This annual report includes certain forward looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995 with respect to the business, strategy and plans of Lloyds Banking Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Lloyds Banking Group’s or its directors and/or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ’will’, ‘would’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar future or conditional expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future.
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 over 30 countries.
Our corporate strategy is focused on: DEVELOPING STRONG CUSTOMER FRANCHISES THAT ARE BASED ON DEEP CUSTOMER RELATIONSHIPS
The Group believes that the successful execution of its strategy to focus on core markets, customer and cost leadership, capital efficiency and a prudent risk appetite will enable the Group to achieve its vision of being recognised as the best financial services company in the UK.
ALL OUR DIVISIONS ASPIRE TO BE RECOGNISED AS THE BEST IN THEIR CHOSEN FINANCIAL MARKETS OUR DIVISIONS
Since the acquisition of HBOS in January 2009 there have been four primary operating divisions: Retail, Wholesale, Wealth and International, and Insurance. The key product markets in which they participate and relative contribution to the Group’s total income are presented below and a more detailed analysis of their strategy, business and performance is outlined within the Business Review.
Banking net interest margin improved to 1.83 per cent in the second half of the year, compared to 1.72 per cent in the first half.
Outlook: economy showing signs of stabilisation, with weak upturn expected in 2010. Significant improvement in the performance of our continuing businesses expected in 2010.
Medium-term goals reflect economic outlook and significant opportunity to leverage relationship-led model across enlarged business base. High single-digit income growth from our continuing businesses targeted within two years. Continued reduction in cost:income ratio. Further run-off of around £140 billion of assets to reduce the balance sheet in the medium term and allow for investment in core relationship businesses.
My first annual statement to you as chairman comes at the end of what has been a momentous and, at times, extraordinary year for Lloyds Banking Group. It has been a year of change but also one of achievement as the business has positioned itself to benefit from what we expect is going to be good earnings momentum over the next few years. The changing economic climate both in the UK and overseas over the past 12 months has presented the banking industry with many difficult challenges. However, as we move into 2010, we believe that we are well positioned to benefit from the encouraging signs of economic recovery, albeit we believe the UK economy will grow at below trend levels over the next few years.
During the last few months of 2009 the Group, together with HM Treasury, concluded negotiations with the European Commission on a restructuring plan required as a result of the state aid received by the Group. We will dispose of a retail banking business with at least 600 branches, a 4.6 per cent market share of the personal current account market in the UK and approximately 19 per cent of the Group’s mortgage assets, along with a number of behavioural remedies. The board is confident that the plan will not have a materially negative impact on the Group.
One of the behavioural commitments we entered into as part of the plan is not to make coupon payments or to exercise voluntary call options on certain securities from 31 January 2010 until 31 January 2012. This will also prevent us from paying dividends on our ordinary shares for the same duration. We fully understand the hardship that the lack of dividend and coupon payments has caused many of our shareholders and stakeholders, and we are working diligently to restore the ability to pay dividends and create shareholder value. The board intends to resume dividend payments on ordinary shares as soon as market conditions and the financial performance of the Group permit, subject to the expiry, in 2012, of the restrictions arising from the European Commission’s remedies.
OUR YEAR IN BRIEF CREATION OF LLOYDS BANKING GROUP Lloyds Banking Group was created in January 2009 and is now the UK’s largest retail bank.
CAPITAL RAISING In December we successfully undertook the largest ever capital raising in Europe comprising a £9 billion debt exchange and a £13.5 billion rights issue. This provided a market-based alternative to our intended participation in the Government Asset Protection Scheme and provided superior economic value to our shareholders.
Since joining the Group in September, I have had the pleasure of meeting many of our colleagues and it is clear we have a strong team who have shown an impressive degree of professionalism, enthusiasm, commitment and sheer hard work in these challenging circumstances. Not only have they successfully undertaken the normal day job of serving our customers and realising the potential of the leading franchise in the UK, but they are engaged in implementing one of the most complex integration and corporate restructurings ever undertaken. They have acquitted themselves admirably and I thank them on behalf of all shareholders.
Importantly, our Group is led by a strong management team who I believe have the skills to ensure this organisation delivers value to our customers and shareholders. They have successfully addressed the key strategic and operational challenges facing the organisation and will continue to do so to the benefit of all our stakeholders.
We are conscious of the current public debate about remuneration in the banking sector. We understand that this is a sensitive issue for many people at a time when their personal finances are challenged, and also in the light of the significant support given by taxpayers to our industry. We have thought carefully and responsibly about the design of our remuneration schemes and have been engaged in discussions with, and listened to, the views of a broad group of our shareholders on the remuneration of senior management. We are committed to maintaining the right balance between reward, risk management and performance and will continue to emphasise consultation with our shareholders with a view to achieving the right balance. Specifically, we are active participants in the debate about the appropriate remuneration structures for the banking sector. We believe deferral and clawback are the way forward and have implemented these two factors in our own remuneration structures. They have also become key features of remuneration design in the banking sector more generally and will be refined further, here in the UK and elsewhere.
The acquisition of HBOS at the beginning of 2009 improved the strategic positioning of Lloyds Banking Group albeit at short-term cost. We now have leading positions in many of the financial markets in which we participate, a market leading distribution capability, well recognised brands and a large customer base. The scale of the organisation provides us with the opportunity to further invest in products and services, systems and training, offering unparalleled choice and service to our customers. This strategic positioning, along with our strong relationship focus and prudent risk appetite, provides the platform for future growth.
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Although we are forecasting a slow, below trend, economic recovery, the Group is successfully addressing the near-term challenges and is well positioned to deliver value for our customers and shareholders. As a result, the financial performance of the Group’s continuing businesses is expected to improve significantly in 2010 and beyond.
On a statutory basis, the Group delivered a profit before tax of £1 billion for 2009. This result includes an £11.2 billion negative goodwill gain associated with the purchase of HBOS, given we acquired the business at half book value in anticipation of the likely losses resulting from their troubled asset portfolios.
INTEGRATION Excellent progress is being made on the integration of the two businesses. Detailed integration plans have been developed and implemented and we exited the year with a cost synergy run-rate of £766 million. The significant progress being made has led us to raise the expected synergies to a £2 billion annualised run-rate by the end of 2011.
EU STATE AID The uncertainty of the state aid repercussions was addressed in November when our restructuring plan was agreed by the European Commission. The board approved the restructuring plan and is confident that this will not have a materially negative impact on the Group.
Total income, net of insurance claims, was up 12 per cent on prior year, helped by lower write-downs on treasury assets and the profits from debt swaps. These gains more than offset the year-on-year decline in margins, which suffered from the impact of very low base rates and increased funding costs as we lengthened our maturity profile.
With over 30 million customers we understand the financial hardships that many households and businesses are experiencing as a result of the recent economic decline in the UK. We are committed to helping our customers in these challenging times, which is reflective of our relationship-based approach. In Retail, we maintained strong levels of mortgage lending, with £35 billion of gross new lending, and helped thousands of our customers to buy new homes. In Wholesale we have provided approximately £10 billion of committed gross lending to small and medium-sized enterprises and approximately £25 billion to Corporate customers. We are acutely aware of the importance of supporting households and businesses as we exit the recession, and we will remain just as focused on this in 2010 as we were in 2009.
A number of steps were taken in the year to extend the Group’s wholesale funding maturity and to further improve our liquidity profile. The Group’s loan to deposit ratio improved and over 50 per cent of the wholesale funding had a maturity of over one year (2008: 44 per cent). We had also established an £88 billion liquidity buffer at the end of 2009. In addition, the Group continued to widen its diverse range of funding sources and had already achieved a significant amount of its expected term funding issuance for 2010 by the end of January.
– Deliver annual reductions in our cost:income ratio of 2 per cent over the next few years.
ISSUE: THE GOVERNMENT SHAREHOLDING As a result of the recapitalisation of the banking sector and the subsequent capital raisings the Government now holds a significant stake in Lloyds Banking Group. What are the implications of this holding, how does the Government intend to reduce its holding and how does the Government’s share ownership impact the Group’s business?
The timing of any share disposal will be at the discretion of UKFI. However, within the publication ‘An Introduction: Who We Are, What We Do and the Framework Document Which Governs the Relationship Between UKFI and HM Treasury’, it is stated that UKFI is to ‘develop and execute an investment strategy for disposing of the investments in the banks in an orderly and active way through sale, redemption, buy-back or other means within the context of an overarching objective of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and to acting in a way that promotes competition’.
ISSUE: STATE AID The European Commission required the Group to agree a restructuring plan as a result of the investment in the Group by HM Treasury. What remedies were agreed with the European Commission and what are the implications of these remedies?
The assets and liabilities, and associated income and expenses, of the business to be divested (referred to above) cannot be determined with precision until nearer the date of sale. However, the Company estimated that, as at 31 December 2008 and after aggregating the elements relating to Lloyds TSB and HBOS, the retail business to be divested comprised approximately £70 billion of customer lending and £30 billion of customer deposits. For the year ended 31 December 2008, the board estimated that the retail business to be divested generated income of approximately £1.4 billion and contributed approximately £500 million of profit before tax to the Group.
ISSUE: FUTURE GROWTH At the time of the acquisition of HBOS the Group indicated that the acquisition was a unique transaction that would position the Group for further growth. Does the Group still believe that this is the case and how is the Group going to deliver earnings growth over the next few years?
Our customer franchise and relationship focus will be key drivers of earnings growth going forward and we believe that the Group can deliver high single-digit income growth within the next few years as we meet the needs of our customers more effectively and extend the depth of our customer relationships.
Overall the Group believes that the successful execution of its strategy focusing on core markets, customer and cost leadership, capital efficiency and a prudent risk appetite should enable the Group to deliver earnings growth and shareholder value whilst achieving its vision to be recognised as the best financial services company in the UK.
As a result of the UK Government’s investment in the Group as part of the initial recapitalisation by the Company in November 2008, the rights issue announced in November 2009 and our participation in the Credit Guarantee Scheme, the Group has been deemed to have accepted state aid and subsequently the European Commission required us to undertake a restructuring plan (see the state aid question for further detail). This, amongst other things, includes a behavioural commitment not to make discretionary payments of coupons or to exercise voluntary call options on hybrid securities from 31 January 2010 until 31 January 2012. This also prevents the Group from paying dividends on its ordinary shares for the same duration.
Perhaps partly in response to such low interest rates, other economic indicators have not turned out so badly in 2009 as many had feared.
Alternative scenarios remain possible. The Bank of England’s most likely outcome, as published in the February 2010 Inflation Report, is for a somewhat faster recovery during 2010 than the consensus forecast. However, the risks around that are skewed towards the downside.
Weakening lending growth appears to have been driven by both supply and demand. Some lenders have pulled back from the market, especially from higher risk segments. But at the same time, data on our own retail customers shows that they have reacted to the recession by prioritising reducing debt. This trend is apparent across all our customer groups, whether split by age, income, or indebtedness. This helps to explain why market deposit growth also weakened in 2009, despite a higher national saving ratio. Households have on average chosen to use the cash freed up by reduced spending and lower debt interest payments to pay off debt rather than save more.
Market mortgage arrears rose during the first half of 2009, but then fell back in the second half. Market credit card arrears also fell during the second half. Improving arrears trends may have been helped by households starting to pay down debt. And many mortgage borrowers will have found their debt servicing costs reduced during 2009 as their variable mortgage rates fell or as their fixed rate loans expired and they rolled off onto lower standard variable rates. Quite strong growth in the average household’s real disposable income in 2009 will also have helped, aided by better-than-expected employment levels in the second half and falling inflation.
During 2009 the Group delivered a resilient trading performance against the backdrop of a marked slowdown in the UK economic environment and continued challenges in financial markets. In addition, the Group has made excellent progress in the integration of HBOS following its acquisition on 16 January 2009. Statutory profit before tax in 2009 was £1,042 million, compared to £760 million in 2008, largely reflecting the impact of an £11,173 million credit to the income statement from the gain arising on the HBOS acquisition (negative goodwill) which offset the significant increase in impairments during the year. Profit attributable to equity shareholders was £2,827 million and earnings per share (EPS) totalled 7.5p.
The Group delivered a resilient revenue performance in 2009 given significant year-on-year margin pressures. Total income, net of insurance claims, was 12 per cent higher at £23,964 million, supported by a good performance in Wholesale largely as a result of the absence of last year’s £3.4 billion impact of market dislocation, more favourable interest and currency rate environments, good transaction volumes in capital markets and strong flows of client driven derivative transactions at improved spreads. Income also includes £1.5 billion gains on a number of liability management transactions.
Year-on-year Group net interest income decreased by £2,177 million, or 15 per cent, to £12,726 million. The net interest margin from our banking businesses was 24 basis points lower at 1.77 per cent, as higher asset pricing was more than offset by the impact of lower deposit margins, reflecting the impact of falling base rates, and higher funding costs, which included the impact of the Group extending its wholesale funding maturity profile. During the second half of 2009 however, the impact of asset pricing more than offset the impact of lower base rates and higher funding costs and the margin increased to 1.83 per cent, compared to 1.72 per cent in the first half of the year. The net interest margin is expected to increase in 2010 to approximately 2 per cent, with further improvements expected in the margin in subsequent years reflecting the impact of continued improvements in asset pricing, moderate base rate rises and greater stability in wholesale funding markets. This margin outlook reflects our core economic assumptions for the medium term and includes the impact of the Group’s asset reduction programme and the assumed costs of refinancing as wholesale funding matures. Other income, net of insurance claims, increased by £4,786 million, or 74 per cent, to £11,238 million, largely reflecting the absence of last year’s investment write-downs, and the gains on liability management transactions.
The Group has an excellent track record in managing its cost base, and has continued to deliver a strong cost performance. During 2009, operating expenses decreased by 5 per cent to £11,609 million, as integration related savings have started to be captured and lower operating lease depreciation offset inflation linked growth and investment in our continuing businesses. Over the last twelve months, the total number of roles has reduced by over 11,500 as the Group has started to achieve its targeted cost synergy savings.
We continue to believe that the overall Wholesale impairment charge peaked in the first half of 2009 and we have seen significant reduction in the Wholesale impairment charge in the second half of 2009. Further significant reductions are expected in 2010 and beyond, assuming current economic expectations. We have spent a significant amount of time analysing and addressing the issues in the legacy HBOS portfolios, with the greatest attention paid to the over concentration in real estate related lending and those portfolios that fall outside the Lloyds TSB risk appetite. As a result of our portfolio review, which applied prudent assumptions to real estate asset expectations, and with the deterioration in the economy translating into lower commercial property valuations, we took prudent and material impairment charges especially in the first half of the year.
