The 2014 Annual Report and Accounts incorporates the Strategic Report and the consolidated financial statements, both of which have been approved by the Board of Directors.
On behalf of the Board Lord Blackwell Chairman Lloyds Banking Group 26 February 2015
Lloyds Banking Group Annual Report and Accounts 2014 1BECOMING THE BEST BANK FOR CUSTOMERS
Our Commercial Banking division has a rich heritage of supporting UK businesses from SMEs to large corporates and financial institutions.
For more on our Consumer Finance division’s financial performance go to page 48 or visit www.lloydsbankinggroup.com
We are also one of the UK’s leading credit card issuers through our Consumer and Commercial Cards businesses meeting the needs of seven million customers daily through purchasing and flexible short-term borrowing propositions and payment acceptance services for UK merchants.
Our Insurance division provides customers with long-term savings, investment and protection products and general insurance.
Statutory profit before tax of £1,762 million, despite legacy items including £2,200 million of PPI charges
Statutory profit 0.75p Delivery of strategy and increased profitability has enabled resumption of dividend
Return on risk-weighted assets increased 0.88 per cent in the year to 3.02 per cent
While we are all proud of these achievements, we recognise that this is a base for the future, not the end of the strategic journey. There are major changes in the environment as well as our own capabilities that we need to address in the next phase of our development to become the best bank for customers and shareholders.
Alongside this strategic challenge, it is essential that we also rebuild trust. This is a major challenge for the UK financial services sector, not just because of the damage caused by the financial crisis but also because of the continuing legacy of past industry misconduct. As well as the continuing impact of issues such as Payment Protection Insurance we also announced settlements on LIBOR and BBA repo rate issues. The Board regards the actions of those individuals responsible for this misconduct as completely unacceptable. Their behaviour involved a gross breach of trust and we condemn it without reservation. Doing the right thing for customers is an integral part of our strategy and I am convinced that these actions are entirely unrepresentative of the vast majority of our staff who are committed to delivering outstanding service, recognising that trust is at the core of our business.
Capital requirements, though not yet finalised, are much clearer and the significant progress made in improving our capital position means we are now well placed. During the year, the Group met the capital benchmarks set out by the European Banking Authority (EBA) and the Prudential Regulation Authority (PRA) stress testing exercises, with no additional capital action required; a further demonstration of our robust capital, liquidity and funding position.
The ring-fence perimeter was clearly set in 2014, although final details and implementation of the rules remain undetermined. Our strategy continues to envisage a simple, low risk organisation with a business model focused on traditional retail and commercial banking, that would predominantly sit within the ring-fence.
Our Board The Board has seen a number of changes this year, and in line with the provisions of the UK Corporate Governance Code and the interests of good corporate governance, all Directors are required to submit themselves for re-election on an annual basis. We are committed to ensuring we have the right balance of skills and experience within the Board, and we annually review its composition, and the diversity of backgrounds of its members.
– the continued creation of a corporate culture that values integrity and best practice standards and that puts customers first.
Remuneration We continue to believe that remuneration policy at all levels, including for senior executives, needs to motivate staff to deliver strong, sustainable growth whilst supporting the business strategy. We strongly believe in ‘rewards for success’, properly earned not just paid by default. That means aligning rewards to the longer term, sustainable success of our business and through this the delivery of value to shareholders. It also means holding back or removing performance rewards where managers have failed to meet their objectives.
More information on how we ensure our approach to remuneration supports the business strategy can be found in the Directors’ remuneration report later in this document.
Outlook As we enter 2015, a ‘milestone’ year during which we celebrate the 200th anniversary of Scottish Widows and the 250th anniversary of Lloyds Bank, it is important that we look back with pride but also keep looking forward and adapt to the changing landscape of the future. I believe we are very well placed to make the most of the opportunities that exist.
This delivery has, in turn, enabled the UK government to make further progress in returning the Group to full private ownership. In 2014 the UK government reduced its shareholding through the second successful sale of part of its stake in March and the launch of a pre-arranged trading plan in December which provides a means for an orderly sell down that will end no later than June 2015. On 20 February 2015, we were advised that UKFI’s interest in the Group had reduced to 23.9 per cent. In the summer, we sold 38.5 per cent of TSB via a well-received Initial Public Offering, with this and the subsequent sale of a further 11.5 per cent stake in September resulting in us being firmly on track to meet our European Commission State Aid commitments.
We are committed to helping Britain and its communities and in March we launched our Helping Britain Prosper Plan. This initiative comprises a number of public commitments in areas where we can make the biggest difference and create value for our customers across households, businesses and our communities, in turn supporting our goal of being the best bank for customers. Since its launch, all of our divisions have made good progress in implementing this Plan, with the Group exceeding each of its lending commitments in 2014 while also delivering lending growth in our key customer segments.
In our Retail division, we provided £11.9 billion of lending to over 89,000 first-time buyers as well as 1 in 5 of all mortgage loans to customers buying their home in the UK in 2014, with total gross mortgage lending of £40 billion, 13 per cent higher than the prior year. We remain the largest participant in the UK government’s Help to Buy mortgage guarantee scheme, lending £1.9 billion through this scheme in the year. In Retail Business Banking, we also supported over 100,000 new business start-ups.
The Commercial Banking division continued to take a leading role in supporting the UK economic recovery, with SME lending growing for the fourth consecutive year against a market that has contracted each year, increasing by 5 per cent in 2014. Lending to Mid Market corporates also increased by 2 per cent in a market that contracted by around 3 per cent. We remain firm supporters of the UK government’s Funding for Lending scheme, committing over £15.5 billion of eligible lending and £1 billion to UK manufacturing during 2014.
For our shareholders, we have delivered a significant improvement in financial performance, while improving the risk profile of the bank and strengthening the balance sheet.
We have strengthened underlying performance from a loss of £0.9 billion in 2010 to a profit of £7.8 billion in 2014, driven by a combination of lower impairment charges and a reduction in the Group’s cost base. While our statutory result has also increased significantly over this period, our pre-tax profit of £1.8 billion in 2014 continued to be affected by PPI and other regulatory provisions as well as costs associated with TSB, the Simplification programme and the ECN exchange. Looking ahead, while regulatory and conduct risks remain, we believe that the Group’s statutory performance will become significantly less impacted by such issues, resulting in a far greater proportion of our underlying financial performance flowing through to shareholder returns over time.
– Reliance on wholesale funding reduced by more than £180 billion – Loan to deposit ratio improved from 154 per cent to 107 per cent
Rebuilding customer trust remains a key imperative for the business. In support of this, we have continued to transform the corporate culture and have completely overhauled the performance and reward framework for our customer-facing colleagues, with performance now predominantly assessed on the basis of customer feedback.
We have also strengthened the control environment through changes to our organisational design and the introduction of standardised templates across the Group to assess and monitor our risk appetite. While these improvements have been essential in helping us to rebuild customer trust, we recognise there is more to do and that we still have legacy issues to work through.
Strategic update In October 2014 we set out the next phase of our strategy, highlighting our key priorities for the next three years and how we intend to deliver value and high quality experiences for customers, alongside strong and sustainable financial performance for our shareholders within a prudent risk and conduct framework.
The first of our three strategic priorities is ‘creating the best customer experience’. We will achieve this through our multi-brand, multi-channel approach by combining comprehensive online and mobile capabilities with face-to-face services delivered through our branch and relationship manager network.
We will invest £1 billion over the next three years in digital capability across all business divisions, delivering better service with greater efficiency. This transformation will reflect our customers’ changing preferences in how they choose to interact with us, providing seamless access through a secure and resilient digital infrastructure.
Secondly, we will create operational capability by ‘becoming simpler and more efficient’, enabling us to be more responsive to changing customer expectations and to maintain our cost leadership position amongst UK high street banks as a source of competitive advantage. Through the simplification and increased automation of key processes, the reduction in third party spend and changes to our organisational design, we expect to deliver a further £1 billion of annual run-rate savings by the end of 2017, creating value for customers and improving our long-term competitiveness.
Over the next three years, we expect the UK financial services industry to undergo an unprecedented rate of change, driven by technology, changing customer behaviour and increasing regulatory requirements at a time when traditional competitors’ strategies converge and new entrants compete for customers.
In the shorter term, we expect the Group to continue to perform strongly in 2015, with our net interest margin expected to strengthen to around 2.55 per cent, other income to remain broadly stable, and our low risk business model expected to be reflected in an asset quality ratio of around 30 basis points. We also expect our capital generation to remain solid, with our CET1 ratio expected to increase by between 150 and 200 basis points per annum pre-dividend.
GROWTH IN OUR MARKETS (yearly % change in UK market balances)
Unsecured debt Long-term average 1Non-financial companies’ borrowing from banks, excluding property and construction
Ring-fencing and resolution regulation, through both the Financial Services (Banking Reform) Act 2013 and the European Commission’s Recovery and Resolution Directive, continues to be a focus. Banks will be required to ring-fence retail and SME activities from their investment banking activities to ensure consumers are protected. As a UK focused retail and commercial bank, most of our operations are expected to be within the ring-fence and therefore the impact is likely to be less than for many of our peers.
Overall however, we believe our simple, low risk, UK focused strategy puts us in a strong position to adapt to the ever evolving regulatory landscape.
– Economic environment: significant progress in reducing the Group’s risk profile and strengthening the balance sheet along with strategic actions taken in the last couple of years means we are better positioned to benefit as the economy recovers.
– Low cost position: this enables us to provide competitive differentiation for the benefit of customers and shareholders.
Delivering for shareholders and customers Our key performance indicators are focused on strategic progress and how we are delivering for our customers and our shareholders.
Executive management are also eligible to participate in a Long-Term Incentive Plan, which encourages delivery on long-term financial objectives including total shareholder return and the Group’s strategic objectives of becoming the best bank for customers and helping Britain prosper.
To read more about how we align remuneration with performance go to pages 27 and 82.
To read more go to page 11 or visit www.lloydsbankinggroup.com 1182
We reached our £2 billion Simplification run-rate cost savings target as outlined in the 2011 strategy.
O ther inform ationTo read more go to page 35 or visit www.lloydsbankinggroup.com 35
As a result of the strategic progress made, we reported improvements in underlying and statutory profit as well as a stronger capital position in 2014, despite legacy charges. We were also able to reinstate dividend payments.
Underlying profit continued to increase in 2014, up 26 per cent.
Earnings per share continued to improve given the increasing profitability of the business.
Pre-tax statutory profit continued to recover and reached £1,762 million in 2014, compared to £415 million in 2013.
Customer relationships are key to our strategy and are critical for all our businesses. Significant differences across our four divisions mean the financial and non-financial strategic indicators for the development of customer relationships are generally tracked at a divisional level.
We offer simple, tailored products with innovation where it matters most to our customers across all our divisions. Our focus on creating a simpler, more efficient and agile organisation is enabling us to provide better product and service propositions, innovating as appropriate, to address customer needs at a fair price while delivering more efficient processes and improving our cost leadership position.
The UK financial services market remains one of the largest in the world and, although our business model and strategy have been formulated in the context of a cautious outlook for the UK economy, we believe they remain appropriate for all stages of the economic cycle, whilst providing real differentiation and positioning us well for future regulatory reform.
We have achieved the strategic objectives we set in 2011. Our focus for the next three years builds upon this success with three new strategic priorities. Our strategy Our low cost, low risk, customer focused, UK retail and commercial banking business model has driven the development of our new strategy. We have a number of distinct assets and capabilities, including our unique multi-brand, multi-channel model, our customer franchise, our market leading cost position, our proven management team and high quality committed people.
Colleagues Our colleagues are fundamental to the achievement of this strategy and engaged and customer focused colleagues will be essential in becoming the best bank for customers and provide further competitive differentiation.
Initiatives – Maintain market leading position in key retail business lines
– Consumer Finance to increase UK customer assets by over £6 billion from 2015 to 2017
– Support our customers in retirement planning, increasing customer assets by over £10 billion
We believe we can make our greatest contribution to society and stakeholders by helping Britain prosper, and that means serving the financial needs of UK households, businesses and communities in a responsible and ethical way. Our approach Operating sustainably and responsibly is integral to our business model and strategy. At the heart of our approach are our three Group Values – putting customers first, keeping it simple and making a difference together. Our Codes of Responsibility define the behaviours required to live up to our Values – as a business, as individual colleagues or as suppliers.
An independent Stakeholder Panel adds extra strength to our governance structure and the quality of our reporting. You can read the Panel’s independent statement online.
Material issues As part of our annual Responsible Business reporting we have conducted a comprehensive process to identify and prioritise the material issues that matter most to our stakeholders. More information on this process can be found in our detailed Materiality Report online.
TREATING CUSTOMERS FAIRLY If we want to rebuild trust in our bank, then we must treat customers fairly, putting their wellbeing at the heart of every decision we make and every action we take
RESPONSIBLE LENDING FOR ALL CUSTOMERS We are focused on lending responsibly to all customers, including Britain’s homebuyers and businesses
Read more about material issues on page 26 or see our Responsible Business Review at www.lloydsbankinggroup.com/RB
Governance Helping Britain Prosper PlanCodes and PoliciesGroup ValuesBusiness Model and Strategy
Our business model positions us as a low cost, low risk, customer focused UK retail and commercial bank, with a distinctive multi-brand, multi-channel offer. By putting customers at the heart of everything we do and operating sustainably and responsibly, we believe we will help Britain prosper and create value for our shareholders.
Our pillars of responsible business: Put customers at the heart of our business
It focuses on: Helping homebuyers Helping people plan for later life
2.2 Number of customers we help post-retirement through providing a continuing annuity income
We’ll take a lead in financial inclusion to enable all individuals to access, and benefit from, the products and services they need to make the most of their money 3.1 Amount of additional funding provided to support Credit Unions per year £1m £1m 3.2 Share of social banking accounts we will support 29% 1 in 4 3.3 Number of community support workers accredited to deliver financial education on the front line1
We’ll help businesses and individuals succeed with expert mentoring and training 5.1 Number of colleagues trained to mentor SMEs and social entrepreneurs through the Business Finance Taskforce accredited scheme and the Lloyds Bank and Bank of Scotland Social Entrepreneurs programme
Includes Commitment; Know-how; Adjustments; Recruitment; Retention; Products & Services; Suppliers and Partners; Communication; Premises; Information and Communication Technology.
7.3 We will consistently increase the engagement levels of disabled colleagues in all roles
Improving accessibility We are working hard to make continuous improvements to our evolving multi-channel offer for all customers. We have made several important improvements for customers with disabilities or in ill-health, including those with dementia. We have launched a new branch disability toolkit across all our brands, advising colleagues on best practice and we’ve installed more talking ATMs in our branches for visually impaired customers.
Business and SMEs This year we have increased lending to SMEs by 5 per cent compared with 2013. We have also focused more attention on start-up businesses, with a 2014 Helping Britain Prosper Plan commitment to help 100,000 start-ups this year. We are pleased to say that we beat this target, helping 107,000 start-ups by the end of the year.
Our Remuneration Policy was approved by shareholders at the AGM in May 2014. The Policy provides a framework to support robust governance in line with the Group’s risk appetite and aligned with the Group’s business strategy, objectives, values and long-term interests, as well as the consideration of our Codes of Responsibility and the Helping Britain Prosper Plan.
Engaging colleagues We have regular dialogue with colleagues to get a picture of how they are feeling and keep them informed of changes to our business and our financial performance. We are committed to providing colleagues with comprehensive coverage of the economic and financial issues affecting the Group. Information is provided through various channels and views are represented through regular dialogue and consultation with the Unions. We offer share schemes to colleagues to encourage their financial involvement.
Colleague scope of reporting: UK payroll headcount includes established and fixed term contract colleagues. Excludes parental leavers, Non-Executive Directors, contractors, temp, agency and internationals.
Sexual orientation: Percentage of colleagues who disclose they are lesbian, gay, bisexual or transgender 0.6% 0.8%
Data source: HR system (HRIS). Apart from gender data, all diversity information is based on colleagues’ voluntary self-declaration. As a result this data is not 100 per cent representative; our systems do not record any diversity data for the proportion of colleagues who have not declared this information.
Our approach towards managing our environmental impact is set out in our Environmental Statement, available online.
All data has been calculated to remove the impact of divestment activity in 2014, both from the current reporting year emissions and prior years.
A definition of Scope 1,2,3 emissions is provided in the Lloyds Banking Group criteria statement available online at www.lloydsbankinggroup.com
The reporting period for emissions is October 2013 to September 2014, which is different to that of our Director’s Report (January 2014 – December 2014). This is in line with Regulations in that the majority of the emissions reporting year falls within the period of the Directors’ Report.
– Omissions Emissions associated with joint ventures and investments are not included in the emissions disclosure as they fall outside the scope of our operational boundary. We do not have any emissions associated with heat, steam or cooling. We are not aware of any other material sources of omissions from our emissions reporting.
13.1% reduction in energy use compared to 2013 £3.8m invested in energy saving technology in 2014
Risks are identified, managed and mitigated using our Risk Management Framework (see page 31). The principal risks we face, which could significantly impact the delivery of our strategy, are discussed on pages 32 and 33.
We believe effective risk management can be a strategic differentiator, in particular: Sustainable growth The role of risk is to provide proactive support and constructive challenge to the business to deliver sustainable growth, which is achieved through informed risk decision making and superior risk and capital management, supported by a consistent risk-focused culture across the Group.
– Effective risk analysis, management and reporting This identifies opportunities as well as risks and ensures risks are managed appropriately and consistent with strategy. Our principal risks and performance against risk appetite are monitored and reported regularly to senior management using quantitative and qualitative analysis and are subject to relevant stress testing. This enables us to understand the risk in the business at both an individual risk type and aggregate portfolio level.
State aid commitments Risk Division continued to support the Group’s divestment of TSB, with the Group selling 35 per cent of ordinary shares by way of an Initial Public Offering in June 2014, 3.5 per cent through utilisation of an over allotment option in July 2014 and a further 11.5 per cent of the ordinary shares by way of an Institutional Placing in September 2014, remaining on course to complete the divestment by the end of 2015.
– Becoming simpler and more efficient Responding quickly to changing customer, business and regulatory needs.
In line with our Code of Responsibility. Culture ensures performance, risk and reward are aligned
The Risk Appetite Framework ensures our risks are being managed in line with our risk appetite
Setting risk appetite and strategy Approval of the risk management framework and Group-wide risk principles
Credit risk Any adverse changes in the economic and market environment we operate in, or the credit quality and/or behaviour of our borrowers and counterparties would reduce the value of our assets and potentially increase our write-downs and allowances for impairment losses, adversely impacting profitability.
