OUR AIM To become the best bank for customers whilst delivering superior and sustainable returns for shareholders
Another way we support millions of people across Britain is through the funding of our independent Foundations. Since the Foundations were set up over 30 years ago, they have donated almost £600 million to charities across the UK. This year, I have once again been delighted to meet with the Foundations and some of the amazing charitable organisations they support, and to see the huge difference our funding makes to so many local communities.
Our purpose as a UK focused bank is to help Britain prosper and we are playing a vital role in supporting people, businesses and communities across the UK.
KEY EVENTS IN THE YEAR There have been a number of notable events and achievements for the Group in 2016, both within the Group and more widely across the UK. Read our timeline for some key events of the past 12 months.
CREATING THE BEST CUSTOMER EXPERIENCE – Improving customer experience with our multi-brand, multi-channel approach, combining digital capabilities with face-to-face services
Helping Britain prosper is about creating opportunities for all to share in the economic and social benefits of a successful UK. As a sustainable, low-risk business we can support this success in many ways Sara Weller Independent Director and Chairman, Responsible Business Committee
We have improved our services for customers who are disabled or have suffered bereavement and work with third sector organisations such as Macmillan to support customers affected by cancer. We provide assistance for customers with mental health problems or dementia, and run dementia awareness training for branch and telephony colleagues. This year, we also reviewed our digital services, together with the charity Abilitynet, to ensure we provide the best service for our 4 million vulnerable customers who bank with us online.
The Board delegates authorities for risk management through the Group Chief Executive and the management hierarchy to individuals, an approach which is consistent with the focus of the Senior Managers and Certification Regime (SM&CR) on the principle of individual accountability. At a senior level, executives are supported in their decision making by a committee-based governance structure. The concept of individual accountability for risk management is embedded in the RMF and culture at every level, and guides the way all employees approach their work, behave and make decisions.
Funding and liquidity risk The risk that we have insufficient financial resources to meet our commitments as they fall due, or can only secure them at excessive cost.
Mitigating actions are implemented to reduce the impact of market movements, resulting in a more stable capital position. This allows us to more efficiently utilise available capital resources to deliver sustainable growth.
Operating lease depreciation increased 17 per cent to £895 million due to continued growth in the Lex Autolease business and additional charges in Commercial Banking related to certain leasing assets.
Creating the best customer experience – Credit Cards launched the innovative Halifax FlexiCard, giving customers more control, with dedicated repayment plans. – In the Motor business, Black Horse launched a personal contract purchase (PCP) product for caravans and motorhomes, which now accounts for 11 per cent of applications in this sector. – Lex Autolease built a bespoke system to manage vehicle servicing and maintenance, including online self-service functionality and has been used by over 10,000 customers since May. – Loans have significantly enhanced the digital sales process with the introduction of an upfront eligibility checker.
Becoming simpler and more efficient – Consumer Finance continues to focus on efficiency with further significant improvements to processes implemented in the year. This has also helped reduce customer complaints by 11 per cent. – Lex Autolease simplified the way it sells c.80,000 vehicles per annum at end of contract, reducing the number of operating sites and associated costs, whilst increasing speed of vehicle disposals. – Black Horse launched the Mobile Finance Calculator across the dealer network, allowing dealers to provide more accurate indicative customer pricing early on in the process.
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 passionate advocate of customers, the community, financial inclusion and the development of digital skills which directly support Lloyds Banking Group’s strategy and her role as Chairman of the Responsible Business Committee. Sara has considerable experience of boards at both executive and non-executive level. Her previous appointments include Managing Director of Argos, various senior positions at J Sainsbury including Deputy Managing Director, Lead Non-Executive Director at the Department of Communities and Local Government, a Non-Executive Director of Mitchells & Butlers as well as a number of senior management roles for Abbey National and Mars Confectionery. She has an MA in Chemistry from Oxford University.
Skills and experience: George has extensive operational and financial expertise including strategic and financial planning and control. He has worked in financial services in the UK and overseas for over 25 years. George was an Executive Director and Chief Financial Officer of RSA Insurance Group, the former Head of Capital Management of Zurich Financial Services and Chief Financial Officer of its UK operations as well as holding various senior management positions at Prudential. He is a Non-Executive Director of Scottish Widows. George is a Chartered Accountant and has a history degree from the University of Cambridge.
