during 2012 we have made good progress regarding the Ec mandated disposal, Project Verde. We have created Verde as a stand-alone bank, which from the summer 2013, will be operating as a separate business within the Group. We are well-positioned to divest the business either through a sale or an initial Public Offering. Our discussions with The co-operative Group plc continue towards signing a binding sale and purchase agreement. The formation of a new banking business, when completed, will be an effective challenger in the uK’s retail banking market.
A COMMiTMenT TO GOOD GOveRnAnCe Governance The Board is committed to achieving long-term success for the Group, and governance plays an integral part in ensuring consistency and rigour in decision making to allow us to maximise shareholder value over time. This remains uppermost in our minds when applying the principles described in relevant provisions relating to the combined code on corporate governance published by the Financial Reporting council. The Board aims to exceed these requirements as we believe that good governance is a key contributor to the Group’s long term success.
in Retail, investment in our digital distribution capabilities continues to be rewarded with the number of active internet customers increasing by 1.2 million in 2012 to 9.5 million, whilst our mobile banking apps, which were launched in October 2011, now have 3.3 million users. We also achieved a major milestone of over a billion customer logons for the year. Alongside our digital services we are committed to investing in our branch network and refurbished 421 branches in 2012 and extended our opening hours. in recognition of our ongoing commitment to customers we received a number of external awards including ‘Best Overall lender’ at the Your Mortgage Awards for the eleventh consecutive year and a three star mark from the Fairbanking Foundation for the lloyds TsB classic Account.
unlOcKinG THE GROuP’s POTEnTiAl customers are at the heart of the organisation and by leveraging our strategic assets and capabilities effectively in all of our divisions we believe we can help Britain prosper and deliver strong, stable and sustainable returns for shareholders.
We believe we can unlock the potential in our franchise and deliver value to customers and shareholders by creating a simpler organisation. Opportunities exist to increase the efficiency of operations and processes and reduce costs whilst addressing changing customer needs and the external environment more effectively.
Reshaping our international presence The strategic reshaping of our international footprint supports our ambition to help Britain prosper, as we focus on countries where we can service customers in the uK and with ties to the uK.
invest to be the best partner for our business customers As part of being the best bank for customers we announced the creation of our commercial Banking division which brings together the Group’s uK corporate and sME focused businesses into one division. The changes will allow us to transfer best practices from sMEs into mid-sized corporates and to deliver operational synergies between the different segments in order to become the best bank for our corporate and sME clients.
q Simplifying processes, policies and systems q Investment in growth initiatives q An appropriate risk appetite q Ensuring the business has the strength in funding and capital to meet the most challenging of headwinds.
Total underlying income for the year decreased 13 per cent to £18,386 million, principally reflecting the effects on the core business of continued subdued lending and customer deleveraging, and further asset reductions in the non-core business.
Earlier in 2012 we concluded a review of the implications of the Retail distribution Review. We will now offer investment advice to customers with over £100,000 of investible assets through our private banking services. it will allow us to focus on providing market leading savings and protection services to mainstream customers.
Progress against strategic initiatives in the fourth quarter of 2012, commercial Banking reshaped the business, bringing sME clients together with larger corporate uK and global clients to ensure consistent and effective client coverage. We continue our exercise to re-segment our client coverage, driven by evolving client behaviours. For sME and Mid Markets clients we are strengthening our face-to-face banking proposition as well as working to improve the delivery of simple products to meet simple needs through enhanced digital capability. For larger corporate clients we are strengthening our product capability through investment in Transaction Banking at the same time as enriching the core proposition in Financial Markets and capital Markets to improve fee generating solutions.
net interest income decreased by £986 million. core net interest income decreased by £604 million as a result of average lending volumes decreasing by £5.4 billion and margin compression. despite lending growth in the former commercial division, corporate client demand in the former Wholesale division was subdued continuing the current market trend of deleveraging, and compressed margins reflecting higher wholesale funding costs and improved recognition of the cost and value of funds across the Group. non-core net interest income decreased by £382 million due to average lending volumes decreasing by £16.9 billion and compressed margins.