In our Wealth and International business the impairment charge rose by £3,347 million to £4,078 million, reflecting significant provisions against our Irish (£1,793 million) and Australian (£508 million) commercial real estate portfolios. We continue to have ongoing concerns with regard to the outlook for the Irish economy although we expect 2009 to have been the peak for the International impairment charge.
Overall, impairment losses increased by £9,108 million to £23,988 million. Impairment losses on loans and advances to customers expressed as a percentage of average lending was 3.25 per cent, compared to 1.81 per cent in 2008. Impaired loans and advances increased by £27,529 million to £58,833 million and now represent 8.9 per cent of total loans and advances to customers, up from 4.4 per cent at 31 December 2008.
As a result of these adjustments, the Group expects some £3.3 billion, net, to unwind positively through the Group’s income statement over the medium to long term. During 2009, the Group’s income statement reflected gains of £6.1 billion. In 2010, we currently expect a further benefit of some £2.5 billion. Thereafter, over the medium term, smaller benefits are expected to accrue.
The Group’s 2009 income statement includes a tax credit of £1,911 million. This primarily reflects a tax credit relating to the Group’s reported loss and a policyholder interests related tax charge offsetting in full the credit for policyholder interests included in the Group’s profit before tax.
At the end of December 2009, the Group’s capital ratios, following the Group’s successful capital raising in December 2009, increased significantly with a total capital ratio on a Basel II basis of 12.4 per cent, a tier 1 ratio of 9.6 per cent and a core tier 1 ratio of 8.1 per cent. These capital ratios were further enhanced by the issuance on 18 February 2010 of £1.5 billion equity, as part of the capital raising programme announced in November 2009, which further increased the core tier 1 capital ratio by 30 basis points to an adjusted 8.4 per cent. During 2009, risk-weighted assets decreased by 1 per cent to £493.3 billion, as the reduction in balance sheet assets was partly offset by the procyclical impact of the weaker economic environment. Over the next few years we expect to see further reductions in risk-weighted assets as a result of both balance sheet asset reductions and a positive procyclical impact from the expected improvement in the UK economic environment.
In the Group’s Interim Results announcement in August 2009, we set out our strategy to reduce assets associated with non-relationship lending and investments, including business which is outside our current risk appetite, by some £200 billion by the end of 2014. It is our intention to manage these assets for value and, given the current economic climate, our primary focus will be on running these assets down over time. During 2009, the Group’s total balance sheet assets reduced by £100 billion of which £60 billion related to the portfolios of assets in run-off (£15 billion customer assets; £30 billion treasury assets; £15 billion impairment). We expect to achieve a further reduction in such assets of approximately £140 billion over the next few years. The impact of running down these portfolios is not expected to have a significant impact on the Group’s financial performance over the medium term.
Profi t (loss) before tax and fair value unwind 975 (11,600) (3,298) 1,024 499 (12,400)
Key balance sheet and other items 31 December 2008 £bn £bn £bn £bn £bn £bn
Strong cost management delivering benefits. Operating expenses decreased by 8 per cent primarily due to tight cost control, cost savings achieved from the integration programme and lower Financial Services Compensation Scheme charges.
New accounts opened in Lloyds TSB in 2009 were broadly in line with 2008 despite the difficult market, with lower mortgage sales being offset by a particularly strong performance in savings. Sales in the Halifax and Bank of Scotland networks have shown an improving trend in the second half of the year. The pilot of the Lloyds TSB leads system in Halifax and Bank of Scotland in the second half resulted in a significant sales uplift. This will be rolled out to the whole network in 2010.
To support Retail customers, who are encountering financial difficulties, a cross-channel support programme has been launched. Lloyds TSB branches and telephone units have at least one trained Financial Health Specialist providing customers with budgeting and money management advice. In the Halifax and Bank of Scotland businesses, customers have a dedicated telephone support line with trained specialists able to guide them through financial difficulties. Support is also available for all customers online and through a specially developed brochure. For those customers requiring more intensive help, assistance is provided through dedicated support units where tailored repayment programmes can be agreed. Customers are actively supported and referred to free money advice agencies where they have multiple credit facilities that require restructuring.
Total income in Mortgages and Savings has decreased by 27 per cent. The reduction in Mortgage income reflected increased wholesale money market funding costs, which was partly offset by higher asset pricing. Lower income in Savings was the result of margin pressures arising from lower base rates and the competitive environment, the impact of which was partly offset by higher customer deposits.
Operating expenses decreased by £397 million, or 8 per cent, to £4,566 million driven primarily by strong cost control, cost savings resulting from integrating the two businesses and the benefit of a lower Financial Services Compensation Scheme levy. The reduction in operating expenses resulting from integrating the Lloyds TSB and HBOS retail businesses was delivered through streamlining management structures, consolidating the number of mortgage operational sites, integrating and simplifying the mortgage operating model, procurement savings from the rationalisation of suppliers and property savings through the consolidation of sites.
Arrears levels in the secured portfolios were higher than 2008 but improved in the second half of 2009, and remained below the industry average. The percentage of mortgage cases more than three months in arrears increased to 2.3 per cent at 31 December 2009 compared to 1.8 per cent as at 31 December 2008. The stock of repossessed properties reduced by 32 per cent to 2,720 properties compared to 4,011 properties at the end of 2008 and, as a proportion of total accounts, remains lower than the industry average. Currently, average proceeds from the sale of repossessed properties are in excess of average valuations assumed in Retail’s provisioning models.
Corporate Markets comprises Corporate, Commercial, Corporate Real Estate, Specialist Finance and Wholesale Markets. Corporate, Commercial and Corporate Real Estate provide relationship-based banking, risk management and advisory services to corporate and commercial customers principally in the UK. Specialist Finance includes the acquisition finance and private equity businesses. Wholesale Markets provides risk management solutions, specialised lending, capital markets advisory and multi-product financing solutions to its customers, whilst managing the Group’s own portfolio of structured credit investments and treasury assets.
Asset Finance consists of a number of leasing and speciality lending businesses including Contract Hire (Lex, Autolease and Hill Hire), Specialist Assets and Consumer Finance (Black Horse Motor and Personal Finance).
Wholesale’s strategic goal is to be recognised as the UK’s leading, ‘through-the-cycle’, relationship-focused wholesale bank. The mission is to deepen and retain recurring, multi-product customer relationships building on deep insight into customer needs to provide a broad range of banking, risk management and capital market products.
Loss before tax and fair value unwind increased by £1,121 million to £11,600 million. This increase was driven by increased impairment losses reflecting the continued weak economic climate and the application of prudent Lloyds Banking Group impairment assumptions, primarily in HBOS Corporate Real Estate and HBOS (UK and US) Corporate businesses, partly offset by an increase in other operating income and a decrease in operating expenses.
Loss before tax and fair value unwind increased by £1,227 million to £11,736 million, due to an increase in impairment losses, partly offset by an increase in other income.
Total income increased by £3,384 million to £6,297 million as a result of the significantly reduced impact from market dislocation and the absence of investment write downs in 2009. Performance in key income drivers across Commercial Banking, Corporate Banking, Wholesale Markets and Corporate Real Estate are further discussed below.
In 2009, Wholesale has spent a significant amount of time continuing to analyse and address the issues in the legacy HBOS portfolios, with the greatest attention paid to over concentrations in real estate, individual entrepreneurial cases and those other portfolios that fall outside the legacy Lloyds TSB credit risk appetite. As a result, and in particular, Wholesale has applied appropriate assumptions about real estate asset expectations and with the deterioration in the economic conditions translating into lower commercial property valuations, has taken prudent and significant impairment charges. Whilst a recent improvement in property valuations has been noted, this has had a limited impact on the property development portfolio.
The share of losses from joint ventures and associates of £717 million, reduced by £226 million. There were fewer write-offs in 2009 as the majority of the book is now valued at nil with a remaining portfolio conservative carrying value of approximately £180 million.
Income performance benefited from strong customer demand for interest rate and foreign exchange products, market volatility and both internal and external demand for Treasury’s pricing and risk management service, albeit at more moderate levels in the second half of 2009. Trading flows are managed with the overriding aim of providing a service to customers, whilst maintaining Treasury and Trading’s conservative risk appetite.
Operating expenses reduced by £1 million to £187 million reflecting a continued focus on cost management and cost savings achieved through integration.
Impairment losses increased by £422 million to £828 million, reflecting increases in impairment in both the retail and non-retail consumer finance businesses. In retail consumer finance, impairment increases reflected both the increase in the number of customers going into arrears and changes in the expected recovery rates on the defaulted second lien portfolio resulting from house price deflation, which has now stabilised. The business has also seen a significant increase in the number of corporate failures within its non-retail books which have also caused an increase in the impairment charge.
Loss before tax and fair value unwind amounted to £3,298 million, compared to a profit of £277 million in 2008 due to higher levels of impairment.
Impairment losses amounted to £4,078 million, compared to £731 million in 2008, reflecting the significant deterioration in the credit risk environment in Ireland and Australia. The impairment charge for Wealth and International is expected to have peaked in 2009, although the economic conditions in Ireland continue to be monitored closely.
Good progress was made in integrating the Lloyds TSB and HBOS Wealth and International businesses. Wealth and International’s integration synergies for 2009 were ahead of expectations.
Loans and advances to customers have decreased by 2 per cent to £63.5 billion, primarily due to net repayments and increased impairment provisions in the International businesses offset by the transfer of a £7 billion European loan portfolio from Wholesale division.
Operating expenses decreased by £11 million to £1,119 million driven by cost savings from integration, particularly in the asset management business, offset by investments to increase distribution capacity in Private Banking to support future growth plans and the negative impact of foreign exchange movements, principally arising from the stronger Euro.
Impairment losses have increased by £48 million to £71 million, reflecting the impact of the economic environment on the UK Private Banking and Expatriate lending portfolios.
The Wealth results include total income of £66 million and operating expenses of approximately £65 million relating to the external fund management business of Insight Investment which was sold in November 2009. No material gain or loss arose on the disposal.
Inflows – SWIP and Insight: Outflows – SWIP and Insight: Investment return, expenses and commission 16.4 (22.3)
Excluding the impact of the sale of Insight Investment’s external fund management business, funds under management are £23.5 billion higher than December 2008 due to strong inflows and a broad recovery in equity values in the second half of 2009.
Excluding favourable foreign exchange movements of approximately £120 million, total income fell by 13 per cent to £959 million reflecting higher wholesale funding costs, the impact on net interest income of the increase in impaired assets and a very competitive deposit market, partly offset by improved customer lending margins.
Loans and advances to customers include the transfer of a £7 billion European loan portfolio from Wholesale division in the second half of the year. The impact of this is offset by net repayments across all businesses and higher impairment provisions.
The Insurance division offers life assurance, pensions, investment products and general insurance and operates through three main businesses: Life, Pensions and Investments UK; Life, Pensions and Investments Europe; and General Insurance.
Profit before tax and fair value unwind amounted to £1,024 million, a decrease of £516 million on 2008, resulting from a reduction in income and an increase in claims, due to factors including demanding market conditions, partly offset by a decrease in operating expenses.
SUSTAINABLE PROFITABLE GROWTH Delivering profitable new business growth remains a key area of focus for the division. The intermediary sales forces of Scottish Widows and Clerical Medical were combined under the Scottish Widows brand on 1 July 2009 and work is well progressed in developing an integrated bancassurance proposition, planned to be launched mid 2010. The combined business will seek to build on the strengths inherent in each of the legacies and will use the financial return and capital disciplines employed by Scottish Widows. During the year certain legacy HBOS products were withdrawn and replaced by higher returning Scottish Widows products. This change in product offering, in keeping with the division’s strategic objectives, enhances the customer proposition, improves capital efficiency and increases shareholder return.
In General Insurance, growth in home insurance sales continued along with a resilient underwriting performance in 2009. Despite adverse weather claims in the year, the underwriting performance of the home book remained strong with a claims ratio of 36 per cent.
Profit before tax and fair value unwind decreased by £209 million. New business profit was significantly impacted by the general contraction in the life, savings and investments market but the reduction also reflects the integration of the intermediary sales forces and the withdrawal of a number of legacy HBOS products with poor returns. The EEV new business margin (UK) fell to 2.6 per cent in 2009 largely due to the transitional basis of commission payable on legacy HBOS products through the bancassurance channel. However, the UK margin increased to 2.7 per cent in the second half of 2009 from 2.5 per cent in the first reflecting strong cost control and increased focus on the profitability of
The capital positions of the UK life insurance companies within the Insurance division remain robust. As at 31 December 2009, the estimated Insurance Groups Directive (IGD) capital surplus for the Scottish Widows
The present value of new business premiums reduced by 26 per cent, reflecting both a general contraction in the UK and European markets as well as the re-positioning of the UK intermediary product range. Sales through the intermediary channel were significantly impacted as the UK intermediary sales forces were integrated and a number of legacy HBOS products with poor returns were withdrawn. As a result, sales in the intermediary channel reduced by 34 per cent. Sales through the bancassurance channel, excluding payment protection, continued to perform relatively robustly with a reduction of 11 per cent. This includes Scottish Widows sales through the bancassurance network which showed good growth of 18 per cent. Sales of OEIC products were strong with an increase of 12 per cent in 2009.
In addition to reporting under IFRS, the Insurance division provides supplementary financial reporting for its Life, Pensions and Investments business on an EEV basis. For the purpose of EEV reporting, covered business is defined as all life, pensions and investments business written in the Insurance division. This definition therefore excludes the results of St. James’s Place and the results of the business sold through the Wealth and International division which is not manufactured by the Insurance division.
Total profit before tax, before volatility and other items, increased by £231 million, or 31 per cent, to £966 million. Excluding the impact of experience variances and assumption changes, the profit before tax decreased by £430 million or 34 per cent to £828 million.
Net positive experience variances and assumption changes are predominantly driven by favourable tax experience and other nonrecurring items. The corresponding figure for 2008 includes a number of adverse impacts within the HBOS legacy business, including significant charges from policyholder lapses and other modelling changes.
NON-MARKET RISK An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk and the With Profit Fund these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.1
This sensitivity shows the impact on the Group’s annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
In addition to this the Integration programme will develop and deliver plans to produce synergy benefits. The focus throughout 2010 will be to combine systems and process legacies onto a single platform. This will primarily be achieved by delivering the IT consolidation, a single and centralised operating model, along with excellent disciplined procurement and rationalisation of the property portfolio.
Group Operations’ direct costs decreased by 3 per cent or £90 million in the year to £3,066 million due to the impact of integration synergies and a continued focus on cost management.
Central items includes certain income and expenditure not recharged to the divisions including the costs of certain central and head office functions and hedge ineffectiveness.
