Resilient underlying trading performance in 2011, in line with expectations Growth initiatives, cost and impairment reductions, and funding mix improvements mitigated the effects of a subdued UK economy, risk and asset reductions, and higher wholesale funding costs
Output measures Although significant progress has been made against our strategic priorities during 2011 this is yet to be seen in the statutory profit numbers and earnings per share due to a number of one off items including the £3.2 billion provision for PPI. Further detail on these measures is contained within the business review.
Supporting the UK economic recovery Lloyds Banking Group plays a vital role in supporting a substantial number of corporates and smaller and medium-sized businesses, helping them to weather the economic uncertainty and build for the future. In doing so we play an active part in supporting the strength and prosperity of the UK, given that, as a largely domestic institution, our success is inextricably linked to the health of the UK: as the nation recovers we can thrive.
Since the year end a number of additional changes have been announced. Lord Leitch will relinquish his role as Deputy Chairman at the end of February 2012 to focus on his other commitments. His wise counsel to the Board and his empathy and involvement with colleagues across the business will be missed. I am pleased he has agreed to continue as an advisor to the Boards of Scottish Widows and of Lloyds Banking Group until the end of 2012.
In the current low interest environment many customers are demanding better value for money but security and reputation remain important factors. Customers want clear and transparent products delivered with good service and access to helpful, relevant, expert advice when they need it. Customers are demanding basic banking services to be delivered well but there is also an increasing demand for advice in more complex areas such as help in planning and saving for retirement. Product innovation is also important for some whereas longstanding relationships remain important for others.
Our strategy, as outlined on the next few pages, reflects the market conditions and the changing needs of customers. Above all it recognizes that we operate in a competitive market where additional challengers continue to emerge and the only way of ensuring success is by focusing on the changing needs of every customer.
the Group’s continued success depends on our colleagues and their ability to build strong and deep relationships with customers.
the results highlight strong levels of engagement in areas such as performance management and learning and development. our pei score of 69 is above the UK industry average, showing that nearly three quarters of colleagues believe their work gives them a sense of personal accomplishment and almost 9 out of 10 colleagues say they receive recognition for a job well done. it also reflects our on-going commitment to provide all colleagues with a promising career at lloyds banking Group. our eei score show that we need to do more to engender trust in the leadership team and confidence in the future of the organisation, with a score of 52 versus a UK industry average of 61.
Following the Graduate development programme, graduates are choosing branch roles as their career choice.
Golden Hopefuls Through Scottish Widows Golden Hopefuls Programme we are helping four of Britain’s new generation of world class sporting hopefuls who share the same goal of competing at London 2012.
Total income, net of insurance claims 10,255 6,526 1,584 2,210 2,233 636 23,444
2011 highlights Profit before tax was £828 million compared to £2,514 million in 2010
Effects of liability management, volatile items and asset sales (1,415) (295)
Against its strategic objectives, Commercial has focused on strengthening its customer relationships and supporting SMEs through the cycle by further developing its understanding and support of individual business requirements. This is demonstrated by: – Sustainable franchise growth in supporting 124,000 start up businesses, and achieving positive net switchers from other banks. – Supporting customers through responsible lending, combined with improving credit quality, balance sheet funding and RWA use. – Improving cross-sales of Wealth Management, Insurance, and Treasury products leading to additional revenue for other businesses in the Group.
The Commercial Finance business, which provides asset backed lending to SMEs, has increased its client base and provided further support to industry sectors including increasing advances to the manufacturing sector by 30 per cent against the prior year.
Balance sheet progress Loans and advances to customers at £28.8 billion, were broadly unchanged from the prior year. However, core lending increased 3 per cent, where Commercial has been successful in encouraging SME customers to invest and attract switchers requiring term lending and invoice finance facilities. Significant effort in promoting support has included running nearly 700 customer events in 2011.
Strategic focus Wealth provides strong growth opportunities for the Group and, through deepening the relationships with existing Group clients alongside targeted customer acquisition, the goal is to be recognised as the primary Wealth advisor to the UK mass affluent, affluent and high net worth customers together with UK expatriates and others with UK connections.
