AnnuAl RepoRt And Accounts 2011
becoming
the best
bank for
customers
Annual Report and Accounts 2011
Annual Report and Accounts 2011
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Overview
Introduction
Group performance
Key performance indicators
At a glance
Chairman’s statement
Group Chief Executive’s review
Business review
Marketplace trends
Business model and strategy
Delivering our action plan
Relationships and responsibility
Customers
Colleagues
Communities
Our London 2012 Partnership
Summary of Group results
Divisional results
Retail
Wholesale
Commercial
Wealth and International
Insurance
Group Operations
Other financial information
Five year financial summary
Risk management
Governance
Board of Directors
Directors’ report
Corporate governance report
Directors’ remuneration report
Financial statements
Report of the independent auditors on the
consolidated financial statements
Consolidated financial statements
Notes to the consolidated financial statements
Report of the independent auditors on the
parent company financial statements
Parent company financial statements
Notes to the parent company financial statements
Other information
Shareholder information
Forward looking statements
Glossary
Abbreviations
Index to annual report
This Annual Report online
A full version of our Annual Report
and Accounts and information relating
to Lloyds Banking Group is available at:
www.lloydsbankinggroup.com
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Lloyds Banking Group is proud
to be the official banking and insurance
partner for the London 2012 Olympic
and Paralympic Games.
CONTENTS 1
Annual Report and Accounts 2011
INTRODUCTION
Our aim is tO
becOme the
best bank fOr
custOmers
We are creating a simpler, more
agile and responsive organisation,
and are making a big investment
in products and services.
This will offer more to our
customers, as well as delivering
strong, stable and sustainable
returns for our shareholders.
Lloyds Banking Group is a
leading UK based financial
services group providing
a wide range of banking and
financial services, primarily
in the UK, to personal and
corporate customers.
The main business activities
are retail, commercial and
corporate banking, general
insurance, and life, pensions
and investment provision.
The Group operates the UK’s
largest retail bank and has a large
and diversified customer base.
Services are offered through
a number of well recognised
brands including Lloyds TSB,
Halifax, Bank of Scotland,
and Scottish Widows, and a range
of distribution channels
including the largest branch
network in the UK.
Lloyds Banking Group is quoted
on both the London Stock
Exchange and the New York
Stock Exchange and is one of
the largest companies within
the FTSE 100.
Through investing in our branches,
such as the Lloyds TSB branch
in Stratford, East London, we are
reinvigorating our brands and enabling
better customer service.
2
Annual Report and Accounts 2011
GROUP PERFORMANCE
Delivering
resilient
performance
“
In 2011, we established our longer
term strategy for the Group, acted
quickly and decisively to mitigate
the effects of a challenging
environment and put in place
the right foundations to deliver
on our objectives over the next
3-5 years. We delivered a resilient
performance and made good
progress against the key elements
of our strategic plan to become the
best bank for our customers.”
António Horta-Osório
Group Chief Executive
Key highlights
Good progress against strategy creating new opportunities for growth
Balance sheet further strengthened
– Capital position strengthened: Core tier 1 capital ratio of 10.8 per cent, improved by 60 basis points
– Strong deposit growth: customer deposits (excluding repos) increased 6 per cent to £406 billion
– Funding position significantly improved: wholesale funding reduced to £251 billion, down 16 per cent
– Strong progress against term funding objectives with £35 billion of wholesale term issuance
– Loan to deposit ratio substantially improved to 135 per cent (31 December 2010: 154 per cent)
Reshaping our business portfolio: reducing risk, focusing on the core, and exiting non-core areas
– Substantial non-core asset reduction of £53 billion to £141 billion
– Conservative approach to, and prudent appetite for, risk fully embedded across the business
– Increased focus on the core business, while substantially decreasing non-core assets
– Announced exit from operations in seven overseas countries
Simplifying the Group: reducing costs and creating a new operational model
– Integration successfully executed, realising annual run-rate savings of more than £2 billion
– Strong initial progress on delivery of simplification initiatives, using our proven capabilities from Integration
– Simplification run-rate cost savings of £242 million at end 2011
Invest to be the best bank for our customers: creating new opportunities for growth
– Successful launch of multi-brand strategy, including relaunch of Halifax as a challenger brand
– Support for Small and Medium-sized Enterprises (SMEs) strengthened: Merlin commitments exceeded,
and Commercial loan growth of 3 per cent against UK market, down 6 per cent
– Good Bancassurance progress with Retail and Commercial (SME) customers
– Increased market shares in key, capital-light Wholesale products, facilitated by Arena platform
– New Wealth propositions developed covering 80 per cent of customers, and processes simplified
3
Annual Report and Accounts 2011
GROUP PERFORMANCE
Key highlights (continued)
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
– Combined businesses profit before tax increased 21 per cent to £2,685 million in 2011
– Core combined businesses profit before tax increased 3 per cent to £6,349 million
– Statutory loss before tax was £3,542 million (2010: profit of £281 million), and includes a £3.2 billion non-recurring
provision for Payment Protection Insurance (PPI) contact and redress costs
Income decreased 10 per cent to £21,123 million, reflecting subdued lending demand and continued customer
deleveraging in the core, a smaller non-core portfolio, and a lower margin
Banking net interest margin reduced by 14 basis points to 2.07 per cent, in line with expectations, with increased
funding costs partially offset by the benefits of asset repricing and funding mix; core net interest margin declined
only 6 basis points to 2.42 per cent given the better funding mix in the core business
Total costs fell 4 per cent, primarily driven by Integration and Simplification related savings and lower bonus accruals,
partially offset by inflationary pressures and UK bank levy and FSCS costs
The impairment charge reduced significantly, by 26 per cent to £9,787 million, with improvements seen across
all divisions, reflecting improving portfolio credit quality
Outlook and financial guidance
Expect the external environment to remain challenging in 2012
Remain confident that our medium-term financial targets, as set out in our June 2011 Strategic Review are
achievable over time
– As anticipated in our Q3 2011 Interim Management Statement, now expect the attainment of income related
targets, including for other operating income, to be delayed beyond 2014 as a result of the weaker than expected
economic outlook
– As a consequence, also expect the attainment of our return on equity target to be delayed beyond 2014
– Continue to expect to deliver our balance sheet, cost and impairment targets in 2014, and in some cases sooner
– In-year cost savings target for 2014 increased by £200 million to £1.7 billion; end 2014 run-rate target increased to £1.9 billion
– Given expectation of further deposit growth, expect to reach medium-term Group loan-to-deposit ratio target
of 130 per cent or below by the end of 2012, two years ahead of plan
In 2012, on a combined businesses basis, we expect:
– Income to be lower than in 2011 given the economic outlook, further non-core asset reductions, subdued demand
in the core loan book, higher wholesale funding costs, and interest rates likely to remain at low levels for longer
– Full year banking net interest margin to be below 2 per cent in 2012, falling year-on-year by approximately
the same amount in 2012 as in 2011, primarily driven by continuing high wholesale funding costs
– A further reduction in costs, and a similar percentage reduction in Group impairment as seen in 2011,
with the largest improvement coming from International
– The benefit from fair value unwind to reduce to approximately £0.5 billion
– To continue to strengthen our balance sheet through: non-core asset reduction of approximately £25 billion, further
deposit growth, at least in line with the market, and strengthening our funding position and our core tier 1 ratio
4
Annual Report and Accounts 2011
GROUP PERFORMANCE
Combined businesses – results summary
Net interest income
Other income
Effects of liability management, volatile items and asset sales1
Total income
Insurance claims
Total income, net of insurance claims
Costs:
Operating expenses
Other costs2
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit (loss) before tax and fair value unwind
Fair value unwind
Profit before tax – combined businesses
2011
£m
12,233
9,307
(74)
21,466
(343)
21,123
(10,253)
(368)
(10,621)
10,502
(9,787)
27
742
1,943
2,685
Reconciliation of combined businesses profit before tax to statutory (loss) profit before tax
Profit before tax – combined businesses
Integration, simplification and EC mandated retail business disposal costs
Volatility arising in insurance businesses
Amortisation of purchased intangibles
Provision in relation to German insurance business litigation
Payment protection insurance provision
Customer goodwill payments provision
Pension curtailment gain
Loss on disposal of businesses
(Loss) profit before tax – statutory
2011
£m
2,685
(1,452)
(838)
(562)
(175)
(3,200)
–
–
–
(3,542)
2010
£m
14,143
9,936
(93)
23,986
(542)
23,444
(10,882)
(196)
(11,078)
12,366
(13,181)
(91)
(906)
3,118
2,212
2010
£m
2,212
(1,653)
306
(629)
–
–
(500)
910
(365)
281
1
2
Includes the gains from liability management exercises, the net effect of banking volatility, changes in the fair valuation of the equity conversion feature of the Group’s Enhanced Capital
Notes, net derivative valuation adjustments and gains or losses on disposals of assets which are not part of normal business operations.
Other costs include FSCS costs and UK bank levy in 2011, and FSCS costs and impairment of tangible fixed assets in 2010.
5
Annual Report and Accounts 2011
GROUP PERFORMANCE
Summary consolidated balance sheet
At 31 December
Assets
Cash and balances at central banks
Trading and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and receivables:
Loans and advances to customers
Loans and advances to banks
Debt securities
Available-for-sale financial assets
Held-to-maturity investments
Other assets
Total assets
Liabilities
Deposits from banks
Customer deposits
Trading and other financial liabilities at fair value through profit or loss
Derivative financial instruments
Debt securities in issue
Liabilities arising from insurance and investment contracts
Subordinated liabilities
Other liabilities
Total liabilities
Total equity
Presentation of information
2011
£ million
2010
£ million
60,722
139,510
66,013
565,638
32,606
12,470
610,714
37,406
8,098
48,083
38,115
156,191
50,777
592,597
30,272
25,735
648,604
42,955
7,905
47,027
970,546
991,574
39,810
413,906
24,955
58,212
185,059
128,927
35,089
37,994
923,952
46,594
50,363
393,633
26,762
42,158
228,866
132,735
36,232
33,923
944,672
46,902
In order to provide more meaningful and relevant comparatives, the results of the Group and divisions are presented on a ‘combined businesses’
basis. The key principles adopted in the preparation of the combined businesses basis of reporting are described below.
In order to reflect the impact of the acquisition of HBOS, the amortisation of purchased intangible assets has been excluded; and the unwind of
acquisition-related fair value adjustments is shown as one line in the combined businesses income statement.
In order to better present business performance the effects of liability management, volatile items and asset sales are shown on a separate line in
the combined businesses income statement and the following items, not related to acquisition accounting, have also been excluded:
– integration, simplification and EC mandated retail business disposal costs;
– volatility arising in insurance businesses;
– insurance gross up;
– provision in relation to German insurance business litigation;
– payment protection insurance provision;
– customer goodwill payments provision;
– curtailment gains and losses in respect of the Group’s defined benefit pension schemes; and
– loss on disposal of businesses.
To enable a better understanding of the Group’s core business trends and outlook, certain income statement, balance sheet and regulatory
capital information is analysed between core and non-core portfolios. The non-core portfolios consist of businesses which deliver below-hurdle
returns, which are outside the Group’s risk appetite or may be distressed, are subscale or have an unclear value proposition, or have a poor fit with
the Group’s customer strategy. The EC mandated retail business disposal (Project Verde) is included in core portfolios. A full reconciliation of the
combined businesses basis to the statutory basis is given in note 4 on pages 231 to 236. Unless otherwise stated, the commentaries on pages 21
to 97 are on a combined businesses basis.
6
Annual Report and Accounts 2011
KEY PERFORMANCE INDICATORS
Measuring
strategic
perforMance
Unlocking the Group’s potential
We are reshaping our business portfolio to fit our assets,
capabilities and risk appetite, simplifying the Group to improve
agility and efficiency, investing to be the best bank for customers
and strengthening the Group’s balance sheet and liquidity position.
A comprehensive set of Key Performance Indicators (KPIs) has
been developed to track progress in these areas and is outlined
in the Strategy section. Selected Group KPIs are outlined below:
Balance sheet reduction
(non-core assets)
£bn
Integration cost synergies £bn
(run-rate)
236
194
2.1
141
1.4
0.8
2009
2010
2011
2009
2010
2011
Excellent progress continues to be
made in reshaping the business
through the reduction of our
non-core assets which now stand at
£141 billion, following a £53 billion
reduction in the year.
The integration programme is now
largely complete and successfully
delivered more than £2 billion per
annum of cost synergies. We are
now progressing the simplification
initiatives.
Our corporate strategy
Our strategy is built around becoming the best bank for individual,
commercial and corporate customers across the UK and creating value
by investing in areas that make a real difference to these customers.
Customer leadership driven by superior customer insight, tailored
products, better service and relationship focus is the overriding
priority. This customer focus will enable delivery of strong, stable and
sustainable returns for shareholders over time.
We have over 30 million customers, iconic brands, including Lloyds TSB,
Halifax, Bank of Scotland and Scottish Widows, and high-quality,
committed people. We are looking to create a simpler, more agile,
efficient and responsive organisation with a real focus on operating
sustainably and responsibly. Whilst focusing on core markets which
offer strong returns and attractive growth, we will maintain a prudent
approach to risk and further strengthen the Group’s balance sheet.
24–29
More on our corporate strategy
Building customer relationships
Customer relationships are key to our strategy and critical for all our
businesses. The significant differences across the divisions means
financial and non-financial strategic indicators for the development of
customer relationships are generally tracked at a divisional level and
commentary is included in the specific divisional commentaries.
To measure progress in our aim of becoming the best bank for
customers we have introduced a new customer satisfaction measure and
are publically committed to reducing complaints. Our colleagues are a
key differentiator and we have also introduced a new engagement survey
to assess individual motivation and organisational processes.
Cost:income ratio
%
Loan to deposit ratio
%
Customer satisfaction
(net promoter score)
%
Staff engagement score %
UK industry average
48.4
46.6
50.3
169
154
135
44
38
69
63
61
52
2009
2010
2011
2009
2010
2011
2010
2011
EEI
2011
PEI
2011
Although the cost:income ratio
increased in 2011, largely as a result of
income reduction associated with the
risk and balance sheet reduction, we
continue to expect simplification
initiatives to help reduce this over time.
We have made good progress
in reducing our loan-to-deposit
ratio, thereby strengthening our
balance sheet.
We have developed a comprehensive
customer experience program
measuring customer service at key
touch points and likelihood to
recommend through the cross industry
Net Promoter Score metric.
The Employee Engagement Index (EEI)
measures the individual motivation of
colleagues whilst the Performance
Excellence Index (PEI) measures how
strongly colleagues believe the Group is
committed to improving customer service.
24–29
More on strategy and KPIs
31–33
34–37
More on customer satisfaction
More on our staff engagement score
7
Annual Report and Accounts 2011
KEY PERFORMANCE INDICATORS
Alignment with remuneration
To help ensure individuals are acting in the best interest of customers and
shareholders, remuneration at all levels of the organisation across the
business is aligned to the strategic development and financial performance
of the business. All staff, including Executive Directors, have a balanced
scorecard comprising five areas (building the business, customer, risk, people
and finance) which is aligned to the Group’s strategic priorities and reviewed
on a regular basis. Executive remuneration, in particular bonuses and
incentive plans, is also assessed against balanced scorecard measures which
incorporate Group financial performance measures, notably profit before
tax, economic profit, earnings per share and total shareholder return.
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.
Profit (loss) before tax
(combined businesses basis)
£m
Statutory profit (loss)
before tax
£m
2,685
2011
2,212
2010
1,042
2009
281
2010
2011
2009
(6,300)
(3,542)
Earnings per share
pence
Core tier 1 ratio
%
10.8
10.2
7.5
2009
8.1
2010
(0.5)
2011
(4.1)
2009
2010
2011
44–53
More on our Group results
8
Annual Report and Accounts 2011
AT A GLANCE
Customer-foCused
operating divisions…
Retail
Retail operates the largest retail bank in the UK and is the leading
provider of current accounts, savings, personal loans, credit cards and
mortgages. With its strong stable of brands, including Lloyds TSB, Halifax,
Bank of Scotland and Cheltenham & Gloucester, it serves customers
through one of the largest branch networks in the UK. Retail is also a
major general insurance and bancassurance distributor, offering a wide
range of long-term savings, investment and general insurance products.
54
Wholesale
The division comprises Wholesale Banking and Markets along with
our Asset Finance business. The Wholesale Banking and Market
business serves corporates with turnover above £15 million with
a range of relationship focused propositions, segmented according
to customer need.
59
Commercial
Commercial serves in excess of a million small and medium-sized
enterprises and community organisations with a turnover of up to
£15 million. Customers range from start-up enterprises to established
corporations, with a range of propositions aligned to customer needs.
Commercial comprises Commercial Banking and Commercial Finance,
the invoice discounting and factoring business.
66
Wealth and International
Wealth and International focuses on the private banking and asset
management businesses of the Group and also operates the Group’s
international business.
70
Insurance
The Life, Pensions and Investments business is the leading
bancassurance provider in the UK and has one of the largest
intermediary channels in the industry. The general insurance business
is a leading distributor of home insurance in the UK and also offers
a range of other general insurance products.
77
1 Excludes Group Operations, central items and insurance claims
47% of total Group income1
Key product markets
– Secured lending – mortgages
– Unsecured lending – credit cards, loans
and overdrafts
– Internet and telephone banking
– Current accounts
– Savings accounts
21% of total Group income1
Key product markets
– Corporate Banking Services
– Treasury and Trading
– Asset Finance
9% of total Group income1
Key product markets
– Commercial Banking
– Commercial Finance
– Invoice discounting and factoring
10% of total Group income1
Key product markets
– Wealth management
– Asset management
– International Banking
13% of total Group income1
Key product markets
– Life assurance,
pensions and investments
– General Insurance
9
Annual Report and Accounts 2011
AT A GLANCE
…leveraged through
our strategiC assets
Iconic and distinct brands
High-quality committed colleagues
The Group operates a range of well recognised brands across our
five operating divisions with different brands utilised for different
customer segments, geographies and markets. The main four brands
operated by the Group are Lloyds TSB, Halifax, Bank of Scotland
and Scottish Widows though a number of other brands are used in
specialist markets.
Our colleagues have continued to perform well despite the challenges
of the economic environment and the significant changes progressing
in the Group. We recognise the importance of our colleagues as
the face of the bank and the fulcrum of our relationship strategy. We
therefore strive to attract, retain and develop the best talent and are
committed to making significant investment in our people.
103,000 employees
34
More on our colleagues
Strong customer relationships
Over the years we have developed long lasting and strong
relationships with our customers. By listening to our customers and
acting accordingly we will continue to build upon these relationships
and become the best bank for customers.
30 million customers
31
More on our customers
An integrated platform
In 2011, the Group successfully completed the majority of its
integration activity, the largest financial services IT integration ever
undertaken. This has not only resulted in significant cost savings
but has provided us with a single banking platform which we can
leverage off to simplify the business further and invest in areas which
provide value for both customers and shareholders. Aligning branch
counter systems, ATMs and Intelligent Deposit Machines, both
reduces training costs and improves the quality of training received,
increasing returns and enhancing the customer experience.
>£2 billion of integration savings
The integrated platform is allowing us to target further simplification
benefits, as announced in June’s Strategic Review, and re-invest in
the Group. Through redesigning our operations and processes, to
reduce bottlenecks and errors, streamlining our product suite and
using a breadth of distribution channels, optimising our sourcing and
delayering our management structure we will be able to quickly and
efficiently react to external pressures and provide improved services
to customers. An element of the savings produced from simplification
will enable us to invest further in the group, creating long lasting value,
improving our strategic outlook and positioning us to deliver strong
and sustainable returns.
Broad multi-channel distribution
The Group operates a comprehensive multi-channel distribution
network, enabling our customers to access products and services at
any time and in a style which suits their individual preferences.
8.3 million active internet users
With 2,900 branches we have the largest branch network in the UK.
This allows a greater number of customers to talk to us face-to-face,
building trust and understanding, and strengthening our relationship
with them. Our investment programme to reinvigorate our branch
network will help ensure these relationships are fostered in a suitable,
comfortable and functional environment. We also operate one of the
largest fee free ATM networks in the UK.
We provide a comprehensive suite of services through other channels
including telephony and the internet.
Our telephony system gives, with 24/7 access, the ability to either use
automated facilities for speed or speak to an operator, meaning that
customers can complete their banking needs day or night, at home
or abroad.
Our industry leading and award winning internet platform allows
people to access and view all their products via a secure network.
We have developed and launched innovative internet tools such as
Money Manager, which breaks down customer spending in to specific
categories, allowing customers to track their spending more effectively.
Digital banking has also taken advantage of other technological and
social changes. Our mobile banking apps have had over 1.5 million
downloads and have been some of the most popular free financial
apps in the Apple App Store in recent months. We are also using
social media to reach our customers, gaining praise for our use of
Twitter and Facebook and Lloyds TSB was the first UK bank to launch
a branded YouTube channel.
10
Annual Report and Accounts 2011
CHAIRMAN’S STATEMENT
Sir Winfried Bischoff
A yeAr of
chAnge And
encourAging
ProgreSS
Overview
2011 was a year of low economic growth and challenging markets
in many parts of the world, which resulted in a difficult year for the
banking industry as a whole. The UK sector in particular was affected
by a weakening UK economic environment, continuing regulatory
uncertainty and the impact of the Euro crisis.
Despite this environment, we made progress against our objective
of being the best bank for customers and on the key actions we are
taking to deliver strong, stable and sustainable returns for shareholders
over time. We created a new management team, presented our new
strategy and are refocusing the business to meet our customers’ needs.
We also delivered a resilient performance in the core business, and
made good progress on the reduction of non-core assets.
Having largely completed one of the biggest integrations ever
undertaken in banking, we are now working hard against a demanding
set of targets to simplify the Group to improve our agility and efficiency,
thereby realising cost savings which we will invest to enhance our
service to customers. By delivering against this plan, we will seek to
unlock the potential in our franchise and deliver increased value to
our shareholders.
We accelerated the EC mandated disposal, the transaction known as
‘Verde’, and made significant progress in strengthening the balance
sheet and our funding position whilst delivering a resilient underlying
trading performance. We took responsible position on Payment
Protection Insurance (PPI), continue to improve switching for current
accounts and have made excellent progress, with more to come, in
reducing the number of complaints. As a result we believe the Group
is in a stronger position as we move into 2012.
Despite the progress made there were a number of challenges. In
particular our share price performance, down 61 per cent over the
year, although partially due to external factors, is not acceptable. This
decline compares with a fall of 30 per cent of an index of UK banks
and of 38 per cent of European banks. Nor are the financial results
satisfactory, particularly given a number of one off items, including the
£3.2 billion provision for PPI. This provision has had a significant impact
on our statutory results but the decision to take this approach reflects
the Bank’s desire to do the right thing for customers.
11
Annual Report and Accounts 2011
CHAIRMAN’S STATEMENT
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.
For this reason I am pleased to note that our involvement in Project
Merlin has been successful: We met and continue to exceed our
agreed lending levels. We provided £45.3 billion of committed gross
lending to UK businesses in 2011, and helped 124,000 new start up
businesses. All of this has been achieved while acting as a responsible
lender. We have more than delivered on our promise to provide gross
new lending for credit-worthy UK businesses and have pledged yet
more lending for the UK economy in 2012.
At the same time, our Insurance business, including Scottish Widows,
has continued to perform well through its established value rather
than volume strategy and through its focus on customers. Our
Bancassurance business continues to highlight the importance of
meeting our customers’ protection needs and has had a successful
year doing so.
We are also well aware of the public concern around the banking
industry and recognise that further progress needs to be made in
rebuilding public trust industry-wide. We can only earn that trust by
addressing the fundamental requirements of all our stakeholders, and
by being open, transparent and engaged in the broader debate about
the role of banking in the UK. We will continue to demonstrate that we
are meeting our obligations to customers and society in a responsible
and appropriate way. At the same time we believe, whatever the
sector’s shortcomings, the debate about the banking industry has
become one-sided which is unhelpful in achieving what those both
inside and outside the banking industry want: a growing, strong
economy supported by a strong banking sector.
Remuneration
The Remuneration Committee undertook a further review of
executive remuneration in 2011. Anthony Watson, the chairman
of the Remuneration Committee, comments on detailed aspects
of our remuneration policy elsewhere in this Report. I want to give
shareholders some additional explanation of our philosophy and the
deliberations underlying incentive compensation for 2011 and for the
2009-2011 Long-Term Incentive Plan.
Remuneration remains an important issue for our stakeholders and the
Group. As we are primarily a retail and commercial bank the awards
under our Group bonus schemes in 2011 are a very small percentage
of our revenues at less than 2 per cent, and at less than 12.5 per cent
of the profits before tax and bonus on a Combined Businesses basis.
Additionally, compensation fell this year in total and average terms.
The bonuses paid, greater than half in shares, averaged less than
£3,900 per employee. We firmly believe that remuneration policy at
all levels, including senior executives, needs to incentivise staff to
deliver strong, sustainable growth whilst reflecting the work required
to reshape the business to fit the new, challenging environment. We
also need, however to be mindful of public concerns about equality
and that remuneration reflects financial results. In asking not to be
considered for a bonus in 2011, António made a principled decision
with regard to his remuneration, a decision the Board fully supported.
We believe that it is fair and reasonable that the activities which led to
the PPI provision are reflected in the Long-Term Incentive Plan (LTIP) for
the years 2009 to 2011 in spite of the longer term nature of the issue.
Our current shareholders who may not have been shareholders at the
time the income on PPI arose have been affected by the impact of the
provision in 2011 and therefore the Board, on the recommendation of
the Remuneration Committee, decided that the provision should also
impact the awards to our senior executives.
With respect to the LTIP, Shareholders will recall that awards for
Executive Directors have not paid out in any of the past three years.
The annual pay-out of the LTIP, averaged over the last four years,
is under 0.2 per cent of total pay, in stark contrast to what is the
general perception.
Regulation
The level of regulatory scrutiny across all areas of the business remains
high, but there is some expectation that in 2012 we will start to see
more clarity in a number of the key areas which will shape the industry’s
future. I believe robust and stable regulation of the sector is an
important component in rebuilding confidence and creating a healthy
and sound financial system. Changes to the regulatory framework are
necessary in the wake of the financial crisis. The reforms proposed by
the Vickers Commission in its Independent Commission on Banking
(ICB) report are an important step towards a safer and stronger sector.
Further clarity is still required on some of the specific detail, and
implementation will have many challenges. However I remain hopeful
that the proposed changes will strengthen the banking sector and
safeguard the interests of individuals and institutions. At the same time
we forget at our peril the importance of financial services in all parts of
the UK to our economy.
In December we were pleased to announce that the Co-operative
Group is our preferred bidder for the EC mandated disposal (Project
Verde). The acquisition will significantly enhance their banking
operations, producing a new and effective competitor in the market,
as the EC mandate envisaged. This transaction combined with
complementary measures to improve current account switching and
actions taken to improve the transparency and comparability of retail
products will, I believe, further enhance the UK’s competitive retail
banking market.
Equity Dividends
The European Commission’s restriction on dividend payments was,
initially placed on us as part of the State Aid restructuring plan which
expired in early 2012. We understand that the absence of dividends
has created difficulties for many of our shareholders and we remain
committed to recommencing progressive dividend payments as soon
as we are able.
It is our intention to do so when the financial position of the Group and
market conditions permit and after regulatory capital requirements are
defined and prudently met. At this time those requirements remain
unclear and although we have made good progress against our
strategic priorities during the year we are not yet able to forecast when
we will be able to resume dividend payments.
12
Annual Report and Accounts 2011
CHAIRMAN’S STATEMENT
Management and Board
The year has seen significant management change within the Group
as we enter the next stage of our development. We have a strong
and experienced management team, which proved its effectiveness
throughout the year.
António Horta-Osório started as Group Chief Executive on 1 March
2011 and we were pleased to recruit someone with his knowledge
and experience of financial services, particularly in the retail and
commercial area. The actions taken by him have already had a positive
impact on the Group. António took a two month leave of absence at
the end of last year and the Board was pleased that he was able to
return to his role on 9 January 2012. In conjunction with the Board,
António has implemented a number of changes to the structure of the
management team since his return to ensure that the most important
aspects of our business are prioritised and the responsibility of
managing our Group is effectively shared.
We announced in September 2011 that Tim Tookey, our Group
Finance Director, would leave the organisation at the end of February
2012. Tim has been an important member of our Board since
October 2008 and helped guide us through the largest merger in UK
banking history and subsequent capital raisings. I thank Tim for his
commitment throughout that time, not least in the last two months of
2011, when he took on the role of Group Chief Executive on an interim
basis in addition to his responsibilities as Group Finance Director.
I am pleased that we were able to announce that George Culmer
will join us as our new Group Finance Director in time for the annual
general meeting on 17 May 2012 His knowledge and experience of
insurance and his track record as a highly regarded FTSE 100 Finance
Director will be of great value to us.
I would also like to thank Helen Weir and Archie Kane, who left the
Group in 2011, for their significant contribution to the Group over
many years. Helen was Group Finance Director and then led our Retail
business. Archie was the Group Executive Director of our successful
Insurance business, Scottish Widows.
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.
Sara Weller joined as a Non-Executive Director on 1 February 2012.
Her background in retail and in the application of new technology
such as the internet directly support our strategy.
Sir Julian Horn-Smith, Independent Director since 2005 will not be
standing for re-election at the annual general meeting. His counsel and
advice on aspects of technology, marketing and customers will be much
missed.
Glen Moreno, our Senior Independent Director and Deputy Chairman,
will not be seeking re-election at the annual general meeting. He has
been a tower of strength on our Board and his wide knowledge of
banking and financial services developed over many years in senior
executive positions has been of great benefit to our strategy and
operations. His constructive and informed contribution will be missed
by all.
The Board has appointed Anthony Watson as Senior Independent
Director and David Roberts as Deputy Chairman with effect from the
annual general meeting.
Finally, Truett Tate, Executive Director for Wholesale, has retired from
the Group. He made a major contribution in a number of senior
roles since joining the Group in 2003. He is the quintessential client
advocate and in addition he was a great ambassador for many of
our corporate responsibility and charitable programmes. I enjoyed
working with him and we wish him well for the future.
As a Board and throughout the organisation we continue to focus on
our commitment to meeting the targets set by the Review on Gender
Diversity on Boards by Lord Davies, and are working proactively to
promote diversity in ethnicity, gender and skills.
People
We employ over 100,000 people. Our colleagues have performed
well in a year which was characterised by much change and a difficult
economic environment for both customers and themselves. Customer
service is at the heart of our activities and I applaud their efforts
to reduce complaints, evidenced by the data for 2011 which show
a 24 per cent reduction in year over year FSA reportable banking
complaints excluding PPI. Our colleagues share the Board’s view that
more needs to be done and I feel confident that 2012 will bring further
progress in this area.
More generally, I would like to thank them for their commitment and
loyalty in what were challenging circumstances and in a climate of
unfavourable public commentary on their work and livelihood. We are
all determined to demonstrate the utility and usefulness of banking,
specifically our type of banking, concentrated as it is on the UK and
within that on retail and commercial banking.
Community
The principal means by which Lloyds Banking Group can benefit
society and the communities where we operate is to be a successful
business. Lloyds Banking Group plays a part in the lives of nearly
everyone in the UK, as a supplier of financial services, a major
employer, and a customer. We look after the financial needs of over
30 million retail and business customers. In addition we employ
100,000 people and are a significant buyer of goods and services to
support our business. We therefore have a relationship with nearly
every home and with many businesses in the UK. We have a presence
in most communities and our brands are well recognised across the
country. At a time when the banking sector is under increased public
scrutiny, we acknowledge our responsibility to provide the proper
flow of credit to the economy by delivering simple products, great
customer service and secure banking every day. We do this for more
customers and businesses than any other bank in the UK.
We also continue to invest actively in the communities where we
operate both directly through our community giving programme,
and indirectly through our charity activities and staff giving days. In
2011, we invested £85 million in local communities, including support
for financial inclusion and donations through the Group’s charitable
foundations. Over the last 25 years, the Group has contributed in
excess of £510 million through its Foundations. Our new programmes
supporting financial literacy, Money for Life, and our funding of
university places through Lloyds Scholars show our continued
commitment to support our communities.
We are excited to be the Official Banking and Insurance Partner of
the London 2012 Olympic and Paralympic Games. We have played
a key role in bringing London 2012 to communities across the UK, by
inspiring children to do more sport through National School Sport
Week, by giving our customers the chance to take part in the Olympic
Torch Relay and by funding and mentoring future stars of Team GB and
13
Annual Report and Accounts 2011
CHAIRMAN’S STATEMENT
ParalympicsGB through our Local Heroes programme. We have also
supported one in three of all businesses who have won London 2012
Games related contracts. We are now entering the final few months
before the Games start and I fully expect that the country at large will
enjoy this historic event, be inspired by its achievements and benefit
from the legacy of this once-in-a-lifetime event.
Outlook
Lloyds Banking Group has made significant structural and strategic
progress during 2011 but there remains much to be done against the
background of the current economic and regulatory environment.
It remains our intention over time to operate as a wholly privately owned,
self-supporting, dividend paying, commercial enterprise. I believe our
approach of focusing on customers in the UK whilst capitalising on
our strong relationships, on our iconic and distinct brands, on our broad
multi-channel distribution and on the clear operating model we have
created is the right one. We saw the early benefits of this approach in
A commitment to good Governance
The Board and I place great importance on Corporate Governance.
Not just because of increasing focus on this area, but because
good governance is in the best interests of the company. The Board
is ultimately responsible for the Group’s success through setting
strategy, devising sound governance arrangements, and establishing
the values and standards of the Group. Throughout the year ending
31 December 2011, the Group complied with all relevant provisions
of the Financial Reporting Council’s UK Corporate Governance Code.
This is an important base level but in undertaking its responsibilities
the Board seeks to exceed these minimum standards, as we believe
that good governance is a key contributor to the Group’s long term
success.
Our Board
There have been significant changes to the composition of the Board
this year. Though experience and a detailed understanding of financial
services will remain important attributes for Board members, a broader
mix of skills is key to the overall effectiveness of the Board. I believe
that the current Board provides the Group with a good balance of
skills and experience, which helps the quality of our decision-making.
We remain committed to keeping this balance right as we respond to
further Board changes in 2012. I continue to ensure that the majority
of Directors are independent and that sufficient emphasis is placed on
ensuring that the Board’s membership reflects appropriate diversity.
In the interests of good governance, all directors now retire voluntarily
each year and submit themselves for re-election at every AGM.
177–186
More on Corporate Governance
187–203
More on Directors’ Remuneration
2011 through the resilient performance of our core business and the good
progress in reducing our non-core assets.
Our support for the wider economy and the communities where we
operate, in conjunction with our prudent risk appetite, a strengthened
balance sheet and integrated systems are a sound platform for a
positive financial trajectory.
Our Board is grateful for the support of our shareholders in 2011 and is
very conscious that they – including most of our staff who themselves
are shareholders – have suffered through the decline of the share price
and the absence of a dividend. We have the right strategy in place and
given our significant assets, our committed leadership team and the
skill of our dedicated workforce we are well positioned over time to
deliver sound performance for our customers, shareholders, colleagues
and communities.
Sir Winfried Bischoff
Chairman
Board oversight in 2011
The Board’s governance processes have placed us in a good position
to deal with key issues which arose during the course of the year,
including with respect to:
the review and approval of the Group’s new strategy;
the change of Group Chief Executive and other significant
management changes;
the short leave of absence for António Horta-Osório, including
ensuring that effective interim arrangements were in place and that a
rigorous process was followed with respect to his return to work; and
the decision to take a significant provision with respect to PPI.
Ensuring that the right mechanisms are in place at the time of change is
critical and I believe that the decisions made in these areas, and others,
have helped ensure that the Group is effectively positioned to deliver
sound performance for all of the Group’s stakeholders over time.
Executive Remuneration
As I have already referenced in my statement, remuneration remains
an important issue for shareholders, and other key stakeholders. This is
a sensitive area, but the Board is committed to ensuring that the right
balance is struck between the need to incentivise staff, at all levels of
the organisation, to deliver strong, sustainable growth, whilst reflecting
the work required to reshape the business, and broader concerns
about fairness.
As a Group we are committed to meeting the regulatory and other
requirements that apply to this topic, including the FSA Code,
and more generally improving the transparency of remuneration
disclosure. We always look to align reward with the Group’s long term
performance and the interests of its shareholders. We fully endorse a
stringent deferral process, as an important element of this alignment.
We maintain an open dialogue with our major shareholders to help
ensure appropriate remuneration policies are developed, and that
shareholder concerns are taken into account.
During 2011 we have continued to be mindful of the need to exercise
restraint as part of the effective governance of executive pay and as a
result a number of actions have been taken, including not increasing
fixed pay for Directors.
14
Annual Report and Accounts 2011
GROUP CHIEF EXECUTIVE’S REVIEW
António Horta-Osório
Becoming
the Best
Bank for
customers
In 2011, we delivered a resilient
“
performance and made good
progress against the key elements
of our strategic plan to become
the best bank for customers.”
15
Annual Report and Accounts 2011
GROUP CHIEF EXECUTIVE’S REVIEW
Summary
In 2011, we established our longer term strategy for the Group,
acted quickly and decisively to mitigate the effects of a challenging
environment and put in place the right foundations to deliver on our
objectives over the next 3-5 years, whilst continuing to support the
UK economy. Using the framework set out in our Strategic Review,
we accelerated strengthening our balance sheet, decreasing risk
and reducing costs. The investments we made behind our brands,
distribution, customer relationships and people have strengthened
our franchise, and created new opportunities which will enable us
to realise over time the Group’s full potential for growth. We also
made good progress on the EC mandated business disposal (Project
Verde), and saw greater clarity emerge on the future UK regulatory
framework following the publication of the Independent Commission
on Banking’s (ICB’s) final report and the Government’s response on
19 December 2011.
As a result, in 2011, we delivered a resilient performance and made
good progress against the key elements of our strategic plan to
become the best bank for our customers, despite a weakening UK
economy, ongoing financial market volatility, continued high levels
of regulatory scrutiny and competitive markets. We are now better
positioned to adapt to the changing economic environment and
to realise over time the full potential of our franchise, brands and
capabilities, and therefore to deliver strong, stable and sustainable
returns for our shareholders.
2011 results overview
The results reflect our focus on rapidly improving the Group’s risk
profile and further strengthening the balance sheet, through improving
the Group’s capital and funding position and making substantial
progress on non-core asset reductions, deposit growth, and our
funding programme.
While this means that we now have a much more resilient balance
sheet, our income performance was affected by these risk and asset
reductions, as well as by the subdued UK economic environment. On a
statutory basis, our results were affected by, amongst other things, the
responsible position we took on Payment Protection Insurance (PPI),
which resulted in a £3.2 billion provision. In addition, with over £2 billion
of run-rate cost savings now realised from integration, we have
now commenced the simplification initiatives which will significantly
improve our efficiency and are allowing us to invest in growing our core
customer business.
In reducing risk and strengthening the balance sheet, our proactive
management of the non-core portfolio and of our funding position
meant that we reduced non-core assets by £53 billion to £141 billion,
against a commitment to decrease the non-core portfolio to less than
£90 billion by the end of 2014, and significantly strengthened our
funding position, raising £35 billion of total term wholesale funding,
around £10 billion more than initially budgeted.
The new pricing management of savings products we introduced in the
year and our multi-brand strategy resulted in customer deposit growth
(excluding repos) of 6 per cent, significantly above market growth,
and without leading the market on rates. We had a particularly strong
performance in our Halifax challenger brand as a result of innovative
products launched in the year. As a consequence of our actions in
reducing non-core loans and increasing deposits, we substantially
improved our loan to deposit ratio, by 19 percentage points to
135 per cent.
Deposit growth and our progress in funding and non-core asset
reductions facilitated further substantial pay-down of government and
central bank facilities from £97 billion at the 2010 year end to £24 billion
at the end of 2011 (with nothing outstanding under the UK Special
Liquidity Scheme). Non-core asset reductions, which were made
broadly in line with book value, were a substantial driver behind the
improvement in our core tier 1 capital ratio from 10.2 per cent at the
2010 year end to 10.8 per cent, notwithstanding the impact of the PPI
provision of around 60 basis points.
The Group reported a combined businesses profit before tax of
£2,685 million in 2011 (2010: £2,212 million), and excluding the effects
of liability management, volatile items and asset sales, profit before tax
was £2,022 million (2010: £1,651 million). The core business delivered
a resilient performance, with profit before tax of £6,349 million
(2010: £6,152 million), and excluding volatile items, liability management
effects and asset sales profit before tax was £5,746 million
(2010: £6,101 million). On a statutory basis, the Group reported
a loss before tax of £3,542 million in the year, which includes the
PPI related provision.
Subdued markets in the core business and the effect of non-core asset
reductions resulted in a reduction in income (excluding volatile items,
liability management effects and asset sales, and net of insurance
claims) of 10 per cent to £21,197 million. This was partly offset by a
6 per cent reduction in operating expenses, despite the headwinds of
inflation and higher taxes, as a result of the management actions we
took during the year, and a 26 per cent reduction in the impairment
charge, reflecting improving credit quality in our portfolios.
The benefits from the improvements we achieved in the Group’s
funding mix, increasing deposit balances and reducing the proportion
of wholesale funding, were most clearly evident in our core net interest
margin. This declined by only 6 basis points to 2.42 per cent, despite
the impact of higher funding costs, the effect of refinancing a significant
amount of government and central bank facilities and lower interest
rates in general. However, our Group net interest margin declined
by 14 basis points to 2.07 per cent, in line with guidance, given that
it reflected the full impact of these effects on our predominantly
wholesale funded non-core business.
Our strategy and action plan to deliver for
customers and shareholders
Our strategy, which we set out on 30 June 2011 following an extensive
and detailed review of the business, is focused on the UK, where we
have distinctive assets and capabilities including our valuable customer
franchise and market position, and multiple strong brands.
It is built on being the best bank for our personal, commercial and
corporate customers, creating value by investing in initiatives where
we can make a real difference for them, and focusing on operating
sustainably and responsibly with the objective of delivering strong,
stable and sustainable returns for shareholders over time.
While our focus is on restoring the Group to sustainable profitability
and delivering returns for all shareholders, we expect the delivery of
our strategic targets to provide, over time, an opportunity for the UK
Government to dispose of its shareholding in the Group in an orderly
manner, and deliver value for taxpayers.
16
Annual Report and Accounts 2011
GROUP CHIEF EXECUTIVE’S REVIEW
Delivering our vision –
managing a more
agile organisation
The Group benefits from the depth and diversity of experience within
the management team. The complementary skill sets across the team
strengthens the Group’s ability to effectively adjust to changing market
environments, deliver on our strategic plan and become the best
bank for customers. Brief biographies of the management team are
outlined below:
Standing L to R:
David Nicholson
Group Director,
Halifax Community Bank
David joined Halifax in 1995, and has over
25 years experience in Retail financial
services. Having developed his career
inside the Group, he now has responsibility
for the Halifax Community Bank. He is
also a director of Sainsburys’ bank and
Chairman of the ‘Your Tomorrow’ pension
fund trustees.
Alison Brittain
Group Director, Retail
Alison joined the Group in September
2011. Alison has 25 years Retail and
Commercial Banking experience, having
previously been Executive Director for
Retail Distribution at Santander and
prior to that worked at Barclays in senior
management roles across a variety of
business areas and functions.
Mark Fisher
Director, Group Operations
Angie Risley
Group HR Director
Mark joined the Group in March 2009
as Director, Group Operations and
Integration. He is a career banker having
started his career in 1981 with NatWest.
Over the past 15 years, Mark has run scale
banking and technology operations,
including complex change programmes.
Angie joined in May 2007 and outside
of Lloyds Banking Group is also a
Non‑Executive Director of Serco Group
plc and a member of the government’s
Employment Engagement Task‑Force.
Before joining the Group, Angie was
Group HR Director and an Executive
Director on the board for Whitbread Plc.
Antonio Lorenzo
Group Director, Wealth & International
and Group Strategy
Tim Tookey
Group Finance Director
Tim joined the Group in 2006 as Deputy
Group Finance Director, before being
appointed acting Group Finance
Director in April 2008. Appointed to
the Board in October 2008 as Group
Finance Director. Tim left the Group on
24 February 2012.
Antonio joined the Group in March 2011.
Previously at Santander, Antonio was CFO
for the UK business and managed the
Wealth and Intermediaries businesses,
and performed in several other
international roles since joining Santander
in 1998. Prior to this Antonio worked for
Arthur Andersen in the financial sector
whilst he was also a Professor at the
Universidad Europea de Madrid.
Matthew Young
Group Corporate Affairs Director
Matthew joined the Group in
February 2011, having previously been
Communications Director at Santander
UK. Matt has worked in a variety of senior
management roles within the industry,
including Abbey National and NatWest.
Seated L to R:
Juan Colombás
Chief Risk Officer
Juan joined the Group in January 2011
having previously been Chief Risk Officer
at Santander UK. Juan has over 25 years
of banking experience, with Risk, Control
and Business Management roles across
Corporate, Investment, Retail and
Risk divisions.
António Horta-Osório
Group Chief Executive
António joined the Board in January 2011
as an Executive Director and become
Group Chief Executive in March 2011.
Further details can be found on page 173.
John Maltby
Group Director, Commercial
John joined Lloyds TSB in 2007 as
Managing Director, Commercial and
was appointed to the Group Executive
Committee in September 2011. He has
over 20 years experience of delivering
business growth, transformation,
IPOs, acquisitions and divestments in
multi‑national and specialist Financial
Services organisations and was
previously CEO Kensington Group Plc.
Toby Strauss
Group Director, Insurance
Toby joined the Group in October 2011
having previously been UK Life CEO at
Aviva, joining them in 2008. He has a
range of experiences in financial services
and technology sectors, with much time
spent at McKinsey.
17
Annual Report and Accounts 2011
GROUP CHIEF EXECUTIVE’S REVIEW
Our strategy will create shareholder value through simplifying
processes, systems and products and policies, and investing a
proportion of the savings realised from this simplification in growth
initiatives targeted at high-return areas of our business, and by ensuring
that capital is primarily allocated to core growth businesses.
The four elements of our action plan to deliver our strategy are to:
Strengthen our balance sheet and liquidity position
Reshape our business portfolio to fit our assets, capabilities
and risk appetite
Simplify the Group to improve agility, service and efficiency
Invest to be the best bank for our customers and to grow our
core customer businesses
Good progress against strategic initiatives
We are already making good progress against the key initiatives set out
in our strategy.
In reshaping our business portfolio, we have fully embedded across the
business a conservative approach to, and prudent appetite for, risk. We
have in place rigorous controls over the risk profile of all new business,
as evidenced, for example, in the Retail mortgage book where we
have seen impaired loans decreasing but where our coverage ratio has
increased, and are managing and successfully reducing our non-core
assets in a disciplined manner and broadly in line with book value. In
the core business, the improving quality of our portfolios and their
decreasing risk profile, has been reflected in a 7 per cent decrease in
risk-weighted assets. We have also reviewed our existing portfolios and
confirmed them as adequately provisioned.
Given our UK-focused strategy to capitalise on the strength of
our capabilities in the UK, we have also committed to reduce our
international presence from 30 countries to less than 15 by 2014. To
date we have announced the exit from operations in seven countries.
Our integration programme has now delivered single platforms
supporting the Halifax, Bank of Scotland and Lloyds TSB brands and,
by the end of 2011, had achieved more than £2 billion per annum of
run-rate cost synergies and other operating efficiencies.
Simplifying the Group is a cornerstone of our strategy, not only in its
delivery of cost savings, but also importantly in simplifying our products
and services from the customer’s point of view, and allowing us to
increase investment in our franchise. We have now commenced the
delivery of the simplification initiatives set out in our strategy, and by
the end of 2011 had achieved initial run rate savings of £242 million in
the first six months of the programme. We have also greatly improved
our cost management through instituting a rigorous process overseen
by a Cost Board, which has helped the Group drive significant
reductions in our operating expenses.
A portion of the savings realised from our simplification programme
will allow us to further invest to be the best bank for our customers,
and to grow our core customer businesses which is at the heart of
our strategy. We commenced the implementation of a number of
key initiatives in 2011, with the revitalisation of the Halifax brand and
strengthening our support for Small and Medium-sized Enterprises
both resulting in a significant outperformance of those business areas
against market trends.
We have also begun to invest behind increasing our share of capital-
light business in our corporate and commercial businesses. Key
successes included the launch of ‘Arena’, our online foreign exchange
and money market deposit platform and our UK government bond
market making operation in our Wholesale business. In Insurance,
our focus on UK customer needs delivered a 23 per cent increase in
LP&I UK protection sales (PVNBP), which now account for 22 per cent
(2010: 13 per cent) of bancassurance sales.
Further details on the good progress we have made against our
strategic initiatives in each business are given in each of the divisional
reviews in this document.
Management team changes
On 1 February 2012, we announced changes to the Group’s senior
management team to ensure we have the right organisational
structure to deliver on our strategy and move to the next phase of
the Group’s transformation. As a result, five business lines, Retail,
Wholesale, Commercial, Wealth and International, and Insurance,
now report directly to me and, further to the centralisation of all
control functions as part of the Strategic Review, five control and
support functions also report to me, namely Group Corporate
Functions (into which Human Resources, Legal and Secretariat and
Group Audit report), Risk, Finance, Operations, and Corporate Affairs.
Supporting our customers and the UK economy
As part of our strategy to be the best bank for customers, and as a
leading financial services provider in the UK, we continue to actively
support sustainable growth in the UK economy through the focused
range of products and services we provide to our business and
personal customers, as well as through partnerships we have built
with industry and Government.
The banking industry has faced much criticism in recent years and
we recognise that significant work is required to rebuild trust with
customers and other stakeholders.The financial services sector does
however have a fundamental role to play in society in supporting
both individuals and businesses through the provision of financial and
payment services, and can be instrumental in helping the economy
prosper and grow. The industry can help ensure the future strength
and economic well being of the UK and its people and given our
strategic assets we aim to play an important part in this.
I am pleased to report that during 2011, despite the challenging
economic climate, the Group exceeded its full year contribution to
the ‘Merlin’ lending commitments which were agreed in February
with the UK Government, both for SMEs and in total. In the full year
we provided £45 billion of committed gross lending to UK businesses,
of which £12.5 billion was to SMEs. In the same period, the Group
supported the start-up of 124,000 new SME businesses. For 2012, we
have relaunched our SME Charter in which we have pledged to make
at least £12 billion of gross new lending available to SMEs.
SMEs are a particularly important source of job creation and growth
in the UK. Our core Commercial business is focused on serving these
customers, and we demonstrated our support for SME customers
in 2011 with year on year net lending growth of 3 per cent in this
business area. This compared favourably with the negative growth
in SME lending across the industry reported in the latest available
market statistics from the Bank of England. In 2012, we have pledged
to make at least £12 billion of gross new lending available to SMEs,
with a further pledge to deliver positive net lending growth, to help
stimulate economic output and improve confidence in the sector.
18
Annual Report and Accounts 2011
GROUP CHIEF EXECUTIVE’S REVIEW
As a member of the Business Finance Taskforce, we have led work to
improve SME customer relationships through mentoring and a right
to appeal and have agreed to contribute £300 million to the Business
Growth Fund to provide better access to equity finance.
For our Retail customers, the Group completed £28 billion of new
mortgage business in 2011, achieving a market share of approximately
20 per cent of gross new residential mortgage lending. We are
committed to supporting the UK housing market and first-time buyers
in particular. We advanced more than £5.6 billion of new lending to
first-time buyers in 2011, helping over 52,000 customers own their
first homes. Our market share of new first-time buyer business was
approximately 24 per cent by value in 2011. In total, we advanced
more than £15.5 billion of new mortgages to over 124,000 customers
buying their home in the UK in 2011. Our Halifax brand is a leading
lender in the affordable housing sector, with a dedicated product range
designed for borrowers seeking shared equity or shared ownership
schemes.
Looking forward, as part of our commitment to customers, we will keep
the same net number of branches in our network for the next three
years, excluding Verde, and we will not close a branch if it is the last one
in a community.
We also committed to reduce the level of FSA reportable complaints
we receive, excluding PPI complaints, by 20 per cent in 2011 compared
to 2010. We achieved a 24 per cent reduction, and reduced our
banking complaints per 1,000 accounts to 1.5. We achieved this
through initiatives such as our Phone a Friend service, training of our
40,000 front line colleagues, and the roll out in the second half of an
externally accredited complaint handling qualification. This makes us
the first financial services organisation to have professionally qualified
complaint handlers. To enable our customers get the right outcome
faster, we are extending the opening hours of our specialist complaints
teams to 24 hours a day, 7 days a week. As a result of these initiatives,
we are now resolving over 90 per cent of complaints at first touch. In
2012, we have committed to improving this performance further, by
reducing banking complaints to just 1.3 per 1,000 current accounts,
and in 2014 to 1.0 per 1,000 current accounts.
Meeting our customers’ needs with successful new
products and services
Our strategy recognises our customers’ needs for product simplicity and
transparency, access through multiple channels, and value-for-money
products and services. I am therefore pleased at the success of the
new products and services launched in 2011, and the widespread
recognition and broad range of external awards achieved across the
Group. In Retail, notable product successes included a number of
innovative Halifax savings products, which while not rate-leading,
delivered strong deposit growth. These included, in the first half, the
ISA Promise which saw our cash ISA balances grow significantly above
our historic share, and, in the second half, the Savers Prize Draw which
saw over 450,000 customers registered for the first draw.
We also received a number of external awards recognising the quality
and consistency of delivery to our customers. Within Wholesale, our
Corporate Markets area won the Best Bank of the Year award for the
seventh consecutive year at the Real FD/CBI Excellence awards, while
in Retail we were named ‘Best Overall Mortgage Lender’ for the tenth
year running in the Your Mortgage Magazine Awards and in Insurance
we were named as Britain’s most popular home insurance provider by
the independent market researchers GFK NOP for the tenth year in a
row. In responding to our customers’ need for access through multiple
channels, in Retail, we launched a suite of Mobile Banking apps, and
have now recorded one and a half million downloads.
Our commitment to our employees
Our success depends on our employees, the service they provide
for our customers, and the long-term partnerships they build with
them. We are committed to attracting, retaining and developing our
people, and in 2011 launched a number of initiatives to identify and
develop our future leaders, to simplify the link between performance
and reward, and to ensure colleagues have the capabilities to deliver
excellent service through learning and development resources such as
our Learning Academies, through supporting external qualifications,
and by introducing development and review programmes.
While the results of the colleague engagement survey we conducted
in the second half of the year reflected both the challenging external
environment and the work that remains to be done in ensuring Lloyds
Banking Group is a great place to work, the progress we have made
during the year reflects the strong capabilities and dedication of our
people which will continue to support the delivery of our strategy.
Remuneration is an important issue for our stakeholders and the Group.
We are keen to ensure we recruit and retain the right employees to
drive our business forward and deliver on our strategy while ensuring
that there is alignment between remuneration and results. Variable pay
is reflective of the performance of the business and total discretionary
bonus awards are approximately 30 per cent lower than last year with
bonuses above £2,000 subject to deferral and adjustment. In addition,
given the continued challenging economic conditions salary awards
have been limited, especially at more senior levels.
EC mandated business disposal (Project Verde)
Following our decision early in 2011 to accelerate Project Verde, we
have made good progress, and, having reviewed the formal offers
for the Verde business, the preferred bidder for the business is The
Co-operative Group. Any final transaction will be subject to regulatory
approval and certain other conditions. The Group will continue to
progress an IPO as an alternative to a direct sale. We remain on track
to complete the transfer of the business before the end of 2013.
Equity dividends
The European Commission’s restriction on equity dividend payments
was part of the conditions of the State Aid restructuring plan which
expired in early 2012. We understand that the absence of dividends
has created difficulties for many of our shareholders and we remain
committed to recommencing progressive dividend payments as soon
as we are able.
It is our intention to do so when the financial position of the Group and
market conditions permit, and after regulatory capital requirements
are defined and prudently met. At this time those requirements remain
unclear and although we have made good progress against our
strategic priorities during the year we are not yet able to forecast when
we will be able to resume dividend payments, although we continue to
strive to recommence them as soon as possible.
Greater clarity emerging on UK regulatory
framework
The publication of the ICB’s final report in September and the
Government’s response to the report in December are significant steps
in providing greater clarity on changes to the regulatory framework for
the UK banking industry to secure greater financial stability.
19
Annual Report and Accounts 2011
GROUP CHIEF EXECUTIVE’S REVIEW
On competition, we are pleased that the Verde sale is seen as creating
an effective new challenger in our market, and that our proposals,
developed with the Payments Council, to make it quicker and simpler
for customers to switch accounts, were recommended by the ICB and
backed by the Government.
We also welcome the Government’s endorsement of the ICB’s
proposals to ring-fence retail banking operations as part of a wider
regulatory framework including capital and liquidity and effective
macro- and micro-prudential supervision, which should remove any
implicit tax-payers’ guarantee for the ring-fenced entities. Given that
we are predominantly a retail and commercial bank, we would expect
to be less affected by the implementation of a retail ring-fence, but
believe it will be important for any transition period to be flexible in
order to minimise any impact on economic growth, and for banks to
implement the required structural changes.
The ICB also recommended that ring-fenced banks should hold a
capital base of at least 10 per cent to absorb the impact of potential
losses or financial crises. The Government’s proposals on capital are
consistent with the capital targets we set in our strategic review in 2011
and, although much work remains to be done on the detail of the
implementation capital requirements, we are on track to achieve the
capital levels the ICB recommends.
We expect the Government to provide further details of its plans in
the spring of 2012 and to outline which of the proposals it intends to
progress to legislation. We will continue to work with HM Treasury and
our regulators in the coming months ahead of the publication of the
final white paper.
Economic outlook
While the outlook for the UK economy remains uncertain, and
vulnerable to developments in the Eurozone, we believe the most
likely scenario is for further weakness in the first half of 2012 followed
by a relatively modest recovery in the second half resulting in broadly
flat real GDP for the year as a whole, with further modest recovery in
2013. As a result, we expect UK base rates to remain at current levels
into 2013, and unemployment to rise from current levels to peak at
around 9 per cent in 2013. However, we expect inflation (CPI) to fall
from current high levels to below 3 per cent in 2012 and possibly below
2 per cent in 2013. UK property prices are likely to reflect the weak
economic environment, with house prices remaining broadly flat in
2012 and 2013 and commercial property prices likely to be marginally
weaker in 2012, and marginally stronger in 2013.
Outlook and financial guidance
We expect the external environment to remain challenging in 2012,
with a subdued economy, continued high levels of regulatory scrutiny
and political uncertainty relating to the banking sector, and the
continued potential for downside effects from financial market volatility
and instability in the Eurozone.
Nevertheless, we remain confident that our medium-term financial
targets, as set out in our June 2011 Strategic Review are achievable
over time, although, as we anticipated in our Q3 2011 Interim
Management Statement, we now expect the attainment of our
income related targets, including for Other Operating Income, to be
delayed as a result of the weaker than expected economic outlook.
As a consequence, we now also expect the attainment of our return
on equity target to be delayed beyond 2014. On the other hand, we
continue to expect to deliver our balance sheet, cost and impairment
targets in 2014, and in some cases sooner, given the good progress
made so far.
In relation to our balance sheet, this progress includes the £53 billion
reduction in non-core assets achieved in the year and the 60 basis point
increase in our core tier 1 ratio to 10.8 per cent. As regards our income
targets, we have reduced our asset quality ratio (impairment as a
percentage of average advances) by 39 basis points to 1.62 per cent, a
significant step towards our target of 50 to 60 basis points. The positive
strong momentum of our Simplification programme, with £242 million
of run-rate cost savings already achieved at the end of 2011, means that
we are now increasing our target cost savings from this programme by
£200 million, to £1.9 billion (from £1.7 billion) by the end of 2014, and to
£1.7 billion from £1.5 billion in 2014.
Given the economic outlook, in 2012, on a combined businesses basis,
we expect income to be lower than in 2011, given further non-core
asset reductions, subdued demand in the core business leading to a
broadly stable core book, higher wholesale funding costs, and interest
rates likely to remain at low levels for longer. We retain significant
capacity to grow core assets subject to demand and to maintaining our
prudent appetite for risk. Our banking net interest margin, as expected,
was marginally below 2 per cent in the fourth quarter of 2011. We
expect our full year banking net interest margin to be below 2 per cent
in 2012, falling year-on-year by approximately the same amount in 2012
as in 2011, as a result of continued higher wholesale funding costs, the
repricing of interest earning assets and higher costs from the spread
between base rates and LIBOR. We expect the benefit from fair value
unwind to reduce to approximately £0.5 billion in 2012. However, we
expect a further reduction in costs, and a similar reduction in Group
impairment in 2012 as seen in 2011, as a result of further asset quality
improvements across the divisions, with the largest improvement
coming from International.
We expect to continue to strengthen our balance sheet in 2012, by
a further reduction in non-core assets of approximately £25 billion,
through targeting further deposit growth of around 3 per cent (based
on a continuation of current market conditions), by strengthening our
funding position, with approximately 50 per cent of our term wholesale
funding target for 2012 already completed, and by further improving
our core tier 1 ratio. Growth in customer deposits remains a key part
of our funding strategy, and, assuming a continuation of current trends,
we would expect to reach our medium-term Group loan-to-deposit
ratio target of 130 per cent or below by the end of 2012, two years
ahead of plan.
While we remain mindful of the challenges of the external environment,
Lloyds Banking Group is now in a significantly stronger position than
it was twelve months ago, and I would like to thank all our people for
their contribution to our progress in 2011. Given we are likely to have
lower interest rates for longer and higher regulatory costs along with
deleveraging in credit markets, it will be those banks who can create
competitive advantage through a lower risk premium combined with
best in class efficiency who will achieve superior returns and will capture
the opportunities as economic conditions improve. Absent a material
deterioration in the economic environment, we remain confident in our
ability to continue to execute against our strategic plan, and therefore
continue to believe we are well positioned to realise over time the full
potential of our organisation, brands and capabilities, and to achieve
strong, stable and sustainable returns for shareholders.
António Horta-Osório
Group Chief Executive
20
Annual Report and Accounts 2011
Business review
Marketplace trends
Business model and strategy
Delivering our action plan
Relationships and responsibility
Customers
Colleagues
Communities
Our London 2012 partnership
Summary of Group results
Divisional results
Retail
Wholesale
Commercial
Wealth and International
Insurance
Group Operations
21
24
26
30
31
34
38
42
44
54
54
59
66
70
77
84
Other financial information
86
Core and non-core business analysis
86
Volatility arising in insurance businesses 94
95
Liability management gains
96
Integration costs and benefits
96
Simplification costs and benefits
97
Banking net interest margin
Five year financial summary
Risk management
98
99
21
Annual Report and Accounts 2011
MARKETPLACE TRENDS
The external macro economic and regulatory environment in which we
operate remains uncertain but we have endeavoured to outline below
some of the key regulatory, economic and social factors impacting our
markets.
Regulation
Stringent UK capital and liquidity standards
More focus on consumer protection and transparency
Recovery and resolution mechanisms and Retail ring-fencing
ICB final recommendations
The quantum of regulatory change remains high and the regulatory
environment remains challenging but we are starting to see greater
clarity in a number of areas. There are however a number of different
issues that are likely to have a fundamental impact on the business
going forward including the recommendations arising from the
Independent Commission on Banking, future capital and liquidity
requirements, and the changes to the UK banking supervisory structure
Independent Commission on Banking
In 2010 the UK Government appointed an Independent Commission
on Banking (ICB) to review possible structural measures to reform
the banking system and promote stability and competition. The ICB
published its final report on the 12 September 2011 putting forward
proposals that require ring-fencing some of the retail and SME activities
of banks from their investment banking activities and additional capital
requirements beyond those required under Basel III.
On 19 December 2011 the Chancellor delivered the Government’s
first formal response to the ICB’s Final Report of 12 September. The
response endorsed many of the key recommendations contained in
the ICB’s Final Report, including the ring-fencing of commercial and
retail operations, higher capital requirements and a 7-day current
account switching service. Importantly for the Group, the Government
also supported the principle of a ‘flexible’ ring fence, which allows
banks to choose where to place some (but not all) services.
While the Group welcomes the increased clarity provided by the
Government’s initial response, significant uncertainty remains over
key elements of the reforms, including what activities could be allowed
inside the ‘ring-fenced bank’, the extent of depositor preference
of other creditors and measures that could see some categories of
wholesale funding ‘bailed-in’ in the instance of resolution.
The Government has announced that it will be producing a formal
White Paper in the spring and we would anticipate that this paper
will provide additional clarity, while still leaving some issues open
to consultation. The Group continues to work to assess the impact
that the reforms may have on its business and continues to play
a constructive role in the debate with the Government and other
stakeholders.
Capital Requirements Directive IV
Evolving capital and liquidity requirements continue to be a priority
for the Group. Separate to the capital recommendations laid out by
the ICB, the Basel Committee on Banking Supervision has put forward
proposals for a reform package which changes regulatory capital
and liquidity standards, the definition of ‘capital’, introduces new
definitions for the calculation of counterparty credit risk and leverage
ratios, additional capital buffers and development of a global liquidity
standard. Implementation of these changes is expected to be phased
in between 2013 and 2018 and the fourth round of changes to the
European Capital Requirements Directive IV is currently in draft form
and progressing through the European legal framework towards
finalisation.
UK Banking Supervisory Structure
The recent ongoing difficulties in global financial markets have
prompted a review and alteration to the banking supervisory structure
in the UK. In April 2011, the FSA commenced an internal reorganisation
as a first step in a process towards the formal transition of regulatory
and supervisory powers from the FSA to the new Financial Conduct
Authority (FCA) and Prudential Regulatory Authority (PRA) in 2012.
Until this time the responsibility for regulating and supervising the
activities of the Lloyds Banking Group and its subsidiaries will remain
with the FSA. However, the reorganisation could lead to changes in
how the Group is regulated and supervised on a day-to-day basis.
In addition, the European Banking Authority, the European Insurance
and Occupational Pensions Authority and the European Securities and
Markets Authority as new EU Supervisory Authorities are likely to have
greater influence on regulatory approaches across the EU.
Greater clarity on the Independent
Commission on Banking’s
recommendations was given during the
year but uncertainty over key elements
of the reform proposals still remain.
22
Annual Report and Accounts 2011
MARKETPLACE TRENDS
The economy
The global economy was split in 2011 between relatively strong growth
in emerging markets, and economies struggling to recover from
recession in much of the Western world. Indeed, the extent of the UK
economic recovery has now fallen behind even the weak recovery after
the late 1970’s recession.
Chart 1: UK GDP, real terms
Early ’70s
Late ’70s
Early ’90s
Current
Source: ONS
0
0
1
=
k
a
e
p
n
o
i
s
s
e
c
e
r
-
e
r
P
115
110
105
100
95
90
85
-12
-8
-4
0
Based on data for the first three quarters of 2011, the Irish economy
appears to have grown in 2011 for the first time since 2007, and the
unemployment rate appears to be stabilising. Strict austerity measures
in recent years targeted at improving international competitiveness
are beginning to pay off – falling domestic demand is now being
more than offset by increasing net exports. Property markets remain
very weak, however; house prices fell by over 16 per cent in 2011 and
CRE prices by 11 per cent. Despite the large fall in prices already, an
overhang of vacant property continues to weigh on market prices.
Future economic developments in the UK and Ireland are highly
contingent on how successful political leaders are at stemming the
Eurozone crisis, to what extent the private sector can offset shrinking
of the public sector, and how the implementation of new regulation
on banks impacts their ability to supply credit whilst meeting tighter
capital and liquidity criteria. The recent weakening in the Eurozone
economy and the balance of risks make double-dip recession there in
early 2012 the most likely scenario – indeed this is now the consensus
view (Chart 2).
Chart 2: Consensus forecasts for 2012 GDP growth
4
12
Quarters from peak
8
16
20
24
UK
Eurozone
Source: Consensus Economics Inc.
The stark difference is due to the high levels of indebtedness that many
developed economies accumulated prior to 2008, which are holding
back economic growth through deleveraging of initially the private
sector, but now governments too. In the Eurozone, countries with
particularly high government debt or deficit levels have lost market
confidence as they struggled to achieve the necessary fiscal tightening
to bring their public finances onto a sustainable trajectory without
damaging economic growth prospects too severely. Ireland, Portugal
and Greece have received further IMF and EU financial support in
return for accepting even more stringent austerity programmes, and
at the time of writing it looks likely that private creditors will suffer
effective haircuts of significantly more than 50 per cent on their Greek
debt. Italy and Spain have also tightened public budgets further,
and given their much greater size this is dragging down Eurozone
economic growth more significantly. In the US, public finance concerns
are less immediate, but the unsustainable long term trajectory of debt
on current policies has led to political stalemate, raising the risk of
sudden fiscal tightening as previous loosening measures expire, and
in turn hurting businesses’ and consumers’ confidence. Global growth
was also hampered in 2011 by natural disasters, including the floods in
Australia and the earthquake and tsunami in Japan, the latter causing
significant disruption to global manufacturing supply chains.
First estimates suggest the UK economy grew by 0.9 per cent in
2011, well below the long term average of 2.3 per cent. The economy
is currently estimated to have shrunk slightly in the final quarter of
the year as consumers’ and businesses’ confidence fell, the result
of relatively high inflation reducing consumers’ spending power, a
faster than expected reduction in public sector employment, and
the worsening outlook for the Eurozone which caused companies
to postpone investment spending and recruitment. Unemployment
rose from 7.7 per cent in the first quarter of 2011 to 8.4 per cent by
December. Company failures in England and Wales rose from a low
point of 3,973 in the final quarter of 2010 to 4,260 by the fourth quarter
of 2011, although the failure rate remained steady over that period
at just 0.7 per cent of companies, close to its pre-recession trough.
Property prices were broadly flat through the year, however – house
prices on average fell marginally by 2 per cent in the year to
December 2011, and commercial property prices rose on average
by just 1 per cent.
2.5
2
1.5
%
1
0.5
0
-0.5
J
F M A M J
A
J
2011
Date of forecast
S
O N
D
F
J
2012
The current consensus view for 2012 UK GDP growth is not yet that
weak, at 0.4 per cent. The low level of imbalances in the economy
relative to the 2008 position suggest that weak growth should not
deteriorate into significant recession provided the Eurozone moves
quickly towards a solution to the sovereign debt crisis. Bank Rate
is likely to stay at or close to current low levels for some time, and
property prices are expected to be broadly stable. Unemployment is
likely to rise further, however, as estimates of public sector job cuts have
increased. The current consensus view for 2012 Irish GDP growth is
broadly flat, and the unemployment rate there is expected to be stable.
Property prices are expected to fall further, but by less than in 2011.
However, whilst a definitive solution to the Eurozone crisis remains
lacking there continues to be a high risk that ongoing uncertainty
around the Eurozone economic outlook, the survival of the Euro
currency and the availability of credit could cause a significant recession
in the UK and Ireland. Such a scenario would likely result in higher
UK corporate failures, a second leg of falling property prices, albeit
by less than during the 2008-9 recession, and rising commercial
tenant defaults. Irish property prices would also fall by more than
currently expected. In turn, this would have a negative impact on the
Group’s income, funding costs and impairment charges.
23
Annual Report and Accounts 2011
MARKETPLACE TRENDS
The impact on our markets
The weak economic recovery has kept growth in our markets subdued.
With the economy expected to grow weakly at best in 2012, our central
expectation is that growth in our markets will remain weak in 2012.
For the market as a whole, net new mortgage lending has amounted
to just 0.7 per cent of outstanding balances during 2011, very similar to
2010. Consumers made net repayments of unsecured debt (excluding
student loans) of around 2 per cent of outstanding balances for the
third consecutive year in 2011. Household deposits rose by 2.6 per cent
in 2011 similar to the rate of increase in the previous two years but well
down from the 8-9 per cent growth per year pre-recession.
Similarly, companies have been focused on paying down existing debt,
for the third successive year in 2011. Non-financial companies made
net repayments of 3.7 per cent of sterling lending from banks and
building societies in 2011, after repayments of 3.5 per cent in 2010 and
2.2 per cent in 2009. Company deposits with UK banks rose by 1.1 per
cent in 2011, slower than the 1.8 per cent rise in 2010 and the 4.5 per
cent increase in 2009. Although companies have held back investment
spending and prioritised cashflow, much of this has fed into lower
borrowing rather than higher deposits.
In Ireland, continued falls in house prices, despite the already steep
reductions prior to 2011, have kept impairments high and we expect
property prices to remain subdued.
We expect that another weak year for the UK economy in 2012 will
be accompanied by weak customer deposit growth and a continued
period of declining demand for borrowing, particularly from
companies. The continuation of low interest rates, and the substantial
adjustments that many companies and households have already made
to their indebtedness, is likely to minimise any deterioration in arrears.
Our central expectation of broadly flat property prices in the UK in 2012
is consistent with the subdued market expected.
Customer drivers, including competition
Want simplicity and transparency
Demand a quality, multi-channel customer service experience
Growing demand for advice to plan/save for retirement
Increasingly demand better value for their money
In the competitive open market in which we operate there is an
increasing range of products and services available to customers, and
with the current public scrutiny of banks the expectations and demands
of customers continue to increase.
Access to convenient branches remains important for many customers
but demand for a quality multi-channel banking proposition is now
more prevalent and the provision of effective telephone, digital and
mobile channels is increasingly important. Service remains one of the
key drivers of customer satisfaction and customers are less accepting
of poor service given the competitive nature of the market.
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.
As highlighted above, there are some clear customer trends emerging
but we recognize that every customer, whether they be retail or
corporate, has their own personal needs and has to be treated
individually. It is clear that different customer segments have different
demands and the opportunity exists to differentiate service for varied
segments but fundamentally the customer has a choice and will select
the provider that can most effectively service their personal needs.
The financial services market remains competitive. We are seeing
a number of new entrants including Virgin Money and Metro Bank
looking to make inroads into the market and the disposal of the
Verde branches along with the improved switching process will further
enhance competition.
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.
Marketplace trends
Key opportunities
Economic environment: Significant progress in reducing the Group’s
risk profile and strengthening the balance sheet in recent years along
with strategic actions taken in 2011 means we are better positioned to
benefit as the economy recovers.
Customer requirements: Our strategic assets, including a
comprehensive multi-channel distribution network, strong customer
relationships, well recognised brands and high quality people mean we
are positioned to address the customer trends.
Regulatory environment: Greater clarity emerging
on regulatory requirements.
Key challenges
Economic environment: a weak, short term outlook for the UK
economy, along with continuing economic uncertainty in the Eurozone
and ongoing pressure on the Euro currency.
Regulatory environment: Uncertainty remains over key elements of
the ICB reforms, particularly recovery and resolution mechanisms and
retail ring fencing, and future capital and liquidity requirements arising
from CRD IV remain unclear.
Competition: Increasingly competitive market for lending and
deposits creates margin pressure.
24
Annual Report and Accounts 2011
BUSINESS MODEL AND STRATEGY
Unlocking the
groUp’s potential
Our business model
Lloyds Banking Group is a
leading UK based financial
services group providing a wide
range of banking and financial
services, primarily in the UK,
to personal, commercial and
corporate customers.
Our business model is designed around our distinctive capabilities in
serving personal, commercial and corporate customers across the UK,
with a focused range of banking, insurance, investment, debt financing
and risk management products to meet customer needs.
In delivering these products to our customers we capitalise on our
strong customer relationships, our iconic and distinct brands, our broad
multi channel distribution and our customer focused people.
We have over 30 million customers and customer leadership driven
by superior customer insight, tailored products, better service and
relationship focus is the overriding priority. We want to meet all the
financial needs of our customers and help them succeed financially.
Only by successfully focusing on the needs of customers can we deliver
sustainable value to our shareholders.
Though the UK financial services market remains one of the largest in
the world our business model and strategy has been formulated in the
context of a cautious outlook for the UK economy.
Fundamentally we remain a more conservative, through the cycle,
relationship focused business and with a stronger balance sheet, a
simpler and more efficient structure and the renewed customer focus
we believe we can deliver strong, stable and sustainable returns
for shareholders.
Halifax is being repositioned as a leading
challenger brand in UK retail banking,
with a value for money proposition and
innovative products.
25
Annual Report and Accounts 2011
BUSINESS MODEL AND STRATEGY
Our action plan for success
The four key elements of our action plan to deliver our strategy are
outlined on the next few pages:
reshape…
our business portfolio to fit our assets,
capabilities and risk appetite.
simplify…
the Group to improve agility and efficiency.
invest…
to be the best bank for customers.
strengthen…
the Group’s balance sheet and liquidity position.
Our strategy
A UK focused strategy to be
the best bank for customers,
which will deliver strong, stable
and sustainable returns for
our shareholders.
We are looking to create a more agile, efficient and responsive
customer focused organisation with a real focus on operating
sustainably and responsibly. We will reshape and simplify the business
and invest a portion of the savings realised from the simplification
initiatives in customer related growth initiatives. Whilst focusing on
core markets which offer strong returns and attractive growth we will
maintain a prudent approach to risk and further strengthen the Group’s
balance sheet and liquidity position.
We intend to reshape our business portfolio to fit our assets, capabilities
and risk appetite. We will further reduce the balance sheet through the
continued reduction of our non-core assets and reduce the risk in the
business through the application of a conservative approach to, and
prudent appetite for risk. We will also reduce our international presence.
We believe we can unlock the potential in the franchise and deliver
value to customers and shareholders by creating a simpler, more
agile and responsive organisation. Opportunities exist to increase the
efficiency of operations and processes and reduce costs whilst still
addressing customer needs more effectively. The creation of a simpler,
more agile organisation will enable the Group to adapt more effectively
to the external environment whilst addressing the changing needs of
the customer base more effectively.
Our customer focus remains the key driver for strategy and business
decision making and substantial customer related investment is
planned. Our strategy reflects our customers’ needs for product
simplicity and transparency, access to credit, help in planning and
saving for retirement, demands for access through multiple channels,
value for money products and services and the importance of our
staff in managing customer relationships.
The Bank of Scotland was founded in
1695 and over the years has developed
long lasting, strong relationships with
its customers.
26
Annual Report and Accounts 2011
DELIVERING OUR ACTION PLAN
Reshape
our business portfolio to fit
our assets, capabilities and
risk appetite.
Aim
We will focus on attractive UK customer segments and their
product needs, to target a sustainable statutory return on equity
of between 12.5 and 14.5 per cent.
We will invest behind core areas which offer strong returns and
attractive growth: these are businesses which are capital and
liquidity efficient, with sustainable competitive advantage, and
which are central to our core customer strategy.
In reshaping our business, we have identified the following areas
of focus:
Continued reduction in non-core assets
A prudent appetite for risk
Streamlining our international presence
Key initiatives and progress in 2011
Significant progress has already been made this year in reshaping our
business, particularly with regard to embedding new risk processes and
reducing non-core assets.
Continued reduction in non-core assets
In 2011 we have continued to make good progress in reducing the level
of non-core assets, which now stand at £141 billion, down £53 billion in
the year.
22.5
Non-core assets are generally businesses which deliver below-hurdle
returns, which are outside our risk appetite or are distressed, are
subscale or have an unclear value proposition, or have a poor fit with
our customer strategy.
We have continued to take a disciplined approach to the management
and reduction of our non-core assets. Our non-core commercial real
estate and corporate loans are managed on a day-to-day basis by a
dedicated workout unit reporting to our Risk function, while non-strategic
activities are managed by dedicated teams until run-off or sale.
0.0
We will continue to divest or run off non-core assets and are targeting
a reduction in our non-core assets to less than or equal to £90 billion
by the end of 2014, and for them to account for less than or equal to
£65 billion of risk-weighted assets by that time. We are also targeting
non-core run-off and disposals to be net capital generative over the
period 2012 to 2014.
A prudent appetite for risk
We have now fully embedded across the business a conservative
approach to, and prudent appetite for, risk, and have in place disciplined
controls over the risk profile of all new business. We have also reviewed
our existing portfolios and confirmed them as adequately provisioned.
The intended reduction of non-core assets and the prudent management
of risk should result in an improvement in the Group’s asset quality ratio to
50 to 60 basis points by the end of 2014, with the core business expected
to be at the bottom end of this range. In 2011 we have made excellent
progress, with our asset quality ratio dropping from 201 to 162.
Streamlining our international presence
We will streamline our international presence from around 30 countries
to less than half that number by 2014 and in 2011 we have already made
good progress having announced the exit from seven countries. We
will also concentrate our skills and investment in these countries which
will enable us to make sure local opportunities can be identified and
initiated in a cost effective value adding manner.
Performance against our targets
Return on equity
Non-core asset reduction
Target
12.5-14.5%
2014 target
< £90bn
–
236
194
Target
2010
(0.7)
2011
(6.2)
As a result of the repositioning we
continue to believe the strategy will
deliver a statutory return on equity
of between 12.5 and 14.5 per cent.
141
Target
2009
2010
2011
Good progress continues to be
made in reducing the level of
non-core assets.
Asset quality ratio
International presence
2014 target
2014 target
50-60 basis points
<15 countries
325
32
32
201
141
162
Target
25
Target
2009
2010
2011
2010
2011
0
Asset quality ratio continues to
improve towards our 50-60 basis
points target.
We will streamline our international
presence from circa 30 countries to
less than half that number by 2014.
Priorities for 2012
Continue to carefully and effectively run down our non-core
assets taking into consideration risk and value
Continued improvement to asset quality ratio
Continued reduction in our International presence
27
Annual Report and Accounts 2011
DELIVERING OUR ACTION PLAN
SIMPLIFY
the Group to improve agility
and efficiency.
Key initiatives and progress in 2011
The integration programme initiated at the time of the HBOS
acquisition was substantially completed during the year, with a run rate
of more than £2 billion per annum of cost savings and other operational
efficiencies now achieved, in line with target. This was a significant
achievement, particularly the successful migration of nearly 30 million
customer accounts to a single operating platform. The implementation
of a single operating platform for our key product areas means the
Group is now in a strong position to undertake further simplification
initiatives, as outlined below.
Simplification initiatives
The Group is now targeting a further £1.7 billion of sustainable annual
total cost savings in 2014, and by leveraging our prior experience from
integration, this can be completed in a cost and time efficient manner.
We have made strong initial progress with run-rate cost savings of
£242 million at end 2011. The main initiatives now being progressed are:
Operations and processes: We are conducting an end-to-end redesign
of our processes, which will include significant process automation, and
will materially reduce the number of IT applications. This will improve
the customer experience (for example through accelerating the
fulfilment of requests and reducing errors), increase productivity and
reduce risk, complexity and costs.
Sourcing: We will optimise our demand management and further
strengthen our supplier relationships, reducing the number of suppliers
to the Group to under 10,000, and further focusing on a core group
of lead suppliers, to achieve approximately a 15 per cent saving
on addressable spend. In 2011 we reduced supplier numbers by
around 2,500.
More agile organisation: We have already made good progress
in creating a more agile organisation through delayering our
management structure and centralising control functions, but further
developments including the creation of a simpler legal structure still
need to be progressed. Our focus will be on reduction in middle
management, bringing our top team closer to the customers and
front-line staff.
Channels and products: We intend to create a highly efficient
distribution platform whilst providing customers with greater choice
and convenience. We will streamline our product suite and migrate
products to digital distribution channels, encompassing the internet,
mobile applications and telephony.
Aim
We are targeting further cost saving and investment initiatives to
attain a cost:income ratio of 42–44 per cent.
Our integration programme was substantially completed in 2011,
delivering a single banking platform and a run-rate of £2 billion per
annum in cost synergies and other operating efficiencies.
We are now targeting a further £1.7 billion of cost savings in 2014
through a series of simplification initiatives. Savings will be realised
by focusing on the four areas below:
Operations and processes
Channels and products
Sourcing
More agile organisation
Performance against our targets
Cost savings (simplification)
Cost:income ratio
2014 target
£1.7bn
Target
Target
42-44%
48.4
46.6
50.3
Target
0.2
2011
We are targeting £1.7 billion of cost
savings in 2014 through a series of
simplification initiatives and have
delivered £0.2 billion in 2011.
Priorities for 2012
2009
2010
2011
Although the cost:income ratio
increased in 2011 we continue to
believe the cost savings and
investment initiatives will deliver a
cost:income ratio of 42-44 per cent.
Creation of a more efficient and agile organisational structure
Increased focus on sourcing and further reducing the number
of supplier relationships
Undertaking a fundamental review of our key processes
Increased utilisation and development of digital
distribution channels
28
Annual Report and Accounts 2011
DELIVERING OUR ACTION PLAN
INVEST
to be the best bank for
customers.
Key initiatives and progress in 2011
Much of the additional investment we intend to make in the business
will be derived from the cost savings delivered from the simplification
initiatives, which have yet to occur. Despite this we have already made
significant investments in 2011, including the revitalisation of Halifax
as a challenger brand and the implementation of a new e-solution
for foreign exchange trading and money market deposits for our
Corporate customers.
Investing to be the best bank for personal customers
In Retail, we have started to revitalise the Halifax brand to be a leading
challenger brand in UK retail banking. We aim to deliver a simple,
efficient and fair customer experience, innovative products such as the
ISA Promise or Savers Prize Draw, and to be a value-for-money leader.
We will also invest in Lloyds TSB and Bank of Scotland as leading
relationship brands in UK retail banking. We will be focused on
recognising and rewarding our customers’ loyalty, and we will invest in
our branches, in new channels such as mobile banking, and services
like Money Manager.
In Wealth, our goal is to be the primary Wealth advisor to our UK mass
affluent, affluent and high net worth customers. We will invest in new
coverage models to better meet our customers’ service needs, electronic
capabilities such as an improved on-line channel and an execution-only
service, and a new investment platform incorporating Scottish Widows’
and third-party products. We will also refocus our International business
on UK expatriates and others with UK connections.
Invest to be the best through-the-cycle partner for our
business customers
Our goal is to be the best through-the-cycle partner for our business
customers, both through our Commercial Banking operations, which
serve Small and Medium-sized Enterprises (SMEs), and our Wholesale
Banking business, which addresses the needs of UK companies and
institutions thereby taking a leading role in supporting the UK economy.
In both businesses, our goal will be to increase our share of capital-
light services, including risk and cash management, general insurance,
pensions and wealth for SMEs, and transaction banking, debt financing,
and rates business for UK corporates and institutions.
Bancassurance is a core part of our proposition
Bancassurance will be a core part of our proposition, through our
multi-brand retail strategy. There is a growing need for advice relating
to investment and protection and we are well placed to address this
through our bancassurance model.
Aim
We intend to invest approximately £500 million annually by 2014,
equivalent to approximately one-third of the savings from our
simplification initiatives, to grow our core income, with approximately
£2 billion invested between 2011 and 2014.
This is in addition to our business-as-usual investment programme
and is expected to result in core income growth above UK GDP
growth, primarily driven by growth in other operating income.
Our investment will be subject to disciplined tests, including the
financial returns, fit to our risk appetite and alignment with our
strategy to be the best bank for customers. The investment will
primarily be focused on:
Becoming the best bank for personal customers
Becoming the best through-the-cycle partner for our
business customers
Maintaining bancassurance as a core element of our proposition
Performance against our targets
NII:OOI split
Target
50:50
100
0
59
NII
62
NII
Target
50
50
41
OOI
2010
38
OOI
2011
We expect other operating income
(net of insurance claims) to increase to
approximately 50 per cent of total income
built on deepening customer
relationships and our focus on less
capital intensive products.
Investment
2014 target
c.£500m
Target
112
2011
We expect to invest approximately
£500 million annually by 2014,
equivalent to approximately one-third
of savings from our simplification
initiatives, to grow our core income in
addition to our business as usual
investment programme.
Priorities for 2012
Further revitalisation of Halifax as a challenger brand
Continued support of the SME sector
Increasing share of capital light business in the corporate and
commercial business
Further investment in improving the bancassurance proposition
29
Annual Report and Accounts 2011
DELIVERING OUR ACTION PLAN
stRenGthen
Aim
We will continue to strengthen the Group’s balance sheet and liquidity
position to ensure a robust core tier 1 capital ratio and stable funding
base by:
the Group’s balance sheet and
liquidity position.
Targeting a robust core tier 1 capital ratio, prudently in
excess of 10 per cent
Exceeding regulatory liquidity requirements
Maintaining a stable funding base
Improving the Group loan to deposit ratio to 130 per cent
or below
Performance against our targets
Loan to deposit ratio
Core tier 1 ratio
2014 target
130%
169
154
2013 target
>10%
10.8
10.2
Target
135
Target
8.1
2009
2010
2011
2009
2010
2011
We have made good progress in
reducing our loan-to-deposit ratio
and though we initially targeted a
loan-to-deposit ratio of <130 per cent
by the end of 2014, we now expect to
attain this in 2012.
We have continued to improve our
core tier 1 ratio, which now stands at
10.8 per cent on a Basel II basis. We
continue to target a core tier 1 ratio
prudently in excess of 10 per cent
from 1 January 2013 when the
transition period to Basel III commences.
Priorities for 2012
Further improvements to the core tier 1 capital ratio
Increased liquidity as a proportion of wholesale funding with
a maturity less than a year
Continued deposit growth from core customer relationships
Attaining our £20-£25 billion wholesale term funding target
Further reductions in the loan to deposit ratio
Key initiatives and progress in 2011
We have made great progress in strengthening the Group’s balance
sheet in 2011. In addition to the continued strengthening of our capital
ratios, we have continued to make excellent progress in our wholesale
funding and continued to reduce the level of government and central
bank funding. Though much progress has been made in the last few
years in this area, it is clear, given the current economic and regulatory
environment that further strengthening is required and we will continue
to target improvement in four main areas: capital position, liquidity,
funding and loan to deposit ratio.
Robust capital position
We are targeting a core tier 1 capital ratio prudently in excess of
10 per cent from 1 January 2013 when the transition period to Basel III
commences. Although we already have a core tier 1 capital ratio of
10.8 at the end of 2011 we expect the implementation of Basel III to
have a negative effect and we therefore continue to target further
improvement.
Exceeding regulatory liquidity requirements
We expect to meet the requirement for our Liquidity Coverage Ratio
and our Net Stable Funding Ratio to be in excess of 100 per cent
by 2014, in advance of regulatory requirements. This will require us
to increase our holdings of primary liquid assets to a level broadly
equivalent to our wholesale funding with a maturity of less than one
year, although the quantum of this will be lower than currently as we
reduce the levels of wholesale funding.
A stable funding base
Given the significant progress made in the last couple of years on
non-core asset reductions, deposit growth and funding our wholesale
funding requirement has fallen significantly. As a result our annual
wholesale term issuance requirement has also now fallen and we now
expect term issuance of £20 to £25 billion per annum going forward.
We also expect a continued reduction in the level of government and
central bank funding with current plans assuming that the remaining
facilities will be repaid in line with contractual maturity dates, the last
of which is in October 2012. The Group remains committed to being
a commercial, self sufficient, dividend paying entity over time.
Group loan-to-deposit ratio
With a reduction in our non-core assets, and further growth in
our relationship customer deposits, we were initially targeting an
improvement in our Group loan-to-deposit ratio to 130 per cent or
below by the end of 2014, but we now expect to attain this in 2012.
30
Annual Report and Accounts 2011
RelAtionships And Responsibility
Building valuaBle
relationships
the successful delivery of our
strategy will be driven by the
relationships we develop with
our customers.
With over 30 million personal and business
customers and a presence in communities across
the country, we are uniquely placed to help
unlock the potential of families, businesses and
communities we serve, making a significant
contribution to the future strength and prosperity
of the UK. Our vision of being the best bank for
customers along with our focus on operating
sustainably and responsibly underpins our
approach to business. Over the next few pages
we set out our approach to:
Customers…
Colleagues…
Communities…
the Group’s continued success depends
on our colleagues and their ability to
build strong and deep relationships with
customers.
investing in communities
lloyds banking Group is the biggest
corporate investor in UK communities,
investing over £85 million last year in
financial inclusion and financial capability,
higher education and sports for young
people and almost £30 million to support
grassroots charities working with
disadvantaged communities.
31
Annual Report and Accounts 2011
RelAtionships And Responsibility
CUSTOMERS
only by focusing on customers’
needs and addressing those
needs can we expect to deliver
benefit to our stakeholders.
Aim
our aim is to be the best bank for customers. becoming the best
bank for customers means being the best bank for families, for
businesses and for our communities. We will achieve this by
focusing on:
UK customers and those connected to the UK
simplifying processes, policies and systems
investment in growth initiatives
An appropriate risk appetite
ensuring the business has the strength in funding and capital to
meet the most challenging of headwinds.
Performance in 2011
Customer complaints
(FSA complaints* per 1,000 a/c)
Customer satisfaction
(net promoter score)
%
2.4
2.1
141
1.7
1.5
44
38
H1
2010
H2
2010
H1
2011
H2
2011
Through our simplification programme
and continued focus on becoming the
best bank for customers, our FSA
reportable banking complaints
continued to fall.
*Excluding PPI
2010
2011
We have developed a comprehensive
customer experience program
measuring customer service at key
touch points and likelihood to
recommend through the cross industry
Net Promoter Score metric.
Priorities for 2012
Further simplify our systems, processes and products, making
it easier and more convenient for customers to bank with us,
thereby improving the overall experience
Continue to improve our complaint handling performance
reducing FSA reportable banking complaints per 1,000 accounts
to 1.3 by the end of 2012
Maximize the use of our customer relationships and insight to
enable us to engage more effectively with our customers and
become more responsive to customers’ needs
Summary
the strategy for the Group is built on being the best bank for
customers, and to create value by investing where we can make a real
difference for these customers. the Customer is therefore at the heart
of everything we do, whether it be our branches, our brands or our
people and is a key driver for our Group values.
We have over 30 million personal, commercial and corporate
customers and operate the largest retail bank in the UK. in 2011 we
made great progress towards our goal of being the best bank for
customers with a number of notable product launches, a significant
reduction in customer complaints and numerous system and process
improvements whilst continuing to support our customers and the
UK economic recovery. We also received a number of external awards
recognising the quality and consistency of delivery to our customers.
our Corporate and Commercial businesses won the best bank
of the year award for the seventh consecutive year at the Real
Fd/Cbi excellence awards, while in Retail we were named ‘best overall
Mortgage lender’ for the tenth year running in the your Mortgage
Magazine Awards and in insurance we were named as britain’s
most popular home insurance provider by the independent market
researchers GFK nop for the tenth year in a row.
our customer focus is increasingly driving key business decisions and
the responsible position we took on ppi and our commitment to keep
our branch network at the same level for the next three years (excluding
Verde) and not to close a branch if it is the last in the community
demonstrates our commitment to do the right thing for customers.
Supporting our customers and the UK
economic recovery
As part of our strategy to be the best bank for customers, and as a
leading financial services provider in the UK, the Group continues to
actively support sustainable growth in the UK economy through the
focused range of products and services we provide to our business and
personal customers, as well as through partnerships we have built with
industry and government.
despite the challenging environment the Group exceeded its full year
contribution to the ‘Merlin’ lending commitments which were agreed
in February with the UK government, both for sMe s and in total. in the
full year we provided £45.3 billion of committed gross lending to UK
businesses of which £12.5 billion was to sMes. in the same period the
Group supported the start up of nearly 124,000 new sMe businesses.
the Group actively looks at all opportunities to support UK businesses
and we continue to innovate in the market to meet our customers’ needs.
32
Annual Report and Accounts 2011
RelAtionships And Responsibility
Customers
sMes are a particularly important source of job creation and growth
in the UK. our Commercial business is focused on serving these
customers, and we demonstrated our support for sMe customers in
2011 with year on year net lending growth of 3 per cent in this business
area. this compared favourably with the negative growth in sMe
lending across the industry reported in the latest available market
statistics from the bank of england. As part of this growth we increased
our advances to manufacturing businesses through invoice finance by
30 per cent net. in 2012, we have pledged to make at least £12 billion
of gross new lending available to sMes, with a further pledge to deliver
positive net lending growth, to help stimulate growth and improve
confidence in the sector. We support corporate and commercial
customers throughout the economic cycle to ensure their financial
health, viability and growth and our business support Unit (bsU)
specifically helps businesses in financial difficulties. since 2009 the bsU
has restructured facility for around 10,000 businesses and has protected
more than 250,000 UK jobs. We are also simplifying processes and
improving transparency for the benefit of customers. We have
successfully piloted a re-egineering of our lending processes, halving
the time to fulfil lending to customers, and intend to roll this out by the
end of 2012 and launched simpler fixed charge money transmission
Monthly price plan tariffs.
For our Retail customers, the Group completed £28 billion of new
mortgage business in 2011, achieving a market share of approximately
20 per cent of gross new residential mortgage lending. We are
committed to supporting the UK housing market and first-time buyers
in particular. We advanced more than £5.6 billion of new lending to
first-time buyers in 2011, helping over 52,000 customers own their
own homes. our market share of new first-time buyer business was
approximately 24 per cent by value in 2011. in total, we advanced more
than £15.5 billion of new mortgages to over 124,000 customers buying
their home in the UK in 2011.
Complaint handling
As part of our strategy to become the best bank for customers we
publicly committed to reduce the level of FsA reportable banking
complaints, excluding ppi, we receive by 20 per cent. We achieved a
reduction from 2.1 complaints per 1,000 accounts in the second half of
2010, to 1.5 in the second half of 2011. We aim to reduce this further
in 2012 to 1.3 complaints per 1,000 accounts, and to 1.0 complaint per
1,000 accounts in 2014. the progress to date has been accomplished
through the success of our phone-a-friend service, a specialist team
which branch staff can refer to, and the training we have provided to
our 40,000 front line colleagues. As a result of these initiatives, we are
now resolving over 90 per cent of complaints at first touch. We are
the first financial services organisation to roll out to all our complaint
handling staff an externally accredited complaint handling qualification.
in addition we have extended the opening hours of the specialist
teams so they can deal with complaints 24 hours a day, 7 days a week,
ensuring customers get the right outcome faster.
We have also introduced a group wide team that focuses on listening
to customers and making improvements to remove the cause of
customers’ complaints. this has reduced complaints received from
customers by more than 30,000 per month in 2011. All these changes
have been driven by listening to our customers.
Delivering Innovative products and services
our strategy recognises our customers needs for product simplicity
and transparency, access through multiple channels and value for
money products and services. We have worked hard to ensure we are
offering products and services that respond to customers evolving
needs and as a result a number of new and innovative products have
been launched in 2011 such as the halifax savers prize draw. in
addition, customers told us they wanted better ways of managing their
money, so we launched lloyds tsb Money Manager, an easy-to-use
internet banking service that helps customers understand how they are
spending their money and using their account. We also understand
that people want to be able to access their accounts and balances
on the move – our new mobile banking applications have been
downloaded 1.5 million times and reached the number one spot in the
Apple App store free apps.
We have enhanced our internet banking offering to enable our retail
customers to do more online, and extended the innovative lloyds
tsb lend a hand Mortgage to help customers purchase a home with
the help of their local authority. to strengthen our strategy of being
the best bank for sMes, we launched our best for business campaign,
reaffirmed our continued support for the sMe Charter to respond to
90 per cent of lending appeals within 15 days which will exceed the
industry standard of 30 days, and maintained our leading part in the
business Growth Fund which is the latest initiative from the business
Finance taskforce.
in developing innovative and quality products and services the bank
liaises closely with internal and external suppliers to access and best
use their expertise. external suppliers are very important in a number
of areas and enable the Group to provide the best products & services
to our customers. engaging with them, and the wider supply market,
in a way that adds mutual value is a key part of our sourcing strategy to
ensure we gain the best value for our customers across price, quality &
social impacts.
Customer service and simplification
by putting customers at the heart of our business, and listening to their
needs we have managed to simplify and enhance our systems and
processes to help serve our customers more quickly and efficiently. the
integration programme has given us a single set of integrated systems
which provides a great base for further development but we have also
rolled out a number of initiatives to help make banking quicker and
easier for customers. in fact we have made over 100 changes to simplify
our systems and processes including the introduction of immediate
deposit Machines and slip free transactions. We have also reviewed
branch roles and opening times to ensure we can meet our customers’
needs and are open when they expect them to be.
Customer satisfaction is assessed through the net promoter score
(nps), which measures the likelihood of customers recommending us
to others and all of our high street brands made significant headway
in 2011, achieving their highest ever nps scores, with the group wide
score rising from 38 in 2010 to 44 in 2011. the Group monitors nps
across a range of touch points to ensure that the customer experience
improves across the board. the process gives insight for specific
channels, such as a branch or telephony network, product experiences,
such as opening a new account, and other key events such as handling
of complaints. this insight allows us to adapt our colleague training and
processes in order to give customers an increasing quality of service.
our halifax brand also received the highly coveted ‘best Customer
service’ award at the Consumer MoneyFacts awards 2012, evidencing
the real progress that’s being made.
33
Annual Report and Accounts 2011
RelAtionships And Responsibility
Customers
Treating Customers fairly
Central to our aim of building deep and lasting customer relationships
is our determination to treat customers fairly and ensure we are
transparent in dealings with them. We conduct regular monitoring
to check that we are complying with our robust customer treatment
policies and are achieving fair outcomes for customers. Customer
outcomes are an important component in colleague reward and
remuneration. our approach to fair customer treatment takes into
consideration product, sales and after sales:
– products: we have strengthened our framework for developing and
managing our product range, including the introduction of new
product governance processes and a comprehensive risk assessment
tool that centres on fair customer treatment.
– sales: our sales processes consider affordability and are designed to
minimise the risk of customers buying products they do not need or
cannot afford. We review these processes continuously and update
them as necessary.
– After sales: we listen carefully to customer feedback, and take
a proactive stance to after sales.
Financial Inclusion
We aim to lead the banking sector in reaching those who are financially
excluded and equip them with the confidence and capability to
manage their money effectively
As the UK’s biggest provider of social bank accounts, we make a
significant investment in helping to bring people into the financial
system. We currently provide over 4.2 million such accounts and in
2011 opened around 250,000 new accounts. We are also the only bank
to offer basic banking facilities to prisoners, in conjunction with the
national offender Management service. Almost as importantly, we can
help our customers move to a full facility current account. in 2011 over
100,000 customers who previously had a social bank account either
upgraded to or opened a mainstream bank account. We have recently
made a number of improvements to make it easier for social bank
account customers to upgrade.
Supplier relationships
having strong relationships with our suppliers is key to the delivery of
our strategy and ensuring both the bank’s and our customers’ needs
are effectively met. the Group looks to build and develop strong
collaborative relationships and engage in regular dialogue, meaning
we can better understand the environment in which we operate and
help access and drive the continuous improvement and innovation in
our value chain. through working with our suppliers, we also get the
opportunity to leverage their unique specialist knowledge in order to
drive increased value and proactively optimise our supply chain. We
consider our suppliers’ social, ethical and environmental performance
as a standard part of our procurement process. We are also a signatory
to the prompt payment Code which requires us to provide clear
guidance on payment procedures and encourage similar good practice
amongst our suppliers and other businesses.
We are committed to making lloyds
banking Group the best bank for
Customers. the image shows how our
customers are at the heart of everything
we do in our retail business. the wheel
brings together how we’ll make the most
of our brands, the investment we’re
making in our branch network, and what’s
needed from colleagues to bring this to life
for our customers.
34
Annual Report and Accounts 2011
RelAtionships And Responsibility
Colleagues
our colleagues deliver the
experiences that will make us
britain’s best bank for customers.
Aim
our ambition is for a more diverse, better engaged and stimulated
employee group to help us achieve our goals. At lloyds banking
Group, we want the diversity of our employee base to more
accurately reflect the diversity in our society; the better we reflect our
marketplace the better we can serve it.
Growing talent is a key priority, we need to motivate and nurture
a developing pool of talent that drives our business in a way that is
sustainable and realistic in the current climate.
All of this goes hand in hand with giving people equal access to a
variety of opportunities and making our business work closely with
our surrounding communities to build relationships and share skills.
Performance in 2011
Staff engagement score
%
Staff training days
UK industry average
61
52
69
63
6.9
5.4
EEI
2011
PEI
2011
The Employee Engagement Index (EEI)
measures the individual motivation of
colleagues whilst the Performance
Excellence Index (PEI) measures how
strongly colleagues believe the Group is
committed to improving customer service.
Priorities for 2012
2010
2011
Colleagues received an average of
6.9 days formal learning in 2011
reflecting ongoing commitment to
learning and development.
Making our customer-facing teams more successful, by ensuring
those colleagues who come into direct contact with our
customers are equipped with the necessary skills and expertise
to provide a positive customer experience
Growing great leaders
Simplifying the way we work
Building long lasting relationships through people
lloyds banking Group’s continued success depends on our colleagues.
our colleagues aim to provide excellent service everyday and spend
time listening to customers to understand what is important to them.
building valued relationships with customers enables our teams to
support customers in getting the most from their money.
to make this happen our organisation aims to attract, retain and
develop the best talent in the industry and embraces diversity.
At lloyds banking Group, we are committed to making a significant
investment in our people. life here is fast-moving and full of challenges;
it’s also incredibly rewarding. our rewards and benefits packages, which
go beyond salary and bonus, are designed to keep our employees
motivated to deliver excellent customer service.
As a leader in financial services, we are committed to professional
development and creating outstanding learning opportunities that
enable people to reach their potential. We invest in our people,
offering the best coaching and training. learning@lloyds banking Group
is one of the largest corporate learning facilities in europe.
We also encourage our people to contribute to our leading corporate
and social responsibility practices; a strong part of our culture.
employees raised £1.4 million for save the Children, a partnership
that will run until June 2012.
during 2011 we set out our new strategy to achieve our vision of
becoming the best bank for customers. to help make that vision
a reality, we consulted with colleagues from across the business to
identify the things that will be important in achieving our vision. this
led us to our three lloyds banking Group values – putting Customers
First. Keeping it simple. Making a difference together.
35
Annual Report and Accounts 2011
RelAtionships And Responsibility
Colleagues
these values define what we stand for when we are at our best;
individually and as a team. they will help shape decisions all colleagues
make and the actions they take and are being woven in to the way
we do business across the Group, to help make us the best bank
for customers.
Integration
inevitably in bringing the two organisations together, there has been
a requirement to rationalise and this has led to a reduction in roles.
Where possible we have redeployed colleagues to other areas of the
Group or reduced numbers through natural attrition. Where it has
been necessary for colleagues to leave the organisation, this has been
achieved by offering voluntary severance and using fewer contractors
and agency colleagues. Compulsory redundancies are always a
last resort.
the focus has been on enabling the business to integrate, while also
building foundations for the future to ensure the organisation can
attract, retain and develop the best talent. people have been at the
heart of the change programme, and a robust communications process
has been followed to ensure that colleagues were aware of the changes
before they happened. We have four recognised Unions who have
been consulted on all changes.
the year has seen an ongoing harmonisation process of different
heritage employment policies, and the unions have been involved
in these discussions.
this year we delivered a significant milestone in our integration when
we harmonised terms and conditions for most employees in the
Group. in addition, over 83,000 employees selected benefits available
through our Flexible benefits plan. We implemented our new defined
Contribution pension scheme, ‘your tomorrow’, which was awarded the
pension Quality Mark plus – the highest quality mark available from the
national Association of pension Funds.
Colleague engagement
in 2011, we launched a new Colleague survey across the Group.
the new survey supports our ambition to drive simplification across
the business and will reduce the time colleagues spend giving
feedback and will provide them with more time to focus on the
activities which will help us to achieve our vision.
the new survey uses a proven engagement model, delivered through
the means of a single focussed question set. the outputs provide
two separate and measurable scores, the employee engagement
index (eei), which measures the individual motivation of colleagues,
and the performance excellence index (pei), measuring how strongly
colleagues believe the Group is committed to improving customer
service. these will be used to create national and local action plans that
prioritise the things that will make the Group a better place to work.
the question set was explicitly designed to support the outcomes of
our strategic Review and to provide an early indication of the extent
to which employees identify with our three new values – putting
Customers First, Keeping it simple and Making a difference together.
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.
to demonstrate our strong commitment to listening and acting on
issues that matter most to colleagues, we will:
Firstly, continue to deliver on our Group strategy to be the best bank
for customers and colleagues. We know this will improve confidence in
the future of our organisation and result in growth, greater efficiencies,
new business opportunities and real career prospects for colleagues
across our business.
secondly, rebuild confidence and trust in our leadership by increasing
the time leaders spend listening and talking to colleagues across all
areas of our business.
thirdly, drive customer focus at all levels in our organisation to stimulate
ongoing quality and improvement. to do this, we must ensure we keep
telling our colleagues about the changes that will be implemented
as a result of the survey and continue to do all we can to make
lloyds banking Group a great place to work.
integration training
A strong focus has been to support
colleagues through the changes
needed to successfully complete our
integration programme, the largest
one in european banking history. this
has included providing training to over
16,000 colleagues in our branches, to
ensure they are fully prepared to work
with new customer systems.
the overriding principles of the training
approach were to ensure colleagues
were confident, competent and that the
customer experience was consistent
and smooth.
the success of the exercise was a
tribute to the way in which colleagues
throughout the Community banks
worked together. the branch
experience involved colleagues from
halifax and bank of scotland working
in lloyds tsb branches. this practical
hands-on experience saw communities
working together, sharing knowledge
and experience that was an essential
ingredient to colleagues learning.
in all, c800,000 hours of training was
invested in colleagues, ensuring that the
integration programme delivered for the
business, colleagues and customers.
36
Annual Report and Accounts 2011
RelAtionships And Responsibility
Colleagues
Talent, recruitment and retention
one of our uppermost priorities is recruiting, retaining and developing
talented leaders. identifying and developing leaders to strengthen
succession planning is vital in supporting our strategic review initiatives.
We have undertaken detailed organisational reviews centred on
assessing our leaders performance and potential to undertake bigger
roles as well as succession planning for our most senior leaders. the
approach led by Group executive Committee, incorporates a rigorous
assessment of the performance, potential and development needs
of the top three layers of leadership in the organisation and was
presented to the board.
We are committed to ensuring that we offer clear career paths to retain
our most able senior leaders. in 2011 we made significant progress and
60 per cent of all senior leader vacancies were filled internally.
earlier this year we had our succession planning and execution
independently assessed as strong and in many instances, industry-
leading when compared with other Ftse 100 businesses. succession
to the Group executive Committee and divisional leadership teams
has materially improved year-on-year with 92 per cent of roles having at
least one identified successor.
We have brought greater focus to building strong talent pipelines
at middle and junior leadership levels. A number of initiatives launched
in 2011 include the MbA programme, lloyds scholars programme
and a new development programme for emerging executives and
middle managers.
Retaining our talent through difficult times continues to be a priority
and we have launched well-being initiatives across several teams this
year which have proved popular and useful resources for colleagues
at all levels.
in 2011 we recruited 167 people into the lloyds banking Group
Graduate leadership programme. the strength of the programme has
been externally acknowledged and the Group has been rated by the
times as one of the top 30 UK organisations for graduate recruitment.
in addition we have attracted 47 interns to the Group along with
under privileged students aged 16-19 in our new 6 week career
academies programme.
Performance and reward
Managing performance plays a critical role in helping us to develop
our colleagues to build long term partnerships with customers
and strong relationships with each other. this year has seen clear steps
taken to improve organisational performance.
Following the completion of the Group strategic Review in June, we
started to simplify and further integrate our approach by aligning
performance and reward for all colleagues. Reflecting the new
regulatory environment, 2011 also saw a strengthening of executive
performance management with the introduction of a new moderation
process to assess risk stewardship by all our senior executives.
this year has seen the design and implementation of an award winning
new defined Contribution pension scheme – your tomorrow which
gives considerable flexibility to employees to plan for retirement.
Learning and development
becoming the best bank for customers means our colleagues must
have the capabilities to deliver excellent service.
We have continued to shape and deploy our learning Academies
which provide easy access to clear learning maps for colleagues
providing further clarity on the technical and leadership capabilities
required to be effective. nearly 100,000 colleagues have access to
the academies which cover critical topics such as risk, relationship
management and financial control.
Graduate development
programme
Following the Graduate development
programme, graduates are choosing
branch roles as their career choice.
“last year i secured the opportunity of
bank Manager at the new lloyds tsb
olympic branch in europe’s largest
shopping centre – Westfield stratford
City. With a successful opening in
september i’m delighted that we
managed to deliver outstanding
performance whilst providing high
quality customer service.”
Jeff Wilkinson, Bank Manager
lloyds tsb stratford Westfield
37
Annual Report and Accounts 2011
RelAtionships And Responsibility
Colleagues
A strong focus has been to support colleagues through the changes
needed to successfully complete our integration programme; this has
included providing training to over 16,000 colleagues in our branches
to ensure they were fully prepared to work with the new customer
systems and applications following the biggest migration of customer
data in europe.
We remain committed to supporting a range of programmes
linked to professional qualifications or relevant external certification
and have reviewed our policy to ensure equality and consistency
for all colleagues.
our executive and leadership development approach in 2011 was
driven by our strategy to create a high-performance culture within
the Group. integral to this strategy, has been the need to develop a
clear articulation internally and externally of the leadership behaviours
and capabilities required to take our business from integration
to transformation.
during 2011, we have delivered the high-profile executive leadership
programme and a new group wide talent development programme.
embedded in both these programmes is the requirement for leaders to
take ownership in progressing our work around diversity and inclusion.
our investment in developing leaders in 2011 included the launch
of 360 degree feedback to the top three layers in the organisation.
in addition, our recently launched management licence programmes
provide foundation line management and leadership skills to managers.
We received a technology4good award for our workplace adjustments
programme, improving the way we support colleagues with disabilities
or long-term health conditions. We have launched a new online
disability awareness programme to ensure colleagues and line
managers have the support they need.
in our ethnic diversity strategy, we have launched a new Career
development programme for ethnic minority managers, targeted at
those colleagues who are looking to achieve their first management
or senior management position. the programme discusses barriers
to progression, how to overcome them and supports participants to
achieve their full potential.
in 2011, we completed our second annual diversity & inclusion Week,
themed: Pride Through Inclusion. this awareness raising campaign
featured each member of the Group executive Committee, our Chief
executive and our Chairman. Colleagues were able to download a
range of articles and tools including a guide to action planning.
We have also begun an unconscious bias programme, starting with our
most senior leaders. the workshop raises issues in a meaningful way,
encouraging participants to draw links with their day-to-day work and
behaviours, and equipping them with tools and techniques to help
combat bias in the workplace.
We will continue to build upon our progress during 2012 to
ensure we reflect the diverse needs of our customers, colleagues
and communities.
Diversity and inclusion
A key element to achieving our vision is having a diverse and
inclusive workforce; an area in which we have made positive progress
during 2011.
our gender strategy is led by members of our Group executive
Committee and sir Win bischoff, our Chairman, and supports the
recommendations of the lord davies Review whereby we aim to
increase our female representation on the board by 25 per cent
by 2015. in december we launched breakthrough; our new women’s
network which has over 600 members and we have established
a series of development interventions, specifically targeted at women
at various stages of their career to ensure they are equipped with
the necessary skills and experience to successfully compete for
senior positions.
the Stonewall 2011 Top 100 Employers for lesbian, gay and
bisexual people, ranked the Group as the top private
sector employer in the UK and as top scottish employer by
stonewall scotland.
Rainbow network –
Marking a milestone
Rainbow – the Group’s network for
lesbian, gay, bisexual and transgender
(lGbt) colleagues – this year reached
1000 members, making it one of the
largest employee networks of its kind
in the UK.
Rainbow helps to engage and support
lGbt colleagues promoting a positive
working environment across the
organisation.
38
Annual Report and Accounts 2011
RelAtionships And Responsibility
communitiES
by doing more through our
responsible business strategy,
we aim to help build thriving
communities.
Aim
We have a presence in every community across the UK. We recognise
that to be the best bank for customers, we must also be the best bank
for communities.
in 2011 we developed a new responsible business strategy which aims
to help build thriving communities, and, in so doing, rebuild trust and
pride in the Group. our vision is to be recognised by shareholders,
customers and colleagues as making a real difference.
We are investing in financial inclusion and projects to improve consumers’
financial capability; access to higher education for students from lower
income families; sports for young people; and almost £30 million a year
to the Group’s Charitable Foundations to support grassroots charities
working with disadvantaged communities. We are also working to reduce
our environmental impact by reducing our use of resources such as energy,
water and paper and by investing in new sources of renewable energy. We
are encouraging the companies we bank, and invest in, to do the same,
using our influence as a large financial services organisation to deliver a
positive impact for communities.
Embedding responsible business
We established a new Responsible business steering Group in 2011 to
drive our new responsible business strategy. it comprises the following
business leaders from across the Group:
Anita Frew, non-executive director
Matt young, director, Group Corporate Affairs
eva eisenschimmel, Managing director, Customers, brands,
digital and telephone banking
stephen pegge, director, sMe Markets in Commercial
paul baker, director, Group property
Kate Guthrie, hR director, insurance
philip Grant, Managing director, UK Wealth
paul turner, director, Community & sustainable business
the steering Group meets every two months and will report to the
board and Group executive Committee twice a year. in 2012, we are
also setting up an independent panel of experts and opinion formers
to provide thought leadership and challenge to the Group.
Colleague volunteers
160
85
16,000
Total community
investment
74
76
£m
85
Community engagement
lloyds banking Group is the UK’s biggest corporate investor in UK
communities. last year, we invested over £85 million in communities,
including support for financial capability, higher education, sports for
young people and support to the Group’s charitable Foundations.
7,300
600
2009
0
2010
2011
0
2009
2010
2011
In 2011, the Group supported over
16,000 colleagues’ volunteering for
charities and community groups. The
Foundations also provided Matched
Giving to some of these organisations
for colleagues’ time spent volunteering
outside of working hours.
We are the biggest corporate investor
in UK communities. Last year, we
invested over £85 million to support
financial inclusion and financial
capability, higher education, sports for
young people and grassroots charities.
Priorities for 2012
Explore opportunities to improve our management of
environmental, social and governance risks and increase
transparency around our management of these
Launch a Fund that will enable colleagues to help their chosen
community organisation with financial support
Launch a five year partnership that will support social
entrepreneurs and create hundreds of jobs across the UK
Funding grassroots charities
in 2011, we donated almost £30 million to the lloyds tsb Foundations
and the bank of scotland Foundation. the Foundations disburse
grants to local, regional and national charities that operate at the
heart of communities. 2011 also marked the 25th anniversary of
the lloyds tsb Foundations. over the last quarter of a century, the
lloyds tsb Foundations and bank of scotland Foundation have
invested more than £510 million supporting over 50,000 community
based charities.
in addition to making grants, the Foundations work in partnership with
the Group to champion colleague fundraising and volunteering efforts
through their Matched Giving scheme. Colleagues in the UK can claim
up to £1,000 in Matched Giving each year. in 2011, over 6,200 applications
were made, totalling £2.3 million in matched giving for charity.
