£1.2bn of new funding support for UK manufacturing companies. We are supporting future talent to make British manufacturing more productive and competitive, today and tomorrow
start-ups helped to get going and grow through funding. We also provide advice and mentoring – including vital support for many charities and social enterprises
This Annual Report and Accounts contains forward looking statements with respect to certain of the Group’s plans and its current goals and expectations relating to its future financial condition, performance, results, strategic initiatives and objectives. For further details, reference should be made to the forward looking statements on page 288.
Financial results Summary of Group results 33 Five year financial summary 39 Divisional results 40 Other financial information 49
Financial statements Independent auditors' report 171 Consolidated financial statements 179 Parent company financial statements 277
Other information Shareholder information 286 Forward looking statements 288 Abbreviations 288 Alternative performance measures 289 Glossary 289 Subsidiaries and related undertakings 293
Doing the right thing for our customers by meeting their financial needs, helping them succeed, improving our service proposition and creating value for them, is key to the long-term sustainable success of our business.
We are the leading provider of financial services to individual and business customers in the UK. Our main business activities are retail and commercial banking, general insurance, and long-term savings, protection and investment. We provide our services under a number of well recognised brands including Lloyds Bank, Halifax, Bank of Scotland and Scottish Widows and through a range of distribution channels including the largest branch network and digital bank in the UK.
Low risk business Being a low risk bank is fundamental to our business model. Our low risk appetite is reflected through the low level of non-performing loans and non-core assets and our credit default swap spread, which is amongst the best in the banking sector worldwide.
Our purpose Our purpose as the UK’s largest retail and commercial bank is to help Britain prosper. This means not only providing outstanding service to our customers, but also responding to the UK’s social and economic issues we believe we are best placed to address. Our investment programmes and extensive range of clear and simple products and services already support this ambition, helping to meet the needs and grow the prosperity of people, businesses and communities across the UK while building the deep, long-term customer relationships that are vital to our future. However, we want to do even more. Our Helping Britain Prosper Plan sets out our targets to support housing, growth, trade and infrastructure and to tackle social disadvantage. We are not just a British bank – we take pride in being a bank for Britain, at the heart of the UK’s economy.
We have agreed a number of changes to our Board composition for 2017. Anthony Watson, our Senior Independent Director, will retire at the 2017 AGM after serving more than eight years on the Board. Anita Frew will succeed Anthony as Senior Independent Director, combining this with the role of Deputy Chairman, which she has held since May 2014. Nick Luff, an independent Non-Executive Director, has notified the Board that in light of his other commitments he does not intend to seek re-election at the 2017 AGM. Nick will be succeeded as Chairman of the Audit Committee by Simon Henry. Both Anthony and Nick leave with our thanks and best wishes for the future.
CONTINUING TO HELP BRITAIN PROSPER IN TIMES OF CHANGE In 2014 we launched our Helping Britain Prosper Plan, focused on the social and economic issues that we believe we are best placed to help people in Britain address. The Plan contains measurable targets to support people, businesses and communities in the UK.
Looking ahead we have set a new target to support the low carbon economy by incentivising energy efficient commercial property development through Britain’s first Green Loan Initiative.
A STRONG FOCUS ON CORPORATE CULTURE The Board places great emphasis on shaping and embedding a healthy corporate culture. Our core values of 'putting customers first', 'keeping it simple' and 'making a difference together' are central to our next stage of cultural transformation.
Measurement and monitoring The Responsible Business Committee (RBC) provides oversight of the work being done to develop measures for reporting on cultural change. The RBC is supported in particular by the work of two executive committees: the Responsible Business Management Committee and the Group Customer First Committee, who drive the development of a culture framework and a culture dashboard to enable us to monitor progress.
Customer migration to digital channels continues at pace with more than 60 per cent of our simple customer needs now met online and digital is now the number one channel for new loans and credit cards. We continue to invest in our customer propositions to improve processes and the way our customers interact with us. In Commercial Banking we have continued to improve the online banking platform and in Retail Business Banking we are now able to open new customer accounts in 5-6 days, down from 21 days previously, with a best-in-class automated digital ID and verification process. In Consumer Finance, Black Horse has reduced processing times for new loans, while increasing security and protection for customers. In Insurance we have introduced online tools which will allow customers to consolidate their workplace pension assets and employers to process employee monthly pension contributions on the same day, down from 22 days in 2014.
Summary Following the simplification and transformation of our business in recent years, the Group is now focused on delivering the best customer experience and on continuing to develop our digital capabilities. Our cost leadership and lower risk positioning provide competitive advantage which enables us to deliver superior returns to shareholders. We continue to believe that our simple, low risk business model is the right one, and our strategic progress and strong financial performance position us well for future success.
Committee cut UK interest rates to a record low of 0.25 per cent
Manufacturers are expecting exports to benefit from the weaker pound, but confidence in the service sector has weakened. Towards the end of 2016 inflation started to rise and is likely to become a bigger headwind to consumers' spending growth through the coming year.
The consensus expectation is that UK GDP growth will slow from 2 per cent in 2016 to 1.6 per cent in 2017, and unemployment will remain low, but will rise from 4.9 per cent at the end of 2016 to 5.2 per cent at the end of 2017. House prices are expected to continue to rise, by around 3 per cent, supported by the ongoing shortage of property for sale, low levels of housebuilding and exceptionally low interest rates, while commercial real estate prices are expected to fall by 4 per cent.
If the economy evolves in line with this consensus view, we would expect growth across our markets to remain broadly stable in aggregate, with a mild weakening in the growth of unsecured consumer credit and commercial real estate lending offset by a marginal rise in mortgages and other lending to businesses.2016
Competition During 2016 the Competition and Markets Authority (CMA) review of current accounts and SME Banking concluded that it needed to intervene in these markets only to increase levels of transparency and comparability in order to promote greater levels of customer switching. In addition, the FCA and PSR reviewed a series of individual markets ranging from credit cards to payments infrastructure. Ensuring fair competition remains a core element of regulatory reform with the mortgage market a key area of focus for 2017.
Customers require different products and services at different stages of their lives, with many motivated by their desire to achieve better value for money, not least in the current low interest rate environment. Security and reputation remain important factors, with customers wanting clear and transparent products delivered with good service and access to relevant, expert advice.
Our strategy, which focuses on our multi-brand, multi-channel distribution model, simpler processes, customer-driven product range and expertise across insurance and banking, puts us in a unique position to respond to these market conditions and meet the needs of individual and corporate customers. Above all, it recognises that our market is competitive, additional challengers continue to emerge and that to succeed we need to focus on the ever-changing needs of our customers.
EXTERNAL ENVIRONMENT Our business model is influenced by external factors which continue to evolve.
As a bank that supports millions of people, businesses and communities, we believe we are in a unique position to help tackle some of the biggest social and economic issues facing the UK today.
Financial strength Our balance sheet and funding position have both been transformed in recent years and they are now amongst the strongest in the banking sector worldwide.
Progress in 2016 digital market share 5-6 days to open a business account, down from 21 days >60% of simple customer needs met via online and mobile 62.7 pts customer satisfaction is increasing, up 3.4 points in the year
– Becoming more responsive to changing customer expectations while maintaining our cost leadership amongst UK high street banks
– Maintain market leadership in key retail business lines - Market leadership retained in current accounts and deposits - Focus on protecting margin in current competitive low growth mortgage market. £39 billion of gross new mortgage lending in 2016 and remain largest lender to first-time buyers
Delivering for customers and shareholders Our key performance indicators have been considered by the Board and identify the most effective output measures for assessing financial performance and progress towards becoming the best bank for customers. As a result of strategic progress in 2016, we have reported good underlying profits, significantly increased statutory profit, strong capital generation, increased ordinary dividends and a special dividend.
Performance is assessed against a balanced scorecard of objectives across five areas (customer, people, control environment, building the business, finance) which are reviewed on a regular basis. Executive management are also eligible to participate in a long-term incentive plan, which encourages delivery of superior and sustainable long-term returns for shareholders, whilst supporting the Group's aim of becoming the best bank for customers and helping Britain prosper. KPIs that are directly linked to remuneration are marked with this symbol .
Read more about our financial performance on page 33 or online at www.lloydsbankinggroup.com
The underlying return on required equity reduced in 2016, reflecting lower underlying profit and a higher tax charge.
Our cost:income ratio further improved to 48.7 per cent and remains the lowest of our major UK banking peers.
Our share price fell by 13 per cent in 2016, and although dividends increased in the year, our total shareholder return still fell by 10 per cent.
This year we made good progress and achieved 20 of our 24 targets.
Reflecting the pace of digital adoption, our number of active digital customers increased in the year, from 11.5 million to 12.5 million.
Supporting mental health We have launched a mental health awareness campaign for colleagues and are introducing training so that line managers can understand and help those affected.
Housing Growth Partnership Mike and Ali Afshar of AMA Homes are one of many smaller house building businesses benefiting from our £30 million Partnership with the government.
HELPING BUSINESSES PROSPER We are helping businesses of all types and sizes to prosper by offering them the funding, support and encouragement they need to grow at home or abroad. We are supporting the transition to a low carbon economy.
Our responsible approach is reflected by our continued presence in the FTSE4Good Index and our position in the CDP Climate A list in recognition of our transparent reporting and efforts to reduce our emissions.
Focusing on what matters most In 2016 we undertook a comprehensive materiality survey to analyse and rank the responsible business issues that our stakeholders deem most important to our business. Using a range of internal and external sources, we identified 30 economic, social, environmental and governance issues across eight key categories and asked stakeholder groups to share their views: colleagues, customers, investors, community groups, government and legislators and special interest groups and opinion formers.
A sustainable and responsible approach to doing business is integral to everything we do
Visit www.lloydsbankinggroup.com/responsible-business for more information 1. HOW WE RUN OUR BUSINESS We must run our business in a responsible and sustainable manner, complying with laws and regulations, managing and mitigating risks and delivering sustainable returns for customers and shareholders.
Ensuring good governance We have an effective top-to-bottom governance structure, providing an environment in which colleagues are encouraged and supported to do the right thing and to work responsibly. This governance structure includes our Group Board and the Board-level Responsible Business Committee and cascades to every part of our business. In 2016 we established an Executive level Responsible Business Management Committee which reports to the Chief Executive and is responsible for recommending and implementing the Group’s Responsible Business strategy. Read more about the Responsible Business Committee’s activity in 2016 on page 79.
We have a comprehensive Anti-Bribery Policy in place which complies with laws and regulations wherever we operate, and which applies to all directors, colleagues, and anyone else acting on our behalf. All colleagues, including contractors, complete annual anti-bribery training and are encouraged to report confidentially any instances of suspected bribery. The Group is a member of Transparency International UK’s Business Integrity Forum, a network of major international companies committed to anti-corruption and high ethical standards in business practices.
Responsible lending and investment We recognise the need to address climate change, protect biodiversity, support local communities and ensure human rights are protected. We assess and manage social, ethical and environmental risk in our lending activity and the Group is a signatory to the Equator Principles, which provide a framework for determining, assessing and managing environmental and social risk in project finance transactions.
We do not finance any activities prohibited by international conventions supported by the UK government, such as the Oslo Convention on Cluster Munitions and the Ottawa Treaty on Anti-Personnel Landmines. Consequently, we will not enter into credit or investment relationships with businesses believed to be in breach of these conventions.
The management of risk for investment funds offered to customers by Scottish Widows is effected through a robust and comprehensive end to end governance and oversight reporting process, including a Responsible Investment Governance Framework. This covers the ongoing engagement process with fund managers, monitoring of mandate adherence and onward reporting through Investment Committees and Boards. The Group is a signatory of the Stewardship Code and the UN Principles of Responsible Investment.
Making an economic contribution to Britain We make a significant direct and indirect contribution to the economy. We employ approximately 75,000 colleagues (full time equivalent). We are helping to create additional jobs and bring talented people into our business through our Graduate and Apprenticeship Schemes. We’ve created more than 4,000 apprenticeships since we launched our Apprenticeship scheme in October 2012. We run a sector-leading and award-winning programme, offering a broad range of apprenticeships at all levels, including a degree-level apprenticeship in IT and Digital. In 2016, we provided a further 1,000 new roles, a third of which have been offered to external candidates from the UK’s most disadvantaged areas. We have committed to create 8,000 new apprenticeships by 2020, as part of our Helping Britain Prosper Plan.
Protecting our customers We protect our 25 million customers including those who bank digitally, using state of the art security measures, including secure log-on and log-off features as well as systems that detect possible anomalies in calls we receive and highlight fraudulent payments in real time. We help customers keep themselves safe by providing best practice information and championing public information campaigns, such as Take 5.
We are a strategic partner of Get Safe Online, a joint initiative between the government, the National Crime agency and many public and private sector organisations. In 2016, we made a significant contribution to the Joint Fraud Task Force, which brings together government, law enforcement and industry partners to set a strategic direction for fraud prevention measures. In London, the Task Force has spearheaded the Banking Protocol, enabling bank colleagues to request immediate police support when they believe that customers are being targeted by fraudsters. We will champion the Protocol’s national rollout in 2017.
Our approach to tax The Group continues to be one of the largest contributors to UK tax revenues. We were ranked as the highest payer of UK taxes in the most recent PwC Total Tax Contribution Survey for the 100 Group which is broadly the FTSE100 and some large UK private companies, having paid £1.8 billion in 2015.
We have improved the customer experience in branch and online using digital. We opened more than 40,000 savings accounts in our branches using digital technology this year, saving customers as much as 20 minutes of their time. We introduced processes to make banking faster and easier, including ‘selfie’ verification for account applications and video meetings and live webchat support for mortgage and remortgage applicants. Our in-house customer innovation labs tested more than 30 new technologies and services with our customers in 2016 including ‘smart’ customer alert services and new ways to upload documents digitally.
Dealing with customer complaints In 2016 we emphasised the need to identify, understand and eradicate the root causes of customer complaints. We encourage colleagues to share ideas about how to remove the issues that drive complaints and improve customers’ experience. When customers do complain, we resolve complaints as quickly as possible, focusing on achieving fair outcomes. Where a complaint is referred to the Financial Ombudsman Service, they tend to agree with our decisions in the majority of cases.
An average of 77 per cent of the colleagues who participated in this year’s ‘Building the Best Team Survey’, responded favourably to questions about training confirming that they believe they get the training and development needed to do their job effectively and meet customer demands. This is an increase of 2 per cent from last year, putting us 15 per cent above the UK average.
Throughout 2016, we continued to support colleagues studying for professional qualifications and contributed to the developing work of the Banking Standards Board, including their independent research into, and subsequent Report on, ‘Professionalism in Banking’.
Percentage of colleagues who disclose they are lesbian, gay, bisexual or transgender 1.5% 1.2%
Developing and rewarding our colleagues We want to ensure that every colleague feels valued and empowered to thrive in a truly inclusive business. We offer a competitive and fair reward package that supports our aims as a responsible business. After a detailed review in 2015 of the variable pay arrangements used to incentivise customer-facing colleagues, variable pay for colleagues in the Retail division is no longer linked to individual or branch level sales or product targets. To build on these changes, a single variable pay arrangement was introduced for these colleagues in 2016. Customer-facing colleagues in Retail are now incentivised by reference to balanced scorecard metrics with clearly identified performance descriptors, in line with the Group annual bonus plan approach. These changes ensure that colleagues are rewarded for action and behaviour which puts customers first. We have recognition agreements with two trade unions, Accord and Unite, which collectively negotiate and consult on behalf of around 95 per cent of our colleagues.
Learning and development All colleagues have access to our learning management system, Discover Learning, and with the launch of our Career Development Resource Centre it is now even easier for them to access learning materials to develop in their current roles or for career moves. During 2016, colleagues logged-in more than 11 million times; overall, almost 480,000 days of formal training were undertaken, an average of 6 days per colleague. In addition, 30,000 active learners use e-learning provided by one of our partners, Skillsoft.
We launched the Group’s Digital Academy, a suite of learning modules available to all colleagues supporting our aim of creating the most digitally capable workforce in Financial Services. In the first six months this received 15,500 colleague visits. We also
Managing and reducing our environmental impacts Our ability to help Britain prosper is inextricably linked to wider environmental issues. Man-made climate change and global trends, such as resource scarcity, extreme weather and rising energy and commodity prices, have an impact on our stakeholders and our own operations. We are committed to managing our direct environmental impact and reducing our greenhouse gas emissions. We manage our impacts through our Environmental Action Plan, which focuses on reducing risk and creating value through improved efficiency.
Total CO2e tonnes 344,316 395,554 437,721 1 Restated 2013/2014 and 2014/2015 emissions data to improve the accuracy of reporting, using actual data to replace estimations.
Supporting the low carbon economy We continue to develop products and services to support customers’ transition to a lower carbon, more resource efficient economy. Since 2014 we have launched two Environmental, Social and Governance (ESG) bonds totalling £500 million. Lloyds Bank became the first UK bank to develop an ESG deposit scheme in response to client demand to invest in products that create positive impacts.
In March 2016 Lloyds Bank launched its innovative £1 billion Green Loan Initiative for commercial real estate lending. The initiative – the first of its kind in the UK – provides clients with loans at discounted margins to help incentivise energy efficiency and finance investment in green buildings. We completed the first tranche of deals in the second half of 2016, totalling £72 million, and have helped borrowers like HPH, a Bath-based property company with a diverse property portfolio, to fund energy efficiency projects. We have now set a target in our Helping Britain Prosper Plan to fund 10 million square feet of commercial real estate to become more energy efficient by 2020, the equivalent of 10 London Shards.
Our approach to risk is founded on an effective control framework which guides how our colleagues approach their work, the way they behave and the decisions they make. Risk appetite – defined as the amount and type of risk that we are prepared to seek, accept or tolerate – is approved by the Board and is embedded within policies, authorities and limits across the Group.