– Credit policy incorporating prudent lending criteria aligned with the Board approved risk appetite to effectively manage credit risk.
– Product approval, review processes and outcome testing supported by conduct management information.
– Comprehensive stress testing analysis to evidence sufficient levels of capital adequacy for the Group under various adverse scenarios.
Further progress has been made in improving our capital position through a strongly capital generative strategy, including Run-off and disposal of assets, and the issuance of new additional tier 1 and tier 2 securities in April and November 2014 respectively.
– Continue to meet current and future regulatory requirements, whilst optimising value for shareholders.
People risk Key people risks include the risk that the Group fails to lead responsibly in an increasing competitive marketplace, particularly with the introduction of the Senior Managers’ Regime and Certification Regime which will come into force in 2015. This may dissuade capable individuals from taking up senior positions within our Group.
– Work collaboratively with regulators to implement the new Individual Accountability Regime in 2015, ensuring burden of proof and attestation requirements are effectively implemented.
PRINCIPAL RISKS KEY MITIGATING ACTIONS KEY RISK INDICATORS Commentary FUTURE FOCUS
– Robust credit processes and controls including well-established governance to ensure distressed and impaired loans are identified, considered and controlled with independent credit risk assurance.
– Close monitoring of capital and leverage ratios to ensure we meet our current and future regulatory requirements.
– Continued investment in our people, processes and IT systems is enabling us to meet our regulatory commitments.
– Create a work environment which listens and acts on colleague feedback, making the Group the best bank for colleagues.
As part of our Colleague Engagement Survey, the Best Bank for Customers index is designed to help the Group understand the colleague views on progress we are making towards becoming the best bank for customers.
– Continued action to further strengthen performance to become the best bank for customers.
This key risk indicator is also a key performance indicator (KPI).1
Lloyds Banking Group Annual Report and Accounts 2014 35BECOMING THE BEST BANK FOR CUSTOMERS
Total loans and advances to customers were £477.6 billion at 31 December 2014, 3 per cent lower than at 31 December 2013, with growth in the key customer segments of mortgages, SME lending, Mid Markets and UK Consumer Finance offset by reductions in balances in the Run‑off portfolio and lending to Global Corporate customers. Customer deposits were £447.1 billion at 31 December 2014, an increase of £10.6 billion, or 2 per cent, since 31 December 2013 with growth of relationship deposits, partly offset by a reduction in tactical brands.
Impaired loans as a % of closing advances 2.9% 6.3% (3.4)pp
The Group expects the asset quality ratio for the 2015 full year will be around 30 basis points.
Statutory profit Statutory profit before tax was £1,762 million compared to a pre‑tax profit of £415 million in 2013. Further information on the reconciliation of underlying to statutory results is included on page 206.
Negative volatility arising in insurance businesses was £228 million in 2014, principally reflecting lower than expected returns on equity markets and cash investments. This compared to positive insurance volatility of £668 million in 2013 driven by strong equity market performance.
Simplification and TSB costs Total Simplification costs in 2014 were £966 million (2013: £830 million). The total spent on Simplification to the end of December 2014 was £2.4 billion with a further £0.2 billion of redundancy costs in 2014 relating to the acceleration of the next phase of the programme. The original programme has delivered annual run‑rate savings of £2.0 billion, meeting the increased target announced with the 2013 results. In the next phase of Simplification the Group is targeting a further £1 billion of annual run‑rate savings by the end of 2017.
The Group holds 50 per cent of TSB’s ordinary shares. TSB build and dual running costs in the year were £232 million and £326 million, respectively. In 2013 TSB build costs were £687 million.
PPI The Group increased the provision for expected PPI costs by a further £700 million in the fourth quarter. This brings the amount provided in 2014 to £2,200 million (2013: £3,050 million), and the total amount provided to £12,025 million. Total costs incurred in the fourth quarter were £700 million and as at 31 December 2014, £2,549 million or 21 per cent of the total provision, remained unutilised.
The Group has now commenced re‑reviewing previously handled cases. During the course of the year the scope of remediation has increased, which combined with higher uphold rates following complaint handling policy changes, has resulted in an additional provision being required of £250 million for the year, of which £140 million was in the fourth quarter.
The total amount provided for PPI represents our best estimate of the likely future costs. The run‑rate of spend in the first quarter of 2015 is expected to increase as a result of cash payments for remediation and residual PBR responses. The run‑rate of spend in the first half of 2015 overall however, is expected to remain broadly in line with the second half of 2014 as remediation spend reduces. These programmes will be largely complete by mid year, and as a result the Group expects a further reduction in cash outflow in the second half of 2015. However, a number of risks and uncertainties remain in particular in respect of complaint volumes, uphold rates, average redress costs, the cost of proactive mailings and remediation, and the outcome of the FCA Enforcement Team investigation. The cost of these factors could differ materially from our estimates, with the risk that a further provision could be required.
Further provisions of £150 million have been made relating to the past sale of interest rate hedging products (IRHPs) to certain small and medium‑sized businesses of which £100 million was recognised in the fourth quarter. The further provision brings the total amount provided for redress and related administration costs for customers in scope of the agreement with the FCA to £680 million of which £109 million was unutilised at 31 December 2014.
Underlying return on equity is calculated as the underlying profit after tax at the standard UK corporation tax rate less the post tax profit attributable to other equity holders divided by the average required equity in the year. Required equity is made up of shareholders’ equity and non‑controlling interests and is the amount required to achieve a common equity tier 1 ratio of 12.0 per cent after allowing for regulatory adjustments and deductions. An adjustment is also made to reflect the notional earnings on any excess or shortfall in equity.
Calculated in accordance with the January 2014 revised Basel III leverage ratio framework.
Loans and advances to customers excluding TSB, Run‑off and other1 £406bn £402bn 1
Excludes balances relating to margins of £2.8 billion (31 December 2013: £2.3 billion) and settlement accounts of £1.4 billion (31 December 2013: £1.3 billion).
The growth in deposits, together with the reduction in total loans and advances, resulted in the loan to deposit ratio improving to 107 per cent from 113 per cent at the end of 2013, and has reduced the Group’s wholesale funding requirement. Wholesale funding at 31 December 2014 was £116.5 billion, with 65 per cent having a maturity of greater than one year.
Loans and advances to customers 315.2 100.9 20.9 19.0 21.6 477.6 20133 £m £m £m £m £m £m £m
Loans and advances to customers 314.3 105.7 19.1 30.3 23.5 492.9
Total customer balances include loans and advances to customers, customer deposit balances and Consumer Finance operating lease assets.
Underlying basis In order to present a more meaningful view of business performance, the results are presented on an underlying basis excluding items that in management’s view would distort the comparison of performance between periods. Based on this principle the following items are excluded from underlying profit: the amortisation of purchased intangible assets and the unwind of acquisition‑related fair value adjustments; the effects of certain asset sales, the impact of liability management actions and the volatility relating to the Group’s own debt and hedging arrangements as well as that arising in the insurance businesses and insurance gross up; Simplification costs, TSB build and dual running costs; payment protection insurance and other regulatory provisions; and certain past service pensions credits or charges in respect of the Group’s defined benefit pension arrangements.
Other includes the specialist mortgage book, Intelligent Finance and Dutch mortgages.
Following PRA guidance, calculated in accordance with the January 2014 revised Basel III leverage ratio framework.
Total income, net of insurance claims 16,399 18,478 20,517 20,802 24,868
Profit (loss) for the year attributable to ordinary shareholders 1,125 (838) (1,471) (2,963) (339) 31 December 31 December 31 December 31 December 31 December
Net asset value per ordinary share 60.7p 55p 60p 66p 67p
Diluted earnings (loss) per ordinary share 1.6p (1.2)p (2.1)p (4.3)p (0.5)p
Common equity tier 1 capital/Core tier 1 capital 12.8 14.0 12.0 10.8 10.2
Capital ratios for 2014 reflect CRD IV transitional rules as implemented by the PRA on 1 January 2014. Capital ratios for 2013 and earlier years have not been restated to reflect the implementation of CRD IV.
Retail offers a broad range of financial service products, including current accounts, savings, personal loans and mortgages, to UK personal customers, including Wealth and small business customers. It is also a distributor of insurance, protection and credit cards, and a range of long‑term savings and investment products. Retail’s aim is to be the best bank for customers in the UK, by building deep and enduring relationships that deliver value to customers, and by providing them with greater choice and flexibility. Retail will maintain its multi‑brand and multi‑channel strategy, and continue to simplify the business and provide more transparent products, helping to improve service levels and reduce conduct risks.
Financial performance – Underlying profit increased 7 per cent to £3,228 million. – Net interest income increased 9 per cent. Margin increased 20 basis points to 2.29 per cent, driven by improved deposit mix and margin, more than offsetting reduced lending rates. – Other income down 16 per cent, with lower protection income partly due to the decision to close the face‑to‑face advised protection role in branches, and lower wealth related income due to regulatory changes. – Total costs increased 7 per cent to £4,464 million, reflecting higher indirect overheads previously absorbed in the TSB segment and costs associated with ongoing investment in the business. – Impairment reduced 21 per cent to £599 million, with unsecured charges decreasing consistent with lower impaired loan and arrears balances. Secured coverage strengthened to 37 per cent, resulting in a 13 per cent increase to the impairment charge. – Return on risk‑weighted assets increased 79 basis points driven by 7 per cent increase in underlying profit and reduced risk‑weighted assets.
Balance sheet – Loans and advances to customers increased slightly to £315.2 billion, with stronger growth of 2 per cent in the open mortgage book (excludes closed specialist book and Intelligent Finance). – Customer deposits increased 1 per cent to £285.5 billion, with relationship balances (including Lloyds, Halifax and BoS) up 4 per cent year‑on‑year. – Risk‑weighted assets decreased by £5.2 billion to £67.7 billion driven by an improvement in the credit quality of retail assets and improving house prices.
Commercial Banking supports UK businesses from SMEs to large corporates and financial institutions. It has a client led, low risk strategy targeting sustainable returns on risk‑weighted assets above 2 per cent by the end of 2015 and 2.4 per cent by the end of 2017, whilst simplifying operating processes, building digital capability and maintaining capital discipline. Commercial Banking aims to be the best bank for clients delivering a through‑the‑cycle relationship approach that provides affordable, simple and transparent finance, as well as support for complex needs and access to Government funding schemes.
Consumer Finance aims to extend its market leadership in Asset Finance by building its digital capability and creating new propositions in both the Black Horse and Lex Autolease businesses. In Credit Cards, better use will be made of Group customer relationships and insight to seek growth within its current risk profile from both franchise and non‑franchise customers.
Progress against strategic initiatives – UK loan growth of 17 per cent year‑on‑year, increasing momentum from the first half of 2014. – New business growth of 48 per cent within Black Horse, supported by the launch of the Jaguar Land Rover partnership in the first quarter of 2014 and strong underlying business performance. – Growth of 23 per cent in new Lex Autolease fleet deliveries with leads from the franchise more than double 2013. – Growth in lending balances within Credit Cards for the first time in eight years.
– Growth in new consumer credit cards including a 4 per cent increase in new accounts opened and a 15 per cent increase in balance transfer volumes from new and existing customers. – Net gainer in balance transfers compared to competitors in Credit Cards new business, leveraging the breadth of product lines, brands, and channels, and making strong progress in building non‑franchise capabilities. – Growth of 45 per cent in transaction volumes within the Cardnet Acquiring Solutions business, driven in part by new partnerships, in addition to increased activity from existing customers. – Successful implementation of initial regulatory changes following change of regulator from the Office of Fair Trading to the Financial Conduct Authority.
Progress against strategic initiatives – Insurance is a market leader in the corporate pensions market serving over 11,500 employers (including 19 per cent of the FTSE 350) and 1.4 million employees with £27 billion of assets invested with us. In 2014 the number of employees covered by these schemes grew by 40 per cent principally reflecting the ongoing support for employers through the auto‑enrolment process. – The roll out of the Pensions Freedoms legislation in 2015 presents a significant opportunity to help customers with their retirement planning needs and a range of products to support this is being developed. With access to 24 million Retail customers, the Group remains very well placed to participate in this market. – Re‑launched the Scottish Widows brand in 2014 and increased investment in strategic initiatives specifically in digital and mobile solutions, demonstrating the Group’s commitment to being a leader in the changing market. – In 2014 the underwriting of the Home insurance direct channel business was brought in‑house offering all customers access to the first class claims service we provide. Investment is being made in the Group’s direct digital capability with the aim of increasing market share in General Insurance and responding to changes in the way customers buy General Insurance, moving more towards online distribution channels. – Continued commitment to supporting customer protection needs, with focus now on the sale of our standalone protection products through investment in digital solutions and in the Independent Financial Adviser distribution channel alongside continued in‑branch protection advice for mortgage applications. In recognition of the change in consumer focus, the Group withdrew standalone protection advice through Retail branches in November. – Completion of the sale of Heidelberger Leben and Scottish Widows Investment Partnership helped simplify the Insurance business, allowing increased focus on the remaining core business.
Cash invested in new business (238) (38) − (12) (288) (270)
Cash generated from existing business 452 177 − 140 769 655
Derived from IFRS underlying profit by removing the effect of movements in intangible (non‑cash) items and assumption changes.
Average interest‑earning banking assets are calculated gross of related impairment allowances, and relate solely to customer and product balances in the banking businesses on which interest is earned or paid.
Other includes adjustments for assets that are netted for interest earning purposes, reverse repos and the timing effects of disposals.
Risk-weighted assets: On a Lloyds Banking Group reporting basis 5.2 5.6
Skills and experience: Extensive insurance, banking, regulatory and public policy experience gained from senior positions in a wide range of industries. He was appointed a Life Peer in 1997. External appointments: Chairman of Interserve plc. Former appointments: Chairman of Scottish Widows Group, Non-Executive Director of Ofcom, Halma plc, Dixons Group and SEGRO. Senior Independent Director of Standard Life and chaired its UK Life and Pensions Board. Member of the Board of the Centre for Policy Studies, Non-Executive Member of the Office of Fair Trading, Partner of McKinsey & Co. and a Director of Group Development at NatWest Group. Head of the Prime Minister’s Policy Unit.
Skills and experience: Extensive board, financial and general management experience across a range of sectors, including banking, asset management, manufacturing and utilities. External appointments: Senior Independent Director of IMI plc. Former appointments: Chairman of Victrex plc, Senior Independent Director of Aberdeen Asset Management, Executive Director of Abbott Mead Vickers, Director of Corporate Development at WPP Group and Non-Executive Director of Northumbrian Water. In addition, Anita has held various investment and marketing roles at Scottish Provident and the Royal Bank of Scotland.
Skills and experience: Extensive digital and online, government and regulatory experience gained across a range of sectors including media and financial services. Her career began as an Economist at the World Bank. External appointments: Non-Executive Director of Capita and The Vitec Group and Chairman of their Remuneration Committees. Trustee of Marie Curie, Non-Executive Director of the Competition and Markets Authority and of the UK Statistics Authority. Former appointments: Non-Executive Director of the Financial Services Authority and Chair of its Risk Committee. Director of Group Development and Strategy at ITV plc and Director of Strategy and a member of the Executive Board at the BBC. Partner of McKinsey & Co. and a policy adviser in the Prime Minister’s Policy Unit.
Skills and experience: Extensive experience in both retail and commercial banking built over a period of more than 25 years, working both internationally and in the UK. In 1993 he joined Grupo Santander having previously worked for Goldman Sachs and for Citibank, and held various senior management positions before becoming Executive Vice President of Grupo Santander and a member of its Management Committee. External appointments: Non-Executive Director of Fundação Champalimaud and of Sociedade Francisco Manuel dos Santos in Portugal, a member of the Board of Stichting INPAR, a Governor of the London Business School and Chairman of the Wallace Collection. Former appointments: Non-Executive Director and Chief Executive of Santander UK. Non-Executive Director of the Court of the Bank of England.
Skills and experience: Deep operational and financial expertise including strategic and financial planning and control. He has worked in financial services in the UK and overseas for over 20 years. With a strong background in insurance and shareholder advocacy, his skills and experience enhance the Board and strengthen further the senior management team. External appointments: None. Former appointments: Executive Director and Chief Financial Officer of RSA Insurance Group and Chief Financial Officer of Zurich Financial Services UK.
Skills and experience: Background in retail and associated sectors, including financial services. Considerable experience of boards at both executive and non-executive level. External appointments: Non-Executive Director of United Utilities Group and Chair of its Remuneration Committee and a Governing Council Member of Cambridge University. Also Chairman of the Planning Inspectorate, Lead Non-Executive Director at the Department of Communities and Local Government and Board member at the Higher Education Funding Council. Former appointments: Managing Director of Argos, various senior positions at J Sainsbury including Deputy Managing Director, Non-Executive Director of Mitchells & Butler and senior management roles for Abbey National and Mars Confectionery.
Skills and experience: Over 40 years of experience in the investment management industry and related sectors. External appointments: Senior Independent Director of Hammerson and of Witan Investment Trust, Chairman of the Lincoln’s Inn Investment Committee and a member of the Norges Bank Investment Management Corporate Governance Advisory Board. Former appointments: Non-Executive Director of Vodafone Group, Chief Executive of Hermes Pensions Management and Chairman of the Asian Infrastructure Fund, MEPC and of the Strategic Investment Board (Northern Ireland). Member of the Financial Reporting Council and the Marks & Spencer Pension Trustees.
Alison joined the Group in 2011 from Santander where her last role had been Executive Director for Retail Distribution and a Board Director. She previously worked at Barclays for almost 20 years in various senior roles including Director of Barclays and Woolwich Retail Networks and Managing Director of Barclays Small Business Banking.
Biographies of the members of the Group Executive Committee (GEC), and in the case of the Group Audit Director, GEC attendee, are provided opposite.
Previously, Mary was a senior Financial Services Audit Partner for KPMG Canada where she was a signing audit partner for a number of global financial institutions. She has over 25 years of experience in the financial services industry. Mary has a reporting line to the Chairman of the Audit Committee and the Group Chief Executive.
David has over 30 years’ experience in retail financial services. He is Chairman of the ‘Your Tomorrow’ pension fund trustees and is a member of the Institute of Financial Services School of Finance Board of Governors. He is also community ambassador for Yorkshire and Humberside and chairs the Group Regional Ambassador programme.
