This publication contains the 2008 report and accounts for lloyds Banking Group plc (formerly lloyds TSB Group plc).
OUR GROUP lloyds Banking Group is a leading uK based financial services group providing a wide range of banking and financial services, primarily in the uK, to personal and corporate customers.
lloyds Banking Group was formed in January 2009 following the acquisition of HBoS and our main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. The new Group also operates an international banking business with a global footprint in 40 countries.
OuR visiOn To be recognised as the best financial services organisation in the uK by customers, colleagues and shareholders.
OuR stRAtEgy our corporate strategy supports this vision and is focused upon: Building strong customer franchises that are based on deep customer relationships
Managing our most valuable resource, our people gROup REsults suMMARy £m £m
Total income, net of insurance claims 11,089 10,882 operating expenses (5,651) (5,330)
Trading surplus 5,438 5,552 profit before tax – continuing businesses* 2,426 3,756
profit before tax – statutory 807 4,000 excluding volatility, a provision in respect of certain historic uS dollar payments, a provision for the financial Services Compensation Scheme levy, goodwill impairment and, in 2007, results of discontinued businesses, profit on sale of businesses and the settlement of overdraft claims.
We believe that the HBoS transaction will prove to be very successful for our shareholders and our other stakeholders as well. lloyds Banking Group is now the largest financial services franchise in the uK with a range of leading market positions in important product lines, such as savings, current accounts, mortgages, insurance and long-term savings. We are also a leading player in the Small and Medium enterprise (SMe) and wholesale banking sectors. The Group clearly has a very significant retail banking footprint and, with approximately 3,000 branches, is present in more uK locations than any other financial institution. We will also have the benefit of substantial synergies.
There is no doubt that the immediate outlook is challenging as indeed it is for most other banks in the uK and overseas. lloyds TSB’s trading performance in 2008 was by no means immune from the continued turbulence in the global financial markets which contributed to the decline in profit before tax to £807 million. HBoS was adversely affected by the challenging market conditions, a sharp decline in asset values and the dramatic contraction in the wholesale markets. Taking all these factors together, HBoS recorded a loss of £10.8 billion. Against this backdrop, it is unsurprising that questions have been asked about the HBoS transaction. i think it is important to remember, as i have already mentioned, that we purchased HBoS when the economic downturn was already well underway. in short, the opportunity to acquire HBoS only came about in the middle of great economic adversity and in conditions which are unlikely to be repeated.
2008 was also, of course, the year when lloyds TSB announced it was acquiring HBoS plc; the transaction was subsequently completed on 16 January 2009. it is this transaction to which i will now devote most of my attention in this review. i will also cover a number of other important issues, however, which i know shareholders would like me to discuss. They include the state sponsored banking recapitalisation last autumn and more recent significant Government measures, our dividend policy, our obligations to society, our corporate governance and the outlook for your company.
Annual report and Accounts 2008 dividEnd As part of the HM Treasury recapitalisation scheme, the Group was required to suspend the payment of cash dividends to ordinary shareholders until the HM Treasury preference shares issued as part of the scheme are repaid. in the meantime, however, as we indicated in our shareholder circular last year, the board has approved a capitalisation issue of one for 40 ordinary shares held.
We know the short-term outlook for the enlarged Group is challenging. Whenever economic conditions do begin to normalise, however, we believe your company will be in a very strong position to reap the benefits. our strong franchise across the whole range of product lines will enable us to do just that. in the meantime, our imperative is to manage your business as effectively as possible on your behalf during these challenging times. i believe we have the right people to do so.
one of the most important ways in which leading businesses differentiate themselves from their peers is through the quality of their people. i have no doubt that we at lloyds Banking Group are very fortunate in having many of the best people in our industry working for us. The last 12 months, however, have been exceptionally difficult for many of our customers and colleagues alike. The unprecedented levels of market turbulence have meant that my colleagues have spent a great deal of time helping customers to understand what is happening and providing them with the necessary reassurance. The job that our colleagues do for our customers is very valuable and highly valued by us. i would therefore like to take this opportunity to thank them on our behalf for their outstanding contribution in 2008.
Shareholder information 191 index to annual report 192 financial calendar 2009 195
The opportunity to acquire HBoS was considered against our other strategic options, and before deciding to proceed the board considered a number of alternatives which included continuing with our existing organic growth strategy, acquiring parts of HBoS and alternate acquisitions. After a thorough review, the board decided that the HBoS acquisition would offer the highest value-creating strategy for our shareholders and we announced the transaction on 18 September 2008.
We are acquiring £17.9 billion of tangible net asset value with consideration valued at £7.7 billion, even taking into account the losses HBoS announced for 2008. All in, we have acquired a franchise that brings extensive distribution, a large customer base, good people and excellent brands. HBoS had developed a number of specialist businesses that brought greater returns at greater risk, and these did not fit the lloyds TSB risk appetite. We recognised this in our due diligence and this was reflected in the price we agreed to pay. We are buying the business in the down part of the economic cycle, at a significant discount to book value, which increases the likelihood of value creation, and we paid in shares rather than cash which in some part insulated the lloyds TSB shareholders from market risk.
The combination of the two businesses provides a strong platform for us to pursue our customer focused growth strategy, built around acquiring relationships and then deepening them. The scale we have now achieved will also allow us to be more efficient and to better leverage future investments.
Whilst it is still relatively early days in terms of the transaction, we have made considerable progress, with the senior 500 executives being appointed to run the new Group and we will quickly integrate the businesses. We are identifying those businesses that are priorities for future investment, those
over the past five years, i have reported on our progress towards the aspiration of building the uK’s best bank and our approach to developing deep, long-lasting customer relationships. Banking is fundamentally a risk business, and early on we took the decision to manage risk on a ‘through the cycle’ basis. This means the business will be less impacted by the extreme points in the cycle and that we can continue to support our customers through the changes in the economic climate. As a result, our rate of growth in earnings in prior periods did not always match those of our competitors but the quality of our earnings has been demonstrated in this past year.
in evaluating the HBoS portfolios last year, we had taken a more conservative forecast than the HBoS internal estimates, recognising they were subject to greater volatility in an economic downturn. once we took control of HBoS in January, we analysed the portfolios in granular detail, updated our diligence and have begun to apply the lloyds TSB operating model across the enlarged business. As we began to apply our more conservative provisioning methodologies to their portfolios, and took account of the economic deterioration in the final quarter of the year, the expected losses in that final quarter increased and were finally set at a level £1.6 billion higher than our initial estimate of £8 billion. Whilst this figure is higher than our earlier estimates, it does reflect the size and nature of the HBoS portfolios and the scale of the change in the economic environment.
thE llOyds tsB gROup pERfORMAncE in 2008 let me now reflect on the performance of the lloyds TSB Group in 2008. Whilst all the headlines this past year have been about the economy, the financial crisis and, for us, the HBoS transaction, it is easy to overlook the fact that the Group and our businesses have performed satisfactorily, delivering positive earnings despite the most difficult operating environment in many years.
i would have liked to have delivered an even stronger performance for our shareholders, but in the context of the environment and when many organisations will be reporting losses, i do feel this is a reasonable out-turn. We again used the year well, strengthening the overall business franchise, with an improvement in efficiency, increases in market share, higher customer advocacy scores and we also added to the depth and experience of the management team. our focus on developing strong franchises continues to offer a strong and sustainable platform for our future growth.
in building our business model, over this period, we have used a balanced scorecard approach throughout the organisation to measure our progress. The balanced scorecard contains five sections: financial performance, franchise growth, customer satisfaction, risk management and people development. As a result of managing each section of the scorecard assiduously, and focusing on a balanced approach to growth, your company was well positioned as the financial crisis struck the industry.
suppORting OuR custOMERs There has been considerable comment about the performance of the financial services sector this last year and, in particular, support for customers seeking mortgages and the owners of small businesses. i am very proud of the way your company has maintained its support to customers, in line with our relationship-based strategy. using Bank of england data for the year to December 2008, our lending to individuals grew by 10.7 per cent against the industry average of 5.4 per cent, whilst our lending to private non-financial corporates grew by 22.2 per cent against the industry average of 3.7 per cent. The commitment to our customers is critical to our business strategy, and will continue to be so in 2009.
suMMARy our key businesses have continued to grow, attracting new customers, improving the service to our customers and building our market share. As the crisis continued to impact the uK banking industry, we acquired HBoS in a deal that brought greater stability to the uK banking system and which has allowed lloyds TSB to rapidly advance its strategic priorities.
THe GloBAl fiNANCiAl CriSiS THAT HAS rAGeD oVer THe lAST 18 MoNTHS HAS leD To THe DeMiSe of MANY fiNANCiAl SerViCeS CoMpANieS ArouND THe WorlD. hOw hAs thE cRisis AffEctEd thE gROup?
Clearly the last 18 months have seen unprecedented change for the worldwide financial services sector and the uK sector has been no different. Within the uK we have seen the nationalisation of Northern rock, the acquisition of Alliance & leicester, the break up of Bradford & Bingley and the recapitalisation of the uK banking sector.
The unprecedented turmoil in the global financial markets has also had a significant impact on bank share prices, many of which have fallen considerably. it is not easy to offer simple explanations as to why the stock market has marked down bank share prices to such a degree in recent months but clearly there are a number of factors at play including the current view of, and future projections for, the uK economy and its impact on future asset write downs and impairments. it is also undoubtedly the case that there is currently a great deal of nervousness in the markets which is reflected in volatile bank share prices.
it is important to note that the board believes that HM Treasury will act as a value-oriented shareholder with regard to the strategic development of the Group and the Government has stressed the importance of institutional and individual investors as well as HM Treasury.
lEnding We have a commitment to maintain the availability and active marketing of competitively priced mortgage lending and lending to Small and Medium enterprises (SMes) but do not expect any impact on our lending policies or on our conduct of business. As a major lender in the uK economy focused on developing enduring relationships with our customers, we recognise that our success is based on a commitment to helping our customers throughout the economic cycle. We are able to do this because we have a robust capital position.
cORpORAtE gOvERnAncE The Government are also keen to see an enlarged board and we are appointing two new independent non-executive directors, in consultation with HM Treasury (see page 66). it is important to note that the new directors will have precisely the same role and responsibilities as any other director on the board.
iSSue: Risk MAnAgEMEnt lloYDS TSB HAS TrADiTioNAllY BeeN perCeiVeD AS HAViNG A CoNSerVATiVe riSK profile. dOEs thE hBOs AcquisitiOn signAl Any chAngE in thE gROup’s Risk AppEtitE?
our conservative approach to managing the Group’s risk has meant that we remain well positioned to capture growth opportunities at a time when others have pulled back from the market. As a result, we have been able to capture market share in a number of key areas without impacting the overall quality of business.
THE ECONOMY AND OUR MARKETS Coming into 2008, the uK economy had enjoyed 60 consecutive quarters of sustained expansion. inflation remained very low during that time, helped by globalisation and the emergence of low cost economies as suppliers to the developed world.
The slowdown during the second half of 2008 means that the economy is now technically in recession (defined as a period of at least two consecutive quarters of negative growth). 2009 is likely to see that recession deepen. Views on 2009 economic prospects have also changed radically during the last year. At the start of 2008, the consensus forecast was that the uK economy would grow by 2 per cent in 2009. By early 2009, the consensus was for a fall of more than 2 per cent.
Against such an economic environment, we expect growth in our main markets to slow further during 2009, again driven by a mixture of demand and supply factors. Net mortgage lending may well turn negative in 2009 as house prices continue to fall. unsecured lending will slow further as consumer spending on non-essentials is reduced. Savings growth will also be slow as pressures on household finances offset a desire to save more in an uncertain environment. Growth in commercial and corporate lending is expected to weaken as companies reduce investment spending further, and corporate deposit growth will remain weak. Given weak deposit growth by both households and firms, banks in aggregate will continue to rely on wholesale markets to fund net new lending. The likely continued high cost of wholesale funding, relative to base rates, will constrain banks’ ability to support the economy through credit growth.
A resilient business performance. Profit before tax, on a continuing businesses basis, totalled £2,426 million, a decrease of 35 per cent which reflected the impact of £1,270 million of market dislocation and higher impairment levels.
Before impact of market dislocation and excluding volatility, a provision in respect of certain historic US dollar payments, a provision for the Financial Services Compensation Scheme levy and Goodwilll impairment. Also excludes central group items.
To enable meaningful comparisons to be made with 2007, the income statement commentaries below are on a continuing businesses basis (see ‘Presentation of information’ on contents page).