Capital strength The Group continues to maintain a strong capital position, with a pro forma CET1 ratio of 13.8 per cent, through a combination of strong statutory profit driven by good underlying profit and lower PPI, along with lower risk-weighted assets. Risk-weighted assets reduced by 3 per cent to £216 billion, reflecting the continued de-risking of the portfolio, and were primarily driven by active portfolio management including asset sales, an improvement in asset quality and capital efficient securitisation activity.
Risks are identified, managed and mitigated using our comprehensive Risk Management Framework (RMF), (see page 27) and our clearly defined risk appetite, embedded in policies, authorities and limits provides a clear framework for effective business decision making. The principal risks we face, which could significantly impact the delivery of our strategy, are discussed on pages 28 to 31.
Strong control framework The Group’s RMF acts as the foundation for the delivery of effective risk control and ensures that the Group risk appetite is continually developed and adhered to.
Business focus and accountability Effective risk management is a key focus and is included in key performance measures against which individual business units are assessed. The business areas in the first line of defence are accountable for risk but with oversight from a strong and importantly independent, second line of defence Risk Division.
The Risk Appetite Framework ensures our risks are managed in line with our risk appetite
The framework is reviewed, updated and approved by the Board at least annually to reflect any changes in the nature of our business and external regulations, law, corporate governance and industry best practice. This helps us to ensure we continue to meet our responsibilities to our customers, shareholders and regulators.
Our risk appetite and the policy framework define clear parameters within which our business units must operate in order to deliver the best outcome for customers and stakeholders. An updated risk appetite statement was approved by the Board in 2016.
– Ensure we develop comprehensive plans for delivery of all legal and regulatory changes and track their progress. Group-wide projects implemented to address significant impacts.
– Continued investment in people, processes, training and IT to assess impact and help meet our legal and regulatory commitments. – Engage with regulatory authorities and industry bodies on forthcoming regulatory changes, market reviews and investigations.
– Continual review of our IT environment to ensure that systems and processes can effectively support customers’ requirements.
– Enhancing the resilience of systems that support critical business processes with independent verification of progress on an annual basis. – Investing in enhanced cyber controls to protect against external threats to the confidentiality or integrity of electronic data, or the availability of systems and responding to findings from third party industry testing.
Example: – Inability to attract or retain colleagues with key skills could impact the achievement of business objectives.
Insurance risk Key insurance risks within the Insurance business are longevity, persistency and property insurance. Longevity risk is expected to increase as our presence in the bulk annuity market increases. Longevity is also the key insurance risk in the Group’s Defined Benefit Pension Schemes.
– The merits of longevity risk transfer and hedging solutions are regularly reviewed for both the Insurance business and the Group’s Defined Benefit Pension Schemes. – Property insurance exposures are mitigated by a broad reinsurance programme.
– Holding liquid assets to meet potential cash and collateral outflows, regulatory requirements and maintaining a further pool of secondary assets that can be used to access central bank liquidity facilities. – Undertaking daily monitoring against a number of market and Group-specific early warning indicators, maintaining a contingency funding plan detailing actions and strategies available in stressed conditions.
Example: – Non-compliance with or breaches of ring-fencing, resolution and SM&CR requirements will result in legal and regulatory consequences.
– Structural hedge programmes implemented to manage liability margins and margin compression, and the Group’s exposure to Bank Base Rate. – Equity and credit spread risks are closely monitored and, where appropriate, asset liability matching is undertaken to mitigate risk. – The Group’s Defined Benefit Pension Schemes have increased their credit allocation and hedged against nominal rate/inflation movements. – Stress and scenario testing of Group risk exposures.
We maintain a strong funding position in line with our low risk strategy. Our funding position has been significantly strengthened in recent years and our loan to deposit ratio remains within our target range.
We manage our exposure to movements in market rates throughout the year, leading us to promote low volatility earnings and offer a comprehensive customer proposition with market risk hedging strategies to support strategic aims, including delivering sustainable growth.
We are committed to meeting the changing needs of customers by working to provide a range of insurance products via multiple channels. The focus is on creating the best customer experience by helping customers protect themselves today whilst preparing for a secure financial future.
Consistent with similar pension schemes, the Group’s Defined Benefit Pension Schemes were adversely impacted by the credit spread volatility in the third quarter of 2016. The interest rate and inflation hedging programmes remain effective.
industry recognised qualifications delivered in 2016 thanks to the Skills Fund
Good underlying performance with strong improvement in statutory profit The Group’s underlying profit was £7,867 million, 3 per cent lower than 2015, with slightly lower income and higher impairments, partly offset by lower costs. The underlying return on required equity was 13.2 per cent and the underlying return on tangible equity was 14.1 per cent. Statutory profit before tax more than doubled to £4,238 million, compared with £1,644 million in 2015, as the level of PPI provisions reduced significantly.
Statutory profit before tax more than doubled to £4,238 million (2015: £1,644 million) primarily due to lower PPI provisions of £1,000 million (2015: £4,000 million).
A provision of £1 billion to cover further operating costs and redress relating to PPI was recognised in the third quarter and complaint levels in the second half have been around 8,300 per week on average. The Group’s current PPI provision reflects our interpretation of the Financial Conduct Authority’s (FCA) consultation paper regarding a potential time bar of the end of June 2019 and the Plevin case.
In addition there was a charge of £1,085 million to cover a range of other conduct issues of which £475 million was recognised in the fourth quarter. The charge for the year included £280 million in respect of complaints relating to packaged bank accounts, £261 million in respect of arrears-related activities on secured and unsecured retail products and £94 million related to insurance products sold in Germany, together with a number of other conduct risk provisions totalling £450 million across all divisions.
1 Excludes reverse repos of £8.3 billion (31 December 2015: £nil).
3 Excludes balances relating to margins of £3.2 billion (31 December 2015: £2.5 billion) and settlement accounts of £1.8 billion (31 December 2015: £1.4 billion).
The Group’s liquidity position remains strong, with the liquidity coverage ratio comfortably meeting regulatory requirements.
The Group is pleased to announce that following their annual review the PRA has reduced our PRA Buffer to reflect the significant de-risking undertaken by the Group in recent years. Going forward however, there remain a number of potential regulatory capital developments (including the introduction of the systemic risk buffer in 2019) and as a result the Board’s view of the current level of CET1 capital required to grow the business, meet regulatory requirements and cover uncertainties remains unchanged at around 13 per cent.
Profit (loss) for the year attributable to ordinary shareholders 2,001 466 1,125 (838) (1,471)
Basic earnings (loss) per ordinary share 2.9p 0.8p 1.7p (1.2)p (2.1)p
Post-tax return on average shareholders’ equity 4.9 1.3 2.9 (2.0) (3.3)
3 Dividends per ordinary share in 2016 include a recommended special dividend of 0.5 pence; and in 2015 included a special dividend of 0.5 pence.
– Customers can now complete their full remortgage application online. – Reduced appointment times for opening a new savings account by 44 per cent and matured savings accounts can now be renewed in just a few minutes. – Extended online and mobile phone application processes to all current accounts. – Lloyds Bank and Bank of Scotland current account online journeys have been rated #1 and #2 respectively by industry researcher eBenchmarkers.
Delivering sustainable growth – Black Horse balances have grown by 20 per cent in the year, ahead of market growth, and continue to benefit from partnerships with key manufacturers such as Jaguar Land Rover. – Credit card balances grew broadly in line with the market at 4 per cent, and the Group was the number one issuer of new cards in the UK. – The acquisition of MBNA will enable the Group to enhance its position and offering within the UK prime credit card market and brings capabilities including data analytics and digital expertise in addition to a well-recognised brand. This will be complementary to the Group’s existing operation and provides further opportunities for growth and delivering excellent customer service. – Unsecured loan balances contracted marginally in the year as the Group continues to focus on low risk franchise customers.
With over £110 billion of funds under management, Scottish Widows is helping 6 million customers protect what they value most and plan financially for the future. In addition, the general insurance business is protecting the homes, belongings, cars and businesses of over three million customers.
Progress against strategic initiatives The Group will continue to invest in developing the Insurance business and will seek to grow in areas where it has competitive advantage and is underrepresented, for the benefit of both customers and shareholders.
Delivering sustainable growth – Successfully completed four bulk annuity transactions in 2016, taking the combined external deal size to over £1.85 billion since entering the market in late 2015. – Continued to leverage Group capabilities to source attractive, low risk, higher yielding assets to back annuity liabilities. Total assets acquired to date are £7 billion. – Growth in corporate pension sales in a competitive environment, driven by increased uptake of new schemes. – Scottish Widows Protect monthly applications have increased tenfold, providing £2.4 billion of life assurance and critical illness cover to individuals and businesses across the UK. – Corporate pension, planning and retirement funds under management increased to over £42 billion reflecting net inflows and positive market movements.
The results in 2015 include TSB for the first quarter only.
Non-banking items: Fee based loans and advances (9.4) (8.7) (9.1) (10.9)
As reported in 2015, we established a board-level Responsible Business Committee, underlining the Group’s commitment to being a responsible business. The Committee focuses its work on the three areas of People, Businesses and Communities and reports on its first full year of activities on page 79.
Culture and values One of my goals as Chairman is to ensure we continue to build a culture in which our colleagues are empowered, inspired and rewarded to do the right thing for customers. Our approach to culture and values is led by the Board, where there is a clear emphasis on setting the ‘tone from the top’. This is reflected in the focus we give in the Board to ensuring every aspect of our management approach – including targets and incentives, organisational structures, values and behaviours – helps support the right culture, and is cascaded through our governance structure to every part of the business. We recognise that everyone is different and a key element to achieving our vision is having a diverse and inclusive workforce that reflects the diversity of modern Britain.
We have a Group Customer First Committee to provide senior level active oversight and governance to upgrade and accelerate our customer focus, embed our target culture and conduct agenda. This committee drives our focus on culture and has encouraged the creation of a culture dashboard, to enable us to monitor our progress. Colleague feedback is combined alongside regular metrics to provide a view that is truly representative.
Skills and experience: Lord Blackwell has deep financial services knowledge including in insurance and banking, as well as regulatory and public policy experience gained from senior positions in a wide range of industries. His breadth of experience, credibility with key stakeholders and strong leadership qualities make him an effective Chairman. Lord Blackwell was previously the Chairman of Scottish Widows Group, and Interserve plc, Director of Group Development at NatWest Group, a Senior Independent Director of Standard Life and also chaired their UK Life and Pensions Board. His past Non-Executive Directorships have included Halma plc, Dixons Group, SEGRO and Ofcom. He was Head of the Prime Minister’s Policy Unit from 1995 to 1997 and was appointed a Life Peer in 1997. He has an MA in Natural Sciences from the University of Cambridge, a Ph.D in Finance and Economics and an MBA from the University of Pennsylvania.
Skills and experience: Nick has significant financial experience in the UK listed environment having served in a number of senior finance positions within a range of sectors. His background and experience enables him to fulfil the role of Audit Committee Chair and, for SEC purposes, the role of Audit Committee Financial Expert. Nick was previously the Group Finance Director of Centrica plc, Finance Director of The Peninsular & Oriental Steam Navigation Company and Chief Financial Officer of P&O Princess Cruises plc. He previously served as a Non-Executive Director and was the Audit Committee Chair of QinetiQ Group plc. He is a Mathematics graduate from the University of Oxford and a Chartered Accountant.
External appointments: Executive Director and Chief Financial Officer of RELX Group.
Skills and experience: Stuart has extensive experience in retail banking, insurance and consumer finance. He is a former Non-Executive Director of TSB Banking Group plc, TSB Bank plc, LV Group and Virgin Direct. In his executive career, he was President and Chief Operating Officer of Aspen Insurance after spending nine years with General Electric, as Chief Executive Officer of the UK Consumer Finance business then President of GE Capital China. Before that he was Chief Executive Officer of Tesco Personal Finance and Director of UK Retail Banking at the Royal Bank of Scotland. He was a Council member of The Royal Institute for International Affairs (Chatham House). He has an MA in Economics from the University of Aberdeen and an MBA from the University of California.
Skills and experience: Malcolm was previously General Counsel and Company Secretary of Standard Life after a career as a corporate lawyer in private practice in London and Edinburgh. He has a wealth of experience in governance, policy and regulation. He is a Fellow of the Institute of Chartered Secretaries and Administrators and a Member of the Chartered Institute for Securities and Investment and the GC100.
02 George Culmer Executive Director and Chief Financial Officer George joined the Board as an Executive Director in May 2012. Full biography on page 57.
03 Juan Colombás Executive Director and Chief Risk Officer Juan joined the Group as Chief Risk Officer in January 2011 and joined the Board as an Executive Director in November 2013. Full biography on page 57.
11 Janet Pope Chief of Staff (GEC attendee) Janet joined the Group in 2008 to run the Savings business. She was previously Chief Executive at Alliance Trust Savings, prior to which she was EVP Global Strategy at Visa International. Janet spent 10 years at Standard Chartered Bank where she held a variety of roles including Retail Banking MD for Africa and non-executive directorships at Standard Chartered Bank Zimbabwe, Kenya, Zambia and Botswana. Janet has held non-executive positions on the audit committees of the Department for Communities and Local Government, The Rent Service (Department for Work and Pensions) and the Office of the Deputy Prime Minister. Janet studied at the London School of Economics. She has a Master’s degree in Economics and holds an MBA from Cass Business School.
The Corporate Governance Framework, which is reviewed annually by the Board, sets out a number of key decisions and matters that are reserved for the Board’s approval.
Non-Executive Directors Alan Dickinson, Simon Henry, Nick Luff, Deborah McWhinney, Nick Prettejohn, Stuart Sinclair, Sara Weller The Non-Executive Directors challenge constructively and help develop and set the Group’s strategy. They actively participate in Board decision making and scrutinise management performance. The NonExecutive Directors satisfy themselves on the integrity of financial information and review the Group’s risk exposures and controls. The Non-Executive Directors, through the Remuneration Committee, determine the remuneration of Executive Directors.
Company Secretary Malcolm Wood The Company Secretary advises the Board and ensures good information flows and comprehensive practical support are provided to Directors. He maintains the Group’s Corporate Governance Framework and organises Directors’ induction and training. The Company Secretary communicates with shareholders as appropriate and ensures due regard is paid to their interests. Both the appointment and removal of the Company Secretary is a matter for the Board as a whole.
Non-Executive Directors regularly meet with senior management and spend time increasing their understanding of the business through site visits, formal briefing sessions or more informal events including breakfast meetings with senior staff, which the Chief People, Legal and Strategy Officer also attends. Board dinners are held prior to each scheduled Board meeting. This allows the Directors greater time to discuss their views, ensuring that there is sufficient time for the Board to discuss matters of a material nature at Board meetings. Some of these pre meetings are for Non-Executive Directors only, some also include the Group Chief Executive and others the full Board and GEC members. At least once a year, a meeting is held without the Chairman in attendance.
A full schedule of all matters reserved to the Board and Terms of Reference for each of the Board Committees can be found at www.lloydsbankinggroup.com/our-group/corporate-governance
3 Mr Prettejohn was unable to join the June Board meeting due to a prior commitment. 4 Joined the Board on 4 January 2016. 5 Retired on 11 May 2016.
In the rare event of a Director being unable to attend a meeting, the Chairman discusses the matters proposed with the Director concerned, seeking their support and or feedback accordingly. The Chairman subsequently represents those views at the meeting.
Ensuring the right focus to deliver the Group’s strategy The Board recognises the need to be adaptable and flexible to respond to changing circumstances and emerging business priorities, whilst ensuring the continuing monitoring and oversight of core issues.
The Non-Executive Directors also receive regular updates from the Group Chief Executive’s office including a weekly email which gives context to current issues. In-depth and background materials are regularly provided via a reading room on the Board portal.
These included amendments to the statements of responsibilities of the Directors and members of the GEC and minor amendments to the terms of reference of a number of Board and Group Chief Executive Committees.
The Board considered the opportunity at a number of meetings during 2016 and spent considerable time at each meeting discussing and reviewing the acquisition and approving next steps. As part of its oversight role, the Board challenged and scrutinised the rationale for the acquisition and received detailed progress updates and papers. Key issues considered by the Board in reaching the decision to approve the acquisition included: strategic context; funding options; financial effects; due diligence findings; cost synergies; risks; and their impact on the Group.
Yearly planner prepared by the Company Secretary to map out the flow of key items of business to the Board
– Approval of large transactions – MBNA acquisition – EU referendum outcome – Review of future environment and business model
Governance and shareholders – Board effectiveness and Chairman’s performance reviews – Board Diversity Policy – Review of Corporate Governance
Framework – Investor Relations updates – AGM briefing – In the first half of 2016, preparation for proposed public offering of shares in the Company by HM Treasury
– Approval of Group risk appetite – Approval of Risk Management Framework – Review of internal control systems – Review and approval of PRA and
The purpose of the sessions is to provide the Board with deeper insight into key areas of strategic focus. The sessions are structured to allow for plenty of opportunity for discussion and include presentations and videos.
The offsite concluded with a group discussion leveraging the broad range of experience and perspectives from across the Board.
The Town Hall sessions are an opportunity for colleagues to hear from the Chairman on the Group’s performance and strategic direction, and importantly, to ask questions. These events are very popular and are always well attended.
Board visit to Halifax Over two days in November the Board visited the Group’s Halifax offices. In addition to the Board and Committee meetings, a separate strategy meeting, attended by GEC members, was held reviewing the Group operating plan. During the visit, the Chairman and several Non-Executive Directors, spent half a day with some of the c.3,000 colleagues based in Halifax. The visit included a walk through the Mortgage Transformation lab to learn about the improvements being made to the customer mortgage journey.
Professional development and training The Chairman leads the learning and development of Directors and the Board generally and regularly reviews and agrees with each Director their training and development needs.
Certification Regime – Detailed risk induction programme – Detailed briefings on each of the
– Specific briefings are provided on the Committees on which the new Director will serve.