Miguel joined the Group in 2011 before which he held a variety of executive positions in the UK, USA and Spain for Santander. Prior to this, Miguel was a Partner at McKinsey where he worked for over 12 years. He assumed his current role in September 2013 having previously held the position of Group Strategy Director and Commercial Director of the Retail Division.
Dear Shareholders I am pleased to present our corporate governance report for the 2014 financial year. This report explains how the Group applies the highest principles of corporate governance, in particular those laid down in the 2012 edition of the Financial Reporting Council (FRC)’s UK Corporate Governance Code (the Code). The Code can be accessed at www.frc.org.uk.
Board composition The Board appointed Alan Dickinson, Simon Henry, Dyfrig John and Nick Prettejohn as directors in 2014. The new directors, whose biographies are set out on pages 58 and 59, possess the necessary technical skills, share our values and have the behavioural characteristics to contribute constructively to our Board, and the self-confidence and analytic capability to form and share independent judgements. More information on the Board’s approach to the recruitment of Directors is set out on page 74. In addition, Anita Frew became Deputy Chairman following the resignation of David Roberts and I took over as Chairman from Sir Winfried Bischoff in April last year. All Directors will stand for election/re-election at the 2015 Annual General Meeting.
Our aim is to be the best bank for our retail and commercial customers, and we are determined to make the Group a company of the highest integrity and standards.
THE BOARD AND ITS MEMBERS Purpose and responsibilities The Group is led by a Board comprising a Non-Executive Chairman, independent Non-Executive Directors and Executive Directors. The Board is collectively responsible for the long-term success of the Company. It achieves this by setting the strategy and overseeing delivery against it, establishing the culture, values and standards of the Group, ensuring that the Group manages risk effectively, monitoring financial performance and reporting and ensuring that appropriate and effective succession planning arrangements and remuneration policies are in place.
Group Chief Executive António Horta-Osório was appointed Group Chief Executive on 1 March 2011. The Group Chief Executive: – manages the Group on a day to day basis, and in accordance with the strategy and long-term objectives approved by the Board; – with the exception of those matters reserved to the Board, the Group Chief Executive makes decisions on matters affecting the operations, performance and strategy of the Group’s businesses; – provides leadership and direction to senior management; and
– represents the Group’s interests to official enquiries and review bodies.
Chairman Lord Blackwell was appointed Chairman on 3 April 2014, following the retirement of Sir Winfried Bischoff. The Chairman: – has overall responsibility for the leadership of the Board and the promotion of the highest standards of corporate governance; – sets the Board meeting agendas to ensure that the Board devotes its time and attention to the right matters; – builds an effective and complementary Board; – plans succession in Board appointments in conjunction with the Nomination & Governance Committee; – ensures the Directors receive timely and relevant information and are kept advised of key developments; and
A full schedule of all matters reserved to the Board can be found on our website at www.lloydsbankinggroup.com
The following table provides an overview of the key matters considered by the Board in 2014.
– conducted a cyber-risk assessment and approved the implementation of measures to address cyber-risk.
Strategy and customer focus The Board: – approved an update to the Group’s strategy and long-term objectives; – approved an update to the 5 Year Operating Plan and the 2014 annual budget and reviewed delivery against plan; – conducted deep dives into the Retail, Commercial Banking, Consumer Finance, Insurance, Group Operations and Digital divisions; – noted the brand revitalisation of the Scottish Widows Group; and
Reviews the Board’s governance arrangements to ensure that they are consistent with best practice, assists the Chairman in reviewing the composition of the Board and leads the appointments process for nominations to the Board
BOARD COMPOSITION Board size and composition The Board should be of sufficient size to reflect a broad range of views and perspectives whilst allowing all Directors to participate effectively in meetings. The Board currently comprises three Executive Directors, nine independent Non-Executive Directors and the Chairman who was independent on appointment. The size of the Board is within the optimal range set by the Nomination & Governance Committee. Further details on the composition of the Board and independence of the Non-Executive Directors are provided in the Nomination & Governance Committee report.
Executive Director service contracts and Non-Executive Director terms of appointment The Chairman and Non-Executive Directors are appointed for a specified term. All Directors are subject to annual re-election by shareholders. Non-Executive Directors may have their appointment terminated, in accordance with statute and the articles of association, at any time with immediate effect and without compensation. Executive Directors have service contracts with the Group. The Chairman, Group Chief Executive, Chief Financial Officer and Chief Risk Officer are each obliged to give six months’ notice of their intention to retire from their respective roles. The terms and conditions of appointment of Non-Executive Directors and Executive Director service agreements are available for inspection at the registered office address.
Election and re-election All Directors appointed to the Board since the Annual General Meeting (AGM) in 2014 will stand for election at the 2015 AGM. All other Directors will retire and those wishing to serve again will submit themselves for re-election at the AGM. Biographies of current Directors are set out on pages 58 and 59. Details of the Directors seeking election or re-election at the AGM are set out in the Notice of Meeting.
At the end of 2013 and during the year, the Board recruited four directors with the assistance of a number of executive search firms, as described in more detail on page 74. Each of the firms was briefed on the Group’s diversity policy, diversity being one important aspect of the search for the right mix of directors. The Board has adopted the recommendations of Lord Davies of 25 per cent female representation by 2015.
Developing diversity The Board recognises that senior management is a group from which future directors may be selected. To promote diversity across the whole Group, a variety of networks have been implemented which include: – Breakthrough, a women’s network committed to encouraging the development of female colleagues and to leverage this talent pool; – The Group Ethnic Minority network which focuses on career development and supports the aspirations of its members; – The Access Network which aims to provide support for colleagues with disabilities via initiatives such as mentoring, advice and social events; and – Rainbow, an inclusive Group-wide network for lesbian, gay, bisexual and transgender colleagues aiming to promote a positive and inclusive working environment.
Conflicts of interest All Directors of the Company and its subsidiaries must avoid any situation which might give rise to a conflict between their personal interests and those of the Group. Prior to appointment, potential conflicts of interest are disclosed and assessed to ensure that there are no matters which would prevent that person from taking on the role.
TRAINING Board induction All Directors are expected to make an informed contribution based on an understanding of the Group’s business model and the key challenges facing the Group and its businesses. The Chairman ensures that all Directors receive a full, formal and tailored induction on joining the Board, facilitated by the Company Secretary and comprising: – a corporate induction, including an introduction to the Board and a detailed overview of the Group, its strategy, operational structures and main business activities. Non-Executive Directors are also afforded opportunities to meet with major shareholders in order to develop an understanding of their views about the Company; – the roles and responsibilities of a Director, including statutory duties and responsibilities of an FCA approved person; – a bespoke induction programme tailored by the Chairman to the individual needs of the Director with regard to their specific role and their skills and experience to date. This takes the form of reading materials and meetings with senior executives across the Group and sessions with the Group’s business divisions; and – a detailed induction programme across Risk, focusing on: risk appetite and the Group’s risk profile; compliance and conduct risk; capital, stress testing, analytics and modelling; liquidity risk; Retail and Wealth credit risk; Commercial Banking credit risk; operational risk and financial crime; EU State aid, risk transformation, ring-fence banking, recovery and resolution planning; global non-core; and the separation of TSB Bank.
Prior to each Board meeting the Chairman reviews the agenda and time allocation with the Group Chief Executive, the Company Secretary and the Chief Financial Officer. The Group Chief Executive holds a separate Board paper review meeting to review the individual papers. That meeting is held with the Chief Financial Officer, the Chief Risk Officer, the Company Secretary and authors of the main papers, as required.
Attendance at meetings The attendance of Directors at Board and Committee meetings is shown in the table overleaf. Whilst all Non-Executive Directors are invited to, and regularly attend, other Committee meetings, only their attendance at Committees of which they are members is recorded.
The Directors attended a number of other Board Committee and Sub-Committee meetings during the year, including meetings in relation to the Initial Public Offering and disposal of a further holding in TSB, the regulatory par call of Enhanced Capital Notes, the Market Practices Committee which provided oversight in relation to the Group’s settlement negotiations on LIBOR and the Sterling Repo Rate, and the oversight of PPI.
2014 BOARD ALLOCATION OF TIME (including deep dives and away days)
Following the comments captured in the 2013 Board effectiveness review and upon becoming Chairman, Lord Blackwell introduced a number of actions to improve the effectiveness of the Board. Actions included: – meeting times extended to include regular deep dives on specific business issues; – additional deep dive sessions on business areas to be held between Board meetings; – all Non-Executive Directors encouraged to attend risk, audit and remuneration committee meetings; – abbreviated routine performance reporting; – self-standing timely papers supporting proposed Board decisions; – informal discussion opportunities to be included in Board sessions; – guest speakers to be invited for informal lunches; and – frequent informal dinners.
The evaluation of the Chairman by the Non-Executive Directors was led by the Senior Independent Director through questionnaires and interviews for those who wanted to discuss anything further. The views of the Executive Directors were also taken into account.
A summary of the Board’s progress against the actions arising from the 2014 and 2013 effectiveness reviews are set out below: Themes Observations Actions taken/to be taken Progress/comments 2014 Board Effectiveness Review (internal)
Dyfrig John, Nick Prettejohn, Simon Henry and Alan Dickinson were appointed in 2014.
Completed – In 2014 the Board gained significant banking, finance, risk and insurance experience with the appointment of four directors.
More time was allocated to customer dashboards and peer analysis, as well as deep dive sessions.
Completed – In 2014 the Board was able to devote significant time on the Group’s strategy and customers.
– Interview phase. Each firm was invited to an extensive series of interviews with members of the Audit Committee, members of the Board and a number of the Group’s senior management team. These interviews formed part of a formal assessment process whereby each firm was scored against key criteria, including matters such as the strength and experience of senior team members and their firm’s ability to serve effectively the Group’s diverse and sizeable operations.
Following the presentations the Selection Committee submitted a summary of the proposals and a recommendation for consideration by the Audit Committee. The Audit Committee in turn provided a recommendation to the Board for consideration and approval.
The Group’s registrar, Equiniti Limited, provides a dedicated shareholder telephone and dealing service to assist shareholders in managing their investments. Investors can also manage their shareholdings online.
The Group engages directly with retail shareholders to respond to enquiries that are specific to the Group covering topics such as legacy matters, results, resumption of dividends and strategic progress.
Group Secretariat runs a programme of asset reunification through ProSearch, a subsidiary of the registrar. This is tailored to specific sections of former and current shareholders and since its inception in 2011 in excess of £13 million has been successfully reunited with more than 185,000 shareholders.
The Annual General Meeting (AGM) The AGM is the principal opportunity for shareholders to engage directly with the Board. It is more commonly used by retail shareholders as an opportunity to share views and raise questions during the meeting, but afterwards there is the opportunity to meet the Directors and members of the Group Executive Committee. All Board members attended the AGM held in Edinburgh in 2014 and will also attend the AGM in 2015.
A description of the Group’s diversity policy can be found on page 67.
Board composition and skills Background Following his appointment as Chairman in April 2014, Lord Blackwell undertook an assessment of the collective technical and governance skills that he sought from the Non-Executive Directors, together with an assessment of how the existing Board members met those desired characteristics. This exercise allowed the creation of a framework which helped determine the desired profile of Board members, now and in the future.
The assessment of individuals’ skills and experience in a skills matrix revealed good coverage amongst the existing Non-Executive Directors, but a high dependency on a limited number of individuals with core retail and commercial banking experience and experience in IT operations.
Following the publication of the new EU Directive in April 2014, the Committee invited three professional services firms, including the incumbent firm (PwC), to tender for the external audit with effect from the 2016 year end. The tender process involved an extensive and robust assessment of the three firms, details of which are set out on page 70. The assessment process was overseen by the Audit Committee Chairman.
Committee purpose and responsibilities The purpose of the Committee is to monitor and review the Group’s financial and narrative reporting arrangements, the effectiveness of the internal controls and the risk management framework, whistleblowing arrangements and each of the internal and external audit processes. The Audit Committee reports to the Board on how it discharges its responsibilities and makes recommendations to the Board, all of which have been accepted during the year. A full list of responsibilities is detailed in the Committee’s terms of reference, which can be found on our website at www.lloydsbankinggroup.com.
Internal control and risk management Full details of the internal control and risk management systems in relation to the financial reporting process are given within the risk management report on pages 107 to 170. Specific matters that the Committee considered during the year included: – the effectiveness of systems for internal control, financial reporting and risk management; – the extent of the work undertaken by the Finance teams across the Group and considering the resources to ensure that the control environment continued to operate effectively; and – the major findings of any internal investigations into control weaknesses, fraud or misconduct and management’s response along with any control deficiencies identified through the assessment of the effectiveness of the internal controls over financial reporting under the US Sarbanes-Oxley Act.
External audit The Committee oversaw the relationship with the external auditor and considered the terms of engagement (including remuneration), their effectiveness, their continued independence and their objectivity.
In the 2014 full year results, an additional provision of £2,200 million was reflected for expected PPI costs. The provision brought the total amount set aside by the Group to cover PPI costs to £12,025 million.
– The Audit Committee spent considerable time in 2014 challenging the assumptions made by management in determining the provision for PPI redress. – The key assumption that the Audit Committee focused on was future complaints volumes and associated operational costs. Management used a combination of analyses to forecast future complaint volumes, including statistical modelling and customer surveys. The Audit Committee challenged the appropriateness of these methods for forecasting complaint volumes, giving consideration to the total PPI policies sold by the Group. – Group Audit provided assurance to the Audit Committee that the process was undertaken in a controlled manner using reasonable, consistent and supportable assumptions and inputs. In 2014, the Audit Committee concluded that the processes followed by management in determining the provision for PPI redress were appropriate, although they will continue to monitor periodically as experience emerges. – The Audit Committee considered the appropriateness of disclosures in the News Release and the Annual Report and Accounts. The Audit Committee oversaw enhancements made to the PPI disclosure to include the total number of PPI policies remediated since 2000 and continued use of sensitivities reflecting the uncertainty that remains around the ultimate cost of PPI. – The Audit Committee was satisfied that the PPI provision and disclosures were appropriate. The disclosures relating to PPI are set out in note 40: ‘Other provisions’ on page 248 of the financial statements.
Recoverability of the deferred tax asset The recoverability of the deferred tax asset in respect of carry forward losses requires the consideration of the future levels of taxable profit in the Group.
– The Audit Committee considered and challenged the calculation of the value of expected future net cash flows from currently in-force insurance contracts and the liabilities arising from those contracts. – The Audit Committee was satisfied that the value of the VIF asset and insurance liabilities were appropriate. The disclosures are set out in note 25: ‘Value of in-force business’ on page 227 and note 35: ‘Liabilities arising from insurance contracts and participating investment contracts’ on page 239 of the financial statements.
Adjustment to derivative valuations Determining the credit, debit and funding valuation adjustments for uncollateralised derivative transactions is judgemental and requires management to assess whether model inputs, such as the creditworthiness of the derivative counterparty, are appropriate.
One-off transactions Determining the appropriate accounting for certain one-off transactions is judgemental and requires management to assess the facts and circumstances specific to each transaction.
– Two examples of one-off transactions considered by the Audit Committee during 2014 were the sales of TSB shares and the exchange of enhanced capital notes for additional tier 1 securities. – The Audit Committee is satisfied that it remains appropriate for the Group to consolidate TSB. Further information on liability management is set out below.
– In the first half of 2014, the Group exchanged a proportion of its enhanced capital notes (ECN) for new additional tier 1 (AT1) securities. The Group recognised a loss of £1,362 million on the transaction. The AT1 securities are classified as equity. – The Audit Committee considered the accounting loss arising on the exchange and the classification of the AT1 securities as equity and was satisfied that the disclosure set out in note 46: ‘Other equity instruments’ on page 260 to the financial statements is appropriate.
I am pleased to report that the Group’s strategy and strong risk discipline continues to build a safer, low risk bank. Anita Frew Chairman, Risk Committee 14 May – 31 December 2014
On 1 January 2015, Anita handed over the chair of the Board Risk Committee to Alan Dickinson. Alan is a highly regarded retail and commercial banker having spent 37 years with the Royal Bank of Scotland, most notably as Chief Executive of RBS UK.
The Committee composition includes core banking and risk knowledge, together with the breadth that brings wider knowledge from other sectors and a clear awareness of customer needs. As a matter of practice and as a reflection of the importance attached to risk in the Group, all Directors regularly attend the Board Risk Committee meetings, including those Directors who are not members. The Group Audit Director and the external auditor also attend Board Risk Committee meetings.
Risk principles and policy The Committee has a key role in relation to the Group’s Risk Principles and Policy Framework and in so doing: – reviewed new and material amendments to the risk principles and policy framework, recommended by the Group Chief Executive and Chief Risk Officer; and – oversaw adherence to Group risk principles, policies and standards and monitored any action taken resulting from material policy breaches.
The insurance business has its own separate board and risk committee.
11. Other (including regulatory 2% update, credit risk and risk adjustments of performance)
Significant risks considered by the Committee Set out below are some of the significant risks facing the company that were considered by the Committee in 2014.
Operational risk The Committee received regular updates across operational risk from both the business and the Risk Division, including incident management, advanced measurement, change, records management, and IT Resilience including cyber risk and financial crime.
The Committee received two reports in the year from the Group’s Money Laundering Reporting Officer along with detailed updates from the businesses on compliance with the Anti Money Laundering requirements.
This statement and Implementation Report will be subject to an advisory vote at the 2015 AGM.
Linking remuneration to business strategy The Committee continues to place great importance on ensuring that there is a clear link between remuneration and the Group’s business strategy.
The core financial measures (economic profit, absolute TSR and cost:income ratio) will remain the same, representing 65 per cent of the total award. For the remaining 35 per cent of the award, quantitative strategic measures relating to customers and digitisation will be used to reflect key areas of strategic focus under the GSR.
With regard to the economic profit measure, which remains a core financial measure, the Group is currently reviewing the calculation methodology for financial reporting purposes in order to better align with current expectations of the Group’s forward-looking plan, including the Group’s capital requirements and asset quality ratio. We are seeking to complete this review as soon as possible and will consult with shareholders in respect of any proposed changes in the first half of 2015.
End-to-end review of annual bonus process and performance adjustment During 2014, the Committee undertook an extensive end-to-end review of our bonus process resulting in a revised methodology for calculating the risk-adjusted bonus outcome being implemented for 2014. As part of this, our approach to performance adjustment was reviewed to ensure that we have clear principles for collective and/or individual adjustments when taking account of material, adverse risk events.