underlying income, net of insurance claims £m impairment charge £m loans and advances to customers1 £bn
Wealth, Asset Finance and international 955 (3,571) 35.1 33.8 1.3 insurance 136 – – – –
impairment charge as a % of average advances 0.37% 0.67% 0.45% 0.44%
Banking net interest income is analysed for asset and liability margins based on interest earned and paid on average assets and average liabilities respectively, adjusted for Funds Transfer Pricing, which prices intra-group funding and liquidity. centrally held wholesale funding costs and related items are included in the Group banking asset margin.
Post-tax return on average shareholders’ equity (3.1) (6.2) (0.7) 8.8 7.0 31 December 31 december 31 december 31 december 31 december
Averages are calculated on a monthly basis from the consolidated financial data of lloyds Banking Group.
Former appointments: Tony is the former chief Executive of Hermes Pensions Management. He was also formerly chairman of the Asian infrastructure Fund, MEPc and of the strategic investment Board (northern ireland). He was a member of the Financial Reporting council and a member of the norges Bank investment Management Advisory Board.
Skills and experience: With a background in retail and associated sectors, including financial services, sara brings a broad perspective to the Board. she is a strong advocate of customers and of the application of new technology, both of which directly support lloyds Banking Group’s strategy. sara has considerable experience of boards at both executive and non-executive level.
Alison joined lloyds Banking Group in september 2011 as Group director for the Retail division. The Retail division consists of lloyds TsB, Bank of scotland and Halifax community banks as well as Retail Products and intermediaries, Marketing, Telephony and digital banking.
– oversight of resources including people and other key resources e.g. iT, and by ensuring that appropriate and effective remuneration policies and succession planning arrangements are in place.
– reviews the results of the external audit and its cost effectiveness.
Based on a combination of performance targets comprising economic profit, absolute total shareholder return and strategic financial objectives (shown on an expected value basis)
Other share plans The Executive directors are also eligible to participate in the Group’s ‘sharesave’ and ‘share incentive’ plans. These are ‘all-employee’ share plans.
Lloyds Banking Group Annual Report and Accounts 2012108 independent non-executive Directors’ fees (2012)
i Exercisable for a period of one year from date of leaving.
Customer satisfaction: Relevant to 10 per cent of the award. Performance will be measured by reference to the total number of FsA reportable complaints per 1,000 customers over the three year period to 31 december 2014.
deloitte provided information for the testing of the TsR performance conditions for the company’s long-term incentive plan. EPs is the Group’s normalised earnings per share as shown in the Group’s report and accounts, subject to such adjustments as the Remuneration committee regards to be necessary for consistency.
The Risk Governance section describes the controls in place to ensure the Group has strong, effective Risk Management.
The Group expects its leaders to have the highest integrity and values, thinking and acting for the long-term.
collateral The principal collateral types for loans and advances are: – mortgages over residential and commercial real estate; – charges over business assets such as premises, inventory and accounts receivables; – charges over financial instruments such as debt securities and equities; and
intensive care of customers in financial difficulty The Group operates a number of schemes to assist borrowers who are experiencing financial stress. The material elements of these schemes through which the Group has granted a concession, whether temporarily or permanently, are set out below and in note 55 on page 329.
– As a percentage of total loans and advances to customers, non-core loans and advances reduced to 28 per cent at 31 december 2012 (2011: 35 per cent). As a percentage of total impaired loans, non-core impaired loans reduced to 75 per cent (2011: 80 per cent).
Overview – in 2012 Wealth, Asset Finance and international impairment charges fell significantly compared to 2011 predominantly reflecting reductions in the ireland (wholesale and retail) portfolio.