Effects of liability management, volatile items and asset sales – 15
In the bancassurance channel the reduction in sales reflects a change in mix away from savings products which generate a higher PVNBP towards protection business, which although more profitable, generates lower PVNBP. Sales of savings products have been particularly affected by recent stock market turbulence and lower consumer confidence, particularly in the second half of the year. Despite the reduction in PVNBP there was an increase in new business profit largely as a result of the increase in protection sales reflecting success in helping customers address their protection needs. As previously communicated in the Group Strategic review the business will continue to focus on meeting the insurance and investment needs of the Group’s existing customers.
operations costs decreased by 9 per cent, through the continuing rationalisation of our major operations functions. operations includes Banking operations, Collections and Recoveries, and payments and Business services group property costs decreased by 6 per cent, with the continuing consolidation of the heritage property portfolios delivering further integration benefits.
Other costs include Fscs costs and UK bank levy in 2011.
Total income, net of insurance claims 8,922 3,559 1,674 1,369 2,141 1,871 19,536
Group hedging arrangements to protect against further deterioration in equity market conditions, and the consequent negative impact on the value of in-force business on the Group balance sheet, the Group purchased put option contracts in 2010, financed by selling some upside potential from equity market movements. these expired in 2011 and the charge booked in 2011 on these options was £3 million. new protection against significant market falls was acquired in 2011 to replace the expired contracts. there was no initial cost associated with these hedging arrangements. on a mark-tomarket valuation basis a gain of £5 million was recognised in relation to the new contracts in 2011.
the second half of 2011 has seen more difficult funding markets as investor confidence was impacted by concerns over the Us debt ceiling and subsequent downgrade. this was followed by increased fears over eurozone sovereign debt levels, downgrades and possible defaults and concerns are ongoing over the potential downside effects from financial market volatility. Despite this the group continued to fund adequately, maintaining a broadly stable stock of primary liquid assets during the year and meeting its regulatory liquidity ratio targets at all times. Liquidity is managed at the aggregate group level, with active monitoring at both business unit and group level. monitoring and control processes are in place to address both internal and regulatory requirements. in a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event.
Risk Definition the risk of reductions in earnings and/or value, through financial loss, as a result of the failure of the party with whom the group has contracted to meet its obligations (both on and off balance sheet).
Liquidity and funding management in 2011 Liquidity and funding continues to remain a key area of focus for the group and the industry as a whole. Like all major banks, the group is dependent on confidence in the short and long term wholesale funding markets. should the group, due to exceptional circumstances, be unable to continue to source sustainable funding, its ability to fund its financial obligations could be impacted.
High-quality ABs/covered bonds 1.4 15.3 8.0 16.3 includes other central bank eligible assets.
in order to pay dividends, the group’s Uk subsidiaries need to have distributable reserves. Whilst the group’s direct subsidiary, Lloyds tsB Bank plc has distributable reserves, one of the group’s indirect principal subsidiaries, Bank of scotland plc, does not and is currently unable to pay dividends. there is a risk that any profits earned by Bank of scotland plc and its subsidiaries may be unable to be remitted to the group holding company as dividends. this risk is mitigated by management who can elect to restructure the capital resources of a subsidiary entity.
shareholders’ funds: Held outside the long-term funds – – – 1,414 721 2,135
Other life insurance business – – 8,527 90 8,617 insurance and participating investment contract liabilities 13,845 10,394 47,173 8,101 79,513 non-participating investment contract liabilities – – 47,058 4,304 51,362
Options and guarantees within the With Profit Funds the most significant options and guarantees provided from within the With Profit Funds are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies.
– Business Finance taskforce: the group through its banking businesses has taken a leading role in the Business Finance taskforce, which committed to a number of key actions in three broad areas: (i) improving customer relationships; (ii) ensuring better access to finance and (iii) providing better information and promoting customer understanding. key elements of this include: – the lending appeals process: if a lending application is declined, customers have the right to appeal that decision. We have committed to respond to 90 per cent of appeals with a decision within 15 working days.
the group’s accounting policy for loan renegotiations and forbearance is set out in note 2(H) to the financial statements.