The Group continues to maintain a strong funding and liquidity profile and has continued to obtain funding at market leading rates, with the overall margin impact of funding the Group’s balance sheet remaining broadly unchanged. The Group has benefited from improvements in a number of individual product margins, particularly in new mortgages and corporate lending, however the lower interest rate environment in the second half of the year has led to increased pressure on deposit spreads.
Profit before tax, excluding the impact of market dislocation, decreased by £340 million, or eight per cent, to £3,696 million, as good relationship banking and insurance business momentum was offset by a significant increase in levels of impairment. On this basis and adjusting for insurance grossing, revenue growth of eight per cent exceeded cost growth of five per cent.
The Group’s relationship focused business model means our Corporate Markets business has limited exposure to assets affected by current capital markets uncertainties. During 2008 the Group has successfully taken steps to reduce and restructure these exposures and the related risk and it is anticipated that this process will continue in 2009.
A large proportion of the investments held by the Group’s insurance business are invested in assets which are expected to be held on a long-term basis and which are inherently subject to short-term investment market fluctuations. Whilst it is expected that those investments will provide enhanced returns over the longer term, the single year impact of investment market volatility can be significant. In 2008, a decline in equity and property markets and a widening of credit spreads in fixed income markets contributed to adverse volatility of £746 million, after adjusting for the effect of illiquidity premia within the annuity business. This principally reflects a reduction in the market consistent valuation of the annuity portfolio, driven by the continued widening of corporate bond spreads in 2008, and lower expected future shareholder income from contracts where the underlying policyholder investments are in equities.
At the end of December 2008, the Group’s capital ratios remained robust with a total capital ratio on a Basel II basis of 11.2 per cent, a tier 1 ratio of 8.0 per cent and a core tier 1 ratio of 5.6 per cent. In September 2008, the Group completed the placing of 284.4 million ordinary shares at a price of 270 pence per share, raising approximately £760 million. Over the last 12 months, risk-weighted assets increased by 20 per cent to £170 billion, reflecting the growth in our Corporate Markets and mortgage businesses, as well as the impact of exchange rate movements which represented 8 percentage points of the increase.
Scottish Widows remains strongly capitalised and, at the end of December 2008, the working capital ratio of the Scottish Widows Long Term Fund was an estimated 21.6 per cent. During 2008 a regular dividend of £0.2 billion was paid to the Group, bringing the total capital repatriation since the beginning of 2005 to over £3.8 billion. As at 31 December 2008, the estimated Insurance Groups Directive (IGD) capital surplus was £0.8 billion, with additional surplus within the Long Term fund totalling an estimated £1.5 billion. This IGD surplus would be unchanged in the event of a 40 per cent reduction in equity markets from the 31 December 2008 position.
The current turbulence in global capital markets has been a severe examination of the banking system’s capacity to absorb sudden significant changes in the funding and liquidity environment, and individual institutions have faced varying, but significant, degrees of stress. Throughout this period, the Group has maintained a strong liquidity position which is supported by our strong and stable retail and corporate deposit base. Both retail and corporate deposit inflows have been robust and the Group continues to benefit from its diversity of funding sources. The Group’s wholesale funding base has proved to be resilient, supporting the Group’s balance sheet growth with an increased level of longer term funding (greater than one year).
Following the completion of the acquisition and the capital raisings in January 2009, the proforma adjusted capital ratios for Lloyds Banking Group, at 31 December 2008, were 6.4 per cent for core tier 1, 9.8 per cent for tier 1 capital and 12.5 per cent for total capital. The proforma adjusted net tangible asset value of the enlarged Group totalled an estimated £29.5 billion, equivalent to 179p per share.
UK Insurance and Central excluding Retail and International group insurance Insurance banking Investments** banking items gross up gross up ** Group 2008 £m £m £m £m £m £m £m
In the year ended 31 December 2008, the contribution from central group items was a negative £552 million compared to a negative contribution of £12 million in 2007. The result in 2008 has been significantly affected by the impact of yield curve volatility on the fair value of derivatives entered into for risk management purposes, after taking into account the effect of hedge accounting adjustments. In addition, there were increased central costs that were not recharged to the divisions in connection with professional advice received during the year and an impairment charge in respect of an available-for-sale investment.
Profit on sale of businesses – 272 385 – 657 – 657
excellent market share of net new mortgage lending, at 27.5 per cent. Mortgage balances outstanding increased by 11 per cent to £112.9 billion.
Strong trading surplus performance, up 11 per cent to £3,265 million.
OUR bUSinESS During 2008, UK Retail Banking provided a wide range of banking and financial services through our diversified, proprietary distribution network and highly recognised and well-regarded brands (Lloyds TSB, Cheltenham & Gloucester and Scottish Widows) to some 16 million personal customers through over 1,950 branches across the UK. At the end of 2008 Lloyds TSB had the UK’s largest personal current account base with over 12 million current account customers, had the largest number of internet banking customers in the UK and operated 11 call centres, all in the UK, taking over 70 million calls per year. In 2008 Lloyds TSB was voted by Reader’s Digest the most trusted bank in Britain for the eighth year running.
Following the acquisition of HBOS, the new ‘Retail’ division now includes the HBOS branch operations and is the largest retail bank in the UK. The Group is now the UK’s leading provider of current accounts, savings, personal loans, credit cards and mortgages and has the largest branch network in the UK, with approximately 3,000 branches, and one of the largest fee free ATM networks in the UK with around 6,800 cash machines.
The new ‘Retail’ division has approximately 30 million customers. In addition to being the largest provider of current accounts in the UK with approximately 22 million current account customers, we are also the largest provider of social banking providing over four million basic bank or social banking accounts in the UK.
A major focus in the implementation of this strategy will be upon ‘putting the relationship back into banking’. We will, through deeper customer insight, offer customers first class products backed by an effective and efficient service as well as strengthening our relationships which, in turn, will generate new sales. This is backed by our extensive multi channel distribution network providing our customers with a wide range of choice and added convenience. We will drive down operating costs by improving efficiency in our processes and effectively managing risk across the bank.
The integration of HBOS will give us additional opportunities to provide products and services to all of our customers whilst carefully managing risk and delivering cost synergies.
The retail bank has continued to make good progress, delivering strong product sales growth and revenue momentum, notwithstanding the challenging UK economic environment. Overall sales increased by seven per cent, with improvements over a broad range of products and through our wide variety of distribution channels. Both the internet and telephone banking channels performed strongly with sales growth of 29 per cent and 19 per cent respectively. Our continued good sales growth has been driven by strong sales of personal loans, bank savings and wealth management products. Our market share of new business in these key product areas has continued to increase, as the retail bank has successfully leveraged the benefit of the Group’s strong brand and balance sheet to support increasing customer sales.
Over the last 12 months, the Group has made significant progress in building its mortgage business, in a mortgage market that has slowed considerably. The Group continues to focus on those segments of the prime mortgage market where value can be created whilst taking a conservative approach to credit risk. The Group continues to manage for value, targeting growth in profitable new business rather than overall market share. This approach, together with a recent uplift in interest spreads, has led to new business net interest margins strengthening over the last 12 months.
Wealth management continues to make good progress with its expansion plans to deliver an enhanced wealth management offer comprising private banking, open architecture portfolio management, retirement planning, insurance and estate planning services. New funds under management increased by 22 per cent, investment portfolio cases grew by 16 per cent and wealth management banking deposits increased by 20 per cent. During a period when the FTSE 100 index fell by 31 per cent, investment portfolio funds under management decreased by 11 per cent and this led to an overall reduction of three per cent in total customer assets.
Telephone banking has continued to improve the quality of the service which it provides to customers, allowing us to focus on better meeting the needs of our customers whilst also improving efficiency.
Impairment losses on loans and advances were 20 per cent higher at £1,472 million, particularly reflecting the impact of lower house values on the mortgage impairment charge. The impairment charge as a percentage of average lending was higher at 1.22 per cent, compared to 1.10 per cent in 2007. Over 99 per cent of new personal loans and 90 per cent of new credit cards sold during 2008 were to existing customers. The level of arrears in the credit card and personal loan portfolios increased by 26 per cent and 15 per cent respectively reflecting the impact of the slowdown in the UK economic environment.
In terms of unsecured lending, our arrears performance remains satisfactory. However, in the context of the uncertain UK economic environment and the potential for increased consumer arrears and insolvencies, we are continuing to enhance our underwriting, collections and fraud prevention procedures. We currently expect retail impairment levels to rise significantly in 2009, largely reflecting the expected increase in unemployment levels in the UK and the impact of further house price falls.
Robust sales performance, in a challenging market environment resulting in an increase in estimated market share. Scottish Widows’ bancassurance sales increased by four per cent, whilst sales through the Independent Financial Adviser (IFA) distribution channel decreased by eight per cent.
Continued high returns. On a European Embedded Value (EEV) basis, the post-tax return on embedded value remained high at 11.4 per cent. New business margins remained resilient at 2.9 per cent.
Strong profit performance in General Insurance. Profits more than doubled in 2008 reflecting the absence of the severe weather related claims experienced in 2007, good increases in home insurance income and more efficient claims processing.
The Scottish Widows brand was the main brand for new sales of Lloyds TSB Group’s life, pension, Open Ended Investment Companies (OEICs) and other long-term savings products in 2008. Scottish Widows was voted Best Individual Pensions Provider by IFAs and was voted the most trusted choice for pensions amongst UK consumers in 2008.
Scottish Widows Investment Partnership (SWIP) managed funds for Lloyds TSB Group’s retail life, pensions, and investment products. Other key clients covered both the retail and institutional segments, with SWIP occupying a top three position in terms of Retail funds under management. Retail and Institutional SWIP had £83 billion of funds under management at the end of 2008.
Within the life assurance operations this will be achieved by developing strong and enduring relationships, developing market-led propositions and being easy to do business with. Scottish Widows’ products are distributed through the Lloyds TSB channels, independent financial advisers and other intermediaries, whilst Clerical Medical products are distributed through the HBOS channels, independent financial advisers and other intermediaries.
Profit before tax, excluding volatility, increased by £38 million, or six per cent, to £635 million.
During 2008, Scottish Widows has continued to make good progress in its key business priorities: to maximise bancassurance success; to profitably grow IFA sales; to improve service and operational efficiency; and to optimise capital management.
Sales through the IFA distribution channel decreased by eight per cent, reflecting the general contraction in sales in the IFA market. Scottish Widows’ participation in the IFA market remains focused on achieving financial returns which meet the Company’s internal targets. Sales performance was strong in corporate pensions where an increase in volumes of 19 per cent was achieved whilst maintaining satisfactory margins and returns. Within individual pensions, sales of the Retirement Account, a capital efficient product with a more transparent charging structure, increased by 75 per cent benefiting from product enhancements introduced during the year. Sales of investment bonds reduced by 56 per cent, partly driven by changes in Capital Gains Tax regulations, but also reflecting the Company’s unwillingness to participate in markets which do not generate an economic return.
Adjusting for the impact of capital repatriation to Group, EEV profit before tax from the Group’s life, pensions and OEICs business increased by three per cent to £818 million in challenging market conditions.
New business profit fell by £31 million, or 10 per cent, to £295 million and the overall new business margin reduced to 2.9 per cent, from 3.1 per cent last year, primarily reflecting higher commission payable on OEIC products. In difficult trading conditions, life and pensions new business profit remained satisfactory with a continued focus on improving product profitability resulting in the new business margin increasing to 3.6 per cent (page 27).
Overall the post-tax return on embedded value increased to 11.4 per cent.
The following table highlights the movement in retail and institutional funds under management.
Managed by third parties 4.9 5.1 closing funds under management 87.9 102.7
DIVISIONAL RESULTS continued INSURANCE AND INVESTMENTS continued european eMbedded value reporting – reSultS for year ended 31 deceMber 2008
This section provides further details of the Scottish Widows EEV financial information.
Shareholders’ net assets 2,809 2,878 total eev of covered business 4,932 5,365
RECONCILIATION OF OPENING EEV BALANCE ShEET TO CLOSING EEV BALANCE ShEET ON COVERED BUSINESS
Shareholders’ net assets value of in-force business total £m £m £m
ANALySIS OF ShAREhOLDERS’ NET ASSETS ON AN EEV BASIS ON COVERED BUSINESS
Impact of corporation tax rate change – 122 total (loss) profit after tax – continuing businesses (213) 682
BREAKDOWN OF INCOME STATEMENT BETWEEN LIFE AND PENSIONS, AND OEICs – CONTINUING BUSINESSES
For OEIC business, recent lapse assumption experience has been collected over a period that has predominantly coincided with favourable investment conditions. Management have used a best estimate of the long-term lapse assumption which is higher than indicated by this experience. In management’s view, the approach and lapse assumption are both reasonable.