The 2016 review sought the Directors’ views on a range of topics including: strategy; planning and performance; risk and control; Board composition and size; balance of skills and experience; diversity; culture and dynamics; the Board’s calendar and agenda; the quality and timeliness of information; and support for Directors and Committees.
If Directors have concerns about the Company or a proposed action which cannot be resolved, it is recorded in the Board minutes. Also on resignation, Non-Executive Directors are encouraged to provide a written statement of any concerns to the Chairman, for circulation to the Board. No such concerns were raised in 2016 and up to the date of this report.
Volume of Board/Committee papers The most common observation by Directors concerned the volume of information which they received. Directors would like to receive more concise reports with clearer signposting of the key issues.
2015 Board effectiveness review (external) In accordance with the three year cycle, the 2015 evaluation was facilitated externally by JCA Group between October 2015 and January 2016. The review was commissioned by the Chairman, assisted by the Company Secretary and overseen by the Nomination and Governance Committee. A summary of the Board’s progress against the actions arising from the 2015 effectiveness review are set out below.
Step 3 Evaluation of the findings by the Company Secretary and report prepared
In establishing and reviewing the risk management and internal control systems, the Directors carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity, the likelihood of a risk event occurring and the costs of control. The process for identification, evaluation and management of the principal risks faced by the Group is integrated into the Group’s overall framework for risk governance. The Group is forward-looking in its risk identification processes to ensure emerging risks are identified. The risk identification, evaluation and management process also identifies whether the controls in place result in an acceptable level of risk. At Group level, a consolidated risk report and risk appetite dashboard are reviewed and regularly debated by the Group Risk Committee, Board Risk Committee and the Board to ensure that they are satisfied with the overall risk profile, risk accountabilities and mitigating actions. The report and dashboard provide a monthly view of the Group’s overall risk profile, key risks and management actions, together with performance against risk appetite and an assessment of emerging risks which could affect the Group’s performance over the life of the operating plan. Information regarding the main features of the internal control and risk management systems in relation to the financial reporting process is provided within the risk management report on pages 116 to 169. The Board concluded that the Group’s risk management arrangements are adequate to provide assurance that the risk management systems put in place are suitable with regard to the Group’s profile and strategy.
REMUNERATION The statement by the Chairman of the Remuneration Committee, the Directors’ Remuneration policy and the Directors’ Remuneration Implementation Report are set out on pages 84 to 114.
in place to address key gaps or weaknesses in the control framework. Business areas and head office functions assess the controls in place to address all material risk exposures across all risk types. The CER considers all material controls, including financial, operational and compliance controls. Senior management complete an attestation to confirm the CER findings which are reviewed and independently challenged by the Risk Division and Group Audit and reported to the Board. Action plans are implemented to address any control deficiencies.
Spotlight on subsidiary governance The Group conducts the majority of its business through a number of subsidiary entities. The Corporate Governance Framework sets out minimum governance standards and a subsidiary directors’ handbook sets out detailed guidance on the role and responsibilities of a subsidiary director.
Statement of compliance UK Corporate Governance Code - The UK Corporate Governance Code 2014 (the 'Code') applied to the 2016 financial year. The Group confirms that it applied the main principles and complied with all provisions of the Code throughout the year, and that it has applied the UK Corporate Governance Code 2016 since its financial year end. The Code is publicly available at www.frc.org.uk
Relationships with institutional investors Investor Relations has primary responsibility for managing and developing the Group’s external relationships with existing and potential institutional equity investors and analysts. With support from senior management, they achieved this through a combination of more than 1,100 meetings and various presentations in 2016. The presentations were primarily aligned to results and included content on strategic progress and financial and operational performance.
As set out earlier in the report, a number of Board changes have been agreed since the year end. Anthony Watson, our Senior Independent Director, will retire at the 2017 AGM after serving more than eight years on the Board, and Nick Luff, an independent Non-Executive Director and Chairman of the Audit Committee, has notified the Board that in light of his other commitments he does not intend to seek re-election at the 2017 AGM. On the Committee’s recommendation, the Board has appointed Anita Frew to succeed Anthony as Senior Independent Director, which she will combine with the role of Deputy Chairman. Anita’s significant board, financial and investment management experience, including as a Senior Independent
The Committee reports to the Board on how it discharges its responsibilities and makes recommendations to the Board, all of which have been accepted during the year. The Committee’s terms of reference can be found at www.lloydsbankinggroup.com/ our-group/corporate-governance
Diversity policy The Committee reviewed the Board Diversity Policy in light of new and emerging best practice and recommended to the Board a specific target to maintain at least three female Board members and to take opportunities to increase the number of female Board members over time. The Board Diversity Policy is set out below.
Based on its assessment for 2016, the Committee is satisfied that, throughout the year, all Non-Executive Directors remained independent as to both character and judgement.
The Board also places high emphasis on ensuring the development of diversity in the senior management roles within the Group and supports and oversees the Group’s objective of achieving 40 per cent of senior roles held by female executives by 2020, along with other metrics which promote the engagement of other underrepresented groups within the business. This is underpinned by a range of policies within the Group to help provide mentoring and development opportunities for female executives and to ensure unbiased career progression opportunities. Progress on this objective is monitored by the Board and built into its assessment of executive performance.
You can read more on the Group’s diversity programmes, including details of the Group’s commitment to raise the percentage of women employed in senior management roles to 40 per cent by 2020 on page 18 of the strategic report.
A copy of the Board Diversity Policy is available on our website at www.lloydsbankinggroup.com/responsible-business and information on Board diversity can be found on page 54.
Female representation on the Board is currently 23 per cent (based on three female directors and 10 male directors).
Deborah McWhinney and Stuart Sinclair who joined the Board in December 2015 and January 2016 respectively, share their insights on their induction and first year on the Board
Anthony Watson 8 8 1 Mr Henry was unable to attend Audit Committee meetings in January, July, October and December due to prior executive commitments. Mr Henry will succeed Mr Luff as Audit Committee Chairman following Mr Luff’s retirement at the AGM in May 2017. Prior to taking on the Chairmanship of the Audit Committee, Mr Henry is retiring as Chief Financial Officer of Royal Dutch Shell plc in March 2017.
Overseeing financial reporting requires an assessment of key accounting judgements and related disclosures. The cost of redress relating to Payment Protection Insurance (PPI) has been substantial, and accounting provisions for this cost remain the most significant judgement made in drawing up the Group’s financial statements.
The Committee also considered other areas of significant judgement that were relevant to the financial statements. These included other conduct provisions, loan impairments, tax matters, actuarial assumptions for insurance and pension accounting, and the appropriate classification of gilts held by the Group for liquidity purposes. Further details are set out in this report.
The transformation of the internal audit function has also been a focus for the Committee. This has included reviewing the scope and direction of internal audit’s work, overseeing changes to the leadership of the function, supporting independence of audit, and encouraging improved reporting of audit findings. The Committee has also monitored the effectiveness of the external audit as the new lead audit partner was introduced.
How Committee meetings are run The management of the Committee is in keeping with the basis on which meetings of the Board are managed, as detailed on page 62. Its structure facilitates open discussion and debate, with steps taken to ensure adequate time for members of the Committee to consider proposals which are put forward.
During the course of the year, the Committee held separate sessions with the internal and external audit teams, without members of the executive management present.
– For packaged bank accounts, the Committee has continued to monitor the utilisation of the provision and management’s assessment of both the remaining exposure and the additional provisions required. This has included reviewing the expected level of complaints and the average redress payments. – The Committee has understood the basis for determining the provision in respect of the Group’s secured and unsecured arrears handling activities. The provision includes the cost of both identifying and rectifying the customers affected. – Group Audit undertook periodic agreed upon procedures over the process that has been used by management to calculate the extent of conduct related provisions. Procedures undertaken were designed to identify the use of reasonable, consistent and supportable assumptions and inputs. No items were raised by exception for consideration by the Committee. – The Committee was satisfied that the provisions for other conduct matters were appropriate. The disclosures relating to other conduct provisions are set out in note 38: ‘Other provisions’ on page 230 of the financial statements.
– The Committee assisted the Board in performing its assessment of the viability of the Company and the Group with input from management. The viability assessment, which was based on the Group’s operating, capital and funding plans, included consideration of the principal and emerging risks which could impact the performance of the Group, and the liquidity and capital projections over the period. – The Committee was satisfied that the viability statement could be provided and advised the Board that three years was a suitable period of review. – The viability statement is disclosed on page 82 of the Directors’ report.
Group Audit In monitoring the activity, role and effectiveness of the internal audit function and their audit programme the Committee: – monitored the effectiveness of Group Audit and their audit programme through quarterly reports on the activities undertaken and a report from the Quality Assurance function within Group Audit; – approved the annual audit plan and budget and reviewed progress against the plan through the year; – oversaw the process for the appointment of an Interim Group Audit Director; and – considered the major findings of significant internal audits, and management’s response.
In order to ensure the objectivity and independence of the external auditor, the policy sets a financial threshold above which all non-audit services provided by the external auditor must be approved in advance by the Committee, with additional provision made for the approval of non-material services which are below the threshold by certain members of senior management. The policy further formalises within the Group the restriction on the provision of non-audit services by the external auditor which the FRC consider to be prohibited.
The total amount of fees paid to the auditor for both audit and non audit related services in 2016 is disclosed in note 11 to the financial statements on page 201.
External auditor The Committee oversees the relationship with the external auditor. During the year, the Committee considered the auditors’ terms of engagement (including remuneration), their independence and objectivity and approved the audit plan (including methodology and risk identification processes).
The Committee has continued to take a dynamic approach to the consideration of existing and emerging risks, through a balanced agenda which included standing areas of risk management, together with specific focus on emerging risks focusing significant additional resource where considered necessary. An example of this has been the establishment of dedicated sub-committees to further enhance focus on particular areas, such as IT resilience and cyber security, enabling members of the Committee to direct more time to better understand, and challenge, the associated risks and actions being taken by management.
The Group continues to operate in an environment subject to considerable change and, during 2016, another key area of activity for the Committee has been the proactive review, oversight and management of risks arising from the outcome of the EU referendum and wider geo-political risks. The Committee will continue to monitor developments and any impact on the Group’s risk profile.
In seeking to achieve this, the Committee assumes responsibility for monitoring the Group’s Risk Management Framework, which embraces risk principles, policies, methodologies, systems, processes, procedures and people. It also includes the review of new, or material amendments to risk principles and polices, and overseeing any action resulting from material breaches of such policy.
Given the dynamic nature and significance of IT and cyber risks the Committee has established a sub-committee to enable more in depth consideration of IT resilience and cyber risks. During the year the sub-committee gave consideration to a wide range of issues including insider risk, cyber reverse stress testing, IT Resilience and Cyber Programme updates, cyber insurance and cloud technology. Alongside this an advisory panel comprising external industry experts has been established to provide the sub-committee with an external view of current and evolving industry wide cyber security threats, challenges and developments.
Conduct risk The Committee continues to focus closely on the Group’s approach to conduct risk.
Throughout 2016, the Committee considered reports on the proactive identification and resolution of conduct issues which have had an impact on customers. The pace and quality of required remediation received particular attention together with actions taken to address root cause analysis and the prevention of similar issues. Consideration was also given to the conduct risks within the collections process for customers in arrears as well as customers in financial difficulties. In addition the Committee considered developments in the Group’s conduct culture as well as reports on complaints, conduct risk appetite metrics and product governance.
Conclusion: Whilst good progress has been made as a result of the Group’s conduct strategy initiatives, continued improvement in the Group’s conduct risk profile will remain a priority for the Group in 2017 and will continue to be a subject of focus for the Committee.
In reviewing the UK Secured portfolio, consideration was given to the quality of new lending, the credit performance of the portfolio, the risk adjusted returns, and the adequacy of impairment and capital provisions under both expected and stressed conditions. The Committee specifically considered appetite for higher loan to value lending following the government’s announcement to discontinue the Help to Buy 2 scheme. Additionally, for the buy-to-let segment, the Committee reviewed management’s plans to implement changes in response to the revised tax regime and additional regulatory requirements for underwriting.
Data risk Data risk has been identified as a key focus within the Group to take into account the growing importance of data as a means of competitive advantage and to underpin key risk decision making and risk management.
Given the increased uncertainty around used car prices in the current market environment, consideration was given to the residual value risk associated with the Group’s growing motor finance businesses and the impact of a range of possible scenarios for the future path of used car prices and deteriorating macro environment.
Assessment was made of the overall governance framework for models including scope, the model landscape, the role of the Group Model Governance Committee and modelling standards. Additionally, the Committee considered the Group’s material models at Divisional level, including their purpose, design and how regular performance monitoring and validation ensure they remain fit-for-purpose and identify areas for improvement in an evolving regulatory environment. The Committee also observed a structured reporting framework which facilitates good senior management awareness and escalation, when required.
Being a responsible business is fundamental to our strategy. We are proud that our colleagues support so many people, businesses and communities across the UK to achieve a better future through the work of our Helping Britain Prosper Plan
Dear Shareholder I am pleased to present the second Responsible Business Committee report, following its establishment in July 2015.
Committee composition and effectiveness The membership of the Committee comprises Sara Weller, independent Non‑Executive Director (Chairman of the Committee) the Group Chairman and the Deputy Chairman. All Non‑Executive Directors are invited to attend the Committee’s meetings. The Group Chief Executive attended two meetings in 2016. During the year, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.
HELPING BRITAIN PROSPER PLAN: THE COMMITTEE'S ROLE The Committee is responsible for overseeing the design and development of the Helping Britain Prosper Plan, the measurement of performance against the Plan and the internal and external communication of the Plan.
JULY Report on progress against the metrics in the 2015/16 Plan with updates from divisional sponsors and review of outline approach to the 2016/17 Plan
Sara Weller joined colleagues, representatives from the SSE Dartington school and a member of South Gloucestershire Council on a panel to select the next cohort of Social Entrepreneurs.
The final dividend in respect of 2015 of 1.5 pence per ordinary share was paid to shareholders on 17 May 2016, the special dividend in respect of 2015 of 0.5 pence per ordinary share was paid to shareholders on 17 May 2016 and an interim dividend for 2016 of 0.85 pence per ordinary share was paid on 28 September 2016; these dividends totalled £2,034 million. Further information on dividends is shown in note 45 on page 238 and is incorporated by reference.
The Company did not repurchase any of its shares during the year (2015: none).
Company on 6 January 2017 that their holding had decreased, to 4,243,603,868 shares, representing 5.95 per cent of the issued share capital, and on 27 January 2017 that their holding had decreased, to 3,567,130,415 shares, representing 4.998 per cent of the issued share capital.
Post balance sheet events There have been no other material post balance sheet events.
In making this assessment, the Directors have considered a wide range of information, including the principal and emerging risks which could impact the performance of the Group, and the Group’s five year operating plan which comprises detailed customer, financial, capital and funding projections together with an assessment of relevant risk factors. In particular in 2016, the assessment included consideration of the effects of the continuing low interest rate environment, the impact of a potential slow-down in economic growth as a result of the uncertainty surrounding the UK’s exit from the EU, the possible effect upon the Group’s financial position of the implementation of IFRS 9 “Financial Instruments” and the implications of ring-fencing, which over the next two years will lead to internal restructuring and the establishment of the ringfenced sub-group and a non-ring-fenced sub-group.
– The financial projections and the underlying assumptions in respect of expected market and business changes, and future expected legal, accounting and regulatory changes are subject to rigorous review and challenge from both divisional and Group executives. The Board obtains independent assurance from Risk Division over the alignment of the plan with Group strategy and Board risk appetite. This assessment also identifies the key risks to delivery of the Group’s operating plan. – The Group operates a robust stress testing framework to assess compliance of the operating plan with the Group risk appetite. The plan, which incorporates detailed capital and funding plans, is subject to both regulatory and internal stress testing scenarios, in addition to reverse stress testing. Further information on stress testing and reverse stress testing is provided on page 119. The internal stress testing scenarios are designed to be severe but plausible; and take full account of the availability and likely effectiveness of the mitigating actions that could be taken to avoid or reduce the impact or occurrence of the underlying risks. In considering the likely effectiveness of such actions, the conclusions of the Board’s regular monitoring and review of risk and internal control systems, as discussed on page 67, is taken into account. – The final five year operating plan, Risk Division assessment and the results of the stress testing are presented to the Board for approval. Once approved, the operating plan drives detailed divisional and Group targets for the following year.
Independent auditor and audit information Each person who is a Director at the date of approval of this report confirms that, so far as the Director is aware, there is no relevant audit information of which the Company’s auditor is unaware and each Director has taken all the steps that he or she ought to have taken as a Director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of the Companies Act 2006.
A copy of the financial statements is placed on our website at www.lloydsbankinggroup.com. The Directors are responsible for the maintenance and integrity of the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
In 2016, the Group has completed the moves to ensure that all customer-facing colleagues in Retail are now incentivised by reference to Balanced Scorecard metrics, rather than individual or branch level sales or product targets. This change ensures that colleagues are rewarded for action and behaviour that puts customers first. All variable remuneration decisions take into consideration the Group’s Value, Codes of Responsibility, and the Conduct Pillars (Integrity, Compliance and Competence).
The plan outcome will be determined ‘top-down’ as a percentage of the Group’s underlying profit, modified based on the Group’s Balanced Scorecard performance and any collective adjustment for risk and conduct matters. The clear and transparent link between risk-adjusted profit and the Group Performance Share plan outcome ensures direct alignment between the interests of colleagues (including Executive Directors) and shareholders.
Over 80 per cent of colleagues hold an interest in the Group through participation in one of our existing share plans. To achieve 100 per cent share ownership, for the first time in 2017, all colleagues in the Group will receive an award of shares valued at £200, which they will be required to hold for at least three years. We will look to repeat awards in future years, dependent on delivering against the Group’s strategic aims.