09 Zaka Mian Group Director, Digital and Transformation Zak joined the Group in 1989 as a Business Analyst in IT. He was appointed Group Director, Digital and Transformation in 2016 and is responsible for the Group-wide digital business across Retail, Consumer Finance, Insurance and Commercial divisions, and the associated Transformation programmes. Before his current role, Zak led the Digital Transformation programme for a number of years and was also Retail CIO and head of IT architecture. Zak has a computer science degree from York University.
Deep dives The Board regularly takes the opportunity to hold ‘deep dive’ sessions with senior management outside of formal Board meetings.
The Company Secretary maintains a training and development log for each Director.
Anthony Watson, Senior Independent Director, is due to retire at the 2017 AGM. At the time of the 2017 AGM, he will have served on the Board for more than eight years and therefore, in compliance with the Code, his review was particularly rigorous.
– Continue to focus on strategy, with particular attention to the longer term horizon and the impact of the changing technology and competitive landscape
The Group’s website enables access to documents and communications as soon as they are published, including a live webcast of the AGM. Recordings of webcasts and other analyst presentations are also available.
During the year the Committee, led by the Chairman, continued to keep under review the structure, size and composition of the Board and its Committees and to make appropriate recommendations to the Board.
Corporate governance In 2016, the Committee: – oversaw the annual review of the Corporate Governance Framework, including the amendments necessary to accommodate the SM&CR and recommended it to the Board for approval – received regular corporate governance updates from the Company Secretary – recommended to the Board a revised share dealing policy for Directors and GEC in light of the new Market Abuse Regulation – reviewed reports from the Chairman on communications from shareholders – received updates on the SM&CR – approved the appointment of Trustees to the Bank’s Foundations – received updates on ring-fencing governance
Board size and composition Under the leadership of the Chairman, the Committee continued to keep under review the structure, size and composition of the Board and its Committees. At the core of the process is an ongoing assessment led by the Chairman of the collective Board’s technical and governance skill set. From this the Chairman creates a board skills matrix which the Committee uses to track the Board’s strengths and identify gaps in the desired collective skills profile of Board members, giving due weight to diversity in its broadest sense. Recommendations are made to the Board as appropriate.
Conclusion: Improvement to risk data systems, governance and controls over the last two years have strengthened risk reporting, whilst there remains opportunity to develop further. Data risk will remain a key area of focus for the Committee in 2017 in line with the growing importance of data as an asset to the Group and maturity of the Group Chief Data Office.
Residual value risk A review of the impact of used car prices on the residual value risk of motor finance businesses was undertaken.
Key areas reviewed have been: work to deepen our customer‑centric culture; programmes to tackle disadvantage, including through our Foundations, our role in supporting UK businesses build for the future; and the development of the programme of skills‑based volunteering undertaken by colleagues across the Group.
To align with the culture of broader share ownership, the long-term element of variable remuneration will be known as the ‘Group Ownership Share plan’. This plan incentivises and rewards Executive Directors and senior colleagues against Group financial and strategic objectives designed to deliver superior and sustainable long-term returns for shareholders. Executives will build a direct ownership interest in the Group if those strategic objectives are met over the three-year performance period. The Committee decided that the performance measures for the 2017 awards should align to the revised Reward Principles, and with that, the Group’s strategic priorities.
Changes Due to regulatory changes, Executive Directors can no longer receive dividend equivalents on deferred shares. The number of shares to be awarded may be calculated using a fair or discounted value. If regulatory requirements change, dividend equivalents may be paid. There are no changes to maximum opportunity.
Awards vest on date of event. Vesting is subject to the performance conditions and time pro-rating (for months worked in performance period unless determined otherwise). Malus and clawback will normally apply. Instead of vesting, awards may be exchanged for equivalent awards over the shares of the acquiring company or another company.
Each measure in the Group and divisional/functional BSC is assigned targets aligned to a five-point rating scale. BSC 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’.