An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. however, in the case of operational risk and the With Profit Fund these are asymmetric in the range of potential outcomes for which an explicit allowance is made.
This sensitivity shows the impact of a 25 basis point increase in corporate bond yields and the corresponding reduction in market values. Government bond yields, the risk-free rate and illiquidity premia are all assumed to be unchanged.
Claims paid on insurance contracts (net of reinsurance) (193) (302) 36 operating income, net of claims 395 264 50
General Insurance continues to make good progress against its key strategic initiatives: groWing Share in our choSen cuStoMer SegMentS
Growth in total home insurance sales developed good momentum during 2008, with sales through the branch network increasing by nine per cent, supported by a positive customer reaction to our 5 Star Defaqto Rated home insurance product and strong claims service proposition.
General Insurance continues to invest in the development of its Corporate Partnership distribution arrangements. New partnerships with Resolution Life, Reader’s Digest, Budget and Post Office Financial Services are expected to underpin further profit delivery over future years.
Investment in our claims processes continues to deliver improved service and efficiency, with a reduction in property claims ratios and recognition of our customer service teams at the European Call Centre Awards.
An ongoing review of our advertising expenditure and the introduction of further improvements to the targeting of promotional activity have led to further efficiencies, and the cost per product sale improving by 13 per cent.
We have also continued to focus on making our key processes easier for our customers to use. For the second year in succession our website www.lloydstsbinsurance.co.uk has been ranked as the best home insurance website by worldwide benchmarking organisation, Global Reviews. In addition, in October 2008 Defaqto recognised LloydsTSBCompare.com as the best car insurance price comparison site.
our risk management remains strong with satisfactory asset quality, despite a rise of £936 million in impairment losses, largely as a result of the £253 million year-on-year impact of market dislocation, a number of high profile financial services company collapses and an increase in the level of impairments reflecting the economic slowdown in the UK.
Our business During 2008, our businesses within the Wholesale and International Banking arena covered a broad scope, serving thousands of customers, ranging from start-ups and small enterprises to large organisations and global corporations.
aWardS for coMMercial Lloyds TSB (Commercial) won two awards in the 2008 National Association of Commercial Finance Brokers Awards, scooping Business Bank of the year and Commercial Mortgage Provider of the year. The winners were nominated by NACFB members in its annual survey. (December 2008)
The acquisition of the hBOS corporate and commercial customer base provides the new ‘Wholesale’ division with a significant and exciting opportunity to accelerate our relationship-led wholesale banking strategy.
Our strategic vision is to be recognised as the UK’s leading, ‘through the cycle’, wholesale bank. As a relationship bank, we place our customers at the forefront of this vision and we strive to understand and meet their needs whilst maintaining satisfactory asset quality.
The charge for impairment losses was £936 million higher at £1,508 million, as a result of an increase of £253 million in the impact of market dislocation, and a significant increase in the level of impairments reflecting the economic slowdown in the UK and the impact of a number of high profile financial services company collapses. Despite this increase in the impairment charge, we believe that we remain relatively well positioned to withstand the economic slowdown as a result of our prudent credit management policy over the last few years.
In Corporate Markets, profit before tax fell by £998 million, compared to last year, reflecting a combination of the impact of market dislocation and a substantial increase in impairment charge. Excluding the impact of market dislocation, profit before tax decreased by £8 million. On this basis, income increased by 34 per cent, supported by strong growth in corporate lending and an 85 per cent increase in cross-selling income. This growth in cross-selling income has continued to be supported by the Group’s ability to leverage its strong funding capabilities and obtain funding at market leading rates, which has enabled the Corporate Markets business to continue to grow during a difficult 2008. Throughout this period, Corporate Markets has continued to invest in building its product capabilities and has been fulfilling substantially increased customer demand for interest rate and currency derivative products. This has enabled the business to further deepen its customer relationships, with Corporate Banking the only UK bank lender to have a positive net promoter score (TNS survey) as well as being awarded with ‘Real Finance/CBI FDs’ Excellence Awards – Corporate Bank of the year’ for the fourth year running.
The Group’s high quality business model means that it has relatively limited exposure to assets affected by current capital markets uncertainties. The following table shows credit market positions in Corporate Markets, on both a gross and net basis.
Gross exposure £m £m £m £m £m available-for-sale assets loans and advances
£2,265 million exposure was reclassified to loans and advances on 1 July 2008 in accordance with amendment to IAS 39.
Profit before tax in Commercial Banking fell by £15 million, or three per cent, as strong growth in business volumes, growth in the Commercial Banking customer franchise and further improvements in operational efficiency and effectiveness, were more than offset by an £89 million increase in the impairment charge, primarily reflecting the impact of recent deterioration in the UK economy. Income increased by seven per cent to £1,431 million, reflecting disciplined growth in lending and deposit balances, and an increased focus on the more valuable higher turnover customer relationships which have substantially greater product needs. During 2008, Commercial Banking has continued to extend lending support throughout its customer franchise and, as a result, the Group’s lending to SME customers increased by 20 per cent to £20.5 billion. Over the last 12 months, the Group has increased its market share of high value customers in the £0.5 to £2 million turnover range by 2 percentage points to 18 per cent, as a result of continuing to make good progress in attracting customers ‘switching’ from other financial services providers.
Financial calendar 2009 195 minorities’ share of the profits earned by investment vehicles which are not wholly owned by the long-term assurance funds.
During 2008, profit before tax included negative policyholder interests volatility of £471 million, being a charge to other income (2007: negative volatility of £222 million, being a charge to other income). In 2008, substantial policyholder tax losses have been generated as a result of a fall in property, bond and equity values. These losses reduce future policyholder tax liabilities and have led to a policyholder tax credit during the year.
The board reviews overall corporate responsibility performance annually and the chairman receives a quarterly progress report. Individual issues are subject to board consideration throughout the year. The chairman has board-level responsibility for corporate responsibility. Our corporate responsibility steering group is chaired by the Group human resources director and comprises senior executives from all business divisions and relevant Group functions. The steering group meets quarterly to recommend strategy and provide direction.
Supporting buSineSS Strategy Lloyds Banking Group’s strategy focuses on building deep, long-lasting relationships with our customers in order to deliver high quality, sustainable results over time. We believe that corporate responsibility, built around the creation of colleague motivation, customer satisfaction and brand loyalty, has a major part to play in supporting our business strategy.
Against the backdrop of unprecedented market turbulence, our reputation for effective risk management is widely recognised. In 2008, Lloyds TSB was rated the sixth safest bank in the world by Global Finance and awarded the Reader’s Digest readers’ most trusted UK bank or building society for the eighth year running. Our commitment to corporate responsibility helps promote trust in the brand and reinforces customer loyalty and advocacy.
Our approach to embedding corporate responsibilty management over recent years has, we believe, helped us achieve competitive advantage.
We have also been at the forefront of developing alternative forms of financial provision and support for those communities where mainstream financial services have traditionally been considered inappropriate or inaccessible. We have one of the largest UK high street networks and, through our partnership with the Post Office, our personal customers can access their banking through more than 12,500 local post offices.
Continuing to grow a successful business is the best way for Lloyds Banking Group to create value for all its stakeholders. As a major employer, finance provider and purchaser of goods and services we are an important contributor to both national and local economies.
In addition to our financial contribution, we recognise that it is in our long-term interest to help improve the social and commercial fabric of local communities where we operate. That is why we have one of the largest community investment programmes in the UK.
Through their shareholding in Lloyds Banking Group, the Lloyds TSB Foundations together received £37.1 million to support their work in 2008, bringing the total contributions since 1997 to over £360 million, making Lloyds Banking Group one of the largest charitable donors in the UK.
Our new Charity of the Year is the British Heart Foundation, the overwhelming choice among the thousands of staff who voted to choose their charity of the year. Recognising the value of longer-term relationships, we have extended our partnership with the British Heart Foundation to two years. We aim to raise at least £2 million to fund the appointment of 15 specialist heart nurses across the UK.
Lloyds Banking Group has a long-standing commitment to managing its environmental impacts. We first introduced an environmental policy in 1996 and followed this with an environmental management system that follows the ISO 14001 standard. We were also one of the first UK banks to develop an environmental risk assessment system for all our business lending. In 2007, we adopted the Equator Principles for project finance, a financial sector initiative aimed at improving the social and environmental impacts of major projects such as road building and power stations.
We want to inspire Lloyds Banking Group colleagues to rise to the challenge of tackling climate change. We have put in place a structured communication programme including dedicated intranet site, regular staff magazine and news features, competitions and seminars. In 2008, we established a Group-wide sustainability network for colleagues at all levels to meet, share experiences and ideas and to help fulfil our commitment to reducing our environmental impact. Our staff have responded enthusiastically to our carbon reduction plans and are keen to help with their delivery.
Examples of initiatives we have taken include: – leading the development of the smallbusinessjourney.com website to provide advice and guidance to small businesses on how they can reduce their environmental impact; – provided guidance to vehicle fleet operators through Lloyds TSB Autolease to help them structure their fleet selection policies to promote more fuel-efficient vehicles; and,
– created an on-line guide to help customers taking out a car loan to select a model with lower CO
emissions from energy consumption and travel. In addition, they introduced new guidelines for the treatment of ‘renewable energy’ in calculating total CO
emissions reported above have been calculated using the old conversion factors to provide a more accurate like-for-like comparison against the baseline. Using the new guidelines, our total emissions for 2008 would increase to 245,385 tonnes. In 2009, a priority for Lloyds Banking Group will be to baseline our environmental impacts across the combined Group.
The engagement index is based on the result of a survey conducted quarterly, asking Lloyds TSB colleagues a series of questions which reflect both the drivers and outcome of engagement. The data captures the percentage of total responses received which were favourable for each question, combined into a simple average overall score. (See chart on page 11).
For 2008 bonus awards, we have worked with the UKFI, (the body responsible for the government’s shareholdings in UK banks) to undertake a review of our bonus arrangements. We are also undertaking an ongoing review for 2009.
A range of delivery media is used including highly successful on-line modules and face-to-face workshops to support skills development. In 2008 the university website, which is accessible from both the corporate intranet and Internet, received over 4.2 million visits (33 per cent increase on 2007) and over 780,000 on-line assessments were completed. The learning environment in our Group Learning Centre has also been upgraded to further enhance our ability to meet the changing development needs of our leaders and managers. We now deliver an average of 2.9 days formal learning per full time equivalent (FTE), an increase of 26 per cent on 2007.
The Group invests in a range of internal media, ensuring our colleagues are informed and involved. These include a company intranet, print publications, e-zines, audio and video. We have also recently introduced group-wide, monthly face-to-face communication briefings to all colleagues through their line managers.
Over the last few years, we have been working to increase the number of women in management and senior management positions across the organisation. At the end of 2008, our group executive committee had one of the highest proportion of women for a FTSE 100 company, and 23.4 per cent of our senior managers were women.
We continue to make significant progress with our disability and sexual orientation programmes. Our disability programme has been ranked first out of 116 organisations by the Employers’ Forum on Disability and we maintained our sixth place ranking in Stonewall’s† Index of the 100 best employers of lesbian, gay and bisexual people.
During October 2008, as part of the co-ordinated package of capital and funding measures for the UK banking sector, implemented by HM Treasury, the Group participated in the Government Funding Package and thereby facilitated access to the UK Government backed provision of liquidity.
During the market dislocation there has been even more rigorous focus on the governance, accountabilities and execution capabilities to ensure adherence to an even lower risk profile. It is part of the Lloyds TSB approach to learn from adverse situations – regardless of whether there has been any direct business impact. Accordingly, ‘lessons learned’ exercises form part of normal activity and have been carried out during this turbulent period. The Lloyds TSB risk culture has manifested itself in some clear and critical pre crunch wholesale and capital markets policy actions that served to limit exposure.
The Group has developed its credit, liquidity and market risk control frameworks. Particular focus has been placed on the control of credit spread risk, associated stress testing and modelling. The Group during the year has further strengthened its oversight of liquidity, funding, capital and asset liability management issues with the upgrading of membership of the group asset and liability committee. Membership consists of group executive committee members and the treasurer, and it is chaired by the chief executive. A senior asset and liability committee has been created to support the group asset and liability committee. There have also been a number of further developments to our liquidity control frameworks that have been instituted including further developments of stress testing. During the height of the crisis, daily meetings with the group chief executive were held to assess the Group’s position which has held up well during the worst aspects of the market dislocation.