The gross bonus that results from underlying profit modifiers and Balanced Scorecard performance is £484.1 million. In reaching the final decision on the 2016 bonus outcome, the Committee considered the conduct-related provisions, including an additional provision for PPI in 2016. This led to a downward adjustment of 19 per cent resulting in a final bonus outcome for 2016 of £392.9 million. This is an increase of 11 per cent compared to 2015.
The Group’s bonus outcome is amongst the lowest of large UK banks and at 4.8 per cent of pre bonus underlying profit, significantly lower than the Group’s funding limit of 10 per cent of pre bonus underlying profit.
Short-term measures (Group Performance Share plan), examples include: Creating the best customer experience
– Underlying profit before tax – Common equity tier 1 (CET1) ratio – PRA stress test
Due to this more onerous approach under the Group Ownership Share plan, awards for Executive Directors under the Group Performance Share plan are deferred for two years as follows: – 40 per cent will be released in the first year following award; – 40 per cent will be released in the second year; and – the remaining 20 per cent will be released in the third year.
The graphic below illustrates how the Group’s deferral approach for Executive Directors (who are PRA Senior Managers for regulatory purposes) continues to be weighted to the long term, underpinning the strategic priority and reward principle of delivering sustainable growth. Any shares released are subject to a further holding period in line with regulatory requirements and market practice. In line with shareholder expectations, no Group Ownership Share awards are unconditionally released until at least five years after grant.
Performance period: 2017 awards are subject to a three-year performance period 20% (held for 6 months)
Annual bonus plan outcome The Group has delivered strong financial performance in 2016 following further strategic progress. In reaching the decision on the 2016 bonus outcome, the Committee considered the conduct-related provisions, including an additional provision for PPI in 2016. This led to a downward adjustment of 19 per cent.
The total bonus award as a percentage of pre-bonus underlying profit before tax increased from 4.2 per cent in 2015 to 4.8 per cent in 2016. This compares favourably to shareholder return from dividend payments over the same period which increased to 26.3 per cent of underlying profit and remains significantly lower than the Group’s funding limit of 10 per cent of pre bonus underlying profit.
Employee engagement index 71 71 1 The underlying profit result used for remuneration purposes was £7,994 million (excluding TSB).
2 The adjusted cost:income ratio result used for remuneration purposes was 50.5 per cent.
Bonus amount post adjustment £m Dividend £m (Dividend includes ordinary and special dividend)
The Group’s policy continues to help ensure that the remuneration proposition is both cost effective and enables the Group to attract and retain executives of the highest calibre. The objective is to align individual reward with the Group’s performance, the interests of its shareholders and a prudent approach to risk management. In this way, the requirements of the major stakeholders are balanced: customers, shareholders, employees, and regulators.
Purpose and link to strategy To provide flexible benefits as part of a competitive remuneration package.
The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance. The Committee may reduce the level of award (including to zero), apply additional conditions to the vesting, or delay the vesting of deferred awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of an event occurring before vesting. Awards may be subject to malus and clawback for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation.
Awards continue and are released at the normal time and the number of shares subject to the award in the current year will be reduced to reflect the date of termination.
Date of letter of appointment Alan Dickinson 26 June 2014 Deborah McWhinney 26 November 2015
ANNUAL REPORT ON REMUNERATION Implementation of the policy in 2017 It is proposed to operate the policy in the following way in 2017: Base salary
Economic profit2 Set relative to 2019 targets Threshold: £3,074m Maximum: £3,769m
Chairman and Non-Executive Director fees in 2017 The annual fee for the Chairman was increased by 2 per cent to £728,280, in line with the overall salary budget for the general colleague population.
Nomination and Governance Committee membership £15,0002 £5,0003 1 New members only.
The Group total bonus outcome is the sum of the divisional and functional bonus outcomes. Performance outcomes are determined by adjusting the Group’s target bonus outcome according to Group underlying profit and Balanced Scorecard performance. These are each used as a modifier to increase or decrease the target bonus outcome in the range of 0 per cent – 145 per cent, subject to an overall funding limit of 10 per cent of pre bonus underlying profit. A collective performance adjustment is then applied.
Group total bonus outcome Subject to a limit of 10% of pre bonus underlying profit
The ratings for each division and function are communicated to all colleagues within the business area to ensure bonus outcomes are transparent and understood. The ratings are considered commercially sensitive; however, as an indication of performance, the overall rating for the Group (as determined by the Committee) was Strong plus and the average of the divisional/functional modifiers applied was 1.26.
Increased dividends Increased ordinary dividend of 2.55 pence per share in 2016 (2015: 2.25 pence), in line with the Group’s progressive and sustainable dividend policy. Additional special dividend of 0.5 pence.
(3) Collective performance adjustment Consideration was given to items not factored into the Group underlying profit or divisional or functional Balanced Scorecards. These included the provisions for legacy conduct-related matters relevant to the year. As a result of these items, the Committee approved an overall collective adjustment of £91.2 million or approximately 19 per cent, resulting in a final bonus outcome of £392.9 million as shown in the table below. The bonus outcome of £392.9 million is significantly below the overall funding limit of 10 per cent of pre bonus underlying profit.
Continued improvement in credit quality of lending portfolio, strong performance in 2016 PRA stress test.
Increased dividends Increase in ordinary dividend to 2.55 pence per share (2015: 2.25 pence) in line with the Group’s progressive and sustainable dividend policy, with additional special dividend of 0.5 pence per share.
Employee engagement survey results strengthened despite uncertain economic outlook and announcement of further role reductions – scores significantly higher than UK benchmark and close to UK high-performing benchmark.
Key Customer Journeys across retail and commercial banking and insurance significantly enhanced, leading to improved customer feedback and trust scores as well as complaints reducing from their low levels relative to the sector.
Remaining the largest lender to first-time buyers and maintaining the recent record of above-market growth in lending to SMEs. Commitments to support communities and charities also exceeded.
Expected outcome as % of salary 0% 0% 42% 91% 140%
George Culmer The Chief Financial Officer’s (CFO) personal performance assessment for 2016, as confirmed by the Committee, reflected a number of considerations including: Strong financial performance Strong financial performance delivered in challenging low interest rate and volatile market environment – key liquidity, funding and capital metrics either strengthened or maintained.
Strong capital generation Group’s pro forma CET1 capital ratio of 13.8 per cent comfortably above regulatory requirements after increased ordinary dividend of 2.55 pence per share and an additional special dividend of 0.5 pence per share.
Resilient business model ‘Stressed’ CET1 capital and leverage ratios of 10.3 per cent and 4.3 per cent from 2016 regulatory (PRA) stress test comfortably above regulatory requirements and strongest across major UK banking peers.
Following the Committee’s assessment of performance against the underlying profit target and the Finance division’s BSC objectives, and taking into account the collective performance adjustment of 19 per cent and the individual rating of Strong plus, the Committee determined a 2016 bonus award for the CFO of £574,326 (77 per cent of maximum).
Effective optimisation of balance sheet leading to further reductions in risk-weighted assets (RWAs) – in turn supporting capital generation.
complaints, any complaints received via Claims Management Companies (CMC) and any complaints relating to TSB activity. With the introduction of the FCA guidance contained in PS15/19 applicable from 1 July 2016, the complaint classification and reporting for the original metric ceased on 30 June 2016. Accordingly, the Remuneration Committee has rebased the original 2014 metrics in line with the new FCA reporting regime. The Remuneration Committee considers the rebased targets equally stretching.
% change in benefits 1 2 per cent delivered in cash (in line with other colleagues) the remainder in shares. 2 The performance rating for the GCE improved from Strong in 2015 to Strong plus in 2016. 3 Adjusted for movements in staff numbers and other impacts to ensure a like-for-like comparison.
2 In addition to the annual bonus of £392.9 million awarded in respect of 2016 performance, the Group made Group Ownership Share awards of £47.6 million and paid approximately £84 million under variable pay arrangements used to incentivise customer-facing colleagues, primarily in the Retail division.
External appointments held by the Executive Directors António Horta-Osório – During the year ended 31 December 2016, the Group Chief Executive served as a Non-Executive Director of Exor, Fundação Champalimaud, Stichting INPAR and Sociedade Francisco Manuel dos Santos for which he received fees of £217,098 in total.
J E Daniels Waived 62% 0% – – – – –
% of base salary plus fixed share award Number of shares1
2 Includes shares owned outright reduced by forfeitable ‘matching’ shares under the Share Incentive Plan.
Deferred bonus awarded in 2016 624,065 – – – 624,065 5
Share buy-out award (share options) 299,732 – – 299,732 – – 6, 7 1 The shares awarded in March 2013 vested on 7 March 2016. The closing market price of the Group’s ordinary shares on that date was 72.75 pence. Shares vested are subject to a further two-year holding period.
3 All LTIPs have performance periods ending 31 December at the end of the three-year period. Awards were made in the form of conditional rights to free shares. 4 Awards (in the form of conditional rights to free shares) in 2016 were made over shares with a value of 300 per cent of reference salary for António Horta-Osório (5,015,210 shares with a face value of £3,660,000); 275 per cent for George Culmer (2,767,409 shares with a face value of £2,019,600); and 275 per cent for Juan Colombás (2,728,973 shares with a face value of £1,991,550). The share price used to calculate face value is the average price over the five days prior to grant (1 March to 7 March 2016), which was 72.978 pence. This was the average share price used to determine the number of shares awarded. Performance conditions for this award have been disclosed in last year’s annual report on remuneration (page 91).
5 Bonus is deferred into shares. The face value of the share awards in respect of bonuses granted in March 2016 was £849,649 (1,164,253 shares) for António Horta-Osório; £461,846 (632,856 shares) for George Culmer; and £455,431 (624,065 shares) for Juan Colombás. The share price used to calculate the face value is the average price over the five days prior to grant (1 March to 7 March 2016), which was 72.978 pence.
The aggregate amount of gains made by Directors on the exercise of share options was £391,270.
George Culmer 7,090,093 08/03/2016 295,534 Release of 2013 Deferred Bonus 08/03/2016 2,005,122 Vesting of 2013 LTIP
Remuneration Committee Committee purpose and responsibilities The Remuneration Committee has responsibility for setting remuneration for all Executive Directors and the Chairman, including pension rights and any compensation payments. The Committee also recommends and monitors the level and structure of remuneration for senior management and material risk takers.
The Committee’s purpose is to consider, agree and recommend to the Board an overall remuneration policy and philosophy for the Group that is aligned with its long-term business strategy, its business objectives, its risk appetite, values and the long-term interests of the Group that recognises the interests of relevant stakeholders. The Committee’s Terms of Reference can be found on the Company’s website at www.lloydsbankinggroup.com/our-group/corporate-governance
Matters considered by the Committee The Committee had seven scheduled meetings during 2016 to consider the following principal matters: – Review of remuneration arrangements for senior executives; – Determination of 2015 bonus outcome based on divisional and functional performance and adjustment for risk; – Review of the Balanced Scorecard for the determination of 2016 bonuses in divisions and functions; – Vesting of the 2013 long-term incentive plan (LTIP); – Performance conditions for the 2016 LTIP; – Bonus and salary awards for Executive Directors and key senior managers; – Performance adjustments in respect of staff, in relation to risk matters in its purview; – Feedback from the Committee Chairman on her meetings with the PRA and shareholders; – Review of services and consideration of a number of advisors with subsequent appointment of Kepler, a brand of Mercer (Kepler); – Results of the Remuneration Committee effectiveness review and the suggestions for improvement; – Variable remuneration and simplification of reward principles; – Approval of the 2015 and 2016 Directors’ remuneration report for publication within the annual report and Form 20-F; – Review and approval of material risk taker identification and approval of the Remuneration Policy Statement; and – Remuneration governance in the light of regulatory changes.
The Committee has not formally evaluated Kepler’s performance since their appointment in mid-2016. A review is due to be undertaken in early 2017. Deloitte LLP, independent consultants to the Committee since 2010, provided advice for the first five months of the year. Deloitte LLP is not connected with the Group. Deloitte’s fees for services to the Committee in 2016 were on a time and materials basis and amounted to £240,800. In addition, Deloitte LLP provided the Group with advice on taxation and other consulting services, and assurance services.
Other information for an analysis of where Enhanced Disclosure Task Force (EDTF) recommendations are disclosed 292
THE GROUP’S APPROACH TO RISK The Group operates a prudent approach to risk with rigorous management controls to support sustainable business growth and minimise losses. Through a strong and independent risk function (Risk Division) a robust control framework is maintained to identify and escalate current and emerging risks to support sustainable business growth within Board Risk Appetite and through good risk reward decision making.
The focus remains on building and sustaining long-term relationships with customers cognisant of the economic climate.
The Board metrics are supported by more detailed sub-Board functional and divisional risk appetite metrics.
Table 1.1: Exposure to risk arising from the business activities of the Group
– Counterparty credit risk3 – 8.6 – – 1.0 – 9.6
2 As a separate regulated business, Insurance maintains its own regulatory solvency requirements, including appropriate management buffers, and reports directly to the Insurance Board. Insurance does not hold any RWAs, as its assets are removed from the Banking Group's regulatory capital calculations. However, part of the Group's investment in Insurance is included In the calculation of Threshold RWAs, subject to CRD IV rules, while the remainder is taken as a capital deduction.
Principal risks The Group’s principal risks are shown in the risk overview (pages 28 to 31). The Group’s emerging risks are shown overleaf. Full analysis of the Group’s risk drivers is on pages 123 to 169.
Macroeconomic headwinds and political uncertainties: Political uncertainties over the UK’s relationship with EU Countries remains with US election outcomes and European elections adding to a globally uncertain political and macroeconomic outlook.
IT resilience and cyber: Increasing digitisation places greater reliance on the provision of resilient and secure services to customers. Potential increases in the volume of cyber-attacks could disrupt service for customers, causing financial loss/reputational damage.
– Continued delivery of cyber control framework and investment in Cyber programme. – Operational Resilience activities will be combined with currency upgrades to form a new Technology Resilience programme.
– Organisational and behavioural effectiveness is regularly reviewed, ensuring simplicity/efficiency, supporting the Group's strategy. – Sustained and continuing investment in digital capability and customer channels; plans updated to reflect market trends/customer behaviour.
Strategic use of customer data: Impacts of Data Regulation in respect of data sharing, data privacy and data loss, noting the need to defend against dynamic external challengers and consumer expectations. Failure to address growth in data movement or understand the Supply Chain/Third party controls may increase exposure to Cyber/Fraud leading to conduct/reputational issues.
Ring-fencing: Legislation and rules impact the business and operating model and cost of serving customers effectively. EU Exit/heightened implementation risk may require a change to target business/ operational model adding complexity, timescales and execution costs.
– Updates reported to Board and GEC on key components of non ring-fence programmes. – The Group is actively engaged with HM Treasury, the PRA and FCA to ensure that it is able to fully implement the restructuring required to implement ring-fencing by the January 2019 deadline.
– Risk appetite criteria limits single counterparty bank/non-bank exposures complemented by a UK-focused strategy. – Financial Stability Forum develops and maintains Stability Response Plan; acting as a Rapid Reaction Group, when external crises occur.
Regulatory stress tests During 2016, the Group was subject to the European Banking Authority’s Europe-wide stress test with the Group's results significantly above our minimum capital requirements. The concurrent UK stress test run by the Bank of England was also undertaken in 2016. As announced in November, the Group comfortably exceeded the capital thresholds set by the Prudential Regulation Authority and was not required to take any action as a result of this test.
Other stress testing activity The Group’s stress testing programme also involves undertaking assessment of liquidity scenarios, market risk sensitivities and scenarios and business specific scenarios (see the principal risks on pages 123 to 169 for further information on risk specific stress testing). If required, ad hoc stress testing exercises are also undertaken to assess emerging risks, as well as in response to regulatory requests. This wide ranging programme provides a comprehensive view of the potential impacts arising from the risks to which the Group is exposed and reflects the nature, scale and complexity of the Group.
Key responsibilities of the Board and senior management include: – setting risk appetite and approval of the RMF; – approval of Group-wide risk principles and policies; – the cascade of delegated authority (for example to Board sub-committees and the Group Chief Executive); and – effective oversight over risk management consistent with the risk appetite.
– Risk appetite is defined within the Group as ‘the amount and type of risk that the Group is prepared to seek, accept or tolerate’ (see The Group’s approach to Risk page 116).
Mandate of the Risk Division – the objective of Risk Division is to provide both proactive advice and constructive challenge to the business. It also has a key role in promoting the implementation of a strategic approach to risk management reflecting the risk appetite and RMF agreed by the Board that encompasses: – embedded effective risk management processes; – transparent focused risk monitoring and reporting; – provision of expert and high quality advice and guidance to the Board, executives and management on strategic issues and horizon scanning including pending regulatory changes; and – a constructive dialogue with the first line through provision of advice, development of common methodologies, understanding, education, training, and development of new tools.
The Risk Directors: – provide independent advice, oversight and challenge to the business; – design, develop and maintain policies, specific functional risk type frameworks and guidance to ensure alignment with business imperatives and regulatory requirements; – establish and maintain appropriate governance structures, culture, oversight and monitoring arrangements which ensure robust and efficient compliance with relevant risk-type risk appetites and policies; – lead regulatory liaison on behalf of the Group including horizon scanning and regulatory development for their risk type; and – propose risk appetite and oversight of the associated risk profile across the Group.
Risk culture – supporting the formal frameworks of the RMF is the underlying culture, or shared behaviours and values, which sets out in clear terms what constitutes good behaviour and good practice. In order to effectively manage risk across the organisation, the functions encompassed within the Three Lines of Defence have a clear understanding of risk appetite, business strategy and an understanding of (and commitment to) the role they play in delivering it. A number of levers are used to reinforce the risk culture, including tone from the top, clear accountabilities, effective communication and challenge and an appropriately aligned performance incentive and structure.
