GOVERNMENT ASSET PROTECTION SCHEME In March, in what was clearly a very difficult external market, the Group announced its intention to participate in the Government Asset Protection Scheme. At the time the Scheme provided an opportunity to reduce the risk profile of the balance sheet and significantly strengthen the Group’s capital position. A more economically favourable alternative was later pursued.
The last 12 months have been very challenging for all of our staff, across the Group. The external environment has been difficult, but our staff have continued to serve and support our customers superbly while delivering one of the largest banking mergers in history. I, along with all the members of the board, am very proud of their achievements this last year, and their performance underpins my confidence in our ability to deliver in the coming years.
As at the date these accounts were approved the Government’s shareholding in Lloyds Banking Group was approximately 41.3 per cent, which is managed by UK Financial Investments (UKFI) on behalf of HM Treasury.
We have a very good working relationship with UKFI who act like any value orientated shareholder with regard to the strategic development and financial performance of the Group, providing significant constructive challenge where they see fit. The Government has made it very clear that UK financial institutions in which it holds substantial stakes will continue to be separate economic units with independent powers of decision and will continue to have their own independent boards and management teams, determining their own strategies and commercial policies (including business plans and budgets).
Lloyds TSB has historically been strong in managing the cost base but the unique positioning of the Group also now provides a number of opportunities not available to other providers. The integration of the two businesses provides the opportunity for significant cost synergies. We have already outlined that we are looking to achieve £2 billion of cost synergies per annum by the end of 2011 and are already well on track for this, having delivered £766 million of synergies on an annualised basis in 2009. To date these synergies have primarily arisen from de-duplication of functions and property consolidation but going forward significant opportunities still exist from system integration and procurement. We believe that the Group can deliver a 200 basis points reduction in the cost:income ratio per annum over the next few years.
We understand the distress the lack of dividend has caused many of our shareholders and are working hard to restore shareholder value. The capital raising in December 2009 was a significant step towards meeting our objective of operating as a wholly privately owned, self-supporting, dividend paying, commercial enterprise over time. The board intends to resume dividend payments on ordinary shares as soon as market conditions and the financial performance of the Group permit, subject to the expiry of the restrictions arising from the European Commission remedies.
Retail has approximately 22 million current account customers and provides social banking to over 4 million people through basic banking or social banking accounts. It is also the largest provider of personal loans in the UK, as well as being the UK’s leading credit card issuer. Retail provides one in four residential mortgages making it the leading UK mortgage lender as well as being a major provider of home finance for the first time buyer. Retail is the largest private sector savings provider in the UK, with over 21 million savers. It is also a major general insurance and bancassurance distributor, selling a wide range of long-term savings, investment and general insurance products.
Share of results of joint ventures and associates (717) (943) 24
Impairment losses as a % of average advances 5.86% 2.53% As at 31 December 2009 2008 Change £bn £bn %
Index to annual report 266 the combined product range. The margin in respect of Scottish Widows products increased to 3.5 per cent in 2009 from 3.2 per cent in 2008.
EUROPEAN BUSINESS Profit before tax decreased by 50 per cent to £75 million. New business profits reduced by £32 million driven by lower sales, reflecting economic and market conditions. Existing business profits decreased, primarily due to lower expected returns. In 2008, as a result of moving to a more market consistent basis of embedded value in HBOS, a one-off benefit of £123 million arose. The impact of this was largely offset by a significant reduction in charges for policyholder lapses in 2009.
Other items represent amounts not considered attributable to the underlying performance of the business.
Operating expenses increased by £273 million to £294 million due to higher professional fees and other costs associated with a number of group wide projects including GAPS and an increase in the amount of pension costs held centrally.
Corporate bonds in unit linked and with Profit Funds (gross) 5.05 4.34 5.15
During the year ended 31 December 2009, the statutory profit before tax in both the Insurance and Wealth and International divisions included credits to other income which relate to the policyholder interests volatility charge of £298 million (2008: £924 million). The market recovery in 2009 increased policyholder tax liabilities and led to a policyholder tax charge of £346 million during the year in the Group’s tax charge. This was partly offset by a credit of £48 million relating to differences in the expected levels of policyholder tax provisions and charges. This compares to 2008 when substantial policyholder tax losses were generated as a result of the fall in property, bond and equity values.