39
Annual Report and Accounts 2011
RelAtionships And Responsibility
Communities
Charity of the Year
our Charity of the year for 2011/2012 is save the Children. We raised
£1.4 million in 2011 for save the Children which will fund 46 FAst
programmes across the UK. FAst (Families and schools together)
increases the life chances of children in the UK’s most deprived
areas by supporting parents to improve their children’s learning and
development at home, so they can reach their full potential at school.
over half of children in the most disadvantaged areas fall behind at
the age of five compared to just over a quarter of children from better
off areas, and many never catch up. teachers report a 10 per cent
improvement in reading, writing and maths among children enrolled
on FAst programmes, after just eight weeks. As well as improving
children’s academic performance, the programme has also been
credited with improving children’s behaviour and bringing children and
parents closer together.
Employee volunteering
our employees are our closest link with the communities in which we
operate, and, as one of the biggest employers in the UK, our colleague
volunteering initiatives can make a real difference. our day to Make
a difference volunteering programme enables colleagues across the
UK to spend one day a year volunteering for a charity or community
project of their choice. in 2011, over 16,000 colleagues volunteered,
compared with 7,300 in 2010. however, we know there is more we can
do to support colleagues in connecting with their communities. We are
redesigning our volunteering programme to make it simpler and more
rewarding for colleagues to participate and hope to engage even more
colleagues in 2012.
in 2011, as in 2010, lloyds banking Group was the largest corporate
participant in business in the Community’s Give & Gain day – the UK’s
largest single day of volunteering. over 2,000 colleagues took part,
undertaking a variety of activities including renovating playgrounds,
clearing conservation areas and hosting employability skills sessions for
schoolchildren. in 2011 we also announced that we are sponsoring Give
& Gain day for the next three years.
Making a Difference Awards
our annual Making a difference Awards celebrate employees who
make an exceptional contribution to charities and community groups.
in 2011 we received nominations for 1,164 colleagues who had made a
huge difference to their communities. the 203 award winners received
a contribution from the Group for their chosen charities. the Group
also donated £20 for every nomination received to our Charity of
the year, totalling £23,280 for save the Children. in total the Group
donated almost £100,000 through these awards to charities and
local communities.
Lloyds Scholars
lloyds scholars, the Group’s flagship higher education programme,
was launched in 2011 for students attending the University of sheffield
and University of bristol. the programme aims to encourage and
support young people from families with below average income to
attend some of britain’s top universities. We believe lloyds scholars is
the only corporate social mobility programme of its kind in the UK.
lloyds scholars provides students with support for their academic and
vocational development, offering a complete financial and support
package. this includes bursaries to help with living costs and study
materials; performance-related cash awards for good grades; hands-on
work experience through paid summer internships with the Group;
and access to advice and support from a dedicated mentor. in return
for these benefits, we ask scholars to champion the scheme to future
applicants and take part in at least 100 hours volunteering in their local
communities each year.
in the 2011/2012 programme we have thirty students participating from
the University of sheffield and University of bristol. We are expanding
the programme to six universities and 120 students for the next
intake of students.
“
lloyds scholars,
our unique social
mobility programme
the national Union of students has always
been supportive of business contributing
to the cost of higher education, so it’s
great to see lloyds banking Group starting
the lloyds scholars scheme. of course
higher education is massively beneficial
to the public, as well as to the student, but
business also benefits from students who
have a higher level of education and an
enriched world-view.”
“
As well as widening participation to
higher education, we’re particularly
pleased that this scheme seeks to deepen
participation through volunteering at
university, ensuring that students not only
receive the appropriate support through
their mentoring scheme but are given
opportunities to get further involved in
their free-time.”
Liam Burns, National President
national Union of students
40
Annual Report and Accounts 2011
RelAtionships And Responsibility
Communities
Environmental responsibility
in 2011, we introduced a set of market leading long-term
environmental targets under our environmental Action programme
to significantly reduce our environmental footprint. We aim to reduce
paper, water and business travel by 20 per cent; ensure that less than
20 per cent of waste is sent to landfill; and reduce energy use by
30 per cent by 2020. We publish a standalone, data-driven Climate and
environment Report on an annual basis which details progress we have
made against our targets, and this is available from the lloyds banking
Group website. last year, we achieved the Carbon trust standard for
our entire UK operations, which recognises our robust approach to
measuring, managing and reducing our carbon emissions. We also
reduced our use of energy by 1 per cent, our use of water by 3 per cent
and paper use by 7 per cent in 2011 compared with 2010. our overall
carbon footprint reduced by 1 per cent in 2011 compared with 2010.
over the last year we have been the UK’s most active provider of
finance to renewable energy projects, having lent over £413 million
across 13 renewable energy projects in the UK, Germany and the Us.
our approach to environmental risk management is covered on pages
162 and 163.
We are also encouraging businesses that bank with us to take action
to address climate change. We have trained over 650 colleagues on
our business & environment programme, to enable them to guide and
support our customers in recognising environmental risks and seizing
the opportunities. We are the only major UK bank to provide this kind
of support to its business customers.
We recognise that our influence extends well beyond the size of our
organisation. our asset management business, scottish Widows
investment partnership (sWip), has over £140 billion invested around
the world and is committed to using its influence to encourage best
practice in corporate governance and management of sustainability
risks. sWip has also launched a new sustainability strategy across its
entire £8.5 billion property portfolio.
CO2 Emissions (tonnes)
total UK Co2 emissions
scope 1 emissions
scope 2 emissions
scope 3 emissions
2011
421,568
52,179
321,698
42,691
2010
425,996
60,302
324,007
41,687
We have improved the accuracy of energy data for the 2010 reporting years, replacing
estimates with actual data. We have also changed our method for reporting car travel data in
2011 and have applied this method to historical data.
Financial wellbeing
We take seriously our responsibility to do more to raise levels of
general financial understanding amongst the communities we serve.
in addition, we make a very significant investment in helping to bring
those who are excluded into mainstream financial services. our
financial inclusion work is covered in more detail on page 33.
Money for Life
Money for life is lloyds banking Group’s flagship £4 million financial
capability and personal money skills programme, targeted at the
Further education, Adult and Community learning sector. We are
providing tutors and support workers with the skills they need to talk
confidently about money management, and to support their learners
to stay out of debt and save for the future.
last year, we launched our teach Me, teach others financial education
training programme. We are providing 1,400 free places on the
programme for colleges and community groups, to enable them to
deliver quality financial education in their communities. in addition, 100
lloyds banking Group employees have taken the teach others course
and are now volunteering in a wide variety of community organisations.
We also launched the Money for life Challenge in 2011, a national
competition providing small grants for 16-24 year olds to run a money
management project in their local community. the most innovative and
impactful projects will be rewarded at national and UK finals in 2012.
teaching others
Jeff McArthur, Regulatory and external
Risk Manager at lloyds tsb, is a graduate
of the Money for life teach others course.
he has delivered financial capability
workshops at dress for success, a charity
offering employment-based services and
workshops to help disadvantaged women
become economically independent.
“
Many of the women have recently returned
to work after long-term unemployment
and wanted to better manage their
finances,” Jeff explains.
“
i provided advice on basic budgeting and
explained how they could use banking
products and services to help them
manage their money.”
41
Annual Report and Accounts 2011
RelAtionships And Responsibility
Communities
We are launching a partnership with the school for social
entrepreneurs that will over five years provide a support package to
500 entrepreneurs to create new social enterprises and hundreds of jobs
in communities across the UK. social entrepreneurs are people who
use their entrepreneurial talent to address a social need or problem in
their community. their businesses are playing an increasingly important
role in the UK economy with an estimated annual turnover worth
£25 billion and a workforce totalling one million. the programme will
enable 100 entrepreneurs every year to go through the school’s unique
action learning programme and receive grants ranging from £4,000
to £25,000.
We will also pilot a community fund that will enable colleagues to help
their chosen community organisation with financial support. small
grants will be made available for community organisations that our
colleagues and customers have elected to support.
Tracking progress
independent consultants verify our performance every year. We
also measure our performance against our peers through external
benchmarks. in 2011, we were re-selected for the dow Jones
sustainability index. We were also ranked top UK bank in the
Ftse4Good index and were re-selected for the Carbon disclosure
leadership index. We have a platinum ranking in business in the
Community’s Corporate Responsibility index and were awarded
business in the Community’s CommunityMark, the national standard
that publicly recognises excellence in community investment.
Summary
the Group’s strategic vision recognises that being the best bank for
customers also means being the best bank for communities. We
believe that, over time, our new responsible business strategy will help
us rebuild public trust and colleague pride in the Group by making a
difference to the UK.
We aim to set an example and demonstrate the highest standards
of integrity in the way we do business. in 2012 we will explore
opportunities to increase transparency of our management of
social, environmental and ethical risks. We also plan to launch a new,
group wide code of ethics, linked to the Group’s values, setting out
values, principles and commitments to stakeholders that underpin
the way we do business.
Andrew Clark - services
to the Community
Andrew Clark, a Relationship director in
our Commercial business and a Making
a difference Award winner, volunteers
as a Community First Responder and also
a st. John Ambulance member. last year
Andrew secured £8,000 for his responder
team and attended 156 calls ranging from
falls to strokes, chest pains, fitting, difficulty
breathing and cardiac arrests, being on call
for a total of 600 hours.
As a volunteer for st. John Ambulance,
Andrew is County staff officer for
the operations department who are
responsible for the management of all
public duties, vehicles and logistics in the
county. For a number of years Andrew
has also crewed an ambulance, having
completed his ambulance service blue
light driving assessment and ambulance
training. in 2010 Andrew contributed
413 hours of voluntary service.
42
Annual Report and Accounts 2011
OUR LONDON 2012 PARTNERSHIP
London 2012
In 2011 we continued to bring the
London 2012 Games closer to people
and communities across the UK.
Bringing the Games closer to communities
With Lloyds TSB and Bank of Scotland branches on nearly every UK
high street we are in a unique position to bring the inspiration and
excitement of the Games closer to communities across the country,
through programmes like National School Sport Week and our
Local Heroes programme, supporting the future of Team GB and
ParalympicsGB.
Giving customers the chance to get involved
We are creating as many opportunities as possible for our customers
and the communities we serve across the UK to get involved in the Games:
In 2011, more than 200,000 people signed up to Trackside, our
customer exclusive programme. Trackside is just one of the ways
we are giving customers the chance to win tickets to the London
2012 Olympic and Paralympic Games. Through Trackside, 1,500
personal banking customers will each win a pair of tickets to the
Games. We are also giving customers chances to win exclusive
experiences with Olympians and Paralympians.
Lloyds TSB is the only Presenting Partner of both the London
2012 Olympic and Paralympic Torch Relays and in 2011 we gave
our customers and the wider public the chance to become
Torchbearers and carry the Flame in the Relay(s).
As the Official Partner of the London 2012 Ticketing programme,
we are helping to ensure customers and communities have access
to information about tickets to the Olympic and Paralympic Games.
Our Official London 2012 Ticket Guides were available in all of
our branches.
Scottish Widows is Pensions and Investment Provider of the
London 2012 Olympic and Paralympic Games and in 2011 we gave
customers the chance to be at the Games - more than 60,000
entered our exclusive competition.
Background
Lloyds Banking Group is proud to be the official banking and insurance
partner for the London 2012 Olympic and Paralympic Games, the biggest
sporting event ever staged in the UK.
Our vision for our partnership, delivered through Lloyds TSB,
Bank of Scotland and Scottish Widows, is to bring the Games even closer
to communities and millions of people across the UK. In 2011 we
continued to realise this vision with a programme of inclusive, inspirational
and engaging activities, resulting in us being seen as the sponsor doing
the most to support the Games.
National School
Sport Week –
York High School
York High School held a number
of events to celebrate National
School Sport Week 2011, promoting
the Olympic and Paralympic Values,
boosting participation in physical
activity and providing young people
with leadership opportunities.
The week had a positive impact on the
students’ attitudes towards sport and
many particularly enjoyed trying new
sports. They developed team-working
skills and created a great atmosphere
around the school.
The students became accustomed
to being physically active and made
a pledge about their future level of
physical activity, which will be monitored
by the school’s Young Ambassadors.
And, links forged with community sports
clubs should encourage a higher uptake
of sports outside of school hours.
43
Annual Report and Accounts 2011
OUR LONDON 2012 PARTNERSHIP
Helping businesses benefit from London 2012
We are focused on supporting our business customers to maximise
the opportunities of the Games and ensure a lasting legacy for
UK businesses. In 2011 we used the power of London 2012 to inspire
businesses all over the UK:
One in three of the £3 billion worth of London 2012 contracts
have been awarded to our business customers with more
contract opportunities still available along the supply chain.
We developed a free, step-by-step guide, to help businesses
understand the various ways in which they can prepare for the
Games and seize the business opportunities.
Our Pace & Power events brought together local business people
with Olympians and Paralympians and Local Heroes, who shared
their thoughts on sporting success and how this can be translated
into the world of business.
As the chosen bank to the Olympic Delivery Authority and
LOCOG, we are proud of our role in supporting the development
of the Olympic Park and other Games venues.
Activation Programmes
Olympic and Paralympic Torch Relays
In 2011 we ran public campaigns to find hundreds of people who have
made a positive difference in their community to be Torchbearers and
carry the Flame in the London 2012 Olympic Torch Relay or Paralympic
Torch Relay. We received thousands of nominations from customers
and the public across the UK, many of whom had uplifting and
inspirational stories to share.
We developed the Lloyds TSB London 2012 Olympic Torch Tour, which
travelled the UK during the summer of 2011. The Tour gave people
the chance to get up close to the new Olympic Torch and learn more
about the history and excitement of the Relay. The Tour visited 76
communities over 84 days, directly engaging 56,000 people with our
London 2012 activity.
National School Sport Week
Delivered in partnership with the Youth Sport Trust, Lloyds TSB
National School Sport Week (with Bank of Scotland and sportscotland
in Scotland) uses the excitement of the London 2012 Games to inspire
more young people to do more sport.
We provide resources to schools to help them plan activities leading up
to and during the week and in 2011 over 4 million young people took
part. 48 per cent of secondary school pupils and 42 per cent of primary
school pupils said they have joined or would like to join a new sports
team or club in school after taking part in National School Sport Week.
Local Heroes
The Local Heroes programme helps some of the most talented emerging
athletes in the UK during one of the toughest stages of their career.
In partnership with SportsAid, the UK’s leading charity for identifying
and supporting young talented athletes, we committed to supporting
more than 1,000 of these future stars of Team GB and ParalympicsGB
by the time of the London 2012 Games.
2011 was the fourth year of the Local Heroes programme and we
supported 324 athletes. Local Heroes also attended a variety of internal
and customer-facing Group events and initiatives including sharing
their experiences with young schoolchildren during National School
Sport Week; attending events with Olympians and business customers
on the parallels between high performance in business and sport; and
visiting branches with the London 2012 Olympic Torch to engage with
our colleagues, customers and their families.
London 2012 Trackside:
Bringing London 2012 closer to our customers
Trackside, launched in February 2011, is a customer exclusive
programme giving Lloyds TSB and Bank of Scotland personal
customers chances to win tickets to the London 2012 Games and
opportunities to meet Olympians and Paralympians, as well as ensuring
customers are the first to hear about our latest London 2012 news and
offers. Registered customers receive regular e-newsletters and in 2011
we gave away more than 1,100 pairs of tickets to the 2012 Games to
these personal customers.
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.
Simon Brown –
Olympic Torchbearer
Simon is 32 and from Morley, West
Yorkshire. In 2006 he was shot in the face
saving the lives of six of his colleagues
in Iraq. Following months of rehabilitation
and dozens of operations to rebuild his
face Simon began to help young people
come to terms with their own loss of
sight at St Dunstan’s charity in Sheffield.
His nominator and friend, Eleanor Noakes
said, “Simon has not had an easy journey
on his road to recovery and has battled
with the impact of his injuries. He now
uses those experiences to help others
overcome their own difficulties and
is a true inspiration to his community.”
44
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Performance in line with our expectations
The Group delivered a combined businesses profit of £2,685 million in 2011 broadly in line with our expectations despite the challenging external
environment, with the core business delivering a resilient performance, and non-core results reflecting the substantial reductions in non-core assets
achieved in the year. In line with our strategy, we continued to further reduce the risk in our balance sheet, strengthening our core tier 1 capital
ratio, significantly reducing non-core assets and improving our funding position.
Group income and margin reductions partially offset by lower costs and impairments
The Group’s 2011 results, which are analysed below on a combined businesses basis (except where stated), were impacted by liability
management, volatile items and asset sales when compared to 2010 (see page 45). Excluding these, income declined by 10 per cent, reflecting a
smaller balance sheet (average interest earning assets are down 6 per cent) primarily driven by substantial reductions of non-core assets, and a net
interest margin which was 14 basis points lower than in 2010. The change in margin reflected continued high funding costs, including the costs of
refinancing of a significant amount of government and central bank facilities.
Costs reduced 4 per cent, driven by Integration and Simplification related savings and lower bonus accruals, partially offset by inflationary
pressures, the new UK bank levy and FSCS costs. The impairment charge reduced by 26 per cent, with lower charges seen across all divisions.
These lower charges were principally supported by the continued application of our prudent risk appetite and strong risk management controls
resulting in improved portfolio and new business quality, continued low interest rates, and broadly stable UK property prices, partly offset by
weakening UK economic growth and rising unemployment.
Profit before tax increased by 21 per cent. Excluding the effects of liability management, volatile items and asset sales, the combined businesses
profit before tax increased by 22 per cent to £2,022 million. A significant improvement in impairment was partly offset by reductions in income,
principally as a result of non-core asset reductions to further strengthen the balance sheet, as well as higher funding costs.
Profit before tax included the unwind of £1,943 million of acquisition-related fair value adjustments, around £250 million lower than previously
anticipated as a more cautious outlook for certain US securities resulted in the deferral of positive fair value unwind. Going forward, over the
medium-term, and in line with previous guidance, declining fair value unwind benefits are expected to accrue, with the benefit expected to be
approximately £0.5 billion in 2012.
The statutory loss before tax was £3,542 million in 2011 included the £3,200 million PPI provision, which is excluded from the combined businesses
results, and which was taken in the first half of 2011. The statutory result also includes, amongst other things, negative insurance volatility of
£838 million (2010: positive volatility of £306 million), and charges totalling £1,452 million (2010: £1,653 million), of which £1,097 million related to
integration, £185 million to simplification and £170 million to the EC mandated retail business disposal costs. After a tax credit of £828 million,
and after taking into account the profit attributable to non-controlling interests of £73 million, the loss attributable to equity shareholders was
£2,787 million and the loss per share amounted to 4.1 pence.
Further progress in reducing the Group’s risk
We continued to further reduce risk in our balance sheet, by increasing customer deposits, and by making excellent progress against our funding
objectives and on the continued reduction of non-core assets, thereby achieving a substantial reduction in wholesale funding requirements. We
strengthened our core tier 1 capital ratio to 10.8 per cent (31 December 2010: 10.2 per cent), largely as a result of a reduction in risk-weighted assets
of £54 billion principally from the run down of higher risk non-core assets. This was partially offset by the implementation of CRD III (20 basis points)
and the negative impact of the PPI provision (60 basis points).
Our loan to deposit ratio, excluding repos, improved to 135 per cent (31 December 2010: 154 per cent), and to 109 per cent in our core business
(31 December 2010: 120 per cent). Customer deposits excluding repos increased by 6 per cent, reflecting good growth in relationship deposits.
Wholesale funding requirements reduced by £47 billion to £251 billion, of which £138 billion (55 per cent) including bank deposits had a
maturity date of more than one year (31 December 2010: £149 billion, 50 per cent). Primary liquid assets at the year-end were £94.8 billion
(31 December 2010: £97.5 billion).
We also continue to closely monitor, control and reduce our exposures to selected European countries. The Group’s aggregate exposure to
Greece, Ireland, Italy, Portugal and Spain totalled £25 billion, of which £16 billion relates to Ireland. Total exposure has reduced by £9 billion since
31 December 2010. Further information on our exposures to these countries, including to banking groups, asset backed securities, and corporate,
retail and other exposures, is given on pages 156 to 161.
The Group made good progress against its balance sheet reduction plans in the year despite challenging market conditions. In 2011, we achieved
a substantial reduction in the non-core portfolio of £53 billion, resulting in the residual portfolio at 31 December 2011 amounting to £141 billion.
Notable progress was made through treasury asset reductions of £26 billion, UK commercial real estate reductions of £4.5 billion and Irish portfolio
reductions of £4.9 billion. Approximately half of the reduction arose from disposals, primarily treasury assets but pleasingly we also saw gross sales
of £0.9 billion in Ireland and around £1.8 billion in Australia. Asset sales overall were made broadly in line with the net book value at a Group level.
Core and non-core business performance
Detailed financial information on core and non-core business performance, including non-core asset reductions, is given on pages 86 to 93.
Our core business delivered a resilient performance given the challenging external environment. The 6 per cent decline in core income excluding
liability management, volatile items and asset sales reflected subdued new lending demand and continued customer deleveraging. The effect
on net interest margin of higher wholesale funding costs was mitigated by improved funding mix in the core business as a result of increased
customer deposits, resulting in a small decline in net interest margin of 6 basis points.
45
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Operating expenses and other costs in the core business fell by 2 per cent despite absorbing additional FSCS and bank levy costs. The core
impairment charge reduced by 20 per cent, reflecting the general stabilisation of our portfolios, and our continued prudent risk appetite applied
to new business. The 2011 core impairment charge as a percentage of average loans and advances to customers improved to 0.64 per cent.
Core loans and advances to customers generated just 24 per cent of the Group’s impaired loans, with a coverage ratio of 39 per cent at
31 December 2011.
Core business profit before tax was £6,349 million compared to £6,152 million in 2010. Excluding liability management, volatile items and asset
sales, core business profit before tax decreased by 6 per cent, principally reflecting higher funding costs and a decline in average interest-earning
assets as a result of subdued market conditions.
In the non-core business, the 54 per cent fall in income reflected the loss of income from the significant reductions achieved in the non-core
portfolio, and losses on asset disposals of £677 million, including losses on treasury assets of £758 million which were largely offset by a related
fair value unwind of £737 million included elsewhere in the income statement. Excluding the losses on disposals of assets, non-core income
decreased by 36 per cent. Net interest margin fell 45 basis points to 1.01 per cent, principally reflecting higher wholesale funding costs, and higher
levels of impaired assets.
Non-core operating expenses and other costs reduced by 21 per cent, reflecting the elimination of certain costs of supporting the non-core
portfolios. The non-core impairment charge reduced, principally as a result of material reductions in the Wholesale and International impairment
charges.
Non-core loans and advances to customers generated 76 per cent of the Group’s impaired loans reflecting their higher risk profile, with a coverage
ratio of 48 per cent at 31 December 2011.
Non-core loss before tax was £3,664 million (2010: loss before tax £3,940 million), with the improvement principally driven by reductions in
impairment and costs, partly offset by lower income, and lower fair value unwind.
Income
Total income, net of insurance claims, decreased by 10 per cent to £21,123 million. The decrease includes the effect of non-core asset reductions, a
number of volatile items including banking volatility, changes in the fair valuation of the equity conversion feature of the Group’s Enhanced Capital
Notes (ECNs), net derivative valuation adjustments and the effect of liability management gains in 2010 and 2011 (together ‘effects of liability
management, volatile items and asset sales’).
Combined businesses results summary – income
Total income
Insurance claims
Total income, net of insurance claims
Adjustments to exclude:
Liability management gains
Banking volatility
Change in fair valuation of equity conversion feature of ECNs
Net derivative valuation adjustments
Gains and losses on asset sales
Change
%
(11)
37
(10)
2011
£m
21,466
(343)
21,123
(1,295)
(3)
5
718
649
74
2010
£m
23,986
(542)
23,444
(423)
(347)
620
42
201
93
Total income, net of insurance claims, excluding effects of liability management,
volatile items and asset sales
21,197
23,537
(10)
Excluding liability management, volatile items and asset sales, total income, net of insurance claims decreased by 10 per cent, reflecting non-core
asset reductions undertaken to strengthen the balance sheet, subdued lending demand, continued customer deleveraging in our core business,
a lower banking net interest margin and lower treasury and trading income. The asset reductions, which resulted in losses of £649 million, were
primarily non-core asset sales (including losses on treasury assets of £758 million, which were largely offset by a related fair value unwind, included
elsewhere in the income statement).
Net interest income
Other operating income
Insurance claims
Total income, net of insurance claims, excluding effects of liability management,
volatile items and asset sales
2011
£m
12,233
9,307
(343)
2010
£m
14,143
9,936
(542)
21,197
23,537
Change
%
(14)
(6)
37
(10)
46
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Net interest income
Net interest income
Net interest margin
Average interest-earning banking assets
2011
£m
12,233
2.07%
2010
£m
14,143
2.21%
Change
%
(14)
£585.4bn
£625.9bn
(6)
Group net interest income decreased by £1,910 million, or 14 per cent, to £12,233 million in 2011. This fall primarily reflects the fall of 6 per cent
in average interest-earning banking assets in the year, along with the 14 basis points reduction in net interest margin.
The net interest margin in our banking businesses was 2.07 per cent, with the decline from 2.21 per cent in 2010 principally reflecting higher
wholesale funding costs, higher deposit rates and the effect of refinancing a significant amount of government and central bank facilities, partially
offset by an improvement in customer margins and funding mix. This fully incorporates the methodology changes outlined in our October 2011
announcement (New Allocation Methodologies for Funding Costs and Capital).
Other operating income
Other operating income
2011
£m
9,307
2010
£m
9,936
Change
%
(6)
Other operating income decreased by 6 per cent to £9,307 million. The decrease of 6 per cent reflected the targeted reduction in non-core assets,
lower core new lending volumes and lower income in Treasury and Trading as a result of market conditions.
Liability management gains
Liability management gains of £1,295 million arose in 2011 on transactions undertaken as part of the Group’s management of capital, primarily
on the exchange of certain debt securities for other debt instruments. The gain comprises £696 million recognised in statutory net interest
income, reflecting a reduction in the carrying value of certain debt securities as a result of changes in expected cash flows, and £599 million
recognised in statutory other operating income relating to the debt securities exchange. The comparable gain in 2010 was £423 million and
was recognised in statutory other operating income.
Comparison of fourth quarter 2011 income with third quarter 2011 income
Total income
Insurance claims
Total income, net of insurance claims
Adjustments to exclude:
Banking volatility
Change in fair valuation of equity conversion feature of ECNs
Net derivative valuation adjustments
Liability management gains
Gains and losses on asset sales
Total income, net of insurance claims, excluding effects of liability management,
volatile items and asset sales
Net interest income
Other operating income
Insurance claims
Total income, net of insurance claims, excluding effects of liability management,
volatile items and asset sales
Net interest margin
Average interest-earning banking assets
Three months
ended
31 December
2011
£m
Three months
ended
30 September
2011
£m
5,928
(58)
5,870
(35)
259
308
(1,295)
(5)
(768)
5,102
2,816
2,344
(58)
5,102
1.97%
5,162
(87)
5,075
(145)
(490)
463
–
24
(148)
4,927
3,051
1,963
(87)
4,927
2.05%
£567.5bn
£581.3bn
Change
%
15
33
16
4
(8)
19
33
4
(2)
In the fourth quarter of 2011, total income, net of insurance claims, increased by 16 per cent to £5,870 million when compared to the third quarter
of 2011. Excluding effects of liability management, volatile items and asset sales, income increased by 4 per cent, with a fall in net interest income
more than offset by an increase in other operating income.
47
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Net interest income fell 8 per cent to £2,816 million, when compared to the third quarter of 2011. This principally reflected a 2 per cent reduction
in average interest-earning banking assets in the quarter, mainly driven by non-core asset reductions, and an 8 basis point fall in net interest
margin to 1.97 per cent.
Other operating income increased by 19 per cent when compared to the third quarter of 2011, reflecting a recovery from poor trading conditions
seen in the third quarter, to a level of other income more comparable with that seen in the first half of the year.
Operating expenses
During 2011, operating expenses reduced by 6 per cent to £10,253 million. Total costs decreased by 4 per cent to £10,621 million, mainly as a
result of further integration-related savings and a lower bonus accrual, partially offset by increased employers’ National Insurance contributions,
the bank levy, and Financial Services Compensation Scheme costs. The bank levy of £189 million was accrued in the final quarter and was lower
than initially anticipated due to the improvement in the Group’s funding profile. In the fourth quarter we recognised a charge relating to Financial
Services Compensation Scheme costs of £115 million.
Combined businesses results summary – costs
Operating expenses
UK bank levy
Financial Services Compensation Scheme costs
Impairment of tangible fixed assets
Total costs
Integration synergies annual run-rate
Simplification savings annual run-rate
2011
£m
2010
£m
10,253
10,882
Change
%
6
189
179
–
10,621
2,054
242
–
46
150
11,078
1,379
–
4
As at 31 December 2011, we had realised annual run-rate savings of £2,054 million from the Integration programme. A major part of the
integration from an IT perspective was the migration of Halifax and Bank of Scotland customer accounts and data to the scaled Lloyds TSB
platforms and this was successfully completed in the third quarter. This was an immense exercise involving the migration of approximately
30 million customer accounts and these platforms will now provide the foundation for the Group’s transformation plans.
On 30 June 2011, we announced, as part of our strategy to deliver for customers and shareholders, that we would simplify the Group to improve
service and are now targeting the delivery of £1.7 billion of annual savings in 2014 (£1.9 billion of run-rate savings by the end of 2014). By the end
of 2011, after the first six months of this programme, we had achieved run-rate cost savings of £242 million.
Comparison of fourth quarter 2011 costs with third quarter 2011 costs
Total costs increased by 5 per cent to £2,712 million in the fourth quarter compared to the third quarter of 2011 as we recognised costs of the bank
levy and Financial Services Compensation Scheme. These were partially offset by a reduction in bonus accruals in the quarter.
Further reductions in the impairment charge
The Group continued to see reductions in the impairment charge in 2011. The impairment charge of £9,787 million in 2011 was 26 per cent lower
than the £13,181 million charge in 2010, with lower charges seen across all divisions. These lower charges were principally supported by the
continued application of our prudent risk appetite and strong risk management controls resulting in improved portfolio and new business quality,
continued low interest rates, and broadly stable UK retail and commercial property prices, partly offset by weakening UK economic growth and
rising unemployment.
Impaired loans decreased by 7 per cent compared to December 2010 to £60.3 billion, representing 10.1 per cent of closing advances, driven by
a decrease in Retail and Wholesale as a result of asset sales, repayments, and write-offs, partially offset by an increase in impaired loans in Ireland.
The Group’s overall coverage ratio was little changed at 46.0 per cent. Further detail on impaired asset trends and coverage ratios is given in the
Credit Risk review commencing on page 129.
48
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Combined businesses results summary – impairment charge
Retail
Secured
Unsecured
Wholesale
Commercial
Wealth and International
Ireland
Other
Central items
Impairment charge
2011
£m
463
2010
£m
292
1,507
2,455
1,970
2,901
303
3,187
1,423
4,610
3
9,787
2,747
4,064
382
4,264
1,724
5,988
–
13,181
Change
%
(59)
39
28
29
21
25
17
23
26
Retail’s impairment charge reduced by 28 per cent, with a reduction in the unsecured charge more than offsetting an increase in the secured
charge. As a percentage of average loans and advances to customers, the impairment charge decreased to 0.54 per cent, from 0.74 per cent in
2010. Credit performance remained strong with fewer assets entering arrears compared to 2010, in both the secured and unsecured portfolios.
Retail’s coverage ratio fell from 31.8 per cent to 30.8 per cent as a result of the smaller unsecured collections portfolio.
During 2011, Retail’s secured impairment charge was £463 million, in line with expectations, with the increase on 2010 largely reflecting a less
certain outlook for house prices, and provisioning against existing credit risks which have longer emergence periods due to current low interest
rates. These factors were partially offset by an improvement in the quality of the secured portfolio. This resulted in provisions as a percentage of
impaired loans increasing from 23.5 per cent at 31 December 2010 to 25.6 per cent at 31 December 2011. Secured asset quality remained good
and the number of customers entering arrears reduced through 2011 compared to 2010. The stock of properties in repossession remained stable
and the sales prices of repossessed properties continued to be at expected values. The proportion of the mortgage portfolio with an indexed
loan-to-value of greater than 100 per cent has decreased to 12 per cent benefitting from the regional mix of lending. The value of the portfolio
with an indexed loan-to-value of greater than 100 per cent and more than three months in arrears has been stable at just over £3 billion.
Retail’s unsecured impairment charge for 2011 was £1,507 million, a decrease of 39 per cent, compared to the same period in 2010. This
reflected continued improving new business quality and portfolio trends as a result of our conservative risk appetite, with a focus on lending to
existing customers. This focus on improving business quality has resulted in the level of early arrears for accounts acquired since 2009 being at
pre-recession levels. Unsecured impaired loans decreased to £2.4 billion from £3.0 billion at 31 December 2010 as a result of tighter credit policy
across the lifecycle, including stronger controls on customer affordability. Impairment provisions as a percentage of impaired loans in collections
increased to 86.5 per cent at 31 December 2011 from 82.5 per cent at 31 December 2010.
The Wholesale impairment charge decreased from £4,064 million in 2010 to £2,901 million in 2011. The reduction was primarily driven by lower
impairment from the corporate real estate and real estate related asset portfolios partly offset by higher impairment on leveraged acquisition
finance exposures. The continued low interest rate environment helped to maintain defaults at a reduced level. In addition, newly impaired assets,
being generally of better quality, are requiring a lower level of provisions once impaired than previously impaired assets. The impairment charge
as a percentage of average loans and advances to customers improved significantly to 1.95 per cent in 2011 compared to 2.23 per cent in 2010.
Impaired loans as a percentage of lending increased slightly to 20.5 per cent from 20.0 per cent but the coverage ratio fell to 41.6 per cent from
46.9 per cent reflecting write-offs of impaired assets with a higher impairment rate, the substantial reductions of poorer quality non-core assets and
lower required impairment rates on newly impaired assets.
In Commercial, the impairment charge decreased by £79 million, or 21 per cent, to £303 million in 2011 reflecting the benefits of the low interest
rate environment, which has helped maintain defaults at a lower level, and the continued application of our prudent credit risk appetite. Portfolio
metrics including delinquencies and assets under close monitoring remain above benign environment levels. The impairment charge as a
percentage of average loans and advances to customers improved to 1.06 per cent in 2011 compared to 1.24 per cent in 2010 and impairment
provisions as a percentage of impaired loans reduced from 34.7 per cent to 30.2 per cent.
In Wealth and International, impairment charges totalled £4,610 million, a decrease of 23 per cent from £5,988 million in 2010. The reduction
predominantly reflects lower impairment charges in our Irish portfolio where the rate of impaired loan migration has slowed. The impairment
charge as a percentage of average loans and advances to customers improved to 7.37 per cent from 8.90 per cent. Impaired loans increased
by £0.4 billion with an increase of £1.9 billion in Ireland partly offset by a reduction in the Australasian book as a result of write-offs and
disposals, resulting in 42.8 per cent of the International portfolios (66.0 per cent of the Irish portfolio) being classified as impaired compared
with 35.1 per cent in 2010. Provisions as a percentage of impaired loans in the International portfolios were 61.0 per cent at the end of 2011
(31 December 2010: 52.9 per cent). Impairment coverage has increased in Ireland to 62.1 per cent from 53.7 per cent, primarily reflecting further
falls in the commercial real estate market during 2011, and further vulnerability exists. Impaired loans accounted for 84.3 per cent of the Irish
wholesale portfolio, with a coverage ratio of 61.1 per cent. Further provisioning has been necessary in the Group’s Australasian portfolio primarily
reflecting geographical real estate concentrations where market conditions and asset valuations have remained weak in 2011.
49
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Comparison of fourth quarter 2011 impairment charge with third quarter 2011 impairment charge
Retail
Wholesale
Commercial
Wealth and International
Ireland
Other
Central items
Impairment charge
Three months
ended
31 December
2011
£m
Three months
ended
30 September
2011
£m
375
658
97
711
565
1,276
3
2,409
422
686
46
697
105
802
–
1,956
Change
%
11
4
(2)
(59)
(23)
As anticipated at the time of our Q3 Interim results Statement on 8 November 2011, the impairment charge increased in the fourth quarter, largely
reflecting higher charges in Other International, primarily as a result of further provisioning in the Group’s Australasian portfolio.
Balance sheet
Improving capital ratios
Risk-weighted assets
Core tier 1 capital ratio
Tier 1 capital ratio
Total capital ratio
Change
%
(13)
2011
2010
£352.3bn
£406.4bn
10.8%
12.5%
15.6%
10.2%
11.6%
15.2%
Our core tier 1 capital ratio improved significantly to 10.8 per cent at 31 December 2011 (31 December 2010: 10.2 per cent). The impact of the
statutory loss, and an increase in risk-weighted assets of approximately £7 billion from the implementation of CRD III which reduced core tier 1
capital ratio by approximately 20 basis points, were more than offset by a reduction in risk-weighted assets of £54.1 billion, principally from
disposals of higher risk non-core assets. The total capital ratio improved to 15.6 per cent (31 December 2010: 15.2 per cent).
Risk-weighted assets reduced 13 per cent to £352.3 billion in 2011, driven by the run-down of our non-core asset portfolio, which accounted for
65 per cent of the reduction, and weak demand for new lending. Modelling changes had no material effect on risk-weighted assets.
In line with our strategy, the capital intensity of the balance sheet continues to reduce, with new lending being of better quality than existing
portfolios, and thus having a lower average risk-weighting.
Further progress on balance sheet reduction
Funded assets
Non-core assets
Non-core risk-weighted assets
2011
£bn
587.7
140.7
108.8
2010
£bn
655.0
193.7
143.9
Change
%
(10)
(27)
(24)
Total Group funded assets decreased to £587.7 billion from £655.0 billion at 31 December 2010, substantially driven by reductions in non-core
portfolios across the banking divisions, continued customer deleveraging and de-risking and subdued demand in lending markets. We are
pleased with the progress made on our balance sheet reduction plans in the period, given challenging market conditions. In 2011, we achieved
a substantial reduction in the non-core portfolio of £53 billion, resulting in the portfolio at 31 December 2011 amounting to £141 billion. This
reduction includes more than A2 billion of cash generated from repayments and disposals from the Irish portfolio.
50
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Further strengthening of our liquidity and funding position
Customer deposits1
Wholesale funding
Loan to deposit ratio2
Core business loan to deposit ratio2
Government and central bank facilities
Proportion of wholesale funding with maturity of greater than one year
Primary liquid assets
1
2
Excluding repos of £8.0 billion (31 December 2010: £11.1 billion).
Excluding repos and reverse repos.
Change
%
6
(16)
2011
2010
£405.9bn
£251.2bn
135%
109%
£382.5bn
£298.0bn
154%
120%
£23.5bn
£96.6bn
55%
50%
£94.8bn
£97.5bn
The Group made excellent progress against its funding objectives in 2011 and further enhanced its general funding and liquidity position which is
supported by a robust and stable customer deposit base. Customer deposits excluding repos increased by 6 per cent, reflecting good growth in
relationship deposits, and now represent 62 per cent of our deposit and wholesale funding.
By the end of 2011, our loan to deposit ratio, excluding repos and reverse repos, had improved to 135 per cent and we expect this will continue to
improve as we reduce our non-core lending balances further. Our core loan to deposit ratio also improved to 109 per cent from 120 per cent at the
end of 2010.
Strong term issuance in 2011 also allowed the Group to further reduce its short-term wholesale funding and extend its maturity profile of
wholesale funding with 55 per cent of wholesale funding having a maturity date greater than one year at 31 December 2011 (50 per cent as at
31 December 2010). Of the funding with maturity less than one year of £113 billion, £24 billion is secured and £24 billion relates to the UK Credit
Guarantee Scheme, leaving £65 billion of other unsecured wholesale funding.
Though funding markets remain challenging, we exceeded our 2011 term funding issuance plans with £35 billion of wholesale term issuance.
We announced in our Q3 2011 Interim Management Statement that we had completed our 2011 term funding programme at the end of
October. The wholesale term issuance of £2 billion in November and December was therefore pre-funding for 2012.
As previously outlined we have a £20 billion to £25 billion term funding requirement during 2012 across all public and private issuance
programmes. Given the pre-funding of 2012 requirements achieved in the fourth quarter of 2011, the benefits of the liability management exercise
in December 2011, and issuance of £8 billion in January and February 2012, we have already achieved over 50 per cent of this target by the end of
February 2012.
At 31 December 2011, the Group had £24 billion of issuance remaining under the UK Credit Guarantee Scheme. As previously outlined, we expect to
repay the remaining facilities in line with their contractual maturity dates, £19 billion in the first half of 2012 and £5 billion in the second half of 2012.
The Group also continues to maintain a strong liquidity position, considerably in excess of current regulatory requirements. Our primary liquidity
portfolio at the end of the year was £94.8 billion, in line with the level at December 2010. This represents approximately 133 per cent of our money
market funding positions as at the end of December 2011 and is approximately 84 per cent of all wholesale funding with a maturity of less than a
year, providing a substantial buffer in the event of continued market dislocation. In addition to this primary liquidity, the Group continues to hold
more than £100 billion of secondary liquidity.
51
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Items arising after combined businesses profit
Integration and simplification costs
Integration costs of £1,097 million and simplification costs of £185 million were incurred in 2011. These costs relate to severance, IT and business
costs of implementation.
The Integration programme has now delivered run-rate recurring savings of £2,054 million per annum as at the end of 2011, at an aggregate
expensed cost of £3,846 million. The Simplification programme is well underway and achieved annual run-rate savings of £242 million in 2011.
Further details on the Integration and Simplification programmes are given on page 96.
Verde
The Verde business comprises a network of 632 branches, and the TSB and Intelligent Finance brands, and serves approximately 5.5 million
customers. Our preferred option for the disposal of the Verde business is a direct sale and the preferred bidder for the business is The
Co-operative Group. Any final transaction will be subject to regulatory approval and certain other conditions. We continue to expect to be in a
position to update shareholders on progress towards the end of March 2012 at which time, and if appropriate, we will provide further details on
the proposed transaction. We will continue to progress an IPO as an alternative to a direct sale.
Volatility arising in insurance businesses
A large proportion of the funds held by the Group’s insurance businesses are invested in assets which are expected to be held on a long-term
basis and which are inherently subject to short-term investment market fluctuations. Whilst it is expected that these investments will provide
enhanced returns compared with less volatile assets over the longer term, the short-term effect of investment market volatility can be significant.
The negative insurance and policyholder interests volatility of £838 million in 2011 reflects lower equity and cash returns compared to long-
term expectations.
Provision in relation to German insurance business litigation
As previously disclosed, Clerical Medical Investment Group Limited (CMIG) has received a number of claims in the German courts, relating to
policies issued by CMIG but sold by independent intermediaries in Germany. The Group has recognised a provision of £175 million in 2011 and
management believes this represents the most appropriate estimate of the financial impact, based upon a series of assumptions, including the
number of claims received, the proportion upheld, and resulting legal and administration costs.
Payment protection insurance
Our review of the compliance with applicable sales standards in respect of PPI continues to make good progress and we continue to believe that
the provision of £3.2 billion we took in the first half of 2011 in respect of the anticipated costs of contact and/or redress, including administration
expenses, is adequate and that we are appropriately provided. Costs incurred in 2011 against this provision amounted to £1,045 million.
Taxation
The tax credit for 2011 was £828 million. This reflects a lower effective tax rate than the UK statutory rate primarily due to the effect on deferred tax
of the reduction in the UK corporation tax rate to 26 per cent with effect from 1 April 2011 and to 25 per cent with effect from 1 April 2012, offset by
the net movement in deferred tax recognised for losses.
Summary of financial progress
During 2011, the Group has continued to make very significant progress in divesting non-core assets and refocusing customer balances (loans and
deposits) to meet our prudent risk appetite and to enable reduced wholesale funding with a strong liquidity position. We have the appropriate
momentum that will allow that journey to continue in the medium-term in line with our strategic objectives. Our customer propositions are now
better aligned to our income generating opportunities and, while headline progress is reflective of economic conditions, we are well positioned
to continue to respond to customer needs by building income through both lending and advice products. Both our derisking and customer focus
are underpinned by the ongoing reshaping of our cost base, exploiting the experience of delivering the complex integration, with significant
investment spend to deliver our strategic priorities.
52
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Combined businesses segmental analysis
2011
Net interest income
Other income
Effects of liability
management, volatile items
and asset sales
Total income
Insurance claims
Total income, net of
insurance claims
Costs:
Operating expenses
Other costs1
Trading surplus
Impairment
Share of results of joint
ventures and associates
Profit (loss) before tax and
fair value unwind
Fair value unwind 2
Profit (loss) before tax
Banking net interest margin3
Cost:income ratio4
Impairment as a percentage
of average advances5
Key balance sheet and
other items
31 December 2011
Loans and advances to customers
excluding reverse repos
Customer deposits excluding repos
Risk-weighted assets
Other costs include FSCS costs and UK bank levy.
Retail
£m
7,497
1,649
48
9,194
–
Wholesale
£m
Commercial
£m
Wealth and
International
£m
2,139
3,335
(1,415)
4,059
–
1,251
446
–
1,697
–
828
1,197
–
2,025
–
Group
Operations and
Central items
£m
585
(7)
1,293
1,871
–
Insurance
£m
(67)
2,687
–
2,620
(343)
Group
£m
12,233
9,307
(74)
21,466
(343)
9,194
4,059
1,697
2,025
2,277
1,871
21,123
(4,438)
(2,518)
–
(4,438)
4,756
(1,970)
–
(2,518)
1,541
(2,901)
11
14
2,797
839
3,636
2.09%
48.3%
(1,346)
2,174
828
1.56%
62.0%
(948)
–
(948)
749
(303)
–
446
53
499
4.21%
55.9%
(1,537)
(11)
(1,548)
477
(4,610)
3
(4,130)
194
(3,936)
1.26%
76.4%
0.54%
1.95%
1.06%
7.37%
(805)
(7)
(812)
(7)
(350)
(357)
1,465
1,514
(3)
(1)
1,510
(1,274)
236
–
–
1,465
(43)
1,422
35.7%
(10,253)
(368)
(10,621)
10,502
(9,787)
27
742
1,943
2,685
2.07%
50.3%
1.62%
£bn
£bn
£bn
£bn
£bn
£bn
£bn
352.8
247.1
103.2
123.3
84.3
163.8
28.8
32.1
25.4
43.8
42.0
47.3
0.1
0.4
12.6
548.8
405.9
352.3
The net credit in 2011 of £1,943 million is mainly attributable to a reduction in the impairment charge of £1,693 million as losses reflected in the acquisition balance sheet valuations of the lending
and securities portfolios have been incurred.
The calculation basis for banking net interest margins is set out on page 97.
Impairment on loans and advances to customers divided by average loans and advances to customers, excluding reverse repurchase transactions, gross of allowance for impairment losses.
Operating expenses excluding impairment of tangible fixed assets divided by total income net of insurance claims.
1
2
3
4
5
53
Annual Report and Accounts 2011
SUMMARY OF GROUP RESULTS
Combined businesses segmental analysis (continued)
2010
Net interest income
Other income
Effects of liability
management, volatile items and
asset sales
Total income
Insurance claims
Total income, net of
insurance claims
Costs:
Operating expenses
Other costs1
Trading surplus
Impairment
Share of results of joint
ventures and associates
Profit (loss) before tax and
fair value unwind
Fair value unwind
Profit (loss) before tax
Banking net interest margin
Cost:income ratio
Impairment as a percentage
of average advances
Key balance sheet and
other items
31 December 2010
Retail
£m
8,648
1,607
–
10,255
–
Wholesale
£m
Commercial
£m
2,847
3,974
(295)
6,526
–
1,127
457
–
1,584
–
10,255
6,526
1,584
(4,598)
(46)
(4,644)
5,611
(2,747)
(2,752)
(150)
(2,902)
3,624
(4,064)
17
(95)
2,881
1,105
3,986
2.31%
45.3%
(535)
3,049
2,514
1.59%
42.2%
(992)
–
(992)
592
(382)
–
210
81
291
3.74%
62.6%
Wealth and
International
£m
1,050
1,123
Insurance
£m
(39)
2,799
37
2,210
–
2,210
(1,536)
–
(1,536)
674
(5,988)
15
2,775
(542)
2,233
(854)
–
(854)
1,379
–
(8)
(10)
(5,322)
372
(4,950)
1.46%
69.5%
1,369
(43)
1,326
38.2%
Group
Operations and
Central items
£m
510
(24)
150
636
–
636
(150)
–
(150)
486
–
5
491
(1,446)
(955)
0.74%
2.23%
1.24%
8.90%
Group
£m
14,143
9,936
(93)
23,986
(542)
23,444
(10,928)
(196)
(11,124)
12,366
(13,181)
(91)
(906)
3,118
2,212
2.21%
46.6%
2.01%
£bn
£bn
£bn
£bn
£bn
£bn
£bn
Loans and advances to customers
excluding reverse repos
Customer deposits excluding repos
Risk-weighted assets
363.7
235.6
109.3
141.5
82.8
196.1
28.6
31.3
26.6
55.3
32.8
58.7
1
Other costs include FSCS costs and impairment of tangible fixed assets.
0.4
–
15.7
589.5
382.5
406.4
54
Annual Report and Accounts 2011
DIVISIONAL RESULTS
Retail
Retail operates the largest retail bank in the UK and is a leading
provider of current accounts, savings, personal loans, credit
cards and mortgages. With its strong stable of brands including
Lloyds TSB, Halifax, Bank of Scotland and Cheltenham & Gloucester,
it serves over 30 million customers through one of the largest
branch and fee free ATM networks in the UK.
Retail is focused on effectively meeting the needs of its customers.
The division provides current accounts including packaged accounts
and basic and 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 five new residential mortgages
making it one of the leading UK mortgage lenders and provided over
52,000 mortgages to help first time buyers in 2011. Retail is the largest
private sector savings provider in the UK. It is also a major general
insurance and bancassurance distributor, offering a wide range
of long‑term savings, investment and general insurance products.
Halifax shakes up savings
Each month, our registered savings
customers have the ability to win one of
3x £100,000, 100x £1,000 or 1,000x £100
prizes in our Savers Prize Draw. Over
450,000 customers registered for the first
prize draw, which is the first of its kind,
giving customers this chance in addition
to their individual product’s interest rate.
Mobile Banking
We’ve now had over 1 million downloads
of the Lloyds TSB app launched in October
2011, and 1.5 million across Lloyds TSB,
Halifax and Bank of Scotland. The app
allows customers to access their online
accounts, transfer funds and make
payments to new and existing recipients.
2011 highlights
Profit before tax decreased by 9 per cent to £3,636 million
Fair value unwind decreased by 24 per cent
Total income decreased by 10 per cent
– Net interest income was 13 per cent lower
– Other income increased by 3 per cent
Operating expenses and other costs reduced by 4 per cent
The impairment charge reduced by 28 per cent
Key operating brands
Loans and advances to customers decreased by 3 per cent
Customer deposit growth was 5 per cent
Retail’s strategy remains focused on building deeper
customer relationships
55
Annual Report and Accounts 2011
DIVISIONAL RESULTS – RETAIL
Performance summary
Net interest income
Other income
Effects of liability management, volatile items and assets sales
Total income
Costs:
Operating expenses
Other costs2
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit before tax and fair value unwind
Fair value unwind
Profit before tax
Banking net interest margin
Impairment as a % of average advances
Cost:income ratio
Change
%
(13)
3
(10)
3
4
(15)
28
(35)
(3)
(24)
(9)
2011
£m
7,497
1,649
48
9,194
(4,438)
–
(4,438)
4,756
(1,970)
11
2,797
839
3,636
2.09%
0.54%
48.3%
20101
£m
8,648
1,607
–
10,255
(4,598)
(46)
(4,644)
5,611
(2,747)
17
2,881
1,105
3,986
2.31%
0.74%
45.3%
1
2
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Other costs include FSCS costs in 2010.
At 31 December
Key balance sheet and other items
Loans and advances to customers (excluding repos):
Secured
Unsecured
Customer deposits (excluding repos):
Savings
Current accounts
Total customer balances
Risk‑weighted assets
Performance indicators
2011
£bn
2010
£bn
Change
%
329.1
23.7
352.8
206.3
40.8
247.1
599.9
103.2
337.3
26.4
363.7
195.3
40.3
235.6
599.3
109.3
(2)
(10)
(3)
6
1
5
(6)
Profit before tax
(combined businesses basis)
£m
Impairment as a percentage %
of average advances
Customer deposits
(excluding repos)
£bn
Active online customers million
3,986
1.11
3,636
224.1
235.6
247.1
7.6
6.9
8.3
0.74
0.54
955
2009
2010
2011
2009
2010
2011
2009
2010
2011
2009
2010
2011
56
Annual Report and Accounts 2011
DIVISIONAL RESULTS – RETAIL
2011 highlights
Profit before tax decreased by 9 per cent to £3,636 million, driven by higher funding costs and muted demand for credit.
Total income decreased by 10 per cent:
– Net interest income was 13 per cent lower, largely as a result of higher funding costs, muted demand for credit, the continued impact
from previous de‑risking of the lending portfolio with a corresponding reduction in impairments and increased competition for deposits
as we continued to reduce our funding gap.
– Other income increased by 3 per cent, principally as a result of higher bancassurance income. Income also includes the gain on the
disposal of VISA Inc. shares.
Operating expenses and other costs reduced by 4 per cent, benefiting from cost savings from both our integration and simplification
programmes partially offset by inflation. We continue to invest in the Retail business to improve products and services for our customers
including in both our digital platforms and our branches.
The impairment charge reduced by 28 per cent, primarily driven by a reduced unsecured charge which reflected our continued
conservative approach to risk, effective portfolio management, and continued focus on existing customers.
Fair value unwind decreased by 24 per cent, driven largely by the maturing balances of the pre‑acquisition portfolio.
Loans and advances to customers decreased by 3 per cent as customers continued to reduce their personal indebtedness particularly
in unsecured lending, as non‑core balances reduced and as we maintained a conservative risk appetite. Risk‑weighted assets fell
6 per cent, principally reflecting reductions in unsecured balances.
Customer deposit growth was 5 per cent, against a market that experienced minimal growth. This strong performance reflected the
compelling customer proposition Retail has developed, and was driven by strong tax‑free cash ISA balance growth. This strong deposit
growth, in addition to the issuance of debt securities backed by Retail assets, provided ongoing support to the Group funding position.
Against its strategic objectives, Retail’s strategy remains focused on building deeper customer relationships, driven by superior
customer insight, and investment in its multi‑brand strategy, new products, multiple channels, and in colleagues. Retail was notably
successful in developing new products to address customer needs, such as the Halifax savers prize draw and ISA promise, and developing
new digital technologies, such as mobile banking, to allow customers multi‑channel access. The majority of integration activity is now
complete and Retail has made good progress on products, sourcing, systems and processes.
Strategic focus
Retail’s goal is to be the UK’s best bank for customers. This will be achieved by building deep and enduring relationships with our customers
which will deliver real value to them, and, by continuing to support the UK economy. Developing our customer insight and having a deeper
understanding of customers and their needs will enable us to better invest in products and services that customers will most value. In addition by
simplifying the business and developing highly efficient and effective processes we will deliver an improved customer experience and increase
the flexibility with which the business can respond to changes in the operating environment. Success for Retail will be reflected in an enhanced
customer experience resulting in strong customer advocacy which in turn, we believe, will lead to lower customer acquisition costs, increased share
of wallet and improved customer retention. Retail believes this strategy will drive sustainable long‑term value for all stakeholders.
Progress against strategic initiatives
Reshaping the business
Retail is reshaping the business in a way that is driven by our customers’ needs and refocusing our efforts on building deeper customer
relationships. As part of this we have continued to make good progress at strengthening the balance sheet through strong customer deposit
growth and by managing down balances outside our risk appetite. Retail has also progressed with plans to divest retail assets and liabilities in line
with state aid obligations (Project Verde).
Retail is committed to understanding more fully what individual customers want from our products and services. Retail has a significant asset in the
customer information it manages and we are investing to further develop our insight into customer needs. This will ensure we continue to do more
to anticipate and meet customers’ financial needs, and help us develop relationships with customers so that they trust us to meet more of their
needs, and stay with us for longer, thereby creating more profitability for the Group.
Retail is committed to a multi‑brand strategy operating relationship brands for Lloyds TSB and Bank of Scotland with a challenger brand for Halifax
and other tactical brands in the portfolio. Through our strategy, Retail can reach more customers with more distinct and considered proposals and
product offerings.
Retail has been successful at developing new challenger propositions that appeal to customers like the savers prize draw in Halifax. The prize
draw offers customers the opportunity to win up to £100,000 and has achieved strong enrolment (with over 450,000 customers registered for the
first draw) and improved customer advocacy. Retail also developed the Halifax ISA promise which delivers a clear service promise that resonates
with customers and helped support record new ISA business performance in 2011. The mortgage offering has also been developed, including the
roll‑out of a new mortgage sales platform that has improved the processing of mortgage applications and significantly simplified the mortgage
application process for both customers and advisors.
57
Annual Report and Accounts 2011
DIVISIONAL RESULTS – RETAIL
Simplifying the Bank
We’re taking decisive steps towards becoming a simpler organisation. Retail has already made good progress with the recent integration which
delivered a common banking platform across the majority of customers and accounts, additional details are provided on page 96. We are now
investing in our infrastructure to ensure our systems support future simplification of the business and improve our capabilities. This includes
the further development of Risk and Finance systems to make decision‑making more agile and enable us to compete more effectively in our
chosen markets.
Retail continues to simplify its sourcing arrangements and flatten its management structure. Retail is making good progress at reducing the
number of suppliers and improving its demand management. Reducing the layers of management is delivering stronger and more effective
functions and empowering managers and colleagues.
Retail is also working to introduce simpler products, systems and processes for customers. This includes developing new digital technologies
to simplify our customers’ interactions with the Group and make banking with us more convenient – in particular services like our award‑
winning internet banking, mobile banking apps (which have achieved over 1.5 million downloads) and Money Manager. Retail has seen strong
improvement in customer advocacy with those customers who use these services.
Investing to be the best bank for customers
Changing our business to be simpler and more customer‑centric will help us to achieve our vision, but we also need to invest in growth to be the
best bank for customers. That means deepening our customer relationships, growing the capabilities and skills of our colleagues, and helping our
communities to grow and prosper.
We are committed to support and build stronger relationships with all customers and as part of this are developing the products and services we
provide to mass affluent and business connected customers so that we can better meet their needs and form deep and enduring relationships.
This includes investing in training for our advisors and more automated systems, ensuring we help address the more complex financial needs of
these customers and improve customer experience.
Retail recognises the importance of the branch for many customers and has made a commitment to maintain the same number of branches for the
next three years, including pledging that it will not close a branch if it’s the last in a community. Retail has also commenced a significant investment
programme across the Lloyds TSB branch network. The programme targets upgrading branch interiors, increasing the opening hours in branches,
simplifying the advisor role structure and improving the queuing experience. Pilots of the revised branch design and roles have delivered strong
improvements in customer advocacy and new product sales.
We believe investing in our colleagues and deepening the pool of talent in the Group will ensure we continue to be an employer of choice. This
includes investing in training Academies and professional qualifications to support colleagues’ development.
Our support for households is vital to the strength of the UK economy. Through our community investment agenda we aim to make a lasting
difference to the country, focusing on key themes such as financial capability and inclusion, and environmental responsibility.
Financial performance
Despite the difficult operating environment Retail delivered a profit before tax in 2011 of £3,636 million which was £350 million, or 9 per cent, lower
than 2010.
Profit before tax and fair value unwind decreased to £2,797 million, a reduction of 3 per cent compared to 2010, driven by higher funding costs and
the muted demand for credit.
Total income decreased by £1,061 million, or 10 per cent, to £9,194 million. This was driven by a reduction in net interest income of £1,151 million,
while other income increased by £42 million. Core income trends were consistent with total income performance described below.
Net interest income reduced by 13 per cent compared to 2010. One of the main drivers was the increase in wholesale funding costs which were
not matched by average customer rates. Net interest margin in 2011 decreased by 22 basis points to 2.09 per cent. Income growth was also
constrained by muted demand for credit. Previous de‑risking of the lending portfolio, with a resulting reduction in unsecured balances, also
contributed to the reduction in income albeit with a proportionately greater reduction in impairment. Net interest margin, minus impairment rate,
remained stable reflecting progress in de‑risking the balance sheet. Finally, increased competition for deposits and strong balance growth resulted
in an increase in the average rate paid on customer deposits.
Other income increased by 3 per cent in 2011 to £1,649 million from £1,607 million largely as a result of higher bancassurance income, driven by an
increase in the value of protection products sold through the branch network. Income also includes the gain on the disposal of VISA Inc shares.
Operating expenses and other costs fell by 4 per cent compared to 2010 and the cost‑income ratio was 48.3 per cent. Operating expenses
benefited from our integration activities, the start of our simplification programme, and other day‑to‑day cost management activities to offset
inflation. We continue to invest in the Retail business to improve products and services for our customers including our digital platforms and our
branches. During 2011 Retail successfully completed a major milestone in the Integration programme, the consolidation of its main Retail product
systems, which is discussed in greater detail on page 96. This now creates a solid platform to deliver the simplification programme.
58
Annual Report and Accounts 2011
DIVISIONAL RESULTS – RETAIL
Credit performance across the business continued to be supported by our conservative approach to risk, a continued focus on existing customers
and low interest rates. The impairment charge on loans and advances decreased by £777 million, or 28 per cent, to £1,970 million driven by
reductions in the unsecured charge. The unsecured impairment charge reduced to £1,507 million from £2,455 million in 2010, reflecting the impact
of our continued conservative approach to risk (resulting in improved new business quality), effective portfolio management and a reduction in
unsecured balances. The secured impairment charge increased to £463 million from £292 million in 2010 largely reflecting a less certain outlook
on house prices and appropriate provisioning against existing credit risks which have longer emergence periods due to current low interest rates.
These factors were partially offset by underlying improvement in the quality of the secured portfolio.
The fair value unwind net credit was £839 million compared with £1,105 million in 2010. This reduction was driven largely by the maturing balances
of the pre‑acquisition portfolio.
Balance sheet progress
Total customer balances remained stable at £599.9 billion as Retail continued to maintain its relationships with customers. The mix of these
balances continued to move towards customer deposits as customers continued to reduce their personal indebtedness and Retail continued to
make strong progress in attracting savings balances. This change in customer balance composition has additionally supported the Group’s funding
although it has also contributed to a reduction in income and profit.
Loans and advances to customers decreased by £10.9 billion, or 3 per cent, to £352.8 billion, compared to 31 December 2010. This was driven
by reduced customer demand for new credit, existing customers continuing to reduce their personal indebtedness, non‑core lending run off
and Retail maintaining a conservative approach to risk. The reduction in lending to customers was in part due to the repayment of unsecured
debt where balances reduced by £2.7 billion, or 10 per cent. Secured balances reduced by £8.2 billion, or 2 per cent, of which £1.9 billion was
a reduction in non‑core mortgage balances. The proportion of mortgages on standard variable rate, or equivalent products, now stands at
56 per cent and is expected to remain broadly stable in 2012.
Retail’s gross mortgage lending was £28.0 billion in 2011 which was equivalent to a market share of 20 per cent. Retail’s new mortgage lending
continued to be focused on home purchase with 70 per cent of lending being for house purchase rather than re‑mortgaging. Retail remains the
UK’s largest lender to first time buyers, helping over 52,000 customers buy their first home in 2011.
Risk‑weighted assets decreased by £6.1 billion to £103.2 billion compared to 31 December 2010. This reflected the impact of lower lending
balances and the reducing mix of unsecured lending.
Total customer deposits increased by £11.5 billion, or 5 per cent, to £247.1 billion in 2011. This increase was largely driven by strong growth in tax
free cash ISA balances. Retail continues to perform well in the savings market despite the high levels of competition, with a strong stable of savings
brands providing customers with an award winning range of products to meet their savings needs.
Retail continues to make a significant contribution to Group funding both through customer deposit growth and the supply of assets supporting
over £64.0 billion of debt securities in external issue. During the year Retail contributed to £16.4 billion of new issuance. The majority of these
securitisations are backed by mortgages and have a fixed repayment schedule and as such provide a stable source of funding for the Group.
Arena
Our Wholesale business has launched
‘Arena’ which is now fully operational. This
online portal allows quick and easy access
to foreign exchange and money market
deposits, allowing our customers to ensure
their business is suitably financed in a way
that suits their needs.
59
Annual Report and Accounts 2011
DIVISIONAL RESULTS
wholesale
The division comprises Wholesale Banking and Markets (WBM)
and our Asset Finance business. The Wholesale Banking and
Markets business serves corporates with turnover above
£15 million, and financial institutions with a range of relationship
focused propositions, segmented according to customer need.
Wholesale Banking and Markets businesses are grouped into three
areas, coverage and product, with a support function providing
centralised coordination of critical business processes and activities.
Coverage comprises Corporate Banking, Mid Markets and Sales.
Corporate Banking is responsible for the overall management
of relationships with major corporate and institutional customers
principally in the UK. Similarly Mid Markets manages the relationships
with mid market corporates, which operate on a pan-UK basis.
Sales provide customers with tailor-made risk management solutions
through liability, foreign exchange, commodity and interest rate
management products.
Product comprises Capital Markets, Portfolio Management, Trading,
Structured Corporate Finance, Transaction Banking, Structured
Transactions Group and Lloyds Development Capital. These product
units work alongside the coverage teams to provide specialised
lending, access to capital markets and multi product financing
solutions to WBM’s customers. In addition, these units provide access
to financial markets in order to meet the Group’s balance sheet
management requirements, and provide trading infrastructure to
support execution of customer driven risk management transactions.
Asset Finance consists of a number of leasing and speciality lending
businesses including Lex Autolease and Consumer Finance
(Black Horse Motor and Personal Finance).
Following the changes to organisational structure announced
in February 2012, the Asset Finance business is being
transferred to Wealth and International division
for 2012 reporting.
Bank of the Year –
7 years running
We won Best Bank of the Year for the
7th consecutive year at the Real FD/CBI
Excellence Awards. This highlights the
consistent support we provide
to businesses through the full course
of the economic cycle.
Fair value unwind decreased by 29 per cent
Assets decreased by 18 per cent
Customer deposits excluding repos were 2 per cent higher
Wholesale continued to deepen its customer relationships
through a measured build out of products and capabilities
2011 highlights
Profit before tax was £828 million compared
to £2,514 million in 2010
Total income decreased 38 per cent
– Net interest income decreased by 25 per cent
– Other income decreased by 48 per cent
Operating expenses decreased by 16 per cent
The impairment charge decreased by 29 per cent
Key operating brands
60
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WHOLESALE
Performance summary
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Costs:
Operating expenses
Other costs2
Trading surplus
Impairment
Share of results of joint ventures and associates
Loss before tax and fair value unwind
Fair value unwind
Profit before tax
Banking net interest margin
Impairment as a % of average advances
Cost:income ratio (excl. impairment of tangible fixed assets)
Change
%
(25)
(16)
(38)
9
13
(57)
29
(29)
(67)
2011
£m
2,139
3,335
(1,415)
4,059
(2,518)
–
(2,518)
1,541
(2,901)
14
(1,346)
2,174
828
1.56%
1.95%
62.0%
20101
£m
2,847
3,974
(295)
6,526
(2,752)
(150)
(2,902)
3,624
(4,064)
(95)
(535)
3,049
2,514
1.59%
2.23%
42.2%
1
2
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Other costs include impairment of tangible fixed assets in 2010.
At 31 December
Key balance sheet and other items
Loans and advances to customers (excluding reverse repos)
Reverse repos
Loans and advances to customers
Loans and advances to banks
Debt securities
Available-for-sale financial assets
Customer deposits (excluding repos)
Repos
Customer deposits including repos
Risk-weighted assets
Performance indicators
2011
£bn
123.3
16.8
140.1
8.4
12.5
12.6
173.6
84.3
7.1
91.4
163.8
2010
£bn
Change
%
141.5
3.1
144.6
12.4
25.8
29.5
212.3
82.8
10.2
93.0
196.1
(13)
(3)
(32)
(52)
(57)
(18)
2
(30)
(2)
(16)
Profit (loss) before tax
(combined businesses basis)
£m
Impairment as a percentage %
of average advances
Customer deposits
(excluding repos)
£bn
Asset reduction
£bn
2,514
6.38
87.5
82.8
84.3
250.7
2009
2010
828
2011
2.23
1.95
212.3
173.6
(4,682)
2009
2010
2011
2009
2010
2011
2009
2010
2011
61
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WHOLESALE
2011 highlights
Profit before tax was £828 million compared to £2,514 million in 2010, with lower income as the balance sheet was materially
strengthened through targeted asset reductions, partially offset by reduced impairment and lower costs. Excluding the impacts of asset
sales and derivative valuation adjustments, profit before tax reduced £649 million or 30 per cent, in the context of a challenging economic
and market environment.
Total income decreased 38 per cent (20 per cent excluding losses on asset sales and derivative valuation adjustments)
– Net interest income decreased by 25 per cent, principally reflecting the substantial reductions in non-core assets, which fell 34 per
cent. Net interest margin fell by three basis points, with the impact of higher funding costs almost fully offset by re-pricing activity and
increased deposit margins and volumes.
– Other income decreased by 16 per cent principally reflecting reduced trading income and a lower level of operating lease asset
income in Asset Finance.
Operating expenses decreased by 9 per cent, with further integration cost savings, reduced operating lease depreciation and lower
bonus accruals, partially offset by continued investment in core customer facing resource and systems, in line with the priorities set out in
June in the Group’s Strategic review.
The impairment charge decreased by 29 per cent, reflecting continued strong risk management and the low interest rate environment.
Fair value unwind decreased by 29 per cent, mainly driven by decreased impairments in the loan book, lower release from the reduced
treasury asset portfolio and reduced general release given a more cautious outlook for the value of certain assets, partially offset by
favourable exchange rate movements.
Assets decreased by 18 per cent, (25 per cent excluding reverse repos), reflecting the targeted reduction in the non-core balance
sheet by £35 billion. Although net lending to core customers (excluding reverse repos) reduced by £9 billion as a result of weak demand
and continued customer deleveraging as credit facilities matured and were not renewed by customers, gross new committed lending to
customers continues to meet our lending commitments. Risk-weighted assets reduced by 16 per cent, in line with the reduction in the
balance sheet.
Customer deposits excluding repos were 2 per cent higher, in line with the Group Strategy to increase customer deposits.
Against its strategic objectives, Wholesale continued to deepen its customer relationships through a measured build out of products
and capabilities in support of the needs of the existing customer base. With the majority of integration now completed, a new, simpler
organisational structure was implemented. Alongside enhanced product capabilities in areas including debt capital markets, money
markets, interest rate management and foreign exchange, a transaction banking transformation programme was initiated in the year, to
build an enhanced cash management, payments and trade customer offering.
Strategic focus
Wholesale’s strategic goal is to be recognised as the UK’s leading, through-the-cycle, partner to UK companies and institutions, with the clear
objective of supporting our customers’ success. We will strengthen the franchise by retaining and deepening our recurring, multi-product
customer relationships, building on deep insight into our customers’ needs and by offering a broad range of lending, deposit, risk management,
debt capital market and transaction banking products. This strategy will enable us to grow our capital light revenues and continue to be a
significant provider of financial support to the UK economy.
Progress against strategic initiatives
Reshaping the business
Against the backdrop of a challenging operating environment, in 2011 Wholesale made significant progress in serving more fully the wider needs
of the core customer franchise in a capital and funding efficient way. Whilst maintaining the through-the-cycle commitment to making lending
available, Wholesale is rebalancing the business towards customers’ known fee based banking and financing needs. This growth path for the core
business is complemented by a clear mandate to limit or reduce the consumption of capital and funding in non-core areas.
In 2011 Wholesale reduced non-core assets by £35 billion significantly contributing towards the reduction of the Group’s wholesale funding
requirement. Whilst this has meant the loss of associated income, it has resulted in a material improvement in the profile of the Group’s balance
sheet, both in terms of risk and absolute size. Further, in total, these asset sales were in line with the net book value.
In 2012, the focus will be on strengthening the franchise in those businesses that generate sustainable, predictable returns on equity at the level
targeted by the Group Strategic Review while continuing to reduce non core assets in a capital efficient way.
Simplifying the Bank
To deliver the strategy, a new, simplified, business model has been implemented to ensure more effective co-ordination of Coverage, Product and
Support. Coverage and Product are now more closely integrated to create a single team offering to allow seamless access to the banking and
financial markets expertise our customers demand. The Support functions have been reconfigured and delayered to provide centralised, efficient
and client focused processes and activities to inform and drive better business decisions and performance. This simpler approach will enable
easier co-ordination of multi-product solutions on behalf of Wholesale’s customers and improve the way we meet their on-going needs.
62
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WHOLESALE
Investing in customer franchise
The Strategic Review in June confirmed Wholesale’s commitment to meet more fully the range of needs of Wholesale’s customer base. In
2011, product capability has been enhanced through the further development of our debt capital markets business and the implementation
of Bloomberg e-trading to support trading of bonds and gilts with financial institution clients. In addition Arena, a scalable online portal for
foreign exchange, interest rate management and money market deposits, is now fully operational, and providing efficient, cost effective, market
access for customers. Lloyds TSB also achieved Gilt-Edged Market Maker status, becoming a primary dealer in UK government bonds, creating
opportunities to further service a wider group of Financial Institutions.
In 2011, Wholesale initiated a Transaction Banking Transformation Programme, to build an improved, cash management, payments and trade
customer offering. This programme will deliver improved customer services in stages, with the bank’s Faster Payments scheme already successfully
extended and a service allowing customers to obtain more easily settlement from their European customers introduced. Lloyds Banking Group
partnership with London 2012 saw the successful processing of card settlements for Olympic and Paralympic Games ticketing and Transaction
Banking also launched the UK’s first contactless prepaid cards for corporate use, with a special range of Visa London 2012 Olympic and Paralympic
Games themed Cards.
Awards
In 2011, Wholesale’s focus on deepening customer relationships and continued commitment to core businesses was once again recognised
by Finance Directors of commercial and corporate companies who voted Lloyds TSB as Bank of the Year in the CBI/Real FD awards for the
seventh year running.
Wholesale also achieved double success at Euroweek’s Syndicated Loan and Leveraged Finance Awards 2011 winning the ‘Best Arranger of
UK Loans’ and ‘Best Arranger of Mid-Cap Loans’ awards. This was the second consecutive year that the Group has won these awards, reinforcing
the market’s recognition of Wholesale’s expertise in arranging these transactions, as well as the ongoing commitment that the Group have made
to our customers. Further notable successes include the Leveraged Finance House of the Year in the Private Equity News Awards for Excellence
in Private Equity, three awards at the Project Finance International Awards 2011 and in debt capital markets where the bank ranked first in 2011 for
sterling corporate UK parent bond issuance (Dealogic).
Financial performance
Profit before tax was £828 million compared to a profit before tax of £2,514 million in 2010. Income reduced by £2,467 million and fair value unwind
fell, partially offset by lower costs and a significant decrease in the impairment charge, and the elimination of losses in joint venture businesses.
The profit performance was significantly impacted by the impact of net derivative valuation adjustments and asset disposals net of associated fair
value. Excluding these effects profit before tax was £1,506 million.
Core profit before tax decreased to £682 million compared to profit before tax of £2,052 million in 2010, largely due to reduced income from
a reduced balance sheet as customers deleverage, a challenging trading environment and as a result of net derivative valuation adjustments.
Impairments increased due to certain specific large cases. Excluding net derivative valuation adjustments core profit before tax was £1,400 million,
down 33 per cent on 2010.
Non-core profit before tax was £146 million compared to a profit of £462 million in 2010, reflecting the effect of lower income from the continued
downward management of the balance sheet, partially offset by lower costs, a continued significant decrease in impairments net of fair value
unwind and elimination of losses in the joint venture businesses.
Income
Wholesale’s income performance was significantly impacted by lower asset balances, losses on asset disposals in the year to strengthen the
balance sheet and net derivative valuation adjustments. Net derivative valuation adjustments of £718 million were driven primarily by a large fall in
long term sterling interest rates and significantly higher market credit spreads. Losses on disposal of £697 million were realised from the disposal
of assets and were offset by a related fair value unwind. Net of these effects, income reduced by £1,347 million or 20 per cent, primarily as a
consequence of economic and market conditions, which resulted in customer deleveraging, higher funding costs, and lower trading revenues.
Total income
Adjustments to exclude:
Net derivative valuation adjustments
Gains and losses on asset sales
Total income net of volatile items and asset sales
2011
£m
4,059
718
697
5,474
2010
£m
6,526
42
253
6,821
Change
%
(38)
(20)
Net interest income decreased by £708 million, or 25 per cent, to £2,139 million. The decrease reflects lower interest-earning asset balances in line
with the Group’s targeted balance sheet reduction of loans and advances to customers and banks, debt securities and available-for-sale positions.
Net interest income was also adversely affected by higher funding costs. This was partially offset by an increase in the liability margin resulting from
the increased market value of deposits.
The net banking margin decreased by three basis points to 1.56 per cent. This principally reflects increased wholesale funding costs, partly offset
by customer re-pricing and increased deposit margins and volumes. Asset margins decreased as the benefit of higher customer rates was more
than offset by funding costs, whilst liability margins improved.
63
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WHOLESALE
Other income decreased by £639 million, or 16 per cent, to £3,335 million, mainly reflecting lower income in Asset Finance and reduced trading
revenues. The effect of losses on asset disposals from the continued focus on balance sheet reductions and net derivative valuations adjustments
due to the increased market implied credit risk associated with customer derivative balances resulted in losses of £1,415 million, compared to
£295 million in 2010.
Core income was £3,559 million compared to £4,793 million in 2010, reflecting the effects of net derivative valuation adjustments and as a
consequence of difficult market and economic conditions, reduced lending balances to corporate customers, and higher wholesale funding costs.
Excluding derivative valuation adjustments income decreased 12 per cent showing resilience in the challenging environment.
Non-core income decreased to £500 million compared to £1,733 million in 2010, due to losses on asset disposals (offset by a related fair
value unwind included elsewhere in the income statement), a significantly lower balance sheet from the continuing successful asset reduction
programme, lower margin due to higher wholesale funding costs and reduced income as the non-core Asset Finance businesses were run down
or sold.
The core banking net interest margin saw a significant increase of 21 basis points to 1.80 per cent, driven primarily by a lower reliance on wholesale
funding as asset balances reduced and deposit balances increased. The non-core banking margin, which is predominantly asset based, decreased
by 32 basis points to 1.28 per cent, largely from increased wholesale funding costs.
Costs
Operating expenses decreased by £234 million, or 9 per cent, to £2,518 million from further savings from the Integration programme, lower
operating lease depreciation, lower bonus accruals and other ongoing cost management actions to mitigate the impact of inflationary increases.
This was partially offset by continued investment in customer facing resources and systems.
Impairment and fair value unwind
The impairment charge decreased by £1,163 million, or 29 per cent, to £2,901 million reflecting a sustained decrease since the peak in 2009. As
a percentage of average loans and advances to customers, the impairment charge improved to 1.95 per cent from 2.23 per cent in 2010. This
reflected robust and proactive risk management and lower defaults from continued low interest rates despite a subdued economic environment.
The core impairment charge was £741 million, compared to £576 million in 2010. The increase is attributable to a few specific large cases reflecting
the nature of impairments in a Wholesale portfolio. The non-core impairment charge decreased by £1,328 million, or 38 per cent, to £2,160 million
in 2011. This was primarily due to lower impairment from non-core corporate real estate and real estate related asset portfolios, reflecting a
stabilisation of commercial property prices in 2011. Non-core impairments in 2010 were significant as a result of the scale and pace of deterioration
in the property sector and poorer quality heritage HBOS lending.
The share of results from joint ventures and associates, which are all non-core, comprised a small profit of £14 million, an improvement of
£109 million, due to the non-recurrence of losses and impairments taken in 2010.
Fair value unwind decreased £875 million to £2,174 million, reflecting the lower impairments in the loan book, reduced release on the smaller
non-core treasury asset book and a risk based approach to release on certain treasury assets given market conditions, partially offset by favourable
exchange rate movements. The fair value unwind predominantly relates to non-core portfolios.
Balance sheet progress
In 2011 Wholesale continued to focus on strengthening the balance sheet by reducing non-core assets. Assets (comprising loans and advances
to customers and banks, debt securities and available-for-sale financial assets) reduced by £38.7 billion, or 18 per cent, to £173.6 billion, primarily
reflecting deleveraging by customers and continued active de-risking of the non-core balance sheet by either selling down or reducing holdings in
debt securities and available-for-sale assets, as well as disposal of £4.8 billion of non-core commercial real estate customer balances. The non-core
reduction was £35.2 billion, primarily driven by a reduction in treasury assets of £26 billion. This overall balance sheet reduction was net of an
increase in reverse repo balances as liquidity was invested in high quality primary liquid assets on a secured basis.
Loans and advances to customers excluding reverse repos reduced by £18.2 billion, or 13 per cent, to £123.3 billion as demand for new corporate
lending and refinancing of existing facilities was more than offset by maturities, reflecting a continued trend of subdued corporate demand for
lending, customer deleveraging and asset sales in non-core sectors. Non-core lending accounted for 51 per cent, of this reduction. Available-for-sale
financial assets balances reduced by £16.9 billion, or 57 per cent, to £12.6 billion and debt securities by £13.3 billion, or 52 per cent, to £12.5 billion.
This was driven by the reduction in the non-core balance sheet through treasury and other asset sales or not replenishing holdings after
amortisations and maturities. The non-core proportion of these reductions was £12.7 billion, or 75 per cent, in the case of available-for-sale assets,
and £13.1 billion, or 98 per cent, in the case of debt securities. Loans and advances to banks reduced by £4.0 billion, or 32 per cent, to £8.4 billion.
Customer deposits excluding repos increased by 2 per cent to £84.3 billion, due to an increase in deposits in line with the Group’s funding strategy.
Customer deposits on the core book increased by 3 per cent to £81.5 billion.
Risk-weighted assets decreased by £32.3 billion, or 16 per cent, to £163.8 billion, primarily reflecting balance sheet reductions and run down
in other non-core asset portfolios, as well as the impact of changes in the risk profile, partially offset by Basel regulatory changes to market risk.
Non-core risk-weighted assets represent £24.7 billion, or 76 per cent, of this reduction.
64
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WHOLESALE
Wholesale (excluding Asset Finance)
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Costs:
Operating expenses
Impairment of tangible fixed assets
Trading surplus
Impairment
Share of results of joint ventures and associates
(Loss) before tax and fair value unwind
Impairment as a % of average advances
Cost:income ratio (excl. impairment of tangible fixed assets)
2011
£m
1,783
2,212
(1,394)
2,601
(1,534)
–
(1,534)
1,067
(2,701)
13
(1,621)
1.93%
59.0%
1
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
At 31 December
Key balance sheet and other items
Loans and advances to customers excl reverse repos
Reverse repos
Loans and advances to customers1
Loans and advances to banks
Debt securities
Available-for-sale financial assets
Customer deposits2
Risk-weighted assets
1
Of which reverse repos represent £16.8 billion (31 December 2010: £3.1 billion).
2
Of which repos represent £7.1 billion (31 December 2010: £10.2 billion).
2011
£bn
116.9
16.8
133.7
8.4
12.5
12.6
167.2
91.4
155.8
20101
£m
2,430
2,631
(295)
4,766
(1,636)
(150)
(1,786)
2,980
(3,800)
(95)
(915)
2.22%
34.3%
2010
£bn
132.6
3.1
135.7
12.4
25.8
29.5
203.4
93.0
184.1
Change
%
(27)
(16)
(45)
6
14
(64)
29
(77)
Change
%
(12)
(1)
(32)
(52)
(57)
(18)
(2)
(15)
Total income decreased by £2,165 million to £2,601 million, mainly driven by a decrease in other operating income. This principally reflects losses
of £676 million on the disposal of assets in 2011, (offset by a related fair value unwind of £737 million, reflected elsewhere in the income statement),
net derivative valuation adjustments of £718 million and the effect of a reduced balance sheet. Excluding asset sales and temporary volatility,
income decreased by £1,066 million or 21 per cent, broadly in line with the balance sheet movement.
Net interest income decreased by £647 million, or 27 per cent, to £1,783 million. The decrease reflects lower interest-earning asset balances in
line with the continued focus on balance sheet reduction and strengthening, mainly in loans and advances to customers, debt securities and
available-for-sale positions. Net interest income was also adversely affected by higher wholesale funding costs, which was partially offset by an
increase in the liability margin resulting from the increased market value of deposits.
Other income decreased by £419 million, or 16 per cent, to £2,212 million, primarily reflecting the lower trading revenue and reduced fees
and commissions.
Operating expenses decreased by £102 million, or 6 per cent, to £1,534 million. The reduction in operating expenses from integration savings,
lower bonus accruals and the continued focus on cost management have been offset by reinvestment into customer facing resources and systems
The impairment charge decreased by £1,099 million to £2,701 million in 2011, reflecting a sustained decrease since the peak in 2009. As a
percentage of average loans and advances to customers, the impairment charge improved to 1.93 per cent in 2011 compared to 2.22 per cent
in 2010. This reflected robust and proactive risk management and lower defaults from continued low interest rates despite a subdued
economic environment
The share of results from joint ventures and associates comprised a small profit of £13 million, an improvement of £108 million, due to the
non-recurrence of losses and impairments taken in 2010.
65
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WHOLESALE
Asset Finance
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Operating expenses
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit before tax and fair value unwind
Impairment as a % of average advances (annualised)
Cost:income ratio
2011
£m
356
1,123
(21)
1,458
(984)
474
(200)
1
275
2.33%
67.5%
1
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
At 31 December
Key balance sheet and other items
Loans and advances to customers
Operating lease assets
Risk-weighted assets
2011
£bn
6.4
2.7
8.0
20101
£m
417
1,343
–
1,760
(1,116)
644
(264)
–
380
2.34%
63.4%
2010
£bn
8.9
3.0
12.0
Change
%
(15)
(16)
(17)
12
(26)
24
(28)
Change
%
(28)
(10)
(33)
Profit before tax and fair value unwind was £275 million, compared to £380 million in 2010. The £105 million reduction was largely due to a
decrease in income.
Total income decreased by £302 million, or 17 per cent, to £1,458 million as a result of lower business volumes, including assets held under
operating leases, the non-recurrence of VAT claims settled in the prior year and a £21 million loss on disposal of Hill Hire plc. The lower business
volumes are in-line with the targeted reduction in this asset class and were partly offset by improved margins.
Operating expenses decreased by £132 million, or 12 per cent, to £984 million. This reflected an £88 million, or 11 per cent, decrease in
depreciation charges on assets held under operating leases largely from a lower fleet size. Other costs decreased by £44 million, or 13 per cent,
reflecting strong cost management and savings achieved from integration.
The impairment charge decreased by £64 million to £200 million, reflecting an improvement in market conditions for both the retail and non-retail
consumer finance businesses. The lower impairment charge has been driven by a reduction in new cases entering arrears, the reduced book size
and the improved credit quality of new business.
66
Annual Report and Accounts 2011
DIVISIONAL RESULTS
commercial
Commercial serves in excess of 1.1 million small and medium-sized
enterprises and community organisations from start-up to those
with a turnover of up to £15 million, as well as providing asset
based finance to business of all sizes.
Commercial comprises Commercial Banking, Commercial Finance,
providing invoice discounting and factoring, hire purchase and leasing
and AMC the long term lender to the agricultural sector. The business
has a ‘through the cycle’ customer relationship approach, drawing
on a wide range of Group service in order to meet their needs
through their business lifecycle – from start-up, through growth,
to maturity and succession. Through the SME Charter, Commercial
have committed to lend £12 billion gross and continue to deliver
positive net lending in 2012 and to help 300,000 start ups in the three
years to end 2012.
Flexible monthly
price plan
Lloyds TSB was the first UK bank to offer a
range of flexible Monthly PricePlans, which
simplify charges and improve transparency
for business banking customers. This
innovative approach offers customers
choice, flexibility and gives them greater
control of their banking.
Supporting start-ups
Through our Relationship Manager
network an innovative company has been
able to research and launch their range
of umbrellas, where the material changes
colour when wet. SquidLondon umbrellas
are stocked in places such as the Conran
Store and the TATE.
2011 highlights
Profit before tax increased by 71 per cent
Customer deposits grew 3 per cent
Total income increased by 7 per cent
– Net interest income grew by 11 per cent
– Other operating income decreased by 2 per cent
Operating expenses reduced by 4 per cent
The impairment charge reduced by 21 per cent
Loans and advances to core customers increased by
3 per cent against a contracting market
Key operating brands
Risk-weighted assets decreased by 5 per cent
Commercial has focused on strengthening its customer
relationships and supporting SMEs through the cycle
demonstrated by:
– Sustainable franchise growth
– Supporting customers through responsible lending
– Improving cross-sales
67
Annual Report and Accounts 2011
DIVISIONAL RESULTS – COMMERCIAL
Performance summary
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Costs:
Operating expenses
Other costs
Trading surplus
Impairment
Profit before tax and fair value unwind
Fair value unwind
Profit before tax
Banking net interest margin
Impairment as a % of average advances
Cost:income ratio
2011
£m
1,251
446
–
1,697
(948)
–
(948)
749
(303)
446
53
499
4 .21%
1.06%
55.9 %
1
Incorporates the methodology cha nges outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
At 31 December
Key balance sheet and other items
Loans and advances to customers (excluding repos)
Customer deposits (excluding repos)
Total customer balances
Risk-weighted assets
Performance indicators
2011
£bn
28.8
32.1
60.9
25.4
20101
£m
1,127
457
–
1,584
(992)
–
(992)
592
(382)
210
81
291
3.74%
1.24%
62.6%
2010
£bn
28.6
31.3
59.9
26.6
Change
%
11
(2)
7
4
4
27
21
(34)
71
Change
%
1
3
2
(5)
Profit (loss) before tax
(combined businesses basis)
£m
Impairment as a percentage %
of average advances
Customer deposits
(excluding repos)
£bn
Commercial net
lending growth 2011 (core)
%
499
2.72
30.4
31.3
32.1
291
2010
2011
1.24
1.06
3.0
Lloyds
Banking
Group
Market
2009
(200)
2009
2010
2011
2009
2010
2011
(6.0)
68
Annual Report and Accounts 2011
DIVISIONAL RESULTS – COMMERCIAL
2011 highlights
Profit before tax increased by 71 per cent, due to higher income, combined with a reduction in impairments and costs.
Total Income increased by 7 per cent:
– Net interest income grew by 11 per cent, due largely to the increase in deposit balances, and a higher net interest margin.
This deposit balance growth, the beneficial effect of the consequently larger funding surplus, and a more favourable deposit
mix were the key drivers behind the 47 basis point increase in banking net interest margin
– Other operating income decreased by 2 per cent, reflecting subdued levels of business activity in the early part of the year
and reduced levels of money transmission income reflecting the greater use of electronic banking facilities by customers.
Operating expenses reduced by 4 per cent, primarily as a result of integration cost savings including lower back office staffing
requirements.
The impairment charge reduced by 21 per cent, due to an overall improvement in the credit quality of the portfolio reflected in
a reduction in observed default and delinquency rates. This is supported by the specialist relationship support, which helps customers
facing difficult business conditions.
Loans and advances to core customers increased by 3 per cent against a contracting market. This reflects the continuing support
given to small and medium sized businesses, fully offsetting the reduction in non-core assets.
Customer deposits grew 3 per cent, reflecting our ongoing success in attracting deposits from new customers, combined with
targeted support in key customer segments such as the education and legal sectors.
Risk-weighted assets decreased by 5 per cent, reflecting the improved mix and risk profile of the portfolio.
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.
Strategic focus
Commercial’s goal is to be the best bank for smaller and medium sized businesses. The main strategic focus is to improve the depth of relationship
with SMEs through specialist customer propositions in key markets, by improving relationship management skills and capacity to cross-sell and
optimising customer service through efficiencies that also contribute to cost effectiveness targets.
Progress against strategic initiatives
Reshaping the business
The business is being reshaped by investing to improve the customer proposition, leveraging wider Group capabilities, and supporting SMEs
through the cycle to help them prosper and develop. This will be achieved through investment in our Relationship Managers and will be
supported by product and system development aligning to customers’ wider financial needs. The number of customer facing industry specialists
has increased improving support in key markets.
In support of the SME sector, the Group has exceeded its agreed full year contribution to the aggregate Merlin capacity lending target in respect
of SMEs. The core net lending balance growth of 3 per cent compares favourably with the contraction of SME lending across the industry reported
by the Bank of England.
Supporting the full range of customer needs has resulted in balanced growth of deposits and lending, which has strengthened the balance sheet
maintaining the funding surplus. The benefit of close relationship support through the cycle is evidenced in the improvement in credit quality.
Risk-weighted assets have reduced in the context of increased lending, reflecting the improvement in risk profiles as well as the higher mix of
secured lending in the book.
Simplifying the Bank
Commercial has made good progress with simplification, with the majority of customers now on a single banking platform. Simpler organisational
structures and processes have been delivered with the benefit of lower back office staffing requirements.
The customer benefits arising from simplification are important with significant progress being made on the re-engineering of the lending process.
A successful pilot of the new process has halved the time taken to fulfil lending to customers. This will be fully rolled out by the end of 2012. The
product range has also been simplified for customers with the launch of the UK’s first range of Monthly Price Plans providing certainty and control
over bank charges to SME customers; over 30,000 customers have already signed up to this new product.
69
Annual Report and Accounts 2011
DIVISIONAL RESULTS – COMMERCIAL
Investing in growth
SMEs are a strategic priority reflecting the Group’s commitment to the sector, the competitive advantage entailed in the Group’s distribution
strengths and relationship expertise, and the potential offered by better co-ordination of the wider range of services across 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.
The Business Support Unit (BSU) is helping businesses in financial difficulties, in line with the commitment to support customers through the
economic cycle. Since 2009 the BSU has restructured facilities for around 10,000 businesses and has protected more than 250,000 UK jobs.
Commercial’s commitments to customers are made in the SME Charter which has been refreshed and extended to encourage enterprise, provide
clear and fair pricing, access to finance and support for communities. As part of this, Commercial has committed to lend £12 billion to customers
in 2012. This will be supported by at least 200 customer networking events which have proved to be a key platform for recruitment and customer
support.
Commercial supports businesses across the SME sector and has supported 124,000 start up businesses in 2011 as part of the three year
commitment to help 300,000 businesses. Support to SME customers will be improved through deepening customer relationships, with internal
investment resources agreed along with detailed plans to achieve this.
Awards
– Awarded Bank of the Year (joint award with Wholesale) for the 7th consecutive year on the basis of votes of Finance Directors in the Real FD
Excellence Awards supported by the CBI and the Institute of Chartered Accountants.
– Awarded best charity account provider in the Business Moneyfacts Awards.
– Awarded Asset Financer of the Year (January 2011) – Credit Today Awards.
Financial performance
Profit before tax and fair value unwind in 2011 was £446 million compared to a profit of £210 million in 2010. The improvement of £236 million was
largely driven by deposit balance growth and the increased value to the Group’s cost of funding from deposits as well as a benefit from a change
in the mix of Commercial’s deposit balances. The increase in income is partially offset by other operating income which has decreased £11 million,
2 per cent, due to subdued levels of trading activity in the early part of the year and reduced levels of money transmission income reflecting the
greater use of electronic banking facilities by customers.
Operating expenses have decreased £44 million, 4 per cent, primarily as a result of integration cost saving programmes delivering positive results,
including lower back office staffing requirements.
Impairment has decreased £79 million, 21 per cent, due to an overall improvement in the credit quality of the portfolio leading to a reduction
in observed default and delinquency rates. Impairment charges as an annualised percentage of average loans and advances to customers has
reduced to 1.06 per cent from 1.24 per cent in 2010, an improvement of 18 basis points year-on-year.
The fair value unwind decreased by 34 per cent, reflecting the decrease in impairment charge.
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.
Customer deposits increased 3 per cent to £32.1 billion reflecting our ongoing success in attracting new customers, combined with targeted
support in key customer segments such as the education and legal sectors.
70
Annual Report and Accounts 2011
DIVISIONAL RESULTS
wealth and
international
Wealth and International combines the private banking
and asset management businesses and the Group’s
international businesses.
The Wealth business comprises private banking and asset
management. Wealth’s private banking operations cater to the
full range of wealth clients from affluent to Ultra High Net Worth
within the UK, Channel Islands and Isle of Man, and internationally.
Our private banking business operates under the Lloyds TSB
and Bank of Scotland brands.
Our asset management business, Scottish Widows Investment
Partnership, has a broad client base, managing assets for
Lloyds Banking Group customers as well as a wide range of clients
including pension funds, charities, local authorities, Discretionary
Managers and Financial Advisers. In addition, the Group holds
a 60 per cent stake in St James’s Place, the UK’s largest independent
listed wealth manager.
The International business comprises the Group’s international
banking businesses outside the UK, with the exception of corporate
business in North America which is managed through the Group’s
Wholesale division. These largely comprise corporate, commercial
and asset finance business in Australia and Continental Europe and
retail businesses in Germany and the Netherlands.
Best UK Private Bank
At the Financial Times and Investors
Chronicle Wealth Management Awards,
Bank of Scotland Private Banking won
Best UK Private Bank. Voted for by industry
experts and readers of the FT, the award
evidences the high quality service our
private banking clients receive.
Developing employee
capabilities
In 2011 we launched the Wealth Academy,
a new learning and development initiative
for our Wealth employees. The academy
offers access to thousands of industry-
leading learning solutions as well as a route
to attaining professional qualifications.
So far the academy has helped over 1,400
of our employees develop their skills and
deliver more for customers as a result.
2011 highlights
Loss before tax decreased by 20 per cent
The impairment charge reduced by 23 per cent
Within the core business, profit before tax and fair value
unwind increased by 20 per cent
Total income decreased by 8 per cent
– Net interest income was 21 per cent lower
– Banking net interest margin reduced by 20 basis points
– Other income increased by 7 per cent
Operating expenses increased by 1 per cent
Fair value unwind decreased by 48 per cent
Net loans and advances to customers decreased
by 21 per cent
Customer deposits grew by 28 per cent
Wealth demonstrated continued strength in client
acquisition through the UK franchise with an 8 per cent
increase in customer numbers
Key operating brands
71
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WEALTH AND INTERNATIONAL
Performance summary
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Costs:
Operating expenses
Other costs2
Trading surplus
Impairment
Share of results of joint ventures and associates
Loss before tax and fair value unwind
Fair value unwind
Loss before tax
Wealth
International
Loss before tax and fair value unwind
Banking net interest margin
Impairment as a % of average advances
Cost:income ratio
2011
£m
828
1,197
–
2,025
(1,537)
(11)
(1,548)
477
(4,610)
3
(4,130)
194
(3,936)
189
(4,319)
(4,130)
1.26%
7.37%
76.4%
1
2
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Other costs include FSCS costs in 2011.
At 31 December
Key balance sheet and other items
Loans and advances to customers (excluding repos)
Customer deposits (excluding repos)
Total customer balances
Risk-weighted assets
Performance indicators
2011
£bn
43.8
42.0
85.8
47.3
20101
£m
1,050
1,123
37
2,210
(1,536)
–
(1,536)
674
(5,988)
(8)
(5,322)
372
(4,950)
220
(5,542)
(5,322)
1.46%
8.90%
69.5%
2010
£bn
55.3
32.8
88.1
58.7
Loss before tax
(combined businesses basis)
£m
Impairment as a percentage %
of average advances
Customer deposits
(excluding repos)
£bn
UK wealth
relationships
8.90
7.37
6.04
32.8
29.0
42.0
166,064
140,085
2009
2010
2011
(2,433)
(3,936)
Change
%
(21)
7
(8)
(29)
23
22
(48)
20
(14)
22
22
Change
%
(21)
28
(3)
(19)
clients
179,331
(4,950)
2009
2010
2011
2009
2010
2011
2009
2010
2011
72
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WEALTH AND INTERNATIONAL
2011 highlights
Loss before tax decreased by 20 per cent, with a fall in impairments partly offset by lower income, fair value unwind and higher
operating expenses.
Within the core business, profit before tax and fair value unwind increased by 20 per cent, primarily due to a 22 per cent growth
in customer core balances and improvement in customer net interest margins partially offset by increased operating expenses reflecting
the continued investment in deposit activity in line with our strategy of strengthening the balance sheet and growing our share of the
Wealth market.
Total income decreased by 8 per cent:
– Net interest income was 21 per cent lower, reflecting lower lending volumes and increased impaired assets, partly offset by the
favourable impact of foreign currency movements, particularly the Australian Dollar. We saw higher deposit balances and margins
in our core business where net interest income has increased by 20 per cent.
– Banking net interest margin reduced by 20 basis points reflecting the increased strains of lost earnings on higher impaired asset
balances and higher funding costs. This was offset by stronger deposit margins in the Wealth businesses and higher deposit balances
and margins in our International on-line deposit business, which drove the banking net interest margin in our core business up by
85 basis points to 4.16 per cent.
– Other income increased by 7 per cent, with foreign exchange benefits in International, partly offset by the impact of lower funds
under management in the Wealth businesses driven by market conditions together with a shift in customer investments from funds
under management to deposits.
Operating expenses increased by 1 per cent, due to higher regulatory costs, investment in growth initiatives and the effect of stronger
foreign currency rates, partly offset by benefits from cost saving initiatives across all businesses.
The impairment charge reduced by 23 per cent. Following higher charges in 2010, especially in the fourth quarter as the economic
environment in Ireland deteriorated, the rate of impaired loan migration has slowed. The coverage ratio increased from 53 per cent to
61 per cent reflecting further provisions in the year, particularly in Ireland.
Fair value unwind decreased by 48 per cent, reflecting accelerated unwind of fair value adjustments in 2010 in line with actual levels
of impairment losses experienced, particularly in Ireland and Australia.
Net loans and advances to customers decreased by 21 per cent, largely driven by de-risking of the balance sheet through reducing
non-core assets across both Wealth & International. Risk-weighted assets decreased by 19 per cent, reflecting lower asset balances and
additional impairment provisions, particularly in International.
Customer deposits grew by 28 per cent, primarily due to continued strong inflows in the on-line deposit business. The funding gap has
reduced by £20.7 billion to £1.8 billion reflecting continued focus within International on de-risking and right-sizing the balance sheet together
with continued strong deposit inflows.
Against its strategic objectives, Wealth demonstrated continued strength in client acquisition through the UK franchise with an 8 per cent
increase in customer numbers. To date the division has announced the exit from seven countries, and corporate lending has been refocused
around selected customers aligned to UK product and sector plans and the Group’s international risk appetite. International is contributing
to a strengthening of the Group’s balance sheet through a significant and managed run-down of non-core assets together with diversification
of sources of funding through international deposits.
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.
In the International businesses, the priority is to maximise value in the medium term. The immediate focus is on close management of the lending
portfolios, particularly in Ireland, and reducing assets where appropriate. At the same time, International is delivering operational efficiencies and
rightsizing the cost base to fit the reshaped business models.
Progress against strategic initiatives
As with the wider Group, Wealth and International’s strategic focus has been on:
Reshaping the business to better fit the Group’s risk appetite
Focus remains on maximising value and aligning with the Group’s risk appetite through close management of the lending portfolio, continuing
disciplined reduction of non-core assets, diversifying sources of funding and rationalisation of our international presence.
Wealth and International have reduced non-core loans and advances to customers by £11.3 billion in 2011 through a mixture of repayments and
selected asset disposals (in addition to foreign exchange and impairments as outlined below), including the sale of £1 billion (gross) of commercial
real estate assets in Australia and New Zealand. Our International on-line deposit business continued to grow strongly with customer balances as
at December 2011 of £13.8 billion. The division has also made good progress towards reducing its International presence.
73
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WEALTH AND INTERNATIONAL
Simplifying the division to right-size cost base and deliver operational efficiencies
The group wide Simplification initiative is well underway, the focus of which is on simplifying operations and processes, delayering management
structures, consolidating supplier relationships and increasing the efficiency of distribution channels. Wealth & International is in the process
of realising additional efficiencies and cost savings through its initiatives to develop a single customer platform across all International Wealth
businesses, streamlining of operating models and creation of a shared support infrastructure.
In 2011, the UK Private Banking and High Net Worth businesses have been successfully integrated to form ‘One Private Bank’, with a simplified
management structure and aligned business models across the heritage brands. During the second half of the year, around 60,000 UK Wealth
accounts have been migrated onto a single operating platform.
Developing a more focused business and investing in growth
The division will focus on serving customers both within the UK and also those with UK connections. In International, corporate lending has been
refocused around selected customers aligned to UK product and sector plans and the Group’s international risk appetite. In Wealth, the focus of
propositions will be within the existing UK customer franchise in addition to customers with UK connections in Commonwealth countries, Europe,
Middle East, and on the Indian Subcontinent.
Significant investment is being made towards growing market share in what is viewed as a key growth opportunity for the Group – UK and
International Wealth. The investment is geared towards developing compelling propositions for mass affluent, affluent and high net worth
customers; this will address a key gap for the Group in the mass affluent market and will enhance our investment management offering in the
affluent and high net worth segments. Underpinning this, we are consolidating our platforms and simplifying the operating model to deliver a
better customer experience in a more efficient manner, thereby improving customer onboarding, retention and value capture through cross sales.
Financial performance
Loss before tax and fair value unwind reduced by 22 per cent to £4,130 million due to a lower impairment charge, predominantly in Ireland, more
than offset by lower income and higher costs.
Total income decreased by 8 per cent to £2,025 million.
Net interest income decreased by 21 per cent, or 25 per cent in constant currency terms. Higher funding costs and the increased strain of impaired
assets, reflected in a 33 per cent reduction in net lending margins together with lower lending volumes impacting net interest income are partially
offset by the impact of the stronger Australian dollar in International. Deposit margins increased by 14 per cent reflecting changing product mix
predominantly as a result of continued deposit inflows in the on-line deposit business at higher margins together with improving margins across
the Wealth businesses.
Other income increased by 7 per cent, mainly due to foreign exchange benefits in International. Excluding the impact of foreign exchange, other
income decreased by 1 per cent.
Operating expenses and other costs increased by 1 per cent, due to increased investment in the International deposit business, the impact of the
stronger Australian dollar and Swiss franc and additional regulatory costs in Wealth. On a constant currency basis, operating expenses reduced by
1 per cent. Despite increased investment in International deposit gathering, the cost: income ratio overall improved by 3 per cent in our core business.
The impairment charge reduced by 23 per cent to £4,610 million. Following increased charges in the last quarter of 2010, driven by the significant
deterioration in the economic environment in Ireland, the rate of impaired loan migration has slowed in 2011.
Balance sheet progress
Net loans and advances to customers decreased by £11.5 billion to £43.8 billion, as we continued to focus management action on de-risking the
balance sheet. The reduction of £11.5 billion reflects net repayments (including asset sales) of £6.0 billion, additional impairment provisions of
£4.6 billion mainly within the International businesses and foreign exchange movements of £0.9 billion.
Risk-weighted assets decreased by £11.4 billion to £47.3 billion, reflecting lower asset balances and increased impairment provisions, particularly
in the non-core portfolios.
Customer deposits increased by £9.2 billion to £42.0 billion mainly due to continued strong deposit inflows in the on-line deposit businesses.
74
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WEALTH AND INTERNATIONAL
Wealth
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Costs:
Operating expenses
Other costs2
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit before tax and fair value unwind
Impairment as a % of average advances
Cost:income ratio
2011
£m
354
990
–
20101
£m
296
981
37
1,344
1,314
(1,044)
(11)
(1,055)
289
(100)
–
189
1.10%
78.5%
(1,047)
_
(1,047)
267
(46)
(1)
220
0.48%
79.7%
2010
£bn
9.1
26.8
35.9
10.4
Change
%
20
1
2
(1)
8
(117)
(14)
Change
%
(7)
1
(1)
(25)
1
2
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Other costs include FSCS costs in 2011.
At 31 December
Key balance sheet and other items
Loans and advances to customers
Customer deposits
Total customer balances
Risk-weighted assets
2011
£bn
8.5
27.2
35.7
7.8
In Wealth, our key focus has been to grow our market share in UK and International Wealth primarily through growing the total amount of deposits
and funds under management that we manage on behalf of franchise customers, whilst improving margins and operating efficiency. Although
funds under management within Private and International Banking decreased by 5 per cent to £12.8 billion, this primarily reflected market
movements and a consequent shift of customer appetite away from investment products.
Profit before tax and fair value unwind decreased by 14 per cent to £189 million mainly due to increased impairment losses partly offset by higher
income. Excluding non-recurring gains on sale of non-core businesses of £36 million which were recognised in the first half of 2010, profit before
tax and fair value unwind increased by 3 per cent.
Total income increased by 2 per cent to £1,344 million. Excluding non-recurring gains on sale, which were recognised in the first half of 2010,
income increased by 5 per cent.
Net interest income increased by 20 per cent, reflecting improving deposit margins across the Wealth business.
Operating expenses and other costs increased by 1 per cent to £1,055 million. Benefits from cost saving initiatives across the Wealth businesses
have been offset by increased regulatory and one-off costs and the impact of the stronger Swiss Franc in the International Wealth business.
Excluding the impact of foreign exchange and one-off costs, operating expenses reduced by 3 per cent.
The impairment charge increased to £100 million primarily due to increased charges in the Group’s Spanish mortgage book reflecting
deterioration in the local property markets and economic outlook in Spain.
Balance sheet progress
Net loans and advances to customers decreased by £0.6 billion or 7 per cent, to £8.5 billion due to net repayments of £0.7 billion and increased
impairment provisions across the non-core portfolios and foreign exchange movements of £0.1 billion.
Risk-weighted assets decreased by £2.6 billion or 25 per cent, to £7.8 billion reflecting lower lending volumes and improved use of collateral.
Customer deposits increased by £0.4 billion, or 1 per cent, to £27.2 billion.
75
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WEALTH AND INTERNATIONAL
Funds under management
Scottish Widows Investment Partnership (SWIP)
Internal
External
Other Wealth:
St James’s Place
Invista Real Estate
Private and International Banking
Closing funds under management
Opening funds under management
Inflows:
SWIP – internal
SWIP – external
Other
Outflows:
SWIP – internal
SWIP – external
Other
Investment return, expenses and commission
Net operating increase (decrease) in funds
Sale of Bank of Scotland Portfolio Management Service
Closing funds under management
As at
31 December
2011
£bn
As at
31 December
2010
£bn
116.8
23.1
139.9
28.5
0.8
12.8
182.0
2011
£bn
192.0
2.7
1.5
8.5
12.7
(4.5)
(5.3)
(10.1)
(19.9)
(2.8)
(10.0)
–
118.2
28.0
146.2
27.0
5.3
13.5
192.0
2010
£bn
184.1
2.0
8.9
6.7
17.6
(5.6)
(13.3)
(5.1)
(24.0)
15.1
8.7
(0.8)
182.0
192.0
Funds under management reduced by £10.0 billion to £182.0 billion. Net outflows of £19.9 billion reflect expected attrition on insurance funds
within SWIP, the market backdrop in the second half of 2011 and fund outflows within Invista Real Estate reflecting both transfers to SWIP during
the year and the wind down of Invista Real Estate business. SWIP’s inflows include £2.4 billion of funds previously managed by Invista Real Estate.
Reductions in global equity values contributed towards investment return, expenses and commission of funds under management by £2.8 billion.
This together with the general market backdrop contributed to a shift in customer investments in our Wealth businesses away from funds towards
Wealth and Retail deposits.
76
Annual Report and Accounts 2011
DIVISIONAL RESULTS – WEALTH AND INTERNATIONAL
International
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Costs:
Operating expenses
Other costs
Trading surplus
Impairment
Share of results of joint ventures and associates
Loss before tax and fair value unwind
Impairment as a % of average advances
Cost:income ratio
2011
£m
474
207
–
681
(493)
–
(493)
188
(4,510)
3
(4,319)
8.43%
72.4%
1
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
At 31 December
Key balance sheet and other items
Loans and advances to customers
Customer deposits
Total customer balances
Risk-weighted assets
2011
£bn
35.3
14.8
50.1
39.5
20101
£m
754
142
–
896
(489)
–
(489)
407
(5,942)
(7)
(5,542)
10.30%
54.6%
2010
£bn
46.2
6.0
52.2
48.3
Change
%
(37)
46
(24)
(1)
(1)
(54)
24
22
Change
%
(24)
(4)
(18)
Within International, our key focus has been to strengthen the balance sheet through material and targeted reductions in non-core assets
and diversifying sources of funding through international deposit raising. Loans and advances to customers reduced by 24 per cent (including
£5.2 billion of net repayments and asset sales) and customer deposits increased by 147 per cent to £14.8 billion.
Loss before tax and fair value unwind reduced by £1,223 million to £4,319 million mainly as a result of a lower impairment charge, reflecting a
reduction of £1,077 million in Ireland and £328 million in Australia.
Total income decreased by 24 per cent, but was 38 per cent lower in constant currency, reflecting lower interest-earning assets and the increased
strain of lost earnings on higher impaired assets.
Operating expenses increased by 1 per cent. On constant currency terms, operating expenses reduced by 4 per cent reflecting cost saving
initiatives across the International business, partly offset by the continued investment in International’s on-line deposit business.
The impairment charge and loans and advances to customers are summarised by key geography in the following table.
Ireland
Australia
Wholesale Europe
Latin America/Middle East
Netherlands
Impairment charges
Loans and advances to customers
2011
£m
3,187
1,034
204
64
21
4,510
2010
£m
4,264
1,362
210
97
9
5,942
2011
£bn
14.7
8.1
5.9
0.4
6.2
35.3
2010
£bn
19.6
12.3
6.9
0.6
6.8
46.2
The impairment charge reduced by £1,432 million, or 24 per cent, to £4,510 million due to reduced impairment charges in Ireland and Australia.
Balance sheet progress
Net loans and advances to customers decreased by £10.9 billion or 24 per cent, to £35.3 billion due to net repayments of £5.2 billion across all
businesses (including the sale of £1 billion of commercial real estate assets in Australia and New Zealand), further impairment provisions and
foreign exchange movements of £0.8 billion. The division is focused on de-risking and right-sizing the balance sheet, focusing on key Group
relationships, as well as reducing concentrations in Commercial Real Estate.
Risk weighted assets decreased by £8.8 billion or 18 per cent, to £39.5 billion reflecting lower asset balances and further impairment provisions
and foreign exchange rate movements. This is partly offset by an increase in risk weighted assets to cover further deterioration in the Irish housing
market and other credit risk model changes which impact risk weighted assets.
Customer deposits increased by £8.8 billion to £14.8 billion driven by continued strong performance within our International on-line deposit business.
77
Annual Report and Accounts 2011
DIVISIONAL RESULTS
insurance
The Insurance division provides long term savings, protection
and investment products and general insurance products
to customers in the UK and Europe and consists of
three business units:
Life, Pensions and Investments UK (LP&I UK): The UK Life, Pensions
and Investments business is the leading bancassurance provider in the
UK and has one of the largest intermediary channels in the industry.
The business provides long-term savings, protection and investment
products distributed through the bancassurance, intermediary and
direct channels through the Lloyds TSB, Halifax, Bank of Scotland and
Scottish Widows brands.
Life, Pensions and Investments Europe: The European Life, Pensions
and Investments business distributes products primarily in the German
market under the Heidelberger Leben and Clerical Medical brands.
General Insurance: The General Insurance business is a leading
distributor of home insurance in the UK, with products sold through
the branch network, direct channels and strategic corporate partners.
The business also has brokerage operations for personal and
commercial insurances. It operates primarily under the Lloyds TSB,
Halifax and Bank of Scotland brands.
Rapid Response
The Group’s new Rapid Response Vehicle
enables quicker service and greater
support for General Insurance customers
impacted by events affecting multiple
households.
For example, more than 150 homes were
flooded in Sutton Coldfield in Birmingham
last November when a water main at
nearby Barr Beacon reservoir burst.
The Rapid Response Vehicle was called to
the scene and colleagues from Insurance
used the van to co-ordinate customer
visits, settle claims and assess the scope
of repairs. Fortunately, we were able to
reach a number of customers before they
contacted us.
5-star rated
Three of LP&I’s flagship intermediary
products, the retirement account, the
investment bond and the global investor
have received a Defaqto 5-star rating
for the second year running.
2011 highlights
Profit before tax increased by 7 per cent
Total income, net of insurance claims, increased by 2 per cent
Operating expenses and other costs decreased by 5 per cent
LP&I UK EEV new business margin increased to 4.2 per cent
from 3.7 per cent in 2010
LP&I UK sales of £10,219 million (PVNBP) reduced by 1 per cent
General Insurance profits increased by 21 per cent
to £497 million
Key operating brands
Capital management initiatives in 2011 have resulted in
£2.3 billion mitigation of the potential impact of CRD IV
Scottish Widows was awarded Defined Contribution (Bundled
Services) Provider of the Year in the Pension and Investment
Provider Awards 2011
Insurance has focused on removing duplication to simplify
the business and is improving customer insight to support
responsiveness to changing customer needs
78
Annual Report and Accounts 2011
DIVISIONAL RESULTS – INSURANCE
Performance summary
Net interest income
Other income
Effects of liability management, volatile items and asset sales
Total income
Insurance claims
Total income, net of insurance claims
Costs:
Operating expenses
Other costs2
Share of results of joint ventures and associates
Profit before tax and fair value unwind
Fair value unwind
Profit before tax
Profit before tax and fair value unwind by business unit
Life, Pensions and Investments:
UK business
European business
General Insurance
Profit before tax and fair value unwind
EEV new business margin
Life, Pensions and Investments sales (PVNBP)
2011
£m
(67)
2,687
–
2,620
(343)
2,277
(805)
(7)
(812)
–
1,465
(43)
1,422
886
82
497
1,465
4.0%
10,662
20101
£m
(39)
2,799
15
2,775
(542)
2,233
(854)
–
(854)
(10)
1,369
(43)
1,326
830
127
412
1,369
3.5%
10,828
Change
%
(72)
(4)
(6)
37
2
6
5
7
7
7
(35)
21
7
(2)
1
2
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Other costs include FSCS costs in 2011.