Risk resources and capabilities – appropriate mechanisms are in place to avoid over-reliance on key personnel or system/technical expertise within the Group. Adequate resources are in place to serve customers both under normal working conditions and in times of stress, and monitoring procedures are in place to ensure that the level of available resource can be increased if required. Colleagues undertake appropriate training to ensure they have the skills and knowledge necessary to enable them to deliver fair outcomes for customers, being mindful of the Group’s strategic conduct agenda, Customer Treatment Policy/Standards and Financial Conduct Authority requirements.
Assisted by the Board Risk and Audit Committees, the Board approves the Group’s overall governance, risk and control frameworks and risk appetite. Refer to the Corporate Governance section on pages 60 to 80, for further information on Board committees.
Group Risk Committee (GRC) Reviews and recommends the Group’s risk appetite and governance, risk and control frameworks, material Group policies and the allocation of risk appetite. The committee also regularly reviews risk exposures and risk/reward returns and approves material risk models.
Leads and shapes the Group’s approach to cost management, ensuring appropriate governance and process over Group-wide cost management activities and effective control of the Group’s cost base.
Loans and advances, contingent liabilities, commitments, debt securities and derivatives also expose the Group to refinance risk. Refinance risk is the possibility that an outstanding exposure cannot be repaid at its contractual maturity date. If the Group does not wish to refinance the exposure then there is refinance risk if the obligor is unable to repay by securing alternative finance. This may be because the borrower is in financial difficulty, or because the terms required to refinance are outside acceptable appetite at the time. Refinance risk exposures are managed in accordance with the Group’s existing credit risk policies, processes and controls, and are not considered to be material given the Group’s prudent and through the cycle credit risk appetite. Where heightened refinance risk exists (such as in Commercial Banking’s Business Support Unit (BSU) or the run-off book) exposures are minimised through intensive account management and are impaired and forborne where appropriate.
Impairment allowances are recognised for financial reporting purposes only for loss events that have occurred at the balance sheet date, based on objective evidence of impairment. Due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements differs from the amount determined from the regulatory expected loss models. Note 2(H) on page 189 provides details of the Group’s approach to the impairment of financial assets.
Prudent, through the cycle credit principles, risk policies and appetite statements: The independent Risk Division sets out the credit principles, risk policies and risk appetite statements. Principles and policies are reviewed regularly, and any changes are subject to a review and approval process. Policies and risk appetite statements, where appropriate, are supported by procedures, which provide a disciplined and focused benchmark for credit decisions. Risk oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes, and test the adequacy of credit risk infrastructure and governance processes throughout the Group, which includes tracking portfolio performance against an agreed set of key appetite tolerances. Oversight and reviews are also undertaken by Credit Risk Oversight and Group Audit.
Additional mitigation for Retail and Consumer Finance customers The Group uses a variety of lending criteria when assessing applications for mortgages and unsecured lending. The general approval process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using information held by Credit Reference Agencies (CRA).
Buy-to-let mortgages are limited to a maximum loan size of £1,000,000 and 75 per cent LTV. Buy-to-let applications must pass a minimum Rental Cover Ratio of 125 per cent under stressed interest rates, after applicable tax liabilities.
Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each exposure type. This includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market movements against agreed confidence intervals. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.
Collateral held as security for financial assets other than loans and advances is determined by the nature of the underlying exposure. Debt securities, including treasury and other bills, are generally unsecured, with the exception of asset-backed securities and similar instruments such as covered bonds, which are secured by portfolios of financial assets. Collateral is generally not held against loans and advances to financial institutions, except where securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement. Derivative transactions with wholesale counterparties are typically collateralised under a Credit Support Annex (CSA) in conjunction with the ISDA Master Agreement. Derivative transactions with non-bank customers are not usually supported by a CSA.
Commercial lending decisions must be based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. The requirement for collateral and the type to be taken at origination will be based upon the nature of the transaction and the credit quality, size and structure of the borrower. For non-retail exposures, the Group will often require the collateral to include a first charge over land and buildings owned and occupied by the business, a debenture over one or more of the assets of a company or limited liability partnership, personal guarantees, limited in amount, from the directors of a company or limited liability partnership and key man insurance. The Group maintains policies setting out acceptable collateral bases for valuation maximum LTV ratios and other criteria to be considered when reviewing an application. Other than for project finance, object finance and income producing real estate where charges over the subject assets are required, the provision of collateral will not determine the outcome of an application. Notwithstanding this, the fundamental business proposition must evidence the ability of the business to generate funds from normal business sources to repay a customer/counterparty’s financial commitment.
Forbearance identification, classification and measurement The Group classifies Retail and Consumer Finance accounts as forborne at the time a customer in financial difficulty is granted a concession. Accounts are classified as forborne only for the period of time which the exposure is known to be, or may still be, in financial difficulty. Where temporary forbearance is granted, exit criteria are applied to include accounts until they are known to no longer be in financial difficulty. Where the treatment involves a permanent change to the contractual basis of the customer’s account such as a capitalisation of arrears or term extension, the Group classifies the balance as forborne for a period of 24 months, after which no distinction is made between these accounts and others where no change has been made.
The Group measures the success of a forbearance scheme for Secured customers based upon the proportion of customers performing (less than or equal to three months in arrears) over the 24 months following the exit from a forbearance treatment. For temporary treatments, 80 per cent of customers accepting reduced payment arrangements are performing. For permanent treatments, 83 per cent of customers who have accepted capitalisations of arrears and 84 per cent of customers who have accepted term extensions are performing.
– Pension Credit customers: Qualifying customers are able to claim for mortgage interest at 3.12 per cent on up to £100,000 of the mortgage and there is no time limit as to how long they can claim.
Types of forbearance The Group’s strategy and offer of forbearance is largely dependent on each customers individual situation. Early identification, control and monitoring are key to supporting the customer and protecting the Group. Concessions are often provided to help the customer with their day to day liquidity and working capital. A number of options are available to the Group where a customer is facing financial difficulty and each case is treated depending on its own specific circumstances.
The main types of forbearance concessions to commercial customers in or facing financial difficulty are set out below: – Covenants: This includes temporary and permanent waivers, amendment or resetting of non-payment contractual covenants (including LTV and interest cover). The granting of this type of concession in itself would not result in the loan being classified as impaired and the customer is kept under review in the event that further forbearance is necessary; – Extensions/Alterations: This includes extension and/or alteration of repayment terms to a level outside of market or the Group’s risk appetite due to the customer’s inability to make existing contractual repayment terms; amendments to an interest rate to a level considered outside of market or the Group’s risk appetite, or other amendments such as changes to capital and/or interest servicing arrangements including capital repayment holidays or conversion to interest only terms; and – Multiple type of forbearance (a combination of the above two).
– Run-off net external assets stood at £11,336 million at 31 December 2016, down from £12,154 million at 31 December 2015. The portfolio represents only 2.1 per cent of the overall Group’s loans and advances (31 December 2015: 2.3 per cent).
2 Impairment provisions as a percentage of impaired loans are calculated excluding loans in recoveries in Retail (31 December 2016: £86 million; 31 December 2015: £118 million) and in Consumer Finance (31 December 2016: £279 million; 31 December 2015: £424 million).
The total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2016 and 31 December 2015 is shown in the table above. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 52 on page 261.
2 Impairment provisions as a percentage of impaired loans are calculated excluding loans in recoveries for Overdrafts (31 December 2016: £70 million; 31 December 2015: £90 million) and Retail Business Banking (31 December 2016: £16 million; 31 December 2015: £28 million).
– Against a backdrop of strong improvement in the housing market, with UK prices rising 6 per cent over 2016 (on a quarterly non-seasonally adjusted basis), provisions remain prudent and reflect the latent risks of the current low interest rate environment. – The average indexed LTV of the portfolio at 31 December 2016 improved to 44.0 per cent compared with 46.1 per cent at 31 December 2015. The percentage of closing loans and advances with an indexed LTV in excess of 100 per cent improved to 0.7 per cent at 31 December 2016, compared with 1.1 per cent at 31 December 2015. – The average LTV for new mortgages written in 2016, including participation in the UK Government’s Help To Buy scheme, was 64.4 per cent compared with 64.7 per cent for 2015. – Additional controls for new buy-to-let lending were implemented ahead of the regulatory deadline, with no relaxation in risk appetite.
Table 1.10: Retail Secured loans and advances to customers At 31 Dec 2016 £m £m
Table 1.11: Mortgages greater than three months in arrears (excluding repossessions) Number of cases Total mortgage accounts % Value of loans1 Total mortgage balances %
The stock of repossessions increased to 678 cases at 31 December 2016 compared to 654 cases at 31 December 2015.
3 Past term interest only balances are reported excluding any element being repaid on a capital and interest basis. December 2015 balances have been restated on the same basis.
2 Includes capitalisation of arrears and term extensions which commenced during the previous 24 months and where the borrowers remain as customers at 31 December.
– The Mid Markets business remains UK-focused and credit quality has been generally stable during 2016. The downturn in global oil and gas prices, which began in 2015, has created pressure on some parts of the oilfield services portfolio but this has not translated into a significant increase in defaults or impairment in the Mid Markets book. Political events during 2016, in particular the EU Exit referendum outcome, have brought volatility to financial markets but to date this has not led to a material increase in stress within the Mid Markets portfolio. – The Global Corporates business continues to have a predominance of investment grade clients, primarily UK based. The portfolio remains of good quality despite the current global economic headwinds particularly relating to the EU Exit referendum outcome and volatile commodity prices in the oil & gas and mining sectors. – The real estate business within the Group’s Mid Markets and Global Corporate portfolio is focused on clients operating in the UK commercial property market ranging in size from medium sized private real estate entities up to publicly listed property companies. The uncertainties created by the EU Exit referendum outcome have reduced activity in the second half of 2016 but the market for UK real estate has continued to be resilient and credit quality remains good with minimal impairments/stressed loans. Recognising this is a cyclical sector, appropriate caps are in place to control exposure and business propositions continue to be written in line with a prudent, through the cycle risk appetite with conservative LTVs, strong quality of income and proven management teams. – Financial Institutions serves predominantly investment grade counterparties with whom relationships are either client focused or held to support the Group’s funding, liquidity or general hedging requirements. Overall limits have been relatively stable as we continue to prudently manage the portfolio within our conservative risk appetite and clearly defined sector strategies. – The Group continues to adopt a conservative stance across the Eurozone maintaining close portfolio scrutiny and oversight particularly given the current macro environment and horizon risks.
Commercial Banking UK Direct Real Estate LTV analysis – The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities, such as hotels, care homes and housebuilders). – Focus remains on the UK market, on good quality customers, with a proven track record in Real Estate and where cash flows are robust. – Commercial Banking saw some growth in its UK Direct Real Estate core portfolio during 2016 with business continuing to be written within conservative risk appetite parameters. Excluding £0.5 billion in the Islands Commercial business, Commercial Banking UK Direct Real Estate gross lending stood at £18.5 billion at 31 December 2016. – Approximately 70 per cent of loans and advances to UK Direct Real Estate relate to commercial real estate with the remainder relating to residential real estate. The portfolio continues to be heavily weighted towards investment real estate (c.90 per cent) over development. – The LTV profile of the UK Direct Real Estate portfolio in Commercial Banking continues to improve.
Commercial Banking forbearance At 31 December 2016, £2,645 million (31 December 2015: £3,529 million) of total loans and advances were forborne of which £2,179 million (31 December 2015: £2,543 million) were impaired. Impairment provisions as a percentage of forborne loans and advances increased marginally from 30.9 per cent at 31 December 2015 to 31.2 per cent at 31 December 2016.
The movements in Commercial Banking impaired forborne loans and advances were as follows: Table 1.20: Movement in Commercial Banking impaired forborne loans and advances (audited)
Impairment provisions as % of loans and advances which are forborne £m £m £m £m
2 Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the last six months. Permanent changes, such as refinancing, for existing customers as at 31 December are also included.
Run-off – The Ireland retail portfolio continues to reduce in volume due to closed book attrition (3 per cent year on year), however exposure has increased by £457 million to £4,497 million in 2016 (31 December 2015: £4,040 million) due to the foreign exchange impact of sterling weakening, partly offset by capital repayments. – Ireland retail loans and advances with an indexed LTV in excess of 100 per cent improved to £1,240 million (27.8 per cent) at 31 December 2016, compared with £1,269 million (31.4 per cent) at 31 December 2015. Of this amount £70 million were impaired (31 December 2015: £71 million). – The Corporate real estate and other corporate portfolio has continued to reduce in line with expectations. Net loans and advances reduced by £337 million, from £1,128 million at 31 December 2015 to £791 million at 31 December 2016. – Total net external assets for the Specialist finance asset based run-off portfolio reduced to £4,668 million at 31 December 2016 (gross £4,779 million), from £5,552 million (gross £5,742 million) for 2015. Assets include Ship Finance, Aircraft Finance, Leasing and Infrastructure loans and advances, as well as the reducing Treasury Asset legacy investment portfolio and operating leases.
Asset quality ratio1 (0.15%) 0.20% (35)bp 1 In respect of loans and advances to customers.
Eurozone exposures The following section summarises the Group’s direct exposure to Eurozone countries at 31 December 2016. The exposures comprise on balance sheet exposures based on their balance sheet carrying values net of provisions and off balance sheet exposures, and are based on the country of domicile of the counterparty unless otherwise indicated.
Derivative balances are included within exposures to financial institutions or corporates, as appropriate, at fair value adjusted for master netting agreements at obligor level and net of cash collateral in line with legal agreements. Exposures in respect of reverse repurchase agreements are included on a gross IFRS basis and are disclosed based on the counterparty rather than the collateral (repos and stock lending are excluded); reverse repurchase exposures are not, therefore, reduced as a result of collateral held. Exposures to central clearing counterparties are shown net.
For Insurance, the Group has reported shareholder exposures i.e. where the Group is directly exposed to risk of loss. These shareholder exposures relate to direct investments where the issuer is resident in the named Eurozone country and the credit rating is consistent with the tight credit criteria defined under the appropriate investment mandate. Insurance also has interests in funds domiciled in Ireland and Luxembourg where, in line with the investment mandates, cash is invested in short term financial instruments. For these funds, the exposure is analysed on a look through basis to the country of risk of the obligors of the underlying assets rather than treating as exposure to country of domicile of the fund.
At 31 December 2015 1 Excludes reverse repurchase exposure to Institutional funds domiciled in Ireland secured by UK gilts of £14,506 million (2015: £11,267 million) on a gross basis.
Mitigation The Group takes a range of mitigating actions with respect to this risk. The transition of the customer-focused UK centric strategy into the Business has strengthened its culture and values, improved systems and processes, and implemented more effective controls. These actions are being further embedded throughout the Group (across all business areas and all supporting functional areas) through the continued evolution of the strategic focus on conduct within business as usual supported by the GCFC, including: – Conduct risk appetite established at Group and business area level, with metrics included in the Board Risk Appetite to ensure ongoing due-focus; – Customer needs explicitly considered within business and product level planning and strategy, with Divisional plans reviewed and challenged by the GCFC; – Cultural transformation, supported by strong direction and tone from senior executives and the Board. This is underpinned by the Group’s values and Codes of Responsibility, to deliver the best bank for customers; – Establishment of the Customer Vulnerability Framework, which operates at a senior level to prioritise change, drive implementation and ensure consistency across the Group; – Development of the Group’s Customer Journey Strategy and Framework to support our focus on conduct from an end-to-end customer perspective; – Enhanced product governance framework to ensure products continue to offer customers fair value, and consistently meet their needs throughout their product life cycle; – Enhanced complaints management through effectively responding to, and learning from, root causes to reduce complaint volumes and the Financial Ombudsman Service change rate; – Enhanced recruitment and training, with a focus on how the Group manages colleagues’ performance with clearer customer accountabilities; and – Ongoing focus on the strategic conduct agenda in our interactions with third parties involved in serving the Group’s customers to ensure consistent delivery of needs met.
The Group has also prioritised activity designed to reinforce good conduct in its engagement with the markets in which it operates. This has included the creation of a Market Conduct Steering Committee, training for relevant colleagues, the development of enhanced procedures, and the enhancement of preventative and detective controls including the Group’s trade surveillance and continuous surveillance capability.
The Group actively engages with regulatory bodies and other stakeholders in developing its understanding of current customer treatment concerns, and those relating to the fairness and effectiveness of markets, to ensure that the Group’s strategic conduct focus in business as usual continues to meet evolving stakeholder expectations.
Trading and other financial assets at fair value through profit or loss 151,174 45,247 4,039 101,888
Loans and advances to customers1 457,958 – 457,958 – Interest rate
Available-for-sale financial assets 56,524 – 56,522 2 Interest rate, foreign exchange, credit spread
Liabilities arising from insurance and investment contracts 114,502 – – 114,502 Credit spread
Other liabilities 37,059 – 9,376 27,683 Interest rate 1 Includes £6.7 billion of lower risk loans within the banking book sold by Commercial Banking and Retail to Insurance to manage market risk arising from annuitant liabilities within the Insurance business.
Table 1.34 shows the key material market risks for the Group’s banking, defined benefit pension schemes, Insurance and trading activities.
Profit before tax Loss Gain >£500m l n £250m – £500m l n £50m – <£250m l n
2 Trading Portfolios; Interest rate -30bps, FX -5 per cent GBP, Credit spread +20 per cent, Inflation +30bps.
Mitigation GALCO is responsible for approving and monitoring group market risks, management techniques, market risk measures, behavioural assumptions, and the market risk policy. Various mitigation activities are assessed and undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits. The mitigation actions will vary dependent on exposure, but will, in general, look to reduce risk in a cost effective manner, by offsetting balance sheet exposures and externalising through to the financial markets dependent on market liquidity. The market risk policy is owned by Group Corporate Treasury (GCT) and refreshed annually. The policy is underpinned by supplementary market risk procedures, which define specific market risk management and oversight requirements.