Taking all of the above into account, the Committee determined that a bonus outcome for 2014 of £369.5 million was appropriate, incorporating a reduction for collective performance adjustment of approximately 25 per cent. This is a 3.6 per cent reduction in the bonus outcome from 2013 (after adjusting for TSB).
In respect of LTIP awards made in 2012, the Bank’s performance to the end of 2014 was very strong. The proposed vesting level of 96.6 per cent reflects strong financial performance, and significant shareholder value created over the period as the Bank’s market capitalisation increased from c.£18 billion to c.£54 billion. This has justifiably led to significant payouts to participants, due not only to the delivery of targets but also the increase in share price. Awards were granted in shares at 34.786 pence and the significant increase over the period has more than doubled the value for recipients, in line with the increase realised by shareholders.
During the year, we consulted with UK Financial Investments (UKFI) and a number of our other major shareholders to gather their views and feedback on remuneration, and in particular the changes to the 2015 LTIP. We also consulted with our main regulators, the Financial Conduct Authority (FCA) and the PRA throughout the year. We are grateful for the supportive feedback we have received from all parties.
DIRECTORS’ REMUNERATION POLICY The policy set out in the 2013 Directors’ remuneration report was formally approved by shareholders at the AGM on 15 May 2014.
It is intended that approval of the remuneration policy will be sought at three year intervals, unless amendments to the policy are required in which case further shareholder approval will be sought. There are no amendments required to the current policy for 2015 and therefore shareholders will not be asked to vote on the Remuneration Policy at the AGM this year.
Incentivise and reward the achievement of the Group’s annual financial and strategic targets.
On vesting, Executive Directors receive an amount (in cash or shares) equal to the dividends which would have been paid during the vesting period on shares vesting.
The Committee retains full discretion to amend the payout levels should the award not reflect business and/or individual performance. The Committee may reduce (including to zero) the level of the award, apply additional conditions to the vesting, or delay the vesting of awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate as a result of an event occurring before vesting. Executive Directors are required to hold the shares which vest for a further two years.
REMUNERATION POLICY TABLE FOR CHAIRMAN AND NON-EXECUTIVE DIRECTORS The table below sets out the remuneration policy that has been applied to Non-Executive Directors (NEDs) from the date of the AGM in 2014.
To provide an appropriate reward to attract and retain a high-calibre individual with the relevant skills, knowledge and experience.
– Comparable fees at FTSE companies of a similar size to Lloyds Banking Group, including the major UK banks.
The Chairman and the NEDs are not entitled to receive any payment for loss of office (other than in the case of the Chairman’s fees for the six month notice period) and are not entitled to participate in the Group’s bonus, share plan or pension arrangements.
The Committee appoints independent consultants to provide advice on specific matters according to their particular expertise. During the year, Deloitte LLP advised the Committee. Deloitte was appointed as remuneration consultants by the Committee following a competitive tendering process. Deloitte has voluntarily signed up to the Remuneration Consultants’ Code of Conduct. The Committee has evaluated Deloitte during 2014 and concluded that it was effective in providing objective and independent advice to the Committee. In particular, it was recognised that Deloitte had the requisite knowledge and provided relevant external updates which enabled the Committee to fulfil its responsibilities. Deloitte is not connected with the Group.
The Committee is satisfied that its processes are robust and diligent and that the Group’s remuneration and incentive plans conform to best practice standards.
The three Executive Directors have made significant contributions to the Group’s success, as reflected in their risk-adjusted performance ratings in 2014, but there is no increase proposed for the Group Chief Executive. Salary increases of 2 per cent are, however, proposed for the Chief Financial Officer and the Chief Risk Officer. Salaries with effect from 1 January 2015 will therefore be as follows: Group Chief Executive (GCE): £1,061,000
Pension In line with the remuneration policy, Executive Directors are entitled to a cash allowance in lieu of pension contributions. The level of allowances has not been increased for 2015.
GCE: 50 per cent of reference salary less flexible benefit allowance
The GCE is also entitled to the provision of an unfunded unapproved retirement benefit scheme (UURBS), subject to performance conditions, as described further in the Implementation Report.
The application of performance adjustment will generally be considered when: – there is reasonable evidence of employee misbehaviour, misconduct or material error or that they participated in conduct which resulted in losses for the Group or failed to meet appropriate standards of fitness and propriety; – material failure of risk management at a Group, business area, division and/or business unit level; – the financial results at a Group, division or business unit level are re-stated or consideration is given to restatement; – the Committee determines that the financial results for a given year do not support the level of variable remuneration awarded; and/or – any other circumstances where the Committee consider adjustments should be made.
In addition, the annual bonus may be subject to clawback up to seven years after the date of award.
Awards in 2015 will be made as follows: GCE: 300 per cent of reference salary
LTIP awards may be subject to clawback up to seven years after the date of award. The scenarios in which the Committee may consider performance adjustment/clawback are outlined in the annual bonus section above.
Average performance over 3 year period Threshold: 1.15 complaints per 1,000 accounts and 32% FOS uphold rate Maximum: 1.05 complaints per 1,000 accounts and 28% FOS uphold rate
Net promoter score Major Group average ranking over 2017 Threshold: 3rd Maximum: 1st
For 2015, the benefits provided to the Chairman include a car allowance, medical insurance, life insurance and transportation.
In addition to deferral and performance adjustment, the GCE’s bonus will only vest if the Group’s share price remains above 75.5 pence on average for any 126 consecutive trading days in the five years following grant or the UK government sells 100 per cent of its shareholding in the Group at any time during the three years following grant. If either condition is met earlier than the third anniversary of grant, vesting will still only occur on the third anniversary. In this event, the award will be subject to a further two year holding period following vesting up to a maximum of five years in total.
– Balanced Scorecard performance: stretching objectives for each division were approved by the Remuneration Committee around the start of the performance year. The objectives were aligned to the Group’s strategy and split across five categories: – Financial – Building the business – Customer service – Risk – People development
Balanced Scorecard ratings are based on a scale ranging from ‘Under’ (at the lowest level), through ‘Developing’, ‘Good’, ‘Strong’ and up to ‘Top’ which is the highest rating. Each of these ratings may be further differentiated by the addition of ‘minus’ or ‘plus’.
– Customer dashboards implemented across the Group and improvements in Net Promoter Scores (our measure of the customer experience), although there has been an increase in FCA reportable complaints. – Continued progress in conduct strategy, although further work is required to continue to drive cultural improvements. – Completion of simplification programme (cost savings of £449 million realised in 2014). – Continued improvement in strengthening the balance sheet and reducing risk: pro forma fully loaded common equity tier 1 ratio increasing by 2.5 percentage points to 12.8 per cent. – Exceeded PRA stress testing threshold measure of 4.5 per cent. – Over £39 billion of gross new lending to British customers was committed during 2014 under the Funding for Lending Scheme (FLS).
Customer satisfaction target is based on the average reportable complaints per 1,000 customers over the three year period.
Adjusted for movements in staff numbers and other impacts to ensure a like-for-like comparison.
Underlying profit has been used for comparison on the basis that it reflects performance, excluding legacy issues and one-off events.
Payments within the reporting year to past directors (audited) As part of arrangements on leaving the Group, deferred bonus was released to Tim Tookey (£135,879).
2014 taxable benefits are made up of car allowance of £3,136, private medical benefit of £608, and transportation of £6,693.
2013 taxable benefits are made up of car allowance of £12,000, private medical benefit of £566, and transportation of £4,864.
Fees for chairing the Responsible Business Steering Group and the Finance Inclusion Committee (non-Board level committees).
Shareholdings held by António Horta-Osório are either wholly or partially in the form of ADRs.
As a result of the above shareholdings, the position for each Executive Director is as follows: Shareholding requirement Current shareholding
Breakdown of shares interests (audited) – Long-term incentive plan awarded in 2014 Awards (in the form of conditional rights to free shares) in 2014 were made over shares with a value of 300 per cent of reference salary for the GCE (4,640,077 shares with a face value of £3,660,000); 275 per cent for the CFO (2,510,205 shares with a face value of £1,980,000); and 275 per cent for the CRO (2,234,780 shares with a face value of £1,762,750). The share price used to calculate face value is the average price over the five days prior to grant (17 March to 21 March 2014), which was 78.878 pence. This was the average share price used to determine the number of shares awarded.
Net promoter score Major Group average ranking over 2016 Threshold: 3rd Maximum: 1st
Former Directors who served during 2014 None Share buy-out award granted on 30 March 2011 for the loss of deferred share awards forfeited on leaving the Santander Group. Awards are consistent with those forfeited and have a nil option price.
27/06/14 174,132 Fixed Share Award 03/09/14 231,604 Release of 2010, 2011 and 2012 Deferred Bonus 25/09/14 86,376 Fixed Share Award 19/12/14 86,693 Fixed Share Award
Dividends The Directors recommend to shareholders a dividend of 0.75 pence per ordinary share in respect of the full financial year ended 31 December 2014, which will be paid on 19 May 2015. Further information on ordinary dividends is shown in note 47 on page 261 and is incorporated into this report by reference.
Lord Blackwell, who has served on the Board since 1 June 2012, was appointed Chairman in place of Sir Winfried Bischoff on 3 April 2014.
The powers of the Directors, including in relation to the issue or buy back of the Company’s shares, are set out in the Companies Act 2006 and the Company’s articles of association. The Directors were granted authorities to issue and allot shares and to repurchase shares at the 2014 annual general meeting. Shareholders will be asked to renew the authorities at the 2015 annual general meeting.
The Company did not repurchase any of its shares during the year (2013: none).
Other information for an analysis of where Enhanced Disclosure Task Force (EDTF) recommendations are disclosed 343
GOVERNANCE AND CONTROL – Governance is maintained through delegation of authority from the Board down through the management hierarchy, supported by a committee-based structure designed to ensure open challenge and that the Group’s risk appetite, principles, policies, procedures, controls and reporting are fully in line with regulations, law, corporate governance and industry good-practice. – Board-level engagement, coupled with the direct involvement of senior management in Group-wide risk issues at Group Executive Committee level, ensures that issues are promptly escalated and remediation plans are initiated where required. – The Group’s approach to risk is founded on a robust control framework and a strong risk management culture which ensures that business units remain accountable for risk and therefore guides the way all employees approach their work, behave and make decisions. – The interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged by both the Board and senior management. – A strong control framework remains a priority for the Group and is the foundation for the delivery of effective risk management.
– Risk analysis and reporting supports the identification of opportunities as well as risks. – An aggregate view of the Group’s overall risk profile, key risks and management actions, and performance against risk appetite, is reported to and discussed monthly at the Group Risk Committee (and a subset at the Group Asset and Liability Committee), with regular reporting to the Board Risk Committee and the Board. – Rigorous stress testing exercises are carried out to assess the impact of a range of adverse scenarios with different probabilities and severities to inform strategic planning. – The Chief Risk Officer regularly informs the Board Risk Committee (BRC) of the aggregate risk profile and has direct access to the Chairman and members of the Board Risk Committee. The Chief Risk Officer was appointed to the Board on 29 November 2013.
Central Items include assets held outside the main operating divisions, including exposures relating to Group Corporate Treasury which holds the Group’s liquidity portfolio and Group Operations.
The Insurance division is one of the UK’s largest insurers and provides longterm savings, protection and investment products and general insurance products to customers in the UK and Europe
EMERGING RISKS The Group considers the following to be risks that have the potential to increase in significance and affect the performance of the Group.
– Close working with the FCA and other regulatory bodies to support positive customer outcomes and compliance. – Rigorous implementation of a well defined and embedded Conduct Strategy and customer redress actions. – Embedding appropriate policies in the Risk Management Framework. – Full participation in all industry wide initiatives and IT investment to support new and secure payment product delivery channels. – Embedding competition risk within key policies.
Digital Internet and mobile technologies are changing the way the Group interfaces with its customers. The evolution of these technologies will require us to assess these services in respect of our conduct approach, multi-channel distribution, operational and legal developments and back office digitalisation.
Impact of accounting standards New reporting requirements under IFRS 9 introduce forward looking credit loss models which could lead to changes in the timing of reporting of impairments and therefore the Group’s capital position.
– The Group will continue to monitor and assess potential impacts while managing all exposures according to current risk policies.
– Risk appetite criteria limits single counterparty bank and non bank exposures, supported by country limits commitments accordingly and a strategy that is UK focused. – The Group has continued to limit the reliance on short-term wholesale funding within the funding structure, favouring customer deposits and long-term wholesale funding coupled with a substantial portfolio of liquid assets.
– Finance teams in the business prepare and review finance related stress testing results including, but not limited to, income, margins, costs, lending and deposit volumes. – Credit risk and market risk teams prepare and review risk-related stress outputs, including, but not limited to, impairment charges, risk-weighted assets, expected loss and trading losses. – The Group Financial Risk team provides objective oversight of the finance and risk stress submissions as well as the consolidated Group position and capital ratios and produces analysis packs for the Group’s senior committees. – The Group Corporate Treasury team reviews the stress outputs and evaluates the impact upon the Group’s Capital and Funding Plan.
REVERSE STRESS TESTING Reverse stress testing is used to explore the vulnerabilities of the Group’s strategies and plans to extreme adverse events, and to help improve contingency planning. The scenarios used in such a stress test are those that would cause a failure in the business model. Where reverse stress testing reveals plausible scenarios with an unacceptably high risk when considered against the Group’s risk appetite, the Group will undertake measures to prevent or mitigate that risk, which are then reflected in strategic plans.
The Group Financial Risk Committee (GFRC), chaired by the Chief Risk Officer, is the Committee that has primary responsibility for oversight of the development and execution of the Group’s stress tests.
Group Chief Executive and GEC members: – Ensure that the Board Risk Appetite Statement is developed in collaboration with the Chief Risk Officer and is fully embedded in the business. – Ensure resources and processes are in place to support the Board Risk Appetite framework. – Are accountable for the integrity of the Board Risk Appetite Statement, including the timely identification and escalation of breaches and for developing mitigating actions. – Ensures risk appetite is fully embedded including/across strategy, planning, decision making processes and remuneration. – Monitor compliance with Board risk appetite.
Three Lines of Defence model – the RMF is implemented through a ‘Three lines of Defence’ model which defines clear responsibilities and accountabilities and ensures effective independent oversight and assurance activities take place covering key decisions.
Mandate of the Risk Division – the objective of Risk Division is to provide both proactive advice and constructive challenge to the business. It also has a key role in promoting the implementation of a strategic approach to risk management reflecting the risk appetite and RMF agreed by the Board that encompasses: – embedded effective risk management processes; – transparent focused risk monitoring and reporting; – provision of expert and high quality advice and guidance to the Board, executives and management on strategic issues and horizon scanning including pending regulatory changes; and – provision of a working environment in which Risk Division is trusted and respected, and promotes a constructive dialogue with the first line through advice, development of common methodologies, understanding, education, training, and development of new tools.
Risk Division, headed by the Chief Risk Officer, consists of seven risk directors and their specialist teams. These teams provide oversight and independent challenge to business management and support senior management and the Board with independent reporting on risks and opportunities. Risk directors, responsible for each risk type, meet on a regular basis under the chairmanship of the Chief Risk Officer to review and challenge the risk profile of the Group and to ensure that mitigating actions are appropriate.
The Chief Risk Officer is accountable for developing and leading an industry-wide recognised Risk function that adds value to the Group by: – providing a regular comprehensive view of the Group’s risk profile, key risks both current and emerging, and management actions; – (with input from the business areas and Risk Division) proposing Group risk appetite to the Board for approval, and oversighting performance of the Group against risk appetite; – developing an effective RMF meeting regulatory requirements for approval by the Board, and oversighting execution and compliance; and – challenging management on emerging risks and providing expert risk and control advice to help management maintain an effective risk and control framework.
Culture – supporting the formal frameworks of the RMF is the underlying culture, or shared behaviours and values, which sets out in clear terms what constitutes good behaviour and good practice. In order to effectively manage risk across the organisation, the functions encompassed within the Three lines of Defence have a clear understanding of risk appetite, business strategy and an understanding of (and commitment to) the role they play in delivering it. A number of levers are used to reinforce the risk culture, including tone from the top, clear accountabilities, effective communication and challenge and an appropriately aligned incentive structure.
Independent challenge 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 the Risk Division and the business, and seeks to ensure objective challenge to the effectiveness of the risk governance framework.
RISK GOVERNANCE The risk governance structure below is integral to implementing the RMF across the Group and, by ensuring risk is appropriately represented on key committees, ensures that risk management is discussed in these meetings. This structure outlines the flow and escalation of risk information and reporting from business areas and Risk Division to the GEC and Board. Conversely, strategic direction and guidance is cascaded down from the Board and GEC.
Th ir d li ne o f d ef en ce
Executive Compensation Committee Provides governance and oversight for Group-wide remuneration matters and policies.
Group Financial Risk Committee Responsible for reviewing, challenging and recommending to GEC/GRC, the Group Individual Liquidity Adequacy Assessment and Internal Capital Adequacy Assessment Process submissions, the Group Recovery Plan, and the annual stress testing of the Group’s operating plan, PRA and EBA stress tests, and other Group-wide macroeconomic stress tests.
The Group considers these to be principal risks. See risk overview pages 30 to 33 for further details.
For regulatory capital purposes the Group’s rating systems assess probability of default and if appropriate, exposure at default and loss given default, in order to derive an expected loss. If not appropriate, regulatory prescribed exposure at default and loss given default values are used in order to derive an expected loss. In contrast, impairment allowances are recognised for financial reporting purposes only for loss events that have occurred at the balance sheet date, based on objective evidence of impairment. Due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements differs from the amount determined from the expected loss models that are used for internal operational management and banking regulation purposes. Note 2(H) on page 193 provides details of the Group’s approach to the impairment of financial assets.
Controls over rating systems: The Group has established an independent team in the Risk Division that sets common minimum standards, designed to ensure risk models and associated rating systems are developed consistently, and are of sufficient quality to support business decisions and meet regulatory requirements. Internal rating systems are developed and owned by the Risk Division. The designated model owner takes responsibility for ensuring the validation of the rating systems, supported and challenged by an independent specialist group function.
