Committee periodically reviews risk exposures and risk/reward returns and monitors the development, implementation and effectiveness of the Group’s Risk Governance Framework. Within the scope of its work the committee also considers reputational risk and any issues which could have a materially adverse impact on the Group.
The Group Business Risk Committee is supported by the following Committees: – The Group Operational and Regulatory Risk Committee, which is responsible for identifying current and emerging significant regulatory and 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 divisional engagement occurs to develop, implement and maintain the Group’s compliance and operational risk management framework.
– The Group Model Governance and Approvals Committee, which is responsible for setting the control framework and standards for models across the Group, including establishing appropriate levels of delegated authority, the approval of models that are considered to be material to the Group (including credit risk rating systems), and the principles underlying the Group’s economic capital framework.
– The Group Financial Crime Committee serves as the principal Group forum for reviewing and challenging the management of financial crime risk including the overall strategy and performance. The Committee is accountable for ensuring that, at Group level, financial crime risks are effectively identified and managed within risk appetite and that strategies for financial crime prevention are effectively co-ordinated and implemented across the Group.
Group 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. Divisional Risk Officers have dual reporting lines to their own divisional executive and also to the Chief Risk Officer and are responsible for the risk profile within their own divisions. This matrix approach enables the Group Executive Committee members to fulfil their risk management accountabilities.
Divisional Risk Officers provide oversight of risk management activity for all risks within each of the Group’s divisions. Reporting directly to the Group Executive Directors responsible for the divisions and to the Chief Risk Officer, their day-to-day contact with business management, business operations and risk initiatives provides an effective risk oversight mechanism.
Group and divisional risk functions have responsibility for overseeing effective implementation of policy. Group Audit provides independent assurance to the Board about the effectiveness of the Group’s control framework and adherence to policy. Policies are reviewed annually to ensure they remain fit for purpose.
Execution of the Group’s risk management framework is dependent upon a clear and consistent risk identification using a common language to define risks and to categorise them (see table 1.3 below).
Legal and regulatory exposure is driven by the significant volume of current legislation and regulation within the UK and overseas with which the Group has to comply, along with new or proposed legislation and regulation which needs to be reviewed, assessed and embedded into day-to-day operational and business practices across the Group as a whole. This is particularly the case in the current market environment, which is witnessing increased levels of government and regulatory intervention in the banking sector.
There is a risk that certain aspects of the Group’s business may be determined by the authorities or the courts as not being conducted in accordance with applicable laws or regulations, or with what is fair and reasonable in their opinion. The Group may also be liable for damages to third parties harmed by the conduct of its business.
The key dependencies for successfully funding the Group’s balance sheet include the continued functioning of the money and capital markets; successful right sizing of the Group’s balance sheet; the continuation of HM Treasury and Bank of England facilities in accordance with the terms agreed; limited further deterioration in the UK’s and the Group’s credit rating and no significant or sudden withdrawal of deposits resulting in increased reliance on wholesale funding markets. A return to the extreme market conditions of 2008 would place a strain on the Group’s ability to meet its financial commitments.
The principal market risks are as follows: There is a risk to the Group’s banking income arising from the level of interest rates and the margin of interbank rates over central bank rates. A further banking risk arises from competitive pressures on product terms in existing loans and deposits, which sometimes restrict the Group in its ability to change interest rates applying to customers in response to changes in interbank and central bank rates.
Insurance risks typically, and longevity in particular, crystallise gradually over time. Actuarial assumption setting for financial reporting and liability management requires expert judgement as to when evidence of an emerging trend is sufficient to require an alteration to long-run assumptions.
Lloyds Banking Group is closely engaged with the UK Government and regulators on reform proposals, and with the EU on disposal arrangements, to influence and manage colleague uncertainty.
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 31 more granular risk types to enable more detailed review and facilitate appropriate reporting and monitoring, as set out in table 1.3.
RISK APPETITE Credit risk appetite is set by the Board and is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio performance measures, which in turn use the various credit risk rating systems as inputs. These metrics are supported by a comprehensive suite of policies, sector caps, product and country limits to manage concentration risk and exposures within the Group’s approved risk appetite.
(Note 56 to the financial statements provides an analysis of the portfolio and pages 79 to 88 provide details of our Credit risk portfolio.)
Controls over rating systems: The Group has established an independent team in Group Risk that sets common minimum standards, designed to ensure risk models and associated rating systems are developed consistently, and are of sufficient quality to support business decisions and meet regulatory requirements. Internal rating systems are developed by risk functions either in the business units or divisions, with the business unit managing directors having ownership of the systems. Line management takes responsibility for ensuring the validation of the rating systems, supported and challenged by independent specialist functions in their respective division.
Cross-border and cross-currency exposures: Country limits are authorised by the country limits panel, taking into account economic, financial, political and social factors. Group policies stipulate that these limits must be consistent with, and support the approved business and strategic plans of the Group.
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.
Master netting agreements Where it is efficient and likely to be effective (generally with counterparties with which it undertakes a significant volume of transactions), the Group enters into master netting agreements. Although master netting agreements do not generally result in an offset of balance sheet assets and liabilities, as transactions are usually settled on a gross basis, they do reduce the credit risk to the extent that, if an event of default occurs, all amounts with the counterparty are terminated and settled on a net basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting agreements can change substantially within a short period, since it is affected by each transaction subject to the agreement.
In addition, the Group participates in the following UK Government (‘Government’) sponsored programmes for households: – Income Support for Mortgage Interest: This is a medium-term Government initiative that provides certain defined categories of customers, principally those who are unemployed, access to a benefit scheme, paid for by the Government, which covers all or part of the interest on the mortgage. Qualifying customers are able to claim for mortgage interest on up to £200,000 of the mortgage, and the benefit is payable for a maximum of two years. All decisions regarding an individual’s eligibility and any amounts payable under the scheme rest solely with the Government. Payments are made directly to the Group by the appropriate Government department.
– Mortgage Rescue Scheme: This is a short-term Government initiative for borrowers in difficulty and facing repossession, who would have priority for re-housing by a local authority (e.g. the elderly, disabled, single parents). Eligible customers can have their property bought in full or part by the social rented sector and then remain in their home as a tenant or shared equity partner. If the property is sold outright the mortgage is redeemed in full.
The Group’s accounting policy for loan renegotiations and forbearance is set out on page 159.
TABLE 1.4: IMPAIRMENTS ON GROUP LOANS AND ADVANCES (audited) As at 31 December 2010
A ‘double-dip’ scenario – a second recession following closely the one from which the economy is just emerging – remains a key downside risk to UK impairment charges. This is because it would result in further significant increases in corporate failures and unemployment during 2011-12, as well as causing a second period of falling prices for residential and commercial property, tenant defaults would increase and central banks would have limited ability to cushion the downturn. Together, these factors could lead to increased impairments across the Group’s UK portfolios.
Retail’s impairment charge decreased by £1,480 million to £2,747 million in 2010 compared with 2009 and was lower in both secured and unsecured portfolios. This improvement was driven primarily by the improved quality of new business and effective portfolio management, coupled with the continuing slow recovery of the economy. The lower secured impairment charge reflected a reduction in impaired loans and improved arrears in the first half of 2010. Across Retail in 2010, there were fewer cases going into arrears. The impairment charge on loans and advances to customers, as an annualised percentage of average loans and advances to customers, decreased to 0.74 per cent from 1.11 per cent in 2009.
TABLE 1.7: IMPAIRMENTS ON RETAIL LOANS AND ADVANCES (audited) As at 31 December 2010
SECURED IMPAIRMENT CHARGE (unaudited) The impairment charge decreased by £497 million, to £292 million in 2010 compared to the previous year. The main drivers of the reduction were continued benefits from internal activities (risk and collections policies), maintained affordability and the continuing slow recovery of the economy. However, for the second half of 2010 the impairment charge was greater than the first half due to falling house prices combined with a worsening house price outlook towards the end of the period. The impairment charge for loans and advances to customers, as a percentage of average loans and advances to customers, decreased to 0.09 per cent from 0.23 per cent in 2009.
TABLE 1.9: MORTGAGES GREATER THAN THREE MONTHS IN ARREARS (EXCLUDING POSSESSIONS) (audited) Greater than three months in arrears (excluding repossessions)
Impaired loans decreased by £0.8 billion to £3.0 billion which represented 10.7 per cent of closing loans and advances to customers at 31 December 2010, compared with 11.9 per cent at 31 December 2009. The movement in impaired loans is consistent with the trends seen in both the flow of accounts to arrears and arrears balances, both of which have fallen across all unsecured products during 2010. This is a result of tightening credit policy across the credit lifecycle, including stronger controls on customer affordability, set against a stable economic environment. Retail’s exposure to revolving credit products has been actively managed to ensure that it is appropriate to customers’ changing financial circumstances. The portfolios’ results are supported by pre-recessionary levels of early arrears for accounts acquired in the last two years, highlighting an underlying improvement in the risk profile of the business.
OVERVIEW (unaudited) – Impairment charge for 2010 decreased significantly to £4,446 million, from £15,683 million for 2009.