Equity risk Equity risk arises primarily from three different sources; (i) the Group’s strategic equity holdings in Banco Sabadell, Aberdeen Asset Management, and Visa Europe; (ii) exposure to Lloyds Banking Group share price through deferred shares and deferred options granted to employees as part of their benefits package; and (iii) the Group’s private equity investments held by Lloyds Development Capital.
Mitigation The Group’s policy is to optimise reward whilst managing its market risk exposures within the risk appetite defined by the Board. The Group Market Risk policy and procedures outlines the hedging process, and the centralisation of risk from divisions into GCT, e.g. via Transfer Pricing Framework. GCT is responsible for managing the centralised risk and does this through natural offsets of matching assets and liabilities, and appropriate hedging activity of the residual exposures, subject to the authorisation and mandate of GALCO within the Board risk appetite. Derivative desks in Financial Markets will then externalise the hedges to the market. The Group has hedge accounting solutions in place, which reduce the accounting volatility arising from the Group’s economic hedging activities by utilising both Libor based and Bank base rate assets.
Measurement Management of the assets is the responsibility of the Trustees of the schemes who are responsible for setting the investment strategy and for agreeing funding requirements with the Group. Should a funding deficit arise, the Group will be liable for meeting it, and as part of a triennial valuation process will agree with the Trustees a funding strategy to eliminate the deficit over an appropriate period.
Further stresses that show the effect of reasonably possible changes in key assumptions, including the risk-free rate, equity investment volatility, widening of credit default spreads on corporate bonds and an increase in illiquidity premia, as applied to profit before tax are set out in note 33.
The market risk for the trading book continues to be low with respect to the size of the Group and compared to our peers. This reflects the fact that the Group’s trading operations are customer-centric and focused on hedging and recycling client risks. Note that the maximum VaR reported at £5.7 million was due to the incomplete booking of a position by end of day 22 March 2016 and hence did not reflect the true end of day position and was not a real limit breach. The VaR returned to normal levels once the booking was completed the next day. The next highest VaR was £3.8 million.
Monitoring Trading risk appetite is monitored daily with 1-day 95 per cent VaR and Stress Testing limits. These limits are complemented with position level action triggers and profit and loss referrals. Risk and position limits are set and managed at both desk and overall trading book levels. They are reviewed at least annually and can be changed as required within the overall Group risk appetite framework.
Exposures The principal operational risks to the Group are: – The risk that the Group is unable to provide services to customers as a result of an IT systems failure; – Cyber risks associated with malicious attacks on the confidentiality or integrity of electronic data, or the availability of systems; – Fraud and financial crime arising from acts of deception or omission; – Ensuring compliance with increasingly complex and detailed anti-money laundering, anti-terrorism, sanctions and prohibitions laws and regulations, as failure to do so would adversely impact the Group’s reputation and potentially incur fines and other legal enforcements; – Risks arising from inadequate delivery of services to customers; – The risk associated with the ongoing provision of services to TSB and other organisations; and – Terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events.
Table 1.40 below shows high level loss and event trends for the Group using Basel II categories. Based on data captured on the Group’s Operational Risk System, in 2016, the highest frequency of events occurred in external fraud (61.58 per cent) and execution, delivery and process management (24.80 per cent). Clients, products and business practices accounted for 77.62 per cent of losses by value, driven by legacy issues where impacts materialised in 2016 (excluding PPI).
Table 1.40: Operational risk events by risk category (losses greater than or equal to £10,000), excluding PPI % of total volume % of total losses
– The Group continues to mature its approach to operational resilience by enhancing the resilience of systems that support the Group’s critical business processes through the IT Resilience programme, with independent verification of progress on an annual basis. The Board recognises the role that resilient technology plays in achieving the Group’s strategy of becoming the best bank for customers and in maintaining banking services across the wider industry. As such, the Board dedicates considerable time and focus to this subject at both the Board and the Board Risk Committee, and continues to sponsor key investment programmes that enhance its resilience. – The threat landscape associated with cyber risk continues to evolve and regulatory attention continues. The Board has defined a Cyber Risk Appetite and is supporting initiatives to protect the Group against malicious cyber-attacks. The Group continues to invest in enhanced protection of customer information, including limiting access to key systems and enhancing the security, durability and accessibility of critical information.
The Group carries out stress testing of its liquidity and potential cash flow mismatch position over both short (up to one month) and longer term (up to three months) horizons against a range of scenarios. The scenarios and the assumptions are reviewed at least annually to gain assurance that they continue to be relevant to the nature of the business. For further information on the Group’s 2016 liquidity stress testing results refer to page 157. The Group funding plan is also stressed against a range of macroeconomic scenarios. Regulatory metrics are calculated and monitored over the life the plan under base and stress conditions.
The LCR became the Pillar 1 standard for liquidity in the UK in October 2015. The Group comfortably meets the requirements. Liquid asset holdings have fallen during the second half of 2016 as excess liquidity held during the EU Referendum is managed down. The Group continues to monitor the Net Stable Funding Ratio (NSFR) requirements and expects to meet them once confirmed by the PRA.
Cash and balances at central bank – non LCR eligible4 4.8 4.7 2
Trading and fair value through profit and loss 1.8 3.0 (40)
Table 1.43: Analysis of 2016 total wholesale funding by residual maturity Less than one month £bn
The Banking business also had £113.8 billion of secondary, non-LCR eligible liquidity, the vast majority of which is eligible for use in a range of central bank or similar facilities and the Group routinely makes use of as part of its normal liquidity management practices. Future use of such facilities will be based on prudent liquidity management and economic considerations, having regard for external market conditions.
The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of liquid assets. This liquidity is managed as a single pool in the centre and is under the control of the function charged with managing the liquidity of the Group. It is available for deployment at immediate notice, subject to complying with regulatory requirements.
The Board and GALCO monitor and manage total balance sheet encumbrance via a number of risk appetite metrics. At 31 December 2016, the Group had £83.5 billion (31 December 2015: £77.4 billion) of externally encumbered on balance sheet assets with counterparties other than central banks. The increase in encumbered assets was driven by an increase in the use of on balance sheet available-for-sale financial assets for repo activity. The Group also had £580.9 billion (31 December 2015: £573.7 billion) of unencumbered on balance sheet assets, and £153.5 billion (31 December 2015: £155.6 billion) of pre-positioned and encumbered assets held with central banks. Primarily the Group encumbers mortgages, unsecured lending and credit card receivables through the issuance programmes and tradable securities through securities financing activity. The Group mainly positions mortgage assets at central banks.
Cash and balances at central banks – – – – – 42,998 – 4,454 47,452 47,452
Available-for-sale financial assets 154 – 24,824 24,978 – 31,017 31 498 31,546 56,524
Cash and balances at central banks – – – – – 56,323 – 2,094 58,417 58,417
Available-for-sale financial assets – – 15,810 15,810 5,548 11,048 31 595 11,674 33,032
Although the SRB will apply at a sub consolidated level within the Group’s structure, the PRA have indicated that they will include in the PRA Buffer that applies to the Group an amount equivalent to the RFB’s Systemic Risk Buffer. The amount included in the PRA Buffer is expected to be lower as a percentage of Group RWAs reflecting the assets of the Group that will not be held in the RFB sub-group and for which the SRB will not apply to.
In addition to the risk-based capital framework outlined above, the Group is also subject to minimum capital requirements under the UK’s Leverage Ratio Framework. The leverage ratio is calculated by dividing fully loaded tier 1 capital resources by a defined measure of on balance sheet assets and off balance sheet items.
In addition, the Group targets a transitional total capital ratio of around 20 per cent.
Lloyds Banking Group plc acts as a holding company which also issues capital and other securities to capitalise and fund the activities of the Group. The profitability of the holding company, and consequently its ability to sustain dividend payments, is therefore dependent upon the continued receipt of dividends from its subsidiaries (representing both banking and insurance). A number of Group subsidiaries, principally those with banking and insurance activities, are also subject to regulatory capital requirements. These require entities to maintain minimum amounts of capital related to their size and risk. The principal operating subsidiary is Lloyds Bank plc which, at 31 December 2016, had a consolidated CET1 capital ratio of 15.2 per cent (31 December 2015: 15.2 per cent). The Group actively manages the capital of its subsidiaries, which includes monitoring the regulatory capital ratios for its banking and insurance subsidiaries against approved risk appetite limits. It operates a formal capital management policy which requires all subsidiary entities to remit any surplus capital to their parent companies.
After accruing for foreseeable dividends, the transitional total capital ratio reduced by 0.1 percentage points to 21.4 per cent, primarily reflecting managed reductions in tier 2 capital, largely due to calls and redemptions, offset by the increase in CET1 capital and the reduction in risk-weighted assets.
Adjustment to retained earnings for foreseeable dividends (1,568) (1,427) (1,568) (1,427)
Deconsolidation of instruments issued by insurance entities1 (1,810) (1,665) (1,810) (1,665)
Adjustments for transitional limit and non-eligible instruments 1,351 (52) (1,694) (3,066)
The key differences between the transitional capital calculation as at 31 December 2016 and the fully loaded equivalent are as follows: – Capital securities that previously qualified as tier 1 or tier 2 capital, but do not fully qualify under CRD IV, can be included in tier 1 or tier 2 capital (as applicable) up to specified limits which reduce by 10 per cent per annum until 2022. – The significant investment deduction from additional tier 1 (AT1) will gradually transition to tier 2.
Dividends paid out on ordinary shares during the year (2,014) – – (2,014)
CET1 capital resources have increased by £740 million in the year largely as a result of profit generation in the year, dividends received from the Insurance business and the favourable movement in the available-for-sale reserve following the accounting reclassification of gilts within the liquidity portfolio from held-to-maturity. These movements in CET 1 capital were partially offset by dividends paid out during the year, movements in the defined benefit pension schemes largely driven by the impact of credit spreads, an increase in the excess of expected losses over impairment provisions and value adjustments primarily as a result of the implementation of recently published EBA guidance restricting prudent valuation adjustments eligible for offset against expected losses, and the accrual of the full year ordinary and special dividends, representing returns to ordinary shareholders following strong capital generation.
Contributions to the default fund of a central counterparty 340 488
Risk-weighted assets at 31 December 2015 151,563 20,443 172,006 10,153 3,775 26,123 212,057
Counterparty credit risk assets decreased by £0.5 billion mainly driven by increased capital relief from CVA related hedges partially offset by increased trading activity, foreign exchange and yield curve movements.
Stress testing The Group undertakes a wide ranging programme of stress testing providing a comprehensive view of the potential impacts arising from the risks to which the Group is exposed. One of the most important uses of stress testing is to assess the resilience of the operational and strategic plans of the Group to adverse economic conditions and other key vulnerabilities. As part of that the Group participates in the UK-wide concurrent stress test run by the Bank of England.
Key movements The Group’s fully loaded leverage ratio increased by 0.1 per cent to 4.9 per cent reflecting the impact of both the increase in tier 1 capital and the £5.1 billion reduction in the exposure measure, the latter largely reflecting the reduction in liquid asset holdings.
The increase in SFT assets over the period, reflecting increased customer volumes, was offset by the reduction in SFT adjustments reflecting both the recognition of additional eligible netting adjustments and a reduction in the counterparty credit risk add-on.
Off-balance sheet items increased by £2.3 billion, primarily reflecting a change in the profile and subsequent classification of commercial off-balance sheet items and a net increase in securitisation financing facilities, partially offset by a planned drawdown on certain liquidity facilities supporting the Group’s conduit programme to provide funding alongside the proceeds of the ABCP issurance.
REGULATORY AND LEGAL RISK Definition Regulatory and legal risk is defined as the risk that the Group is exposed to fines, censure, or legal or enforcement action; or to civil or criminal proceedings in the courts (or equivalent) and/or the Group is unable to enforce its rights due to failing to comply with applicable laws (including Codes of Practice which could have legal implications), regulations, codes of conduct or legal obligations.
Mitigation We have taken a number of steps and have outlined below the following key components: – The Board establishes a Group-wide risk appetite and metrics for Regulatory and Legal Risk; – Group policies and procedures set out the principles and key controls that should apply across the business which are aligned to the group risk appetite. Mandated policies and processes require appropriate control frameworks, management information, standards and colleague training to be implemented to identify and manage regulatory and legal risk; – Business units assess and implement policy and regulatory requirements and establish local control, processes and procedures to ensure governance and compliance; – Material risks and issues are escalated to divisional and then Group-level bodies which challenge and support the business on its management of them;
– Business units regularly produce management information to assist in the identification of issues and test management controls are working effectively; – Risk Division and Legal provide oversight and proactive support and constructive challenge to the business in identifying and managing regulatory and legal issues; – Risk Division will conduct thematic reviews of regulatory compliance across businesses and divisions where appropriate; – Business units with the support of divisional and Group-Level bodies conduct ongoing horizon scanning to identify and address changes in regulatory and legal requirements.
The prime insurance risk of the Group’s defined benefit pension schemes is longevity.
Measurement Insurance risks are measured using a variety of techniques including stress, reverse stress and scenario testing, as well as stochastic modelling. Current and potential future insurance risk exposures are assessed and aggregated on a range of stresses including risk measures based on 1-in-200 year stresses for Insurance’s regulatory capital assessments and other supporting measures where appropriate, including those set out in note 33 to the financial statements. For measuring the longevity risk in the Group’s defined benefit pension schemes both 1-in-20 year stresses (risk appetite) and 1-in200 year stresses (regulatory capital) are utilised. For further information on defined benefit schemes please refer to note 36 to the financial statements.
PEOPLE RISK Definition People risk is defined as the risk that the Group fails to lead, manage and enable colleagues to deliver the Group’s strategy for customers, shareholders and regulators.
Exposures Exposure represents the sufficiency of the Group’s policies and procedures to maintain adequate systems, processes and controls to support statutory, prudential regulatory and tax reporting, to prevent and detect financial reporting fraud, to manage the Group’s tax position and to support regulatory disclosures.
Mitigation The Group’s Risk Management Framework (RMF) establishes robust arrangements for risk governance, in particular by: – Defining individual and collective accountabilities for risk management, risk oversight and risk assurance through a Three Lines of Defence model which supports the discharge of responsibilities to customers, shareholders and regulators; – Outlining governance arrangements which articulate the enterprise-wide approach to risk management; and – Supporting a consistent approach to Group-wide behaviour and risk decision making through a Group Policy Framework which helps everyone understand their responsibilities by clearly articulating and communicating rules, standards, boundaries and risk appetite measures which can be controlled, enforced and monitored.
REPORT ON THE FINANCIAL STATEMENTS Our opinion In our opinion: – Lloyds Banking Group plc’s consolidated financial statements and parent company financial statements (the ‘financial statements’) give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2016 and of the Group’s profit and the Group’s and the parent company’s cash flows for the year then ended; – the consolidated financial statements have been properly prepared in accordance with International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union; – the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and – the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the consolidated financial statements, Article 4 of the IAS Regulation.
Certain required disclosures have been presented elsewhere in the Annual Report, rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited.
The financial reporting framework that has been applied in the preparation of the financial statements is IFRSs as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006, and applicable law.
Our audit approach Overview – Overall Group materiality: £325 million which represents 5 per cent of the 3 year average of adjusted profit before tax. Statutory profits were adjusted to remove the effects of certain items which are exceptional and/or one-off in nature. – The scope of our audit and the nature, timing and extent of audit procedures performed were determined by our risk assessment, the financial significance of reporting units and other qualitative factors (including history of misstatement through fraud or error). – We performed audit procedures over reporting units we considered financially significant in the context of the Group (full scope audit) or in the context of individual primary statement account balances (audit of specific account balances). We also performed other procedures including testing entity level controls and analytical review procedures to mitigate the risk of material misstatement in the residual reporting units.
In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by
How we determined it 5 per cent of the 3 year average of adjusted statutory profit before tax.
Rationale for benchmark applied We have used a 3 year average of adjusted profit before tax in order to reduce the potential for volatility and large changes in materiality year-on-year. This is a generally accepted auditing practice. Statutory profits before tax for 2014, 2015 and 2016 were adjusted to remove the disproportionate impact of several items which are considered exceptional and/or one-off in nature. These adjustments included charges related to PPI and other conduct provisions, charges relating to redemption of Enhanced Capital Notes (ECNs) and Additional Tier 1 securities (AT1s), the credit in relation to the disposal of the stake in Visa Europe Ltd., and the credit in relation to pension scheme curtailment.
We agreed with the Audit Committee that we would report to them misstatements identified during our audit above £20 million (2015: £20 million) as well as misstatements below that amount that, in our view, warranted reporting for qualitative reasons.
We assessed the use of historic experience to estimate impairment events which have been incurred but not reported and to derive estimates of future cashflows.
The models rely upon the accuracy of underlying data including the delinquency status of the borrower. Our work therefore focused on agreed customer treatments such as forbearance, including the presentation of such information in the financial statements, in order to validate the accuracy of such delinquency status markers.
– the review and approval process that management have in place for the outputs of the Group’s impairment models, and the adjustments and overlays that are applied to modelled outputs.
In addition we have performed the following substantive procedures: Retail and Consumer Finance
We understood and evaluated the processes for identifying impairment events within the loan portfolios, as well as the impairment assessment processes for loans within the Business Support Unit and run-off portfolio.
The most significant provisions have related to past sales of payment protection insurance policies, arrears handling activities, packaged bank accounts and insurance products of the German branch of Clerical Medical Investment Group Ltd (now Scottish Widows Ltd).
We read the Group’s correspondence with the Financial Conduct Authority and Prudential Regulation Authority and discussed the output of any meetings held. We met on a trilateral basis with the Financial Conduct Authority, Prudential Regulation Authority and the Chair of the Audit Committee. We also met on a bilateral basis with each regulator.
