Regulation 2013 was an important year for the uK’s supervisory framework for financial services companies, with two new bodies coming into existence in April, the Prudential Regulatory Authority and the Financial Conduct Authority, replacing the FSA. While uncertainty remains in relation to the impact of many reforms affecting our industry, both in the uK and from abroad, there is now greater clarity on regulatory capital requirements. Our simplified, low risk, uK focused model is closely aligned to the new regulatory landscape, and with the reshaping we have undertaken, we are better positioned than ever to adapt to the changes we may face in the future and conduct our day-to-day business in a way that puts our customers’ needs first. We also continue to work with the relevant authorities on the evolution of regulation connected to the Financial Services (Banking Reform) Act, although we expect the majority of our operations to be within the ring-fence which this legislation will create when it comes into effect at the start of 2019.
Key initiatives and progress in 2013 We made excellent progress in further strengthening the balance sheet and reducing risk, whilst growing core lending in the year. The transformation of the Group’s funding position is now substantially complete with wholesale funding reduced, customer deposits up and our loan to deposit ratio further improved. We have also achieved both a strong capital position and a strong liquidity position.
Core return on risk-weighted assets increased from 5.07 per cent to 6.67 per cent, largely as a result of repricing of liabilities.
Supporting funding schemes We were the first British bank to participate in the Funding for lending Scheme. Since its launch in mid-2012 we have committed more than £37 billion to help customers, including lending to businesses and mortgages for personal customers. Through Halifax we provided one in three of all mortgages completed via the uK government’s newBuy scheme to support purchases of new build properties.
Priorities for 2014 Invest £7 million in specific energy efficiency projects.
Complete the environmental accreditation of even more of our property estate.
Board approved pensions risk appetite covering interest rate, credit spreads and equity risks.
Close monitoring of actual capital ratios to ensure that we comply with current regulatory capital requirements and are well positioned to meet future requirements.
Asset sales, liability management and volatile items: Asset sales (687) (660)
In addition, the PRA has now confirmed that it will consider the Group’s application to make dividend payments in line with its normal procedures for other banks. In arriving at this assessment, the PRA considered the Group’s financial plans including any actions contained therein. The PRA’s assessment was made in the context of previous announcements as to uK regulatory capital targets and expectations, including the PRA’s news release on capital standards issued on 29 november 2013. Subject to a return to sustainable profitability and there being no major unexpected changes in the Group’s business outlook or regulatory requirements, the Board expects that it will apply to the PRA in the second half of 2014 to restart dividend payments.
Core loans and advances to customers increased by 23 per cent driven mainly by Asset Finance as a result of continued growth in uK motor finance business.
Total uK lP&I sales down 1 per cent to £9,934 million primarily due to the Group’s decision to stop providing investment advice to retail customers with savings below £100,000. Corporate pensions grew by 21 per cent, reflecting the strength of our proposition and the conversion of pipeline generated in the run up to implementation of the Retail Distribution Review.
The positive insurance volatility during 2013 in the Insurance division was £218 million, primarily reflecting the favourable performance of equity investments in the period relative to the expected return. This has been partially offset by an increase in the long-term level of market implied inflation and lower cash returns compared to long-term expectations.
External appointments: Member of the Strategy Board of Henley Business School.
External appointments: Dyfrig is the Chairman of Principality Building Society and will step down from that position on 17 April 2014. He is a Member of the Welsh Rugby union’s Audit Committee.
External appointments: António is a non-executive Director of Fundação Champalimaud and Sociedade Francisco Manuel dos Santos in Portugal and is a Governor of the london Business School.
Juan Colombás executive Director and Chief Risk Officer Joined the Board on 29 november 2013
External appointments: Member of the International Financial Risk Institute executive Committee.
TSB Bank – Following the european Commission’s ruling in 2009 requiring the Group to divest part of its business, the Group created a fresh competitor on Britain’s high streets in TSB Bank, with over 600 branches across Britain. The process required the Group to balance the need for the Group’s oversight obligations with the need to deliver an independently functioning bank. A governance structure was created to ensure this was achieved. In September 2013, TSB Bank was launched as a fully operational bank and a new chairman was appointed in February 2014. For more detail, see page 81.
Board authority The board authority sets out the matters reserved to the Board. These include decisions concerning the strategy and long-term objectives of the Group, the Group’s capital, medium-term plan and financial budgets, significant contracts and transactions and various statutory and regulatory approvals. The approval of the remuneration policy, risk appetite and risk management framework are also reserved to the Board. The board authority delegates responsibility for day-to-day management of the business to the Group Chief executive and sets out the basis for delegation of authorities from the Board to Board Committees.
Provides leadership and direction to implement strategy in accordance with the goals and objectives set by the Board.