CORPORATE (unaudited) The £81,171 million of loans and advances to customers in the Corporate portfolio is structured across a number of different portfolios and sectors as discussed below: UK and US Corporate – Showed resilience during 2010 with the impairment charge significantly lower than 2009 levels and modest recoveries as asset prices improved during the first half of the year. Sentiment among UK corporates during the second half of the year changed as the scale of the Government austerity measures became clearer although most effects are not expected to be felt until 2011. Major corporate balance sheets are relatively strong with adequate levels of undrawn committed bank facilities available and continued access to the capital markets. In the Corporate North American portfolio significant reductions were achieved in the non-core portfolio, mostly in the first half when secondary markets were fairly buoyant. Impairments were significantly lower than in 2009 albeit the overall position is improved by some write backs.
CORPORATE REAL ESTATE BUSINESS SUPPORT UNIT (unaudited) The Corporate Real Estate Business Support Unit portfolios have endured a significant level of stress as a consequence of the unprecedented scale and pace of deterioration in the property sector since the peak in 2007, coupled with the previous aggressive lending appetite in the heritage HBOS business. Against significant impairments taken in 2009, experience in 2010 is materially lower. This reflects the stabilising economic environment and the prudent provisioning undertaken on the HBOS corporate real estate and real estate related portfolio in 2009. The Group continues to remain cautious regarding the short to medium term prospects for the sector.
WHOLESALE MARKETS Loans and advances to customers of £40.0 billion largely comprise balances in the Structured Corporate Finance portfolio, which includes Acquisition Finance (leveraged lending – £11.6 billion), Project Finance and asset based finance. The Acquisition Finance portfolio continues to be significantly affected by the economic environment, with a relatively high proportion of deals being restructured. The rate of new problem loans started to abate in the second half of 2009 and this trend continued during 2010. Refinancing risk is an issue for Acquisition Finance, with significant loan maturities due in the next few years. In Ship Finance, global markets, especially the dry bulk and container sectors, experienced considerable pressure during 2009, leading to higher impairment levels. The container sector strengthened during 2010, but the Group expects the shipping sector to remain challenging into 2011.
Wholesale Markets is also responsible for the Treasury Assets portfolio which mainly encompasses a portfolio of Asset-Backed Securities (ABS) and financial institution Floating Rate Note positions. Further details of Wholesale Division’s Asset-Backed Securities is provided in note 18 to the financial statements on page 183. The size of the Treasury Assets portfolio has reduced through asset sales and amortisation.
– Impairment charges in Ireland increased significantly in the last quarter of 2010 reflecting a material deterioration in market conditions that resulted in EU-IMF financial support in late November 2010.
– Increased impairment charges in Australia are primarily due to real estate concentrations in specific geographical and industry sectors where liquidity has significantly contracted in 2010.
Although the economic performance for Australia has been more robust, exposure to the New Zealand and non-metropolitan Australian commercial real estate sectors remains a key influence on impairment performance. These markets have suffered a significant reduction in liquidity in 2010, driving increased impaired lending and also constraining recoveries.
The Group’s defined benefit staff pension schemes are exposed to significant risks from the constituent parts of their assets and from the present value of their liabilities, primarily equity and real interest rate risk. For further information on pension scheme assets and liabilities please refer to note 43 to the financial statements on page 208.
MEASUREMENT The following market risk measures are used for risk reporting and setting risk appetite limits and triggers: Value at Risk: for short term liquid positions a 1-day 95 per cent VaR is used; for structural positions a 1-year 95 per cent VaR is used
Both VaR and standard stress measures are also used in setting divisional market risk appetite limits and triggers.
Although an important measure of risk, VaR has limitations as a result of its use of historical data, assumed distribution, holding periods and frequency of calculation. In addition, the use of confidence levels does not convey any information about potential loss when the confidence level is exceeded. Where VaR models are less well suited to the nature of positions, the Group recognises these limitations and supplements its use with a variety of other techniques. These reflect the nature of the business activity, and include interest rate repricing gaps, open exchange positions and sensitivity analysis. Stress testing and scenario analysis are also used in certain portfolios and at group level, to simulate extreme conditions to supplement these core measures. Trading book VaR (1-day 99 per cent) is back-tested daily against profit and loss.
Banking – trading assets and other treasury positions Based on the commonly used 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding 300 business days, the VaR for the years ended 31 December 2010 and 2009 based on the Group’s global trading positions was as detailed in table 1.16.
Risk exposure is monitored monthly using, primarily, market value sensitivity. This methodology considers all re-pricing mismatches in the current balance sheet and calculates the change in market value that would result from a set of defined interest rate shocks. Where re-pricing maturity is based on assumptions about customer behaviour these assumptions are also reviewed monthly.
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.
RISK APPETITE Insurance risk appetite is defined with regard to the quantum and composition of insurance risk that exists currently in the Group and the direction in which the Group wishes to manage this. It takes account of the need for each entity in the Group to maintain solvency in excess of the minimum level required by the entity’s jurisdictional legal or regulatory requirements.
The Group’s appetite for insurance risk is reviewed and approved annually by the Board.
MITIGATION A key element of the control framework is the consideration of insurance risk by a suitable combination of high level Committees/Boards. For the life assurance businesses the key control bodies are the Board of Scottish Widows Group Limited and the Board of HBOS Financial Services Limited with the more significant risks also being subject to review by the Group Executive Committee and/or Lloyds Banking Group Board. For the general insurance businesses the key control bodies are the Boards of the legal entities including Lloyds TSB General Insurance Limited, St. Andrew’s Insurance plc and the Irish subsidiaries, with the more significant risks again being subject to Group Executive Committee and/or Lloyds Banking Group Board review. All Group staff pension schemes issues are covered by the Group Asset and Liability Committee and the Group Business Risk Committee.
There are a number of categories of operational risk: Legal and regulatory Legal and regulatory risk is the risk of reductions in earnings and/or value, through financial or reputational loss, from failing to comply with the laws, regulations or codes applicable.
IT systems The risk of reductions in earnings and/or value through financial or reputational loss resulting from the development, delivery and maintenance of effective IT solutions.
The integration programme continues to be one of the largest integration exercises undertaken by a financial services firm. The breadth of the integration programme is such that all parts of the Group are impacted to a large or small degree, with the greatest impact being on the Retail bank. Although now over two years into the successful implementation of the programme, there continue to be delivery risks as the programme moves into its final phase of execution.
MITIGATION The Group’s operational risk management framework consists of the following key components: – Identification and categorisation of the key operational risks facing a business area.
MONITORING Business unit risk exposure is aggregated at divisional level and reported to Group Risk where a group-wide report is prepared. The report is discussed at the monthly Group Operational and Regulatory Risk Committee. This committee can escalate matters to the Chief Risk Officer, or higher committees if appropriate.
MITIGATION (audited) The Group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through both short-term liquidity management and long-term funding strategy. Short-term liquidity management is considered from two perspectives; business as usual and liquidity under stressed conditions, both of which relate to funding in the less than one year time horizon. Longer term funding is used to manage the Group’s strategic liquidity profile which is determined by the Group’s balance sheet structure. Longer term is defined as having an original maturity of more than one year.
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.
LIQUIDITY AND FUNDING MANAGEMENT IN 2010 (unaudited) During 2010 liquidity and funding remained a key area of focus for the Group and the industry as a whole. Like all major banks, the Group is dependent on confidence in the short and longer term wholesale funding markets; should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding and liquidity where necessary, its ability to fund its financial obligations could be affected.
During 2010, the Group further improved the diversification of funding supporting its balance sheet. Wholesale funding reduced by £27.5 billion whilst customer deposits increased by £11.3 billion, resulting in a more stable liability base. The customer loan to deposit ratio improved to 154 per cent compared with 169 per cent at 31 December 2009.
At 31 December 2010, the Group’s further overall support from legacy Government and central bank facilities totalled £96.6 billion, a reduction of £60.6 billion compared with 31 December 2009. These facilities have various maturity dates, the last of which is in the fourth quarter of 2012. The Group’s plan to right size the balance sheet is expected to avoid the necessity to refinance much of this. Repayment of the remaining amount will be achieved by a combination of customer deposit growth and term wholesale issuance.
The Group’s wholesale term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total funding) at 31 December 2010 has been maintained at 50 per cent.
The first measure promotes short term resilience of the liquidity profile by ensuring that banks have sufficient high quality liquid assets to meet potential funding outflows in a stressed environment within a one month period. This is measured by the LCR. The second promotes resilience over a longer time horizon by requiring banks to fund their activities with a more stable source of funding on a going concern basis. This is measured by NSFR which has a time horizon of one year and has been developed to ensure a sustainable maturity structure of assets and liabilities.
The Group welcomes the Basel Committee’s Sound Principles. The introduction of the LCR (January 2015) and NSFR (January 2018) will raise the resilience of banks to potential liquidity shocks and provide the basis for a harmonised approach to liquidity risk management. At 31 December 2010, the Group’s internal calculation of the LCR was 71 per cent and the NSFR was 88 per cent; the guidance issued by the Basel Committee is still subject to final ratification by the EU and the methodology is likely to be refined on the basis of feedback from banks and regulators during the observation period. The actions already announced to right size the balance sheet are expected to ensure compliance with the future minimum standards, which are expected to be 100 per cent for both ratios by their respective effective dates.
Secondary liquidity assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
Secondary liquidity comprises a diversified pool of highly rated unencumbered collateral (including retained issuance).
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.