The Group’s insurance businesses have liability products that are supported by substantial holdings of investments, including equities, property and fixed interest investments, all of which are subject to variations in their value. The value of the liabilities does not move exactly in line with changes in the value of the investments, yet IFRS requires that the changes in both the value of the liabilities and investments be reflected within the income statement. As these investments are substantial and movements in their value can have a significant impact on the profitability of the Group, management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to results based on the actual return.
To protect against further deterioration in equity market conditions, and the consequent negative impact on the value of business in-force on the Group balance sheet, the Group purchased put option contracts. The charge booked for 2009 was £57 million. These options expired on 15 January 2010.
We are a business based on building deep and lasting relationships with our customers through the efforts of our people. Colleagues are our most valuable resource, as it is our colleagues who will build these relationships. Managing our colleagues effectively is therefore fundamental to the success of the business and achieving our vision of being the best financial services organisation.
The overall Engagement Index1 for the newly formed Lloyds Banking Group finished the year at 72 index points for 2009, 2 points above the target. Outputs from the survey are used to inform local action planning activities across the Group.
Our business strategy is translated into the Group’s balanced scorecard and this is aligned at each level of the organisation. This ensures colleagues understand how their personal objectives relate to the strategy. Contribution is measured against five factors: building the business; customer service; risk management; personal development and financial control. In addition, colleagues are also measured on how they achieve their goals against the core values of the company.
The Engagement Index is based on the result of a survey conducted quarterly, asking Lloyds Banking Group colleagues the same 13 questions used by Lloyds TSB since 2005 which refl ect 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.
In 2009 the number of on-line assessments totalled over 899,000. We delivered an average of 2.9 days formal learning per full time equivalent (FTE), which is commensurate with the continued investment in colleague development.
We continue to make progress on sexual orientation. Lloyds TSB won first place in Stonewall’s3 2009 Index of the best UK employers for lesbian, gay and bisexual (LGB) people. Following consultation with LGB colleagues we will refresh our sexual orientation programme for 2010. We continue to work closely with Stonewall, and in 2009 colleagues from Lloyds Banking Group attended their leadership programme.
Ensuring that we offer a Total Reward package that is market competitive and supports our strategy to attract and retain talented people to the business, continues to be a key driver for our reward framework. Throughout 2009, we have been developing and consulting with our unions about proposals for harmonised Terms and Conditions of employment. This will provide our colleagues with a market competitive Total Reward package while also supporting choice for our people, enabling us to support the diverse nature of our workforce.
In 2009 we won two Industry awards for our benefits provision, including Most Effective Use of a Voluntary Benefits Plan and Most Effective All Employee Share Scheme Strategy. This has set the standard to achieve for the reward package moving forward.
RADAR is the UK’s leading pan disability charity. Stonewall is the UK’s leading sexual orientation campaigning organisation.
Our key stakeholders are those who are impacted significantly by the business or who might impact on it. These include our shareholders, customers, colleagues, suppliers and wider society and the environment. Our commitment to our shareholders is covered in the chairman’s statement, the group chief executive’s review and throughout this annual report and accounts. In the following pages we cover our approach to customers, communities and climate change.
We are dedicated to building deep, lasting customer relationships that distinguish us as the best bank in the UK. We want to build a great organisation, which is recognised for operating to high standards and is built on strong customer relationships. We lent nearly £70 billion in new lending to homeowners and businesses in 2009. Lloyds TSB was voted the most trusted brand by Reader’s Digest readers in 2009, for the 9th year running, and came 1st in the Superbrands Retail Banks Sector survey.
We worked with the Council of Mortgage Lenders, Department of Communities and Local Government, Ministry of Justice, the Civil Justice Council and the financial advice sector throughout the year on the development of Government initiatives for customers facing difficulty. We are now participating in the Homeowner Mortgage Support Scheme, the Mortgage Rescue Scheme and the Support for Mortgage Interest scheme. We are fully committed to doing everything reasonably possible to support customers in financial difficulties and keep them in their homes. Through this focus, the level of Lloyds Banking Group repossessions has remained well below the Council of Mortgage Lenders industry average.
We have robust systems in place to ensure that our credit card lending is suitable to the financial circumstances of our customers. We check customers’ ability to make repayments at the time at which the account is opened, and then on a regular monthly basis to ensure that the borrowing remains suitable to their circumstances. We proactively contact customers showing signs of financial distress to discuss a range to solutions to help them manage short term difficulties.
We have committed £4 million to a new ‘further education’ financial capability project, working with The Treasury, the Department for Business, Innovation and Skills and the FSA, to improve the range of web based resources available to financial capability bodies across the further education and skills sector in the UK. The programme aims to develop
We also work to ensure our customers are aware of how to protect themselves from financial crime. Our various brand websites contain information to assist customers in understanding how to mitigate the risks of common types of internet fraud. We run regular financial crime awareness campaigns, support industry education initiatives and sponsor the charity Crimestoppers.
Our suppliers are important to us. We want to ensure we treat them fairly and pay them on time. In 2009, we became signatories to the new Prompt Payment Code. We commit to pay suppliers on time and not change the payment terms agreed at the outset of the contract. The Code requires that we provide clear guidance on payment procedures, including redress for any disputes, and encourage similar good practice amongst our suppliers and other businesses.
The UK Government is committed to reducing the country’s carbon emissions by 80 per cent from 1990 levels by 2050. A central part of its strategy is the introduction of a mandatory climate change and energy savings scheme, the Carbon Reduction Commitment Energy Efficiency Scheme, due to start in April 2010. We qualify as a participant in this scheme, which requires a collective 22 per cent emissions reduction from participants by 2012. We fully understand our obligations and are committed to driving down CO2 emissions. We are developing a carbon management policy and strategy to deliver a single approach for the new combined Group, and continue to invest significant capital in carbon reduction projects across the Group’s estate.
Lloyds Banking Group is represented by Group Executive Director Truett Tate on the ‘Corporate Leaders Group on Climate Change’. This group of leading businesses released the ‘Copenhagen Communiqué’, widely viewed as the progressive voice of business, for the Copenhagen Climate Change talks in December 2009.
We achieved a reduction of 143,000 journeys in 2009 compared with 2008. Across the combined Group, the volume of teleconferences increased by over 40 per cent to over 1.1 million. We will continue to promote virtual conferencing technologies to colleagues as an environmentally friendly, cost efficient alternative to travelling.
EQUATOR PRINCIPLES Lloyds Banking Group is a signatory to the Equator Principles. The Equator Principles are voluntary guidelines for the financial industry to manage social and environmental issues in project financing.
SUMMARY Our approach to our key stakeholders underpins our vision to be recognised as the best financial services company in the UK. We proactively manage our relationships with all of them.
The Group’s approach to risk is founded on robust corporate governance practices and a risk management culture which guides the way all employees approach their work, the way they behave and the decisions they make. The board takes the lead by establishing the ‘tone at the top’ and approving professional standards and corporate values for itself, senior management and other colleagues. The board ensures that senior management implements strategic policies and procedures designed to promote professional behaviour and integrity. The board also ensures that senior management implements risk policies and risk appetites that either limit, or where appropriate, prohibit activities, relationships, and situations that could diminish the quality of corporate governance. All colleagues including the group chief executive are assessed against a balanced scorecard that explicitly addresses their risk performance.
The group business risk committee and the group asset and liability committee are chaired by the group chief executive and include all members of the group executive committee. The aggregate group wide risk profile and portfolio appetite are discussed at these monthly meetings. The risk oversight committee, chaired by the deputy group chairman, comprises non-executive directors and oversees the Group’s risk exposures. This second-line-of-defence committee is supported by the chief risk officer, who is independent of the front line business units, is a full member of the group executive committee and reports to the group chief executive. The chief risk officer regularly informs the risk oversight committee of the aggregate risk profile and has direct access to the deputy group chairman and the members of the risk oversight committee.
The maintenance of a strong control framework remains a priority for the new Lloyds Banking Group and is the foundation for the delivery of effective risk management. The Group optimises performance by allowing divisions and business units to operate within approved capital, liquidity and risk parameters and within the Group’s policy framework. The Group’s approach to risk management ensures that business units remain accountable for risk whilst realising individual strategies to meet business performance targets. The combination of divisional and group risk management maintains effective independent oversight.
HM Treasury currently holds approximately 41.3 per cent of the Group’s ordinary share capital. There is a risk that this shareholding could in future be used to seek to exercise infl uence over the affairs or strategic business plans of the Group, particularly if other Government priorities or HM Treasury’s interests as a major shareholder in other fi nancial institutions do not align with their interests purely as a shareholder in the Group.
BOARD AND COMMITTEES The board, assisted by its key risk committees (risk oversight committee and group audit committee), approves the Group’s overall risk management framework. The board also reviews the Group’s aggregate risk exposures and concentrations of risk to seek to ensure that these are consistent with the board’s appetite for risk. The role of the board, audit committee and risk oversight committee are shown in the corporate governance section on pages 100 to 104, and further key risk oversight roles are described below.
The group business risk committee is supported by the following committees: – The group compliance and operational risk committee, which is responsible for proactively identifying current and emerging significant compliance and operational risks or accumulation of risks and control deficiencies across the Group and reviewing associated oversight plans to ensure pre-emptive risk management action. The committee also seeks to ensure that adequate divisional engagement occurs to develop, implement and maintain the Group’s compliance and operational risk management framework.
– The group credit risk committee, which is responsible for the development and effectiveness of the Group’s credit risk management framework, clear description of the Group’s credit risk appetite, setting of high level Group credit policy, and compliance with regulatory credit requirements. On behalf of the group business risk committee, the group credit risk committee monitors and reviews the Group’s aggregate credit risk exposures and concentrations of risk.
The director of group audit provides independent assurance to the audit committee and the board that risks within the Group are recognised, monitored and managed within acceptable parameters. Group audit is fully independent of group risk, seeking to ensure objective challenge to the effectiveness of the risk governance framework.
Oversight Reporting line Functional reporting line from BU risk officer or function to divisional risk officersa Functional reporting line to support the committees
RISK MANAGEMENT FRAMEWORK The Group’s risk management principles and risk management framework cover the full spectrum of risks that a group, which encompasses both banking and insurance businesses, would encounter.
The risk principles are executed through the policy framework and accountabilities. These principles are supported by the policy levels below: Principles – high level principles for the six primary risk drivers
Proportionate control activities are in place to design mitigating controls, to transfer risk where appropriate and seeks to ensure executives are content with the residual level of risk accepted.
Risk and control assessments are undertaken to assess the effectiveness of current mitigations and whether risks taken are consistent with the Group’s risk appetite (this includes the annual control self-assessment exercise).
The impact of risks and issues (including financial, reputational and regulatory capital) are determined through effective risk measurement including modelling, stress testing and scenario analysis.
Lloyds Banking Group’s policy is to maintain high levels of compliance with regulatory requirements and it will organise its business to maintain this level of compliance as the requirements become clearer, being mindful of maintaining an appropriate balance between risk and reward.
The key dependencies for successfully funding the Group’s balance sheet include the continued functioning of the money and capital markets at their current levels; successful right sizing of the Group’s balance sheet; the continuation of HM Treasury facilities in accordance with the terms agreed; limited further deterioration in the UK’s and the Group’s credit rating and no significant or sudden withdrawal of deposits resulting in increased reliance on money markets or UK Government support schemes. A return to the extreme market conditions of 2008 would place a strain on the Group’s ability to meet its financial commitments.
The Offi ce of Fair Trading’s (OFT) investigation and legal test case in respect of unarranged overdraft charges on personal current accounts concluded in 2009, for further details see note 52 (Notes to the consolidated fi nancial statements). The OFT is however continuing to discuss its concerns in relation to the personal current account market with the banks, consumer groups and other organisations under the auspices of its Market Study into personal current accounts. In October 2009, the OFT published voluntary initiatives agreed with the industry and consumer groups to improve transparency of the costs and benefi ts of personal current accounts and improvements to the switching process. The OFT aims to report on progress in respect of further changes it believes are required to make the market work in the best interest of bank customers by the end of March 2010.
EXPOSURES 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
MONITORING The Group’s strategy is reviewed and approved by the board. Reputational risk is covered at a number of levels throughout the organisation, which includes the group executive committee and the group business risk committee. Regular reports are provided to the group executive committee and the board on the progress of the Group’s key strategies and plans. Group risk conducts oversight to seek to ensure that business plans remain consistent with the Group’s strategy.
The Group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of counterparty. In its principal retail portfolios and a growing number of wholesale lending portfolios, exposure at default and loss given default models are also in use. They have been developed internally and use statistical analysis, combined, where appropriate, with external data and subject matter expert judgement. Each rating model is subject to a rigorous validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. All material rating models are authorised by the group model governance committee.
Each probability of default model segments counterparties into a number of rating grades, each representing a defined range of default probabilities. Exposures migrate between classifications if the assessment of the obligor probability of default changes. Each rating system is required to map to a master scale, which supports the consolidation of credit risk information across portfolios through the adoption of a common rating scale. Given the differing risk profiles and credit rating considerations, the underlying risk reporting has been split into two distinct master scales, a retail master scale and a wholesale master scale.
(Note 54 to the financial statements provides an analysis of the portfolio and page 68 relates to the divisional analysis that is set out on pages 69 to 75.)
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 2(H) to the consolidated financial statements on page 138). 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 models that are used for internal operational management and banking regulation purposes.
Index to annual report 266 from market movements. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.
– Controls over rating systems: The Group has established an independent team in group risk that sets common minimum standards, designed to challenge the discriminatory powers of systems, accuracy of calibration and seeks to ensure consistency over time and across obligors. Internal rating systems are developed and implemented by independent risk functions either in the business units or divisions with the business unit managing directors having ownership of the systems. Line management takes responsibility for ensuring the validation of the respective internal rating systems, supported and challenged by specialist functions in their respective division.
– Cross-border and cross-currency exposures: Country limits are authorised by the Country Limits Panel taking into account economic and political factors.
The Group’s total impairment losses increased by £9,108 million to £23,988 million in 2009. Impairment losses for loans and advances as a percentage of average gross loans and advances to customers, increased to 3.25 per cent from 1.81 per cent in 2008. This was principally due to the material deterioration in UK economic conditions in 2009. The rapid economic and asset value declines, together with aggressive lending polices in the heritage HBOS business, caused wholesale impairment losses to increase substantially during 2009. This was especially so in the HBOS Corporate Real Estate portfolio which has been particularly vulnerable to the deterioration in asset values as well as the HBOS (UK and US) Corporate portfolios.