Credit quality Prudent lending criteria reflected in credit quality across all lending portfolios and reduced gross impairment charges.
– Conduct – the Group’s product design and sales practices ensure that products are transparent and meet customer needs. – Market – the Group takes minimal proprietary trading risk, reflecting the customer focused nature of the Group’s activities. – Operational – the Group has robust controls in place to manage operational losses, reputational events and regulatory breaches. It identifies and assesses emerging risks and acts to mitigate these. – Funding and liquidity – the Group maintains a prudent liquidity profile to ensure it can survive under stressed conditions, and a balance sheet structure that limits its reliance on potentially volatile sources of funding. – Capital and earnings – the Group maintains capital levels commensurate with a prudent level of solvency, even under stressed conditions. It aims to deliver consistent and high quality earnings and has low appetite for earnings shocks or surprises from any risk type. – Regulatory and legal – the Group complies with all relevant regulation and all applicable laws (including Codes of Practice which could have legal implications) and/or legal obligations. – People – the Group leads responsibly and proficiently, manages its people resource effectively, supports and develops colleague talent, and meets legal and regulatory obligations related to its people. – Financial reporting – the Group meets regulatory reporting and tax requirements in jurisdictions where it operates and ensures the timely and transparent disclosure and dissemination of information relating to its listed debt or equity. – Governance – the Group has governance arrangements that support the effective long-term operation of the business, maximise shareholder value and meet regulatory and societal expectations. – As a separate regulated entity with its own Board, the Insurance business has its own Risk Appetite and maintains its own Risk Appetite framework, aligned to the Group Risk Appetite framework.
– Assessment of the possible impacts of legislation is ongoing; delivery of enhanced systems and processes to fulfil related regulatory requirements. – Chief Data Officer reviewing operating model and identifying opportunities to enhance the associated control environment.
Business area principal Enterprise Risk Committees Retail Risk Committee Consumer Finance Risk Committee Customer Products and Markets Risk Committee Commercial Banking Risk Committee Digital Risk Committee Insurance Risk Committee Finance Risk Committee Group Operations Risk Committee Group Functions Executive/Risk Committees Risk Division Risk Committee
For commercial customers, the Group currently looks at forbearance concessions including changes to: – Contractual payment terms (for example loan maturity extensions, or changes to capital and/or interest servicing arrangements, including capital repayment holidays or conversion to interest only terms); and – Non-payment contractual terms (for example covenant amendments or waivers) where the concession enables default to be avoided.
Commercial Banking – The Commercial Banking net impairment charge was £16 million in 2016, compared to a net impairment release of £22 million in 2015, with the increase largely due to one material charge related to a case within the oil & gas sector, rather than a deterioration in the underlying portfolio. Other than this, gross charges remained relatively low in 2016. – The portfolio continues to benefit from effective risk management and the continued low interest rate environment. – Credit quality of the portfolio and new business remains generally good. – Impaired loans reduced by 14 per cent to £2,179 million at 31 December 2016 compared with £2,543 million at 31 December 2015 and as a percentage of closing loans and advances reduced to 2.2 per cent from 2.5 per cent at 31 December 2015. – Impairment provisions reduced to £824 million at 31 December 2016 (31 December 2015: £1,091 million) and includes collective unidentified impairment provisions of £183 million (31 December 2015: £229 million). Provisions as a percentage of impaired loans reduced from 42.9 per cent to 37.8 per cent during 2016, heavily influenced by the net movement of three material cases with different coverage levels that has impacted the portfolio average. – The UK faces a number of significant headwinds including the changing global economic outlook and the impact of the EU Exit referendum outcome which have the ability to impact the Commercial Banking portfolios.
1 Includes temporary treatments where the customer is currently benefiting from the change or the treatment has ended within the last six months. Permanent changes, such as returning a Card account in arrears to an in-order status, which commenced during the last 24 months for existing customers as at 31 December are also included.