Additional mitigation for commercial customers Individual credit assessment and independent sanction: With the exception of small exposures on SME customers where relationship managers have limited delegated sanctioning authority, credit risk in commercial customer portfolios are subject to sanction by the independent Risk Division, which considers the strengths and weaknesses of individual transactions, the balance of risk and reward and how credit risk aligns to the Group’s risk appetite. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities and limit guidelines. Approval requirements for each decision are based on a number of factors including the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s credit risk appetite criteria for counterparty and customer underwriting is generally the same as that for assets intended to be held to maturity.
One component of the Group’s relationship management approach is to contact customers showing signs of financial difficulty to discuss their circumstances and offer solutions to prevent their accounts falling into arrears.
The level of Commercial Banking Division BSU gross lending to customers reduced from £7.3 billion to £5.0 billion between 31 December 2013 and 31 December 2014. The net reduction of £2.3 billion in BSU managed lending in Commercial Banking was driven by returns to mainstream, disposals, write-offs and repayments. In addition, as a result of the continued deleverage of the non-retail Run-off portfolio during 2014 and the focus on reducing the level of higher risk loans, the level of Run-off assets managed by BSU has reduced materially during the year.
The Group credit risk portfolio in 2014 Significant reduction in impairments – The impairment charge decreased by 60 per cent from £3,004 million in 2013 to £1,200 million in 2014. The impairment charge has decreased across all divisions. The material reduction reflects lower levels of new impairment as a result of effective risk management, improving economic conditions and the continued low interest rate environment. – The charge also benefited from significant provision releases but at lower levels than seen during 2013. – The impairment charge as a percentage of average loans and advances to customers improved to 24 basis points compared to 57 basis points during 2013. – Impaired loans as a percentage of closing advances reduced to 2.9 per cent at 31 December 2014, from 6.3 per cent at 31 December 2013, driven by improvements in all divisions. Impaired loans reduced substantially by £18 billion during the period, mainly due to disposals and write-offs, and lower levels of newly impaired loans. – Impairment provisions as a percentage of impaired loans increased from 50.1 per cent at 31 December 2013 to 56.4 per cent at 31 December 2014, driven by the Retail, Commercial Banking and Run-off divisions.
Transferred to not impaired during the year (1,751) (745) (91) (1,872) (67) (4,526) (3,054)
The fair value adjustments relating to loans and advances were those required to reflect the HBOS assets in the Group’s consolidated financial records at their fair value and took into account both the expected losses and market liquidity at the date of acquisition. The unwind relating to future impairment losses requires significant management judgement to determine its timing which includes an assessment of whether the losses incurred in the current period were expected at the date of the acquisition and assessing whether the remaining losses expected at the date of the acquisition will still be incurred. The element relating to market liquidity unwinds to the income statement over the estimated expected lives of the related assets (until 2014 for commercial loans and 2018 for retail loans) although if an asset is written-off or suffers previously unexpected impairment then this element of the fair value will no longer be considered a timing difference (liquidity) but permanent (impairment). The fair value unwind in respect of impairment losses incurred was £251 million for the period ended 31 December 2014 (31 December 2013: £512 million). The fair value unwind in respect of loans and advances is expected to continue to decrease in future years as fixed-rate periods on mortgages expire, loans are repaid or written-off, and will reduce to zero over time.
Loans and advances to customers restated. See note 1, page 188.
– Impairment provisions remained stable at £1,446 million at 31 December 2014 (31 December 2013: £1,447 million). As a result of this impairment provisions as a percentage of impaired loans increased to 37.0 per cent from 26.3 per cent at 31 December 2013. – The impairment charge increased by £32 million, to £281 million compared with 2013. The impairment charge as an annualised percentage of average loans and advances to customers, increased to 9 basis points in 2014 from 8 basis points in 2013. – The value of mortgages greater than three months in arrears (excluding repossessions) decreased by £2,249 million to £6,344 million at 31 December 2014 compared to £8,593 million at 31 December 2013.
Loans and overdrafts – The impairment charge decreased by £199 million, to £279 million compared with 2013. The annualised impairment charge, as a percentage of average loans and advances to customers, reduced to 2.6 per cent in 2014 from 4.2 per cent in 2013. – Impaired loans have decreased by £124 million since 31 December 2013 to £695 million at 31 December 2014 which represents 6.7 per cent of closing loans and advances to customers, compared with 7.7 per cent at 31 December 2013. – Impairment provisions decreased by £65 million compared with 31 December 2013.
Table 1.13: Mortgages greater than three months in arrears (excluding repossessions) Number of cases Total mortgage accounts % Value of loans1 Total mortgage balances %
Table 1.14: Period end and average LTVs across the Retail mortgage portfolios Mainstream
Interest only mortgages The Group provides interest only mortgages to customers, whereby payments of interest only are made for the term of the mortgage, with the customer responsible for repaying the principal outstanding at the end of the loan term.
Excludes mortgage accounts which consist of partial interest only and partial capital repayment.
– Portfolio credit quality has remained stable or improved across all key metrics.
Table 1.19: LTV – UK direct real estate At 31 December 20141 At 31 December 20131
Consumer Finance – The Consumer Finance impairment charge reduced by 37 per cent to £215 million in 2014 with a substantial improvement in the asset quality ratio. This has been driven by a continued underlying improvement of portfolio quality supported by the sale of recoveries assets in the Credit Cards and Asset Finance portfolios. – Total impaired loans as a percentage of closing loans and advances to customers decreased to 3.4 per cent (£720 million) at 31 December 2014 compared to 4.8 per cent (£946 million) at 31 December 2013.
Specialist Finance – The Specialist Finance Run-off portfolio has been proactively deleveraged down from £9.0 billion gross (£8.5 billion net) to £4.8 billion gross (£4.6 billion net). – Gross loans and advances to customers include the Run-off Asset Based Finance portfolios (which mainly include Ship Finance, Aircraft Finance and Infrastructure) and the element of the Acquisition Finance (leverage lending) portfolio classified as Run-off. The Specialist Finance Run-off portfolio also includes a significantly reduced Treasury Asset legacy investment portfolio. – The majority of remaining lending of £4.8 billion is in the lower risk Leasing sector where gross drawn lending totalled £2.5 billion as at 31 December 2014.
Excludes reverse repurchase exposure to Institutional funds domiciled in Ireland secured by UK gilts of £10,456 million (2013: £4,590 million) on a gross basis. 1
Financial institutions Asset backed securities Corporate Personal Insurance assets TotalBanks Other1 £m £m £m £m £m £m £m £m £m
Measurement To articulate its conduct risk appetite, the Group has sought more granularity through the use of suitable conduct risk metrics and tolerances that indicate where it may potentially be operating outside its conduct appetite. Conduct Risk Appetite Metrics (CRAMs) have been designed for all 139 product families offered by the Group; a set of common metrics have been agreed for all products to support a consistent approach. These contain a range of product, sales and post-sales metrics to provide a more holistic view of conduct risks; each product also has additional bespoke metrics. These metrics are part of the Board approved risk appetite. The Group also continues to measure how effectively the overall conduct strategy is embedded across all divisions and functions and its impact on customer outcomes. The common metrics are sales volume, product governance adherence, target market, outcome testing: meet customer needs, outcome testing: information disclosure, outcome testing: regulatory compliance, retention, usage, claims (decline rates), complaints per 1,000 accounts, Financial Ombudsman Service (FOS) uphold rate and complaints outcome testing. Each of the tolerances for the metrics are agreed for the individual product and are tracked month by month. In relation to market conduct, metrics have also been generated, covering, for example, the way in which confidential information and potential conflicts of interest are managed.
The Group has also prioritised activity designed to reinforce good conduct in its engagement with the markets in which it operates, together with the development of preventative and detective controls in order to be able to demonstrate this.
All Group business areas continue to apply significant resources to the Conduct Strategy and ambitious conduct transformation plans are aligned with the Group’s strategy.
Monitoring Monitoring and reporting is undertaken at Board, Group and business area committees. As part of the reporting of Conduct Risk Appetite Measures, a robust outcomes testing regime is in place to test performance of customer critical activities. Customer metrics are proactively used when reviewing business performance and feedback loops have been established to take learnings from root cause/outcome testing. There is also focus on the enhancement of preventative and detective controls to encourage and demonstrate the Group’s support for the fair and effective operation of relevant markets.
The information provided in table 1.30 (below) aims to facilitate the understanding of linkages between balance sheet items and the positions disclosed in the Group’s market risk disclosures. This breakdown of financial instruments included and not included in trading book VaR provides a linkage with the market risk measures reported later on in the market risk section. It is important to highlight that this table does not reflect how the Group manages market risk, since it does not discriminate between assets and liabilities in its VaR model.
Assets Cash and balances at central banks 50,492 – 50,492 – Interest rate
Derivative financial instruments 36,128 30,209 4,233 1,686 Interest rate, foreign exchange, credit spread
Loans and receivables: Loans and advances to banks 26,155 – 4,843 21,312 Interest rate
Trading and other financial liabilities at fair value through profit or loss 62,102 55,359 6,743 – Interest rate, foreign exchange
Liabilities arising from insurance and investment contracts 114,166 – – 114,166 Credit spread
Insurance business assets and liabilities relate to unit-linked funds and with-profit funds, as well as shareholder invested assets, including annuity funds. The Group recognises the value of in-force business (VlF) in respect of Insurance’s long-term life assurance contracts as an asset in the balance sheet. This asset represents the present value of future profits expected to arise from the portfolio of in-force life assurance contracts.
Defined benefit pension schemes The Group’s defined benefit pension schemes are exposed to significant risks from the constituent parts of their assets and from the present value of their liabilities, primarily real interest rate, credit spread, equity, and alternative asset risks. Interest rate risk arises from the liability discount rate, with partial offsets from fixed interest assets such as gilts and corporate bonds, and swaps. Credit spread risk also arises from the liability discount rate, with partial offsets from the credit portfolio. Equity and alternative asset risk arises from direct asset holdings.
Trading portfolios The Group’s trading activity is small relative to its peers and the Group does not have a programme of proprietary trading activities. All the trading VaR resides within Commercial Banking. The average 95 per cent 1-day trading VaR was £4.3 million for the year to 31 December 2014 (31 December 2013: £4.1 million). The Group’s trading activity is undertaken to meet the requirements of commercial and retail customers for foreign exchange, credit spread and interest rate products.
Basis risk arises from the possible changes in spreads, for example where the bank lends with reference to a central bank rate but funds with reference to LIBOR and the spread between these widens or tightens.
Foreign currency risk arises from: – translational exposure: the Group’s investment in its overseas operations. Net investment exposures are disclosed (see note 54 on page 293) and it is Group policy to hedge non-functional currency exposures; and – transactional exposure: where assets and liabilities are denominated in currencies other than the business’ functional currency. The Group has a policy of forward hedging its forecasted currency income less impairments to year end.
Insurance portfolios The Group’s insurance activities expose it to market risk including equity, credit and credit spread, interest rate, exchange rate and property risk: – With-profits funds are managed with the aim of generating smoothed returns consistent with policyholders’ expectations. Exposure arises where the value of the underlying funds are insufficient to meet the obligations, termed burnthrough. – Unit-linked funds where policyholders select their investments. Exposure arises as future fee income is dependent upon the performance of those assets. This fee income forms part of the value of in-force business, see note 25 on page 227. – Annuities where policyholders’ future cashflows are guaranteed at retirement. Exposure arises if the assets, predominantly bonds and loans, backing the liabilities do not perform in line with expectations. – Insurance’s surplus assets also result in market risk exposure. These assets are held primarily in three portfolios: (i) in the long-term funds within the life insurance companies; (ii) in the corresponding shareholder funds; and (iii) in investment portfolios within the general insurance business.
Measurement Market risk is managed within a Board approved framework and risk appetite. This is supplemented by divisional market risk appetite limits and triggers. A variety of risk measures are used such as: – Scenario/stress based measures (e.g. single factor stresses, macroeconomic scenarios); – Percentile based measures (e.g. VaR and Stressed VaR); and – Sensitivity based measures (e.g. sensitivity to 1 basis point move in interest rates).
These measures are reviewed regularly by senior management to inform effective decision making.
Table 1.32: Trading portfolios: VaR (1-day 95 per cent confidence level) (audited) At 31 December 2014 At 31 December 2013
Trading risk appetite is controlled with VaR limits. Limits are allocated on a 95 per cent 1-day VaR. VaR limits are complemented with profit and loss referrals, positional limits, and stress test triggers. VaR limits are set and managed at both desk and overall trading book levels.
The Group has an integrated Asset and Liability Management (ALM) system which supports non traded asset and liability management of the Group. This provides a single consolidated tool to measure and manage interest rate repricing profiles (including behavioural assumptions), perform stress testing and produce forecast outputs. Interest rate repricing profiles are reported by currency and used to calculate the income and value sensitivities (in GBP equivalent). Repricing assumptions and customer reaction to changes in product pricing is a major determinant of the risk profile. The Group is aware that any assumptions based model is open to challenge. However, a full behavioural review is performed annually by Group ALM functions to ensure the assumptions remain appropriate, and is reviewed by Risk Division.
Client facing activity and associated hedges (4.6) (46.0) 176.3 (222.3) 48.2 (136.0) 390.3 (364.4)
Monitoring The Group Asset and Liability Committee and the Group Market Risk Committee regularly review high level market risk exposure, as part of the wider risk management framework. They also make 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 and triggers are monitored by Risk Division and where appropriate, escalation procedures are in place.
Mitigation The Group has a strong control environment that is subject to ongoing enhancements through regular reviews and investment. Risks are reported and discussed at local governance forums and escalated to executive management as appropriate. This ensures the correct level of visibility and engagement. The Group employs a range of risk management strategies, including: avoidance, mitigation, transfer (which would also include insurance) and acceptance. Contingency plans are maintained for a range of potential scenarios, with regular disaster recovery and scenario testing scheduled to test and challenge the readiness of the Group to respond in the event of an incident.
Risk appetite Funding and liquidity risk is managed separately for the Banking and Insurance businesses. Funding and liquidity risk appetite for the Banking business is set with the support of the Group Asset and Liability Committee (GALCO). Within the Banking business, funding and liquidity risks are managed separately for TSB. The liquidity risk appetite for the Insurance business is reviewed and set annually by the Insurance Board.
In addition, the monitoring framework has two other important components. Firstly, the Group carries out stress testing of its liquidity and potential cash flow mismatch position over both short (up to two weeks) and longer term (up to three months) horizons against a range of scenarios, including those prescribed by the PRA (the idiosyncratic, market wide and combined stresses) and the Group’s own scenarios reflecting possible future liquidity risks. The Group’s scenarios cover US market disruption, market counterparty failure, UK sovereign rating downgrade, Eurozone stress and a cyber attack. The key risk driver assumptions applied to the scenarios are: Liquidity risk driver Market wide and Group specific stresses
The scenarios and the assumptions are reviewed at least annually to gain assurance that they continue to be relevant to the nature of the business. The Group’s liquidity risk appetite is calibrated against a number of stressed liquidity metrics. For further information on the Group’s 2014 liquidity stress testing results refer to page 151. In addition to the liquidity stress testing framework, the Group funding plan is stressed against a range of macroeconomic scenarios, including those prescribed by the PRA. The Group also applies its own macroeconomic stress scenarios, including a one in 20 year recession. Liquidity risk appetite and regulatory metrics are calculated and monitored over the life the plan under base and stress conditions.
Loans and advances to customers and customer deposits restated. See note 1, page 188.
Debt securities in issue: Medium-term notes include funding from the National Loan Guarantee Scheme (31 December 2014: £1.4 billion; 31 December 2013: £1.4 billion).
The entire primary liquidity portfolio and a subset of the secondary portfolio are LCR eligible. The Group considers diversification across geography, currency, markets and tenor when assessing appropriate holdings of primary and secondary liquid assets. This liquidity is managed as a single pool in the centre and is under the control of the function charged with managing the liquidity of the Group apart from the TSB Liquidity Buffer which is managed separately. It is available for deployment at immediate notice, subject to complying with regulatory requirements, and is a key component of the Group’s liquidity management process.
The liquidity stress testing assumes that further credit rating downgrades may reduce investor appetite for some of the Group’s liability classes and therefore funding capacity. A hypothetical idiosyncratic two notch downgrade of the Group’s current long-term debt rating and accompanying short-term downgrade implemented instantaneously by all major rating agencies, could result in an outflow of £2.5 billion of cash over a period of up to one year, £2.4 billion of collateral posting related to customer financial contracts and £8.6 billion of collateral posting associated with secured funding. The Group’s internal liquidity risk appetite includes such a stress scenario. The stress scenario modelling demonstrates the Group has available liquidity resources to manage such an event.
Trading and other financial assets at fair value through profit or loss 13,389 5,149 2,259 7,408 36,725 94,409 131,134 151,931
Available-for-sale financial assets 18,440 37,711 30 37,741 – 312 312 56,493
Cash and balances at central banks – 46,272 – 46,272 – 3,643 3,643 49,915
Trading and other financial assets at fair value through profit or loss 5,415 7,258 2,233 9,491 29,288 98,489 127,777 142,683
Measurement The Group measures the amount of capital it holds using the regulatory framework defined by the Capital Requirements Directive and Regulation (CRD IV) as implemented in the UK by the Prudential Regulation Authority (PRA) policy statement PS7/13. Full details on the Group’s regulatory capital framework are provided on page 20 of the Pillar 3 Report.
The minimum requirement for capital is supplemented by Pillar 2 of the regulatory framework.
In addition to the CPB, a countercyclical capital buffer could potentially apply of up to 2.5 per cent. This buffer is time-varying and is designed to require banks to hold additional capital to remove or reduce the build up of systemic risk in times of credit boom, providing additional loss absorbing capacity and acting as an incentive for banks to constrain further credit growth. The Group is not currently required to hold a countercyclical capital buffer.
The Financial Policy Committee (FPC) of the Bank of England can also set sectoral capital requirements which are temporary increases to banks’ capital requirements on exposures to specific sectors, if the FPC judges that exuberant lending to these sectors poses risks to financial stability. No sectoral capital requirements currently apply to the Group.
Under CRD IV two other CET1 capital buffers, the capital conservation buffer of 2.5 per cent and the systemic risk buffer of up to 3 per cent, will be phased in over the period from 1 January 2016 to 2019. To recognise these new buffers the PRA intends to rename the CPB as the PRA buffer and when setting the PRA buffer, will take into account the extent to which these CRD IV buffers already capture the risks identified in the PRA buffer assessment.