– non-core represents 8 per cent of total Retail assets as at 31 December 2011 and is primarily specialist mortgages which is closed to new business and has been in run-off since 2009.
Wealth total impaired loans increased by £46 million, or 13 per cent to £399 million compared with £353 million at 31 December 2010 and as a percentage of closing loans and advances increased to 4.6 per cent from 3.7 per cent at 31 December 2010. impairment charges increased by £54 million to £100 million compared with 2010 primarily due to increased charges in the group’s spanish mortgage book reflecting a deteriorating housing market and economy in spain. impairment charges as a percentage of average loans and advances to customers increased to 1.1 per cent from 0.5 per cent in 2010.
Direct sovereign exposures – Our sovereign exposures are primarily to the Uk and the group continues to have minimal exposure, in aggregate, which could be considered to be direct recourse to the sovereign risk of the selected countries. total exposures to the selected countries are £33 million (31 December 2010: £85 million) and are primarily in respect of loans and advances held at amortised cost, with no impairments recognised. Direct sovereign exposures include those to the export Credit Agencies for italy and spain. since 2009, the group has proactively managed and reduced limits and exposures to these countries. Derivatives with sovereigns and sovereign referenced credit default swaps are insignificant.
– Oversight and assurance of the risk management framework in businesses.
Joined the Board on 1 February 2012. Between 2004 and 2011, Managing Director of Argos, the second biggest internet retailer in the UK. From January 2000 to April 2004, Marketing Director for Sainsbury’s Supermarkets, before being promoted to the position of Deputy Managing Director and serving on the Board of J Sainsbury from January 2003 to the end of March 2004. Retail Marketing Director for Abbey National from December 1996 to December 1999 and worked for Mars Confectionery from September 1983 to December 1996, rising to European Franchise Manager. Non-Executive Director of Mitchells & Butlers from April 2003 to January 2010. Non-Executive Director of United Utilities Group from 1 March 2012. Aged 50.
– reviews the financial statements published in the name of the Board and the quality and acceptability of the related accounting policies, practices and financial reporting disclosures; – reviews the scope of the work of the Group Audit Department, reports from that department and the adequacy of its resources; – reviews the effectiveness of the systems for internal control, risk management and compliance with financial services legislation and regulations; – approves the external auditors’ terms of engagement and remuneration; – assesses the external auditors’ independence and objectivity; – recommends the external auditors’ appointment, re-appointment and removal; – reviews the results of the external audit and its cost effectiveness; – reviews reports from the auditors on audit planning and their findings on accounting and internal control systems; and
– Feedback from the Remuneration Committee Chairman on his meetings with the FSA and shareholders
The following table contains information on the performance conditions for executive options granted since 2001.
Options granted in 2005 became exercisable as the performance condition was met when tested. Grants vested at 82.5 per cent for all options granted to Executive Directors.
Absolute Total Shareholder Return: Relevant to 331/3 per cent of the award. Performance will be measured against the annualised return over the three year period ending 31 December 2013.
Net cash provided by (used in) operating activities 19,893 (2,037) (33,735)
This provision requires significant judgement by management in determining appropriate assumptions, including the number of claims received, the proportion upheld, and resulting legal and administration costs. Assuming that all other assumptions remain unchanged, if in the longer term the level of claims was ten percentage points higher (lower) than estimated then the cost would increase (decrease) by approximately £3 million; and if uphold rates were ten percentage points higher (lower) than estimated then the cost would increase (decrease) by approximately £13 million.
Share of results of joint ventures and associates 17 (95) – (8) (10) 5 (91)
Profit (loss) before tax and fair value unwind 2,881 (535) 210 (5,322) 1,369 491 (906)
Liability management gains During December 2011, the Group completed the exchange of certain subordinated debt securities issued by Lloyds TSB Bank plc and HBOS plc for new subordinated debt securities issued by Lloyds TSB Bank plc by undertaking an exchange offer on certain securities which were eligible for call before 31 December 2012. This exchange resulted in a gain on extinguishment of the existing securities of £599 million being the difference between the carrying amount of the securities extinguished and the fair value of the new securities issued together with related fees and costs.