EXPOSURE A capital exposure arises where the Group has insufficient regulatory capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures whilst optimising value for shareholders.
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.
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.
The Group is able to accumulate additional capital through profit retention, by raising equity via, for example, a rights issue or debt exchange and by raising tier 1 and tier 2 capital by issuing subordinated liabilities. The cost and availability of additional capital is dependent upon market conditions and perceptions at the time.
Additional measures which have been used to manage the Group’s capital position include seeking to strike an appropriate balance of capital held within its insurance and banking subsidiaries and through improving the quality of its capital through liability management exercises. Regulatory requirements are primarily controlled through the quality and volume of lending but are also affected through the modelling approaches used to determine risk weighted assets and expected losses.
TABLE 1.27: MOVEMENTS IN CORE TIER 1 AND TIER 1 CAPITAL DURING THE YEAR
TIER 2 CAPITAL Tier 2 capital has increased principally as a result of new issues of tier 2 debt and favourable foreign exchange rate movements partially offset by the redemption of undated subordinated debt described above, amortisation for regulatory purposes of dated subordinated debt and lower eligible provisions.
The FSA has issued the Group an integrated waiver direction effective from 31 December 2010. The principal changes resulting from this are to move the heritage HBOS non-retail Advanced IRB portfolios to a Foundation IRB approach. All material retail portfolios across the Group remain on Retail IRB. In anticipation of moving to The Standardised Approach (TSA) for measurement of operational risk, the Group has calculated operational risk weighted assets on the basis of TSA.
LIFE INSURANCE BUSINESSES The business transacted by the life insurance companies within the Group comprises unit-linked business, non profit business and with-profits business. Several companies transact either unit-linked and/or non-profit business, but Scottish Widows plc (Scottish Widows) and Clerical Medical Investment Group Limited (Clerical Medical) hold the only large With Profit Funds managed by the Group.
AVAILABLE CAPITAL RESOURCES Available capital resources represent the excess of assets over liabilities calculated in accordance with detailed regulatory rules issued by the FSA.
Statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. If the market is not active, the Group establishes a fair value by using valuation techniques. Liabilities are calculated using a projection of future cash flows after making prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the FSA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for with-profits policies that are at the discretion of management, but does include a value for policyholder options likely to be exercised.
The valuation of with-profits assets in a With Profit Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-profits business written in a With Profit Fund (a relatively small amount of business in the case of Scottish Widows and Clerical Medical), it includes the present value of the anticipated future release of the prudent margins for adverse deviation. In addition, the realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above.
The ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the With Profit Fund with a further deduction to cover various stress tests (the Risk Capital Margin). In circumstances where the ‘realistic excess capital’ position is less than the ‘statutory excess capital’, the company is required to hold additional capital to cover the shortfall. Any additional capital requirement under this test is referred to as the With Profit Insurance Capital Component.
Estimated share of ‘realistic’ liabilities consistent with the FSA reporting treatment (409) (58) – – – (467)
Available capital resources for With-Profit Funds are presented in the table on a ‘realistic’ basis as this is more onerous than on a regulatory basis.
Other restrictions in the Non-Participating Fund: In addition to the policies which existed at the date of demutualisation, the With Profit Fund includes policies which have been written since that date. As a result of statements made to policyholders that investment policy will usually be the same for both types of business, there is an implicit requirement to hold additional regulatory assets in respect of the business written after demutualisation. The estimated amount required to provide such support at 31 December 2010 is £147 million (31 December 2009: £132 million). Scottish Widows has obtained from the FSA permission to include the value of this support in assessing the realistic value of assets available to the With Profit Fund. There is a further test requiring that no amounts can be transferred from the Non-Participating Fund of Scottish Widows unless there are sufficient assets within the Long Term Fund to meet both policyholders’ reasonable expectations in light of liabilities in force at a year end and the new business expected to be written over the following year.
The movements in the Group’s available capital resources in the life business can be analysed as follows: TABLE 1.31: MOVEMENTS IN AVAILABLE CAPITAL RESOURCES
OVERSEAS LIFE BUSINESS Available capital has increased over 2010 due to profits emerging on the in force business partially offset by new business strain.
OPTIONS AND GUARANTEES WITHIN THE WITH PROFIT FUNDS The most significant options and guarantees provided from within the With Profit Funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
– Investment volatility. The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2010, the 10 year equity-implied at-the-money assumption was set at 26.1 per cent (31 December 2009: 26.6 per cent). The assumption for property volatility was 15 per cent (31 December 2009: 15 per cent). The volatility of interest rates has been calibrated to the implied volatility of swaptions which was broadly 15 per cent (31 December 2009: 15 per cent).
Joined the Board and was appointed Chairman in September 2009. Previously Chairman of Citigroup Inc. from December 2007 to February 2009. He joined J Henry Schroder & Co in January 1966 and became Managing Director of Schroders Asia in 1971, Group Chief Executive of Schroders in 1984 and Chairman in 1995. Following the acquisition of Schroders’ investment banking business by Citigroup in 2000, became Chairman of Citigroup Europe before being appointed acting Chief Executive Officer of Citigroup in 2007 and subsequently as Chairman in the same year. A Non-Executive Director of Eli Lilly and Company, and The McGraw Hill Companies Inc. in the United States. He is a member of the National Advisory Board of UK Career Academy Foundation (Chairman until October 2010) and a member of the Akbank International Advisory Board. Chairman of the Advisory Council of TheCityUK. Aged 69.
Joined the Board in 2005. Held a number of senior and general management appointments in Vodafone from 1984 to 2006 including a directorship of that company from 1996, Group Chief Operating Officer from 2001 and Deputy Chief Executive Officer from 2005. Previously held positions in Philips from 1978 to 1982 and Mars GB from 1982 to 1984. A Non-Executive Director of De La Rue, Digicel Group and Emobile (Japan), a Director of Sky Malta, a member of the Altimo International Advisory Board and a senior adviser to UBS and CVC Capital Partners in relation to the global telecommunications sector. Deputy Chairman of Vallar plc. Pro Vice-Chancellor of University of Bath. A former Chairman of The Sage Group. Aged 62.
Joined the Board on 1 March 2010. Chairman of Pearson, the media group, since October 2005. A Director of Fidelity International, one of the world’s largest fund management companies, and Chairman of its Audit Committee. Deputy Chairman of The Financial Reporting Council. From 1987 to 1991 was Chief Executive of Fidelity International. Until mid 2009, was a Non-Executive Director and Senior Independent Director of Man Group, the FTSE 100 financial services group, and acting Chairman of UKFI. Former Group Executive of Citigroup from 1969 to 1987 and he held a number of senior positions at the bank in Europe and Asia. Aged 67.
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.
Joined the Board in 2004 as Group Finance Director. Appointed as Group Executive Director, UK Retail Banking in April 2008. Group Finance Director of Kingfisher from 2000 to 2004. Previously Finance Director of B&Q, having joined that company in 1995, from McKinsey & Co where she was a senior manager. Began her career at Unilever. Member of the Financial Services Practitioner Panel and the Said Business School Advisory Council. Chair of the British Bankers’ Association Retail Committee. A former member of the Accounting Standards Board. Fellow of the Chartered Institute of Management Accountants. Aged 48.
PRINCIPAL ACTIVITIES, BUSINESS REVIEW, FUTURE DEVELOPMENTS AND FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES 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. A review of the development and performance of the business during the financial year and an indication of the likely future developments are given on pages 3 to 108. Key performance indicators are shown on page 5. Information regarding the financial risk management objectives and internal control policies of the Company and its subsidiary undertakings in relation to the preparation of consolidated financial statements is given within the risk management report and corporate governance report respectively. Details of the Company’s principal risks and uncertainties are set out on pages 70 to 108. The financial risk management objectives and internal control policies in relation to the use of financial instruments is given on pages 65 to 108 and in notes 55 and 56 on pages 240 to 265.
CHANGE OF CONTROL The Company is party to significant contracts that are subject to change of control provisions in the event of a takeover bid.
In the UK, Lloyds Banking Group belongs to the major employer groups campaigning for equality for the above groups of staff, including Employers’ Forum on Disability, Employers’ Forum on Age, Stonewall and the Race for Opportunity. Our involvement with these organisations enables us to identify and implement best practice for our staff.
Lloyds Banking Group is committed to providing employees with comprehensive coverage of the economic and financial issues affecting the Group. We have established a full suite of communication channels, including an extensive face-to-face briefing programme which allows us to update our employees on our performance and any financial issues throughout the year.
DONATIONS The income statement includes a charge for charitable donations totalling £30,750,000 in 2010 (2009: £33,477,000), including £28,228,000 (2009: £28,228,000) which will be paid under the deeds of covenant to the four Lloyds TSB Foundations during 2011.
DIRECTORS’ RESPONSIBILITY STATEMENT Each of the directors, whose names and functions are listed on pages 110 and 111 of this annual report, confirm that, to the best of his or her knowledge: – the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and Group; and
As Chairman of Lloyds Banking Group plc, a role that I am honoured to perform, I am responsible for leadership of the Board and for ensuring its effectiveness.
I have enjoyed a constructive relationship with Eric Daniels, our Group Chief Executive, and with the wider Board over the last 18 months. I look forward to a similar relationship with António Horta-Osório, our new Group Chief Executive, when he takes over on 1 March 2011.