Supporting the chief risk officer, the risk forum consists of the divisional risk officers and the group risk directors. The risk forum regularly reviews a summary of risks across the risk management spectrum to determine areas of focus for remedial action across the Group.
1st line of defence Business Management 3rd line of defence Group Audit
BU Risk BU Risk BU Risk BU Risk BU Risk BU Risk
Business risk management forms part of a tiered risk management model, as shown on page 44, with the divisional risk officers and group risk providing oversight and challenge, as described above, and the chief risk officer and group committees establishing the group-wide perspective.
The framework is dynamic and allows for proportionate adjustment of policies and controls where business strategy and risk appetite is amended in response to changes in market conditions.
The more detailed description of the risk principles and distribution of the risk appetite measures amongst the divisions and businesses are determined by the group chief executive, in consultation with the group business risk committee and the group asset and liability committee.
Credit risk: arising in the Retail and Wholesale and International Banking divisions and the Treasury function reflecting the risks inherent in the Group’s lending activities. Over the last year the banking crisis has impacted the financial services industry resulting in high profile losses and writedowns. The deteriorating economic outlook, both in the UK and overseas, is also leading to significant rises in impairments. The Group is impacted by the economic downturn and a further worsening of the business environment could adversely impact earnings. This poses a major risk to the Group and its lending businesses in: – Retail, where rising unemployment impacts the ability of customers to meet repayment dates on unsecured and secured lending and leads to a consequent increase in arrears. Additionally, the downturn in the housing market reduces collateral values for residential property and this impacts upon the profitability of secured lending.
liquidity and funding: arising in the banking business of the Group and impacting the Retail and Wholesale and International Banking divisions reflecting the risk that the Group is unable to attract and retain retail/wholesale deposits or issue debt securities. Like all major banks, the Group is dependent on confidence in the short and longer term wholesale funding markets; should the Group, due to exceptional circumstances, be unable to continue to source sustainable funding and provide liquidity when necessary, it could impact its ability to fund its financial obligations. Throughout the market dislocation, the Group has maintained a robust liquidity position based on its significant retail and corporate deposit base and has funded strongly in the wholesale markets. Since completion of the HBOS transaction, the Group has been able to fund the Enlarged Group in the wholesale markets at rates comparable to the period prior to completion. In addition the Group has reinforced its strong funding position by actively participating in the support initiatives introduced by the Bank of England and HM Treasury. Prior to the year end 2008 additional liquidity resilience was built up to mitigate the potential for hightened liquidity risk faced by Lloyds TSB Group plc upon the acquisition of HBOS plc. The recent down grade by rating agencies has not had a material impact on the cost of short term wholesale funding.
Capital: during the year there was unprecedented turbulence in global financial markets which led to the UK Government taking action to stabilise the UK banking system. After discussion with HM Treasury on the additional capital required by the UK Government if the Group was to continue to have access to the Government backed provision of liquidity, the board decided it was in the best interests of shareholders for the Group to participate in the industry wide recapitalisation exercise which took place in October 2008. However, should the economic downturn worsen and consequently the Group sustain further sudden and significant shocks to its capital base, it could be necessary to raise additional capital to remain above the FSA’s minimum target ratios. Any additional capital raised which was not taken up by existing shareholders would be dilutive to their earnings.
On the completion date the Lloyds TSB governance structure became the overriding governance structure for Lloyds Banking Group. This represented a change to the committee structures and delegated authorities for the heritage HBOS businesses. The major areas of change included material event escalation, sanctions, conflicts of interest, delegated authorities for expenditure and the credit sanctioning process where authorities were changed to align with those within the heritage Lloyds TSB Group plc businesses.
Business risk appetite is encapsulated in the Group’s budget and medium-term plan, which are sanctioned by the board on an annual basis. Divisions and business units subsequently align their plans to the Group’s overall business risk appetite.
The Group’s portfolio of businesses exposes it to a number of internal and external factors: – internal factors: resource capability and availability, customer treatment, service level agreements, products and funding and the risk appetite of other risk categories; and
The risk of reductions in earnings and/or value, through financial or reputational loss, as a result of the failure of the party with whom the Group has contracted to meet its obligations (both on and off balance sheet).
The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions and corporate clients. The credit risk exposures of the Group are set out in note 49 to the financial statements.
In measuring the credit risk of loans and advances to customers and to banks at a counterparty level, the Group reflects three components: (i) the ‘probability of default’ by the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and their likely future development, from which the Group derives the ‘exposure at default’; and (iii) the likely loss ratio on the defaulted obligations (the ‘loss given default’).
The rating systems described above assess probability of default, exposure at default and loss given default, in order to derive an expected loss. In contrast, impairment allowances are recognised for financial reporting purposes only for losses that have been incurred at the balance sheet date based on objective evidence of impairment (see note 20 to the consolidated financial statements on page 129). 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 expected loss model that is used for internal operational management and banking regulation purposes.
The Group uses a range of approaches to mitigate credit risk.
– Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite. Credit policy is aligned to the Group’s risk appetite and restricts exposure to certain high risk and more vulnerable sectors. Note 19 to the accounts provides an analysis of loans and advances to customers by industry (for wholesale) and product (for retail). Exposures are monitored to prevent excessive concentration of risk. These concentration risk controls are not necessarily in the form of a maximum limit on lending but may instead require new business in concentrated sectors to fulfil additional hurdle requirements. The Group’s large exposures are reported in accordance with regulatory reporting requirements.
The Group also undertakes asset sales, securitisations and credit derivativebased transactions as a means of mitigating or reducing credit risk, taking into account the nature of assets and the prevailing market conditions.
Market risk appetite is defined with regard to the quantum and composition of market risk that exists currently in the Group and the direction in which the Group wishes to manage this.
The primary market risk measure used within the Group is the Value at Risk (VaR) methodology, which incorporates the volatility of relevant market prices and the correlation of their movements. This is used for determining the Group’s overall market risk appetite and for the high level allocation of risk appetite across the Group.
BANKING – TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS
The risk of loss measured by the VaR model is the potential loss in earnings. The total and average trading VaR does not assume any diversification benefit across the four risk types. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported as a whole. VaR numbers have increased during 2008 due to the significant rise in market volatility reflected in all the Group’s VaR models across all markets.
The estimated impact of an immediate 25 basis point increase in interest rates on economic value for the years ended 31 December 2008 and 2007 is shown below (in the 2007 accounts a 200 basis point increase was used). Economic value is defined as the present value of the non-trading portfolios concerned. Impacts have only been shown in one direction but can be assumed to be reasonably symmetrical. No currency breakdown has been provided as most of the exposure is in pounds sterling. These calculations are made monthly using assumptions regarding the maturity of interest rate insensitive assets and liabilities. The portfolio is updated monthly to reflect any changes in the relationship between customer behaviour and the level of interest rates.
This is a risk based disclosure and the amounts below would be amortised in the income statement over the duration of the portfolio. During the year, management reviewed the basis of reporting banking non-trading to a value at risk measure to reflect better the internal measurement used to control this exposure. The decrease compared to the previous year is due to the impact on retail balances of significant cuts in base rate during the last few months of 2008. In view of the unprecedented low interest rate environment in 2009, the assumptions underlying this particular risk measure are under review and likely to change.
Interest rate risk (impact of 25 basis point reduction pre-tax) 59 58
Credit spread risk (impact of 25 basis point increase pre-tax) (82) (110)
Market risk exposures from the insurance businesses are controlled via approved investment policies and limits set with reference to the Group’s overall risk appetite and regularly reviewed by the senior asset and liability committee: – The With Profit Fund is managed in accordance with the relevant fund’s principles and practices of financial management and legal requirements. – The investment strategy for other insurance liabilities is determined by the term and nature of the underlying liabilities and asset/liability matching positions are actively monitored. Actuarial tools are used to project and match the cash flows. – Investment strategy for surplus assets held in excess of liabilities takes account of the legal, regulatory and internal business requirements for capital to be held to support the business now and in the future.
Insurance risk appetite is defined with regard to the quantum and composition of insurance risk that exists currently in the Group and the direction in which the Group wishes to manage this.
In respect of insurance risks in the staff pension schemes, the Group ensures that effective communication mechanisms are in place for consultation with the trustees and that risk management is in line with the Group’s risk appetite.
There are a number of categories of operational risk: LEGAL AND REGULATORy RISK
Operational risk appetite is defined as the quantum and composition of operational risk identified in the Group and the direction in which the Group wishes to manage it.
In setting operational risk appetite, the Group looks at both impact on solvency and the Group’s reputation, including customer service requirements.
Integral to this operational risk management framework is a hybrid approach to calculating capital to support unexpected losses. The capital model calculations are driven by internal data which captures past losses, and forward looking scenarios which value potential future risk events. External industry-wide data is collected to help with validating scenarios.
Lloyds Banking Group Annual Report and Accounts 2008 taBle 1.7: grouP BalanCe sheet £bn £bn %
The group balance sheet has grown by 23.4 per cent during the year. The funding for this has been primarily raised in the wholesale markets with customer deposit growth of £14.4 billion.
Other Treasury operations include those businesses that are run on a standalone basis in jurisdictions outside London to support local banking businesses often in different time zones. The residual maturity profile of these operations is less than one year.
taBle 1.10: reConCiliation of amounts shown aBove with the statutory BalanCe sheet london treasury other treasury other statutory Balance functions functions repos retail sheet 2008 £bn £bn £bn £bn £bn
Debt securities in issue and trading and other liabilities at fair value through profit or loss 73.4 9.1 – – 82.5
Capital risk appetite is set by the board and reported through various metrics that enable the Group to manage capital constraints and shareholder expectations. The chief executive, assisted by the group asset and liability committee, regularly reviews performance against risk appetite. The board formally reviews capital risk on an annual basis.
The Group’s regulatory capital is divided into tiers defined by the European Community Banking Consolidation Directive as implemented in the UK by the Financial Services Authority’s General Prudential Sourcebook. Tier 1 capital comprises mainly shareholders’ equity, tier 1 capital instruments and minority interests, after deducting goodwill, other intangible assets and 50 per cent of the net excess of expected loss over accounting provisions and certain securitisation positions. During the year the FSA has defined core tier 1 capital. Accounting equity is adjusted in accordance with FSA requirements, particularly in respect of pensions and available-for sale assets. Tier 2 capital comprises qualifying subordinated debt after deducting 50 per cent of the excess of expected loss over accounting provisions, and certain securitisation positions. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting investments in subsidiaries and associates that are not consolidated for regulatory purposes. In the case of Lloyds TSB Group, this means that the net assets of its life assurance and general insurance businesses are excluded from its total regulatory capital.
In the context of the current market conditions the FSA has made further statements to explain the approach it has taken to the capital framework these include core tier 1 and tier 1 targets under stressed conditions.
The Group has developed procedures meant to ensure that compliance with both current and potential future requirements are understood and that policies are aligned to its risk appetite.
In addition to the regulatory framework, the Group also operates an internal capital framework.
Total tier 1 and tier 2 capital 23,887 20,539 supervisory deductions
Operational risk 12.3 10.1 total risk-weighted assets 170.5 142.6 risk asset ratios (unaudited)
Financial calendar 2009 195 finanCial and Prudential regulatory rePorting, disClosure and tax
The risk of reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies, ineffective controls over financial, prudential regulatory and tax reporting and the failure to disclose information on a timely basis about the Group.
The Group maintains a system of internal controls, which are designed to be consistently applied, and to provide a reasonable assurance that transactions are recorded and undertaken in accordance with delegated authorities that permit the preparation and disclosure of financial statements, prudential regulatory reporting and tax returns in accordance with International Financial Reporting Standards, statutory and regulatory requirements.
Adjustments to remove differences between IFRS and regulatory valuation of assets and liabilities – (435) (435) (602) (1,037)
Available capital in the With Profit Fund has decreased from £3,607 million at 31 December 2007 to an estimated £649 million at 31 December 2008. The key driver is investment market performance.
with Profit long term With Profit Long Term fund fund Fund Fund £m £m £m £m
Realistic value of assets available to the fund 13,517 16,665 17,803 21,005
Recognition of future profits allowable for ‘realistic’ capital purposes – 1,830 – 2,063
Analysis of policyholder liabilities in respect of the Group’s life assurance business: scottish widows plc with Profit fund other
(in accordance long-term total life with frs 27) funds business £m £m £m as at 31 december 2008
Unit-linked business (excluding that accounted for as investment contracts) – 11,480 11,480
Non-participating investment contract liabilities – 14,243 14,243 total policyholder liabilities 13,293 34,087 47,380 Scottish Widows plc
Unit-linked business (excluding that accounted for as investment contracts) – 14,282 14,282
Non-participating investment contract liabilities – 18,197 18,197 total policyholder liabilities 16,404 39,193 55,597
Certain personal pension policyholders, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £65 million (31 December 2007: £65 million) in respect of those guarantees. If future salary growth were 0.5 per cent per annum greater than assumed, the liability would increase by some £3 million. If yields were 0.5 per cent lower than assumed, the liability would increase by some £11 million.