There is an ongoing high level of scrutiny regarding financial institutions’ treatment of customers, including those in vulnerable circumstances, from regulatory bodies, the media, politicians and consumer groups. As a result, there is a risk that certain aspects of the Group’s current or legacy business may be determined by the Financial Conduct Authority, other regulatory bodies or the courts as not being conducted in accordance with applicable laws or regulations, or in a manner that fails to deliver fair and reasonable customer treatment. The Group may also be liable for damages to third parties harmed by the conduct of its business. There is also a significant regulatory focus on market misconduct, resultant from previous issues around LIBOR and FX.
The credit ratings on Lloyds Bank were unchanged over 2016, and the median credit rating among the three major credit rating agencies remains ‘A+’. Following the EU referendum in June, both S&P and Moody’s revised their outlooks on Lloyds Bank, among other UK banks, in order to reflect increased macroeconomic uncertainty. S&P revised the outlook on Lloyds Bank’s ‘A’ rating to ‘Negative’ from ‘Stable’ whilst Moody’s revised the outlook on Lloyds Bank’s ‘A1’ rating to ‘Stable’ from ‘Positive’. Moody’s also revised their outlook on the UK banking system to ‘Negative‘ from ‘Stable’. Fitch’s outlook on Lloyds Bank’s ‘A+’ rating remained ‘Stable’ as Fitch expect the economic effects of the referendum to be manageable. The effects of a potential downgrade from all three credit rating agencies are included in Group liquidity stress testing.
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). Full details of the Group’s regulatory capital and leverage frameworks will be provided in the Group’s Pillar 3 Report.
The leverage ratio framework does not currently give rise to higher capital requirements for the Group than the risk-based capital framework.
In 2020 the Group will have to meet a Minimum Requirement for Own Funds and Eligible Liabilities (MREL). During 2016 the Group commenced issuance of senior unsecured securities from Lloyds Banking Group plc, which, while not included in total capital, are eligible to meet MREL, £2.5 billion (Sterling equivalent) was issued in 2016 and a further £2.2 billion (Sterling equivalent) was issued in January 2017 leaving the Group well positioned to meet MREL requirements from 2020.
An analysis of the Group’s capital position as at 31 December 2016 is presented in the following section applying CRD IV transitional arrangements and also on a fully loaded CRD IV basis, both as implemented in the UK by the PRA.
Measurement Financial reporting risk is measured by the adequacy of, and compliance with, a number of key controls. Identification of potential financial reporting risk also forms a part of the Group’s Operational Risk management framework.
Issue of other equity instruments – – (21) (21) 5,355 – 5,334
(L) Taxation Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
Consumer Finance comprises all the Group’s consumer lending products including motor finance, credit cards, and unsecured personal loans along with its European business.
Profit attributable to equity shareholders – basic and diluted 2,001 466 1,125
Later than 1 year and not later than 5 years 1,618 1,225
Cash deposits of £9,018 million (2015: £8,383 million) which support the debt securities issued by the structured entities, the term advances related to covered bonds and other legal obligations are held by the Group. Additionally, the Group had certain contractual arrangements to provide liquidity facilities to some of these structured entities. At 31 December 2016 these obligations had not been triggered; the maximum exposure under these facilities was £373 million (2015: £381 million).
NOTE 32: LIABILITIES ARISING FROM INSURANCE CONTRACTS AND PARTICIPATING INVESTMENT CONTRACTS continued
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 2014 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 6.84 per cent (2015: 6.59 per cent).
Deferred tax assets of £723 million (2015: £893 million) have not been recognised in respect of trading losses carried forward, mainly in respect of temporary differences in the insurance businesses and in certain overseas companies. Trading losses can be carried forward indefinitely, except for losses in the USA which expire after 20 years.
Share issuances No shares were issued in 2016 or 2015; in 2014, 5 million shares were issued in respect of employee share schemes.
Interim dividend paid in the year 0.85 0.75 – 607 535 –
The weighted average fair value of options granted in the year was £0.68 (2015: £0.75). The fair values of options granted have been determined using a standard Black-Scholes model. The weighted average share price at the time that the options were exercised during 2016 was £0.64 (2015: £0.83). The weighted average remaining contractual life of options outstanding at the end of the year was 5.1 years (2015: 6.1 years).