In 2010, we held a total of 17 Board meetings of which nine were scheduled at the start of the year. The much larger number of meetings than anticipated reflects the challenging environment in which we continue to operate and the need to keep the Board informed of developments in a timely manner.
Independence The Nomination & Governance Committee is responsible for assessing the independence of Non-Executive Directors on appointment and annually. It is satisfied that throughout the year, all Non-Executive Directors were independent as to both character and judgement.
Non-Executive succession planning Non-Executive succession planning is addressed as part of our ongoing review of Board composition. Our policy takes account of the need regularly to refresh our intake of Non-Executives to bring new perspectives, to ensure appropriate representation on each of the Board’s Committees and
In view of our succession plan, we did not appoint an executive search firm to assist with the search and selection process. The executive search firm, JCA Group, was involved in the process which enabled us to appoint our new Group Chief Executive. However I handled the approach to and the appointment of, António Horta-Osório in conjunction with the Succession Committee.
Executive Directors and senior executives The Nomination & Governance Committee and the Board are responsible for oversight of the process for succession and management development of the most senior executives both at and below Board level, including Executive Directors and members of the Group Executive Committee. The primary responsibility for this, however, rests with the Group Chief Executive. Arrangements are reviewed at least annually with the latest review taking place in June 2010.
Early in 2010, the Board reviewed and refreshed its induction programme to meet the Walker Review recommendation of a formal, substantive and personalised induction. All Directors appointed during 2010 have undertaken a three stage induction process comprising: – a corporate induction, which provides an overview of the Group, its strategy, operational structures and main business activities; – governance and Directors’ responsibilities, which explains the role and statutory duties of a Non-Executive Director including the roles and responsibilities owed by banks and other financial services firms to the FSA and other regulatory bodies; and
Time commitments The Nomination & Governance Committee reviewed and formalised the expected time commitments for Non-Executive Directors. The review laid down the expected time commitment for the Board, Committees and special responsibilities, eg Senior Independent Director, based on scheduled meetings only.
In 2010, as in 2009, the time commitment demanded of all Non-Executive Directors was considerable and substantially in excess of the time envisaged in their terms of appointment. There has been no adjustment to fees to reflect the increased workload since January 2008. I am grateful to our Non-Executives for the considerable personal contribution that they make to our Board and for accommodating the additional demands, often at short notice and at unsociable hours.
The Board is kept advised of the views of major shareholders by means of regular updates at Board and Committee meetings. It also receives monthly reports on market and investor sentiment and shareholder analysis.
Scottish Widows Investment Partnership, one of Europe’s largest asset managers and a Group company, complies with the principles of the Financial Reporting Council’s Stewardship Code, published in July 2010. Details of Scottish Widows Investment Partnership’s approach to stewardship and corporate governance can be found on its website, www.swip.com.
Regular Ad hoc Total Regular Ad hoc Regular Ad hoc Regular Ad hoc Regular
Appointed to the Board, Audit, Remuneration and Risk Committees on 1 March 2010. Appointed as Chairman of the Risk Committee and to the Nomination & Governance Committee with effect from 1 September 2010.
To set the principles and parameters of remuneration policy for the Group, and to oversee remuneration policy and outcomes for those colleagues specified in the terms of reference.
Risk David Roberts Sir Winfried Bischoff Anita Frew Sir Julian Horn-Smith Anthony Watson Martin Scicluna
– facilitates the involvement of Non-Executive Directors in risk issues and aids their understanding of these issues; – oversees adherence to Group risk policies and standards and considers any material amendments to them; and
– 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 directors are responsible for preparing the Annual Report, the Directors’ remuneration report and the financial statements in accordance with applicable law and regulations.
A copy of the financial statements is placed on our website www.lloydsbankinggroup.com. The Directors are responsible for the maintenance and integrity of the Company’s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
In September 2010, the British Bankers’ Association published a Code for Financial Reporting Disclosure (the ‘Disclosure Code’). The Disclosure Code sets out five disclosure principles together with supporting guidance. The principles are that UK banks: commit to providing high quality, meaningful and decision-useful disclosures; commit to ongoing review of, and enhancement to, their financial instrument disclosures for key areas of interest; will assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of such guidance; will seek to enhance the comparability of financial statement disclosures across the UK banking sector; and will clearly differentiate in their annual reports between information that is audited and information that is unaudited.
The Group and other major UK banks have voluntarily adopted the Disclosure Code in their 2010 financial statements. The Group’s 2010 financial statements have therefore been prepared in compliance with the Disclosure Code’s principles.
The Audit Committee evaluated the performance of the external auditors during the year and will periodically continue to do so. The Audit Committee has not considered it necessary to require an independent tender process.
Information that is required to be disclosed in the corporate governance report under the Companies Act 2006 and the FSA’s Disclosure and Transparency rules can be found in the Directors’ report, on the Shareholder information page and in the share capital note.
During the past year the Committee has undertaken a great deal of work to ensure a continued prudent approach to our remuneration policy while recognising the need to attract, incentivise and retain our key people. Shareholders may care to note that of the six current members of the Committee, four have joined within the last 18 months.
We have carried out a wide-ranging and considered consultation with shareholders. I have very much enjoyed the opportunity that this has given me to exchange views on the Group’s remuneration strategy. We have carefully reflected on the feedback from shareholders and this has directly influenced our approach.
2010 REMUNERATION OUTCOMES The Group has made significant progress during the year. We have also reduced the level of risk in our business in reaction to the economic events that had a particularly deep impact on the banking sector and we are endeavouring, as a business, to continue to support the UK’s economic recovery.
– Furthermore, 100 per cent of any award will be deferred into shares and will not be released until March 2013 at the earliest. In order to increase alignment with shareholders, this will be subject to malus if performance is not sustained.
– Awards made in March 2010 under the Long Term Incentive Plan (‘LTIP’) were below 2008 levels by up to 100 per cent of salary and lower than the market practice for long-term incentives in our sector.
We continue to have concerns that our remuneration framework is uncompetitive and this is an area that will be kept under close and continuous review by the committee. However, our approach to remuneration in 2011 remains broadly unchanged from last year: – We are proposing increases to Executive Director base salaries for 2011, in line with those for the wider workforce. This will be our first increase since 2008.
– The bonus will continue to be based on a combination of Group financial measures and a balanced scorecard of business financial and non-financial measures, including customers, people and risk.
During 2010, the Committee met 15 times and considered the following principal matters: – Review of remuneration arrangements for senior executives. Upon the appointment of the new Group Chief Executive we have deferred the implementation of this work until the completion of the strategy review and will consult shareholders during 2011
During 2010, Alithos Limited continued to provide information on behalf of the Committee for the testing of TSR performance conditions for the Group’s long-term incentive plans (calculated by reference to both dividends and growth in share price).
We summarise below how each of these policy objectives is met by our remuneration offer.
Our incentive measures are not just financial. Our Balanced scorecards include objectives that cover effective risk management, lending to Corporates including SMEs and retail customers, performance against targets that measure how satisfied our customers are and the extent to which our employees feel engaged with and committed to working for the Lloyds Banking Group.
We select incentive plan targets that are directly linked to the business strategy and priorities, ensuring alignment with company performance, targets that are meaningful to executives and incentive packages that are valued by executives and cost effective.
In light of circumstances, there will be increases to base salaries in line with the wider population of employees resulting in a lower quartile position
His award will be made under Listing Rule 9.4(2) of the Listing Rules in order to facilitate his appointment as Group Chief Executive. The Board considered that it was essential to the success of the recruitment process to make this LTIP award to him. The award is on similar terms to awards granted under the LTIP including the performance conditions which will apply to LTIP awards granted in 2011 described on page 131.
The awards above vest in different proportions at different times to reflect the vesting periods of the Santander Group share awards which the awards replace. On his resignation from Banco Santander, he suffered significant loss in relation to his previous pension accrual. Lloyds Banking Group will compensate him in part for the loss of this income through the provision of an unfunded unapproved retirement benefit scheme (UURBS) up to a maximum of 26.5 per cent of base salary. If he achieves the performance conditions described below at the maximum level, the pension accrued would still only represent 60 per cent of the pension forfeited by him. This pension is payable from retirement at age 65.
– Plus an additional 2 per cent for each year if the Average Share Price exceeds: – Year 1: 90p
Horta-Osório A G Kane G T Tate T J W Tookey H A Weir
Incentive awards for Executive Directors are based upon individual contribution and overall corporate results. Incentive opportunity is driven by corporate performance based on profit before tax and economic profit, together with divisional achievement and individual performance. Individual targets relevant to improving overall business performance are contained in a balanced scorecard and are grouped under the following headings: – Financial
The committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if they deem this appropriate.
The calculation of the annual incentive plan outcomes for Executive Directors, based on the achievement of performance against targets in respect of performance in 2010, has been vigorously discussed by the Remuneration Committee. The bonuses awarded to directors are shown in the table below: Name J E Daniels A G Kane G T Tate T J W Tookey H A Weir
At the date of this report, two executive directors remain in a defined benefit scheme. pension accruals under the defined benefits scheme for eric Daniels and Archie Kane will continue until the date of retirement or April 2012 whichever is earlier. thereafter Archie Kane will have the opportunity to either participate in a defined contribution scheme or to receive a cash supplement with no compensation for ceasing final salary accrual. there is no entitlement to an immediate and unreduced pension should their employment be terminated before the normal date of retirement. the defined benefit schemes are closed to new entrants.