Performance indicators
Profit before tax
(combined businesses basis)
£m
LP&I UK
new business profit
£m
LP&I UK
new business margin (EEV)
%
LP&I UK
(PVNBP) sales
£m
1,422
1,326
1,203
331
4.2
12,973
267
3.7
2.6
10,316
10,219
132
2009
2010
2011
2009
2010
2011
2009
2010
2011
2009
2010
2011
79
Annual Report and Accounts 2011
DIVISIONAL RESULTS – INSURANCE
2011 highlights
Profit before tax increased by 7 per cent. In 2010 income was reduced by a non-recurring charge of £70 million in respect of the
Group’s decision to cease writing new payment protection insurance (PPI) business. Excluding this charge profit before tax and fair value
unwind increased by 2 per cent in 2011.
Total income, net of insurance claims, increased by 2 per cent, (reduction of 1 per cent excluding the £70 million charge in 2010).
This is attributable to strong sales of corporate pensions through the intermediary channel and the continued change in new business
mix within Life, Pensions and Investments UK (LP&I UK) towards more profitable protection business reflecting a focus on meeting
customer needs in an area where there is a general level of under provision in the UK. Improved claims experience within General
Insurance which has been offset by lower PPI related income is also a significant contributor to this.
Operating expenses and other costs decreased by 5 per cent due mainly to a continued focus on cost management and delivery
of integration cost savings, partly offset by an additional charge in relation to an industry wide Financial Services Compensation Scheme
(FSCS) levy in 2011.
LP&I UK EEV new business margin increased to 4.2 per cent from 3.7 per cent in 2010. The improvement reflects the growth
in protection sales and the business ceasing to write certain low margin products in 2010. The Internal Rate of Return (IRR) on new
business remains in excess of 16 per cent.
LP&I UK sales of £10,219 million (PVNBP) reduced by 1 per cent, partly reflecting the continuing change in mix towards protection
products to meet customer protection needs, which generate a lower PVNBP compared to investments but generate a higher new
business profit. Sales through our Intermediary channel have increased by 20 per cent to £6,415 million reflecting strong sales of
Corporate Pensions.
General Insurance profits increased by 21 per cent to £497 million primarily due to lower freeze and unemployment claims year
on year offset by lower income resulting from the Group ceasing to write new PPI business in 2010.
Capital management initiatives in 2011 have resulted in £2.3 billion mitigation of the potential impact of Capital Requirements
Directive IV (CRD IV). The capital position of the UK life insurance group under the Insurance Groups Directive (IGD) remains strong
with an estimated capital surplus of £3.7 billion.
Scottish Widows was awarded Defined Contribution (Bundled Services) Provider of the Year in the Pension and Investment Provider
Awards 2011 and Best Group Pension Provider in the Corporate Adviser Awards 2012.
Against its strategic objectives, Insurance has focused on removing duplication to simplify the business and is improving customer
insight to support responsiveness to changing customer needs. LP&I (UK) has built upon successful sales force integration and single
bancassurance proposition launch to deliver a number of further improvements to its operations and capability. General Insurance has
improved customer experience by the introduction of a single telephony and e-commerce platform across all brands.
Strategic focus
Insurance is a relationship business focused on helping our customers to protect themselves today whilst preparing for a secure financial future.
Having renewed its strategic vision Insurance confirmed its objective to be the best Insurance business for customers.
Progress against strategic initiatives
Reshaping the business
In 2012, Insurance is being reshaped to run as one insurance business with a customer focused corporate and management structure. By operating
as one business and actively managing the combined capital, Insurance expects to leverage significant benefits from risk diversification which will
give further competitive advantage. Insurance continues to progress well with the implementation of Solvency II requirements.
The business continues to make good progress in improving the profitability of the customer focused product set. In 2011, the Life, Pensions and
Investments EEV new business margin improved to 4.0 per cent (from 3.5 per cent in 2010) and the focus on value over volume will continue as
Insurance grows a business that is focused on developing long term relationships with customers. The General Insurance business also focuses on
generating value with a targeted participation and underwriting strategy in attractive market segments and efficient and effective management of
claims. This value is demonstrated by a combined ratio of 69 per cent in 2011.
Capital management initiatives in 2011 have resulted in £2.3 billion mitigation of the potential impact of CRD IV. This includes capital restructuring
within the business that occurred in July 2011 which reduced the Group’s estimated total core tier 1 impact of CRD IV by over £2 billion. Since
1 January 2010, the mitigation of the potential impact of CRD IV is estimated to be £4.6 billion in total.
In 2011 LP&I (UK) built upon the successful sales force integration and proposition launch to deliver a number of further improvements to its
operational capability and cost effectiveness. These include in-sourcing life and pensions policies from a third party, the further consolidation
of locations, delivery of new eCommerce capability for intermediaries and enhanced investment accounting capabilities through a single
outsourced arrangement.
Within General Insurance significant improvements have been delivered in improving the customer experience through the delivery of combined
claims and administration platforms.
80
Annual Report and Accounts 2011
DIVISIONAL RESULTS – INSURANCE
Simplification
Insurance continues to focus on cost reduction with costs decreasing by 5 per cent in 2011. Efficiencies have been achieved without compromising
the quality of customer service and customer satisfaction ratings have remained robust across the division.
The Simplification programme will deliver further improvements through the provision of simpler systems and processes.
Investing in growth
There is a focus on growth across the Insurance business to support our multi-brand strategy and to deliver sustainable growth in key markets.
A Group Strategic Initiative is investing in building lasting relationships with our bancassurance customers through the introduction of new advice
models, enhanced products and access to new direct channels.
Selective participation in the important Intermediary and Direct channels will be supported by investment in new and enhanced product
propositions and improved channels to market.
In General Insurance, the strategy is focused around protecting and growing home insurance business whilst seeking to expand its role in
other markets.
Strong and enduring relationships with distributors are essential to the success of the business. The business is working collaboratively with our
colleagues across the Group to design and deliver value adding propositions aligned to channel customers’ insurance needs. In the intermediary
channel, it continues to support Independent Financial Advisers (IFAs) in their preparation for the Retail Distribution Review (RDR). Inevitably, as a
result of RDR, some IFAs will choose to exit markets and therefore some customers will no longer receive advice from their IFAs. The business is
committed to providing a direct proposition to maintain a high quality of service to these customers.
Life, Pensions and Investments
UK Business
Net interest income
Other income
Total income
Operating expenses
Profit before tax and fair value unwind
Profit before tax and fair value unwind by business unit
New business profit – insurance business2
New business profit – investment business2
Total new business profit
Existing business profit
Experience and assumption changes
Profit before tax and fair value unwind
EEV new business margin (UK)
Life, Pensions and Investments sales (PVNBP)
2011
£m
(62)
1,458
1,396
(510)
886
382
(51)
331
539
16
886
20101
£m
(48)
1,408
1,360
(530)
830
332
(65)
267
611
(48)
830
4.2%
10,219
3.7%
10,316
Change
%
(29)
4
3
4
7
15
22
24
(12)
7
(1)
1
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
2
As required under IFRS, products are split between insurance and investment contracts depending on the level of insurance risk contained. For insurance contracts, the new business profit includes
the net present value of profits expected to emerge over the lifetime of the contract, including profits anticipated in periods after the year of sale; for investment contracts the figure reflects the
profit in the year of sale only, after allowing for the deferral of income and expenses. Consequently the recognition of profit from investment contracts is deferred relative to insurance contracts.
Life, Pensions and Investments (LP&I UK) delivered profit growth, before tax and fair value unwind, of £56 million, or 7 per cent. In 2010 income
was reduced by a non-recurring charge of £70 million in respect of the Group’s decision to cease writing new payment protection insurance (PPI)
business which, although a General Insurance product, impacted LP&I as a result of the life cover contained within PPI contracts. Excluding this
charge profit before tax and fair value unwind decreased by 2 per cent in 2011.
Total new business profit increased by £64 million, or 24 per cent, to £331 million. The increase is primarily attributable to strong sales of corporate
pensions through the intermediary channel, the continued growth of our protection business in the bancassurance channel as we help more
customers and address the sizeable protection gap that exists in the UK and reduction in lower margin business following the launch of the
integrated bancassurance proposition in June 2010.
LP&I UK margin on an EEV basis increased to 4.2 per cent in 2011 from 3.7 per cent in 2010. The improved margin reflects the strategic choices
made in respect of product and channel propositions. The Internal Rate of Return (IRR) on new business remains in excess of 16 per cent.
Existing business profit has decreased by £72 million, or 12 per cent, to £539 million. The decrease predominantly reflects higher interest payments
following capital restructuring initiatives, a reduction in the assumed rate of return, and lower levels of shareholder net assets following capital
repatriation initiatives in 2010.
81
Annual Report and Accounts 2011
DIVISIONAL RESULTS – INSURANCE
The net impact of experience variances and assumption changes has increased to a credit of £16 million in 2011 from a charge of £48 million in
2010. The benefit mainly reflects the absence of the £70 million charge taken in 2010 from the Group’s decision to cease writing new PPI business.
The capital position of the UK life insurance companies remains robust. Following the legal entity reorganisation of the Insurance division in July
2011, there is now one insurance group reporting under the Insurance Groups Directive (IGD) with an estimated capital surplus of £3.7 billion. This
compares with £1.3 billion and £1.6 billion for the Scottish Widows and HBOS Insurance groups, respectively, at the end of 2010.
European business
Profit before tax decreased by £45 million, 35 per cent, to £82 million. The reduction is driven largely by a non-recurring charge following
clarification by the German regulator (BaFin) surrounding the deduction of tax and policy-holder distributions and experience and assumption
charges.
The strategy is to secure value in the existing business, building on the relationship with its key distributor.
New business
An analysis of the present value of new business premiums for business written by the Insurance division, split between the UK and European Life,
Pensions and Investments Businesses is given below:
Present value of new business premiums (PVNBP)
Analysis by product
Protection
Payment protection
Savings and investments
Individual pensions
Corporate and other pensions
Retirement income
Managed fund business
Life and pensions
OEICs
Total
Analysis by channel
Intermediary
Bancassurance
Direct
Total
UK
£m
708
21
1,133
1,480
4,423
747
116
8,628
1,591
10,219
6,415
3,216
588
10,219
2011
Europe
£m
Total
£m
UK
£m
2010
Europe
£m
Total
£m
Change
%
53
–
246
144
–
–
–
443
–
443
443
–
–
761
21
1,379
1,624
4,423
747
116
9,071
1,591
10,662
6,858
3,216
588
443
10,662
574
70
1,617
1,606
2,750
889
177
7,683
2,633
10,316
5,365
4,432
519
10,316
56
–
315
141
–
–
–
512
–
512
512
–
–
512
630
70
1,932
1,747
2,750
889
177
8,195
2,633
10,828
5,877
4,432
519
10,828
21
(70)
(29)
(7)
61
(16)
(34)
11
(40)
(2)
17
(27)
13
(2)
Total sales (PVNBP) have reduced by 2 per cent to £10,662 million. New business margins have improved to 4.0 per cent in 2011 from 3.5 per cent
in 2010. This partly reflects the launch of the integrated bancassurance proposition in June 2010 which has resulted in a change in mix away from
higher single premium savings products towards lower premium, higher margin, protection business.
Despite the reduction in sales total new business profit within LP&I UK increased by £64 million, or 24 per cent, to £331 million.
Sales (PVNBP), excluding OEICs have increased by 11 per cent, and although OEIC sales have decreased by 40 per cent the new business margin
on these sales has increased, reflecting the focus on value over volume.
Within the intermediary channel the increase in sales of £981 million, or 17 per cent, mainly reflects strong sales of corporate pensions in LP&I UK.
The increase in sales has been achieved whilst maintaining the new business margin on corporate pension business.
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.
The direct channel, although relatively small at this time, is performing well and is being developed for future growth. This channel will become
even more important following the introduction of RDR.
82
Annual Report and Accounts 2011
DIVISIONAL RESULTS – INSURANCE
Funds under management
The table below shows the funds of the Life, Pensions and Investment companies within the Insurance division. These funds are predominantly
managed within the Group by the Wealth and International division.
Opening funds under management
UK business
Premiums
Claims and surrenders
Net outflow of business
Investment return, expenses and commission
Other movements1
Net movement
European business
Net movement
Dividends and capital repatriation
Closing funds under management
Managed by the Group
Managed by third parties
Closing funds under management
2011
£bn
133.1
10.1
(14.6)
(4.5)
(0.2)
–
(4.7)
(0.5)
(0.3)
127.6
103.4
24.2
127.6
2010
£bn
122.1
11.2
(14.9)
(3.7)
10.5
4.3
11.1
0.4
(0.5)
133.1
109.3
23.8
133.1
1
Other movements in funds under management incorporates alignment changes and the inclusion of managed pension funds.
The net outflow of business is primarily a result of the move in sales away from savings products which generate large single premiums, caused
in part by more difficult economic conditions for long-term savings and the run-off of the in-force book.
The key drivers of investment return are equity and gilt movements. In the year UK equity markets fell 3 per cent and European markets fell
15 per cent while gilt markets increased by 16 per cent. In 2010 both equities and gilts performed strongly, creating large investment gains.
Maturity profile of in-force business
The table below shows the profile of the Value of In-Force (VIF) asset recognised on the IFRS balance sheet based on the date when the profit
is expected to emerge.
2011
2010
VIF
Total
£m
5,247
5,898
VIF emergence in years (%)
0-5
37
36
6-10
24
23
11-15
16-20
16
16
10
10
> 20
13
15
The total VIF has decreased from 2010 to 2011. The increase in VIF from new business has been more than offset by a combination of the expected
run-off in VIF on in-force business, the reduction in VIF from market volatility (particularly on equities) and the change in assumptions used in the
calculation of the VIF over the year.
The profile of the emergence of VIF in future years show that almost 40 per cent of the VIF is expected to be released within 5 years, with nearly
80 per cent expected to be released within 15 years.
83
Annual Report and Accounts 2011
DIVISIONAL RESULTS – INSURANCE
General Insurance
Home insurance
Payment protection insurance
Other
Net operating income
Claims paid on insurance contracts (net of reinsurance)
Operating income, net of claims
Operating expenses
Share of results of joint ventures and associates
Profit before tax and fair value unwind
Combined ratio
2011
£m
857
125
53
20101
£m
862
253
70
1,035
1,185
(343)
692
(195)
–
497
69%
(542)
643
(221)
(10)
412
79%
Change
%
(1)
(51)
(24)
(13)
37
8
12
21
1
Incorporates the methodology changes outlined in the October 2011 announcement (New Allocation Methodologies for Funding Costs and Capital).
Profit before tax and fair value unwind from General Insurance increased by 21 per cent to £497 million. The increase was primarily due to
improved PPI claims experience from the run off of this business line, the absence of severe weather related claims as experienced in 2010 and
lower expenses. As a result of these factors the combined ratio has improved to 69 per cent.
Total income for home insurance was broadly unchanged from 2010 at £857 million and reflects the maturity and competitiveness of the market.
Claims of £343 million were 37 per cent lower than in 2010, mainly due to improved claims experience as a result of the run off of the PPI business
and lower unemployment claims and lower property claims following the freeze events that impacted January and December 2010.
Operating expenses decreased by £26 million, or 12 per cent, to £195 million primarily as a result of further delivery of integration savings and
a continued focus on cost management.
84
Annual Report and Accounts 2011
DivisionAl Results – gRoup opeRAtions
total income
Direct costs:
information technology
operations
property
sourcing
support functions
Result before recharges to divisions
total net recharges to divisions
share of results of joint ventures and associates
Loss before tax
2011
£m
42
1,2
2010
£m
(12)
Change
%
(1,031)
(1,204)
(596)
(909)
(56)
(73)
(2,665)
(2,623)
2,567
–
(56)
(656)
(966)
(58)
(89)
(2,973)
(2,985)
2,930
3
(52)
14
9
6
3
18
10
12
(12)
(8)
1
2
incorporates the methodology changes outlined in the october 2011 announcement (new Allocation Methodologies for Funding Costs and Capital).
2010 comparative figures have also been amended to reflect the centralisation of operations across the group as part of the integration programme. to ensure a fair comparison of 2011
performance, 2010 direct costs have been changed with an equivalent offsetting adjustment in recharges to divisions.
Strategy
group operations aim is to be a world class operations business whilst ensuring value through cost and process efficiency. this will be achieved by
providing excellent technology and effective process to support the businesses; driving simplification, automation and continuous improvement;
developing world class operations, leadership and capability; and maintaining strong controls to protect the group.
the success of the integration programme in delivering a platform and single set of processes now enables the group to commence its
simplification programme as part of the group strategic transformational journey. the simplification programme is well underway and is now
targeting cost savings of £1.7 billion in 2014 as well as improving service and the customer experience. group operations will play a major part in
the whole programme but particularly through sourcing, end to end processes, and property initiatives.
sourcing: we will optimise our demand management, simplify specifications and further strengthen our supplier relationships, reducing
the number of suppliers to the group from around 18,000 to under 10,000, and further focus on a core group of lead suppliers to achieve
approximately a 15 per cent saving on addressable spend.
end to end processes: we will conduct an end-to-end redesign of our processes, which will include significant process automation, simplifying
processes for our staff, increasing accuracy, and reducing complaints. this will result in more time to serve customers, generate sales, and create
an improved customer experience.
property: we will further consolidate the group’s property portfolio, enabled by the delivery of process and efficiency savings from the
simplification programme.
group operations will also play a key role in delivering the technical expertise and support for the other group strategic initiatives.
Financial performance
2011 direct costs decreased by £308 million, or 10 per cent, to £2,665 million reflecting the continued focus on cost management and the delivery
of integration synergy savings and simplification benefits.
information technology costs decreased by 14 per cent, with integration savings offsetting inflationary rises.
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.
sourcing includes the cost of running the department and certain centrally managed contracts. Costs have decreased by 3 per cent and sourcing
has also played a major part in helping to deliver group wide sourcing synergies.
support functions (includes group security & Fraud and group Change Management) costs decreased by 18 per cent through the delivery of
integration synergy savings and simplification benefits.
85
Annual Report and Accounts 2011
centRAl items
net interest income
Other income
effects of liability management, volatile items and asset sales
Total income
Operating expenses and other costs2
Trading surplus
impairment
share of results of joint ventures and associates
Profit before tax and fair value unwind
Fair value unwind
Profit (loss) before tax
2011
£m
585
(49)
1,293
1,829
(259)
1,570
(3)
(1)
1,566
(1,274)
292
20101
£m
571
(73)
150
648
(107)
541
–
2
543
(1,446)
(903)
1
2
incorporates the methodology changes outlined in the October 2011 announcement (new Allocation methodologies for Funding costs and capital).
Other costs include Fscs costs and UK bank levy in 2011.
central items include income and expenditure not recharged to the divisions, including the costs of certain central and head office functions and
the financial impact of banking volatility taken centrally.
total income increased by £1,181 million to £1,829 million primarily due to a £1,143 million increase in volatility and liability management effects.
these included a £872 million increase in liability management gains. in addition, there was a £615 million reduction in the mark-to-market
losses arising from the equity conversion feature of the Group’s enhanced capital notes, partly offset by a £344 million adverse movement on
banking volatility, which is attributed to ineffectiveness in hedge accounting relationships and banking book derivatives not mitigated through
hedge accounting.
liability management gains arose on transactions undertaken as part of the Group’s management of capital, largely the exchange of certain
debt securities for other debt instruments or, for 2010 only, ordinary shares. these transactions resulted in a gain of £1,295 million in 2011, which
comprises £696 million recognised in statutory net interest income, reflecting a reduction in the carrying value of certain debt securities as a result
of changes in expected cash flows, and £599 million recognised in statutory other income relating to the exchange of existing securities into new
securities. the gain in 2010 (£423 million) was recognised in statutory other income.
in 2011, volatile items comprised changes in fair valuation of the equity conversion feature of the Group’s enhanced capital notes of £(5) million
(2010: £(620) million) and banking volatility of £3 million (2010: £347 million). there were no asset sales in either 2011 or 2010 taken in central items.
Operating expenses and other costs increased by £152 million to £259 million primarily due to Financial services compensation scheme costs of
£161 million (Group total: £179 million) and bank levy costs of £189 million, £55 million of which has been attributed to non-core, partly offset by
lower pension costs held centrally.
Fair value unwind decreased by £172 million to a charge of £1,274 million primarily due to deal maturities leading to reduced amortisation.
86
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis
Core and non-core income statement
Core
net interest income
other income
effects of liability management, volatile items and asset sales
Total income
insurance claims
Total income, net of insurance claims
operating expenses
other costs1
Trading surplus
impairment
Share of results of joint ventures and associates
Profit before tax and fair value unwind
fair value unwind
Profit before tax – core
Banking net interest margin
impairment as a % of average advances
Non-core
net interest income
other income
effects of liability management, volatile items and asset sales
Total income
insurance claims
Total income, net of insurance claims
operating expenses
other costs1
Trading surplus
impairment
Share of results of joint ventures and associates
Loss before tax and fair value unwind
fair value unwind
Loss before tax – non-core
Banking net interest margin
impairment as a % of average advances
2011
£ million
10,916
8,360
603
19,879
(343)
19,536
(9,369)
(313)
9,854
(2,887)
10
6,977
(628)
6,349
2.42%
0.64%
1,317
947
(677)
1,587
–
1,587
(884)
(55)
648
(6,900)
17
(6,235)
2,571
(3,664)
1.01%
4.60%
2010
£ million
11,745
8,769
51
20,565
(542)
20,023
(9,838)
(46)
10,139
(3,612)
14
6,541
(389)
6,152
2.48%
0.75%
2,398
1,167
(144)
3,421
–
3,421
(1,044)
(150)
2,227
(9,569)
(105)
(7,447)
3,507
(3,940)
1.46%
5.56%
Profit before tax – combined businesses
2,685
2,212
1
other costs include fScS costs and UK bank levy in 2011, and fScS costs and impairment of tangible fixed assets in 2010.
the basis of preparation of the core and non-core income statement is set out on page 5.
non-core portfolios consist of non-relationship assets and liabilities together with assets and liabilities which are outside the Group’s current
risk appetite.
87
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Core and non-core business
2011
Core portfolios
Retail
Wholesale
commercial
Wealth and international
insurance
Group operations & central items
Non-core portfolios
Retail
Wholesale
commercial
Wealth and international
insurance
Total Group
core portfolios
non-core portfolios
2010
core portfolios
Retail
Wholesale
commercial
Wealth and international
insurance
Group operations & central items
non-core portfolios
Retail
Wholesale
commercial
Wealth and international
insurance
total Group
core portfolios
non-core portfolios
1
includes reverse repos and repos.
Income, net
of insurance
claims
£m
Impairment
charge
£m
Loans and
advances to
customers1
£bn
Risk-weighted
assets
£bn
Customer
deposits1
£bn
8,922
3,559
1,674
1,369
2,141
1,871
19,536
272
500
23
656
136
1,587
21,123
%
92
8
1,796
325.1
741
296
51
–
3
2,887
174
2,160
7
4,559
–
6,900
9,787
%
30
70
93.3
27.4
7.9
–
0.1
453.8
27.7
46.8
1.4
35.9
–
111.8
565.6
%
80
20
92.6
104.7
23.8
9.8
–
12.6
243.5
10.6
59.1
1.6
37.5
–
108.8
352.3
%
69
31
247.1
88.6
31.8
40.7
–
1.3
409.5
–
2.8
0.3
1.3
–
4.4
413.9
%
99
1
income, net
of insurance
claims
£m
impairment
charge
£m
loans and
advances to
customers1
£bn
Risk-weighted
assets
£bn
customer
deposits1
£bn
9,695
4,793
1,543
1,295
2,061
636
20,023
560
1,733
41
915
172
3,421
23,444
%
85
15
2,629
576
381
26
–
–
3,612
118
3,488
1
5,962
–
9,569
13,181
%
27
73
333.7
88.5
26.6
8.1
–
0.4
457.3
30.0
56.1
2.0
47.2
–
135.3
592.6
%
77
23
98.0
112.3
24.5
12.0
–
15.7
262.5
11.3
83.8
2.1
46.7
–
143.9
406.4
%
65
35
235.6
89.0
31.0
31.6
–
0.9
388.1
–
4.0
0.3
1.2
–
5.5
393.6
%
99
1
88
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Core business
net interest income
other income
effects of liability management, volatile items and asset sales
Total income
insurance claims
Total income, net of insurance claims
costs:
operating expenses
other costs
Trading surplus
impairment
Share of results of joint ventures and associates
Profit before tax and fair value unwind
fair value unwind
Profit before tax – core
Banking net interest margin
impairment as a % of average advances
Key balance sheet items
loans and advances to customers (excluding reverse repos)
Reverse repos
loans and advances to banks
Debt securities held as loans and receivables
Available-for-sale financial assets
other assets:
Derivative financial instruments
trading and other financial assets at fair value through profit and loss
other
Total core assets
Risk-weighted assets
customer deposits (excluding repos)
Repos
2011
£ million
10,916
8,360
603
19,879
(343)
19,536
(9,369)
(313)
(9,682)
9,854
(2,887)
10
6,977
(628)
6,349
2.42%
0.64%
2010
£ million
11,745
8,769
51
20,565
(542)
20,023
(9,838)
(46)
(9,884)
10,139
(3,612)
14
6,541
(389)
6,152
2.48%
0.75%
change
%
(7)
(5)
(3)
37
(2)
5
2
(3)
20
(29)
7
(61)
3
As at
31 December
2011
£bn
As at
31 December
2010
£bn
change
%
437.0
16.8
32.0
0.2
27.9
66.0
138.8
111.1
315.9
829.8
243.3
401.5
8.0
454.2
3.1
29.9
0.3
20.9
50.7
154.6
84.2
289.5
797.9
262.5
377.0
11.1
(4)
7
(33)
33
30
(10)
32
9
4
(7)
6
(28)
89
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Combined businesses consolidated income statement – core
2011
net interest income
other income
effects of liability
management, volatile items
and asset sales
Total income
insurance claims
Total income, net of
insurance claims
operating expenses
other costs
Trading surplus
impairment
Share of results of joint
ventures and associates
Profit before tax and fair
value unwind
fair value unwind
Profit before tax – core
Banking net interest margin
impairment as a % of
average advances
Key balance sheet and
other items
Assets
loans and advances to
customers excl reverse repos
customer deposits
excluding repos
Risk-weighted assets
Retail
£m
7,246
1,628
48
8,922
–
8,922
(4,432)
–
4,490
(1,796)
10
2,704
657
3,361
2.20%
Wholesale
£m
Commercial
£m
1,566
2,731
(738)
3,559
–
3,559
(2,107)
–
1,452
(741)
–
711
(29)
682
1,229
445
–
1,674
–
1,674
(942)
–
732
(296)
–
436
53
489
Wealth
and Int’l
£m
367
1,002
–
1,369
–
1,369
(1,116)
(11)
242
(51)
1
192
8
200
Group
Operations and
Central items
£m
585
(7)
1,293
1,871
–
1,871
(7)
(295)
1,569
(3)
(1)
1,565
(1,274)
291
Insurance
£m
(77)
2,561
–
2,484
(343)
2,141
(765)
(7)
1,369
–
–
1,369
(43)
1,326
1.80%
4.37%
4.16%
0.54%
0.89%
1.09%
0.63%
Group
£m
10,916
8,360
603
19,879
(343)
19,536
(9,369)
(313)
9,854
(2,887)
10
6,977
(628)
6,349
2.42%
0.64%
£bn
£bn
£bn
£bn
£bn
£bn
£bn
325.1
247.1
92.6
76.5
81.5
104.7
27.4
31.8
23.8
7.9
40.7
9.8
0.1
0.4
12.6
437.0
401.5
243.5
90
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Combined businesses consolidated income statement – core (continued)
2010
net interest income
other income
effects of liability
management, volatile items
and asset sales
total income
insurance claims
total income, net of
insurance claims
operating expenses
other costs
trading surplus
impairment
Share of results of joint
ventures and associates
Profit before tax and fair
value unwind
fair value unwind
Profit before tax – core
Banking net interest margin
impairment as a % of
average advances
Key balance sheet and
other items
Assets
loans and advances to
customers excl reverse repos
customer deposits
excluding repos
Risk-weighted assets
Wholesale
£m
commercial
£m
Retail
£m
8,112
1,583
–
9,695
–
9,695
(4,591)
(46)
5,058
(2,629)
1,777
3,130
(114)
4,793
–
4,793
(2,191)
–
2,602
(576)
1,088
455
–
1,543
–
1,543
(984)
–
559
(381)
–
178
81
259
17
2
2,446
965
3,411
2.37%
2,028
24
2,052
1.59%
3.86%
3.31%
0.77%
0.57%
1.34%
0.31%
Wealth
and int’l
£m
305
990
–
1,295
–
1,295
(1,109)
–
186
(26)
–
160
30
190
Group
operations and
central items
£m
510
(24)
150
636
–
636
(150)
–
486
–
5
491
(1,446)
(955)
insurance
£m
(47)
2,635
15
2,603
(542)
2,061
(813)
–
1,248
–
(10)
1,238
(43)
1,195
Group
£m
11,745
8,769
51
20,565
(542)
20,023
(9,838)
(46)
10,139
(3,612)
14
6,541
(389)
6,152
2.48%
0.75%
£bn
£bn
£bn
£bn
£bn
£bn
£bn
333.7
85.4
235.6
98.0
78.8
112.3
26.6
31.0
24.5
8.1
31.6
12.0
0.4
454.2
–
15.7
377.0
262.5
91
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Non-core business
net interest income
other income
effects of liability management, volatile items and asset sales
Total income
insurance claims
Total income, net of insurance claims
costs:
operating expenses
other costs
Trading surplus
impairment
Share of results of joint ventures and associates
(Loss) before tax and fair value unwind
fair value unwind
(Loss) before tax – non-core
Banking net interest margin
impairment as a % of average advances
Key balance sheet items
loans and advances to customers
loans and advances to banks
Debt securities held as loans and receivables
Available-for-sale financial assets
other
Total non-core assets
Risk-weighted assets
customer deposits (excluding repos)
2010
£ million
change
%
2011
£ million
1,317
947
(677)
1,587
–
1,587
(884)
(55)
(939)
648
(6,900)
17
(6,235)
2,571
(3,664)
1.01%
4.60%
2,398
1,167
(144)
3,421
–
3,421
(1,044)
(150)
(1,194)
2,227
(9,569)
(105)
(7,447)
3,507
(3,940)
1.46%
5.56%
As at
31 December
2011
£bn
As at
31 December
2010
£bn
111.8
0.6
12.3
9.5
6.5
140.7
108.8
4.4
135.3
0.4
25.4
22.1
10.5
193.7
143.9
5.5
(45)
(19)
(54)
(54)
15
21
(71)
28
16
(27)
7
change
%
(17)
50
(52)
(57)
(38)
(27)
(24)
(20)
92
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Combined businesses consolidated income statement – non-core
2011
net interest income
other income
effects of liability
management, volatile items
and asset sales
Total income
insurance claims
Total income, net of
insurance claims
costs:
operating expenses
other costs
Trading surplus
impairment
Share of results of joint
ventures and associates
Profit before tax and fair
value unwind
fair value unwind
Profit before tax – non-core
Retail
£m
251
21
–
272
–
272
(6)
–
(6)
266
(174)
1
93
182
275
Banking net interest margin
0.83%
Wholesale
£m
Commercial
£m
Wealth
and Int’l
£m
Group
Operations and
Central items
£m
Insurance
£m
573
604
(677)
500
–
500
(411)
–
(411)
89
(2,160)
14
(2,057)
2,203
146
1.28%
22
1
–
23
–
23
(6)
–
(6)
17
(7)
–
10
–
10
1.40%
461
195
–
656
–
656
(421)
–
(421)
235
(4,559)
2
(4,322)
186
(4,136)
0.80%
10
126
–
136
–
136
(40)
–
(40)
96
–
–
96
–
96
–
–
–
–
–
–
–
(55)
(55)
(55)
–
–
(55)
–
(55)
Group
£m
1,317
947
(677)
1,587
–
1,587
(884)
(55)
(939)
648
(6,900)
17
(6,235)
2,571
(3,664)
1.01%
4.60%
impairment as a % of average
advances
Key balance sheet and
other items
Assets
0.59%
3.35%
0.41%
8.39%
£bn
£bn
£bn
£bn
£bn
£bn
£bn
loans and advances to
customers excl reverse repos
27.7
customer deposits excluding repos –
total non-core assets
Risk-weighted assets
27.7
10.6
46.8
2.8
73.3
59.1
1.4
0.3
1.4
1.6
35.9
1.3
37.7
37.5
0.6
–
111.8
4.4
140.7
108.8
93
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Core and non-core business analysis (continued)
Combined businesses consolidated income statement – non-core (continued)
2010
net interest income
other income
effects of liability management,
volatile items and asset sales
total income
insurance claims
total income, net of
insurance claims
costs:
operating expenses
other costs
trading surplus
impairment
Share of results of joint
ventures and associates
Profit before tax and fair
value unwind
fair value unwind
Profit before tax – non-core
Wholesale
£m
commercial
£m
Retail
£m
536
24
–
560
–
1,070
884
(181)
1,733
–
560
1,733
(7)
–
(7)
553
(118)
(561)
(150)
(711)
1,022
(3,488)
–
(97)
435
140
575
(2,563)
3,025
462
1.60%
39
2
–
41
–
41
(8)
–
(8)
33
(1)
–
32
–
32
1.97%
Group
operations and
central items
£m
insurance
£m
8
164
–
172
–
172
(41)
–
(41)
131
–
–
131
–
131
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
Wealth
and int’l
£m
745
133
37
915
–
915
(427)
–
(427)
488
(5,962)
(8)
(5,482)
342
(5,140)
1.18%
Banking net interest margin
1.64%
impairment as a % of average
advances
0.37%
4.37%
0.05%
10.15%
Key balance sheet and other items
£bn
£bn
£bn
£bn
£bn
£bn
Assets
loans and advances to
customers excl reverse repos
customer deposits excluding repos
total non-core assets
Risk-weighted assets
30.0
–
30.0
11.3
56.1
4.0
109.7
83.8
2.0
0.3
2.0
2.1
47.2
1.2
49.1
46.7
0.7
2.2
Group
£m
2,398
1,167
(144)
3,421
–
3,421
(1,044)
(150)
(1,194)
2,227
(9,569)
(105)
(7,447)
3,507
(3,940)
1.46%
5.56%
£bn
135.3
5.5
193.7
143.9
94
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Volatility arising in insurance businesses
the Group’s statutory result before tax is affected by insurance volatility, caused by movements in financial markets, and policyholder interests
volatility, which primarily reflects the gross up of policyholder tax included in the Group tax charge.
in 2011 the Group’s statutory result before tax included negative insurance and policyholder interests volatility totalling £838 million compared to
positive volatility of £306 million in 2010.
Volatility comprises the following:
insurance volatility
Policyholder interests volatility1
total volatility
insurance hedging arrangements
Total
1
includes volatility relating to the Group’s interest in St James’s Place.
2011
£m
(557)
(283)
(840)
2
(838)
2010
£m
100
216
316
(10)
306
Insurance volatility
the Group’s insurance business has liability products that are supported by substantial holdings of investments, including equities, property
and fixed interest investments, all of which are subject to variations in their value. the value of the liabilities does not move exactly in line with
changes in the value of the investments, yet ifRS requires that the changes in both the value of the liabilities and investments be reflected within
the income statement. As these investments are substantial and movements in their value can have a significant impact on the profitability of the
Group, management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to results based
on the actual return.
the expected sterling investment returns used to determine the normalised profit of the business, which are based on prevailing market rates and
published research into historical investment return differentials, are set out below:
United Kingdom (Sterling)
Gilt yields (gross)
equity returns (gross)
Dividend yield
Property return (gross)
corporate bonds in unit-linked and With Profit funds (gross)
fixed interest investments backing annuity liabilities (gross)
2012
%
2.48
5.48
3.00
5.48
3.08
3.89
2011
%
3.99
6.99
3.00
6.99
4.59
4.78
2010
%
4.45
7.45
3.00
7.45
5.05
5.30
the impact on the results due to the actual return on these investments differing from the expected return (based upon economic assumptions
made at the beginning of the year) is included within insurance volatility. changes in market variables also affect the realistic valuation of the
guarantees and options embedded within the With Profits funds, the value of the in-force business and the value of shareholders’ funds.
the negative insurance volatility during the period ended 31 December 2011 in the insurance division was £557 million, primarily reflecting the
underperformance of equity markets in the second half of 2011 and lower cash returns compared to long-term expectations.
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-to-
market valuation basis a gain of £5 million was recognised in relation to the new contracts in 2011.
95
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Volatility arising in insurance businesses (continued)
Policyholder interests volatility
the application of accounting standards results in the introduction of other sources of significant volatility into the pre-tax profits of the life,
pensions and investments business. in order to provide a clearer representation of the performance of the business, and consistent with the way in
which it is managed, adjustments are made to remove this volatility from underlying profits. the effect of these adjustments is separately disclosed
as policyholder interests volatility; there is no impact upon profit attributable to equity shareholders over the long term.
the most significant of these additional sources of volatility is policyholder tax. Accounting standards require that tax on policyholder investment
returns should be included in the Group’s tax charge rather than being offset against the related income. the impact is, therefore, to either
increase or decrease profit before tax with a corresponding change in the tax charge. over the longer term the charges levied to policyholders to
cover policyholder tax on investment returns and the related tax provisions are expected to offset. in practice timing and measurement differences
exist between provisions for tax and charges made to policyholders. consistent with the normalised approach taken in respect of insurance
volatility, differences in the expected levels of the policyholder tax provision and policyholder charges are adjusted through policyholder interests
volatility. other sources of volatility include the minorities’ share of the profits earned by investment vehicles which are not wholly owned by the
long-term assurance funds.
in the year to 31 December 2011, the statutory results before tax in both the insurance and Wealth and international divisions included a charge
to other income which relates to policyholder interests volatility totalling £283 million (2010: £216 million credit). this charge included the impact
of deferred tax asset impairments due to less optimistic economic forecasts and changes in expected policyholder tax provisions. Policyholder tax
liabilities increased during 2011 and led to a tax charge during the period.
Liability management gains
liability management gains arose on transactions undertaken in both 2010 and 2011. As a result of transactions in 2011 the Group has
recognised gains of £1,295 million (2010: gain of £423 million). in December 2011, the Group carried out an exercise allowing the holders of
certain lloyds tSB Bank and hBoS securities to exchange their securities (exchange Securities) for other securities issued by lloyds tSB Bank.
the gain relating to the 2011 transaction consists of £599 million recognised in other operating income relating to the extinguishment of the
existing liability in respect of the exchange Securities for which new securities were issued and £570 million recognised in net interest income,
principally relating to the change in carrying value, arising as a result of a change in the estimated maturities of the remaining exchange Securities.
the gain recognised in net interest income will reverse as the securities accrete to par over the remaining life.
in December 2011, the Group decided to defer payment of non-mandatory coupons on certain securities and, instead, settle them using an
Alternative coupon Satisfaction mechanism on their contractual terms. this change in expected cashflows resulted in a gain of £126 million in net
interest income from the recalculation of the carrying value of these securities.
96
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Integration costs and benefits
the Group has successfully achieved the integration programme target of delivering run-rate cost synergies and other operating efficiencies of
£2 billion per annum from the programme by the end of 2011.
the sustainable run-rate synergies achieved as at 31 December 2011 totalled £2,054 million, excluding a number of one-off savings. the table
below analyses the run-rate synergies as at 31 December 2011 by division.
Retail
Wholesale and commercial
Wealth and international
insurance
Group operations
central items
Total
Synergy
run-rate
as at
31 December
2011
£m
346
324
273
204
857
50
2,054
2011
Allocation
of Group
Operations
run-rate to
divisions
£m
454
270
31
59
(857)
43
–
Run-rate
by market
facing
division
£m
800
594
304
263
–
93
2,054
cost synergies have been delivered through the integration of hBoS operations, processes and it systems. these synergies have arisen through
procurement; property with 83 head office sites vacated; it cost savings and job reductions.
integration costs of £1,097 million were incurred in the year and have been excluded from the combined businesses results. this brings the total
integration costs since the hBoS acquisition to £3,846 million.
Migrating our business systems to a single platform
2011 saw the single biggest event of the integration programme with the successful migration of our core business systems to a single it platform.
the Group has moved 30 million customer accounts and transferred 35 billion pieces of data between systems successfully. this has been the
largest ever financial services it integration, and at its peak it involved many thousands of colleagues across the organisation.
there were three major components to the system migrations:
– the lloyds tSB Branch counter System (icS) was introduced to all halifax and Bank of Scotland branches and 3,800 hBoS Automated teller
machines (Atms) and 667 intelligent Deposit machines (iDms) were moved across to the lloyds Banking Group it network
– the market leading mortgage Sales Platform, already in use in halifax and Bank of Scotland branches, was successfully rolled out to
800 lloyds tSB mortgage advisors in england and Wales
– in September 2011 30 million hBoS current accounts and savings accounts and commercial and UK Private Banking accounts, were migrated
onto the lloyds Banking Group it system. this customer data migration was successfully achieved after five proving cycles, 11 dress rehearsals
including two full trial account migrations, over 250,000 business tests and 27,000 colleagues trained totalling 1.5 million hours
the vast majority of integration activity is now complete, with a handful of peripheral migrations to be completed in 2012.
Simplification costs and benefits
the successful delivery of the integration programme has provided a platform and single set of processes that now enables the Group to
commence its next transformational journey. A core element of this transformational agenda is the Simplification programme. the programme
is structured around four key initiatives:
operations & Processes – getting our processes right end-to-end, with the right it in the right places.
Sourcing – better understanding what we need across the Group and getting the right deals from our suppliers.
organisation – focusing on how the Group is structured and the way we work.
channels and Products – simplifying our products whilst continuing to improve and innovate our channels.
the programme is well underway having achieved £178 million of Simplification and other cost savings in 2011, equivalent to an annual run-rate
saving of £242 million. the programme is now targeting £1.7 billion of savings in 2014, an increase of £0.2 billion over previous guidance.
Simplification costs of £185 million were incurred in the year and have been excluded from the combined businesses results.
97
Annual Report and Accounts 2011
otheR finAnciAl infoRmAtion
Banking net interest margin
Banking net interest income
Average interest-earning banking assets
Average interest-bearing banking liabilities
Banking net interest margin
Banking asset margin
Banking liability margin
Core
Banking net interest margin
Banking net interest income
Non-core
Banking net interest margin
Banking net interest income
2011
2010
£12,094m
£13,839m
£585,386m
£625,854m
£363,967m
£341,169m
2.07%
1.46%
0.98%
2.21%
1.71%
0.92%
2.42%
2.48%
£10,612m
£11,428m
1.01%
1.46%
£1,482m
£2,411m
Banking net interest income is analysed for asset and liability margins based on interest earned and paid on average assets and average liabilities
respectively, adjusted for funds transfer Pricing, which prices intra-group funding and liquidity. centrally held wholesale funding costs and related
items are included in the Group banking asset margin.
Average interest-earning banking assets, which are calculated gross of related impairment allowances, and average interest-bearing banking
liabilities relate solely to customer and product balances in the banking businesses on which interest is earned or paid. funding and capital
balances including debt securities in issue, subordinated debt, repos and shareholders’ equity are excluded from the calculation of average
interest-bearing banking liabilities. however, the cost of funding these balances allocated to the banking businesses is included in banking net
interest income.
A reconciliation of banking net interest income to Group net interest income showing the items that are excluded in determining banking net
interest income follows:
Banking net interest income – combined businesses
insurance division
other net interest income (including trading activity)
Group net interest income – combined businesses
fair value unwind
Banking volatility and liability management gains
insurance gross up
Volatility arising in insurance businesses
Group net interest income – statutory
2011
£m
2010
£m
12,094
13,839
(67)
206
(39)
343
12,233
14,143
(710)
820
336
19
(301)
(321)
(949)
(26)
12,698
12,546
98
Annual Report and Accounts 2011
FIVE YEAR FINANCIAL SUMMARY
The statutory financial information set out in the table below has been derived from the annual report and accounts of Lloyds Banking Group plc
for each of the past five years.
The financial statements for each of the years presented have been audited by PricewaterhouseCoopers LLP, independent auditors.
Income statement data for the year ended 31 December (£m)
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment
Gain on acquisition
(Loss) profit before tax
(Loss) profit for the year
(Loss) profit for the year attributable to equity shareholders
Total dividend for the year1
Balance sheet data (£m)
Share capital
Shareholders’ equity
Net asset value per ordinary share
Customer deposits
Subordinated liabilities
Loans and advances to customers
Total assets
Share information
Basic earnings per ordinary share
Diluted earnings per ordinary share
Total dividend per ordinary share1
Market price (year end)
Number of shareholders (thousands)
Number of ordinary shares in issue (millions)2
Financial ratios (%)3
Dividend payout ratio
Post-tax return on average shareholders’ equity
Cost:income ratio4
Capital ratios (%)5
Total capital
Tier 1 capital
Core tier 1 capital
2011
2010
2009
20086
20076
20,771
(16,250)
4,521
(8,094)
–
(3,542)
(2,714)
(2,787)
–
24,956
(13,270)
11,686
(10,952)
–
281
(258)
(320)
–
23,278
(15,984)
7,294
(16,673)
11,173
1,042
2,953
2,827
–
9,868
(6,100)
3,768
(3,012)
–
760
798
772
648
10,696
(5,568)
5,128
(1,796)
–
3,999
3,320
3,288
2,026
31 December
2011
31 December
2010
31 December
2009
31 December
2008
31 December
2007
6,881
45,920
67p
413,906
35,089
565,638
970,546
2011
(4.1)p
(4.1)p
–
25.9p
2,770
68,727
2011
–
(6.2)
78.2
6,815
46,061
68p
393,633
36,232
592,597
991,574
2010
(0.5)p
(0.5)p
–
65.7p
2,798
68,074
2010
–
(0.7)
53.2
10,472
43,278
68p
406,741
34,727
626,969
1,027,255
2009
7.5p
7.5p
–
50.7p
2,834
63,775
2009
–
8.8
68.7
1,513
9,393
155p
170,938
17,256
240,344
436,033
2008
6.7p
6.6p
11.4p
126.0p
824
5,973
2008
83.9
7.0
61.8
1,432
12,141
212p
156,555
11,958
209,814
353,346
2007
28.9p
28.7p
35.9p
472.0p
814
5,648
2007
61.6
28.1
52.1
31 December
2011
31 December
2010
31 December
20097
31 December
20087
31 December
2007
15.6
12.5
10.8
15.2
11.6
10.2
12.4
9.6
8.1
11.1
7.9
5.5
11.0
8.1
7.4
1
2
3
4
5
6
7
Annual dividends comprise both interim and estimated final dividend payments. Under IFRS, the total dividend for the year represents the interim dividend paid during the year and the final
dividend which will be paid and accounted for during the following year.
This figure excludes 81 million (2007 to 2008: 79 million) limited voting ordinary shares.
Averages are calculated on a monthly basis from the consolidated financial data of Lloyds Banking Group.
The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims).
Capital ratios are in accordance with Basel II requirements; other than the ratios for 2007 which reflect Basel I.
Restated in 2009 for IFRS 2 (Revised) and to separate the share of results of joint ventures and associates from total income.
Restated in 2010 to reflect a prior year adjustment to available-for-sale revaluation reserves.
99
Annual Report and Accounts 2011
RISK
MANAGEMENT
All narrative is unaudited unless otherwise stated.
Tables are both audited and unaudited as stated.
The audited information is required to comply
with the requirements of relevant International
Financial Reporting Standards.
The Group’s approach to risk
Risk as a strategic differentiator
State funding and state aid
Risk governance
Principal risks and uncertainties
Full analysis of risk drivers
Financial soundness
Credit risk
Market risk
Operational risk
Insurance risk
Business risk
100
101
102
102
106
112
112
129
164
167
169
170
100
Annual Report and Accounts 2011
Risk mAnAgement
the group’s approach to risk
is founded on a robust control
framework and a strong risk
management culture which
guides the way all employees
approach their work, the way
they behave and the decisions
they make.
Progress in 2011
Priorities for 2012
The Group has a fully embedded conservative approach to, and
prudent appetite for, risk and has in place disciplined controls over
the risk profile for all new business, aligned to the strategic review.
The Group has made good progress in reducing non-core assets
and improving the asset quality ratio.
Excellent progress in de-risking the Retail books. Solid progress
in Wholesale and good progress to tackle the issues in the
international books.
Our continued focus on our conduct risk agenda to ensure we
are achieving the best outcomes for our customers is completely
aligned with being the best bank for customers.
Risk Division’s mission in 2012 is to support sustainable growth through:
Strategy: Supporting the delivery of the Group’s strategic plan,
within risk appetite
Risk Infrastructure: Continue to invest in and develop our
risk systems
Risk Culture: Build and leverage on our strong risk culture of
business ownership
Regulatory Change: Be a role model
People Agenda: Continue to attract, retain and develop
high quality people
The Group’s approach to risk
Governance
– the group’s approach to risk is founded on a robust control framework and a strong risk management culture which guides the way all
employees approach their work, behave and make decisions promptly.
– Board-level engagement, coupled with the direct involvement of senior management in group wide risk issues at group executive Committee
level, ensures that issues are promptly escalated and remediation plans are initiated.
– the interaction of the executive and non-executive governance structures relies upon a culture of transparency and openness that is encouraged
by both the Board and senior management.
Risk Appetite
– the Board takes the lead by establishing the ‘tone at the top’ and approving group risk appetite which is then cascaded throughout the group
in terms of policies, authorities and limits. the Board ensures that senior management implements policies and procedures designed to promote
professional behaviour and integrity.
Culture
– the Board ensures that senior management implements risk policies and risk appetites that either limit or, where appropriate, prohibit activities,
relationships, and situations that could be detrimental to the group’s risk profile.
– the group has a conservative business model embodied by a risk culture founded on prudence and individual accountability, where the needs
of customers are paramount.
– the focus has been and remains on building and sustaining long-term relationships with customers, through good and bad economic times.
Enterprise-Wide Risk Management
– the group uses an enterprise-Wide Risk management framework for the identification, assessment, measurement and management of risk.
– it seeks to maximise value for shareholders over time by aligning risk appetite with corporate strategy, assessing the impact of emerging risks
and developing risk tolerances and mitigating strategies.
– the framework seeks to strengthen the group’s ability to identify and assess risks, aggregate and report group wide risks and refine risk appetite.
101
Annual Report and Accounts 2011
Risk mAnAgement
Decision Making
– the Risk Committee, chaired by a non-executive Director, comprises other non-executive Directors and oversees the group’s risk exposures.
the Chief Risk Officer regularly informs the Risk Committee of the aggregate risk profile and has direct access to the Chairman and members of
the Risk Committee.
– the group Risk Committee and the group Asset and Liability Committee are chaired by the group Chief executive. the aggregate group wide
risk profile and risk appetite are discussed at these monthly meetings.
Risk as a strategic differentiator
the group’s strategy and risk appetite were developed together to ensure one informed the other in creating a strategy that delivered on
becoming the best bank for our customers whilst creating sustainable growth over time.
Strong Control Framework
– A strong control framework remains a priority for the group and is the foundation for the delivery of effective risk management.
– the group optimises performance by allowing business units to operate within approved parameters.
– the group’s approach to risk management ensures that business units remain accountable for risk.
Conservative Approach
– the group has a fully embedded conservative approach to, and prudent appetite for risk.
Board Level Reporting
– the group continues to enhance its capabilities by providing to the Board both qualitative and quantitative data including stress testing analysis
on risks associated with strategic objectives.
– taking risks which are well understood, consistent with strategy and appropriately remunerated, is a key driver of shareholder return.
– Risk analysis and reporting supports the identification of opportunities as well as risks and provide an aggregate view of the overall risk portfolio.
– the group’s key risks, management actions and performance against risk appetite are monitored and reported at group level.
Accountability
– Risk is included as one of the five principal criteria within the group’s balanced scorecard on which business area and individual’s performance
is judged.
– Business executives have specified risk management objectives, and incentive schemes take account of performance against these.
– the Risk function oversees the performance assessment of business areas and senior staff to ensure adherence to the group’s risk and control frameworks
and oversees that performance has been achieved within risk appetite.
Risk Division
– During 2011 good progress has been made in creating a more agile Risk function through further delayering the management structure and
simplifying the operating model.
– this reinforces the model of a strong and independent Risk function that keeps the group safe, supports sustainable business growth and
minimises losses within risk appetite.
Risk Transformation
– the group’s continued investment agenda, ensures Risk systems, processes and management information continue to meet the needs of the
group and external stakeholders.
Reflecting the importance the group
places on risk management, risk is
included as one of the five principle
criteria within the group’s balanced
scorecard on which business areas
and individual staff performance and
remuneration is judged.
Conservative risk appetite across the
shape of our existing and new business –
taking into account customer outcomes,
operational risks, impact on our people,
as well as credit, funding and stressed
earnings metrics. Approved by the Board
and now fully embedded through the
whole control framework – policies,
procedures and limits.
the group achieved a significant
reduction in it’s impairment charge in
2011, due primarily to lower corporate
real estate charges in Wholesale and
strong Retail performance. All divisions
experienced a reduction in impairment
charges of above 20 per cent from 2010.
in 2011, there has been a significant
improvement in our Balance sheet,
capital and funding position.
As part of the allocation of investment
under the group strategic Review, the
continued development of risk systems
was a key priority to maintain our robust
control framework over the long-term.
102
Annual Report and Accounts 2011
Risk mAnAgement
State funding and state aid
Hm treasury currently holds approximately 40.2 per cent of the group’s ordinary share capital. United kingdom Financial investments Limited
(UkFi) as manager of Hm treasury’s shareholding continues to operate in line with the framework document between UkFi and Hm treasury
managing the investment in the group on a commercial basis without interference in day-to-day management decisions. there is a risk that
a change in government priorities could result in the framework agreement currently in place being replaced leading to interference in the
operations of the group, although there have been no indications that the government intends to change the existing operating arrangements.
the group made a number of undertakings to Hm treasury arising from the capital and funding support, including the provision of additional
lending to certain mortgage and business sectors for the two years to 28 February 2011, and other matters relating to corporate governance and
colleague remuneration. the lending commitments were subject to prudent commercial lending and pricing criteria, the availability of sufficient
funding and sufficient demand from creditworthy customers. these lending commitments were delivered in full in the second year.
the subsequent agreement (known as ‘merlin’) between five major Uk banks (including the group) and the government in relation to gross
business lending capacity in the 2011 calendar year was subject to a similar set of criteria. the group delivered in full its share of the commitments
by the five banks, both in respect of lending to smes in respect of overall gross business lending. the group has made a unilateral lending pledge
for 2012 as part of its publicly announced sme charter.
in addition, the group is subject to european state aid obligations in line with the Restructuring Plan agreed with Hm treasury and the eU College of
Commissioners in november 2009, which is designed to support the long-term viability of the group and remedy any distortion of competition and
trade in the european Union (eU) arising from the state aid given to the group. this has placed a number of requirements on the group including
an asset reduction target from a defined pool of assets by the end of 2014 and the disposal of certain portions of its retail business by the end of
november 2013. in June 2011 the group issued an information memorandum to potential bidders of this retail banking business, which the european
Commission confirmed met the requirements to commence the formal sale process for the sale no later than 30 november 2011. On 14 December
2011 the group announced that having reviewed the formal offers made, its preferred option was for a direct sale and that it was entering into
exclusive discussions with the Co-operative group. the group is also continuing to progress an initial Public Offering (iPO) in parallel. the group
continues to work closely with the eU Commission, Hm treasury and the monitoring trustee appointed by the eU Commission to ensure the
successful implementation of the Restructuring Plan.
Risk governance
the embedding of integrated governance, risk and control frameworks throughout the group has continued, through a consistent approach to
risk appetite, policies, delegated authorities and governance committee structures.
the risk governance structure is intended to strengthen risk evaluation and management, whilst also positioning the group to manage the changing
regulatory environment in an efficient and effective manner. the risk governance structure for Lloyds Banking group is shown in table 1.1.
Board and Board Committees
the Board, assisted by Risk Committee and Audit Committee, approves the group’s overall governance, risk and control frameworks and risk
appetite. the Board also reviews the group’s aggregate risk exposures and concentrations of risk to ensure that these are consistent with the
Board’s agreed appetite for risk. the roles of the Board, Audit Committee and Risk Committee are shown in the corporate governance section on
pages 177 to 186 and further key risk oversight roles are described below.
the Risk Committee, which comprises non-executive Directors, oversees and challenges the development, implementation and maintenance
of the group’s risk management framework, ensuring that its strategy, principles, policies and resources are aligned internally to its risk appetite as
well as externally to regulation, corporate governance and industry best practice. the Risk Committee regularly reviews the group’s risk exposures
across the primary risk drivers and the detailed risk types.
the Group Executive Committee supports the group Chief executive in ensuring the effectiveness of the group’s risk management framework
and the clear articulation of the group’s risk policies, whilst also reviewing the group’s aggregate risk exposures and concentrations of risk.
throughout 2011 businesses provided the group executive Committee with regular updates on business performance, always including a review
of their key risks. the group executive Committee is supported by other group committees as shown in table 1.1, and in particular by:
– the Group Asset and Liability Committee is responsible for the strategic management of the group’s assets and liabilities and the profit and
loss implications of balance sheet management actions. it is also responsible for the risk management framework for market risk, liquidity risk,
capital risk and earnings volatility.
– the Group Incident Executive sets the strategic direction for the group’s response to significant incidents which could affect its ability to
continue to operate, and instigates any tactical initiatives required.
– the Group Stress Testing Committee is responsible for reviewing, challenging and recommending to group executive Committee the annual
stress testing of the group’s operating plan based on internal and FsA recommended scenarios, annual european Banking Authority stress tests,
and other group wide macroeconomic stress tests.
– the Group Product Governance Committee provides strategic and senior oversight over design, launch and management of products,
including new product approval, annual product reviews and management of risk in the back book.
– the Group Risk Committee reviews and recommends the group’s risk appetite and governance, risk and control frameworks, high-level group
policies and the allocation of risk appetite. the group Risk Committee regularly reviews risk exposures and risk/reward returns.
During 2011, the group’s risk committee framework has been reviewed in order to ensure more effective risk management, clearer accountabilities,
and more efficient and simplified processes. A new risk committee framework has been implemented, whereby the group Risk Committee is
supported by the following Committees:
103
Annual Report and Accounts 2011
Risk mAnAgement
– Credit Risk Committees, which are responsible for the development and effectiveness of the relevant credit risk management framework, clear
description of the group’s credit risk appetite, setting of high-level group credit policy, and compliance with regulatory credit requirements. Risk
Committees monitor and review the group’s aggregate credit risk exposures and concentrations of risk on behalf of the group Risk Committee.
– the Group Market Risk Committee, which on behalf of the group Asset and Liability Committee, monitors and reviews the group’s aggregate
market risk exposures and concentrations and provides a proactive and robust challenge around business activities giving rise to market risks.
– the Insurance Risk Committee monitors, reviews and makes recommendations on the risk management framework, risk strategy and appetite
for the insurance business, ensuring that the policy and oversight framework for insurance risk management is appropriate. the committee
reviews and challenges relevant insurance reporting and issues arising, including: the group’s aggregate portfolio of insurance risk against
approved plans and risk appetite and the need and opportunity for effecting insurance risk mitigation.
– the Group Operational Risk Committee, which is responsible for identifying significant current and emerging operational risks or
accumulation of risks and control deficiencies across the group and reviewing associated oversight plans to ensure pre-emptive risk
management action. the Committee also seeks to ensure that adequate business area engagement occurs to develop, implement and maintain
the group’s operational risk management framework.
– the Group Compliance and Conduct Risk Committee is responsible for forming a group wide view of the group’s compliance and conduct risk
profile, reviewing the effectiveness of compliance and conduct risk frameworks and reviewing relevant polices and engagement with regulators.
– the Group Financial Crime Committee serves as the principal group forum for reviewing and challenging the management of financial
crime risk including the overall strategy and performance and engagement with financial crime authorities. the Committee is accountable for
ensuring that, at group level, financial crime risks are effectively identified and managed within risk appetite and that strategies for financial crime
prevention are effectively co-ordinated and implemented across the group.
– the Group Model Governance Committee is responsible for setting the framework and standards for model governance across the
group, including establishing appropriate levels of delegated authority and principles underlying the group’s risk modelling framework,
specifically regarding consistency of approach across business units and risk types. it approves risk models other than a small number defined
as highly material to the group, which are approved by the group Risk Committee. this also meets FsA BiPRU requirements regarding
the governance and approval for internal Ratings Based models, including internal Assessment models, market Risk VaR and Advanced
measurement approach models.
table 1.1: Risk governance structures
Reporting
Audit
Commit ee
t
Board
Risk
Committee
Reporting
e
c
n
e
f
e
d
f
o
e
n
i
l
d
r
i
h
T
Group
Audit
Aggregation,
escalation
Independent
challenge
Independent
challenge
Reporting
G
G
EC members’ Committees
Group
Executive
Committee
Group Asset
and Liability
Committee
Group
Incident
Executive
Group Stress
Testing
Committee
Group
Product
Governance
Committee
Group Risk
Committee
Primary
escalation
Business areas’ Enterprise Risk Committees
Retail and
Wealth Risk
Committee
Wholesale
Banking and
Markets Risk
Committee
Commercial
Risk
Committee
Asset
Finance
Risk
Committee
Insurance
Division
Executive
Committee
International
Business
Risk
Committees
Group
Functions
Executive
Committees
Group
Operations
Risk
Committee
First line of defence
Independent Challenge
Independent
challenge
Aggregation,
escalation
Independent
challenge
Reporting
Risk Division
Committees
Wholesale,
Commercial and
International
Credit Risk
Committees
Retail and
Wealth
Credit Risk
Committees
Group
Market Risk
Committee
Insurance
Risk
Committee
Group
Operational
Risk
Committee
Group
Compliance
and Conduct
Risk
Committee
Group
Financial
Crime
Committee
Group Model
Governance
Committee
e
c
n
e
f
e
d
f
o
e
n
i
l
d
n
o
c
e
S
104
Annual Report and Accounts 2011
Risk mAnAgement
Risk Division, headed by the Chief Risk Officer, consists of eleven Risk Directors and their specialist teams. these teams provide oversight and
independent challenge to business management and support the senior executive and the Board with independent reporting on risks and
opportunities. Risk Directors, responsible for each risk type, meet on a regular basis under the Chairmanship of the Chief Risk Officer to review and
challenge the risk profile of the group and to ensure that mitigating actions are appropriate.
Business Unit managing Directors/executives have primary responsibility for measuring, monitoring and controlling risks within their areas of
accountability and are required to establish control frameworks for their businesses that are consistent with the group’s policies and are within
the parameters set by the Board, group executive Committee and Risk Division. Compliance with policies and parameters is overseen by the
Risk Committee, the group Risk Committee, the group Asset and Liability Committee, and Risk Division, and independently challenged by
group Audit.
Risk management oversight
the Chief Risk Officer oversees and promotes the development and implementation of consistent group wide governance risk and control
frameworks. the Chief Risk Officer, supported by the Risk Directors, provides objective challenge to the group’s senior management. the group
executive Committee and the Board receive regular briefings and guidance from the Chief Risk Officer to ensure awareness of the overarching risk
management framework and a clear understanding of their accountabilities for risk and internal control.
Risk Directors, who report directly to the Chief Risk Officer, are allocated responsibility for specific risk types and are responsible for ensuring the
adequacy of the framework for their risk types as well as the oversight of the risk profile across the group. Risk Directors also support specific
business areas to provide an enterprise-wide risk management perspective.
the Director of group Audit provides independent assurance to the Audit Committee and the Board that risks within the group are recognised,
monitored and managed within acceptable parameters. group Audit is fully independent of Risk, seeking to ensure objective challenge to the
effectiveness of the risk governance framework.
table 1.2: Risk management framework
The Lloyds Banking Group business strategy and objectives
Policy framework and accountability and risk appetite
Risk
Identification
Control
Activities
Risk and Control
Assessment
Risk
Measurement
Independent
Reviews
Monitoring
Risk
Reporting
Action plans and tracking
People
Systems and tools
Risk management in the business
Line management is directly accountable for the management of risks arising in their individual businesses. A key objective is to ensure that
business decisions strike an appropriate balance between risk and reward, consistent with the group’s risk appetite.
All business areas complete a control effectiveness review annually (see page 186), reviewing the effectiveness of their internal controls and putting
in place a programme of enhancements where appropriate. executives of each business area and each group executive Committee member
certify the accuracy of their assessment.
Risk management in the business forms part of a tiered risk management model, as shown above, with Risk Division providing oversight and
challenge, and the Chief Risk Officer and group committees establishing the group wide perspective.
this approach provides the group with an effective mechanism for developing and embedding risk policies and risk management strategies which
are aligned with the risks faced by its businesses. it also seeks to facilitate effective communication on these matters across the group.
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Risk management framework
the group’s risk management principles and framework cover all the types of risk which could impact on its banking and insurance businesses.
the group uses an enterprise-wide risk management framework to maximise shareholder value over time by aligning risk management with the
corporate strategy, assessing the impact of emerging risks, and developing tolerances and mitigating strategies. the framework ensures that
policies and controls can be adapted to reflect adjustments to business strategy and risk appetite in response to changing market conditions.
the principal elements of the framework are shown in table 1.2. these map to the components of the internal control framework issued by the
Committee of sponsoring Organisations of the treadway Commission.
the Lloyds Banking Group business strategy and objectives are used to determine the group’s high level risk appetite and measures and
metrics for the primary risk drivers (see table 1.3).
the risk appetite is proposed by the group Chief executive following review by the group Risk Committee and group Asset and Liability
Committee, and is approved by the Board. the approved high level appetite and limits are delegated to the group Chief executive and
then cascaded in consultation with the group Risk Committee and group Asset and Liability Committee to members of the group executive
Committee and the business.
the risk appetite is executed through Policy Framework and Accountabilities, comprising the following levels of policy:
– Principles: Board-level statements of principle for the six primary risk drivers
– High-level group policy: policy statements for the main risk types which align to each risk driver
– Detailed group policy: more specific and detailed policy statements of group policy
– Business Area policy: local policy which is produced by exception where a greater level of detail is needed by a business area than is appropriate
for group-level policy.
All policies are reviewed annually to ensure they remain fit for purpose.
During 2011, the group’s Policy Framework has been reviewed with a view to simplification, which will be implemented over the coming year.
Colleagues are expected to be aware of and to comply with the policies and procedures which apply to them and their work. Line management in
each business area has primary responsibility for ensuring that they do so.
Risk Division oversees the effective implementation of policy, and group Audit provides independent assurance to the Board about the
effectiveness of the group’s internal control framework and adherence to policy.
Clear and consistent risk identification is undertaken using a common risk language to define and categorise risks (see table 1.3), also supporting
risk aggregation and standardised reporting.
Proportionate control activities are in place mitigating or transferring risk where appropriate. Risk and control assessments including the
annual control effectiveness review are undertaken assessing the effectiveness of mitigating actions and whether risk exposures are consistent with
the group’s risk appetite.
the impact of risks and issues is determined through effective risk measurement, including modelling, stress testing and scenario analysis to
assess financial, reputational and regulatory capital implications.
the outcomes of independent reviews (including internal and external audit and regulatory reviews) are reflected in risk management activities
and action plans.
Monitoring processes are in place supporting the reporting and escalation of significant issues or losses to appropriate levels of management.
Business areas monitor and report on their risk levels against risk appetite and their performance against relevant limits or policies.
Risk reporting is reviewed by the business executive sitting as a risk committee, to ensure that senior management is satisfied with the overall
risk profile, risk accountabilities and progress on any necessary action plans and tracking. information is provided to Risk Division for review and
aggregation to feed into regular reporting on risk exposures and material issues.
At group level a consolidated risk report and risk appetite dashboard are produced which are reviewed and debated by the group Risk
Committee, Risk Committee and the Board to ensure that they are satisfied with the overall risk profile, risk accountabilities and mitigating actions.
the report and dashboard provide a monthly assessment of the aggregate residual risk for the primary risk drivers, comparing the assessment with
the previous periods and providing a forecast for the next twelve months and also provides an assessment of emerging risks, which could impact
the group over the next five years.
the overall effectiveness of the risk management framework depends on the people undertaking these activities and the quality of the supporting
systems and tools. the risk transformation programme has initiated a significant investment in risk infrastructure to strengthen the group’s risk
management capability.
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Principal risks and uncertainties
At present the most significant risks faced by the group, which are derived from the primary risk drivers and detailed risk types in table 1.3
(page 112), are shown below. these risks could impact on the success of delivering against the group’s long-term strategic objectives. For further
information on the economy see pages 21 and 22.
Liquidity and funding
Risk Definition
Liquidity risk is defined as the risk
that the group has insufficient
financial resources to meet its
commitments as they fall due, or
can only secure them at excessive
cost.
Funding risk is defined as the risk
that the group does not have
sufficiently stable and diverse
sources of funding or the funding
structure is inefficient.
Principal Risks
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.
the combination of right-sizing the balance sheet and continued development of the retail deposit base has
seen the group’s wholesale funding requirement reduce in the past year. the progress the group has made
to date in diversifying its funding sources has further strengthened its funding base.
During the first half of 2011 the group accelerated term funding initiatives and the run down of certain
non-core asset portfolios allowing a further reduction in total government and central bank facilities.
the group repaid its remaining drawings under the Bank of england sLs scheme in full during 2011.
Outstandings under the Credit guarantee scheme reduced in line with their contractual maturities, with
£23.5 billion remaining at end December. the outstanding amount matures during 2012.
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.
the group carries out stress testing of its liquidity position against a range of scenarios, including those
prescribed by the FsA. the group’s liquidity risk appetite is also calibrated against a number of stressed
liquidity metrics.
the group’s stress testing framework considers these factors, including the impact of a range of economic
and liquidity stress scenarios over both short and longer term horizons. internal stress testing results at
31 December 2011 show that the group has liquidity resources representing more than 130 per cent of
modelled outflows from all wholesale funding sources, corporate deposits and rating dependent contracts
under the group’s severe liquidity stress scenario. in 2011, the group has maintained its liquidity levels in
excess of the iLg regulatory minimum (FsA’s individual Liquidity Adequacy standards) at all times. Funding
projections show the group will achieve the proposed Basel iii liquidity and funding requirements in advance
of expected implementation dates.
the group’s stress testing shows that further credit rating downgrades may reduce investor appetite for some of
the group’s liability classes and therefore funding capacity. in the fourth quarter of 2011, the group experienced
downgrades in its long-term rating of between one and two notches from three of the major rating agencies.
the impact that the group experienced following the downgrades was consistent with the group’s modelled
outcomes based on the stress testing framework. the group has materially reduced its wholesale funding in
recent years and operates a well diversified funding platform which together lessen the impact of stress events.
the group’s borrowing costs and issuance in the capital markets are dependent on a number of factors, and
increased cost or reduction of capacity could materially adversely affect the group’s results of operations,
financial condition and prospects. in particular, reduction in the credit rating of the group or deterioration in
the capital markets’ perception of the group’s financial resilience, could significantly increase its borrowing
costs and limit its issuance capacity in the capital markets. As an indicator over the last 12 months the spread
between an index of A rated long term senior unsecured bank debt and an index of similar BBB rated bank
debt, both of which are publicly available, has ranged between 60 and 115 basis points. the applicability to
and implications for the group’s funding cost would depend on the type of issuance, and prevailing market
conditions. the impact on the group’s funding cost is subject to a number of assumptions and uncertainties
and is therefore impossible to quantify precisely.
Downgrades of the group’s long term debt rating could lead to additional collateral posting and cash
outflow. A hypothetical simultaneous two notch downgrade of the group’s long-term debt rating from all
major rating agencies, after initial actions within management’s control, could result in an outflow of £11 billion
of cash, £4 billion of collateral posting related to customer financial contracts and £24 billion of collateral
posting associated with secured funding. these effects do not take into account additional management
and restructuring actions that the group has identified that could materially reduce the amount of required
collateral postings under derivative contracts related to its own secured funding programmes.
the downgrades that the group experienced in the fourth quarter of 2011 did not significantly change
its borrowing costs, reduce its issuance capacity or require significant collateral posting. the group notes
the February 2012 announcement from moody’s placing the ratings of 114 european financial institutions,
including Lloyds Banking group, on review for downgrade. even in the case of a simultaneous two notch
downgrade from all rating agencies, the group would remain investment grade.
At 31 December 2011, the group had £202 billion of highly liquid unencumbered assets in its liquidity
portfolio which are available to meet cash and collateral outflows. this liquidity is available for deployment
at immediate notice, subject to complying with regulatory requirements, and is a key component of the
group’s liquidity management process.
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Liquidity and funding (continued) Mitigating Actions
the group takes many mitigating actions with respect to this principle risk, key examples include:
the group has maintained its liquidity levels in excess of the iLg regulatory minimum (FsA’s individual
Liquidity Adequacy standards) at all times. Funding projections show the group will achieve the proposed
Basel iii liquidity and funding metrics in advance of expected implementation dates. the Liquidity Coverage
Ratio (LCR) is due to be implemented on 1 January 2015 and the net stable Funding Ratio (nsFR) has a
1 January 2018 implementation date. the european Commission released its proposal for implementing
Basel iii into europe (CRD iV) in July 2011 and we note that discussions over the final detail are ongoing.
the group carries out monthly stress testing of its liquidity position against a range of scenarios, including those
prescribed by the FsA. the group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
the key dependencies on successfully funding the group’s balance sheet include the continued functioning
of the money and capital markets; successful right-sizing of the group’s balance sheet; the repayment of the
government Credit guarantee scheme facilities in accordance with the agreed terms; no more than limited
further deterioration in the Uk’s and the group’s credit rating; and no significant or sudden withdrawal
of deposits resulting in increased reliance on money markets. Additionally, the group has entered into a
number of eU state aid related obligations to achieve reductions in certain parts of its balance sheet by the
end of 2014. these are assumed within the group’s funding plan. the requirement to meet this deadline may
result in the group having to provide funding to support these asset reductions and/or disposals and may
also result in a lower price being achieved.
term wholesale funding issuance for the year totalled £35 billion, in excess of plan, representing £2 billion
pre-funding of the requirement for 2012.
the group term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total
wholesale funding) improved to 55 per cent (50 per cent at 31 December 2010) due to good progress in new
term issuance and a reduction in short term money market funding the wholesale funding position includes debt
issued under the legacy government Credit guarantee scheme, for which the last maturity will occur in 2012.
total wholesale funding reduced by £47 billion to £251 billion, with the volume with a residual maturity less
than one year falling £36 billion to £113 billion.
the ratio of customer loans to deposits improved to 135 per cent compared with 154 per cent at
31 December 2010. Loans and advances reduced by £41 billion and customer deposits increased by
£23 billion, representing growth of 6 per cent in 2011.
For further information on Liquidity and funding risk, see page 112.
Principal Risks
Arising in the Retail, Wholesale, Commercial, and Wealth and international divisions, reflecting the risks
inherent in the group’s lending activities and, to a much lesser extent in the insurance division in respect
of investment of own funds. Adverse changes in the credit quality of the group’s Uk and/or international
borrowers and counterparties, or in their behaviour, would be expected to reduce the value of the group’s
assets and materially increase the group’s write-downs and allowances for impairment losses. Credit risk can
be affected by a range of factors, including, inter alia, increased unemployment, reduced asset values, lower
consumer spending, increased personal or corporate insolvency levels, reduced corporate profits, increased
interest rates or higher tenant defaults. Over the last four years, the global banking crisis and economic
downturn has driven cyclically high bad debt charges. these have arisen from the group’s lending to:
– Wholesale customers (including those in Wealth and international): where companies continue to face difficult
business conditions. impairment levels have reduced materially since the peak of the economic downturn
and more aggressive risk appetite in the HBOs businesses when elevated corporate default levels and illiquid
commercial property markets resulted in heightened impairment charges. the Uk economy remains fragile.
Consumer and business confidence is low, consumer spending has been falling over the past year, the reduction in
public sector spending is deepening and exports are failing to offset domestic weakness. the possibility of further
economic weakness remains. Financial market instability represents an additional downside risk. the group
has exposure in both the Uk and internationally, including europe, ireland, UsA and Australia, particularly in
commercial real estate lending, where we have a high level of lending secured on secondary and tertiary assets.
– Retail customers (including those in Wealth and international): have seen Uk bad debts reduce further in
2011 as a result of risk management activity and more stable, low interest rate Uk economic conditions.
these portfolios will remain strongly linked to the economic environment, with inter alia house price falls,
unemployment increases, consumer over-indebtedness and rising interest rates being possible impacts to
the secured and unsecured retail exposures.
Mitigating Actions
the group takes many mitigating actions with respect to this principle risk, key examples include:
the group follows a relationship based business model with risk management processes, appetites and
experienced staff in place. Further details on mitigating actions are detailed on pages 130 to 132.
For further information on Credit risk, see page 129.
Credit
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).
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Regulatory
Risk Definition
Regulatory risk is the risk of
reductions in earnings and/
or value, through financial or
reputational loss, from failing to
comply with the applicable laws,
regulations or codes.
Principal Risks
Regulatory exposure is driven by the significant volume of current legislation and regulation within the Uk
and overseas with which the group has to comply, along with new or proposed legislation and regulation
which needs to be reviewed, assessed and embedded into day-to-day operational and business practices
across the group. this is particularly the case in the current market environment, which continues to witness
high levels of government and regulatory intervention in the banking sector.
Lloyds Banking group faces increased political and regulatory scrutiny as a result of the group’s perceived
size and systemic importance following the acquisition of HBOs group.
Independent Commission on Banking
the government appointed an independent Commission on Banking (iCB) to review possible measures
to reform the banking system and promote stability and competition. the iCB published its final report on
12 september 2011 putting forward recommendations to require ring-fencing of the retail activities of banks
from their investment banking activities and additional capital requirements beyond those required under
current drafts of the Capital Requirements Directive iV. the Report also makes recommendations in relation
to the competitiveness of the Uk banking market, including enhancing the competition remit of the new
Financial Conduct Authority (FCA), implementing a new industry-wide switching solution by september
2013, and improving transparency. the iCB, which following the final report was disbanded, had the authority
only to make recommendations, which the government could choose to accept or reject.
the iCB specifically recommended in relation to the group’s eC mandated branch disposal (Project Verde), that,
to create a strong challenger in the Uk banking market, the entity which results from the divestment should have
a share of the personal current account (PCA) market of at least 6 per cent (although this does not need to arise
solely from the current accounts acquired from the Company) and a funding position at least as strong as its
peers. the iCB did not specify a definitive timeframe for the divested entity to achieve a 6 per cent market share
of PCAs but recommended that a market investigation should be carefully considered by competition authorities
if ‘a strong and effective challenger’ has not resulted from the Company’s divestment by 2015. the iCB did not
recommend explicitly that the Company should increase the size of the Project Verde disposal agreed with
the european Commission but recommended that the government prioritise the emergence of a strong new
challenger over reducing market concentration through a ‘substantially enhanced’ divestment by the group.
the government published its response to the iCB recommendations on 19 December 2011. the government
supported the recommendation that an entity with a larger share of the PCA market than the 4.6 per cent
originally proposed might produce a more effective competitor. in relation to the group’s announcement that
it was to pursue exclusive negotiations with the Co-operative group, the government commented that such
a transaction would deliver a significant enhancement of the PCA market share, with the share divested by
the group combining with the Co-operative group’s existing share to create a competitor with approximately
7-8 per cent. the government also stated that the execution of the divestment is a commercial matter, and it
has no intention of using its shareholding to deliver an enhancement.
New Regulatory Regime
On 27 January 2012, the government published the Financial services Bill. the proposed new Uk regulatory
architecture will see the transition of regulatory and supervisory powers from the FsA to the new Financial
Conduct Authority (FCA) and Prudential Regulatory Authority (PRA). the PRA will be responsible for
supervising banks, building societies and other large firms. the FCA will focus on consumer protection
and market regulation. the Bill is also proposing new responsibilities and powers for the FCA. the most
noteworthy are the proposed greater powers for the FCA in relation to competition and the proposal to
widen its scope to include consumer credit. the Bill is expected to take effect in early 2013.
in April 2011, the FsA commenced an internal reorganisation as a first step in a process towards the formal
transition of regulatory and supervisory powers from the FsA to the new FCA and PRA in 2013. Until this time
the responsibility for regulating and supervising the activities of the group and its subsidiaries will remain
with the FsA. On 2 April the FsA will introduce a new ‘twin peaks’ model and the intention is to move the
FsA as close as possible to the new style of regulation outlined in the Bill. there will be two independent
groups of supervisors for banks, insurers and major investment firms covering prudential and conduct. (All
other firms (ie those not dual regulated) will be solely supervised by the conduct supervisors.)
in addition, the european Banking Authority, the european insurance and Occupational Pensions Authority
and the european securities and markets Authority as new eU supervisory Authorities are likely to have
greater influence on regulatory matters across the eU.
Capital and Liquidity
evolving capital and liquidity requirements continue to be a priority for the group. the Basel Committee
on Banking supervision has put forward proposals for a reform package which changes the regulatory
capital and liquidity standards, the definition of ‘capital’, introduces new definitions for the calculation of
counterparty credit risk and leverage ratios, additional capital buffers and development of a global liquidity
standard. implementation of these changes is expected to be phased in between 2013 and 2018.
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Regulatory (continued)
Anti Bribery
the Bribery Act 2010 came fully into force on 1 July 2011. it enhances previous laws on bribery and is
supported by some detailed guidance issued by the ministry of Justice on the steps a business needs to
take to embed ‘adequate procedures’ to prevent bribery. A company convicted of failing to have ‘adequate
procedures’ to prevent bribery could receive an unlimited fine. the group operates a group wide Anti-
Bribery Policy, applicable to all of its businesses, operations and employees, which incorporates the
requirements of the Uk Bribery Act 2010.
Sanctions
the group takes very seriously its responsibilities for complying with legal and regulatory sanctions
requirements in all the jurisdictions in which it operates. in order to assist adherence to relevant economic
sanctions legislation, the group has enhanced its internal compliance processes including those associated
with customer and payment screening. the group has continued the delivery of a programme of staff training
regarding policies and procedures for detecting and preventing economic sanctions non-compliance.
US Regulation
significant regulatory initiatives from the Us impacting the group include the Dodd-Frank Act (which
imposes specific requirements for systemic risk oversight, securities market conduct and oversight, bank
capital standards, arrangements for the liquidation of failing systemically significant financial institutions and
restrictions to the ability of banks to engage in proprietary trading activities known as the ‘Volcker Rule’). the
Act will have both business and operational implications for the group within and beyond the Us. in addition
the Foreign Account tax Compliance Act requires non-Us financial institutions to enter into disclosure
agreements with the Us treasury and all non-financial non-Us entities to report and or certify their ownership
of Us assets in foreign accounts or be subject to 30 per cent withholding tax.
European Regulation
At a european level, the pace of regulatory reform has increased with a number of new directives or changes
to existing directives planned in the next 12 months including a revised markets in Financial instruments
Directive, transparency Directive, insurance mediation Directive and a Fifth Undertakings in Collective
investments in transferable securities Directive as well as a proposed Directive regulating Packaged Retail
investment Products.
Mitigating Actions
the group takes many mitigating actions with respect to this principal risk, key examples include:
Independent Commission on Banking
We continue to play a constructive role in the debate with the government and other stakeholders on all
issues under consideration in relation to the iCB’s recommendations.
New Regulatory Regime
the group continues to work closely with the regulatory authorities and industry associations to ensure
that it is able to identify and respond to regulatory changes and mitigate against risks to the group and
its stakeholders.
Capital and Liquidity
the group is continuously assessing the impacts of regulatory developments which could have a material
effect on the group and is progressing its plans to implement regulatory changes and directives through
change management programmes.
Anti Bribery
the group has no appetite for bribery and explicitly prohibits the payment, offer, acceptance or request of a
bribe, including ‘facilitation payments’.
the group has enhanced its internal compliance processes including those associated with payment
screening, colleague training and hospitality.
US and European Regulation
the group is continuously assessing the impacts of regulatory developments which could have a material
effect on the group and is progressing its plans to implement regulatory changes and directives through
change management programmes. the group is also continuing to progress its plans to achieve
solvency ii compliance.
For further information on Regulatory risk, see page 167.
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Market Risk
Risk Definition
the risk of reductions in earnings
and/or value, through financial
or reputational loss, from
unfavourable market moves;
including changes in, and
increased volatility of, interest
rates, market-implied inflation
rates, credit spreads, foreign
exchange rates, equity, property
and commodity prices.
Customer treatment
Risk Definition
the risk of regulatory censure
and/or a reduction in earnings/
value, through financial
or reputational loss, from
inappropriate or poor customer
treatment.
Principal Risks
the group has a number of market risks, the principal ones being:
– there is a risk to the group’s banking income arising from the level of interest rates and the margin of
interbank rates over central bank rates. A further banking risk arises from competitive pressures on product
terms in existing loans and deposits, which sometimes restrict the group in its ability to change interest
rates applying to customers in response to changes in interbank and central bank rates.
– equity market movements and changes in credit spreads impact the group’s results.
– the main equity market risks arise in the life assurance companies and staff pension schemes.
– Credit spread risk arises in the life assurance companies, pension schemes and banking businesses.
Continuing concerns about the fiscal position in eurozone countries resulted in increased credit spreads in
the areas affected, and fears of contagion affected the euro and widened spreads between central bank and
interbank rates.
Mitigating Actions
the group takes many mitigating actions with respect to this principal risk, key examples include:
market risk is managed within a Board approved framework using a range of metrics to monitor the group’s
profile against its stated appetite and potential market conditions.
market Risk is reported regularly to appropriate committees.
the group’s trading activity is small relative to our peers and is not considered to be a principal risk. the
average 95 per cent 1-day trading Value at Risk (VaR) was £6 million for the year to 31 December 2011.
For further information on market risk, see page 164.
Principal Risks
Customer treatment and how the group manages its customer relationships affect all aspects of the group’s
operations and are closely aligned with achievement of the group’s strategic vision to be the best bank for
customers. As a provider of a wide range of financial services products across different brands and numerous
distribution channels to an extremely broad and varied customer base, we face significant conduct risks, such
as: products or services not meeting the needs of our customers; sales processes which could result in selling
products to customers which do not meet their needs; failure to deal with a customer’s complaint effectively
where we have got it wrong and not met customer expectations.
there remains a high level of scrutiny regarding the treatment of customers by financial institutions from
regulatory bodies, the press and politicians. the FsA in particular continues to drive focus on conduct of
business activities through its supervision activity.
there is a risk that certain aspects of the group’s business may be determined by regulatory bodies or the
courts as not being conducted in accordance with applicable laws or regulations, or fair and reasonable
treatment in their opinion. the group may also be liable for damages to third parties harmed by the conduct
of its business.
Mitigating Actions
the group takes many mitigating actions with respect to this principal risk, key examples include:
the group’s Conduct Risk strategy and supporting framework have been designed to support our vision and
strategic aim to put the customer at the heart of everything we do. We have developed and implemented
a framework to enable us to deliver the right outcomes for our customers, which is supported by policies
and standards in key areas, including product governance, sales, responsible lending, customers in financial
difficulties, claims and complaints handling.
the group actively engages with regulatory bodies and other stakeholders in developing its understanding
of current customer treatment concerns.
For further information on Customer treatment, see page 167.
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People
Risk Definition
the risk of reductions in earnings
or value through financial or
reputational loss arising from
ineffectively leading colleagues
responsibly and proficiently,
managing people resource,
supporting and developing
colleague talent, or meeting
regulatory obligations related to
our people.
Insurance Risk
Risk Definition
the risk of reductions in earnings
and/or value, through financial
or reputational loss, due to
fluctuations in the timing,
frequency and severity of insured/
underwritten events and to
fluctuations in the timing and
amount of claims settlements.
Principal Risks
the quality and effectiveness of the group’s people are fundamental to its success. Consequently, the
group’s management of material people risks is critical to its capacity to deliver against its long-term
strategic objectives. Over the next year the group’s ability to manage people risks successfully may be
affected by the following key drivers:
– the group’s continuing structural consolidation and the sale of part of our branch network under Project
Verde may result in disruption to our ability to lead and manage our people effectively.
– the continually changing, more rigorous regulatory environment may impact our people strategy,
remuneration practices and retention.
– macroeconomic conditions and negative media attention on the banking sector may impact retention,
colleague sentiment and engagement.
Mitigating Actions
the group takes many mitigating actions with respect to this principal risk, key examples include:
– strong focus on leadership and colleague engagement, through delivery of strategies to attract, retain and
develop high calibre staff together with implementation of rigorous succession planning.
– A continued focus on people risk management across the group.
– ensuring compliance with legal and regulatory requirements related to Approved Persons and the FsA
Remuneration Code, and embedding compliant and appropriate colleague behaviours in line with group
policies, values and people risk priorities.
– strengthening risk management culture and capability across the group, together with further embedding
of risk objectives in the colleague performance and reward process.
For further information on People risk, see page 167.
Principal Risks
the major sources of insurance risk are within the insurance businesses and the group’s defined benefit
staff pension schemes (pension schemes). insurance risk is inherent in the insurance business and can be
affected by customer behaviour. insurance risks accepted relate primarily to mortality, longevity, morbidity,
persistency, expenses, property and unemployment. the primary insurance risk of the group’s pension
schemes is related to longevity.
insurance risk within the insurance businesses has the potential to significantly impact the earnings and
capital position of the insurance Division of the group. For the group’s pension schemes, insurance risk
could significantly increase the cost of pension provision and impact the balance sheet of the group.
Mitigating Actions
the group takes many mitigating actions with respect to this principal risk, key examples include:
insurance risk is reported regularly to appropriate committees and boards.
Actuarial assumptions are reviewed in line with experience and in-depth reviews are conducted regularly.
Longevity assumptions for the group’s pension schemes are reviewed annually together with other iFRs
assumptions. expert judgement is required.
insurance risk is controlled by robust processes including underwriting, pricing-to-risk, claims management,
reinsurance and other risk mitigation techniques.
For further information on insurance risk, see page 169.
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Full analysis of risk drivers
table 1.3: Risk drivers
Primary
risk drivers
Financial
Soundness
Credit
Risk
Market
Risk
Detailed
risk types
Liquidity and funding
Capital
Financial and
prudential regulatory
reporting
Disclosure
Tax
Retail
Wholesale
Commercial
Wealth and
International
Basis risk
Interest rate
Foreign exchange
Equity
Credit spread
Operational
Risk
Regulatory
Customer treatment
People
Supplier management
Customer processes
Financial crime
Money laundering
and sanctions
Security
IT systems
Change
Organisational
Infrastructure
Insurance
Risk
Business
Risk
Mortality
Longevity
Morbidity
Persistency
Property
Expenses
Unemployment
Execution of
strategy
Page 112
Page 129
Page 164
Page 167
Page 169
Page 170
Risk drivers
the group’s risk language is designed to capture the group’s ‘primary risk drivers’. A description of each ‘primary risk driver’, including definition,
appetite, control and exposures, is included below. these are further sub-divided into 33 more granular risk types to enable more detailed review
and facilitate appropriate reporting and monitoring, as set out in table 1.3.
through the group’s risk management processes, these risks are assessed on an ongoing basis and seek to ensure optimisation of risk and reward
and that, where required, appropriate mitigation is in place. Both quantitative and qualitative factors are considered in assessing the group’s
current and potential future risks.
Financial soundness
Financial soundness risk has three key risk components covering liquidity and funding risk; capital risk; and financial and prudential regulatory
reporting, disclosure and tax risk.
Liquidity and funding risk
Definition
Liquidity risk is defined as the risk that the group does not have sufficient financial resources to meet its commitments when they fall due, or can
secure them only at excessive cost. Funding risk is further defined as the risk that the group does not have sufficiently stable and diverse sources
of funding or the funding structure is inefficient.
Risk appetite
Liquidity and funding risk appetite for the banking businesses is set by the Board and reviewed on an annual basis. this statement of the group’s overall
appetite for liquidity risk is reviewed and approved annually by the Board. With the support of the group Asset and Liability Committee, the group Chief
executive allocates this risk appetite across the group. it is reported through various metrics that enable the group to manage liquidity and funding
constraints. the group Chief executive, assisted by the group Asset and Liability Committee regularly reviews performance against risk appetite.
exposure
Liquidity exposure represents the amount of potential outflows in any future period less committed inflows. Liquidity is considered from both an
internal and regulatory perspective.
measurement
A series of measures are used across the group to monitor both short and long-term liquidity including: ratios, cash outflow triggers, wholesale
funding maturity profile, early warning indicators and stress test survival period triggers. the Board approved liquidity risk appetite links a number
of these measures to balance sheet progression set out in the group funding plan, with regular reporting to the group Asset and Liability Committee
and the Board. strict criteria and limits are in place to ensure highly liquid marketable securities are available as part of the portfolio of liquid assets.
Details of contractual maturities for assets and liabilities form an important source of information for the management of liquidity risk. note 56 to
the financial statements on page 337 sets out an analysis of assets and liabilities by relevant maturity grouping. in order to reflect more accurately
the expected behaviour of the group’s assets and liabilities, measurement and modelling of the behavioural aspects of each is constructed. this
forms the foundation of the group’s liquidity controls.
mitigation
the group mitigates the risk of a liquidity mismatch in excess of its risk appetite by managing the liquidity profile of the balance sheet through
both short-term liquidity management and long-term funding strategy. short-term liquidity management is considered from two perspectives;
113
Annual Report and Accounts 2011
Risk mAnAgement
business as usual and liquidity under stressed conditions, both of which relate to funding in the less than one year time horizon. Longer term
funding is used to manage the group’s strategic liquidity profile which is determined by the group’s balance sheet structure. Longer term is
defined as having an original maturity of more than one year.
the group’s funding and liquidity position is underpinned by its significant customer deposit base, and has been supported by stable funding
from the wholesale markets with a reduced dependence on short-term funding. A substantial proportion of the retail deposit base is made up
of customers’ current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of
funding. Additionally, the group accesses the short-term wholesale markets to raise interbank deposits and to issue certificates of deposit and
commercial paper to meet short-term obligations. the group’s short-term money market funding is based on a qualitative analysis of the
market’s capacity for the group’s credit. the group has developed strong relationships with certain wholesale market segments, and also has
access to corporate customers to supplement its retail deposit base.
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. the group holds sizeable balances of high grade marketable debt securities as set out in table 1.4 which can be
sold to provide, or used to secure, additional short term funding should the need arise from either market counterparties or central bank facilities
(european Central Bank, Federal Reserve, Bank of england and Reserve Bank of Australia).
monitoring
Liquidity is actively monitored at business unit and group level. Routine reporting is in place to senior management and through the group’s
committee structure, in particular the group Asset and Liability Committee which meets monthly. in a stress situation the level of monitoring and
reporting is increased commensurate with the nature of the stress event. Liquidity policies and procedures are subject to independent oversight.
Daily monitoring and control processes are in place to address both statutory and prudential liquidity requirements. in addition, the framework
has two other important components:
– Firstly, the group stress tests its potential cash flow mismatch position under various scenarios on an ongoing basis. the cash flow mismatch
position considers on-balance sheet cash flows, commitments received and granted, and material derivative cash flows. specifically,
commitments granted include the pipeline of new business awaiting completion as well as other standby or revolving credit facilities. Behavioural
adjustments are developed, evaluating how the cash flow position might change under each stress scenario to derive a stressed cash flow
position. scenarios cover both Lloyds Banking group name specific and systemic difficulties. the scenarios and the assumptions are reviewed at
least annually to gain assurance they continue to be relevant to the nature of the business.
– secondly, the group has a contingency funding plan embedded within the group Liquidity Policy which has been designed to identify emerging
liquidity concerns at an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing.
the group has invested considerable resource to ensure that it satisfies the governance, reporting and stress testing requirements of the FsA’s
new iLAs liquidity regime. the group has noted the industry move towards strategic balance sheet measures of the funding profile and has
started to monitor and forecast the group’s net stable Funding Ratio (nsFR) and Liquidity Coverage Ratio (LCR). the group is aware that the
regulatory liquidity landscape is subject to potential change. specifically, in relation to the papers issued by the Basel Committee on Banking
supervision (‘strengthening the resilience of the banking sector’ and ‘international framework for liquidity risk measurement, standards and
monitoring’) the group has actively participated in the industry-wide consultation and calibration exercises which took place through 2010.
During the year, the individual entities within the group, and the group, complied with all of the externally imposed liquidity and funding
requirements to which they are subject.
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.
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 ratios at all times.
the key dependencies on successfully funding the group’s balance sheet include the continued functioning of the money and capital markets;
successful right-sizing of the group’s balance sheet; the repayment of the government Credit guarantee scheme facilities in accordance with
the agreed terms; no further deterioration in the group’s credit rating; and no significant or sudden withdrawal of deposits resulting in increased
reliance on money markets. Additionally, the group has entered into a number of eU state aid related obligations to achieve reductions in certain
parts of its balance sheet by the end of 2014. these are assumed within the group’s funding plan. the requirement to meet this deadline may
result in the group having to provide funding to support these asset reductions and/or disposals and may also result in a lower price being
achieved.
the combination of right-sizing the balance sheet and continued development of the retail deposit base has seen the group’s wholesale funding
requirement reduce materially in the past two years. the progress the group has made to date in diversifying its funding sources has further
strengthened its funding base.
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Annual Report and Accounts 2011
Risk mAnAgement
table 1.4: Group funding by type (audited)
Deposits from banks1
Debt securities in issue:1
Certificates of deposit
Commercial paper
medium-term notes2
Covered bonds
securitisation
subordinated liabilities1
total wholesale funding3
Customer deposits
Total Group funding4
2011
£bn
25.4
28.0
18.0
69.8
36.6
37.5
189.9
35.9
251.2
405.9
657.1
2011
%
3.9
4.3
2.7
10.6
5.6
5.7
28.9
5.4
38.2
61.8
100.0
2010
£bn
26.4
42.4
32.5
87.7
32.1
39.0
233.7
37.9
298.0
382.5
680.5
2010
%
3.9
6.2
4.8
12.9
4.7
5.7
34.3
5.6
43.8
56.2
100.0
1
2
3
4
A reconciliation to the group’s balance sheet is provided on page 116.
medium-term notes include £23.5 billion of funding from the Credit guarantee scheme.
the group’s definition of wholesale funding aligns with that used by other international market participants; including interbank deposits, debt securities in issue and subordinated liabilities.
excluding repos and total equity.
total wholesale funding reduced by £47 billion to £251 billion, with the volume with a residual maturity less than one year falling £35 billion to
£113 billion. term wholesale funding for the year totalled £35 billion, in excess of plan, representing £2 billion pre-funding of the requirement for
2012. the group term funding ratio (wholesale funding with a remaining life of over one year as a percentage of total wholesale funding) improved
to 55 per cent (50 per cent at 31 December 2010) due to good progress in new term issuance and a reduction in short term money market funding.
total wholesale funding is analysed by residual maturity as follows:
table 1.5: Wholesale funding by residual maturity (audited)
Less than one year
One to two years
two to five years
more than five years
Total wholesale funding
Less than one year:
Of which secured
Of which unsecured
greater than one year:
Of which secured
Of which unsecured
2011
£bn
113.3
26.0
60.2
51.7
251.2
24.4
88.9
113.3
63.0
74.9
137.9
2011
%
45.1
10.4
23.9
20.6
100.0
21.5
78.5
45.1
45.7
54.3
54.9
2010
£bn
148.6
46.8
52.3
50.3
298.0
38.4
110.2
148.6
55.4
94.0
149.4
2010
%
49.9
15.7
17.6
16.8
100.0
25.8
74.2
49.9
37.1
62.9
50.1
the table below summarises the group’s term issuance during 2011. the challenge of meeting the group’s 2011 issuance plan in a very volatile
market was successfully accomplished by the ability of the group to access a diverse range of markets and currencies, both in unsecured and
secured form.
table 1.6: Analysis of 2011 term issuance (audited)
securitisation
medium-term notes
Covered bonds
Private placements1
Total issuance
1
Private placements include structured bonds and term repurchase agreements (repos).
Sterling
£bn
US Dollar
£bn
Euro Other currencies
£bn
£bn
2.5
0.2
1.2
3.7
7.6
6.1
4.2
–
1.6
11.9
1.9
2.6
2.4
4.8
11.7
0.8
2.8
–
0.5
4.1
Total
£bn
11.3
9.8
3.6
10.6
35.3
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Annual Report and Accounts 2011
Risk mAnAgement
the wholesale funding position includes debt issued under the legacy government Credit guarantee scheme, for which the last maturity will
occur in October 2012.
table 1.7: Analysis of government and central bank facilities (audited)
Credit guarantee scheme
Other
Total government and central bank facilities
2011
£bn
23.5
–
23.5
2010
£bn
45.4
51.2
96.6
the ratio of customer loans to deposits improved to 135 per cent compared with 154 per cent at 31 December 2010. Loans and advances reduced
by £41 billion and customer deposits increased by £23 billion, representing growth of 6 per cent in 2011.
table 1.8: Group funding position (audited)
As at 31 December
Funding requirement
Loans and advances to customers1
Loans and advances to banks2
Debt securities
Available-for-sale financial assets – secondary3
Cash balances4
Funded assets
Other assets5
On balance sheet primary liquidity assets:6
Reverse repurchase agreements
Balances at central banks – primary4
Available-for-sale financial assets – primary
Held to maturity
trading and fair value through profit or loss7
Repurchase agreements
Total Group assets
Less: other liabilities5
Funding requirement
Funded by
Customer deposits7
Wholesale funding
Repurchase agreements
total equity
Total funding
2011
£bn
2010
£bn
Change
%
548.8
10.3
12.5
12.0
4.1
587.7
286.1
873.8
17.3
56.6
25.4
8.1
(3.5)
(7.2)
96.7
970.5
(251.6)
718.9
405.9
251.2
15.2
46.6
718.9
589.5
10.5
25.7
25.7
3.6
655.0
269.6
924.6
7.3
34.5
17.3
7.9
–
–
67.0
991.6
(229.1)
762.5
382.5
298.0
35.1
46.9
762.5
(7)
(2)
(51)
(53)
14
(10)
6
(5)
64
47
3
44
(2)
10
(6)
6
(16)
(57)
(1)
(6)
1
2
3
4
5
6
7
excludes £16.8 billion (31 December 2010: £3.1 billion) of reverse repurchase agreements.
excludes £21.8 billion (31 December 2010: £15.6 billion) of loans and advances to banks within the insurance businesses and £0.5 billion (31 December 2010: £4.2 billion) of reverse
repurchase agreements.
secondary liquidity assets comprise a diversified pool of highly rated unencumbered collateral (including retained issuance).
Cash balances and balances at central banks – primary are combined in the group’s balance sheet.
Other assets and other liabilities primarily include balances in the group’s insurance businesses and the fair value of derivative assets and liabilities.
Primary liquidity assets are FsA eligible liquid assets including Uk gilts, Us treasuries, euro AAA government debt and unencumbered cash balances held at central banks.
excluding repurchase agreements of £8.0 billion (31 December 2010: £11.1 billion).
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Annual Report and Accounts 2011
Risk mAnAgement
encumbered assets
the group remains a consistent issuer in a number of secured funding markets, in particular RmBs and covered bonds (see table 1.6).
the group’s level of encumbrance arising from external issuance of securitisation and covered bonds has remained broadly constant, reflecting
the maturity and stability of the group’s utilisation of this form of term funding, and the established cycle of redemptions and new issuance.
total notes issued externally from secured programmes (ABs and covered bonds) have increased from £71.1 billion at 31 December 2010 to
£74.1 billion, reflecting gross issuance of £14.9 billion in 2011. A total of £118.5 billion (2010: £143.6 billion) of notes issued under securitisation and
covered bond programmes have also been retained internally, the bulk of which are held to provide a pool of collateral eligible for use at central
bank liquidity facilities. A small proportion of the retained collateral has been pledged in bilateral financing transactions.
Other assets pledged as collateral in special purpose entities (for example ABCP conduits) decreased from £17.1 billion at 31 December 2010 to
£8.8 billion, largely as a result of a reduction in the size of the group’s holdings of debt securities. Within the asset-backed conduits, assets are
encumbered as security for short term asset-backed CP investors in the vehicles; such funding forms part of debt securities in issue disclosed in
note 37 on page 266.
table 1.9: Reconciliation of Group funding figure from table 1.4 to the balance sheet (audited)
At 31 December 2011
Deposits from banks
Debt securities in issue
subordinated liabilities
total wholesale funding
Customer deposits
Total
At 31 December 2010
Deposits from banks
Debt securities in issue
subordinated liabilities
total wholesale funding
Customer deposits
total
Included in
funding
analysis
(table 1.4)
£bn
25.4
189.9
35.9
251.2
405.9
657.1
26.4
233.7
37.9
298.0
382.5
680.5
Fair value
and other
accounting
methods
£bn
–
(4.8)
(0.8)
Balance
Sheet
£bn
39.8
185.1
35.1
–
413.9
–
(4.8)
(1.7)
50.4
228.9
36.2
–
393.6
Repos
£bn
14.4
–
–
14.4
8.0
22.4
24.0
–
–
24.0
11.1
35.1
Liquidity management
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.
the group carries out stress testing of its liquidity position against a range of scenarios, including those prescribed by the FsA. the group’s
liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
the group’s stress testing framework considers these factors, including the impact of a range of economic and liquidity stress scenarios over
both short and longer term horizons. internal stress testing results at 31 December 2011 show that the group has liquidity resources representing
more than 130 per cent of modelled outflows from all wholesale funding sources, corporate deposits and rating dependent contracts under
the group’s severe liquidity stress scenario. in 2011, the group has maintained its liquidity levels in excess of the iLg regulatory minimum (FsA’s
individual Liquidity Adequacy standards) at all times. Funding projections show the group will achieve the proposed Basel iii liquidity and funding
requirements in advance of expected implementation dates.
the group’s stress testing shows that further credit rating downgrades may reduce investor appetite for some of the group’s liability classes
and therefore funding capacity. in the fourth quarter of 2011, the group experienced downgrades in its long-term rating of between one and
two notches from three of the major rating agencies. the impact that the group experienced following the downgrades was consistent with the
group’s modelled outcomes based on the stress testing framework. the group has materially reduced its wholesale funding in recent years and
operates a well diversified funding platform which together lessen the impact of stress events.
the group’s borrowing costs and issuance in the capital markets are dependent on a number of factors, and increased cost or reduction of
capacity could materially adversely affect the group’s results of operations, financial condition and prospects. in particular, reduction in the credit
rating of the group or deterioration in the capital markets’ perception of the group’s financial resilience, could significantly increase its borrowing
costs and limit its issuance capacity in the capital markets. As an indicator over the last 12 months the spread between an index of A rated long
term senior unsecured bank debt and an index of similar BBB rated bank debt, both of which are publicly available, has ranged between 60 and
115 basis points. the applicability to and implications for the group’s funding cost would depend on the type of issuance, and prevailing market
conditions. the impact on the group’s funding cost is subject to a number of assumptions and uncertainties and is therefore impossible to
quantify precisely.
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Annual Report and Accounts 2011
Risk mAnAgement
Downgrades of the group’s long term debt rating could lead to additional collateral posting and cash outflow. A hypothetical simultaneous
two notch downgrade of the group’s long-term debt rating from all major rating agencies, after initial actions within management’s control,
could result in an outflow of £11 billion of cash, £4 billion of collateral posting related to customer financial contracts and £24 billion of collateral
posting associated with secured funding. these effects do not take into account additional management and restructuring actions that the
group has identified that could materially reduce the amount of required collateral postings under derivative contracts related to its own secured
funding programmes.
the downgrades that the group experienced in the fourth quarter of 2011, did not significantly change its borrowing costs, reduce its issuance
capacity or require significant collateral posting. the group notes the February 2012 announcements from moody’s placing the ratings of
114 european financial institutions, including Lloyds Banking group, on review for downgrade. even in the case of a simultaneous two notch
downgrade from all rating agencies, the group would remain investment grade.
At 31 December 2011, the group had £202 billion of highly liquid unencumbered assets in its liquidity portfolio which are available to meet cash
and collateral outflows, as illustrated in the table below. this liquidity is available for deployment at immediate notice, subject to complying with
regulatory requirements, and is a key component of the group’s liquidity management process.
table 1.10: Liquidity portfolio (unaudited)
Primary liquidity
secondary liquidity
Total
Primary liquidity
Central bank cash deposits
government bonds
Total
Secondary liquidity
High-quality ABs/covered bonds
Credit institution bonds
Corporate bonds
Own securities (retained issuance)
Other securities
Other1
Total
1
includes other central bank eligible assets.
2011
£bn
94.8
107.4
202.2
Average
2011
£bn
51.4
48.4
99.8
Average
2011
£bn
8.0
3.7
0.6
76.8
9.2
6.4
104.7
2010
£bn
97.5
62.4
159.9
Average
2010
£bn
46.7
41.3
88.0
Average
2010
£bn
16.3
7.2
0.3
27.4
5.9
–
57.1
2011
£bn
56.6
38.2
94.8
2011
£bn
1.4
2.1
0.3
81.6
8.6
13.4
107.4
2010
£bn
34.5
63.0
97.5
2010
£bn
15.3
5.4
0.4
34.1
7.2
–
62.4
Following the introduction of the FsA’s individual Liquidity guidance under iLAs, the group now manages its liquidity position as a coverage ratio
(proportion of stressed outflows covered by primary liquid assets) rather than by reference to a quantum of liquid assets; the liquidity position
reflects a buffer over the regulatory minimum. the group receives no recognition under iLAs for assets held for secondary liquidity purposes.
Primary liquid assets of £94.8 billion represent approximately 133 per cent (95 per cent at 31 December 2010) of our money market funding
positions and are approximately 84 per cent (66 per cent at 31 December 2010) of all wholesale funding with a maturity of less than a year, and thus
provides substantial buffer in the event of continued market dislocation.
in addition to primary liquidity holdings the group has significant secondary liquidity holdings providing access to open market operations at a
number of central banks which the group routinely makes use of as part of its normal liquidity management practices. Future use of such facilities
will be based on prudent liquidity management and economic considerations, having regard for external market conditions.
the group notes the Basel Committee’s Principles of sound Liquidity Risk management and supervision (sound Principles). the planned
introduction of the Liquidity Coverage Ratio (LCR - January 2015) and net stable Funding Ratio (nsFR - January 2018) contained within CRD
iV are intended to raise the resilience of banks to potential liquidity shocks and provide the basis for a harmonised approach to liquidity risk
management. the LCR measure promotes short term resilience of the liquidity profile by ensuring that banks have sufficient high quality liquid
assets to meet potential funding outflows in a stressed environment within a one month period. the nsFR promotes resilience over a longer time
horizon by requiring banks to fund their activities with a more stable source of funding on a going concern basis. this has a time horizon of one
year and has been developed to ensure a sustainable maturity structure of assets and liabilities.
the guidance issued by the Basel Committee is still subject to final ratification by the eU and the methodology is likely to be refined on the basis
of feedback from banks and regulators during the observation period. the actions already announced to right size the balance sheet are expected
to ensure compliance with the future minimum standards. these standards are expected to be 100 per cent for both ratios by their respective
effective dates.
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Annual Report and Accounts 2011
Risk mAnAgement
Hybrid capital securities coupon payments
since 31 January 2010, the group has been prohibited under the terms of an agreement with the european Commission, from paying discretionary
coupons and dividends on certain of its hybrid capital securities. this prohibition ended on 31 January 2012. We recommenced payments on
certain hybrid capital securities from 31 January 2012. Future coupons and dividends on these hybrid capital securities will only be paid subject to,
and in accordance with, the terms of the relevant securities.
the payments on those of the hybrid capital securities that are not cash-cumulative and which are expected, subject to their terms and conditions,
to be paid in 2012 are estimated to amount to approximately £170 million. in the context of recent macro prudential policy discussions, the Board
of Lloyds Banking group has decided to issue new Lloyds Banking group ordinary shares to raise this amount. the group has entered into an
agreement with a third-party financial institution in connection with the issue of these new ordinary shares. such ordinary shares are expected to
be issued, subject to market conditions, by the end of April 2012 at a price determined by reference to the volume weighted average price of our
ordinary shares in a period prior to their date of issue.
Capital risk
Definition
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.
Risk appetite
Capital risk appetite is set by the Board and reported through various metrics that enable the group to manage capital constraints and market
expectations. the group Chief executive, assisted by the group Asset and Liability Committee, regularly reviews performance against risk
appetite. A key metric is the group’s core tier 1 capital ratio which the group currently aims to maintain prudently in excess of 10 per cent. this
and other aspects of appetite will be kept under review in the light of further clarity of regulatory and accounting reforms.
exposure
A capital exposure arises where the group has insufficient regulatory capital resources to support its strategic objectives and plans, and to meet
external stakeholder requirements and expectations. the group’s capital management approach is focused on maintaining sufficient capital
resources to prevent such exposures whilst optimising value for shareholders.
measurement
the group’s regulatory capital is divided into tiers depending on level of subordination and ability to absorb losses. Core tier 1 capital as defined in
the FsA letter to the British Bankers’ Association in may 2009, comprises mainly shareholders’ equity and non-controlling interests, after deducting
goodwill, other intangible assets and 50 per cent of the net excess of expected loss over accounting provisions and certain securitisation positions.
Accounting equity is adjusted in accordance with FsA requirements, particularly in respect of pensions and Available-for-sale assets. tier 1 capital,
as defined by the european Community Banking Consolidation Directive as implemented in the Uk by the FsA’s general Prudential sourcebook
(genPRU), is core tier 1 capital plus tier 1 capital securities less 50 per cent of material holdings in financial companies. tier 2 capital, defined by
genPRU, comprises qualifying subordinated debt and some additional provisions and reserves after deducting 50 per cent of the excess of
expected loss over accounting provisions, and certain securitisation positions and material holdings in financial companies. total capital is the sum
of tier 1 and tier 2 capital after deducting investments in subsidiaries and associates that are not consolidated for regulatory purposes. in the case of
Lloyds Banking group, this means that the net assets of its life assurance and general insurance businesses and the non-financial entities that are held
by our private equity (including venture capital) businesses, are excluded from its total regulatory capital.
A number of limits are imposed by the FsA on the proportion of the regulatory capital base that can be made up of subordinated debt and
preferred securities; for example the amount of qualifying tier 2 capital cannot exceed that of tier 1 capital.
the minimum total capital required under pillar 1 of the Basel ii framework is the Capital Resources Requirement (CRR) calculated as 8 per cent
of risk weighted assets. in addition to the minimum requirements for total capital, the FsA has made statements to explain it also operates a
framework of targets and expected buffers for core tier 1 and tier 1 capital.
in order to address the requirements of pillar 2 of the Basel ii framework, the FsA currently sets additional minimum requirements through the
issuance of individual Capital guidance (iCg) for each Uk bank calibrated by reference to the CRR. A key input into the FsA’s iCg setting process
is each bank’s internal Capital Adequacy Assessment Process. the group has been given an iCg by the FsA. the FsA has made it clear, however,
that iCg remains a confidential matter between each bank and the FsA.
the group maintains its own buffer to ensure that the regulatory minimum requirements and regulatory targets and buffers are met at all times.
Additionally an extensive series of stress analyses is undertaken during the year to determine the adequacy of the group’s capital resources
against the FsA minimum requirements in severe economic conditions.
During the course of 2011 the eBA undertook two european wide exercises to assess the capital strength of the larger banks within the sector.
the first of these, in July 2011, sought to assess the resilience of european banks to severe shocks and their specific solvency in hypothetical stress
events under certain restrictive conditions. the stress test was carried out based on common methodology and key common assumptions. the
assumptions and methodology were established to assess banks’ capital adequacy against a 5 per cent core tier 1 capital benchmark. As a result
of the assumed shock the estimated consolidated core tier 1 ratio of the group was 7.7 per cent at the worst point of the stress in 2012.
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the second exercise, in December 2011, required banks to strengthen their capital position by building up temporary capital buffers against
sovereign debt exposures to reflect market prices. in addition, it required banks to establish a buffer such that the core tier 1 ratio reaches a
minimum level of 9 per cent by the end of June 2012. the group’s consolidated core tier 1 ratio from this exercise was 10.1 per cent.
During the course of the year there have been a number of significant regulatory reform developments:
– ‘CRD iii’ came into force on 31 December 2011 resulting in increased risk weighted assets for market and credit risk.
– the european Commission published a draft of the new Capital Requirements Directive and Regulation (CRD iV) which will implement within the
eU the so called ‘Basel iii’ reforms for an enhanced global capital accord developed by the Basel Committee on Banking supervision.
– Lloyds Banking group was one of 29 banks identified by the Financial stability Board as being of global systemic importance (g-siFis) and which
will be subject to stronger capital adequacy requirements than Basel iii. the list of g-siFis will be reviewed annually from a pool of around initially
70 institutions.
– in December the government announced that it would implement the key recommendations of the Uk’s independent Commission on
Banking covering the ring-fencing of certain banking activities, ‘bail-in’ of senior unsecured debt, higher loss absorption capability and
depositor preference.
– the group is aware that there is currently a review of the endorsed ratings that may be used in internal Ratings Based (iRB) models and the
group is working on the assumption that no material changes to our modelling approaches will result from the review.
many of the details of the way these reforms will be integrated within the Uk are still to be finalised. in the meantime the group continues to
monitor their development very closely and to analyse their potential impact whilst ensuring that the group continues to have a strong loss
absorption capacity exceeding regulatory requirements as currently formulated.
the impact of the reforms will gradually phase in as they are subject to a long transition period through to 2022. that allows time for the group
to further strengthen its capital position as necessary through business performance and mitigating actions.
mitigation
the group has developed procedures to ensure that compliance with both current and potential future requirements are understood and that
policies are aligned to its risk appetite.
the group is able to accumulate additional capital through profit retention, by raising equity via, for example, a rights issue or debt exchange
and by raising tier 1 and tier 2 capital by issuing subordinated liabilities. the cost and availability of additional capital is dependent upon market
conditions and perceptions at the time.
the group has in issue, as part of tier 2 capital resources, enhanced Capital notes which will convert to core tier 1 capital in the event that group’s
published core tier 1 ratio (as defined by the FsA in may 2009) falls below 5 per cent.
Additional measures which have been used to manage the group’s capital position include seeking to strike an appropriate balance of capital held
within its insurance and banking subsidiaries and through improving the quality of its capital through liability management exercises. Regulatory
requirements are primarily controlled through the quality and volume of lending but are also affected through the modelling approaches used to
determine risk weighted assets and expected losses.
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.
monitoring
Capital is actively managed and regulatory ratios are a key factor in the group’s budgeting and planning processes. Capital raised takes account of
expected growth and currency of risk assets. Capital policies and procedures are subject to independent oversight. Regular reporting of actual and
projected ratios, including those that would occur under stressed scenarios, is made to the senior Asset and Liability Committee, the group Asset
and Liability Committee, the group Risk Committee and the Board.