Procurement benefits in 2009 have also been significant at £174 million with approximately £1.5 billion of spend having gone through e-auctions and the Group has in parallel reviewed and consolidated key supplier contracts with over 90 per cent of spend now being through its top 1,000 suppliers.
Recruiting, retaining and developing talented people continues to be a high priority for the Group. Top performers are attracted to the Group because of our strong brand and values; together with top class development and career opportunities.
In addition to our successful internally developed content our learning and development teams work with best-practice suppliers to develop and deliver learning. We continue to use a range of delivery media including award winning on-line modules and face-to-face workshops to support skills development.
Diversity and Inclusion remains a high priority for Lloyds Banking Group. In a challenging economic climate we believe more than ever that our success depends on building strong and enduring relationships with diverse groups – colleagues, customers and suppliers.
Our executive management team has one of the highest female representations in the FTSE 100, with three female directors.
– Wholesale customers (including those in Wealth and International): where companies are facing increasingly difficult business conditions, resulting in corporate default levels rising and leading to increases in corporate impairment. The Group has high levels of exposure in both the UK and internationally, including Ireland, USA, Australia and Spain. There are particular concentrations to: financial institutions, commercial real estate, and joint ventures, with high leverage and exposures through capital structure.
MEASUREMENT In measuring the credit risk of loans and advances to customers and to banks at a counterparty level, the Group reflects three components: (i) the ‘probability of default’ by the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and their likely future development, from which the Group derives the ‘exposure at default’; and (iii) the likely loss ratio on the defaulted obligations (the ‘loss given default’).
Master netting agreements Where it is efficient and likely to be effective (generally with counterparties with which it undertakes a significant volume of transactions), the Group enters into master netting agreements. Although master netting agreements do not generally result in an offset of balance sheet assets and liabilities, as transactions are usually settled on a gross basis, they do reduce the credit risk to the extent that, if an event of default occurs, all amounts with the counterparty are terminated and settled on a net basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting agreements can change substantially within a short period since it is affected by each transaction subject to the agreement.
To understand the trends in each portfolio the comparatives for 2008 have been provided for the combined businesses which are unaudited. Consequently pages 67 to 75 covering credit risk management in 2009 are unaudited.
Total includes £4.8 billion relating to unsuccessful syndications and £0.3 billion in syndication.
KEY HIGHLIGHTS – Impairment losses have increased by 14 per cent to £4,227 million particularly reflecting the impact of increases in unemployment during 2009 on the unsecured charge, partly offset by a lower secured impairment charge as the housing market stabilised.
SECURED The UK mortgage market for both house purchase and re-mortgaging slowed considerably in 2009, with gross market lending falling to £143 billion from £254 billion in 2008. The re-mortgage market is the main contributor to this fall, as reductions in base rate have brought the interest rate on standard variable mortgages to below new business rates across the industry, thereby reducing the incentive for borrowers to re-mortgage.
UNSECURED Consumer Banking has aligned risk appetite across the business to focus on lending to its existing customers. Personal loan balances outstanding at 31 December 2009 were £16.9 billion (31 December 2008: £18.1 billion), the reduction reflected lower demand, a tightening of lending criteria and the write-off of unsecured loans and advances which had been provided against in earlier years, as reported at the half-year.
Credit cards: Impaired credit cards advances were 13.6 per cent of closing advances (31 December 2008: 20.2 per cent) and provisions, as a percentage of closing advances, decreased to 7.1 per cent (31 December 2008: 13.6 per cent).
– Volume of individual cases passing into Business Support Units continued to rise in the second half of 2009.
– The Group remains cautious about the extent of corporate recovery in 2010.
Acquisition Finance – The Acquisition Finance (leveraged) portfolio has been impacted significantly by the economic environment, with a relatively high proportion of deals being restructured, and higher impairment levels seen than in the same period in 2008. The rate of new problem loans abated in the second half of 2009.