Total impaired loans increased by £27,529 million to £58,833 million at 31 December 2009 and as a percentage of closing loans and advances to customers increased to 8.9 per cent from 4.4 per cent at 31 December 2008 driven by the deterioration in the economic environment, and in particular by declines in commercial real estate values and higher unemployment. The Group’s coverage ratio (impairment provisions as a percentage of impaired loans) has decreased to 44.2 per cent from 45.2 per cent in 2008. Whilst the ratio has increased within Wholesale and Wealth and International, the overall fall is due to the write-off of unsecured loans and advances within Retail that had been provided against in earlier years, as reported at the half-year. The Group believes it has adequate coverage.
The Group remains cautious about a number of downside risks, including a renewed macro-economic deterioration in the UK and Ireland. However, based on its latest economic assumptions, the Group expects a significantly lower impairment charge in 2010 compared to 2009.
Retail impairment losses increased by £532 million to £4,227 million in 2009, driven primarily by deteriorating economic conditions in the latter part of 2008 and the first half of 2009. Impairment losses were lower in the second half of 2009, compared to the first half, driven by lower secured impairment losses. The improvement in secured impairment losses reflected increases in UK house prices, slowing unemployment growth, better affordability with lower interest rates and management actions. Impairment losses for loans and advances, as a percentage of average loans and advances to customers, increased to 1.11 per cent from 0.97 per cent in 2008.
Total impaired loans increased by £909 million to £11,015 million at 31 December 2009 and as a percentage of closing advances to customers, increased to 2.9 per cent from 2.6 per cent at 31 December 2008. This is lower than the £11,394 million reported at 30 June 2009, as there was a gradual improvement in the second half of the year in secured loans, with unsecured lending remaining stable.
The Retail division’s loans and advances to customers are analysed in the following table: TABLE 1.8: LOANS AND ADVANCES TO CUSTOMERS As at 31 December 2009 2008 £m £m
Gross new mortgage lending by Retail in 2009 was £35 billion compared to £78 billion for 2008, representing a market share of gross new lending of 24 per cent compared with 31 per cent in 2008. Overall, mortgage balances outstanding at 31 December 2009 were £345.9 billion, a reduction of £3.7 billion in the year.
Management actions taken have resulted in new lending quality improving to pre-recessionary levels, with fewer customers now going into arrears. Specialist lending is now closed to new business and this book is in run-off.
The percentage of mortgage cases greater than three months in arrears (excluding possessions) increased to 2.3 per cent at 31 December 2009 compared to 1.8 per cent at 31 December 2008. Based on the most recent published figures by the Council of Mortgage Lenders, the Group is performing marginally better than the industry average.
Provisions held against secured assets appropriately reflect the risk of further losses from events that have already occurred. This includes adequate allowance for losses yet to emerge on accounts currently
Index to annual report 266 on repayment plans or benefiting from the very low interest rate environment.
Total impaired unsecured loans were £3.8 billion (31 December 2008: £5.4 billion) and represented 11.9 per cent of closing advances compared to 14.7 per cent at 31 December 2008. Provisions as a percentage of impaired loans decreased to 55.3 per cent (31 December 2008: 64.3 per cent). The reduction in both the level of impaired loans and the impairment provisions coverage reflected the write-off of £2.1 billion of unsecured loans which had been provided against in the prior years, as reported at the half-year.
As part of the process of allocating assets to the new management structure, the legacy HBOS portfolios have been resegmented and the 2008 comparative numbers are presented on an organisational basis consistent with 2009.
CORPORATE The Corporate (UK and US) portfolios felt the impact of the adverse economic environment in the first half of 2009 but this has stabilised during the second half with a lower rate of impairments raised against the portfolio and a slower rate of new cases being transferred into Business Support Units. A higher volume of impaired cases is expected in 2010 as the lag from the UK recession bites. This impact is expected to be biased toward the mid size franchise, of which the HBOS heritage portfolio is characterised by high levels of obligor concentration to riskier counterparties many with a property related component, thereby impacting the level of the impairment charge in 2009. The significant level of impairments taken in 2009 in the HBOS corporate business is not expected to be repeated.
The position in North America has stabilised with a lower rate of impairments in the second half of 2009. The Group retains some material single obligor concentrations on weaker credits. Concentrations remain in gaming, residential real estate and to some poorer sub prime non-bank financial institutions loan originators. Although the portfolio is appropriately impaired, a weakening in some of the Group’s gaming exposures could well result in the need for further impairments during 2010.
2009 has seen a significant reduction in the size of the Treasury Assets portfolio, both in terms of notional exposure and Risk Weighted Assets. In addition, the potential for volatility within the portfolio has been significantly reduced. As financial market conditions have improved, write-downs of investment securities have eased. Although both Lloyds TSB and HBOS heritage portfolios contain US residential mortgage-backed securities, which are exposed to a greater risk of further impairment, it is believed that previous write-downs and acquisition fair value adjustments for HBOS Treasury assets remain adequate to cover the losses the Group expects to incur on these portfolios.
TREASURY AND TRADING Treasury and Trading acts as the link between the wholesale markets and the Group’s balance sheet management activities and provides pricing and risk management solutions to both internal and external clients. The majority of Treasury and Trading’s funding and risk management activity is transacted with investment grade counterparties and much of it is on a secured basis such as Repo. Derivative transactions with wholesale counterparties are typically collateralised under CSAs.
For both the Asset Finance retail and non-retail portfolios the outlook for 2010 remains cautious although the Group expects impairment levels to reduce compared to 2009.
Wealth and International’s gross loans and advances to customers increased by £1.9 billion to £69.4 billion following the transfer of a £7 billion European loan portfolio from Wholesale division offset by repayments in most portfolios.
The division has established Credit Risk Policies which have been rolled out across all of the businesses with local policies being fully aligned. Reviews of risk appetite were undertaken throughout 2009 which have reemphasised management’s commitment to maximising value from existing lending portfolios, seeking to reduce sector concentrations and move to ‘Trusted Advisor’ status thereby maximising income from selected clients.
TABLE 1.13: ANALYSIS OF GROSS LOANS AND ADVANCES BY ASSET CLASS As at 31 December 2009 Ireland £bn Australia £bn Other £bn Total £bn
AUSTRALIA Impairment losses in Australia amount to £849 million, representing 6.2 per cent of average advances as compared with 3.1 per cent as at June 2009. The Australian economy has fared better than many others and did not formally enter recession. However, high sector concentrations in Property and in other sectors hardest hit by the economic downturn (Printing, Transport and Media) have resulted in increased impairment losses in 2009.
Market risk in the Group’s retail portfolios and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets and liabilities. Interest rate risk arises predominantly from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets.
The risk of loss measured by the VaR model is the potential loss in earnings given the confidence level and assumptions noted above. The total and average trading VaR does not assume any diversification benefit across the four risk types, with the exception of the 2008 HBOS comparatives. VaR is a statistical measure and the trading book exposures for the two independently managed heritage banks arose from different management strategies and were measured against differing risk appetites. Separate disclosures have therefore been made for each heritage trading book for 2008 as this is considered to be a more informative approach. The 2008 HBOS comparatives have also been converted from 99 per cent 1-day to 95 per cent 1-day VaR numbers. 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. The Group internally uses VaR as the primary measure for all treasury positions arising from short term market facing activity, whether trading or banking book. Therefore the numbers below will include some risks which are also included in Banking non-trading, primarily those relating to the funding of lending activities.
This is a risk based disclosure and the amounts shown would be amortised in the income statement over the duration of the portfolio.
MONITORING The group asset and liability committee regularly reviews high level market risk exposure including, but not limited to, the data described above. It also makes recommendations to the group chief executive concerning overall market risk appetite and market risk policy. Exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits are monitored locally by independent risk functions and at a high level by group risk. Where appropriate, escalation procedures are in place.
Insurance activities Market risk exposures from the insurance businesses are controlled via approved investment policies and triggers set with reference to the Group’s overall risk appetite and regularly reviewed by the group asset and liability committee: – The With Profit Funds are managed in accordance with the relevant fund’s principles and practices of financial management and legal requirements.
MONITORING Ongoing monitoring is in place to track the progression of insurance risks. This normally involves monitoring relevant experiences against expectations (for example claims experience, option take up rates, persistency experience, expenses, non-disclosure at the point of sale), as well as evaluating the effectiveness of controls put in place to manage insurance risk. Reasons for any significant divergence from experience are investigated and remedial action is taken.
There are a number of categories of operational risk: Legal and regulatory risk Legal and regulatory risk is the risk of reductions in earnings and/or value, through financial or reputational loss, from failing to comply with the laws, regulations or codes applicable.
Business process risk The risk of reductions in earnings and/or value, through financial or reputational loss, resulting from inadequate or failed internal processes and systems, people-related events and deficiencies in the performance of external suppliers/service providers.
For legal and regulatory risk the Group has minimal risk appetite for non-compliance with mandatory requirements and seeks to operate to high ethical standards. The Group encourages and maintains an appropriately balanced legal and regulatory compliance culture and promotes policies and procedures to enable businesses and their staff to operate in accordance with the laws, regulations and voluntary codes which impact on the Group and its activities.
MITIGATION Both Lloyds TSB and HBOS’s operational risk management frameworks consist of the following key components: – Identification and categorisation of the key operational risks facing a business area.
MONITORING Business unit risk exposure is aggregated at divisional level and reported to group risk where a group-wide report is prepared. The report is discussed at the monthly group compliance and operational risk committee. This committee can escalate matters to the chief risk officer, or higher committees if appropriate.
RISK APPETITE Liquidity and funding risk appetite for the banking businesses is set by the board and reviewed on an annual basis. This statement of the Group’s overall appetite for liquidity risk is reviewed and approved annually by the board. With the support of the group asset and liability committee, the group chief executive allocates this risk appetite across the Group. Individual members of the group executive committee ensure that liquidity risk appetite is further delegated to an appropriate level within their areas of responsibility. It is reported through various metrics that enable the Group to manage liquidity and funding constraints. The Group chief executive, assisted by the group asset and liability committee and its sub-committee the senior asset and liability committee, regularly reviews performance against risk appetite.
EXPOSURE Liquidity exposure represents the amount of potential outflows in any future period less committed inflows. Liquidity is considered from both an internal and regulatory perspective.
MEASUREMENT A series of measures are used across the Group to monitor both short and long term liquidity including: ratios, cash outflow triggers, liquidity gaps, early warning indicators and stress test survival period triggers. Strict criteria and limits are in place to ensure highly liquid marketable securities are available as part of the portfolio of liquid assets.
Details of contractual maturities for assets and liabilities form an important source of information for the management of liquidity risk. Note 54(4) sets out an analysis of assets and liabilities by relevant maturity grouping. In order to reflect more accurately the expected behaviour of the Group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. This forms the foundation of the Group’s liquidity controls.
The Group’s funding and liquidity position is underpinned by its significant retail deposit base, and has been supported by stable funding from the wholesale markets with a reduced dependence on short-term funding. A substantial proportion of the retail deposit base is made up of customers’ current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to raise inter-bank deposits and to issue certificates of deposit and commercial paper to meet short-term obligations. The Group’s short-term money market funding is based on a qualitative analysis of the market’s capacity for the Group’s credit. The Group has developed strong relationships with certain wholesale market segments, and also has access to central banks and corporate customers, to supplement its retail deposit base.
The ability to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of high grade marketable debt securities as set out in Table 1.18 which can be sold to provide, or used to secure, additional short term funding should the need arise from either market counterparties or central bank facilities (European Central Bank, Federal Reserve, Bank of England).
– Secondly, the Group has a contingency funding plan embedded within the Group Liquidity Policy which has been designed to identify emerging liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing.
Lloyds Banking Group Annual Report and Accounts 2009 liquidity landscape is subject to potential change. Specifi cally, in relation to the consultation papers issued by the Basel Committee on Banking Supervision (‘Strengthening the resilience of the banking sector’ and ‘International framework for liquidity risk measurement, standards and monitoring’) the Group is actively participating in the industry-wide consultation and calibration exercises taking place through 2010.
The global upheaval in the financial markets that occurred during 2008 has abated during the latter part of 2009. The steps taken in 2008 by HM Treasury, through the introduction of the Government Credit Guarantee (‘CGS’) for senior funding and other facilities including the Special Liquidity Scheme have together continued to provide assurance of liquidity support to the banking markets. Notwithstanding the improvement in market liquidity during 2009, the Group continues to be reliant upon these facilities in order to maintain its wholesale funding position. At 31 December 2009, the Group’s overall support from government and central bank sponsored funding facilities totalled £157 billion, with a significant portion maturing over the course of the next two years. The Group’s balance sheet reduction plans will avoid the necessity to refinance much of this funding.
GROUP RETAIL AND WHOLESALE FUNDING MIX Loans and advances to customers is set out on page 67.
Wholesale funding has been analysed between that monitored by the London Treasury and Trading operations and the Group’s overseas Treasury operations. The wholesale funding shown excludes any repo activity.
During the period the Group has changed the definition of wholesale to align with that used by other international market participants to include interbank deposits, debt securities in issue and subordinated debt within this category.
Primary liquidity is defined as FSA eligible liquid assets (UK Gilts, US Treasuries, Euro AAA government debt, unencumbered cash balances held at central banks).
DEFINITION Capital risk is defined as the risk that the Group has insufficient capital to provide a sufficient resource to absorb losses or that the capital structure is inefficient.
EXPOSURE A capital exposure arises where the Group has insufficient regulatory capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. The Group’s capital management approach is focused on optimising value for shareholders.
The Capital Resources Requirement (CRR), is 8 per cent of risk weighted assets and represents the capital required under Pillar 1 of the Basel II framework. In addition, the FSA currently sets Individual Capital Guidance (ICG) for each UK bank calibrated by reference to the CRR, to address the requirements of pillar 2 of the Basel II framework.
MITIGATION 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.
The Group is able to raise equity either via a rights issue, placing or an open offer. Placing and open offers were completed in January as part of the Group’s participation in the recapitalisation of the banking sector and in June when the Group repaid preference shares which were issued to HM Treasury as part of GAPS, and a rights issue and liability management exercise was completed in December.
The Group has in issue enhanced capital notes (ECNs) which will convert to core tier 1 capital in the event that Group’s published core tier 1 ratio (as defined by the FSA in May 2009) falls below 5 per cent.
TIER 1 CAPITAL Core tier 1 capital increased by £30.4 billion largely reflecting the issuance of share capital during the year and retained profits.
Tier 1 capital increased by £33.8 billion principally as a result of the increase in core tier 1 capital. The remainder of the increase reflects the inclusion of HBOS tier 1 instruments, an increase in innovative securities of £2 billion as part of a liability management exercise to exchange upper tier 2 debt and a further issuance of £1.2 billion innovative securities in December 2009. This increase is offset by the effects of the offer of enhanced capital notes during December 2009; as part of the Group’s recapitalisation and exit from GAPS, certain preference shares and preferred securities were exchanged for enhanced capital notes included within tier 2 capital.