Executive Director service contracts and Non-Executive Director terms of appointment The Chairman and non-executive Directors are appointed for a specified term and 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 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.
2013 evaluation of Board performance The annual evaluation of the Board’s effectiveness provides an opportunity to consider ways of identifying greater efficiencies, maximising strengths and highlighting areas for further development.
An annual control effectiveness review (CeR) is undertaken to evaluate the effectiveness of the Group’s control framework, with regard to its material risks, to ensure management actions are in place to address key gaps or weaknesses in the control framework and to discharge its obligations under the Turnbull guidance. Business areas and head office functions assess the controls in place to address all material risk exposures across all risk types. The CeR considers all material controls, including financial, operational and compliance controls.
Committee reports The following pages contain reports from each of the Board’s Committees.
The Salz recommendations will be subjected to regular review by the Committee and the Board to ensure the desired outcomes are being realised and embedded throughout the business. Further information on the Group’s Responsible Business agenda can be downloaded from www.lloydsbankinggroup-cr.com.
The Audit Committee was satisfied that the disclosures made in respect of uncertain tax positions were appropriate. The relevant disclosures are set out in note 52: ‘Contingent liabilities and commitments’ on page 308 of the financial statements.
Risk Division Reviews and discusses with the Chief Risk Officer the scope of work of the Risk Division, its plans, the issues identified as a result of its work, how management is addressing these issues and the effectiveness of systems of risk management.
Insurance risk The Committee agrees the specific insurance risk appetite, which aligns with the Group risk appetite, and monitors against this as part of the suite of risk reporting.
The Committee considered remuneration governance and refined the design of incentive plans whilst being mindful of market and regulatory developments. The changes have led to more consistent and effective consideration of risk in reward management across the Group. This ensures a robust framework exists to mitigate key regulatory and people risks associated with reward decisions and supports sustainable growth, consistent with the risk appetite framework agreed by the Board. The Committee is working with the Risk Division to further embed effective risk management into the culture of the organisation.
The Committee reviews annually a report from the Group HR Director on the operation of the remuneration governance policy and its effectiveness. In 2013, the report concluded that effective systems and controls are in place for all requirements of the governance policy and that it delivers outcomes in line with the Group’s values, reward principles and the PRA Remuneration Code.
Operation Benefits may include those currently provided and disclosed in the Implementation Report.
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.
– Further reductions in the number of customer complaints, now down to 1.0 per 1,000 accounts (excluding PPI), the lowest of any major uK bank.
The changes in beneficial interests for António Horta-Osório and George Culmer relate to ‘partnership’ and ‘matching’ shares acquired under the lloyds Banking Group Share Incentive Plan between 31 December 2013 and 27 February 2014.
Evolving requirements on capital While there is now greater clarity on regulatory capital requirements, there remains some uncertainty as uK and european regulatory frameworks continue to evolve. For example, in 2013, the PRA introduced significant additional capital requirements on an adjusted basis that major uK banks are required to meet. Areas of uncertainty include the calibration of the leverage ratio in the uK, evolving CRD IV technical standards and potential changes to the calculation of capital requirements (i.e. risk-weighted assets). Key mitigating actions – The Group has made significant progress and continues to deliver on its strategy of strengthening the balance sheet, including its capital position, to improve the resilience of the Group. – The Group has strong governance, processes and controls which, combined with the Group’s proactive management of risk, result in an appropriate level of capital.
Scottish independence The impact of a ‘yes’ vote in favour of Scottish independence is uncertain. The outcome could have a material impact on compliance costs, the tax position, and cost of funding for the Group. Key mitigating actions – Monitoring and assessment of the potential impact on the Group’s business and impact on customers of a vote in favour of Scottish independence.
The methodologies and modelling approach used for stress testing ensures that a clear link is shown between the macro-economic scenarios, the business drivers for each area and the resultant stress testing outputs. All material assumptions used in modelling are documented and justified, with a clearly communicated review and sign off process. Modelling is supported by expert judgement is subject to the Group Risk Model Governance Policy.
– The Central Group Stress testing team which sits in Risk Division reviews the finance and risk stress submissions and produces a consolidated Group view of the results, including analysis packs for the Group’s senior committees.
Se co nd li ne o f d ef en ce
Risk directors – provide independent advice, oversight and challenge to the business; – design, develop and maintain policies, specific risk frameworks and guidance to ensure alignment with business imperatives and regulatory requirements; – establish and maintain appropriate governance structures, culture, oversight and monitoring arrangements which ensure robust and efficient compliance with relevant risk-type risk appetites and policies; – lead regulatory liaison on behalf of the Group including horizon scanning and regulatory development for their risk type; and
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, governance and role definition, capability development, performance management and reward.