NOTE 47: RELATED PARTY TRANSACTIONS Key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the Lloyds Banking Group plc Group Executive Committee together with its Non‑Executive Directors.
– The European Commission continues to pursue certain competition investigations into MasterCard and Visa probing, amongst other things, MIFs paid in respect of cards issued outside the EEA; – Litigation continues in the English Courts against both Visa and MasterCard. This litigation has been brought by several retailers who are seeking damages for allegedly ‘overpaid’ MIFs. From publicly available information, it is understood these damages claims are running to different timescales with respect to the litigation process. It is also possible that new claims may be issued; – Any ultimate impact on the Group of the above investigations and the litigation against Visa and MasterCard remains uncertain at this time.
Residential mortgage repossessions In August 2014, the Northern Ireland High Court handed down judgment in favour of the borrowers in relation to three residential mortgage test cases concerning certain aspects of the Group’s practice with respect to the recalculation of contractual monthly instalments of customers in arrears. The FCA is actively engaged with the industry in relation to these considerations. The Group will respond as appropriate to this and any investigations, proceedings, or regulatory action that may in due course be instigated as a result of these issues. The FCA has issued a consultation on new guidance on the treatment of customers with mortgage payment shortfalls. The guidance covers remediation for mortgage customers who may have been affected by the way firms calculate these customers’ monthly mortgage instalments. The output from this consultation is expected in the first quarter of 2017.
The carrying amount of the following financial instruments is a reasonable approximation of fair value: cash and balances at central banks, items in the course of collection from banks, items in course of transmission to banks, notes in circulation and liabilities arising from non‑participating investment contracts.
Losses (gains) recognised in the income statement within other income 1 –
The table below analyses movements in level 3 derivative assets and liabilities carried at fair value. 2016 2015
Debt securities Reasonably possible alternative assumptions have been determined in respect of the Group’s structured credit investment by flexing credit spreads.
Assets arising from reinsurance contracts held 714 – 714 675 – 675
Available-for-sale financial assets 109 269 56 535 120 1,000 7,178 23,765 33,032
The Group’s financial guarantee contracts are accounted for as financial instruments and measured at fair value, upon initial recognition, on the balance sheet. The majority of the Group’s financial guarantee contracts are callable on demand, were the guaranteed party to fail to meet its obligations. It is, however, expected that most guarantees will expire unused. The contractual nominal amounts of these guarantees totalled £6,883 million at 31 December 2016 (2015: £7,165 million) with £3,815 million expiring within one year; £667 million between one and three years; £1,334 million between three and five years; and £1,067 million over five years (2015: £4,014 million expiring within one year; £942 million between one and three years; £1,182 million between three and five years; and £1,027 million over five years).
During 2016 the Company has reviewed the treatment of certain holdings of preference shares issued by its subsidiary, Lloyds Bank plc. As a result loans to subsidiaries and other liabilities have been increased by £585 million; comparatives have been restated accordingly.
Underlying return on required equity Underlying profit after tax at the standard UK corporation tax rate adjusted to reflect the banking tax surcharge and the notional earnings on any excess or shortfall in equity less the post-tax profit attributable to other equity holders divided by the average required equity for the period.
Asset quality ratio The impairment charge for the year in respect of loans and advances to customers expressed as a percentage of average loans and advances to customers.
Enhanced Capital Notes (ECNs) The Group’s ECNs are subordinated notes issued by the Group that contained an embedded equity conversion feature.
Risk Governance and risk management strategies/business model 5 Summarise prominently the bank’s risk management organisation, processes and key functions. 121-122 6 Describe risk culture and how procedures and strategies are applied to support the culture. 116 7 Describe the key risks that arise from the bank’s business models and activities, the bank’s risk appetite in the context of its business models and how the bank manages such risks. 116-117, 123-169 8 Describe the use of stress testing within the bank’s risk governance and capital frameworks. 119 Capital adequacy and risk-weighted assets 9 Pillar 1 capital requirements and the application of counter-cyclical and capital conservation buffers or the minimum internal ratio established by management.