TIER 2 CAPITAL Tier 2 capital has increased in the period by £14.9 billion, largely due to the acquisition of HBOS. The liability management exercises undertaken reduced tier 2 capital and increased tier 1 capital. The enhanced capital notes exchange offer completed during 2009 resulted in the exchange of certain existing tier 1 and tier 2 securities for tier 2 notes valued at £7.2 billion for regulatory purposes. Under certain specified conditions, these securities would convert to ordinary share capital and increase core tier 1 capital.
SUPERVISORY DEDUCTIONS Supervisory deductions mainly consist of investments in subsidiary undertakings that are not within the banking group for regulatory purposes. These investments are primarily the Scottish Widows and Clerical Medical life and pensions businesses.
Risk-weighted assets increased by £322.9 billion to £493.3 billion, principally as a result of the acquisition of HBOS plc which had risk-weighted assets of £328.0 billion at 31 December 2008. Subsequent to the acquisition, deteriorating economic conditions have led to increased average risk weightings. This has been offset, primarily within Whoesale, by a reduction in exposures due to impairments and asset run-off, and movements due to currency retranslations.
Capital ratios increased from the prior year in both Lloyds TSB and BOS Group primarily due to capital downstreamed in the year by Lloyds Banking Group.
MONITORING The Group has in place a disclosure committee whose responsibility is to review all significant disclosures made by the Group and to assist the group chief executive and group finance director fulfil their responsibilities under the Listing Rules and regulations emanating from the US Sarbanes-Oxley Act of 2002. A programme of work is undertaken and is designed to support an annual assessment of the effectiveness of internal controls over financial reporting, in accordance with the requirements of section 404 of the US Sarbanes-Oxley Act. It also has in place an assurance mechanism over its prudential regulatory reporting; additionally, monitoring activities are designed to identify and maintain tax liabilities and to assess the impact of emerging regulation and legislation on financial, prudential regulatory and tax reporting.
Following the acquisition of the life companies within HBOS plc, the format of the capital position statement has been revised to accommodate the reporting of all life assurance businesses within the Group.
Estimated share of ‘realistic’ liabilities consistent with the FSA reporting treatment (407) (40) – – – (447)
SCOTTISH WIDOWS Scottish Widows was created following the demutualisation of Scottish Widows Fund and Life Assurance Society in 2000. The terms of the demutualisation are governed by a Court-approved Scheme of Transfer (the ‘Scheme’) which, inter alia, created a With Profit Fund and a Non-Participating Fund and established protected capital support for the with-profits policyholders in existence at the date of demutualisation. Much of that capital support is held in the Non-Participating Fund and, as such, the capital held in that fund is subject to the constraints noted below.
Other restrictions in the Non-Participating Fund: In addition to the policies which existed at the date of demutualisation, the With Profit Fund includes policies which have been written since that date. As a result of statements made to policyholders that investment policy will usually be the same for both types of business, there is an implicit requirement to hold additional regulatory assets in respect of the business written after demutualisation. The estimated amount required to provide such support at 31 December 2009 is £132 million (31 December 2008: £171 million). Scottish Widows has obtained from the FSA permission to include the value of this support in assessing the realistic value of assets available to the With Profit Fund. There is a further test requiring that no amounts can be transferred from the Non-Participating Fund of Scottish Widows unless there are sufficient assets within the Long Term Fund to meet both policyholders’ reasonable expectations in light of liabilities in force at a year end and the new business expected to be written over the following year.
UK NON-PROFIT FUNDS Available capital in the UK non-profit funds has increased from £1,523 million at 31 December 2008 to an estimated £2,397 million at 31 December 2009. The acquisition of Clerical Medical resulted in a £1,205 million increase. Further increases due to new business were offset by changes in assumptions and actual and proposed transfers to the UK life shareholders funds.
Overseas life business includes several life companies outside the UK, including Germany and Ireland. In all cases the available capital resources are subject to local regulatory requirements, and transfer to other parts of the Group is subject to additional complexity surrounding the transfer of capital from one country to another.
WITH-PROFIT FUNDS The with-profit realistic liabilities and the available capital for the withprofit funds are sensitive to both market conditions and changes to a number of non-economic assumptions that affect the valuation of the liabilities of the fund. The available capital resources (and capital requirements) are sensitive to the level of the stock market, with the position worsening at low stock market levels as a result of the guarantees to policyholders increasing in value. However, the exposure to guaranteed annuity options increases under rising stock market levels. An increase in the level of equity volatility implied by the market cost of equity put options also increases the market consistent value of the options given to policyholders and worsens the capital position.
Assets held in excess of those backing actuarial reserves are invested across a range of investment categories including fixed interest securities, equities, properties and cash. The mix of investments is determined in line with the policy of Lloyds Banking Group to minimise the working capital (defined as available capital less minimum required capital) required to ensure all capital requirements continue to be met under a range of stress tests.
Post-tax return on average shareholders’ equity 8.8 7.0 28.1 26.6 25.5 31 December 31 December 31 December 31 December 31 December
Capital ratios for 2009 and 2008 are in accordance with Basel II requirements; ratios for 2007 and earlier years reflect Basel I.
Joined the board and was appointed chairman on 15 September 2009. Previously chairman of Citigroup Inc. from December 2007 to February 2009. He joined J Henry Schroder & Co in January 1966 and became managing director of Schroders Asia in 1971, group chief executive of Schroders Plc in 1984 and chairman in 1995. Following the acquisition of Schroders’ investment banking business by Citigroup in 2000 became chairman of Citigroup Europe before being appointed acting chief executive offi cer of Citigroup in 2007 and subsequently as chairman in the same year. A non-executive director of Eli Lilly and Company, and The McGraw Hill Companies Inc. in the United States, and chairman of the UK Career Academy Foundation. A member of the Akbank International advisory board. Aged 68.
Member of the audit, nomination and governance, and remuneration committees and chairman of the risk oversight committee
Joined the group in 1986 and held a number of senior and general management appointments before being appointed to the board in 2000, as group executive director, IT and operations. Appointed group executive director, insurance and investments in October 2003. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as fi nance director in the UK from 1983 to 1985. Chairman of the Association of British Insurers and a member of The Takeover Panel. Aged 57.
Joined the group in 2003 as managing director, corporate banking before being appointed to the board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was president and chief executive offi cer of eCharge Corporation from 1999 to 2001 and co-founder and vice chairman of the board of Chase Cost Management Inc from 1996 to 2003. A non-executive director of BritishAmerican Business Inc. Chairman of Arora Holdings and a director of Business in the Community and a director and trustee of In Kind Direct. Aged 59.
Biographical details of directors are shown on pages 96 and 97. Particulars of their emoluments and interests in shares in the Company are given on pages 105 to 125.
The directors have entered into individual deeds of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ for the purposes of the Companies Act 2006. These deeds were in force during the whole of the financial year or from the date of appointment in respect of the three directors who joined the board in 2009. The indemnities remain in force for the duration of a director’s period of office. Deeds for existing directors are available for inspection at the Company’s registered office.
The income statement includes a charge for charitable donations totalling £33,477,000 in 2009 (2008: £29,603,000), including £28,228,000 (2008: £28,997,000) which will be paid under the deeds of covenant to the four Lloyds TSB Foundations during 2010.
This report gives detailed information on our corporate governance arrangements for 2009 and outlines how we apply the principles of the 2006 Combined Code (the ‘Code’). The Company believes it has complied throughout the year with all of the provisions of section 1 of the Code.
The chairman is responsible for the clarity and timeliness of information provided to the board and for facilitating the effective contribution of all directors and ensures that directors receive appropriate induction and ongoing training.
INDEPENDENCE All the non-executive directors are considered by the board to be independent both in character and judgment and free of relationships or circumstances which could affect their judgement. Throughout the year at least half of the board comprised independent non-executive directors.
INDUCTION AND TRAINING All new directors and committee members receive a full and tailored induction. The primary aim of the induction programme is to provide directors with a comprehensive introduction to the Group; its individual businesses; business models; strategy; and risks. This enables directors to make an early, informed and effective contribution to board debates, based on an understanding of the key challenges facing the Group, the Group’s businesses, and the business model. The induction programme is supplemented by ongoing training and development.
BOARD EVALUATION In autumn 2009, the board, supported by JCA Group, conducted a rigorous process of evaluating its effectiveness, and the effectiveness of its principal committees. The process included confidential, unattributable, one-on-one interviews with every board member and with UKFI and the Group’s external auditors. The review covered corporate governance, board effectiveness, strategy development, risk management and board and committee organisation, composition, operation and dynamics. In addition, although early in his tenure, the review also considered the performance of the chairman, including the effectiveness of his relationships with the group chief executive and other members of the board. The outcomes of the review were subsequently discussed by the board as a whole.
Index to annual report 266 of the review are addressed in a timely manner. As part of this, it has been agreed that issues of risk, liquidity and funding should receive particularly high attention in 2010.
ELECTION AND RE-ELECTION OF DIRECTORS All directors are subject to election by shareholders at the first annual general meeting (AGM). Following their appointment, Sir Winfried Bischoff, Mr Moreno and Mr Roberts will stand for election at the forthcoming AGM.
DIRECTORS’ CONFLICTS OF INTEREST The board, as permitted by the Group’s articles of association, has authorised all potential conflicts of interest declared by individual directors. Decisions regarding these conflicts of interest could only be taken by directors who had no interest in the matter. In taking the decision, the directors acted in a way they considered, in good faith, would be most likely to promote the Company’s success. The directors had the ability to impose conditions, if thought appropriate, when granting authorisation. Any authorities given will be reviewed at least every 15 months. No director is permitted to vote on any resolution or matter where he or she has an actual or potential conflict of interest.
The committee’s terms of reference are available from the company secretary and are displayed on our website, www.lloydsbankinggroup.com.
The views of institutional shareholders including UKFI were sought prior to any decision being made. Those shareholders consulted confirmed that they were satisfied that the search and selection process had been robust and extensive.
RISK OVERSIGHT COMMITTEE The risk oversight committee comprises Lord Leitch (chairman), Sir Winfried Bischoff, Sir Julian Horn-Smith, Mr Ryan, Mr Scicluna and Mr Watson. There is a standing invitation for all other non-executive directors to attend meetings of the committee. The risk oversight committee’s duties include overseeing the development, implementation and maintenance of the Group’s overall risk management framework, and its risk appetite, strategy, principles and policies, to ensure they are in line with emerging regulatory, corporate governance and industry best practice. The committee also oversees the Group’s risk exposures; facilitates the involvement of non-executive directors in risk issues and aids their understanding of these issues; oversees adherence to Group risk policies and standards and considers any material amendments to them; and reviews the work of the group risk division.
Appointed to the remuneration committee on 23 January 2009. Left the board on 31 December 2009.
Both the board and the external auditors have safeguards in place to protect the independence and objectivity of the external auditors. The audit committee has a comprehensive policy to regulate the use of auditors for non-audit services. This policy sets out the nature of work the external auditors may not undertake, which includes work which will ultimately be subject to external audit, internal audit services and secondments to senior management positions in the Group that involve decision-making. It also includes the Group’s policy on hiring former external audit staff. For those services that are deemed appropriate for the auditors to carry out, the policy sets out the approval process that must be followed for each type of assignment. The chairman of the audit committee must be consulted regarding potential instructions in respect of defined non-audit services with a value above defined limits.
We therefore recommend this report to shareholders and ask for your support at the forthcoming AGM.
The following key decisions have been made for 2009/2010 remuneration: – 2010 base salaries for executive directors will continue to be frozen at 2008 levels
Based half on financial measures and half on a balanced scorecard of non-financial measures30% Deferred into shares until 2012, subject to clawback
The 2010 package is designed to encourage a long-term and risk-based focus: – Salary is a significant proportion of the total package, avoiding excessive leverage
– All incentives will be paid on a deferred basis at the end of three years
The committee determines the pensions policy for all colleagues and advises on other major changes to employee benefits schemes. It also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated power for settling remuneration for the chairman, the group executive directors, the company secretary and any group employee whose salary exceeds a specified amount, currently £350,000, and/or whose short-term incentive opportunity exceeds £250,000.
The committee monitors the application of the authority delegated to the group executive committee and the divisional remuneration committees to ensure that policies and principles are being fairly and consistently applied. The committee liaises with the risk oversight committee and the risk function in relation to risk-adjusted performance measures.
We also thank all committee members for their commitment during the last year and attendance at the unprecedented number of meetings.
The remuneration committee ensures that appropriate remuneration and governance arrangements are in place throughout the organisation, with the Group functions providing an oversight role in the development of remuneration policy and practice below the senior executive population. During 2009 as part of the review of compliance with the new FSA Code of Practice on Remuneration and the developing governance environment, the committee reviewed and adopted new terms of reference. In addition divisional remuneration committees were established to ensure a strong oversight from the group remuneration committee into the divisions.
The role of the divisional remuneration committees is to ensure a strong oversight from the group remuneration committee into the divisions. Specifically: – The relevant group executive director will be accountable for the effective implementation of the remuneration policy in their division; – The divisional remuneration committee, which will have representation from both divisional and group reward and risk functions, will ensure that the policy is effectively and efficiently executed in the division; – Formal positive assurance (through annual reporting) as to how the remuneration policy is being applied across the group will be provided to the group remuneration committee from each divisional remuneration committee; and
The Group’s remuneration policy supports our business strategy, which is based on building long-term relationships with our customers and employees, and managing the financial consequences of our business decisions across the entire economic cycle. The policy is to position base salaries to reflect the relevant market median and the total package is designed to enable upper quartile performance to be rewarded with upper quartile remuneration levels. Overall the policy is designed to ensure that cost effective packages are provided which attract and retain executive directors and senior management of the highest calibre and motivate them to perform to the highest standards. At the same time, the objective is to align individual rewards with the Group’s performance, the interests of its shareholders, and a prudent approach to risk management. In this way we balance the requirements of our various stakeholders: customers, shareholders, employees, and regulators. We believe that this approach is in line with the Association of British Insurers best practice code on remuneration as well as the FSA Code of Practice on Remuneration, as the policy seeks to reward long-term value creation whilst not encouraging excessive risk taking.
Therefore, for example, in good times, when default rates on loans are low, we adjust the economic profit measure downwards based on a higher average expected default experience over the economic cycle. This encourages us to avoid business and funding strategies that are only profitable during boom times but turn bad in a recession. Economic profit plays a prominent role in our incentive plans for executives, a role which was further enhanced in 2009, with its inclusion in the long-term incentive plan performance measures.
Executives are aligned with shareholders through the long-term incentive plan, which pays out based on performance against Group targets over a three year period, and which is paid in shares to further improve alignment with shareholders.