Definition Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
Terrorist acts, other acts of war or hostility, geopolitical, pandemic or other such events and responses to those acts/events may create economic and political uncertainties, which could have a material adverse effect on uK and international macroeconomic conditions generally, and more specifically on the Group’s results of operations, financial condition or prospects in ways that cannot necessarily be predicted.
Business disruption and system failures 1.08 1.03 1.46 1.63 clients, products and business practices 15.27 18.89 58.65 54.40 damage to physical assets 0.32 0.16 0.24 0.26
– Political and regulatory scrutiny of sales practices, culture and ethical behaviours within the financial services industry will remain a key risk to the Group’s strategic direction for the foreseeable future.
Measurement People risk is measured through a series of quantitative and qualitative indicators, calibrated against the Group’s risk appetite and monitored on a monthly basis via the Group’s risk reporting structure.
– Finally, the Group takes a proactive approach in fostering an ethical banking model and enforcing against lapses in ethical behaviour, through strong management of staff incentive adjustments, effective people risk and performance management, and promoting strong risk-based behaviours within its culture.
exposure liquidity exposure represents the amount of potential outflows in any future period less expected inflows. liquidity is considered from both an internal and regulatory perspective.
Total wholesale funding in 2011 was £251.2 billion of which £113.3 billion had a residual maturity of less than one year.
The Board monitors and manages total balance sheet encumbrance via a risk appetite metric. The Group’s level of encumbrance arising from external issuance of securitisation and covered bonds has remained broadly constant, reflecting the maturity and stability of the Group’s utilisation of this form of term funding, and the established cycle of redemptions and new issuance. Total notes issued externally from secured programmes (asset-backed securities (ABs) and covered bonds) have fallen from £75.6 billion at 31 december 2011 to £68.8 billion, reflecting a reduction in the number of outstanding programmes as well as lower issued balances. A total of £85.1 billion (2011: £118.5 billion) of notes issued under securitisation and covered bond programmes have also been retained internally, most of which are held to provide a pool of collateral eligible for use with central bank liquidity facilities. This reduction in retained notes partially reflects the Group’s increased use of whole loans as eligible collateral at central banks.
Measurement Regulatory risks are measured against a set of risk appetite metrics, with appropriate limits and triggers, which have been approved by the Board and which are regularly reviewed and monitored at the Group conduct and compliance committee. Metrics include assessments of control and material regulatory rule breaches.
Retail risk-weighted assets reduced by £7,767 million mainly due to lower lending volumes.
– The ‘cRd iV fully loaded’ basis uses the tier 1 capital calculated by applying the rules laid out in the July 2011 draft publication of cRd iV, without applying any transitional provisions and corresponds to the amount shown in the third column in table 1.61.
The realistic excess capital is calculated as the difference between realistic assets and realistic liabilities of the With-Profit Fund with a further deduction to cover various stress tests (the Risk capital Margin). in circumstances where the realistic excess capital position is less than the statutory excess capital, the company is required to hold additional capital to cover the shortfall. Any additional capital requirement under this test is referred to as the With-Profits insurance capital component.
Transactions with owners issue of ordinary shares 492 – – 492 – 492
Report of the independent auditors on the consolidated financial statements 204 Consolidated financial statements 206 Notes to the consolidated financial statements 214 Report of the independent auditors on the parent company financial statements 344 Parent company financial statements 345 Notes to the parent company financial statements 348 cOnsOlidATEd cAsH FlOW sTATEMEnT for the year ended 31 december
The principal derivatives used by the Group are as follows: – interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a specified future date.
– change in the assumption in respect of current and future mortality rates (£4 million increase).
increase (decrease) in liabilities: Arising from current year claims 470 – 470
With effect from 1 January 2013 the Group will adopt amendments to iAs 19 Employee Benefits. These amendments will change the calculation of the Group’s defined benefit schemes’ income statement expense, replacing expected return on scheme assets and interest cost with a net interest amount that is calculated by applying the discount rate to the net defined benefit liability (asset) (see note 57 on page 342). The above expected return on scheme assets will be used in determining the effect of this new accounting policy on the Group’s 2013 income statement expense.