The assessment included reference to our independent benchmarking data which considers each of these principal areas. For persistency, longevity and expenses we considered recent experience and the appropriateness of the judgements applied by management on how future experience will evolve. For persistency, we also considered the appropriateness of assumptions set by management in light of regulatory changes. In particular, we considered how the assumptions reflect expected persistency improvements from the removal of commission for qualifying pension schemes and greater outflows of funds expected as a result of increased options available to pension policyholders (Finance Act 2014). For longevity and expenses we assessed the appropriateness of the assumptions by comparing them to experience and latest industry data.
We tested the consensus and employee data used in calculating the obligation. Where material, we also considered the treatment of curtailments, settlements, past service costs and measurements, and any other amendments made to obligations during the year.
Based on the evidence obtained, we found that the data and assumptions used by management in the actuarial valuations for pension obligations are within a range we consider to be reasonable.
We examined hedge documentation to assess whether the documentation complied with all IAS 39 requirements. We tested key year-end reconciliations between underlying source systems and spreadsheets used to manage hedging models, including testing of hedging capacity after considering the impact of structural reform, designation of hedges and the measurement and recording of hedge effectiveness adjustments. In monitoring hedging effectiveness against stresses, we noted that despite significant market uncertainty and volatility during the year, all significant hedge accounting relationships continued to be effective. We also tested a sample of manual adjustments posted to hedge reserves relating to hedge ineffectiveness arising in cash flow hedging models. We specifically considered the re-designations that were required as a result of the reclassification of gilts from held-to-maturity to available-for-sale. We found that hedge accounting methodology was appropriately applied.
When considering the availability of future taxable profits, judgement is required when assessing projections of future taxable income which are based on approved business plans/forecasts.
We have evaluated the impact of recent tax law changes on the calculation of the Group's deferred tax balances, including confirming that the loss restriction rules, the banking surcharge and the restriction of deductions for certain customer compensation payments have been correctly applied. In addition, we ensured that management’s forecasts considered the impacts of structural reform.
The most significant uncertainties at present relate to a claim for group relief of group losses incurred in its former Irish banking subsidiary and the tax treatment of certain costs arising from the divestment of TSB Banking Group plc.
We understood and tested key controls surrounding the governance procedures in evaluating such uncertain exposures as well as performed an assessment over the experience of management in evaluating these exposures. We found the key controls were designed, implemented and operated effectively, and therefore we were able to place reliance on these controls for the purposes of our audit.
Based on the results of our audit work we concluded that the accounting treatment applied to significant transactions entered into in the year is reasonable.
The Group’s financial reporting processes are heavily reliant on automated processes and controls performed by IT systems. As part of the audit, we validate the design and operating effectiveness of in-scope automated and IT dependent controls at a point in time as well as review the supporting IT General Computer Controls (ITGCs) that provide assurance over the continued integrity of these controls for the full financial reporting period.
In our 2015 audit, we identified control matters in relation to the management of IT privileged access to IT systems and therefore relied on compensating controls and performed additional procedures.
We have observed significant progress in terms of remediating the control matters, however several of the controls did not operate effectively for the full financial reporting period.
Where these control matters affected applications and supporting IT systems within the scope of our audit, we performed a combination of additional controls testing, including compensating controls where relevant and substantive audit procedures.
Under ISAs (UK & Ireland) we are required to report to you if we have anything material to add or to draw attention to in relation to the directors’ statement about whether they considered it appropriate to adopt the going concern basis in preparing the financial statements. We have nothing material to add or to draw attention to.
– the statement given by the directors on page 83, in accordance with provision C.1.1 of the UK Corporate Governance Code (the ‘Code’), that they consider the Annual Report taken as a whole to be fair, balanced and understandable and provides the information necessary for members to assess the Group’s and parent company’s position and performance, business model and strategy is materially inconsistent with our knowledge of the Group and parent company acquired in the course of performing our audit.
Adequacy of accounting records and information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion: – we have not received all the information and explanations we require for our audit; or – adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or – the parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns.
Items that may subsequently be reclassified to profit or loss: Movements in revaluation reserve in respect of available-for-sale financial assets: Adjustment on transfer from held-to-maturity portfolio 1,544 – –
Trading and other financial assets at fair value through profit or loss 15 151,174 140,536
Loans and receivables: Loans and advances to banks 17 26,902 25,117
Trading and other financial liabilities at fair value through profit or loss 30 54,504 51,863
Movements in cash flow hedging reserve, net of tax – 1,409 – 1,409 – – 1,409
Post-retirement defined benefit scheme remeasurements, net of tax – – 539 539 – – 539
Movements in cash flow hedging reserve, net of tax – 2,194 – 2,194 – – 2,194
Value of employee services: Share option schemes – – 123 123 – – 123
Adjustment on sale of non-controlling interest in TSB Banking Group plc – – (171) (171) – 805 634
Movements in cash flow hedging reserve, net of tax – (412) – (412) – – (412)
Distributions on other equity instruments, net of tax – – (314) (314) – – (314)
Net cash provided by (used in) operating activities 2,074 16,372 10,353
Effects of exchange rate changes on cash and cash equivalents 21 2 (6)
Cash and cash equivalents at beginning of year 71,953 65,147 66,797
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 82, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements.
During the year the Group has reviewed its holding of government securities classified as held‑to‑maturity in light of the current low interest rate environment and they have been reclassified as available‑for‑sale; this has resulted in a credit of £1,544 million to the available‑for‑sale revaluation reserve (£1,127 million after tax).
NOTE 2: ACCOUNTING POLICIES The Group’s accounting policies are set out below. These accounting policies have been applied consistently.
(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. The Group initially recognises loans and receivables, deposits, debt securities in issue and subordinated liabilities when the Group becomes a party to the contractual provisions of the instrument. Regular way 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.
(1) Fair value hedges Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk; this also applies if the hedged asset is classified as an available-for-sale financial asset. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the income statement. The cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using the effective interest method over the period to maturity.
In certain circumstances, the Group will renegotiate the original terms of a customer’s loan, either as part of an ongoing customer relationship or in response to adverse changes in the circumstances of the borrower. Where the renegotiated payments of interest and principal will not recover the original carrying value of the asset, the asset continues to be reported as past due and is considered impaired. Where the renegotiated payments of interest and principal will recover the original carrying value of the asset, the loan is no longer reported as past due or impaired provided that payments are made in accordance with the revised terms. Renegotiation may lead to the loan and associated provision being derecognised and a new loan being recognised initially at fair value.
Operating lease assets are included within tangible fixed assets at cost and depreciated over their estimated useful lives, which equates to the lives of the leases, after taking into account anticipated residual values. Operating lease rental income is recognised on a straight-line basis over the life of the lease.
(1) Pension schemes The Group operates a number of post-retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation to pay further contributions.
Liabilities Changes in the value of liabilities are recognised in the income statement through insurance claims.
– Insurance and participating investment contracts which are unit-linked Liabilities for unit-linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Benefit claims in excess of the account balances incurred in the period are also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
(iii) Value of in-force business The Group recognises as an asset the value of in-force business in respect of insurance contracts and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date. This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency rates and includes allowances for both non-market risk and for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
(Q) Cash and cash equivalents For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non-mandatory balances with central banks and amounts due from banks with a maturity of less than three months.
NOTE 3: CRITICAL ACCOUNTING ESTIMATES 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.
Retail offers a broad range of financial service products, including current accounts, savings and mortgages, to UK personal customers, including wealth and small business customers. It is also a distributor of insurance and a range of long-term savings and investment products.
Commercial Banking is client-led, helping UK-based clients and international clients with a link to the UK. Through its four client facing divisions – SME, Mid Markets, Global Corporates and Financial Institutions – it provides clients with a range of products and services such as lending, transactional banking, working capital management, risk management, debt capital markets services, as well as access to private equity through Lloyds Development Capital.
Total underlying income, net of insurance claims 7,550 4,722 3,279 1,609 340 17,500
Segment underlying income, net of insurance claims 7,779 4,648 3,313 1,664 233 17,637
Total income, net of insurance claims 16,399 2,101 (926) (132) – – 17,442
1 Comprises the write-off of the ECN embedded derivative and premium paid on redemption of the remaining notes in the first quarter (loss of £790 million); the effects of asset sales (gain of £217 million); volatile items (gain of £99 million); liability management (gain of £123 million); the amortisation of purchased intangibles (£340 million); restructuring costs (£622 million, principally comprising the severance related costs related to phase II of the Simplification programme); and the fair value unwind and other items (loss of £231 million).
Debt securities held as loans and receivables 1.47 1.87 2.57 56 40 42
Total interest and similar income 2.77 2.86 3.03 16,620 17,615 19,211
Total interest and similar expense 1.44 1.19 1.51 (7,346) (6,297) (8,551)
Securities and other gains comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows: £m £m £m
Liability management In April 2014, the Group completed exchange offers with holders of certain series of its Enhanced Capital Notes (ECNs) and a tender offer to eligible retail holders outside the United States. A loss of £1,362 million was recognised in relation to these exchange and tender transactions in the year ended 31 December 2014. The Group completed tender offers and redemptions in respect of the remaining ECNs in March 2016, resulting in a net loss to the Group of £721 million, principally comprising the write-off of the embedded equity conversion feature and premiums paid under the terms of the transaction.
Profits of £123 million arose in the year ended 31 December 2016 (2015: losses of £28 million; 2014: losses of £24 million) on other transactions undertaken as part of the Group’s management of its wholesale funding and subordinated debt.
NOTE 10: INSURANCE CLAIMS Insurance claims comprise: 2016 £m 2015 £m 2014 £m
Pensions and other post-retirement benefit schemes (note 36): Past service (credits) charges1 – – (822)
Average headcount The average number of persons on a headcount basis employed by the Group during the year was as follows: Fees payable to the auditors Fees payable to the Company’s auditors by the Group are as follows: 2016 £m 2015 £m 2014 £m
Fees payable for the audit of the Company’s current year annual report 1.5 1.2 1.4
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 14.7 14.9 15.5
Deferred tax (note 37): Origination and reversal of temporary differences (557) (185) (72)
The charge for tax on the profit for 2016 is based on a UK corporation tax rate of 20 per cent (2015: 20.25 per cent; 2014: 21.5 per cent).
(B) Factors affecting the tax charge for the year A reconciliation of the charge that would result from applying the standard UK corporation tax rate to the profit before tax to the actual tax charge for the year is given below: 2016 £m 2015 £m 2014 £m
Impact of changes in UK corporation tax rates (201) (27) (24)
Weighted average number of ordinary shares in issue – diluted 72,024 72,340 72,447
The weighted-average number of anti-dilutive share options and awards excluded from the calculation of diluted earnings per share was 0.3 million at 31 December 2016 (2015: 1 million; 2014: 7 million).
Loans and advances to customers 30,473 – 30,473 30,109 – 30,109
Asset-backed securities: Corporate and other debt securities 224 19,608 19,832 612 19,704 20,316
For amounts included above which are subject to repurchase and reverse repurchase agreements see note 52.
Exchange rate contracts: Interest rate contracts: Embedded equity conversion feature (note 9) – – – – 545 –
Hedged cash flows For designated cash flow hedges the following table shows when the Group’s hedged cash flows are expected to occur and when they will affect income.
For amounts included above which are subject to reverse repurchase agreements see note 52.
Gross investment in finance leases, receivable: Not later than 1 year 551 497
(C) Unconsolidated collective investment vehicles and limited partnerships The Group’s direct interests in unconsolidated structured entities comprise investments in collective investment vehicles, such as Open‑Ended Investment Companies, and limited partnerships with a total carrying value of £15,611 million at 31 December 2016 (2015: £13,282 million), included within financial assets designated at fair value through profit and loss (see note 15). These investments include both those entities managed by third parties and those managed by the Group. At 31 December 2016, the total asset value of these unconsolidated structured entities, including the portion in which the Group has no interest, was £1,849 billion (2015: £603 billion).
NOTE 21: ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES Critical accounting estimates and judgements The allowance for impairment losses on loans and receivables is management’s best estimate of losses incurred in the portfolio at the balance sheet date. In determining the required level of impairment provisions, the Group uses the output from various statistical models. Management judgement is required to assess the robustness of the outputs from these models and, where necessary, make appropriate adjustments. Impairment allowances are made up of two components, those determined individually and those determined collectively.
Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the retail portfolios. For these portfolios the asset is included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. Segmentation takes into account factors such as the type of asset, industry sector, geographical location, collateral type, past‑due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.
The value of collateral supporting the Group’s UK mortgage portfolio is estimated by applying changes in the house price indices to the original assessed value of the property. Given the relative size of the portfolio, this is a key variable in determining the Group’s impairment charge for loans and receivables. If average house prices were ten per cent lower than those estimated at 31 December 2016, the impairment charge would increase by approximately £190 million in respect of UK mortgages.
Recoveries of advances written off in previous years 861 1 862 764 4 768
Charge (release) to the income statement (note 12) 592 – 592 443 (2) 441
Key assumptions The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set out below: Economic assumptions Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate. The certainty equivalent approach covers all investment assets relating to insurance and participating investment contracts, other than the annuity business (where an illiquidity premium is included, see below).
The risk-free rate is derived from the relevant swap curve with a deduction for credit risk.
The acquired value of in-force non-participating investment contracts includes £206 million (2015: £228 million) in relation to OEIC business.
Movement in the value of in-force business taken to income statement (note 9) 472 (162)
Balance sheet amount at 31 December 2015 447 310 6 66 1,009 1,838
Included within brands above are assets of £380 million (31 December 2015: £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.
The core deposit intangible is the benefit derived from a large stable deposit base that has low interest rates, and the balance sheet amount at 31 December 2016 shown above will become fully amortised during 2017.
The purchased credit card relationships represent the benefit of recurring income generated from the portfolio of credit cards purchased.
NOTE 26: PROPERTY, PLANT AND EQUIPMENT Investment properties £m Premises £m Equipment £m
Expenditure on investment properties (see below) 272 – – – 272
Change in fair value of investment properties (note 7) (83) – – – (83)
Rental income of £229 million (2015: £268 million) and direct operating expenses arising from properties that generate rental income of £26 million (2015: £27 million) have been recognised in the income statement.
The table above analyses movements in investment properties, all of which are categorised as level 3. See note 49 for details of levels in the fair value hierarchy.
In addition, total future minimum sub-lease income of £109 million at 31 December 2016 (£72 million at 31 December 2015) is expected to be received under non-cancellable sub-leases of the Group’s premises.
Liabilities in respect of securities sold under repurchase agreements 7,279 7,061
For amounts included above which are subject to repurchase agreements see note 52.
For amounts included above which are subject to repurchase agreements, see note 52.
NOTE 30: TRADING AND OTHER FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements 42,067 38,431
Trading and other financial liabilities at fair value through profit or loss 54,504 51,863
Change in liabilities charged to the income statement (note 10) (2,259) (639) (2,898) 7 (2,891)
Change in liabilities charged to the income statement (note 10) 13,636 524 14,160 (42) 14,118
NOTE 32: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued (iv) 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.
Future maintenance and investment expenses4 10% reduction 318 264 231 190
Widening of credit default spreads on corporate bonds8 0.25% addition (200) (166) (183) (151)
The total amount recognised in the balance sheet relates to: 2016 £m 2015 £m
The latest full valuations of the three main schemes were carried out as at 30 June 2014; the results have been updated to 31 December 2016 by qualified independent actuaries. The last full valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2016 by qualified independent actuaries.
Net amount recognised in the balance sheet (244) 736 2016 £m 2015 £m
Corporate and other debt securities 7,464 – 7,464 7,243 – 7,243
Money market instruments, cash, derivatives and other assets and liabilities 1,462 (1,636) (174) 525 (458) 67 1 Of the total debt instruments, £25,219 million (31 December 2015: £18,428 million) were investment grade (credit ratings equal to or better than ‘BBB’).
Past service credits and curtailments (see page 222) – – (822)
Longevity risk: The majority of the schemes obligations are to provide benefits for the life of the members so increases in life expectancy will result in an increase in the plans’ liabilities.
The sensitivity analysis (including the inflation sensitivity) does not include the impact of any change in the rate of salary increases as pensionable salaries have been frozen since 2 April 2014.
Asset-liability matching strategies The main schemes’ assets are invested in a diversified portfolio, consisting primarily of debt securities. The investment strategy is not static and will evolve to reflect the structure of liabilities within the schemes. Specific asset-liability matching strategies for each pension plan are independently determined by the responsible governance body for each scheme and in consultation with the employer.
At 31 December 2016 the asset-liability matching strategy mitigated 89 per cent of the liability sensitivity to interest rate movements and 102 per cent of the liability sensitivity to inflation movements. Much of the residual interest rate sensitivity is mitigated through holdings of corporate and other debt securities.
Other post-retirement benefit schemes The Group operates a number of schemes which provide post-retirement healthcare benefits and concessionary mortgages to certain employees, retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post-retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future insurance premiums payable.
NOTE 37: DEFERRED TAX Critical accounting estimates and judgements The largest category of deferred tax asset relates to tax losses carried forward. The recoverability of the Group’s deferred tax assets in respect of carry forward losses is based on an assessment of future levels of taxable profit expected to arise that can be offset against these losses. The Group’s expectations as to the level of future taxable profits take into account the Group’s long-term financial and strategic plans, and anticipated future tax adjusting items.
The Finance Act 2016 was enacted on 15 September 2016. The Act further reduced the corporation tax rate applicable from 1 April 2020 to 17 per cent and further restricts the amount of banks’ profits that can be offset by carried forward losses for the purposes of calculating corporation tax liabilities from 50 per cent to 25 per cent with effect from 1 April 2016.
The charge to the provision in 2016 was largely driven by a higher total volume of complaints expected as a result of the Financial Conduct Authority’s (FCA) proposed industry deadline being extended to the end of June 2019 in its consultation paper published on 2 August 2016 (CP16/20: Rules and guidance on payment protection insurance complaints: feedback on CP15/39 and further consultation). The paper also consulted on some changes to the proposed rules and guidance that should apply when firms handle PPI complaints in light of the Supreme Court’s decision in Plevin v Paragon Personal Finance Limited [2014] UKSC 61 (Plevin). In December 2016, the FCA stated that a further announcement in relation to the consultation would follow in 2017.