For the 2009 annual incentive we increased the alignment to long-term prudent risk management by deferring all of the award. For executive directors any cash incentive earned will be deferred 100 per cent into shares and paid out in 2012. If the performance that led to the incentive is found to be unsustainable during the deferral period, then some or all of the award may be forfeited.
The remuneration committee undertook an extensive review of executive remuneration during late 2008 and into 2009 in light of the HBOS acquisition. That review in conjunction with detailed consultation with shareholders led to the remuneration decisions for 2009. The committee continued to review remuneration during 2009 in light of the FSA Code of Practice on Remuneration, the outcomes of the G20 meeting in September 2009 and Sir David Walker’s review of corporate governance in UK banks and other financial industry entities. This ongoing review process has found that the structure of the remuneration package, in particular the focus on risk through the long-term incentive plan measures and balanced scorecard, was well aligned with emergent best practice in the sector.
SUMMARY OF REMUNERATION ELEMENTS The key remuneration elements for 2010 are summarised below. Each individual element is then described in more detail in the subsequent sub-sections.
BASE SALARY Basic salaries are reviewed annually, usually in December, taking into account individual performance and market information (which is provided by Towers Perrin and supplemented with information from Kepler Associates as appropriate) and then adjusted from 1 January of the following year. The remuneration committee confirmed during the 2009 review that the FTSE 20 was the most appropriate comparator group to use to benchmark overall competitiveness of the remuneration package whilst taking particular account of the remuneration practice of our direct competitors, namely the major UK banks. The FTSE 20 is regarded as providing a realistic and relevant comparison in terms of company size and complexity, as well as being a key market for talent.
Name J E Daniels A G Kane G T Tate T J W Tookey H A Weir
The maximum annual incentive opportunity remains unchanged at 200 per cent (225 per cent for the group chief executive) of base salary for the achievement of exceptional performance targets.
For the EPS element of the award, performance will be measured based on EPS growth over a three year period from the baseline EPS of 2009.
Performance will be measured based on the average absolute share price achieved during the 90 days at the end of the three year period.
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 target 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 extent 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
In 2009, the Group delivered a resilient trading performance against the backdrop of a marked slow down in the UK economic environment and continued challenges in financial markets. This has been a year of substantial achievement with the creation of a sound platform for future growth of the combined franchise. Positive trends have been established in margins, costs and impairments. The interest margin improved in the second half of the year and is expected to increase in 2010, with further improvements expected in subsequent years. Costs fell by five per cent in the year as integration related savings have started to be realised, with £534 million of cost synergy savings in 2009. Impairments peaked in the first half of the year, falling off by 21 per cent in the second half. A similar rate of improvement is expected through 2010. The Group’s funding and liquidity positions were also strengthened during the year.
Franchise growth has been strong in both Retail and Wholesale and there has been a 48 per cent improvement in cross sales income from the Lloyds TSB customers. There were strong levels of mortgage lending with over £34 billion of gross new lending. The Lloyds TSB conservative approach to risk management has been implemented across the Group. All new lending is within the Group’s risk appetite. Our employee engagement index has remained high through the year and has performed well against the UK norm.
Additionally a number of significant activities were delivered on during 2009 which were not anticipated when the targets were set. These activities have contributed to placing the Group in the best position possible to grow and develop the combined franchise. They include the largest ever capital raising and the successful conclusion of negotiations with the European Commission on State Aid. These have all been achieved at the same time as delivering the ‘business as usual’ agenda and the integration programme.
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.
Directors have a normal retirement age of 60. However, following the implementation of The Employment Equality (Age) Regulations 2006, they may now choose to delay their retirement until age 65. In the event of death in service, a lump sum of four times salary is payable plus, for members of a defined benefit scheme, a spouse’s pension of two-thirds of the member’s prospective pension. On death in retirement, a spouse’s pension of two-thirds of the member’s pension is payable. The defined benefit schemes are non-contributory. Members of defined contribution schemes are required to contribute.
The interests, all beneficial, of those who were directors at 31 December 2009 in shares in Lloyds Banking Group were: NUMBER OF SHARES
None of the other directors at 31 December 2009 had options to acquire shares in Lloyds Banking Group plc or its subsidiaries.
March 2000 – March 2001 As for March 1999 – August 1999 except that there must have been growth in the earnings per share equal to the change in the retail price index plus three percentage points for each complete year of the relevant period.
Options granted in 2005 became exercisable as the performance condition was met when tested. The performance condition vested at 82.5 per cent for all options granted to executive directors.
At Awarded Adjusted Lapsed At during the year number of shares during the year
INDEPENDENT AUDITORS’ REPORT TO THE MEMBERS OF LLOYDS BANKING GROUP PLC We have audited the group financial statements of Lloyds Banking Group plc for the year ended 31 December 2009 which comprises the consolidated income statement, consolidated statement of comprehensive income, consolidated balance sheet, consolidated statement of changes in equity, consolidated cash flow statement and the related notes. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards as adopted by the European Union.
OPINION ON OTHER MATTERS PRESCRIBED BY THE COMPANIES ACT 2006 In our opinion: – the information given in the Directors’ Report for the financial year for which the group financial statements are prepared is consistent with the group financial statements; and – the information given in the Corporate Governance Statement set out on pages 100 to 104 with respect to internal control and risk management systems and about share capital structures is consistent with the financial statements.
MATTERS ON WHICH WE ARE REQUIRED TO REPORT BY EXCEPTION We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion: – certain disclosures of directors’ remuneration specified by law are not made; or – we have not received all the information and explanations we require for our audit; or – a corporate governance statement has not been prepared by the parent company.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME for the year ended 31 December 2009 £ million £ million
Movement in cash fl ow hedging reserve, net of tax: Effective portion of changes in fair value taken to other comprehensive income (382) (24)
To provide a more relevant presentation of the Group’s financial instruments, additional line items have been added to the consolidated balance sheet to show debt securities classified as loans and receivables separately. Comparatives have been reclassified to conform to the revised presentation.
The following IFRS pronouncements relevant to the Group have been adopted in these consolidated financial statements: (i) IAS 1 Presentation of Financial Statements. The revised standard prohibits the presentation of items of income and expense (that is ‘non-owner changes in equity’) in the statement of changes in equity, requiring ‘non-owner changes in equity’ to be presented separately from owner changes in equity. All non-owner changes in equity are required to be shown in a performance statement. Entities can choose whether to present one performance statement (the statement of comprehensive income) or two statements (the income statement and statement of comprehensive income). The Group has elected to present two statements: an income statement and a statement of comprehensive income. The financial statements have been prepared under the revised disclosure requirements; the application of this revised standard, which affects presentation only, has not had any impact on amounts recognised in these financial statements.
– IFRIC 13 Customer Loyalty Programmes. This interpretation addresses accounting by entities who grant customer loyalty award credits to customers as part of sales transactions and which can be redeemed in the future for free or discounted goods or services. The majority of customer loyalty award schemes are operated by third parties.
– IFRIC 16 Hedges of a Net Investment in a Foreign Operation. This interpretation provides guidance on accounting for hedges of net investments in foreign operations in an entity’s consolidated financial statements.
– IAS 23 Borrowing Costs. This revised standard requires interest and other costs incurred in connection with the borrowing of funds to be recognised as an expense excepting that those which are directly attributable to the acquisition, construction or production of assets that take a substantial period of time to get ready for their intended use or sale must be capitalised as part of the cost of those assets.
(B) GOODWILL Goodwill arises on business combinations, including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and associates; goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities acquired. Where the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities of the acquired entity is greater than the cost of acquisition, the excess is recognised immediately in the income statement.
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Refer to note 3 (Critical accounting estimates and judgements: Valuation of financial instruments) and note 53(3) (Financial instruments: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
(3) Loans and receivables Loans and receivables include loans and advances to banks and customers and eligible assets including those transferred into this category out of the fair value through profit or loss or available-for-sale financial assets categories. Loans and receivables are initially recognised when cash is advanced to the borrowers at fair value inclusive of transaction costs or, for eligible assets transferred into this category, their fair value at the date of transfer. Financial assets classified as loans and receivables are accounted for at amortised cost using the effective interest method (see accounting policy 2(D)) less provision for impairment (see accounting policy 2(H)).
(6) Derecognition of financial assets and liabilities Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has transferred its contractual right to receive the cash flows from the assets and either: – substantially all of the risks and rewards of ownership have been transferred; or
(1) Assets accounted for at amortised cost At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition and prior to the balance sheet date, there is objective evidence that a financial asset or group of financial assets has become impaired.
The criteria that the Group uses to determine that there is objective evidence of an impairment loss include: – Delinquency in contractual payments of principal and/or interest; – Indications that the borrower or group of borrowers is experiencing significant financial difficulty; – Restructuring of debt to reduce the burden on the borrower; – Breach of loan covenants or conditions; and
Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an acquisition of equity securities. Where control is obtained over an entity as a result of the transaction, the entity is consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity method of accounting (see accounting policy 2(A)). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant asset or business and not as an impairment of the original instrument.
(M) SHARE-BASED COMPENSATION The Group operates a number of equity-settled, share-based compensation plans in respect of services received from certain of its employees. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting period, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated as non-vesting conditions and in accordance with the revised IFRS 2 the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement over any remaining vesting period.
For the Group’s long-term insurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable on equity holders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under current UK tax rules.
Premiums and claims Premiums received in respect of insurance and participating investment contracts are recognised as revenue when due except for unit-linked contracts on which premiums are recognised as revenue when received. Claims are recorded as an expense on the earlier of the maturity date or the date on which the claim is notified.
(iii) VALUE OF IN-FORCE BUSINESS The Group recognises as an asset the value of in-force business in respect of insurance contracts and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date. This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency rates and includes allowances for both non-market risk and for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
The calculation of the collective impairment allowance is therefore subject to estimation uncertainty. The variables used in the collective impairment models are kept under regular review to ensure that as far as possible they reflect current economic circumstances. However, significant management judgement is applied in assessing whether current economic conditions and borrowers’ behaviour are fully reflected in the historical loss data and other inputs to the impairment models.
TAXATION At 31 December 2009 the Group carried deferred tax assets on its balance sheet of £5,006 million (2008: £833 million) and deferred tax liabilities of £209 million (2008: £nil) (note 42).
This statutory presentation takes into account the ability of the Group to net deferred tax assets and liabilities only where there is a legally enforceable right of offset. Note 42 also presents the Group’s deferred tax assets and liabilities by tax category. The largest category of deferred tax asset which contains significant estimation uncertainty and which requires management judgement in assessing its recoverability relates to tax losses carried forward. At 31 December 2009, the Group recognised a deferred tax asset of £5,925 million (2008 £856 million) in respect of tax losses carried forward. The significant increase reflects the taxable losses generated by certain Group companies, primarily Bank of Scotland plc in the last two years and Lloyds TSB Bank plc during 2009.
LIFE INSURANCE BUSINESS The Group carries in its balance sheet a value in-force asset, representing the present value of future profits expected to arise from the portfolio of in-force life insurance and participating investment contracts, of £5,140 million at 31 December 2009 (2008: £1,893 million). The Group also recognises an acquired value in-force asset of £1,545 million at 31 December 2009 (2008: nil) representing contractual rights to benefits from providing investment management services in relation to non-participating investment contracts acquired in business combinations and portfolio transfers. The methodology used to value these assets is set out in note 2(O)(1). The valuation or recoverability of these assets requires assumptions to be made about future economic and operating conditions. These assumptions are inherently uncertain and changes could significantly affect the value attributed to these assets.
GENERAL INSURANCE BUSINESS At 31 December 2009 the Group held a provision of £502 million (2008: £183 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 methodology for valuing these liabilities, which includes the use of statistical techniques, is described in note 2(O)(2).
The Wholesale division serves in excess of a million businesses ranging from start-ups and small enterprises to global corporations, with a range of propositions fully segmented according to customer need. The enlarged division, following the acquisition of HBOS, comprises Corporate Markets, Treasury and Trading and Asset Finance. Corporate Markets comprises Corporate, Commercial, Corporate Real Estate, Specialist Finance and Wholesale Markets.
Wealth and Reported basis Retail Wholesale International Insurance Other total £m £m £m £m £m £m
Other income (net of fee and commission expense) 2,739 (302) 1,191 3,493 (188) 6,933
Total income, net of insurance claims 11,193 5,450 2,505 2,667 (460) 21,355
Other segment items: Additions to tangible fixed assets 127 2,241 254 411 735 3,768
Results of intangibles Statutory HBOS Reclassifi- BankWest and and goodwill Insurance Reported basis1 statutory cations St. Andrews Volatility impairments gross up basis £m £m £m £m £m £m £m £m
Share of results of joint ventures and associates 4 (956) – – – – – (952)
Interest payable on liabilities held at amortised cost 2.13 3.67 (17,591) (9,851)
In the first half of 2009, undated subordinated notes issued by a number of Group companies were exchanged for innovative tier 1 securities and senior unsecured notes issued by Lloyds TSB Bank plc. These exchanges resulted in a gain of £745 million.
Claims and claims paid: Change in liabilities (note 36(2)): Total non-life insurance (634) (193)
The average number of persons on a headcount basis employed by the Group during the year was as follows: Restated for IFRS 2 (Revised)
Audits of the unconsolidated Open Ended Investment Companies managed by the Group 0.6 0.5
Reviews of the financial position of corporate and other borrowers 19.3 1.4
Other non-audit fees include the costs associated with the Group’s preparations for ensuring the HBOS Group complies fully with the requirements of the Sarbanes-Oxley Act by 31 December 2010.
The Group’s share of results of and investments in joint ventures and associates comprises: Joint ventures Associates Total £m £m £m £m £m £m
At the time of the recommended offer for HBOS in September 2008, it had become increasingly difficult for HBOS to raise funds in wholesale markets and their board sought to restore confidence and stability through an agreement to be acquired by Lloyds TSB Group plc announced on 18 September 2008 at the original terms of 0.833 Lloyds TSB Group plc shares for each HBOS share. However turbulence in the markets continued and the UK Government decided in October 2008 that it would be appropriate for the UK banking sector to increase its level of capitalisation. As a consequence of the recapitalisation of HBOS and the impact of the deteriorating market conditions the terms of the final agreed offer were revised down to a ratio of 0.605 per HBOS share.
Foreign tax: Current tax on profi t for the year (221) (144)
Movements in available-for-sale financial assets: Change in fair value 2,234 (298) 1,936
Movements in available-for-sale financial assets: Change in fair value (2,721) 690 (2,031)
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Company has dilutive potential ordinary shares in respect of share options and awards granted to employees. The number of shares that could have been acquired at the average annual share price of the Company’s shares based on the monetary value of the subscription rights attached to outstanding share options and awards is determined. This is deducted from the number of shares issuable under such options and awards to leave a residual bonus amount of shares which are added to the weighted-average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.