Total income, net of insurance claims 9,872 10,706 11,104 10,540 9,661
Net asset value per ordinary share 155p 212p 195p 180p 167p
Post-tax return on average shareholders’ equity 7.4 28.2 26.6 25.6 22.8 31 december 31 December 31 December 31 December 1 January
Joined the board in 1999 and was chairman of Lloyds TSB Scotland until May 2008. Joined Noble Grossart in 1969 and was an executive director of that company until December 2003. A non-executive director of Noble Grossart and Stagecoach Group, chairman of Creative Scotland 2009, senior governor of the Court of the University of St Andrews and vice chairman of the Edinburgh International Festival. A former chairman of tie and non-executive director of John Wood Group. Aged 66
Joined the board on 1 October 2008. Appointed group chief executive of Guardian Media Group in 2006 having joined that organisation in 1986 and held a number of senior and general management appointments before becoming a director in 2000. Chair of Opportunity Now and a director of Business in the Community. Aged 47
President and chief executive of the Securities Industry and Financial Markets Association. Held a number of senior appointments in JP Morgan Chase from 1993 to 2008 including vice chairman, financial institutions and governments, from 2005. A director of the US-Japan Foundation and the International Foundation of Electoral Systems and a member of the Global Markets Advisory Committee for the National Intelligence Council. A former director in the Office of Thrift Supervision, US Department of the Treasury and Koram Bank. Aged 63
Vodafone and Witan Investment Trust and chairman of Marks and Spencer Pension Trust, Asian Infrastructure Fund and Lincoln’s Inn investment committee. A former chairman of MEPC and a former member of the Financial Reporting Council. Aged 63
Joined the board in May 2007. Appointed chief executive of United Utilities in 2006. Former chief executive of Royal P&O Nedlloyd from 2003 to 2005. Previously held senior positions in DHL from 1990 to 1999, becoming chief operating officer for Europe and Africa in 1994, and the Reuters Group from 1999 to 2003, becoming chief operating officer in 2001. A director of Business in the Community and the UK Commission for Employment and Skills. A trustee of the Philharmonia Orchestra. Aged 55
Joined the board on 1 September 2008. Chairman of Deloitte UK from 1995 to 2007 and a member of the board from 1991 to 2007. Joined the firm in 1973 and was a partner from 1982 until he retired in 2008. A member of the board of directors of Deloitte Touche Tohmatsu from 1999 to 2007. A non-executive director of Great Portland Estates. A member of the council of Leeds University and a governor of Berkhamsted School. Aged 58
An interim dividend of 11.4p per ordinary share was paid on 1 October 2008. This dividend absorbed £648 million.
POST BALANCE SHEET EVENTS Details are given in note 52 on page 181.
SHARE CAPITAL Information about share capital is shown in note 41 on pages 152 to 154; in note 6 of the parent company accounts, included within this document, on page 187; in the corporate governance report on pages 70 to 73; and in the directors’ remuneration report on pages 74 to 95.
DONATIONS The income statement includes a charge for charitable donations totalling £29,603,000 in 2008 (2007: £37,463,000), including £28,997,000 (2007: £37,183,000) which will be paid under the deeds of covenant to the four Lloyds TSB Foundations during 2009.
POLICy AND PRACTICE ON PAyMENT OF CREDITORS The Company follows ‘The Better Payment Practice Code’ published by the Department of Business, Enterprise and Regulatory Reform (BERR), regarding the making of payments to suppliers. A copy of the code and information about it may be obtained from the BERR as shown on page 191.
Harry F Baines Company Secretary and General Counsel 26 February 2009
During the year, Dr Tracy Long, of Boardroom Review, conducted a formal evaluation of the performance of the board, its committees and individual directors. Directors were invited to comment, through questionnaires and interviews, and Dr Long’s report was subsequently reviewed and discussed by the board. Where areas for improvement were identified, action has been agreed.
In order to develop an understanding of the views of major shareholders, the board receives regular reports from the group finance director and the director of investor relations.
The chairman’s committee, comprising the chairman and the group chief executive, meets to assist the chairman in preparing for board meetings.
The group executive committee, comprising the group chief executive, the group executive directors, the wealth and international director, the chief risk officer, the group human resources director, the group integration director and the director of group operations, meets to assist the group chief executive in performing his duties. Specifically, the committee considers the development and implementation of strategy, operational plans, policies and budgets; the monitoring of operating and financial performance; the assessment and control of risk; the prioritisation and allocation of resources; and the monitoring of competitive forces in each area of operation. The committee, assisted by its sub-committees, the group business risk and group asset and liability committees, also supports the group chief executive in endeavouring to ensure the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, and in reviewing the Group’s aggregate risk exposures and concentrations of risk.
In addition, the directors agreed with the committee’s recommendation that Mr Brown be asked to remain on the board until the annual general meeting in 2009. This would enable the Group to continue to benefit from his wide experience and maintain an appropriate balance of skills and experience on the board, as part of the plans for orderly succession for appointments. His continuing membership of the audit committee and understanding of the Group’s activities was particularly helpful to the new chairman of that committee. Mr Brown remains the senior independent director until he is succeeded at the conclusion of the annual general meeting by Lord Leitch. The board considered the matter very carefully and concluded that both Mr Brown and Lord Leitch were independent in character and there were no relationships or circumstances which were likely to affect, or could appear to affect, their judgement.
Information about the remuneration committee’s membership and work is given in the directors’ remuneration report on pages 74 to 95 and its terms of reference are available from the company secretary and are displayed on the Company’s website, www.lloydsbankinggroup.com.
Number of meetings during the year 18 6 7 9 5
Appointed to the board, nomination, remuneration and risk oversight committees on 1 May 2008.
Appointed to the board, audit and risk oversight committees on 1 September 2008.
STATEMENT OF DIRECTORS’ RESPONSIBILITIES The directors are responsible for preparing the annual report, the directors’ remuneration report and the financial statements in accordance with applicable law and regulations.
INTERNAL CONTROL The board of directors is responsible for the establishment and review of Lloyds Banking Group’s system of internal control, which is designed to ensure effective and efficient operations, quality of internal and external reporting, internal control, and compliance with laws and regulations. It should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control, the directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss.
It is my privilege once again to introduce the board’s report on remuneration policy and practice.
Deciding how executives should be paid in these extraordinary circumstances has been an immensely difficult task. We know that many of our stakeholders will want to understand how we came to our decisions. For this reason, we have adopted a different approach to this year’s remuneration report. In addition to the normal information provided, much of which is required by regulations, we have decided to set out the principles underlying our remuneration philosophy. We have also decided to describe how the committee came to the decisions it did during the year in more detail than would be normal. Given the current environment, we believe that our shareholders, customers, employees, and regulators are entitled to this information. We hope that in whatever capacity you are reading this report, you find it helpful.
Like many other banks, we have been unable to avoid the problems created by the sharp decline in the willingness of banks to lend to each other and by the recession in the UK and many other countries around the world. In addition we recognise that while the acquisition of HBOS creates significant opportunities for Lloyds Banking Group, in the short term it has created a number of challenges and the need to participate in the Government recapitalisation programme. However, we remain an inherently prudent and well-managed bank, and will be in a very strong position to continue to serve our customers and shareholders in the future.
During 2009 we will be undertaking a further review of our remuneration policy and practices. The committee intends to undertake this review mindful of the requirements of our shareholders and regulators whilst doing the utmost to ensure that we are not competitively disadvantaged against the market with respect to our approach to remuneration going forward; particularly our ability to attract and retain the best talent for the future of the Group.
The committee believes that we have an approach to remuneration aligned with our business strategy that remains sound in its fundamental principles. We do not believe that remuneration led to adverse behaviour at Lloyds TSB. Indeed we believe that our prudent approach to remuneration helped us to avoid many of the problems experienced by a number of our competitors. However, we are not complacent. We recognise that there are areas where our remuneration arrangements can be improved. We have studied the developments in the industry and the recommendations put forward by regulators and industry commentators. We are adopting many of these recommendations in our remuneration for 2009 and beyond. We are committed to rolling out these remuneration practices across the Lloyds Banking Group.
One key challenge that the committee has been grappling with has been how best to motivate and incentivise the management team of the Lloyds Banking Group to undertake the huge task ahead, while recognising that we are operating in a very difficult environment for banks generally. We recognise the extreme scrutiny that remuneration in the financial services sector is attracting and the current sentiment of shareholders. At the same time, the Board strongly believes that we have the executive management team required to take on the complexity of issues that the integration of HBOS will bring. The retention of this team is central to the future success of the bank and it is important that they are paid in a fair and responsible way.
REMUNERATION DECISIONS FOR 2008/2009 KEy HIGHLIGHTS In 2009, our remuneration package will continue to have the same main elements as for 2008: – base salary – annual incentive – long-term incentive plan
Based on role, market competitiveness, and performance33% Paid in cash Salary
The committee’s terms of reference are available from the company secretary and are displayed on the Group’s website, www.lloydsbankinggroup.com.
Executives are required to build up a holding in the Lloyds Banking Group shares of value equal to 1.5 times salary for executive directors (2 times salary for the group chief executive). They are expected to retain half of the net-of-tax proceeds of share plan pay-outs until they reach this target.
We aim to ensure that the totality of remuneration for executive directors is competitive against our benchmark groups. These groups are other major UK banks, and also the top 20 companies in the FTSE 100, reflecting practices in comparably sized large UK companies across all sectors. We aim to be competitively but conservatively positioned against the market.
The changes introduced as a result of this review are summarised below.
The key remuneration elements for 2009 as a result of the review are summarised below. Each individual element is then described in more detail in the subsequent sub-sections.
Annual incentive 200 per cent of salary maximum (225 per cent for CEO), as for 2008
Based 50 per cent on Group financial targets relating to profit before tax and economic profit
Despite the significantly increased responsibilities of the executive directors, the maximum total pay opportunity for an executive director in 2009 is reduced by 175 per cent of salary from 2008.
At the same time, the committee has been very aware of developments in the financial services sector and in relation to remuneration practices more widely. The committee reviewed trends in relation to base salary and incentives at other major financial firms globally, including those participating in Government funding programmes. The committee also considered the implications of the Financial Services Authority’s draft code on remuneration. Finally the committee considered developments at the other UK and international banks, including the terms on which senior executives at banks were hired through the year (including executives departing from Lloyds TSB).
This approach has also been applied to the Chairman’s salary and non-executive director fees for 2009 which remain unchanged from 2008.
However, there is a strong overall focus on cost control within the business, and rapid changes within the industry make it difficult to assess what will, in future, be market competitive. Therefore, the committee has determined not to seek authority from shareholders to increase the LTIP award to the level required to achieve a market median value of remuneration. Instead, the committee has determined that for 2009 the grant level for executive directors should be set at 200 per cent of base salary.
This means that, in its totality, the maximum remuneration opportunity for executive directors in 2009 will be reduced by 175 per cent of salary from the maximum awarded to a director in 2008, despite a doubling in the size of the Group, and despite the challenges ahead in integrating the businesses to create the Lloyds Banking Group.
SyNERGy TARGETS (APPLyING TO AWARD OF 40 PER CENT OF SALARy, BEING 50 PER CENT OF THE INTEGRATION AWARD)
In April 2012, all executive directors will transition to defined contribution pension arrangements with contributions of 25 per cent of base salary for the chief executive and other executive directors, with no compensation for ceasing final salary accrual.
The committee recognises that the above proposals for executive remuneration for 2009 are being made at a time of high uncertainty and great volatility, and therefore the committee has decided to undertake a further review of executive remuneration during 2009. This is to ensure that the overall positioning of remuneration remains appropriate when compared with the external market and ensures that the Lloyds Banking Group is able to attract and retain the high calibre of talent needed to lead the combined Group, while reflecting latest trends in the sector and any updated guidance from shareholders and regulators. The committee will continue to engage with shareholders during this review.
The chairman’s remuneration comprises salary and benefits which are broadly similar to those extended to the executive directors. However, he does not participate in the annual bonus and long-term incentive arrangements, nor is he entitled to pension benefits.