For those Directors who are members of a defined benefit pension scheme, pension will continue to accrue until 5 April 2012, or the date of leaving if earlier. On 6 April 2012, defined benefit pension accrual will cease and Directors will be offered the option to participate in the defined contribution pension scheme in operation at that date. Alternatively, they may choose not to join the scheme and elect to receive a pension cash allowance.
DEFINED CONTRIBUTION SCHEME MEMBERS During the year to 31 December 2010 the Group has made the following contributions to the defined contribution scheme: T J W Tookey 150
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2010 and 2009, respectively.
March 2004 – August 2004 That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international financial services companies including Lloyds Banking Group) must be at least ninth, when 14 per cent of the option will be exercisable. If the Company is ranked first in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met.
March 2005 – August 2005 That the Company’s ranking based on TSR over the relevant period against a comparator group (15 companies including Lloyds Banking Group) must be at least eighth, when 30 per cent of the option will be exercisable. If the Company is ranked first to fourth position in the group, then 100 per cent of the option will be exercisable and if ranked ninth or below, the performance condition is not met.
LLOYDS TSB EXECUTIVE RETENTION PLAN 2006 On 26 March 2008 (prior to his appointment as an Executive Director), Tim Tookey was granted an award under the Lloyds TSB Executive Retention Plan 2006. The award is satisfied in cash only and, subject to continued employment, gives him the right to receive an amount equal to the total value of 218,400 Lloyds Banking Group shares on the dates of vesting, as adjusted in August 2010 as a result of various corporate actions in 2009 on the same basis as the Lloyds TSB Long Term Incentive Plan. The award vests as to 50 per cent on 26 March 2011 and 50 per cent on 26 March 2013. He has agreed to reinvest the cash proceeds into Lloyds Banking Group shares. As an Executive Director, he is no longer eligible to be granted awards under this plan.
LLOYDS TSB LONG-TERM INCENTIVE PLAN The following table shows conditional shares awarded under the plan. Further information regarding this plan can be found on pages 140 and 141.
The following table contains information on the performance conditions for awards made under the long-term incentive plan. 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 2007 For 50 per cent of the award (the ‘EPS Award’) – the percentage increase in earnings per share of the Group (on a compound annualised basis) over the relevant period needed to be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the retail price index over the same period. If it was less than 3 per cent per annum, the EPS Award would lapse. If the increase was more than 3 per cent but less than 6 per cent per annum, then the proportion of shares released would be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2007 and ended on 31 December 2009.
Synergy Savings: The release of 50 per cent of the shares will be dependent on the achievement of target run-rate synergy savings in 2009 and 2010 as well as the achievement of sustainable synergy savings of at least £1.5 billion by the end of 2011. The award will be broken down into three equally weighted annual tranches. Performance will be assessed at the end of each year against annual performance targets based on a trajectory to meet the 2011 target. The extent to which targets have been achieved will determine the proportion of shares to be banked each year. Any release of shares will be subject to the Remuneration Committee judging the overall success of the delivery of the integration programme.
March 2010 EPS: Relevant to 36 per cent of the award. Performance will be measured based on absolute improvement in adjusted EPS over the three financial years starting on 1 January 2010 relative to an adjusted fully diluted 2009 EPS base.
Absolute Share Price: Relevant to 28 per cent of the award. Performance will be measured based on the Absolute Share Price on 26 March 2013, being the third anniversary of the award date.
The aggregate remuneration of Directors and Senior Management (being members of the Group Executive Committee) for the year ended 31 December 2010 was £16,466,363
Executive Directors and members of Senior Management are generally subject to notice periods of up to 12 months. António Horta-Osório has a notice period of 24 months diminishing to 12 months over the first year of his employment.
Notes to the parent company financial statements 276 1. Accounting policies 2. Deferred tax asset 3. Amounts due from subsidiaries 4. Share capital and share premium 5. Other reserves 6. Retained profits 7. Subordinated liabilities 8. Debt securities in issue 9. Related party transactions 10. Financial instruments 11. Post balance sheet events 12. Approval of the financial statements and other information
Trading and other financial assets at fair value through profit or loss 18 156,191 150,011
Employee share option schemes: Value of employee services – – 154 154 – 154
Movement in cash flow hedging reserve, net of tax – (290) – (290) – (290)
Employee share option schemes: Value of employee services – – 116 116 – 116
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties, available-for-sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all derivative contracts. As stated on page 113, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the accounts.
Also during 2010, the Group has classified assets as held-to-maturity for the first time. Purchases of government debt securities of £4,228 million made in the second half of 2010 were classified as held-to-maturity on acquisition, were initially recognised at fair value including direct and incremental transaction costs and are being measured subsequently at amortised cost, using the effective interest method. Further, on 1 November 2010, government debt securities with a carrying value of £3,601 million, previously classified as available-for-sale, were reclassified to held-to-maturity. Unrealised gains on the transferred securities of £223 million previously taken to equity continue to be held in the available-for-sale revaluation reserve and will be amortised to the income statement over the remaining lives of the securities using the effective interest method or until the assets become impaired.
(i) IFRS 3 Business Combinations. This revised standard applies prospectively to business combinations from 1 January 2010. The revised standard continues to require the use of the acquisition method of accounting for business combinations. All payments to purchase a business are to be recorded at fair value at the acquisition date, some contingent payments are subsequently remeasured at fair value through income, goodwill may be calculated based on the parent’s share of net assets or it may include goodwill related to the non-controlling interest, and all transaction costs are expensed (other than those in relation to the issuance of debt instruments or share capital).
(iv) Amendment to IAS 39 Financial Instruments: Recognition and Measurement – ‘Eligible Hedged Items’. Clarifies how the principles underlying hedge accounting should be applied in particular situations.
(2) Joint ventures and associates Joint ventures are entities over which the Group has joint control under a contractual arrangement with other parties. Associates are entities over which the Group has significant influence, but not control or joint control, over the financial and operating policies. Significant influence is the power to participate in the financial and operating policy decisions of the entity and is normally achieved through holding between 20 per cent and 50 per cent of the voting share capital of the entity.
(C) OTHER INTANGIBLE ASSETS Other intangible assets include brands, core deposit intangibles, purchased credit card relationships, customer-related intangibles and 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
(E) FINANCIAL ASSETS AND LIABILITIES On initial recognition, financial assets are classified into fair value through profit or loss, available-for-sale financial assets, held-to-maturity investments or loans and receivables. Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are held at fair value. Purchases and sales of securities and other financial assets and trading liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.
Trading securities are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is managed for short-term gains. Such securities are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur.
Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. Such assets and liabilities are carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur. Financial assets and liabilities are designated at fair value through profit or loss on acquisition in the following circumstances:
Financial liabilities are derecognised when they are extinguished (ie when the obligation is discharged), cancelled or expire.
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 the same. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item and the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.
(1) Assets accounted for at amortised cost At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition of the financial asset and prior to the balance sheet date, there is objective evidence that a financial asset or group of financial assets has become impaired.
In respect of the Group’s secured mortgage portfolios, the impairment allowance is calculated based on a definition of impaired loans which are those six months or more in arrears (or where the borrower is bankrupt or is in possession). The estimated cash flows are calculated based on historical experience and are dependent on estimates of the expected value of collateral which takes into account expected future movements in house prices, less costs to sell.
WRITE OFFS A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement.
DEBT FOR EQUITY EXCHANGES Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity securities. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.
(J) TANGIBLE FIXED ASSETS Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): – Freehold/long and short leasehold premises: shorter of 50 years and the remaining period of the lease
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.
(4) Reinsurance Contracts entered into by the Group with reinsurers under which the Group is compensated for losses on one or more contracts issued by the Group and that meet the classification requirements for insurance contracts are classified as reinsurance contracts held.
Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when recognised in other comprehensive income as qualifying cash flow or net investment hedges. Non-monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was determined. Translation differences on equities and similar non-monetary items held at fair value through profit and loss are recognised in profit or loss as part of the fair value gain or loss. Translation differences on available-for-sale non-monetary financial assets, such as equity shares, are included in the fair value reserve in equity unless the asset is a hedged item in a fair value hedge.
(Q) PROVISIONS AND CONTINGENT LIABILITIES Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the obligations and they can be reliably estimated.
The preparation of the Group’s financial statements in accordance with IFRS requires management to make judgements, estimates and assumptions in applying the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.
The Wholesale division serves in excess of a million businesses ranging from start-ups and small enterprises to global corporations, with a range of propositions segmented according to customer need. The division comprises Corporate Markets, Treasury and Trading and Asset Finance.
Inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.
Other segment items: Additions to tangible fixed assets 126 1,708 20 585 777 3,216
Other income (net of fee and commission expense) 1,804 4,199 1,128 2,944 1,800 11,875
Other segment items: Additions to tangible fixed assets 65 2,969 53 255 487 3,829
Share of results of joint ventures and associates (88) – – – – (3) (91)
Share of results of joint ventures and associates (752) – – (10) – (5) (767)
Comprises the gain on acquisition (£11,173 million), the Government Asset Protection Scheme fee (£2,500 million), integration costs (£1,096 million), amortisation of purchased intangibles (£753 million) and goodwill impairment (£240 million).