In December 2009, as part of the Group’s recapitalisation and exit from GAPS, the Group entered into an agreement with holders of certain existing liabilities to exchange these for ordinary shares or for cash on 18 February 2010. The weighted average number of anti-dilutive shares arising from this transaction that have been excluded from the calculation of diluted earnings per share was 294 million at 31 December 2009. As set out in note 57, on 18 February 2010, the above exchange completed and 3,141 million new ordinary shares in Lloyds Banking Group plc were issued.
These assets are comprised as follows: Other financial Other financial assets at fair assets at fair
(iii) private equity investments of £1,880 million (31 December 2008: £947 million) that are managed, and evaluated, on a fair value basis in accordance with a documented risk management or investment strategy and reported to key management personnel on that basis.
Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS39. Derivatives are held at fair value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 53.
17 TRADING AND OTHER FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS continued
Derivatives designated as fair value hedges: Interest rate swaps 80,085 3,989 985
The Group holds collateral with a fair value of £1,110 million (31 December 2008: £1,736 million), which it is permitted to sell or repledge, of which £1,102 million (31 December 2008: £366 million) was repledged or sold to third parties for periods not exceeding three months from the transfer. The Group is obliged to return collateral with a fair value of £1,102 million (2008: £366 million).
Commitments for expenditure in respect of equipment to be leased (8) (174)
Later than 1 year and not later than 5 years 2,403 974
Gross assets Notes Gross assets Notes securitised in issue securitised in issue
Cash deposits of £31,480 million (31 December 2008: £1,846 million) held by the Group are restricted in use to repayment of the debt securities issued by the securitisation vehicles and other legal obligations.
Index to annual report 266 22 SPECIAL PURPOSE ENTITIES In addition to the special purpose entities disclosed in note 21, which are used for securitisation and covered bond programmes, the Group sponsors three asset-backed conduits, Cancara, Grampian and Landale, which invest in debt securities and client receivables. All the external assets in these conduits are consolidated in the Group’s financial statements and are included in the credit market exposures set out in note 54. The total consolidated exposures in these conduits are set out in the table below: Cancara £m
During 2009, the Group established Lloyds TSB Pension ABCS (No 1) LLP and Lloyds TSB Pension ABCS (No 2) LLP and transferred approximately £5 billion of assets, primarily comprising notes in certain of the Group’s securitisation programmes, in aggregate to these entities. The Group transferred interests in the LLPs with a fair value of approximately £1 billion in aggregate to the Lloyds TSB Group Pension Scheme No 1 and the Lloyds TSB Group Pension Scheme No 2 entitling these schemes to annual payments of approximately £215 million in aggregate until 31 December 2014 (see note 41).
Debt securities: Other public sector securities – 31 31 – 12 12
Details of the Group’s asset-backed conduits shown in the table above are included in note 22.
The carrying value of assets that are subject to stock lending arrangements was £4,616 million at 31 December 2009 (31 December 2008: nil) all of which the secured party is permitted by contract or custom to sell or repledge.
Risk-free rate (financial options and guarantees) 0.87 to 4.76 1.11 to 4.24
NON-MARKET RISK An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk and the with-profit funds these can be asymmetric in the range of potential outcomes for which an explicit allowance is made.
The majority of the customer-related intangibles as well as the brands, core deposit intangibles and purchased credit card relationships have arisen from the acquisition of HBOS. Included within brands above are assets of £380 million (31 December 2008: £nil) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not continue indefinitely.
Accumulated depreciation and impairment: Exchange and other adjustments 1 10 21 32
Liabilities for life insurance contracts and participating investment contracts can be split into with-profit fund liabilities, accounted for using the FSA’s realistic capital regime (realistic liabilities) and non-profit fund liabilities, accounted for using a prospective actuarial discounted cash flow methodology, as follows: With-profit fund £m
The primary purpose of the conventional and unitised business written in the with-profit funds is to provide a long-term smoothed investment vehicle to the policyholder, protecting them against short-term market fluctuations. With-profit policyholders are entitled to at least 90 per cent of the distributed profits, the shareholders receiving the balance. The policyholder is also usually insured against death and the policy may carry a guaranteed annuity option at maturity.
(ii) Method of calculation of liabilities With-profit liabilities are stated at their realistic value, the main components of which are: – With-profit benefit reserve, the total asset shares for with-profit policies; – Cost of options and guarantees
MORTALITY The mortality assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this is significant, and relevant industry data otherwise.
LAPSE RATES (PERSISTENCY) Lapse rates refer to the rate of policy termination or the rate at which policyholders stop paying regular premiums due under the contract.
German insurance and pensions business is written through the subsidiary Heidelberger Leben and comprises policies similar to the UK definitions above, except that there is participation by the policyholder in the investment, insurance and expense profits of Heidelberger Leben. A minimum level of policyholder participation is prescribed by German law. The following types of life insurance contracts are written under which there is policyholder participation in Heidelberger Leben profits: – Unit linked endowment or pensions business; – Traditional endowment or pensions business; – Life insurance business in which the policyholder is protected against temporary disability; and
– Life insurance business in which the policyholder is protected against death.
Margins for risk are allowed for in the assumed interest rates. These are derived from the limits in the guidelines set by local regulatory bodies, including reductions made to the available yields to allow for default risk based upon the credit rating of the securities allocated to the insurance liability.
Change in liabilities charged to income statement (note 10) (24) 5 (19)
Estimate of ultimate claims costs: At end of accident year 211 208 317 205 639 1,580
This balance includes £19 million of claims relating to general insurance business acquired during the year.
Widening of credit default spreads on corporate bonds8 0.25% addition (144) (104)
This sensitivity shows the impact on the annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
ASSUMPTIONS The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 5.70 6.30
Life expectancy for member aged 60, on the valuation date: Life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 as at 31 December 2009 is assumed to live for, on average, 27.1 years for a male and 28.2 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
The expected return on scheme assets in 2010 will be calculated using the following assumptions: %
The expense recognised in the income statement for the year ended 31 December comprises: £m £m
Lloyds Banking Group Annual Report and Accounts 2009 42 DEFERRED TAX continued
DEFERRED TAX LIABILITIES Future transfers from Scottish Widows plc’s long-term business funds to its Shareholder Fund will be subject to a shareholder tax charge. Under IAS 12, no provision is required to be made to the extent that the timing of such transfers is under Scottish Widows plc’s control. Accordingly, deferred tax liabilities of £90 million (2008: £90 million) have not been recognised.
OTHER Other provisions include the provisions which the Group carries 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.
6.369% Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2015 (£600 million) c, e – 584 6.267% Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2016 (US$1,000 million) c, e 327 824 9¼% Non-cumulative Irredeemable £1 preference shares (£300 million) b, c, e 197 –
e As described in note 9, in November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to 31 January 2012.
6.85% Non-cumulative Perpetual Preferred Securities of US$1,000 each (US$1,000 million) b, c – –
8.117% Non-cumulative Perpetual Preferred Securities Series 1 of £1,000 each (Class A) (£250 million) b, c 234 –
7.754% Non-cumulative Perpetual Preferred Securities Series 2 of £1,000 each (Class B) (£150 million) b, c 93 –
7.627% Fixed to Floating Rate Guaranteed Non-voting Non-cumulative Preferred Securities (€415 million) b, c 259 –
4.875% Undated Subordinated Fixed to Floating Rate Instruments (€750 million) b, c, d, e 60 –
5.375% Undated Fixed to Floating Rate Subordinated Notes (US$1,000 million) d, e 3 –
5.125% Undated Subordinated Fixed to Floating Notes (€750 million) b, c, d, e 39 –
8.625% Perpetual Subordinated Notes (£200 million) b, c, d, e 18 –
Floating Rate Undated Subordinated Step-up Notes (€300 million) b, c, d, e 58 –
4.25% Perpetual Fixed/Floating Rate Reset Subordinated Guaranteed Notes (€750 million) (Clerical Medical Finance plc) d, f 190 –
Index to annual report 266 a Scottish Widows plc may elect to defer interest on these securities although in that event Scottish Widows plc cannot declare or pay a dividend on any ordinary share capital until any deferred payments have been made.
b Following an exchange offer, on 7 January 2009 certain holders elected to exchange all or some of the notes they held for innovative Tier 1 securities issued by Lloyds TSB Bank plc.
c Following an exchange offer, on 25 March 2009 certain holders elected to exchange all or some of the notes they held for senior unsecured notes issued by Lloyds TSB Bank plc.
f Following an exchange offer, on 30 June 2009, certain holders elected to exchange all or some of the notes for senior unsecured notes by Lloyds TSB Bank plc.
7.869% Enhanced Capital Notes due 2020 (Series 8) (£596 million) 572 –
8.875% Enhanced Capital Notes due 2020 (Series 12) (€125 million) 117 –
11.04% Enhanced Capital Notes due 2020 (Series 19) (£736 million) 871 –
15% Enhanced Capital Notes due 2029 (Series 23) (£68 million) 108 –
7.375% Enhanced Capital Notes due 2020 (Series 32) (€95 million) 80 –
8.07% Enhanced Capital Notes due 2020 (Series 35) (¥20,000 million) 156 –
14.5% Enhanced Capital Notes due 2022 (Series 42) (£79 million) 115 –
9.875% Enhanced Capital Notes due 2023 (Series 44) (£57 million) 62 –
11.25% Enhanced Capital Notes due 2023 (Series 45) (£95 million) 115 –
8% Fixed to Floating Rate Undated Enhanced Capital Notes callable 2022 (US$1,259 million) b 639 –
8.5% Undated Enhanced Capital Notes callable 2021 (Series 2) (US$277 million) b 143 –
Enhanced capital notes are a new liability class developed for the purposes of the liability management exercise conducted by Lloyds Banking Group in the fi nal quarter of 2009. With the exception of the two series identifi ed in note b, the ECNs were issued in lower tier 2 format and are convertible into ordinary shares on the breach of a defi ned trigger. The trigger on the ECNs offered in the exchange will be if the published core tier 1 ratio of the Group falls below 5 per cent (as defi ned by the Financial Services Authority in May 2009).
c Following an exchange offer on 30 June 2009, certain holders elected to exchange all or some of the notes for senior unsecured notes issued by Lloyds TSB Bank plc.
Details of preference shares that are classified as debt for accounting purposes are given in note 44.
ORDINARY SHARES On 13 January 2009 the Company issued 2,597 million shares under a placing and open offer, subscribed for by HM Treasury as part of the recapitalisation of the banking industry by the UK Government, which raised £4,430 million (net of £70 million issue costs). This issue resulted in an increase of £649 million in share capital and an increase of £3,781 million in the merger reserve.
In lieu of a dividend the Group announced a capitalisation issue of 1 for 40 ordinary shares held and on 11 May 2009 408 million ordinary shares of 25 pence were issued. This resulted in an increase in share capital of £102 million with a corresponding decrease in the share premium account.
PREFERENCE SHARES The Company has in issue various classes of preference shares which are all classifi ed as liabilities under IFRS and details of which are shown in note 44.
Premium arising on issue of shares under share option schemes – 109
The directors do not propose to pay a final dividend (2008: none).
In addition, the trustees of the following holdings of Lloyds Banking Group plc shares in relation to employee share schemes retain the right to receive dividends but chose to waive their entitlement to the dividends on those shares as indicated: the Lloyds TSB Group Shareplan (holding at 31 December 2009: 3,028,623 shares, at 31 December 2008: 972,151 shares, waived right to all dividends), the Lloyds TSB Group Employee Share Ownership Trust (holding at 31 December 2009: 1,301,968 shares, at 31 December 2008: 1,442,116 shares, waived right to all dividends), Lloyds TSB Group Holdings (Jersey) Limited (holding at 31 December 2009: 42,846 shares, at 31 December 2008: 41,801 shares, waived right to all but a nominal amount of 1 penny in total) and the Lloyds TSB Qualifying Employee Share Ownership Trust (holding at 31 December 2009: 1,398 shares, at 31 December 2008: 1,364 shares, waived right to all but a nominal amount of 1 penny in total).
March 2000 – March 2001 As for March 1999 – August 1999 except that there must have been growth in the earnings per share equal to the change in the Retail Price Index plus three percentage points for each complete year of the relevant period.
To meet the performance conditions, the Group’s ranking against the comparator group required to be at least ninth. The full grant of options only became exercisable if the Group was ranked fi rst. A performance multiplier (of between nil and 100 per cent) was applied below this level to calculate the number of shares in respect of which options granted to executive directors would become exercisable, and were calculated on a sliding scale. If Lloyds Banking Group plc was ranked below median the options would not be exercisable.
No options were exercised during 2009 therefore the weighted average share price was £nil (2008: £4.53). The weighted average remaining contractual life of options outstanding at the end of the year was 4.3 years (2008: 5.1 years).
(ii) For the other 50 per cent of the award (the ‘TSR Award’) – the performance condition is as described for May 2006 with the relevant performance period commencing on 8 March 2007 (the date of the first award) and ending on 7 March 2010.
The performance conditions for awards made in March, April, August and September 2008 are as follows: (i) For 50 per cent of the award (the EPS Award) – the performance condition is as described for May 2006 with the relevant performance period commencing on 1 January 2008 and ending on 31 December 2010.
The EPS and economic profi t performance measures applying to this 2009 LTIP award were set on the basis that the Group would enter into the Government Asset Protection Scheme (GAPS). Now that the Group is not participating in GAPS, the Remuneration Committee has determined that these performance measures be restated on a basis consistent with the EPS and economic profi t measures used for the 2010 LTIP awards.
The weighted average share price at the date the shares were released during 2008 was £4.4613.
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
Free shares An award of shares may be made annually to employees based on a percentage of each employee’s salary in the preceding year up to a maximum of £3,000. The percentage is normally announced concurrently with the Group’s annual results and the price of the shares awarded is announced at the time of award. The shares awarded are held in trust for a mandatory period of three years on the employee’s behalf. The award is subject to a non-market based condition: if an employee leaves the Group within this three year period for other than a ‘good’ reason, all of the shares awarded will be forfeited.
The number of shares awarded relating to matching shares in 2009 was 16,746,310 (2008: 4,475,264), with an average fair value of £0.69 (2008: £2.56), based on market prices at the date of award.
No provisions have been recognised in respect of loans given to key management personnel (2008: £nil).
SUBSIDIARIES Details of the principal subsidiaries are given in note 9 to the parent company fi nancial statements. In accordance with IAS 27, transactions and balances with subsidiaries have been eliminated on consolidation.