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table 1.11: Capital resources (audited)
Core tier 1
shareholders’ equity per balance sheet
non-controlling interests per balance sheet
Regulatory adjustments to non-controlling interests
Regulatory adjustments:
Adjustment for own credit
Defined benefit pension adjustment
Unrealised reserve on AFs debt securities
Unrealised reserve on AFs equity
Cash flow hedging reserve
Prudent valuation adjustments
Other items
Less: deductions from core tier 1
goodwill
intangible assets
50% excess of expected losses over impairment
50% of securitisation positions
Core tier 1 capital
non-controlling preference shares1
Preferred securities1
Less: deductions from tier 1
50% of material holdings
Total tier 1 capital
Tier 2
Undated subordinated debt
Dated subordinated debt
Less: restriction in amount eligible
Unrealised gains on available for sale equity
eligible provisions
Less: deductions from tier 2
50% excess of expected losses over impairment
50% of securitisation positions
50% of material holdings
Total tier 2 capital
Supervisory deductions
Unconsolidated investments – life
Unconsolidated investments – general insurance and other
Total supervisory deductions
Total capital resources
1
Covered by grandfathering provisions issued by FsA.
table 1.12: Risk Weighted Assets and Capital Ratio’s (unaudited)
Risk-weighted assets
Ratios
Core tier 1 ratio
tier 1 capital ratio
total capital ratio
2011
£m
2010
£m
45,920
46,061
674
(577)
(136)
(1,004)
(940)
(386)
(325)
(32)
(4)
841
(524)
(8)
(1,052)
747
(462)
391
–
(3)
43,190
45,991
(2,016)
(2,310)
(720)
(153)
37,991
1,613
4,487
(94)
43,997
1,859
21,229
–
386
1,259
(720)
(153)
(94)
(2,016)
(2,390)
–
(214)
41,371
1,507
4,338
(69)
47,147
1,968
23,167
–
462
2,468
–
(214)
(69)
23,766
27,782
(10,107)
(2,660)
(12,767)
54,996
(10,042)
(3,070)
(13,112)
61,817
2011
£m
2010
£m
352,341
406,372
10.8%
12.5%
15.6%
10.2%
11.6%
15.2%
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table 1.13: Analysis of risk-weighted assets (unaudited)
Divisional analysis of risk-weighted assets
Retail
Wholesale
Commercial
Wealth and international
group Operations and Central items
Risk type analysis of risk-weighted assets
Foundation iRB
Retail iRB
Other iRB
Advanced Approach
standardised Approach
Credit risk
Operational risk
market and counterparty risk
Total risk-weighted assets
2011
£m
2010
£m
103,237
163,766
25,434
47,278
12,626
109,254
196,164
26,552
58,714
15,688
352,341
406,372
90,450
98,823
9,433
198,706
103,525
302,231
30,589
19,521
352,341
114,490
105,475
14,483
234,448
124,492
358,940
31,650
15,782
406,372
Risk-weighted assets reduced by £54,031 million to £352,341 million, a decrease of 13 per cent. this reflects risk weighted asset reductions across
all banking divisions driven by balance sheet reductions of non-core assets, lower core lending balances and stronger management of risk.
Retail risk weighted assets reduced by £6,017 million mainly due to lower lending balances and the reducing mix of unsecured lending.
the reduction of Wholesale risk weighted assets of £32,398 million primarily reflects the balance sheet reductions including treasury asset sales
and the run down in other non-core asset portfolios. this has been partly offset by an increase in market risk weighted assets, as a result of the
implementation of CRD iii.
Risk weighted assets within Wealth and international have reduced by £11,436 million as a result of asset run-off and write off and foreign exchange
movements.
integration of model activity previously undertaken on a separate heritage basis was largely completed in 2010 and there have been no significant
migrations to iRB methodologies during 2011. in common with other banking groups operating on an iRB basis we anticipate moving some
activity that is currently measured on the standardised approach over to an iRB methodology. these changes will take place primarily during 2012
and 2013.
tier 1 capital
Core tier 1 capital has decreased by £3,380 million largely reflecting losses in the period. in addition there has been an increase in excess of
expected losses over impairment losses, reflecting the reduction of legacy lending that is subject to very high provision levels and replacement
with new lending.
tier 2 capital
tier 2 capital has decreased in the period by £4,016 million reflecting the increase in excess of expected losses over impairment, as noted above,
and a reduction in eligible provisions. in addition, dated subordinated debt has also reduced in the period, partly due to amortisation and partly
due to a capital restructuring exercise in December 2011, which resulted in a net overall redemption of dated subordinated debt.
supervisory deductions
supervisory deductions mainly consist of investments in subsidiary undertakings that are not within the banking group for regulatory purposes.
these investments are primarily the scottish Widows and Clerical medical life and pensions businesses together with general insurance business.
Also included within deductions for other unconsolidated investments are investments in non-financial entities that are held by the group’s private
equity (including venture capital) businesses. During the period there has been a decrease in supervisory deductions primarily due to reduced
holdings in private equity businesses, and in some cases changes to the level and/or nature of investments resulting in a reclassification as
material holdings.
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Risk mAnAgement
the movements in core tier 1 and total capital in the period are shown below:
table 1.14: Movements in core tier 1 and total capital during the year (audited)
At 1 January 2011
Loss attributable to ordinary shareholders
Decrease in regulatory post-retirement benefit adjustments
Decrease in goodwill and intangible assets deductions
increase in excess of expected losses over impairment allowances
increase in material holdings deduction
Decrease in eligible provisions
Decrease in supervisory deductions from total capital
Decrease in dated subordinated debt
Other movements
At 31 December 2011
table 1.15: Analysis of capital ratios (unaudited)
tier 1
tier 2
supervisory deductions
Total capital
RWAs
Ratios
Core tier 1
tier 1
total capital
Core tier 1
£m
41,371
(2,787)
48
80
(720)
–
–
–
–
(1)
Total
£m
61,817
(2,787)
48
80
(1,440)
(50)
(1,209)
345
(1,938)
130
37,991
54,996
Lloyds TSB Bank Group
Bank of Scotland Group
2011
£m
50,220
25,214
(23,159)
52,275
2010
£m
49,375
21,073
(13,112)
57,336
2011
£m
17,432
13,148
(983)
29,597
2010
£m
21,470
15,002
(1,672)
34,800
352,341
406,372
199,249
250,598
12.2%
14.3%
14.8%
10.5%
12.2%
14.1%
8.4%
8.7%
14.9%
8.3%
8.6%
13.9%
Capital ratios for Lloyds tsB Bank group reflect a restructuring of internal capital undertaken in the period, which has significantly strengthened
the core tier 1 and tier 1 positions. Capital ratios in both entities have benefited from a reduction in risk-weighted assets in the period.
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Risk mAnAgement
Life insurance businesses
the business transacted by the life insurance companies within the group comprises unit-linked business, non profit business and with-profits
business. several companies transact either unit-linked and/or non-profit business, but scottish Widows plc (scottish Widows) and Clerical medical
investment group Limited (Clerical medical) hold the only large With Profit Funds managed by the group.
Basis of determining regulatory capital of the life insurance businesses
Available capital resources
Available capital resources represent the excess of assets over liabilities calculated in accordance with detailed regulatory rules issued by the FsA.
Statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain
cases, the value attributed to assets is limited) and which follows a market value approach where possible. if the market is not active, the group
establishes a fair value by using valuation techniques. Liabilities are calculated using a projection of future cash flows after making prudent
assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference
to the risk adjusted yields on the underlying assets in accordance with the FsA rules. Other assumptions are based on recent actual experience,
supplemented by industry information where appropriate. the assessment of liabilities does not include future bonuses for with-profits policies
that are at the discretion of management, but does include a value for policyholder options likely to be exercised.
Regulatory capital requirements
each life insurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FsA; the basis of
calculating the regulatory capital requirement is given below. except for scottish Widows and Clerical medical, the regulatory capital requirement
is a combination of amounts held in respect of actuarial reserves, sums at risk and maintenance expenses (the Long-term insurance Capital
Requirement) and amounts required to cover various stress tests (the Resilience Capital Requirement). the regulatory capital requirement is
deducted from the available capital resources to give ‘statutory excess capital’.
For scottish Widows and Clerical medical, no Resilience Capital Requirement is required. However, a further test is required in respect of the
With Profit Funds. this involves comparing the statutory basis of assessment with a realistic basis of assessment as described below.
‘Realistic’ basis. the FsA requires each life insurance company which contains a With Profit Fund in excess of £500 million to also carry out a
‘realistic’ valuation of that fund. the group has two such funds; one within scottish Widows and one within Clerical medical. the word ‘realistic’
in this context reflects the fact that assumptions are best-estimate as opposed to prudent. this realistic valuation is an assessment of the financial
position of a With Profit Fund calculated under a methodology prescribed by the FsA.
the valuation of with-profits assets in a With Profit Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-
profits business written in a With Profit Fund, it includes the present value of the anticipated future release of the prudent margins for adverse
deviation. in addition, the realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above.
the realistic valuation of liabilities includes an allowance for future bonuses. Options and guarantees are valued using a stochastic simulation
model which values these liabilities on a basis consistent with tradable market option contracts (a ‘market-consistent’ basis). the model takes
account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options
by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given in the section entitled ‘Options and
guarantees’ on page 127.
the ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the With Profit Fund with a further
deduction to cover various stress tests (the Risk Capital margin). in circumstances where the ‘realistic excess capital’ position is less than the
‘statutory excess capital’, the company is required to hold additional capital to cover the shortfall. Any additional capital requirement under this
test is referred to as the With Profit insurance Capital Component.
the determination of realistic liabilities of the With Profit Funds includes the value of internal transfers expected to be made from each With Profit
Fund to the non Profit Fund held within the same life insurance entity. these internal transfers may include charges on policies where the
associated costs are borne by the non Profit Fund. the With Profit insurance Capital Component may be reduced by the value, calculated in
the stress test scenario, of these internal transfers, but only to the extent that credit has not been taken for the value of these charges in deriving
actuarial reserves for the relevant non Profit Fund.
Capital statement
the following table provides more detail regarding the capital resources available to meet regulatory capital requirements in the life insurance
businesses. the figures quoted are based on management’s current expectations pending completion of the annual financial returns to the
FsA. the figures allow for an anticipated transfer of £85 million from the non Profit Fund of scottish Widows Annuities Ltd to its shareholder fund.
During 2011, as part of a project to rationalise the group structure Clerical medical was purchased by scottish Widows for £1,846 million. scottish
Widows recovered £1,485 million of this amount as a result of capital transactions with its holding company.
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Risk mAnAgement
table 1.16: Capital resources (unaudited)
At 31 December 2011
(statutory basis)
shareholders’ funds:
Held outside the long-term funds
Held within the long-term funds
total shareholders’ funds
Adjustments onto a regulatory basis:
Unallocated surplus within insurance business
Value of in-force business
Other differences between iFRs and
regulatory valuation of assets and liabilities
estimated share of ‘realistic’ liabilities
consistent with the FsA reporting treatment
Qualifying loan capital
support arrangement assets
Available capital resources
At 31 December 2010
(statutory basis)
shareholders’ funds:
Held outside the long-term funds
Held within the long-term funds
total shareholders’ funds
Adjustments onto a regulatory basis:
Unallocated surplus within insurance business
Value of in-force business
Other differences between iFRs and
regulatory valuation of assets and liabilities
estimated share of ‘realistic’ liabilities
consistent with the FsA reporting treatment
Qualifying loan capital
support arrangement assets
Available capital resources
Scottish Widows
With Profit Fund
£m
Clerical Medical
With Profit Fund
£m
UK Non Profit
Fund
£m
UK Life
Shareholder
Fund
£m
Overseas
Life Business
£m
Total
Life Business
£m
–
–
–
242
–
–
(341)
–
184
85
–
–
–
322
–
–
(409)
–
344
257
–
–
–
58
–
–
(58)
–
–
–
–
–
–
321
–
–
(58)
–
–
263
–
6,592
6,592
–
(5,491)
1,843
–
1,843
–
–
107
(163)
–
–
(184)
1,024
–
8,029
8,029
–
(6,172)
–
1,997
–
3,677
1,414
–
1,414
–
–
625
(919)
–
–
(344)
2,138
–
1,991
–
2,486
632
312
944
2,475
6,904
9,379
–
(818)
124
–
–
–
250
300
(6,309)
68
(399)
1,997
–
5,036
721
401
1,122
2,135
8,430
10,565
–
(843)
111
–
–
–
390
643
(7,015)
(183)
(467)
1,991
–
5,534
Available capital resources for With Profit Funds are presented in the table on a ‘realistic’ basis as this is more onerous than on a regulatory basis.
Formal intra-group capital arrangements
scottish Widows has a formal arrangement with one of its subsidiary undertakings, scottish Widows Unit Funds Limited, whereby the subsidiary
company can draw down capital from scottish Widows to finance new business which is reinsured from the parent to its subsidiary. scottish
Widows has also provided subordinated loans to its fellow group undertaking scottish Widows Bank plc. no such arrangement exists for
Clerical medical.
Constraints over available capital resources
Scottish Widows
scottish Widows was created following the demutualisation of scottish Widows Fund and Life Assurance society in 2000. the terms of the
demutualisation are governed by a Court-approved scheme of transfer (the ‘scheme’) which, inter alia, created a With Profit Fund and a
non-Participating Fund and established protected capital support for the with-profits policyholders in existence at the date of demutualisation. much
of that capital support is held in the non-Participating Fund and, as such, the capital held in that fund is subject to the constraints noted below.
Requirement to maintain a Support Account: the scheme requires the maintenance of a ‘support Account’ within the non-Participating
Fund. the quantum of the support Account is calculated with reference to the value of assets backing current with-profits policies which also
existed at the date of demutualisation. Under the scheme assets can only be transferred from the non-Participating Fund if the value of the
remaining assets in the fund exceeds the value of the support Account. scottish Widows has obtained from the FsA permission to include the
value of the support Account or, if greater, the excess of realistic liabilities for business written before demutualisation over the relevant assets
(subject to the non-Participating Fund being able to cover this amount by its surplus admissible assets) in assessing the realistic value of assets
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Annual Report and Accounts 2011
Risk mAnAgement
available to the With Profit Fund. At 31 December 2011, the estimated value of surplus admissible assets in the non-Participating Fund was
£1,198 million (31 December 2010: £1,693 million) and the estimated value of the support Account was zero (31 December 2010: £197 million).
However, at 31 December 2011, the excess of realistic liabilities with-profits business written down before demutualisation over the relevant assets
was £67 million (31 December 2010: £55 million) which, in accordance with the FsA’s permission, has been used to assess the estimated value of
realistic assets available to the With Profit Fund (and has therefore reduced the value of the non-Participating Fund’s surplus admissible assets by
that amount).
Further Support Account: the Further support Account is an extra tier of capital support for the with-profits policies in existence at the date of
demutualisation. the scheme requires that assets can only be transferred from the non-Participating Fund if the economic value of the remaining
assets in the fund exceeds the aggregate of the support Account and Further support Account. Unlike the support Account test, the economic
value used for this test includes both admissible assets and the present value of future profits of business written in the non-Participating Fund or
by any subsidiaries of that fund. the balance of the Further support Account is expected to reduce to nil by the year 2030. At 31 December 2011,
the estimated net economic value of the non-Participating Fund and its subsidiaries for the purposes of this test was £5,494 million
(31 December 2010: £4,322 million) and the estimated combined value of the support Account and Further support Account was £2,291 million
(31 December 2010: £2,446 million).
Other restrictions in the Non-Participating Fund: in addition to the policies which existed at the date of demutualisation, the With Profit Fund
includes policies which have been written since that date. As a result of statements made to policyholders that investment policy will usually be
the same for both types of business, there is an implicit requirement to hold additional regulatory assets in respect of the business written after
demutualisation. the estimated amount required to provide such support at 31 December 2011 is £117 million (31 December 2010: £147 million).
scottish Widows has obtained from the FsA permission to include the value of this support in assessing the realistic value of assets available to the
With Profit Fund. there is a further test requiring that no amounts can be transferred from the non-Participating Fund of scottish Widows unless
there are sufficient assets within the Long-term Fund to meet both policyholders’ reasonable expectations in light of liabilities in force at a year
end and the new business expected to be written over the following year.
Clerical Medical
the surplus held in the Clerical medical With Profit Fund can only be applied to meet the requirements of the fund itself or distributed according
to the prescribed rules of the fund. shareholders are entitled to an amount not exceeding one ninth of the amount distributed to policyholders
in the form of bonuses on traditional with-profits business. the use of capital within the fund is also subject to the terms of the scheme of
demutualisation effected in 1996 and the conditions contained in the Principles and Practices of Financial management of the fund. Capital within
the Clerical medical non Profit Fund is available to meet the With Profit Fund requirements.
Other life insurance businesses
except as described above capital held in Uk non Profit Funds is potentially transferable to other parts of the group, subject to meeting the
regulatory requirements of these businesses. there are no prior arrangements in place to allow capital to move freely between life insurance
entities or other parts of the group.
Overseas life business includes several life companies outside the Uk, including germany and ireland. in all cases the available capital resources
are subject to local regulatory requirements, and transfer to other parts of the group is subject to additional complexity surrounding the transfer
of capital from one country to another.
Movements in regulatory capital
the movements in the group’s available capital resources in the life business can be analysed as follows:
table 1.17: Movements in available capital resources (unaudited)
At 31 December 2010
257
263
2,138
2,486
390
5,534
Scottish Widows
With Profit Fund
£m
Clerical Medical
With Profit Fund
£m
UK Non Profit
Fund
£m
UK Life
Shareholder
Fund
£m
Overseas
Life Business
£m
Total
Life Business
£m
Changes in estimations and in demographic
assumptions used to measure life assurance
liabilities
Dividends and capital transactions
Change in support arrangements
new business and other factors
At 31 December 2011
(24)
–
(160)
12
85
41
–
–
(304)
–
289
(1,483)
160
(80)
1,024
91
1,057
–
43
3,677
(6)
(156)
–
22
250
391
(582)
–
(307)
5,036
With Profits Funds
Available capital in the scottish Widows With Profit Fund has decreased from £257 million at 31 December 2010 to an estimated £85 million at
31 December 2011. this is largely as a result of a reduction in the support arrangements from the non Profit Fund. Available capital in the Clerical
medical With Profit Fund has decreased from £263 million at 31 December 2010 to an estimated zero at 31 December 2011. the fund is in the
process of distributing the free estate. Ultimately all surplus will be distributed to policyholders hence the available capital at 31 December 2011
is zero.
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Annual Report and Accounts 2011
Risk mAnAgement
Uk non Profit Funds
Available capital in the Uk non Profit Funds has decreased from £2,138 million at 31 December 2010 to an estimated £1,024 million at
31 December 2011. the main cause of the decrease was the impact of capital transactions supporting the purchase of Clerical medical by
scottish Widows in July 2011. this was partially offset by increases in available capital from changes in assumptions. it should be noted that the
decrease in the non Profit Fund from the purchase of Clerical medical is largely compensated for by an increase in the available capital in the
shareholder Funds.
Uk Life shareholder Funds
Available capital in the Uk Life shareholder Funds has increased from £2,486 million at 31 December 2010 to an estimated £3,677 million at
31 December 2011. the main cause of the increase was the impact of capital transactions supporting the purchase of Clerical medical by scottish
Widows.
Overseas life business
Available capital has decreased during 2011 due to a significant dividend payment which was only partially offset by profits emerging on new and
in force business.
Analysis of policyholder liabilities reported in the balance sheet in respect of the group’s life insurance business is as follows. With Profit Fund
liabilities are valued in accordance with FRs 27.
table 1.18: Analysis of policyholder liabilities (unaudited)
At 31 December 2011
With Profit Fund liabilities
Unit-linked business (excluding that accounted for as
non-participating investment contracts)
Other life insurance business
insurance and participating investment contract liabilities
non-participating investment contract liabilities
Total policyholder liabilities
At 31 December 2010
With Profit Fund liabilities
Scottish Widows
With Profit Fund
£m
Clerical Medical
With Profit Fund
£m
UK Non Profit
Funds
£m
Overseas
Life Business
£m
Total
Life Business
£m
13,651
9,300
4
–
22,955
–
–
13,651
–
13,651
–
–
9,300
–
9,300
38,474
8,745
47,223
45,469
92,692
7,801
55
7,856
4,167
46,275
8,800
78,030
49,636
12,023
127,666
13,845
10,394
5
–
24,244
Unit-linked business (excluding that accounted for as
non-participating investment contracts)
Other life insurance business
–
–
–
–
insurance and participating investment contract liabilities
13,845
10,394
non-participating investment contract liabilities
total policyholder liabilities
–
–
13,845
10,394
38,641
8,527
47,173
47,058
94,231
8,011
90
8,101
4,304
12,405
46,652
8,617
79,513
51,362
130,875
Capital sensitivities
shareholders’ funds
shareholders’ funds outside the long-term business fund, other than those used to match regulatory requirements, are mainly invested in assets
that are less sensitive to market conditions.
With Profit Funds
the with-profit realistic liabilities and the available capital for the With Profit Funds are sensitive to both market conditions and changes to
a number of non-economic assumptions that affect the valuation of the liabilities of the fund. the available capital resources (and capital
requirements) are sensitive to the level of the stock market, with the position worsening at low stock market levels as a result of the guarantees to
policyholders increasing in value. However, the exposure to guaranteed annuity options increases under rising stock market levels. An increase
in the level of equity volatility implied by the market cost of equity put options also increases the market consistent value of the options given to
policyholders and worsens the capital position. Various hedging strategies are used to manage these exposures.
the most critical non-economic assumptions are the level of take-up of options inherent in the contracts (higher take-up rates are more onerous),
mortality rates (lower mortality rates are generally more onerous) and lapses prior to dates at which a guarantee would apply (lower lapse rates
are generally more onerous where guarantees are in the money). the sensitivity of the capital position and capital requirements of the With Profit
Funds is partly mitigated by the actions that can be taken by management.
Other long-term funds
Outside the With Profit Funds, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets
and liabilities are broadly matched. the most critical non-economic assumptions are mortality rates in respect of annuity business written (lower
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mortality rates are more onerous). Reinsurance arrangements are in place to reduce the group’s exposure to deteriorating mortality rates in
respect of life insurance contracts. in addition, poor cost control would gradually reduce the available capital and lead to an increase in the
valuation of the liabilities (through an increased allowance for future costs).
Assets held in excess of those backing reserves are invested predominantly in cash and cash like instruments. the investment strategy is
determined in line with the policy of Lloyds Banking group to minimise both the profit volatility and the working capital (defined as available
capital less minimum required capital) required to ensure all capital requirements continue to be met under a range of stress tests.
Options and guarantees
the group has sold insurance products that contain options and guarantees, both within the With Profit Funds and in other funds.
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.
For those policies written in scottish Widows pre-demutualisation containing potentially valuable options and guarantees, under the terms of
the scheme a separate memorandum account was set up within the With Profit Fund of scottish Widows called the Additional Account which
is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. the Additional Account had
a value at 31 December 2011 of £2.0 billion (2010: £1.8 billion). the eventual cost of providing benefits on policies written both pre and post
demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as
mortality, and the proportion of policyholders who seek to exercise their options. the ultimate cost will therefore not be known for many years.
As noted above, under the realistic capital regime of the FsA, the liabilities of both the Clerical medical and scottish Widows With Profit Funds
are valued using a market-consistent stochastic simulation model. this model is used in order to place a value on the options and guarantees
which captures both their intrinsic value and their time value.
the most significant economic assumptions included in the model are:
– Risk-free yield. the risk-free yield is defined as spot yields derived from the Uk gilt yield curve.
– investment volatility. the calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical
observed volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2011, the 10 year equity-implied
at-the-money assumption was set at 27.2 per cent (31 December 2010: 26.1 per cent). the assumption for property volatility was 15 per cent
(31 December 2010: 15 per cent). the volatility of interest rates has been calibrated to the implied volatility of swaptions which was broadly
19 per cent (31 December 2010: 15 per cent).
the model includes a matrix of the correlations between each of the underlying modelled asset types. the correlations used are consistent
with long-term historical returns. the most significant non-economic assumptions included in the model are management actions (in respect of
investment policy and bonus rates), guaranteed annuity option take-up rates and assumptions regarding persistency (both of which are based on
recent actual experience and include an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase
liabilities), and assumptions regarding mortality (which are based on recent actual experience and industry tables).
Options and guarantees outside the With Profit Funds
A number of typical guarantees are provided outside the With Profit Funds such as guaranteed payments on death (e.g. term assurance) or
guaranteed income for life (e.g. annuities). in addition, certain personal pension policyholders in scottish Widows, for whom reinstatement to their
occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the
benefits of the relevant occupational pension scheme. the key assumptions affecting the ultimate value of the guarantee are future salary growth,
gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. there is currently a provision,
calculated on a deterministic basis, of £61 million (31 December 2010: £57 million) in respect of those guarantees. if future salary growth were
0.5 per cent per annum greater than assumed, the liability would increase by some £2 million. if yields were 0.5 per cent lower than assumed, the
liability would increase by some £9 million.
Financial and prudential regulatory reporting, disclosure and tax risk
Definition
the risk of reputational damage, loss of investor confidence and/or financial loss arising from the adoption of inappropriate accounting policies,
ineffective controls over financial, prudential regulatory and tax reporting, failure to manage the associated risks of changes in taxation rates, law,
ownership or corporate structure and the failure to disclose accurate information about the group on a timely basis.
Risk appetite
the risk appetite is set by the Board and reviewed on an annual basis or more frequently. it includes complying with statutory and regulatory
reporting requirements and avoiding the need for restatement of publicly disclosed information.
exposure
exposure represents the sufficiency of the group’s policies and procedures to maintain adequate systems, processes and controls to support
statutory, prudential regulatory and tax reporting, to prevent and detect financial reporting fraud, to manage the group’s tax position and to
support market disclosures.
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mitigation
the group maintains a system of internal controls, which is designed to:
– ensure that accounting policies are consistently applied, transactions are recorded and undertaken in accordance with delegated authorities, that
assets are safeguarded and liabilities are properly recorded;
– enable the calculation, preparation and reporting of financial, prudential regulatory and tax outcomes in accordance with applicable international
Financial Reporting standards, statutory and regulatory requirements;
– ensure that disclosures are made on a timely basis in accordance with statutory and regulatory requirements and as far as possible are consistent
with best practice and in compliance with the British Bankers’ Association Code for Financial Reporting Disclosure.
monitoring
Financial reporting risk, prudential regulatory reporting risk, tax risk and disclosure risk are all actively monitored at business unit and group levels.
there are specific programmes of work undertaken across the group to support:
– annual assessments of (1) the effectiveness of internal controls over financial reporting and (2) the effectiveness of the group’s disclosure controls
and procedures, both in accordance with the requirements of the Us sarbanes Oxley Act;
– annual certifications by the senior Accounting Officer with respect to the maintenance of appropriate tax accounting arrangements, in
accordance with the requirements of the 2009 Finance Act.
the group also has in place an assurance process to support its prudential regulatory reporting and monitoring activities designed to identify
and review tax exposures on a regular basis. there is ongoing monitoring to assess the impact of emerging regulation and legislation on financial,
prudential regulatory and tax reporting.
the group has a disclosure committee which assists the group Chief executive and group Finance Director in fulfilling their disclosure
responsibilities under relevant listing requirements.
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Credit risk
Definition
the risk of reductions in earnings and/or value, through financial or reputational 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).
Risk appetite
Credit risk appetite is set at Board level and is described and reported through a suite of metrics derived from a combination of accounting and
credit portfolio performance measures, which include the use of various credit risk rating systems as inputs. these metrics are supported by more
detailed appetite metrics at Divisional and business level and by a comprehensive suite of policies, sector caps, product and country limits to
manage concentration risk and exposures within the group’s approved risk appetite.
this statement of the group’s overall appetite for credit risk is reviewed and approved annually. With the support of the group Risk Committee,
the group Chief executive allocates this risk appetite across the group.
Exposures
the principal sources of credit risk within the group arise from loans and advances to retail customers, financial institutions, sovereigns and
corporate clients. the credit risk exposures of the group are set out in note 56 to the financial statements on page 322. Credit risk exposures are
categorised as ‘retail’, arising primarily in the Retail and Wealth and international Divisions, ‘commercial’ and ‘corporate’, ‘financial institutions’ or
‘sovereigns’ arising in the Wholesale, Commercial and Wealth and international Divisions.
in terms of loans and advances, credit risk arises both from amounts lent and commitments to extend credit to a customer as required. these
commitments can take the form of loans and overdrafts, or credit instruments such as guarantees and standby, documentary and commercial
letters of credit. With respect to commitments to extend credit, the group is potentially also exposed to loss in an amount equal to the total
unused commitments. However, the likely amount of loss is less than the total unused commitments, as most retail term commitments to extend
credit can be cancelled without notice and the creditworthiness of customers is monitored frequently. in addition, most wholesale commitments
to extend credit are contingent upon customers maintaining specific credit standards, which are monitored regularly.
Credit risk can also arise from debt securities, private equity investments, derivatives and foreign exchange activities. note 19 to the financial
statements on page 251 shows the total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts
outstanding at 31 December 2011. the notional principal amount does not, however, represent the group’s credit risk exposure, which is limited
to the current cost of replacing contracts with a positive value to the group. such amounts are reflected in note 56 to the financial statements on
page 322.
Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers. A significant proportion
of the investments are held in unit-linked and with-profits funds where the shareholder risk is limited, subject to any guarantees given.
note 2(H) to the financial statements on page 221 provides details of the group’s approach to the impairment of financial assets.
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 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’).
For regulatory capital purposes the group’s rating systems assess probability of default and if permitted, exposure at default and loss given
default, in order to derive an expected loss. if not permitted, regulatory prescribed exposure at default and loss given default values are used
in order to derive an expected loss. in contrast, impairment allowances are recognised for financial reporting purposes only for loss events that
have occurred at the balance sheet date, based on objective evidence of impairment. Due to the different methodologies applied, the amount of
incurred credit losses provided for in the financial statements differs from the amount determined from the expected loss models that are used for
internal operational management and banking regulation purposes.
the group assesses the probability of default of individual counterparties using internal rating models tailored to the various categories of
counterparty. in its principal retail portfolios exposure at default and loss given default models are also in use. they have been developed internally
and use statistical analysis, combined, where appropriate, with external data and subject matter expert judgement. each rating model is subject to
a validation process, undertaken by independent risk teams, which includes benchmarking to externally available data, where possible. the most
material rating models are approved by the group Risk Committee. Responsibility for the approval of the remaining material rating models, and
the governance framework in place around all Lloyds Banking group models, is delegated to the group model governance Committee.
each probability of default model segments counterparties into a number of rating grades, each representing a defined range of default
probabilities (details of these rating scales are published in Lloyds Banking group’s Pillar iii disclosure). exposures migrate between rating grades
if the assessment of the counterparty probability of default changes. each rating system is required to map to a master scale, which supports the
consolidation of credit risk information across portfolios through the adoption of a common rating scale. given the differing risk profiles and credit
rating considerations, the underlying risk reporting has been split into two distinct master scales, a retail master scale and a wholesale master scale
(note 56 to the financial statements on page 323 provides an analysis of the portfolio and page 134 provides details of our Credit risk portfolio).
the quality definition of both retail and non-retail counterparties/exposures is largely based on the outcomes of credit risk (probability of default
– PD) models. the group operates a significant number of different rating models, typically developed internally using statistical analysis and
may use management judgement – retail models rely more on the former; non-retail models include more of the latter, especially in the larger
corporate and more specialised lending portfolios. internal data is supplemented with external data in model development, where appropriate.
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the models vary, inter alia, in the extent to which they are point in time versus through the cycle. the models are subject to rigorous validation and
oversight/governance, including where appropriate, benchmarking to external information.
in non-retail portfolios the PD models segment counterparties into a number of rating grades, with each grade representing a defined range of default
probabilities, and there are a number of different model rating scales. Counterparties/exposures migrate between rating grades if the assessment of
the PD changes. the modelled PDs ‘map’ to a (non-retail) master scale which enables the consolidation of credit risk information, and it is this that
forms the basis for the iFRs credit quality characterisation.
in retail, for reporting purposes, counterparties are also segmented into a number of rating grades, each representing a defined range of default
probabilities and exposures migrate between rating grades if the assessment of the counterparty probability of default changes.
the nature, construction and calibration of retail and non-retail models are very different and so too are their respective master scales (not least in
their graduality). the distribution of probabilities of default is also different, which precludes reportage on a single consolidated basis.
Mitigation
the group uses a range of approaches to mitigate credit risk.
internal control
Credit principles and policy: Risk Division sets out the credit principles and policy according to which credit risk is managed. Principles and
policies are reviewed at least annually, and any changes are subject to a review and approval process. Policies, where appropriate, include
lending guidelines, which define the responsibilities of lending officers and provide a disciplined and focused benchmark for credit decisions.
these policies and procedures define chosen target market and risk acceptance criteria. these have been and will continue to be fine-tuned as
appropriate and include the use of early warning indicators to help anticipate future areas of concern and allow us to take early and proactive
mitigating actions.
the group uses a variety of lending criteria within Retail when assessing applications for mortgages and unsecured lending. the general approval
process uses credit acceptance scorecards and involves a review of an applicant’s previous credit history using information held by credit reference
agencies (CRA). the group also assesses the affordability of the borrowings to the borrower under stressed scenarios including increased interest
rates. in addition, the group has in place quantitative limits such as product maximum limits, the level of borrowing to income and the ratio of
borrowing to collateral. some of these limits relate to internal approval levels and others are hard limits above which the group will reject the
application. the group also has certain criteria that are applicable to specific products such as for applications for a mortgage on a property that is to
be let by the applicant.
the group’s lending practices within Retail have changed since 2009 in several ways: the group has lowered its maximum loan-to-value thresholds,
which have been reduced across all mortgage product types; the group has withdrawn from ‘specialist’ secured lending since early 2009 (self-
certificated and sub-prime lending) and increased credit scorecard cut-offs for both secured and unsecured lending; the group has tightened its
assessments and the maximum limit for affordability of borrowings for both secured and unsecured lending. in addition, the number of properties
permitted in buy-to-let portfolios has been reduced.
For Uk mortgages, the group’s policy is to reject all standard applications with a loan-to-value (LtV) greater than 90 per cent. For mainstream
mortgages the group has maximum per cent LtV limits which depend upon the loan size. these limits are currently:
(Unaudited)
Loan size
From
£1
£750,001
£1,000,001
£2,000,001
To
£750,000
£1,000,000
£2,000,000
£5,000,000
Maximum LTV
90% LtV
85% LtV
80% LtV
70% LtV
For mainstream mortgages greater than £5,000,000 the maximum LtV is 50 per cent. Buy-to-let mortgages are limited to a maximum of £1,000,000
and 75 per cent LtV. All mortgage applications above £500,000 are subject to manual underwriting.
the group’s approach to underwriting applications for unsecured products in Retail takes into account the total unsecured debt held by a
customer and their affordability. the group rejects any application for an unsecured product where a customer is registered as bankrupt or
insolvent, or has a County Court Judgment registered at a CRA used by the group. in addition, for credit cards the group rejects any applicant
with total unsecured debt greater than £50,000 registered at the CRA; or revolving debt-to-income ratio greater than 75 per cent; or total
unsecured debt-to-income ratio greater than 100 per cent. For unsecured personal loan applications, we reject any applicant with total unsecured
debt greater than £50,000 registered at the CRA. Rules around refinancing of debt have also been made more stringent since 2009 as a result
of the application of rules relating to the total unsecured debt held by a customer and the group’s approach in assessing affordability. this has
resulted in fewer customers being eligible to refinance unsecured debt.
Counterparty limits: Limits are set against all types of exposure in a counterparty name, in accordance with an agreed methodology for each
exposure type. this includes credit risk exposure on individual derivative transactions, which incorporates potential future exposures from market
movements. Aggregate facility levels by counterparty are set and limit breaches are subject to escalation procedures.
Credit scoring: in its principal retail portfolios, the group uses statistically based decisioning techniques (primarily credit scoring models). the
Risk Division reviews model effectiveness, while new models and model changes are referred by them to the appropriate model governance
Committees for approval. the most material changes are approved in accordance with the governance framework set by the group model
governance Committee.
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individual credit assessment and sanction: Credit risk in wholesale portfolios is subject to individual credit assessments, which consider the strengths
and weaknesses of individual transactions and the balance of risk and reward. exposure to individual counterparties, groups of counterparties or
customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are
based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. the group’s credit risk
appetite criteria for counterparty underwriting is generally the same as that for assets intended to be held over the period to maturity.
Controls over rating systems: the group has established an independent team in the Risk Division that sets common minimum standards, designed
to ensure risk models and associated rating systems are developed consistently, and are of sufficient quality to support business decisions and
meet regulatory requirements. internal rating systems are developed and owned by the Risk Division. Line management takes responsibility for
ensuring the validation of the rating systems, supported and challenged by independent specialist functions in their respective division.
Cross-border and cross-currency exposures: the Board sets country risk appetite. Within these, country limits are authorised by the country limits
panel, taking into account economic, financial, political and social factors. group policies stipulate that these limits must be consistent with, and
support the approved business and strategic plans of the group.
Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines to reflect risk appetite.
Credit policy is aligned to the group’s risk appetite and restricts exposure to certain high risk countries and more vulnerable sectors and segments.
note 21 to the financial statements on page 255, provides an analysis of loans and advances to customers by industry (for wholesale customers)
and product (for retail customers). exposures are monitored to prevent an excessive concentration of risk. these concentration risk controls are
not necessarily in the form of a maximum limit on lending, but may instead require new business in concentrated sectors to fulfil additional hurdle
requirements. the group’s large exposures are reported in accordance with regulatory reporting requirements.
stress testing and scenario analysis: the credit portfolio is also subjected to stress testing and scenario analysis, to simulate outcomes and
calculate their associated impact. events are modelled at a group wide level, at divisional and business unit level and by rating model and
portfolio, for example, within a specific industry sector.
specialist expertise: Credit quality is maintained by specialist units providing, for example: intensive management and control (see intensive
Care section); security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector specific
expertise; and legal services applicable to the particular market place and product range offered by the business.
Daily settlement limits: settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a
corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of
all settlement risk arising from the group’s market transactions on any single day.
Credit risk assurance and review: Risk oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes,
and test the adequacy of credit risk infrastructure and governance processes throughout the group. this includes tracking portfolio performance
against an agreed set of key risk indicators. group Credit Risk Assurance, a group level function comprising experienced credit professionals,
is also in place. in conjunction with Risk senior management, this team carries out independent risk based credit reviews, providing individual
business unit assessment of the effectiveness of risk management practices and adherence to risk controls across the diverse range of the group’s
wholesale businesses and activities, facilitating a wide range of audit, assurance and review work. these include cyclical (‘standard’) credit reviews,
non-standard reviews, project reviews, credit risk rating model reviews and bespoke assignments, including impairment reviews as required. the
work of group Credit Risk Assurance continues to provide executive and senior management with assurance and guidance on credit quality,
effectiveness of credit risk controls and accuracy of impairments.
the determination of cash flows for cases in the Business support Units (BsU) is undertaken by a specialist risk team who gather a range of
information from various sources including the customer, professional advisers and the group’s own credit teams to fully understand and
appraise the customer’s business and circumstances. A more detailed assessment is undertaken to assist in reducing risk exposure and
highlighting potential strategic options. this often involves the group, in addition to using its own internal experts, engaging professional advisers
to perform independent Business Reviews (iBRs) and, where relevant, independently value collateral held. in more complex cases, such as those
involving work-out strategies, the review may also involve:
– critically assessing customer’s ability to successfully manage the business effectively in a distressed situation where turnaround is required;
– analysis of market sector factors, i.e. products, customers, suppliers, pricing and margin issues;
– performance review of operational areas that should be considered in terms of current effectiveness and efficiency and scope for improvements;
– financial analysis to model plans and factor in potential sensitivities, vulnerabilities and upsides; and
– determining the most appropriate corporate and capital structure suitable for the work-out strategy concerned.
the above assessment, monitoring and control processes continue throughout the period the case is managed within the BsU.
Collateral
the principal collateral types for loans and advances are:
– mortgages over residential and commercial real estate;
– charges over business assets such as premises, inventory and accounts receivables;
– charges over financial instruments such as debt securities and equities; and
– guarantees received from third parties.
the group maintains guidelines on the acceptability of specific classes of collateral.
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Collateral held as security for financial assets other than loans and advances is determined by the nature of the instrument. Debt securities,
treasury and other eligible bills are generally unsecured, with the exception of asset-backed securities and similar instruments, which are secured
by portfolios of financial assets. Collateral is generally not held against loans and advances to financial institutions, except where securities are held
as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting
agreement. Derivative transactions with wholesale counterparties are typically collateralised under a Credit support Annex in conjunction with the
isDA master Agreement.
it is the group’s policy that collateral should always be realistically valued by an appropriately qualified source, independent of both the credit
decision process and the customer, at the time of borrowing. Collateral is reviewed on a regular basis in accordance with business unit credit
policy, which will vary according to the type of lending and collateral involved. For residential mortgages, the group adjusts open market property
values to take account of the costs of realisation and any discount associated with the realisation of the collateral. in order to minimise the credit
loss, the group may seek additional collateral from the counterparty as soon as impairment indicators are identified for the relevant individual
loans and advances.
the group considers risk concentrations by collateral providers and collateral type, as appropriate, with a view to ensuring that any potential
undue concentrations of risk are identified and suitably managed by changes to strategy, policy and/or business plans.
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.
Other credit risk transfers
the group also undertakes asset sales, securitisations and credit derivative based transactions as a means of mitigating or reducing credit risk,
taking into account the nature of assets and the prevailing market conditions.
Monitoring
in conjunction with Risk, businesses identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and
characteristics by which those portfolios are managed in terms of credit risk exposure. this entails the production and analysis of regular portfolio
monitoring reports for review by senior management. Risk Division in turn produces an aggregated review of credit risk throughout the group,
including reports on significant credit exposures, which are presented to the group Risk Committee and the Board Risk Committee.
the performance of all rating models is monitored on a regular basis, in order to seek to ensure that models provide appropriate risk differentiation
capability, the generated ratings remain as accurate and robust as practical, and the models assign appropriate risk estimates to grades/pools. All models
are monitored against a series of agreed key performance indicators. in the event that the monitoring identifies material exceptions or deviations
from expected outcomes, these will be escalated in accordance with the governance framework set by the group model governance Committee.
Intensive care of customers in difficulty
Retail Assets
the group’s aim in offering forbearance and other assistance to retail customers in financial distress is to benefit both the customer and the group
by: discharging the group’s regulatory and social responsibilities to support its customers and act in their best long-term interests; and bringing
customer facilities back into a sustainable position which, for residential mortgages, also means keeping customers in their homes.
the group offers a range of tools and assistance to support retail customers who are encountering financial difficulties. Cases are managed on an
individual basis, with the circumstances of each customer considered separately and the action taken judged as being affordable and sustainable
for the customer. Operationally, the provision and review of such assistance is controlled through the application of an appropriate policy
framework; controls around the execution of policy; regular review of the different treatments to confirm that they remain appropriate; monitoring
of customers’ performance and the level of payments received; and management visibility of the nature and extent of assistance provided and the
associated risk.
Assistance is provided through trained colleagues in branches and dedicated telephony units, and via online guidance material. For those
customers requiring more intensive help, assistance is provided through dedicated support units where tailored repayment programmes can be
agreed. Customers are actively supported and referred to free money advice agencies when they have multiple credit facilities, including those at
other lenders, that require restructuring. Within the Collections and Recoveries functions, the sharing of best practice and alignment of policies
across the group has helped to drive more effective customer outcomes and achieve operational efficiencies.
One component of our relationship management approach is to contact customers showing signs of financial difficulty, discussing with them their
circumstances and offering solutions to prevent their accounts falling into arrears.
the specific tools available to assist customers vary by territory and product and the customer’s status. in defining the treatments offered to
customers who have experienced financial distress, the group distinguishes between the following three categories:
– Forbearance – a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original
contractual payments such as a temporary capital payment break.
– Financial distress assistance – an account change for customers in financial distress where arrears accrue at the contractual payment such as a
short-term arrangement to pay.
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– Repair – an account change used to repair a customer’s position when they have emerged from financial difficulty, such as capitalisation of arrears
when a payment track record has been re-established.
to assist customers in financial distress, the group also participates in, or benefits from, the following Uk government (government) sponsored
programmes for households:
– income support for mortgage interest: this is a government medium-term initiative that provides certain defined categories of customers,
principally those who are unemployed, access to a benefit scheme, paid for by the government, which covers all or part of the interest on
the mortgage. Qualifying customers are able to claim for mortgage interest on up to £200,000 of the mortgage. All decisions regarding an
individual’s eligibility and any amounts payable under the scheme rest solely with the government. Payments are made directly to the group by
the appropriate government department.
– Homeowner mortgage support scheme: this is a government medium-term initiative that enables borrowers affected by temporary reductions
in income to access reduced payments for a period of up to two years. the government provides a partial guarantee to the group whilst a
customer participates in the plan. Decisions on eligibility, principally whether the group expects the borrower’s earnings to recover fully, initially
rest with the group and must be made on the basis of detailed information received from an independent fee-free advisor. After a year, the
customer must undergo a further full assessment made by the advice agency. the customer must pay at least 30 per cent of the interest due.
Any shortfall in payments made during the period covered by the scheme is collected through increased payments over the remaining term.
the scheme was closed to new customer applications in April 2011 by the Department of Communities and Local government.
– mortgage Rescue scheme: this is a government short-term initiative for borrowers in difficulty and facing repossession, who would have priority
for re-housing by a local authority (e.g. the elderly, disabled, single parents). eligible customers can have their property bought in full or part
by the social rented sector and then remain in their home as a tenant or shared equity partner. if the property is sold outright the mortgage is
redeemed in full.
Wholesale Assets (including Commercial)
in order to support wholesale customers that encounter difficulties during the current economic downturn, the group increased the size of its
dedicated Business support Unit (BsU) to cover all its Uk and international portfolios.
Wholesale credit facilities are reviewed on a regular basis and more frequently where required. When financial stress is exhibited, the customer
would be transferred at an early stage to our specialist BsU and Customer support teams.
the over-arching aim of BsU is to work with each customer to try and resolve the issues, to restore the business to a financially viable position
and facilitate a business turnaround. this could be through a number of channels, including providing advice on how to develop and implement
turnaround strategies, and considering potential restructuring of debt and forbearance. this may involve using turnaround professionals, for
example accountants and valuers.
BsU Relationship managers are highly experienced and operate in a closely controlled and monitored environment, including regular oversight
and ongoing close scrutiny by senior management. exposure is minimised through a combination of appropriate forbearance, asset sales,
restructuring and work-out strategies.
Customer support provides intensive care and support to Commercial sme customers in difficulty. Whilst the customer relationship remains with
the Relationship manager, they are supported by a Customer support manager to oversee and manage identified risk.
the main types of forbearance for wholesale customers in financial distress could include:
– Covenant resets and breach of covenant waivers
– extension of facilities outside of agreed terms
– Capital repayment holidays
– Debt for equity swaps
– Partial debt write off
Forbearance alone is not necessarily an indicator of impairment but will always be a trigger point for the Bank to review the customer’s credit and
assess whether the risk has changed.
multiple types of forbearance concessions often occur on the more distressed cases managed in BsU or Customer support. each case is treated
depending on its own specific circumstances and our strategy and offer of forbearance is largely dependent on the individual situation. early
identification, control and monitoring are key.
One of the components of the approach to forbearance and early identification of issues used for wholesale assets is our Credit Risk Classification
Policy, which is designed to identify and highlight portfolio levels of asset quality as well as individual problem credits. this policy includes
our good book/mainstream early warning process identifying “special mention” and “sub standard” cases. this process seeks to ensure that
Relationship managers act promptly to identify, and highlight to senior management, customers that have the possibility to become higher risk in the
future. Customers classified as special mention/sub standard are subject to additional controls and regular monitoring routines, including oversight
by BsU and the independent Credit sanctioning function.
Concessions granted under forbearance would be classified in our Credit Risk Classification system according to the severity of the customer’s
financial distress. management information is produced which gives a high level view of asset quality, with clearly defined parameters and features.
trends and warning signs are reported and advised to senior management promptly, which include issues not yet identified by rating models.
A robust review and challenge process is applied to each credit if asset quality declines, initiating an appropriate and measured response. As
the financial stress of a credit deteriorates the Credit Risk Classification helps to determine the route and management of the customer. Repeat
134
Annual Report and Accounts 2011
Risk mAnAgement
transgressions of forbearance would be reflected in the strategy to manage the customer and an objective reassessment of any impairment will
be undertaken on a regular basis. this is subject to independent review and sanctioning.
in addition, the group, through its banking businesses, participates in a number of initiatives designed to assist small and medium-sized
enterprises. these include:
– the Lending Code: introduced by the British Bankers’ Association in november 2009, the Lending Code is a voluntary set of commitments
and standards of good practice to ensure that lenders act fairly and reasonably in all dealings with customers. this has been reviewed and
updated in march 2011, not only to incorporate the key elements of the statement of Principles, a previously issued brochure which outlined
an agreed approach to working with micro-enterprise customers (entities with fewer than 10 employees and having a turnover of less than
A2 million), but also to introduce key elements of the work of the Business Finance taskforce (see below). A leaflet ‘A guide to the Lending Code
for micro-enterprises’ provides an introduction to the standards customers should expect from the banks, building societies and credit-card
providers who follow the Lending Code.
– 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 finance application checklist: Details of the type of information we may ask customers to provide in order to support their lending
application.
– Business mentoring: Businesses may benefit from the support of a business mentor. www.mentorsme.co.uk is a free online service that enables
businesses to locate local independent mentoring organisations that suit their specific business needs.
– 2012 sme Charter: Our 2012 sme Charter details our commitment to supporting Uk business and incorporates our pledge to support any viable
business through temporary difficulties and into recovery. As part of our commitment to this, we issue a Letter of Concern to customers when we
have concerns about their business or the group’s relationship with them. this aims to generate early dialogue between the customer and the
group, so that a joint approach to the situation can be agreed with them.
the group’s accounting policy for loan renegotiations and forbearance is set out in note 2(H) to the financial statements.
Our credit risk portfolio in 2011
Overview
– the group achieved a significant reduction in its impairment charge in 2011 to £9,787 million (from £13,181 million in 2010), due primarily to lower
corporate real estate and real estate related charges in Wholesale, lower charges in the irish portfolio together with strong Retail performance.
All divisions experienced impairment charge reductions by over 20 per cent from 2010.
– these lower charges were principally supported by the continued application of our prudent risk appetite and strong risk management controls
resulting in improved portfolio and new business quality, continued low interest rates, and broadly stable Uk property prices, partly offset by
weakening Uk economic growth and rising unemployment.
– the group’s overall core impairment charge during 2011 was materially lower compared to 2010, due primarily to strong Retail performance
offset by higher core impairments in Wholesale due to a few specific cases.
– the group’s non-core impairment charge in 2011 was also materially lower compared to 2010. this is primarily driven by lower impairment from
the non-core corporate real estate and real estate related lending portfolios in Wholesale, together with the non-core irish portfolio.
– Prudent credit policies and procedures are in place throughout the group, focusing on development of enduring client relationships. As a result
of this approach, the credit quality of new lending remains strong.
– the group’s more difficult exposures are being managed successfully in the current challenging economic environment by the Wholesale
Business support Units and Retail Collection and Recovery Units. the group’s exposure to ireland has been closely managed, with a dedicated
Uk-based business support team in place to manage the winding down of the irish book.
– the group continues to proactively manage down sovereign as well as banking and trading book exposure to selected eurozone countries.
– Divestment strategy is focused on balance sheet reduction and disposal of higher risk positions.
table 1.19: Impairments on Group loans and advances (audited)
Retail
Wholesale
Commercial
Wealth and international
Central items
Total impairment charge
2011
£m
1,970
2,901
303
4,610
3
9,787
2010
£m
2,747
4,064
382
5,988
–
13,181
Change
%
28
29
21
23
26
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Risk mAnAgement
table 1.20: Impairment charge by division (audited)
At 31 December 2011
Retail
Wholesale
Commercial
Wealth and international
Reverse repos and other items
impairment provisions1
Fair value adjustments2
Total Group
At 31 December 2010
Retail
Wholesale
Commercial
Wealth and international
Reverse repos and other items
impairment provisions1
Fair value adjustments2
total group
Impaired loans
as a % of
closing
advances
%
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
2.5
20.5
9.8
36.8
–
10.1
2.6
20.0
9.6
30.7
–
10.3
2,718
11,537
880
12,583
–
27,718
3,096
14,863
992
10,684
–
29,635
30.8
41.6
30.2
60.6
–
46.0
31.8
46.9
34.7
52.5
–
45.9
Loans and
advances
to customers
£m
356,907
135,395
29,681
56,394
17,066
Impaired
loans
£m
8,822
27,756
2,915
20,776
–
595,443
60,269
(27,718)
(2,087)
565,638
368,981
158,002
29,649
66,368
3,378
626,378
(29,635)
(4,146)
592,597
9,750
31,658
2,856
20,342
–
64,606
1
2
impairment provisions include collective unimpaired provisions.
the fair value adjustments relating to loans and advances were those required to reflect the HBOs assets in the Company’s consolidated financial records at their fair value and took into account
both the expected future impairment losses and market liquidity at the date of acquisition. the unwind relating to future impairment losses requires significant management judgement to
determine its timing which includes an assessment of whether the losses incurred in the current period were expected at the date of the acquisition and assessing whether the remaining losses
expected at the date of the acquisition will still be incurred. the element relating to market liquidity unwinds to the income statement over the estimated useful lives of the related assets (until 2014
for wholesale loans and 2018 for retail loans) although if an asset is written off or suffers previously unexpected impairment then this element of the fair value will no longer be considered a timing
difference (liquidity) but permanent (impairment). in 2011, a net credit of £1,943 million (2010: £3,118 million) relates to the unwind of HBOs acquisition fair value adjustments. Of that amount,
£1,693 million (2010: £2,229 million) relates to impairment losses incurred which were expected at the date of acquisition. the fair value unwind in respect of loans and advances is expected to
continue to decrease in future years as fixed-rate periods on mortgages expire, loans are repaid or written off, and will reduce to zero over time.
table 1.21: Total impairment charge (audited)
total impairment losses on loans and advances to customers
Loans and advances to banks
Debt securities classified as loans and receivables
Available-for-sale financial assets
Other credit risk provisions
Total impairment charge
2011
£m
9,712
–
49
81
(55)
9,787
2010
£m
12,958
(13)
57
115
64
13,181
Change
%
25
14
30
26
136
Annual Report and Accounts 2011
Risk mAnAgement
table 1.22: Impairment charge by division – core (unaudited)
At 31 December 2011
Retail
Wholesale
Commercial
Wealth and international
Reverse repos and other items
impairment provisions
Fair value adjustments
Total Group
At 31 December 2010
Retail
Wholesale
Commercial
Wealth and international
Reverse repos and other items
impairment provisions
Fair value adjustments
total group
1
impairment provisions include collective unimpaired provisions.
table 1.23: Total impairment charge – core (unaudited)
Retail
Wholesale
Commercial
Wealth and international
Central items
Total impairment charge
Loans and
advances
to customers
£m
328,524
78,772
28,289
7,991
17,066
Impaired
loans
£m
7,151
3,904
2,885
265
–
460,642
14,205
(5,588)
(1,171)
453,883
338,174
87,892
27,618
8,435
3,378
8,067
4,430
2,835
202
–
465,497
15,534
(6,088)
(2,138)
457,271
Impaired loans
as a % of
closing
advances
%
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
2.2
5.0
10.2
3.3
–
3.1
2.4
5.0
10.3
2.4
–
3.3
2011
£m
1,796
741
296
51
3
2,310
2,320
858
100
–
5,588
2,715
2,323
976
74
–
6,088
2010
£m
2,629
576
381
26
–
2,887
3,612
32.3
59.4
29.7
37.7
–
39.3
33.7
52.4
34.4
36.6
–
39.2
Change
%
32
(29)
22
(96)
20
137
Annual Report and Accounts 2011
Risk mAnAgement
table 1.24: Impairment charge by division – non-core (unaudited)
At 31 December 2011
Retail
Wholesale
Commercial
Wealth and international
Reverse repos and other items
impairment provisions
Fair value adjustments
Total Group
At 31 December 2010
Retail
Wholesale
Commercial
Wealth and international
Reverse repos and other items
impairment provisions
Fair value adjustments
total group
1
impairment provisions include collective unimpaired provisions.
table 1.25: Total impairment charge – non-core (unaudited)
Retail
Wholesale
Commercial
Wealth and international
Total impairment charge
Impaired loans
as a % of
closing
advances
%
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
5.9
42.1
2.2
42.4
–
34.2
5.5
38.8
1.0
34.8
–
30.5
408
9,217
22
12,483
–
22,130
381
12,540
16
10,610
–
23,547
24.4
38.6
73.3
60.9
–
48.0
22.6
46.1
76.2
52.7
–
48.0
Impaired
loans
£m
1,671
23,852
30
20,511
–
46,064
1,683
27,228
21
20,140
–
49,072
Loans and
advances
to customers
£m
28,383
56,623
1,392
48,403
–
134,801
(22,130)
(916)
111,755
30,807
70,110
2,031
57,933
–
160,881
(23,547)
(2,008)
135,326
2011
£m
174
2,160
7
4,559
6,900
2010
£m
118
3,488
1
5,962
9,569
Change
%
(47)
38
24
28
Pages 138 to 155 provide the Credit risk divisional split.
Outlook – group
the Uk economy is fragile with a weak short-term economic outlook generally expected. Consumer and business confidence remains low,
relatively high inflation has reduced consumer spending power and exports are falling.
in addition to the possibility of further economic deterioration, financial market instability represents an additional downside risk. Uncertainty over
the best way forward for the highly indebted eurozone persists and poses a serious threat to the global economic recovery, with political instability
and contagion to other eurozone countries increasing in the last quarter of 2011. Financial markets are expected to remain dislocated and volatile,
with the risk of contagion unlikely to dissipate in the near term, and this continues to place strains on funding markets at a time when many
financial institutions (in particular) have material ongoing funding needs.
the group’s Wholesale leveraged finance portfolios and its commercial real estate and real estate related property lending portfolios remain
particularly vulnerable, especially in the significant secondary and tertiary asset lending book. the impact of further economic weakness will also
be felt in the traditional lending portfolios in Corporate and Commercial. in addition, the irish economic outlook remains challenging and the
property market depressed, and both these factors could further adversely impact the wholesale and retail irish portfolios.
However, despite the downside risks, against its base case economic assumptions, the group expects the total impairment charge in
2012 to reduce by a similar percentage amount to the reduction in 2011, reflecting the stabilisation of its portfolios and proactive risk
management activities.
138
Annual Report and Accounts 2011
Risk mAnAgement
Credit Risk – Retail
Overview
– the Retail impairment charge was £1,970 million in 2011, a decrease of £777 million, or 28 per cent, from 2010.
– the decrease in the Retail impairment charge was driven by the unsecured portfolio as a result of the improved quality of new business and
effective portfolio management. the Retail impairment charge for loans and advances to customers, as an annualised percentage of average
loans and advances to customers, decreased to 0.54 per cent in 2011 from 0.74 per cent in 2010.
– the overall value of assets entering arrears in 2011 were lower in both unsecured and secured lending compared to 2010.
– 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.
table 1.26: Retail impairment charge
(audited)
secured
Unsecured
Total impairment charge
(unaudited)
Core:
secured
Unsecured
non-core:
secured
Unsecured
Total impairment charge
2011
£m
463
1,507
1,970
2011
£m
330
1,466
1,796
133
41
174
1,970
2010
£m
292
2,455
2,747
2010
£m
250
2,379
2,629
42
76
118
2,747
Change
%
(59)
39
28
Change
%
32
(47)
28
impaired loans and provisions
Retail impaired loans decreased by £0.9 billion to £8.8 billion compared with 31 December 2010 and, as a percentage of closing loans and
advances to customers, decreased to 2.5 per cent from 2.6 per cent at 31 December 2010. impairment provisions, as a percentage of impaired
loans, reduced to 30.8 per cent from 31.8 per cent at 31 December 2010.
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Annual Report and Accounts 2011
Risk mAnAgement
the Retail division’s loans and advances to customers are analysed in the following table:
table 1.27: Impairments on Retail loans and advances (audited)
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
As at 31 December 2011
secured
Unsecured:
Collections
Recoveries2
total gross lending
impairment provisions1
Fair value adjustments
Total
As at 31 December 2010
secured
Unsecured:
Collections
Recoveries2
total gross lending
impairment provisions1
Fair value adjustments
total
332,143
6,452
1,233
1,137
2,370
8,822
24,764
356,907
(2,718)
(1,377)
352,812
1.9
5.0
4.6
9.6
2.5
1,651
25.6
1,067
–
1,067
2,718
341,069
6,769
2.0
1,589
1,826
1,155
2,981
9,750
6.6
4.1
10.7
2.6
1,507
–
1,507
3,096
27,912
368,981
(3,096)
(2,154)
363,731
86.5
30.8
23.5
82.5
31.8
1
2
impairment provisions include collective unimpaired provisions.
Recoveries assets are written down to the present value of future expected cash flows on these assets.
the Retail division’s loans and advances to customers are analysed in the following table:
table 1.28: Retail loans and advances to customers (audited)
secured:
mainstream
Buy to let
specialist
Unsecured:
Credit cards
Personal loans
Bank accounts
Others
Total Retail gross lending
2011
£m
2010
£m
256,518
48,276
27,349
332,143
10,192
11,970
2,602
–
24,764
356,907
265,368
46,356
29,345
341,069
11,207
13,881
2,624
200
27,912
368,981
140
Annual Report and Accounts 2011
Risk mAnAgement
table 1.29: Impairments on Retail loans and advances – core (unaudited)
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
At 31 December 2011
secured
Unsecured:
Collections
Recoveries2
total gross lending
impairment provisions
Fair value adjustments
Total Retail
As at 31 December 2010
secured
Unsecured:
Collections
Recoveries2
total gross lending
impairment provisions
Fair value adjustments
total Retail
304,589
4,895
1,202
1,054
2,256
7,151
23,935
328,524
(2,310)
(1,111)
325,103
1.6
5.0
4.4
9.4
2.2
1,265
25.8
1,045
–
1,045
2,310
311,500
5,231
1.7
1,247
1,777
1,059
2,836
8,067
6.6
4.0
10.6
2.4
1,468
–
1,468
2,715
26,674
338,174
(2,715)
(1,755)
333,704
86.9
32.3
23.8
82.6
33.7
1
2
impairment provisions include collective unimpaired provisions.
Recoveries assets are written down to the present value of future expected cash flows on these assets.
141
Annual Report and Accounts 2011
Risk mAnAgement
table 1.30: Impairments on Retail loans and advances – non-core (unaudited)
At 31 December 2011
secured
Unsecured:
Collections
Recoveries2
total gross lending
impairment provisions
Fair value adjustments
Total Retail
As at 31 December 2010
secured
Unsecured:
Collections
Recoveries2
total gross lending
impairment provisions
Fair value adjustments
total Retail
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
27,554
1,557
5.7
31
83
114
1,671
829
28,383
(408)
(266)
27,709
29,569
1,538
49
96
145
1,683
1,238
30,807
(381)
(399)
30,027
3.8
10.0
13.8
5.9
5.2
4.0
7.7
11.7
5.5
386
22
–
22
408
342
39
–
39
381
24.8
71.0
24.4
22.2
79.6
22.6
1
2
impairment provisions include collective unimpaired provisions.
Recoveries assets are written down to the present value of future expected cash flows on these assets.
secured
Secured impairment charge
the impairment charge increased by £171 million, to £463 million in 2011 compared to the previous year. the impairment charge as a percentage
of average loans and advances to customers, increased to 0.14 per cent from 0.09 per cent in 2010. the provision coverage increased reflecting a
less certain outlook on house prices and appropriate provisioning against existing credit risks which have longer emergence periods due to current
low interest rate environment, partially offset by underlying improvements in the quality of the portfolio.
impairment provisions held against secured assets reflect the group’s view of appropriate allowance for incurred losses. the group holds
appropriate impairment provisions for customers who are experiencing financial difficulty, either on a forbearance arrangement or who may
be able to maintain their repayments whilst interest rates remain low. At December 2011, 1.2 per cent of loan balances were on a forbearance
arrangement, compared to 1.3 per cent at 31 December 2010.
Secured impaired loans
impaired loans decreased by £0.3 billion to £6.5 billion at 31 December 2011 and, as a percentage of closing loans and advances to customers,
reduced to 1.9 per cent from 2.0 per cent at 31 December 2010.
the number of customers going into arrears reduced throughout 2011 in comparison with 2010. specialist lending remains closed to new business
and this book has been in run-off since 2009.
142
Annual Report and Accounts 2011
Risk mAnAgement
Secured arrears
the percentage of mortgage cases greater than three months in arrears (excluding repossessions) remained stable at 2.3 per cent at
31 December 2011 compared to 31 December 2010 and 30 June 2011. the percentage of specialist mortgage cases greater than three months
in arrears (excluding repossessions) increased to 7.5 per cent at 31 December 2011 from 6.4 per cent at 31 December 2010 with the majority of this
growth occurring in the first half of 2011.
table 1.31: Mortgages greater than three months in arrears (excluding repossessions) (unaudited)
Greater than three months in arrears (excluding repossessions)
mainstream
Buy to let
specialist
Total
Greater than three months in arrears (excluding repossessions)
mainstream
Buy to let
specialist
Total
Number of cases
Total mortgage accounts %
31 Dec
2011
Cases
53,734
7,805
13,677
75,216
31 Dec
2010
Cases
55,675
7,577
12,582
75,834
31 Dec
2011
%
31 Dec
2010
%
2.0
1.8
7.5
2.3
2.1
1.8
6.4
2.3
Value of debt1
Total mortgage balances %
31 Dec
2011
£m
5,988
1,145
2,427
9,560
31 Dec
2010
£m
6,247
1,157
2,262
9,666
31 Dec
2011
%
31 Dec
2010
%
2.3
2.4
8.9
2.9
2.4
2.5
7.7
2.8
1
Value of debt represents total book value of mortgages in arrears.
the stock of repossession was stable with 3,043 cases at 31 December 2010 and 3,054 at 31 December 2011, and is broadly consistent with prior
years and below the Council of mortgage Lender’s average.
Secured loan to value analysis
the average indexed loan-to-value (LtV) on the mortgage portfolio at 31 December 2011 was 55.9 per cent compared with 55.6 per cent at
31 December 2010. the average LtV for new mortgages and further advances written in 2011 was 62.1 per cent compared with 60.9 per cent for
2010. the tables below show LtVs across the principal mortgage portfolios.
the indexed LtV in excess of 100 per cent as a percentage of closing loans and advances ending 31 December 2011 reduced to 12.0 per cent
(£39.7 billion), compared with 13.2 per cent (£44.9 billion) at 31 December 2010. this decrease in negative equity was driven by the regional mix of
business being biased towards areas experiencing house price growth despite national house prices falling.
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Annual Report and Accounts 2011
Risk mAnAgement
table 1.32: Actual and average LTVs across the Retail mortgage portfolios (audited)
At 31 December 2011
Less than 60%
60% to 70%
70% to 80%
80% to 90%
90% to 100%
greater than 100%
Total
Average loan-to-value:2
stock of residential mortgages
new residential lending
impaired mortgages
At 31 December 2010
Less than 60%
60% to 70%
70% to 80%
80% to 90%
90% to 100%
greater than 100%
total
Average loan-to-value:2
stock of residential mortgages
new residential lending
impaired mortgages
Mainstream
%
Buy to let
%
Specialist1
%
32.5
12.7
17.2
16.0
11.2
10.4
12.7
13.0
24.1
17.3
17.1
15.8
14.6
10.1
17.2
19.3
19.0
19.8
Total
%
28.1
12.5
18.2
16.5
12.7
12.0
100.0
100.0
100.0
100.0
52.2
61.4
72.0
33.0
12.1
16.1
15.3
11.9
11.6
74.0
65.8
99.8
11.4
11.1
21.9
18.0
19.1
18.5
72.6
n/a
88.0
14.0
9.4
15.9
21.3
20.0
19.4
55.9
62.1
78.4
28.5
11.7
16.8
16.2
13.6
13.2
100.0
100.0
100.0
100.0
51.9
60.0
72.3
75.6
66.5
97.8
72.9
n/a
87.3
55.6
60.9
78.0
1
2
specialist lending is closed to new business and is in run-off.
Average loan-to-value is calculated as total loans and advances as a percentage of the total collateral assigned to these loans and advances.
Unsecured
in 2011 the impairment charge on loans and advances to customers reduced by £948 million to £1,507 million compared with 2010. this reflected
continued improving business quality and portfolio trends resulting from the group’s conservative risk appetite, with a focus on lending to existing
customers.
A combination of the group’s risk appetite, reduced demand from customers for new unsecured borrowing and existing customers continuing to
reduce their personal indebtedness contributed to loans and advances to customers reducing by £3.1 billion to £24.8 billion at 31 December 2011.
the impairment charge as a percentage of average loans and advances to customers decreased to 5.66 per cent in 2011 from 8.11 per cent in
2010, with the impairment charge reducing at a greater rate than the reduction in average loans and advances in 2011.
impaired loans decreased by £0.6 billion to £2.4 billion which represented 9.6 per cent of closing loans and advances to customers at
31 December 2011, compared with 10.7 per cent at 31 December 2010. the reduction in impaired loans is a result of tightening credit policy across
the credit lifecycle, including stronger controls on customer affordability. Retail’s exposure to revolving credit products has been actively managed
to ensure that it is appropriate to customers’ changing financial circumstances. the portfolios show a level of early arrears for accounts acquired
since 2009 which are at pre-recession levels, highlighting an underlying improvement in the risk profile of the business.
impairment provisions decreased by £0.4 billion, compared with 31 December 2010, to £1.1 billion. this reduction was primarily a result of the
movement of assets from Collections to Recoveries, at which point they are written down to the present value of future expected cash flows.
the proportion of impaired loans that have been written down to the present value of future expected cash flows on these assets has increased
to 48.0 per cent at 31 December 2011 from 38.7 per cent at 31 December 2010. impairment provisions as a percentage of impaired loans in
collections increased to 86.5 per cent at 31 December 2011 from 82.5 per cent at 31 December 2010.
144
Annual Report and Accounts 2011
Risk mAnAgement
Credit Risk – Wholesale
Overview
– impairment losses for 2011 decreased significantly to £2,901 million, from £4,064 million for 2010.
– the decrease in the underlying impairment charge during 2011 is primarily driven by lower impairment from the corporate real estate and real
estate-related lending portfolios, partly offset mainly by higher impairment on leveraged acquisition finance exposures during 2011 where the
dampened effect of Uk economic conditions had the most impact.
– Whilst subdued Uk economic conditions and weaker consumer confidence is evident in a number of sectors, the reduction in the impairment
charge also reflects continued strong risk management and the low interest rate environment, helping to maintain defaults at a lower level.
– the group has proactively managed down sovereign as well as banking and trading book exposures to selected european countries.
Divestment strategy was focused on balance sheet reduction and disposing of higher risk positions.
– A robust credit risk management and control framework is in place across the combined portfolios and a prudent risk appetite approach
continues to be embedded across the division. significant resources continue to be deployed into the Business support Units, which focuses
on key and vulnerable obligors and asset classes.
table 1.33: Wholesale impairment charge (unaudited)
Wholesale excluding Asset Finance
Asset Finance
Total impairment charge
Core
non-core
Total impairment charge
2011
£m
2,701
200
2,901
741
2,160
2,901
2010
£m
3,800
264
4,064
576
3,488
4,064
Change
%
29
24
29
(29)
38
29
Wholesale’s impairment charge decreased £1,163 million, or 29 per cent, compared to £4,064 million during 2010. Despite a subdued Uk
economic environment in 2011, impairment charges have decreased substantially compared with 2010 due to robust proactive risk management,
an appropriately impaired portfolio (against our current economic assumptions) and a low interest rate environment helping to maintain defaults
at a lower level. impairment charges as an annualised percentage of average loans and advances to customers reduced to 1.95 per cent from
2.23 per cent in 2010.
impairment charge – core
Core impairments during 2011 were higher compared to 2010, which is primarily attributable to a few specific cases reflecting the nature of
impairments in a wholesale portfolio.
impairment charge – non-core
non-core impairments in 2011 were lower than 2010, primarily reflecting lower impairment from non-core corporate real estate and real estate
related asset portfolios. this reflected a stabilisation of commercial property prices in 2011. non-core impairments in 2010 (particularly the first half)
were significant as a result of the scale and pace of deterioration in the property sector and poorer quality heritage HBOs lending.
impaired loans and provisions
Wholesale’s impaired loans reduced by £3,902 million to £27,756 million compared with 31 December 2010. the reduction is due to new impaired
assets mainly in the Corporate Real estate Business support Unit being more than offset by write-offs on irrecoverable assets, the sale of previously
impaired assets, net repayments and transfers back to good book. Furthermore, the flow of assets into impaired status reduced during the year
compared to 2010. impairment provisions also reduced as a result of write-offs and a lower impairment rate on newly impaired assets especially in
the corporate real estate and real estate related portfolios. As a result of this, impairment provisions as a percentage of impaired loans reduced to
41.6 per cent from 46.9 per cent at 31 December 2010.
As a percentage of closing loans and advances to customers, impaired loans increased to 20.5 per cent from 20.0 per cent at 31 December 2010.
this increase is a result of the reducing level of total loans and advances to customers as at 31 December 2011 compared with 31 December 2010.
We continue to monitor our vulnerable portfolios within Wholesale and, where appropriate, remedial risk mitigating actions are being undertaken.
impaired loans and provisions – core
Core impaired loans reduced by £526 million to £3,904 million compared with 31 December 2010. the reduction is primarily due to the
restructuring of assets. these restructured assets had a lower impairment coverage resulting in core impairment provisions as a percentage of core
impaired loans increasing to 59.4 per cent from 52.4 per cent at 31 December 2010. As a percentage of closing core advances, core impaired loans
remained unchanged compared 31 December 2010 at 5.0 per cent.
145
Annual Report and Accounts 2011
Risk mAnAgement
impaired loans and provisions – non-core
non-core impaired loans reduced by £3,376 million to £23,852 million compared with 31 December 2010. the reduction reflects the strategy to
de-risk the group through deleverage of the non-core portfolio, with significant disposals achieved mostly in the real estate and leveraged finance
portfolios. these portfolios continue to be the main contributor of newly impaired assets, but lower coverage ratios are required now than seen in
previous years. this is driving the reduced coverage ratio. non-core impairment provisions as a percentage of non-core impaired loans reduced to
38.6 per cent from 46.1 per cent at 31 December 2010. As a percentage of closing non-core advances, impaired loans increased to 42.1 per cent
from 38.8 per cent at 31 December 2010. this increase is a result of impaired loans reducing more slowly than total non-core advances.
non-core impairment provisions as a percentage of non-core impaired assets are lower at 38.6 per cent compared to 59.4 per cent for core, mainly
a factor of the asset mix, where the non-core portfolios are heavily weighted toward real estate and real estate related portfolios where security is
often a larger influence on the impairment outcome.
146
Annual Report and Accounts 2011
Risk mAnAgement
table 1.34: Impairments on Wholesale loans and advances (audited)
Impaired loans
as a % of
closing
advances
%
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
8.2
71.3
100.0
15.6
–
17.0
20.5
3,051
5,631
100
2,009
–
746
11,537
54.2
37.0
88.5
36.0
–
61.3
41.6
Impaired
loans
£m
5,631
15,211
113
5,584
–
1,217
27,756
As at 31 December 2011
Corporate
Corporate Real estate BsU
Wholesale equity
Wholesale markets
treasury and trading
Asset Finance
total Wholesale
Reverse repos
impairment provisions
Fair value adjustments
Loans and advances to customers
Loans and advances to banks
Debt securities2
Available-for-sale financial assets3
impairment provisions include collective unimpaired provisions.
Loans and
advances to
customers
£m
68,772
21,326
113
35,802
2,220
7,162
135,395
16,836
(11,537)
(617)
140,077
8,443
12,489
12,554
Of which Wholesale markets is £12,135 million, Wholesale equity £195 million, treasury and trading £150 million, Asset Finance £7 million, and Corporate £2 million.
Of which Wholesale markets is £7,798 million, Wholesale equity £1,797 million, treasury and trading £2,922 million and Corporate £37 million.
impaired loans
as a % of
closing
advances
%
impairment
provisions1
£m
impairment
provisions
as a % of
impaired loans
%
8.2
67.0
77.1
14.3
–
16.9
20.0
3,629
8,092
107
1,992
–
1,043
14,863
54.7
46.2
99.1
34.8
–
62.1
46.9
impaired
loans
£m
6,635
17,518
108
5,718
–
1,679
31,658
At 31 December 2010
Corporate
Corporate Real estate BsU
Wholesale equity
Wholesale markets
treasury and trading
Asset Finance
total Wholesale
Reverse repos
impairment provisions
Fair value adjustments
Loans and advances to customers
Loans and advances to banks
Debt securities2
Available-for-sale financial assets3
impairment provisions include collective unimpaired provisions.
Loans and
advances to
customers
£m
80,670
26,151
140
40,042
1,050
9,949
158,002
3,096
(14,863)
(1,562)
144,673
12,401
25,779
29,458
Of which Wholesale markets is £25,120 million, Wholesale equity £487 million, treasury and trading £163 million, Asset Finance £7 million, Corporate £2 million and Commercial £2 million.
Of which Wholesale markets is £21,279 million, Wholesale equity £2,109 million, treasury and trading £6,011 million and Corporate £59 million.
1
2
3
1
2
3
147
Annual Report and Accounts 2011
Risk mAnAgement
table 1.35: Impairments on Wholesale loans and advances – core (unaudited)
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
At 31 December 2011
total Wholesale
Reverse repos
impairment provisions
Fair value adjustments
Loans and advances to customers
Loans and advances to banks
Debt securities
Available-for-sale financial assets
At 31 December 2010
total Wholesale
Reverse repos
impairment provisions
Fair value adjustments
Loans and advances to customers
Loans and advances to banks
Debt securities
Available-for-sale financial assets
3,904
5.0
2,320
59.4
4,430
5.0
2,323
52.4
78,772
16,836
(2,320)
(9)
93,279
8,153
155
3,110
87,892
3,096
(2,323)
(136)
88,529
11,994
402
7,377
1
impairment provisions include collective unimpaired provisions.
table 1.36: Impairments on Wholesale loans and advances – non-core (unaudited)
At 31 December 2011
total Wholesale
Reverse repos
impairment provisions
Fair value adjustments
Loans and advances to customers
Loans and advances to banks
Debt securities
Available-for-sale financial assets
At 31 December 2010
total Wholesale
Reverse repos
impairment provisions
Fair value adjustments
Loans and advances to customers
Loans and advances to banks
Debt securities
Available-for-sale financial assets
1
impairment provisions include collective unimpaired provisions
.
Loans and
advances to
customers
£m
Impaired
loans
£m
Impaired
loans as a % of
closing advances
%
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
56,623
23,852
42.1
9,217
38.6
–
(9,217)
(608)
46,798
290
12,334
9,444
70,110
27,228
38.8
12,540
46.1
–
(12,540)
(1,426)
56,144
407
25,377
22,081
148
Annual Report and Accounts 2011
Risk mAnAgement
Corporate
the £68,772 million of loans and advances to customers in the Corporate portfolio is structured across a number of different portfolios and sectors
as detailed below:
UK Corporate – major Corporate balance sheets remained relatively stable during the first half of 2011 with corporates continuing to reduce
debt and build up liquidity reserves. mergers and acquisition activity has been minimal and focus has been on refinancing existing facilities. in line
with economic commentary, some consumer related sectors in the Uk are now feeling the impact of a slowdown in spending. Commodity price
volatility is a potential concern in terms of required funding and customer profitability.
Financial Institutions – Continuing concerns over sovereign fiscal deficits and public sector debt levels have necessitated increased scrutiny and
risk reduction to the european banking sector, in particular banks domiciled in the weaker eurozone countries. trading exposures are in large part
either short term and/or collateralised and inter bank lending activity is mainly very short term with strong investment grade counterparties.
Mid-Markets Corporate – Customers in this sector are predominantly Uk-focused and mainly dependent on the performance of the domestic
economy. some of our clients’ trading has, unsurprisingly, proved challenging in a number of sectors in 2011, particularly those reliant on consumer
discretionary expenditure. Retail, hotels, leisure and construction have all been vulnerable to the wider economic environment during the year,
with the majority of impairments in the year arising in these sectors. the impact of public sector austerity measures has also been evident in some
sectors, with these also contributing to the impairment charge in the year. the mid-markets segment of the Uk Corporate market appears to have
limited direct vulnerability to events in the weaker eurozone countries, however the segment is more directly exposed to any flow-through effect
on the Uk economy resulting from weaker export demand.
US Corporate – the business continues to be predominately investment grade focused and the balance sheets of Us major Corporates remain
relatively strong, with good levels of liquidity. the reduction in the non-core corporate portfolio has continued through a combination of secondary
sales, refinancings, and realisation of property assets. the year-end impairment position is one of modest net write backs with new impairments on
existing cases more than offset by recoveries. Overall, portfolio asset quality remains strong.
Corporate Real Estate – Outside of London and the south east, activity in the Corporate Real estate market remains weak, in part due to
declining values and the focus on only prime properties and prime tenants. Rental growth, where achievable by our clients in the regions, is slow.
market demand for debt is low, especially for new facilities from our core customers, despite messaging that we are open for business which
meets our lending criteria. Customers are adopting a ‘wait and see’ approach, de-gearing where they can, and conserving cash. in addition, with
a significant proportion of our assets supporting property investments, tenant default is an area of continuing vulnerability especially where the
lending is underpinned by secondary or tertiary assets. With a continuing high level of loan maturities due over the next few years, refinancing
risk remains a market-wide issue. However, our core portfolios are characterised by strong management teams with proven asset management
skills and/or acceptable lease maturity profiles with borrowers meeting their interest cover and debt service obligations. new propositions are
structured and priced in line with our prudent risk appetite.
Corporate Real estate Business support Unit
the Corporate Real estate Business support Unit has continued to make strong progress executing on its active asset management programme
for the complex portfolio of over 1800 cases it manages. this has resulted in a further fall in the impairment total to £1,273 million (2010:
£2,427 million), after the peak experienced in 2009.
Despite capital values improving 17.8 per cent from their trough in 2009, we have seen the improving trend in the real estate market in 2011
weaken for all but prime or central London based real estate.
the management of the portfolio has focussed on continuing to support its long-term customers and at the same time reduce the exposure
to real estate through managed sales, which has resulted in a realisation of over £4.8 billion of cash receipts in 2011 despite the worsening
transactional market. in addition there has been over £5 billion of restructurings undertaken with longer term facilities put in place to support our
customer base.
Over the past two years, a total of over £8.5 billion of asset sales through managed disposals has occurred which has resulted in an overall
£14.6 billion reduction of gross loan exposure in the Uk. We have also concluded one of the largest loan portfolio sales in the market in December
which provided a significant £923 million deleveraging of our real estate exposure.
During the year a number of new initiatives have been introduced including the sale of assets specifically grouped under receivership, which is
the first time such a sale has been achieved; and an arrangement with a publicly quoted asset manager to facilitate certain residential portfolios
through the receivers. such arrangements demonstrate our desire to find solutions to ensure we maximise the recovery from these loan positions
or portfolios through managing for value the underlying real estate and we continue to seek innovative ways to achieve this aim.
Wholesale equity
the Wholesale equity portfolio (assets representing ‘equity Risk’ including ordinary equity, preference shares and debt securities) totals £4.9 billion
(split £3.8 billion on balance sheet commitments and £1.1 billion as yet undrawn, the majority of which relates to Lloyds Development Capital and
the Funds investment business).
the overall size of the portfolio has shown a downward trend in the second half of 2011, in the main due to significant disposals of a number of
assets from the Project Finance business. Continuing concerns around sovereign debt in the eurozone and disappointing economic data from the
major economies has resulted in ongoing volatility in equity markets.
149
Annual Report and Accounts 2011
Risk mAnAgement
Wholesale markets
Loans and advances to customers of £35.8 billion largely comprise balances in the structured Corporate Finance portfolio, which includes
Acquisition Finance (leveraged lending), Project Finance and Asset Based Finance (ship Finance, Aircraft Finance, Rail Capital and Corporate
Asset finance). the dampened effect of Uk economic conditions has been felt in the Acquisition Finance portfolio resulting in a higher impairment
charge on leveraged exposures during 2011 compared to 2010. However, a number of sectors remain vulnerable, especially retail, leisure and
healthcare, and refinancing risk is also an issue, with significant loan maturities due in the next few years. in ship Finance, the outlook for the
container, tanker and dry bulk sectors is challenging.
Wholesale markets is also responsible for the treasury Assets portfolio which mainly encompasses a portfolio of Asset-Backed securities and
financial institution Floating Rate note positions. Portfolio credit quality remained relatively stable over the year and the portfolio size continues
to be actively reduced through asset sales and from bond maturities. Further details of Wholesale Division’s Asset-Backed securities portfolio is
provided in note 56 to the financial statements on pages 335 and 336.
treasury and trading
treasury and trading acts as the link between the wholesale markets and the group’s balance sheet management activities and provides pricing
and risk management solutions to both internal and external clients.
the portfolio comprises £6.0 billion of loans and advances to banks, £2.9 billion of Available-for-sale debt securities and £2.2 billion of loans and
advances to customers (excluding reverse repos).
the majority of treasury and trading’s funding and risk management activity is transacted with investment grade counterparties including
sovereign central banks and much of it is on a secured basis, such as repos facing a Central Counterparty (“CCP”). Derivative transactions with
wholesale counterparties are typically collateralised under a Credit support Annex in conjunction with the isDA master Agreement. During
the year Lloyds Banking group became a member of LCH swapClear as part of a move to reduce counterparty risk by clearing standardised
derivative contracts through a CCP. treasury and trading has reduced the government bond portfolio in response to growing concern over market
conditions in the eurozone resulting in minimal exposure to weaker eurozone sovereigns. the credit quality of the government bond portfolio is
almost solely AAA/AA rated sovereign debt.
Asset Finance
there has been a marginal improvement in credit quality in relation to the retail portfolios during the year. impairments remain lower than
anticipated, particularly in the Personal Financial services portfolios and the retail motor loans portfolio. Asset quality also continues to improve
in response to the continuing strategy to enhance the quality of new business written (especially motor Finance) and following the closure of
Personal Financial services to new business. the credit quality profile across the non-retail portfolios also remains relatively stable, and underlying
impairment levels have reduced against 2010 levels, reflecting a material slow down in new default cases.
150
Annual Report and Accounts 2011
Risk mAnAgement
Credit Risk – Commercial
Overview
– impairment losses for 2011 decreased significantly to £303 million, from £382 million for 2010.
– the decrease reflects the continued application of our prudent credit risk appetite approach and the benefits of the low interest rate
environment which has helped maintain defaults at a lower level.
– Portfolio metrics including delinquencies and assets under close monitoring have generally remained steady or improved.
– Due to the continuing uncertainty regarding the economic outlook, we remain cautious. Downward pressures on consumer spending from a
weakening labour market, still-high household indebtedness and rising government budgetary pressures continue to imply vulnerability for a
number of sectors, most notably retail, motor traders and restaurants.
– Commercial continues to operate rigorous processes to enhance control and monitoring activities which play a crucial role in identifying
customers showing early signs of financial distress and bringing them into our support model.
table 1.37: Impairment charge (unaudited)
Core
non-core
Total impairment charge
2011
£m
296
7
303
2010
£m
381
2
382
Change
%
22
21
Commercial’s impairment charge decreased £79 million, or 21 per cent, compared to £382 million during 2010. this reflects the continued application
of a prudent credit risk appetite for new business and a low interest rate environment helping to maintain defaults at a lower level. impairment charges
as an annualised percentage of average loans and advances to customers reduced to 1.06 per cent from 1.24 per cent in 2010. the majority of the
business is based around full banking relationships. the relatively small non-core portfolio has continued to reduce throughout 2011.
impaired loans and provisions
Commercial’s impaired loans increased by £59 million to £2,915 million compared with 31 December 2010. Despite this small increase, impairment
provisions reduced. this is as a result of lower default rates at the smaller end of the portfolio and write-offs. As a result, impairment provisions as a
percentage of impaired loans reduced to 30.2 per cent from 34.7 per cent at 31 December 2010. As a percentage of closing loans and advances to
customers, impaired loans increased to 9.8 per cent from 9.6 per cent at 31 December 2010.
table 1.38: Impaired loans and provisions (audited)
At 31 December 2011
Commercial
impairment provisions
Fair value adjustments
Loans and advances to customers
At 31 December 2010
Commercial2
impairment provisions
Fair value adjustments
Loans and advances to customers
1
2
impairment provisions include collective unimpaired provisions.
2010 figures have been restated for transfers from Corporate.
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
29,681
2,915
9.8
880
30.2
(880)
(51)
28,750
29,649
2,856
9.6
992
34.7
(992)
(103)
28,554
151
Annual Report and Accounts 2011
Risk mAnAgement
table 1.39: Impaired loans and provisions – core (unaudited)
At 31 December 2011
Commercial
impairment provisions
Fair value adjustments
Loans and advances to customers
At 31 December 2010
Commercial
impairment provisions
Fair value adjustments
Loans and advances to customers
1
impairment provisions include collective unimpaired provisions.
table 1.40: Impaired loans and provisions – non-core (unaudited)
At 31 December 2011
Commercial
impairment provisions
Fair value adjustments
Loans and advances to customers
At 31 December 2010
Commercial
impairment provisions
Fair value adjustments
Loans and advances to customers
1
impairment provisions include collective unimpaired provisions.
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
28,289
2,885
10.2
858
29.7
(858)
(51)
27,380
27,618
2,835
10.3
976
34.4
(976)
(103)
26,539
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
30
2.2
22
73.3
21
1.0
16
76.2
1,392
(22)
–
1,370
2,031
(16)
–
2,015
152
Annual Report and Accounts 2011
Risk mAnAgement
Credit Risk – Wealth and International
Overview
– in Wealth and international, impairment charges totalled £4,610 million, a decrease of 23 per cent from £5,988 million in 2010. the reduction
predominantly reflects lower impairment charges in our irish portfolio where the rate of impaired loan migration has slowed.
– impairment coverage has increased in ireland to 62 per cent from 54 per cent, primarily reflecting further falls in the commercial real estate
market during 2011, and further vulnerability exists.
– On the irish Wholesale portfolio, 84 per cent of the portfolio is now impaired at a coverage ratio of 61 per cent.
– On the irish Retail portfolio, impairment provisions as a percentage of impaired loans has increased to 73 per cent against a backdrop of falling
house prices and an increase in borrowers falling into arrears.
– Further provisioning has been necessary in the group’s Australasian portfolio primarily reflecting geographical real estate concentrations where
market conditions and asset valuations have remained weak in 2011.
– the group has successfully started to reduce its non-core exposure to ireland with a reduction in gross advances in excess of £2.6 billion during
2011 with disposals in the period being broadly in line with current provisioning levels.
– the group has also significantly reduced its exposure in its Australasian business by Aus $2.1 billion including the successful disposal of
a £1 billion portfolio of impaired Australasian real estate loans in the last quarter of 2011. the levels of disposals during the year represent
40 per cent of the gross impaired portfolio.
– the majority of Wealth and international’s assets are non-core and in run-off.
table 1.41: Wealth and International impairment charge (audited)
Wealth
international:
ireland
Australia
Wholesale europe
Other international
Total impairment charge
table 1.42: Wealth and International impairment charge – core (unaudited)
Wealth
international
Total impairment charge
table 1.43: Wealth and International impairment charge – non-core (unaudited)
Wealth
international
Total impairment charge
2011
£m
100
3,187
1,034
204
85
4,510
4,610
2011
£m
33
18
51
2011
£m
67
4,492
4,559
2010
£m
46
4,264
1,362
210
106
5,942
5,988
2010
£m
26
–
26
2010
£m
20
5,942
5,962
Change
%
(117)
25
24
3
20
24
23
Change
%
(27)
(96)
Change
%
(235)
24
24
Wealth and international’s impairment charge in 2011 almost entirely related to non-core portfolios. the impairment charge decreased by
£1,378 million to £4,610 million compared with 2010. impairment charges as an annualised percentage of average loans and advances to
customers decreased to 7.37 per cent from 8.9 per cent in 2010.
153
Annual Report and Accounts 2011
Risk mAnAgement
impaired loans and provisions
total impaired loans increased by £434 million to £20,776 million compared with £20,342 million at 31 December 2010 and as a percentage of
closing loans and advances to customers increased to 36.8 per cent from 30.7 per cent at 31 December 2010. the increase in impaired loans
predominantly relates to the group’s non-core book in ireland where impaired loans increased by £1.9 billion during 2011 reflecting ongoing
difficulties in the economy. this results in 66 per cent of the total irish portfolio now being classified as impaired (84 per cent wholesale). impaired
loans in the Australasian book reduced by £1.4 billion driven by write offs and impaired asset disposals.
impairment provisions as a percentage of impaired loans increased to 60.6 per cent from 52.5 per cent at 31 December 2010. the coverage ratio
in the group’s irish Portfolio has increased further reflecting continuing weakness in real estate markets where further vulnerability exists.
table 1.44: Impairments on Wealth and International loans and advances (audited)
At 31 December 2011
Wealth
international:
ireland Retail
ireland Wholesale
Australia
Wholesale europe
Other
Wealth and international
impairment provisions
Fair value adjustments
Total Wealth and International
At 31 December 2010
Wealth
international:
ireland Retail
ireland Wholesale
Australia
Wholesale europe
Other
Wealth and international
impairment provisions
Fair value adjustments
total Wealth and international
1
impairment provisions include collective unimpaired provisions.
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
8,781
399
4.5
162
40.6
1,415
14,945
2,780
978
259
20,377
20,776
20.1
84.3
28.5
15.4
3.8
42.8
36.8
1,034
9,133
1,609
475
170
12,421
12,583
73.1
61.1
57.9
48.6
65.6
61.0
60.6
7,036
17,737
9,745
6,356
6,739
47,613
56,394
(12,583)
(42)
43,769
9,472
353
3.7
116
32.9
870
13,575
4,187
1,007
350
19,989
20,342
11.3
68.7
28.7
13.8
4.6
35.1
30.7
616
7,147
2,208
420
177
10,568
10,684
70.8
52.6
52.7
41.7
50.6
52.9
52.5
7,673
19,755
14,587
7,322
7,559
56,896
66,368
(10,684)
(327)
55,357
154
Annual Report and Accounts 2011
Risk mAnAgement
table 1.45: Impairments on Wealth and International loans and advances – core (unaudited)
As at 31 December 2011
Wealth
international
Wealth and international
impairment provisions
Fair value adjustments
Total
As at 31 December 2010
Wealth
international
Wealth and international
impairment provisions
Fair value adjustments
total
Loans and
advances to
customers
£m
Impaired loans
as a % of
closing
advances
%
Impaired
loans
£m
Impairment
provisions1
£m
Impairment
provisions
as a % of
impaired loans
%
245
20
265
202
–
202
4.9
0.7
3.3
3.7
–
2.4
82
18
100
74
–
74
33.5
90.0
37.7
36.6
–
36.6
4,998
2,993
7,991
(100)
–
7,891
5,513
2,922
8,435
(74)
(144)
8,217
1
impairment provisions include collective unimpaired provisions.
table 1.46: Impairments on Wealth and International loans and advances – non-core (unaudited)
As at 31 December 2011
Wealth
international
Wealth and international
impairment provisions
Fair value adjustments
Total
As at 31 December 2010
Wealth
international
Wealth and international
impairment provisions
Fair value adjustments
total
1
impairment provisions include collective unimpaired provisions.
Impaired loans
as a % of
closing
advances
%
4.1
45.6
42.4
Impaired
loans
£m
154
20,357
20,511
Impairment
provisions1
£m
80
12,403
12,483
Impairment
provisions
as a % of
impaired loans
%
51.9
60.9
60.9
151
19,989
20,140
3.8
37.0
34.8
42
10,568
10,610
27.8
52.9
52.7
Loans and
advances to
customers
£m
3,783
44,620
48,403
(12,483)
(42)
35,878
3,959
53,974
57,933
(10,610)
(183)
47,140
155
Annual Report and Accounts 2011
Risk mAnAgement
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.
ireland
total impaired loans increased by £1,915 million, or 13 per cent to £16,360 million compared with £14,445 million at 31 December 2010 and as a
percentage of closing loans and advances increased to 66.0 per cent from 52.7 per cent at 31 December 2010. impairment charges decreased by
£1,077 million to £3,187 million compared to 2010. impairment charges as an annualised percentage of average loans and advances to customers
decreased to 11.9 per cent from 15.4 per cent in 2010.
Continuing weakness in the irish real estate markets resulted in a further increase in impaired wholesale loans and coverage in 2011. the majority
of irish retail provisions relate to a residential mortgage portfolio where impairment charges have increased in relation to 2010 due to a continued
decline in residential property prices and higher arrears levels, including customers on a forbearance arrangement.
table 1.47: Impairments on Ireland loans and advances (audited)
Commercial Real estate
Corporate
Retail
Total
Gross
loans
£m
10,872
6,865
7,036
2011
Impaired
loans
£m
9,807
5,138
1,415
Provisions
£m
gross
loans
£m
6,194
11,685
2,939
1,034
8,070
7,673
2010
impaired
loans
£m
9,232
4,343
870
24,773
16,360
10,167
27,428
14,445
Provisions
£m
4,791
2,356
616
7,763
the most significant contribution to impairment in ireland is the Commercial Real estate portfolio. impairment provisions provide 63 per cent
coverage on impaired commercial real estate loans. mortgage lending at the year end comprised 99 per cent of the retail portfolio with impaired
loans of £1.4 billion and impairment coverage of 70 per cent.
£2.6 billion of wholesale lending within the Commercial Real estate and corporate portfolios relates to sterling loans secured on Uk property.
Within the Commercial Real estate portfolio, over 90 per cent of the portfolio is now impaired. the average impairment coverage ratio has
increased in the year to 63 per cent (52 per cent 31 December 2010) reflecting the continued deteriorating irish economic conditions and irish
commercial property market.
the group has successfully started to reduce its non-core exposure to ireland with disposals in excess of A1 billion in the period broadly in line
with current provisioning levels.
Australasia
total impaired loans decreased by £1,407 million, or 34 per cent to £2,780 million compared with £4,187 million at 31 December 2010. the decrease
in impaired loans in the period is as a result of impaired asset disposals and write offs partially offset by further migration of cases to impaired status.
total impaired loans as a percentage of closing loans and advances decreased to 28.5 per cent from 28.7 per cent at 31 December 2010.
impairment charges decreased by £328 million to £1,034 million compared to 2010. impairment charges as an annualised percentage of average
loans and advances to customers decreased to 8.2 per cent from 9.3 per cent in 2010.
impairment on the group’s Commercial Real estate portfolio in Australasia was the main contributor to the full year charge. this portfolio is
exposed to Australian non-metropolitan real estate markets where market conditions and asset valuations in 2011 have remained weak. the group
has significantly reduced its remaining exposure to these markets following the successful disposal of a £1 billion portfolio of loans during the
last quarter of 2011 in our two most challenging markets (gold Coast and new Zealand). A specific charge of £70 million was also incurred in the
period as a result of losses arising from the earthquake in new Zealand.
Wholesale europe
total impaired loans decreased by £29 million, or 3 per cent to £978 million compared with £1,007 million at 31 December 2010 and as a
percentage of closing loans and advances increased to 15.4 per cent from 13.8 per cent at 31 December 2010. impairment charges decreased
by £5 million to £204 million compared to 2010. impairment charges as an annualised percentage of average loans and advances to customers
increased to 2.9 per cent compared to 2.8 per cent in 2010. Commercial real estate was the primary driver of the impairment charge in Wholesale
europe reflecting provisions on a small number of specific transactions.
Other international
impairments mainly relate to the corporate business in Dubai and the Dutch mortgage business. total impaired loans decreased by £91 million,
or 26 per cent to £259 million compared with £350 million at 31 December 2010 and as a percentage of closing loans and advances decreased
to 3.8 per cent from 4.6 per cent at 31 December 2010. impaired loans predominantly relate to a limited number of corporate exposures and
the reduction in impaired balances primarily reflects write offs in respect of two loans that have been exited in the period. impairment charges
decreased by £21 million to £85 million compared to 2010. impairment charges as an annualised percentage of average loans and advances to
customers decreased to 1.2 per cent from 1.3 per cent in 2010.
156
Annual Report and Accounts 2011
Risk mAnAgement
Exposures to selected Eurozone countries
the following section summarises the group’s direct exposure to certain european countries which have been identified on the basis of a standard
& Poor’s rating of A or less, as at 31 December 2011. the exposures are shown at their balance sheet carrying values and are based on the country
of domicile of the counterparty, unless otherwise indicated.
the group manages its exposures to individual countries through authorised country limits which take into account economic, financial, political
and social factors. in addition, the group manages its direct risks to the selected countries by establishing and monitoring risk limits for individual
banks, financial institutions and corporates. indirect risk is taken into account, where it is determined that counterparties have material direct
exposures to the selected countries.
the group has established a eurozone instability steering group in order to monitor developments within the eurozone on a daily basis, carry out
stress testing through detailed scenario analysis and complete appropriate due diligence on the group’s exposures.
the following tables summarise exposures to the selected eurozone countries by type of counterparty:
table 1.48: Eurozone exposure – by counterparty (unaudited)
At 31 December 2011
Direct sovereign exposure
Central Bank balances
Banks
Asset backed securities
Other financial institutions
Other corporate
Retail
insurance assets
Total
At 31 December 2010
Direct sovereign exposure
Central Bank balances
Banks
Asset backed securities
Other financial institutions
Other corporate
Retail
insurance assets
total
Greece
£m
Ireland
£m
–
–
–
55
–
431
–
–
–
–
207
376
272
8,894
6,027
68
Italy
£m
16
–
433
39
88
81
–
47
486
15,844
704
–
–
–
75
–
473
–
–
548
–
–
1,818
867
74
11,632
7,202
107
21,700
31
–
596
594
151
228
–
294
Portugal
£m
–
–
142
341
19
298
11
–
811
–
–
362
447
65
267
10
–
1,894
1,151
Spain
£m
17
35
1,692
375
27
2,935
1,649
39
6,769
54
44
2,437
987
146
2,769
1,769
110
8,316
Total
£m
33
35
2,474
1,186
406
12,639
7,687
154
24,614
85
44
5,213
2,970
436
15,369
8,981
511
33,609
in addition to the above countries, the group has total exposures with six other european countries which are rated A or below. no balance with
one individual country exceeds £350 million. these balances primarily relate to corporate exposures.
157
Annual Report and Accounts 2011
Risk mAnAgement
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.
in addition to direct sovereign exposures, the group maintains deposit balances with a number of european Central banks for regulatory and
liquidity management purposes. For the selected countries, the group has a central bank balance with spain of £35 million (2010: £44 million).
table 1.49: Exposures to Banks (unaudited)
Greece
£m
Ireland
£m
At 31 December 2011
Amortised cost
Available for sale:
Cost
AFs reserve
net trading assets
Derivatives – net CDs assets
and liabilities
Derivatives – other
Total exposure
At 31 December 2010
Amortised cost
Available for sale:
Cost
AFs reserve
net trading assets
Derivatives – net CDs assets
and liabilities
Derivatives – other
total exposure
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
46
193
(57)
136
–
–
25
207
42
923
(82)
841
919
–
16
1,818
Italy
£m
41
Portugal
£m
Spain
£m
17
33
Total
£m
137
194
(14)
198
1,848
2,433
(74)
(300)
(445)
180
188
–
24
433
124
1,548
–
–
1
59
–
52
142
1,692
1,988
247
–
102
2,474
59
62
52
215
512
(9)
503
25
9
–
596
362
(62)
300
–
–
–
2,586
(265)
2,321
38
–
26
4,383
(418)
3,965
982
9
42
362
2,437
5,213
included within exposures to banks and other financial institutions, and treated as available for sale assets, are Covered Bonds of £1.7 billion
(2010: £2.0 billion). the covered bonds are ultimately secured on a pool of mortgage assets in the countries concerned and benefit from
over-collaterisation, with an overall weighted maturity of approximately five years.
Remaining exposures to banks held at amortised cost are predominantly short-term and relate to general banking facilities, money market
and repo facilities and fixed and floating rate notes. no impairments are held against these exposures. in addition there are unitilised and
uncommitted money market lines and repo facilities of approximately £1.7 billion predominantly in respect of spanish and italian banks. Bank
limits have been closely monitored with amounts and tenors reduced where appropriate.
net trading assets relate to exposures within the credit trading market-making business. there has been a large reduction in trading assets
in the year in line with the overall group balance sheet.
Derivative balances are shown at fair value adjusted where master netting agreements exist and net of cash collateral of £155 million. there are
credit default swap positions referenced to banking groups domiciled in italy (net long of £1 million and net short of £4 million) and spain (net
short of £10 million).
158
Annual Report and Accounts 2011
Risk mAnAgement
table 1.50: Asset Backed Securities (unaudited)
At 31 December 2011
Amortised cost
Available for sale:
Cost
AFs reserve
Total exposure
At 31 December 2010
Amortised cost
Available for sale:
Cost
AFs reserve
total exposure
Greece
£m
Ireland
£m
32
221
44
(21)
23
55
37
51
(13)
38
75
268
(113)
155
376
558
417
(108)
309
867
Italy
£m
26
14
(1)
13
39
467
149
(22)
127
594
Portugal
£m
208
219
(86)
133
341
241
261
(55)
206
447
Spain
£m
211
213
Total
£m
698
758
(49)
(270)
164
375
488
1,186
600
1,903
471
(84)
387
987
1,349
(282)
1,067
2,970
Country of exposure for asset backed securities are based on the location of the underlying assets.
Within the asset backed securities exposures, the underlying assets are primarily residential mortgages. no impairments are held against these
exposures. significant exposure reductions were achieved during 2011, primarily through asset sales.
159
Annual Report and Accounts 2011
Risk mAnAgement
table 1.51: Other financial institutions (unaudited)
At 31 December 2011
Amortised cost
Available for sale:
Cost
AFs reserve
net trading assets
Derivatives – other
Total exposure
At 31 December 2010
Amortised cost
Available for sale:
Cost
AFs reserve
net trading assets
Derivatives – other
total exposure
Greece
£m
Ireland
£m
–
–
–
–
–
–
–
–
–
–
–
–
–
–
255
–
–
–
5
12
272
33
23
–
23
17
1
74
Italy
£m
18
–
–
–
34
36
88
43
4
–
4
99
5
151
Portugal
£m
Spain
£m
–
–
–
–
8
11
19
58
–
–
–
5
2
65
–
–
–
–
27
–
27
77
–
–
–
68
1
146
Total
£m
273
–
–
–
74
59
406
211
27
–
27
189
9
436
exposures to other financial institutions primarily relate to balances held within insurance companies and funds. no impairments are held against
these exposures.
160
Annual Report and Accounts 2011
Risk mAnAgement
table 1.52: Other Corporate Exposures (unaudited)
At 31 December 2011
Amortised cost:
gross exposure
impairment allowances
net trading assets
Derivatives – other
On balance sheet exposures
Off balance sheet exposures
Total exposure
At 31 December 2010
Amortised cost:
gross exposure
impairment allowances
net trading assets
Derivatives – other
On balance sheet exposures
Off balance sheet exposures
total exposure
Greece
£m
Ireland
£m
Italy
£m
Portugal
£m
Spain
£m
Total
£m
407
(43)
364
–
19
383
48
431
384
(19)
365
–
6
371
102
473
15,910
(7,961)
7,949
–
31
7,980
914
8,894
17,512
(6,561)
10,951
47
36
11,034
598
11,632
69
(1)
68
–
–
68
13
81
135
(7)
128
–
2
130
98
228
125
(25)
100
–
2
102
196
298
130
(2)
128
–
–
128
139
267
2,192
18,703
(149)
(8,179)
2,043
10,524
–
167
2,210
725
2,935
1,849
(111)
1,738
–
38
1,776
993
2,769
–
219
10,743
1,896
12,639
20,010
(6,700)
13,310
47
82
13,439
1,930
15,369
Other Corporate balances within individual countries comprise:
greece – the exposures in greece principally relate to shipping loans to greek shipping companies where the assets are generally secured
and the vessels operate in international waters; repayment is mainly dependent on international trade and the industry is less sensitive to the
greek economy.
ireland – see page 155 for further details on irish exposures.
italy and Portugal – exposures comprise lending to corporates, including a small amount of commercial real estate exposure.
spain – the corporate exposure in spain is mainly local lending (90 per cent of the total spanish exposures) comprising corporate loans and
project finance facilities (81 per cent) and commercial real estate portfolio (19 per cent).
161
Annual Report and Accounts 2011
Risk mAnAgement
table 1.53: Retail Exposures (unaudited)
At 31 December 2011
Amortised cost:
gross exposure
impairment allowances
On balance sheet exposures
Off balance sheet exposures
Total exposure
At 31 December 2010
Amortised cost:
gross exposure
impairment allowances
On balance sheet exposures
Off balance sheet exposures
total exposure
Greece
£m
Ireland
£m
Italy
£m
Portugal
£m
Spain
£m
Total
£m
–
–
–
–
–
–
–
–
–
–
7,061
(1,034)
6,027
–
6,027
7,818
(616)
7,202
–
7,202
–
–
–
–
–
–
–
–
–
–
11
–
11
–
11
10
–
10
–
10
1,685
(70)
1,615
34
1,649
1,712
(35)
1,677
92
1,769
8,757
(1,104)
7,653
34
7,687
9,540
(651)
8,889
92
8,981
Retail exposures within spain are predominantly secured residential mortgages, where about half of the borrowers are expatriates. impaired
lending represents 6 per cent (31 December 2010: 6 per cent) of the portfolio, with a coverage ratio of 49 per cent (31 December 2010:
31 per cent). see page 155 for further details on irish exposures.
table 1.54: Insurance Assets (unaudited)
At 31 December 2011
At 31 December 2010
Greece
£m
–
–
Ireland
£m
68
107
Italy
£m
47
294
Portugal
£m
–
–
Spain
£m
39
110
Total
£m
154
511
Assets held by the insurance Business are held outside the with profits and unit linked funds. Approximately £127 million of these exposures relate
to direct investments where the issuer is resident in spain, italy or ireland and the credit rating is consistent with the tight credit criteria defined
under the appropriate investment mandate. the remaining exposures relate to interests in two funds administered by sWiP (the global Liquidity
Fund and the short term Fund) where in line with the investment mandates, cash is invested in the money markets. For these funds, which are
domiciled in ireland, the exposure is analysed on a look through basis to the underlying assets held and the insurance business’s pro rata share of
these assets rather than treating all the holding in the fund as exposure to ireland. Within the above exposures there are no sovereign exposures.
table 1.55: Other European Exposures (unaudited)
the group has the following exposures to sovereigns, banks, asset backed securities and other financial institutions in the following european
countries:
Austria
£m
Belgium
£m
France
£m
Germany
£m
Luxembourg
£m
Netherlands
£m
Switzerland
£m
At 31 December 2011
Direct sovereign exposure
Central Bank balances
Banks
Asset backed securities
Other financial institutions
At 31 December 2010
Direct sovereign exposure
Central Bank balances
Banks
Asset backed securities
Other financial institutions
2
–
202
–
5
–
–
762
–-
289
74
4
404
–
11
78
3
1,009
75
21
217
–
656
203
1,517
1,291
525
143
842
4
1,675
806
308
703
100
1,837
70
3,007
1,678
313
2
3
4
–
14
153
4
35
7
34
–
9,594
712
176
173
2
10,846
1,342
1,319
788
–
125
937
–
77
–
297
1,072
–
74
Banks and Financial institutions in the above countries may have exposures to other european countries that have standard and Poor’s rating of
A or lower.
162
Annual Report and Accounts 2011
Risk mAnAgement
environmental risk management
We work in line with group policies and procedures to manage the environmental impact of our lending activities. Our group wide Credit Risk
Policy requires all business loans to be assessed for material environmental risks as part of the credit sanctioning process.
in 2011, we launched an electronic environmental risk screening system, which is the primary mechanism for assessing environmental risk in
Wholesale. this provides real time screening of location specific and sector based risks that may be present in a transaction. Where a risk is
identified, the transaction is referred to our expert in-house environmental Risk team for further review and assessment, as outlined below.
Additional support is provided by the group’s panel of environmental consultants as required.
table 1.56: Our environmental risk management approach
Group Credit Policy
Environmental Risk
Divisional
C
redit Policies
Business Unit Processes
Initial
transaction
screening
Relationship
teams
Supporting tools
Detailed
review
Environmental
due diligence
Environmental
risk approval
In-house team, retained
consultancy
Panel
consultants
(including any conditions)
Sector briefings
Legislation briefings
Colleagues are trained in environmental risk management as part of our standard credit risk training course, and the team provides bespoke
training to teams upon request. supporting this training, a range of documents are provided to all colleagues online including environmental risk
theory, procedural guidance, and information on environmental legislation and sector-specific environmental impacts.
Project Finance: equator Principles
Lloyds Banking group is a signatory to the equator Principles. these support our approach to assessing and managing environmental and social
issues in project finance. Project finance is often used to fund the development and construction of major infrastructure and industrial projects.
the equator Principles are applicable to project finance transactions above Us$10 million and provide a framework to support responsible
decision-making.
We have a robust, group wide approach to assess, monitor and report equator Principle transactions. We also provide ongoing training for lending
officers; information on the equator Principles is included in all our training and we offer more in-depth training for staff working in project finance.
Projects are categorised depending on the level of perceived risk and magnitude of impact they pose, in relation to a set of criteria issued by the
international Finance Corporation (iFC).
the categories are as follows:
Category A – Projects with potential significant adverse social or environmental impacts that are diverse, irreversible or unprecedented;
Category B – Projects with potential limited adverse social or environmental impacts that are few in number, generally site-specific, largely
reversible and readily addressed through mitigation measures; and
Category C – Projects with minimal or no social or environmental impacts.
Lending officers are responsible for undertaking initial classification of transactions that qualify under the equator Principles. their assessments
are subject to further review by our in-house environmental Risk team, and for higher risk transactions by our equator Principles Review group,
comprising experts from both our Risk and Project Finance teams. this ensures that each transaction is compliant and is consistent with our
environmental risk policy. We provide a range of training and support materials to our risk and transactional staff to ensure that they are familiar
with the requirements of the Principles.
in 2011, we participated in the equator Principles strategic Review process which examined the scope of application, transparency,
implementation and governance of the Principles. it is the first step of a longer term process to determine the future direction of the Principles and
ensure they are fit for purpose. We believe that the collective effort of financial institutions will ensure that the equator Principles continue to play
an industry leading role and will continue to engage in the update process.
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Risk mAnAgement
table 1.57: Status of Categorised Projects (unaudited)
Completed
in Progress
not Completed
table 1.58: Status of Projects by Industry (unaudited)
Completed
in Progress
not Completed
A
–
1
–
1
B
15
4
2
21
C
10
4
4
18
Renewables
Infrastructure
Energy and
Utilities
16
5
2
23
4
3
4
11
5
1
–
6
Total
25
9
6
40
Total
25
9
6
40
throughout 2011, the group continued to provide finance for a wide range of projects within the renewables, energy & utilities and infrastructure
sectors that have the capability to deliver positive social and environmental outcomes. this year saw a 56 per cent increase in the value of
renewables projects that the group provided finance for compared to 2010. When completed, renewable projects within the Uk funded during
2011 will provide over 540,000 homes with renewable energy, avoiding tens of thousands of tonnes of CO2 emissions each year.
table 1.59: Industry of Completed Transactions (unaudited)
Renewables
infrastructure
energy & Utilities
table 1.60: Geography of Completed Transactions (unaudited)
Uk
Americas
europe
Australasia
No.
16
5
4
25
C
4
5
–
1
10
£m
611
316
123
1,050
Total
9
12
1
3
25
A
–
–
–
–
–
B
5
7
1
2
15
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Risk mAnAgement
Market risk
Definition
the risk of reductions in earnings, value, capital and/or reserves, through financial or reputational loss, arising from unexpected changes in financial
prices, including interest rates, inflation rates, exchange rates, credit spreads and prices for bonds, commodities, equities, property and other
instruments. it arises in all areas of the group’s activities and is managed by a variety of different techniques.
Risk appetite
market risk appetite is defined with regard to the quantum and composition of market risk that currently exists in the group and the group’s risk
preferences.
this statement of the group’s overall appetite for market risk is reviewed and approved annually by the Board. With the support of the group
Asset and Liability Committee, the group Chief executive allocates this risk appetite across the group. individual members of the group executive
Committee ensure that market risk appetite is further delegated to an appropriate level within their areas of responsibility.
Exposures
the group’s banking activities expose it to the risk of adverse movements in interest rates, credit spreads, exchange rates and equity prices,
with little or no exposure to commodity risk. the volatility of market values can be affected by both the transparency of prices and the amount of
liquidity in the market for the relevant asset.
most of the group’s trading activity is undertaken to meet the requirements of wholesale and retail customers for foreign exchange and interest
rate products. However, some interest rate, exchange rate and credit spread positions are taken using derivatives and other on-balance sheet
instruments with the objective of earning a profit from favourable movements in market rates.
market risk in the group’s retail portfolios and in the group’s capital and funding activities arises from the different repricing characteristics of the
group’s non-trading assets and liabilities. interest rate risk arises predominantly from the mismatch between interest rate insensitive liabilities and
interest rate sensitive assets.
Risk also arises from the margin of interbank rates over central bank rates. A further banking risk arises from competitive pressures on product
terms in existing loans and deposits, which sometimes restricts the group in its ability to change interest rates applying to customers in response
to changes in interbank and central bank rates.
Foreign currency risk also arises from the group’s investment in its overseas operations.
the group’s insurance activities also expose it to market risk, encompassing interest rate, exchange rate, property, credit spreads and equity risk:
– With Profit Funds are managed with the aim of generating rates of return consistent with policyholders’ expectations and this involves the
mismatch of assets and liabilities.
– Unit-linked liabilities are matched with the same assets that are used to define the liability but future fee income is dependent upon the
performance of those assets. (this forms part of the Value of in-force business, see note 30 to the financial statements on page 260).