Resources and capabilities – appropriate mechanisms are in place to avoid over-reliance on key personnel or system/technical expertise within the Group. Adequate resources are in place to deal with customers both under normal working conditions and in times of stress, and monitoring procedures are in place to ensure that the level of available resource can be increased if required. Colleagues undertake appropriate training to ensure they have the skills and knowledge necessary to enable them to deliver fair outcomes for customers, being mindful of the Group’s Conduct Strategy, Customer Treatment Policy/Standards and Financial Conduct Authority requirements.
Trading exposures continue to be predominantly short-term and/or collateralised with inter bank activity mainly undertaken with strong investment grade counterparties. While conditions in the eurozone stabilised during 2013, the Group continues to adopt a conservative stance maintaining close portfolio scrutiny and oversight. Detailed contingency plans are in place and exposures to financial institutions domiciled in peripheral eurozone countries are kept modest and managed within tight risk parameters. Overall, portfolio credit quality remains good and outlook is stable.
Table 1.27: Key market risks for the Group (PBT impact measured against Group single stress scenarios)
Insurance portfolios Market risks within the Insurance business are measured using a variety of techniques including stress and scenario testing and, where appropriate, stochastic modelling. Current and potential future market risk exposures are assessed and aggregated using a range of stresses and risk measures including 1-in-200 year stresses for Insurance’s Individual Capital Assessment (ICA) and alternative stresses for profit before tax and other measures. The effect of changes in key assumptions including sensitivities to the risk-free rate, equity investment volatility, widening of credit spreads on corporate bonds and an increase in illiquidity premia, as applied to profit before tax and equity are set out in note 37.
The ability to deploy assets quickly, either through the repo market or through outright sale, is also an important source of liquidity for the Group’s banking businesses. In addition to central bank reserves, the Group holds sizeable balances of high grade marketable debt securities as set out in table 1.34 which can be sold to provide, or used to secure, additional cash inflows should the need arise from either market counterparties or central bank facilities (Bank of england, european Central Bank and Federal Reserve).
– Core tier 1 ratio, based on the capital regulations as at 31 December 2013, increased 2.0 percentage points from 12.0 per cent to 14.0 per cent.
InDePenDenT AuDITORS’ RePORT TO THe MeMBeRS OF llOYDS BAnKInG GROuP PlC Report on the financial statements
– substantiated the Group’s unencumbered collateral position and potential to access central bank liquidity facilities.
(loss) profit for the year – – (2,963) (2,963) 73 (2,890)
Net cash (used in) provided by financing activities (3,068) (3,104) (3,242)
Gross written premiums 972 1,081 1,198 net written premiums 954 1,050 1,146
Amortisation of acquired value of in-force non-participating investment contracts (note 28) 54 79 78
During 2012, following a review of policy in respect of discretionary pension increases in relation to the Group’s defined benefit pension schemes, increases in certain schemes are now linked to the Consumer Price Index rather than the Retail Price Index. The impact of this change was a reduction in the Group’s defined benefit obligation of £258 million, recognised in the Group’s income statement in 2012, net of a charge of £8 million resulting from a change to the commutation factors in one of the Group’s smaller schemes.
Weighted average number of ordinary shares in issue – basic 71,009 69,841 68,470
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares, if any, that arise in respect of share options and awards granted to employees. The number of shares that could have been acquired at the average annual share price of the Company’s shares based on the monetary value of the subscription rights attached to outstanding share options and awards is determined. This is deducted from the number of shares issuable under such options and awards to leave a residual bonus amount of shares which are added to the weighted-average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.
Assets of disposal groups classified as held for sale 7,988 194
Liabilities liabilities arising from insurance contracts and participating investment contracts 4,901 –
The effect of deriving risk-free rates from swap curves instead of government bond yields has been to increase the value of in-force business by £132 million at 31 December 2013. This is included as an assumption change in the table above. The effect of this change on profit before tax, after including the impacts of movements in liabilities, is given in note 36.
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2013 was £6,625 million, which was £1,358 million higher than the balance sheet carrying value (2012: £6,553 million, which was £853 million higher than the balance sheet carrying value). At 31 December 2013 there was a cumulative £214 million increase in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of lloyds Bank plc, the issuing entity within the Group. Of the cumulative amount a decrease of £40 million arose in 2013 and an increase of £437 million arose in 2012.
Widening of credit default spreads on corporate bonds8 0.25% addition (239) (184)
A significant goal of the asset-liability matching strategies adopted by Group schemes is to reduce volatility caused by changes in market expectations of interest rates and inflation. In the main, this is achieved by investing scheme assets in bonds, primarily fixed interest gilts and index linked gilts, and by entering into interest rate and inflation swap arrangements. These investments are structured to take into account the profile of scheme liabilities, and actively managed to reflect both changing market conditions and changes to the liability profile.