On 2 November 2009, the Group entered into a Cost Reimbursement Deed with HM Treasury under which the Group has agreed to pay for the UK Government’s set-up costs relating to the proposed participation in GAPS and the UK Government’s costs associated with the European Union’s approval of state aid to the Group.
Credit Guarantee Scheme HM Treasury launched the Credit Guarantee Scheme in October 2008 as part of a range of measures announced by the UK Government intended to ease the turbulence in the UK banking system. It charges a commercial fee for the guarantee of new short and medium-term debt issuance. The fee payable to HM Treasury on guaranteed issues is based on a per annum rate of 50 basis points plus the median fi ve-year Credit Default Swap spread. At 31 December 2009, the Group had £49,070 million of debt issued under the CGS. During the year, fees of £498 million payable to HM Treasury in respect of guaranteed funding were included in the Group’s income statement.
INTERCHANGE FEES The European Commission has adopted a formal decision fi nding that an infringement of European Commission competition laws has arisen from arrangements whereby MasterCard issuers charged a uniform fallback interchange fee in respect of cross-border transactions in relation to the use of a MasterCard or Maestro branded payment card. The European Commission has required that the fee be reduced to zero for relevant cross-border transactions within the European Economic Area. This decision has been appealed to the General Court of the European Union (the ‘General Court’). Bank of Scotland plc and Lloyds TSB Bank plc (along with certain other MasterCard issuers) have successfully applied to intervene in the appeal in support of MasterCard’s position that the arrangements for the charging of a uniform fallback interchange fee are compatible with European Commission competition laws. Meanwhile, the European Commission and the UK’s OFT are pursuing investigations with a view to deciding whether arrangements adopted by other payment card schemes for the levying of uniform fallback interchange fees in respect of domestic and/or cross-border payment transactions also infringe European Commission and/or UK competition laws. As part of this initiative the OFT will also intervene in the General Court appeal supporting the European Commission’s position. The ultimate impact of the investigations on the Group can only be known at the conclusion of these investigations and any relevant appeal proceedings.
The contingent liabilities of the Group, as detailed above, arise in the normal course of its banking business and it is not practicable to quantify their future fi nancial effect.
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: Mortgage offers made 9,058 3,056 1 year or over original maturity 53,693 31,761
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £74,477 million (2008: £46,890 million) was irrevocable.
CAPITAL COMMITMENTS Excluding commitments in respect of investment property (note 26), capital expenditure contracted but not provided for at 31 December 2009 amounted to £203 million (2008: £92 million). Of this amount, £198 million (2008: £85 million) related to assets to be leased to customers under operating leases. The Group’s management is confi dent that future net revenues and funding will be suffi cient to cover these commitments.
(1) MEASUREMENT BASIS OF FINANCIAL ASSETS AND LIABILITIES The accounting policies in note 2 describe how different classes of fi nancial 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 fi nancial assets and liabilities by category and by balance sheet heading.
Trading and other fi nancial assets at fair value through profi t or loss – 27,245 122,766 – – – – 150,011
Loans and receivables: Loans and advances to banks – – – – 35,361 – – 35,361
Available-for-sale fi nancial assets – – – 46,602 – – – 46,602
Derivative fi nancial instruments 8,687 31,798 – – – – – 40,485
Derivatives through profi t or loss designated Designated Held at as hedging Held for upon initial Available- Loans and amortised Insurance instruments trading recognition for-sale receivables cost contracts Total £m £m £m £m £m £m £m £m
Items in the course of collection from banks – – – – – 946 – 946
Loans and receivables: Loans and advances to banks – – – – 38,733 – – 38,733
Available-for-sale fi nancial assets – – – 55,707 – – – 55,707
From held for trading to loans and receivables 1,833 1,822 2,883 2,926
From available-for-sale fi nancial assets to loans and receivables – 161 161 (108) (108)
(3) FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES The following table summarises the carrying values of fi nancial assets and liabilities presented on the Group’s balance sheet. The fair values presented in the table are at a specifi c date and may be signifi cantly different from the amounts which will actually be paid or received on the maturity or settlement date.
Carrying value Carrying value Fair value Fair value £m £m £m £m
Because a variety of estimation techniques are employed and signifi cant estimates made, comparisons of fair values between fi nancial institutions may not be meaningful. Readers of these fi nancial statements are thus advised to use caution when using this data to evaluate the Group’s fi nancial position.
Fair value information is not provided for items that do not meet the defi nition of a fi nancial instrument. These items include intangible assets, such as the value of the Group’s branch network, the long-term relationships with depositors and credit card relationships; premises and equipment; and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.
Debt securities in issue and subordinated liabilities The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities is estimated using quoted market prices.
Level 1 portfolios level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities. Products classifi ed as level 1 predominantly comprise treasury bills and other government securities.
Derivative fi nancial instruments Industry standard model / consensus pricing from market data provider
The valuation techniques used for unlisted equities and venture capital investments vary depending on the nature of the investment. Further details of these are given below. Third party valuers have been used to determine the value of unlisted equities and property partnerships included in the Group’s life insurance funds. As these factors differ for each investment depending on the nature of the valuation technique used and the inputs there is no single common factor that could be adjusted to provide a reasonable alternative valuation for these investments portfolios.
Venture capital investments The investments in venture capital activities comprise interests in funds and unlisted equity investments that are valued using techniques that are considered appropriate for that investment. Interests in funds are valued in the same manner as investments in the life funds below.
– Discounted cash fl ow valuations use estimated future cash fl ows, usually based on management forecasts, with the application of appropriate exit yields or terminal multiples and discounted using rates appropriate to the specifi c investment, business sector or recent economic rates of return.
Derivatives Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash fl ow and options pricing models, as appropriate. The types of derivatives classifi ed as level 2 and the valuation techniques used include: – Interest rate swaps are valued using discounted cash fl ow models; the most signifi cant inputs into those models are interest rate yield curves which are developed from publicly quoted rates.
The Group’s level 3 derivatives include £1,797 million in respect of the value of the embedded equity conversion feature of the enhanced capital notes issued in December 2009. Level 3 derivatives also include £140 million of credit default swaps written on level 3 negative basis ABS and £197 million of embedded derivatives included in investments of synthetic CDOs. The embedded equity conversion feature is valued by comparing the market price of the ECNs with the market price of similar bonds without the conversion feature. The latter is calculated by discounting the expected ECN cash fl ows in the absence of a conversion using prevailing market yields for similar capital securities without the conversion feature. The market price of the ECNs was calculated with reference to multiple broker quotes. Movements in the fair value of the derivative are recorded in net trading income.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum for 2008 and 2009 are disclosed on page 77.
Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to reserves.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using cross currency swaps and borrowings. At 31 December 2009 the aggregate notional principal of these cross currency swaps was £2,507 million (2008: £6,318 million) with a net fair value asset of £25 million (2008: liability of £2,413 million) (note 18) and they were designated on an after-tax basis as hedges of net investments in foreign operations. In 2009, ineffectiveness of £nil before tax and £nil after tax (2008: ineffectiveness of £14 million before tax and £10 million after tax) was recognised in the income statement arising from net investment hedges.
A general description of collateral held in respect of fi nancial instruments is disclosed on page 65.
Financial guarantees – these represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be signifi cantly less; most commitments to extend credit are contingent upon customers maintaining specifi c credit standards.
In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets held as collateral against wholesale lending. In such cases, the assets are carried on the Group’s balance sheet and are classifi ed according to the Group’s accounting policies.
Greater than 90 per cent 98,361 23,342 54 FINANCIAL RISK MANAGEMENT continued
Debt securities, treasury and other bills – analysis by credit rating: Rated BB AAA AA A BBB or lower Not rated Total £m £m £m £m £m £m £m
Total held as available-for-sale assets 20,415 11,653 9,952 1,707 468 376 44,571
Total held as trading assets 114 187 38 68 87 80 574
Net exposure as at 31 December £m £m £m £m £m £m
Exposures to Monolines During the year all exposure to sub-investment grade monolines on CDS contracts was written down to zero, leaving limited exposure to monoline insurers as set out below.
In addition, the Group has £2,703 million of monoline wrapped bonds and £791 million of monoline liquidity commitments on which the Group currently places no reliance on the guarantor.
Non-US residential mortgage-backed securities 9,655 8,742 862 48 3 – – –
The external credit rating is based on the bond ignoring the benefi t of the CDS.1 54 FINANCIAL RISK MANAGEMENT continued
Derivative fi nancial instruments, trading and other liabilities at fair value through profi t or loss 26,494 4,655 9,330 17,827 10,450 68,756
Derivative fi nancial instruments, trading and other liabilities at fair value through profi t or loss 6,725 1,977 3,204 11,871 9,869 33,646
Liabilities arising from non-participating investment contracts 46,040 4 58 185 186 46,473
Gross settled derivatives – infl ows (6,547) (4,501) (8,165) (35,306) (36,311) (90,830)
Within 1-3 3-5 Over 5 1 year years years years Total £m £m £m £m £m
Change in derivative fi nancial instruments, trading and other fi nancial assets at fair value through profi t or loss 12,063 (8,990)
Share capital (including share premium account and merger reserve): Issued on acquisition of HBOS 7,651 –
Derivatives, trading and other fi nancial assets at fair value through profi t or loss 137,889 –
Net cash infl ow arising from acquisitions in the year 16,262 –
Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 (35) (19)
The following pronouncements will be relevant to the Group but were not effective at 31 December 2009 and have not been applied in preparing these fi nancial statements. The full impact of these accounting changes is being assessed by the Group. With the exception of IFRS 9 Financial Instruments: Classifi cation and Measurement, the initial view is that none of these pronouncements are expected to cause any material adjustments to reported numbers in the fi nancial statements.
IFRS 3 Business Combinations The revised standard continues to apply the acquisition method to business combinations, however all payments to purchase a business are to be recorded at fair value at the acquisition date, some contingent payments are subsequently remeasured at fair value through income, goodwill may be calculated based on the parent’s share of net assets or it may include goodwill related to the minority interest, and all transaction costs are expensed.
Provides accounting guidance for non-reciprocal distributions of non-cash assets to owners (and those in which owners may elect to receive a cash alternative).
(issued April 2009) Sets out minor amendments to IFRS standards as part of annual improvements process.
Requires rights issues denominated in a currency other than the functional currency of the issuer to be classifi ed as equity regardless of the currency in which the exercise price is denominated.
We have audited the parent company fi nancial statements of Lloyds Banking Group plc for the year ended 31 December 2009 which comprises the parent company balance sheet, the parent company statement of changes in equity, the parent company cash fl ow statement and the related notes. The fi nancial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006.
RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As explained more fully in the Directors’ Responsibilities Statement on page 99, the directors are responsible for the preparation of the parent company fi nancial statements and for being satisfi ed that they give a true and fair view. Our responsibility is to audit the parent company fi nancial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
(a) The maintenance and integrity of the Lloyds Banking Group plc website is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the fi nancial statements since they were initially presented on the website.
(b) Legislation in the United Kingdom governing the preparation and dissemination of fi nancial statements may differ from legislation in other jurisdictions.
Capital Share capital Merger redemption Retained and premium reserve reserve profi ts1 Total1 £ million £ million £ million £ million £ million
Employee share option schemes: value of employee services – – – 59 59 proceeds from shares issued 119 – – – 119
Costs incurred in respect of the acquisition of HBOS plc (138) –
Details of the Company’s share capital and share premium account are as set out in notes 45 and 46 to the consolidated financial statements.
These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer. Any repayments of subordinated liabilities require the consent of the Financial Services Authority.
These comprise the US$528 million Thirteen-Month Extendible Short-Term Notes issued by the Company in July 2008.
On 13 January 2009 HM Treasury became a related party of the Company. Further information on the relationship and transactions with HM Treasury are given in note 51 to the consolidated fi nancial statements.
Related party information in respect of other related party transactions is given in note 51 to the consolidated fi nancial statements.
Note 53 to the consolidated financial statements outlines the valuation hierarchy into which financial instruments measured at fair value are categorised.
The derivative assets designated as hedging instruments represent level 2 portfolios. Of derivative assets classified as held for trading (not being designated as hedging instruments) shown above, £120 million represents level 2 portfolios and £1,797 million represents level 3 portfolios. The level 3 derivatives reflect the value at 31 December 2009 of the equity conversion feature of the Enhanced Capital Notes issued in December 2009 as part of Lloyds Banking Group’s recapitalisation and exit from the Government Asset Protection Scheme.
LIQUIDITY RISK 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 £282 million (2008: £111 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.
Carrying Carrying Fair Fair value value value value £m £m £m £m
For details contact: The Bank of New York Mellon Shareowner Services, PO Box 358516, Pittsburgh, Pennsylvania 15252-8516. Telephone: 877-353-1154 (US toll free), international callers: +1 201-680-6825. Alternatively visit www.bnymellon.com or email shrrelations@bnymellon.com
CORPORATE RESPONSIBILITY 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
SHAREHOLDER ENQUIRIES The Company’s share register and the Lloyds Banking Group Shareholder Account (formerly the HBOS Shareholder Account) are maintained by Equiniti Limited. Contact them if you have enquiries about your Lloyds Banking Group shareholding, including those concerning the following matters: – Change of name or address
Alt-A Alt-A is defined as loans regarded as lower risk than sub-prime, but they share higher risk characteristics than lending under normal criteria. Further information on the Group’s exposure to Alt-A investments is given in note 54.
Covered mortgage bonds A bond backed by a pool of mortgage loans. The mortgages remain on the issuer’s balance sheet. The issuing bank can change the make-up of the loan pool or the terms of the loans to preserve credit quality. Covered bonds thus have a higher risk weighting than mortgage-backed securities because the holder is exposed to both the non-payment of the mortgages and the fi nancial health of the issuer. The Group issues covered bonds as part of its funding activities (note 21).
Customer deposits Money deposited by account holders. Such funds are recorded as liabilities of the Group. The Group includes certain repos within customer deposits.
Impairment is measured individually for assets that are individually signifi cant, and collectively where a portfolio comprises homogenous assets and where appropriate statistical techniques are available.
Medium Term Notes Medium term notes are a form of corporate borrowing covering maturity periods ranging from nine months to 30 years. Details of the notes issued under the Group’s medium term notes programmes are given in note 35.
Residential Mortgage-Backed Securities are a category of ABS. They are securities that represent interests in a group of residential mortgages. Investors in these securities have the right to cash received from future mortgage payments (interest and/or principal).
Wrapped loans and bonds If a loan or bond (usually an ABS security) is originally issued with a credit default swap already attached, the package is called a ‘wrapped bond’ or ‘wrapped loan’. The Group’s exposure to wrapped loans and bonds is set out in note 54.