Incentive awards for executive directors are based upon individual contribution and overall corporate results. Half of the incentive opportunity is driven by corporate performance based on the stretching budget relating to profit before tax and economic profit. The level of achievement against the targets for profit before tax and economic profit that results in the lower payout will determine the exent to which the target has been met. The other half of the incentive opportunity is determined by divisional achievement driven through individual performance. Individual targets relevant to improving overall business performance are contained in a balanced scorecard and are grouped under the following headings: – Financial – Franchise growth – Customer service – Risk – People development
These targets are weighted differently for each of the executive directors, reflecting differing strategic priorities. The non-financial measures include key performance indicators relating to process efficiency, service quality and employee engagement.
In recognition of the current environment, the executive directors have elected not to receive any annual incentive in respect of 2008.
SERVICE AGREEMENTS The Group’s policy is for executive directors to have service agreements with notice periods of no more than one year. All current executive directors are entitled to receive 12 months’ notice from the Group, but would be required to give six months’ notice if they wished to leave. Executive directors normally retire at age 60. However, following the implementation of The Employment Equality (Age) Regulations 2006, they may now choose to delay their retirement until age 65.
Notice to be given by the Company Date of service agreement/letter of appointment
During 2008, Mr Daniels and Mrs Weir received fees of £54,718 and £42,500 respectively, which were retained by them, for serving as non-executive directors of other companies.
For the period 1 January – 30 June 2008, Mr Fairey waived fees payable to him as a director of Lloyds TSB Group Pension Trust (No.1) Limited and Lloyds TSB Group Pension Trust (No.2) Limited, which totalled £5,000 (2007: £10,750 waived). For the period 1 July – 31 December 2008, Mr Fairey received fees payable to him as a director and chairman of the Lloyds TSB Group Pension Trust (No.1) Limited and Lloyds TSB Group Pension Trust (No.2) Limited which totalled £35,000.
DIRECTORS’ PENSIONS The executive directors are currently members of one of the pension schemes provided by the Lloyds TSB Group with benefits either on a defined benefit or defined contribution basis. Those directors who joined the Lloyds TSB Group after 1 June 1989 and are members of a defined benefit scheme have pensions provided on salary in excess of the earnings cap either through membership of a funded unapproved retirement benefits scheme (FURBS) or by an unfunded pension promise. Retirement pensions accrue at rates of between 1/60 and 1/30 of basic salary.
During the year to 31 December 2008 (from 30 October 2008 for Mr Tookey), the employer has made the following (£000) contributions to the defined contribution scheme: T J W Tookey 23
Column (f) is the capital value of the pension in column (e).
Mr Fairey retired as at 30 June 2008 and took his non-approved benefit entitlement in the form of a lump sum in accordance with the scheme rules. A tax free amount of £4.523 million was paid from the FURBS, with a further taxable amount of £2.446 million made by the bank from provisions set aside. The total amount of £6.969 million covered the bank’s liability to provide benefits in respect of salary in excess of the earnings cap.
T A Dial 242,825 242,825 – (see page 95) 1/6/2008 30/11/2008 i
The market price for a share in the Company at 1 January 2008 and 31 December 2008 was 467.5p and 126p, respectively. The range of prices between 1 January 2008 and 31 December 2008 was 118.5p to 483.1229p.
March 2004 – August 2004 That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international financial services companies including Lloyds TSB) must be at least ninth, when 14 per cent of the option will be exercisable. If the Company is ranked first in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met.
In addition, on 26 March 2008 (prior to his appointment as an executive director), Mr Tookey was granted an award under the Lloyds TSB Executive Retention Plan 2006. The award is satisfied in cash only and, subject to continued employment, gives Mr Tookey the right to receive an amount equal to the value of 108,342 Lloyds Banking Group Shares on the date of vesting. The award vests as to 50 per cent on 26 March 2011 and 50 per cent on 26 March 2013. Mr Tookey has agreed to reinvest the cash proceeds into Lloyds Banking Group Shares. As an executive director, he is no longer eligible to be granted awards under this plan.
We have reported separately on the parent company financial statements of Lloyds Banking Group plc for the year ended 31 December 2008 and on the information in the directors’ remuneration report that is described as having been audited.
Our responsibility is to audit the consolidated financial statements in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). This report, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with section 235 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Profit attributable to equity shareholders 819 3,289 profit for the year 845 3,321 basic earnings per share 15 14.3p 58.3p diluted earnings per share 15 14.2p 57.9p
Annual Report and Accounts 2008 equity and liabilities Note £ million £ million
Movement in available-for-sale financial assets, net of tax: – change in fair value – (436) – (436) – (436)
Net income recognised directly in equity – (396) – (396) (1) (397)
– proceeds from shares issued 35 – – 35 – 35
Repayment of capital to minority shareholders – – – – (80) (80)
Movement in available-for-sale financial assets, net of tax: – change in fair value – (2,059) – (2,059) 28 (2,031)
– other transfers to income statement – (66) – (66) – (66)
Net income recognised directly in equity – (2,416) – (2,416) 28 (2,388)
Cash and cash equivalents at beginning of year 31,891 25,438 cash and cash equivalents at end of year 50(D) 32,760 31,891
The following IFRS pronouncements relevant to the Group have been adopted in these consolidated financial statements: (i) IFRIC 11 IFRS 2 – Group and Treasury Share Transactions. This interpretation clarifies the application of IFRS 2 Share-based Payment to certain share-based payment arrangements involving own equity instruments and arrangements involving equity instruments of a parent entity. The application of this new interpretation has not had any impact for amounts recognised in these financial statements.
(iii) Amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures – Reclassification of Financial Assets. The amendment to IAS 39 permits reclassification of non-derivative financial assets (other than those designated at fair value through profit or loss by the entity upon initial recognition) out of the fair value through profit or loss category in certain circumstances and permits the transfer of a financial asset from the available-for-sale category to the loans and receivables category where that financial asset would have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been designated as available-for-sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. The amendment to IFRS 7 requires additional disclosures about the situations in which any such reclassification is made and the effects on the financial statements including details of the carrying amounts and fair values for all financial assets that have been reclassified until they are derecognised and the fair value gain or loss that would have been recognised in the income statement or equity, as appropriate, if the financial asset had not been reclassified. For eligible reclassifications made before 1 November 2008, these amendments became effective from 1 July 2008. Details of the financial assets reclassified in accordance with this amendment are set out in note 49.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2008 and which have not been applied in preparing these financial statements are given in note 51.
Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable net assets and contingent liabilities of the acquired entity at the date of acquisition. Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written down immediately through the income statement and is not subsequently reversed. At the date of disposal of a Group undertaking, the carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal except where it has been written off directly to reserves in the past.
– Where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would otherwise need to be separately accounted for.
Debt securities and equity shares, other than those classified as trading securities or at fair value through profit or loss, are classified as available-forsale and recognised in the balance sheet at their fair value; available-for-sale investments are those intended to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of investments classified as available-for-sale are recognised directly in equity, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in equity is recognised in the income statement. Interest calculated using the effective interest method is recognised in the income statement.
Loans and advances to banks and customers, including any eligible assets transferred into these categories out of the fair value through profit or loss or available-for-sale financial assets categories, are accounted for at amortised cost using the effective interest method, except those which the Group intends to sell in the near term and which are accounted for at fair value, with the gains and losses arising from changes in their fair value reflected in the income statement. Loans and advances are initially recognised when cash is advanced to the borrowers at fair value inclusive of transaction costs. Loans and advances are derecognised when the rights to receive cash flows from them have expired or where the Group has transferred substantially all risks and rewards of ownership.
Derivatives embedded in financial instruments and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. In accordance with IFRS 4, a policyholder’s option to surrender an insurance contract for a fixed amount is not treated as an embedded derivative.
The Group designates certain derivatives as either: (1) hedges of the fair value of the particular risks inherent in recognised assets or liabilities (fair value hedges); (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges of net investments in foreign operations (net investment hedges). These are accounted for as follows: (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 attributable to the hedged risk are no longer recognised in the income statement; the adjustment that has been made to the carrying amount of a hedged item is amortised to the income statement over the period to maturity.
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in equity. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement.
Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in equity; the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of.
The estimated period between a loss occurring and its identification is determined by local management for each identified portfolio. In general, the periods used vary between two months and twelve months.
A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery (as a result of the customer’s insolvency, ceasing to trade or other reason) and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the income statement.
The Group assesses at each balance sheet date whether there is objective evidence that an available-for-sale financial asset is impaired. In addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial circumstances (including creditworthiness) and future prospects of the issuer assessing the future cash flows expected to be realised and, in the case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. If an impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment and amortisation) and the current fair value, less any impairment loss on that asset previously recognised, is removed from equity and recognised in the income statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original impairment loss is credited to the income statement; any excess is taken to the available-for-sale reserve. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.
Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred tax is provided on temporary differences arising from investments in subsidiaries and associates, except where the timing of the reversal of the temporary difference is controlled by the Group and it is probable that the difference will not reverse in the foreseeable future. Income tax payable on profits is recognised as an expense in the period in which those profits arise. The tax effects of losses available for carry forward are recognised as an asset when it is probable that future taxable profits will be available against which these losses can be utilised. Deferred tax related to fair value re-measurement of available-for-sale investments and cash flow hedges, which are charged or credited directly to equity, is also credited or charged directly to equity and is subsequently recognised in the income statement together with the deferred gain or loss.
For accounting purposes the general insurance business only issues insurance contracts.
– insurance or participating investment contracts in the group’s With profit fund
The Group recognises as an asset the value of in-force business in respect of life insurance 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 conditions and other matters 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.
At each balance sheet date liability adequacy tests are performed to ensure the adequacy of insurance and participating investment contract liabilities net of related deferred tax assets and acquired value of in-force business. In performing these tests current best estimates of discounted future contractual cash flows and claims handling and administration expenses, as well as investment income from the assets backing such liabilities, are used. Any deficiency is immediately charged to profit or loss by establishing a provision for losses arising from liability adequacy tests.
The benefits to which the Group is entitled under its reinsurance contracts held are recognised as reinsurance assets. These assets consist of short-term balances due from reinsurers as well as longer term receivables that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts. Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured insurance contracts and in accordance with the terms of each reinsurance contract and are regularly reviewed for impairment. Reinsurance liabilities are primarily premiums payable for reinsurance contracts and are recognised as an expense when due.
The Group uses widely recognised valuation models for determining the fair value of common and less complex financial instruments that use only observable market data. Observable prices and model inputs are usually available in the market for listed debt and equity securities, exchange traded derivatives and simple over-the-counter derivatives like interest rate swaps. Availability of observable market prices and model inputs reduces the need for management judgement and estimation and any uncertainty associated with determination of fair values. Availability of that observable information depends on the products and markets and is prone to changes based on specific events and general conditions in the financial markets.
Financial markets in certain financial instruments such as asset backed securities (ABS) and secondary loans, which were previously active and had been valued using market observable inputs in previous years, became inactive during 2008. The fair values of those assets are determined predominantly from lead manager quotes and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market standard consensus pricing services, broker quotes and other research data. For interest rate and foreign exchange option products and more complex option products, some or all of the inputs into the Group’s valuation models may not be observable in the market and are derived from market prices or rates or are estimated based on market standard consensus data. The process of calculating the fair value of these instruments may necessitate the estimation of certain pricing parameters, assumptions or model characteristics. Management judgement and estimation are usually required when determining such matters as the expected cash flows on the financial instruments being valued, the probability of counterparty default, prepayment assumptions, and selection of appropriate discount rates.
The Group reviews the goodwill for impairment at least annually or when events or changes in economic circumstances indicate that impairment may have taken place. The impairment review is performed by projecting future cash flows, excluding finance and tax, based upon budgets and plans and making appropriate assumptions about rates of growth and discounting these using a rate that takes into account prevailing market interest rates and the risks inherent in the business. If the present value of the projected cash flows is less than the carrying value of the underlying net assets and related goodwill an impairment charge is required in the income statement. This calculation requires the exercise of significant judgement by management; if the estimates made prove to be incorrect or performance does not meet expectations which affects the amount and timing of future cash flows, goodwill may become impaired in future periods. Further details are given in note 23.
At 31 December 2008 the Group held a provision of £183 million (2007: £207 million) in respect of the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for claims incurred but not reported at the balance sheet date.