Interest and similar expense: Deposits from banks, excluding liabilities under sale and repurchase transactions 0.78 0.95 (319) (883)
Securities and other gains comprise net gains arising on assets and liabilities held at fair value through profit or loss and for trading as follows: £m £m
Net income arising on assets held at fair value through profit or loss: Debt securities, loans and advances 2,292 4,297
Total net gains arising on assets and liabilities held at fair value through profit or loss 12,394 15,647
Claims and claims paid: Change in liabilities (note 38(2)): Total non-life insurance (539) (634)
Lloyds Banking Group Annual Report and Accounts 2010 11 OPERATING EXPENSES continued £m £m
Fees payable for the audit of the Company’s current year annual report 1.9 2.2
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 17.9 18.8
Movement in investments over the year: Adjustment on acquisition – 956 – 219 – 1,175
Trading and other financial assets at fair value through profit or loss 83,857 – 83,857
Trading and other financial liabilities at fair value through profit or loss 16,360 – 16,360
Lloyds Banking Group Annual Report and Accounts 2010 15 LOSS ON DISPOSAL OF BUSINESSES
(B) FACTORS AFFECTING THE TAX (CHARGE) CREDIT FOR THE YEAR A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the tax (charge) credit for the year is given below: £m £m
(Loss) profit attributable to equity shareholders – basic and diluted (320) 2,827 million million
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: Bank and building society certificates of deposit 3,692 606 4,298 2,034 – 2,034
The maximum exposure to credit risk at 31 December 2010 of the loans and advances to banks and customers designated at fair value through profit or loss was £325 million (2009: £166 million); the Group does not hold any credit derivatives or other instruments in mitigation of this risk. There was no significant movement in the fair value of these loans attributable to changes in credit risk which is determined by reference to the publicly available credit ratings of the instruments involved.
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £12,211 million (2009: £17,991 million). Collateral is held with a fair value of £14,299 million (2009: £21,462 million), all of which the Group is able to repledge. At 31 December 2010, £3,161 million had been repledged (2009: £14,963 million).
– Derivatives held in policyholder funds as permitted by the investment strategies of those funds,
– Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise, in combination with external funding, £4,149 million (2009: £6,455 million) of corporate and commercial banking loans.
– Equity derivatives are also used by the Group as part of its equity based retail product activity to eliminate the Group’s exposure to fluctuations in various international stock exchange indices. Index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £3,096 million (2009: £1,108 million). Collateral is held with a fair value of £2,987 million (2009: £1,102 million), all of which the Group is able to repledge. Included in the amounts reported above are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £42 million (2009: £22 million).
Gross investment in finance leases, receivable: Not later than 1 year 1,358 1,374
SECURITISATION PROGRAMMES Loans and advances to customers and debt securities classified as loans and receivables include loans securitised under the Group’s securitisation programmes, the majority of which have been sold by subsidiary companies to bankruptcy remote special purpose entities (SPEs). As the SPEs are funded by the issue of debt on terms whereby the majority of the risks and rewards of the portfolio are retained by the subsidiary, the SPEs are consolidated fully and all of these loans are retained on the Group’s balance sheet, with the related notes in issue included within debt securities in issue. In addition to the SPEs described below, the Group sponsors four conduit programmes, Argento, Cancara, Grampian and Landale.
Total debt securities classified as loans and receivables before allowance for impairment losses 26,293 33,082
Of the total allowance in respect of loans and advances to customers, £15,585 million (2009: £12,756 million) related to lending that had been determined to be impaired (either individually or on a collective basis) at the reporting date.
Of the total allowance in respect of loans and advances to customers, £6,076 million (2009:£5,297 million) was assessed on a collective basis.
Equity shares: Treasury bills and other bills: Treasury bills and similar securities – 6,068 6,068 – 2,532 2,532
All assets have been individually assessed for impairment. The criteria used to determine whether an impairment loss has been incurred are disclosed in note 2(H). Included in available-for-sale financial assets at 31 December 2010 are debt securities individually determined to be impaired whose gross amount before impairment allowances was £2 million (31 December 2009: £144 million) and in respect of which no collateral was held.
On 1 November 2010, the Group reclassified £3,601 million of government securities from available-for-sale financial assets to held-to-maturity investments (note 27). Further information on the reclassification of financial assets is provided in note 55.
The recoverable amount of Scottish Widows has been based on a value in use calculation. The calculation uses projections of future cash flows based upon budgets and plans approved by management covering a five-year period, and a discount rate of 12 per cent (gross of tax). The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. Cash flows beyond the five-year period have been extrapolated using a steady 3 per cent growth rate which does not exceed the long-term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
The movement in the value of in-force insurance and participating investment contracts over the year is as follows: 2010 £m 2009 £m
This breakdown shows the movement in the value of in-force business only, and does not represent the full contribution that each item in the breakdown contributes to profit before tax, which would also contain changes in the other assets and liabilities of the relevant businesses. Economic variance is the element of earnings which is generated from changes to economic experience in the period and to economic assumptions over time. The presentation of economic variance includes the impact of financial market conditions being different at the end of the reporting period from those included in assumptions used to calculate new and existing business returns.
Further information about the effect of changes in key assumptions is given in note 39.
Included within brands above are assets of £380 million (31 December 2009: £380 million) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not have an indefinite useful life.
Lloyds Banking Group Annual Report and Accounts 2010 32 TANGIBLE FIXED ASSETS Operating Total tangible
Assets arising from reinsurance contracts held (note 38 and note 40) 2,146 1,875
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £22,420 million (2009: £28,924 million) and a fair value of £25,626 million (2009: £36,016 million).
Included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting to £122 million (2009: £203 million).
Change in liabilities charged to the income statement (note 10) 5,155 (533) 4,622 (256) 4,366
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.
(2) NON-LIFE INSURANCE Gross non-life insurance contract liabilities are analysed by line of business as follows: £m £m
Change in provision for unearned premiums charged to income statement (note 8) (156) 9 (147)
Estimate of ultimate claims costs: At end of accident year 211 208 317 205 639 609 2,189
This balance includes £2 million of claims relating to general insurance business acquired during 2009.
The liability of £568 million shown in the above table excludes £16 million of unallocated claims handling expenses.
Lloyds Banking Group Annual Report and Accounts 2010 40 LIABILITIES ARISING FROM NON-PARTICIPATING INVESTMENT CONTRACTS
Expected life expectancy of members: Increase of one year 40 79 (620) (590)
Lloyds Banking Group Annual Report and Accounts 2010 43 RETIREMENT BENEFIT OBLIGATIONS continued
During the year ended 31 December 2010 the charge to the income statement in respect of defined contribution schemes was £173 million (2009: £208 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
PROVISIONS FOR CONTINGENT LIABILITIES AND COMMITMENTS Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s ability to meet its repayment obligations.
CUSTOMER GOODWILL PAYMENTS Lloyds Banking Group has been in discussion with the FSA regarding the application of an interest variation clause in certain Bank of Scotland plc variable rate mortgage contracts where the wording in the offer documents received by certain customers had the potential to cause confusion. The relevant mortgages were written between 2004 and 2007 by Bank of Scotland plc under the ‘Halifax’ brand. In February 2011, the Group reached agreement with the FSA in relation to initiating a customer review and contact programme and making goodwill payments to affected customers. In order to make these goodwill payments, Bank of Scotland plc has applied for a Voluntary Variation of Permission to carry out the customer review and contact programme to bring it within section 404F(7) of FSMA 2000. The Group has made a provision of £500 million in relation to this programme.
VACANT LEASEHOLD PROPERTY Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on a biennial basis and will normally run off over the period of under-recovery of the leases concerned, currently averaging five years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
OTHER Other provisions include the provisions which the Group carries in respect of its obligations arising from the liquidation of UIC Insurance Company Limited (UIC). The Group has indemnified a third party against losses arising from a reinsurance contract written by UIC which is subject to asbestos and pollution claims in the US. The ultimate cost and timing of payments under the indemnity remain uncertain. The provision held represents management’s current best estimate of the cost after having regard to actuarial estimates of future losses. 45 OTHER PROVISIONS
6.267% Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2016 (US$1,000 million) d, e 269 327 9¼% Non-cumulative Irredeemable £1 preference shares (£300 million) e 235 197 9¾% Non-cumulative Irredeemable £1 preference shares (£100 million) b, c, e 30 72 6.413% Fixed-to-Floating Rate US$1 series A preference shares (US$750 million) e 113 115 5.92% Fixed-to-Floating Rate US$1 series B preference shares (US$750 million) d, e 9 90 6.657% Fixed-to-Floating rate US$1 preference shares (US$750 million) e 5 28 7.875% Non-cumulative callable preference shares (US$1,250 million) b, e 277 680 7.875% Non-cumulative callable preference shares (€500 million) b, e 182 417 6.475% fixed rate non-cumulative callable preference shares (£186 million) b, c, e 34 45 6.0884% fixed-to-floating rate non-cumulative callable preference shares (£745 million) b, e 9 10 6.3673% fixed-to-floating non-cumulative callable preference shares (£335 million) b, e 2 2
c Following an invitation to certain eligible retail holders on 15 December 2009, certain holders of certain series elected to sell some or all of the preference shares they held to Lloyds Banking Group plc in January 2010.