– For other insurance liabilities the aim is to invest in assets such that the cash flows on investments will match those on the projected future
liabilities. it is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the
required maturities. As a result, the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.
– surplus assets are held primarily in four portfolios: (a) in the long-term funds of scottish Widows plc and its subsidiaries; (b) in the shareholder
funds of life assurance companies; (c) investment portfolios within the general insurance business and (d) within the main fund of Heidelberger
Lebensversicherung Ag.
the group’s defined benefit staff pension schemes are exposed to significant risks from the constituent parts of their assets and from the present
value of their liabilities, primarily equity and real interest rate risk. For further information on pension scheme assets and liabilities please refer to
note 43 to the financial statements on page 275.
Measurement
the following market risk measures are used for risk reporting and setting risk appetite limits and triggers:
– Value at Risk (VaR): for short term liquid positions a 1-day 95 per cent VaR is used; for structural positions a 1-year 95 per cent VaR is used
– standard stresses: interest Rates 25bp; equities 10 per cent; Credit spreads relative 30 per cent widening
– Bespoke extreme stress scenarios: e.g. stock market crash
Both VaR and standard stress measures are also used in setting divisional market risk appetite limits and triggers.
Although an important market standard measure of risk, VaR has limitations. these arise from the use of limited historical data, an assumed
distribution, defined holding periods, set confidence intervals and frequency of calculation. the exposure level at the confidence interval does
not convey any information about potential losses which may arise if this level is exceeded. A 95 per cent confidence interval with a 1 day holding
period is equivalent to an expected 1 in 20 day loss. Where VaR models are less well suited to the nature of positions, the group recognises these
limitations and supplements its use with a variety of other techniques. these reflect the nature of the business activity, and include interest rate
repricing gaps, open exchange positions and sensitivity analysis. stress testing and scenario analysis are also used in certain portfolios and at
group level, to simulate extreme conditions to supplement these core measures. trading book VaR (1-day 99 per cent) is compared daily against
both forecast and actual profit and loss.
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Risk mAnAgement
trading assets and other treasury positions
Based on the 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding 300 business
days, the VaR for the years ended 31 December 2011 and 2010 based on the group’s global trading positions as detailed in table 1.61.
the risk of loss measured by the VaR model is the potential loss in earnings given the confidence level and assumptions noted above. the total
and average trading VaR does not assume any diversification benefit across the five risk types, which now includes inflation. the maximum and
minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported as a whole.
the group internally uses VaR as the primary measure for all trading book positions arising from short term market facing activity.
table 1.61: VaR trading assets and other treasury positions (see ‘Measurement’ page 164) (audited)
interest rate risk
Foreign exchange risk
equity risk
Credit spread risk
inflation risk
Total VaR
Close
£m
2.6
0.4
–
3.1
0.2
6.3
2011
Average
£m
Maximum
£m
Minimum
£m
2010
Close
£m
3.0
0.5
–
2.3
0.2
6.0
5.9
1.6
–
4.5
0.5
9.7
1.8
0.2
–
1.0
0.1
4.1
3.9
0.4
–
1.6
0.3
6.2
non-trading
market risk in non-trading books consists almost entirely of exposure to changes in interest rates including the margin between interbank and
central bank rates. this is the potential impact on earnings and value that could occur when, if rates fall, liabilities cannot be re-priced as quickly
or by as much as assets; or when, if rates rise, assets cannot be re-priced as quickly or by as much as liabilities.
Risk exposure is monitored monthly using, primarily, market value sensitivity. this methodology considers all re-pricing mismatches in the current
balance sheet and calculates the change in market value that would result from a set of defined interest rate shocks. Where re-pricing maturity is
based on assumptions about customer behaviour these assumptions are also reviewed monthly.
A limit structure exists to ensure that risks stemming from residual and temporary positions or from changes in assumptions about customer
behaviour remain within the group’s risk appetite.
the following table shows, split by material currency, Lloyds Banking group sensitivities as at 31 December 2011 to an immediate up and down
25 basis points change to all interest rates.
table 1.62: Non-trading (audited)
sterling
Us Dollar
euro
Australian Dollar
Other
Total
2011
2010
Up 25bps
£m
Down 25bps
£m
Up 25bps
£m
Down 25bps
£m
(53.1)
(0.4)
(15.7)
(1.8)
(1.4)
(72.4)
54.7
0.3
15.9
1.8
1.3
74.0
(86.9)
11.1
8.9
(1.2)
(3.0)
(71.1)
88.4
(11.4)
(9.0)
1.2
3.1
72.3
Base case market value is calculated on the basis of the Lloyds Banking group current balance sheet with re-pricing dates adjusted according to
behavioural assumptions. the above sensitivities show how this projected market value would change in response to an immediate parallel shift
to all relevant interest rates – market and administered.
this is a risk based disclosure and the amounts shown would be amortised in the income statement over the duration of the portfolio.
the measure, however, is simplified in that it assumes all interest rates, for all currencies and maturities, move at the same time and by the
same amount.
Pension schemes
management of the assets of the group’s defined benefit pension schemes is the responsibility of the scheme trustees, who also appoint the
scheme Actuaries to perform the triennial valuations. the group monitors its pensions exposure holistically using a variety of metrics including
accounting and economic deficits and contribution rates. these and other measures are regularly reviewed by the group Asset and Liability
Committee and the group market Risk Committee and used in discussions with the trustees, through whom any risk management and mitigation
activity must be conducted.
the schemes’ main exposures are to equity risk, real rate risk and credit spread risk. Accounting for the pension schemes under international
Accounting standard (iAs)19 spreads any adverse impacts of these risks over time.
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Risk mAnAgement
insurance portfolios
the group’s market risk exposure in respect of insurance activities described above is measured using eeV as a proxy for economic value. the
pre-tax sensitivity of eeV to standardised stresses is shown below for the years ended 31 December 2011 and 2010. impacts have only been shown
in one direction but can be assumed to be reasonably symmetrical. Opening and closing numbers only have been provided as this data is not
volatile and consequently is not tracked on a daily basis.
table 1.63: Insurance portfolios (audited)
equity risk (impact of 10% fall pre-tax)
interest rate risk (impact of 25 basis point reduction pre-tax)
Credit spread risk (impact of relative 30% widening)
2011
£m
(339.4)
59.2
(237.3)
2010
£m
(367.4)
82.1
(163.0)
Mitigation
Various mitigation activities are undertaken across the group to manage portfolios and seek to ensure they remain within approved limits.
Banking – non-trading activities
interest rate risk arising from the different repricing characteristics of the group’s non-trading assets and liabilities, and from the mismatch between
interest rate insensitive assets and interest rate sensitive liabilities, is managed centrally. matching assets and liabilities are offset against each other
and interest rate swaps are also used to manage the residual exposure to within the non-traded market Risk Appetite.
the corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign
exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled within the trading Risk
Appetite and any residual risk is hedged in the market.
insurance activities
investment holdings are diversified across markets and, within markets, across sectors. Holdings are diversified to minimise specific risk and
the relative size of large individual exposures is monitored closely. For assets held outside unit-linked funds, investments are only permitted in
countries and markets which are sufficiently regulated and liquid.
Monitoring
the group Asset and Liability Committee and the group market Risk Committee regularly review high level market risk exposure including, but
not limited to, the data described above. they also make recommendations to the group Chief executive concerning overall market risk appetite
and market risk policy. exposures at lower levels of delegation are monitored at various intervals according to their volatility, from daily in the case
of trading portfolios to monthly or quarterly in the case of less volatile portfolios. Levels of exposures compared to approved limits are monitored
by Risk Division and where appropriate, escalation procedures are in place.
Banking activities
trading is restricted to a number of specialist centres, the most important centre being the treasury and trading business in London. these centres
also manage market risk in the wholesale non-trading portfolios, both in the Uk and internationally. the level of exposure is strictly controlled and
monitored within approved limits. Active management of the wholesale portfolios is necessary to meet customer requirements and changing
market circumstances.
market risk in the group’s retail portfolios and in the group’s capital and funding activities is managed centrally within limits defined in the detailed
group policy for interest rate risk in the banking book, which is reviewed and approved annually.
insurance activities
market risk exposures from the insurance businesses are controlled via approved investment policies and triggers set with reference to the group’s
overall risk appetite and regularly reviewed by the group market Risk Committee:
– the With Profit Funds are managed in accordance with the relevant fund’s principles and practices of financial management and legal
requirements.
– the investment strategy for other insurance liabilities is determined by the term and nature of the underlying liabilities and asset/liability
matching positions are actively monitored. Actuarial tools are used to project and match the cash flows.
– investment strategy for surplus assets held in excess of liabilities takes account of the legal, regulatory and internal business requirements for
capital to be held to support the business now and in the future.
the group also agrees strategies for the overall mix of pension assets with the pension scheme trustees.
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Risk mAnAgement
Operational risk
Definition
the risk of reductions in earnings and/or value, through financial or reputational loss, from inadequate or failed internal processes and systems,
or from people related or external events.
there are a number of categories of operational risk:
Regulatory
Regulatory risk is the risk of reductions in earnings and/or value, through financial or reputational loss, from failing to comply with the applicable
laws, regulations or codes.
Customer treatment
the risk of regulatory censure and/or a reduction in earnings/value through financial or reputational loss, from inappropriate or poor
customer treatment.
People
the risk of reductions in earnings or value through financial or reputational loss arising from ineffectively leading colleagues responsibly and
proficiently, managing people resource, supporting and developing colleague talent, or meeting regulatory obligations related to our people.
supplier management
the risk of reductions in earnings and/or value through financial or reputational loss from services with outsourced partners or third-party suppliers.
Customer processes
the risk of reductions in earnings and/or value, through financial or reputational loss, resulting from poor externally facing business processes.
Customer process risk includes customer transaction and processing errors due to incorrect capturing of customer information and/or
system failure.
Financial crime
the risk of reductions in earnings and/or value, through financial or reputational loss, associated with financial crime and failure to comply with
related regulatory obligations, these losses may include censure, fines or the cost of litigation. this includes risks associated with fraud and bribery.
money laundering and sanctions
the risk of reductions in earnings and/or value, through financial or reputational loss, associated with failure to comply with prevailing regulatory
obligations on activities related to money laundering, sanctions and counter terrorism, these losses may include censure, fines or the cost
of litigation.
security
the risk of reductions in earnings and/or value, through financial or reputational loss, resulting from theft of or damage to the group’s assets, the
loss, corruption, misuse or theft of the group’s information assets or threats or actual harm to the group’s people. this also includes risks relating
to terrorist acts, other acts of war, geopolitical, pandemic or other such events.
it systems
the risk of reductions in earnings and/or value through financial or reputational loss resulting from the failure to develop, deliver or maintain
effective it solutions.
Change
the risk of reductions in earnings and/or value, through financial or reputational loss, from change initiatives failing to deliver to requirements,
budget or timescale, failing to implement change effectively or failing to realise desired benefits.
Organisational infrastructure
the risk of reductions in earnings and/or value, through financial or reputational loss, resulting from poor internally facing business processes at
group, divisional or business unit level. Organisational infrastructure in this context embraces the structures, systems and processes that provide
direction, control and accountability for the enterprise.
Risk appetite
the group has developed an impact on earnings approach to operational risk appetite. this involves looking at how much the group could lose
due to operational risk losses at various levels of certainty.
in setting operational risk appetite, the group looks at both impact on solvency and the group’s reputation.
the group has zero risk appetite for regulatory breaches or systemic unfair outcomes for customers. to achieve this, the group encourages and
maintains an appropriately balanced regulatory compliance culture and promotes policies and procedures to enable businesses and their staff to
operate in accordance with the laws, regulations and voluntary codes which impact on the group and its activities.
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Risk mAnAgement
Exposures
By its very nature, operational risks can arise from a wide range of the group’s activities that involve people, processes and systems. the group’s
principal operational risks relate to the group’s ability to attract, retain and motivate its people, the rate and scale of change arising from the
group’s strategic review programme, the way in which the group treats its customers and the regulatory environment in which it operates.
the group continues to face risks relating to its ability to attract, retain, and develop high calibre talent, as a result of challenges arising from
ongoing regulatory and public interest in remuneration practices. in addition there is uncertainty from eU state aid requirements and independent
Commission on Banking proposals on banking reform.
the breadth of the strategic review programme is such that all parts of the group are impacted to a degree. the risks associated with the
programme, including implementation and delivery, are the subject of rigorous oversight by business areas and Risk Division, with challenges by
internal Audit, commensurate to the scale of the change.
Customer treatment and how the group manages its customer relationships affect all aspects of the group’s operations and are closely aligned
with achievement of the group’s strategic aim – to be the best bank for customers. there is currently a high level of scrutiny regarding the
treatment of customers by financial institutions from the press, politicians and regulatory bodies (see note 54 to the financial statements).
Regulatory exposure is driven by the significant volume of current legislation and regulation within the Uk and overseas with which the
group has to comply, along with new or proposed legislation and regulation which needs to be reviewed, assessed and embedded into day-to-day
operational and business practices across the group as a whole. this is particularly the case in the current market environment, which is witnessing
increased levels of government and regulatory intervention in the banking sector.
Measurement
Operational risks are measured against a set of risk appetite metrics, with appropriate limits and triggers, which have been approved by the Board.
Mitigation
the group’s operational risk management framework consists of the following key components:
– identification and categorisation of the key operational risks facing a business area, including defining risk appetite.
– Risk assessment, including impact assessment of financial and non-financial impacts (e.g. reputational risk) for each of the key risks to which the
business area is exposed.
– Control assessment, evaluating the effectiveness of the control framework covering each of the key risks to which the business area is exposed.
– Loss and incident management, capturing actions to manage any losses facing a business area.
– the development of key Risk indicators for management reporting, including the monitoring of risk appetite.
– Oversight and assurance of the risk management framework in businesses.
– scenarios for estimation of potential loss exposures for material risks.
the group purchases insurance to mitigate certain operational risk events.
Monitoring
Business unit risk exposure is reported to Risk Division where it is aggregated at group level and a report prepared. the report is discussed at the
monthly group Operational Risk Committee and Compliance & Conduct Committee. these committees can escalate matters to the Chief Risk
Officer, or higher committees, if appropriate.
the insurance programme is monitored and reviewed regularly, with recommendations being made to the group’s senior management annually
prior to each renewal. insurers are monitored on an ongoing basis, to ensure counterparty risk is minimised. A process is in place to manage any
insurer rating changes or insolvencies.
the group has adopted a formal approach to operational risk event escalation. this involves the identification of an event, an assessment of the
materiality of the event in accordance with a risk event impact matrix and appropriate escalation.
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Risk mAnAgement
Insurance risk
Definition
the risk of reductions in earnings capital and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity
of insured/underwritten events and to fluctuations in the timing and amount of claim settlements. this includes fluctuations in profits due to customer
behaviour.
Risk appetite
insurance risk appetite is defined with regard to the quantum and composition of insurance risk that exists currently in the group and the group’s
risk preferences. it takes account of the need for each entity in the group to maintain solvency in excess of the minimum level required by the
entity’s jurisdictional legal or regulatory requirements.
the group’s appetite for solvency and earnings in insurance entities is reviewed and approved annually by the Board.
Exposures
the major sources of insurance risk within the group are the insurance businesses and the group’s defined benefit staff pension schemes.
the nature of insurance business involves the accepting of insurance risks which relate primarily to mortality, longevity, morbidity, persistency,
expenses, property damage and unemployment. the prime insurance risk of the group’s staff pension schemes is related to longevity.
Measurement
insurance risks are measured using a variety of techniques including stress and scenario testing; and, where appropriate, stochastic modelling.
Current and potential future insurance risk exposures are assessed and aggregated using risk measures based on 1-in-2001 year stresses and other
supporting measures where appropriate, including those set out in notes 38 and 39 to the financial statements.
Mitigation
A key element of the control framework is the consideration of insurance risk by a suitable combination of high level Committees/Boards. For the life
assurance businesses the key control bodies are the Board of scottish Widows group Limited (sWg) with the more significant risks also being subject to
review by the group executive Committee and/or Board. For the general insurance businesses the key control bodies which are subsidiary entity Boards
of sWg are the Boards of the legal entities including Lloyds tsB general insurance Limited, st. Andrew’s insurance plc and the irish subsidiaries.
All group staff pension schemes issues are covered by the group Asset and Liability Committee and the group Risk Committee.
the overall insurance risk is mitigated through pooling and through diversification across large numbers of individuals, geographical areas, and
different types of risk exposure.
insurance risk is primarily controlled via the following processes:
– Underwriting (the process to ensure that new insurance proposals are properly assessed)
– Pricing-to-risk (new insurance proposals are priced to cover the underlying risks inherent within the products)
– Claims management
– Product design
– Policy wording
– Product management
– the use of reinsurance or other risk mitigation techniques.
in addition, exposure limits by risk type are derived from the business planning process and used as a control mechanism to ensure risks are taken
within solvency risk appetite.
At all times, close attention is paid to the adequacy of reserves, solvency management and regulatory requirements.
the most significant insurance risks in the life assurance companies are longevity risk and persistency risk. the merits of longevity risk transfer and
hedging solutions are regularly reviewed.
general insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread
over different reinsurers. Detailed modelling, including that of the potential losses under various catastrophe scenarios, supports the choice of
reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses with significant mortality risk
and morbidity risk being transferred to our chosen reinsurers.
Options and guarantees are incorporated in new insurance products only after careful consideration of the risk management issues that they present.
in respect of insurance risks in the staff pension schemes, the group ensures that effective communication mechanisms are in place for
consultation with the trustees to assist with the management of risk in line with the group’s risk appetite.
Monitoring
Ongoing monitoring is in place to track the progression of insurance risks. this normally involves monitoring relevant experiences against
expectations (for example claims experience, option take up rates, persistency experience, expenses, non-disclosure at the point of sale), as well
as evaluating the effectiveness of controls put in place to manage insurance risk. Reasons for any significant divergence from experience
are investigated and remedial action is taken.
1
group pension schemes utilise 1-in-20 year stresses
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Annual Report and Accounts 2011
Risk mAnAgement
Business risk
Definition
Business risk is defined as the risk that the group’s earnings are adversely impacted by a sub optimal business strategy or the sub optimal
implementation of the strategy. in assessing business risk, consideration is given to internal and external factors.
Risk appetite
Business risk appetite is encapsulated in the group’s budget and medium-term plan, which are sanctioned by the Board on an annual basis.
Divisions’ and business units’ plans are aligned to the group’s overall business risk appetite.
Exposures
the group’s portfolio of businesses exposes it to a number of internal and external factors:
– internal factors: resource capability and availability, customer treatment, service level agreements, products and funding and the risk appetite
of other risk categories; and
– external factors: economic, technological, political, social and ethical, environmental, regulatory, market expectations, reputation and
competitive behaviour.
Measurement
An annual business planning process is conducted at group, divisional and business unit level which includes a quantitative and qualitative
assessment of the risks that could impact the group’s plans. Within the planning round, the group conducts both scenario analysis and stress tests
to assess risks to future earning streams. stress testing and scenario analysis are fully embedded in the group’s risk management practice. the
group assesses a wide array of scenarios including economic recessions, regulatory action scenarios, scenarios specific to the operations of each
part of the business, as well as reverse stress tests.
Mitigation
As part of the annual business planning process, the group develops a set of management actions to prevent or mitigate the impact on earnings
in the event that business risks materialise. Additionally, business risk monitoring, through regular reports and oversight, results in corrective
actions to plans and reductions in exposures where necessary.
Revenue and capital investment decisions require additional formal assessment and approval. Formal risk assessment is conducted as part of the
financial approval process. significant mergers and acquisitions by business units require specific approval by the Board. in addition to the standard due
diligence conducted during a merger or acquisition, Risk Division conducts, where appropriate, an independent risk assessment of the target company.
Monitoring
the group’s strategy is reviewed and approved by the Board, which includes the group executive Committee and the group Risk Committee.
Regular reports are provided to the group executive Committee and the Board on the progress of the group’s key strategies and plans, including
assessment of performance against Risk Appetite.
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Annual Report and Accounts 2011
governanceBoard of Directors 172Directors’ report 174Corporate governance report 177Directors’ remuneration report 187 172
Annual Report and Accounts 2011
BOARD OF DIRECTORS
Non-Executive Directors
Sir Winfried Bischoff
Chairman
Lord Leitch
Deputy Chairman
Independent Director
(Until 29 February 2012)
NG
Re
Ri
A
NG Re
Joined the Board and was appointed Chairman in September 2009. Previously Chairman
of Citigroup Inc. from December 2007 to February 2009. He joined J Henry Schroder & Co in
January 1966 and became Managing Director of Schroders Asia in 1971. Group Chief Executive
of Schroders in 1984 and Chairman in 1995. Following the acquisition of Schroders’ investment
banking business by Citigroup in 2000, became Chairman of Citigroup Europe before being
appointed acting Chief Executive Officer of Citigroup in 2007 and subsequently as Chairman
in the same year. A Non-Executive Director of Eli Lilly and Company, and The McGraw Hill
Companies Inc. in the United States. He is a member of Akbank International Advisory Board
and Chairman of the Advisory Council of TheCityUK. Aged 70.
Joined the Board in October 2005 and was appointed Deputy Chairman in May 2009.
Appointed Chairman of Scottish Widows in 2007. Held a number of senior and general
management appointments in Allied Dunbar, Eagle Star and Threadneedle Asset
Management before the merger of Zurich Group and British American Tobacco’s financial
services businesses in 1998. Subsequently served as Chairman and Chief Executive Officer
of Zurich Financial Services United Kingdom, Ireland, Southern Africa and Asia Pacific, until his
retirement in 2004. Chairman of the Government’s Review of Skills (published in December
2006). Chairman of BUPA and Intrinsic Financial Services. Chairman of Medical Aid Films and
Chancellor of Carnegie College. Former Chairman of the National Employment Panel and of
the ABI. Aged 64.
Anita M Frew
Independent Director
Sir Julian Horn-Smith
Independent Director
(Until 17 May 2012)
A
Ri
NG Re
Ri
Joined the Board in December 2010. Chairman of Victrex, the FTSE 250 global manufacturer
of high performance polymers, having previously been the Senior Independent Director.
Since 2000, she has held a portfolio of Non-Executive Directorships, currently holding positions
as Senior Non-Executive Director of Aberdeen Asset Management and as Non-Executive
Director of IMI. Prior to this she was Executive Director of Abbott Mead Vickers, Director of
Corporate Development at WPP Group and a Non-Executive Director of Northumbrian Water
and has held various investment and marketing roles at Scottish Provident and the Royal Bank
of Scotland. Aged 54.
Joined the Board in January 2005. Held a number of senior and general management
appointments in Vodafone from 1984 to 2006 including a directorship of that company from
1996, Group Chief Operating Officer from 2001 and Deputy Chief Executive Officer from 2005.
Previously held positions in Philips from 1978 to 1982 and Mars GB from 1982 to 1984.
A Non-Executive Director of Acer Incorporated (Taiwan), De La Rue, Digicel Group and
Emobile (Japan), a Director of Sky Malta, a member of the Altimo International Advisory Board
and a senior adviser to UBS and CVC Capital Partners in relation to the global
telecommunications sector. Deputy Chairman of BUMI. Pro Chancellor of University of Bath.
A former Chairman of The Sage Group. Aged 63.
Glen R Moreno
Senior Independent Director
(Until 17 May 2012)
(Deputy Chairman from
1 March 2012 to 17 May 2012)
David L Roberts
Independent Director
(Deputy Chairman from 17 May 2012)
NG
A
NG
Re
Ri
Joined the Board in March 2010. Chairman of Pearson, the media group, since October 2005.
Director of Fidelity International, one of the world’s largest fund management companies, and
Chairman of its Audit Committee. Deputy Chairman of The Financial Reporting Council. From
1987 to 1991 was Chief Executive of Fidelity International. Until mid 2009, was a Non-Executive
Director and Senior Independent Director of Man Group, a FTSE 100 financial services group,
and acting Chairman of UKFI. Former Group Executive of Citigroup; from 1969 to 1987 he held a
number of senior positions at the bank in Europe and Asia. Aged 68.
Joined the Board in March 2010. Executive Director, member of the Group Executive
Committee and Chief Executive, International Retail and Commercial Banking at Barclays until
December 2006. Joined Barclays in 1983 and held various senior management positions,
including Chief Executive, Personal Financial Services, and Chief Executive, Business Banking.
Was also a Non-Executive Director of BAA until June 2006 and a Non-Executive Director of
Absa Group Limited, one of South Africa’s largest financial services groups, until October 2006.
From 2007 to 2009 he was also the Chairman and Chief Executive of BAWAG P.S.K. AG, the
second largest retail bank in Austria. Non-Executive Chairman of The Mind Gym. Aged 49.
T Timothy Ryan, Jr
Independent Director
Martin A Scicluna
Independent Director
A
Re
Ri
A
NG
Ri
Joined the Board in March 2009. President and Chief Executive of the Securities Industry and
Financial Markets Association. Held a number of senior appointments in JP Morgan Chase from
1993 to 2008 including Vice Chairman, financial institutions and governments, from 2005.
A Director of the US-Japan Foundation, Great-West Life Insurance Co., Power Corporation of
Canada and Power Financial Corporation and a member of the Global Markets Advisory
Committee for the National Intelligence Council. A former Director in the Office of Thrift
Supervision, US Department of the Treasury and Koram Bank and the International Foundation
of Election Systems. Aged 66.
Joined the Board in September 2008. Chairman of Deloitte UK from 1995 to 2007 and a
member of the Board from 1991 to 2007. Joined the firm in 1973 and was a partner from 1982
until he retired in 2008. A member of the Board of directors of Deloitte Touche Tohmatsu from
1999 to 2007. Chairman of Great Portland Estates. A Governor of Berkhamsted School. Aged 61.
173
Annual Report and Accounts 2011
BOARD OF DIRECTORS
Anthony Watson cbe
Independent Director
(Senior Independent Director
from 17 May 2012)
A
NG Re
Executive Directors
António Horta-Osório
Group Chief Executive
Joined the Board in April 2009. Previously Chief Executive of Hermes Pensions Management.
Held a number of senior appointments in AMP Asset Management from 1991 to 1998.
A Non-Executive Director of Hammerson, Vodafone and Witan Investment Trust, a member
of the Norges Bank Investment Management Advisory Board and Chairman of Lincoln’s Inn
Investment Committee. A former Chairman of MEPC, the Asian Infrastructure Fund and
of the Strategic Investment Board (Northern Ireland) and a former member of the Financial
Reporting Council. Aged 66.
Joined the Board in January 2011 as an Executive Director and became Group Chief Executive
in March 2011. Started his career at Citibank Portugal where he was head of capital markets.
At the same time, was an assistant professor at Universidade Catolica Portuguesa. Then worked
for Goldman Sachs in New York and London. In 1993, joined Grupo Santander as Chief
Executive of Banco Santander de Negocios Portugal and then became Chief Executive Officer
of Banco Santander Brazil. In 2000, became Chief Executive Officer of Santander Totta, and
Chairman from 2006 until 2011, as well as Executive Vice President of Grupo Santander and a
member of its Management Committee. Joined Santander UK, as a Non-Executive Director in
November 2004 and from August 2006 until November 2010, was its Chief Executive. Formerly
a Non-Executive Director of the Court of the Bank of England. A Non-Executive Director of
Fundação Champalimaud in Portugal. Aged 48.
Sara V Weller
Independent Director
Re
Ri
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.
Committee roles and responsibilities
Harry F Baines
Company Secretary
A
Audit Committee
To monitor and review the formal arrangements established by the
Board in respect of the financial statements and reporting of the
Group; internal controls and the risk management framework; internal
audit; and the Group’s relationship with its external auditors.
NG
Nomination & Governance Committee
To keep the Board’s governance arrangements under review and
make appropriate recommendations to the Board to ensure that the
Company’s arrangements are consistent with best practice corporate
governance standards.
Re
Remuneration Committee
To set the principles and parameters of remuneration policy for the
Group, and to oversee remuneration policy and outcomes for those
colleagues covered by the scope of the Committee.
Ri
Risk Committee
To review and report its conclusions to the Board on the Group’s
risk appetite and risk management framework. The Committee has
a forward looking perspective, anticipating changes in business
conditions.
Chairman of committee
174
Annual Report and Accounts 2011
DIRECTORS’ REPORT
Results
The consolidated income statement shows a loss attributable to equity shareholders for the year ended 31 December 2011 of £2,714 million.
Principal activities
The Company is a holding company and its subsidiary undertakings provide a wide range of banking and financial services through branches and
offices in the UK and overseas.
Business review, future developments and financial risk management objectives and policies
The information that fulfils the requirements of the business review, future developments and financial risk management objectives and policies
can be found in the following sections of the annual report, which are incorporated into this report by reference:
Business review and future developments
Key performance indicators
Financial risk management objectives and internal control policies
Principal risks and uncertainties
Pages
10 to 170
6 and 7
99 to 170 and page 186
106 to 111
Financial risk management objectives and internal control policies in relation to the use
of financial instruments
99 to 170 (and in note 56 on pages 320 to 339)
Post balance sheet events
There have been no material post balance sheet events.
Going concern
The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining
adequate levels of capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the
foreseeable future, the directors have considered a number of key dependencies which are set out in the risk management section under principal
risks and uncertainties: liquidity and funding on pages 106 and 107 and financial soundness on pages 112 to 128 and additionally have considered
projections for the Group’s capital and funding position. Having considered these, the directors consider that it is appropriate to continue to adopt
the going concern basis in preparing the accounts.
Directors
Biographical details of directors are shown on pages 172 and 173. Particulars of their emoluments and interests in shares in the Company are given
on pages 187 to 203. Changes to the composition of the Board since 1 January 2011 up to the date of this report are shown below:
Joined the Board
Retired from the Board
Mr A Horta-Osório (became Group Chief Executive on 1 March 2011)
17 January 2011
Mr J E Daniels
Mr A G Kane
Mrs H A Weir
Ms S V Weller
Mr G T Tate
Mr T J W Tookey
1 February 2012
28 February 2011
18 May 2011
18 May 2011
6 February 2012
24 February 2012
Lord Leitch will retire from the Board on 29 February 2012. Sir Julian Horn-Smith and Mr Moreno will retire from the Board on 17 May 2012.
Ms S V Weller has been appointed to the Board since the annual general meeting held in 2011 and will therefore stand for election at the
forthcoming annual general meeting.
In the interests of good corporate governance and in accordance with the provisions of the UK Corporate Governance Code, the Board has
decided that all of the other directors will retire voluntarily and those willing to serve again will submit themselves for re-election at the annual
general meeting.
Directors’ conflicts of interest
The Board, as permitted by the Company’s articles of association, has authorised all potential conflicts of interest that have been declared by
individual directors. Decisions regarding these conflicts of interest could be and were only taken by directors who had no interest in the matter.
In taking the decision, the directors acted in a way they considered, in good faith, would be most likely to promote the Company’s success. The
directors have the ability to impose conditions, if thought appropriate, when granting authorisation. Any authorities given are reviewed at least
every 15 months. No director is permitted to vote on any resolution or matter where he or she has an actual or potential conflict of interest. The
Board confirms that no material conflicts were reported to it during the year.
175
Annual Report and Accounts 2011
DIRECTORS’ REPORT
Directors’ indemnities
The directors of the Company, including the former directors who retired during the year and since the year end, have entered into individual
deeds of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity
provisions’ for the purposes of the Companies Act 2006. In addition, the Company has granted a deed of indemnity through deed poll which
constituted ‘third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ to the directors of the Group’s subsidiary
companies, including to former directors who retired during the year and since the year end. The deeds were in force during the whole of the
financial year or from the date of appointment in respect of the directors who joined the boards in 2011 and 2012. The indemnities remain in force
for the duration of a director’s period of office. The deeds indemnify the directors to the maximum extent permitted by law. Deeds for existing
directors are available for inspection at the Company’s registered office.
Corporate governance report
The corporate governance report can be found on pages 177 to 186 and, together with this directors’ report of which it forms part, fulfils the
requirements of the Corporate Governance Statement for the purpose of the FSA’s Disclosure and Transparency Rules.
Share capital
Information about share capital and dividends is shown in notes 47 and 51 on pages 290 to 292 and page 295 and is incorporated into this report
by reference. The Company did not repurchase any ordinary shares of 10p each during the year.
As at the date of this report a notification had been received that The Solicitor for the Affairs of Her Majesty’s Treasury had a direct interest of
40.56 per cent in the issued share capital with rights to vote in all circumstances at general meetings. No other notification has been received that
anyone has an interest of 3 per cent or more in the issued ordinary share capital.
Change of control
The Company is not party to any significant contracts that are subject to change of control provisions in the event of a takeover bid.
The Company is party to a deed of covenant with each of the four Lloyds TSB Foundations (the Foundations) which hold limited voting shares in
the Company (the limited voting shares are further described in note 47 on page 292). Under the terms of the deeds of covenant, the Company
makes an annual payment to each of the Foundations. In the event of a successful offer for more than 50 per cent of the issued ordinary share
capital of the Company, each limited voting share would convert to an ordinary share under the terms of the Company’s articles of association. The
payment obligation under the deeds of covenant would come to an end one year following the conversion of the limited voting shares.
Employees
Lloyds Banking Group is committed to providing employment practices and policies which recognise the diversity of our workforce and ensure
equality for employees regardless of sex, race, disability, age, sexual orientation or religious belief.
In the UK, Lloyds Banking Group belongs to the major employer groups campaigning for equality for the above groups of staff, including
Employers’ Forum on Disability, Employers’ Forum on Age, Stonewall and the Race for Opportunity. Our involvement with these organisations
enables us to identify and implement best practice for our staff.
Employees are kept closely involved in major changes affecting them through such measures as team meetings, briefings, internal
communications and opinion surveys. There are well established procedures, including regular meetings with recognised unions, to ensure that
the views of employees are taken into account in reaching decisions.
Schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement in
Lloyds Banking Group.
Lloyds Banking Group is committed to providing employees with comprehensive coverage of the economic and financial issues affecting the
Group. We have established a full suite of communication channels, including an extensive face-to-face briefing programme which allows us
to update our employees on our performance and any financial issues throughout the year.
Further information on employees can be found on pages 34 to 37.
Donations
The income statement includes a charge for charitable donations totalling £32,972,000 in 2011 (2010: £30,750,000), including £28,228,000
(2010: £28,228,000) which will be paid under the deeds of covenant to the four Lloyds TSB Foundations during 2012 and £2,000,000 paid to
the Bank of Scotland Foundation during 2011.
Research and development activities
During the ordinary course of business the Group develops new products and services within the business units.
176
Annual Report and Accounts 2011
DIRECTORS’ REPORT
Policy and practice on payment of creditors
The Company has signed up to the ‘Prompt Payment Code’ published by the Department for Business Innovation and Skills, regarding the making
of payments to suppliers. Information about the ‘Prompt Payment Code’ may be obtained by visiting www.promptpaymentcode.org.uk.
The Company’s policy is to agree terms of payment with suppliers and these normally provide for settlement within 30 days after the date of
the invoice, except where other arrangements have been negotiated. It is the policy of the Company to abide by the agreed terms of payment,
provided the supplier performs according to the terms of the contract.
The number of days required to be shown in this report, to comply with the provisions of the Companies Act 2006, is 23. This bears the same
proportion to the number of days in the year as the aggregate of the amounts owed to trade creditors at 31 December 2011 bears to the
aggregate of the amounts invoiced by suppliers during the year.
Essential business contracts
There are no persons with whom the Group has contractual or other arrangements that are considered essential to the business of the Group.
Significant contracts
Details of related party transactions are set out in note 53 on pages 302 to 305.
Statement of directors’ responsibilities
The directors are responsible for preparing the annual report, the directors’ remuneration report and the financial statements in accordance with
applicable law and regulations. Company law requires the directors to prepare financial statements for each financial year. Under that law the
directors have prepared the Group and parent Company financial statements in accordance with IFRSs as adopted by the European Union. Under
company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of
affairs of the Group and the Company and of the profit or loss of the Company and Group for that period. In preparing these financial statements,
the directors are required to: select suitable accounting policies and then apply them consistently; make judgements and accounting estimates
that are reasonable and prudent; and state whether applicable IFRSs as adopted by the European Union have been followed.
The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and
disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial
statements and the directors’ remuneration report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4
of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps
for the prevention and detection of fraud and other irregularities.
A copy of the financial statements is placed on our website www.lloydsbankinggroup.com. The directors are responsible for the maintenance and
integrity of the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from
legislation in other jurisdictions.
Each of the directors, whose names and functions are listed on pages 172 and 173 of this annual report, confirm that, to the best of his or her
knowledge:
– the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the European Union, give a true and fair
view of the assets, liabilities, financial position and profit or loss of the Company and Group; and
– the management report contained in the business review includes a fair review of the development and performance of the business and the
position of the Company and Group, together with a description of the principal risks and uncertainties that they face.
Auditors and audit information
Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no relevant audit
information of which the Company’s auditors are unaware and each director has taken all the steps that he or she ought to have taken as a director
to make himself or herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This
confirmation is given and should be interpreted in accordance with the provisions of the Companies Act 2006.
Resolutions concerning the re-appointment of PricewaterhouseCoopers LLP as auditors and authorising the Audit Committee to set their
remuneration will be proposed at the annual general meeting.
On behalf of the Board
Harry F Baines
Company Secretary
27 February 2012
Company number 95000
177
Annual Report and Accounts 2011
CORPORATE GOVERNANCE REPORT
The Board is committed to achieving long term success for the Company by being the best bank for customers and generating strong, stable
and sustainable returns for shareholders. The Board’s strategy is underpinned by high standards of corporate governance designed to ensure
consistency and rigour in its decision making. This report explains how those standards, in particular, those laid down in the Financial Reporting
Council’s UK Corporate Governance Code (the Code), apply in practice to ensure that the Board and management work together for the long term
benefit of the Company and its shareholders. The Code can be accessed at www.frc.org.uk
Leadership and accountability
The Chairman has overall responsibility for the leadership of the Board. His role is separate from that of the Group Chief Executive who
manages and leads the business. A sound relationship between the Chairman and Group Chief Executive, based on a mutual understanding
of their respective roles, is essential to maintaining an open culture with the Board. Establishing an effective working relationship with
António Horta-Osório, the new Group Chief Executive, has therefore been a key area of focus for the Chairman this year.
The Board is collectively responsible for the long term success of the Company including setting the strategy and establishing the values and
standards of the Group. The Group Strategic Review, initiated by António Horta-Osório in March 2011, has been a key area of focus for the Board
during 2011 and all Directors participated fully in its formulation. An internal project team supported by McKinsey & Co, was established under
the direction of the Group Chief Executive. Detailed plans and proposals were developed by the executive between March and June 2011.
During that period, the Board met a number of times to consider, evaluate and challenge the proposals. Additional meetings took place with the
Non-Executive Directors individually. The final challenge process took place during a two day Board Strategy session in June 2011. This meeting
was held offsite to allow Directors to fully consider and evaluate the strategic options before they were put to the Board for approval. The offsite
meeting also provided an opportunity to foster closer working relationships between Board members and the new senior team.
The Chairman has overall responsibility for leadership of the Board and for ensuring that the Board devotes its attention to the right matters. He
oversees the content of the agendas which are finalised at Board Agenda Review meetings involving the Chairman, Group Chief Executive and
Company Secretary. The Deputy Chairman and Senior Independent Director also attend. Details of the matters reserved to the Board are set out
in the Board Governance Framework which is explained further below.
The Chairman, with the support of the Company Secretary, ensures that Directors receive timely and relevant information and are kept advised of
key developments, both during and between formal meetings. During 2011, the timeliness of Board communications has been enhanced by the
introduction of a secure board portal which enables Directors to access papers electronically as they become available. A weekly Board dashboard
ensures that Directors are kept informed of key developments and emerging issues.
It is expected that all directors, but particularly the Non-Executive Directors, constructively challenge proposals that come to the Board for
decision. Facilitating an open culture is key to achieving this. During 2011, the Board, led by the Deputy Chairman, developed a charter of values
aimed at encouraging strong individual and independent views to broaden the Board’s outlook and strengthen its collective judgement.
Open dialogue is encouraged between Directors. To this end, the Chairman meets regularly with the Non-Executive Directors in the absence
of Executive Directors either in private sessions held following regular Board or Committee meetings or in separately arranged meetings. The
Executive Directors are aware of such meetings through the Board calendar. Non-Executive Directors meet at least once a year without the
Chairman being present to discuss his performance. Such meetings are led by the Senior Independent Director. All Non-Executive Directors have
ready access to the Group Chief Executive and other senior executives.
All Directors, including Non-Executive Directors, have access to the services of the Company Secretary in relation to discharging their duties as a
director, or as a member of any Board Committee. The appointment, and removal, of the Company Secretary is a matter reserved for the Board as
a whole. In addition, the Group provides access, at its expense, to the services of external advisers in order to assist directors in their role, wherever
this is deemed necessary.
In 2011, a total of sixteen Board meetings were held of which nine were scheduled at the start of the year. The number of meetings held reflects
the continuing challenging environment in which the Group operates and the emphasis placed on keeping the Board informed of developments
on a timely basis. Details of attendance at meetings are set out on page 182.
To assist the Board in carrying out its functions and to provide independent oversight of internal control and risk management, certain
responsibilities are delegated to the Board’s Committees. The Board is kept up to date on the activities of the Committees through reports from
each of the Committee Chairmen. Terms of reference for each of the Committees are available on the website at www.lloydsbankinggroup.com.
Information on the membership, role and activities of each of the Committees can be found on pages 183 to 185.
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Annual Report and Accounts 2011
CORPORATE GOVERNANCE REPORT
Governance framework
The Board operates through a Governance Framework which is reviewed at least annually to ensure that it remains fit for purpose. During 2011,
the Governance Framework was reviewed and updated to reflect the Group Strategic Review and organisational changes. The revised
Governance Framework was approved by the Board in December 2011 and comprises:
– The Board Governance Framework. This is, in effect, the Board’s operating manual and sets out:
– the matters that the Board has reserved to itself including the development and setting of strategy and long term objectives; approval of the
medium term plan and financial budgets; capital and structure of capital; significant contracts; and various statutory and regulatory approvals;
– terms of reference of, and delegations to, the Board Committees to ensure an appropriate level of independent oversight by the
Non-Executive Directors;
– delegation of the responsibility for day to day management of the business to the Group Chief Executive; and
– the respective roles and responsibilities of each of the Chairman, Group Chief Executive, Senior Independent Director and Non-Executive
Directors.
– The Executive Governance Framework. This is the means by which the Group Chief Executive delegates responsibilities at executive level
to assist him in carrying out his duties. The Group Chief Executive reserves certain matters to himself and, subject to financial limits, delegates
responsibilities to the Executive Directors, his direct reports and other senior executives who collectively make up the Group Executive
Committee.
– The Group Subsidiaries Manual. Lloyds Banking Group conducts its business through a large number of subsidiary entities. To help manage
the legal, regulatory and reputational risks associated with these entities, the Group requires its subsidiaries to adopt consistent, proportionate
and appropriate standards. The Group Subsidiaries Manual provides guidance on the required governance structures and controls having regard
to the nature and risk profile of the entity. The Group Subsidiaries Manual was introduced in April 2011 and was updated in the second half of the
year to reflect changes made to the overall Governance Framework in response to the Group Strategic Review.
Board effectiveness
As Chairman, Sir Winfried Bischoff leads the ongoing review of the Board’s effectiveness. The Nomination & Governance Committee, which he
also chairs, oversees the process and makes recommendations to the Board as appropriate. To ensure a broad representation of independent
views including perspectives from each of the Committees, membership of the Nomination & Governance Committee comprises the Deputy
Chairman, the Senior Independent Director, the Chairmen of the Audit, Remuneration and Risk Committees and one other independent Non-
Executive Director. The Group Chief Executive also attends meetings as appropriate.
Key activities of the Nomination & Governance Committee are summarised in the Committees’ section on page 184. Given the importance of its role
in ensuring effective governance of the Board, a more detailed review of the work of the Nomination & Governance Committee is provided here.
Board composition
The Nomination & Governance Committee is responsible for reviewing the composition of the Board, including size and structure. During 2011,
it oversaw the search and selection process for new directors, including Sara Weller, who was appointed as a Non-Executive Director on 1 February
2012, and the new Group Finance Director. In reviewing Board composition, the Committee has regard to a range of factors, including:
Skills and experience
In reviewing composition, the Board aims to ensure that its membership represents a mix of backgrounds and experience that will enhance the
quality of its deliberations and decisions. As part of the ongoing review of composition, specific skills required by the Board are identified with
reference to the overall skills of the Board at the time, the need to address longer term succession and current business priorities. All Directors
are required to have good – and in most cases have deep – experience and understanding of the banking and financial services sector. The
complexity of the Group means that broader skills are also required. Maintaining the right balance is an ongoing priority.
The annual Board evaluation is instrumental in identifying any new skills requirements, as well as possible shortcomings, gaps and inefficiencies.
As part of its longer term succession plans, the Board has identified a need for at least two new Non-Executive Directors: one with substantial
insurance experience and another with in-depth accounting and financial expertise to continue to meet the FRC and SEC’s ‘financial expert’
criteria.
Diversity
The Board continues to place emphasis on ensuring that its membership reflects diversity in the broadest sense including diversity of gender, ethnicity
and background. The Group welcomes and publicly supports the Davies Review. The Board has committed to show demonstrable progress towards
the goal of achieving at least 25 per cent (and ultimately 30 per cent) female representation on the Board by 2013 and expects to meet this by 2015.
As a founder member of the 30% Club, which encourages UK companies to aim for at least 30 per cent female representation on their boards by 2015,
Sir Winfried Bischoff takes an active interest in promoting diversity within the Group and in business more generally. The Nomination & Governance
Committee currently utilises the services of an Executive search firm which has signed up to the 30% Club's voluntary Code of Conduct for Executive
Search firms.
The Group aims over time to be a leader in its approach to gender diversity. It will continue to focus on diversity and inclusion in order to build a
diverse talent pipeline so that there is an appropriate number of talented women ready to make the next move in their careers.
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Annual Report and Accounts 2011
CORPORATE GOVERNANCE REPORT
Board size
Our aim is to ensure that the size of the Board is sufficient to reflect a broad range of views and perspectives whilst allowing all Directors to
participate effectively in meetings. At year end, the Board comprised twelve directors which is within the range agreed by the Nomination &
Governance Committee.
Independence
The Board’s preference is to ensure a strong majority of independent directors. At year end, our Board comprised three Executive Directors,
eight independent Non-Executive Directors and the Chairman. The Code requirement that at least half the Board should be independent
Non-Executive Directors has been met throughout the year.
The Nomination & Governance Committee is responsible for assessing the independence of Non-Executive Directors on appointment and
annually thereafter. Based on its 2011 assessment, it is satisfied that throughout the year, all Non-Executive Directors were independent as to both
character and judgement.
In assessing independence, the Committee does not rely solely on the Code criteria but considers whether, in fact, the Non-Executive Director is
demonstrably independent and free of relationships and other circumstances that could affect their judgement. It does this with reference to the
individual performance and conduct in reaching decisions. It also takes account of any relationships that have been disclosed and authorised by
the Board. In the view of the Nomination & Governance Committee, Glen Moreno, who between January and August 2009, was acting Chairman
of United Kingdom Financial Investments (UKFI), the body which manages the Government’s shareholding in the Group, continues to exercise his
own, and robustly independent judgement, at all times.
Board changes
Non-Executive Directors
The Nomination & Governance Committee is responsible for leading and overseeing appointments to the Board. The process of identification of
potential new Non-Executive Directors, is undertaken on a rolling basis alongside the continuous review of the composition of the Board. Where
appropriate, this is conducted with the support of an executive search firm.
On 1 February 2012 the Group announced the appointment of Sara Weller as a Non-Executive Director and as a member of each of the
Remuneration and Risk Committees. Sara’s career, characterised by strong advocacy of customers and of the application of new technology,
directly supports the Group’s strategy. In addition, her background in a range of retail and associated sectors enhances the diversity of
perspectives on the Board.
On 27 February 2012, the Group announced that with effect from 17 May 2012, the Board had appointed David Roberts as Deputy Chairman and
Tony Watson as Senior Independent Director.
Group Chief Executive succession and interim arrangements
On 1 March 2011, António Horta-Osório was appointed Group Chief Executive replacing Eric Daniels who retired on 28 February 2011. Consistent
with his contractual entitlement to notice, Eric Daniels remained employed by the Group until the end of September 2011.
The detailed process leading to the appointment of António Horta-Osório was explained in the 2010 Corporate Governance Report. He joined
the Board as an Executive Director on 17 January 2011. This allowed him time to get to know the business and to complete an orderly handover
before assuming the role of Group Chief Executive on 1 March 2011.
On 2 November 2011, the Board announced that, acting on medical advice, António Horta-Osório would be taking a short leave of absence
due to exhaustion. He returned to work in full health on 9 January 2012. In the period from 2 November 2011 to 8 January 2012, Tim Tookey was
appointed Interim Group Chief Executive in addition to his role as Group Finance Director. Interim governance arrangements were implemented
to ensure that:
– all authorities vested in the Group Chief Executive were automatically deemed to vest in the Interim Group Chief Executive for as long as that
office was required; and
– where internal governance arrangements required a ‘four eyes’ approval, these could not be achieved by one person acting in the capacity
of both the Group Chief Executive and Group Finance Director. Arrangements were put in place to ensure that either the Chief Risk Officer or
Company Secretary provided the necessary second pair of eyes.
Throughout António’s absence, the Board kept its contingency arrangements under review. On 21 November 2011, the Board announced that one
of its Non-Executive Directors, David Roberts, would be appointed to the role of Interim Group Chief Executive in the event that António Horta-
Osório was unable to return by the end of the year. In the event, this contingency was not required.
The Board kept in close contact with António during his absence. Prior to his return to work, the Board followed a rigorous process to ensure that
it was in the best interests of the Group and its shareholders for António to return as Group Chief Executive. This process involved independent
medical assessment as well as individual meetings between António and each Board member. As a result of this process, the Board concluded
that António was fit to return to work on 9 January 2012. To avoid a recurrence and to assist him in adjusting to the role, the Board agreed to an
initiative from António to restructure and reduce his direct reporting lines in order to strengthen the accountabilities of his senior management
team. The new structure was announced on 1 February 2012.
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Retirements
The following retirements took place in the course of the year:
– Eric Daniels: see Group Chief Executive succession above;
– Archie Kane: Group Executive Director, Insurance who retired at the Company’s general meeting on 18 May 2011; and
– Helen Weir: Group Executive Director, Retail who stepped down at the Company’s general meeting on 18 May 2011.
On 19 September 2011, we announced the retirement of Lord Leitch as Deputy Chairman of the Group and Chairman of Scottish Widows. Lord
Leitch will remain on the Board until 29 February 2012.
On 19 September, the Group also announced that Tim Tookey would stand down as Group Finance Director with effect from the end of
February 2012 to pursue interests outside the Group. On 24 February 2012, the Group announced that Tim Tookey would stand down as Group
Finance Director with effect from that date.
Since the year end the following announcements have been made:
– On 1 February 2012, the Group announced that Sir Julian Horn-Smith would retire from the Board at the annual general meeting and would not
stand for re-election as a Director;
– On 6 February 2012, the Group announced that Truett Tate would resign from the Board with immediate effect; and
– On 27 February 2012, the Group announced that Glen Moreno would retire from the Board at the annual general meeting and would not stand
for re-election as a Director.
Time commitments
In 2011, as in 2009 and 2010, the time commitment demanded of all Non-Executive Directors was considerable and substantially in excess of
the time envisaged in their terms of appointment. The detail set out on page 182 shows the Board meetings that the directors have attended
including those called at short notice. There has been no increase to fees since January 2008 to reflect the increased workload and additional time
spent on Lloyds Banking Group business.
Election and re-election
As indicated in 2010, in the interests of good corporate governance and in accordance with provisions of the Code now in force, Directors will
retire voluntarily and submit themselves for re-election at the annual general meeting. Biographies of the career experience of the current directors
are set out on pages 172 to 173. To assist in the voting process, details of the Directors seeking re-election at the annual general meeting are set
out in the notice of meeting sent to all shareholders.
Succession planning
The Nomination & Governance Committee oversees the Board’s arrangements for the longer term succession of Board and Committee members.
Non-Executive succession planning
Non-executive director succession planning is addressed as part of the ongoing review of Board composition. The policy takes account of the
need regularly to refresh the intake of Non-Executives to bring new perspectives, to ensure appropriate representation on each of the Board’s
Committees and to plan for longer term succession. The average tenure of the Non-Executive Directors is just over two years. Following the move
to annual re-election of directors, non-executive directors are appointed on a rolling 12 months basis.
Executive Directors and senior executives
The Nomination & Governance Committee and the Board are responsible for oversight of the process for succession and management
development of the most senior executives both at and below Board level, including Executive Directors and members of the Group Executive
Committee. The primary responsibility rests with the Group Chief Executive who is responsible for developing and maintaining a succession plan
for key leadership positions in the senior executive team. Arrangements are reviewed with the Nomination & Governance Committee at least
annually with the latest review taking place in September 2011.
The Chairman is responsible for developing and maintaining a succession plan in relation to the Group Chief Executive and for reviewing the plan
with the Nomination & Governance Committee at least annually. During 2011, emphasis was also placed on contingency arrangements during the
Group Chief Executive's leave of absence.
Board training
Directors’ induction
All Directors are expected to make an informed contribution based on an understanding of the Group’s business model and the key challenges
facing the Group and its businesses. To ensure that they can contribute from an early stage, all Directors undergo an extensive three stage
induction on appointment comprising:
– a corporate induction, which provides an overview of the Group, its strategy, operational structures and main business activities;
– governance and directors’ responsibilities, which explains the role and statutory duties of a Non-Executive Director including the roles and
responsibilities owed by banks and other financial services firms to the FSA and other regulatory bodies; and
– a bespoke induction plan prepared in consultation with the Chairman, tailored to the individual needs of the director, to the specific role that
they will carry out, and their skills/experience to date.
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Board training
The Board receives regular refresher training and information sessions to address current business or emerging issues. In the course of 2011,
Non-Executives Directors undertook approximately two days of training, including nine hours of structured training during Board meetings. This is
delivered through a variety of means, including sessions on matters such as capital and liquidity (including stress testing requirements); regulatory
updates for approved persons; accounting development updates and updates on credit rating agency developments. In addition, the Audit
Committee arranged a series of ‘deep dives’ to which all Board members were invited, and which provided an in-depth review of the operations of
each of the business divisions and of the latest accounting standards and operating methodologies. Sessions were delivered for several business
areas amounting to three and a half days in total.
Board evaluation and performance
Having conducted thorough and rigorous externally facilitated evaluations in 2009 and 2010 (as well as in earlier years), the Board accepted the
recommendation of the Nomination & Governance Committee that the 2011 evaluation should be facilitated internally, reverting to an external
review for 2012.
The 2011 Board evaluation process was overseen by the Nomination & Governance Committee and took the form of:
– a detailed questionnaire, drafted by Group Secretariat in conjunction with the Chairman, to assess the effectiveness of the Board, its Committees
and individual Directors;
– individual follow up interviews with the Chairman; and
– formulation of an action plan for adoption by the Board.
Remuneration
The Remuneration Committee, chaired by Anthony Watson, is responsible for overseeing the Group’s remuneration arrangements and
compliance with the FSA’s Remuneration Code. The Remuneration Committee’s terms of reference are available on the website at
www.lloydsbankinggroup.com.
An overview of the Remuneration Committee is set out on page 184. The work of the Remuneration Committee is explained in the Directors’
remuneration report on pages 187 to 204.
Shareholder engagement
The Board recognises the importance of promoting mutual understanding between the Company and its shareholders through greater
engagement. In 2011, there was regular dialogue with institutional shareholders with more than 400 equity investor meetings undertaken in the
year. Many of these meetings were undertaken by senior management (primarily the Group Chief Executive and Group Finance Director) or Board
members. The Chairman has also attended a number of meetings with shareholders to discuss governance and strategic direction. Anthony
Watson, as Chairman of the Remuneration Committee, regularly meets the larger shareholders to discuss executive remuneration issues while the
Senior Independent Director separately meets with a range of major shareholders.
The Board is kept advised of the views of major shareholders by means of regular updates at Board and Committee meetings. It also receives
monthly reports on market and investor sentiment and shareholder analysis.
Investor Relations has primary responsibility for managing day-to-day communications with institutional shareholders. Supported by the Group
Chief Executive and Group Finance Director, they achieve this through a combination of briefings to analysts and institutional shareholders (both
at results briefings and throughout the year), as well as site visits and individual discussions with institutional shareholders.
The Company Secretary oversees communications with private shareholders. The Group’s annual general meeting provides an opportunity to
meet the Group’s Directors and to hear more about the strategy of the Group. Shareholders are encouraged to attend the annual general meeting
and to raise any questions at the meeting or in advance, using the email address shown in the pack which will be sent to shareholders
in March 2012.
Scottish Widows Investment Partnership, one of Europe’s largest asset managers and a Group company, complies with the principles of the
Financial Reporting Council’s Stewardship Code, as published in July 2010. Details of Scottish Widows Investment Partnership’s approach
to stewardship and corporate governance can be found on its website, www.swip.com.
Conclusion
In conclusion, the Group confirms its compliance with all relevant provisions of the Code throughout the year ending 31 December 2011.
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Attendance at meetings
The attendance of Directors at Board meetings and at meetings of the Audit, Nomination & Governance, Remuneration and Risk Committees of
which they were members during 2011 is shown in the table. In addition, the Audit Committee arranged five half day and one full day ‘deep dive’
meetings during 2011 which were open to, and attended by, other members of the Board.
Numbers in brackets show the maximum number of meetings that each Director could have attended in 2011 including ad hoc meetings or those
called at short notice.
Nomination &
Governance
Committee
Remuneration
Committee
Risk Committee
Regular
Regular
Regular
Ad hoc
4
4
3
4
4
4
4
4
12
12
8
11
12
10
12
6
1
5
5
2
6
6
6
1
1
1
1
1
Number of meetings during
the year
Current directors who
served during 2011
Sir Winfried Bischoff
António Horta-Osório1
A M Frew
Sir Julian Horn-Smith2
Lord Leitch3
G R Moreno2
D L Roberts
T T Ryan
M A Scicluna
Anthony Watson
Former directors who
served during 2011
J E Daniels4
A G Kane5
G T Tate6
T J W Tookey7
H A Weir8
Board meetings
Regular
Ad hoc
Total
Audit Committee
Ad hoc
Regular
9
7
16
8
7
6
6
2
4
3
7
5
7
7
7
8
8
8
8
8
9
7
7(7)
4(5)
9
7
9
9
9
8
9
9
5
4
5
5
6
3
7
5
2(2)
3(4)
9
9
2(3)
3(4)
6
7
2(4)
3(4)
1
2
3
4
5
6
7
8
Appointed to the Board on 17 January 2011. On leave of absence from 2 November 2011 to 8 January 2012 and was therefore absent from meetings between these dates. See page 179 for details.
Director until 17 May 2012.
Director until 29 February 2012.
Director until 28 February 2011.
Director until 18 May 2011. Archie Kane attended all Board meetings prior to the announcement that he would be retiring from the Board.
Director until 6 February 2012.
Director until 24 February 2012.
Director until 18 May 2011. Helen Weir attended all Board meetings prior to the announcement that she would be stepping down from the Board.
Some Directors attended Committee meetings as attendees periodically throughout the year. This attendance is not shown in the table.
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Board committees
The tables below set out a summary of the membership and role of each of the Board Committees, along with the activities they performed during
2011. There is a standing invitation for all Non-Executive Directors to attend Committee meetings of which they are not members. All Committee
terms of reference are displayed on the website, www.lloydsbankinggroup.com or are available from the Company Secretary.
Committee
Audit
Chairman
Martin Scicluna
Members
Anita Frew
Lord Leitch
(until 29 February 2012)
David Roberts
Tim Ryan
Anthony Watson
Purpose
To monitor and review the formal arrangements established by the Board in respect of:
(a) the financial statements and reporting of the Group;
(b) internal controls and the risk management framework;
(c) internal audit; and
(d) the Group’s relationship with its external auditors.
Responsibilities
– 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
– reviews procedures for handling complaints regarding accounting, internal accounting controls or auditing
matters and for staff to raise concerns in confidence.
2011 Activities
– reviewed and recommended to the Board the Group annual and interim reports and accounts;
– reviewed significant accounting matters as discussed with the auditors;
– reviewed the Group’s position as a going concern;
– reviewed the appointment of the auditors and approved their remuneration;
– attended one full day and five half day ‘deep dive’ sessions with each of the divisions;
– reviewed litigation and regulatory risks;
– received reports from the Divisional Financial Control Committees and the Group Risk Committee;
– received reports from the internal audit department on internal controls, including SOX reports;
– reviewed the Group’s key finance programmes;
– reviewed details of the Group’s whistle blowing procedures and incidents; and
– discussed the level of impairments.
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Committee
Purpose
Nomination &
Governance
Chairman
Sir Winfried Bischoff
Members
Sir Julian Horn-Smith
(until 17 May 2012)
Lord Leitch
(until 29 February 2012)
Glen Moreno
(until 17 May 2012)
David Roberts
Martin Scicluna
Anthony Watson
To keep the Board’s governance arrangements under review and make appropriate recommendations to the
Board to ensure that the Company’s arrangements are consistent with best practice corporate governance
standards.
Responsibilities
– reviews the structure, size and composition of the Board;
– oversees the selection process for prospective directors;
– makes recommendations to the Board on potential appointments and reappointments of Directors at the
end of their specified term;
– considers Board succession;
– oversees the annual evaluation of the performance of the Board;
– reviews the Board’s governance arrangements;
– oversees the Group’s implementation of governance requirements; and
– oversees the process for appointments of new Non-Executive Directors and makes recommendations to
the Board.
2011 Activities
– reviewed Board composition including the Group’s response to the Davies Review and diversity targets;
– oversaw the search and selection process for new non executive directors and the Group Finance Director;
– oversaw the Board Evaluation process including formulation of the action plan;
– reviewed the Governance Framework to ensure consistency with the Group Strategic Review,
organisational changes and emerging developments; and
– reviewed the adequacy of the Group’s succession plan, including contingency arrangements during the
Group Chief Executive’s leave of absence.
Committee
Purpose
To set the principles and parameters of remuneration policy for the Group, and to oversee remuneration
policy and outcomes for those colleagues specified in the terms of reference.
Responsibilities
Information about the Remuneration Committee’s responsibilities is given in the Directors’ remuneration
report on pages 187 to 204.
2011 Activities
Information about the Remuneration Committee’s activities during 2011 is given in the Directors’
remuneration report on pages 187 to 204.
Remuneration
Chairman
Anthony Watson
Members
Sir Winfried Bischoff
Sir Julian Horn-Smith
(until 17 May 2012)
Lord Leitch
(until 29 February 2012)
David Roberts
Tim Ryan
Sara Weller
(from 1 February 2012)
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Committee
Risk
Chairman
David Roberts
Members
Sir Winfried Bischoff
Anita Frew
Sir Julian Horn-Smith
(until 17 May 2012)
Tim Ryan
Martin Scicluna
Sara Weller
(from 1 February 2012)
Purpose
To review and report its conclusions to the Board on:
(a) the Group’s risk appetite; and
(b) the Group’s risk management framework, taking a forward looking perspective and anticipating changes
in business conditions.
Responsibilities
– facilitates the involvement of Non-Executive Directors in risk issues and aids their understanding of these
issues;
– oversees adherence to Group risk policies and standards and considers any material amendments to them;
and
– reviews the work of the Group Risk Division.
2011 Activities
– reviewed the Group consolidated risk report and received an update from the Chief Risk Officer at each
meeting;
– reviewed the risk and control frameworks;
– reviewed the Internal Capital Adequacy Assessment Process report;
– reviewed the Group’s funding plan and stress testing process;
– participated in deep dives in conjunction with each division and with members of the group risk team;
– reviewed the Group’s risk appetite framework; and
– reviewed the Group’s report on financial crime.
Compliance with the British Bankers’ Association Code for Financial Reporting Disclosure
In September 2010, the British Bankers’ Association published a Code for Financial Reporting Disclosure (the ‘Disclosure Code’). The Disclosure
Code sets out five disclosure principles together with supporting guidance. The principles are that UK banks: commit to providing high quality,
meaningful and decision-useful disclosures; commit to ongoing review of, and enhancement to, their financial instrument disclosures for key areas
of interest; will assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of
such guidance; will seek to enhance the comparability of financial statement disclosures across the UK banking sector; and will clearly differentiate
in their annual reports between information that is audited and information that is unaudited.
The Group and other major UK banks have voluntarily adopted the Disclosure Code in their 2011 financial statements. The Group’s 2011 financial
statements have therefore been prepared in compliance with the Disclosure Code’s principles.
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Internal control
The Board of Directors is responsible for the establishment and review of the Group’s system of internal control, which is designed to ensure
effective and efficient operations, quality of internal and external reporting, internal control, and compliance with laws and regulations. It should be
noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing
and reviewing the system of internal control, the Directors have regard to the nature and extent of relevant risks, the likelihood of a loss being
incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance
against the risk of material loss.
The Directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is
communicated to all employees by way of published policies and procedures and regular management briefings. A requirement to comply with
internal control risk policies is a key component of individual staff objectives expressed in the balanced scorecard. Key business risks are identified,
and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties.
In addition, there is an annual control self assessment exercise whereby the key businesses and head office functions review specific controls and
attest to the accuracy of their assessments. The assessment covers all enterprise-wide risk management categories and is in accordance with the
principles of the Code. As in previous years, this exercise was completed for the year ended 31 December 2011. All returns have been satisfactorily
completed and appropriately certified.
The effectiveness of the internal control system is reviewed regularly by the Board and the Audit Committee, which also receives reports of
reviews undertaken around the Group by group risk and group audit. The Audit Committee receives reports from the Company’s auditors,
PricewaterhouseCoopers LLP (which include details of significant internal control matters that they have identified), and has a discussion with the
auditors at least once a year without executives present, to ensure that there are no unresolved issues of concern.
There is an ongoing process for identifying, evaluating and managing the significant risks faced by the Company. This process has been in place
for the year under review and up to the date of the approval of the annual report and is regularly reviewed by the Board. Information regarding
the main features of the internal control and risk management systems in relation to the financial reporting process is given within the Risk
Management Report on pages 99 to 170.
Auditor independence and remuneration
Both the Board and the external auditors have safeguards in place to protect the independence and objectivity of the external auditors. The Audit
Committee has a comprehensive policy to regulate the use of auditors for non-audit services. This policy sets out the nature of work the external
auditors may not undertake, which includes work which will ultimately be subject to external audit, internal audit services and secondments to
senior management positions in the Group that involve decision-making. It also includes the Group’s policy on hiring former external audit staff.
For those services that are deemed appropriate for the auditors to carry out, the policy sets out the approval process that must be followed for
each type of assignment. The Chairman of the Audit Committee must be consulted regarding potential instructions in respect of allowable non-
audit services with a value above defined fee limits.
Each year the Audit Committee establishes a limit on the fees that can be paid to the external auditors in respect of non-audit services and
monitors quarterly the amounts paid to the auditors in this regard. The external auditors also report regularly to the Audit Committee on
the actions that they have taken to comply with professional and regulatory requirements and current best practice in order to maintain their
independence. This includes the rotation of key members of the audit team. Total auditor remuneration analysed between audit and other services
is shown in note 11 to the financial statements on page 243.
The Audit Committee evaluated the performance of the external auditors during the year and will periodically continue to do so. The Audit
Committee has not considered it necessary to require an independent tender process.
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DIRECTORS’ REMUNERATION REPORT
Statement by the Chairman of the Remuneration Committee
As Chairman of the Group’s Remuneration Committee, I am pleased to introduce the Directors’ Remuneration Report for 2011 and highlight some
of the key decisions and activities of the Remuneration Committee this year.
Once again, there has been considerable external focus and scrutiny of executive remuneration in the past twelve months. In light of this we have
worked as a Committee to ensure that we motivate, incentivise and retain our talent while continuing to be mindful both of the economic outlook
and the views of our numerous stakeholders.
During 2011, a thorough Strategic Review of the business was conducted by the Board, which is now in its implementation phase. Following
this review, the Remuneration Committee has worked towards translating our new strategic objectives into meaningful metrics against which to
measure performance.
We believe that the introduction of a balanced scorecard approach to measure long-term performance from 2012 will enable the Committee
to assess the performance of the Company and its senior executives in a consistent and performance driven way. These targets are described
on pages 190 and 191.
While there have been no material changes to the overall structure of executive remuneration, we have continued to maintain an open and
transparent dialogue with shareholders. This valuable engagement is something we will seek to continue into 2012, as we recognise our
responsibilities to the providers of our equity capital in setting fair and appropriate remuneration policies.
The approximate make-up of the main components of our package for Executive Directors on an expected value basis is shown below:
Long-term incentive
Short-term incentive
Salary
Pension and benefits
20%
35%
35%
10%
Based on a combination of performance targets comprising
economic profit, absolute total shareholder return and
strategic financial objectives
Paid in shares after
three years
Based on financial measures and on a balanced scorecard
of non-financial measures
Deferred into shares until
at least March 2014, subject
to malus
Based on role, market competitiveness, and performance
Paid in cash
Based on role and market competitiveness
Paid into pension or taken
as cash
The split in the components in the above chart are for Executive Directors. Comparable numbers for the Group Chief Executive are: long-term
incentive 24 per cent, short-term incentive 32 per cent, salary 29 per cent and pension and benefits 15 per cent.
We have continued to be mindful of the need to exercise restraint as part of the effective governance of executive pay. In particular, we have
focused on the need to manage aggregate variable pay in the prevailing environment. This has been demonstrated through a number of
decisions made in the last twelve months including not increasing fixed pay, as others in the market have done, and the decision by the
Group Chief Executive not to be considered for a bonus for 2011.
Furthermore, the Committee has proactively taken the decision to adjust bonus awards made to Executive Directors and certain senior executives
in respect of the performance year 2010 to reflect the PPI provision made in this year’s accounts. While there is no suggestion of wrongdoing or
culpability, the Committee has made the adjustment, known as malus, to reflect the provision that was made after the annual results and bonus
awards were finalised in February 2011.
The Remuneration Committee carefully considered what size bonus pool would be appropriate to distribute across the Bank as a whole. In making
their decision, the Committee took into account the success of the integration programme, the Group’s overall performance and the views of
shareholders and the general public. As a result, the bonus pool was reduced by 30 per cent with the greater reductions being applied to more
senior staff. Annual incentives for Executive Directors and the Group Executive Committee are down approximately 50 per cent against 2010 on
a like for like basis.
Salary increases have also been restricted. Salaries as part of the annual review will increase by less than 2.5 per cent, with lower or zero increases
at more senior levels.
The Long Term Incentive Plan remains a core part of our reward strategy. We have changed the performance conditions to better ensure
alignment with the objectives and timeline of the Strategic Plan as well as to link to retaining our key employees and align with other elements
of reward.
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Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
The Committee believes the LTIP will be more motivational by introducing measures with clear milestones and outcomes that can be
communicated regularly, providing a sense of purpose and achievement throughout the life of the plan. The Committee recognises that core
financial measures remain an important element for top management to ensure alignment with shareholders. Accordingly, it is proposed that
Economic Profit and Absolute Total Shareholder Return targets remain in place for Executive Directors, but at a reduced level, with a significant
percentage of LTIP based on balanced scorecard measures.
Despite the uncertain economic outlook, the market for talent is no less competitive and the Group must compete for this in the UK and overseas
markets with varying levels of regulation and scrutiny. Nonetheless, the Committee recognises the impact that recruitment premiums can have
on the total pay bill, and therefore we have continued to recruit successfully paying at appropriate market levels. Where possible, we also seek
to link recruitment awards to Company performance (as demonstrated by the share price targets applied to the Group Chief Executive's pension
opportunity) and through a recently introduced process to carefully monitor new joiners’ performance as they become established in their roles.
In the same way, for leavers we are conscious of the importance of mitigating the Company’s costs and not paying more than is appropriate
through previously agreed exit terms. Other than in exceptional circumstances we pay only that required under contractual entitlements.
As a Committee we are also keen to maintain alignment between our senior executives and shareholders so that executives share the same
experience in terms of Company and share price performance. As such, we will continue to operate a stringent deferral policy to ensure senior
executives experience variability in remuneration dependent on Company performance.
The final point I want to touch on is the importance of risk in the formulation and evaluation of our remuneration policies and practices.
Given the events in the financial services sector over the past few years, the impact of risk underpins every decision we make as a Committee,
manifested through our use of economic profit to measure performance and therefore determine remuneration levels. We consider risk when
making decisions on remuneration outcomes and re-consider the Group’s experience when deferred awards come to vest, demonstrated by the
adjustment made to 2010 bonus awards.
The Committee is dedicated to ensuring that remuneration policies and practices set out in this Report are well placed to support the successful
delivery of the business strategy going forward. This Report will be tabled for shareholder approval at the AGM, which I hope you will support.
Anthony Watson CBE
Chairman, Remuneration Committee
This is a report made by the Board of Lloyds Banking Group plc, on the recommendation of the Remuneration Committee. It covers the current
and proposed components of the remuneration policy and details the remuneration for each serving Director during 2011.
The Group has complied throughout the period with the requirements of the UK Corporate Governance Code (previously known as the
Combined Code) in relation to Directors’ remuneration. In addition, the report has been prepared in accordance with the Large and Medium sized
Companies and Groups (Accounts and Reports) Regulations 2008.
The Committee recognises the attention which Bank remuneration receives and is very aware both of the importance of getting the right balance
between the linkage of rewards to performance and the competitive process; recruiting, retaining and motivating staff as well as a more widely
perceived concept of fairness for all involved.
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DIRECTORS’ REMUNERATION REPORT
Governance and Risk Management
An essential component of our approach to remuneration is the governance process that underpins it. This ensures that our policy is robustly
applied and risk is managed appropriately.
The overarching purpose of the Remuneration Committee is to consider, agree and recommend to the board an overall remuneration policy
and philosophy for the Group that is defined by, supports and is closely aligned to its long-term business strategy, business objectives, risk
appetite and values and recognises the interests of relevant stakeholders. The Group has a conservative business model characterised by a risk
culture founded on prudence and accountability. The remuneration policy and philosophy covers the whole Group, but the Committee pays
particular attention to the top management population, including the highest paid employees in each division, those colleagues who perform
significant influence functions for the Group and those who could have a material impact on the Group’s risk profile. The Committee’s role is to
ensure that these colleagues are provided with appropriate incentives and reward to encourage them to enhance the performance of the Group
and that they are recognised for their individual contribution to the success of the organisation, whilst ensuring that there is no reward for excessive
risk taking. The Committee works closely with the Risk Committee in ensuring the bonus pool is moderated. The two Committees meet every
year to determine whether the proposed bonus pool and performance assessments adequately reflected the risk appetite and framework of the
Group; whether it took account of current and future risks; and whether any further adjustment is required or merited. We are also determined to
ensure that the aggregate of the variable remuneration for all our colleagues is appropriate and balanced with the interests of shareholders and all
other stakeholders.
The Committee determines the pensions policy for the Group and advises on other major changes to employee benefits schemes. It also agrees
the policy for authorising claims for expenses from the Group Chief Executive and the Chairman. It has delegated power for settling remuneration
for the Chairman, the Group Executive Directors, the Company Secretary and any group employee whose salary and annual bonus exceeds a
specified amount, currently £750,000. To ensure compliance with the FSA Code of Practice, the Committee approves remuneration for Code Staff
and that of senior risk and compliance officers.
The Committee monitors the application of the authority delegated to the Group Chief Executive who in turn delegates to the Group Executive
Committee, the Executive Compensation Committee and the divisional Remuneration Committees, to ensure that policies and principles are
being fairly and consistently applied. The Committee liaises closely with the Risk Committee and the risk function in relation to risk-adjusted
performance measures, including consideration of both current and future risk. Together the management of remuneration and risk form an
integral part of the Board’s determination of Group corporate strategy.
All the independent Non-Executive Directors are invited to attend meetings and have the opportunity to comment on proposals and have their
views taken into account before the Committee’s decisions are implemented.
The Committee’s terms of reference are available from the Company Secretary and are displayed on the Group’s website, www.lloydsbankinggroup.
com. These terms were last updated in March 2011 to ensure continued compliance with the FSA Code.
The members of the Committee during 2011 were as follows:
– Anthony Watson (chairman)
– Sir Winfried Bischoff
– Sir Julian Horn-Smith
– Lord Leitch
– David Roberts (also chairman of the Risk Committee)
– Tim Ryan
During 2011, the Committee met 12 times and considered the following principal matters:
– Review of remuneration arrangements for senior executives
– Determination of the appropriate remuneration packages for a number of senior new hires
– Determination of bonus pools based on Group performance and adjustment for risk
– Performance conditions for the Long-Term Incentive Plan
– Bonus and salary awards for Executive Directors and key senior managers
– Approval of remuneration and terms of service that fall within the Committee’s terms of reference, including new appointments
– Feedback from the Remuneration Committee Chairman on his meetings with the FSA and shareholders
We thank all committee members for their commitment during the last year and attendance at meetings.
The Committee appoints independent consultants to provide advice on specific matters according to their particular expertise. During the year,
Deloitte LLP advised the Committee. Deloitte has voluntarily signed up to the Remuneration Consultants’ Code of Conduct and are judged by
the Committee to be independent. Deloitte’s fees for 2011 amounted to £350,000.
During 2011, Deloitte provided information on behalf of the Committee for the testing of TSR performance conditions for the Group’s long-term
incentive plans (calculated by reference to both dividends and growth in share price).
Eric Daniels (until 28 February 2011), António Horta-Osório (from 1 March 2011), Angie Risley (Group HR Director) and Liz Jackson (HR Director,
Reward) provided guidance to the Committee (other than for their own remuneration). Juan Colombás (Chief Risk Officer) and Tim Tookey (Group
Finance Director) also attended the Committee to advise as and when necessary on risk and financial matters.
190
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DIRECTORS’ REMUNERATION REPORT
Directors’ remuneration policy
The Group’s remuneration policy continues to support our business values and strategy, based on building long-term relationships with our
customers and employees and managing the financial consequences of our business decisions across the entire economic cycle.
Our policy is intended to ensure that our remuneration offer is both cost effective and enables us to attract and retain Executive Directors and
senior management of the highest calibre, motivating them to perform to the highest standards.
Our objective is to align individual reward with the Group’s performance, the interests of its shareholders, and a prudent approach to risk
management. In this way we balance the requirements of our various stakeholders: our customers, shareholders, employees, and regulators. This
approach is in line with the Association of British Insurers best practice code on remuneration and the FSA Remuneration Code of Practice, as the
policy seeks to reward long-term value creation whilst not encouraging excessive risk taking.
Our overall policy objective is met by a focus on the particular aspects detailed below.
Policy objective
How achieved
Building long-term
relationships
We build relationships with our customers and people. Working for Lloyds Banking Group is about more than pay.
Our relationship with our people means that we want to pay them fairly and competitively, but our pay is positioned
conservatively against the market and we do not seek to align with the highest payers in the sector. In setting pay for
Executive Directors and senior managers, we take account of relative pay positioning and target levels of variable
remuneration opportunity for all levels of employees in the Group.
Our incentive measures are not just financial. Our Balanced Scorecards, which all of our senior executives have as part
of their objectives for the year, include objectives that cover effective risk management, lending to Corporates including
SMEs and retail customers, performance against targets that measure how satisfied our customers are and the extent to
which our employees feel engaged with and committed to working for Lloyds Banking Group.
Managing the financial
consequences of our
business through the
economic cycle
Economic profit is a key measure by which we manage our business. This measure takes into account the level of capital
required to generate profits as well as the risks taken. The same level of profit generated at lower risk results in higher
economic profit. Economic profit also measures risk based on an assessment of how the business will perform through
the economic cycle and is a key measure for short term incentives.
Aligning individual
rewards with Group
performance and
shareholders
For example, in good times, when default rates on loans are low, we adjust the economic profit measure downwards
based on a higher average expected default experience over the economic cycle. This encourages us to avoid business
and funding strategies that are only profitable during boom times but turn bad in a recession. Economic profit plays a
prominent role in our incentive plans for executives, with its inclusion in both the annual and LTIP performance measures.
Our executives’ annual incentives are based on stretching performance objectives and targets in the Group Balanced
Scorecard. This Balanced Scorecard is derived from the Medium Term Plan which defines the financial and non-financial
targets within our agreed risk appetite over a three year period.
Any annual bonus for Executive Directors is deferred into shares and released over time, helping to increase alignment
with shareholders. These deferrals are subject to malus in the event of unsustainable performance.
Executives are also aligned with shareholders through the LTIP, which pays out in shares based on performance against
Group financial targets over a three year period. In addition to purely financial metrics of Economic Profit and Total
Shareholder Return, the performance conditions for the 2012 LTIP will comprise measures linked to the Strategic Review
that reflect the wider Group objectives. These measures are short-term funding as a percentage of total funding, non-
core assets at the end of 2014, run-rate simplification benefits achieved at the end of 2014 and customer satisfaction.
We operate tough contract provisions relative to market practice, whereby no executive has an entitlement to more
than 12 months’ notice (not taking into account recruitment provisions), pay in lieu of notice is limited to basic salary,
is paid monthly over 12 months and is mitigated if the executive gets another job. This approach avoids the risk
of payment for failure.
A prudent approach
to risk management
We also have non-financial measures of performance against risk objectives in both the annual and long-term plans
for executives.
For the 2011 annual incentive plan we continue to align the award to long-term prudent risk management by deferring
100 per cent of the award for Executive Directors, which is subject to malus. Executive Directors are also required
to retain any shares vesting from LTIP awards for a further 2 years, after allowing for tax and national insurance
requirements. For other employees, the immediate cash bonus award is limited to £2,000 with a percentage of larger
bonuses being subject to deferral and malus. If the performance is unsustainable during the deferral period some or all
of the award may be forfeited.
We have a robust governance framework with an independent Remuneration Committee reviewing all compensation
decisions for senior executives. This approach to governance and review is cascaded through the organisation. We
also ensure that all control function employees are assessed and their remuneration determined jointly by the relevant
business Director and the control function Director. Senior risk and compliance officers are also reviewed by the
Remuneration Committee.
191
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DIRECTORS’ REMUNERATION REPORT
Policy objective
How achieved
Cost effective packages
to attract and retain
executives
We aim to ensure that the totality of remuneration for Executive Directors is competitive against our benchmark groups.
These groups are other major UK banks and the top 20 companies in the FTSE 100, reflecting practices in large UK
companies across all sectors. We aim to be competitively but conservatively positioned against the market.
We select incentive plan targets that are directly linked to the business strategy and priorities, ensuring alignment with
company performance, targets that are meaningful to executives and incentive packages that are valued by executives
and cost effective.
Summary
Following extensive consultation with shareholders, the Remuneration Committee is proposing a package for Executive Directors for 2012 that is
closely based on the structure and principles applied in previous years as follows:
Element
Base salary
Level/design for 2012
Key purpose
Base pay should be set relative to FTSE 20 and banking
sector competitors
There are no increases to base salaries for Executive Directors
Pension
Defined contribution pension provision for new entrants
Annual incentive
200 per cent of salary maximum (225 per cent for the
Group Chief Executive)
Based on Group financial targets relating to profit before tax and
economic profit as well as Balanced Scorecard measures covering
divisional financial targets, customers (e.g. SME lending), people,
risk and building the business
Subject to deferral and malus in line with FSA requirements
Annual awards of 275 per cent of salary for the Group Chief
Executive and 225 per cent for other Executive Directors.
Vesting based on financial measures comprising Absolute Total
Shareholder Return, Economic Profit and strategic financial
objectives. Details of the performance conditions are as follows:
Long-term
incentive plan
Measure
Economic Profit
Absolute TSR
Growth in share price including dividends
Short term funding as % of total funding
Payout range set relative to 2014 targets
Non-core assets at end of 2014
Net simplification benefits (run rate achieved
at 2014 year-end)
Customer satisfaction (FSA reportable
complaints per 1,000 customers over 3 years)
To provide the basis for a competitive package
Enable executives to build long-term
retirement savings
Retention
Alignment with Group performance
Motivation of executives
Pay for performance
Alignment with sound risk management
Motivation and retention of executives
Alignment with sound risk management
Alignment with long-term shareholder interests
Threshold: £160 million
Maximum: £1,653 million
Threshold: 12% per annum
Maximum: 30% per annum
Threshold: 20%
Maximum: 15%
Threshold: <= £95 billion
Maximum: <= £80 billion
Threshold: £1.5 billion
Maximum: £1.8 billion
Threshold: 1.5
Maximum: 1.3
30%
30%
10%
10%
10%
10%
Basis
Metric
Weighting
Payout range set relative to 2014 targets
192
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Base salary
Base salaries are reviewed annually, taking into account individual performance and market information (which is provided by Towers Watson
and supplemented with information from Deloitte LLP) and normally adjusted from 1 January of the relevant year. The remuneration committee
confirmed during the 2011 review that the FTSE remains the most appropriate comparator group to use to benchmark overall competitiveness
of the remuneration package whilst taking particular account of the remuneration practice of our direct competitors, namely the major UK banks.
No increase to salaries will be made in 2012.
Name
At 1 January 2012
At 1 January 2011
1
With effect from 17 January 2011.
A Horta-Osório
G T Tate
T J W Tookey
£1,061,000
£1,061,0001
£656,000
£656,000
£615,000
£615,000
Annual incentive plan
The annual incentive scheme for Executive Directors is designed to reflect specific goals linked to the performance of the business.
Incentive awards for Executive Directors are based upon individual contribution and overall corporate results. Incentive opportunity is driven
by corporate performance based on profit before tax and economic profit, together with divisional achievement and individual performance.
Individual targets relevant to improving overall business performance are contained in a Balanced Scorecard and are grouped under the following
headings:
– Financial
– Building the Business
– Customer Service
– Risk
– People Development
These targets apply differently for the Executive Directors, reflecting differing strategic priorities. The non-financial measures include key
performance indicators relating to risk management, SME lending, process efficiency, service quality and employee engagement.
The remuneration committee believes that the structure of the incentive – in particular the use of risk-adjusted and non-financial measures – has
been highly successful in promoting a long-term focus within the senior management team.
The maximum annual incentive opportunity is 200 per cent (225 per cent for the Group Chief Executive) of base salary for the achievement of
exceptional performance targets.
Consistent with the aim of ensuring that short-term financial results are only rewarded if they promote sustainable growth, the 2011 annual
incentive is subject to deferral in shares until at least 2014. This deferred amount is subject to malus if the performance that generated the
incentive is found to be unsustainable.
The committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if they deem
this appropriate.
The key achievements of the Group are set out in the Group Chief Executive’s review on pages 14 to 19 of this Annual Report.
The calculation of the annual incentive plan outcomes for Executive Directors, based on the achievement of performance against targets in respect
of performance in 2011, has been vigorously discussed by the Remuneration Committee. Mr Horta-Osório advised the Board that he did not wish
to be considered for a bonus in respect of the 2011 performance year. The bonuses awarded to directors are shown in the table below:
Name
Maximum Opportunity
% awarded for 2011
Bonus awarded for 2011
A Horta-Osório
G T Tate
T J W Tookey
225%
Declined bonus
200%
53%
200%
20%
–
£345,000
£120,000
193
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Long-term incentive award
The current LTIP rules allow for awards to be made of up to 400 per cent of base salary. Under normal circumstances, awards can be made of up to
300 per cent of salary with the additional 100 per cent available for circumstances that the Remuneration Committee deems to be exceptional. In
2011, awards were made of up to 300 per cent of base salary to the Executive Directors and 420 per cent for the Group Chief Executive. The award
for Mr Horta-Osório was made in order to facilitate his appointment as Group Chief Executive. In 2012, the committee intends to make an award
of 275 per cent of salary to Mr Horta-Osório. Mr Tookey and Mr Tate are not eligible to receive an award following Mr Tookey’s resignation and
Mr Tate’s retirement from the Group.
Long-term incentive performance measures
During 2011, the Committee has consulted widely with shareholders on the topic of performance measures and sharing the growth in the Company
appropriately between shareholders and management. The Committee believes that the performance measures for the 2012 LTIP award for the
Executive Committee should be Economic Profit, Absolute Total Shareholder Return and strategic financial measures. These measures capture risk
measurement, profit growth and shareholder experience and align shareholder experience and management reward.
Details of current LTIP awards are provided on page 201.
Pension
Executive directors may participate in the Group’s defined contribution scheme (under which their pension entitlement will be based upon both
employer and employee contributions). Company contributions are 25 per cent of salary, with the exception of António Horta-Osório who is
eligible for 50 per cent of reference salary, including his flexible benefit allowance. These can be taken as cash or pension contributions, or a
mixture of each.
Details of pension contributions and accruals are shown on page 197.
Other share plans
The Executive Directors are also eligible to participate in the Group’s ‘sharesave’ and ‘share incentive’ plans. These are ‘all-employee’ share plans.
Shareholding guidelines
Directors are required to build up a holding in Lloyds Banking Group shares of value equal to 1.5 times gross salary (2 times gross salary for the
Group Chief Executive) and expected to achieve these targets within 5 years of joining the Board. They are required to retain any shares vesting
from the share price performance element of the 2010 LTIP and 2011 LTIP for a further two years post vesting. The Group Chief Executive is making
significant progress in reaching this target.
Chairman’s remuneration
The Chairman’s remuneration comprises salary and benefits. He does not participate in the annual bonus and long-term incentive arrangements,
nor is he entitled to pension benefits.
The Chairman’s salary remained unchanged in 2011, at £700,000 per annum.
194
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Independent Non-Executive Directors’ fees
The fees of the Independent Non-Executive Directors are agreed by the Board within a total amount determined by the shareholders. Non-
Executive Directors may also receive fees, agreed by the Board, for membership of Board Committees. The fees are designed to recognise the
various responsibilities of a Non-Executive Director’s role and to attract individuals with relevant skills, knowledge and experience. The fees are
neither performance related nor pensionable and are comparable with those paid by other companies. The annual fees were reviewed in 2011
and remain unchanged as listed below.
Non-Executive Director – base fee
Deputy Chairman
Senior Independent Director
Audit Committee Chairmanship
Audit Committee Membership
Remuneration Committee Chairmanship
Remuneration Committee Membership
Risk Committee Chairmanship
Risk Committee Membership
Nomination & Governance Committee Membership
£65,000
£100,000
£60,000
£50,000
£20,000
£30,000
£15,000
£40,000
£15,000
£5,000
In the case of the Nomination & Governance Committee, membership currently comprises the Deputy Chairman, Senior Independent Director
and chairs of the Board Committees (the fees for which include membership of the Nomination & Governance Committee) and one other
Independent Non-Executive Director. Only this director receives an attendance fee, which is £5,000.
Independent Non-Executive Directors who serve on the Boards of subsidiary companies may also receive fees from the subsidiaries.
2011 Non-Executive Directors’ fees (£)
Deputy
Board
Chairman
Senior
Independent
Director
Audit
Committee
Remunera-
tion
Committee
Nomination &
Governance
Committee
Risk
Committee
SW Board
fees1
2011
Total
A M Frew
Sir Julian Horn-Smith
Lord Leitch
G R Moreno
D L Roberts
T T Ryan
M A Scicluna
Anthony Watson
1
Scottish Widows Services Limited
65
65
65
65
65
65
65
65
100
60
20
20
20
20
50
20
15
15
15
15
30
120
5
15
15
40
15
15
100
100
320
125
140
115
130
115
Dilution limits
The following charts illustrate the shares available for the Group’s share plans.
ALL PLANS (10% OF THE ISSUED ORDINARY SHARE CAPITAL OF THE GROUP IN ANY CONSECUTIVE 10 YEARS)
2010
1,255.1
2011
1,252.6
5,552.3
4,620.0
Shares used (million)
Shares available (million)
EXECUTIVE PLANS (5% OF THE ISSUED ORDINARY SHARE CAPITAL OF THE GROUP IN ANY CONSECUTIVE 10 YEARS)
2010
481.0
2011
1,622.5
2,922.7
1,813.8
2944.699951
Shares used (million)
Shares available (million)
195
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Service agreements
The Group’s policy is for Executive Directors to have service agreements with notice periods of no more than one year. All current Executive
Directors are entitled to receive 12 months’ notice from the Group, but would be required to give at least six months’ notice.
It is the Group’s policy that where compensation on early termination is due, it should be paid on a phased basis, mitigated in the event that
alternative employment is secured, and that bonus payments should relate to the period of actual service, rather than the full notice period, and
will be determined on the basis of performance.
Any entitlements under the pension scheme or equity plans will be in accordance with the scheme rules on leaving.
Sir Winfried Bischoff
António Horta-Osório
G T Tate
T J W Tookey
Notice to be given by the Company
Date of service agreement/letter of appointment
6 months
12 months
12 months
12 months
27 July 2009
3 November 2010
9 February 2009
26 January 2009
Independent Non-Executive Directors do not have service agreements and their appointment may be terminated, in accordance with the articles
of association, at any time without compensation.
External appointments
The Group recognises that Executive Directors may be invited to become Non-Executive Directors of other companies and that these
appointments may broaden their knowledge and experience, to the benefit of the Group. Fees are normally retained by the individual directors as
the post entails personal responsibility.
Executive Directors are generally allowed to accept one Non-Executive Directorship.
During 2011, Eric Daniels received fees of £76,000 which was retained by him, for serving as Non-Executive Director of BT plc. Truett Tate received
fees of £30,000 as chairman of Arora Holdings Ltd and £20,000 as a Director of Towergate Partnership Ltd. These fees were retained by him.
Performance graph
The graph below illustrates the performance of the Group measured by TSR against a ‘broad equity market index’ over the past five years.
The Group has been a constituent of the FTSE 100 index throughout this five year period.
Total shareholder return – FTSE 100 index
Lloyds Banking Group plc
FTSE 100 index
Rebased to 100 on 31 December 2006
Source: Deloitte
150
125
100
75
50
25
0
Dec
2006
Dec
2007
Dec
2008
Dec
2009
Dec
2010
Dec
2011
196
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Directors’ emoluments for 2011 (audited)
Other benefits
Salaries/
fees
£000
Pension
allowance1
£000
One-off
payments2
£000
Other cash
benefits3
£000
Non-cash
benefits4
£000
Performance-
related
payments5
£000
2011
Total
£000
20106
Total
£000
Current Directors who served during 2011
Executive Directors
António Horta-Osório (from 17 January 2011)
1,019
514
172
50
12
10
1
Non-Executive Directors
Sir Winfried Bischoff
A M Frew
Sir Julian Horn-Smith
Lord Leitch
G R Moreno
D L Roberts
T T Ryan
M A Scicluna
Anthony Watson
Former Directors who served during 2011
J E Daniels (until 28 February 2011)
A G Kane (until 18 May 2011)
G T Tate (until 6 February 2012)
T J W Tookey (until 24 February 2012)
H A Weir (until 18 May 2011)
Others (for 2010 only)
700
100
100
320
125
140
115
130
115
776
590
656
615
625
6,126
80
164
90
125
973
25
73
40
24
27
36
35
270
224
14
27
26
5
6
89
1,765
713
100
100
320
125
140
115
130
115
855
721
1,218
939
791
712
8
100
308
134
104
113
130
115
2,572
1,408
1,745
1,579
1,578
35
345
120
465
8,147
10,641
1
Following changes to the amount of tax relief available on pension contributions in each year, Directors may elect to receive some or all of their allowances as cash. Contributions into the pensions
scheme shown on page 197 are commensurately reduced.
2
One-off payments comprise a contractual cash payment to António Horta-Osório as part of the buyout of his benefits from his previous employer, an allowance to Tim Tookey to reflect his
additional responsibilities as Interim Group Chief Executive and a tax planning allowance for Eric Daniels.
3
4
5
6
Other cash benefits includes flexible benefits payments (4 per cent of basic salary), payments to certain directors who elect to take cash rather than a company car under the car scheme.
The non-cash benefits column includes amounts relating to the use of a company car, use of a company driver and private medical insurance. It also includes a spouse's travel allowance for
Truett Tate, Sir Winfried Bischoff and Eric Daniels and the value of any matching shares which are received under the terms of Sharematch, through which employees have the opportunity to
purchase shares up to a maximum of £125 per month and receive matching shares on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share.
Bonuses awarded in respect of 2011 performance will be subject to 100 per cent deferral into shares until at least 2014.
Bonus awards made to Executive Directors in respect of 2010 were amended in February 2012 by reducing the amounts awarded in Deferred Shares. The reduction amounted to 40 per cent of
the award in respect of Mr Daniels and 25 per cent of the awards in respect of Mr Kane, Mr Tate, Mr Tookey and Mrs Weir. The Board’s decision is based on the fact that had the outcome of the
Judicial Review into Payment Protection Insurance (PPI) in April 2011 been known, and had the consequential provision made been effected at the time of the award of the 2010 bonus in February
2011, the bonus pool would have been lower and individual bonus awards would also have been lower.
197
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Directors’ pensions (audited)
The Executive Directors are members of one of the pension schemes provided by Lloyds Banking Group with benefits either on a defined benefit
or defined contribution basis. There are now no Directors accruing further pensionable service on a defined benefit basis.
Defined benefit scheme members
Accrued
pension at
31 December
2011
£000
(a)
223
379
Accrued
pension at
31 December
2010
£000
(b)
210
372
Change in
accrued
pension
£000
(a)-(b)
13
7
Transfer
value at
31 December
2011
£000
(c)
5,081
8,734
Transfer
value at
31 December
2010
£000
(d)
5,030
8,657
J E Daniels
A G Kane
Change in
transfer
value
£000
(c)-(d)
51
77
Additional
pension
earned to
31 December
2011
£000
(e)
13
7
Transfer
value of the
increase
£000
(f)
294
154
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2011
and 2010, respectively. For Mr Daniels the 2011 figure is the pension put into payment upon retirement on 30 September 2011. For Mr Kane, the
2011 figure is the deferred pension entitlement as at the date of opting-out of the pension scheme on 15 June 2011.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2011 based on factors supplied by the actuary
of the pension scheme.
Column (d) is the equivalent transfer value, but calculated as at 31 December 2010 on the assumption that the Director left service at that date.
Column (e) is the increase in pension built up during the year, recognising (i) the accrual rate for the additional service based on the pensionable
salary in force at the year end, and (ii) where appropriate the effect of pay changes in ‘real’ (inflation adjusted) terms on the pension already earned
at the start of the year.
Column (f) is the capital value of the pension in column (e).
The disclosures in columns (e) and (f) are as required by the UK Listing Authority listing rules. The requirements of the listing rules differ from those
of the Companies Act. The listing rules require the additional pension earned over the year to be calculated as the difference between the pension
accrued at the end of the financial year and the pension accrued at the start of the financial year less the increase in the pension earned over the
year solely due to inflation. The transfer value in column (f) can differ significantly from the change in transfer value as required by the Companies
Act because the additional pension accrued over the year calculated in accordance with the listing rules makes allowance for inflation, and the
change in the transfer value required by the Companies Act will be significantly influenced by changes in the assumptions underlying the transfer
value calculation at the beginning and end of the financial year.
Benefits from a registered pension scheme are subject to the Lifetime Allowance, currently £1.8 million, which is equivalent to an annual pension
of £90,000. Any benefit in excess of this amount will incur a tax charge for the individual. The Lifetime Allowance will decrease to £1.5 million from
April 2012. The Group has agreed that if an Executive Director has benefits in excess of the Lifetime Allowance he may cease to accrue benefits in
the Scheme and receive a salary supplement as an alternative. This will not cost the Group more than the current arrangements. The Group will
not compensate any individual in respect of any tax liability arising from the provision of pension.
Defined contribution scheme members
During the year to 31 December 2011 the Group has made the following contributions to the defined contribution scheme:
António Horta-Osório
G T Tate
T J W Tookey
H A Weir
Pension
contributions
£000
31
41
64
31
198
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Directors’ interests (audited)
The beneficial interests, of those who were directors at 31 December 2011 in ordinary shares of Lloyds Banking Group were:
Number of shares
Executive Directors
António Horta-Osório1
G T Tate1
T J W Tookey
Non-Executive Directors
Sir Winfried Bischoff
A M Frew
Sir Julian Horn-Smith
Lord Leitch
G R Moreno1
D L Roberts
T T Ryan1
M A Scicluna
Anthony Watson
At 1 January 2011
(or later date of
appointment)
At 31 December
2011
At 27 February
2012
100,000
529,015
123,891
1,067,099
789,181
315,957
789,7452
316,9433
800,000
1,100,000
–
227,890
55,787
500,000
378,670
100,877
56,226
226,357
300,000
227,890
55,787
1,200,000
968,641
400,877
92,572
376,357
1
2
3
Shareholdings held by Mr A Horta-Osório, Mr G T Tate, Mr G R Moreno and Mr T T Ryan are either wholly or partially in the form of ADRs.
The beneficial interests for Mr G T Tate relate to changes to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2011 and
6 February 2012, the date of his resignation from the Board of Lloyds Banking Group.
The beneficial interests for Mr T J W Tookey relate to changes to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2011
and 24 February 2012, the date of his resignation from the Board of Lloyds Banking Group.
A summary of the awards vested, purchases and sales made by directors is shown on page 204.
199
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Interests in share options (audited)
At
1 January
2011
Granted
during
the year
Exercised
during
the year
Lapsed
during
the year
At
31 December
2011
Exercise
price
António Horta-Osório
–
342,265
342,265
– 1,452,401
–
662,116
– 1,452,401
–
438,846
– 1,707,763
Former directors who served during 2011
J E Daniels
A G Kane
G T Tate
T J W Tookey
H A Weir
265,051
867,914
19,399
70,068
147,669
499,709
19,399
129,820
55,147
499,709
19,399
19,399
156,968
499,709
19,399
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
– 1,452,401
–
662,116
– 1,452,401
–
438,846
– 1,707,763
–
–
–
–
–
–
Exercise periods
From
–
To
–
15/6/2011
30/3/2021
31/1/2012
30/3/2021
15/6/2012
30/3/2021
31/1/2013
30/3/2021
15/6/2013
30/3/2021
–
–
–
265,051
207.97p
18/3/2007
30/9/2012
867,914
235.26p
17/3/2008
30/9/2012
19,399
46.78p
1/10/2011
31/3/2012
70,068
–
324.92p
6/3/2004
5/3/2011
–
–
–
–
–
–
–
–
–
–
147,669
207.97p
18/3/2007
17/3/2014
499,709
235.26p
17/3/2008
16/3/2015
19,399
46.78p
1/06/2013 30/11/2013
129,820
207.97p
18/3/2007
17/3/2014
55,147
199.91p
12/8/2007
11/8/2014
499,709
235.26p
17/3/2008
16/3/2015
19,399
19,399
46.78p
46.78p
1/6/2013 30/11/2013
1/6/2013 30/11/2013
156,968
210.70p
29/4/2007
28/4/2014
499,709
235.26p
17/3/2008
16/3/2015
19,399
–
46.78p
–
–
Notes
j, k
j
j
g, j
g, j
g, j, l
c, e, h
d, e, h
a, i
b, f
c, e
d, e
a, g
c, e
c, e
d, e
a, g
a, g
c, e
d, e
a
a Sharesave. Mrs Weir’s Sharesave award lapsed during 2011 at her request.
b Executive option granted in March 2001.
c Executive option granted between March 2004 and August 2004.
d Executive option granted between March 2005 and August 2005.
e Exercisable to the extent that the performance condition was satisfied.
f Lapsed on 10th anniversary of date of grant as the performance conditions had not been met.
g Not exercisable as the option has not been held for the period required by the relevant scheme.
h Exercisable for period of one year from date of leaving.
i Exercisable for period of six months from date of leaving.
j Share buy out award granted on 30 March 2011 for the loss of deferred share awards forfeited on leaving the Santander Group. Awards are consistent with those forfeited and have a nil option
price.
k Award exercised on 30 March 2011 at a price of 58.75p.
l The extent that the award will become exercisable is subject to performance. The performance condition has not changed since the award was made.
None of the other directors at 31 December 2011 had options to acquire shares in Lloyds Banking Group plc or its subsidiaries.
The market price for a share in the Company at 1 January 2011 and 31 December 2011 was 65.70p and 25.91p, respectively. The range of prices
between 1 January 2011 and 31 December 2011 was 21.84p to 69.61p.
The following table contains information on the performance conditions for executive options granted since 2001.
The Remuneration Committee chose the relevant performance conditions because they were felt to be challenging, aligned to shareholders’
interests and appropriate at the time.
200
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Options granted
March 2001
March 2004 – August 2004
March 2005 – August 2005
March 2011
(Applicable only to award made
to António Horta-Osório on
30 March 2011 over
1,707,763 shares)
Performance conditions
Growth in earnings per share which is equal to the aggregate percentage change in the retail price index
plus three percentage points for each complete year of the relevant period plus a further condition that the
Company’s ranking based on TSR over the relevant period should be in the top 50 companies of the FTSE 100.
As the performance conditions for those options granted in March 2001 were not met, the options lapsed in
March 2011.
That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and
international financial services companies including Lloyds Banking Group) must be at least ninth, when 14 per
cent of the option will be exercisable. If the Company is ranked first in the group, then 100 per cent of the option
will be exercisable and if ranked tenth or below the performance condition is not met.
Options granted in 2004 became exercisable as the performance condition was met on the re-test. The
performance condition vested at 24 per cent for Truett Tate’s March option and at 14 per cent for all other
options granted to Executive Directors during 2004.
That the Company’s ranking based on TSR over the relevant period against a comparator group (15 companies
including Lloyds Banking Group) must be at least eighth, when 30 per cent of the option will be exercisable.
If the Company is ranked first to fourth position in the group, then 100 per cent of the option will be exercisable
and if ranked ninth or below, the performance condition is not met.
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.
That the Company’s ranking based on TSR over the relevant period against a comparator group (18 companies
including Lloyds Banking Group) must be at least ninth, when 30 per cent of the option will be exercisable. If the
Company is ranked first to fifth position in the group, then 100 per cent of the option will be exercisable and if
ranked tenth or below, the performance condition is not met.
Lloyds TSB executive retention plan 2006
On 26 March 2008 (prior to his appointment as an Executive Director), Tim Tookey was granted an award under the Lloyds TSB Executive
Retention Plan 2006. The award is satisfied in cash only and, subject to continued employment, gave him the right to receive an amount equal
to the total value of 218,400 Lloyds Banking Group shares on the dates of vesting. On 26 March 2011 50 per cent of his award vested at 60.48p.
Mr Tookey had agreed to reinvest the cash proceeds and he acquired 52,896 Lloyds Banking Group shares. Following notification of Mr Tookey’s
resignation from Lloyds Banking Group, the remaining 50 per cent of the award lapsed.
201
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
Lloyds TSB long-term incentive plan (audited)
The following table shows conditional shares awarded under the plan. Further information regarding this plan can be found on pages 202 and 203.
At
1 January
2011
Awarded
during
the year
Vested
during
the year
António Horta-Osório
–
7,154,187
Former Directors who served during 2011
J E Daniels
A G Kane
G T Tate
T J W Tookey
H A Weir
1,690,757
2,304,135
3,456,204
5,135,781
833,165
1,313,469
1,970,202
2,927,643
1,045,491
1,424,778
2,137,169
3,175,748
–
–
–
–
–
–
–
–
–
–
–
–
Lapsed
during
the year
–
1,690,757
–
–
–
833,165
–
–
–
1,045,491
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
– 3,159,517
–
143,567
1,335,730
2,003,597
2,977,264
–
–
–
–
– 2,962,047
1,020,987
1,391,386
2,087,079
3,101,317
–
–
–
–
46,430
101,933
–
–
–
–
–
–
–
–
–
–
–
–
1,020,987
–
–
–
At
31 December
2011
End of
performance
period
7,154,187
31/12/2013
–
31/12/2010
2,304,135
31/12/2011
3,456,204
31/12/2011
5,135,781
31/12/2012
–
31/12/2010
1,313,469
31/12/2011
1,970,202
31/12/2011
2,927,643
31/12/2012
–
31/12/2010
1,424,778
31/12/2011
2,137,169
31/12/2011
3,175,748
31/12/2012
3,159,517
31/12/2013
–
31/12/2010
1,335,730
31/12/2011
2,003,597
31/12/2011
2,977,264
31/12/2012
2,962,047
31/12/2013
–
31/12/2010
1,391,386
31/12/2011
2,087,079
31/12/2011
3,101,317
31/12/2012
Notes
b
c
c
c
b
a
c
b
c
a Award vested at 29 per cent for Tim Tookey as he was not a director at the time the award was made. The ‘vested during the year’ figure includes 4,796 dividend shares accumulated prior to the
stopping of dividend payments. The closing market price of the Group’s ordinary shares on the date of release was 58.54p.
b Award price 62.288p.
c The Absolute Share Price element of this award has an end of performance period date of 26 March 2013.
Mr Daniels’ LTIP and Integration Awards will continue, but will be pro-rated to reflect the number of months employed during each performance
period. For the awards made on 8 April 2009, this will be 33 months and for the award made on 26 March 2010, this will be 21 months.
Mr Tookey’s unvested awards all lapsed upon his departure from the Group on 24 February 2012.
202
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
The following table contains information on the performance conditions for awards made under the long-term incentive plan. The Remuneration
Committee chose the relevant performance conditions because they were felt to be challenging, aligned to shareholders’ interests and
appropriate at the time.
LTIP awarded
Performance conditions
March and April 2008
For 50 per cent of the award (the ‘EPS Award’) – the percentage increase in earnings per share of the Group
(on a compound annualised basis) over the relevant period needed to be at least an average of 6 percentage
points per annum greater than the percentage increase (if any) in the Retail Prices Index over the same period.
If it was less than 3 per cent per annum, the EPS Award would lapse. If the increase was more than 3 per cent
but less than 6 per cent per annum, then the proportion of shares released would be on a straight line basis
between 17.5 per cent and 100 per cent. The relevant period commenced on 1 January 2008 and ended on
31 December 2010.
For the other 50 per cent of the award (the ‘TSR Award’) – the Group’s TSR needed to exceed the median of a
comparator group (13 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR
Award to vest in full. 17.5 per cent of the TSR Award would vest where the Group’s TSR was equal to median
and vesting would occur on a straight line basis in between these points. Where the Group’s TSR was below the
median of the comparator group, the TSR Award would lapse. The relevant period commenced on 6 March 2008
(the date of award) and ended on 5 March 2011.
At the end of the relevant period, neither of the performance conditions had been met and the Awards lapsed.
Tim Tookey was not an Executive Director when his award was made in 2008, and as such his award vested at
29 per cent on the same basis as other award recipients below the Group Executive Committee level.
April 2009
EPS: The release of 50 per cent of the shares will be dependent on the extent to which growth in EPS achieves
cumulative EPS targets over the three year period from January 2009 to December 2011.
Economic profit: The release of the remaining 50 per cent of shares will be dependent on the extent to
which the Group achieves cumulative Economic Profit targets over the three year period from January 2009 to
December 2011.
April 2009
Integration award
EPS
Threshold
Maximum
Economic profit
Threshold
Maximum
Vesting %
25%
100%
Growth in EPS
26%
36%
Vesting %
Absolute improvement in adjusted EP
25%
100%
100%
202%
Synergy Savings: The release of 50 per cent of the shares will be dependent on the achievement of target
run-rate synergy savings in 2009 and 2010 as well as the achievement of sustainable synergy savings of at least
£1.5 billion by the end of 2011. The award will be broken down into three equally weighted annual tranches.
Performance will be assessed at the end of each year against annual performance targets based on a trajectory
to meet the 2011 target. The extent to which targets have been achieved will determine the proportion of shares
to be banked each year. Any release of shares will be subject to the Remuneration Committee judging the overall
success of the delivery of the integration programme.
Integration Balanced Scorecard: The release of the remaining 50 per cent of the shares will be dependent on
the outcome of a Balanced Scorecard of non-financial measures of the success of the integration in each of 2009,
2010 and 2011. The Balanced Scorecard element will be broken down into three equally weighted tranches.
The tranches will be crystallised and banked for each year of the performance cycle subject to separate annual
performance targets across the four measurement categories of Building the Business, Customer, Risk and
People and Organisation Development.
203
Annual Report and Accounts 2011
DIRECTORS’ REMUNERATION REPORT
March 2010
EPS: Relevant to 36 per cent of the award. Performance will be measured based on absolute improvement in
adjusted EPS over the three financial years starting on 1 January 2010 relative to an adjusted fully diluted 2009
EPS base.
Economic Profit: Relevant to 36 per cent of the award. Performance will be measured based on the compound
annual growth rate of adjusted Economic Profit over the three financial years starting on 1 January 2010 relative
to 2009 adjusted Economic Profit base.
Absolute Share Price: Relevant to 28 per cent of the award. Performance will be measured based on the
Absolute Share Price on 26 March 2013, being the third anniversary of the award date.
The targets are:
EPS
Threshold
Maximum
Vesting between threshold and maximum will be on a straight line basis.
Economic profit
Threshold
Maximum
Vesting between threshold and maximum will be on a straight line basis.
Absolute Share Price
Threshold
Maximum
Vesting %
Absolute improvement in adjusted EPS
25%
100%
158%
180%
Vesting % Compound annual growth rate of adjusted EP
25%
100%
Vesting %
0%
100%
57% per annum
77% per annum
Absolute Share Price
75p
114p
Vesting between threshold and maximum will be on a straight line basis, provided that shares comprised in the Absolute Share Price element of the
award may only be released if both the EPS and Economic Profit performance measures have been satisfied at the threshold level or above.
March 2011
EPS: Relevant to 331/3 per cent of the award. Performance will be based on 2013 EPS outcome.
Economic Profit: Relevant to 331/3 per cent of the award. The performance target is based on 2013 adjusted
Economic Profit.
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.
The targets are:
EPS
Threshold
Maximum
Vesting between threshold and maximum will be on a straight line basis.
Economic profit
Threshold
Maximum
Vesting %
25%
100%
Vesting %
25%
100%
Target
6.4p
7.4p
Target
£567m
£1,234m
Vesting between threshold and maximum will be on a straight line basis.
Absolute Total Shareholder Return
Vesting %
Annualised Absolute Shareholder Return
Threshold
Maximum
25%
100%
8%
14%
Vesting between threshold and maximum will be on a straight line basis, provided that shares comprised in the Absolute Share Price element of the
award may only be released if both the EPS and Economic Profit performance measures have been satisfied at the threshold level or above.
Deloitte provided information for the testing of the TSR performance conditions for the Company’s long-term incentive plan. EPS is the Group’s
normalised earnings per share as shown in the Group’s report and accounts, subject to such adjustments as the Remuneration Committee regards
as necessary for consistency.
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.
The register of Directors’ interests, which is open to inspection, contains full particulars of Directors’ shareholdings and options to acquire shares
in Lloyds Banking Group.
On behalf of the Board
Harry F Baines
Company Secretary
27 February 2012
204
Annual Report and Accounts 2011
OTHER REMUNERATION DISCLOSURES
Emoluments of the eight highest paid senior executives (unaudited)
Emoluments of the eight highest paid senior executives can be found on the Group's website at www.lloydsbankinggroup.com
Directors’ interests – summary of awards vested, purchases and sales made by directors in 2011 (unaudited)
At 1 January 2011
(or appointment
date)
Transactions during year
Date
Shares
Notes
31 December 2011
Executive Directors
António Horta-Osório
100,000
1/3/11
Purchase on appointment
30/3/11
5/8/11
167,099 March 2011 Share Buy Out award
200,000 Purchase
15/12/11
600,000 Purchase (150,000 ADRs)
1,067,099
G T Tate
529,015
T J W Tookey
123,891
Non-Executive Directors
Sir Winfried Bischoff
800,000
A M Frew
–
Sir Julian Horn-Smith
Lord Leitch
G R Moreno
227,890
55,787
500,000
D L Roberts
378,670
T T Ryan
100,877
M A Scicluna
56,226
Anthony Watson
226,357
Monthly
4,420 2011 Share Incentive Plan purchase
and matching shares
23/8/11
24/8/11
175,746 Purchase
80,000 Purchase (20,000 ADRs)
Monthly
4,420 2011 Share Incentive Plan purchase
30/3/11
30/3/11
8/6/11
8/6/11
and matching shares
22,750 2008 Long Term Incentive Plan release
52,896 2006 Executive Retention Plan release
57,810 2008 Deferred Bonus Plan release
-57,810 Sale
789,181
24/11/11
112,000 Purchase
315,957
5/8/11
24/11/11
200,000 Purchase
100,000 Purchase
28/2/11
28/2/11
19/8/11
19/8/11
50,000 Purchase
50,000 Purchase
100,000 Purchase
100,000 Purchase
–
–
25/2/11
5/8/11
200,000 Purchase (50,000 ADRs)
300,000 Purchase (75,000 ADRs)
23/11/11
200,000 Purchase (50,000 ADRs)
5/8/11
24/11/11
479,102 Purchase
110,869 Purchase
28/2/11
5/8/11
100,000 Purchase
200,000 Purchase
6/5/11
36,346 Purchase
5/8/11
15/8/11
19/8/11
50,000 Purchase
50,000 Purchase
50,000 Purchase
1,100,000
300,000
227,890
55,787
1,200,000
968,641
400,877
92,572
376,357
205 Annual Report and Accounts 2011
Report of the independent auditors on the parent company financial statements 344Parent company balance sheet 345Parent company statement of changes in equity 346Parent company cash flow statement 347Notes to the parent company financial statements 3481. Accounting policies2. Deferred tax asset3. Amounts due from subsidiaries4. Share capital and share premium5. Other reserves6. Retained profits7. Subordinated liabilities 8. Debt securities in issue9. Related party transactions10. Financial instruments11. Approval of the financial statements and other information financial statementsReport of the independent auditors on the consolidated financial statements 206Consolidated income statement 208Consolidated statement of comprehensive income 209Consolidated balance sheet 210Consolidated statement of changes in equity 212Consolidated cash flow statement 215Notes to the consolidated financial statements 2161. Basis of preparation2. Accounting policies3. Critical accounting estimates and judgements4. Segmental analysis 5. Net interest income6. Net fee and commission income7. Net trading income8. Insurance premium income9. Other operating income10. Insurance claims11. Operating expenses12. Impairment 13. Investments in joint ventures and associates14. Gain on acquisition in 200915. Loss on disposal of businesses in 201016. Taxation17. Earnings per share18. Trading and other financial assets at fair value through profit or loss19. Derivative financial instruments20. Loans and advances to banks21. Loans and advances to customers22. Securitisations and covered bonds23. Special purpose entities24. Debt securities classified as loans and receivables25. Allowance for impairment losses on loans and receivables26. Available-for-sale financial assets27. Held-to-maturity investments 28. Investment properties29. Goodwill30. Value of in-force business31. Other intangible assets32. Tangible fixed assets33. Other assets34. Deposits from banks35. Customer deposits36. Trading and other financial liabilities at fair value through profit or loss37. Debt securities in issue38. Liabilities arising from insurance contracts and participating investment contracts39. Life insurance sensitivity analysis40. Liabilities arising from non-participating investment contracts 41. Unallocated surplus within insurance businesses42. Other liabilities 43. Retirement benefit obligations44. Deferred tax45. Other provisions 46. Subordinated liabilities47. Share capital48. Share premium account49. Other reserves50. Retained profits51. Ordinary dividends52. Share-based payments53. Related party transactions54. Contingent liabilities and commitments55. Financial instruments56. Financial risk management57. Consolidated cash flow statement58. Future accounting developments59. Approval of financial statements 206
Annual Report and Accounts 2011
REPORT OF THE INDEPENDENT AUDITORS ON THE
CONSOLIDATED FINANCIAL STATEMENTS
Independent auditors’ report to the members of Lloyds Banking Group plc
We have audited the group financial statements of Lloyds Banking Group plc for the year ended 31 December 2011 which comprise the
consolidated income statement, the consolidated statement of comprehensive income, the consolidated balance sheet, the consolidated
statement of changes in equity, the consolidated cash flow statement and the related notes. The financial reporting framework that has been
applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union.