The regulatory framework within which the Group operates continues to be developed at a global level through the Financial Stability Board (FSB) and Basel Committee, at a European level mainly through the issuance of CRD IV technical standards and guidelines and within the UK by the PRA and through directions from the FPC.
Adjustment to retained earnings for foreseeable dividends (535) – (535) –
Excess of expected losses over impairment provisions and value adjustments (565) (866) (565) (866)
The key differences between the transitional capital calculation as at 31 December 2014 and the fully loaded equivalent are as follows: – Capital securities that previously qualified as tier 1 or tier 2 capital, but do not qualify under CRD IV, can be included in tier 1 or tier 2 capital (as applicable) up to a specified limit which reduces by 10 per cent per annum until 2022. – The significant investment deduction from AT1 in 2014 will transition to tier 2 by 2018.
Subordinated debt movements: Restructuring to ensure CRD IV compliance – 5,355 (4,006) 1,349
CET1 capital resources have increased by £2,471 million in the period, mainly due to profit attributable to ordinary shareholders, reflecting underlying profit, dividends from the Insurance business, and a pensions credit resulting from changes to the Group‘s defined benefit pension arrangements, partly offset by charges relating to legacy issues and the ECN exchange and lender offers. Additionally, favourable pension variations through other comprehensive income, favourable movements in available-for-sale (AFS) reserves, a reduction in the excess of expected losses over impairment provisions and value adjustments and a reduction in deferred tax and significant investment deductions, further increased CET1 capital resources partially offset by an increase in the pensions asset deducted from capital and foreseeable dividends.
Risk type analysis of risk-weighted assets: Foundation Internal Ratings Based (IRB) Approach 72,393 84,882
Risk-weighted assets at 31 December 2013 212,526 10,736 11,082 26,594 260,938
Includes the pro forma benefit of the sales of Heidelberger Leben, Scottish Widows Investment Partnership and the Group’s 50 per cent stake in Sainsbury’s Bank.
Assets related to Group subsidiaries that fall outside of the Group’s regulatory capital consolidation are deconsolidated. These are replaced with a proportion of the Group’s investment in the subsidiaries, reflecting amounts not already deducted from tier 1 capital as part of significant investment deductions. This primarily applies to the Group’s Insurance subsidiaries resulting in the removal of assets related to Insurance division.
Adjustments are applied to the balance sheet asset value of derivatives financial instruments to reflect the application of regulatory netting rules, adjustments for the recognition of cash variation margin (subject to certain restrictions), the addition of notional amounts of written credit derivatives and the requirement to reflect potential future exposure amounts in accordance with regulatory rules.
The valuation of with-profits assets in a With-Profit Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-profit business written therein, it includes the present value of the anticipated future release of the prudent margins for adverse deviation. In addition, the realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above. The realistic valuation of liabilities differs from the statutory basis in including an allowance for future bonuses whilst the value of options and guarantees are assessed using a stochastic simulation model which values these liabilities on a basis consistent with tradable market option contracts (a market-consistent basis). In calculating the realistic liabilities, the model also takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given in the section entitled Options and guarantees on page 164.
Shareholders’ funds: Held outside the long-term funds – – – 2,362 4 2,366
Formal intra group capital arrangements Scottish Widows has also provided subordinated loans to its fellow group undertaking Scottish Widows Bank plc. No such arrangement exists for Clerical Medical.
Other life insurance businesses Except as described above capital held in UK Non-Profit Funds is potentially transferable to other parts of the Group, subject to meeting the regulatory requirements of these businesses. There are no prior arrangements in place to allow capital to move freely between life insurance entities or other parts of the Group.
Movements in regulatory capital The movements in the Group’s available capital resources in the life business can be analysed as follows: Table 1.52: Movements in available capital resources Scottish Widows
UK Non-Profit Funds Available capital in the UK Non-Profit Funds has increased from £1,382 million at 31 December 2013 to an estimated £1,509 million at 31 December 2014. This is mainly due to emergence of surplus on existing business and assumption charges offset by new business strain and a reduction due to transfers to Shareholder Funds.
Analysis of policyholder liabilities reported in the balance sheet in respect of the Group’s life insurance business is as follows. With-Profit Fund liabilities are valued in accordance with FRS 27.
Insurance and participating investment contract liabilities 14,345 6,946 61,006 3,973 86,270
The most significant economic assumptions included in the model are: – Risk-free yield. The risk-free yield is defined as spot yields derived from swap yield curves. – Investment volatility. The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, at 31 December 2014, the 10 year equity-implied at-the-money assumption was set at 22.3 per cent (2013: 22.1 per cent). The assumption for property volatility was 13 per cent (2013: 15 per cent). The volatility of interest rates has been calibrated to the implied volatility of swaptions which was broadly 27 per cent (2013: 17 per cent).
Exposures The Group periodically experiences material regulatory breaches outside its risk appetite. Regulatory exposure is also driven by the significant volume of current legislation and regulation within the UK and overseas with which the Group has to comply, along with new or proposed legislation and regulation which needs to be interpreted, implemented and embedded into day-to-day operational and business practices across the Group. This is particularly the case currently; the industry still continues to witness increased levels of government and regulatory intervention in the financial sector with an increasing number of regulatory rules from both the UK and overseas affecting the Group’s operations. It is clear that regulatory challenges remain, including the area of conduct where the Group incurred a combined fine of £217 million by UK and US regulators for serious misconduct relating to the Special Liquidity Scheme (SLS), the Repo Rate benchmark and the London Interbank Offered Rate (LIBOR).
Risk appetite Insurance risk appetite in the Insurance business is set by the Insurance Board and includes maximum earnings exposures to longevity and persistency risk in defined stresses. Insurance risk appetite for longevity in the defined benefit pension schemes is set by the Board using two key metrics: a one year increase to life expectancy and a combined market and longevity stress. Insurance risk appetite is monitored through Group, Insurance business and pension scheme governance.
Mitigation A key element of the control framework is the consideration of insurance risk by an appropriate combination of high level committees and Boards. For the Insurance business the ultimate control body is the Insurance Board but significant risks from Insurance and the defined benefit pension schemes are reviewed by the Group executive and Group Risk Committees and/or Board. Governance of the Group’s defined benefit pension schemes also includes two specialist pension committees (one Group executive sub committee and a supporting management committee).
PEOPLE RISK Definition People risk is defined as the risk that the Group fails to lead, manage and enable colleagues to deliver to customers, shareholders and regulators leading to reductions in earnings and/or value.
Mitigation The Group takes many mitigating actions with respect to people risk. Key areas of focus include: – Working with the Regulators to ensure their guidance on increased accountability in the new regimes and strengthening remuneration governance is clear and pragmatic to balance implementation costs with the benefits gained from enhanced governance; – Continued focus on the Group’s culture by developing and delivering initiatives that reinforce behaviours which generate the best possible long-term outcomes for customers and colleagues; – Maintain effective remuneration arrangements to ensure they promote an appropriate culture and colleague behaviours that meet customer needs and regulatory expectations; – Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation of rigorous succession planning; – Ensuring compliance with legal and regulatory requirements related to Senior Manager Regime and Certification Regime, embedding compliant and appropriate colleague behaviours in line with Group policies, values and its people risk priorities; and – Ongoing consultation with the Group’s recognised unions on changes which impact their members.
GOVERNANCE RISK Definition Governance risk is defined as the risk that the Group’s organisational infrastructure fails to provide robust oversight of decision making and the control mechanisms to ensure strategies and management instructions are implemented effectively.
WHAT WE HAVE AUDITED Lloyds Banking Group plc’s financial statements comprise: – the Consolidated and Parent Company balance sheets as at 31 December 2014; – the Consolidated income statement and the Consolidated statement of comprehensive income for the year then ended; – the Consolidated and Parent Company cash flow statements for the year then ended; – the Consolidated and Parent Company statements of changes in equity for the year then ended; and – the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information.
– Uncertain tax positions – Recognition of deferred tax assets – Pension valuations and obligations – One-off transactions – Fair value adjustments applied to uncollateralised derivative financial instruments
We understood and tested key controls and focused on: – the identification of impairment events; – the governance controls over the impairment processes, including the continuous re-assessment by management that impairment models are still calibrated in a way which is appropriate for the impairment risks in the Group’s loan portfolios; – the transfer of data between underlying source systems and the impairment models that the Group operates; and
Commercial Banking We understood and evaluated the processes for identifying impairment events within the loan portfolios, as well as the impairment assessment processes for loans within the business support unit and run-off portfolio.
Overview Set out below is an overview of our audit approach, highlighting key aspects including materiality level, scope and areas of focus of our audit. These are described in further detail later in this audit report.
For significant provisions made, we understood and challenged the provisioning methodologies and underlying assumptions used by management. For example, we challenged the basis that management used for forecasting the number of PPI complaints that will be received in the future.
The Group’s accounting policy is that the discount rate applied to cash flows is consistent with that applied to such cash flows in the capital markets. Management use the actual asset mix as a proxy for deriving a market consistent view of the illiquidity adjustment to the discount rate. Small changes in each of these assumptions can result in material impacts to the valuation of insurance contract liabilities, the value of in-force assets and the related movements in the income statement.
We understood and tested key controls and governance around the processes for analysing economic and non-economic assumptions. We found the key controls for the setting of assumptions, including the experience analysis data, were designed, implemented and operated effectively, and therefore we determined that we could place reliance on these controls for the purposes of our audit.
The recognition of a deferred tax asset in respect of tax losses is permitted only to the extent that it is probable that future taxable profits will be available to utilise the tax losses carried forward.
We understood and tested key controls over the production and approval of the forecast taxable profits used to support the recognition of the deferred tax asset. We found the key controls were designed, implemented and operated effectively, and therefore we were able to place reliance on these controls for the purposes of our audit.
We assessed whether the forecast profits were appropriate by challenging both the underlying and economic assumptions, focusing on those directly impacting the adjusted profit figures, for example interest rates, consumer spending rates and Gross Domestic Product. We used our independent benchmarking data to benchmark a number of the economic assumptions to external data sources where possible, and also assessed the accuracy of previous forecasts.
We met with management and their actuary to understand the judgements made in determining key economic assumptions used in the calculation of the liability. We assessed the reasonableness of those assumptions by comparing to our own independently determined benchmarks and concluded that the assumptions used by management were appropriate.
Based on the evidence obtained, we found that the data and assumptions used by management in the actuarial valuations and the fair value of the scheme assets are within a range we consider to be reasonable.
Fair value adjustments applied to uncollateralised derivative financial instruments Refer to page 75 (Audit Committee Report), page 188 (Significant Accounting Policies), and page 285 (notes).
In order to comply with the IFRS definition of fair value, the Group continues to apply fair value adjustments to uncollateralised derivative positions, such as credit and debit valuation adjustments (CVA and DVA) and funding valuation adjustments (FVA).
We found the key controls were designed, implemented and operated effectively, and therefore we determined that we could place reliance on these controls for the purposes of our audit.
How we tailored the audit scope We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, taking into account the geographic structure of the Group, the accounting processes and controls, and the industry in which the Group operates.
The business reporting units within our audit scope contributed 87 per cent of Group total assets. The scope of our audit of Income Statement account balances was based on our risk assessment and focussed on the larger balances. The range of audit scope on Income Statement account balances was between 55 per cent and 97 per cent.
How we determined it 5 per cent of adjusted profit before tax.
GOING CONCERN Under the Listing Rules we are required to review the directors’ statement, set out on page 104, in relation to going concern. We have nothing to report having performed our review.
Under the Listing Rules we are required to review the part of the Corporate Governance Statement relating to the Parent Company’s compliance with ten provisions of the UK Corporate Governance Code. We have nothing to report having performed our review.
This report, including the opinions, has been prepared for and only for the Parent Company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Items that will not subsequently be reclassified to profit or loss: Post-retirement defined benefit scheme remeasurements: Remeasurements before taxation 674 (136) (2,136)
Trading and other financial assets at fair value through profit or loss 15 151,931 142,683
Loans and receivables: Loans and advances to banks 17 26,155 25,365
Trading and other financial liabilities at fair value through profit or loss 31 62,102 43,625
Profit for the year – – 1,412 1,412 – 87 1,499
Total other comprehensive income – 2,739 539 3,278 – – 3,278
Movement in treasury shares – – (286) (286) – – (286)
Other employee award schemes – – 233 233 – – 233
Adjustment on sale of non-controlling interest in TSB Banking Group plc (TSB) (note 56) – – (171) (171) – 805 634
Other changes in non-controlling interests – – – – – 1 1
(Loss) profit for the year – – (838) (838) 36 (802)
(Loss) profit for the year – – (1,471) (1,471) 84 (1,387)
Value of employee services: Share option schemes – – 81 81 – 81
Disposal of businesses, net of cash disposed 55(E) 543 696 37
Net cash (used in) provided by investing activities (7,722) (15,609) 15,232
Effects of exchange rate changes on cash and cash equivalents (6) (53) (8)
Amendments to IAS 32 Financial Instruments: Presentation – Offsetting Financial Assets and Financial Liabilities The amendments to IAS 32 clarify the requirements for offsetting financial instruments and address inconsistencies identified in applying the offsetting criteria used in the standard.
The Group is permitted to reclassify, at fair value at the date of transfer, non‑derivative financial assets (other than those designated at fair value through profit or loss by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or repurchased in the near term, as follows:
The Group is permitted to transfer a financial asset from the available‑for‑sale category to the loans and receivables category where that asset would have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been designated as available‑for‑sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a financial asset from the available‑for‑sale category to the held‑to‑maturity category is permitted when the Group has the ability and intent to hold that financial asset to maturity.
(F) DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGE ACCOUNTING All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and option pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 3 (Critical accounting estimates and judgements: Fair value of financial instruments) and note 51(3) (Financial instruments: Financial assets and liabilities carried at fair value) for details of valuation techniques and significant inputs to valuation models.
Individual assessment In respect of individually significant financial assets in the Group’s commercial lending portfolios, assets are reviewed on a regular basis and those showing potential or actual vulnerability are placed on a watchlist where greater monitoring is undertaken and any adverse or potentially adverse impact on ability to repay is used in assessing whether an asset should be transferred to a dedicated Business Support Unit. Specific examples of trigger events that would lead to the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of additional impairment allowances) include (i) trading losses, loss of business or major customer of a borrower; (ii) material breaches of the terms and conditions of a loan facility, including non‑payment of interest or principal, or a fall in the value of security such that it is no longer considered adequate; (iii) disappearance of an active market because of financial difficulties; or (iv) restructuring a facility with preferential terms to aid recovery of the lending (such as a debt for equity swap).
Collective assessment Impairment is assessed on a collective basis for (1) homogenous groups of loans that are not considered individually impaired; and (2) to cover losses which have been incurred but have not yet been identified on loans subject to individual impairment.
Homogenous groups of loans In respect of portfolios of smaller balance, homogenous loans, the asset is included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. Segmentation takes into account factors such as the type of asset, industry sector, geographical location, collateral type, past‑due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.
Deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the non‑participating investment contract liability.
(2) General insurance business The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included in insurance premium income, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods are deferred in the balance sheet within liabilities arising from insurance contracts and participating investment contracts and only credited to the income statement when earned. Broking commission is recognised when the underwriter accepts the risk of providing insurance cover to the customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience.
NOTE 2: ACCOUNTING POLICIES (CONTINUED) through profit and loss are recognised in profit or loss as part of the fair value gain or loss. Translation differences on available‑for‑sale non‑monetary financial assets, such as equity shares, are included in the fair value reserve in equity unless the asset is a hedged item in a fair value hedge.
NOTE 3: CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS The preparation of the Group’s financial statements in accordance with IFRS requires management to make judgements, estimates and assumptions in applying the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.
NOTE 3: CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS (CONTINUED) resulting trading performance of the customer, and the value of the security held, for which there may not be a readily accessible market. In particular, significant judgement is required by management in assessing the borrower’s cash flows and debt servicing capability together with the realisable value of collateral. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.
The Group’s total deferred tax asset includes £5,758 million (2013: £6,338 million) in respect of trading losses carried forward. The tax losses have arisen in individual legal entities and will be used as future taxable profits arise in those legal entities, though substantially all of the unused tax losses for which a deferred tax asset has been recognised arise in Bank of Scotland plc and Lloyds Bank plc.
NOTE 3: CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS (CONTINUED) The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptions is set out in note 38.
Note 40 contains more detail on the nature of the assumptions that have been made and key sensitivities.
Valuation techniques for level 2 financial instruments use inputs that are based on observable market data. Level 3 financial instruments are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Determining the appropriate assumptions to be used for level 3 financial instruments requires significant management judgement.
In addition certain regulatory costs, such as UK bank levy and charges in relation to the Financial Services Compensation Scheme, which were previously reported in Central items, are now attributed to the operating divisions. Comparative figures have been restated for all of these changes. The Group’s underlying profit and statutory results are unchanged as a result of these restatements.
TSB is a separately listed multi‑channel retail banking business with branches in England, Wales and Scotland; it has a digital distribution platform and four telephony contact centres. It serves retail and small business customers; providing a full range of retail banking products.
Total underlying income, net of insurance claims 8,291 4,436 2,654 1,594 926 467 18,368
Other segment items: Investments in joint ventures and associates at end of year 12 – – – – 62 74
Other income (net of insurance claims) 1,406 2,254 1,396 1,880 179 936 8,051
Other segment items: Investments in joint ventures and associates at end of year 185 – 6 – – 122 313
NOTE 4: SEGMENTAL ANALYSIS (CONTINUED) RECONCILIATION OF UNDERLYING BASIS TO STATUTORY RESULTS The underlying basis is the basis on which financial information is presented to the chief operating decision maker which excludes certain items included in the statutory results. The table below reconciles the statutory results to the underlying basis.
Comprises the payment protection insurance provision (£2,200 million) and other regulatory provisions (£925 million).
GEOGRAPHICAL AREAS Following the continuing reduction in the Group’s non‑UK activities, an analysis between UK and non‑UK activities is no longer provided.