6.461% Guaranteed Non-voting Non-cumulative Perpetual Preferred Securities Series A of £1,000 each (£600 million) 421 398 8.117% Non-cumulative Perpetual Preferred Securities Series 1 of £1,000 each (Class A) (£250 million) c, d 253 234 7.754% Non-cumulative Perpetual Preferred Securities Series 2 of £1,000 each (Class B) (£150 million) 98 93 7.881% Guaranteed Non-voting Non-cumulative Preferred Securities (£245 million) 173 151 7.627% Fixed to Floating Rate Guaranteed Non-voting Non-cumulative Preferred Securities (€415 million) c 308 259 4.939% Non-voting Non-cumulative Perpetual Preferred Securities (€750 million) b 17 10
Primary Capital Undated Floating Rate Notes: Series 1 (US$750 million) b, c, d 173 408
c Following an exchange offer, on 28 May 2010 and 14 June 2010, certain holders elected to exchange some or all of the notes they held for equity issued by Lloyds Banking Group plc.
Total enhanced capital notes 9,235 9,047 a Interest is payable quarterly in arrears at a rate of 3 month EURIBOR plus 3.1 per cent per annum.
Dated subordinated liabilities 61/4% Subordinated Notes 2010 (€400 million) – 375 7.70% Notes 2010 (US$500 million) – 327 5.50% Subordinated Fixed Rate Notes 2012 (€750 million) 657 654 4.25% Subordinated Guaranteed Notes 2013 (US$1,000 million) 619 594 57/8% Subordinated Guaranteed Bonds 2014 (€750 million) 739 768
– pursuant to the rules of some of the Company’s employee share plans where certain restrictions may apply while the shares are subject to the plans.
Ordinary shares The holders of ordinary shares (excluding the limited voting ordinary shares), who held 99.9 per cent of the total ordinary share capital as at 31 December 2010, are entitled to receive the Company’s report and accounts, attend, speak and vote at general meetings and appoint proxies to exercise voting rights. Holders of ordinary shares (excluding the limited voting ordinary shares) may also receive a dividend (subject to the provisions of the Company’s articles of association and the restrictions noted below) and on a winding up may share in the assets of the Company.
Shares issued on redemption and exchange of preference shares and other subordinated liabilities1 1,808 –
In January 2010, the Company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital redemption reserve and a transfer of £11 million from the merger reserve to the share premium account. In December 2009, the Group redeemed eight issues of preference shares in exchange for the issuance of enhanced capital notes. This resulted in a transfer of £26 million from the merger reserve to the capital redemption reserve and a transfer of £2,684 million from the merger reserve to the share premium account.
Retained profits are stated after deducting £47 million (2009: £48 million) representing 49 million (2009: 49 million) treasury shares held.
During the year ended 31 December 2010 the Group operated the following share-based payment schemes, all of which are equity settled.
The weighted average share price at the time that the options were exercised during 2010 was £0.69 (2009: £nil). The weighted average remaining contractual life of options outstanding at the end of the year was 2.7 years (2009: 2.7 years).
Lloyds Banking Group Long-Term Incentive Plan The Long-Term Incentive Plan (LTIP) introduced in 2006 is aimed at delivering shareholder value by linking the receipt of shares to an improvement in the performance of the Group over a three year period. Awards are made within limits set by the rules of the plan, with the limits determining the maximum number of shares that can be awarded equating to three times annual salary. In exceptional circumstances this may increase to four times annual salary.
If the growth in EPS reaches 26 per cent, 25 per cent of this element of the award, being the threshold, will vest. If growth in EPS reaches 36 per cent, 100 per cent of this element will vest.
(ii) Integration balanced scorecard: The release of the remaining 50 per cent of the shares will be dependent on the outcome of a Balanced Scorecard of non-financial measures of the success of the integration in each of 2009, 2010 and 2011. The Balanced scorecard element will be broken down into three equally weighted tranches. The tranches will be crystallised and banked for each year of the performance cycle subject to separate annual performance targets across the four measurement categories of Building the Business, Customer, Risk and People and Organisation Development.
(ii) Economic Profit: relevant to 50 per cent of the award. Performance will be measured based on the compound annual growth rate of adjusted Economic Profit over the three financial years starting on 1 January 2010 relative to an adjusted 2009 Economic Profit base.
If the compounded annual growth rate of adjusted Economic Profit reaches 57 per cent per annum, 25 per cent of this element of the award, being the threshold, will vest. If the compounded annual growth rate of adjusted Economic Profit reaches 77 per cent per annum, 100 per cent of this element will vest.
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.
Lloyds Banking Group Annual Report and Accounts 2010 53 RELATED PARTY TRANSACTIONS continued
Adjustments have been made, using a standard HMRC formula, to negate the dilutionary impact of the Group’s 2009 capital raising activities.
At 31 December 2010, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £2 million with six directors and four connected persons (2009: £2 million with seven directors and four connected persons).
SUBSIDIARIES Details of the principal subsidiaries are given in note 9 to the parent company financial statements. In accordance with IAS 27, transactions and balances with subsidiaries have been eliminated on consolidation.
Capital transactions During 2010 HM Treasury has not subscribed for any of the Company’s ordinary or preference share capital, with the decline in the percentage of ordinary shares held by HM Treasury reflecting the issuance by the Company of ordinary shares as set out in note 47.
The OFT however continued to discuss its concerns in relation to the personal current account market with the banks, consumer groups and other organisations under the auspices of its Market Study into personal current accounts. In October 2009, the OFT published voluntary initiatives agreed with the industry and consumer groups to improve transparency of the costs and benefits of personal current accounts and improvements to the switching process. On 16 March 2010 the OFT published a further update announcing several further voluntary industry wide initiatives to improve a customer’s ability to control whether they used an unarranged overdraft and to assist those in financial difficulty. However, in light of the progress it noted in the unarranged overdraft market since July 2007 and the progress it expects to see over the next two years, it has decided to take no further action at this time and will review the unarranged overdraft market again in 2012.
Performance bonds and other transaction-related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs and Excise bonds and standby letters of credit relating to a particular contract or non-financial transaction) are undertakings where the requirement to make payment under the guarantee depends on the outcome of a future event.
Cash and balances at central banks – – – – – 38,115 – 38,115
Items in course of transmission to banks – – – – – 802 – 802
Cash and balances at central banks – – – – – 38,994 – 38,994
Trading and other financial assets at fair value through profit or loss – 27,245 122,766 – – – – 150,011
Trading and other financial liabilities at fair value through profit or loss – 22,111 6,160 – – – – 28,271
Liabilities arising from non-participating investment contracts – – – – – – 46,348 46,348
From held for trading to loans and receivables 750 727 1,833 1,822 2,883 2,926
From available-for-sale financial assets to loans and receivables 313 340 394 422 454 402
From available-for-sale financial assets to held-to-maturity investments 3,455 3,539 – – – –
During the year ended 31 December 2010, the carrying value of assets reclassified to loans and receivables decreased by £1,164 million due to sales and maturities of £1,220 million, accretion of discount of £34 million and foreign exchange and other movements of £22 million.
Additional fair value gains (losses) that would have been recognised had the reclassifications not occurred The table below shows the additional gains (losses) that would have been recognised in the Group’s income statement if the reclassifications had not occurred.
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. 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.
DEPOSITS FROM BANKS AND CUSTOMER DEPOSITS The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits is estimated using discounted cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.
LEVEL 1 PORTFOLIOS Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities. Products classified as level 1 predominantly comprise treasury bills and other government securities.
LEVEL 3 PORTFOLIOS Level 3 portfolios are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Such instruments would include the Group’s venture capital and unlisted equity investments which are valued using various valuation techniques that require significant management judgement in determining appropriate assumptions, including earnings multiples and estimated future cash flows. Certain of the Group’s asset-backed securities and derivatives, principally where there is no trading activity in such securities, are also classified as level 3.
– Discounted cash flow valuations use estimated future cash flows, usually based on management forecasts, with the application of appropriate exit yields or terminal multiples and discounted using rates appropriate to the specific investment, business sector or recent economic rates of return. Recent transactions involving the sale of similar businesses may sometimes be used as a frame of reference in deriving an appropriate multiple.
– For fund investments the most recent capital account value calculated by the fund manager is used as the basis for the valuation and adjusted, if necessary, to align valuation techniques with the Group’s valuation policy.
(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 The valuation techniques used for unlisted equities and venture capital investments vary depending on the nature of the investment. Third party valuers have been used to determine the value of unlisted equities and property partnerships included in the Group’s life insurance funds. As these factors differ for each investment, depending on the nature of the valuation technique used and the inputs, there is no single common factor that could be adjusted to provide a reasonable alternative valuation for these investment portfolios.
Market Credit Default Swap (CDS) spreads are used to develop the probability of default for quoted counterparties. For unquoted counterparties, internal credit ratings and market sector CDS curves and recovery rates are used. The Loss Given Default (LGD) is based on market recovery rates and internal credit assessments. The combination of a one notch deterioration in the credit rating of derivative counterparties and a 10 per cent increase in LGD increases the CVA by £120 million. Current market value is used to estimate the projected exposure for products not supported by the model, which are principally complex interest rate options that are traded in very low volumes. For these, the CVA is calculated on an add-on basis (in total contributing £29 million of the overall CVA balance at 31 December 2010).