Respective responsibilities of directors and auditors
As explained more fully in the Directors’ Responsibilities Statement on page 176, the directors are responsible for the preparation of the group
financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the group
financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to
comply with the Auditing Practices Board’s Ethical Standards for Auditors.
This report, including the opinions, has been prepared for and only for the Company’s members as a body in accordance with Chapter 3 of Part 16
of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose
or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Scope of the audit of the financial statements
An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the
financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting
policies are appropriate to the group’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of
significant accounting estimates made by the directors; and the overall presentation of the financial statements. In addition, we read all the
financial and non-financial information in the Annual Report and Accounts to identify material inconsistencies with the audited financial statements.
If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Opinion on financial statements
In our opinion the group financial statements:
– give a true and fair view of the state of the group’s affairs as at 31 December 2011 and of its loss and cash flows for the year then ended;
– have been properly prepared in accordance with IFRSs as adopted by the European Union; and
– have been prepared in accordance with the requirements of the Companies Act 2006 and Article 4 of the IAS Regulation.
Opinion on other matters prescribed by the Companies Act 2006
In our opinion:
– the information given in the Directors’ Report for the financial year for which the group financial statements are prepared is consistent with the
group financial statements; and
– the information given in the Corporate Governance Report set out on pages 177 to 186 with respect to internal control and risk management
systems and about share capital structures is consistent with the financial statements.
207
Annual Report and Accounts 2011
REPORT OF THE INDEPENDENT AUDITORS ON THE
CONSOLIDATED FINANCIAL STATEMENTS
Matters on which we are required to report by exception
We have nothing to report in respect of the following:
Under the Companies Act 2006 we are required to report to you if, in our opinion:
– certain disclosures of directors’ remuneration specified by law are not made; or
– we have not received all the information and explanations we require for our audit; or
– a corporate governance statement has not been prepared by the parent company.
Under the Listing Rules we are required to review:
– the directors’ statement, on page 174, in relation to going concern;
– the part of the Corporate Governance Report relating to the company’s compliance with the nine provisions of the UK Corporate Governance
Code specified for our review; and
– certain elements of the report to shareholders by the Board on directors’ remuneration.
Other matter
We have reported separately on the parent company financial statements of Lloyds Banking Group plc for the year ended 31 December 2011
and on the information in the Directors’ Remuneration Report that is described as having been audited.
Philip Rivett
Senior Statutory Auditor
for and on behalf of PricewaterhouseCoopers LLP
Chartered Accountants and Statutory Auditors
London
27 February 2012
(a)
The maintenance and integrity of the Lloyds Banking Group plc website is the responsibility of the directors; the work carried out by the
auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have
occurred to the financial statements since they were initially presented on the website.
(b) Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in
other jurisdictions.
208
Annual Report and Accounts 2011
CONSOLIDATED INCOME STATEMENT
for the year ended 31 December
Interest and similar income
Interest and similar expense
Net interest income
Fee and commission income
Fee and commission expense
Net fee and commission income1
Net trading income
Insurance premium income
Other operating income
Other income
Total income
Insurance claims1
Total income, net of insurance claims
Government Asset Protection Scheme fee
Payment protection insurance provision
Other operating expenses
Total operating expenses
Trading surplus
Impairment
Share of results of joint ventures and associates
Gain on acquisition
Loss on disposal of businesses
(Loss) profit before tax
Taxation
(Loss) profit for the year
Profit attributable to non-controlling interests
(Loss) profit attributable to equity shareholders
(Loss) profit for the year
Basic earnings per share
Diluted earnings per share
1
See notes 6 and 10.
The accompanying notes are an integral part of the consolidated financial statements.
Note
5
6
7
8
9
10
11
12
13
14
15
16
17
17
2011
£ million
26,316
(13,618)
12,698
4,935
(1,391)
3,544
(368)
8,170
2,768
14,114
26,812
(6,041)
20,771
–
(3,200)
(13,050)
(16,250)
4,521
(8,094)
31
–
–
(3,542)
828
(2,714)
73
(2,787)
(2,714)
2010
£ million
29,340
(16,794)
12,546
4,992
(1,682)
3,310
15,724
8,148
4,316
31,498
44,044
(19,088)
24,956
–
–
(13,270)
(13,270)
11,686
(10,952)
(88)
–
(365)
281
(539)
(258)
62
(320)
(258)
(4.1)p
(4.1)p
(0.5)p
(0.5)p
2009
£ million
28,238
(19,212)
9,026
4,728
(1,517)
3,211
19,098
8,946
5,490
36,745
45,771
(22,493)
23,278
(2,500)
–
(13,484)
(15,984)
7,294
(16,673)
(752)
11,173
–
1,042
1,911
2,953
126
2,827
2,953
7.5p
7.5p
209
Annual Report and Accounts 2011
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
for the year ended 31 December
(Loss) profit for the year
Other comprehensive income
Movements in revaluation reserve in respect of available-for-sale financial assets:
Change in fair value
Income statement transfers in respect of disposals
Income statement transfers in respect of impairment
Other income statement transfers
Taxation
Movement in cash flow hedging reserve:
Effective portion of changes in fair value taken to other comprehensive income
Net income statement transfers
Taxation
Currency translation differences:
Currency translation differences, before tax
Taxation
Other comprehensive income for the year, net of tax
Total comprehensive income for the year
Total comprehensive income attributable to non-controlling interests
Total comprehensive income attributable to equity shareholders
Total comprehensive income for the year
2011
£ million
(2,714)
2010
£ million
(258)
2009
£ million
2,953
2,603
(343)
80
(155)
(575)
1,610
916
70
(270)
716
(84)
–
(84)
2,242
(472)
72
(544)
(472)
1,231
(399)
114
(110)
(343)
493
(1,048)
932
30
(86)
(129)
–
(129)
278
20
57
(37)
20
2,035
(97)
621
(93)
(417)
2,049
(530)
121
119
(290)
162
(182)
(20)
1,739
4,692
107
4,585
4,692
210
Annual Report and Accounts 2011
CONSOLIDATED BALANCE SHEET
at 31 December
Assets
Cash and balances at central banks
Items in the course of collection from banks
Trading and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and receivables:
Loans and advances to banks
Loans and advances to customers
Debt securities
Available-for-sale financial assets
Held-to-maturity investments
Investment properties
Investments in joint ventures and associates
Goodwill
Value of in-force business
Other intangible assets
Tangible fixed assets
Current tax recoverable
Deferred tax assets
Retirement benefit assets
Other assets
Total assets
The accompanying notes are an integral part of the consolidated financial statements.
Note
2011
£ million
2010
£ million
60,722
1,408
139,510
66,013
32,606
565,638
12,470
610,714
37,406
8,098
6,122
334
2,016
6,638
3,196
7,673
434
4,496
1,338
14,428
970,546
18
19
20
21
24
26
27
28
13
29
30
31
32
44
43
33
38,115
1,368
156,191
50,777
30,272
592,597
25,735
648,604
42,955
7,905
5,997
429
2,016
7,367
3,496
8,190
621
4,164
736
12,643
991,574
211
Annual Report and Accounts 2011
CONSOLIDATED BALANCE SHEET
at 31 December
Equity and liabilities
Liabilities
Deposits from banks
Customer deposits
Items in course of transmission to banks
Trading and other financial liabilities at fair value through profit or loss
Derivative financial instruments
Notes in circulation
Debt securities in issue
Liabilities arising from insurance contracts and participating investment contracts
Liabilities arising from non-participating investment contracts
Unallocated surplus within insurance businesses
Other liabilities
Retirement benefit obligations
Current tax liabilities
Deferred tax liabilities
Other provisions
Subordinated liabilities
Total liabilities
Equity
Share capital
Share premium account
Other reserves
Retained profits
Shareholders’ equity
Non-controlling interests
Total equity
Total equity and liabilities
The accompanying notes are an integral part of the consolidated financial statements.
The directors approved the consolidated financial statements on 27 February 2012.
Sir Winfried Bischoff
Chairman
António Horta-Osório
Group Chief Executive
Note
2011
£ million
2010
£ million
34
35
36
19
37
38
40
41
42
43
44
45
46
47
48
49
50
39,810
413,906
844
24,955
58,212
1,145
50,363
393,633
802
26,762
42,158
1,074
185,059
228,866
78,991
49,636
300
32,041
381
103
314
3,166
35,089
923,952
6,881
16,541
13,818
8,680
45,920
674
46,594
970,546
80,729
51,363
643
29,696
423
149
247
1,532
36,232
944,672
6,815
16,291
11,575
11,380
46,061
841
46,902
991,574
212
Annual Report and Accounts 2011
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Balance at 1 January 2011
Comprehensive income
(Loss) profit for the year
Other comprehensive income
Movements in revaluation reserve in respect
of available-for-sale financial assets, net of tax
Movements in cash flow hedging reserve,
net of tax
Currency translation differences, net of tax
Total other comprehensive income
Total comprehensive income
Transactions with owners
Dividends
Issue of ordinary shares
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
Change in non-controlling interests
Total transactions with owners
Balance at 31 December 2011
Attributable to equity shareholders
Share capital
and premium
£ million
23,106
Other
reserves
£ million
11,575
Retained
profits
£ million
11,380
Total
£ million
46,061
Non-controlling
interests
£ million
841
Total
£ million
46,902
–
–
–
–
–
–
–
316
–
–
–
–
316
23,422
–
(2,787)
(2,787)
73
(2,714)
1,611
716
(84)
2,243
2,243
–
–
–
–
–
–
–
–
–
–
–
(2,787)
–
–
(276)
125
238
–
87
1,611
716
(84)
2,243
(544)
–
316
(276)
125
238
–
403
13,818
8,680
45,920
(1)
–
–
(1)
72
(50)
–
–
–
–
(189)
(239)
674
1,610
716
(84)
2,242
(472)
(50)
316
(276)
125
238
(189)
164
46,594
Further details of movements in the Group’s share capital and reserves are provided in notes 47, 48, 49 and 50.
213
Annual Report and Accounts 2011
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Balance at 1 January 2010
Comprehensive income
(Loss) profit for the year
Other comprehensive income
Movements in revaluation reserve in respect
of available-for-sale financial assets, net of tax
Movements in cash flow hedging reserve,
net of tax
Currency translation differences, net of tax
Total other comprehensive income
Total comprehensive income
Transactions with owners
Dividends
Issue of ordinary shares
Redemption of preference shares
Cancellation of deferred shares
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
Change in non-controlling interests
Total transactions with owners
Balance at 31 December 2010
Attributable to equity shareholders
Share capital
and premium
£ million
24,944
Other
reserves
£ million
7,217
Retained
profits
£ million
11,117
Total
£ million
43,278
–
(320)
(320)
–
–
–
–
–
–
–
2,237
11
(4,086)
–
–
–
–
498
(86)
(129)
283
283
–
–
(11)
4,086
–
–
–
–
–
–
–
–
(320)
–
–
–
–
20
154
409
–
583
11,380
498
(86)
(129)
283
(37)
–
2,237
–
–
20
154
409
–
2,820
46,061
(1,838)
23,106
4,075
11,575
Non-controlling
interests
£ million
829
62
(5)
–
–
(5)
57
(47)
–
–
–
–
–
–
2
(45)
841
Total
£ million
44,107
(258)
493
(86)
(129)
278
20
(47)
2,237
–
–
20
154
409
2
2,775
46,902
214
Annual Report and Accounts 2011
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Share capital
and premium
£ million
3,609
Attributable to equity shareholders
Other
reserves
£ million
(2,345)
Retained
profits
£ million
8,129
Total
£ million
9,393
–
2,827
2,827
Currency translation differences, net of tax
–
Balance at 1 January 2009
Comprehensive income
Profit for the year
Other comprehensive income
Movements in revaluation reserve in respect
of available-for-sale financial assets, net of tax
Movements in cash flow hedging reserve,
net of tax
Total other comprehensive income
Total comprehensive income
Transactions with owners
Dividends
Issue of ordinary shares:
Placing and open offer
Issued on acquisition of HBOS
Placing and compensatory open offer
Rights issue
Issued to Lloyds TSB Foundations
Adjustment on acquisition
Transfer to merger reserve
Redemption of preference shares
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
Extinguishment of non-controlling interests
Total transactions with owners
Balance at 31 December 2009
–
–
–
–
–
–
649
1,944
3,905
13,112
41
–
(1,000)
2,684
–
–
–
–
2,248
(290)
(200)
1,758
1,758
–
3,781
5,707
–
–
–
–
1,000
(2,684)
–
–
–
–
–
–
–
–
2,827
–
–
–
–
–
–
–
–
–
10
116
35
–
161
11,117
21,335
24,944
7,804
7,217
Non-controlling
interests
£ million
306
126
–
–
(19)
(19)
107
Total
£ million
9,699
2,953
2,248
(290)
(219)
1,739
4,692
2,248
(290)
(200)
1,758
4,585
–
(116)
(116)
4,430
7,651
3,905
13,112
41
–
–
–
10
116
35
–
29,300
43,278
–
–
–
–
–
5,567
–
–
–
–
–
(5,035)
416
829
4,430
7,651
3,905
13,112
41
5,567
–
–
10
116
35
(5,035)
29,716
44,107
215
Annual Report and Accounts 2011
CONSOLIDATED CASH FLOW STATEMENT
for the year ended 31 December
(Loss) profit before tax
Adjustments for:
Change in operating assets
Change in operating liabilities
Non-cash and other items
Tax (paid) received
Net cash provided by (used in) operating activities
Cash flows from investing activities
Purchase of financial assets
Proceeds from sale and maturity of financial assets
Purchase of fixed assets
Proceeds from sale of fixed assets
Acquisition of businesses, net of cash acquired
Disposal of businesses, net of cash disposed
Net cash provided by (used in) investing activities
Cash flows from financing activities
Dividends paid to non-controlling interests
Interest paid on subordinated liabilities
Proceeds from issue of subordinated liabilities
Proceeds from issue of ordinary shares
Repayment of subordinated liabilities
Change in non-controlling interests
Net cash (used in) provided by financing activities
Effects of exchange rate changes on cash and cash equivalents
Change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
The accompanying notes are an integral part of the consolidated financial statements.
Note
57(A)
57(B)
57(C)
57(E)
57(F)
57(D)
2011
£ million
(3,542)
44,097
(19,187)
(1,339)
(136)
19,893
(28,995)
36,523
(3,095)
2,214
(13)
298
6,932
(50)
(2,126)
–
–
(1,074)
8
(3,242)
6
23,589
62,300
85,889
2010
£ million
281
31,860
(45,683)
11,173
332
(2,037)
(46,890)
45,999
(3,216)
1,354
(73)
428
(2,398)
(47)
(1,942)
3,237
–
(684)
2
566
479
(3,390)
65,690
62,300
2009
£ million
1,042
61,942
(105,927)
8,907
301
(33,735)
(455,816)
490,561
(2,689)
2,129
16,227
411
50,823
(116)
(2,622)
4,187
21,533
(6,897)
(33)
16,052
(210)
32,930
32,760
65,690
216
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of preparation
The consolidated financial statements of Lloyds Banking Group plc have been prepared in accordance with International Financial Reporting
Standards (IFRS) as adopted by the European Union (EU). IFRS comprises accounting standards prefixed IFRS issued by the International
Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the
International Financial Reporting Interpretations Committee (IFRIC) and its predecessor body. The EU endorsed version of IAS 39 Financial
Instruments: Recognition and Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this
relaxation, and therefore there is no difference in application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.
The financial information has been prepared under the historical cost convention, as modified by the revaluation of investment properties,
available‑for‑sale financial assets, trading securities and certain other financial assets and liabilities at fair value through profit or loss and all
derivative contracts. As stated on page 174, the directors consider that it is appropriate to continue to adopt the going concern basis in preparing
the accounts.
In previous years the Group has included annual management charges on non‑participating investment contracts within insurance claims. In light
of developing industry practice, these amounts (2011: £606 million; 2010: £577 million; 2009: £474 million) are now included within net fee and
commission income.
The Group has adopted the following new standards and amendments to standards which became effective for financial years beginning on or
after 1 January 2011. None of these standards or amendments have had a material impact on these financial statements.
(i) Amendment to IAS 32 Financial Instruments: Presentation – ‘Classification of Rights Issues’. Requires rights issues denominated in a currency
other than the functional currency of the issuer to be classified as equity regardless of the currency in which the exercise price is denominated.
(ii)
IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments. Clarifies that when an entity renegotiates the terms of its debt with the
result that the liability is extinguished by the debtor issuing its own equity instruments to the creditor, a gain or loss is recognised in the
income statement representing the difference between the carrying value of the financial liability and the fair value of the equity instruments
issued; the fair value of the financial liability is used to measure the gain or loss where the fair value of the equity instruments cannot be
reliably measured.
(iii) Improvements to IFRSs (issued May 2010). Amends IFRS 7 Financial Instruments: Disclosure to require further disclosures in respect of collateral
held by the Group as security for financial assets and sets out minor amendments to other standards as part of the annual improvements
process.
(iv) Amendment to IFRIC 14 Prepayments of a Minimum Funding Requirement. Applies when an entity is subject to minimum funding
requirements and makes an early payment of contributions to cover those requirements and permits such an entity to treat the benefit of such
an early payment as an asset.
(v) IAS 24 Related Party Disclosures (Revised). Simplifies the definition of a related party and provides a partial exemption from the requirement
to disclose transactions and outstanding balances with the government and government‑related entities. The Group has taken advantage
of an exemption in respect of government and government‑related transactions that permits an entity to disclose only transactions that are
individually or collectively significant. Details of related party transactions are disclosed in note 53.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2011 and which have not
been applied in preparing these financial statements are given in note 58.
217
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2: Accounting policies
The Group’s accounting policies are set out below.
(A) Consolidation
The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis
of accounts made up to the reporting date. Group undertakings include subsidiaries, associates and joint ventures.
(1) Subsidiaries
Subsidiaries include entities over which the Group has the power to govern the financial and operating policies which generally accompanies
a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or
convertible are considered when assessing whether the Group controls another entity. Subsidiaries are fully consolidated from the date on which
control is transferred to the Group; they are de‑consolidated from the date that control ceases. Details of the principal subsidiaries are given in
note 9 to the parent company financial statements.
Investment vehicles, such as Open Ended Investment Companies (OEICs), where the Group has control are consolidated. Control arises when
the Group manages the funds and also has a majority beneficial interest. In circumstances where the Group holds a majority beneficial interest,
but is not the fund manager, the Group does not consolidate the entity as it does not have the fund manager’s decision‑making powers over the
investment activities of the OEIC necessary to establish control. The interests of parties other than the Group are reported in other liabilities.
Special purpose entities (SPEs) are consolidated if, in substance, the Group controls the entity. A key indicator of such control, amongst others,
is where the Group is exposed to the risks and benefits of the SPE.
The treatment of transactions with non‑controlling interests depends on whether, as a result of the transaction, the Group loses control of the
subsidiary. Changes in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions;
any difference between the amount by which the non‑controlling interests are adjusted and the fair value of the consideration paid or received is
recognised directly in equity and attributed to the owners of the parent entity. Where the group loses control of the subsidiary, at the date when
control is lost the amount of any non‑controlling interest in that former subsidiary is derecognised and any investment retained in the former
subsidiary is remeasured to its fair value; the gain or loss that is recognised in profit or loss on the partial disposal of the subsidiary includes the
gain or loss on the remeasurement of the retained interest.
Intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
The acquisition method of accounting is used to account for business combinations by the Group. The consideration for the acquisition of a
subsidiary is the fair value of the assets transferred, the liabilities incurred and the equity interests issued by the Group. The consideration includes
the fair value of any asset or liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred
except those relating to the issuance of debt instruments (see (E)(5) below) or share capital (see (R)(1) below). Identifiable assets acquired and
liabilities assumed in a business combination are measured initially at their fair value at the acquisition date.
(2) Joint ventures and associates
Joint ventures are entities over which the Group has joint control under a contractual arrangement with other parties. Associates are entities over
which the Group has significant influence, but not control or joint control, over the financial and operating policies. Significant influence is the
power to participate in the financial and operating policy decisions of the entity and is normally achieved through holding between 20 per cent
and 50 per cent of the voting share capital of the entity.
The Group utilises the venture capital exemption for investments where significant influence or joint control is present and the business unit
operates as a venture capital business. These investments are designated at initial recognition at fair value through profit or loss. Otherwise, the
Group’s investments in joint ventures and associates are accounted for by the equity method of accounting and are initially recorded at cost and
adjusted each year to reflect the Group’s share of the post‑acquisition results of the joint venture or associate based on audited accounts which are
coterminous with the Group or made up to a date which is not more than three months before the Group’s reporting date. The share of any losses
is restricted to a level that reflects an obligation to fund such losses.
(B) Goodwill
Goodwill arises on business combinations, including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and
associates; goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable assets, liabilities
and contingent liabilities acquired. Where the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities of the
acquired entity is greater than the cost of acquisition, the excess is recognised immediately in the income statement.
Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the
goodwill is written down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of
associates and joint ventures is included in the Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the
carrying value of attributable goodwill is included in the calculation of the profit or loss on disposal except where it has been written off directly
to reserves in the past.
218
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2: Accounting policies (continued)
(C) Other intangible assets
Other intangible assets include brands, core deposit intangibles, purchased credit card relationships, customer‑related intangibles and both
internally and externally generated capitalised software enhancements. Intangible assets which have been determined to have a finite useful life
are amortised on a straight line basis over their estimated useful life as follows:
Capitalised software enhancements
Brands (which have been assessed as having finite lives)
Customer‑related intangibles
Core deposit intangibles
Purchased credit card relationships
up to 5 years
10‑15 years
up to 10 years
up to 8 years
5 years
Intangible assets with finite useful lives are reviewed at each reporting date to assess whether there is any indication that they are impaired.
If any such indication exists the recoverable amount of the asset is determined and in the event that the asset’s carrying amount is greater than its
recoverable amount, it is written down immediately. Certain brands have been determined to have an indefinite useful life and are not amortised.
Such intangible assets are reassessed annually to reconfirm that an indefinite useful life remains appropriate. In the event that an indefinite life is
inappropriate a finite life is determined and an impairment review is performed on the asset.
(D) Revenue recognition
Interest income and expense are recognised in the income statement for all interest‑bearing financial instruments using the effective interest
method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised
cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument.
The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial
instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.
The effective interest rate is calculated on initial recognition of the financial asset or liability by estimating the future cash flows after considering
all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts expected to be paid or received by
the Group including expected early redemption fees and related penalties and premiums and discounts that are an integral part of the overall
return. Direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument are also taken into account in the
calculation. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is
recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see (H) below).
Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided.
Loan commitment fees for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an
adjustment to the effective interest rate on the loan once drawn. Where it is unlikely that loan commitments will be drawn, loan commitment fees
are recognised over the life of the facility. Loan syndication fees are recognised as revenue when the syndication has been completed and the
Group retains no part of the loan package for itself or retains a part at the same effective interest rate for all interest‑bearing financial instruments,
including loans and advances, as for the other participants.
Dividend income is recognised when the right to receive payment is established.
Revenue recognition policies specific to life insurance and general insurance business are detailed below (see (O) below).
(E) Financial assets and liabilities
On initial recognition, financial assets are classified into fair value through profit or loss, available‑for‑sale financial assets, held‑to‑maturity
investments 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 trading liabilities are recognised on trade date, being the date that the Group is committed to purchase or sell an asset.
Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has
transferred its contractual right to receive the cash flows from the assets and either:
– substantially all of the risks and rewards of ownership have been transferred; or
– the Group has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.
Financial liabilities are derecognised when they are extinguished (ie when the obligation is discharged), cancelled or expire.
(1) Financial instruments at fair value through profit or loss
Financial instruments are classified at fair value through profit or loss where they are trading securities or where they are designated at fair value
through profit or loss by management. Derivatives are carried at fair value (see (F) below).
Trading securities are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a
portfolio which is managed for short‑term gains. Such securities are classified as trading securities and recognised in the balance sheet at their fair
value. Gains and losses arising from changes in their fair value together with interest coupons and dividend income are recognised in the income
statement within net trading income in the period in which they occur.
219
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2: Accounting policies (continued)
Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. Such
assets and liabilities are carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest
coupons and dividend income are recognised in the income statement within net trading income in the period in which they occur. Financial
assets and liabilities are designated at fair value through profit or loss on acquisition in the following circumstances:
– it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising
gains or losses on different bases. The main type of financial assets designated by the Group at fair value through profit or loss are assets backing
insurance contracts and investment contracts issued by the Group’s life insurance businesses. Fair value designation allows changes in the fair
value of these assets to be recorded in the income statement along with the changes in the value of the associated liabilities, thereby significantly
reducing the measurement inconsistency had the assets been classified as available‑for‑sale financial assets.
– the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a
documented risk management or investment strategy, with management information also prepared on this basis. As noted in (A)(2) above
certain of the Group’s investments are managed as venture capital investments and evaluated on the basis of their fair value and these assets are
designated at fair value through profit or loss.
– where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and
would otherwise need to be separately accounted for.
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active
the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other
instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used
by market participants. Refer to note 3 (Critical accounting estimates and judgements: Fair value of financial instruments) and note 55(3) (Financial
instruments: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
The Group is permitted to reclassify, at fair value at the date of transfer, non‑derivative financial assets (other than those designated at fair value
through profit or loss by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or
repurchased in the near term, as follows:
– if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at
initial recognition), they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the
foreseeable future or until maturity;
– if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into
available‑for‑sale financial assets in ‘rare circumstances’.
(2) Available-for-sale financial assets
Debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss, held‑to‑maturity investments or
as loans and receivables are classified as available‑for‑sale financial assets and are recognised in the balance sheet at their fair value, inclusive of
transaction costs. Available‑for‑sale financial assets are those intended to be held for an indeterminate period of time and may be sold in response
to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of
investments classified as available‑for‑sale are recognised directly in other comprehensive income, until the financial asset is either sold, becomes
impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income
statement. Interest calculated using the effective interest method and foreign exchange gains and losses on debt securities denominated in
foreign currencies are recognised in the income statement.
The Group is permitted to transfer a financial asset from the available‑for‑sale category to the loans and receivables category where that asset
would have met the definition of loans and receivables at the time of reclassification (if the financial asset had not been designated as
available‑for‑sale) and where there is both the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a
financial asset from the available‑for‑sale category to the held‑to‑maturity category is permitted when the Group has the ability and intent to hold
that financial asset to maturity.
Reclassifications are made at fair value as of the reclassification date. Fair value becomes the new cost or amortised cost as applicable. Effective
interest rates for financial assets reclassified to the loans and receivables and held‑to‑maturity categories are determined at the reclassification
date. Any previous gain or loss on a transferred asset that has been recognised in equity is amortised to profit or loss over the remaining life of
the investment using the effective interest method or until the asset becomes impaired. Any difference between the new amortised cost and the
expected cash flows is also amortised over the remaining life of the asset using the effective interest method.
When an impairment loss is recognised in respect of available‑for‑sale assets transferred, the unamortised balance of any available‑for‑sale reserve
that remains in equity is transferred to the income statement and recorded as part of the impairment loss.
(3) Loans and receivables
Loans and receivables include loans and advances to banks and customers and eligible assets including those transferred into this category out
of the fair value through profit or loss or available‑for‑sale financial assets categories. Loans and receivables are initially recognised when cash is
advanced to the borrowers at fair value inclusive of transaction costs or, for eligible assets transferred into this category, their fair value at the date
of transfer. Financial assets classified as loans and receivables are accounted for at amortised cost using the effective interest method (see (D)
above) less provision for impairment (see (H) below).
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Note 2: Accounting policies (continued)
The Group has entered into securitisation and similar transactions to finance certain loans and advances to customers. In cases where the
securitisation vehicles are funded by the issue of debt, on terms whereby the majority of the risks and rewards of the portfolio of securitised
lending are retained by the Group, these loans and advances continue to be recognised by the Group, together with a corresponding liability
for the funding.
(4) Held-to-maturity investments
Held‑to‑maturity investments are non‑derivative financial assets with fixed or determinable payments and fixed maturities that the Group’s
management has the positive intention and ability to hold to maturity other than:
– those that the Group designates upon initial recognition as at fair value through profit or loss;
– those that the Group designates as available‑for‑sale; and
– those that meet the definition of loans and receivables.
These are initially recognised at fair value including direct and incremental transaction costs and measured subsequently at amortised cost, using
the effective interest method, less any provision for impairment.
(5) Borrowings
Borrowings (which include deposits from banks, customer deposits, debt securities in issue and subordinated liabilities) are recognised initially
at fair value, being their issue proceeds net of transaction costs incurred. These instruments are subsequently stated at amortised cost using the
effective interest method.
Preference shares and other instruments which carry a mandatory coupon or are redeemable on a specific date are classified as financial liabilities.
The coupon on these instruments is recognised in the income statement as interest expense.
An exchange of financial liabilities on substantially different terms is accounted for as an extinguishment of the original financial liability and the
recognition of a new financial liability. The difference between the carrying amount of a financial liability extinguished and the new financial liability
is recognised in profit or loss together with any related costs or fees incurred.
When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between
the original carrying value of the liability and the fair value of the new equity is recognised in the profit or loss together with any related costs or
fees incurred.
(6) Sale and repurchase agreements
Securities sold subject to repurchase agreements (repos) continue to be recognised on the balance sheet where substantially all of the risks and
rewards are retained. Funds received under these arrangements are included in deposits from banks, customer deposits, or trading liabilities.
Conversely, securities purchased under agreements to resell (reverse repos), where the Group does not acquire substantially all of the risks and
rewards of ownership, are recorded as loans and receivables or trading securities. The difference between sale and repurchase price is treated
as interest and accrued over the life of the agreements using the effective interest method.
Securities lent to counterparties are retained in the financial statements. Securities borrowed are not recognised in the financial statements, unless
these are sold to third parties, in which case the obligation to return them is recorded at fair value as a trading liability.
(F) Derivative financial instruments and hedge accounting
All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market
transactions, and using valuation techniques, including discounted cash flow and option pricing models, as appropriate. Derivatives are carried
in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 3 (Critical accounting
estimates and judgements: Fair value of financial instruments) and note 55(3) (Financial instruments: Fair values of financial assets and liabilities)
for details of valuation techniques and significant inputs to valuation models.
Changes in the fair value of any derivative instrument that is not part of a hedging relationship are recognised immediately in the income
statement.
Derivatives embedded in financial instruments and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated
as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is
not carried at fair value through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the
income statement. In accordance with IFRS 4 Insurance Contracts, a policyholder’s option to surrender an insurance contract for a fixed amount
is not treated as an embedded derivative.
The method of recognising the movements in the fair value of derivatives depends on whether they are designated as hedging instruments
and, if so, the nature of the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to
be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the
hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item and the hedging instrument and the
methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value or cash flow of the
hedged risk. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded
that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued.
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Note 2: Accounting policies (continued)
The Group designates certain derivatives as either: (1) hedges of the fair value of the particular risks inherent in recognised assets or liabilities
(fair value hedges); (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges
of net investments in foreign operations (net investment hedges). These are accounted for as follows:
(1) Fair value hedges
Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together
with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk; this also applies if the hedged asset is
classified as an available‑for‑sale financial asset. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the
hedged item attributable to the hedged risk are no longer recognised in the income statement. The cumulative adjustment that has been made
to the carrying amount of the hedged item is amortised to the income statement using the effective interest method over the period to maturity.
(2) Cash flow hedges
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other
comprehensive income in the cash flow hedge reserve. The gain or loss relating to the ineffective portion is recognised immediately in the income
statement. Amounts accumulated in equity are reclassified to the income statement in the periods in which the hedged item affects profit or loss.
When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss
existing in equity at that time remains in equity and is recognised in the income statement when the forecast transaction is ultimately recognised
in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is
immediately transferred to the income statement.
(3) Net investment hedges
Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument
relating to the effective portion of the hedge is recognised in other comprehensive income, the gain or loss relating to the ineffective portion
is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when
the foreign operation is disposed of. The hedging instrument used in net investment hedges may include non‑derivative liabilities as well as
derivative financial instruments.
(G) Offset
Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set‑off and
there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously. In certain situations, even though master
netting agreements exist, the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported
gross on the balance sheet.
(H) Impairment of financial assets
(1) Assets accounted for at amortised cost
At each balance sheet date the Group assesses whether, as a result of one or more events occurring after initial recognition of the financial asset
and prior to the balance sheet date, there is objective evidence that a financial asset or group of financial assets has become impaired.
Where such an event has had an impact on the estimated future cash flows of the financial asset or group of financial assets, an impairment
allowance is recognised. The amount of impairment allowance is the difference between the asset’s carrying amount and the present value of
estimated future cash flows discounted at the asset’s original effective interest rate. If the asset has a variable rate of interest, the discount rate
used for measuring the impairment allowance is the current effective interest rate.
Subsequent to the recognition of an impairment loss on a financial asset or a group of financial assets, interest income continues to be recognised
on an effective interest rate basis, on the asset’s carrying value net of impairment provisions. If, in a subsequent period, the amount of the
impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, such as an
improvement in the borrower’s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the income statement.
Impairment allowances are assessed individually for financial assets that are individually significant. Such individual assessment is used primarily
for the Group’s wholesale lending portfolios in the Wholesale, Commercial and Wealth and International divisions. Impairment allowances for
portfolios of smaller balance homogenous loans such as most residential mortgages, personal loans and credit card balances in the Group’s retail
portfolios in both the Retail and Wealth and International divisions that are below the individual assessment thresholds, and for loan losses that
have been incurred but not separately identified at the balance sheet date, are determined on a collective basis.
Individual assessment
In respect of individually significant financial assets in the Group’s wholesale lending portfolios, assets are reviewed on a regular basis and those
showing potential or actual vulnerability are placed on a watch list where greater monitoring is undertaken and any adverse or potentially adverse
impact on ability to repay is used in assessing whether an asset should be transferred to a dedicated Business Support Unit. Specific examples of
trigger events that would lead to the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of
additional impairment allowances) include (i) trading losses, loss of business or major customer of a borrower, (ii) material breaches of the terms
and conditions of a loan facility, including non‑payment of interest or principal, or a fall in the value of security such that it is no longer considered
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Note 2: Accounting policies (continued)
adequate, (iii) disappearance of an active market because of financial difficulties, or (iv) restructuring a facility with preferential terms to aid recovery
of the lending (such as a debt for equity swap).
For such individually identified financial assets, a review is undertaken of the expected future cash flows which requires significant management
judgement as to the amount and timing of such cash flows. Where the debt is secured, the assessment reflects the expected cash flows from the
realisation of the security, net of costs to realise, whether or not foreclosure or realisation of the collateral is probable.
For impaired debt instruments which are held at amortised cost, impairment losses are recognised in subsequent periods when it is determined
that there has been a further negative impact on expected future cash flows. A reduction in fair value caused by general widening of credit spreads
would not, of itself, result in additional impairment.
Collective assessment
Impairment is assessed on a collective basis for (1) homogenous groups of loans that are not considered individually impaired, and (2) to cover
losses which have been incurred but have not yet been identified on loans subject to individual impairment.
Homogenous groups of loans
In respect of portfolios of smaller balance, homogenous loans, the asset is included in a group of financial assets with similar risk characteristics
and collectively assessed for impairment. Segmentation takes into account factors such as the type of asset, industry sector, geographical location,
collateral type, past‑due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of
such assets as they are indicative of the borrower’s ability to pay all amounts due according to the contractual terms of the assets being evaluated.
Generally, the impairment trigger used within the impairment calculation for a loan, or group of loans, is when they reach a pre‑defined level of
delinquency or where the customer is bankrupt. Loans where the Group provides arrangements that forgive a portion of interest or principal are
also deemed to be impaired and loans that are originated to refinance currently impaired assets are also defined as impaired.
In respect of the Group’s secured mortgage portfolios, the impairment allowance is calculated based on a definition of impaired loans which are
those six months or more in arrears (or certain cases where the borrower is bankrupt or is in possession). The estimated cash flows are calculated
based on historical experience and are dependent on estimates of the expected value of collateral which takes into account expected future
movements in house prices, less costs to sell.
For unsecured personal lending portfolios, the impairment trigger is generally when the balance is two or more instalments in arrears or where the
customer has exhibited one or more of the impairment characteristics set out above. While the trigger is based on the payment performance or
circumstances of each individual asset, the assessment of future cash flows uses historical experience of cohorts of similar portfolios such that the
assessment is considered to be collective. Future cash flows are estimated on the basis of the contractual cash flows of the assets in the cohort
and historical loss experience for similar assets. Historical loss experience is adjusted on the basis of current observable data about economic and
credit conditions (including unemployment rates and borrowers’ behaviour) to reflect the effects of current conditions that did not affect the period
on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. The
methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss
estimates and actual loss experience.
Incurred but not yet identified impairment
The collective provision also includes provision for inherent losses, that is losses that have been incurred but have not been separately identified at
the balance sheet date. The loans that are not currently recognised as impaired are grouped into homogenous portfolios by key risk drivers. Risk drivers
for secured retail lending include the current indexed loan‑to‑value, previous mortgage arrears, internal cross‑product delinquency data and external
credit bureau data; for unsecured retail lending they include whether the account is up‑to‑date and, if not, the number of payments that have been
missed; and for wholesale lending they include factors such as observed default rates and loss given default. An assessment is made of the likelihood
of each account becoming recognised as impaired within the loss emergence period, with the economic loss that each portfolio is likely to generate
were it to become impaired. The loss emergence period is determined by local management for each portfolio and the Group has a range of loss
emergence periods which are dependent upon the characteristics of the portfolios. Loss emergence periods are reviewed regularly and updated when
appropriate. In general the periods used across the Group vary between one month and twelve months based on historical experience. Unsecured
portfolios tend to have shorter loss emergence periods than secured portfolios.
Loan renegotiations and forbearance
In certain circumstances, the Group will renegotiate the original terms of a customer’s loan, either as part of an ongoing customer relationship or
in response to adverse changes in the circumstances of the borrower. There are a number of different types of loan renegotiation, including the
capitalisation of arrears, payment holidays, interest rate adjustments and extensions of the due date of payment (see note 56 Credit risk sections
F and G). Where the renegotiated payments of interest and principal will not recover the original carrying value of the asset, the asset continues to
be reported as past due and is considered impaired. Where the renegotiated payments of interest and principal will recover the original carrying
value of the asset, the loan is no longer reported as past due or impaired provided that payments are made in accordance with the revised terms.
Renegotiation may lead to the loan and associated provision being derecognised and a new loan being recognised initially at fair value.
Write offs
A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available
security have been received or there is no realistic prospect of recovery and the amount of the loss has been determined. Subsequent recoveries
of amounts previously written off decrease the amount of impairment losses recorded in the income statement. For both secured and unsecured
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Note 2: Accounting policies (continued)
retail balances, the write‑off takes place only once an extensive set of collections processes has been completed, or the status of the account
reaches a point where policy dictates that forbearance is no longer appropriate. For wholesale lending, a write‑off occurs if the loan facility with
the customer is restructured, the asset is under administration and the only monies that can be received are the amounts estimated by the
administrator, the underlying assets are disposed and a decision is made that no further settlement monies will be received, or external evidence
(for example, third party valuations) is available that there has been an irreversible decline in expected cash flows.
Debt for equity exchanges
Equity securities acquired in exchange for loans in order to achieve an orderly realisation are accounted for as a disposal of the loan and an
acquisition of equity securities, held as available‑for‑sale. Where control is obtained over an entity as a result of the transaction, the entity is
consolidated; where the Group has significant influence over an entity as a result of the transaction, the investment is accounted for by the equity
method of accounting (see (A) above). Any subsequent impairment of the assets or business acquired is treated as an impairment of the relevant
asset or business and not as an impairment of the original instrument.
(2) Available-for-sale financial assets
The Group assesses, at each balance sheet date, whether there is objective evidence that an available‑for‑sale financial asset is impaired. In
addition to the criteria for financial assets accounted for at amortised cost set out above, this assessment involves reviewing the current financial
circumstances (including creditworthiness) and future prospects of the issuer, assessing the future cash flows expected to be realised and, in the
case of equity shares, considering whether there has been a significant or prolonged decline in the fair value of the asset below its cost. If an
impairment loss has been incurred, the cumulative loss measured as the difference between the acquisition cost (net of any principal repayment
and amortisation) and the current fair value, less any impairment loss on that asset previously recognised, is reclassified from equity to the income
statement. For impaired debt instruments, impairment losses are recognised in subsequent periods when it is determined that there has been
a further negative impact on expected future cash flows; a reduction in fair value caused by general widening of credit spreads would not, of
itself, result in additional impairment. If, in a subsequent period, the fair value of a debt instrument classified as available‑for‑sale increases and
the increase can be objectively related to an event occurring after the impairment loss was recognised, an amount not greater than the original
impairment loss is credited to the income statement; any excess is taken to other comprehensive income. Impairment losses recognised in the
income statement on equity instruments are not reversed through the income statement.
(I) Investment property
Investment property comprises freehold and long leasehold land and buildings that are held either to earn rental income or for capital
appreciation or both. The Group’s investment property primarily relates to property held for long‑term rental yields and capital appreciation within
the life insurance funds. Investment property is carried in the balance sheet at fair value, being the open market value as determined in accordance
with the guidance published by the Royal Institution of Chartered Surveyors. If this information is not available, the Group uses alternative valuation
methods such as discounted cash flow projections or recent prices. These valuations are reviewed at least annually by an independent valuation
expert. Investment property being redeveloped for continuing use as investment property, or for which the market has become less active,
continues to be measured at fair value. Changes in fair value are recognised in the income statement as net trading income.
(J) Tangible fixed assets
Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation
on other assets is calculated using the straight‑line method to allocate the difference between the cost and the residual value over their estimated
useful lives, as follows:
Premises (excluding land):
– Freehold/long and short leasehold premises: shorter of 50 years and the remaining period of the lease
– Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease
Equipment:
– Fixtures and furnishings: 10‑20 years
– Other equipment and motor vehicles: 2‑8 years
The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
In the event that an asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately. The
recoverable amount is the higher of the asset’s fair value less costs to sell and its value in use.
(K) Leases
(1) As lessee
The leases entered into by the Group are primarily operating leases. Operating lease rentals payable are charged to the income statement on
a straight‑line basis over the period of the lease.
When an operating lease is terminated before the end of the lease period, any payment made to the lessor by way of penalty is recognised as
an expense in the period of termination.
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Note 2: Accounting policies (continued)
(2) As lessor
Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the
lessee but not necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value
of the lease payments, together with any unguaranteed residual value, is recognised as a receivable, net of provisions, within loans and advances to
banks and customers. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance lease
income. Finance lease income is recognised in interest income over the term of the lease using the net investment method (before tax) so as to give
a constant rate of return on the net investment in the leases. Unguaranteed residual values are reviewed regularly to identify any impairment.
Operating lease assets are included within tangible fixed assets at cost and depreciated over their estimated useful lives, which equates to the
lives of the leases, after taking into account anticipated residual values. Operating lease rental income is recognised on a straight‑line basis over
the life of the lease.
The Group evaluates non‑lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then
accounted for separately.
(L) Pensions and other post-retirement benefits
The Group operates a number of post‑retirement benefit schemes for its employees including both defined benefit and defined contribution
pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement,
dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group
pays fixed contributions; there is no legal or constructive obligation to pay further contributions.
Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening
years; these valuations are updated to 31 December each year by qualified independent actuaries, or in the case of the Scottish Widows
Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows. For the purposes of these annual updates scheme assets
are included at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method adjusted for
unrecognised actuarial gains and losses. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the
balance sheet date on high‑quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms
to maturity approximating to the terms of the related pension liability.
The Group’s income statement charge includes the current service cost of providing pension benefits, the expected return on the schemes’
assets, net of expected administration costs, and the interest cost on the schemes’ liabilities. Actuarial gains and losses arising from experience
adjustments and changes in actuarial assumptions are not recognised unless the cumulative unrecognised gain or loss at the end of the previous
reporting period exceeds the greater of 10 per cent of the scheme assets or liabilities (‘the corridor approach’). In these circumstances the excess
is charged or credited to the income statement over the employees’ expected average remaining working lives. Past service costs are charged
immediately to the income statement, unless the charges are conditional on the employees remaining in service for a specified period of time (the
vesting period). In this case, the past service costs are amortised on a straight‑line basis over the vesting period.
The Group’s balance sheet includes the net surplus or deficit, being the difference between the fair value of scheme assets and the discounted
value of scheme liabilities at the balance sheet date adjusted for any cumulative unrecognised actuarial gains or losses. Surpluses are only
recognised to the extent that they are recoverable through reduced contributions in the future or through refunds from the schemes.
The Group recognises the effect of material changes to the terms of its defined benefit pension plans which reduce future benefits as curtailments;
gains and losses are recognised in the income statement when the curtailments occur.
The costs of the Group’s defined contribution plans are charged to the income statement in the period in which they fall due.
(M) Share-based compensation
The Group operates a number of equity‑settled, share‑based compensation plans in respect of services received from certain of its employees.
The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the
vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number
of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of
grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique,
such as a Black‑Scholes option pricing model. The determination of fair values excludes the impact of any non‑market vesting conditions, which
are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate
is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting
period, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans
are treated as non‑vesting conditions and in accordance with IFRS 2 (Revised) the Group recognises, in the year of cancellation, the amount of
the expense that would have otherwise been recognised over the remainder of the vesting period. Modifications are assessed at the date of
modification and any incremental charges are charged to the income statement over any remaining vesting period.
(N) Taxation
Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
For the Group’s long‑term insurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax
that is payable on equity holders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under
current UK tax rules.
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Note 2: Accounting policies (continued)
Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their
carrying amounts in the consolidated financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset
or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss.
Deferred tax is determined using tax rates that have been enacted or substantially enacted by the balance sheet date which are expected to apply
when the related deferred tax asset is realised or the deferred tax liability is settled.
Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be
utilised. Income tax payable on profits is recognised as an expense in the period in which those profits arise. The tax effects of losses available for
carry forward are recognised as an asset when it is probable that future taxable profits will be available against which these losses can be utilised.
Deferred and current tax related to gains and losses on the fair value re‑measurement of available‑for‑sale investments and cash flow hedges,
where these gains and losses are recognised in other comprehensive income, is also recognised in other comprehensive income. Such tax is
subsequently transferred to the income statement together with the gain or loss.
Deferred and current tax assets and liabilities are offset when they arise in the same tax reporting group and where there is both a legal right of
offset and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously.
(O) Insurance
The Group undertakes both life insurance and general insurance business. Insurance and participating investment contracts are accounted for
under IFRS 4 Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and
participating investment contracts that applied prior to the adoption of IFRS. The Group, therefore, continues to account for these products using
UK GAAP, including FRS 27 Life Assurance, and UK established practice.
Products sold by the life insurance business are classified into three categories:
Insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance
risk as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the
insured event were not to occur. These contracts may or may not include discretionary participation features.
Investment contracts containing a discretionary participation feature (participating investment contracts) – these contracts do not transfer significant
insurance risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional
discretionary benefits or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at
the discretion of the Group, within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets.
Non‑participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
The general insurance business issues only insurance contracts.
(1) Life insurance business
(i) Accounting for insurance and participating investment contracts
Premiums and claims
Premiums received in respect of insurance and participating investment contracts are recognised as revenue when due except for unit‑linked
contracts on which premiums are recognised as revenue when received. Claims are recorded as an expense on the earlier of the maturity date
or the date on which the claim is notified.
Liabilities
– Insurance and participating investment contracts in the Group’s with-profit funds
Liabilities of the Group’s with‑profit funds, including guarantees and options embedded within products written by these funds, are stated at
their realistic values in accordance with the Financial Services Authority’s realistic capital regime, except that projected transfers out of the funds
into other Group funds are recorded in the unallocated surplus (see below). Further details on the realistic capital regime are given on page 123.
Changes in the value of these liabilities are recognised through insurance claims.
– Insurance and participating investment contracts which are not unit-linked or in the Group’s with-profit funds
A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is
calculated by estimating the future cash flows over the duration of in‑force policies and discounting them back to the valuation date allowing for
probabilities of occurrence. The liability will vary with movements in interest rates and with the cost of life insurance and annuity benefits where
future mortality is uncertain.
Assumptions are made in respect of all material factors affecting future cash flows, including future interest rates, mortality and costs.
Changes in the value of these liabilities are recognised in the income statement through insurance claims.
– Insurance and participating investment contracts which are unit-linked
Liabilities for unit‑linked insurance contracts and participating investment contracts are stated at the bid value of units plus an additional
allowance where appropriate (such as for any excess of future expenses over charges). The liability is increased or reduced by the change in the
unit prices and is reduced by policy administration fees, mortality and surrender charges and any withdrawals. Changes in the value of the liability
are recognised in the income statement through insurance claims. Benefit claims in excess of the account balances incurred in the period are
also charged through insurance claims. Revenue consists of fees deducted for mortality, policy administration and surrender charges.
226
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2: Accounting policies (continued)
Unallocated surplus
Any amounts in the with‑profit funds not yet determined as being due to policyholders or shareholders are recognised as an unallocated surplus
which is shown separately from liabilities arising from insurance contracts and participating investment contracts.
(ii) Accounting for non‑participating investment contracts
The Group’s non‑participating investment contracts are primarily unit‑linked. These contracts are accounted for as financial liabilities whose value
is contractually linked to the fair values of financial assets within the Group’s unitised investment funds. The value of the unit‑linked financial
liabilities is determined using current unit prices multiplied by the number of units attributed to the contract holders at the balance sheet date.
Their value is never less than the amount payable on surrender, discounted for the required notice period where applicable. Investment returns
(including movements in fair value and investment income) allocated to those contracts are recognised in insurance claims.
Deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments
to the non‑participating investment contract liability.
The Group receives investment management fees in the form of an initial adjustment or charge to the amount invested. These fees are in respect
of services rendered in conjunction with the issue and management of investment contracts where the Group actively manages the consideration
received from its customers to fund a return that is based on the investment profile that the customer selected on origination of the contract.
These services comprise an indeterminate number of acts over the lives of the individual contracts and, therefore, the Group defers these fees and
recognises them over the estimated lives of the contracts, in line with the provision of investment management services.
Costs which are directly attributable and incremental to securing new non‑participating investment contracts are deferred. This asset is
subsequently amortised over the period of the provision of investment management services and is reviewed for impairment in circumstances
where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written down immediately through fee
and commission expense in the income statement. All other costs are recognised as expenses when incurred.
(iii) Value of in‑force business
The Group recognises as an asset the value of in‑force business in respect of insurance contracts and participating investment contracts. The asset
represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date.
This is determined after making appropriate assumptions about future economic and operating conditions such as future mortality and persistency
rates and includes allowances for both non‑market risk and for the realistic value of financial options and guarantees. Each cash flow is valued
using the discount rate consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is
presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
The Group’s contractual rights to benefits from providing investment management services in relation to non‑participating investment contracts
acquired in business combinations and portfolio transfers are measured at fair value at the date of acquisition. The resulting asset is amortised
over the estimated lives of the contracts. At each reporting date an assessment is made to determine if there is any indication of impairment.
Where impairment exists, the carrying value of the asset is reduced to its recoverable amount and the impairment loss recognised in the income
statement.
(2) General insurance business
The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included in insurance
premium income, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods
are deferred in the balance sheet within liabilities arising from insurance contracts and participating investment contracts and only credited to the
income statement when earned. Broking commission are recognised when the underwriter accepts the risk of providing insurance cover to the
customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience.
The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at
the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the
outstanding claims after taking into account all known facts. In those cases where there is insufficient information to determine the required
provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about
the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for claims incurred but not
reported at the balance sheet date. Claims liabilities are not discounted.
(3) Liability adequacy test
At each balance sheet date liability adequacy tests are performed to ensure the adequacy of insurance and participating investment contract
liabilities net of related deferred cost assets and value of in‑force business. In performing these tests current best estimates of discounted future
contractual cash flows and claims handling and policy administration expenses, as well as investment income from the assets backing such
liabilities, are used. Any deficiency is immediately charged to the income statement, initially by writing off the relevant assets and subsequently
by establishing a provision for losses arising from liability adequacy tests.
(4) Reinsurance
Contracts entered into by the Group with reinsurers under which the Group is compensated for losses on one or more contracts issued by the
Group and that meet the classification requirements for insurance contracts are classified as reinsurance contracts held.
227
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 2: Accounting policies (continued)
The benefits to which the Group is entitled under its reinsurance contracts held are recognised as reinsurance assets. These assets consist of
short‑term balances due from reinsurers as well as longer term receivables that are dependent on the expected claims and benefits arising under
the related reinsured contracts. Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the
reinsured contracts and in accordance with the terms of each reinsurance contract and are regularly reviewed for impairment. Premiums payable
for reinsurance contracts are recognised as an expense when due within insurance premium income. Changes in the reinsurance recoverable
assets are recognised in the income statement through insurance claims.
(P) Foreign currency translation
Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment
in which the entity operates (the functional currency). The consolidated financial statements are presented in sterling, which is the Company’s
functional and presentation currency.
Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the
transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange
rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when recognised in
other comprehensive income as qualifying cash flow or net investment hedges. Non‑monetary assets that are measured at fair value are translated
using the exchange rate at the date that the fair value was determined. Translation differences on equities and similar non‑monetary items held
at fair value through profit and loss are recognised in profit or loss as part of the fair value gain or loss. Translation differences on available‑for‑sale
non‑monetary financial assets, such as equity shares, are included in the fair value reserve in equity unless the asset is a hedged item in a fair value
hedge.
The results and financial position of all group entities that have a functional currency different from the presentation currency are translated into
the presentation currency as follows:
– The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are
translated into sterling at foreign exchange rates ruling at the balance sheet date.
– The income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the
foreign exchange rates ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.
Foreign exchange differences arising on the translation of a foreign operation are recognised in other comprehensive income and accumulated
in a separate component of equity together with exchange differences arising from the translation of borrowings and other currency instruments
designated as hedges of such investments (see (F)(3) above). On disposal of a foreign operation, the cumulative amount of exchange differences
relating to that foreign operation are reclassified from equity and included in determining the profit or loss arising on disposal.
(Q) Provisions and contingent liabilities
Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required
to settle the obligations and they can be reliably estimated.
The Group recognises provisions in respect of vacant leasehold property where the unavoidable costs of the present obligations exceed
anticipated rental income.
Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations
where the outflows of resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements
but are disclosed unless they are remote.
(R) Share capital
(1) Share issue costs
Incremental costs directly attributable to the issue of new shares or options or to the acquisition of a business are shown in equity as a deduction,
net of tax, from the proceeds.
(2) Dividends
Dividends paid on the Group’s ordinary shares are recognised as a reduction in equity in the period in which they are paid.
(3) Treasury shares
Where the Company or any member of the Group purchases the Company’s share capital, the consideration paid is deducted from shareholders’
equity as treasury shares until they are cancelled. Where such shares are subsequently sold or reissued, any consideration received is included in
shareholders’ equity.
(S) Cash and cash equivalents
For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non‑mandatory balances with central banks and
amounts due from banks with a maturity of less than three months.
228
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 3: Critical accounting estimates and judgements
The preparation of the Group’s financial statements in accordance with IFRS requires management to make judgements, estimates and
assumptions in applying the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent
uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates.
Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations
of future events that are believed to be reasonable under the circumstances.
The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty
in these financial statements, which together are deemed critical to the Group’s results and financial position, are as follows.
Allowance for impairment losses on loans and receivables
At 31 December 2011 gross loans and receivables totalled £629,736 million (2010: £667,555 million) against which impairment allowances of
£19,022 million (2010: £18,951 million) had been made (see note 25). The Group’s accounting policy for losses arising on financial assets classified
as loans and receivables is described in note 2(H)(1); this note also provides an overview of the methodologies applied.
The allowance for impairment losses on loans and receivables is management’s best estimate of losses incurred in the portfolio at the balance
sheet date. Impairment allowances are made up of two components, those determined individually and those determined collectively.
Individual impairment allowances are generally established against the Group’s wholesale lending portfolios. The determination of individual
impairment allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions
and the resulting trading performance of the customer, and the value of the security held, for which there may not be a readily accessible market.
In particular, significant judgement is required by management in the current economic environment in assessing the borrower’s cash flows and
debt servicing capability together with the realisable value of collateral. The actual amount of the future cash flows and their timing may differ
significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be
subject to variation as time progresses and the circumstances of the customer become clearer.
Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the Retail portfolios. The collective
impairment allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including
the interdependency of house prices, unemployment rates, interest rates, borrowers’ behaviour, and consumer bankruptcy trends. It is, however,
inherently difficult to estimate how changes in one or more of these factors might impact the collective impairment allowance.
Given the relative size of the mortgage portfolio, a key variable is house prices which determine the collateral value supporting loans in such
portfolios. The value of this collateral is estimated by applying changes in house price indices to the original assessed value of the property.
If average house prices were ten per cent lower than those estimated at 31 December 2011, the impairment charge would increase by
approximately £285 million in respect of UK mortgages and a further £75 million in respect of Irish mortgages.
In addition, a collective unimpaired provision is made for loan losses that have been incurred but have not been separately identified at the balance
sheet date. This provision is sensitive to changes in the time between the loss event and the date the impairment is specifically identified. This
period is known as the loss emergence period. In the Wholesale division, an increase of one month in the loss emergence period in respect of
the loan portfolio assessed for collective unimpaired provisions would result in an increase in the collective unimpaired provision of approximately
£181 million (at 31 December 2010, a one month increase in the loss emergence period would have increased the collective unimpaired provision
by an estimated £333 million).
Unwind of HBOS acquisition fair value adjustments
The acquisition of HBOS in January 2009 required the Group to recognise the identifiable assets acquired and liabilities assumed at their
acquisition‑date fair values. The overall effect was to increase the book value of HBOS’s net assets by £1,241 million primarily reflecting a reduction
in the value of HBOS’s debt securities and subordinated liabilities of £15,439 million, partially offset by a reduction in the carrying value of HBOS’s
loans and receivables of £14,880 million, including loans and advances to customers of £13,512 million (see note 14).
In the periods subsequent to the acquisition, all of the fair value adjustments unwind. The fair value adjustments made to debt securities and
subordinated liabilities unwind over the expected remaining life of the related securities except in the event that the liability is extinguished,
in which case the remaining unamortised fair value adjustment is recognised in the income statement immediately. The timing of the unwind
of the fair value adjustment relating to loans and receivables requires significant management judgement. This includes the identification of
losses which were expected at the date of acquisition and assessing whether anticipated losses will still be incurred. In 2011, there was a benefit
of £1,943 million (2010: £3,118 million) to the income statement either from the reversal of a fair value adjustment being credited to the income
statement or through a lower impairment charge as a result of the initial HBOS acquisition fair value adjustments.
Fair value of financial instruments
In accordance with IFRS 7, the Group categorises financial instruments carried on the balance sheet at fair value using a three level hierarchy.
Financial instruments categorised as level 1 are valued using quoted market prices and therefore there is minimal judgement applied in
determining fair value. However, the fair value of financial instruments categorised as level 2 and, in particular, level 3 is determined using valuation
techniques including discounted cash flow analysis and valuation models. These valuation techniques involve management judgement and
estimates the extent of which depends on the complexity of the instrument and the availability of market observable information.
229
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 3: Critical accounting estimates and judgements (continued)
Valuation techniques for level 2 financial instruments use inputs that are largely based on observable market data. Level 3 financial instruments
are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data.
Determining the appropriate assumptions to be used for level 3 financial instruments requires significant management judgement.
At 31 December 2011, the Group classified £7,646 million of financial assets and £790 million of financial liabilities as level 3. Further details
of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative
assumptions in determining their fair value are set out in note 55. Details about sensitivities to market risk arising from trading assets and other
treasury positions can be found in the Risk Management section on page 164.
Recoverability of deferred tax assets
At 31 December 2011 the Group carried deferred tax assets on its balance sheet of £4,496 million (2010: £4,164 million) and deferred tax liabilities
of £314 million (2010: £247 million) (note 44). This presentation takes into account the ability of the Group to net deferred tax assets and liabilities
only where there is a legally enforceable right of offset. Note 44 presents the Group’s deferred tax assets and liabilities by type. The largest
category of deferred tax asset relates to tax losses carried forward.
The recoverability of the Group’s deferred tax assets in respect of carry forward losses is based on an assessment of future levels of taxable profit
expected to arise that can be offset against these losses. The Group’s expectations as to the level of future taxable profits take into account the
Group’s long‑term financial and strategic plans, and anticipated future tax adjusting items.
In making this assessment account is taken of business plans, the five year board approved operating plan and the following future risk factors:
– The expected future economic outlook as set out in the Group Chief Executive’s Statement;
– The retail banking business disposal as required by the European Commission; and
– Future regulatory change.
The Group’s total deferred tax asset includes £5,862 million (2010: £6,572 million) in respect of trading losses carried forward. The tax losses have
arisen in individual legal entities and will be used as future taxable profits arise in those legal entities, though substantially all of the unused tax
losses for which a deferred tax asset has been recognised arise in Bank of Scotland plc and Lloyds TSB Bank plc. The deferred tax asset will be
utilised over different time periods in each of the entities in which the tax losses arise. The Group’s assessment is that these tax losses will be fully
used within eight years.
Under current UK tax law there is no expiry date for unused tax losses.
As disclosed in note 44, deferred tax assets totalling £1,288 million (2010: £685 million) have not been recognised in respect of certain capital losses
carried forward, trading losses carried forward (mainly in certain overseas companies) and unrelieved foreign tax credits as there are no predicted
future capital or taxable profits against which these losses can be recognised.
Retirement benefit obligations
The net asset recognised in the balance sheet at 31 December 2011 in respect of the Group’s retirement benefit obligations was £957 million
(comprising an asset of £1,338 million and a liability of £381 million) (2010: a net asset of £313 million) of which an asset of £1,131 million
(2010: £479 million) related to defined benefit pension schemes. As explained in note 2(L), the Group adopts the corridor approach to the
recognition of actuarial gains and losses in respect of its pension schemes and as a consequence has not recognised actuarial losses of £539 million
(2010: £959 million). After allowing for this, the defined benefit pension schemes’ net accounting surplus totalled £592 million (2010: deficit of
£480 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
The value of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of
estimation uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The accounting
surplus or deficit is sensitive to changes in the discount rate, which is affected by market conditions and therefore potentially subject to significant
variation. The cost of the benefits payable by the schemes will also depend upon the longevity of the members. Assumptions are made regarding
the expected lifetime of scheme members based upon recent experience and extrapolate the improving trend, however given the rate of advance
in medical science and increasing levels of obesity, it is uncertain whether they will ultimately reflect actual experience.
The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal
actuarial assumptions is set out in note 43.
Valuation of assets and liabilities arising from life insurance business
At 31 December 2011, the Group recognised a value in‑force business asset of £5,247 million (2010: £5,898 million) and an acquired value
in‑force business asset of £1,391 million (2010: £1,469 million). The value in‑force business asset represents the present value of future profits
expected to arise from the portfolio of in‑force life insurance and participating investment contracts. The acquired value in‑force business asset
represents the contractual rights to benefits from providing investment management services in relation to non‑participating investment contracts
acquired in business combinations and portfolio transfers. The methodology used to value these assets is set out in note 2(O)(1). The valuation or
recoverability of these assets requires assumptions to be made about future economic and operating conditions which are inherently uncertain
and changes could significantly affect the value attributed to these assets. The key assumptions that have been made in determining the carrying
value of the value in‑force business assets at 31 December 2011 are set out in note 30.
230
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 3: Critical accounting estimates and judgements (continued)
At 31 December 2011, the Group carried liabilities arising from insurance contracts and participating investment contracts of £78,991 million
(2010: £80,729 million). The methodology used to value these liabilities is described in note 2(O)(1). Elements of the liability valuations require
assumptions to be made about future investment returns, future mortality rates and future policyholder behaviour and are subject to significant
management judgement and estimation uncertainty. The key assumptions that have been made in determining the carrying value of these
liabilities are set out in note 38.
The effect on the Group’s profit before tax and shareholders’ equity of changes in key assumptions used in determining the life insurance assets
and liabilities is set out in note 39.
Payment protection insurance
The Group has charged a provision of £3,200 million in respect of payment protection insurance (PPI) policies as a result of discussions with the
FSA and a judgment handed down by the UK High Court (see note 45 for more information).
The provision represents management’s best estimate of the anticipated costs of related customer contact and/or redress, including
administration expenses. However, there are still a number of uncertainties as to the eventual costs from any such contact and/or redress given
the inherent difficulties of assessing the impact of detailed implementation of the FSA Policy Statement of 10 August 2010 for all PPI complaints,
uncertainties around the ultimate emergence period for complaints, the availability of supporting evidence and the activities of claims
management companies, all of which will significantly affect complaints volumes, uphold rates and redress costs.
The provision requires significant judgement by management in determining appropriate assumptions, which include the level of complaints,
uphold rates, proactive contact and response rates, Financial Ombudsman Service referral and uphold rates as well as redress costs for each of the
many different populations of customers identified by the Group in its analyses used to determine the best estimate of the anticipated costs of
redress. If the level of complaints had been one percentage point higher (lower) than estimated for all policies open within the last six years then
the provision made in 2011 would have increased (decreased) by approximately £70 million. There are a large number of inter‑dependent
assumptions under‑pinning the provision; the above sensitivity assumes that all assumptions, other than the level of complaints, remain constant.
The sensitivity is, therefore, hypothetical and should be used with caution.
The Group will re‑evaluate the assumptions underlying its analysis at each reporting date as more information becomes available. As noted above,
there is inherent uncertainty in making estimates; actual results in future periods may differ from the amount provided.
Provision in relation to German insurance business litigation
Clerical Medical Investment Group Limited (CMIG) has received a number of claims in the German courts relating to policies issued by CMIG but
sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. CMIG’s strategy includes defending claims
robustly and appealing against adverse judgments. The ultimate financial effect, which could be significant, will only be known once all relevant
claims have been resolved. The Group has charged a provision of £175 million (see note 54 for more information). Management believes this
represents the most appropriate estimate of the financial impact, based upon a series of assumptions, including the number of claims received,
the proportion upheld, and resulting legal and administration costs.
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.
The Group will re‑evaluate the assumptions underlying its analysis at each reporting date as more information becomes available. As noted above,
there is inherent uncertainty in making estimates; actual results in future periods may differ from the amount provided.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Segmental analysis
Lloyds Banking Group provides a wide range of banking and financial services in the UK and in certain locations overseas.
The Group Executive Committee has been determined to be the chief operating decision maker for the Group. The Group’s operating segments
reflect its organisational and management structures. The Group Executive Committee reviews the Group’s internal reporting based around these
segments in order to assess performance and allocate resources. This assessment includes a consideration of each segment’s net interest revenue
and consequently the total interest income and expense for all reportable segments is presented on a net basis. The segments are differentiated
by the type of products provided, by whether the customers are individuals or corporate entities and by the geographical location of the customer.
During 2011 the chief operating decision maker has commenced reviewing the results of the Group’s Commercial business separately to the
Wholesale segment. As a consequence, the Group’s activities are now organised into five financial reporting segments: Retail, Wholesale,
Commercial, Wealth and International, and Insurance. The comparatives for 2009 include the pre‑acquisition results of HBOS for the period from
1 January 2009 to 16 January 2009.
During the third quarter of 2011, the Group implemented a new approach to its allocation methodologies for funding costs and capital that
ensures that the cost of funding is more fully reflected in each segment’s results. The new methodology is designed to ensure that funding
costs are allocated to the segments and that the allocation is more directly related to the size and behavioural duration of asset portfolios,
with a similar approach applied to recognise the value to the business from the Group’s growing deposit base. Comparative figures have
been restated. The impact of this restatement on the year ended 31 December 2010 was to reduce net interest income and profit before tax in
Retail by £730 million, in Wholesale by £404 million, in Commercial by £48 million and in Wealth and International by £126 million; and to increase
net interest income and profit before tax in Insurance by £224 million, in Group Operations by £11 million and in Central items by £1,073 million.
Retail offers a broad range of retail financial service products in the UK, including current accounts, savings, personal loans, credit cards and
mortgages. It is also a major general insurance and bancassurance distributor, selling a wide range of long‑term savings, investment and general
insurance products.
The Wholesale division serves businesses with turnover above £15 million with a range of propositions segmented according to customer need.
The division comprises Wholesale Banking and Markets, Wholesale Business Support Unit and Asset Finance.
Commercial serves in excess of a million small and medium‑sized enterprises and community organisations with a turnover of up to £15 million.
Customers extend from start‑up enterprises to established corporations, and are supported with a range of propositions aligned to customer
needs. Commercial comprises Commercial Banking and Commercial Finance, the invoice discounting and factoring business.
Wealth and International was created to give increased focus and momentum to the Group’s private banking and asset management activities
and to closely co‑ordinate the management of its international businesses. Wealth comprises the Group’s private banking, wealth and asset
management businesses in the UK and overseas. International comprises corporate, commercial, asset finance and retail businesses, principally
in Australia and Continental Europe.
Insurance provides long‑term savings, investment and protection products distributed through the bancassurance, intermediary and direct
channels in the UK. It is also a distributor of home insurance in the UK with products sold through the retail branch network, direct channels and
strategic corporate partners. The business consists of Life, Pensions and Investments UK; Life, Pensions and Investments Europe; and General
Insurance.
Other includes the costs of managing the Group’s technology platforms, branch and head office property estate, operations (including payments,
banking operations and collections) and procurement services, the costs of which are predominantly recharged to the other divisions. It also
reflects other items not recharged to the divisions, including hedge ineffectiveness, UK bank levy, Financial Services Compensation Scheme costs,
gains on liability management, volatile items such as hedge accounting volatility managed centrally, and other gains from the structural hedging
of interest rate risk.
Inter‑segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch
and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged.
Inter‑segment lending and deposits are generally entered into at market rates, except that non‑interest bearing balances are priced at a rate that
reflects the external yield that could be earned on such funds.
For the majority of those derivative contracts entered into by business units for risk management purposes, the business unit recognises the net
interest income or expense on an accrual accounting basis and transfers the remainder of the fair value of the swap to the central group segment
where the resulting accounting volatility is managed where possible through the establishment of hedge accounting relationships. Any change in
fair value of the hedged instrument attributable to the hedged risk is also recorded within the central group segment. This allocation of the fair
value of the swap and change in fair value of the hedged instrument attributable to the hedged risk avoids accounting asymmetry in segmental
results and records volatility in the central group segment where it is managed.
232
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Segmental analysis (continued)
Year ended 31 December 2011
Net interest income
Other income (net of fee and commission expense)
Effects of liability management, volatile items and
asset sales
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit (loss) before tax and fair value unwind
Fair value unwind
Profit (loss) before tax
External revenue
Inter‑segment revenue
Segment revenue
Segment external assets
Segment customer deposits
Segment external liabilities
Retail
£m
Wholesale
£m
Commercial
£m
Wealth and
International
£m
Insurance
£m
Other
£m
Reported
basis
total
£m
7,497
1,649
2,139
3,335
1,251
446
828
1,197
(67)
585
12,233
2,687
(7)
9,307
48
(1,415)
–
–
9,194
4,059
1,697
2,025
–
–
–
9,194
4,059
1,697
(4,438)
(2,518)
4,756
1,541
(1,970)
(2,901)
11
14
2,797
(1,346)
839
3,636
12,267
(3,073)
9,194
2,174
828
2,895
1,164
4,059
356,295
320,435
247,088
91,357
(948)
749
(303)
–
446
53
499
1,263
434
1,697
28,998
32,107
–
2,620
(343)
2,277
(812)
1,293
1,871
(74)
21,466
–
(343)
1,871
21,123
(357)
(10,621)
–
2,025
(1,548)
477
1,465
1,514
10,502
(4,610)
3
–
–
(3)
(1)
(4,130)
1,465
1,510
194
(3,936)
2,144
(119)
2,025
(43)
(1,274)
1,422
3,253
(633)
2,620
236
(356)
2,227
1,871
(9,787)
27
742
1,943
2,685
21,466
–
21,466
74,623
140,754
49,441
970,546
42,019
–
1,335
413,906
279,162
259,209
32,723
75,791
129,350
147,717
923,952
Other segment items reflected in income statement above:
Depreciation and amortisation
Increase (decrease) in value of in‑force business
Defined benefit scheme charges
Other segment items:
364
–
121
967
–
33
Additions to tangible fixed assets
189
1,435
Investments in joint ventures and associates
at end of year
147
80
53
–
33
2
–
60
3
25
91
(625)
23
67
–
(36)
1,602
(622)
199
212
451
806
3,095
104
–
3
334
233
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Segmental analysis (continued)
Retail
£m
Wholesale
£m
Commercial
£m
Wealth and
International
£m
Insurance
£m
Other
£m
Year ended 31 December 2010
Net interest income
Other income (net of fee and commission expense)
Effects of liability management, volatile items and
asset sales
Total income
Insurance claims
8,648
1,607
–
10,255
–
2,847
3,974
(295)
6,526
–
1,127
457
–
1,584
–
1,050
1,123
37
2,210
–
Total income, net of insurance claims
10,255
6,526
1,584
2,210
Costs:
Operating expenses
Impairment of tangible fixed assets
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit (loss) before tax and fair value unwind
Fair value unwind
Profit (loss) before tax
External revenue
Inter‑segment revenue
Segment revenue
Segment external assets1
Segment customer deposits
Segment external liabilities
Other segment items reflected in income statement above:
Depreciation and amortisation
Increase in value of in‑force business
Defined benefit scheme charges
Other segment items:
Additions to tangible fixed assets
Investments in joint ventures and associates
at end of year
(4,644)
–
(4,644)
5,611
(2,747)
17
2,881
1,105
3,986
13,603
(3,348)
10,255
(2,752)
(150)
(2,902)
3,624
(4,064)
(95)
(535)
3,049
2,514
3,911
2,615
6,526
369,170
327,055
235,591
92,951
275,945
289,257
384
–
176
126
139
1,071
–
52
1,703
127
(992)
–
(992)
592
(382)
–
210
81
291
1,378
206
1,584
28,938
31,311
31,952
62
–
37
5
–
(1,536)
–
(1,536)
674
(5,988)
(8)
(5,322)
372
(4,950)
3,000
(790)
2,210
85,508
32,784
65,658
87
2
36
20
158
1
Segment external assets as at 31 December 2010 have been restated to reflect the reclassification of certain central adjustments.
Reported
basis
total
£m
14,143
9,936
(93)
23,986
(542)
23,444
(10,928)
(150)
(11,078)
12,366
(13,181)
(91)
(906)
3,118
2,212
510
(24)
150
636
–
636
(150)
–
(150)
486
–
5
491
(1,446)
(955)
(39)
2,799
15
2,775
(542)
2,233
(854)
–
(854)
1,379
–
(10)
1,369
(43)
1,326
3,180
(405)
2,775
(1,086)
23,986
1,722
–
636
23,986
143,300
37,603
991,574
–
996
393,633
132,133
149,727
944,672
135
787
28
585
–
64
–
126
1,803
789
455
777
3,216
5
429
234
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Segmental analysis (continued)
Year ended 31 December 2009
Net interest income
Other income (net of fee and commission expense)
Effects of liability management, volatile items and
asset sales
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus
Impairment
Share of results of joint ventures and associates
Profit (loss) before tax and fair value unwind
Fair value unwind
Profit (loss) before tax
External revenue
Inter‑segment revenue
Segment revenue
Other segment items reflected in income statement above:
Depreciation and amortisation
(Decrease) increase in value of in‑force business
Defined benefit scheme charges
Other segment items:
Additions to tangible fixed assets
Investments in joint ventures and associates
at end of year
Retail
£m
Wholesale
£m
Commercial
£m
Wealth and
International
£m
Insurance
£m
Other
£m
Reported
basis
total
£m
7,543
1,804
–
9,347
–
9,347
(4,566)
4,781
3,447
3,787
(77)
7,157
–
7,157
(3,018)
4,139
(4,227)
(14,861)
(6)
548
407
955
14,221
(4,874)
9,347
196
–
190
65
30
(720)
(11,442)
6,760
(4,682)
2,719
4,438
7,157
1,214
–
65
2,960
189
1,084
489
1,140
1,128
–
–
1,573
2,268
–
1,573
(1,088)
485
(822)
–
(337)
137
(200)
1,446
127
1,573
70
–
47
9
–
–
2,268
(1,544)
724
(4,078)
(21)
(3,375)
942
(2,433)
2,859
(591)
2,268
84
(5)
40
53
123
(59)
2,944
–
2,885
(637)
2,248
(974)
1,274
–
(22)
1,252
(49)
1,203
3,780
(895)
2,885
152
1,097
39
255
(14)
(89)
(69)
13,066
10,083
1,529
1,371
–
1,371
(419)
952
–
2
1,452
24,601
(637)
23,964
(11,609)
12,355
(23,988)
(767)
954
(12,400)
(2,097)
(1,143)
6,100
(6,300)
(424)
24,601
1,795
1,371
–
24,601
147
–
156
487
151
1,863
1,092
537
3,829
479
235
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Segmental analysis (continued)
Reconciliation of reported basis to statutory results
The reported basis is the basis on which financial information is presented to the chief operating decision maker which excludes certain items
included in the statutory results. The table below reconciles the statutory results to the reported basis.
Year ended 31 December 2011
Net interest income
Other income
Effects of liability management,
volatile items and asset sales
Total income
Insurance claims
Total income, net of insurance claims
Operating expenses
Trading surplus (deficit)
Impairment
Share of results of joint ventures and
associates
Fair value unwind
Lloyds
Banking
Group
statutory
£m
12,698
14,114
26,812
(6,041)
20,771
(16,250)
4,521
(8,094)
31
Acquisition
related and
other items1
£m
Volatility arising
in insurance
businesses
£m
(820)
894
(74)
–
–
–
2,014
2,014
–
–
–
(19)
857
–
838
–
838
–
838
–
–
–
(Loss) profit before tax
(3,542)
2,014
838
Removal of:
Insurance
gross up
£m
(336)
(5,530)
–
(5,866)
5,698
(168)
168
–
–
–
–
–
Legal and
regulatory
provisions2
£m
Fair value
unwind
£m
Reported
basis
£m
–
–
–
–
–
–
3,375
3,375
–
–
–
3,375
710
(1,028)
12,233
9,307
–
(318)
–
(318)
72
(246)
(74)
21,466
(343)
21,123
(10,621)
10,502
(1,693)
(9,787)
(4)
1,943
–
27
1,943
2,685
1
Comprises integration and simplification costs related to severance, IT and business costs of implementation (£1,282 million), EC mandated retail business disposal costs (£170 million),
amortisation of purchased intangibles (£562 million) and the effects of liability management. volatile items and asset sales (£74 million).
2
Comprises the payment protection insurance provision (£3,200 million) and the provision in relation to German insurance business litigation (£175 million).
Lloyds
Banking
Group
statutory
£m
12,546
31,498
44,044
(19,088)
24,956
(13,068)
(202)
(13,270)
11,686
(10,952)
(88)
(365)
Acquisition
related and
other items1
£m
Volatility arising
in insurance
businesses
£m
321
(228)
(93)
–
–
–
1,320
52
1,372
1,372
–
–
–
–
26
(332)
–
(306)
–
(306)
–
–
–
(306)
–
–
–
–
281
1,372
(306)
Removal of:
Insurance
gross up
£m
949
(19,739)
–
(18,790)
18,544
(246)
246
–
246
–
–
–
–
–
–
Customer
goodwill
payments
provision and
loss on
disposal
of businesses
£m
Fair value
unwind
£m
Reported
basis
£m
–
–
–
–
–
–
500
–
500
500
–
–
365
–
865
301
(1,263)
–
(962)
2
(960)
74
–
74
(886)
(2,229)
(3)
–
3,118
–
14,143
9,936
(93)
23,986
(542)
23,444
(10,928)
(150)
(11,078)
12,366
(13,181)
(91)
–
3,118
2,212
Year ended 31 December 2010
Net interest income
Other income
Liability management gains
Total income
Insurance claims
Total income, net of insurance claims
Costs:
Operating expenses
Impairment of tangible fixed assets
Trading surplus (deficit)
Impairment
Share of results of joint ventures and
associates
Loss on disposal of businesses
Fair value unwind
Profit (loss) before tax
1
Comprises the pension curtailment gain (£910 million, see note 43), integration costs (£1,653 million), amortisation of purchased intangibles (£629 million) and the effects of liability management,
volatile items and asset sales (£93 million).
236
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Segmental analysis (continued)
Year ended 31 December 2009
Net interest income
Other income
Effects of liability management,
volatile items and asset sales
Total income
Insurance claims
Total income, net of insurance
claims
Operating expenses
Trading surplus (deficit)
Impairment
Share of results of joint ventures
and associates
Gain on acquisition
Fair value unwind
Profit (loss) before tax
Government
Asset Protection
Scheme fee
and acquisition
related and other
items1
£m
Removal of:
Volatility arising
in insurance
businesses
£m
Pre‑acquisition
results of HBOS
£m
243
(1,123)
–
(880)
1,349
469
(293)
176
(456)
–
–
–
(280)
340
(1,792)
1,452
–
–
–
4,589
4,589
–
–
(11,173)
–
(6,584)
11
(479)
–
(468)
–
(468)
–
(468)
–
(10)
–
–
(478)
Lloyds
Banking
Group
statutory
£m
9,026
36,745
45,771
(22,493)
23,278
(15,984)
7,294
(16,673)
(752)
11,173
–
1,042
Insurance
gross up
£m
1,280
(22,133)
–
(20,853)
20,792
(61)
61
–
–
–
–
–
–
Fair value
unwind
£m
Reported
basis
£m
2,166
(1,135)
–
1,031
(285)
746
18
764
(6,859)
(5)
–
6,100
–
13,066
10,083
1,452
24,601
(637)
23,964
(11,609)
12,355
(23,988)
(767)
–
6,100
(6,300)
1
Comprises the gain on acquisition (£11,173 million), the Government Asset Protection Scheme fee (£2,500 million), integration costs (£1,096 million), amortisation of purchased intangibles
(£753 million), goodwill impairment (£240 million) and the effects of liability management, volatile items and asset sales (£1,452 million).
Geographical areas
The Group’s activities are focused in the UK and the analyses of income and assets below are based on the location of the branch or entity
recording the income or assets.
Total income
Total assets
2011
Non-UK
£m
UK
£m
Total
£m
UK
£m
24,392
2,420
26,812
39,840
2010
Non‑UK
£m
4,204
Total
£m
UK
£m
44,044
43,046
2009
Non‑UK
£m
2,725
Total
£m
45,771
875,918
94,628
970,546
873,138
118,436
991,574
916,734
110,521
1,027,255
There was no individual non‑UK country contributing more than 5 per cent of total income or total assets.
237
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 5: Net interest income
Interest and similar income:
Loans and advances to customers, excluding
lease and hire purchase receivables
Loans and advances to banks
Debt securities held as loans and receivables
Lease and hire purchase receivables
Interest receivable on loans and receivables
Available‑for‑sale financial assets
Held‑to‑maturity investments
Total interest and similar income
Interest and similar expense:
Deposits from banks, excluding liabilities
under sale and repurchase transactions
Customer deposits, excluding liabilities under
sale and repurchase transactions
Debt securities in issue
Subordinated liabilities
Liabilities under sale and repurchase
agreements
Interest payable on liabilities held at
amortised cost
Other
Total interest and similar expense
Net interest income
Weighted average
effective interest rate
2011
%
20101
%
20091
%
2011
£m
2010
£m
2009
£m
4.00
0.78
3.17
5.13
3.63
2.58
3.29
3.58
0.80
1.66
2.22
6.35
1.39
2.04
(1.14)
1.95
4.37
0.72
4.41
6.74
4.03
2.88
2.51
3.95
0.78
1.56
2.49
10.98
1.18
2.22
6.97
2.31
3.67
1.18
3.68
6.01
3.50
1.78
–
3.39
0.95
1.29
2.56
10.05
1.95
2.17
14.92
2.34
23,208
628
590
742
25,168
886
262
26,316
25,459
512
1,377
626
27,974
1,311
55
29,340
24,171
769
1,469
852
27,261
977
–
28,238
(222)
(319)
(883)
(6,080)
(5,045)
(2,155)
(5,381)
(5,833)
(3,619)
(4,410)
(6,318)
(4,325)
(335)
(744)
(1,655)
(13,837)
219
(13,618)
12,698
(15,896)
(898)
(16,794)
12,546
(17,591)
(1,621)
(19,212)
9,026
1
During 2011 the Group has revised its treatment of offset accounts; average balances for 2009 and 2010 have been restated accordingly.
Included within interest and similar income is £1,405 million (2010: £1,288 million; 2009: £971 million) in respect of impaired financial assets. Net
interest income also includes a charge of £70 million (2010: charge of £932 million; 2009: charge of £121 million) transferred from the cash flow
hedging reserve (see note 49).
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. As part of the exchange, the Group announced that all decisions to
exercise calls on those original securities that remained outstanding following the exchange offer would be made with reference to the prevailing
regulatory, economic and market conditions at the time. These securities will not, therefore, be called at their first available call date which will lead
to coupons continuing to be being paid until possibly the final redemption date of the securities. Consequently, the Group is required to adjust
the carrying amount of these securities to reflect the revised estimated cash flows over their revised life and to recognise this change in carrying
value in interest expense. Included within net interest income is a credit of £570 million in respect of the securities that remained outstanding
following the exchange offer.
In December 2011, the Group decided to defer payment of non‑mandatory coupons on certain securities and, instead, settle them using an
Alternative Coupon Satisfaction Mechanism on their contractual terms. This change in expected cashflows resulted in a gain of £126 million in
net interest income from the recalculation of the carrying value of these securities.
238
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 6: Net fee and commission income
Fee and commission income:
Current accounts
Credit and debit card fees
Other1
Total fee and commission income
Fee and commission expense
Net fee and commission income
2011
£m
1,053
877
3,005
4,935
(1,391)
3,544
2010
£m
1,086
812
3,094
4,992
(1,682)
3,310
2009
£m
1,088
765
2,875
4,728
(1,517)
3,211
1
In previous years the Group has included annual management charges on non‑participating investment contracts within insurance claims. In light of developing industry practice, these amounts
(2011: £606 million; 2010: £577 million; 2009: £474 million) are now included within net fee and commission income.
As discussed in note 2, fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in
note 5. Fees and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown
in note 7.
Note 7: Net trading income
Foreign exchange translation gains
Gains on foreign exchange trading transactions
Total foreign exchange
Investment property (losses) gains (note 28)
Securities and other (losses) gains (see below)
Net trading income
2011
£m
317
341
658
(107)
(919)
(368)
2010
£m
70
377
447
434
14,843
15,724
2009
£m
283
488
771
(214)
18,541
19,098
Securities and other gains comprise net gains arising on assets and liabilities held at fair value through profit or loss and for trading as follows:
Net income arising on assets held at fair value through profit or loss:
Debt securities, loans and advances
Equity shares
Total net income arising on assets held at fair value through profit or loss
Net expense arising on liabilities held at fair value through profit or loss – debt securities in issue
Total net gains arising on assets and liabilities held at fair value through profit or loss
Net (losses) gains on financial instruments held for trading
Securities and other (losses) gains
2011
£m
2010
£m
2009
£m
5,293
(4,917)
376
(230)
146
(1,065)
(919)
2,292
10,333
12,625
(231)
12,394
2,449
14,843
4,297
11,475
15,772
(125)
15,647
2,894
18,541
239
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 8: Insurance premium income
Life insurance
Gross premiums
Ceded reinsurance premiums
Net earned premiums
Non-life insurance
Gross written premiums
Ceded reinsurance premiums
Net written premiums
Change in provision for unearned premiums (note 38(2))
Change in provision for ceded unearned premiums (note 38(2))
Net earned premiums
Total net earned premiums
Life insurance gross premiums can be further analysed as follows:
Life and pensions
Annuities
Other
Gross premiums
Non‑life insurance gross written premiums can be further analysed as follows:
Credit protection
Home
Health
Gross written premiums
2011
£m
7,276
(322)
6,954
1,198
(52)
1,146
70
–
1,216
8,170
2011
£m
6,737
529
10
7,276
2011
£m
231
963
4
2010
£m
7,026
(253)
6,773
1,332
(104)
1,228
156
(9)
1,375
8,148
2010
£m
6,428
583
15
7,026
2010
£m
363
964
5
2009
£m
7,768
(308)
7,460
1,390
(101)
1,289
171
26
1,486
8,946
2009
£m
7,070
685
13
7,768
2009
£m
417
968
5
1,198
1,332
1,390
240
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 9: Other operating income
Operating lease rental income
Rental income from investment properties (note 28)
Other rents receivable
Gains less losses on disposal of available‑for‑sale financial assets (note 49)
Movement in value of in‑force business (note 30)
Liability management gains
Other income
Total other operating income
2011
£m
1,268
388
34
343
(622)
599
758
2,768
2010
£m
1,410
337
41
399
789
423
917
4,316
2009
£m
1,509
358
51
97
1,169
1,498
808
5,490
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 18 February 2010, as part of the Group’s recapitalisation and exit from its proposed participation in the Government Asset Protection Scheme,
Lloyds Banking Group plc issued 3,141 million ordinary shares in exchange for certain existing preference shares and preferred securities. This
exchange resulted in a gain of £85 million. During March 2010 the Group entered into a bilateral exchange, under which certain Enhanced Capital
Notes denominated in Japanese yen were exchanged for an issue of new Enhanced Capital Notes denominated in US dollars; the securities
subject to the exchange were cancelled and a profit of £20 million arose. In addition, during May and June 2010 the Group completed the
exchange of a number of outstanding capital securities issued by Lloyds Banking Group plc and certain of its subsidiaries for ordinary shares in
Lloyds Banking Group plc. The securities subject to exchange were cancelled, generating a total profit of £318 million for the Group.
In the first half of 2009, undated subordinated securities issued by a number of Group companies were exchanged for innovative tier 1 securities
and senior unsecured securities issued by Lloyds TSB Bank plc. These exchanges resulted in a gain of £745 million. In July 2009, dated and
undated subordinated securities issued by Clerical Medical Finance plc were exchanged for senior unsecured securities issued by Lloyds TSB
Bank plc resulting in a gain of £30 million. In November 2009, as part of the restructuring plan that was a requirement for European Commission
approval of state aid received by the Group, the Group agreed to suspend the payment of coupons and dividends on certain of the Group’s
preference shares and preferred securities for the two year period from 31 January 2010 to 31 January 2012. This suspension gave rise to a partial
extinguishment of the original liability, equivalent to the present value of the suspended cash flows. During December 2009, as part of the Group’s
recapitalisation and exit from GAPS, preference shares, preferred securities and undated subordinated securities were exchanged for Enhanced
Capital Notes. These exchanges, together with the partial extinguishment of liabilities arising from the suspension of payments of coupons,
resulted in a gain of £723 million.
241
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 10: Insurance claims
Insurance claims comprise:
Life insurance and participating investment contracts
Claims and surrenders:
Gross
Reinsurers’ share
Change in insurance and participating investment contract liabilities (note 38(1)):
Change in gross liabilities
Change in reinsurers’ share of liabilities
Change in non‑participating investment contract liabilities:
Change in gross liabilities1
Change in reinsurers’ share of liabilities
Change in unallocated surplus (note 41)
2011
£m
2010
£m
2009
£m
(8,622)
230
(8,392)
1,383
451
1,834
520
–
520
340
(9,397)
159
(9,238)
(4,622)
256
(4,366)
(5,449)
65
(5,384)
439
(8,010)
146
(7,864)
(5,922)
177
(5,745)
(7,932)
–
(7,932)
(318)
Total life insurance and participating investment contracts
(5,698)
(18,549)
(21,859)
Non-life insurance
Claims and claims paid:
Gross
Reinsurers’ share
Change in liabilities (note 38(2)):
Gross
Reinsurers’ share
Total non-life insurance
Total insurance claims
Life insurance and participating investment contracts gross claims can also be analysed as follows:
Deaths
Maturities
Surrenders
Annuities
Other
Total life insurance gross claims
(521)
4
(517)
186
(12)
174
(343)
(470)
11
(459)
(82)
2
(80)
(539)
(542)
16
(526)
(111)
3
(108)
(634)
(6,041)
(19,088)
(22,493)
(625)
(1,861)
(5,041)
(764)
(331)
(8,622)
(662)
(1,763)
(5,904)
(741)
(327)
(9,397)
(637)
(2,107)
(4,225)
(710)
(331)
(8,010)
1
In previous years the Group has included annual management charges on non‑participating investment contracts within insurance claims. In light of developing industry practice, these amounts
(2011: £606 million; 2010: £577 million; 2009: £474 million) are now included within net fee and commission income.
A non‑life insurance claims development table is included in note 38.
242
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 11: Operating expenses
Staff costs:
Salaries
Performance‑based compensation
Social security costs
Pensions and other post‑retirement benefit schemes (note 43):
Curtailment gain2
Other
Restructuring costs
Other staff costs
Premises and equipment:
Rent and rates
Hire of equipment
Repairs and maintenance
Other
Other expenses:
Communications and data processing
Advertising and promotion
Professional fees
Customer goodwill payments provision (note 45)
UK bank levy
Financial services compensation scheme management expenses levy (note 54)
Provision in relation to German insurance business litigation (note 45)
Other
Depreciation and amortisation:
Depreciation of tangible fixed assets (note 32)
Amortisation of acquired value of in‑force non‑participating investment contracts (note 30)
Amortisation of other intangible assets (note 31)
Impairment of tangible fixed assets3 (note 32)
Goodwill impairment
Total operating expenses, excluding payment protection insurance provision and
Government Asset Protection Scheme fee
Payment protection insurance provision (note 45)
Government Asset Protection Scheme fee
Total operating expenses
2011
£m
3,784
361
432
–
401
401
124
2010
£m1
3,787
533
396
(910)
628
(282)
119
1,064
1,069
6,166
5,622
547
22
188
294
1,051
954
398
576
–
189
179
175
1,122
3,593
1,434
78
663
2,175
65
–
13,050
3,200
–
602
18
199
358
1,177
1,126
362
742
500
–
46
–
1,061
3,837
1,635
76
721
2,432
202
–
13,270
–
–
16,250
13,270
2009
£m
3,902
491
383
–
744
744
412
743
6,675
569
20
226
341
1,156
668
335
540
–
–
73
–
1,237
2,853
1,716
75
769
2,560
–
240
13,484
–
2,500
15,984
1
2
3
During 2011, the Group has reviewed the analysis of certain cost items and as a result has reclassified some items of expenditure; comparatives for 2010 have been restated accordingly.
Following changes by the Group to the terms of its defined benefit pension schemes in 2010, all future increases to pensionable salary will be capped each year at the lower of: Retail Prices Index
inflation; each employee’s actual percentage increase in pay; and 2 per cent of pensionable pay. In addition to this, during the second half of 2010 there was a change in commutation factors in
certain defined benefit schemes. The combined effect of these changes was a reduction in the Group’s defined benefit obligation of £1,081 million and a reduction in the Group’s unrecognised
actuarial losses of £171 million, resulting in a net curtailment gain of £910 million recognised in the income statement and a reduction in the balance sheet liability.
£65 million (2010: £52 million; 2009: £nil) of the impairment of tangible fixed assets relates to integration activities.
243
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 11: Operating expenses (continued)
Performance-based compensation
The table below analyses the Group’s performance‑based compensation costs (excluding branch‑based sales incentives) between those relating
to the current performance year and those relating to earlier years.
Performance‑based compensation expense comprises:
Awards made in respect of the year ended 31 December
Awards made in respect of earlier years
Performance‑based compensation expense deferred until later years comprises:
Awards made in respect of the year ended 31 December
Awards made in respect of earlier years
2011
£m
363
(2)
361
43
29
72
2010
£m
505
28
533
39
39
78
2009
£m
480
11
491
60
11
71
Performance‑based awards expensed in 2011 include cash awards amounting to £160 million (2010: £163 million; 2009: £180 million).
Average headcount
The average number of persons on a headcount basis employed by the Group during the year was as follows:
UK
Overseas
Total
Fees payable to the auditors
Fees payable to the Company’s auditors by the Group are as follows:
Fees payable for the audit of the Company’s current year annual report
Fees payable for other services:
Audit of the Company’s subsidiaries pursuant to legislation
Other services supplied pursuant to legislation
Total audit fees
Other services – audit related fees
Total audit and audit related fees
Services relating to taxation
Other non‑audit fees:
Services relating to corporate finance transactions
Other services
Total other non‑audit fees
Total fees payable to the Company’s auditors by the Group
2011
116,371
4,078
120,449
2010
118,149
4,830
122,979
2009
125,109
6,891
132,000
2011
£m
1.7
16.9
4.8
23.4
2.9
26.3
1.1
6.3
2.6
8.9
36.3
2010
£m
1.9
17.9
6.2
26.0
1.8
27.8
1.0
1.9
9.7
11.6
40.4
2009
£m
2.2
18.8
4.2
25.2
5.3
30.5
1.0
0.3
8.9
9.2
40.7
Other non‑audit fees cover a variety of services and in 2009 and 2010 included the costs associated with the Group’s preparations for ensuring that
the heritage HBOS businesses complied fully with the requirements of the Sarbanes‑Oxley Act by 31 December 2010.
The following types of services are included in the categories listed above:
Audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with
regulatory filings. Other services supplied pursuant to legislation relate primarily to the costs associated with the Sarbanes‑Oxley Act audit
requirements together with the cost of the audit of the Group’s Form 20‑F filing.
Audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the
performance of the audit or review of the financial statements, for example acting as reporting accountants in respect of prospectuses and
circulars required by the UKLA listing rules.
Services relating to taxation: This category includes tax compliance and tax advisory services.
244
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 11: Operating expenses (continued)
Other non-audit fees: This category includes due diligence relating to corporate finance, including venture capital transactions and other
assurance and advisory services.
It is the Group’s policy to use the auditors on assignments in cases where their knowledge of the Group means that it is neither efficient nor cost
effective to employ another firm of accountants. Such assignments typically relate to the provision of advice on tax issues, assistance in transactions
involving the acquisition and disposal of businesses and accounting advice.
The Group has procedures that are designed to ensure auditor independence, including that fees for audit and non‑audit services are approved
in advance. This approval can be obtained either on an individual engagement basis or, for certain types of non‑audit services, particularly those of
a recurring nature, through the approval of a fee cap covering all engagements of that type provided the fee is below that cap. All statutory audit
work as well as non‑audit assignments where the fee is expected to exceed the relevant fee cap must be pre‑approved by the Audit Committee
on an individual engagement basis. On a quarterly basis, the Audit Committee receives a report detailing all pre‑approved services and amounts
paid to the auditors for such pre‑approved services.
During the year, the auditors also earned fees payable by entities outside the consolidated Lloyds Banking Group in respect of the following:
Audits of Group pension schemes
Audits of the unconsolidated Open Ended Investment Companies managed by the Group
Reviews of the financial position of corporate and other borrowers
2011
£m
0.4
0.6
11.0
Acquisition due diligence and other work performed in respect of potential venture capital investments
1.0
2010
£m
0.3
0.8
17.2
1.2
2009
£m
0.3
0.6
19.3
1.4
Note 12: Impairment
Impairment losses on loans and receivables:
Loans and advances to banks
Loans and advances to customers
Debt securities classified as loans and receivables
Total impairment losses on loans and receivables (note 25)
Impairment of available‑for‑sale financial assets
Other credit risk provisions (note 45)
2011
£m
–
8,020
49
8,069
80
(55)
2010
£m
2009
£m
(13)
10,727
57
10,771
106
75
(3)
15,783
248
16,028
602
43
Total impairment charged to the income statement
8,094
10,952
16,673
245
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 13: Investments in joint ventures and associates
The Group’s share of results of and investments in joint ventures and associates comprises:
Share of income statement amounts:
Income
Expenses
Impairment
Insurance claims
Profit (loss) before tax
Tax
Share of post-tax results
Share of balance sheet amounts:
Current assets
Non‑current assets
Current liabilities
Non‑current liabilities
Share of net assets at
31 December
Movement in investments over
the year:
At 1 January
Exchange and other adjustments
Adjustment on acquisition
Additional investments
Acquisitions
Disposals
Share of post‑tax results
Dividends paid
Share of net assets at
31 December
2009
£m
2011
£m
Associates
2010
£m
2009
£m
2011
£m
Joint ventures
2010
£m
318
(209)
(126)
–
(17)
(22)
(39)
2011
£m
316
(261)
(20)
–
35
(4)
31
3,346
2,148
(714)
(4,471)
3,370
2,868
(588)
(5,324)
708
(544)
(272)
(465)
(573)
24
(549)
2,754
4,662
(2,175)
(4,871)
160
(161)
1
–
–
–
–
246
976
(293)
(904)
Total
2010
£m
453
(300)
(218)
–
(65)
(23)
(88)
2009
£m
713
(640)
(386)
(465)
(778)
26
(752)
135
(91)
(92)
–
(48)
(1)
(49)
5
(96)
(114)
–
(205)
2
(203)
476
(422)
(19)
–
35
(4)
31
378
1,184
(433)
(1,026)
605
1,611
(494)
(1,613)
3,592
3,124
(1,007)
(5,375)
3,748
4,052
(1,021)
(6,350)
3,359
6,273
(2,669)
(6,484)
309
326
370
25
103
109
334
429
479
326
(3)
–
7
–
(47)
31
(5)
370
(8)
–
71
–
(68)
(39)
–
55
(15)
956
140
3
(199)
(549)
(21)
309
326
370
103
(1)
–
3
–
(79)
–
(1)
25
109
40
–
6
–
(2)
(49)
(1)
–
60
219
12
60
(39)
(203)
–
429
479
(4)
–
10
–
(126)
31
(6)
32
–
77
–
(70)
(88)
(1)
55
45
1,175
152
63
(238)
(752)
(21)
103
109
334
429
479
During 2011, the Group recognised a net £8 million of losses of associates not previously recognised. The Group’s unrecognised share of losses
of associates during 2010 was £8 million (2009: £64 million) and of joint ventures is £85 million in 2011 (2010: £180 million; 2009: £424 million).
For entities making losses, subsequent profits earned are not recognised until previously unrecognised losses are extinguished. The Group’s
unrecognised share of losses net of unrecognised profits on a cumulative basis of associates is £56 million (2010: £104 million; 2009: £64 million)
and of joint ventures is £299 million (2010: £339 million; 2009: £424 million).
The Group’s principal joint venture investment at 31 December 2011 was in Sainsbury’s Bank plc; the Group owns 50 per cent of the ordinary share
capital of Sainsbury’s Bank plc, whose business is banking and principal area of operation is the UK. Sainsbury’s Bank plc is incorporated in the UK
and the Group’s interest is held by a subsidiary.
Where entities have statutory accounts drawn up to a date other than 31 December management accounts are used when accounting for them
by the Group.
246
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 14: Gain on acquisition in 2009
On 16 January 2009, the Group acquired 100 per cent of the ordinary share capital of HBOS plc, which together with its subsidiaries undertakes
banking, insurance and other financial services related activities in the UK and in certain overseas locations.
The table below sets out the fair value of the identifiable net assets acquired.
At the time of the recommended offer for HBOS in September 2008, it had become increasingly difficult for HBOS to raise funds in wholesale
markets and their Board sought to restore confidence and stability through an agreement to be acquired by Lloyds TSB Group plc announced on
18 September 2008 at the original terms of 0.833 Lloyds TSB Group plc shares for each HBOS share. However turbulence in the markets continued
and the UK Government decided in October 2008 that it would be appropriate for the UK banking sector to increase its level of capitalisation.
As a consequence of the recapitalisation of HBOS and the impact of the deteriorating market conditions the terms of the final agreed offer were
revised down to a ratio of 0.605 per HBOS share.
As the fair value of the identifiable net assets acquired was greater than the total consideration paid, negative goodwill arose on the acquisition.
The negative goodwill was recognised as a ‘Gain on acquisition’ in the income statement for the year ended 31 December 2009. In accordance
with accounting requirements, the measurement period for the fair values of the acquired assets and liabilities ended on 15 January 2010
(one year from the date of acquisition); no further fair value adjustments were made beyond those reflected in the Group’s 31 December 2009
financial statements.
Assets
Cash and balances at central banks
Items in the course of collection from banks
Trading and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and receivables:
Loans and advances to banks
Loans and advances to customers
Debt securities
Available‑for‑sale financial assets
Investment properties
Investments in joint ventures and associates
Value of in‑force business
Other intangible assets
Tangible fixed assets
Current tax recoverable
Deferred tax assets
Other assets
Total assets
Book value
at 16 January
2009
£m
Fair value
adjustments
£m
Fair value
at 16 January
2009
£m
2,123
523
83,857
54,840
15,751
450,351
39,819
27,151
3,002
1,152
3,152
104
5,721
1,050
2,556
7,601
–
–
–
(808)
43
(13,512)
(1,411)
–
–
23
561
4,650
(14)
–
(602)
(905)
2,123
523
83,857
54,032
15,794
436,839
38,408
27,151
3,002
1,175
3,713
4,754
5,707
1,050
1,954
6,696
698,753
(11,975)
686,778
247
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 14: Gain on acquisition in 2009 (continued)
Liabilities
Deposits from banks
Customer deposits
Items in course of transmission to banks
Trading and other financial liabilities at fair value through profit or loss
Derivative financial instruments
Notes in circulation
Debt securities in issue
Liabilities arising from insurance contracts and participating investment contracts
Liabilities arising from non‑participating investment contracts
Unallocated surplus within insurance businesses
Other liabilities
Retirement benefit obligations
Current tax liabilities
Deferred tax liabilities
Other provisions
Subordinated liabilities
Total liabilities
Net assets acquired
Fair value of net assets acquired
Adjust for:
Preference shares1
Non‑controlling interests
Adjusted net assets of HBOS acquired
Consideration inclusive of acquisition costs:
Issue of 7,776 million ordinary shares of 25p in Lloyds Banking Group plc2
Fees and expenses related to the transaction
Total consideration
Gain on acquisition in 2009
Book value
at 16 January
2009
£m
Fair value
adjustments
£m
Fair value
at 16 January
2009
£m
87,731
223,859
521
16,360
45,798
936
109
835
–
–
–
–
87,840
224,694
521
16,360
45,798
936
191,566
(6,247)
185,319
36,405
28,168
526
14,732
(474)
58
245
146
29,240
675,817
22,936
282
13
–
(312)
832
–
(142)
606
(9,192)
(13,216)
1,241
36,687
28,181
526
14,420
358
58
103
752
20,048
662,601
24,177
24,177
(3,917)
(1,300)
18,960
(7,651)
(136)
(7,787)
11,173
1
2
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.
The calculation of consideration was based on the closing price of Lloyds TSB ordinary shares of 98.4p on 16 January 2009; 12,852 million HBOS shares were exchanged for Lloyds Banking Group
shares at a ratio of 0.605 shares per HBOS share.
248
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 15: Loss on disposal of businesses in 2010
During 2009, the Group acquired an oil drilling rig construction business through a previous lending relationship and consolidated the results
and net assets of the business from the date it exercised control.
In the first half of 2010, as a result of a deteriorating market, the Group impaired the oil drilling rigs under construction held by the business
by £150 million to reflect their reduced value in use. This impairment was recognised in the Wholesale segment.
In the second half of 2010, the Group reached agreement to dispose of its interests in the two wholly‑owned subsidiary companies through which
this business operates; the sale was completed in January 2011. These companies, which had gross assets of £860 million, were sold to Seadrill
Limited; a loss of £365 million arose on disposal.
The Group extended vendor financing, on normal commercial terms and negotiated on an arms length basis, to Seadrill to facilitate the
acquisition of the rig holding companies. The loan is not contingent on the performance of the oil rigs under construction. Accordingly, as
at 31 December 2010, the subsidiaries were derecognised.
Note 16: Taxation
(A) Analysis of tax credit (charge) for the year
UK corporation tax:
Current tax on profit for the year
Adjustments in respect of prior years
Double taxation relief
Foreign tax:
Current tax on profit for the year
Adjustments in respect of prior years
Current tax (charge) credit
Deferred tax (note 44):
Origination and reversal of temporary differences
Reduction in UK corporation tax rate
Adjustments in respect of prior years
Tax credit (charge)
2011
£m
(93)
(146)
(239)
–
(239)
(90)
36
(54)
(293)
1,621
(404)
(96)
1,121
828
2010
£m
(146)
310
164
1
165
(82)
49
(33)
132
(393)
(137)
(141)
(671)
(539)
The credit (charge) for tax on the profit for 2011 is based on a UK corporation tax rate of 26.5 per cent (2010 and 2009: 28.0 per cent).
The above income tax credit (charge) is made up as follows:
Tax credit (charge) attributable to policyholders
Shareholder tax credit (charge)
Tax credit (charge)
2011
£m
72
756
828
2010
£m
(315)
(224)
(539)
2009
£m
(227)
(310)
(537)
10
(527)
(221)
40
(181)
(708)
2,429
–
190
2,619
1,911
2009
£m
(410)
2,321
1,911
249
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16 Taxation (continued)
(B) Factors affecting the tax credit (charge) for the year
A reconciliation of the credit (charge) that would result from applying the standard UK corporation tax rate to (loss) profit before tax to the actual
tax credit (charge) for the year is given below:
(Loss) profit before tax
Tax credit (charge) thereon at UK corporation tax rate of 26.5 per cent (2010 and 2009: 28.0 per cent)
Factors affecting credit (charge):
UK corporation tax rate change
Goodwill
Disallowed and non‑taxable items
Overseas tax rate differences
Gains exempted or covered by capital losses
Policyholder interests
Tax losses where no deferred tax recognised
Deferred tax on tax losses not previously recognised
Adjustments in respect of previous years
Effect of results of joint ventures and associates
Other items
Tax credit (charge) on (loss) profit on ordinary activities
Note 17: Earnings per share
(Loss) profit attributable to equity shareholders – basic and diluted
Weighted average number of ordinary shares in issue – basic
Adjustment for share options and awards
Weighted average number of ordinary shares in issue – diluted
Basic (loss) earnings per share
Diluted (loss) earnings per share
2011
£m
(3,542)
939
2010
£m
281
(79)
(404)
(137)
–
238
17
106
53
(261)
332
(206)
8
6
828
2011
£m
(2,787)
2011
million
68,470
–
68,470
(4.1)p
(4.1)p
–
5
134
65
(227)
(487)
–
218
(25)
(6)
(539)
2010
£m
(320)
2010
million
67,117
–
67,117
(0.5)p
(0.5)p
2009
£m
1,042
(292)
–
3,061
408
(352)
(14)
(295)
(332)
–
(66)
(211)
4
1,911
2009
£m
2,827
2009
million
37,674
255
37,929
7.5p
7.5p
Basic earnings per share are calculated by dividing the net profit attributable to equity shareholders by the weighted average number of ordinary
shares in issue during the year, which has been calculated after deducting 10 million (2010: 8 million; 2009: 10 million) ordinary shares representing
the Group’s holdings of own shares in respect of employee share schemes.
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.
In December 2009, as part of the Group’s recapitalisation and exit from the Government Asset Protection Scheme, the Group entered into
an agreement with holders of certain existing liabilities to exchange these for ordinary shares or for cash on 18 February 2010. The weighted
average number of anti‑dilutive shares arising from this transaction that have been excluded from the calculation of diluted earnings per
share was 294 million at 31 December 2009. On 18 February 2010, the above exchange completed and 3,141 million new ordinary shares in
Lloyds Banking Group plc were issued.
The weighted‑average number of anti‑dilutive share options and awards excluded from the calculation of diluted earnings per share was
619 million at 31 December 2011 (2010: 92 million; 2009: 393 million).
250
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 18: Trading and other financial assets at fair value through profit or loss
These assets are comprised as follows:
Loans and advances to customers
Loans and advances to banks
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of
deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Equity shares
Treasury and other bills
Total
2011
Other financial
assets at fair
value through
profit or loss
£m
124
–
Total
£m
9,766
1,355
21,367
1,183
23,367
1,183
385
3,248
612
1,764
20,282
45,593
75,737
–
711
1,986
21,858
52,353
75,737
299
Trading
assets
£m
9,642
1,355
2,000
–
2,863
99
222
1,576
6,760
–
299
2010
Other financial
assets at fair
value through
profit or loss
£m
325
–
22,217
919
606
422
1,592
Total
£m
9,811
2,734
23,840
919
4,298
422
2,612
16,190
21,109
41,946
90,213
–
53,200
90,219
227
Trading
assets
£m
9,486
2,734
1,623
–
3,692
–
1,020
4,919
11,254
6
227
18,056
121,454
139,510
23,707
132,484
156,191
Other financial assets at fair value through profit or loss include the following assets designated into that category:
(i)
(ii)
financial assets backing insurance contracts and investment contracts of £118,890 million (2010: £129,702 million) which are so designated
because the related liabilities either have cash flows that are contractually based on the performance of the assets or are contracts whose
measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise arise;
loans and advances to customers of £124 million (2010: £109 million) which are economically hedged by interest rate derivatives which are not
in hedge accounting relationships and where significant measurement inconsistencies would otherwise arise if the related derivatives were
treated as trading liabilities and the loans and advances were carried at amortised cost; and
(iii) private equity investments of £1,850 million (2010: £1,733 million) that are managed, and evaluated, on a fair value basis in accordance with
a documented risk management or investment strategy and reported to key management personnel on that basis.
The maximum exposure to credit risk at 31 December 2011 of the loans and advances to banks and customers designated at fair value through
profit or loss was £124 million (2010: £325 million); the Group does not hold any credit derivatives or other instruments in mitigation of this risk.
There was no significant movement in the fair value of these loans attributable to changes in credit risk which is determined by reference to the
publicly available credit ratings of the instruments involved.
The Group’s Wholesale division had exposure to negative basis asset‑backed securities of £150 million (2010: £1,067 million) which were protected
by monoline financial guarantors (note 56).
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £10,990 million
(2010: £12,211 million). Collateral is held with a fair value of £15,765 million (2010: £14,299 million), all of which the Group is able to repledge.
At 31 December 2011, £3,740 million had been repledged (2010: £3,161 million).
For amounts included above which are subject to repurchase agreements see note 56.
251
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 19: Derivative financial instruments
The Group holds derivatives as part of the following strategies:
– Customer driven, where derivatives are held as part of the provision of risk management products to Group customers;
– To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy
adopted by the Group is to utilise a combination of fair value, cash flow and net investment hedge approaches as described in note 56; and
– Derivatives held in policyholder funds as permitted by the investment strategies of those funds.
Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS 39. Derivatives
are held at fair value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial
instruments and the effect of using reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out
in note 55.
The principal derivatives used by the Group are as follows:
– Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between
two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the
underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and
a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of
a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a
specified future date.
– Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract
is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally
involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual.
A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed
rates of exchange on or before a specified future date.
– Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit
risk. A credit default swap is a swap in which one counterparty receives a premium at pre‑set intervals in consideration for guaranteeing to make
a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise, in combination with external
funding, £3,436 million (2010: £4,149 million) of corporate and commercial banking loans.
– Equity derivatives are also used by the Group as part of its equity based retail product activity to eliminate the Group’s exposure to fluctuations
in various international stock exchange indices. Index‑linked equity options are purchased which give the Group the right, but not the obligation,
to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.
252
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 19: Derivative financial instruments (continued)
The fair values and notional amounts of derivative instruments are set out in the following table:
At 31 December 2011
Trading and other
Exchange rate contracts:
Spot, forwards and futures
Currency swaps
Options purchased
Options written
Interest rate contracts:
Interest rate swaps
Forward rate agreements
Options purchased
Options written
Futures
Credit derivatives
Embedded equity conversion feature
Equity and other contracts
Total derivative assets/liabilities – trading and other
Hedging
Derivatives designated as fair value hedges:
Currency swaps
Interest rate swaps
Options written
Derivatives designated as cash flow hedges:
Interest rate swaps
Futures
Currency swaps
Derivatives designated as net investment hedges:
Cross currency swaps
Total derivative assets/liabilities – hedging
Total recognised derivative assets/liabilities
Contract/notional
Fair value
amount
£m
assets
£m
Fair value
liabilities
£m
204,629
138,120
17,992
18,924
2,542
3,498
610
–
2,780
2,027
–
616
379,665
6,650
5,423
1,627,013
38,806
39,899
261,125
69,554
67,858
118,921
586
3,693
–
1
606
–
3,524
2
2,144,471
43,086
44,031
9,980
–
23,032
238
1,172
2,017
2,557,148
53,163
328
–
1,184
50,966
19,130
93,215
657
113,002
152,314
103,467
16,582
272,363
708
6,720
–
7,428
5,250
–
172
5,422
302
1,236
9
1,547
5,608
–
90
5,698
49
385,414
2,942,562
–
12,850
66,013
1
7,246
58,212
The principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing
contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement
techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 56 Credit risk.
The embedded equity conversion feature of £1,172 million (31 December 2010: £1,177 million) reflects the value of the equity conversion feature
contained in the Enhanced Capital Notes issued by the Group in 2009; the loss of £5 million arising from the change in fair value over 2011
(2010: loss of £620 million; 2009: loss of £427 million) is included within net gains on financial instruments held for trading within net trading income
(note 7).