At 31 December 2008 the Group had a current tax asset of £300 million and a deferred tax asset of £833 million (2007: a current tax liability of £484 million and a deferred tax liability of £948 million). During 2008, the Group’s net tax position has shifted from a liability of £1,432 million at 31 December 2007 to an asset of £1,133 million at 31 December 2008. While the Group has taken account of tax issues that are subject to ongoing discussion with HM Revenue & Customs and other tax authorities in recognising these assets a significant feature is the management judgement in determining the timing, forecasting and probability of them reversing. This involved a detailed review of profit and loss numbers for 2007 and 2008 to ensure any carry forward positions were optimised at 31 December 2008. The outcome of this exercise has been mapped into 2009 profit and loss estimates and beyond and supports the above assets.
Impairment of goodwill – – – – 100 – – 100
UK Retail General and asset and International Central Inter-segment Banking insurance management Investments Banking group items eliminations Total £m £m £m £m £m £m £m £m year ended 31 december 2007
Profit on sale of businesses – – 272 272 385 – – 657
Interest payable on liabilities held at amortised cost 3.67 4.24 (9,851) (10,580)
Net income (expense) arising on assets held at fair value through profit or loss: Loans and advances to banks and customers 20 23
Net expense arising on liabilities held at fair value through profit or loss – debt securities in issue (232) (153)
Total net (losses) gains arising on assets and liabilities held at fair value through profit or loss (7,053) 2,965
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 8 insurance premium income £m £m
Life insurance gross written premiums can be further analysed as follows: £m £m
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 11 operaTing expenses £m £m
The average number of persons on a headcount basis employed by the Group during the year was as follows:
Acquisition due diligence and other work performed in respect of potential venture capital investments 1.0 0.6
The following types of services are included in the categories listed above: audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with regulatory filings. Other services supplied pursuant to legislation relate primarily to the costs associated with the Sarbanes-Oxley Act audit requirements together with the cost of the audit of the Group’s Form 20-F filing. audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of prospectuses and circulars required by the UKLA listing rules. services relating to taxation: This category includes tax compliance and tax advisory services.
Foreign tax: Current tax on profit for the year (144) (98)
As a result of the Finance Act 2007, the statutory rate of corporation tax in the UK was reduced from 30 per cent to 28 per cent with effect from 1 April 2008. Therefore the charge for tax on the profit for the year is based on a UK corporation tax rate of 28.5 per cent (2007: 30 per cent).
The Group, as a proxy for policyholders in the UK, is required to record taxes on investment income, gains and losses each year. Accordingly, the tax attributable to UK life insurance policyholder earnings is included in income tax expense. The tax credit attributable to policyholders was £471 million (2007: £243 million credit), including a prior year tax charge of £4 million (2007: tax charge of £5 million).
15 earnings per share Basic earnings per share are calculated by dividing the net profit attributable to shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 5 million (2007: 5 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes.
As discussed in note 52, the Group issued 2,596,653,203 ordinary shares at 173.3p on 13 January 2009 and issued 7,775,694,993 ordinary shares as purchase consideration for the acquisition of 100 per cent of the ordinary share capital of HBOS plc on 16 January 2009.
Other financial assets at fair value through profit or loss 44,207 53,248
These assets are comprised as follows: other financial Other financial assets at fair assets at fair
The carrying value of assets that are subject to stock lending arrangements was £809 million at 31 December 2008 (2007: £1,450 million) all of which the secured party is permitted by contract or custom to sell or repledge.
At 31 December 2008, £578 million (2007: £14 million) of fair value liabilities were valued using unobservable inputs; a charge of £512 million (2007: charge of £14 million) was recognised in the income statement relating to the change in fair value. The effect of using reasonably possible favourable and adverse valuation assumptions would be to increase or decrease net trading income by up to £80 million respectively.
Derivatives designated as cash flow hedges: Interest rate swaps 867 1 91
Derivatives designated as net investment hedges: Cross currency swaps 6,318 – 2,413
Later than 1 year and not later than 5 years 1,779 1,917
Commitments for expenditure in respect of equipment to be leased (174) (184)
At 31 December 2008 £15,627 million (2007: £15,265 million) of available-for-sale financial assets had a contractual residual maturity of greater than one year.
Direct operating expenses arising from investment properties that generate rental income 29 24
24 vaLue of in-force business The asset in the consolidated balance sheet and movement recognised in the income statement are as follows: Gross value of in-force insurance and participating investment business £m £m
A market consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. The risk free rate used for the value of financial options and guarantees is defined as the spot yield derived from the UK gilt yield curve in line with Scottish Widows’ FSA realistic balance sheet assumptions.
Software enhancements principally comprise identifiable and directly associated internal staff and other costs.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 26 TangibLe fixed asseTs
Operating Total tangible Premises Equipment lease assets fixed assets £m £m £m £m
Accumulated depreciation and impairment: Exchange and other adjustments – 2 (3) (1)
At 31 December 2008 £1,956 million (2007: £25 million) of deposits from banks had a contractual residual maturity of greater than one year.
At 31 December 2008 £29,967 million (2007: £35,603 million) of liabilities arising from insurance contracts and participating investment contracts had a contractual residual maturity of greater than one year.
The realistic capital regime dictates that With Profit Fund liabilities are valued on a market-consistent basis. This is achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The With Profit Fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk-free yield and all cash flows are discounted using the risk-free yield. The risk-free yield is defined as the spot yield derived from the UK gilt yield curve.
During 2008, following a detailed review of the Group’s current and expected experience, there has been a change in the key assumption in respect of lapse and paid-up rates. The impact of this change has been to decrease profit before tax by £143 million; this amount includes movements in liabilities and value of the in-force business in respect of insurance contracts and participating investment contracts.
The movements in non-life insurance contract liabilities and reinsurance assets over the year have been as follows: Gross Reinsurance Net £m £m £m provisions for unearned premiums
Gross Reinsurance Net £m £m £m claims and loss adjustment expenses
Increase (decrease) in liabilities: Arising from current year claims 221 – 221
Incurred but not reported 19 – 19 non-Life insurance cLaims deveLopmenT TabLe
This sensitivity shows the impact of reducing mortality and morbidity rates on non-annuity business to 95 per cent of the expected rate. This sensitivity shows the impact on the annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate. This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate. This sensitivity shows the impact of reducing maintenance expenses and investment expenses to 90 per cent of the expected rate.
35 unaLLocaTed surpLus wiThin insurance businesses The movement in the unallocated surplus within long-term insurance business over the year can be analysed as follows: £m £m
37 reTiremenT benefiT obLigaTions £m £m charge to the income statement
Exchange and other adjustments 105 12 £m £m changes in the fair value of scheme assets
Actual return on scheme assets (2,435) 1,174 37 reTiremenT benefiT obLigaTions continued
The expected return on scheme assets in 2009 will be calculated using the following assumptions: %
Present value of defined benefit obligation 15,617 16,795 17,378 17,320 14,866
Experience (losses) gains on scheme assets (3,520) 139 314 1,538 361
Deferred tax assets are recognised for tax losses and foreign tax credit carry forwards to the extent that the realisation of the related tax benefit through future taxable profits is probable. Scottish Widows plc has recognised a deferred tax asset of £388 million and other Group companies have recognised deferred tax assets totalling £468 million in relation to tax losses carried forward. For all of these losses, after reviewing medium term profit forecasts, the Group considers that there will be sufficient profits in the future against which these losses will be offset.
The Group also carries provisions in respect of its obligations relating to UIC Insurance Company Limited (UIC), which is in provisional liquidation. The Group has indemnified a third party against losses in the event that UIC does not honour its obligations under a reinsurance contract, which is subject to asbestosis and pollution claims in the US. The ultimate cost of settling the Group’s exposure in respect of the insurance business of UIC and the timing remains uncertain. The provision held represents management’s current best estimate of the cost after having regard to the financial condition of UIC and actuarial estimates of future claims.
7.875% Perpetual Capital Securities (US$1,250 million) d, f, p 921 –
Sterling Step-up non-Voting non-Cumulative Preferred Securities callable 2015 (£250 million) d, n 248 248 4.385% Step-up Perpetual Capital Securities callable 2017 (€750 million) d, f, k 720 504 undated subordinated liabilities
Undated Step-up floating Rate notes callable 2009 (€150 million) d, e 144 110 65/8% Undated Subordinated Step-up notes callable 2010 (£410 million) d, j 409 408 5.125% Step-up Perpetual Subordinated notes callable 2015 (£560 million) d, h 536 534 5.57% Undated Subordinated Step-up Coupon notes callable 2015 (¥20,000 million) d, l 189 111 5.125% Undated Subordinated Step-up notes callable 2016 (£500 million) d, j 455 449 6½% Undated Subordinated Step-up notes callable 2019 (£270 million) d, j 241 238 8% Undated Subordinated Step-up notes callable 2023 (£200 million) d, j 186 188 6½% Undated Subordinated Step-up notes callable 2029 (£450 million) d, j 444 444 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million) d, j 452 450
Lloyds Banking Group Annual Report and Accounts 2008 noTES To THE ConSoLIDATED fInAnCIAL STATEmEnTS continued note £m £m dated subordinated liabilities 51/4% Subordinated notes 2008 (Dm 750 million) – 281 10 5/8% Guaranteed Subordinated Loan Stock 2008 (£100 million) i – 100 57/8% Subordinated Guaranteed Bonds 2014 (€750 million) 821 591
Subordinated Step-up floating Rate notes 2016 callable 2011 (€500 million) e 480 371
Subordinated fixed to floating Rate notes due 2018 callable 2013 (€1,000 million) k, p 992 –
Subordinated floating Rate notes 2020 (€100 million) e 96 73 5.75% Subordinated Step-up notes 2025 callable 2020 (£350 million) 309 305
e) These notes bear interest at rates fixed periodically in advance based on London interbank rates.
p) Issued during 2008 to finance the general business of the Group.
Limited voting ordinary shares of 25p each share Capital and Control
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary shares in accordance with the articles of association. The authority for the Company to purchase, in the market, 572,712,063 of its shares, representing some 10 per cent of the issued share capital, expires at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
Increases in the authorised and issued share capital of the Company during January 2009 are discussed in note 52.
Amounts transferred to income statement in respect of hedge ineffectiveness 14 –
Employee share option schemes – value of employee services (4) 16
Retained profits are stated after deducting £40 million (2007: £75 million) representing 15 million (2007: 15 million) treasury shares held.
The directors do not propose to pay a final dividend (2007: 24.7 pence per share, which represented a total cost of £1,394 million).
The charge to the income statement is set out below: £m £m
movements in the number of share options outstanding under the Executive share option schemes during 2007 and 2008 are set out below: weighted average Weighted average number of exercise price number of exercise price options (pence) options (pence)
weighted average Weighted average number of exercise price number of exercise price options (pence) options (pence)
The weighted average fair value of options granted in the year was £2.92 (2007: £5.27). The weighted average share price at the time that the options were exercised during 2008 was 291.04 pence (2007: 539.77 pence). no options outstanding at 31 December were exercisable. The weighted average remaining contractual life of options outstanding at the end of the year was 2.5 years (2007: 1.8 years).
This plan was adopted by the Group in 2005, specifically to facilitate the recruitment of ms Dial. ms Dial was the only participant in the plan. options granted under this plan were not subject to any performance conditions and would have normally become exercisable if ms Dial remained as an employee, and had not given notice of resignation, on 31 may 2008. on 28 march 2008, the Group announced that ms Dial had decided to leave the Group and, in accordance with the terms of the plan, the options lapsed.
The performance conditions for awards made in may and August 2006 are as follows: (i) for 50 per cent of the award (the ‘EPS Award’) – the percentage increase in earnings per share of the Group (on a compound annualised basis) over the relevant period must be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in the Retail Price Index over the same period. If it is less than 3 per cent per annum the EPS Award will lapse. If the increase is more than 3 per cent but less than 6 per cent per annum then the proportion of shares released will be on a straight line basis between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
(ii) for the other 50 per cent of the award (the ‘TSR Award’) – it will be necessary for the Group’s total shareholder return (calculated by reference to both dividends and growth in share price) to exceed the median of a comparator group (14 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award will vest where the Group’s total shareholder return is equal to median and vesting will occur on a straight line basis in between these points. Where the Group’s total shareholder return is below the median of the comparator group, the TSR Award will lapse. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
Under the performance share plan, introduced during 2005, participating executives will be eligible for an award of free shares, known as performance shares, to match the bonus shares awarded as part of their 2004 and 2005 bonus. The maximum match will be two performance shares for each bonus share, awarded at the end of a three year period. The actual number of shares awarded will depend on the Group’s total shareholder return performance measured over a three year period, compared to other companies in the comparator group. The maximum of two performance shares for each bonus share will be awarded only if the Group’s total shareholder return performance places it first in the comparator group; one performance share for each bonus share will be granted if the Group is placed fifth; and one performance share for every two bonus shares if the Group is placed eighth (median). Between first and fifth position, and fifth and eighth position, sliding scales will apply. If the total shareholder return performance is below median, no performance shares will be awarded. There will be no retest. Whilst income tax is deducted from the bonus before deferral into the plan, where a match of performance shares is justified, these shares will be awarded as if income tax had not been deducted.
number of shares number of shares outstanding at 1 January 1,767,594 1,849,102
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding for the option schemes were as follows: executive schemes saye schemes other share option plans weighted weighted weighted weighted weighted weighted average average average average average average exercise price remaining life number of exercise price remaining life number of exercise price remaining life number of (pence) (years) options (pence) (years) options (pence) (years) options
The fair value calculations at 31 December 2008 for grants made in the year are based on the following assumptions: other option other share saye schemes plans
no provisions have been recognised in respect of loans given to key management personnel (2007: £nil).