Debt securities in issue: Certifi cates of deposit 50.9 7.3 77.5 10.7
Total dividend for the year1 – 648 2,026 1,927 1,915 31 December 31 December 31 December 31 December 31 December
The board members individually and collectively considered that the board is working as an effective whole. After the significant challenges faced by the Group and the board in 2009, the review highlighted the importance of returning to a more normal operating mode by focusing on delivering the integration, developing the future strategy, and reviewing the operations and risk management for the Group as a whole and within each of the key areas. In addition, the review encouraged continued vigorous debate in the board and committees and emphasised the importance of succession plans for the management team and non-executive directors. An action plan has been developed to ensure that the chief conclusions
Sir Victor Blank 6,906 – – – 6,906 139p 1/2/2010 31/7/2010 a, k a Sharesave.
Year of vesting Notes a Conditional awards of shares made under this plan were adjusted on 2 July 2009 as a result of the Placing and Compensatory Open Offer. The adjustment was made using a standard HMRC formula, to negate the dilutionary impact of the capital raising event.
None of those who were directors at the end of the year had any other interest in the capital of Lloyds Banking Group plc or its subsidiaries.
Ian Rankin Senior Statutory Auditor for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors Edinburgh
Lloyds Banking Group Annual Report and Accounts 2009 1 BASIS OF PREPARATION continued
(E) FINANCIAL ASSETS AND LIABILITIES On initial recognition, financial assets are classified into fair value through profit or loss, available-for-sale financial assets or loans and receivables. Financial liabilities are measured at amortised cost, except for trading liabilities and other financial liabilities designated at fair value through profit or loss on initial recognition which are held at fair value. Purchases and sales of securities and other financial assets and liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.
Other segment items reflected in income statement above: Movement in value of in-force business – – – (625) – (625)
Movement in cash flow hedge: Effective portion of changes in fair value taken to other comprehensive income (530) 148 (382)
Tax charge thereon at UK corporation tax rate of 28 per cent (2008: 28.5 per cent) (292) (217)
Gross investment in finance leases, receivable: Not later than 1 year 1,374 541
Securitisations utilising a combination of external funding and credit default swaps.
Life insurance (see (1) below): Non-life insurance contracts (see (2) below): Reinsurance balances are reported within other assets (note 31).
The assets of all the funded plans are held independently of the Group’s assets in separate trustee administered funds.
As described in note 51, in January 2009 the Company issued £1,000 million 12 per cent fi xed-to-fl oating non-cumulative callable preference shares to HM Treasury as part of the recapitalisation of the Lloyds Banking Group and a further £3,000 million 12 per cent fi xed-to-fl oating non-cumulative callable preference shares in respect of the recapitalisation of the HBOS Group. These shares were redeemed out of the proceeds from the placing and compensatory open offer in June 2009 (see note 45) and are excluded from the table above.
d On 19 January 2009 the Company issued US$1,250,000,000 7.875 per cent non-cumulative callable preference shares and €500,000,000 7.875 per cent non-cumulative callable preference shares by exercising its option to convert preferred securities into preference shares. Both issues are callable on 29 November 2013.
No options were exercised during 2009. The options outstanding under the HBOS Share Option Plan and St James’s Place Share Option Plan at 31 December 2009 had exercise prices in the range of £1.05 to £17.576 and a weighted average remaining contractual life of 1.4 years.
(2) RECLASSIFICATION OF FINANCIAL ASSETS In accordance with the amendment to IAS39 that became applicable during 2008, the Group reviewed the categorisation of its fi nancial assets classifi ed as held for trading and available-for-sale.
From held for trading to loans and receivables – 208 208 (347) (347)
Included within the gains (losses) recognised in the income statement are losses of £1,542 million related to fi nancial instruments that are held in the Level 3 portfolio at the year end. These amounts are included in other operating income.
Derivative assets – the Group reduces exposure to credit risk by using master netting agreements and by obtaining cash collateral. An analysis of derivative assets is given in note 18. Of the net derivative assets of £28,230 million (31 December 2008: £18,286 million), cash collateral of £6,645 million (31 December 2008: £2,970 million) was held and a further £13,004 million was due from OECD banks (31 December 2008: £5,840 million).
US residential mortgage-backed securities: Sub-prime – – – – – – – –
Gross settled derivatives – net fl ows 4,160 343 144 487 2,194 7,328
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS continued 10 FINANCIAL INSTRUMENTS
Financial liabilities: Debt securities in issue – – – 326 326