On 16 January 2009, the Group cancelled the following HBOS preference share issuances in exchange for preference shares issued by Lloyds Banking Group plc: 6.475 per cent non‑cumulative preference shares of £1 each, 6.3673 per cent non‑cumulative fixed to floating preference shares of £1 each and 6.0884 per cent non‑cumulative preference shares of £1 each. The fair value of the Lloyds Banking Group preference shares issued was deducted from the net assets acquired for the purposes of calculating the gain arising on acquisition.
Of the total allowance in respect of loans and advances to customers, £17,021 million (2010: £15,585 million) related to lending that had been determined to be impaired (either individually or on a collective basis) at the reporting date.
Life expectancy for member aged 60, on the valuation date: Life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 as at 31 December 2011 is assumed to live for, on average, 27.3 years for a male and 28.4 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
The statutory position reflects the deferred tax assets and liabilities as disclosed in the consolidated balance sheet and takes account of the inability to offset assets and liabilities where there is no legally enforceable right of offset. The tax disclosure of deferred tax assets and liabilities ties to the amounts outlined in the table below which splits the deferred tax assets and liabilities by type.
In addition, deferred tax assets have not been recognised in respect of unrelieved foreign tax carried forward as at 31 December 2011 of £171 million (31 December 2010: £62 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised. These tax credits can be carried forward indefinitely.
Share issuances The shares issued in 2011 were in respect of employee share schemes.
Exercised/lapsed (includes 31 million entitlements of former directors) (33) (2) (5)
Employee disputes The Group is aware that a union representing a number of the Group’s employees and former employees is seeking to challenge the cap on pensionable pay introduced by the Group in 2011 on the grounds that it is unlawful. This challenge is at a very early stage. The Group will resist the challenge should it be pursued.
Trading liabilities: Liabilities in respect of securities sold under repurchase agreements – 12,378 – 12,378
Bank and building society certificates of deposit 15 392 – 407
Liabilities held at fair value through profit or loss (debt securities) – 6,665 – 6,665
Financial guarantees and irrevocable loan commitments These represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments, however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards.
Forbearance – Capital payment break These allow customers who are currently on a capital and interest repayment basis to temporarily transfer their loan onto an interest only basis in order to reduce their contractual monthly payment and help them through their period of financial difficulty. During this period, the Group regularly reviews the customer’s situation and works with them to try to restore their position and return them to a full capital and interest repayment basis. Prior to allowing the transfer, the Group undertakes a full financial review to confirm the customer’s financial difficulty and ability to maintain the revised level of payment. The transfers are initially for twelve months and are limited to a maximum of three years during the lifetime of the mortgage.
The loans analysed above comprise 1.9 per cent of the overall UK and Irish retail secured portfolios at 31 December 2011 (2010: 2.5 per cent). At 31 December 2011, 10.9 per cent (2010: 8.7 per cent) of the balances receiving treatment were impaired.
Loans and advances to customers 68,983 10,146 31,056 105,808 349,645 565,638
Loans and advances to customers 58,392 10,549 28,193 114,102 381,361 592,597
Capital risk Capital risk is defined as the risk of the Group having a sub‑optimal amount or quality of capital or that capital is inefficiently deployed across the Group.
A number of capital transactions entered into by the Group in 2009, 2010 and 2011 involved the exchange of existing securities for new issues and as a result there was no related cash flow.
PARENT COMPANY CASH FLOW STATEMENT at 31 December £ million £ million £ million
Tier 1 capital A measure of a bank’s financial strength defined by the FSA. It captures core tier 1 capital plus other tier 1 securities in issue, but is subject to a deduction in respect of material holdings in financial companies. Further details are given in the Capital Risk section on page 118.