As at 31 December 2016, a provision of £2,258 million remained unutilised relating to reactive complaints and associated administration costs. Total cash payments were £2,200 million during the year to 31 December 2016. Spend continues to reduce following the completion of the re-review of previously handled cases (remediation).
Deferred tax assets not recognised Deferred tax assets of £92 million (2015: £140 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
NOTE 38: OTHER PROVISIONS Critical accounting estimates and judgements At 31 December 2016, the Group carried provisions of £3,597 million (2015: £4,463 million) against the cost of making redress payments to customers and the related administration costs in connection with historical regulatory breaches, principally the mis-selling of payment protection insurance (2016: £2,258 million; 2015: £3,458 million).
Sensitivities The Group estimates that it has sold approximately 16 million PPI policies since 2000. These include policies that were not mis-sold and those that have been successfully claimed upon. Since the commencement of the PPI redress programme in 2011 the Group estimates that it has contacted, settled or provided for approximately 50 per cent of the policies sold since 2000.
Key metrics and sensitivities are highlighted in the table below: Sensitivities (exclude claims where no PPI policy was held)
Customer initiated complaints since origination (m)1 3.9 1.0 0.1 = £210m
2 Actuals to date are based on the last six months to 31 December 2016. Anticipated future and sensitivities are impacted by a proportion of complaints falling under the Plevin rules and guidance.
Customer claims in relation to insurance branch business in Germany The Group continues to receive claims in Germany from customers relating to policies issued by Clerical Medical Investment Group Limited (subsequently renamed Scottish Widows Limited). The German industry-wide issue regarding notification of contractual ‘cooling off’ periods has continued to lead to an increasing number of claims in 2016. Accordingly a provision increase of £94 million was recognised in the year ended 31 December 2016 giving a total provision of £639 million; the remaining unutilised provision as at 31 December 2016 is £168 million (31 December 2015: £124 million). The validity of the claims facing the Group depends upon the facts and circumstances in respect of each claim. As a result the ultimate financial effect, which could be significantly different from the current provision, will be known only once all relevant claims have been resolved.
Tender offers and redemptions in respect of Enhanced Capital Notes – – – (3,568) – (3,568)
5.125% Undated Subordinated Step-up Notes callable 2016 – – (2) – – (2)
10.125% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 – – – – (233) (233)
10.75% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 – – – – (466) (466)
Foreign exchange and other movements 203 568 109 (42) 2,234 3,072
Issued during the year: 5.3% Subordinated Fixed Rate Notes 2045 (US$824 million) – – – – 543 543 4.582% Subordinated Fixed Rate Notes 2025 (US$1,353 million) – – – – 893 893
6.625% Undated Subordinated Step-Up Notes callable 2010 – – (5) – – (5)
5.109% Callable Fixed to Floating Rate Notes 2017 – – – – (14) (14)
Foreign exchange and other movements 39 184 51 (73) (210) (9)
Issued under employee share schemes – – 5,299,416 – – 1
The Company has entered into deeds of covenant with the Foundations under the terms of which the Company makes annual donations. The deeds of covenant in effect as at 31 December 2016 provide that such annual donations will cease in certain circumstances, including the Company providing nine years’ notice. Such notice has been given to the Lloyds TSB Foundation for Scotland.
Distributions on other equity instruments (net of tax) (321) (314) (225)
The payment of dividends by subsidiaries and the ability of members of the Group to lend money to other members of the Group may be subject to regulatory or legal restrictions, the availability of reserves and the financial and operating performance of the entity. Details of such restrictions and the methods adopted by the Group to manage the capital of its subsidiaries are provided under Capital Risk on page 161.
Dividends paid during the year were as follows: pence per share
The weighted average share price at the time that the options were exercised during 2016 was £0.67 (2015: £0.77). The weighted average remaining contractual life of options outstanding at the end of the year was 2.9 years (2015: 1.9 years).
The weighted average fair value of awards granted in the year was £0.64 (2015: £0.78).
The table below details, on an aggregated basis, key management personnel compensation: £m £m £m
Exercised/lapsed (includes entitlements of former key management personnel) (9) (7) (1)
Granted, including certain adjustments (includes entitlements of appointed key management personnel) 29 37 19
Exercised/lapsed (includes entitlements of former key management personnel) (46) (57) (22)
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other transactions between the Group and its key management personnel: 2016 £m 2015 £m 2014 £m
Repayments (includes loans of former key management personnel) (4) (2) (1)
Placed (includes deposits of appointed key management personnel) 41 58 32
Withdrawn (includes deposits of former key management personnel) (42) (61) (29)
Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. At 31 March 2016, the end of the latest FSCS scheme year for which it has published accounts, the principal balance outstanding on these loans was £15,655 million (31 March 2015: £15,797 million). Although it is anticipated that the substantial majority of this loan will be repaid from funds the FSCS receives from asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted, any shortfall will be funded by deposit-taking participants of the FSCS. The amount of future levies payable by the Group depends on a number of factors including the amounts recovered by the FSCS from asset sales, the Group’s participation in the deposit-taking market at 31 December, the level of protected deposits and the population of deposit-taking participants.
Operating lease commitments Where a Group company is the lessee the future minimum lease payments under non-cancellable premises operating leases are as follows: 2016 £m 2015 £m
Liabilities arising from non-participating investment contracts – – – – – – 20,112 20,112
Derivative financial instruments 2,686 26,781 – – – – – 29,467
Loans and advances to customers – – – – 455,175 – – 455,175
Items in course of transmission to banks – – – – – 717 – 717
Model validation covers both qualitative and quantitative elements relating to new models. In respect of new products, a product implementation review is conducted pre‑ and post‑trading. Pre‑trade testing ensures that the new model is integrated into the Group’s systems and that the profit and loss and risk reporting are consistent throughout the trade life cycle. Post‑trade testing examines the explanatory power of the implemented model, actively monitoring model parameters and comparing in‑house pricing to external sources. Independent price verification procedures cover financial instruments carried at fair value. The frequency of the review is matched to the availability of independent data, monthly being the minimum. Valuation differences in breach of established thresholds are escalated to senior management. The results from independent pricing and valuation reserves are reviewed monthly by senior management.
Bank and building society certificates of deposit – 135 – 135
Transfers out of the level 3 portfolio (177) – (177) (146) – (146)
(B) Financial liabilities, excluding derivatives Valuation hierarchy At 31 December 2016, the Group’s financial liabilities carried at fair value, excluding derivatives, comprised its trading and other financial liabilities at fair value through profit or loss and totalled £54,504 million (31 December 2015: £51,863 million). (Financial guarantees are also recognised at fair value, on initial recognition, and are classified as level 3; but the balance is not material). The table below analyses these financial liabilities by balance sheet classification and valuation methodology (level 1, 2 or 3, as described on page 247). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.
The table below analyses movements in the level 3 financial liabilities portfolio, excluding derivatives. There were no transfers into or out of level 3 during 2015 or 2016.
Gains recognised in the income statement, within other income, relating to the change in fair value of those liabilities held at 31 December 1 –
Gains (losses) recognised in the income statement within other income 220 (299) (87) (36)
Gains (losses) recognised in the income statement, within other income, relating to the change in fair value of those assets or liabilities held at 31 December 284 (262) (95) (12)
The combination of a one notch deterioration in the credit rating of derivative counterparties and a ten per cent increase in LGD increases the CVA by £64 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 £1 million of the overall CVA balance at 31 December 2016).
The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise. A one per cent rise in interest rates would lead to a £221 million fall in the overall valuation adjustment to £341 million. The CVA model used by the Group does not assume any correlation between the level of interest rates and default rates.
The Group has also recognised a Funding Valuation Adjustment to adjust for the net cost of funding uncollateralised derivative positions. This adjustment is calculated on the expected future exposure discounted at a suitable cost of funds. A ten basis points increase in the cost of funds will increase the funding valuation adjustment by approximately £32 million.
(D) Sensitivity of level 3 valuations At 31 December 2016 At 31 December 2015
Level 3 financial liabilities carried at fair value 962 724 1 Ranges are shown where appropriate and represent the highest and lowest inputs used in the level 3 valuations.
(4) Financial assets and liabilities carried at amortised cost (A) Financial assets Valuation hierarchy The table below analyses the fair values of the financial assets of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 247). Loans and receivables are mainly classified as level 3 due to significant unobservable inputs used in the valuation models. Where inputs are observable, debt securities are classified as level 1 or 2.
Loans and receivables: Loans and advances to customers: unimpaired 448,010 447,808 – – 447,808
(B) Financial liabilities Valuation hierarchy The table below analyses the fair values of the financial liabilities of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 247).
(5) Reclassifications of financial assets In 2015 the Group had reviewed its approach to managing a portfolio of government securities held as a separately identifiable component of the Group’s liquidity portfolio. Given the long-term nature of this portfolio, and reflecting the Group’s positive intent and ability to hold them until maturity in the economic environment at the time, the Group concluded that certain of these securities would be able to be held until they reached maturity and consequently, on 1 May 2015, government securities with a fair value of £19,938 million were reclassified from available-for-sale financial assets to held-to-maturity investments. During 2016, the Group has reassessed this holding of government securities classified as held-to-maturity in light of the current low interest rate environment and they have been reclassified as available-for-sale; this resulted in a credit of £1,544 million to the available-forsale revaluation reserve (£1,127 million after tax).
Loans and receivables: Loans and advances to customers1 52,184 7,253 58,090 7,763 1 The carrying value of associated liabilities excludes securitisation notes held by the Group of £26,435 million (31 December 2015: £29,303 million).
NOTE 51: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES The following information relates to financial assets and liabilities which have been offset in the balance sheet and those which have not been offset but for which the Group has enforceable master netting agreements or collateral arrangements in place with counterparties.
Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However, a significant proportion of the Group’s lending assets, for example many personal loans and mortgages, bear interest rates which are contractually fixed.
At 31 December 2016 the aggregate notional principal of interest rate swaps designated as fair value hedges was £194,416 million (2015: £121,063 million) with a net fair value asset of £725 million (2015: asset of £848 million) (note 16). The losses on the hedging instruments were £1,946 million (2015: losses of £618 million). The gains on the hedged items attributable to the hedged risk were £2,017 million (2015: gains of £511 million).
Currency risk The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 151.
Total structural foreign currency exposures, after net investment hedges 31 – 36 (8) 32 31
Loans and receivables: Loans and advances to banks, net1 26,902 – 26,902 25,117 – 25,117
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(H). Included in loans and receivables are advances which are individually determined to be impaired with a gross amount before impairment allowances of £2,870 million (31 December 2015: £4,406 million).
The table below sets out the reconciliation of the allowance for impairment losses of £2,412 million (2015: £3,033 million) shown in note 21 to the allowance for impairment losses on an underlying basis of £3,532 million (2015: £4,172 million) shown above: 2016 £m
NOTE 52: FINANCIAL RISK MANAGEMENT continued Loans and advances which are neither past due nor impaired
2 Other comprises sub-investment grade (2016: £91 million; 2015: £87 million) and not rated (2016: £72 million; 2015: £116 million).
Debt securities: Bank and building society certificates of deposit 142 – 142 186 – 186
Asset-backed securities: Corporate and other debt securities 6,030 – 6,030 5,808 – 5,808
2 Other comprises sub-investment grade (2016: £5 million; 2015: £4 million) and not rated (2016: £nil; 2015: £nil).
Trading assets: Asset-backed securities: Corporate and other debt securities 221 3 224 582 30 612
Treasury bills and other bills 20 – 20 74 – 74
Derivative assets An analysis of derivative assets is given in note 16. The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the Group’s net credit risk relating to derivative assets of £17,599 million (2015: £10,001 million), cash collateral of £6,472 million (2015: £3,228 million) was held and a further £613 million was due from OECD banks (2015: £94 million).
2 Other comprises sub-investment grade (2016: £1,830 million; 2015: £1,418 million) and not rated (2016: £271 million; 2015: £632 million).
At 31 December 2016, impaired secured commercial lending amounted to £204 million, net of an impairment allowance of £401 million (2015: £1,245 million, net of an impairment allowance of £577 million). The fair value of the collateral held in respect of impaired secured commercial lending was £1,160 million (2015: £1,367 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation. For the purposes of determining the total collateral held by the Group in respect of impaired secured commercial lending, the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any over-collateralisation and to provide a clearer representation of the Group’s exposure.
Unimpaired secured lending Unimpaired secured commercial lending amounted to £36,275 million (2015: £51,298 million).
Derivative assets, after offsetting of amounts under master netting arrangements The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the net derivative assets after offsetting of amounts under master netting arrangements of £17,599 million (2015: £10,001 million), cash collateral of £6,472 million (2015: £3,228 million) was held.
Collateral repossessed During the year, £241 million of collateral was repossessed (2015: £203 million), consisting primarily of residential property.
Repurchase transactions Deposits from banks Included in deposits from banks are deposits held as collateral for facilities granted, with a carrying value of £7,279 million (2015: £7,061 million) and a fair value of £8,395 million (2015: £6,707 million).
Loans and advances to banks 9,801 6,049 3,894 1,201 867 1,281 3,692 117 26,902
Cash and balances at central banks 58,411 2 4 – – – – – 58,417
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. In particular, amounts in respect of customer deposits are usually contractually payable on demand or at short notice. However, in practice, these deposits are not usually withdrawn on their contractual maturity.
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss 11,265 (16,924) 24,020
Net gain on sale of available-for-sale financial assets (575) (51) (131)
Accretion of discounts and amortisation of premiums and issue costs 465 339 122
Payments in respect of payment protection insurance provision (2,200) (3,091) (2,458)
Less: amounts with a maturity of three months or more (11,052) (10,640) (10,520)
Cash consideration received on losing control of group undertakings and businesses 5 972 548
The Group has undertaken an assessment to determine the potential impact of changes in classification and measurement of financial assets. The adoption of IFRS 9 is unlikely to result in significant changes to existing asset measurement bases, however, the final impact will be dependent on the facts and circumstances that exist on 1 January 2018.
IFRS 9 retains most of the existing requirements for financial liabilities. However, for financial liabilities designated at fair value through profit or loss, gains or losses attributable to changes in own credit risk may be presented in other comprehensive income. It is expected that the Group will elect to early adopt this presentation of gains and losses on financial liabilities from 1 January 2017. These gains and losses are currently recognised in profit or loss and are disclosed in note 30 to the financial statements.
PD – 12 month PD – Through-the-cycle using long run average economic and risk data to reduce sensitivity to changes in the economic cycle – Default defined as 90 days past due, except 180 days past due definition for certain mortgage portfolios secured by UK residential real estate, plus unlikeliness to pay factors
– Forward looking LGD – No floors prescribed – Discount rate is effective interest rate as defined by IFRS 9
Other employee award schemes – – – 233 233 – 233
Movement in treasury shares – – – (753) (753) – (753)
Other employee award schemes – – – 172 172 – 172
Net cash provided by (used in) operating activities (7,054) (955) (2,712)
NOTE 3: SHARE CAPITAL, SHARE PREMIUM AND OTHER EQUITY INSTRUMENTS Details of the Company’s share capital, share premium account and other equity instruments are as set out in notes 40, 41 and 44 to the consolidated financial statements.
NOTE 4: OTHER RESERVES The merger reserve comprises the premium on shares issued on 13 January 2009 under the placing and open offer and shares issued on 16 January 2009 on the acquisition of HBOS plc, offset by adjustments on the redemption of preference shares. Substantially all of the Company’s merger reserve is available for distribution.
Movements in the merger reserve were as follows: £m £m £m
Distributions on other equity instruments, net of tax (330) (314) (225)
NOTE 7: SUBORDINATED LIABILITIES These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer. Any repayments of subordinated liabilities require the consent of the Prudential Regulation Authority.
Certain subsidiary companies currently have insufficient distributable reserves to make dividend payments, however, there were no further significant restrictions on any of the Company’s subsidiaries in paying dividends or repaying loans and advances. All regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may impact those subsidiaries’ ability to make distributions.
Derecognised following completion of the Group’s ECN tender offers and redemptions (476) –
Valuation hierarchy The table below analyses the assets and liabilities of the Company. With the exception of derivatives all assets and liabilities are held at amortised cost. They are categorised into levels 1 to 3 based on the degree to which their fair value is observable. No assets or liabilities were categorised as level 1 (2015: nil).
Preliminary results and publication of Annual Report and Accounts Feb ✔ ✔ ✔
Mailing of Annual Report and Accounts, Annual Review or Performance Summary Mar ✔ ✔ ✔
2 To be published on the Group’s website by 1 July 2017 in accordance with the Capital Requirements (country analysis) Regulations 2013.
As described on page 37, the Group analyses its performance on an underlying basis. The Group also calculates a number of metrics that are used throughout the banking and insurance industries on an underlying basis as these provide management with a relevant and consistent view of these measures from period to period. A description of the Group’s alternative performance measures and their calculation is set out below.
Banking net interest margin Banking net interest income on customer and product balances in the banking businesses as a percentage of average banking gross interest-earning assets.
Gross asset quality ratio The underlying impairment charge for the period (on an annualised basis) in respect of loans and advances to customers before releases and write-backs expressed as a percentage of average loans and advances to customers.
Underlying profit Statutory profit adjusted for certain items as detailed in the Basis of Preparation.
Commercial paper Commercial paper is an unsecured promissory note issued to finance short-term credit needs. It specifies the face amount paid to investors on the maturity date. Commercial paper can be issued as an unsecured obligation of the Group or, for example when issued by the Group’s conduits, as an asset-backed obligation (in such case it is referred to as asset-backed commercial paper). Commercial paper is usually issued for periods from as little as a week up to nine months.