The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise. A 1 per cent rise in interest rates would lead to a £109 million fall in the overall valuation adjustment to £461 million. The CVA model used by the Group does not assume any correlation between the level of interest rates and default rates.
In addition, in 2010 the Group has included a Funding Valuation Adjustment to adjust for the net cost of funding certain uncollateralised derivative positions where the Group considers that this cost is included in market pricing. This adjustment is calculated on the expected future exposure discounted at a suitable cost of funds. A 10 bps increase in the cost of funds will increase the funding valuation adjustment by £5 million.
(iii) Market liquidity The Group includes mid to bid-offer valuation adjustments against the expected cost of closing out the net market risk in the Group’s trading positions within a timeframe that is consistent with historical trading activity and spreads that the trading desks have accessed historically during the ordinary course of business in normal market conditions.
(iv) Libor/Overnight Index Swap (OIS) basis The Group’s derivative trading business applies £70 million (31 December 2009: £nil) of valuation adjustments against the changing market approach to valuing derivatives that are subject to daily collateral margin, where standard market practice is to pay interest on an Overnight Index Swap (OIS) basis rather than a Libor rate.
(3) CREDIT RISK The Group’s credit risk exposure arises predominantly in the United Kingdom, the European Union, Australia and the United States.
Available-for-sale debt securities, treasury and other bills, held-to-maturity investments, and trading and other financial assets at fair value through profit or loss – the credit quality of the Group’s available-for-sale debt securities, treasury and other bills, held-to-maturity investments, and the majority of the Group’s trading and other financial assets at fair value through profit or loss held is set out below. An analysis of trading and other financial assets at fair value through profit or loss is included in note 18 and a similar analysis for available-for-sale financial assets is included in note 26. The Group’s held-to-maturity investments are all government debt securities. The Group’s non-participating investment contracts are all unit-linked. Trading and other financial assets at fair value through profit or loss which back those investment contracts were £129,702 million (2009: £118,573 million). Movements in the fair value of such assets, including movements arising from credit risk, are borne by the contract holders.
Reverse repo and repo transactions – for reverse repo transactions which are accounted for as collateralised loans, it is the Group’s policy to seek collateral which is at least equal to the amount loaned. At 31 December 2010, the fair value of collateral accepted under reverse repo transactions that the Group is permitted by contract or custom to sell or repledge was £21,195 million (2009: £26,731 million). Of this, £3,161 million (2009: £14,963 million) was sold or repledged as at 31 December 2010. The fair value of collateral pledged in respect of repo transactions, accounted for as secured borrowings, where the secured party is permitted by contract or custom to repledge was £53,781 million (31 December 2009: £96,409 million).
Total residential mortgage lending which is neither past due nor impaired 339,509 347,292
Rated BB AAA AA A BBB or lower Not rated Total £m £m £m £m £m £m £m
Treasury bills and other bills 4,439 – 1,629 – – – 6,068 Total held as available-for-sale financial assets 24,470 6,581 7,937 1,250 129 333 40,700 Held-to-maturity investments Government securities 7,905 – – – – – 7,905
Bank and building society certificates of deposit – 1,037 997 – – – 2,034
Asset-backed securities: Corporate and other debt securities 4,070 1,359 4,540 3,407 1,062 3,133 17,571
Total held as available-for-sale financial assets 20,415 11,653 9,952 1,707 468 376 44,571
CREDIT MARKET EXPOSURES The Group’s credit market exposures primarily relate to asset-backed securities exposures held in Wholesale division. These exposures are classified as loans and receivables (note 24), available-for-sale financial assets (note 26) or trading and other financial assets at fair value through profit or loss (note 18) depending on the nature of the investment.
An analysis of the Wholesale division’s asset-backed securities portfolio by credit rating is provided below.
The external credit rating is based on the bond ignoring the benefit of the CDS.1
Trading and other financial assets at fair value through profit or loss 7,579 9,541 8,948 6,192 123,931 156,191
The above tables are provided on a contractual basis. The Group’s assets and liabilities may be repaid or otherwise mature earlier or later than implied by their contractual terms and readers are, therefore, advised to use caution when using this data to evaluate the Group’s liquidity position.
Derivative financial liabilities: Gross settled derivatives – net flows 15,627 (146) (328) (498) 595 15,250
Trading and other financial liabilities at fair value through profit or loss 14,592 3,668 6,116 3,224 1,275 28,875
Issued on redemption of preference shares and other subordinated securities in 2010 2,237 –
Derivatives, trading and other financial assets at fair value through profit or loss – 137,889
Requires rights issues denominated in a currency other than the functional currency of the issuer to be classified as equity regardless of the currency in which the exercise price is denominated.
Sets out minor amendments to IFRS standards as part of the annual improvements process.
Simplifies the definition of a related party and provides a partial exemption from the disclosure requirements for related party transactions with government related entities.
IFRS 9 Financial Instruments1 Replaces those parts of IAS 39 Financial Instruments: Recognition and Measurement relating to the classification, measurement and derecognition of financial assets and liabilities. Requires financial assets to be classified into two measurement categories, fair value and amortised cost, on the basis of the objectives of the entity’s business model for managing its financial assets and the contractual cash flow characteristics of the instrument. The available-for-sale financial asset and held-tomaturity investment categories in the existing IAS 39 will be eliminated. The requirements for financial liabilities and derecognition are broadly unchanged from IAS 39.
Capital Share capital Merger redemption Retained and premium reserve reserve profits1 Total £ million £ million £ million £ million £ million
Employee share option schemes: Value of employee services – – – 129 129
Total comprehensive income comprises only the profit (loss) for the year; no income statement has been shown for the parent company, as permitted by section 408 of the Companies Act 2006.1
The capital redemption reserve represents transfers from the merger reserve in accordance with companies’ legislation and amounts transferred from share capital following the cancellation of the deferred shares.
b In certain circumstances, these bonds would acquire the characteristics of preference share capital. They are accounted for as liabilities as coupon payments are mandatory as a consequence of the terms of the 6 per cent non-cumulative redeemable preference shares. At the callable date the coupon on these bonds will be reset by reference to the applicable five year benchmark gilt rate. Further information regarding this can be found in note 46 to the consolidated financial statements.
Lloyds Banking Group Annual Report and Accounts 2010 8 DEBT SECURITIES IN ISSUE
In January 2009 HM Treasury became a related party of the Company and has remained so during 2010. Further information on the relationship and transactions with HM Treasury is given in note 53 to the consolidated financial statements.
The principal area of operation for each of the above subsidiaries is the United Kingdom.
The following reconciliation shows the movements in derivative financial instrument assets within level 3 portfolios: Total £m
Financial liabilities: Debt securities in issue 549 326 549 326 11 POST BALANCE SHEET EVENTS
Internet services are available 24/7 and telephone dealing services are available between 8.00am and 9.15pm, Monday to Friday, and 9.00am to 1pm, Saturday. To open a Halifax Share Dealing Account you must be 18 years of age or over and be resident in the UK, Jersey, Guernsey or the Isle of Man.
Asset-Backed Securities (ABS) Asset-backed securities are securities that represent an interest in an underlying pool of referenced assets. The referenced pool can comprise any assets which attract a set of associated cash flows but are commonly pools of residential or commercial mortgages but could also include leases, credit card receivables, motor vehicles, student loans. Further information on the Group’s investments in ABS is given in note 56.
Alt-A Alt-A are mortgage loans regarded as lower risk than sub-prime, but they share higher risk characteristics than lending under normal criteria. Further information on the Group’s exposure to Alt-A investments is given in note 56.
Debt restructuring This is when the terms and provisions of outstanding debt agreements are changed. This is often done in order to improve cash flow and the ability of the borrower to repay the debt. It can involve altering the repayment schedule as well as reducing the debt or interest charged on the loan.
First/Second Lien A first lien gives the holder (usually the bank lending the funds) the first right to collect compensation from the sale of the underlying collateral in the event of a default on the loan. A second lien may be issued against the same collateral but in the case of default, compensation for this debt will only be received after the first lien has been repaid.
Loan to deposit ratio The ratio of loans and advances to customers net of allowance for impairment losses and excluding reverse repurchase agreements divided by customer deposits excluding repurchase agreements.
Net interest margin Net interest margin is net interest income as a percentage of average interest-earning assets. Details of the Group’s banking net interest margin are given on page 54.
Tier 1 capital A measure of a bank’s financial strength defined by the FSA. It captures Core Tier 1 capital plus other Tier 1 securities in issue, but is subject to a deduction in respect of material holdings in financial companies. Further details are given in the Capital Risk section on page 97.
Tier 2 capital A component of regulatory capital defined by the FSA, mainly comprising qualifying subordinated loan capital, certain non-controlling interests and eligible collective impairment allowances. Further details are given in the Capital Risk section on page 97.
ACCOUNTING Accounting policies 154 Critical accounting estimates and judgements 165 Future accounting developments 269
AUDITORS Report on the consolidated financial statements 144 Report on the parent company financial statements 272 Fees 177
GOVERNANCE Compliance with the Combined Code 114 Risk management 65 Board Committees 120
VALUE OF IN-FORCE BUSINESS Accounting policy 163 Notes to the consolidated financial statements 194