Vacant leasehold property Other Total £m £m £m £m £m £m
The weighted average share price at the time the options were exercised during 2013 was £0.72. no options were exercised in 2012.
(ii) EP: relevant to 50 per cent of the award. Performance was measured based on the compound annual growth rate of adjusted eP over the three financial years starting on 1 January 2010 relative to an adjusted 2009 eP base.
Vesting between threshold and maximum will be on a straight line basis.
(ii) Investment performance: relevant to 40 per cent of the award. The performance target is based on the percentage of SWIP funds achieving at or above benchmark performance (on a competitor median or index basis) over the three year period. If 50 per cent of funds exceed benchmark performance, 25 per cent of this element of the award, being the threshold, will vest. If 55 per cent of funds exceed benchmark performance, 100 per cent of this element, being the target, will vest. If 70 per cent of funds exceed benchmark performance, 200 per cent of this element of the award, being the maximum, will vest.
UK Government In January 2009, the uK Government through HM Treasury became a related party of the Company following its subscription for ordinary shares issued under a placing and open offer. At 31 December 2013, HM Treasury held a 32.7 per cent interest in the Company’s ordinary share capital and consequently HM Treasury remained a related party of the Company during the year ended 31 December 2013; this percentage holding has reduced from 39.2 per cent at 31 December 2012 following the uK Government’s sale of 4,282 million shares on 17 September 2013 and the impact of issues of ordinary shares.
The contingent liabilities of the Group arise in the normal course of its banking business and it is not practicable to quantify their future financial effect.
Operating lease commitments Where a Group company is the lessee the future minimum lease payments under non-cancellable premises operating leases are as follows: £m £m not later than 1 year 292 310 later than 1 year and not later than 5 years 928 987
From held for trading to loans and receivables – – 11 9 67 56 750 727 1,833 1,822 2,883 2,926
Carrying value Fair value Carrying value Fair value £m £m £m £m
Transfers out of the level 3 portfolio (337) (4) (8) (349)
The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities is estimated using discounted cash flow techniques at a rate which reflects market rates of interest and the Group’s own credit spread.
Retail – other £m Wholesale £m Total £m neither past due nor impaired 25,219 318,668 36,789 110,093 465,550 29,443
Total other assets held at fair value through profit or loss 8,310 13,462 8,425 6,353 619 1,738 38,907
unimpaired non-mortgage retail lending amounted to £36,081 million (2012: £42,145 million). 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 and are thereafter monitored in accordance with business unit credit policy.
Restated to reflect the change in forbearance probation periods. Previously only temporary arrangements in place at the year end and permanent changes commenced during the year were shown.
At 31 December £28 million of forborne loans and advances were not impaired at 31 December 2013 (31 December 2012: £42 million).
Change in non-controlling interests 23 – – 23 net cash used in financing activities (3,104) – – (3,104)
Debt securities in issue 117,369 (116) – 117,253 liabilities arising from insurance contracts and participating investment contracts 82,953 – – 82,953 liabilities arising from non-participating investment contracts 54,372 – – 54,372 unallocated surplus within insurance businesses 267 – – 267
Trading and other financial liabilities at fair value through profit or loss 24,955 (2,598) – 22,357
Debt securities in issue 228,866 – – 228,866 liabilities arising from insurance contracts and participating investment contracts 80,729 – – 80,729 liabilities arising from non-participating investment contracts 51,363 – – 51,363 unallocated surplus within insurance businesses 643 – – 643
Other reserves 11,575 – – 11,575 non-controlling interests 841 – – 841
Shareholder enquiries including the Lloyds Banking Group Shareholder Account For queries about your shareholding or to tell us about changes to your circumstances, please contact equiniti limited using the details shown below. equiniti limited maintain shareholder records on our behalf and deal with shareholder enquiries either in writing or by telephone: equiniti limited Aspect House Spencer Road Telephone 0871 384 2990
Conduits A financial vehicle that holds asset-backed securities which are financed with short-term deposits (generally commercial paper) that use the asset-backed securities as collateral. The conduit will often have a liquidity line provided by a bank that it can draw down on in the event that it is unable to issue funding to the market. The Group sponsors three asset-backed conduits, Argento, Cancara and Grampian. Further details are provided in note 22.
Full time equivalent A full time employee is one that works a standard five day week. The hours or days worked by part time employees are measured against this standard and accumulated along with the number of full time employees and counted as full time equivalents. This is a more consistent measure of the amount of time worked than employee numbers which will fluctuate as the mix of part-time and full-time employees changes.
Head office 25 Gresham Street london eC2V 7Hn Telephone +44 (0)20 7626 1500
Registered office The Mound edinburgh eH1 1YZ Registered in Scotland no SC95000