253
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 19: Derivative financial instruments (continued)
At 31 December 2010
Trading and other
Exchange rate contracts:
Spot, forwards and futures
Currency swaps
Options purchased
Options written
Interest rate contracts:
Interest rate swaps
Forward rate agreements
Options purchased
Options written
Futures
Credit derivatives
Embedded equity conversion feature
Equity and other contracts
Total derivative assets/liabilities – trading and other
Hedging
Derivatives designated as fair value hedges:
Currency swaps
Interest rate swaps
Derivatives designated as cash flow hedges:
Interest rate swaps
Futures
Currency swaps
Derivatives designated as net investment hedges:
Cross currency swaps
Total derivative assets/liabilities – hedging
Total recognised derivative assets/liabilities
Contract/notional
amount
£m
Fair value
assets
£m
Fair value
liabilities
£m
212,832
108,216
18,096
19,387
358,531
1,397,157
718,227
59,578
60,828
23,361
2,259,151
7,108
–
22,597
2,647,387
9,418
75,831
85,249
112,507
1,299
17,745
131,551
86
216,886
2,864,273
2,513
5,696
602
–
8,811
28,448
309
2,371
–
3
31,131
256
1,177
1,996
43,371
606
4,366
4,972
2,199
1
232
2,432
2
7,406
50,777
2,242
1,773
–
536
4,551
29,202
287
–
2,180
1
31,670
207
–
1,332
37,760
35
1,200
1,235
3,042
–
121
3,163
–
4,398
42,158
254
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 19: Derivative financial instruments (continued)
Hedged cash flows
For designated cash flow hedges the following table shows when the Group’s hedged cash flows are expected to occur and when they will affect
income.
2011
Hedged forecast cash flows expected to occur:
Forecast receivable cash flows
Forecast payable cash flows
Hedged forecast cash flows affect profit or loss:
Forecast receivable cash flows
Forecast payable cash flows
2010
Hedged forecast cash flows expected to occur:
Forecast receivable cash flows
Forecast payable cash flows
Hedged forecast cash flows affect profit or loss:
Forecast receivable cash flows
Forecast payable cash flows
0-1 years
£m
1-2 years
£m
2-3 years
£m
3-4 years
£m
4-5 years
£m
5-10 years
£m
10-20 years
£m
Over 20
years
£m
Total
£m
140
(178)
234
(224)
239
(181)
232
(154)
475
(63)
388
(53)
208
(81)
208
(81)
35
355
191
66
1,709
(78)
(1,394)
(1,163)
(354)
(3,492)
47
383
163
54
1,709
(145)
(1,475)
(1,110)
(250)
(3,492)
0‑1 years
£m
1‑2 years
£m
2‑3 years
£m
3‑4 years
£m
4‑5 years
£m
5‑10 years
£m
10‑20 years
£m
223
(70)
223
(70)
328
(44)
445
(97)
560
(165)
443
(113)
434
(93)
434
(93)
310
(67)
310
(67)
451
(616)
466
(675)
445
(916)
435
(884)
Over 20
years
£m
160
(200)
155
(172)
Total
£m
2,911
(2,171)
2,911
(2,171)
There were no transactions for which cash flow hedge accounting had to be ceased in 2011 or 2010 as a result of the highly probable cash flows no
longer being expected to occur.
Note 20: Loans and advances to banks
Lending to banks
Money market placements with banks
Total loans and advances to banks before allowance for impairment losses
Allowance for impairment losses (note 25)
Total loans and advances to banks
2011
£m
1,810
30,810
32,620
(14)
32,606
2010
£m
1,042
29,250
30,292
(20)
30,272
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £508 million
(2010: £4,185 million). Collateral is held with a fair value of £511 million (2010: £3,909 million), all of which the Group is able to repledge.
Included in the amounts reported above in 2010 are collateral balances in the form of cash provided in respect of reverse repurchase agreements
amounting to £4 million.
255
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 21: Loans and advances to customers
Agriculture, forestry and fishing
Energy and water supply
Manufacturing
Construction
Transport, distribution and hotels
Postal and telecommunications
Property companies
Financial, business and other services
Personal:
Mortgages
Other
Lease financing
Hire purchase
Total loans and advances to customers before allowance for impairment losses
Allowance for impairment losses (note 25)
Total loans and advances to customers
2011
£m
5,198
4,013
10,061
9,722
32,882
1,896
64,752
64,046
348,210
30,014
7,800
5,776
584,370
(18,732)
565,638
2010
£m
5,558
3,576
11,495
7,904
34,176
1,908
78,263
59,363
356,261
36,967
8,291
7,208
610,970
(18,373)
592,597
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £16,835 million
(2010: £3,096 million). Collateral is held with a fair value of £16,936 million (2010: £2,987 million), all of which the Group is able to repledge.
Included within this are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £34 million
(2010: £42 million).
Loans and advances to customers include finance lease receivables, which may be analysed as follows:
Gross investment in finance leases, receivable:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
Unearned future finance income on finance leases
Rentals received in advance
Commitments for expenditure in respect of equipment to be leased
Net investment in finance leases
The net investment in finance leases represents amounts recoverable as follows:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
Net investment in finance leases
2011
£m
2010
£m
1,168
2,754
6,355
10,277
(2,391)
(56)
(30)
7,800
2011
£m
724
2,307
4,769
7,800
1,358
2,522
7,218
11,098
(2,603)
(183)
(21)
8,291
2010
£m
986
1,965
5,340
8,291
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft,
ships and other large individual value items. During 2011 and 2010 no contingent rentals in respect of finance leases were recognised in the
income statement. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £92 million
(2010: £287 million).
256
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 21: Loans and advances to customers (continued)
The unguaranteed residual values included in finance lease receivables were as follows:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
Total unguaranteed residual values
Note 22: Securitisations and covered bonds
2011
£m
56
137
20
213
2010
£m
45
101
20
166
Securitisation programmes
Loans and advances to customers and debt securities classified as loans and receivables include loans securitised under the Group’s securitisation
programmes, the majority of which have been sold by subsidiary companies to bankruptcy remote special purpose entities (SPEs). As the SPEs
are funded by the issue of debt on terms whereby the majority of the risks and rewards of the portfolio are retained by the subsidiary, the SPEs are
consolidated fully and all of these loans are retained on the Group’s balance sheet, with the related notes in issue included within debt securities
in issue. In addition to the SPEs described below, the Group sponsors three conduit programmes, Argento, Cancara and Grampian.
Covered bond programmes
Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of
covered bonds by the Group. The Group retains all of the risks and rewards associated with these loans and the partnerships are consolidated fully
with the loans retained on the Group’s balance sheet and the related covered bonds in issue included within debt securities in issue.
The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to these arrangements
and the carrying value of the notes in issue at 31 December, are listed below. The notes in issue are reported in note 37.
Securitisation programmes1
UK residential mortgages
US residential mortgage‑backed securities
Commercial loans
Irish residential mortgages
Credit card receivables
Dutch residential mortgages
Personal loans
PFI/PPP and project finance loans
Motor vehicle loans
Less held by the Group
Total securitisation programmes (note 37)
Covered bond programmes
Residential mortgage‑backed
Social housing loan‑backed
Less held by the Group
Total covered bond programmes (note 37)
Total securitisation and covered bond programmes
1
Includes securitisations utilising a combination of external funding and credit default swaps.
Loans and
advances
securitised
£m
129,764
398
13,313
5,497
6,763
4,933
–
767
3,124
164,559
91,023
3,363
94,386
2011
2010
Notes
in issue
£m
Loans and
advances
securitised
£m
Notes
in issue
£m
94,080
398
11,342
5,661
4,810
4,777
–
110
2,871
124,049
(86,637)
37,412
67,456
2,605
70,061
(31,865)
38,196
75,608
146,200
114,428
–
11,860
6,007
7,327
4,526
3,012
776
926
180,634
93,651
3,317
96,968
–
8,936
6,191
3,856
4,316
2,011
110
975
140,823
(100,081)
40,742
73,458
2,181
75,639
(43,489)
32,150
72,892
Cash deposits of £20,435 million (2010: £36,579 million) held by the Group are restricted in use to repayment of the debt securities issued by the
SPEs, the term advances relating to covered bonds and other legal obligations.
257
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 23: Special purpose entities
In addition to the special purpose entities discussed in note 22, which are used for securitisation and covered bond programmes, the Group
sponsors three asset‑backed conduits, Argento, Cancara and Grampian, which invest in debt securities and client receivables. All the external
assets in these conduits are consolidated in the Group’s financial statements and are included in the credit market exposures set out in note 56.
The total consolidated exposures in these conduits are set out in the table below:
At 31 December 2011
Loans and advances
Debt securities classified as loans and receivables (note 24):
Asset‑backed securities
Corporate and other debt securities
Debt securities classified as available‑for‑sale financial assets (note 26):
Asset‑backed securities
Corporate and other debt securities
Total assets
At 31 December 2010
Loans and advances
Debt securities classified as loans and receivables (note 24):
Asset‑backed securities
Corporate and other debt securities
Debt securities classified as available‑for‑sale financial assets (note 26):
Asset‑backed securities
Corporate and other debt securities
Total assets
Argento
£m
Cancara
£m
Grampian
£m
Total
£m
130
3,962
73
4,165
1,022
–
1,022
733
73
806
1,958
–
–
–
21
–
21
2,004
–
2,004
796
–
796
3,983
2,873
3,026
–
3,026
1,550
73
1,623
8,814
–
3,957
–
3,957
1,448
202
1,650
1,436
463
1,899
3,549
–
–
–
2,587
–
2,587
6,544
6,957
–
6,957
–
–
–
6,957
8,405
202
8,607
4,023
463
4,486
17,050
Other special purpose entities
During 2009, the Group established Lloyds TSB Pension ABCS (No 1) LLP and Lloyds TSB Pension ABCS (No 2) LLP and transferred approximately
£5 billion of assets, primarily comprising notes in certain of the Group’s securitisation programmes, in aggregate to these entities. Further details
are provided in note 43.
Note 24: Debt securities classified as loans and receivables
Debt securities accounted for as loans and receivables comprise:
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Total debt securities classified as loans and receivables before allowance for impairment losses
Allowance for impairment losses (note 25)
Total debt securities classified as loans and receivables
For amounts included above which are subject to repurchase agreements see note 56.
2011
£m
2010
£m
7,179
5,030
537
12,746
(276)
12,470
11,650
12,827
1,816
26,293
(558)
25,735
258
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 25: Allowance for impairment losses on loans and receivables
Loans and
advances
to customers
£m
Loans and
advances
to banks
£m
Debt
securities
£m
At 1 January 2010
Exchange and other adjustments
Advances written off
Recoveries of advances written off in previous years
Unwinding of discount
Charge (release) to the income statement (note 12)
At 31 December 2010
Exchange and other adjustments
Advances written off
Recoveries of advances written off in previous years
Unwinding of discount
Charge to the income statement (note 12)
At 31 December 2011
14,801
(2)
(6,966)
216
(403)
10,727
18,373
(369)
(7,487)
421
(226)
8,020
18,732
149
(5)
(111)
–
–
(13)
20
–
(6)
–
–
–
14
Total
£m
15,380
112
(7,125)
216
(403)
10,771
18,951
(367)
430
119
(48)
–
–
57
558
2
(341)
(7,834)
8
–
49
276
429
(226)
8,069
19,022
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.
Of the total allowance in respect of loans and advances to customers, £3,832 million (2010: £6,076 million) was assessed on a collective basis.
Note 26: Available-for-sale financial assets
Conduits
£m
2011
Other
£m
Total
£m
Conduits
£m
2010
Other
£m
Total
£m
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Equity shares
Treasury and other bills
–
–
–
1,255
295
73
1,623
–
–
Total available-for-sale financial assets
1,623
25,236
25,236
27
366
548
769
5,172
32,118
1,938
1,727
35,783
27
366
1,803
1,064
5,245
33,741
1,938
1,727
37,406
–
–
–
3,203
820
463
4,486
–
–
4,486
12,552
12,552
29
407
1,090
4,399
29
407
4,293
5,219
11,669
12,132
30,146
2,255
6,068
38,469
34,632
2,255
6,068
42,955
Details of the Group’s asset‑backed conduits shown in the table above are included in note 23.
Included within asset‑backed securities are £2,867 million (31 December 2010: £9,392 million) managed by the Wholesale division. Further
information on these exposures is provided in note 56.
For amounts included above which are subject to repurchase agreements see note 56.
All assets have been individually assessed for impairment. The criteria used to determine whether an impairment loss has been incurred are
disclosed in note 2(H).
259
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 27: Held-to-maturity investments
Debt securities: government securities
Note 28: Investment properties
At 1 January
Exchange and other adjustments
Additions:
Acquisitions of new properties
Consolidation of new subsidiary undertakings
Additional expenditure on existing properties
Total additions
Disposals
Changes in fair value (note 7)
At 31 December
2011
£m
8,098
2011
£m
5,997
(16)
396
922
81
1,399
(1,151)
(107)
6,122
2010
£m
7,905
2010
£m
4,757
(6)
398
921
52
1,371
(559)
434
5,997
The investment properties are valued at least annually at open‑market value, by independent, professionally qualified valuers, who have recent
experience in the location and categories of the investment properties being valued.
In addition, the following amounts have been recognised in the income statement:
Rental income (note 9)
Direct operating expenses arising from investment properties that generate rental income
Capital expenditure in respect of investment properties:
Capital expenditure contracted for at the balance sheet date but not recognised in the financial statements
2011
£m
388
50
2011
£m
33
2010
£m
337
77
2010
£m
86
260
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 29: Goodwill
At 1 January and 31 December
Cost1
Accumulated impairment losses
At 31 December
2011
£m
2,016
2,362
(346)
2,016
2010
£m
2,016
2,362
(346)
2,016
1
For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill
is allocated to the appropriate cash generating unit; of the total balance of £2,016 million (31 December 2010: £2,016 million), £1,836 million, or
91 per cent of the total (2010: £1,836 million, 91 per cent of the total) has been allocated to Scottish Widows in the Group’s Insurance division and
£170 million, or 8 per cent of the total (2010: £170 million, 8 per cent of the total) to Asset Finance in the Group’s Wholesale division.
The recoverable amount of Scottish Widows has been based on a value‑in‑use calculation. The calculation uses post‑tax projections of future cash
flows based upon budgets and plans approved by management covering a five‑year period, and a discount rate of 12 per cent (net of tax). The
budgets and plans are based upon past experience adjusted to take into account anticipated changes in sales volumes, product mix and margins
having regard to expected market conditions and competitor activity. The discount rate is determined with reference to internal measures and
available industry information. Cash flows beyond the five‑year period have been extrapolated using a steady three per cent growth rate which
does not exceed the long‑term average growth rate for the life assurance market. Management believes that any reasonably possible change in
the key assumptions above would not cause the recoverable amount of Scottish Widows to fall below its balance sheet carrying value.
The recoverable amount of Asset Finance has also been based on a value‑in‑use calculation using pre‑tax cash flow projections based on financial
budgets and plans approved by management covering a five‑year period and a discount rate of 17.75 per cent (gross of tax). The cash flows
beyond the five‑year period are extrapolated using a growth rate of 0.5 per cent which does not exceed the long‑term average growth rates for
the markets in which Asset Finance participates. Management believes that any reasonably possible change in the key assumptions above would
not cause the recoverable amount of Asset Finance to fall below the balance sheet carrying value.
Note 30: Value of in-force business
The gross value of in‑force business asset in the consolidated balance sheet is as follows:
Acquired value of in‑force non‑participating investment contracts
Value of in‑force insurance and participating investment contracts
Total value of in-force business
The movement in the acquired value of in‑force non‑participating investment contracts over the year is as follows:
At 1 January
Amortisation taken to income statement (note 11)
At 31 December
2011
£m
1,391
5,247
6,638
2011
£m
1,469
(78)
1,391
2010
£m
1,469
5,898
7,367
2010
£m
1,545
(76)
1,469
The acquired value of in‑force non‑participating investment contracts includes £329 million (2010: £356 million) in relation to OEIC business.
261
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 30: Value of in-force business (continued)
The movement in the value of in‑force insurance and participating investment contracts over the year is as follows:
At 1 January
Adjustment on acquisition
Exchange and other adjustments
Movements in the year:
New business
Existing business:
Expected return
Experience variances
Non‑economic assumption changes
Economic variance
Movement in the value of in‑force business taken to income statement (note 9)
At 31 December
2011
£m
5,898
–
(29)
2010
£m
5,140
–
(31)
552
497
(437)
117
(576)
(278)
(622)
5,247
(400)
85
306
301
789
5,898
This breakdown shows the movement in the value of in‑force business only, and does not represent the full contribution that each item in the
breakdown contributes to profit before tax. This will also contain changes in the other assets and liabilities, including the effects of changes
in assumptions used to value the liabilities, of the relevant businesses. Economic variance is the element of earnings which is generated from
changes to economic experience in the period and to economic assumptions over time. The presentation of economic variance includes the
impact of financial market conditions being different at the end of the reporting period from those included in assumptions used to calculate
new and existing business returns.
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in‑force
business are set out below:
Economic assumptions
Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve
the same result, where the cash flows are either independent of or move linearly with market movements, a method has been applied known as
the ‘certainty equivalent’ approach whereby it is assumed that all assets earn a risk‑free rate and all cash flows are discounted at a risk‑free rate.
A market consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique
calibrated to be consistent with the market price of relevant options at each valuation date. The risk‑free rate used for the value of financial
options and guarantees is defined as the spot yield derived from the relevant government bond yield curve in line with FSA realistic balance
sheet assumptions. Further information on options and guarantees can be found on page 127.
The liabilities in respect of the Group’s UK annuity business are matched by a portfolio of fixed interest securities, including a large proportion
of corporate bonds. The value of the in‑force business asset for UK annuity business has been calculated after taking into account an estimate
of the market premium for illiquidity in respect of corporate bond holdings. The illiquidity premium is estimated to be 119 basis points as
at 31 December 2011 (31 December 2010: 75 basis points).
The risk‑free rate assumed in valuing the non‑annuity in‑force business is the 15 year government bond yield for the appropriate territory.
The risk‑free rate assumed in valuing the in‑force asset for the UK annuity business is presented as a single risk‑free rate to allow a better
comparison to the rate used for other business. That single risk‑free rate has been derived to give the equivalent value to the UK annuity book,
had that book been valued using the UK gilt yield curve increased to reflect the illiquidity premium described above.
The table below shows the resulting range of yields and other key assumptions at 31 December for UK business:
Risk‑free rate (value of in‑force non‑annuity business)
Risk‑free rate (value of in‑force annuity business)
Risk‑free rate (financial options and guarantees)
Retail price inflation
Expense inflation
2011
%
2.48
3.76
2010
%
3.99
4.66
0.22 to 3.36
0.63 to 4.50
3.35
4.01
3.56
4.20
262
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 30: Value of in-force business (continued)
Non-market risk s
An allowance for non‑market risk is made through the choice of best estimate assumptions based upon experience, which generally will give
the mean expected financial outcome for shareholders and hence no further allowance for non‑market risk is required. However, in the case
of operational risk, reinsurer default and the with‑profit funds these can be asymmetric in the range of potential outcomes for which an explicit
allowance is made.
Non-economic assumptions
Future mortality, morbidity, expenses, lapse and paid‑up rate assumptions are reviewed each year and are based on an analysis of past experience
and on management’s view of future experience.
Mortality and morbidity
The mortality and morbidity assumptions, including allowances for improvements in longevity, are set with regard to the Group’s actual experience
where this provides a reliable basis and relevant industry data otherwise. For German business, appropriate industry tables have been considered.
Lapse (persistency) and paid-up rates
Lapse and paid up rates assumptions are reviewed each year. The most recent experience is considered along with the results of previous
analyses and management’s views on future experience. In determining this best estimate view, a number of factors are considered, including the
credibility of the results (which will be affected by the volume of data available), any exceptional events that have occurred during the period under
consideration and any known or expected trends in underlying data.
Maintenance expenses
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future
costs. Explicit allowance is made for future expense inflation. For German business appropriate cost assumptions have been set in accordance
with the rules of the local regulatory body.
These assumptions are intended to represent a best estimate of future experience, and further information about the effect of changes in key
assumptions is given in note 39.
263
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 31: Other intangible assets
Cost:
At 1 January 2010
Additions
Disposals
At 31 December 2010
Exchange and other adjustments
Additions
Disposals
At 31 December 2011
Accumulated amortisation:
At 1 January 2010
Charge for the year
Disposals
At 31 December 2010
Exchange and other adjustments
Charge for the year
Disposals
At 31 December 2011
Balance sheet amount at 31 December 2011
Balance sheet amount at 31 December 2010
Brands
£m
Core deposit
intangible
£m
Purchased
credit card
relationships
£m
Customer-
related
intangibles
£m
Capitalised
software
enhancements
£m
596
–
–
596
–
–
–
2,770
–
–
2,770
–
–
–
596
2,770
21
25
–
46
–
19
–
65
531
550
393
400
–
793
–
399
–
1,192
1,578
1,977
300
–
–
300
–
–
–
300
58
60
–
118
–
60
–
178
122
182
877
–
–
877
–
4
–
881
237
161
–
398
–
88
–
486
395
479
487
153
(30)
610
5
369
(25)
959
234
75
(7)
302
2
97
(12)
389
570
308
Total
£m
5,030
153
(30)
5,153
5
373
(25)
5,506
943
721
(7)
1,657
2
663
(12)
2,310
3,196
3,496
Included within brands above are assets of £380 million (31 December 2010: £380 million) that have been determined to have indefinite useful
lives and are not amortised. These brands use the Bank of Scotland name which has been in existence for over 300 years. These brands are well
established financial services brands and there are no indications that they should not have an indefinite useful life.
The customer‑related intangibles include customer lists and the benefits of customer relationships that generate recurring income. The purchased
credit card relationships represent the benefit of recurring income generated from the portfolio of credit cards purchased and the core deposit
intangible is the benefit derived from a large stable deposit base that has low interest rates.
Capitalised software enhancements principally comprise identifiable and directly associated internal staff and other costs.
264
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 32: Tangible fixed assets
Cost:
At 1 January 2010
Exchange and other adjustments
Additions
Disposals
Disposal of businesses
At 31 December 2010
Exchange and other adjustments
Additions
Disposals
Disposal of businesses
At 31 December 2011
Accumulated depreciation and impairment:
At 1 January 2010
Exchange and other adjustments
Impairment charged to the income statement
Depreciation charge for the year
Disposals
Disposal of businesses
At 31 December 2010
Exchange and other adjustments
Impairment charged to the income statement
Depreciation charge for the year
Disposals
Disposal of businesses
At 31 December 2011
Balance sheet amount at 31 December 2011
Balance sheet amount at 31 December 2010
Premises
£m
Equipment
£m
Operating
lease assets
£m
Total tangible
fixed assets
£m
2,461
26
175
(222)
–
2,440
–
149
(121)
(14)
2,454
884
2
–
146
(31)
–
1,001
–
–
137
(38)
(3)
1,097
1,357
1,439
5,122
34
766
(338)
(1,005)
4,579
(45)
660
(395)
(7)
4,792
6,384
(76)
1,672
(1,693)
–
6,287
(22)
1,436
(1,852)
(330)
5,519
2,597
1,262
(3)
202
535
(338)
(148)
2,845
17
65
411
(349)
(6)
2,983
1,809
1,734
30
–
954
(976)
–
1,270
18
–
886
(967)
(195)
1,012
4,507
5,017
2011
£m
987
1,389
628
3,004
13,967
(16)
2,613
(2,253)
(1,005)
13,306
(67)
2,245
(2,368)
(351)
12,765
4,743
29
202
1,635
(1,345)
(148)
5,116
35
65
1,434
(1,354)
(204)
5,092
7,673
8,190
2010
£m
1,168
1,791
638
3,597
At 31 December the future minimum rentals receivable under non‑cancellable operating leases were as follows:
Receivable within 1 year
1 to 5 years
Over 5 years
Total future minimum rentals receivable
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2011 and 2010 no
contingent rentals in respect of operating leases were recognised in the income statement.
In addition, total future minimum sub‑lease income of £40 million at 31 December 2011 (£55 million at 31 December 2010) is expected to be
received under non‑cancellable sub‑leases of the Group’s premises.
The impairment charge in 2011 relates to integration activities; the impairment charge of £202 million in 2010 comprised £150 million relating to oil
drilling rigs under construction acquired from a previous lending relationship in Wholesale (note 15) and £52 million relating to integration activities
(note 11).
265
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 33: Other assets
Assets arising from reinsurance contracts held (note 38 and note 40)
Deferred acquisition and origination costs (see below)
Settlement balances
Corporate pension asset
Other assets and prepayments
Total other assets
Deferred acquisition and origination costs:
At 1 January
Costs deferred, net of amounts amortised to the income statement
Exchange and other adjustments
At 31 December
Note 34: Deposits from banks
Liabilities in respect of securities sold under repurchase agreements
Other deposits from banks
Deposits from banks
2011
£m
2,534
693
1,193
3,873
6,135
14,428
2011
£m
602
92
(1)
693
2011
£m
14,389
25,421
39,810
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £13,933 million
(2010: £22,420 million) and a fair value of £14,258 million (2010: £25,626 million).
Note 35: Customer deposits
Non‑interest bearing current accounts
Interest bearing current accounts
Savings and investment accounts
Liabilities in respect of securities sold under repurchase agreements
Other customer deposits
Customer deposits
2011
£m
29,468
72,562
238,132
7,996
65,748
413,906
2010
£m
2,146
602
985
2,320
6,590
12,643
2010
£m
533
69
–
602
2010
£m
24,017
26,346
50,363
2010
£m
22,897
77,785
222,226
11,145
59,580
393,633
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £7,987 million
(2010: £11,112 million) and a fair value of £8,088 million (2010: £11,278 million).
Included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting
to £323 million (2010: £122 million).
266
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 36: Trading and other financial liabilities at fair value through profit or loss
Liabilities held at fair value through profit or loss (debt securities)
Trading liabilities:
Liabilities in respect of securities sold under repurchase agreements
Short positions in securities
Other
Trading and other financial liabilities at fair value through profit or loss
2011
£m
5,339
12,378
3,701
3,537
19,616
24,955
2010
£m
6,665
14,612
1,755
3,730
20,097
26,762
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2011 was
£5,487 million, which was £148 million higher than the balance sheet carrying value (31 December 2010: £6,607 million, which was £58 million lower
than the balance sheet carrying value). At 31 December 2011 there was a cumulative £183 million decrease 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 TSB Bank plc, the issuing entity
within the Group. Of the cumulative amount, a decrease of £194 million arose in 2011 and none arose in 2010.
Liabilities designated at fair value through profit or loss represent debt securities in issue which either contain substantive embedded derivatives
which would otherwise need to be recognised and measured at fair value separately from the related debt securities, or which are accounted for
at fair value to significantly reduce an accounting mismatch.
Note 37: Debt securities in issue
Medium‑term notes issued
Covered bonds (note 22)
Certificates of deposit issued
Securitisation notes (note 22)
Commercial paper
Total debt securities in issue
2011
£m
63,366
38,196
27,994
37,412
18,091
2010
£m
80,975
32,150
42,276
40,742
32,723
185,059
228,866
Note 38: Liabilities arising from insurance contracts and participating investment contracts
Insurance contract and participating investment contract liabilities are comprised as follows:
Life insurance (see (1) below):
Insurance contracts
Participating investment contracts
Non‑life insurance contracts (see (2) below):
Unearned premiums
Claims outstanding
Total
1
Reinsurance balances are reported within other assets (note 33).
Gross
£m
62,399
15,631
78,030
566
395
961
78,991
2011
Reinsurance1
£m
Net
£m
Gross
£m
2010
Reinsurance1
£m
(2,452)
59,947
–
15,631
(2,452)
75,578
(23)
(2)
(25)
543
393
936
(2,477)
76,514
61,871
17,642
79,513
632
584
1,216
80,729
(2,044)
–
(2,044)
(22)
(15)
(37)
(2,081)
Net
£m
59,827
17,642
77,469
610
569
1,179
78,648
267
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 38: Liabilities arising from insurance contracts and participating investment contracts (continued)
(1) Life insurance
The movement in life insurance contract and participating investment contract liabilities over the year can be analysed as follows:
At 1 January 2010
New business
Changes in existing business
Change in liabilities charged to the income statement
(note 10)
Exchange and other adjustments
At 31 December 2010
New business
Changes in existing business
Change in liabilities charged to the income statement
(note 10)
Exchange and other adjustments
At 31 December 2011
Insurance
contracts
56,800
3,807
1,348
5,155
(84)
61,871
4,340
(3,713)
627
(99)
Participating
investment
contracts
18,089
325
(858)
(533)
86
17,642
86
(2,096)
(2,010)
(1)
62,399
15,631
Gross
£m
74,889
4,132
490
4,622
2
79,513
4,426
(5,809)
(1,383)
(100)
78,030
Reinsurance
£m
(1,831)
(48)
(208)
(256)
43
(2,044)
(156)
(295)
(451)
43
(2,452)
Net
£m
73,058
4,084
282
4,366
45
77,469
4,270
(6,104)
(1,834)
(57)
75,578
Liabilities for insurance contracts and participating investment contracts can be split into with‑profit fund liabilities, accounted for using the
FSA’s realistic capital regime (realistic liabilities) and non‑profit fund liabilities, accounted for using a prospective actuarial discounted cash flow
methodology, as follows:
With-profit
fund
£m
13,467
9,488
22,955
2011
Non-profit
fund
£m
48,932
6,143
55,075
Total
£m
62,399
15,631
78,030
With‑profit
fund
£m
13,598
10,647
24,245
2010
Non‑profit
fund
£m
48,273
6,995
55,268
Total
£m
61,871
17,642
79,513
Insurance contracts
Participating investment contracts
Total
With-profit fund realistic liabilities
(i) Business description
The Group has with‑profit funds within Scottish Widows plc and Clerical Medical Investment Group Limited containing both insurance contracts
and participating investment contracts.
The primary purpose of the conventional and unitised business written in the with‑profit funds is to provide a smoothed investment vehicle to
policyholders, protecting them against short‑term market fluctuations. Payouts may be subject to a guaranteed minimum payout if certain policy
conditions are met. With‑profit policyholders are entitled to at least 90 per cent of the distributed profits, with the shareholders receiving the
balance. The policyholders are also usually insured against death and the policy may carry a guaranteed annuity option at retirement.
(ii) Method of calculation of liabilities
With‑profit liabilities are stated at their realistic value, the main components of which are:
– With‑profit benefit reserve, the total asset shares for with‑profit policies;
– Cost of options and guarantees (including guaranteed annuity options);
– Deductions levied against asset shares;
– Planned enhancements to with‑profits benefits reserve; and
– Impact of the smoothing policy.
The realistic assessment is carried out using a stochastic simulation model which values liabilities on a market consistent basis. The calculation of
realistic liabilities uses best estimate assumptions for mortality, persistency rates and expenses. These are calculated in a similar manner to those
used for the value of in‑force business as discussed in note 30.
268
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 38: Liabilities arising from insurance contracts and participating investment contracts (continued)
(iii) Assumptions
Key assumptions used in the calculation of with‑profit liabilities, and the processes for determining these, are:
Investment returns and discount rates
The realistic capital regime dictates that with‑profit fund liabilities are valued on a market‑consistent basis. This is achieved by the use of a
valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The with‑profit
fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the
risk‑free yield and all cash flows are discounted using the risk‑free yield. The risk‑free yield is defined as the spot yield derived from the relevant
government bond yield curve. Further information on significant options and guarantees is given on page 127.
Guaranteed annuity option take-up rates
Certain pension contracts contain guaranteed annuity options that allow the policyholder to take an annuity benefit on retirement at annuity rates
that were guaranteed at the outset of the contract. For contracts that contain such options, key assumptions in determining the cost of options are
economic conditions in which the option has value, mortality rates and take up rates of other options. The financial impact is dependent on the
value of corresponding investments, interest rates and longevity at the time of the claim.
Investment volatility
The calibration of the stochastic simulation model uses implied volatilities of derivatives where possible, or historical volatility where it is not
possible to observe meaningful prices.
Mortality
The mortality assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience
where this is significant, and relevant industry data otherwise.
Lapse rates (persistency)
Lapse rates refer to the rate of policy termination or the rate at which policyholders stop paying regular premiums due under the contract.
Historical persistency experience is analysed using statistical techniques. As experience can vary considerably between different product types
and for contracts that have been in force for different periods, the data is broken down into broadly homogenous groups for the purposes of this
analysis.
The most recent experience is considered along with the results of previous analyses and management’s views on future experience, taking into
consideration potential changes in future experience that may result from guarantees and options becoming more valuable under adverse market
conditions, in order to determine a ‘best estimate’ view of what persistency will be. In determining this best estimate view a number of factors
are considered, including the credibility of the results (which will be affected by the volume of data available), any exceptional events that have
occurred during the period under consideration, any known or expected trends in underlying data and relevant published market data.
Non-profit fund liabilities
(i) Business description
The Group principally writes the following types of life insurance contracts within its non‑profit funds. Shareholder profits on these types of
business arise from management fees and other policy charges.
Unit-linked business – This includes unit‑linked pensions and unit‑linked bonds, the primary purpose of which is to provide an investment vehicle
where the policyholder is also insured against death.
Life insurance – The policyholder is insured against death or permanent disability, usually for predetermined amounts. Such business includes
whole of life and term assurance and long‑term creditor policies.
Annuities – The policyholder is entitled to payments for the duration of their life and is therefore insured against surviving longer than expected.
German insurance business is written through the Group’s subsidiary Heidelberger Leben and comprises policies similar to the UK definitions
above, except that there is participation by the policyholder in the investment, insurance and expense profits of Heidelberger Leben. A minimum
level of policyholder participation is prescribed by German law. The following types of life insurance contracts are written:
– Traditional and unit linked endowment or pensions business; and
– Life insurance business.
(ii) Method of calculation of liabilities
The non‑profit fund liabilities are determined on the basis of recognised actuarial methods and consistent with the approach required by
regulatory rules. The methods used involve estimating future policy cash flows over the duration of the in‑force book of policies, and discounting
the cash flows back to the valuation date allowing for probabilities of occurrence.
269
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 38: Liabilities arising from insurance contracts and participating investment contracts (continued)
(iii) Assumptions
Generally, assumptions used to value non‑profit fund liabilities are prudent in nature and therefore contain a margin for adverse deviation.
This margin for adverse deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty.
The key assumptions used in the measurement of non‑profit fund liabilities are:
Interest rates
The rates used are derived in accordance with the guidelines set by local regulatory bodies. These limit the rates of interest that can be used
by reference to a number of factors including the redemption yields on fixed interest assets at the valuation date.
Margins for risk are allowed for in the assumed interest rates. These are derived from the limits in the guidelines set by local regulatory bodies,
including reductions made to the available yields to allow for default risk based upon the credit rating of the securities allocated to the insurance
liability.
Mortality and morbidity
The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s
actual experience where this provides a reliable basis, and relevant industry data otherwise, and include a margin for adverse deviation. For
German business appropriate industry tables have been considered.
Lapse rates (persistency)
Lapse rates are allowed for on some non‑profit fund contracts. The process for setting these rates is as described for with‑profit liabilities, however
a prudent scenario is assumed by the inclusion of a margin for adverse deviation within the non‑profit fund liabilities.
Maintenance expenses
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected
future costs plus a margin for adverse deviation. Explicit allowance is made for future expense inflation. For German business appropriate cost
assumptions have been set in accordance with the rules of the local regulatory body.
Key changes in assumptions
A detailed review of the Group’s assumptions in 2011 resulted in the following key impacts on profit before tax:
– Change in persistency assumptions (£5 million increase)
– Change in the assumption in respect of current and future mortality rates (£74 million decrease)
– Change in expense assumptions (£22 million increase)
These amounts include the impacts of movements in liabilities and value of the in‑force business in respect of insurance contracts and participating
investment contracts.
270
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 38: Liabilities arising from insurance contracts and participating investment contracts (continued)
(2) Non-life insurance
Gross non‑life insurance contract liabilities are analysed by line of business as follows:
Credit protection
Home
Health
Total gross non-life insurance contract liabilities
2011
£m
206
753
2
961
2010
£m
380
833
3
1,216
For non‑life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims
provisioning levels are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or
expected outcome. There has been no significant change in the assumptions and methodologies used for setting reserves.
The reserving methodology and associated assumptions are set out below:
The unearned premium reserve is determined on a basis that reflects the length of time for which contracts have been in force and the projected
incidence of risk over the term of each contract.
Claims outstanding comprise those claims that have been notified and those that have been incurred but not reported. Claims incurred but not
reported are determined based on the historical emergence of claims and their average cost. The notified claims element represents the best
estimate of the cost of claims reported using projections and estimates based on historical experience.
The movements in non‑life insurance contract liabilities and reinsurance assets over the year have been as follows:
Provisions for unearned premiums
At 1 January 2010
Increase in the year
Release in the year
Change in provision for unearned premiums charged to income statement (note 8)
Exchange and other adjustments
At 31 December 2010
Increase in the year
Release in the year
Change in provision for unearned premiums charged to income statement (note 8)
Exchange and other adjustments
At 31 December 2011
Gross
£m
Reinsurance
£m
Net
£m
788
1,230
(1,386)
(156)
–
632
1,082
(1,152)
(70)
4
566
(31)
(104)
113
9
–
(22)
(52)
52
–
(1)
(23)
757
1,126
(1,273)
(147)
–
610
1,030
(1,100)
(70)
3
543
271
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 38: Liabilities arising from insurance contracts and participating investment contracts (continued)
These provisions represent the liability for short‑term insurance contracts for which the Group’s obligations are not expired at the year end.
Gross
£m
Reinsurance
£m
Claims outstanding
Notified claims
Incurred but not reported
At 1 January 2010
Cash paid for claims settled in the year
Increase (decrease) in liabilities:
Arising from current year claims
Arising from prior year claims
Change in liabilities charged to income statement (note 10)
At 31 December 2010
Cash paid for claims settled in the year
Increase (decrease) in liabilities:
Arising from current year claims
Arising from prior year claims
Change in liabilities charged to income statement (note 10)
Exchange and other adjustments
At 31 December 2011
Notified claims
Incurred but not reported
At 31 December 2011
Notified claims
Incurred but not reported
At 31 December 2010
289
213
502
(467)
581
(32)
82
584
(485)
470
(171)
(186)
(3)
395
313
82
395
420
164
584
(9)
(4)
(13)
11
(12)
(1)
(2)
(15)
–
–
12
12
1
(2)
(1)
(1)
(2)
(4)
(11)
(15)
Net
£m
280
209
489
(456)
569
(33)
80
569
(485)
470
(159)
(174)
(2)
393
312
81
393
416
153
569
272
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 38: Liabilities arising from insurance contracts and participating investment contracts (continued)
Non-life insurance claims development table
The development of insurance liabilities provides a measure of the Group’s ability to estimate the ultimate value of claims. The top half of the table
below illustrates how the Group’s estimate of total claims outstanding for each accident year shown has changed at successive year ends. The
bottom half of the table reconciles the cumulative claims to the amount appearing in the balance sheet. The accident year basis is considered the
most appropriate for the business written by the Group.
Non-life insurance all risks – gross
Accident year
Estimate of ultimate claims costs:
At end of accident year
One year later
Two years later
Three years later
Four years later
Five years later
Six years later
Current estimate in respect of above claims
Current estimate of claims relating to general
insurance business acquired in 2009
Current estimate of cumulative claims
Cumulative payments to date
Liability recognised in the balance sheet
Liability in respect of earlier years
Total liability included in the balance sheet
2005
£m
211
207
204
202
201
201
201
201
273
474
(470)
4
2006
£m
208
206
204
204
205
203
203
316
519
(514)
5
2007
£m
317
311
299
292
285
2008
£m
2009
£m
2010
£m
2011
£m
Total
£m
205
199
195
187
639
539
494
609
517
446
2,635
285
187
494
517
446
2,333
388
673
(668)
5
256
443
(432)
11
–
494
(463)
31
–
517
(443)
74
–
446
(195)
251
1,233
3,566
(3,185)
381
5
386
The liability of £386 million shown in the above table excludes £9 million of unallocated claims handling expenses.
273
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 39: Life insurance sensitivity analysis
The following table demonstrates the effect of changes in key assumptions on profit before tax and equity disclosed in these financial statements
assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated.
These amounts include movements in assets, liabilities and the value of the in‑force business in respect of insurance contracts and participating
investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
At 31 December 2011
Non‑annuitant mortality1
Annuitant mortality2
Lapse rates3
Future maintenance and investment expenses4
Risk‑free rate5
Guaranteed annuity option take up6
Equity investment volatility7
Widening of credit default spreads on corporate bonds8
Increase in illiquidity premia9
At 31 December 2010
Non‑annuitant mortality1
Annuitant mortality2
Lapse rates3
Future maintenance and investment expenses4
Risk‑free rate5
Guaranteed annuity option take up6
Equity investment volatility7
Widening of credit default spreads on corporate bonds8
Increase in illiquidity premia9
Increase
(reduction) in
profit before tax
£m
Increase
(reduction) in
equity
£m
Change in
variable
5% reduction
5% reduction
10% reduction
10% reduction
0.25% reduction
5% addition
1% addition
0.25% addition
0.10% addition
48
(154)
123
207
55
(4)
(9)
(164)
87
36
(115)
92
156
41
(3)
(7)
(123)
66
Increase
(reduction) in
profit before tax
£m
Increase
(reduction) in
equity
£m
Change in
variable
5% reduction
5% reduction
10% reduction
10% reduction
0.25% reduction
5% addition
1% addition
0.25% addition
0.10% addition
64
(131)
163
201
61
(4)
(8)
(152)
78
46
(96)
117
145
44
(3)
(6)
(110)
56
Assumptions have been flexed on the basis used to calculate the value of in‑force business and the realistic and statutory reserving bases.
This sensitivity shows the impact of reducing mortality and morbidity rates on non‑annuity business to 95 per cent of the expected rate.
This sensitivity shows the impact on the annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.
This sensitivity shows the impact of reducing maintenance expenses and investment expenses to 90 per cent of the expected rate.
This sensitivity shows the impact on the value of in‑force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk‑free rate by 25 basis points.
This sensitivity shows the impact of a flat 5 per cent addition to the expected rate.
This sensitivity shows the impact of a flat 1 per cent addition to the expected rate.
This sensitivity shows the impact of a 25 basis point increase in credit default spreads on corporate bonds and the corresponding reduction in market values. Government bond yields, the risk‑free
rate and illiquidity premia are all assumed to be unchanged.
This sensitivity shows the impact of a 10 basis point increase in the allowance for illiquidity premia. It assumes the overall corporate bond spreads are unchanged and hence market values are
unchanged. Government bond yields and the non‑annuity risk‑free rate are both assumed to be unchanged. The increased illiquidity premium increases the annuity risk‑free rate.
1
2
3
4
5
6
7
8
9
274
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 40: Liabilities arising from non-participating investment contracts
The movement in liabilities arising from non‑participating investment contracts may be analysed as follows:
At 1 January 2010
New business
Changes in existing business
Exchange and other adjustments
At 31 December 2010
New business
Changes in existing business
Exchange and other adjustments
At 31 December 2011
Gross
£m
46,348
3,953
1,070
(8)
51,363
4,194
(5,922)
1
49,636
Note 41: Unallocated surplus within insurance businesses
The movement in the unallocated surplus within long‑term insurance businesses over the year can be analysed as follows:
At 1 January
Change in unallocated surplus recognised in the income statement (note 10)
Exchange and other adjustments
At 31 December
Note 42: Other liabilities
Settlement balances
Unitholders’ interest in Open Ended Investment Companies
Other creditors and accruals
Total other liabilities
Reinsurance
£m
–
(65)
–
–
(65)
(3)
11
–
(57)
2011
£m
643
(340)
(3)
300
2011
£m
1,937
18,249
11,855
32,041
Net
£m
46,348
3,888
1,070
(8)
51,298
4,191
(5,911)
1
49,579
2010
£m
1,082
(439)
–
643
2010
£m
1,269
15,617
12,810
29,696
275
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 43: Retirement benefit obligations
Charge (credit) to the income statement
Defined benefit pension schemes1
Other post‑retirement benefit schemes
Total defined benefit schemes
Defined contribution pension schemes
Total charge (credit) to the income statement
2011
£m
186
13
199
202
401
2010
£m
(467)
12
(455)
173
(282)
2009
£m
529
7
536
208
744
1
In 2010, the amount is shown net of a credit of £910 million following the Group’s decision to cap all future increases to pensionable salary in its principal UK defined benefit pension schemes,
together with a change in commutation factors in certain schemes (note 11).
Amounts recognised in the balance sheet
Defined benefit pension schemes
Other post‑retirement benefit schemes
Total amounts recognised in the balance sheet
Amounts recognised in the balance sheet
Retirement benefit assets
Retirement benefit obligations
Total amounts recognised in the balance sheet
Pension schemes
2011
£m
1,131
(174)
957
2011
£m
1,338
(381)
957
2010
£m
479
(166)
313
2010
£m
736
(423)
313
Defined benefit schemes
The Group has established a number of defined benefit pension schemes in the UK and overseas, the three most significant being the defined
benefit sections of the Lloyds TSB Group Pension Schemes No’s 1 and 2 and the HBOS Final Salary Pension Scheme. These schemes provide
retirement benefits calculated as a percentage of final salary depending upon the length of service; the minimum retirement age under the rules of
the schemes at 31 December 2011 was generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
The latest full valuations of the two Lloyds TSB schemes were carried out as at 30 June 2008; the latest full valuation of the HBOS scheme was
carried out as at 31 December 2008. The results have been updated to 31 December 2011 by qualified independent actuaries. The last full
valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2011 by qualified
independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows.
The Group’s obligations in respect of its defined benefit schemes are funded. During 2009, the Group made one‑off contributions to the
Lloyds TSB Group Pension Scheme No 1 and Lloyds TSB Group Pension Scheme No 2 of approximately £1 billion in aggregate. These
contributions took the form of interests in limited liability partnerships for each of the two schemes which contained assets of approximately
£5 billion in aggregate entitling the schemes to annual payments of approximately £215 million in aggregate until 31 December 2014. Thereafter,
assuming that all distributions have been made, the value of the partnership interests will equate to a nominal amount. At 31 December 2011, the
limited liability partnerships held assets of approximately £4.7 billion; cash payments of £215 million were made to the pension schemes during
the year (2010: £215 million). The limited liability partnerships are fully consolidated in the Group’s balance sheet (see note 23).
The Group currently expects to pay contributions of approximately £650 million to its defined benefit schemes in 2012.
276
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 43: Retirement benefit obligations (continued)
Amount included in the balance sheet
Present value of funded obligations
Fair value of scheme assets
Unrecognised actuarial losses
Net amount recognised in the balance sheet
Movements in the defined benefit obligation
At 1 January
Current service cost
Employee contributions
Interest cost
Actuarial (losses) gains
Benefits paid
Past service cost
Curtailments
Settlements
Exchange and other adjustments
At 31 December
Changes in the fair value of scheme assets
At 1 January
Expected return
Employer contributions
Employee contributions
Actuarial gains
Benefits paid
Settlements
Exchange and other adjustments
At 31 December
Actual return on scheme assets
2011
£m
2010
£m
(28,236)
28,828
592
539
1,131
2011
£m
(26,862)
26,382
(480)
959
479
2010
£m
(26,862)
(27,073)
(380)
(1)
(1,423)
(514)
912
(20)
25
15
12
(384)
(4)
(1,474)
140
950
(46)
1,081
6
(58)
(28,236)
(26,862)
2011
£m
2010
£m
26,382
1,627
833
1
926
(912)
(23)
(6)
28,828
2,553
23,518
1,507
648
4
1,624
(950)
(9)
40
26,382
3,131
277
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 43: Retirement benefit obligations (continued)
Assumptions
The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows:
Discount rate
Rate of inflation:
Retail Prices Index
Consumer Price Index
Rate of salary increases
Rate of increase for pensions in payment
Life expectancy for member aged 60, on the valuation date:
Men
Women
Life expectancy for member aged 60, 15 years after the valuation date:
Men
Women
2011
%
5.00
3.00
2.00
2.00
2.80
Years
27.3
28.4
28.8
30.0
2010
%
5.50
3.40
2.90
2.00
3.20
Years
27.2
28.3
28.2
29.9
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.
Sensitivity analysis
The effect of changes in key assumptions on the pension charge in the Group’s income statement and on the net defined benefit pension scheme
asset or liability is set out below:
Inflation:1
Increase of 0.2 per cent
Decrease of 0.2 per cent
Discount rate:2
Increase of 0.2 per cent
Decrease of 0.2 per cent
Expected life expectancy of members:
Increase of one year
Decrease of one year
1
2
At 31 December 2011, the assumed rate of inflation is 3.00 per cent (31 December 2010: 3.40 per cent).
At 31 December 2011, the assumed discount rate is 5.00 per cent (31 December 2010: 5.50 per cent).
Increase (decrease) in the
income statement charge
Increase (decrease) in the
net defined benefit
pension scheme asset
2011
£m
12
(6)
(10)
17
38
(40)
2010
£m
14
(15)
(20)
15
40
(41)
2011
£m
(798)
783
909
(957)
(655)
667
2010
£m
(791)
754
930
(976)
(620)
632
278
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 43: Retirement benefit obligations (continued)
The expected return on scheme assets has been calculated using the following assumptions:
Equities and alternative assets
Fixed interest gilts
Index linked gilts
Non‑government bonds
Property
Money market instruments and cash
The expected return on scheme assets in 2012 will be calculated using the following assumptions:
Equities and alternative assets
Fixed interest gilts
Index linked gilts
Non‑government bonds
Property
Money market instruments and cash
Composition of scheme assets:
Equities
Fixed interest gilts
Index linked gilts
Non‑government bonds
Property
Money market instruments, cash and other assets and liabilities
At 31 December
2011
%
8.3
4.0
3.9
4.9
7.3
3.9
2011
£m
10,728
995
6,211
4,250
1,708
4,936
2010
%
8.3
4.5
4.1
6.0
7.5
4.3
2012
%
7.3
3.0
2.8
4.9
6.6
2.6
2010
£m
11,856
2,237
4,159
2,922
1,654
3,554
28,828
26,382
The assets of all the funded plans are held independently of the Group’s assets in separate trustee administered funds.
The expected return on plan assets was determined by considering the expected returns available on the assets underlying the current investment
policy. Expected yields on fixed interest investments are based on gross redemption yields at the balance sheet date at a term and credit rating
broadly appropriate for the bonds held. Expected returns on equity and property investments are long‑term rates based on the views of the
plan’s independent investment consultants. The expected return on equities allows for the different expected returns from the private equity,
infrastructure and hedge fund investments held by some of the funded plans. Some of the funded plans also invest in certain money market
instruments and the expected return on these investments has been assumed to be the same as cash.
Experience adjustments history:
Present value of defined benefit obligation
Fair value of scheme assets
Experience gains (losses) on scheme liabilities
Experience gains (losses) on scheme assets
2011
£m
(28,236)
28,828
592
(277)
926
2010
£m
(26,862)
26,382
(480)
496
1,624
2009
£m
(27,073)
23,518
(3,555)
31
886
2008
£m
(15,617)
13,693
(1,924)
(39)
(3,520)
2007
£m
(16,795)
16,112
(683)
(185)
139
2006
£m
(17,378)
15,279
(2,099)
(50)
314
279
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 43: Retirement benefit obligations (continued)
The expense recognised in the income statement for the year ended 31 December comprises:
Current service cost
Interest cost
Expected return on scheme assets
Net actuarial losses recognised in year
Curtailments (see below)
Settlements
Past service cost
Total defined benefit pension expense (credit)
2011
£m
380
1,423
(1,627)
7
(25)
8
20
186
2010
£m
384
1,474
(1,507)
43
(910)
3
46
(467)
2009
£m
395
1,383
(1,320)
–
–
4
67
529
In 2010 the Group made changes to the terms of its principal UK defined benefit pension schemes, all future increases to pensionable salary
will be capped each year at the lower of: Retail Prices Index inflation; each employee’s actual percentage increase in pay; and 2 per cent of
pensionable pay. In addition to this, during the second half of 2010 there was a change in the commutation factors in certain defined benefit
schemes. The combined effect of these changes was a reduction in the Group’s defined benefit obligation of £1,081 million and a reduction in
the Group’s unrecognised actuarial losses of £171 million, resulting in a net curtailment gain of £910 million recognised in the income statement
in 2010 and an equivalent reduction in the balance sheet liability.
Defined contribution schemes
The Group operates a number of defined contribution pension schemes in the UK and overseas, principally the defined contribution sections
of the Lloyds TSB Group Pension Schemes No’s 1 and 2.
During the year ended 31 December 2011 the charge to the income statement in respect of defined contribution schemes was £202 million
(2010: £173 million; 2009: £208 million), representing the contributions payable by the employer in accordance with each scheme’s rules.
Other post-retirement benefit schemes
The Group operates a number of schemes which provide post‑retirement healthcare benefits and concessionary mortgages to certain employees,
retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has
undertaken to meet the cost of post‑retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January
1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future
insurance premiums payable.
For the principal post‑retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 30 June 2008; this valuation has
been updated to 31 December 2011 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 6.61 per cent (2010: 7.54 per cent).
Amount included in the balance sheet:
Present value of unfunded obligations
Unrecognised actuarial losses
Retirement benefit obligation recognised in the balance sheet
Movements in the other post‑retirement benefits obligation:
At 1 January
Exchange and other adjustments
Insurance premiums paid
Charge for the year
At 31 December
2011
£m
(188)
14
(174)
2011
£m
(175)
(5)
5
(13)
(188)
2010
£m
(175)
9
(166)
2010
£m
(170)
2
5
(12)
(175)
280
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 44: Deferred tax
The movement in the net deferred tax balance is as follows:
Asset at 1 January
Exchange and other adjustments
Disposals
Income statement credit (charge) (note 16):
Due to change in UK corporation tax rate
Other
Amount (charged) credited to equity:
Available‑for‑sale financial assets (note 49)
Cash flow hedges (note 49)
Share‑based compensation
2011
£m
3,917
3
10
(404)
1,525
1,121
(574)
(270)
(25)
(869)
2010
£m
4,797
68
–
(137)
(534)
(671)
(330)
33
20
(277)
Asset at 31 December
4,182
3,917
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.
Statutory position
Deferred tax assets
Deferred tax liabilities
Asset at 31 December
2011
£m
4,496
(314)
4,182
2010
£m
4,164
(247)
3,917
Tax disclosure
Deferred tax assets
Deferred tax liabilities
Asset at 31 December
2011
£m
7,995
(3,813)
4,182
2010
£m
8,513
(4,596)
3,917
281
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 44: Deferred tax (continued)
The deferred tax credit (charge) in the income statement comprises the following temporary differences:
Accelerated capital allowances
Pensions and other post‑retirement benefits
Long‑term assurance business
Allowances for impairment losses
Trading losses
Tax on fair value of acquired assets
Other temporary differences
Deferred tax credit (charge) in the income statement
Deferred tax assets and liabilities are comprised as follows:
Deferred tax assets:
Pensions and other post‑retirement benefits
Allowances for impairment losses
Other provisions
Derivatives
Available‑for‑sale asset revaluation
Tax losses carried forward
Other temporary differences
Total deferred tax assets
Deferred tax liabilities:
Accelerated capital allowances
Long‑term assurance business
Pensions and other post‑retirement benefits
Tax on fair value of acquired assets
Effective interest rates
Other temporary differences
Total deferred tax liabilities
2011
£m
319
(153)
596
(56)
(55)
(107)
577
1,121
2010
£m
(470)
(391)
(110)
73
873
(715)
69
(671)
2011
£m
–
559
218
–
288
5,862
1,068
7,995
2011
£m
(243)
(980)
(120)
(1,890)
(45)
(535)
(3,813)
2009
£m
1,039
(199)
(188)
(128)
4,000
(2,022)
117
2,619
2010
£m
33
612
231
221
519
6,572
325
8,513
2010
£m
(562)
(1,630)
–
(2,097)
(74)
(233)
(4,596)
282
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 44: Deferred tax (continued)
On 23 March 2011, the Government announced that the corporation tax rate applicable from 1 April 2011 would be 26 per cent. This change
passed into legislation on 29 March 2011. In addition, the Finance Act 2011, which passed into law on 19 July 2011, included legislation to reduce
the main rate of corporation tax from 26 per cent to 25 per cent with effect from 1 April 2012. The change in the main rate of corporation tax from
27 per cent to 25 per cent has resulted in a reduction in the Group’s net deferred tax asset at 31 December 2011 of £394 million, comprising the
£404 million charge included in the income statement and a £10 million credit included in equity.
The proposed further reductions in the rate of corporation tax by 1 per cent per annum to 23 per cent by 1 April 2014 are expected to be
enacted separately each year. The effect of these further changes upon the Group’s deferred tax balances and leasing business cannot be reliably
estimated at this stage.
Deferred tax assets
Deferred tax assets are recognised for tax losses carried forward to the extent that the realisation of the related tax benefit through future taxable
profits is probable. Group companies have recognised deferred tax assets of £5,862 million (2010: £6,572 million) in relation to trading tax losses
carried forward. After reviews of medium‑term profit forecasts, the Group considers that there will be sufficient profits in the future against which
these losses will be offset (see note 3).
Deferred tax assets of £384 million (31 December 2010: £396 million) have not been recognised in respect of capital losses carried forward as there
are no predicted future capital profits. Capital losses can be carried forward indefinitely.
Deferred tax assets of £733 million (31 December 2010: £227 million) have not been recognised in respect of trading losses carried forward, mainly
in certain overseas companies and in respect of other temporary differences in the insurance businesses. Trading losses can be carried forward
indefinitely, except losses in Spain which expire after 18 years.
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.
Deferred tax liabilities
Scottish Widows plc has a taxable difference of £152 million (2010: £152 million) in respect of its holding of a life insurance subsidiary. No deferred
tax liability is required to be recognised in respect of this taxable temporary difference as Scottish Widows plc does not intend to dispose of this
subsidiary company.
Note 45: Other provisions
At 1 January 2011
Exchange and other adjustments
Provisions applied
(Release) charge for the year
At 31 December 2011
Provisions for
commitments
£m
Customer
remediation
provisions
£m
Customer
goodwill
payments
£m
Vacant
leasehold
property
£m
154
(14)
(4)
(55)
81
344
51
(1,280)
3,381
2,496
500
–
(497)
–
3
146
(21)
–
15
140
Other
£m
388
79
(56)
35
446
Total
£m
1,532
95
(1,837)
3,376
3,166
283
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 45: Other provisions (continued)
Provisions for commitments
Provisions are held in cases where the Group is irrevocably committed to advance additional funds, but where there is doubt as to the customer’s
ability to meet its repayment obligations.
Customer remediation provisions
Payment protection insurance
There has been extensive scrutiny of the Payment Protection Insurance (PPI) market in recent years.
In October 2010, the UK Competition Commission confirmed its decision to prohibit the active sale of PPI by a distributor to a customer within
seven days of a sale of credit. This followed the completion of its formal investigation into the supply of PPI services (other than store card PPI) to
non‑business customers in the UK in January 2009 and a referral of the proposed prohibition to the Competition Appeal Tribunal. The Competition
Commission consulted on the wording of a draft Order to implement its findings from October 2010, and published the final Order on 24 March
2011 which became effective on 6 April 2011. Following an earlier decision to stop selling single premium PPI products, the Group ceased to offer
PPI products to its customers in July 2010.
On 29 September 2009 the FSA announced that several firms had agreed to carry out reviews of past sales of single premium loan protection
insurance. Lloyds Banking Group agreed in principle that it would undertake a review in relation to sales of single premium loan protection
insurance made through its branch network since 1 July 2007. That review will now form part of the ongoing PPI work referred to below.
On 1 July 2008, the Financial Ombudsman Service (FOS) referred concerns regarding the handling of PPI complaints to the Financial Services
Authority (FSA) as an issue of wider implication. On 29 September 2009 and 9 March 2010, the FSA issued consultation papers on PPI complaints
handling. The FSA published its Policy Statement on 10 August 2010, setting out evidential provisions and guidance on the fair assessment
of a complaint and the calculation of redress, as well as a requirement for firms to reassess historically rejected complaints which had to be
implemented by 1 December 2010.
On 8 October 2010, the British Bankers’ Association (BBA), the principal trade association for the UK banking and financial services sector, filed an
application for permission to seek judicial review against the FSA and the FOS. The BBA sought an order quashing the FSA Policy Statement and
an order quashing the decision of the FOS to determine PPI sales in accordance with the guidance published on its website in November 2008.
The Judicial Review hearing was held in late January 2011 and on 20 April 2011 judgment was handed down by the High Court dismissing the
BBA’s application. On 9 May 2011, the BBA confirmed that the banks and the BBA did not intend to appeal the judgment.
After publication of the judgment, the Group entered into discussions with the FSA with a view to seeking clarity around the detailed
implementation of the Policy Statement. As a result, and given the initial analysis that the Group has conducted of compliance with applicable
sales standards, which is continuing, the Group has concluded that there are certain circumstances where customer contact and/or redress will
be appropriate. Accordingly the Group has made a provision in its financial statements for the year ended 31 December 2011 of £3,200 million
in respect of the anticipated costs of such contact and/or redress, including administration expenses. During 2011, the Group made redress
payments of £1,045 million to customers. The Group anticipates that all claims will have been settled by 2015. However, there are still a number of
uncertainties as to the eventual costs from any such contact and/or redress given the inherent difficulties of assessing the impact of the detailed
implementation of the Policy Statement for all PPI complaints, uncertainties around the ultimate emergence period for complaints, the availability
of supporting evidence and the activities of claims management companies, all of which will significantly affect complaints volumes, uphold rates
and redress costs.
Litigation in relation to insurance branch business in Germany
During the year ended 31 December 2011 the Group has recognised a provision of £175 million in respect of litigation involving Clerical Medical
Investment Group Limited in Germany. Further details are provided in note 54.
Other
The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales, in those cases
where the original sales processes have been found to be deficient. During 2011 management has again reviewed the adequacy of the provisions
held having regard to current complaint volumes and the level of payments being made. At 31 December 2011 the remaining such provisions held
relate to past sales of a number of products, including mortgage endowment policies, sold through the branch networks.
Customer goodwill payments
Following discussions with the FSA regarding the application of an interest rate variation clause in certain Bank of Scotland plc variable rate
mortgage contracts Bank of Scotland plc applied for a Voluntary Variation of Permission (VVOP) in February 2011 and agreed to initiate a customer
review and contact programme and to make goodwill payments to affected customers. The Group made a provision of £500 million within its 2010
accounts in respect of this matter. Since that time further information has become available which has resulted in Bank of Scotland plc applying
for, and being granted, an amended VVOP by the FSA in November 2011. No additional charge is required at this time.
284
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 45: Other provisions (continued)
Vacant leasehold property
Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub‑let income, compared to the head rent,
and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are
reassessed on a biannual basis and will normally run off over the period of under‑recovery of the leases concerned, currently averaging three years;
where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
Other
Provisions are made for staff and other costs related to Group restructuring initiatives at the point at which the Group becomes irrevocably
committed to the expenditure.
Other provisions include those arising out of the insolvency of a third party insurer, which remains exposed to asbestos and pollution claims in
the US. The ultimate cost and timing of payments are uncertain. The provision held of £38 million at 31 December 2011 represents management's
current best estimate of the cost after having regard to actuarial estimates of future losses.
Note 46: Subordinated liabilities
Preference shares
Preferred securities
Undated subordinated liabilities
Enhanced Capital Notes
Dated subordinated liabilities
Total subordinated liabilities
2011
£m
1,216
4,893
1,949
9,085
17,946
35,089
2010
£m
1,165
4,538
2,002
9,235
19,292
36,232
These securities will, in the event of the winding‑up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer,
other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination
of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference
shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims
of holders of the dated subordinated liabilities. The subordination of the dated Enhanced Capital Notes ranks equally with that of the dated
subordinated liabilities. The Group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities
during the year (2010: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity
without the consent of the Financial Services Authority.
285
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 46: Subordinated liabilities (continued)
The movement in subordinated liabilities during the year was as follows:
At 1 January 2011
Issued during the year
Repurchases and redemptions during the year
Foreign exchange and other movements
At 31 December 2011
£m
36,232
2,302
(4,021)
576
35,089
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 December 2012. This exchange resulted in a gain on the 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.
Preference shares
6% Non‑cumulative Redeemable Preference Shares
7.875% Non‑cumulative Preference Shares callable 2013 (US$1,250 million)
7.875% Non‑cumulative Preference Shares callable 2013 (e500 million)
6.0884% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2015 (£745 million)
5.92% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2015 (US$750 million)
6.267% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2016 (US$1,000 million)
6.3673% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2019 (£335 million)
6.475% Non‑cumulative Preference Shares callable 2024 (£186 million)
6.413% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2035 (US$750 million)
6.657% Non‑cumulative Fixed to Floating Rate Preference Shares callable 2037 (US$750 million)
9.25% Non‑cumulative Irredeemable Preference Shares (£300 million)
9.75% Non‑cumulative Irredeemable Preference Shares (£100 million)
Total preference shares
Note
a
b
b
b
b
b
b
b
b
b
b
b
2011
£m
–
249
150
10
11
301
2
38
131
26
262
36
2010
£m
–
277
182
9
9
269
2
34
113
5
235
30
1,216
1,165
a Since 2004, the Company has had in issue 400 6 per cent non‑cumulative preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the
rights to a fixed rate non‑cumulative preferential dividend of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not
be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company. The holder of the 400 25p 6 per cent preference
shares has waived its right to payment for the period from 1 March 2010 to 1 March 2012.
b In November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to
31 January 2012.
286
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 46: Subordinated liabilities (continued)
Preferred securities
6.90% Perpetual Capital Securities (US$1,000 million)
6.85% Non‑cumulative Perpetual Preferred Securities (US$1,000 million)
8.117% Non‑cumulative Perpetual Preferred Securities (Class A) (£250 million)
7.627% Fixed to Floating Rate Guaranteed Non‑voting Non‑cumulative Preferred Securities
(e415 million)
7.375% Euro Step‑up Non‑voting Non‑cumulative Preferred Securities callable 2012 (e430 million)
6.35% Step‑up Perpetual Capital Securities callable 2013 (e500 million)
6.071% Non‑cumulative Perpetual Preferred Securities (US$750 million)
7.834% Sterling Step‑up Non‑voting Non‑cumulative Preferred Securities callable 2015
(£250 million)
4.939% Non‑voting Non‑cumulative Perpetual Preferred Securities (e750 million)
7.286% Perpetual Regulatory Tier One Securities (Series A) (£150 million)
4.385% Step‑up Perpetual Capital Securities callable 2017 (e750 million)
6.461% Guaranteed Non‑voting Non‑cumulative Perpetual Preferred Securities (£600 million)
13% Step‑up Perpetual Capital Securities callable 2019 (£785 million)
13% Step‑up Perpetual Capital Securities callable 2019 (e532 million)
7.754% Non‑cumulative Perpetual Preferred Securities (Class B) (£150 million)
12% Fixed to Floating Rate Perpetual Tier 1 Capital Securities callable 2024 (US$2,000 million)
7.281% Perpetual Regulatory Tier One Securities (Series B) (£150 million)
13% Step‑up Perpetual Capital Securities callable 2029 (£700 million)
7.881% Guaranteed Non‑voting Non‑cumulative Preferred Securities (£245 million)
Total preferred securities
Note
b
b
b, c
b, d
a
a
a
a
a
a
a
2011
£m
247
316
260
340
16
239
389
5
20
112
88
444
12
47
104
1,301
113
612
228
4,893
2010
£m
249
107
253
308
16
241
336
4
17
119
85
421
10
56
98
1,288
95
662
173
4,538
a In November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from
31 January 2010 to 31 January 2012.
b These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the FSA. In November 2009, as part of the state aid restructuring
plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012.
c The fixed rate on this security was reset from 8.117 per cent to 6.059 per cent with effect from 31 May 2010.
d The fixed rate on this security was reset from 7.627 per cent to 3 months Euribor plus 2.875 per cent with effect from 9 December 2011.
287
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 46: Subordinated liabilities (continued)
Undated subordinated liabilities
6.625% Undated Subordinated Step‑up Notes (£410 million)
Floating Rate Undated Subordinated Step‑up Notes (e300 million)
6.05% Fixed to Floating Rate Undated Subordinated Notes (e500 million)
5.375% Undated Fixed to Floating Rate Subordinated Notes (US$1,000 million)
8.625% Perpetual Subordinated Notes (£200 million)
4.875% Undated Subordinated Fixed to Floating Rate Instruments (e750 million)
Floating Rate Undated Subordinated Notes (e500 million)
4.25% Perpetual Fixed to Floating Rate Reset Subordinated Guaranteed Notes (e750 million)
(Clerical Medical Finance plc)
10.25% Subordinated Undated Instruments (£100 million)
5.125% Step‑up Perpetual Subordinated Notes callable 2015 (£560 million) (Scottish Widows plc)
5.125% Undated Subordinated Fixed to Floating Notes (e750 million)
7.5% Undated Subordinated Step‑up Notes (£300 million)
5.125% Undated Subordinated Step‑up Notes callable 2016 (£500 million)
6.5% Undated Subordinated Step‑up Notes callable 2019 (£270 million)
7.375% Undated Subordinated Guaranteed Bonds (£200 million) (Clerical Medical Finance plc)
5.625% Cumulative Callable Fixed to Floating Rate Undated Subordinated Notes callable 2019
(£500 million)
12% Perpetual Subordinated Bonds (£100 million)
5.75% Undated Subordinated Step‑up Notes (£600 million)
7.375% Subordinated Undated Instruments (£150 million)
8.75% Perpetual Subordinated Bonds (£100 million)
8% Undated Subordinated Step‑up Notes callable 2023 (£200 million)
9.375% Perpetual Subordinated Bonds (£50 million)
5.75% Undated Subordinated Step‑up Notes (£500 million)
6.5% Undated Subordinated Step‑up Notes callable 2029 (£450 million)
6% Undated Subordinated Step‑up Guaranteed Bonds callable 2032 (£500 million)
Floating Rate Primary Capital Notes (US$250 million)
Primary Capital Undated Floating Rate Notes:
Series 1 (US$750 million)
Series 2 (US$500 million)
Series 3 (US$600 million)
13.625% Perpetual Subordinated Bonds (£75 million)
11.75% Perpetual Subordinated Bonds (£100 million)
Total undated subordinated liabilities
Note
a, b, c
b, e
b, d, e
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a, b
a, b
a, b
a, b
a
2011
£m
1
10
4
12
24
75
45
231
1
554
52
5
2
–
36
–
30
3
–
4
–
17
3
–
11
118
175
183
235
16
102
2010
£m
6
63
57
12
21
65
42
215
1
550
47
3
–
1
35
–
21
3
1
4
–
16
3
–
10
118
173
181
232
20
102
1,949
2,002
a In November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from 31 January 2010 to
31 January 2012.
b These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the FSA. In November 2009, as part of the state aid restructuring
plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012.
c The fixed rate on this security was reset from 6.625 per cent to 4.64821 per cent with effect from 15 July 2010.
d The fixed rate on this security was reset from 6.05 per cent to 3 month Euribor plus 2.25 per cent with effect from 23 November 2011.
e Following an exchange, on 1 December 2011, certain holders elected to exchange some or all of the notes they held for dated subordinated liabilities issued by Lloyds TSB Bank plc.
288
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 46: Subordinated liabilities (continued)
With the exception of the two series identified in note b, the ECNs were issued in lower tier 2 format and are convertible into ordinary shares on
the breach of a defined trigger. The trigger on the ECNs offered in the exchange will be if the published core tier 1 ratio of the Group falls below
5 per cent (as defined by the Financial Services Authority in May 2009).
Enhanced Capital Notes
7.625% Enhanced Capital Notes due 2019 (£151 million)
8.125% Enhanced Capital Notes due 2019 (£4 million)
9% Enhanced Capital Notes due 2019 (£97 million)
7.8673% Enhanced Capital Notes due 2019 (£331 million)
15% Enhanced Capital Notes due 2019 (£775 million)
15% Enhanced Capital Notes due 2019 (e487 million)
8.875% Enhanced Capital Notes due 2020 (e125 million)
9.334% Enhanced Capital Notes due 2020 (£208 million)
7.375% Enhanced Capital Notes due 2020 (e95 million)
Floating Rate Enhanced Capital Notes due 2020 (e53 million)
7.875% Enhanced Capital Notes due 2020 (US$408 million)
11.04% Enhanced Capital Notes due 2020 (£736 million)
7.5884% Enhanced Capital Notes due 2020 (£732 million)
6.385% Enhanced Capital Notes due 2020 (e662 million)
6.439% Enhanced Capital Notes due 2020 (e711 million)
8% Fixed to Floating Rate Undated Enhanced Capital Notes callable 2020 (US$1,259 million)
9.125% Enhanced Capital Notes due 2020 (£148 million)
12.75% Enhanced Capital Notes due 2020 (£57 million)
7.869% Enhanced Capital Notes due 2020 (£597 million)
7.625% Enhanced Capital Notes due 2020 (e226 million)
7.875% Enhanced Capital Notes due 2020 (US$986 million)
11.125% Enhanced Capital Notes due 2020 (£39 million)
8.5% Undated Enhanced Capital Notes callable 2021 (US$277 million)
14.5% Enhanced Capital Notes due 2022 (£79 million)
9.875% Enhanced Capital Notes due 2023 (£57 million)
11.25% Enhanced Capital Notes due 2023 (£95 million)
10.5% Enhanced Capital Notes due 2023 (£69 million)
11.875% Enhanced Capital Notes due 2024 (£35 million)
7.975% Enhanced Capital Notes due 2024 (£102 million)
16.125% Enhanced Capital Notes due 2024 (£61 million)
15% Enhanced Capital Notes due 2029 (£68 million)
9% Enhanced Capital Notes due 2029 (£107 million)
8.5% Enhanced Capital Notes due 2032 (£104 million)
Total Enhanced Capital Notes
a Interest is payable quarterly in arrears at a rate of 3 month EURIBOR plus 3.1 per cent per annum.
b Issued in upper tier 2 format.
Note
a
b
b
2011
£m
142
4
98
330
1,120
601
107
232
79
38
313
861
681
503
548
687
157
73
588
184
629
44
153
114
63
106
67
45
96
97
108
112
105
2010
£m
142
4
103
336
1,145
635
116
233
82
41
288
872
694
525
562
674
158
75
589
189
631
45
150
115
67
115
79
45
98
99
111
112
105
9,085
9,235
289
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note
a
b, c
b, c
b, c
b, c
b, c
c
c
c
c
c
c
d
d
d
d
d
Note 46: Subordinated liabilities (continued)
Dated subordinated liabilities
9.125% Subordinated Bonds 2011 (£150 million)
12% Guaranteed Subordinated Bonds 2011 (£100 million)
6.50% Notes 2011 (US$150 million)
4.75% Subordinated Notes 2011 (e850 million)
Subordinated Step‑up Floating Rate Notes 2016 (e500 million)
Subordinated Step‑up Floating Rate Notes 2016 (£300 million)
Callable Floating Rate Subordinated Notes 2016 (e500 million)
Callable Floating Rate Subordinated Notes 2016 (e500 million)
Subordinated Callable Notes 2016 (US$750 million)
Subordinated Callable Notes 2017 callable 2012 (e1,000 million)
6.75% Subordinated Callable Fixed to Floating Rate Instruments 2017 callable 2012 (Aus$200 million)
Subordinated Callable Floating Rate Instruments 2017 callable 2012 (Aus$400 million)
5.109% Callable Fixed to Floating Rate Notes 2017 callable 2012 (Can$500 million)
6.25% Instruments 2012 (e12.8 million)
Subordinated Callable Notes 2017 callable 2012 (US$1,000 million)
6.305% Subordinated Callable Fixed to Floating Rate Notes 2017 callable 2012 (£500 million)
5.50% Subordinated Fixed Rate Notes 2012 (e750 million)
6.125% Notes 2013 (e325 million)
5.625% Subordinated Fixed to Floating Rate Notes due 2018 callable 2013 (e1,000 million)
4.25% Subordinated Guaranteed Notes 2013 (US$1,000 million)
6.45% Fixed to Floating Subordinated Guaranteed Bonds 2023 (e400 million) (Clerical Medical Finance plc)
11% Subordinated Bonds 2014 (£250 million)
5.875% Subordinated Notes 2014 (£150 million)
5.875% Subordinated Guaranteed Bonds 2014 (e750 million)
4.375% Callable Fixed to Floating Rate Subordinated Notes 2019 (e750 million)
4.875% Subordinated Notes 2015 (e1,000 million)
6.625% Subordinated Notes 2015 (£350 million)
6.9625% Callable Subordinated Fixed to Floating Rate Notes 2020 callable 2015 (£750 million)
11.875% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (e1,147 million)
10.75% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (£466 million)
9.875% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (US$568 million)
10.125% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (Can$387 million)
13% Subordinated Fixed to Fixed Rate Notes 2021 callable 2016 (Aus$417 million)
10.5% Subordinated Bonds 2018 (£150 million)
6.75% Subordinated Fixed Rate Notes 2018 (US$2,000 million)
6.375% Subordinated Instruments 2019 (£250 million)
6.5% Dated Subordinated Notes 2020 (e1,500 million)
7.375% Dated Subordinated Notes 2020
5.75% Subordinated Fixed to Floating Rate Notes 2025 callable 2020 (£350 million)
6.5% Subordinated Fixed Rate Notes 2020 (US$2,000 million)
Subordinated Floating Rate Notes 2020 (e100 million)
9.375% Subordinated Bonds 2021 (£500 million)
5.374% Subordinated Fixed Rate Notes 2021 (e160 million)
9.625% Subordinated Bonds 2023 (£300 million)
7.07% Subordinated Fixed Rate Notes 2023 (e175 million)
4.50% Fixed Rate Step‑up Subordinated Notes due 2030 (e750 million)
7.625% Dated Subordinated Notes 2025 (£750 million)
6% Subordinated Notes 2033 (US$750 million)
Total dated subordinated liabilities
2011
£m
–
–
–
–
179
184
88
124
191
219
5
38
8
8
192
22
640
283
902
636
176
290
154
713
621
854
357
725
977
467
368
246
276
177
1,205
274
1,407
3
367
1,360
87
709
150
319
174
463
876
432
17,946
20010
£m
147
109
99
764
432
296
401
417
440
758
127
255
305
10
548
486
657
289
946
619
173
297
149
739
600
838
343
715
–
–
–
–
–
171
1,176
236
1,353
4
324
1,202
86
647
139
332
162
463
763
275
19,292
a Issued by a group undertaking under the Company’s subordinated guarantee.
b These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval of the FSA. In November 2009, as part of the state aid restructuring
plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012. The interest rate payable on these securities reset
during 2011.
c Following an exchange, on 1 December 2011, certain holders elected to exchange some or all of the notes they held for new dated subordinated liabilities issued by Lloyds TSB Bank plc.
d These securities were issued in December 2011 as a result of an exchange offer.
290
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 47: Share capital
(1) Authorised share capital
As permitted by the Companies Act 2006, the Company removed references to authorised share capital from its articles of association at the
annual general meeting on 5 June 2009. This change took effect from 1 October 2009.
(2) Issued and fully paid share capital
2011
Number of shares
2010
Number of shares
2009
Number of shares
2011
£m
2010
£m
2009
£m
Ordinary shares of 10p
(formerly 25p) each
At 1 January
68,074,129,454
63,774,511,536
5,972,855,669
6,807
6,378
1,493
Issued on redemption of preference
shares and other subordinated
liabilities in 2010
Placing and open offer
Issued on acquisition of HBOS
Capitalisation issue
Placing and compensatory
open offer
Subdivision
Rights issue
Issued to the Lloyds TSB
Foundations
Issued under employee share
schemes
–
–
–
–
–
–
–
–
4,299,422,579
–
–
–
–
–
–
–
–
2,596,653,203
7,775,694,993
407,943,501
10,408,535,000
–
36,505,088,579
107,740,591
652,497,658
195,339
–
At 31 December
68,726,627,112
68,074,129,454
63,774,511,536
Limited voting ordinary shares
of 10p (formerly 25p) each
At 1 January
Capitalisation issue
Subdivision
At 31 December
Deferred shares of 15p each
At 1 January
Subdivision of ordinary shares
Subdivision of limited voting
ordinary shares
Cancellation of deferred shares
At 31 December
Total issued share capital
80,921,051
80,921,051
–
–
–
–
78,947,368
1,973,683
–
80,921,051
80,921,051
80,921,051
–
–
–
–
–
27,242,603,417
–
–
–
(27,242,603,417)
27,161,682,366
80,921,051
–
–
27,242,603,417
–
–
–
–
–
–
–
–
66
6,873
8
–
–
8
–
–
–
–
–
6,881
429
–
–
–
–
–
–
–
–
–
649
1,944
102
2,602
(4,074)
3,651
11
–
6,807
6,378
8
–
–
8
4,086
–
–
(4,086)
–
6,815
20
–
(12)
8
–
4,074
12
–
4,086
10,472
On 5 November 2010 the Company cancelled all of its deferred shares and an amount of £4,086 million was credited to the capital redemption
reserve.
Share subdivision in 2009
At the general meeting held on 26 November 2009 the Company’s shareholders approved the subdivision of the ordinary shares with each
ordinary share of 25 pence subdivided into one ordinary share of 10 pence and a deferred share of 15 pence. In addition, the shareholders
approved the subdivision of the limited voting ordinary shares with each share of 25 pence subdivided into one limited voting ordinary share of
10 pence and a deferred share of 15 pence.
291
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 47: Share capital (continued)
Share issuances
The shares issued in 2011 were in respect of employee share schemes.
On 18 February 2010, the Company issued 3,141 million ordinary shares as consideration for the redemption of certain preference shares and
preferred securities. During May and June 2010, the Company issued a further 1,158 million ordinary shares in relation to three separate exchanges
for preference shares and other subordinated liabilities issued by the Group.
(3) Share capital and control
There are no restrictions on the transfer of shares in the Company other than as set out in the articles of association and:
– certain restrictions which may from time to time be imposed by law and regulations (for example, insider trading laws);
– pursuant to the UK Listing Authority’s listing rules where directors and certain employees of the Company require the approval of the Company
to deal in the Company’s shares; and
– pursuant to the rules of some of the Company’s employee share plans where certain restrictions may apply while the shares are subject to the
plans.
Where, under an employee share plan operated by the Company, participants are the beneficial owners of shares but not the registered owners,
the voting rights are normally exercised by the registered owner at the direction of the participant. Outstanding awards and options would
normally vest and become exercisable on a change of control, subject to the satisfaction of any performance conditions at that time.
In addition, the Company is not aware of any agreements between shareholders that may result in restrictions on the transfer of securities and/or
voting rights.
Information regarding significant direct or indirect holdings of shares in the Company can be found on page 175.
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares
as granted at the annual general meeting on 18 May 2011. The authority to issue shares and the authority to make market purchases of shares will
expire at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
Subject to any rights or restrictions attached to any shares, on a show of hands at a general meeting of the Company every holder of shares
present in person or by proxy and entitled to vote has one vote and on a poll every member present and entitled to vote has one vote for every
share held.
Further details regarding voting at the annual general meeting can be found in the notes to the notice of the annual general meeting.
Ordinary shares
The holders of ordinary shares (excluding the limited voting ordinary shares), who held 99.9 per cent of the total ordinary share capital as at
31 December 2011, are entitled to receive the Company’s report and accounts, attend, speak and vote at general meetings and appoint proxies
to exercise voting rights. Holders of ordinary shares (excluding the limited voting ordinary shares) may also receive a dividend (subject to the
provisions of the Company’s articles of association and the restrictions noted below) and on a winding up may share in the assets of the Company.
292
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 47: Share capital (continued)
In November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received by the Group,
the Group agreed to suspend the payment of coupons and dividends on certain of the Group’s preference shares and preferred securities for the
two‑year period from 31 January 2010 to 31 January 2012. Consequently, the terms of these instruments prevented the Company from making
dividend payments on ordinary shares during the year.
Limited voting ordinary shares
The limited voting ordinary shares are held by the Lloyds TSB Foundations (the Foundations). The holders of the limited voting ordinary shares,
who held 0.1 per cent of the total ordinary share capital as at 31 December 2011, are entitled to receive copies of every circular or other document
sent out by the Company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary
shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other
than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the
Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued
ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary
shares in all respects from the date of conversion.
Preference shares
The Company has in issue various classes of preference shares which are all classified as liabilities under IFRS and details of which are shown in
note 46.
Note 48: Share premium account
At 1 January
Issued under employee share schemes
Shares issued on redemption and exchange of preference shares
and other subordinated liabilities1
Capitalisation issue
Placing and Compensatory Open Offer of ordinary shares
Transfer to merger reserve2
Rights issue
Issued to Lloyds TSB Foundations
Redemption of preference shares3
At 31 December
2011
£m
16,291
250
–
–
–
–
–
–
–
16,541
2010
£m
14,472
–
1,808
–
–
–
–
–
11
16,291
2009
£m
2,096
–
–
(102)
1,303
(1,000)
9,461
30
2,684
14,472
1
2
3
On 18 February 2010, the Company issued 3,141 million ordinary shares as consideration for the redemption of certain preference shares and preferred securities; and during May and June 2010,
the Company issued a further 1,158 million ordinary shares in relation to three separate exchanges for preference shares and other subordinated liabilities issued by the Group. A total share
premium of £1,808 million was recorded in respect of these transactions.
Distributable reserves of £1,000 million arose on the issue of preference shares in January 2009 which were classified as debt. In June 2009, these preference shares were redeemed out of the
proceeds of the placing and compensatory open offer of ordinary shares and the distributable element of this issue was transferred from the share premium account to the merger reserve.
In January 2010, the Company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital
redemption reserve and a transfer of £11 million from the merger reserve to the share premium account. In December 2009, the Group redeemed eight issues of preference shares in exchange for
the issuance of Enhanced Capital Notes. This resulted in a transfer of £26 million from the merger reserve to the capital redemption reserve and a transfer of £2,684 million from the merger reserve
to the share premium account.
293
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 49: Other reserves
Other reserves comprise:
Merger reserve
Capital redemption reserve
Revaluation reserve in respect of available‑for‑sale financial assets
Cash flow hedging reserve
Foreign currency translation reserve
At 31 December
2011
£m
8,107
4,115
1,326
325
(55)
2010
£m
8,107
4,115
(285)
(391)
29
2009
£m
8,121
26
(783)
(305)
158
13,818
11,575
7,217
The merger reserve primarily comprises the premium on shares issued on 13 January 2009 under the placing and open offer and shares issued on
16 January 2009 on the acquisition of HBOS plc.
The capital redemption reserve represents transfers from the merger reserve in accordance with companies’ legislation and amounts transferred
from share capital following the cancellation of the deferred shares.
The revaluation reserve in respect of available‑for‑sale financial assets represents the cumulative after tax unrealised change in the fair value of
financial assets classified as available‑for‑sale since initial recognition, or in the case of available‑for‑sale financial assets obtained on acquisitions
of businesses, since the date of acquisition.
The cash flow hedging reserve represents the cumulative after tax gains and losses on effective cash flow hedging instruments that will be
reclassified to the income statement in the periods in which the hedged item affects profit or loss.
The foreign currency translation reserve represents the cumulative after‑tax gains and losses on the translation of foreign operations and exchange
differences arising on financial instruments designated as hedges of the Group’s net investment in foreign operations.
Movements in other reserves were as follows:
Merger reserve
At 1 January
Placing and open offer
Shares issued on acquisition of HBOS
Issue of preference shares1
Redemption of preference shares2
At 31 December
Capital redemption reserve
At 1 January
Cancellation of deferred shares (note 47)
Redemption of preference shares2
At 31 December
2011
£m
2010
£m
8,107
8,121
–
–
–
–
8,107
2011
£m
4,115
–
–
4,115
–
–
–
(14)
8,107
2010
£m
26
4,086
3
4,115
2009
£m
343
3,781
5,707
1,000
(2,710)
8,121
2009
£m
–
–
26
26
1
2
Distributable reserves of £1,000 million arose on the issue of preference shares in January 2009 which were classified as debt. In June 2009, these preference shares were redeemed out of the
proceeds of the placing and compensatory open offer of ordinary shares and the distributable element of this issue was transferred to the merger reserve.
In January 2010, the Company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital
redemption reserve and a transfer of £11 million from the merger reserve to the share premium account. Details of the preference shares repurchased are set out in note 46. In December 2009,
the Group redeemed eight issues of preference shares in exchange for the issuance of Enhanced Capital Notes. This resulted in a transfer of £26 million from the merger reserve to the capital
redemption reserve and a transfer of £2,684 million from the merger reserve to the share premium account.
294
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 49: Other reserves (continued)
Revaluation reserve in respect of available-for-sale financial assets
At 1 January
Change in fair value of available‑for‑sale financial assets
Change in fair value attributable to non‑controlling interests
Deferred tax
Current tax
Income statement transfers:
Disposals (note 9)
Deferred tax
Impairment
Deferred tax
Other transfers
Deferred tax
At 31 December
Cash flow hedging reserve
At 1 January
Change in fair value of hedging derivatives
Deferred tax
Current tax
Income statement transfer (note 5)
Deferred tax
At 31 December
Foreign currency translation reserve
At 1 January
Currency translation differences arising in the year
Foreign currency losses on net investment hedges
Current tax
Deferred tax
At 31 December
2011
£m
(285)
2,603
–
(673)
–
1,930
(343)
30
(313)
80
29
109
(155)
40
(115)
1,326
2011
£m
(391)
916
(257)
–
659
70
(13)
57
325
2011
£m
29
(58)
(26)
–
–
(26)
(55)
2010
£m
(783)
1,231
–
(460)
(8)
763
(399)
106
(293)
114
(5)
109
(110)
29
(81)
(285)
2010
£m
(305)
(1,048)
272
(3)
(779)
932
(239)
693
(391)
2010
£m
158
33
(162)
–
–
(162)
29
2009
£m
(2,851)
2,035
(1)
(276)
(2)
1,756
(97)
23
(74)
621
(168)
453
(93)
26
(67)
(783)
2009
£m
(15)
(530)
148
–
(382)
121
(29)
92
(305)
2009
£m
178
(652)
814
176
(358)
632
158
295
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 50: Retained profits
At 1 January
(Loss) profit for the year
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
At 31 December
2011
£m
11,380
(2,787)
(276)
125
238
2010
£m
11,117
(320)
20
154
409
2009
£m
8,129
2,827
10
116
35
8,680
11,380
11,117
Retained profits are stated after deducting £33 million (2010: £47 million; 2009: £48 million) representing 58 million (2010 and 2009: 49 million)
treasury shares held.
Note 51: Ordinary dividends
No dividends were paid on ordinary shares during 2010 or 2011 and the directors do not propose to pay a final dividend in respect of 2011; in
November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received by the Group,
the Group agreed to suspend the payment of coupons and dividends on certain of the Group’s preference shares and preferred securities, for the
two year period from 31 January 2010 to 31 January 2012. Consequently, the terms of these instruments prevented the Company from making
dividend payments on ordinary shares during the year.
In addition, the trustees of the following holdings of Lloyds Banking Group plc shares in relation to employee share schemes retain the right to
receive dividends but chose to waive their entitlement to the dividends on those shares as indicated: the Lloyds Banking Group Share Incentive
Plan (holding at 31 December 2011: 8,091,460 shares, at 31 December 2010: 5,744,722 shares, waived right to all dividends), the Lloyds TSB Group
Employee Share Ownership Trust (holding at 31 December 2011: 120,085,543 shares, at 31 December 2010: 283,109,984 shares, on which it waived
right to all dividends and holding at 31 December 2011: 253,052 shares, at 31 December 2010: nil shares, on which it waived right to all but a
nominal amount of one penny in total), Lloyds TSB Group Holdings (Jersey) Limited (holding at 31 December 2011: 42,846 shares, at 31 December
2010: 42,846 shares, waived right to all but a nominal amount of one penny in total) and the Lloyds TSB Qualifying Employee Share Ownership
Trust (holding at 31 December 2011: 1,398 shares, at 31 December 2010: 1,398 shares, waived right to all but a nominal amount of one penny in
total).
Note 52: Share-based payments
Charge to the income statement
The charge to the income statement is set out below:
Deferred bonus plan
Executive and SAYE plans:
Options granted in the year
Options granted in prior years
Share plans:
Shares granted in the year
Shares granted in prior years
Total charge to the income statement
2011
£m
221
13
130
143
3
9
12
376
2010
£m
355
59
75
134
3
49
52
541
2009
£m
18
13
98
111
26
102
128
257
296
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Share-based payments (continued)
During the year ended 31 December 2011 the Group operated the following share‑based payment schemes, all of which are equity settled.
Deferred bonus plans
Bonuses in respect of the performance in 2011 of employees within certain of the Group’s bonus plans have been recognised in these financial
statements in full. The amounts to be settled in shares are included within the total charge to the income statement detailed above.
Lloyds Banking Group executive share option schemes
The executive share option schemes were long‑term incentive schemes available to certain senior executives of the Group, with grants usually
made annually. Options were granted within limits set by the rules of the schemes relating to the number of shares under option and the
price payable on the exercise of options. The last grant of executive options was made in August 2005. These options were granted without a
performance multiplier and the maximum limit for the grant of options in normal circumstances was three times annual salary. Between April 2001
and August 2004, the aggregate value of the award based upon the market price at the date of grant could not exceed four times the executive’s
annual remuneration and, normally, the limit for the grant of options to an executive in any one year would be equal to 1.5 times annual salary
with a maximum performance multiplier of 3.5. Prior to 18 April 2001, the normal limit was equal to one year’s remuneration and no performance
multiplier was applied.
Performance conditions for executive options
For options granted up to March 2001
The performance condition was that growth in earnings per share must be equal to the aggregate percentage change in the Retail Prices Index
plus three percentage points for each complete year of the relevant period together with a further condition that Lloyds Banking Group plc’s
ranking based on total shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be
in the top fifty companies of the FTSE 100.
The relevant period for the performance conditions began at the end of the financial year preceding the date of grant and continued until the
end of the third subsequent year following commencement or, if not met, the end of such later year in which the conditions were met. Once the
conditions were satisfied the options remained exercisable without further conditions. If they were not satisfied by the tenth anniversary of the
grant the options would lapse.
For options granted from August 2001 to August 2004
The performance condition was linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both
dividends and growth in share price) against a comparator group of 17 companies including Lloyds Banking Group plc.
The performance condition was measured over a three year period which commenced at the end of the financial year preceding the grant of the
option and continued until the end of the third subsequent year. If the performance condition was not then met, it was measured at the end of the
fourth financial year. If the condition was not then met, the options would lapse.
To meet the performance conditions, the Group’s ranking against the comparator group was required to be at least ninth. The full grant of options
only became exercisable if the Group was ranked first. A performance multiplier (of between nil and 100 per cent) was applied below this level to
calculate the number of shares in respect of which options granted to Executive Directors would become exercisable, and were calculated on a
sliding scale. If Lloyds Banking Group plc was ranked below median the options would not be exercisable.
Options granted to senior executives other than Executive Directors were not so highly leveraged and, as a result, different performance
multipliers were applied to their options. For the majority of executives, options were granted with the performance condition but with no
performance multiplier.
Options granted in 2004 became exercisable as the performance condition was met on the re‑test. The performance condition vested at
14 per cent for Executive Directors, 24 per cent for Managing Directors, and 100 per cent for all other executives.
For options granted in 2005
The same conditions applied as for grants made up to August 2004, except that:
– the performance condition was linked to the performance of Lloyds Banking Group plc’s total shareholder return (calculated by reference to both
dividends and growth in share price) against a comparator group of 15 companies including Lloyds Banking Group plc;
– if the performance condition was not met at the end of the third subsequent year, the options would lapse; and
– the full grant of options became exercisable only if the Group was ranked in the top four places of the comparator group. A sliding scale applied
between fourth and eighth positions. If Lloyds Banking Group was ranked below the median (ninth or below) the options would lapse.
Options granted in 2005 became exercisable as the performance condition was met when tested. The performance condition vested at
82.5 per cent for all options granted.
297
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Share-based payments (continued)
Movements in the number of share options outstanding under the executive share option schemes during 2010 and 2011 are set out below:
Outstanding at 1 January
Rebasement adjustment
Exercised
Forfeited
Lapsed
Outstanding at 31 December
Exercisable at 31 December
2011
2010
Number of
options
Weighted average
exercise price
(pence)
13,363,301
233.09
–
–
(2,140,790)
(1,047,642)
10,174,869
10,174,869
–
–
225.91
324.92
225.15
225.15
Number of
options
8,784,978
7,523,547
–
(2,945,224)
–
13,363,301
13,363,301
Weighted average
exercise price
(pence)
476.56
(26.43)
–
296.36
–
233.09
233.09
No options were exercised during 2011 or 2010. The weighted average remaining contractual life of options outstanding at the end of the year
was 2.9 years (2010: 3.6 years).
Save-As-You-Earn schemes
Eligible employees may enter into contracts through the Save‑As‑You‑Earn schemes to save up to £250 per month and, at the expiry of a fixed
term of three, five or seven years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the
Group at a discounted price of no less than 80 per cent of the market price at the start of the invitation.
Movements in the number of share options outstanding under the SAYE schemes are set out below:
Outstanding at 1 January
Rebasement adjustment
Granted
Exercised
Forfeited
Cancelled
Expired
Outstanding at 31 December
Exercisable at 31 December
2011
2010
Number of
options
Weighted average
exercise price
(pence)
Number of
options
Weighted average
exercise price
(pence)
668,044,034
49.59
130,133,992
–
–
(2,497,658)
(18,408,624)
(181,350,614)
(12,768,106)
453,019,032
25,490,233
–
–
47.34
50.52
47.78
69.08
49.74
77.82
22,382,641
655,712,663
(195,339)
(13,922,185)
(107,144,275)
(18,923,463)
668,044,034
663,942
177.60
(416.83)
46.78
49.30
57.34
66.53
179.35
49.59
172.93
The weighted average share price at the time that the options were exercised during 2011 was £0.54 (2010: £0.69). The weighted average
remaining contractual life of options outstanding at the end of the year was 1.7 years (2010: 2.7 years).
No SAYE options were granted in 2011. The weighted average fair value of SAYE options granted during 2010 was £0.33. The values for the SAYE
options have been determined using a standard Black‑Scholes model.
For the HBOS sharesave plan, no options were exercised during 2011 or 2010. The options outstanding at 31 December 2011 had an exercise price
of £1.8066 (2010: £1.8066) and a weighted average remaining contractual life of 2.0 years (2010: 2.9 years).
298
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Share-based payments (continued)
Other share option plans
Lloyds Banking Group executive share plan 2003
The plan was adopted in December 2003 and under the plan share options may be granted to senior employees. Options under this plan have
been granted specifically to facilitate recruitment and as such were not subject to any performance conditions. The plan’s usage has now been
extended to not only compensate new recruits for any lost share awards but also to make grants to key individuals for retention purposes with,
in some instances, the grant being made subject to individual performance conditions.
Outstanding at 1 January
Granted
Rebasement adjustment
Exercised
Forfeited
Outstanding at 31 December
Exercisable at 31 December
2011
2010
Number of
options
Weighted average
exercise price
(pence)
Number of
options
Weighted average
exercise price
(pence)
47,694,757
16,395,016
–
(7,591,526)
(3,498,178)
53,000,069
2,310,418
Nil
Nil
–
Nil
Nil
Nil
Nil
26,099,185
13,429,561
12,501,246
(2,661,703)
(1,673,532)
47,694,757
–
Nil
Nil
Nil
Nil
Nil
Nil
Nil
The weighted average fair value of options granted in the year was £0.46 (2010: £0.63). The weighted average share price at the time that the
options were exercised during 2011 was £0.51 (2010: £0.63). The weighted average remaining contractual life of options outstanding at the end
of the year was 2.1 years (2010: 2.4 years).
Lloyds Banking Group Share Buy Out Awards
As part of arrangements to facilitate the recruitment of certain Executives, options have been granted by individual deed and, where appropriate,
in accordance with the Listing Rules of the UK Listing Authority.
The awards were granted in recognition that the Executives’ outstanding awards over shares in their previous employing company lapsed on
accepting employment with the Group.
Movements in the number of options outstanding are set out below:
Outstanding at 1 January
Granted
Exercised
Outstanding at 31 December
Exercisable at 31 December
2011
Number of
options
Weighted average
exercise price
(pence)
–
21,728,172
(406,935)
21,321,237
2,398,593
–
Nil
Nil
Nil
Nil
The weighted average fair value of options granted in the year was £0.38. The weighted average share price at the time that the options were
exercised during 2011 was £0.54. The weighted average remaining contractual life of options outstanding at the end of the year was 9.6 years.
299
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Share-based payments (continued)
HBOS share option plans
The table below details the outstanding options for the HBOS Share Option Plan and the St James’s Place Share Option Plan. The final award
under the HBOS Share Option Plan was made in 2004. Under this plan, options over shares, at market value with a face value equal to 20 per cent
of salary, were granted to employees with the exception of certain senior executives. A separate option plan exists for some partners of St James’s
Place, which granted options in respect of Lloyds Banking Group plc shares. The final award under the St James’s Place Share Option Plan was
made in 2009. Movements in the number of share options outstanding under these schemes are set out below:
Outstanding at 1 January
Rebasement adjustment
Forfeited
Lapsed
Outstanding at 31 December
Exercisable at 31 December
2011
2010
Number of
options
Weighted average
exercise price
(pence)
Number of
options
Weighted average
exercise price
(pence)
24,695,494
415.70
14,301,748
–
–
12,899,990
(213,498)
(2,423,444)
22,058,552
14,227,020
253.88
624.75
394.30
582.82
(2,506,244)
–
24,695,494
15,320,780
880.27
(61.23)
611.90
–
415.70
593.79
No options were exercised during 2011 or 2010. The options outstanding under the HBOS Share Option Plan and St James’s Place Share Option
Plan at 31 December 2011 had exercise prices in the range of £0.5183 to £8.7189 (2010: £0.5183 to £8.7189) and a weighted average remaining
contractual life of 2.0 years (2010: 3.0 years).
Other share plans
Lloyds Banking Group long-term incentive plan
The Long‑Term Incentive Plan (LTIP) introduced in 2006 is aimed at delivering shareholder value by linking the receipt of shares to an improvement
in the performance of the Group over a three year period. Awards are made within limits set by the rules of the plan, with the limits determining
the maximum number of shares that can be awarded equating to three times annual salary. In exceptional circumstances this may increase to four
times annual salary.
The performance conditions for awards made in March, April and August 2008 are as follows:
(i)
(ii)
For 50 per cent of the award (the EPS Award) – the percentage increase in earnings per share of the Group (on a compound annualised basis)
over the relevant period needed to be at least an average of 6 percentage points per annum greater than the percentage increase (if any) in
the Retail Prices Index over the same period. If it was less than 3 per cent per annum the EPS Award would lapse. If the increase was more than
3 per cent but less than 6 per cent per annum then the proportion of shares released would be on a straight line basis between 17.5 per cent
and 100 per cent. The relevant period commenced on 1 January 2008 and ended on 31 December 2010.
For the other 50 per cent of the award (the TSR Award) – it was necessary for the Group’s total shareholder return (calculated by reference to
both dividends and growth in share price) to exceed the median of a comparator group (13 companies) over the relevant period by an average
of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award would vest where the Group’s total shareholder
return was equal to median and vesting would occur on a straight line basis in between these points. Where the Group’s total shareholder
return was below the median of the comparator group, the TSR Award would lapse. The relevant period commenced on 6 March 2008 and
ended on 5 March 2011.
In 2008, awards were made of 375 per cent of base salary to the Group Chief Executive and two of the Executive Directors for retention purposes,
and in light of data reviewed by the Remuneration Committee which showed total remuneration to be behind median both for the FTSE 20, and
the other major UK banks.
As a consequence of the acquisition of HBOS and the general market turmoil, in March 2009 the Remuneration Committee decided that
the performance test for the 2008 awards should be based on the performance of the Group up to 17 September 2008, the date prior to the
announcement of the HBOS acquisition. The performance test was on a fair value basis, on the estimated probability, as at that date, of achieving
the performance conditions. As a consequence, for all participants, other than those who were Executive Directors at the time the award was
granted and a small number of other senior executives, the share awards vested at 29 per cent in March 2011.
The performance conditions for awards made in April, May and September 2009 are as follows:
(i)
Earnings per share (EPS): relevant to 50 per cent of the award. Performance will be measured based on EPS growth over a three‑year period
from the baseline EPS of 2008.
If the growth in EPS reaches 26 per cent, 25 per cent of this element of the award, being the threshold, will vest. If growth in EPS reaches
36 per cent, 100 per cent of this element will vest.
(ii) Economic Profit (EP): relevant to 50 per cent of the award. Performance will be measured based on the extent to which cumulative EP targets
are achieved over the three‑year period.
300
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Share-based payments (continued)
If the absolute improvement in adjusted EP reaches 100 per cent, 25 per cent of this element of the award, being the threshold, will vest.
If the absolute improvement in adjusted EP reaches 202 per cent, 100 per cent of this element will vest.
The EPS and EP performance measures applying to this 2009 LTIP award were set on the basis that the Group would enter into the Government
Asset Protection Scheme. As the Group is not participating in the Government Asset Protection Scheme, in June 2010 the Remuneration
Committee approved restated performance measures on a basis consistent with the EPS and EP measures used for the 2010 LTIP awards.
An additional discretionary award was made in April, May and September 2009. The performance conditions for those awards are as follows:
(i)
(ii)
Synergy Savings: The release of 50 per cent of the shares will be dependent on the achievement of target run‑rate synergy savings in 2009
and 2010 as well as the achievement of sustainable synergy savings of at least £1.5 billion by the end of 2011. The award will be broken down
into three equally weighted annual tranches. Performance will be assessed at the end of each year against annual performance targets based
on a trajectory to meet the 2011 target. The extent to which targets have been achieved will determine the proportion of shares to be banked
each year. Any release of shares will be subject to the Remuneration Committee judging the overall success of the delivery of the integration
programme.
Integration Balanced Scorecard: The release of the remaining 50 per cent of the shares will be dependent on the outcome of a Balanced
Scorecard of non‑financial measures of the success of the integration in each of 2009, 2010 and 2011. The Balanced Scorecard element will be
broken down into three equally weighted tranches. The tranches will be crystallised and banked for each year of the performance cycle subject
to separate annual performance targets across the four measurement categories of Building the Business, Customer, Risk and People and
Organisation Development.
The performance conditions for awards made in March and August 2010 are as follows:
(i)
EPS: relevant to 50 per cent of the award. Performance will be measured based on EPS growth over a three‑year period from the baseline
EPS of 2009.
If the absolute improvement in adjusted EPS reaches 158 per cent, 25 per cent of this element of the award, being the threshold, will vest.
If absolute improvement in adjusted EPS reaches 180 per cent, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
(ii)
EP: relevant to 50 per cent of the award. Performance will be 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.
If the compounded annual growth rate of adjusted EP reaches 57 per cent per annum, 25 per cent of this element of the award, being the
threshold, will vest. If the compounded annual growth rate of adjusted EP reaches 77 per cent per annum, 100 per cent of this element will
vest.
Vesting between threshold and maximum will be on a straight line basis.
For awards made to Executive Directors, a third performance condition was set, relating to Absolute Share Price, relevant to 28 per cent of the
award. Performance will be measured based on the Absolute Share Price on 26 March 2013, being the third anniversary of the award date. If the
share price at the end of the performance period is 75 pence or less, none of this element of the award will vest. If the share price is 114 pence
or higher, 100 per cent of this element will vest. Vesting between threshold and maximum will be on a straight line basis, provided that shares
comprised in the Absolute Share Price element may only be released if both the EPS and EP performance measures have been satisfied at the
threshold level or above. The EPS and EP performance conditions will each relate to 36 per cent of the total award.
The performance conditions for awards made in March and September 2011 are as follows:
(i)
EPS: relevant to 50 per cent of the award. The performance target is based on 2013 adjusted EPS outcome.
If the adjusted EPS reaches 6.4p, 25 per cent of this element of the award, being the threshold, will vest.
If adjusted EPS reaches 7.4p, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
(ii) EP: relevant to 50 per cent of the award. The performance target is based on 2013 adjusted EP outcome.
If the adjusted EP reaches £567 million, 25 per cent of this element of the award, being the threshold, will vest. If the adjusted EP reaches
£1,234 million, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
301
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Share-based payments (continued)
For awards made to Executive Directors, a third performance condition was set, relating to Absolute Total Shareholder Return, relevant to one
third of the award. Performance will be measured based on the annualised Absolute Total Shareholder Return over the three year performance
period. If the annualised Absolute Total Shareholder Return at the end of the performance period is less than 8 per cent, none of this element of
the award will vest. If the Absolute Total Shareholder Return is 8 per cent, 25 per cent of this element of the award, being the threshold, will vest.
If the Absolute Total Shareholder Return is 14 per cent or higher, 100 per cent of this element will vest. Vesting between threshold and maximum
will be on a straight line basis. The EPS and EP performance conditions will each relate to 33.3 per cent of the total award.
Outstanding at 1 January
Granted
Rebasement adjustment
Vested
Forfeited
Outstanding at 31 December
2011
Number of shares
2010
Number of shares
447,142,491
223,233,052
147,280,077
148,810,591
–
106,990,259
(3,918,013)
(1,985,339)
(46,766,369)
(29,906,072)
543,738,186
447,142,491
The fair value of the share awards granted in 2011 was £0.54 (2010: £0.61).
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding
for the option schemes were as follows:
Executive schemes
SAYE schemes
Other share option plans
Weighted
average
exercise price
(pence)
Weighted
average
remaining life
(years)
Weighted
average
exercise price
(pence)
Weighted
average
remaining life
(years)
Weighted
average
exercise price
(pence)
Weighted
average
remaining life
(years)
Number of
options
Number of
options
Number of
options
At 31 December 2011
Exercise price range
£0 to £1
£1 to £2
£2 to £3
£3 to £4
£5 to £6
At 31 December 2010
Exercise price range
£0 to £1
£1 to £2
£2 to £3
£3 to £4
£5 to £6
–
199.91
225.74
–
–
–
–
2.6
233,714
2.9 9,941,155
–
–
–
–
47.94
179.16
214.16
–
–
1.7
2.0
0.9
–
–
446,965,447
4.94
4.1 82,152,838
5,563,072
490,513
–
–
–
–
–
–
–
–
–
–
–
582.82
1.8 14,227,020
Executive schemes
SAYE schemes
Other share option plans
Weighted
average
exercise price
(pence)
Weighted
average
remaining life
(years)
Weighted
average
exercise price
(pence)
Weighted
average
remaining life
(years)
Number of
options
Weighted
average
exercise price
(pence)
Weighted
average
remaining life
(years)
Number of
options
Number of
options
–
199.91
225.83
324.92
–
–
3.6
–
262,725
3.9 12,052,934
0.2
1,047,642
–
–
47.74
178.74
210.74
–
–
2.7
2.8
1.4
–
–
658,912,847
7.41
2.5
55,656,496
7,984,764
1,146,423
–
–
–
–
–
–
–
–
–
–
–
567.65
2.9
15,462,949
302
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 52: Shared-based payments (continued)
The fair value calculations at 31 December 2011 for grants made in the year, using Black‑Scholes models and Monte Carlo simulation, are based
on the following assumptions:
Risk‑free interest rate
Expected life
Expected volatility
Expected dividend yield
Weighted average share price
Weighted average exercise price
Expected forfeitures
Executive
Share Plan
2003
0.73%
LTIP
1.77%
Share Buy
Out Awards
0.86%
1.4 years
3.0 years
1.3 years
54%
1.7%
0.48
Nil
4%
86%
2.9%
0.62
Nil
4%
51%
1.6%
0.41
Nil
4%
Expected volatility is a measure of the amount by which the Group’s shares are expected to fluctuate during the life of an option. The expected
volatility is estimated based on the historical volatility of the closing daily share price over the most recent period that is commensurate with the
expected life of the option. The historical volatility is compared to the implied volatility generated from market traded options in the Group’s
shares to assess the reasonableness of the historical volatility and adjustments made where appropriate.
Share incentive plan
Free shares
An award of shares may be made annually to employees based on a percentage of each employee’s salary in the preceding year up to a maximum
of £3,000. The percentage is normally announced concurrently with the Group’s annual results and the price of the shares awarded is announced
at the time of award. The shares awarded are held in trust for a mandatory period of three years on the employee’s behalf, during which period the
employee is entitled to any dividends paid on such shares. The award is subject to a non‑market based condition: if an employee leaves the Group
within this three year period for other than a ‘good’ reason, all of the shares awarded will be forfeited.
The last award of free shares was made in 2008.
Matching shares
The Group undertakes to match shares purchased by employees up to the value of £30 per month; these matching shares are held in trust for a
mandatory period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The
award is subject to a non‑market based condition: if an employee leaves within this three year period for other than a ‘good’ reason, 100 per cent
of the matching shares are forfeited. Similarly if the employees sell their purchased shares within three years, their matching shares are forfeited.
The number of shares awarded relating to matching shares in 2011 was 30,999,387 (2010: 17,411,651), with an average fair value of £0.42 (2010:
£0.63), based on market prices at the date of award.
Note 53: 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 table below details, on an aggregated basis, key management personnel compensation:
Compensation
Salaries and other short‑term benefits
Post‑employment benefits
Share‑based payments
Total compensation
2011
£m
12
–
11
23
2010
£m
7
2
8
17
2009
£m
17
1
–
18
303
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 53: Related party transactions (continued)
Aggregate contributions in respect of key management personnel to defined contribution pension schemes were £0.2 million (2010: £0.4 million).
Share option plans
At 1 January
Granted, including certain adjustments1 (includes entitlements of appointed directors)
Exercised/lapsed (includes entitlements of former directors)
At 31 December
1
2010 includes adjustments, using a standard HMRC formula, to negate the dilutionary impact of the Group’s 2009 capital raising activities.
Share plans
At 1 January
Granted, including certain adjustments1 (includes entitlements of appointed directors)
Exercised/lapsed (includes 31 million entitlements of former directors)
At 31 December
1
2010 includes adjustments, using a standard HMRC formula, to negate the dilutionary impact of the Group’s 2009 capital raising activities.
2011
million
2010
million
2009
million
6
20
(4)
22
2
4
–
6
2
–
–
2
2011
million
2010
million
2009
million
56
35
(33)
58
19
39
(2)
56
7
17
(5)
19
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with
information relating to other transactions between the Group and its key management personnel:
2011
£m
2010
£m
2009
£m
Loans
At 1 January
Advanced (includes loans of appointed directors)
Repayments (includes loans of former directors)
At 31 December
3
1
(1)
3
2
2
(1)
3
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between
1.09 per cent and 27.5 per cent in 2011 (2010: 0.5 per cent and 17.90 per cent; 2009: 1.28 per cent and 24.90 per cent).
No provisions have been recognised in respect of loans given to key management personnel (2010 and 2009: £nil).
Deposits
At 1 January
Placed (includes deposits of appointed directors)
Withdrawn (includes deposits of former directors)
At 31 December
2011
£m
4
17
(15)
6
2010
£m
4
12
(12)
4
3
–
(1)
2
2009
£m
6
12
(14)
4
Deposits placed by key management personnel attracted interest rates of up to 5 per cent (2010: 4.25 per cent; 2009: 6.50 per cent).
At 31 December 2011, the Group did not provide any guarantees in respect of key management personnel (2010 and 2009: none).
At 31 December 2011, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected
persons included amounts outstanding in respect of loans and credit card transactions of £3 million with four directors and three connected
persons (2010: £2 million with six directors and four connected persons; 2009: £2 million with seven directors and four connected persons).
Subsidiaries
Details of the principal subsidiaries are given in note 9 to the parent company financial statements. In accordance with IAS 27, transactions and
balances with subsidiaries have been eliminated on consolidation.
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. As at 31 December 2011, HM Treasury held a 40.2 per cent (31 December 2010: 40.6 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 2011.
304
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 53: Related party transactions (continued)
From 1 January 2011, in accordance with IAS 24 (Revised), UK Government‑controlled entities became related parties of the Group. The Group
regards the Bank of England and entities controlled by the UK Government, including The Royal Bank of Scotland Group plc, Northern Rock (Asset
Management) plc and Bradford & Bingley plc, as related parties.
Since 31 December 2010, the Group has had the following significant transactions with the UK Government or UK Government‑related entities:
Government and central bank facilities
During the year ended 31 December 2011, the Group participated in a number of schemes operated by the UK Government and central banks
and made available to eligible banks and building societies.
Special liquidity scheme and credit guarantee scheme
The Bank of England’s UK Special Liquidity Scheme was launched in April 2008 to allow financial institutions to swap temporarily illiquid assets for
treasury bills, with fees charged based on the spread between 3‑month LIBOR and the 3‑month gilt repo rate. The scheme will operate for up to
three years after the end of the drawdown period (30 January 2009) at the Bank of England’s discretion. At 31 December 2011, the Group did not
utilise the Special Liquidity Scheme.
HM Treasury launched the Credit Guarantee Scheme in October 2008 as part of a range of measures announced by the UK Government intended
to ease the turbulence in the UK banking system. It charged a commercial fee for the guarantee of new short and medium term debt issuance.
The fee payable to HM Treasury on guaranteed issues was based on a per annum rate of 50 basis points plus the median five‑year credit default
swap spread. The drawdown window for the Credit Guarantee Scheme closed for new issuance at the end of February 2010. At 31 December 2011,
the Group had £23.5 billion of debt in issue under the Credit Guarantee Scheme (31 December 2010: £45.4 billion). During the year, fees of
£28 million paid to HM Treasury in respect of guaranteed funding were included in the Group’s income statement.
Lending commitments
The formal lending commitments entered into in connection with the Group’s proposed participation in the Government Asset Protection Scheme
have now expired and in February 2011, the Company (together with Barclays, Royal Bank of Scotland, HSBC and Santander) announced, as part
of the ‘Project Merlin‘ agreement with HM Treasury, its capacity and willingness to increase business lending (including to small and medium‑sized
enterprises) during 2011.
Business Growth Fund
In May 2011 the Group agreed, together with The Royal Bank of Scotland plc (and three other non‑related parties), to subscribe for shares in
the Business Growth Fund plc which is the company created to fulfil the role of the Business Growth Fund as set out in the British Bankers’
Association’s Business Taskforce Report of October 2010. During 2011, the Group has incurred sunk costs of £4 million which have been written off.
As at 31 December 2011, the Group’s investment in the Business Growth Fund was £20 million.