At 31 December 2008, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £3 million with eight directors and six connected persons (2007: £2 million with five directors and three connected persons).
Details of the principal subsidiaries are given in note 8 to the parent company financial statements. In accordance with IAS 27, transactions and balances with subsidiaries have been eliminated on consolidation.
on 27 July 2007, following agreement between the ofT and a number of UK financial institutions, the ofT issued High Court legal proceedings against those institutions, including Lloyds TSB Bank plc, to determine the legal status and enforceability of certain of the charges applied to their personal customers in relation to requests for unplanned overdrafts. on 24 April 2008, the High Court determined, in relation to the current terms and conditions of those financial institutions (including Lloyds TSB Bank plc), that the relevant charges are not capable of amounting to penalties but that they are assessable for fairness under the Unfair Terms in Consumer Contracts Regulations 1999. on 23 may 2008, Lloyds TSB Bank plc, along with the other relevant financial institutions, was given permission to appeal the finding that unplanned overdraft charges are assessable for fairness. The appeal hearing commenced on 28 october 2008 and concluded on 5 november 2008. on 26 february 2009, the Court of Appeal dismissed the banks’ appeal and held that the charges are assessable for fairness. The banks will now be applying to the House of Lords for permission to appeal this judgment.
If the fSCS does not receive sufficient funds from the failed institutions to repay Hm Treasury in full, it will raise compensation levies. At this time, it is not possible to estimate the quantum or timing of any shortfall resulting from the cash flows received from the failed institutions and, accordingly, no provision for compensation levies, which could be significant, has been made in these financial statements.
Acceptances and endorsements arise where Lloyds Banking Group agrees to guarantee payment on a negotiable instrument drawn up by a customer.
Excluding commitments in respect of investment property (see note 22), capital expenditure contracted but not provided for at 31 December 2008 amounted to £92 million (2007: £102 million). of this amount, £85 million (2007: £96 million) related to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk and the Group’s management of capital can be found on pages 42 to 64. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.
Available-for-sale financial assets – – – 55,707 – – – 55,707 financial liabilities
Trading and other financial assets at fair value through profit or loss – 4,663 53,248 – – – – 57,911
Deposits from banks – – – – – 39,091 – 39,091
for the year ended 31 December 2007, a negative valuation movement of £34 million, including exchange movements, was recognised in the revaluation reserve in respect of available-for-sale financial assets and £32 million was recognised in interest income.
In addition the Group has a small number of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. These cash flows are expected to occur over the next six years and the hedge accounting adjustments will be reported in the income statement as the cash flows arise. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2008 was £867 million (2007: £630 million) with a net fair value liability of £90 million (2007: £23 million) (see note 17). In 2008, there is no ineffectiveness recognised in the income statement that arises from cash flow hedges (2007: nil). There were no transactions for which cash flow hedge accounting had to be ceased in 2008 or 2007 as a result of the highly probable cash flows no longer being expected to occur.
Swiss franc: Gross exposure 2,784 1,945 net investment hedge (2,663) (1,875)
Assets arising from reinsurance contracts held 385 350 financial guarantees 10,382 9,753
See note 48 – Contingent liabilities and commitments for further information.
Index to annual report 192 financial calendar 2009 195 is included in note 16 and a similar analysis for available-for-sale financial assets is included in note 21. The Group’s non-participating investment contracts are all unit-linked. movements in the fair values of trading and other financial assets at fair value through profit or loss which back those investment contracts, including movements arising from credit risk, are borne by the contract holders.
derivative assets – the Group reduces exposure to credit risk by using master netting agreements and by obtaining cash collateral. An analysis of derivative assets is given in note 17. of the net derivative assets of £18,286 million (2007 £5,372 million), cash collateral of £2,970 million (2007: £2,004 million) was held and a further £5,840 million was due from oECD banks (2007: £1,459 million).
Past due but not impaired 3,134 1,146 555 4,835 – 17
Allowance for impairment losses (note 20) (186) (2,345) (1,038) (3,569) – (158)
Past due but not impaired 2,153 966 639 3,758 – –
loans and advances designated loans and advances to customers at fair value loans and retail – retail – through advances mortgages other wholesale total profit or loss to banks £m £m £m £m £m £m
loans and advances designated loans and advances to customers at fair value loans and retail – retail – through advances mortgages other wholesale total profit or loss to banks £m £m £m £m £m £m fair value of collateral held 2,637 n/a n/a n/a fair value of collateral held 2,111 n/a n/a n/a
Loans and advances that were renegotiated during the year and that would otherwise have been past due or impaired at 31 December 2008 totalled £144 million (2007: £579 million).
Total held at fair value through profit or loss 11,726 3,685 4,591 2,749 402 1,823 24,976 available-for-sale financial assets
Treasury bills and other bills 31 1,596 – – – – 1,627
Derivative financial instruments, trading and other liabilities at fair value through profit or loss 29,479 1,077 5,295 7,203 3,818 46,872
Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IfRS 4, as follows: up to 1-3 3-12 1-5 over 5 1 month months months years years total £m £m £m £m £m £m
Within 1-3 3-5 over 5 1 year years years years Total £m £m £m £m £m fair values of finanCial assets and liabilities financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, or are unreliable because of poor liquidity, fair values have been determined using valuation techniques which, to the extent possible, use market observable inputs. Valuation techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics either identical or similar to those of the instruments held by the Group. These estimation techniques are necessarily subjective in nature and involve several assumptions.
TRADInG AnD oTHER fInAnCIAL ASSETS AT fAIR VALUE THRoUGH PRofIT oR LoSS
All derivatives are recognised at their fair value. fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and options pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative.
Change in derivative financial instruments, trading and other financial assets at fair value through profit or loss (8,990) (4,348)
Total other items 886 53 non-cash and other items (4,064) 2,784
Less: amounts with a maturity of three months or more (12,461) (6,946)
IfRIC 16 Hedges of a net Investment in a foreign operation1
Amendments to IAS 32 financial Instruments: Presentation and IAS 1 Presentation of financial Statements – Puttable financial Instruments and obligations Arising on Liquidation
Improvements to IfRSs Sets out minor amendments to IfRS standards as part of annual improvements process.
on 15 January 2009, the Company issued £1,000,000,000 12 per cent fixed to floating non-cumulative callable preference shares to Hm Treasury pursuant to the preference share subscription agreement entered into with effect from 13 october 2008 by the Company and Hm Treasury. These preference shares became fungible with the £3,000,000,000 12 per cent fixed to floating non-cumulative callable preference shares issued by the Company on 16 January 2009 (see below); under the terms of these preference shares, the payment of cash dividends to ordinary shareholders is not permitted until the preference shares are repaid.
The total fair value of the purchase consideration was £7,751 million, comprising 7,775,694,993 Lloyds Banking Group ordinary shares with a fair value of £7,651 million based on the closing price of 98.4p per ordinary share on 15 January 2009, the trading day immediately prior to completion, and directly attributable transaction costs of approximately £100 million.
53 approval of finanCial statements The consolidated financial statements were approved by the directors of Lloyds Banking Group plc on 26 february 2009.
We have reported separately on the consolidated financial statements of Lloyds Banking Group plc for the year ended 31 December 2008.
our responsibility is to audit the parent company financial statements and the part of the directors’ remuneration report to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). This report, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with section 235 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the parent company financial statements and the part of the directors’ remuneration report to be audited. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the parent company financial statements, and of whether the accounting policies are appropriate to the Company’s circumstances, consistently applied and adequately disclosed.
pricewaterhouseCoopers llp Chartered Accountants and Registered Auditors Southampton, England 26 february 2009
Index to annual report 192 financial calendar 2009 195 at 31 december 2008 note £ million £ million assets non-current assets: Investment in subsidiaries 8 5,589 5,589
Current assets: Derivative financial instruments 1,297 169 other assets 205 165
Cash and cash equivalents 1,201 58 total assets 11,517 8,895 equity and liabilities
The directors approved the parent company financial statements on 26 february 2009.
Employee share option schemes: Value of employee services – 30 30
Employee share option schemes: Value of employee services – 12 12
Report of the independent auditors on the parent company financial statements 182 parent company financial statements 183 notes to the parent company financial statements 186 shareholder information
Proceeds from issue of ordinary shares via private placement 760 –
1 aCCounting poliCies The parent company has applied International financial Reporting Standards (IfRS) as adopted by the European Union (EU) in its financial statements for the year ended 31 December 2008. IfRS comprises accounting standards prefixed IfRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International financial Reporting Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 ‘financial Instruments: Recognition and measurement’ relaxes some of the hedge accounting requirements; the Company has not taken advantage of this relaxation, and therefore there is no difference in application to the Company between IfRS as adopted by the EU and IfRS as issued by the IASB.
The accounting policies of the parent company are the same as those of the Group which are set out in note 2 to the consolidated financial statements, except that it has no policy in respect of consolidation and investments in subsidiaries are carried at historical cost, less any provisions for impairment.
3 amounts due from subsidiaries These comprise short-term lending to subsidiaries, repayable on demand. The fair values of amounts owed by subsidiaries are equal to their carrying amounts. no provisions have been recognised in respect of amounts owed by subsidiaries.
The key management personnel of the Group and parent company are the same. The relevant disclosures are given in note 47 to the consolidated financial statements.
Country of share capital registration/ and voting incorporation rights held nature of business
The principal area of operation for each of the above subsidiaries is the United Kingdom and the Channel Islands, except as follows: Lloyds TSB Bank plc operates principally in the UK but also through branches in Belgium, Dubai, Ecuador, france, Germany, Gibraltar, Hong Kong, Japan, Jersey, Luxembourg, malaysia, monaco, netherlands, Singapore, Spain, Switzerland, Uruguay and the USA, and representative offices in China, Colombia, Guatemala and Paraguay.
The accounting policies in note 2 to the consolidated financial statements describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet heading.
Amounts due from subsidiaries – – 92 – 92 financial liabilities: Derivative financial instruments 29 – – – 29
The table below analyses financial instrument liabilities of the Company, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date, balances with no fixed maturity are included in the over 5 years category.
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £111 million (2007: £97 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years.
The valuation techniques for the Company’s financial instruments are as discussed in note 49 to the consolidated financial statements.
Lloyds Banking Group plc was incorporated as a public limited company and registered in Scotland under the UK Companies Act 1985 on 21 october 1985 with the registered number 95000. Lloyds Banking Group plc’s registered office is Henry Duncan House, 120 George Street, Edinburgh EH2 4LH, Scotland, and its principal executive offices in the UK are located at 25 Gresham Street, London EC2V 7Hn.
A copy of the Group’s corporate responsibility report may be obtained by writing to Corporate Responsibility, Lloyds Banking Group plc, 25 Gresham Street, London EC2V 7Hn. This information together with the Group’s code of business conduct is also available on the Group’s website www.lloydsbankinggroup.com the better payment praCtiCe Code
analysis of shareholders at 31 december 2008 shareholders number of ordinary shares
Critical accounting estimates and judgements 111 future accounting developments 180 aCquisition
Critical accounting estimates and judgements 111 notes to the consolidated financial statements 130
Currency risk 167, 189 fair values of financial assets and liabilities 175, 190
Critical accounting estimates and judgements 112 notes to the consolidated financial statements 131
Shareholder information 191 index to annual report 192 financial calendar 2009 195 governanCe
Valuation 176 marKetplaCe trends 8 net fee and Commission inCome 116 net interest inCome 116 net trading inCome 117 operating expenses 120 other operating inCome 118 pensions
Insurance and Investments 22 notes to the consolidated financial statements 114
Accounting policy 107 notes to the consolidated financial statements 134 taxation