Loans and advances to banks 0.52 0.45 0.54 406 457 603
Interest and similar expense: Deposits from banks, excluding liabilities under sale and repurchase transactions 0.74 0.65 1.14 (86) (129) (324)
Interest payable on liabilities held at amortised cost 1.45 1.88 2.08 (7,949) (10,734) (13,032)
Net income arising on assets held at fair value through profit or loss: Debt securities, loans and advances 4,805 55 4,042
Net expense arising on liabilities held at fair value through profit or loss – debt securities in issue (75) (93) (576)
Change in provision for ceded unearned premiums (note 33(2)) (3) (6) (7)
LIABILITY MANAGEMENT In April 2014, the Group completed concurrent Sterling, Euro and Dollar exchange offers with holders of certain series of its Enhanced Capital Notes (ECNs) to exchange the ECNs for new Additional Tier 1 (AT1) securities. In addition the Group completed a tender offer to eligible retail holders outside the United States to sell their Sterling‑denominated ECNs for cash. The exchange offers completed with the equivalent of £5.0 billion of ECNs being exchanged for the equivalent of £5.35 billion of AT1 securities, before issue costs. The retail tender offer completed with approximately £58.5 million of ECNs being repurchased for cash. A loss of £1,362 million has been recognised in relation to these exchange and tender transactions in the year ended 31 December 2014.
During 2013 the Group had completed a number of disposals of assets and businesses, including the sale of its shareholding in St James’s Place plc (profit of £540 million), a portfolio of US residential mortgage‑backed securities (profit of £538 million), its Spanish retail banking operations (loss of £256 million), its Australian operations (profit of £49 million) and its German life insurance business (this disposal completed in the first quarter of 2014, but an impairment of £382 million was recognised in the year ended 31 December 2013).
NOTE 10: INSURANCE CLAIMS Insurance claims comprise: 2014 £m 2013 £m 2012 £m
Change in assets arising from reinsurance contracts held 8 (48) (186)
Change in non‑participating investment contracts: Change in gross liabilities (1,448) (5,409) (5,058)
Change in assets arising from reinsurance contracts held 32 – –
Change in liabilities (note 33(2)): Total non-life insurance (330) (356) (365)
Life insurance and participating investment contracts gross claims can also be analysed as follows: Total life insurance gross claims (7,506) (8,495) (8,719)
A non‑life insurance claims development table is included in note 33.
Depreciation and amortisation: Depreciation of tangible fixed assets (note 27) 1,391 1,374 1,431
Regulatory provisions: Payment protection insurance provision (note 40) 2,200 3,050 3,575
On 11 March 2014 the Group announced a change to its defined benefit pension schemes, revising the existing cap on the increases in pensionable pay used in calculating the pension benefit, from 2 per cent to nil with effect from 2 April 2014. The effect of this change was to reduce the Group’s retirement benefit obligations recognised on the balance sheet by £843 million with a corresponding curtailment gain recognised in the income statement. This has been partly offset by a charge of £21 million following changes to pension arrangements for staff within the TSB business.
Performance‑based awards expensed in 2014 include cash awards amounting to £104 million (2013: £126 million; 2012: £128 million).
Audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of prospectuses and circulars required by the UKLA listing rules.
All statutory audit work as well as non‑audit assignments where the fee is expected to exceed the relevant fee cap must be pre‑approved by the Audit Committee on an individual engagement basis. On a quarterly basis, the Audit Committee receives a report detailing all pre‑approved services and amounts paid to the auditors for such pre‑approved services. The audit committee reviews on an on‑going basis the total level of non‑audit fees paid to PwC against various regulatory and other thresholds. The regulation, which was issued by the European Parliament in April 2014, specifies a cap of 70 per cent for non‑audit fees as a percentage of total audit fees for the last three years, although the precise requirement remains subject to the national implementation process. Whilst noting that uncertainties remain regarding the detailed application of the requirement and that it is a three year measure, the Group estimates that the level of non‑audit fees versus audit fees stood at 72 per cent for the year to 31 December 2014.
Total impairment losses on loans and receivables (note 21) 737 2,726 5,121
UK corporation tax: Current tax on profit for the year (162) (226) (181)
Foreign tax: Current tax on profit for the year (39) (60) (86)
Deferred tax (note 39): Origination and reversal of temporary differences (72) (434) (329)
Deferred tax on Australian tax losses not previously recognised – 60 12
Tax relief on distributions to other equity holders 62 – –
Other financial assets at fair value through profit or loss £m Total £m
Loans and advances to customers 28,513 – 28,513 21,083 27 21,110
Loans and advances to banks 8,212 – 8,212 8,333 – 8,333
NOTE 16: DERIVATIVE FINANCIAL INSTRUMENTS The Group holds derivatives as part of the following strategies: – Customer driven, where derivatives are held as part of the provision of risk management products to Group customers; – To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by the Group is to utilise a combination of fair value and cash flow hedge approaches as described in note 54; and – Derivatives held in policyholder funds as permitted by the investment strategies of those funds.
Derivatives designated as fair value hedges: Interest rate swaps 115,394 2,342 831
Total loans and advances to banks before allowance for impairment losses 26,155 25,365
Later than 1 year and not later than 5 years 1,214 1,736
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. During 2014 and 2013 no contingent rentals in respect of finance leases were recognised in the income statement. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £1 million (2013: £6 million).
All debt securities and lending assets held by the Group in Cancara are restricted in use, as they are held by the collateral agent for the benefit of the commercial paper investors and the liquidity providers only. The Group provides liquidity facilities to Cancara under terms that are usual and customary for standard lending activities in the normal course of the Group’s banking activities. The Group could be asked to provide support under the contractual terms of these arrangements if Cancara experienced a shortfall in external funding, which may occur in the event of market disruption. As at 31 December 2014 and 2013 these obligations had not been triggered.
The external assets in all of the Group’s conduits are consolidated in the Group’s financial statements.
NOTE 21: ALLOWANCE FOR IMPAIRMENT LOSSES ON LOANS AND RECEIVABLES Loans and advances to customers £m
Recoveries of advances written off in previous years 456 – – 456
Details of the Group’s asset‑backed conduits shown in the table above are included in note 20.
Direct operating expenses arising from investment properties that generate rental income 37 59
The table above analyses movements in investment properties, all of which are categorised as level 3.
NOTE 24: GOODWILL (CONTINUED) The recoverable amount of the goodwill relating to Scottish Widows has been based on a value‑in‑use calculation. The calculation uses pre‑tax projections of future cash flows based upon budgets and plans approved by management covering a five‑year period, and a discount rate of 10 per cent. The budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and available industry information. Cash flows beyond the five‑year period have been extrapolated using a steady 3 per cent growth rate which does not exceed the long‑term average growth rate for the life assurance market. Management believes that any reasonably possible change in the key assumptions above would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
The movement in the value of in‑force insurance and participating investment contracts over the year is as follows: £m £m
Risk‑free rate (value of in‑force non‑annuity business)1 0.00 to 3.27 0.00 to 4.04
Risk‑free rate (financial options and guarantees)1 0.29 to 2.20 0.21 to 3.45
All risk‑free rates are quoted as the range of rates implied by the relevant swap curve.
Maintenance expenses Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs. Explicit allowance is made for future expense inflation.
These assumptions are intended to represent a best estimate of future experience, and further information about the effect of changes in key assumptions is given in note 34.
Cost: Exchange and other adjustments – – – – 22 22
Accumulated amortisation: Exchange and other adjustments – – – – 9 9
Balance sheet amount at 31 December 2013 489 910 15 96 769 2,279
Included within brands above are assets of £380 million (31 December 2013: £380 million) that have been determined to have indefinite useful lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well established financial services brands and there are no indications that they should not have an indefinite useful life.
Accumulated depreciation and impairment: Exchange and other adjustments 4 18 (10) 12
Assets arising from reinsurance contracts held (notes 33 and 35) 682 732
For amounts included above which are subject to repurchase agreements, see note 54.
Liabilities held at fair value through profit or loss 6,744 5,306
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements 50,007 28,902
NOTE 33: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS (CONTINUED) (1) LIFE INSURANCE The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows: Insurance contracts £m
For non‑life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims provisioning levels are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or expected outcome. There has been no significant change in the assumptions and methodologies used for setting reserves.
Increase (decrease) in liabilities: Arising from current year claims 379 – 379
Change in liabilities charged to income statement (note 10) (33) 1 (32)
Cash paid for claims settled in the year (398) – (398)
Increase (decrease) in liabilities: Arising from current year claims 368 – 368
Change in liabilities charged to income statement (note 10) (70) – (70)
Current estimate of claims relating to general insurance business acquired in 2009 257 – – – – – – 257
NOTE 34: LIFE INSURANCE SENSITIVITY ANALYSIS The following table demonstrates the effect of reasonably possible changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in‑force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
Widening of credit default spreads on corporate bonds8 0.25% addition (260) (208)
This sensitivity shows the impact of a 25 basis point increase in credit default spreads on corporate bonds and the corresponding reduction in market values. Swap curves, the risk‑free rate and illiquidity premia are all assumed to be unchanged.
NOTE 36: UNALLOCATED SURPLUS WITHIN INSURANCE BUSINESSES The movement in the unallocated surplus within long‑term insurance businesses over the year can be analysed as follows: 2014 £m 2013 £m
Total (credit) charge to the income statement (note 11) (226) 758 339
The latest full valuations of the three main schemes were carried out as at 30 June 2011; the results have been updated to 31 December 2014 by qualified independent actuaries. The last full valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2014 by qualified independent actuaries.
The Group has also established two private limited companies which hold assets to provide security for the Group’s obligations to the HBOS Final Salary Pension Scheme and a section of the Lloyds Bank Pension Scheme No 1. At 31 December 2014 these held assets of approximately £2.8 billion in aggregate; they do not make any distributions to the pension schemes. The private limited companies are consolidated fully in the Group’s balance sheet. The terms of these arrangements require the Group to maintain assets in these vehicles to agreed minimum values in order to secure obligations owed to the relevant Group pension schemes. The Group has satisfied this requirement during 2014.
The total defined benefit obligation comprises: Amounts owing to active members (7,801) (8,647)
Return on plan assets excluding amounts included in interest income 4,928 1,133
Expected life expectancy of members: Increase of one year 34 38 750 686
Benefits expected to be paid between 1 and 2 years 1,059 1,009
Benefits expected to be paid in more than 45 years 9,617 11,403
OTHER POST-RETIREMENT BENEFIT SCHEMES The Group operates a number of schemes which provide post‑retirement healthcare benefits and concessionary mortgages to certain employees, retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post‑retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future insurance premiums payable.
Asset at 31 December 4,091 5,101 Asset at 31 December 4,091 5,101
The deferred tax charge in the income statement comprises the following temporary differences: £m £m £m
Deferred tax assets are recognised for tax losses carried forward to the extent that the realisation of the related tax benefit through future taxable profits is probable. Group companies have recognised deferred tax assets of £5,758 million (2013: £6,338 million) in relation to trading tax losses carried forward. After reviews of medium‑term profit forecasts, the Group considers that there will be sufficient profits in the future against which these losses will be offset (see note 3).
PAYMENT PROTECTION INSURANCE Following the unsuccessful legal challenge by the British Bankers’ Association against the Financial Services Authority (FSA) (now known as the Financial Conduct Authority (FCA)) and the Financial Ombudsman Service (FOS), the Group made provisions totalling £9,825 million to 31 December 2013 against the costs of paying redress to customers in respect of past sales of PPI policies, including the related administrative expenses.
NOTE 40: OTHER PROVISIONS (CONTINUED) Expenses The Group expects to maintain the PPI operation on its current scale for longer than previously expected given the update to volume related assumptions and the re‑review of previously handled cases continuing into 2015. The estimate for administrative expenses, which comprise litigation and complaint handling costs as well as costs arising from cases subsequently referred to the FOS, has increased by approximately £420 million in 2014.
Litigation in relation to insurance branch business in Germany Clerical Medical Investment Group Limited (CMIG) has received a number of claims in the German courts relating to policies issued by CMIG but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. Following decisions in July 2012 from the Federal Court of Justice in Germany the Group recognised provisions totalling £400 million in 2012 and 2013. Volumes of claims have not decreased as quickly as expected and as a result the Group has recognised a further £120 million during 2014 bringing the total provision to £520 million. The remaining unutilised provision as at 31 December 2014 is £199 million.
LIBOR and other trading rates During 2014 the Group charged £225 million to the income statement in respect of this matter. In July, the Group announced that it had reached settlements totalling £217 million (at 30 June 2014 exchange rates) to resolve with UK and US federal authorities legacy issues regarding the manipulation several years ago of Group companies’ submissions to the British Bankers’ Association (BBA) London Interbank Offered Rate (LIBOR) and Sterling Repo Rate.
The Group has paid £70 million to the FCA in connection with the resolution of the BBA Repo Rate issue and related systems and controls failings. Both the CFTC and DOJ settlements are in respect of LIBOR only and neither agency has taken action regarding the BBA Repo Rate.
Floating Rate Undated Subordinated Notes (e500 million) – 49 4.25% Perpetual Fixed to Floating Rate Reset Subordinated Guaranteed Notes (e750 million) (Clerical Medical Finance plc) 295 283 10.25% Subordinated Undated Instruments (£100 million) 1 1 7.375% Subordinated Undated Instruments (£150 million) – –
Primary Capital Undated Floating Rate Notes: Series 1 (US$750 million) a 172 162
NOTE 41: SUBORDINATED LIABILITIES (CONTINUED) With the exception of the two series identified in footnote b below, the ECNs were issued in lower tier 2 format and are convertible into ordinary shares on the breach of a defined trigger. The trigger is if the published core tier 1 ratio of the Group (as defined by the Financial Services Authority in May 2009) falls below 5 per cent.
Floating Rate Enhanced Capital Notes due 2020 (e53 million) a 34 37 7.875% Enhanced Capital Notes due 2020 (US$408 million) 220 258 11.04% Enhanced Capital Notes due 2020 (£736 million) 67 824 7.5884% Enhanced Capital Notes due 2020 (£732 million) 59 706 6.385% Enhanced Capital Notes due 2020 (e662 million) 457 524 6.439% Enhanced Capital Notes due 2020 (e711 million) 36 563 8% Fixed to Floating Rate Undated Enhanced Capital Notes callable 2020 (US$1,259 million) b 373 662 9.125% Enhanced Capital Notes due 2020 (£148 million) 50 157 12.75% Enhanced Capital Notes due 2020 (£57 million) 16 71 7.869% Enhanced Capital Notes due 2020 (£597 million) 26 593 7.625% Enhanced Capital Notes due 2020 (e226 million) 174 185 7.875% Enhanced Capital Notes due 2020 (US$986 million) 44 595 11.125% Enhanced Capital Notes due 2020 (£39 million) 5 44 8.5% Undated Enhanced Capital Notes callable 2021 (US$277 million) b 156 146 14.5% Enhanced Capital Notes due 2022 (£79 million) 20 110 9.875% Enhanced Capital Notes due 2023 (£57 million) 6 66 11.25% Enhanced Capital Notes due 2023 (£95 million) 22 115 10.5% Enhanced Capital Notes due 2023 (£69 million) 10 78 11.875% Enhanced Capital Notes due 2024 (£35 million) 20 44 7.975% Enhanced Capital Notes due 2024 (£102 million) 26 99 16.125% Enhanced Capital Notes due 2024 (£61 million) 21 94 15% Enhanced Capital Notes due 2029 (£68 million) 106 108 9% Enhanced Capital Notes due 2029 (£107 million) 1 112 8.5% Enhanced Capital Notes due 2032 (£104 million) 3 105
c The interest rate payable on this security was reset from 5.109 per cent fixed to Canadian Dealer Offered Rate plus 0.65 per cent with effect from 21 June 2012.
Share issuances The 5 million shares issued in 2014 were in respect of employee share schemes (2013: 312 million shares; 2012: 1,137 million shares). In 2013 the Group issued 713 million new ordinary shares (2012: 479 million shares) in relation to payment of coupons in the year on certain hybrid capital securities that are non‑cumulative.
NOTE 42: SHARE CAPITAL (CONTINUED) Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary shares in all respects from the date of conversion.
Revaluation reserve in respect of available‑for‑sale financial assets (67) (615) 399
Change in fair value of available‑for‑sale financial assets 690 (680) 900
Adjustment on sale of non‑controlling interest in TSB (note 56) (171) – –
NOTE 47: ORDINARY DIVIDENDS The directors have recommended a dividend, which is subject to approval by the shareholders at the Annual General Meeting, of 0.75 pence per share (2013: nil pence per share; 2012: nil pence per share) representing a total dividend of £535 million (2013: £nil; 2012: £nil), which will be paid on 19 May 2015. These financial statements do not reflect this recommended dividend.
For options granted in 2004 The performance condition was linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 17 companies including Lloyds Banking Group plc.
No options were exercised during 2014 or 2013. The weighted average remaining contractual life of options outstanding at the end of the year was 0.2 years (2013: 0.8 years). The fair values of the executive share options have been determined using a standard Black‑Scholes model.
The weighted average fair value of SAYE options granted during 2014 was £0.22 (2013: £0.24). The fair values of the SAYE options have been determined using a standard Black‑Scholes model.
For options granted on 27 March 2014 under the Commercial Banking Transformation Plan (CBTP), the number of options that may be delivered in March 2017 may vary by a factor of 0‑4 from the original ‘on‑target’ award, depending on the degree to which the performance conditions have been met. An ‘on‑target’ vesting is contingent upon Commercial Banking achieving £2.5 billion Underlying Profit and 2 per cent Return on Risk Weighted Assets (‘RoRWA’) on 31 December 2016. The Plan will pay out at between £1.9 billion and £3 billion underlying profit, and between 1.6 per cent and 2.5 per cent RoRWA.
No options were granted in 2014 or 2013. The weighted average remaining contractual life of options outstanding at the end of the year was 6.7 years (2013: 7.5 years).
The options under the HBOS Share Option Plan and St James’s Place Share Option Plan lapsed on 15 March 2014 and 20 April 2014 respectively.
Lloyds Banking Group Long-Term Incentive Plan The Long‑Term Incentive Plan (LTIP) introduced in 2006 is aimed at delivering shareholder value by linking the receipt of shares to an improvement in the performance of the Group over a three year period. Awards are made within limits set by the rules of the Plan, with the limits determining the maximum number of shares that can be awarded equating to three times annual salary. In exceptional circumstances this may increase to four times annual salary.
If the adjusted EP reaches £567 million, 25 per cent of this element of the award, being the threshold, will vest. If the adjusted EP reaches £1,534 million, 100 per cent of this element will vest.
(iii) Short-term funding as a percentage of total funding: relevant to 10 per cent of the award. Performance will be measured relative to 2014 targets.
(v) Net Simplification benefits: relevant to 10 per cent of the award. Performance will be measured by reference to the run rate achieved by the end of 2014.