13 Explain how risk-weighted assets (RWAs) relate to business activities and related risks. 117, 164-165, Pillar 3 14 Present a table showing the capital requirements for each method used for calculating RWAs for each Basel asset class. Pillar 3 15 Tabulate credit risk for Basel asset classes. Pillar 3 16 Present a flow statement that reconciles movements in RWAs for the period for each RWA risk type. 164 17 Provide narrative putting Basel Pillar 3 back-testing requirements into context. Pillar 3
County Wide Property Investments Ltd (in liquidation) 100% 13 Create Services Ltd 100% 1 Dalkeith Corporation 100% 25 Delancey Rolls UK Ltd 100% 26 i # Denham Funding Ltd (in liquidation) 100% 13 Deva Lease 2 Ltd (in liquidation) 100% 13 Deva Lease 3 Ltd (in liquidation) 100% 13 Direct LB Ltd 100% 1 Dunstan Investments (UK) Ltd 100% 1 Enterprise Car Finance Ltd 100% 7 ii # Equipment Leasing (No. 3) Ltd (in liquidation) 100% 13
Harrogate, North Yorkshire, HG2 2PB & Iglufastnet Ltd 41.9% 2nd Floor, 165 The Broadway, Wimbledon, London, SW19 1NE Ingleby (1884) Ltd 76% Fontana House, Works Road, Letchworth Garden City, SG6 1LD & Ingleby (2016) Ltd 41.5% Unit 22, Lodge Way, Lodge Farm Industrial Estate, Northampton, NN5 7US Inprova Group Ltd 21.1% Unit 2, Olympic Park, Woolston Grange Avenue, Warrington, Cheshire, WA2 0YL Kee Safety Group Ltd 20.9% Unit A2, Cradley Business Park, Overend Road, Cradley Heath, West Midlands, B64 7DW Kenmore Capital 2 Ltd (in liquidation) 100% Grant Thornton UK LLP, 95 Bothwell Street, Glasgow, G2 7JZ ii Kenmore Capital 3 Ltd (in receivership) 100% Grant Thornton UK LLP, 95 Bothwell Street, Glasgow, G2 7JZ ii Kenmore Capital Ltd (in liquidation) 100% Grant Thornton UK LLP, 95 Bothwell Street, Glasgow, G2 7JZ ii Keoghs Topco Ltd 22.3% 2 The Parklands, Bolton, Lancashire, BL6 4SE Kimberly Holdings Ltd 59.1% 13 Hornbeam Square South, Harrogate, North Yorkshire, HG2 8NB & LCP Baby Investors LP (in process of disposal) n/a International Corporation Services Ltd, Harbour Place, 2nd Floor, 103 South Church Street, George Town, Grand Cayman, KY1106, Cayman Islands * Lesprit Ltd 71% Apollo House 6 Bramley Road, Mount Farm, Milton Keynes, England, MK1 1PT & Lighthouse Healthcare Group Ltd 71.96% 2nd Floor Bezant House, Bradgate Park View, Chellaston, Derbyshire, DE73 5UH v 59.71% i 77.07% ii London Topco Ltd 48.7% Gloucester Road, Cheltenham, Gloucester, GL51 8NR Lothian Fifty (150) Ltd (in liquidation) 100% 55 Baker Street, London, W1U 7EU i Magicard Holdings Ltd 69.3% Waverley House, Hampshire Road, Granby Industrial Estate, Weymouth, DT4 9XD & Marvel Newco Ltd 44.1% Paston House, Princess Street, Norwich, Norfolk, NR3 1AZ Mini-Cam Enterprise Ltd 38.3% Unit 4, Yew Tree Way, Golborne, Warrington, WA3 3FN Mitrefinch Holdings Ltd 51.9% Mitrefinch House, Green Lane Trading Estate, Clifton, York, North Yorkshire, YO30 5YY & Morston Assets Ltd (in administration) 20% KPMG LLP, Arlington Business Park, Theale, Reading, Berkshire, RG7 4SD Motability Operations Group plc 20% (40%) City Gate House, 22 Southwark Bridge Road, London, SE1 9HB