The expense recognised in the income statement for the year ended 31 december comprises: £m £m £m current service cost 360 380 384
8.75% Perpetual subordinated Bonds (£100 million) a 5 4 8% undated subordinated step-up notes callable 2023 (£200 million) a – –
Total enhanced Capital notes 8,947 9,085 a interest is payable quarterly in arrears at a rate of 3 month Euribor plus 3.1 per cent per annum.
Limited voting ordinary shares The limited voting ordinary shares are held by the lloyds TsB Foundations (the Foundations). The holders of the limited voting ordinary shares, who held 0.1 per cent of the total ordinary share capital at 31 december 2012, are entitled to receive copies of every circular or other document sent out by the company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the company, or for a variation in the class rights of the limited voting ordinary shares. in the event of an offer for more than 50 per cent of the issued ordinary share capital of the 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.
To meet the performance conditions, the Group’s ranking against the comparator group was required to be at least ninth. The full grant of options only became exercisable if the Group was ranked first. A performance multiplier (of between nil and 100 per cent) was applied below this level to calculate the number of shares in respect of which options granted to Executive directors would become exercisable, and were calculated on a sliding scale. if lloyds Banking Group plc was ranked below median the options would not be exercisable.
note 53: Contingent liabilities and commitments interchange fees On 24 May 2012, the General court of the European union upheld the European commission’s 2007 decision that an infringement of Eu competition law had arisen from arrangements whereby Mastercard issuers charged a uniform fallback interchange fee (MiFs) in respect of cross border transactions in relation to the use of a Mastercard or Maestro branded payment card.
Lloyds Banking Group Annual Report and Accounts 2012304 note 54: Financial instruments
Trading and other financial assets at fair value through profit or loss 153,990 153,990 139,510 139,510 loans and receivables: loans and advances to banks 29,417 29,406 32,606 32,554 loans and advances to customers 517,225 506,418 565,638 549,829
Other asset-backed securities – 687 73 760 corporate and other debt securities 22 1,826 – 1,848
Derivatives Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include: – interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are developed from publicly quoted rates.
Transfers out of the level 3 portfolio arise when inputs that could have a significant impact on the instrument’s valuation become market observable after previously having been non-market observable. in the case of asset-backed securities this can arise if more than one consistent independent source of data becomes available. conversely transfers into the portfolio arise when consistent sources of data cease to be available.
Following a forbearance event, should the customer show a sustained period of stabilisation on their new terms and conditions or where the forbearance has reversed or cured, it would be expected that the customer would likely be returned to the mainstream good classification, at which point they may no longer be considered forborne. such a decision can be made only by the independent Risk division.
capital risk appetite is set by the Board and reported through various metrics that enable the Group to manage capital constraints and market expectations. The Group chief Executive, assisted by the Group Asset and liability committee, regularly reviews performance against risk appetite. A key metric is the Group’s core tier 1 capital ratio which the Group currently aims to maintain prudently in excess of 10 per cent.
(A) Change in operating assets £m £m £m change in loans and receivables 53,842 39,361 40,101 change in derivative financial instruments, trading and other financial assets at fair value through profit or loss (2,003) 5,867 (7,378)
Respective responsibilities of directors and auditors As explained more fully in the statement of directors’ responsibilities on page 84, the directors are responsible for the preparation of the parent company financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the parent company financial statements in accordance with applicable law and international standards on Auditing (uK and ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical standards for Auditors.
note 2: Deferred tax asset The movement in the net deferred tax asset is as follows: £m £m income statement credit 1 2
Core tier 1 capital As defined by the FsA mainly comprising shareholders’ equity and equity non-controlling interests after deducting goodwill, other intangible assets and other regulatory deductions. Further details are given in the capital Risk section on page 187.