If complaints per 1,000 customers average 1.5 per annum or less over three years, 25 per cent of this element of the award, being the threshold, will vest.
If the movement in SME lending equates to this market movement, 25 per cent of this element of the award, being the threshold, will vest.
If the movement in SME lending is 4 per cent or more greater than the market movement, 100 per cent of this element will vest.
The weighted average fair value of the share awards granted in 2014 was £0.62 (2013: £0.34). The fair values of the majority of share awards granted have been determined using a standard Black‑Scholes model. The fair values of the remaining share awards have been determined by Monte Carlo simulation.
If the final averaged ranking position of Lloyds Banking Group is third, 25 per cent of this element will vest.
If the final averaged ranking position of Lloyds Banking Group is first, 100 per cent of this element will vest.
The number of shares awarded relating to matching shares in 2014 was 16,248,562 (2013: 19,870,495), with an average fair value of £0.78 (2013: £0.63), based on market prices at the date of award.
Fixed Share Awards Fixed share awards were introduced in 2014 in order to ensure that total fixed remuneration is commensurate with role and to provide a competitive reward package for certain Lloyds Banking Group employees, with an appropriate balance of fixed and variable remuneration, in line with regulatory requirements. The Fixed Share Awards are delivered in Lloyds Banking Group shares, released over five years with 20 per cent being released each year following the year of award. The number of shares purchased in 2014 was 7,761,624.
Placed (includes deposits of appointed key management personnel) 32 29 39
Withdrawn (includes deposits of former key management personnel) (29) (26) (35)
At 31 December 2014, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £1 million with six directors and six connected persons (2013: £1 million with six directors and five connected persons; 2012: £1 million with five directors and three connected persons).
Pension funds The Group provides banking and some investment management services to certain of its pension funds. At 31 December 2014, customer deposits of £129 million (2013: £145 million) and investment and insurance contract liabilities of £3,278 million (2013: £4,728 million) related to the Group’s pension funds.
At 31 December 2014 there were loans and advances to customers of £1,901 million (2013: £4,448 million) outstanding and balances within customer deposits of £24 million (2013: £70 million) relating to other joint ventures and associates.
Certain Group companies, together with other panel banks, have also been named as defendants in private lawsuits, including purported class action suits, in the US in connection with their roles as panel banks contributing to the setting of US Dollar and Japanese Yen LIBOR. The claims have been asserted by plaintiffs claiming to have had an interest in various types of financial instruments linked to US Dollar and Japanese Yen LIBOR. The allegations in these cases, the majority of which have been coordinated for pre‑trial purposes in multi‑district litigation proceedings (MDL) in the US Federal Court for the Southern District of New York (the ‘District Court’), are substantially similar to each other. The lawsuits allege violations of the Sherman Antitrust Act, the Racketeer Influenced and Corrupt Organizations Act (RICO) and the Commodity Exchange Act (CEA), as well as various state statutes and common law doctrines. Certain of the plaintiffs’ claims have been dismissed by the District Court.
The Group is also reviewing its activities in relation to the setting of certain foreign exchange daily benchmark rates and related matters, following the FCA’s publicised initiation of an investigation into other financial institutions in relation to this activity. The Group is co‑operating with the FCA and other regulators and is providing information about the Group’s review to those regulators. In addition, the Group, together with a number of other banks, was named as a defendant in several actions filed in the District Court between late 2013 and February 2014, in which the plaintiffs alleged that the defendants manipulated WM/Reuters foreign exchange rates in violation of US antitrust laws. On 31 March 2014, plaintiffs effectively withdrew their claims against the Group (but not against all defendants) by filing a superseding consolidated and amended pleading against a number of other defendants without naming any Group entity as a defendant.
UK SHAREHOLDER LITIGATION In August 2014, the Group and a number of former directors were named as defendants in a claim filed in the English High Court by a number of claimants who held shares in Lloyds TSB Group plc (LTSB) prior to the acquisition of HBOS plc, alleging breaches of fiduciary and tortious duties in relation to information provided to shareholders in connection with the acquisition and the recapitalisation of LTSB. The claim is at an early stage and so it is currently not possible to determine the ultimate impact on the Group (if any), but it intends to defend the claim vigorously.
INVESTIGATION INTO BANK OF SCOTLAND AND REPORT ON HBOS The FSA’s enforcement investigation into Bank of Scotland plc’s Corporate division between 2006 and 2008 concluded with the publication of a Final Notice on 9 March 2012. No financial penalty was imposed on the Group or Bank of Scotland plc. On 12 September 2012 the FSA confirmed it was starting work on a public interest report on HBOS. That report is now being produced as a joint PRA / FCA report. Although the Terms of Reference for the HBOS review (issued on 11 July 2014) stated an aim to publish the final report by the end of 2014, the report has not yet been published.
US-SWISS TAX PROGRAMME The US Department of Justice (the DOJ) and the Swiss Federal Department of Finance announced on 29 August 2013 a programme (the Programme) for Swiss banks to obtain resolution concerning their status in connection with on‑going investigations by the DOJ into individuals and entities that use foreign (i.e. non‑US) bank accounts to evade US taxes and reporting requirements, and individuals and entities that facilitate or have facilitated the evasion of such taxes and reporting requirements. Swiss banks that chose to participate notified the DOJ of their election to categorise their relevant banking operations according to one of a number of defined categories under the Programme.
Items in the course of collection from banks – – – – – 1,173 – 1,173
Trading and other financial assets at fair value through profit or loss – 48,494 103,437 – – – – 151,931
Loans and advances to customers – – – – 482,704 – – 482,704
Available‑for‑sale financial assets – – – 56,493 – – – 56,493
Deposits from banks – – – – – 10,887 – 10,887
Notes in circulation – – – – – 1,129 – 1,129
Unallocated surplus within insurance businesses – – – – – – 320 320
Available‑for‑sale financial assets – – – 43,976 – – – 43,976
Derivative financial instruments 4,518 23,140 – – – – – 27,658
Notes in circulation – – – – – 1,176 – 1,176
Unallocated surplus within insurance businesses – – – – – – 391 391
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) (2) FAIR VALUE MEASUREMENT Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is a measure as at a specific date and may be significantly different from the amount which will actually be paid or received on maturity or settlement date.
Fair value information is not provided for items that are not financial instruments or for other assets and liabilities which are not carried at fair value in the Group’s consolidated balance sheet. 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.
Repurchase agreements included in the above amounts: Customer deposits – – 2,978 2,978
Bank and building society certificates of deposit – 554 – 554
Bank and building society certificates of deposit – 298 – 298
Total financial assets carried at fair value, excluding derivatives 133,630 69,420 5,374 208,424
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) Movements in Level 3 portfolio The table below analyses movements in level 3 financial assets, excluding derivatives, carried at fair value (recurring measurement).
Gains recognised in other comprehensive income within the revaluation reserve in respect of available‑for‑sale financial assets – 40 40
Gains recognised in other comprehensive income within the revaluation reserve in respect of available‑for‑sale financial assets – (61) (61)
Total financial liabilities carried at fair value, excluding derivatives 2,700 59,397 56 62,153
Losses (gains) recognised in the income statement within other income (5) 1 (4)
(C) Derivatives All of the Group’s derivative assets and liabilities are carried at fair value. At 31 December 2014, such assets totalled £36,128 million (31 December 2013: £30,804 million) and liabilities totalled £33,187 million (31 December 2013: £27,658 million). The table below analyses these derivative balances by valuation methodology (level 1, 2 or 3, as described on page 277). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and level 2 during the year.
Gains recognised in the income statement, within other income, relating to the change in fair value of those assets or liabilities held at 31 December 2013 159 20
NOTE 51: FINANCIAL INSTRUMENTS (CONTINUED) (D) Sensitivity of level 3 valuations
Unlisted equities and debt securities, property partnerships in the life funds
Valuation hierarchy The table below analyses the fair values of the financial assets of the Group which are carried at amortised cost by valuation methodology (level 1, 2 or 3, as described on page 277). Loans and receivables are mainly classified as level 3 due to significant unobservable inputs used in the valuation models. Where inputs are observable, debt securities are classified as level 1 or 2.
Loans and receivables: Loans and advances to customers: unimpaired 462,124 – – 462,124
Debt securities in issue The fair value of short‑term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities is calculated based on quoted market prices where available. Where quoted market prices are not available, fair value is estimated using discounted cash flow techniques at a rate which reflects market rates of interest and the Group’s own credit spread.
Debt securities classified as loans and receivables 88 – 88 –
NOTE 53: OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES The following information relates to financial assets and liabilities which have been offset in the balance sheet and those which have not been offset but for which the Group has enforceable master netting agreements in place with counterparties.
Potential net amounts if offset of related amounts permitted £mAt 31 December 2013
MARKET RISK The Group uses various market risk measures for risk reporting and setting risk appetite limits and triggers. These measures include Value at Risk and Stress Scenarios.
Interest rate risk In the Group’s retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. There is a relatively small volume of deposits whose rate is contractually fixed for their term to maturity.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non‑structural foreign exchange exposures in the non‑trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 139.
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows: Functional currency of Group operations £m £m
Total structural foreign currency exposures, after net investment hedges 191 225
Off‑balance sheet items: Other items serving as direct credit substitutes 330 – 330 710 – 710
Neither past due nor impaired 25,219 318,668 36,789 107,764 463,221 29,443
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(H). All impaired loans which exceed certain thresholds, principally within the Group’s Commercial Banking division, are individually assessed for impairment by reviewing expected future cash flows including those that could arise from the realisation of security. Included in loans and receivables are advances which are individually determined to be impaired with a gross amount before impairment allowances of £8,522 million (31 December 2013: £22,390 million).
Allowance for impairment losses on loans and advances to customers on an underlying basis 7,652 15,707
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Loans and advances which are past due but not impaired
Debt securities classified as loans and receivables An analysis by credit rating of the Group’s debt securities classified as loans and receivables is provided below: Investment grade1 £m
Bank and building society certificates of deposit 208 – – 208
Total held at fair value through profit or loss 50,910 629 2,091 53,630
Total held at fair value through profit or loss 44,419 666 1,752 46,837
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Derivative assets An analysis of derivative assets is given in note 16. The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly liquid securities. In respect of the Group’s maximum credit risk relating to derivative assets of £14,199 million (2013: £11,325 million), cash collateral of £3,651 million (2013: £2,702 million) was held and a further £2,043 million was due from OECD banks (2013: £2,372 million).
Other No collateral is held in respect of retail credit cards or overdrafts, or unsecured personal loans. For non‑mortgage retail lending to small businesses, collateral will often include second charges over residential property and the assignment of life cover.
Reverse repurchase transactions There were reverse repurchase agreements which are accounted for as collateralised loans with a carrying value of £5,148 million (2013: £120 million), against which the Group held collateral with a fair value of £5,155 million (2013: £112 million), all of which the Group is able to repledge. Included in these amounts are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £35 million (2013: £49 million). These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.
Unimpaired secured lending Unimpaired secured commercial lending amounted to £57,647 million (2013: £69,108 million). Commercial lending decisions are predominantly based on an obligor’s ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the time of loan origination. The types of collateral taken and the frequency with which collateral is required at origination is dependent upon the size and structure of the borrower. For exposures to corporate customers and other large institutions, the Group will often require the collateral to include a first charge over land and buildings owned and occupied by the business, a mortgage debenture over the company’s undertaking and one or more of its assets, and keyman insurance. The Group maintains policies setting out acceptable collateral, maximum loan‑to‑value ratios and other criteria to be considered when reviewing a loan application. The decision as to whether or not collateral is required will be based upon the nature of the transaction and the credit worthiness of the customer. Other than for project finance, object finance and income producing real estate where charges over the subject assets are a basic requirement, the provision of collateral will not determine the outcome of a credit application. The fundamental business proposition must evidence the ability of the business to generate funds from normal business sources to repay debt.
Trading and other financial assets at fair value through profit or loss (excluding equity shares) Included in trading and other financial assets at fair value through profit or loss are repurchase agreements treated as collateralised loans with a carrying value of £36,725 million (2013: £29,288 million). Collateral is held with a fair value of £42,858 million (2013: £32,434 million), all of which the Group is able to repledge. At 31 December 2014, £10,319 million had been repledged (2013: £8,195 million).
In addition, securities held as collateral in the form of stock borrowed amounted to £33,721 million (2013: £46,552 million). Of this amount, £32,686 million (2013: £45,277 million) had been resold or repledged as collateral for the Group’s own transactions.
Deposits from banks Included in deposits from banks are deposits held as collateral for facilities granted, with a carrying value of £1,075 million (2013: £1,874 million) and a fair value of £1,075 million (2013: £1,874 million).
Forbearance identification and classification The Group classifies a retail account as forborne at the time a customer in financial difficulty is granted a concession. Accounts are classified as forborne only for the period of time which the exposure is known to be, or may still be, in financial difficulty. Where temporary forbearance is granted, exit criteria are applied to include accounts until they are known to no longer be in financial difficulty. Details of the exit criteria are shown in the analysis below. Where the treatment involves a permanent change to the contractual basis of the customer’s account such as a capitalisation of arrears or term extension, the Group classifies the balance as forborne for a period of 24 months, after which no distinction is made between these accounts and others where no change has been made.
Retail lending At 31 December 2014, UK retail secured loans and advances currently or recently subject to forbearance were 1.4 per cent (31 December 2013: 2.0 per cent) of total UK retail secured loans and advances. The Group no longer offers temporary interest‑only as a forbearance treatment to secured lending customers in financial difficulty, and this is the primary driver of the reduction in forbearance balances in 2014.
Impairment provisions as % of loans and advances which are currently or recently forborne 2014 £m £m £m £m
Secured forborne loans have reduced by £1,759 million in 2014 to £4,394 million, driven primarily by an improvement in the underlying quality of the portfolio, with a greater value exiting forbearance than entering forbearance. Unsecured forborne loans have reduced by £29 million in 2014.
Permanent treatments £239 million of current and recent forborne loans and advances were not impaired at 31 December 2014 (31 December 2013: £398 million).
Forbearance treatments may include changes to: – Contractual payment terms (for example loan extensions, or changes to debt servicing terms), and – Non‑payment contractual terms (for example covenant amendments or waivers) where the modifications enable default to be avoided. – The four main types of forbearance concessions to commercial customers in financial difficulty are set out below: – Covenants: This includes temporary and permanent waivers, amendment or resetting of non‑payment contractual covenants (including LTV and interest cover). The granting of this type of concession in itself would not result in the loan being classified as impaired; – Extensions/Alterations: This includes extension and/or alteration of repayment terms to a level outside of market or the Group’s risk appetite due to the customer’s inability to make existing contractual repayment terms; amendments to an interest rate to a level considered outside of market or the Group’s risk appetite, or other amendments such as changes to debt servicing arrangements; – Forgiveness: This includes debt for equity swaps or partial debt forgiveness. This type of forbearance will always give rise to impairment; and – Multiple type of forbearance (a combination of the above three).
The Group no longer reports as forborne non‑payment concessions to unimpaired obligors if the revised terms are within the Group’s risk appetite and the overall risk is acceptable, taking into account the overall structure of facilities together with the current state and expectations of financial strength. There is no significant impact as a result of this change.
Classified as impaired during the year: UK exposures >£5 million 557
Includes £475 million in respect of two loans classified as impaired during the year and subsequently transferred to Commercial Banking.
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Maturities of assets and liabilities
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 34,690 14,446 5,078 3,708 846 3,867 6,461 26,193 95,289
Debt securities held as loans and receivables – 150 10 – – 41 66 1,088 1,355
NOTE 54: FINANCIAL RISK MANAGEMENT (CONTINUED) Further information on the Group’s liquidity exposures is provided on pages 146 to 150.
CAPITAL RISK Capital risk is defined as the risk that the Group has a sub‑optimal amount or quality of capital or that capital is inefficiently deployed across the Group.
Capital risk appetite is set by the Board, reflecting the Group’s strategic plans, regulatory capital constraints and market expectations. It includes a number of minimum capital ratios in normal and stressed conditions as well as a specific measure for the Insurance business, set by the Insurance Board, taking account of the need to maintain regulatory solvency including appropriate management buffers. The Board and the Group Chief Executive, assisted by the Group Asset and Liability Committee and the Group Risk Committee, regularly review performance against the risk appetite. A key metric is the Group’s common equity tier 1 (CET1) capital ratio for which the Group is now assuming a steady state ratio requirement of around 12 per cent.
Change in derivative financial instruments, trading and other financial assets at fair value through profit or loss (11,767) (5,078) 1,447
A number of capital transactions entered into by the Group involved the exchange of existing securities for new issues and as a result there was no related cash flow.
NOTE 55: CONSOLIDATED CASH FLOW STATEMENT (CONTINUED) (D) ANALYSIS OF CASH AND CASH EQUIVALENTS AS SHOWN IN THE BALANCE SHEET
Included within cash and cash equivalents at 31 December 2014 is £12,855 million (2013: £14,058 million; 2012: £17,889 million) held within the Group’s life funds, which is not immediately available for use in the business.
As none of these transactions resulted in the Group ceding control of TSB, no gain or loss has been recognised in the Group’s income statement. The shortfall of £171 million between the net proceeds of the three sales and the share of TSB’s net assets (at book value) disposed of has been deducted from the Group’s retained earnings.
Movement in treasury shares – – – (282) (282) – (282)
Other employee award schemes – – – 256 256 – 256
Net cash (used in) provided by investing activities (3,274) (2,885) 209
NOTE 1: ACCOUNTING POLICIES The Company has applied International Financial Reporting Standards as adopted by the European Union in its financial statements for the year ended 31 December 2014. IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Company has not taken advantage of this relaxation, and therefore there is no difference in application to the Company between IFRS as adopted by the EU and IFRS as issued by the IASB.
Dated subordinated liabilities 5.875% Subordinated Guaranteed Bonds 2014 (€750 million) – 658 4.5% Fixed Rate Subordinated Debt Securities due 2024 (US$1,000 million) 639 –
KEY MANAGEMENT PERSONNEL The key management personnel of the Group and the Company are the same. The relevant disclosures are given in note 49 to the consolidated financial statements.
As discussed in note 2 to the consolidated financial statements, the Group provides share-based compensation to employees through a number of schemes; these are all in relation to shares in the Company and the cost of providing those benefits is recharged to the employing companies in the Group.
NOTE 9: RELATED PARTY TRANSACTIONS (CONTINUED) The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of Lloyds Banking Group plc, are: Share class