Other government-related entities
Other than the transactions referred to above, there were no other significant transactions with the UK Government and UK Government‑controlled
entities (including UK Government‑controlled banks) during the period that were not made in the ordinary course of business or that were unusual
in their nature or conditions.
Other related party transactions
Pensions funds
The Group provides banking and some investment management services to certain of the Group pension funds. At 31 December 2011, customer
deposits of £63 million (2010: £64 million) and investment and insurance contract liabilities of £928 million (2010: £850 million) related to the Group’s
pension funds. During 2011, the Group sold at fair value certain non‑government bonds, equities and alternative assets to Lloyds TSB Group
Pension Scheme No 1 for £336 million and to Lloyds TSB Group Pension Scheme No 2 for £67 million.
Open Ended Investment Companies (OEICs)
The Group manages 249 (2010: 402) OEICs, and of these 142 (2010: 111) are consolidated. The Group invested £1,283 million (2010: £1,460 million)
and redeemed £884 million (2010: £982 million) in the unconsolidated OEICs during the year and had investments, at fair value, of £4,431 million
(2010: £7,920 million) at 31 December. The Group earned fees of £318 million from the unconsolidated OEICs (2010: £271 million).
Joint ventures and associates
The Group provides both administration and processing services to its principal joint venture, Sainsbury’s Bank plc. The amounts receivable by
the Group during the year were £21 million (2010: £31 million), of which £10 million was outstanding at 31 December 2011 (2010: £8 million). At
31 December 2011, Sainsbury’s Bank plc also had balances with the Group that were included in loans and advances to banks of £1,173 million
(2010: £1,277 million), deposits by banks of £780 million (2010: £1,358 million) and trading liabilities of £340 million (2010: nil).
At 31 December 2011 there were loans and advances to customers of £5,185 million (2010: £5,660 million) outstanding and balances within
customer deposits of £88 million (2010: £151 million) relating to other joint ventures and associates.
305
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 53: Related party transactions (continued)
In addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair
value through profit or loss. At 31 December 2011, these companies had total assets of approximately £11,500 million (2010: £12,216 million),
total liabilities of approximately £10,807 million (2010: £11,937 million) and for the year ended 31 December 2011 had turnover of approximately
£7,376 million (2010: £3,829 million) and made a net loss of approximately £83 million (2010: net profit of £182 million). In addition, the Group
has provided £5,767 million (2010: £3,316 million) of financing to these companies on which it received £106 million (2010: £93 million) of interest
income in the year.
Note 54: Contingent liabilities and commitments
Interchange fees
The European Commission has adopted a formal decision finding that an infringement of European Commission competition laws has arisen
from arrangements whereby MasterCard set a uniform Multilateral Interchange Fee (MIF) in respect of cross‑border transactions in relation to the
use of a MasterCard or Maestro branded payment card. The European Commission has required that the MIF be reduced to zero for relevant
cross‑border transactions within the European Economic Area. This decision has been appealed to the General Court of the European Union
(the General Court). Lloyds TSB Bank plc and Bank of Scotland plc (along with certain other MasterCard issuers) have successfully applied to
intervene in the appeal in support of MasterCard’s position that the arrangements for the charging of the MIF are compatible with European Union
competition laws. The UK Government has also intervened in the General Court appeal supporting the European Commission position. An oral
hearing took place on 8 July 2011 but judgment is not expected for six to twelve months. MasterCard has reached an understanding with the
European Commission on a new methodology for calculating intra‑European Economic Area MIF on an interim basis pending the outcome of
the appeal.
Meanwhile, the European Commission is pursuing an investigation with a view to deciding whether arrangements adopted by Visa for the
levying of the MIF in respect of cross‑border payment transactions also infringe European Union competition laws. In this regard Visa reached an
agreement with the European Commission to reduce the level of interchange for cross‑border debit card transactions to the interim levels agreed
by MasterCard. The UK’s OFT has also commenced similar investigations relating to the MIF in respect of domestic transactions in relation to both
the MasterCard and Visa payment schemes. The ultimate impact of the investigations on the Group can only be known at the conclusion of these
investigations and any relevant appeal proceedings.
Interbank offered rate setting investigations
Several government agencies in the UK, US and overseas, including the US Commodity Futures Trading Commission, the US SEC, the US
Department of Justice and the FSA as well as the European Commission, are conducting investigations into submissions made by panel members
to the bodies that set various interbank offered rates. The Group, and/or its subsidiaries, were (at the relevant time) and remain members of
various panels that submit data to these bodies. The Group has received requests from some government agencies for information and is
co‑operating with their investigations. In addition, recently the Group has been named in private lawsuits, including purported class action suits in
the US with regard to the setting of London interbank offered rates (LIBOR). It is currently not possible to predict the scope and ultimate outcome
of the various regulatory investigations or private lawsuits, including the timing and scale of the potential impact of any investigations and private
lawsuits on the Group.
Financial Services Compensation Scheme (FSCS)
The FSCS is the UK’s independent statutory compensation fund for customers of authorised financial services firms and pays compensation if a
firm is unable to pay claims against it. The FSCS is funded by levies on the industry (and recoveries and borrowings where appropriate). The levies
raised comprise both management expenses levies and, where necessary, compensation levies on authorised firms.
Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for
customers of those firms. The borrowings with HM Treasury, which total circa £20 billion, are on an interest‑only basis until 31 March 2012 and the
FSCS and HM Treasury are currently discussing the terms for refinancing these borrowings to take effect from 1 April 2012. Each deposit‑taking
institution contributes towards the management expenses levies in proportion to their share of total protected deposits on 31 December of
the year preceding the scheme year, which runs from 1 April to 31 March. In determining an appropriate accrual in respect of the management
expenses levy, certain assumptions have been made including the proportion of total protected deposits held by the Group, the level and timing
of repayments to be made by the FSCS to HM Treasury and the interest rate to be charged by HM Treasury. For the year ended 31 December
2011, the Group has charged £179 million (2010: £46 million; 2009: £73 million) to the income statement in respect of the costs of the FSCS.
Whilst it is expected that the substantial majority of the principal will be repaid from funds the FSCS receives from asset sales, surplus cash flow or
other recoveries in relation to the assets of the firms that defaulted, to the extent that there remains a shortfall, the FSCS will raise compensation
levies on all deposit‑taking participants. The amount of any future compensation levies also depends on a number of factors including the level of
protected deposits and the population of deposit‑taking participants and will be determined at a later date. As such, although the Group’s share
of such compensation levies could be significant, the Group has not recognised a provision in respect of them in these financial statements.
306
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 54: Contingent liabilities and commitments (continued)
Litigation in relation to insurance branch business in Germany
Clerical Medical Investment Group Limited (CMIG) has received a number of claims in the German courts, relating to policies issued by CMIG
but sold by independent intermediaries in Germany, principally during the late 1990s and early 2000s. CMIG has won the majority of decisions
to date, although a small number of regional district and appeal courts have found against CMIG on specific grounds. CMIG’s strategy includes
defending claims robustly and appealing against adverse judgments. The ultimate financial effect, which could be significant, will only be known
once all relevant claims have been resolved. However, consistent with this strategy, and having regard to the costs involved in managing these
claims, and the inherent risks of litigation, the Group has recognised a provision of £175 million. Management believes this represents the most
appropriate estimate of the financial impact, based upon a series of assumptions, including the number of claims received, the proportion upheld,
and resulting legal and administration costs.
Shareholder complaints
The Group and two former members of the Group’s Board of Directors have been named as defendants in a purported securities class action
pending in the United States District Court for the Southern District of New York. The complaint, dated 23 November 2011, asserts claims
under the Securities Exchange Act of 1934 in connection with alleged material omissions from statements made in 2008 in connection with the
acquisition of HBOS. No quantum is specified.
In addition, a UK‑based shareholder action group has threatened multi‑claimant claims on a similar basis against the Group and two former
directors in the UK. No claim has yet been issued.
The Group considers that the claims are without merit and will defend them vigorously. The claims have not been quantified and it is not possible
to estimate the ultimate financial impact on the Group at this early stage.
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.
The Group also faces a number of other threats of legal action from employees in relation to terms of employment including pay and bonuses.
The Group considers that the complaints are without merit and, should proceedings be issued, they will be vigorously defended.
FSA investigation into Bank of Scotland
In 2009 the FSA commenced a supervisory review into HBOS. The supervisory review has now been superseded as the FSA has commenced
enforcement proceedings against Bank of Scotland plc in relation to its Corporate division pre 2009. The proceedings are ongoing and the Group
is co‑operating fully. It is too early to predict the outcome or estimate reliably any potential financial effects of the enforcement proceedings but
they are not currently expected to be material to the Group.
Regulatory matters
In the course of its business, the Group is engaged in discussions with the FSA in relation to a range of conduct of business matters, including
complaints handling, packaged bank accounts, savings accounts, product terms and conditions, interest‑only mortgages, sales processes and
remuneration schemes. The Group is keen to ensure that any regulatory concerns are understood and addressed. The ultimate impact on the
Group of these discussions can only be known at the conclusion of such discussions.
Other legal actions and regulatory matters
In addition, during the ordinary course of business the Group is subject to other threatened and actual legal proceedings (which may include
class action lawsuits brought on behalf of customers, shareholders or other third parties), regulatory investigations, regulatory challenges and
enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional
advisers where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more
likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the
obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because
further time is needed properly to assess the merits of the case and no provisions are held against such matters. However the Group does not
currently expect the final outcome of any such case to have a material adverse effect on its financial position.
307
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 54: Contingent liabilities and commitments (continued)
Contingent liabilities
Acceptances and endorsements
Other:
Other items serving as direct credit substitutes
Performance bonds and other transaction‑related contingencies
Total contingent liabilities
2011
£m
81
1,060
2,729
3,789
3,870
2010
£m
48
1,319
2,812
4,131
4,179
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.
Commitments
Documentary credits and other short‑term trade‑related transactions
Forward asset purchases and forward deposits placed
Undrawn formal standby facilities, credit lines and other commitments to lend:
Less than 1 year original maturity:
Mortgage offers made
Other commitments
1 year or over original maturity
Total commitments
2011
£m
105
596
7,383
56,527
63,910
40,972
105,583
2010
£m
255
887
8,113
60,528
68,641
47,515
117,298
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £53,459 million
(2010: £63,630 million) was irrevocable.
Operating lease commitments
Where a Group company is the lessee the future minimum lease payments under non‑cancellable premises operating leases are as follows:
Not later than 1 year
Later than 1 year and not later than 5 years
Later than 5 years
Total operating lease commitments
2011
£m
348
1,187
1,489
3,024
2010
£m
356
1,120
1,706
3,182
Operating lease payments represent rental payable by the Group for certain of its properties. Some of these operating lease arrangements have
renewal options and rent escalation clauses, although the effect of these is not material. No arrangements have been entered into for contingent
rental payments.
Capital commitments
Excluding commitments in respect of investment property (note 28), capital expenditure contracted but not provided for at 31 December 2011
amounted to £296 million (2010: £339 million). Of this amount, £292 million (2010: £282 million) related to assets to be leased to customers under
operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
308
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments
(1) Measurement basis of financial assets and liabilities
The accounting policies in note 2 describe how different classes of financial instruments are measured, and how income and expenses, including
fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and
by balance sheet heading.
Derivatives
designated
as hedging
instruments
£m
At fair value
through profit or loss
Held for
trading
£m
Designated
upon initial
recognition
Available-
for-sale
Loans and
receivables
£m
£m
£m
Held at
amortised
cost
£m
Insurance
contracts
£m
Total
£m
At 31 December 2011
Financial assets
Cash and balances at central banks
Items in the course of collection from banks
Trading and other financial assets at fair value
through profit or loss
–
–
–
–
–
–
–
18,056
121,454
Derivative financial instruments
12,850
53,163
12,850
71,219
121,454
37,406
610,714
70,228
–
–
–
–
–
–
–
–
37,406
–
–
–
–
–
32,606
565,638
12,470
610,714
–
–
60,722
1,408
–
–
–
–
–
–
–
8,098
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
39,810
413,906
844
–
–
1,145
185,059
–
–
–
–
35,089
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
19,616
50,966
–
–
–
–
–
–
–
–
–
–
5,339
–
–
–
–
–
–
49
–
–
–
–
–
–
–
60,722
1,408
139,510
66,013
32,606
565,638
–
12,470
–
–
–
–
–
–
–
–
–
–
–
610,714
37,406
8,098
923,871
39,810
413,906
844
24,955
58,212
1,145
185,059
78,991
78,991
49,636
49,636
300
–
–
300
49
35,089
7,246
70,582
5,388
675,853
128,927
887,996
Loans and receivables:
Loans and advances to banks
Loans and advances to customers
Debt securities
Available‑for‑sale financial assets
Held‑to‑maturity investments
Total financial assets
Financial liabilities
Deposits from banks
Customer deposits
Items in course of transmission to banks
Trading and other financial liabilities at fair
value through profit or loss
Notes in circulation
Debt securities in issue
Liabilities arising from insurance contracts
and participating investment contracts
Liabilities arising from non‑participating
investment contracts
Unallocated surplus within insurance
businesses
Financial guarantees
Subordinated liabilities
Total financial liabilities
Derivative financial instruments
7,246
309
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Derivatives
designated
as hedging
instruments
£m
At fair value
through profit or loss
Held for
trading
£m
Designated
upon initial
recognition
£m
Available‑
for‑sale
£m
Loans and
receivables
£m
Held at
amortised
cost
£m
Insurance
contracts
£m
Total
£m
At 31 December 2010
Financial assets
Cash and balances at central banks
Items in the course of collection from banks
Trading and other financial assets at fair value
through profit or loss
–
–
–
Derivative financial instruments
7,406
–
–
23,707
43,371
Loans and receivables:
Loans and advances to banks
Loans and advances to customers
Debt securities
Available‑for‑sale financial assets
Held‑to‑maturity investments
Total financial assets
Financial liabilities
Deposits from banks
Customer deposits
Items in course of transmission to banks
Trading and other financial liabilities at fair
value through profit or loss
Derivative financial instruments
4,398
Notes in circulation
Debt securities in issue
Liabilities arising from insurance contracts
and participating investment contracts
Liabilities arising from non‑participating
investment contracts
Unallocated surplus within insurance
businesses
Financial guarantees
Subordinated liabilities
Total financial liabilities
(2) Reclassification of financial assets
No financial assets were reclassified in 2011
–
–
132,484
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
42,955
–
–
–
–
–
30,272
592,597
25,735
648,604
–
–
–
–
–
–
–
–
–
–
–
–
–
–
7,406
67,078
132,484
42,955
648,604
–
–
–
–
–
–
–
–
–
–
–
–
–
–
20,097
37,760
–
–
–
–
–
–
–
–
–
–
6,665
–
–
–
–
–
–
54
–
4,398
57,857
6,719
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
38,115
1,368
–
–
–
–
–
–
–
7,905
47,388
50,363
393,633
802
–
–
1,074
228,866
–
–
–
–
36,232
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
38,115
1,368
156,191
50,777
30,272
592,597
25,735
648,604
42,955
7,905
945,915
50,363
393,633
802
26,762
42,158
1,074
228,866
80,729
80,729
51,363
51,363
643
–
–
643
54
36,232
710,970
132,735
912,679
In 2010 the Group reviewed its approach to managing a portfolio of government securities held as a separately identifiable component of the
Group’s liquidity portfolio. Given the long‑term nature of this portfolio, the Group concluded that certain of these securities will be able to be
held until they reach maturity. Consequently, on 1 November 2010, government securities with a fair value of £3,601 million were reclassified from
available‑for‑sale financial assets to held‑to‑maturity investments reflecting the Group’s positive intent and ability to hold them until maturity.
In 2009, no financial assets were reclassified.
In 2008, in accordance with the amendment to IAS39 that became applicable during that year, the Group reviewed the categorisation of its
financial assets classified as held for trading and available‑for‑sale. On the basis that there was no longer an active market for some of those assets,
which are therefore more appropriately managed as loans, with effect from 1 July 2008, the Group transferred £2,993 million of assets previously
classified as held for trading into loans and receivables. With effect from 1 November 2008, the Group transferred £437 million of assets previously
classified as available‑for‑sale financial assets into loans and receivables. At the time of these transfers, the Group had the intention and ability to
hold them for the foreseeable future or until maturity. As at the date of reclassification, the weighted average effective interest rate of the assets
transferred was 6.3 per cent with the estimated recoverable cash flows of £3,524 million.
310
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Carrying value and fair value of reclassified assets
The table below sets out the carrying value and fair value of reclassified financial assets.
2011
2010
2009
2008
From held for trading to loans and receivables
67
Carrying
value
£m
Fair
value
£m
56
From available‑for‑sale financial assets to
loans and receivables
From available‑for‑sale financial assets to
held‑to‑maturity investments
Total carrying value and fair value
217
219
3,624
3,908
3,846
4,121
Carrying
value
£m
750
313
3,455
4,518
Fair
value
£m
727
Carrying
value
£m
Fair
value
£m
Carrying
value
£m
Fair
value
£m
1,833
1,822
2,883
2,926
340
394
422
454
402
3,539
4,606
–
–
–
–
2,227
2,244
3,337
3,328
During the year ended 31 December 2011, the carrying value of assets reclassified to loans and receivables decreased by £779 million due to sales
and maturities of £734 million and foreign exchange and other movements of £58 million less accretion of discount of £13 million.
In respect of government securities reclassified from available‑for‑sale financial assets to held‑to‑maturity investments, there was no change in the
amounts recognised in the Group’s income statement as interest income (2011: £138 million; 2010: £23 million) and, for relevant securities, foreign
exchange gains and losses (2011: £14 million loss; 2010: £39 million gain) as such items are recognised in profit or loss on the same basis.
No financial assets were reclassified in accordance with paragraphs 50B, 50D or 50E of IAS 39 in 2011, 2010 and 2009; the following disclosures
relate to those assets which were so reclassified in 2008.
a) Additional fair value gains (losses) that would have been recognised had the reclassifications not occurred
The table below shows the additional gains (losses) that would have been recognised in the Group’s income statement if the reclassifications had
not occurred.
From held for trading to loans and receivables
2011
£m
(3)
2010
£m
(34)
2009
£m
208
2008
£m
(347)
The table below shows the additional gains (losses) that would have been recognised in other comprehensive income if the reclassifications had
not occurred.
From available‑for‑sale financial assets to loans and receivables
2011
£m
(68)
2010
£m
69
b) Actual amounts recognised in respect of reclassified assets
After reclassification the reclassified financial assets contributed the following amounts to the Group income statement.
From held for trading to loans and receivables:
Net interest income
Impairment losses
Total amounts recognised
From available‑for‑sale financial assets to loans and receivables:
Net interest income
Impairment losses
Total amounts recognised
2011
£m
1
–
1
2011
£m
2
(8)
(6)
2010
£m
24
(6)
18
2010
£m
1
(2)
(1)
2009
£m
161
2009
£m
55
(49)
6
2009
£m
34
(56)
(22)
2008
£m
(108)
2008
£m
31
(158)
(127)
2008
£m
3
(23)
(20)
311
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
(3) Fair values of financial assets and liabilities
The following table summarises the carrying values of financial assets and liabilities presented on the Group’s balance sheet. The fair values
presented in the table are at a specific date and may be significantly different from the amounts which will actually be paid or received on the
maturity or settlement date.
Financial assets
Cash and balances at central banks
Items in the course of collection from banks
Trading and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and receivables:
Loans and advances to banks
Loans and advances to customers
Debt securities
Available‑for‑sale financial assets
Held‑to‑maturity investments
Financial liabilities
Deposits from banks
Customer deposits
Items in course of transmission to banks
Trading and other financial liabilities at fair value through profit or loss
Derivative financial instruments
Notes in circulation
Debt securities in issue
Liabilities arising from non‑participating investment contracts
Financial guarantees
Subordinated liabilities
2011
2010
Carrying value
£m
Fair value
£m
Carrying value
£m
Fair value
£m
60,722
1,408
139,510
66,013
32,606
565,638
12,470
37,406
8,098
39,810
413,906
844
24,955
58,212
1,145
185,059
49,636
49
60,722
1,408
139,510
66,013
32,554
549,829
10,953
37,406
8,144
40,012
414,654
844
24,955
58,212
1,145
183,113
49,636
49
35,089
27,838
38,115
1,368
156,191
50,777
30,272
592,597
25,735
42,955
7,905
50,363
393,633
802
26,762
42,158
1,074
228,866
51,363
54
36,232
38,115
1,368
156,191
50,777
30,236
580,343
26,937
42,955
7,716
50,520
394,393
802
26,762
42,158
1,074
229,375
51,363
54
38,083
Valuation methodology
Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
Wherever possible, fair values have been calculated using unadjusted quoted market prices in active markets for identical instruments held by
the Group. Where quoted market prices are not available, or are unreliable because of poor liquidity, fair values have been determined using
valuation techniques which, to the extent possible, use market observable inputs, but in some cases use non‑market observable inputs. Valuation
techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics
similar to those of the instruments held by the Group.
Because a variety of estimation techniques are employed and significant estimates made, comparisons of fair values between financial institutions
may not be meaningful. Readers of these financial statements are thus advised to use caution when using this data to evaluate the Group’s
financial position.
Fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets,
such as the value of the Group’s branch network, the long‑term relationships with depositors and credit card relationships; premises and
equipment; and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does
not represent the underlying value of the Group.
312
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Valuation control framework
The key elements of the control framework for the valuation of financial instruments include model validation, product implementation review and
independent price verification. These functions are carried out by appropriately skilled risk and finance teams, independent of the business area
responsible for the products.
Model validation covers both qualitative and quantitative elements relating to new models. In respect of new products, a product implementation
review is conducted pre‑ and post‑trading. Pre‑trade testing ensures that the new model is integrated into the Group’s systems and that the profit
and loss and risk reporting are consistent throughout the trade life cycle. Post‑trade testing examines the explanatory power of the implemented
model, actively monitoring model parameters and comparing in‑house pricing to external sources. Independent price verification procedures
cover financial instruments carried at fair value. The frequency of the review is matched to the availability of independent data, monthly being the
minimum. Valuation differences in breach of established thresholds are escalated to senior management. The results from independent pricing
and valuation reserves are reviewed monthly by senior management.
Formal committees, consisting of senior risk, finance and business management, meet at least quarterly to discuss and approve valuations in more
judgemental areas, in particular for unquoted equities, structured credit, over‑the‑counter options and the Credit Valuation Adjustment (CVA) reserve.
Fair value of financial instruments carried at amortised cost
Cash and balances at central banks and items in the course of collection from banks
The fair value approximates carrying value due to their short‑term nature.
Loans and receivables
The Group provides loans and advances to commercial, corporate and personal customers at both fixed and variable rates. The carrying value of
the variable rate loans and those relating to lease financing is assumed to be their fair value. For fixed rate lending, several different techniques are
used to estimate fair value, as considered appropriate. These techniques also take account of expected credit losses and changes in interest rates
and expected future cash flows in establishing fair value. For commercial and personal customers, fair value is principally estimated by discounting
anticipated cash flows (including interest at contractual rates) at market rates for similar loans offered by the Group and other financial institutions.
The fair value for corporate loans is estimated by discounting anticipated cash flows at a rate which reflects the effects of interest rate changes,
adjusted for changes in credit risk. Certain loans secured on residential properties are made at a fixed rate for a limited period, typically two to five
years, after which the loans revert to the relevant variable rate. The fair value of such loans is estimated by reference to the market rates for similar
loans of maturity equal to the remaining fixed interest rate period. The fair values of asset‑backed securities and secondary loans, which were
previously within assets held for trading and were reclassified to loans and receivables, are determined predominantly from lead manager quotes
and, where these are not available, by alternative techniques including reference to credit spreads on similar assets with the same obligor, market
standard consensus pricing services, broker quotes and other research data.
Held‑to‑maturity investments
The fair values of government securities are based on market prices.
Deposits from banks and customer deposits
The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits is estimated
using discounted cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.
Items in course of transmission to banks
The fair value approximates carrying value due to their short‑term nature.
Notes in circulation
The fair value of notes in circulation which are payable on demand is considered to be equal to their carrying value.
Debt securities in issue and subordinated liabilities
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 quoted market prices.
Valuation of financial instruments carried at fair value
The valuations of financial instruments have been classified into three levels according to the quality and reliability of information used to
determine the fair values.
Level 1 portfolios
Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities. Products
classified as level 1 predominantly comprise equity shares, treasury bills and other government securities.
Level 2 portfolios
Level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not
considered to be active or valuation techniques are used to determine fair value and where these techniques use inputs that are based significantly
on observable market data. Examples of such financial instruments include most over‑the‑counter derivatives, financial institution issued securities,
certificates of deposit and certain asset‑backed securities.
313
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Level 3 portfolios
Level 3 portfolios are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable
market data. Such instruments would include the Group’s venture capital and unlisted equity investments which are valued using various valuation
techniques that require significant management judgement in determining appropriate assumptions, including earnings multiples and estimated
future cash flows. Certain of the Group’s asset‑backed securities and derivatives, principally where there is no trading activity in such securities, are
also classified as level 3.
The table below provides an analysis of the financial assets and liabilities of the Group that are carried at fair value in the Group’s consolidated
balance sheet, grouped into levels 1 to 3 based on the degree to which the fair value is observable.
Valuation hierarchy
At 31 December 2011
Trading and other financial assets at fair value through profit or loss
Loans and advances to customers
Loans and advances to banks
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Equity shares
Treasury and other bills
Level 1
£m
Level 2
£m
Level 3
£m
Total
£m
–
–
21,326
375
–
187
178
5,098
27,164
74,381
299
9,766
1,355
2,041
808
3,248
524
1,605
15,337
23,563
41
–
–
–
–
–
–
–
203
1,423
1,626
1,315
–
9,766
1,355
23,367
1,183
3,248
711
1,986
21,858
52,353
75,737
299
Total trading and other financial assets at fair value through profit or loss
101,844
34,725
2,941
139,510
Available‑for‑sale financial assets
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Equity shares
Treasury and other bills
Total available‑for‑sale financial assets
Derivative financial instruments
Total financial assets carried at fair value
Trading and other financial liabilities at fair value through profit or loss
Liabilities held at fair value through profit or loss (debt securities)
Trading liabilities:
Liabilities in respect of securities sold under repurchase agreements
Short positions in securities
Other
Total trading and other financial liabilities at fair value through profit or loss
Derivative financial instruments
Financial guarantees
25,143
27
323
–
–
41
25,534
55
972
26,561
204
93
–
43
1,803
807
5,192
7,938
96
755
8,789
63,160
128,609
106,674
–
–
3,168
–
3,168
3,168
35
–
5,339
12,378
533
3,537
16,448
21,787
57,436
–
Total financial liabilities carried at fair value
3,203
79,223
There were no significant transfers between level 1 and level 2 during the year.
–
–
–
–
257
12
269
1,787
–
2,056
2,649
7,646
–
–
–
–
–
–
741
49
790
25,236
27
366
1,803
1,064
5,245
33,741
1,938
1,727
37,406
66,013
242,929
5,339
12,378
3,701
3,537
19,616
24,955
58,212
49
83,216
314
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
At 31 December 2010
Trading and other financial assets at fair value through profit or loss
Loans and advances to customers
Loans and advances to banks
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Equity shares
Treasury and other bills
Total trading and other financial assets at fair value through profit or loss
Available‑for‑sale financial assets
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Equity shares
Treasury and other bills
Total available‑for‑sale financial assets
Derivative financial instruments
Total financial assets carried at fair value
Trading and other financial liabilities at fair value through profit or loss
Liabilities held at fair value through profit or loss (debt securities)
Trading liabilities:
Liabilities in respect of securities sold under repurchase agreements
Short positions in securities
Other
Total trading and other financial liabilities at fair value through profit or loss
Derivative financial instruments
Financial guarantees
Total financial liabilities carried at fair value
Valuation methodology
Level 1
£m
Level 2
£m
Level 3
£m
Total
£m
–
–
21,053
199
–
2
5
2,950
24,209
88,806
227
113,242
11,517
29
15
–
–
711
12,272
49
2,160
14,481
985
9,811
2,734
2,787
720
4,298
420
2,324
16,973
27,522
46
–
40,113
1,035
–
392
4,293
4,640
11,399
21,759
161
3,908
25,828
47,806
128,708
113,747
–
–
861
3
864
864
42
–
906
6,665
14,612
894
3,727
19,233
25,898
41,913
–
67,811
–
–
–
–
–
–
283
9,811
2,734
23,840
919
4,298
422
2,612
1,186
21,109
1,469
1,367
–
2,836
–
–
–
–
579
22
601
2,045
–
2,646
1,986
7,468
–
–
–
–
–
–
203
54
257
53,200
90,219
227
156,191
12,552
29
407
4,293
5,219
12,132
34,632
2,255
6,068
42,955
50,777
249,923
6,665
14,612
1,755
3,730
20,097
26,762
42,158
54
68,974
Asset-backed securities
Where there is no trading activity in asset‑backed securities, valuation models, consensus pricing information from third party pricing services and
broker or lead manager quotes are used to determine an appropriate valuation. Asset‑backed securities are then classified as either level 2 or level
3 depending on whether there is more than one consistent independent source of data. If there is a single, uncorroborated market source for a
significant valuation input or where there are materially inconsistent levels then the security is reported as level 3. Asset classes classified as level 3
mainly comprise certain collateralised loan obligations and collateralised debt obligations.
315
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Equity investments (including venture capital)
Unlisted equities and fund investments are accounted for as trading and other financial assets at fair value through profit or loss or as available‑
for‑sale financial assets. These investments are valued using different techniques as a result of the variety of investments across the portfolio in
accordance with the Group’s valuation policy and are calculated using International Private Equity and Venture Capital Guidelines.
Depending on the business sector and the circumstances of the investment, unlisted equity valuations are based on earnings multiples, net asset
values or discounted cash flows.
– A number of earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before
interest, tax, depreciation and amortisation. The particular multiple selected being appropriate for the type of business being valued and is
derived by reference to the current market‑based multiple. Consideration is given to the risk attributes, growth prospects and financial gearing
of comparable businesses when selecting an appropriate multiple.
– Discounted cash flow valuations use estimated future cash flows, usually based on management forecasts, with the application of appropriate exit
yields or terminal multiples and discounted using rates appropriate to the specific investment, business sector or recent economic rates of return.
Recent transactions involving the sale of similar businesses may sometimes be used as a frame of reference in deriving an appropriate multiple.
– For fund investments the most recent capital account value calculated by the fund manager is used as the basis for the valuation and adjusted,
if necessary, to align valuation techniques with the Group’s valuation policy.
Unquoted equities and property partnerships in the life funds
Third party valuations are used to obtain the fair value of unquoted investments. Management take account of any pertinent information, such
as recent transactions and information received on particular investments, to adjust the third party valuations where necessary.
Derivatives
Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted
cash flow and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include:
– Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield
curves which are developed from publicly quoted rates.
– Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources.
– Credit derivatives are valued using standard models with observable inputs, except for the items classified as level 3, which are valued using
publicly available yield and credit default swap (CDS) curves.
– Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available
interest rate cap, interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard
consensus pricing service. For more complex option products, the Group calibrates its models using observable at‑the‑money data; where
necessary, the Group adjusts for out‑of‑the‑money positions using a market standard consensus pricing service.
Complex interest rate and foreign exchange products where there is significant dispersion of consensus pricing or where implied funding costs are
material and unobservable are classified as level 3.
Where credit protection, usually in the form of credit default swaps, has been purchased or written on asset‑backed securities, the security is
referred to as a negative basis asset‑backed security and the resulting derivative assets or liabilities have been classified as either level 2 or level 3
according to the classification of the underlying asset‑backed security.
The Group’s level 3 derivative assets include £1,172 million (31 December 2010: £1,177 million) in respect of the value of the embedded equity
conversion feature of the Enhanced Capital Notes issued in December 2009. The embedded equity conversion feature is valued by comparing
the market price of the Enhanced Capital Notes with the market price of similar bonds without the conversion feature. The latter is calculated
by discounting the expected enhanced capital note cash flows in the absence of a conversion using prevailing market yields for similar capital
securities without the conversion feature. The market price of the Enhanced Capital Notes was calculated with reference to multiple broker quotes.
Movements in the fair value of the derivative are recorded in net trading income.
Level 3 derivative assets also include £14 million (31 December 2010: £96 million) in respect of credit default swaps written on level 3 negative basis
asset‑backed securities calculated as set out in the table below:
Fair value before credit valuation adjustment
Less: credit valuation adjustment
Carrying value
2011
£m
18
(4)
14
2010
£m
114
(18)
96
316
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Movements in Level 3 Portfolio
The table below analyses movements in the level 3 financial assets portfolio.
At 1 January 2010
Exchange and other adjustments
Gains (losses) recognised in the income statement
Gains recognised in other comprehensive income
Purchases
Sales
Transfers into the level 3 portfolio
Transfers out of the level 3 portfolio
At 31 December 2010
Exchange and other adjustments
Gains recognised in the income statement
Losses recognised in other comprehensive income
Purchases
Sales
Transfers into the level 3 portfolio
Transfers out of the level 3 portfolio
At 31 December 2011
Gains recognised in the income statement relating to those
assets held at 31 December 2011
Losses recognised in other comprehensive income relating to those
assets held at 31 December 2011
Gains (losses) recognised in the income statement relating to those
assets held at 31 December 2010
Gains recognised in other comprehensive income relating to those
assets held at 31 December 2010
The table below analyses movements in the Level 3 financial liabilities portfolio.
At 1 January 2010
Exchange and other adjustments
Additions
Redemptions
Transfers into the level 3 portfolio
At 31 December 2010
Losses recognised in the income statement
Redemptions
Transfers into the level 3 portfolio
Transfers out of the level 3 portfolio
At 31 December 2011
Losses recognised in the income statement relating to
those liabilities held at 31 December 2011
Gains (losses) recognised in the income statement relating to
those liabilities held at 31 December 2010
Trading and other
financial assets at
fair value through
profit or loss
£m
2,912
28
199
–
921
(550)
64
(738)
2,836
(8)
139
–
518
(747)
331
(128)
Available-
for-sale
£m
2,611
12
(56)
271
664
(560)
–
(296)
2,646
(45)
78
(148)
343
(580)
146
(384)
Derivative
assets
£m
1,937
2
(667)
–
–
–
780
(66)
1,986
(8)
672
–
–
–
47
(48)
2,941
2,056
2,649
203
–
151
–
31
(132)
(81)
269
178
–
(667)
–
Total financial
assets
£m
7,460
42
(524)
271
1,585
(1,110)
844
(1,100)
7,468
(61)
889
(148)
861
(1,327)
524
(560)
7,646
412
(132)
(597)
269
Derivative
liabilities
£m
Financial
guarantees
£m
Total financial
liabilities
£m
197
13
–
(210)
203
203
585
–
18
(65)
741
(93)
–
38
–
16
–
–
54
5
(10)
–
–
49
(5)
–
235
13
16
(210)
203
257
590
(10)
18
(65)
790
(98)
–
Transfers out of the level 3 portfolio arise when inputs that could have a significant impact on the instrument’s valuation become market observable
after previously having been non‑market observable. In the case of asset‑backed securities this can arise if more than one consistent independent
source of data becomes available. Conversely transfers into the portfolio arise when consistent sources of data cease to be available.
317
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Included within the gains (losses) recognised in the income statement are gains of £412 million (2010: losses of £597 million) related to financial
instruments that are held in the level 3 portfolio at the year end. These amounts are included in other operating income.
Included within the gains (losses) recognised in other comprehensive income are losses of £132 million (2010: gains of £269 million) related to
financial instruments that are held in the level 3 portfolio at the year end.
At 31 December 2011
At 31 December 2010
Effect of reasonably possible
alternative assumptions
Effect of reasonably possible
alternative assumptions
Carrying
value
£m
Favourable
changes
£m
Unfavourable
changes
£m
Carrying
value
£m
Favourable
changes
£m
Unfavourable
changes
£m
203
1
(1)
283
8
(8)
1,823
56
(59)
2,072
135
(111)
915
2,941
257
–
1
–
481
–
–
2,836
(1)
579
34
(34)
1,799
183
(88)
2,067
141
(91)
2,056
2,646
2,649
134
(20)
1,986
157
(27)
Trading and other financial assets at fair value through profit or loss
Valuation basis/technique Main assumptions
Asset‑backed
securities
Lead manager
or broker quote/
consensus pricing
from market data
provider
Equity and venture
capital investments
Various valuation
techniques
Unlisted equities and
property partnerships
in the life funds
Available-for-sale financial assets
Asset‑backed
securities
Lead manager
or broker quote/
consensus pricing
from market data
provider
Equity and venture
capital investments
Various valuation
techniques
Derivative financial assets
Use of single pricing
source
Earnings, net asset
value and earnings
multiples, forecast
cash flows
Use of single pricing
source
Earnings, net asset
value, underlying asset
values, property prices,
forecast cash flows
Industry standard
model/consensus
pricing from market
data provider
Prepayment rates,
probability of default,
loss given default and
yield curves. Equity
conversion feature
spread
Financial assets
Derivative financial liabilities
Industry standard
model/consensus
pricing from market
data provider
Prepayment rates,
probability of default,
loss given default and
yield curves
Financial guarantees
Financial liabilities
7,646
741
49
790
–
–
–
–
7,468
203
54
257
–
–
–
–
318
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
Sensitivity of level 3 valuations
Asset-backed securities
Reasonably possible alternative valuations have been calculated for asset‑backed securities by using alternative pricing sources and calculating
an absolute difference. The pricing difference is defined as the absolute difference between the actual price used and the closest, alternative price
available.
Derivative financial instruments
(i)
In respect of the embedded equity conversion feature of the Enhanced Capital Notes, the sensitivity was based on the absolute difference
between the actual price of the enhanced capital note and the closest, alternative broker quote available plus the impact of applying a
10 bps increase/decrease in the market yield used to derive a market price for similar bonds without the conversion feature. The effect
of interdependency of the assumptions is not material to the effect of applying reasonably possible alternative assumptions to the valuations
of derivative financial instruments.
(ii)
In respect of credit default swaps written on level 3 negative basis asset‑backed securities, reasonably possible alternative valuations have
been calculated by flexing the spread between the underlying asset and the credit default swap, or adjusting market yields, by a reasonable
amount. The sensitivity is determined by applying a 60 bps increase/decrease in the spread between the asset and the credit default swap.
Venture capital and equity investments
Third party valuers have been used to determine the value of unlisted equities and property partnerships included in the Group's life insurance
funds.
The valuation techniques used for unlisted equities and venture capital investments vary depending on the nature of the investment, as described
in the valuation methodology section above. Reasonably possible alternative valuations for these investments have been calculated by reference
to the relevant approach taken as appropriate to the business sector and investment circumstances and as such the following inputs have been
considered:
– for valuations derived from earnings multiples, consideration is given to the risk attributes, growth prospects and financial gearing of comparable
businesses when selecting an appropriate multiple;
– the discount rates used in discounted cash flow valuations; and
– in line with International Private Equity and Venture Capital Guidelines, the values of underlying investments in fund investments portfolios.
Derivative valuation adjustments
Derivative financial instruments which are carried in the balance sheet at fair value are adjusted where appropriate to reflect credit risk, market
liquidity and other risks.
(i) Uncollateralised derivative valuation adjustments, excluding monoline counterparties
The following table summarises the movement on this valuation adjustment account during 2011:
At 1 January
Income statement charge
Transfers
At 31 December
Represented by:
Credit Valuation Adjustment
Debit Valuation Adjustment
Funding Valuation Adjustment
2011
£m
570
718
(62)
1,226
2011
£m
1,425
(493)
294
1,226
2010
£m
662
20
(112)
570
2010
£m
671
(298)
197
570
Credit and Debit Valuation Adjustments (CVA and DVA) are applied to the Group’s over‑the‑counter derivative exposures with counterparties that
are not subject to standard interbank collateral arrangements. These exposures largely relate to the provision of risk management solutions for
corporate customers within the Wholesale division.
A CVA is taken where the Group has a positive future uncollateralised exposure (asset). A DVA is taken where the Group has a negative future
uncollateralised exposure (liability). These adjustments reflect interest rates and expectations of counterparty creditworthiness and the Group’s
own credit spread respectively.
319
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
The CVA is sensitive to:
– the current size of the mark‑to‑market position on the uncollateralised asset;
– expectations of future market volatility of the underlying asset; and
– expectations of counterparty creditworthiness.
In circumstances where exposures to a counterparty become impaired, any associated derivative valuation adjustment is transferred and assessed
for specific loss alongside other non‑derivative assets and liabilities that the counterparty may have with the Group.
Market Credit Default Swap (CDS) spreads are used to develop the probability of default for quoted counterparties. For unquoted counterparties,
internal credit ratings and market sector CDS curves and recovery rates are used. The Loss Given Default (LGD) is based on market recovery rates
and internal credit assessments.
The combination of a one per cent deterioration in the credit rating of derivative counterparties and a ten per cent increase in LGD increases
the CVA by £140 million. Current market value is used to estimate the projected exposure for products not supported by the model, which
are principally complex interest rate options that are traded in very low volumes. For these, the CVA is calculated on an add‑on basis (in total
contributing £84 million of the overall CVA balance at 31 December 2011).
The DVA is sensitive to:
– the current size of the mark‑to‑market position on the uncollateralised liability;
– expectations of future market volatility of the underlying liability; and
– the Group’s own CDS spread.
A one per cent rise in the CDS spread would lead to an increase in the DVA of £125 million to £618 million.
The risk exposures that are used for the CVA and DVA calculations are strongly influenced by interest rates. Due to the nature of the Group’s
business the CVA/DVA exposures tend to be on average the same way around such that the valuation adjustments fall when interest rates rise.
A one per cent rise in interest rates would lead to a £369 million fall in the overall valuation adjustment to £563 million. The CVA model used by
the Group does not assume any correlation between the level of interest rates and default rates.
The Group has also recognised a Funding Valuation Adjustment to adjust for the net cost of funding certain uncollateralised derivative positions
where the Group considers that this cost is included in market pricing. This adjustment is calculated on the expected future exposure discounted
at a suitable cost of funds. A ten basis points increase in the cost of funds will increase the funding valuation adjustment by approximately
£11 million.
(ii) Uncollateralised derivative valuation adjustments – monoline counterparties
The Group has no significant derivative exposures remaining against monoline counterparties as shown in note 56 Credit risk.
(iii) Market liquidity
The Group includes mid to bid‑offer valuation adjustments against the expected cost of closing out the net market risk in the Group’s trading
positions within a timeframe that is consistent with historical trading activity and spreads that the trading desks have accessed historically during
the ordinary course of business in normal market conditions.
At 31 December 2011, the Group’s derivative trading business held mid to bid‑offer valuation adjustments of £85 million (31 December 2010:
£66 million).
(iv) Libor/Overnight Index Swap basis
The Group’s derivative trading business applies £74 million (31 December 2010: £70 million) of valuation adjustments against the changing market
approach to valuing derivatives that are subject to daily collateral margin, where standard market practice is to pay interest on an Overnight Index
Swap basis rather than a Libor rate.
No credit valuation adjustment is taken on collateralised swaps.
Own credit adjustments
The carrying amount of issued notes that are designated under the IAS 39 fair value option is adjusted to reflect the effect of changes in own credit
spreads. The resulting gain or loss is recognised in the income statement.
At 31 December 2011, the own credit adjustment arising from the fair valuation of £5,339 million (31 December 2010: £6,665 million) of the Group’s
debt securities in issue designated at fair value through profit or loss resulted in a gain of £194 million (2010: no gain or loss).
320
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 55: Financial instruments (continued)
(4) Transferred financial assets that are not derecognised
Repurchase and securities lending transactions
The Group enters into repurchase and securities lending transactions in the normal course of business that do not result in derecognition of the
financial assets concerned. The carrying value of financial assets transferred under such arrangements, that did not qualify for derecognition, and
their associated liabilities are as follows:
Trading and other financial assets at fair value through profit or loss
Debt securities classified as loans and receivables
Available‑for‑sale financial assets
Total
In all cases the transferee has the right to sell or repledge the assets concerned.
2011
2010
Carrying
value of
transferred
assets
£m
523
5,045
2,435
8,003
Carrying
value of
associated
liabilities
£m
513
4,326
2,258
7,097
Carrying
value of
transferred
assets
£m
824
1,386
1,467
3,677
Carrying
value of
associated
liabilities
£m
828
1,043
1,378
3,249
Securitisations and covered bonds
Details about the Group’s securitisation and covered bond programmes, which may also result in financial assets not being derecognised in full,
are provided in note 22.
Note 56: Financial risk management
As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial
instruments represent a significant component of the risks faced by the Group.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and
foreign exchange risk; liquidity risk; capital risk; and insurance risk. Information about the Group’s exposure to each of the above risks and capital
can be found on pages 99 to 170. The following additional disclosures, which provide quantitative information about the risks within financial
instruments held or issued by the Group, should be read in conjunction with that earlier information.
Market risk
The Group uses various market risk measures for risk reporting and setting risk appetite limits and triggers. These measures include Value at Risk
and Stress Scenarios.
Interest rate risk
In the Group’s retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either
insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but
bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base
rate. There is a relatively small volume of deposits whose rate is contractually fixed for their term to maturity.
Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages
which may be considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However, a significant proportion
of the Group’s lending assets, for example many personal loans and mortgages, bear interest rates which are contractually fixed for periods of
up to five years or longer.
The Group establishes two types of hedge accounting relationships for interest rate risk: fair value hedges and cash flow hedges. The Group is
exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt,
and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The majority of the
Group’s hedge accounting relationships are fair value hedges where interest rate swaps are used to hedge the interest rate risk inherent in the
fixed rate mortgage portfolio.
At 31 December 2011 the aggregate notional principal of interest rate swaps designated as fair value hedges was £93,215 million (2010:
£75,831 million) with a net fair value asset of £5,484 million (2010: asset of £3,166 million) (note 19). The gains on the hedging instruments were
£1,982 million (2010: gains of £280 million). The losses on the hedged items attributable to the hedged risk were £1,999 million (2010: losses of
£452 million).
In addition the Group has cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business.
Note 19 shows when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. The notional
principal of the interest rate swaps designated as cash flow hedges at 31 December 2011 was £152,314 million (2010: £112,507 million) with a net
fair value liability of £358 million (2010: liability of £843 million) (note 19). In 2011, ineffectiveness recognised in the income statement that arises
from cash flow hedges was a loss of £13 million (2010: gain of £160 million).
321
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Currency risk
Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from
investment in the Group’s overseas operations.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non‑structural foreign
exchange exposures in the non‑trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the
authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the market and
liquidity risk function in London. Associated VaR and the closing, average, maximum and minimum are disclosed on page 165.
Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net
asset value of the foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign
currency exposures are taken to reserves.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using currency borrowings and cross
currency derivatives. At 31 December 2011 the aggregate notional principal of these currency borrowings was £2,245 million; the aggregate
notional principal of the cross currency derivatives was £49 million (2010: cross currency derivatives £86 million) with a fair value liability of
£1 million (2010: asset of £2 million) and they were designated on an after‑tax basis as hedges of net investments in foreign operations. In 2011, an
ineffectiveness gain of £23 million before tax and £17 million after tax (2010: ineffectiveness loss of £28 million before tax and £20 million after tax)
was recognised in the income statement arising from net investment hedges.
The Group’s main overseas operations are in the Americas, Asia, Australasia and Europe. Details of the Group’s structural foreign currency
exposures, after net investment hedges, are as follows:
Functional currency of Group operations
Euro:
Gross exposure
Net investment hedge
US dollar:
Gross exposure
Net investment hedge
Swiss franc:
Gross exposure
Net investment hedge
Australian dollar:
Gross exposure
Net investment hedge
Japanese yen:
Gross exposure
Net investment hedge
Other non‑sterling
Total structural foreign currency exposures, after net investment hedges
2011
£m
585
(848)
(263)
341
(122)
219
15
–
15
1,232
(1,226)
6
20
–
20
170
167
2010
£m
2,468
(3,270)
(802)
47
(145)
(98)
53
–
53
1,567
(1,634)
(67)
17
–
17
155
(742)
322
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Credit risk
The Group’s credit risk exposure arises in respect of the instruments below and predominantly in the United Kingdom, the European Union,
Australia and the United States. Credit risk appetite is set at Board level and is described and reported through a suite of metrics devised from
a combination of accounting and credit portfolio performance measures, which include the use of various credit risk rating systems as inputs.
The Group uses a range of approaches to mitigate credit risk, including internal control policies, obtaining collateral, using master netting
agreements and other credit risk transfers, such as asset sales and credit derivative based transactions.
A. Maximum credit exposure
The maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is
taken of any collateral held and the maximum exposure to loss, which includes amounts held to cover unit‑linked and With Profits funds liabilities,
is considered to be the balance sheet carrying amount or, for non‑derivative off‑balance sheet transactions and financial guarantees, their
contractual nominal amounts.
Loans and receivables:
Loans and advances to banks, net1
Loans and advances to customers, net1
Debt securities, net1
Deposit amounts available for offset2
Available‑for‑sale financial assets (excluding equity shares)
Held‑to‑maturity investments
Trading and other financial assets at fair value through profit or loss (excluding equity shares)3:
Loans and advances
Debt securities, treasury and other bills
Derivative assets:
Derivative assets, before offsetting under master netting arrangements
Amounts available for offset under master netting arrangements2
Assets arising from reinsurance contracts held
Financial guarantees
Irrevocable loan commitments and other credit‑related contingencies4
Maximum credit risk exposure
Maximum credit risk exposure before offset items
Amounts shown net of related impairment allowances.
2011
£m
2010
£m
32,606
565,638
12,470
(4,174)
606,540
35,468
8,098
30,272
592,597
25,735
(8,105)
640,499
40,700
7,905
11,121
12,545
52,652
53,427
63,773
65,972
66,013
(46,618)
19,395
2,534
10,831
57,329
803,968
854,760
50,777
(31,740)
19,037
2,146
22,975
67,809
867,043
906,888
Deposit amounts available for offset and amounts available for offset under master netting arrangements do not meet the criteria under IAS 32 to enable loans and advances and derivative assets
respectively to be presented net of these balances in the financial statements.
Includes assets within the Group’s unit‑linked funds for which credit risk is borne by the policyholders and assets within the Group’s With Profits funds for which credit risk is largely borne by the
policyholders. Consequently, the Group has no significant exposure to credit risk for such assets which back related contract liabilities.
See note 54 – Contingent liabilities and commitments for further information.
1
2
3
4
323
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
B. Credit quality of assets
Loans and receivables
The disclosures in the table below and those on pages 324 to 325 are produced under the combined businesses approach used for the Group’s
segmental reporting. The Group believes that, for reporting periods immediately following a significant acquisition such as the acquisition of
HBOS in 2009, this combined businesses basis, which includes the allowance for loan losses at the acquisition date on a gross basis, more fairly
reflects the underlying provisioning status of the loans. The remaining acquisition‑related fair value adjustments in respect of this lending are
therefore identified separately in this table.
The analysis of lending between retail and wholesale has been prepared based upon the type of exposure and not the business segment in which
the exposure is recorded. Included within retail are exposures to personal customers and small businesses, whilst included within wholesale are
exposures to corporate customers and other large institutions.
Loans and advances
At 31 December 2011
Neither past due nor impaired
Past due but not impaired
Impaired – no provision required
– provision held
Gross
Allowance for impairment losses
Fair value adjustments
Net balance sheet carrying value
At 31 December 2010
Neither past due nor impaired
Past due but not impaired
Impaired – no provision required
– provision held
Gross
Allowance for impairment losses
Fair value adjustments
Net balance sheet carrying value
Loans and advances to customers
Retail –
mortgages
£m
Retail –
other
£m
Wholesale
£m
Total
£m
Loans and
advances
designated
at fair value
through
profit or loss
£m
Loans and
advances
to banks
£m
32,494
15
6
105
330,727
12,742
1,364
6,701
32,620
351,534
(2,731)
339,509
13,215
2,189
5,591
360,504
(2,073)
(14)
–
32,606
30,259
–
–
20
30,279
(20)
13
30,272
41,448
146,655
518,830
11,121
1,093
1,604
2,940
47,085
(1,848)
2,509
3,544
44,116
196,824
(23,139)
16,344
6,512
53,757
595,443
(27,718)
(2,087)
565,638
–
–
–
11,121
–
–
11,121
45,058
159,274
543,841
12,545
1,289
433
5,149
51,929
(2,587)
3,427
5,313
45,931
213,945
(24,975)
17,931
7,935
56,671
626,378
(29,635)
(4,146)
592,597
–
–
–
12,545
–
–
12,545
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(H). All impaired loans
which exceed certain thresholds, principally within the Group’s Wholesale division, are individually assessed for impairment by reviewing expected
future cash flows including those that could arise from the realisation of security. Included in loans and receivables are advances which are
individually determined to be impaired with a gross amount before impairment allowances of £48,142 million (31 December 2010: £51,608 million).
324
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
The table below sets out the reconciliation of the allowance for impairment losses of £18,732 million (31 December 2010: £18,373 million) shown in
note 25 to the allowance for impairment losses on a combined businesses basis of £27,718 million (31 December 2010: £29,635 million) shown above:
Allowance for impairment losses on loans and advances to customers
HBOS allowance at 16 January 20091
HBOS charge covered by fair value adjustments2
Amounts subsequently written off
Foreign exchange and other movements
Allowance for impairment losses on loans and advances to customers on a combined businesses basis
2011
£m
18,732
11,147
10,474
(13,083)
8,538
448
27,718
2010
£m
18,373
11,147
8,823
(9,136)
10,834
428
29,635
1
2
Comprises an allowance held at 31 December 2008 of £10,693 million and a charge for the period from 1 January 2009 to 16 January 2009 of £454 million.
This represents the element of the charge on loans and advances to customers in HBOS’s results that was included within the Group’s fair value adjustments in respect of the acquisition of HBOS
on 16 January 2009.
Loans and advances which are neither past due nor impaired
At 31 December 2011
Good quality
Satisfactory quality
Lower quality
Below standard, but not impaired
Total loans and advances which are
neither past due nor impaired
At 31 December 2010
Good quality
Satisfactory quality
Lower quality
Below standard, but not impaired
Total loans and advances which are neither
past due nor impaired
Loans and
advances
to banks
£m
Loans and advances to customers
Retail –
mortgages
£m
Retail –
other
£m
Wholesale
£m
Total
£m
32,141
323,060
29,123
171
9
173
5,432
970
1,265
9,747
1,127
1,451
71,907
42,311
24,676
7,761
Loans and
advances
designated
at fair value
through
profit or loss
£m
11,065
45
11
–
32,494
330,727
41,448
146,655
518,830
11,121
29,835
265
16
143
332,614
5,259
834
802
30,076
11,084
1,170
2,728
57,552
42,906
45,750
13,066
12,220
163
83
79
30,259
339,509
45,058
159,274
543,841
12,545
The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale are not
the same, reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not
provided. Wholesale lending has been classified using internal probability of default rating models mapped so that they are comparable to
external credit ratings. Good quality lending comprises the lower assessed default probabilities, with other classifications reflecting progressively
higher default risk. Classifications of retail lending incorporate expected recovery levels for mortgages, as well as probabilities of default assessed
using internal rating models. Further information about the Group’s internal probabilities of default rating models can be found on pages 129 to 130.
325
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Loans and advances which are past due but not impaired
At 31 December 2011
0‑30 days
30‑60 days
60‑90 days
90‑180 days
Over 180 days
Total loans and advances which are past
due but not impaired
At 31 December 2010
0‑30 days
30‑60 days
60‑90 days
90‑180 days
Over 180 days
Total loans and advances which are past due
but not impaired
Loans and
advances
to banks
£m
Loans and advances to customers
Retail –
mortgages
£m
Retail –
other
£m
Wholesale
£m
Total
£m
Loans and
advances
designated
at fair value
through
profit or loss
£m
1
9
4
–
1
5,989
2,618
1,833
2,302
–
868
195
25
4
1
1,163
481
260
159
446
8,020
3,294
2,118
2,465
447
15
12,742
1,093
2,509
16,344
–
–
–
–
–
–
6,498
2,674
1,811
2,223
9
1,004
246
29
10
–
1,331
498
394
337
867
8,833
3,418
2,234
2,570
876
13,215
1,289
3,427
17,931
–
–
–
–
–
–
–
–
–
–
–
–
A financial asset is ‘past due’ if a counterparty has failed to make a payment when contractually due.
326
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Debt securities classified as loans and receivables
An analysis by credit rating of the Group’s debt securities classified as loans and receivables is provided below:
At 31 December 2011
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Gross exposure
Allowance for impairment losses
Total debt securities classified as loans and receivables
At 31 December 2010
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Gross exposure
Allowance for impairment losses
Total debt securities classified as loans and receivables
AAA
£m
AA
£m
A
£m
BBB
£m
Rated BB
or lower
£m
Not rated
£m
Total
£m
2,008
3,585
5,593
150
5,743
6,524
7,535
14,059
163
14,222
2,326
430
2,756
–
2,756
1,423
374
1,797
67
1,864
1,024
237
1,261
–
1,261
2,856
2,514
5,370
164
5,534
1,057
1,377
2,434
459
2,893
840
475
1,315
106
1,421
369
403
772
–
772
222
823
1,045
166
1,211
29
1
30
320
350
151
103
254
758
1,012
7,179
5,030
12,209
537
12,746
(276)
12,470
.
11,650
12,827
24,477
1,816
26,293
(558)
25,735
Available‑for‑sale financial assets (excluding equity shares)
An analysis of the Group’s available‑for‑sale financial assets is included in note 26. The credit quality of the Group’s available‑for‑sale financial assets
(excluding equity shares) is set out below:
AAA
£m
AA
£m
A
£m
BBB
£m
Rated BB
or lower
£m
Not rated
£m
Total
£m
At 31 December 2011
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Total debt securities
Treasury bills and other bills
Total held as available-for-sale financial assets
At 31 December 2010
Debt securities:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Total debt securities
Treasury bills and other bills
Total held as available‑for‑sale financial assets
19,051
–
81
626
399
1,025
1,609
21,766
1,717
23,483
12,462
–
–
2,809
3,625
6,434
1,135
20,031
4,439
24,470
6,179
–
177
491
299
790
856
8,002
–
8,002
78
–
225
673
781
1,454
4,824
6,581
–
6,581
–
–
71
398
224
622
2,351
3,044
10
3,054
–
–
162
601
395
996
5,150
6,308
1,629
7,937
–
–
37
185
34
219
341
597
–
597
–
–
20
202
115
317
913
1,250
–
1,250
–
–
–
103
90
193
–
193
–
193
–
–
–
8
79
87
42
129
–
129
6
27
–
–
18
18
88
139
–
139
12
29
–
–
224
224
68
333
–
333
25,236
27
366
1,803
1,064
2,867
5,245
33,741
1,727
35,468
12,552
29
407
4,293
5,219
9,512
12,132
34,632
6,068
40,700
327
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Held‑to‑maturity investments
An analysis of the credit quality of the Group’s held‑to‑maturity investments is provided below:
At 31 December 2011
Government securities
At 31 December 2010
Government securities
AAA
£m
AA
£m
A
£m
BBB
£m
Rated BB
or lower
£m
Not rated
£m
Total
£m
6,319
1,779
7,905
–
–
–
–
–
–
–
–
–
8,098
7,905
Debt securities, treasury and other bills held at fair value through profit or loss
An analysis of the Group’s trading and other financial assets at fair value through profit or loss is included in note 18. The credit quality of the
Group’s debt securities, treasury and other bills held at fair value through profit or loss is set out below:
AAA
£m
AA
£m
A
£m
BBB
£m
Rated BB
or lower
£m
Not rated
£m
Total
£m
At 31 December 2011
Debt securities, treasury and other bills held at fair
value through profit or loss
Trading assets:
Government securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Total debt securities held as trading assets
Treasury bills and other bills
Total held as trading assets
Other assets held at fair value through profit or loss:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Total other assets held at fair value through
profit or loss
Total held at fair value through profit or loss
1,994
–
63
19
82
304
2,380
224
2,604
17,667
908
–
194
320
514
3,415
22,504
25,108
6
1,147
34
151
185
141
1,479
75
–
1,574
1
52
53
312
1,939
–
1,554
1,939
1,027
170
330
45
198
243
2,111
3,881
5,435
950
35
55
255
794
1,049
6,197
8,286
10,225
–
142
–
–
–
489
631
–
631
642
59
–
116
383
499
5,195
6,395
7,026
–
–
1
–
1
151
152
–
152
644
11
–
–
53
53
1,199
1,907
2,059
–
–
–
–
–
179
179
–
179
437
–
–
2
16
18
2,165
2,620
2,799
2,000
2,863
99
222
321
1,576
6,760
299
7,059
21,367
1,183
385
612
1,764
2,376
20,282
45,593
52,652
328
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
At 31 December 2010
Debt securities, treasury and other bills held at fair
value through profit or loss
Trading assets:
Government securities
Bank and building society certificates of deposit
Other asset‑backed securities
Corporate and other debt securities
Total debt securities held as trading assets
Treasury bills and other bills
Total held as trading assets
Other assets held at fair value through profit or loss:
Government securities
Other public sector securities
Bank and building society certificates of deposit
Asset‑backed securities:
Mortgage‑backed securities
Other asset‑backed securities
Corporate and other debt securities
Total other assets held at fair value through profit or loss
Total held at fair value through profit or loss
AAA
£m
AA
£m
A
£m
BBB
£m
Rated BB
or lower
£m
Not rated
£m
Total
£m
651
–
191
1,205
2,047
219
2,266
20,509
778
52
259
298
557
3,870
25,766
28,032
888
3,086
633
1,209
5,816
8
5,824
1,113
62
107
68
372
440
1,619
3,341
9,165
–
506
196
1,839
2,541
–
2,541
408
68
447
48
458
506
4,397
5,826
8,367
84
100
–
183
367
–
367
33
2
–
23
384
407
3,269
3,711
4,078
–
–
–
13
13
–
13
6
–
–
–
70
70
1,275
1,351
1,364
–
–
–
470
470
–
470
148
9
–
24
10
34
1,760
1,951
2,421
1,623
3,692
1,020
4,919
11,254
227
11,481
22,217
919
606
422
1,592
2,014
16,190
41,946
53,427
Credit risk in respect of trading and other financial assets at fair value through profit or loss held within the Group’s unit‑linked funds is borne by
the policyholders and credit risk in respect of With Profits funds is largely borne by the policyholders. Consequently, the Group has no significant
exposure to credit risk for such assets which back those contract liabilities.
Derivative assets
An analysis of derivative assets is given in note 19. The Group reduces exposure to credit risk by using master netting agreements and by
obtaining collateral in the form of cash or highly liquid securities. In respect of the Group's maximum credit risk relating to derivative assets of
£19,395 million (2010: £19,037 million), cash collateral of £5,269 million (2010: £1,429 million) was held and a further £7,875 million was due from
OECD banks (2010: £8,385 million).
At 31 December 2011
Trading and other
Hedging
Total derivative financial instruments
At 31 December 2010
Trading and other
Hedging
Total derivative financial instruments
AAA
£m
AA
£m
A
£m
BBB
£m
313
35
348
157
57
214
25,268
8,718
33,986
14,474
3,237
17,711
18,161
1,992
20,153
13,486
4,368
17,854
6,612
786
7,398
1,006
46
1,052
Rated BB
or lower
£m
3,588
9
3,597
86
–
86
Not rated
£m
Total
£m
2,908
65
2,973
10,475
943
11,418
53,163
12,850
66,013
43,371
7,406
50,777
Assets arising from reinsurance contracts held
Of the assets arising from reinsurance contracts held at 31 December 2011 of £2,534 million (2010: £2,146 million), £842 million (2010: £671 million)
were due from insurers with a credit rating of AA or above.
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.
329
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
C. Collateral held as security for financial assets
A general description of collateral held as security in respect of financial instruments is provided on pages 131 and 132. The Group holds collateral
against loans and receivables and irrevocable loan commitments; qualitative and, where appropriate, quantitative information is provided in
respect of this collateral below. Collateral held as security for trading and other financial assets at fair value through profit or loss and for derivative
assets is also shown below.
Loans and receivables
The disclosures below are produced under the combined businesses approach used for the Group’s segmental reporting. The Group believes
that, for reporting periods immediately following a significant acquisition, such as the acquisition of HBOS in 2009, this combined businesses basis,
which includes the allowance for loan losses at the acquisition on a gross basis, more fairly reflects the underlying provisioning status of the loans.
The Group holds collateral in respect of loans and advances to banks and customers as set out below. The Group does not hold collateral against
debt securities, comprising asset‑backed securities and corporate and other debt securities, which are classified as loans and receivables.
Loans and advances to banks
The Group may require collateral before entering into a credit commitment with another bank, depending on the type of financial product and the
counterparty involved, and netting arrangements are obtained whenever possible and to the extent that such agreements are legally enforceable.
Collateral is held as part of reverse repurchase or securities borrowing transactions.
There were reverse repurchase agreements which are accounted for as collateralised loans within loans and advances to banks with a carrying
value of £508 million (2010: £4,185 million), against which the Group held collateral with a fair value of £511 million (2010: £3,909 million), all of
which the Group is able to repledge. Included in these amounts in 2010 are collateral balances in the form of cash provided in respect of reverse
repurchase agreements amounting to £4 million.
These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.
Loans and advances to customers
The Group holds collateral against loans and advances to customers in the form of mortgages over residential and commercial real estate, charges
over business assets such as premises, inventory and accounts receivable, charges over financial instruments such as debt securities and equities,
and guarantees received from third parties.
Retail lending
Mortgages
An analysis by loan‑to‑value ratio of the Group’s residential mortgage lending is provided below. The value of collateral used in determining the
loan‑to‑value ratios has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house
prices, after making allowance for indexation error and dilapidations.
At 31 December 2011
Less than 70 per cent
70 per cent to 80 per cent
80 per cent to 90 per cent
90 per cent to 100 per cent
Greater than 100 per cent
Total
At 31 December 2010
Less than 70 per cent
70 per cent to 80 per cent
80 per cent to 90 per cent
90 per cent to 100 per cent
Greater than 100 per cent
Total
Neither
past due
nor impaired
£m
Past due but
not impaired
£m
137,224
60,236
53,113
40,236
39,918
330,727
Neither
past due
nor impaired
£m
140,267
57,979
53,732
43,263
44,268
3,203
1,894
2,250
2,182
3,213
12,742
Past due but
not impaired
£m
3,191
1,869
2,381
2,413
3,361
339,509
13,215
Impaired
£m
Gross
£m
1,420
843
1,103
1,196
3,503
8,065
141,847
62,973
56,466
43,614
46,634
351,534
Impaired
£m
Gross
£m
1,376
787
1,138
1,359
3,120
7,780
144,834
60,635
57,251
47,035
50,749
360,504
330
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Other
No collateral is held in respect of retail credit cards or overdrafts, or unsecured personal loans. For non‑mortgage retail lending to small
businesses, collateral will often include second charges over residential property and the assignment of life cover.
The majority of non‑mortgage retail lending is unsecured. At 31 December 2011, total non‑mortgage lending amounted to £47,085 million
(2010: £51,929 million), against which the Group held an impairment allowance of £1,848 million (2010: £2,587 million). Gross impaired
non‑mortgage lending amounted to £4,544 million (2010: £5,582 million). The fair value of the collateral held in respect of this lending was
£43 million (2010: £40 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation and
the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any
over‑collateralisation and to provide a clearer representation of the Group’s exposure.
Unimpaired non‑mortgage retail lending amounted to £42,541 million (2010: £46,347 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.
The Group credit risk disclosures for unimpaired non‑mortgage retail lending report assets gross of collateral and therefore disclose the maximum
loss exposure. The Group believes that this approach is appropriate. The value of collateral is reassessed if there is observable evidence of distress
of the borrower. Unimpaired non‑mortgage retail lending, including any associated collateral, is managed on a customer‑by‑customer basis rather
than a portfolio basis. No aggregated collateral information for the entire unimpaired non‑mortgage retail lending portfolio is provided to key
management personnel.
Wholesale lending
Reverse repurchase transactions
There were reverse repurchase agreements which are accounted for as collateralised loans with a carrying value of £16,835 million
(2010: £3,096 million), against which the Group held collateral with a fair value of £16,936 million (2010: £2,987 million), all of which the Group is
able to repledge. Included in these amounts are collateral balances in the form of cash provided in respect of reverse repurchase agreements
amounting to £34 million (2010: £42 million). These transactions were generally conducted under terms that are usual and customary for standard
secured lending activities.
Impaired lending
The value of collateral is re‑evaluated and its legal soundness re‑assessed if there is observable evidence of distress of the borrower; this evaluation
is used to determine potential loss allowances and management’s strategy to try to either repair the business or recover the debt.
At 31 December 2011, total wholesale lending amounted to £196,824 million (2010: £213,945 million), against which the Group held an impairment
allowance of £23,139 million (2010: £24,975 million). Gross impaired wholesale lending amounted to £47,660 million (2010: £51,244 million). The fair
value of the collateral held in respect of impaired wholesale lending which is secured was £13,977 million (2010: £14,520 million). In determining
the fair value of collateral, no specific amounts have been attributed to the costs of realisation. For the purposes of determining the total collateral
held by the Group in respect of impaired secured wholesale lending, the value of collateral for each loan has been limited to the principal amount
of the outstanding advance in order to eliminate the effects of any over‑collateralisation and to provide a clearer representation of the Group’s
exposure.
Impaired secured wholesale lending and associated collateral relates to lending to property companies and to customers in the financial, business
and other services; transport, distribution and hotels; and construction industries.
Unimpaired lending
Wholesale unimpaired lending amounted to £149,164 million (2010: £162,701 million). Wholesale 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. The types of collateral taken and the frequency with which collateral is required at origination
is dependent upon the size and structure of the borrower. For exposures to corporate customers and other large institutions, the Group will
often require the collateral to include a first charge over land and buildings owned and occupied by the business, a mortgagee debenture over
the company’s undertaking and one or more of its assets, and keyman insurance. The Group maintains policies setting out acceptable collateral,
maximum loan‑to‑value ratios and other criteria to be considered when reviewing a loan application. The decision as to whether or not collateral is
required will be based upon the nature of the transaction and the credit worthiness of the customer. Other than for project finance, object finance
and income producing real estate where charges over the subject assets are a basic requirement, the provision of collateral will not determine the
outcome of a credit application. The fundamental business proposition must evidence the ability of the business to generate funds from normal
business sources to repay debt.
The extent to which collateral values are actively managed will depend on the credit quality and other circumstances of the obligor. Although
lending decisions are predominantly based on expected cash flows, any collateral provided may impact the pricing and other terms of a loan or
facility granted; this will have a financial impact on the amount of net interest income recognised and on internal loss‑given‑default estimates that
contribute to the determination of asset quality.
For unimpaired wholesale lending which is secured the Group reports assets gross of collateral and therefore discloses the maximum loss
exposure. The Group believes that this approach is appropriate as collateral values at origination and during a period of good performance may
not be representative of the value of collateral if the obligor enters a distressed state.
331
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Unimpaired secured wholesale lending is predominantly managed on a cash flow basis. On occasion, it may include an assessment of underlying
collateral, although, for impaired lending, this will not always involve assessing it on a fair value basis. No aggregated collateral information for the
entire unimpaired secured wholesale lending portfolio is provided to key management personnel.
Trading and other financial assets at fair value through profit or loss (excluding equity shares)
In respect of trading and other financial assets at fair value through profit or loss, the fair value of collateral accepted under reverse repurchase
transactions which are accounted for as collateralised loans that the Group is permitted by contract or custom to sell or repledge was
£15,765 million (2010: £14,299 million). Of this, £3,740 million was sold or repledged (2010: £3,161 million).
In addition, securities held as collateral in the form of stock borrowed amounted to £10,438 million (2010: £72,224 million). Of this amount,
£5,308 million (2010: £52,393 million) had been resold or repledged as collateral for the Group’s own transactions.
These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.
Derivative assets, after offsetting of amounts under master netting arrangements
The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in the form of cash or highly
liquid securities. In respect of the net derivative assets after offsetting of amounts under master netting arrangements of £19,395 million
(2010: £19,037 million), cash collateral of £5,269 million (2010: £1,429 million) was held.
Irrevocable loan commitments and other credit-related contingencies
At 31 December 2011, the Group held irrevocable loan commitments and other credit‑related contingencies of £57,329 million
(2010: £67,809 million). Collateral is held as security, in the event that lending is drawn down, on £13,279 million (2010: £13,011 million) of these
balances.
Lending decisions in respect of irrevocable loan commitments are based on the obligor’s ability to repay from normal business operations rather
than reliance on the disposal of any security provided. For wholesale commitments, it is the Group’s practice to request collateral whose value is
commensurate with the nature of the commitment. For retail mortgage commitments, the majority are for mortgages with a loan ‑to‑value ratio of
less than 100 per cent. Aggregated collateral information covering the entire balance of irrevocable loan commitments over which security will be
taken is not provided to key management personnel.
D. Collateral pledged as security
Repo and stock lending transactions
The Group pledges assets primarily for repurchase agreements and securities lending transactions which are generally conducted under terms
that are usual and customary for standard securitised borrowing contracts.
The fair value of collateral pledged in respect of repurchase transactions, accounted for as secured borrowings, where the secured party is
permitted by contract or custom to repledge was £39,679 million (2010: £53,781 million). In addition, the following financial assets on the balance
sheet have been pledged as collateral as part of securities lending transactions:
Assets pledged
Trading and other financial assets at fair value through profit or loss
Loans and advances to customers
Debt securities classified as loans and receivables
Available‑for‑sale financial assets
2011
£m
3,102
37,926
398
1,618
43,044
2010
£m
4,289
102,151
4,324
13,375
124,139
In addition to the assets detailed above, the Group also holds assets that are encumbered through the Group’s asset‑backed conduits and its
securitisation and covered bond programmes. Further details of these assets are provided in notes 22 and 23.
E. Collateral repossessed
Residential property
Other
2011
£m
968
13
981
2010
£m
1,046
32
1,078
In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents
to realise the value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are
otherwise dealt with in accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets
held as collateral against wholesale lending. In such cases, the assets are carried on the Group’s balance sheet and are classified according to the
Group’s accounting policies.
332
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
F. Treatment of customers experiencing financial difficulty
The Group operates a number of schemes to assist borrowers who are experiencing financial difficulties. Details of the material elements of these
schemes are set out below and in the Risk Management report on pages 132 to 134.
Retail customers
The Group classifies the treatments offered to customers who have experienced financial difficulty into the following categories:
– Forbearance: a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original
contractual payments, for example capital payment breaks and payment assistance breaks. Any arrears existing at the commencement of the
arrangement are retained.
– Financial distress assistance: an arrangement for customers in financial distress where arrears accrue at the contractual payment, for example
short‑term arrangements to pay and term extensions.
– Repair: an account change used to repair a customer’s position when they have emerged from financial difficulty, for example capitalisation
of arrears.
Treatments offered to UK retail secured customers in financial difficulty
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.
Commensurate with the aim of this activity (i.e. to manage customers through their temporary financial difficulty) during the capital payment break
arrears accrue based on the temporary interest only contractual monthly payment. On expiry of the break, the customer is transferred back onto
capital and interest repayment terms, with the outstanding balance recovered across the remaining term of the original loan.
Forbearance – Payment assistance break
These agreements allow customers to suspend monthly payments for a limited period in order to address short‑term financial difficulties. This
treatment is only available as a forbearance tool to customers who are less than one monthly payment in arrears and for a maximum period of
three months during the term of the mortgage.
Arrears do not accrue during the break. The contractual monthly payment is recalculated at the end of the break to take account of missed interest
and, if appropriate, capital payments.
Financial distress – Term extension
These allow customers to permanently extend their mortgage term in order to reduce their contractual monthly payment. Term extensions are
rarely granted to customers in financial distress as the focus is on minimising the longer term impact on the customer. The maximum term for the
extension is aligned to the overall standard term limits for mortgages and, in general, the mortgage must be up to date.
The contractual monthly payment is reset when the term extension is implemented and any subsequent arrears will accrue based on this revised
payment.
Financial distress – Arrangement to pay
Customers who are experiencing short‑term financial difficulties may reach agreement with the Group to pay an amount differing from their
normal contractual monthly payment for a specified period of time. This is agreed with the customer as being affordable and practical based on
their individual circumstances. Arrangements to pay less than the contractual monthly payment can be granted for up to three months after which
the customer’s circumstances will be reviewed.
During the arrangement period, there is no clearing down of arrears such that, unless the customer is paying more than their contractual monthly
payment, arrears balances will remain and the loan will continue to be reported as impaired or past due. When customers come to the end of their
arrangement period they will continue to be managed as a mainstream collections case, if still in arrears.
Repair – Capitalisation of arrears
Once customers have evidenced recovery from financial difficulty and re‑established a strong payment record, this treatment allows the repair of
the customer’s financial position through the permanent capitalisation of arrears. Customers must demonstrate that they can meet the contractual
terms of their loan by making six consecutive contractual monthly payments and must give their permission for the capitalisation. Arrears may not
be capitalised more than twice in a five year period.
The contractual monthly payment is reset when the capitalisation is implemented to enable repayment over the original term. Any subsequent
arrears will accrue based on this revised payment.
333
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Customers receiving support from UK Government sponsored programmes
The Group participates in a number of UK Government sponsored programmes designed to support households, which are described on
page 133. Where these schemes provide borrowers with a state benefit that is used to service the loan, there is no change in the reported status of
the loan which is managed and reported in accordance with its original terms.
The Group assesses whether a loan benefitting from a UK Government sponsored programme is impaired using the same accounting policies
and practices as it does for loans not benefitting from such a programme. There is no direct impact on the impairment status of a loan benefitting
from the Mortgage Rescue schemes, as these schemes involve the purchase, and eventual sale, of the property. The loans included within the
Income Support for Mortgage Interest scheme and the Homeowner Mortgage Support scheme may be impaired, in accordance with the normal
definition of impairment.
The Income Support for Mortgage Interest scheme remains the most successful of the Government backed schemes. It is the longest‑running,
is the most widely known and provides both the customer and the Group with an assurance as to the maintenance of at least two years’ worth of
interest payments. The Group estimates that around £3 billion of its mortgage exposures are receiving this benefit. This includes those who are
also receiving other treatments for financial difficulty.
The Group’s own UK retail secured schemes have also shown signs of success with over 86 per cent of customers who have accepted capital
payment breaks having maintained or improved their arrears position over the twelve months after transfer. The Group believes that its mortgage
payment arrangements continue to be an effective way to manage short‑term affordability issues.
Treatments offered to Irish retail secured customers in financial difficulty
While the treatments offered to mortgage customers in financial difficulty in the UK and in Ireland are broadly similar, the current period of
economic distress in Ireland and resultant regulatory Code of Conduct on Mortgage Arrears have resulted in an environment of ongoing
assistance to customers, with greater flexibility within policy as to the duration and frequency of treatments. Care is taken to keep customers
informed of their position and their circumstances are regularly reviewed; at least every six months.
UK and Irish retail secured loans and advances
The amount of UK and Irish retail secured loans and advances subject to forbearance, financial distress and repair treatment at the period end is
set out below:
Total loans and advances receiving
treatment
Impairment allowance as % of loans
and advances receiving treatment
Forbearance
Financial distress1,2
Repair1
2011
£m
4,028
729
1,772
2010
£m
4,424
603
3,719
Total UK and Irish retail secured loans and advances
339,121
348,433
2011
%
2.7
9.8
6.7
0.8
2010
%
1.6
10.1
3.7
0.6
1
2
Where the treatment involves a permanent change to the contractual basis of the customer’s account (i.e. capitalisation of arrears and term extensions), those commenced during the year and
remaining as customers at the year end are shown.
The financial distress balances include arrangements to pay where the customer is paying less than the contractual payment and had such arrangements at the year end.
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.
Collective impairment assessment of retail secured loans subject to forbearance and similar treatments
Loans which have received forbearance or similar treatments are grouped with other assets with similar risk characteristics and assessed collectively
for impairment as described below. The loans are not considered as impaired loans unless they meet the standard definitions.
The Group's approach is to ensure that provisioning models, supported by management judgement, appropriately reflect the underlying loss risk
of exposures. The Group uses sophisticated behavioural scoring to assess customers' credit risk. The underlying behavioural scorecards consider
many different characteristics of customer behaviour, both static and dynamic, from internal sources and also from credit bureaux data, including
characteristics that may identify when a customer has been in arrears on products held with other firms. Hence, these models take a range of
potential indicators of customer financial distress into account.
The performance of such models is monitored and challenged on an ongoing basis, in line with the Group’s model governance policies. The
models are also regularly recalibrated to reflect up to date customer behaviour and market conditions. Specifically, regular detailed analysis of
modelled provision outputs is undertaken to demonstrate that the risk of forbearance or other similar activities is recognised, that the outcome
period adequately captures the risk and that the underlying risk is appropriately reflected. Where this is not the case, additional provisions are
applied to capture the risk.
334
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Treatments offered to UK retail unsecured customers in financial difficulty
Customers who are experiencing short‑term financial difficulties may reach agreement with the Group to pay an amount differing from their
normal contractual payment for a specified period of time. This is agreed with the customer as being affordable and practical based on their
individual circumstances. The terms of the arrangements and qualifying criteria depend on the unsecured product and on the assessment of
the customer’s ability to return to making normal payments.
UK retail unsecured loans and advances
UK retail unsecured loans and advances receiving forbearance and financial distress treatments at 31 December 2011 represent less than
2.5 per cent of the unsecured portfolios and, of that, over 90 per cent is already reported and provisioned for as impaired loans; in aggregate,
impairment provisions as a percentage of impaired loans in collections represent 86.5 per cent.
Collective impairment assessment of UK retail unsecured loans and advances subject to forbearance and similar treatments
Credit risk provisioning for the UK retail unsecured portfolio is undertaken on a purely collective basis. The approach used is based on segmented
cash flow models, divided into two primary streams for loans judged to be impaired and those that are not. Accounts subject to repayment plans
and collections refinance loans are among those considered to be impaired.
For exposures that are judged to be impaired, provisions are determined through modelling the expected cure rates, write‑off propensity and cash
flows. The segmentation is very granular with segments explicitly relating to repayment plans and refinance loans treatments. Payments of less
than the monthly contractual amount are reflected in reduced cash flow forecasts when calculating the impairment allowance for these accounts.
The output of the models is monitored and challenged on an ongoing basis. The models are run monthly meaning that current market conditions
and customer processes are reflected in the output. Where the risks identified are not captured in the underlying models, appropriate additional
provisions are made.
Wholesale customers
Wholesale credit facilities are reviewed on a regular basis and more frequently where required. When financial stress is exhibited, the customer is
typically transferred at an early stage to the specialist Business Support Unit (BSU) and Customer Support teams. In order to support wholesale
customers that encounter difficulties during the current economic downturn, the Group increased the size of its dedicated BSU to cover all its
UK and International portfolios. The Group has detailed processes to identify customers in financial distress. These are designed to ensure that
early warning signs are acted upon and the Group takes appropriate action and, where possible, works with each customer to try to resolve the
issues, to restore the business to a financially viable position and to facilitate a business turnaround. The main types of forbearance for wholesale
customers in financial distress are set out below.
Treatments offered to wholesale customers
Covenant resets and breach of covenant waivers
This consists of an agreement by the Group either to amend a clause in a loan agreement (or similar document) or to waive a breach of a clause,
which will typically relate to a financial commitment linked to the credit quality of the customer. The identification of a covenant breach will usually
occur through one of the following:
– the processing of audited or management accounts;
– contact from the customer during preparation of their compliance certificate;
– the receipt of customer information from which covenant compliance is calculated; or
– the receipt of a compliance certificate from a customer or agent.
A customer is not automatically classed as being in default as a result of a covenant breach, but an actual or projected breach will prompt a review
of the customer’s circumstances and their facilities.
Extension of facilities outside of agreed terms
These allow customers to formally extend their facility term in order to reduce their contractual repayments or to improve their liquidity position.
Term extensions are also granted as part of normal corporate activities.
Capital repayment holidays
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 repayments 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 repayment. The aim of this activity is to manage customers through their temporary financial distress, and accordingly, on expiry
of the break, the customer is transferred back onto capital and interest repayment terms, with the outstanding balance recovered across the
remaining term of the original loan.
Debt for equity swaps
This type of forbearance involves the Group writing off debt, either partially or in whole, in exchange for equity in the company, usually in the form
of ordinary shares, warrants, options or other equity instruments. The primary goals of debt for equity swaps are to reduce the debt service (capital
335
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
and interest) burden on the borrower, to encourage early repayment of outstanding loans to the Group, to protect the value of the residual debt
provided, and/or to benefit from any future growth in value of the borrower. Debt for equity swaps are typically used as a last resort.
Partial debt write off
An agreement to write off part of a contractual financial obligation in order to facilitate survival of a corporate entity on a going concern basis.
Partial debt write‑offs are typically used as a last resort.
G. Loans renegotiated during the year
Loans and advances that were renegotiated during the year that would otherwise have been past due or impaired totalled £2,505 million at
31 December 2011 (2010: £5,475 million). Details of loans and advances renegotiated are provided below:
Capitalisation of arrears
Interest rate adjustment
Payment holidays
Interest capitalisation
Forbearance of principal
Total
H. Credit market exposures
Total loans and advances
renegotiated during the year that
would otherwise have been past
due or impaired
2011
£m
1,677
28
172
269
359
2,505
2010
£m
2,804
337
221
10
2,103
5,475
The Group’s credit market exposures primarily relate to asset‑backed securities exposures held in Wholesale division. An analysis of the carrying
value of these exposures, which are classified as loans and receivables (note 24), available‑for‑sale financial assets (note 26) or trading and other
financial assets at fair value through profit or loss (note 18) depending on the nature of the investment, is set out below.
Asset-backed securities
Mortgage‑backed securities:
US residential
Non‑US residential
Commercial
Collateralised debt obligations:
Collateralised loan obligations
Other
Federal family education loan programme
Personal sector
Other asset‑backed securities
Total uncovered asset‑backed securities
Negative basis1
Total Wholesale asset-backed securities
Direct
Conduits (note 23)
Total Wholesale asset-backed securities
1
Negative basis means bonds held with separate matching credit default swap protection.
Loans and
receivables Available-for-sale
£m
£m
Trading
£m
Net exposure
at 31 December
2011
£m
Net exposure
at 31 December
2010
£m
4,063
1,837
1,175
7,075
915
264
1,179
3,380
145
314
12,093
–
12,093
9,067
3,026
12,093
–
1,189
613
1,802
195
–
195
146
366
322
2,831
36
2,867
1,317
1,550
2,867
–
99
–
99
52
–
52
–
–
20
171
150
321
321
–
321
4,063
3,125
1,788
8,976
1,162
264
1,426
3,526
511
656
15,095
186
15,281
10,705
4,576
15,281
4,242
7,898
3,516
15,656
4,686
494
5,180
7,777
3,967
1,035
33,615
1,109
34,724
22,296
12,428
34,724
336
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Exposures to monolines
At 31 December 2011, the Group had no direct exposure to sub‑investment grade monolines on credit default swap (CDS) contracts. Its exposure
to investment grade monolines through CDS contracts was £14 million (gross exposure: £168 million) and through wrapped loans and receivables
was £178 million (gross exposure: £274 million).
The exposure to monolines arising from negative basis trades is calculated as the mark‑to‑market of the CDS protection purchased from the
monoline insurer after credit valuation adjustments. The exposure to monolines on wrapped loans and receivables and bonds is the internal
assessment of amounts that will be recovered on interest and principal shortfalls.
In addition, the Group has £1,550 million (2010: £1,985 million) of monoline wrapped bonds and £274 million (2010: £425 million) of monoline
wrapped liquidity commitments on which the Group currently places no reliance on the guarantor.
An analysis of the Wholesale division’s asset‑backed securities portfolio by credit rating is provided below.
Net
Exposure
£m
AAA
£m
AA
£m
A
£m
BBB
£m
BB
£m
B
£m
Below
B
£m
Asset class
Mortgage‑backed securities:
US residential mortgage‑backed securities:
Prime
Alt‑A
Sub‑prime
Non‑US residential mortgage‑backed
securities
Commercial mortgage‑backed securities
Collateralised debt obligations:
Collateralised loan obligations
Other
Federal family education loan programme
Personal sector
Other asset‑backed securities
777
3,286
–
175
1,144
–
393
781
–
4,063
1,319
1,174
3,125
1,788
8,976
1,162
264
1,426
3,526
511
656
1,318
273
2,910
274
1
275
3,419
273
61
935
604
455
1
456
107
165
52
Total uncovered asset‑backed securities
15,095
6,938
3,493
Negative basis:1
Monolines
Banks
150
36
186
–
36
36
150
–
150
Total at 31 December 2011
Total at 31 December 2010
15,281
34,724
6,974
20,805
3,643
7,310
2,320
3,713
1,529
1,764
1
The external credit rating is based on the bond ignoring the benefit of the CDS.
2,713
1,777
1,259
97
633
–
730
399
648
100
651
–
751
309
199
331
–
331
–
15
197
2,320
–
–
–
7
111
118
–
58
94
1,529
–
–
–
12
77
–
89
164
64
317
50
151
201
–
–
252
770
–
–
–
770
763
–
–
–
–
–
–
–
16
–
16
–
–
–
16
–
–
–
16
147
–
–
–
–
–
–
–
29
–
29
–
–
–
29
–
–
–
29
222
337
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Liquidity risk
Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only
secure them at excessive cost. The Group carries out monthly stress testing of its liquidity position against a range of scenarios, including those
prescribed by the FSA. The Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics.
The table below analyses assets and liabilities of the Group into relevant maturity groupings based on the remaining contractual period at the
balance sheet date; balances with no fixed maturity are included in the over 5 years category.
Maturities of assets and liabilities
At 31 December 2011
Assets
Cash and balances at central banks
Trading and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and advances to banks
Loans and advances to customers
Debt securities held as loans and receivables
Available‑for‑sale financial assets
Held‑to‑maturity investments
Other assets
Total assets
Liabilities
Deposits from banks
Customer deposits
Derivative financial instruments, trading and other financial liabilities at
fair value through profit or loss
Debt securities in issue
Liabilities arising from insurance and investment contracts
Other liabilities
Subordinated liabilities
Total liabilities
At 31 December 2010
Assets
Cash and balances at central banks
Trading and other financial assets at fair value through profit or loss
Derivative financial instruments
Loans and advances to banks
Loans and advances to customers
Debt securities held as loans and receivables
Available‑for‑sale financial assets
Held‑to‑maturity investments
Other assets
Total assets
Liabilities
Deposits from banks
Customer deposits
Derivative financial instruments, trading and other financial liabilities at
fair value through profit or loss
Debt securities in issue
Liabilities arising from insurance and investment contracts
Other liabilities
Subordinated liabilities
Total liabilities
Up to
1 month
£m
1-3
months
£m
3-12
months
£m
1-5
years
£m
Over 5
years
£m
Total
£m
60,420
10,508
2,327
22,976
68,983
98
296
6,791
1,719
3,261
6
2,919
3,699
2,241
–
–
60,722
7,968
111,324
139,510
20,498
37,770
3,671
457
66,013
32,606
10,146
31,056
105,808
349,645
565,638
–
1,389
1,247
–
5,273
–
532
8
712
–
841
689
6,348
340
448
11,675
27,710
7,758
12,470
37,406
8,098
40,989
48,083
171,974
23,992
41,482
145,770
587,328
970,546
19,284
3,680
4,459
324,702
15,995
33,518
11,315
38,067
1,072
1,624
39,810
413,906
10,612
31,285
11,723
14,951
157
4,838
6,729
21,407
39,581
83,167
22,158
29,137
55,350
47,129
185,059
1,786
5,568
19,971
89,879
128,927
407
149
963
1,006
3,406
7,581
18,267
37,994
26,196
35,089
412,714
49,013
81,380
157,097
223,748
923,952
37,737
7,579
2,889
22,520
58,392
57
2,745
110
4,920
250
5,503
–
585
136,949
30,943
24,445
311,899
11,938
24,151
15,425
15,426
122
10,308
14,557
4,313
39,243
1,550
595
1,294
70
9,541
1,691
2,754
308
8,948
3,860
2,550
–
6,192
17,492
1,529
–
38,115
123,931
156,191
24,845
919
50,777
30,272
10,549
28,193
114,102
381,361
592,597
374
3,535
–
1,140
48,908
4,152
30,790
8,469
46,629
5,337
933
1,317
2,941
12,761
–
604
22,113
18,411
7,795
39,778
25,735
42,955
7,905
47,027
155,621
619,153
991,574
9,467
33,802
20,003
67,190
20,174
8,049
9,049
1,991
2,585
50,363
393,633
24,197
51,653
90,249
8,920
24,450
68,920
228,866
132,735
33,923
36,232
403,406
71,860
97,627
167,734
204,045
944,672
338
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
The above tables are provided on a contractual basis. The Group’s assets and liabilities may be repaid or otherwise mature earlier or later than
implied by their contractual terms and readers are, therefore, advised to use caution when using this data to evaluate the Group’s liquidity position.
The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment
contracts, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining
period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
At 31 December 2011
Deposits from banks
Customer deposits
Up to
1 month
£m
1-3
months
£m
3-12
months
£m
1-5
years
£m
Over 5
years
£m
Total
£m
19,504
4,368
5,517
10,469
1,292
41,150
322,752
16,253
33,558
41,398
1,816
415,777
Trading and other financial liabilities at fair value through profit or loss
10,284
2,336
3,516
6,491
3,602
26,229
Debt securities in issue
34,801
27,173
26,040
74,735
32,855
195,604
Liabilities arising from non‑participating investment contracts
27,429
–
–
–
22,207
49,636
Subordinated liabilities
284
392
3,538
17,296
33,604
55,114
Total non-derivative financial liabilities
415,054
50,522
72,169
150,389
95,376
783,510
Derivative financial liabilities:
Gross settled derivatives – outflows
Gross settled derivatives – inflows
Gross settled derivatives – net flows
Net settled derivatives liabilities
Total derivative financial liabilities
At 31 December 2010
Deposits from banks
Customer deposits
Trading and other financial liabilities at fair value through profit or loss
Debt securities in issue
Liabilities arising from non‑participating investment contracts
Subordinated liabilities
Total non‑derivative financial liabilities
Derivative financial liabilities:
Gross settled derivatives – outflows
Gross settled derivatives – inflows
Gross settled derivatives – net flows
Net settled derivatives liabilities
Total derivative financial liabilities
28,830
4,610
6,700
26,496
17,893
84,529
(2,258)
(2,911)
(5,655)
(21,243)
(13,835)
(45,902)
26,572
20,339
46,911
24,911
306,469
11,293
31,234
12,944
–
386,851
1,699
179
1,878
11,804
15,031
2,218
41,143
91
1,107
71,394
1,045
1,071
2,116
4,301
32,626
5,125
52,582
265
4,615
5,253
2,684
7,937
10,557
38,529
5,544
91,893
1,743
17,702
4,058
38,627
863
25,136
4,921
63,763
922
3,019
3,632
35,201
36,320
35,067
52,495
395,674
27,812
252,053
51,363
58,491
99,514
165,968
114,161
837,888
26,069
14,832
8,942
65,734
42,410
157,987
(10,442)
(14,978)
(9,270)
(66,232)
(41,815)
(142,737)
15,627
2,492
18,119
(146)
2,066
1,920
(328)
5,797
5,469
(498)
11,576
11,078
595
3,331
3,926
15,250
25,262
40,512
In addition, the Group has a maximum credit risk exposure of £10,831 million (2010: £22,975 million) in respect of financial guarantees.
The majority of the Group’s non‑participating investment contract liabilities are unit‑linked. These unit‑linked products are invested in accordance
with unit fund mandates. Clauses are included in policyholder contracts to permit the deferral of sales, where necessary, so that linked assets can
be realised without being a forced seller.
The principal amount for undated subordinated liabilities with no redemption option is included within the over five years column; interest of
approximately £187 million (2010: £448 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not
included beyond five years.
Further information on the Group’s liquidity exposures is provided on pages 112 to 118.
339
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 56: Financial risk management (continued)
Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows:
At 31 December 2011
At 31 December 2010
Up to
1 month
£m
748
2,481
1-3
months
£m
1,724
1,459
3-12
months
£m
5,257
5,072
1-5
years
£m
18,132
18,431
Over 5
years
£m
53,130
53,286
Total
£m
78,991
80,729
The following tables set out the amounts and residual maturities of Lloyds Banking Group’s off balance sheet contingent liabilities and
commitments.
At 31 December 2011
Acceptances and endorsements
Other contingent liabilities
Total contingent liabilities
Lending commitments
Other commitments
Total commitments
Total contingents and commitments
At 31 December 2010
Acceptances and endorsements
Other contingent liabilities
Total contingent liabilities
Lending commitments
Other commitments
Total commitments
Total contingents and commitments
Within
1 year
£m
81
1,514
1,595
71,216
701
71,917
73,512
Within
1 year
£m
48
1,897
1,945
76,456
1,038
77,494
79,439
1-3
years
£m
–
1,092
1,092
13,999
–
13,999
15,091
1‑3
years
£m
–
1,248
1,248
22,537
61
22,598
23,846
3-5
years
£m
–
426
426
17,380
–
17,380
17,806
3‑5
years
£m
–
269
269
13,424
–
13,424
13,693
Over 5
years
£m
–
757
757
2,287
–
2,287
3,044
Over 5
years
£m
–
717
717
3,739
43
3,782
4,499
Total
£m
81
3,789
3,870
104,882
701
105,583
109,453
Total
£m
48
4,131
4,179
116,156
1,142
117,298
121,477
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.
Capital risk appetite is set by the Board and reported through various metrics that enable the Group to manage capital constraints and market
expectations. The Group Chief Executive, assisted by the Group Asset and Liability Committee, regularly reviews performance against risk
appetite. A key metric is the Group’s core tier 1 capital ratio which the Group currently aims to maintain prudently in excess of 10 per cent.
The Group maintains its own buffer to ensure that the regulatory minimum requirements and regulatory targets and buffers are met at all times.
Additionally an extensive series of stress analyses is undertaken during the year to determine the adequacy of the Group’s capital resources
against the FSA minimum requirements in severe economic conditions.
Insurance risk
Insurance risk is the risk of reductions in earnings, capital and/or value, through financial or reputational loss, due to fluctuations in the timing,
frequency and severity of insured/underwritten events and to fluctuations in the timing and amount of claim settlements. This includes fluctuations
in profits due to customer behaviour.
The Group’s appetite for solvency and earnings in insurance entities is reviewed and approved annually by the Board. Insurance risks are measured
using a variety of techniques including stress and scenario testing, and, where appropriate, stochastic modelling. Ongoing monitoring is in place
to track the progression of insurance risks. This normally involves monitoring relevant experiences against expectations, as well as evaluating the
effectiveness of controls put in place to manage insurance risk.
340
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 57: Consolidated cash flow statement
(A) Change in operating assets
Change in loans and receivables
Change in derivative financial instruments, trading and other financial assets
at fair value through profit or loss
Change in other operating assets
Change in operating assets
(B) Change in operating liabilities
Change in deposits from banks
Change in customer deposits
Change in debt securities in issue
Change in derivative financial instruments, trading and other liabilities
at fair value through profit or loss
Change in investment contract liabilities
Change in other operating liabilities
Change in operating liabilities
2011
£m
39,361
5,867
(1,131)
44,097
2011
£m
(10,480)
20,283
(43,893)
14,249
793
(139)
(19,187)
2010
£m
40,101
(7,378)
(863)
31,860
2010
£m
(32,162)
(13,249)
(5,655)
160
8,161
(2,938)
(45,683)
2009
£m
50,935
12,063
(1,056)
61,942
2009
£m
(71,267)
11,474
(26,578)
(27,037)
5,415
2,066
(105,927)
341
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 57: Consolidated cash flow statement (continued)
(C) Non-cash and other items
Depreciation and amortisation
Impairment of tangible fixed assets
Revaluation of investment properties
Allowance for loan losses
Write‑off of allowance for loan losses
Impairment of available‑for‑sale financial assets
Impairment of goodwill
Change in insurance contract liabilities
Customer goodwill payments provision
Payment protection insurance provision
German insurance business litigation provision
Other provision movements
Net charge (credit) in respect of defined benefit schemes
Gain on acquisition
Impact of consolidation and deconsolidation of OEICs1
Unwind of discount on impairment allowances
Foreign exchange impact on balance sheet2
Liability management gains within other income3
Interest expense on subordinated liabilities
Loss on disposal of businesses
Other non‑cash items
Total non-cash items
Contributions to defined benefit schemes
Payments in respect of customer goodwill payments provision
Payments in respect of payment protection insurance provision
Other
Total other items
Non-cash and other items
2011
£m
2,175
65
107
8,069
(7,405)
80
–
(2,081)
–
3,200
175
(294)
199
–
(6,094)
(226)
302
(599)
2,155
21
1,186
1,035
(838)
(497)
(1,045)
6
(2,374)
(1,339)
2010
£m
2,432
202
(434)
10,771
(6,909)
106
–
4,021
500
–
–
49
(455)
–
(878)
(403)
(1,159)
(423)
3,619
314
472
11,825
(653)
–
–
1
(652)
11,173
2009
£m
2,560
–
214
16,028
(4,090)
602
240
5,986
–
–
–
95
529
(11,173)
(660)
(446)
156
(1,498)
2,550
–
(340)
10,753
(1,867)
–
–
21
(1,846)
8,907
1
2
3
These OEICs (Open‑ended investment companies) are mutual funds which are consolidated if the Group manages the funds and also has a majority beneficial interest. The population of OEICs
to be consolidated varies at each reporting date as external investors acquire and divest holdings in the various funds. The consolidation of these funds is effected by the inclusion of the fund
investments and a matching liability to the unitholders; and changes in funds consolidated represent a non‑cash movement on the balance sheet.
When considering the movement on each line of the balance sheet, the impact of foreign exchange rate movements is removed in order to show the underlying cash impact.
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.
342
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 57: Consolidated cash flow statement (continued)
(D) Analysis of cash and cash equivalents as shown in the balance sheet
Cash and balances at central banks
Less: mandatory reserve deposits1
Loans and advances to banks
Less: amounts with a maturity of three months or more
Total cash and cash equivalents
2011
£m
60,722
(1,070)
59,652
32,606
(6,369)
26,237
85,889
2010
£m
38,115
(1,089)
37,026
30,272
(4,998)
25,274
62,300
2009
£m
38,994
(728)
38,266
35,361
(7,937)
27,424
65,690
1
Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day‑to‑day operations.
Included within cash and cash equivalents at 31 December 2011 is £21,601 million (2010: £14,694 million; 2009:£13,323 million) held within the
Group’s life funds, which is not immediately available for use in the business.
(E) Acquisition of group undertakings and businesses
Net assets of HBOS acquired (note 14)
Satisfied by:
Issue of shares
Gain on acquisition
Cash and cash equivalents acquired, net of acquisition costs
Net cash inflow arising from acquisition of HBOS
Acquisition of and additional investment in joint ventures
Net cash (outflow) inflow arising from acquisitions in the year
Payments to former members of Scottish Widows Fund and Life Assurance Society acquired
during 2000
Net cash (outflow) inflow
(F) Disposal and closure of group undertakings and businesses
Intangible assets
Other net assets and liabilities
Loss on sale of businesses
Net cash inflow from disposals
2011
£m
–
–
–
–
–
–
(10)
(10)
(3)
(13)
2011
£m
–
319
319
(21)
298
2010
£m
–
–
–
–
–
–
(65)
(65)
(8)
(73)
2010
£m
–
742
742
(314)
428
2009
£m
18,960
(7,651)
(11,173)
16,341
(2,483)
16,477
(215)
16,262
(35)
16,227
2009
£m
170
241
411
–
411
343
Annual Report and Accounts 2011
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 58: Future accounting developments
The following pronouncements may have a significant effect on the Group’s financial statements but are not applicable for the year ending
31 December 2011 and have not been applied in preparing these financial statements. Save as disclosed, the full impact of these accounting
changes is being assessed by the Group.
Pronouncement
Nature of change
IASB effective date
Amendments to IFRS 7 Financial
Instruments: Disclosures –
‘Disclosures-Offsetting Financial
Assets and Financial Liabilities’
IFRS 10 Consolidated
Financial Statements
IFRS 12 Disclosure of Interests in
Other Entities
IFRS 13 Fair Value Measurement
IAS 19 Employee Benefits
Amendments to IAS 32 Financial
Instruments: Presentation –
‘Offsetting Financial Assets and
Financial Liabilities’
IFRS 9 Financial Instruments1
Requires an entity to disclose information to enable users of its
financial statements to evaluate the effect or potential effect of netting
arrangements on the entity’s balance sheet.
Annual and interim periods
beginning on or after
1 January 2013.
Supersedes IAS 27 Consolidated and Separate Financial Statements
and SIC‑12 Consolidation – Special Purpose Entities and establishes
principles for the preparation of consolidated financial statements when
an entity controls one or more entities.
Requires an entity to disclose information that enables users of financial
statements to evaluate the nature of, and risks associated with, its
interests in other entities and the effects of those interests on its financial
position, financial performance and cash flows.
The standard defines fair value, sets out a framework for measuring fair
value and requires disclosures about fair value measurements. It applies
to IFRSs that require or permit fair value measurements or disclosures
about fair value measurements.
Prescribes the accounting and disclosure by employers for employee
benefits. Actuarial gains and losses (remeasurements) in respect of
defined benefit pension schemes can no longer be deferred using
the corridor approach and must be recognised immediately in other
comprehensive income. At 31 December 2011, unrecognised actuarial
losses were £539 million. The income statement charge for 2011
would have been approximately £200 million higher under the revised
standard.
Inserts application guidance to address inconsistencies identified
in applying the offsetting criteria used in the standard. Some gross
settlement systems may qualify for offsetting where they exhibit certain
characteristics akin to net settlement.
Replaces those parts of IAS 39 Financial Instruments: Recognition
and Measurement relating to the classification, measurement and
derecognition of financial assets and liabilities. Requires financial
assets to be classified into two measurement categories, fair value and
amortised cost, on the basis of the objectives of the entity’s business
model for managing its financial assets and the contractual cash flow
characteristics of the instruments. The available‑for‑sale financial asset
and held‑to‑maturity investment categories in IAS 39 will be eliminated.
The requirements for financial liabilities and derecognition are broadly
unchanged from IAS 39.
Annual periods beginning
on or after 1 January 2013.
Annual periods beginning
on or after 1 January 2013.
Annual periods beginning
on or after 1 January 2013.
Annual periods beginning
on or after 1 January 2013.
Annual periods beginning
on or after 1 January 2014.
Annual periods beginning
on or after 1 January 2015.
1
IFRS 9 is the initial stage of the project to replace IAS 39. Future stages are expected to result in amendments to IFRS 9 to deal with changes to the impairment of financial assets measured at
amortised cost and hedge accounting. Until all stages of the replacement project are complete, it is not possible to determine the overall impact on the financial statements of the replacement
of IAS 39.
At the date of this report, these pronouncements are awaiting EU endorsement.
Note 59: Approval of financial statements
The consolidated financial statements were approved by the directors of Lloyds Banking Group plc on 27 February 2012.
344
Annual Report and Accounts 2011
REPORT OF THE INDEPENDENT AUDITORS ON THE
PARENT COMPANY FINANCIAL STATEMENTS
Independent auditors’ report to the members of Lloyds Banking Group plc
We have audited the parent company financial statements of Lloyds Banking Group plc for the year ended 31 December 2011 which comprise
the parent company balance sheet, the parent company statement of changes in equity, the parent company cash flow statement and the
related notes. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting
Standards (IFRSs) as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006.
Respective responsibilities of directors and auditors
As explained more fully in the Directors’ Responsibilities Statement on page 176, the directors are responsible for the preparation of the parent
company financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the
parent company financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards
require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
This report, including the opinions, has been prepared for and only for the Company’s members as a body in accordance with Chapter 3 of Part 16
of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose
or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
Scope of the audit of the financial statements
An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the
financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting
policies are appropriate to the parent company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness
of significant accounting estimates made by the directors; and the overall presentation of the financial statements. In addition, we read all the
financial and non-financial information in the Annual Report and Accounts to identify material inconsistencies with the audited financial statements.
If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Opinion on financial statements
In our opinion the parent company financial statements:
– give a true and fair view of the state of the Company’s affairs as at 31 December 2011 and of its cash flows for the year then ended;
– have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of
the Companies Act 2006; and
– have been prepared in accordance with the requirements of the Companies Act 2006.
Opinion on other matters prescribed by the Companies Act 2006
In our opinion:
– the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and
– the information given in the Directors’ Report for the financial year for which the parent company financial statements are prepared is consistent
with the parent company financial statements.
Matters on which we are required to report by exception
We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion:
– adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from
branches not visited by us; or
– the parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the
accounting records and returns; or
– certain disclosures of directors’ remuneration specified by law are not made; or
– we have not received all the information and explanations we require for our audit.
Other matter
We have reported separately on the group financial statements of Lloyds Banking Group plc for the year ended 31 December 2011.
Philip Rivett
Senior Statutory Auditor
for and on behalf of PricewaterhouseCoopers LLP
Chartered Accountants and Statutory Auditors
London
27 February 2012
(a)
The maintenance and integrity of the Lloyds Banking Group plc website is the responsibility of the directors; the work carried out by the
auditors does not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have
occurred to the financial statements since they were initially presented on the website.
(b) Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in
other jurisdictions.
345
Annual Report and Accounts 2011
PARENT COMPANY BALANCE SHEET
at 31 December
Assets
Non-current assets:
Investment in subsidiaries
Loans to subsidiaries
Deferred tax asset
Current assets:
Derivative financial instruments
Other assets
Amounts due from subsidiaries
Cash and cash equivalents
Current tax recoverable
Total assets
Equity and liabilities
Capital and reserves:
Share capital
Share premium account
Merger reserve
Capital redemption reserve
Retained profits
Total equity
Non-current liabilities:
Debt securities in issue
Subordinated liabilities
Current liabilities:
Debt securities in issue
Current tax liabilities
Other liabilities
Total liabilities
Total equity and liabilities
The accompanying notes are an integral part of the parent company financial statements.
The directors approved the parent company financial statements on 27 February 2012.
Sir Winfried Bischoff
Chairman
António Horta-Osório
Group Chief Executive
Note
2011
£ million
2010
£ million
9
9
2
3
4
4
5
5
6
8
7
40,534
8,286
8
48,828
1,660
880
212
1,105
–
3,857
52,685
6,881
16,541
7,764
4,115
2,198
37,499
38,194
8,332
6
46,532
1,664
1,040
217
375
109
3,405
49,937
6,815
16,291
7,764
4,115
2,276
37,261
555
–
4,308
4,074
4,863
4,074
–
10
10,313
10,323
15,186
52,685
549
–
8,053
8,602
12,676
49,937
346
Annual Report and Accounts 2011
PARENT COMPANY STATEMENT OF CHANGES IN EQUITY
PARENT COMPANY STATEMENT OF CHANGES IN EQUITY
at 31 December 2011
Balance at 1 January 2009
Total comprehensive income1
Issue of ordinary shares:
Placing and open offer
Issued on acquisition of HBOS
Placing and compensatory open offer
Rights issue
Issued to Lloyds TSB Foundations
Transfer to merger reserve
Redemption of preference shares
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
Balance at 31 December 2009
Total comprehensive income1
Issue of ordinary shares
Cancellation of deferred shares
Redemption of preference shares
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
Balance at 31 December 2010
Total comprehensive income1
Issue of ordinary shares
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
Balance at 31 December 2011
Share capital
and premium
£ million
Merger
reserve
£ million
Capital
redemption
reserve
£ million
3,609
–
649
1,944
3,905
13,112
41
(1,000)
2,684
–
–
–
24,944
–
2,237
(4,086)
11
–
–
–
23,106
–
316
–
–
–
–
–
3,781
5,707
–
–
–
1,000
(2,710)
–
–
–
7,778
–
–
–
(14)
–
–
–
–
–
–
–
–
–
–
26
–
–
–
26
–
–
4,086
3
–
–
–
7,764
4,115
–
–
–
–
–
–
–
–
–
–
23,422
7,764
4,115
Retained
profits1
£ million
2,147
303
–
–
–
–
–
–
–
(12)
74
35
2,547
(799)
–
–
–
(10)
129
409
2,276
(168)
–
(291)
Total
£ million
5,756
303
4,430
7,651
3,905
13,112
41
–
–
(12)
74
35
35,295
(799)
2,237
–
–
(10)
129
409
37,261
(168)
316
(291)
143
238
2,198
143
238
37,499
1
Total comprehensive income comprises only the profit (loss) for the year; no income statement has been shown for the parent company, as permitted by section 408 of the Companies Act 2006.
347
Annual Report and Accounts 2011
PARENT COMPANY CASH FLOW STATEMENT
at 31 December
(Loss) profit before tax
Dividend income
Fair value and exchange adjustments
Change in other assets
Change in other liabilities and other items
Tax received (paid)
Net cash provided by (used in) operating activities
Cash flows from investing activities
Costs incurred in respect of the acquisition of HBOS plc
Capital injection into HBOS plc
Capital injection into Lloyds TSB Bank plc
Amounts advanced to subsidiaries
Redemption of loans to subsidiaries
Net cash used in investing activities
Cash flows from financing activities
Dividends received from subsidiaries
Interest paid on subordinated liabilities
Proceeds from issue of debt securities
Repayment of debt securities in issue
Proceeds from issue of subordinated liabilities
Repayment of subordinated liabilities
Proceeds from issue of ordinary shares
Net cash (used in) provided by financing activities
Change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
The accompanying notes are an integral part of the parent company financial statements.
2011
£ million
(202)
–
329
255
2,576
151
3,109
–
–
(2,340)
–
–
(2,340)
–
(39)
–
–
–
–
–
(39)
730
375
1,105
2010
£ million
(961)
–
198
1,021
(2,466)
122
(2,086)
–
–
–
(1,425)
850
(575)
–
–
549
(350)
–
–
–
199
(2,462)
2,837
375
2009
£ million
182
(354)
(428)
(1,277)
7,020
(70)
5,073
(138)
(8,500)
(5,600)
(7,593)
1,552
(20,279)
354
–
–
(2,045)
1,000
(4,000)
21,533
16,842
1,636
1,201
2,837
348
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 1: Accounting policies
The Company has applied International Financial Reporting Standards as adopted by the European Union in its financial statements for the year
ended 31 December 2011. IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board and
those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations
Committee and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments: Recognition and Measurement relaxes some of
the hedge accounting requirements; the Company has not taken advantage of this relaxation, and therefore there is no difference in application
to the Company between IFRS as adopted by the EU and IFRS as issued by the IASB.
The financial information has been prepared under the historical cost convention, as modified by the revaluation of all derivative contracts.
The accounting policies of the Company are the same as those of the Group which are set out in note 2 to the consolidated financial statements,
except that it has no policy in respect of consolidation and investments in subsidiaries are carried at historical cost, less any provisions for
impairment.
Note 2: Deferred tax asset
The movement in the net deferred tax asset is as follows:
At 1 January
Income statement credit
At 31 December
The deferred tax asset relates to temporary differences.
Note 3: Amounts due from subsidiaries
2011
£m
6
2
8
2010
£m
3
3
6
These comprise short-term lending to subsidiaries, repayable on demand. The fair values of amounts owed by subsidiaries are equal to their
carrying amounts. No provisions have been recognised in respect of amounts owed by subsidiaries.
Note 4: Share capital and share premium
Details of the Company’s share capital and share premium account are as set out in notes 47 and 48 to the consolidated financial statements.
349
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 5: Other reserves
The merger reserve comprises the premium on shares issued on 13 January 2009 under the placing and open offer and shares issued on
16 January 2009 on the acquisition of HBOS plc.
The capital redemption reserve represents transfers from the merger reserve in accordance with companies’ legislation and amounts transferred
from share capital following the cancellation of the deferred shares.
Movements in other reserves were as follows:
Merger reserve
At 1 January
Placing and open offer
Shares issued on acquisition of HBOS
Issue of preference shares1
Redemption of preference shares2
At 31 December
Capital redemption reserve
At 1 January
Redemption of preference shares2
Cancellation of deferred shares
At 31 December
2011
£m
2010
£m
7,764
7,778
–
–
–
–
7,764
2011
£m
4,115
–
–
4,115
–
–
–
(14)
7,764
2010
£m
26
3
4,086
4,115
2009
£m
–
3,781
5,707
1,000
(2,710)
7,778
2009
£m
–
26
–
26
1
2
Distributable reserves of £1,000 million arose on the issue of preference shares in January 2009 which were classified as debt. In June 2009, these preference shares were redeemed out of the
proceeds of the placing and compensatory open offer of ordinary shares and the distributable element of this issue was transferred to the merger reserve.
In January 2010, the Company repurchased and cancelled certain preference shares amounting to £14 million. This resulted in a transfer of £3 million from the merger reserve to the capital
redemption reserve and a transfer of £11 million from the merger reserve to the share premium account. Details of the preference shares redeemed are set out in note 46 to the consolidated
financial statements. In December 2009, the Group redeemed eight issues of preference shares in exchange for the issuance of Enhanced Capital Notes. This resulted in a transfer of £26 million
from the merger reserve to the capital redemption reserve and a transfer of £2,684 million from the merger reserve to the share premium account.
Note 6: Retained profits
At 1 January 2009
Profit for the year
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
At 31 December 2009
Loss for the year
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
At 31 December 2010
Loss for the year
Movement in treasury shares
Value of employee services:
Share option schemes
Other employee award schemes
At 31 December 2011
Details of the Company’s dividends are as set out in note 51 to the consolidated financial statements.
£m
2,147
303
(12)
74
35
2,547
(799)
(10)
129
409
2,276
(168)
(291)
143
238
2,198
350
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 7: Subordinated liabilities
These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer.
Any repayments of subordinated liabilities require the consent of the Financial Services Authority.
Preference shares
6% Non-Cumulative Redeemable Preference Shares
7.875% Non-Cumulative Preference Shares callable 2013 (US$1,250 million)
7.875% Non-Cumulative Preference Shares callable 2013 (e500 million)
6.0884% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2015 (£745 million)
5.92% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2015 (US$750 million)
6.267% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2016 (US$1,000 million)
6.3673% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2019 (£335 million)
6.475% Non-Cumulative Preference Shares callable 2024 (£186 million)
6.413% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2035 (US$750 million)
6.657% Non-Cumulative Fixed to Floating Rate Preference Shares callable 2037 (US$750 million)
9.25% Non-Cumulative Irredeemable Preference Shares (£300 million)
9.75% Non-Cumulative Irredeemable Preference Shares (£100 million)
Total preference shares
Undated subordinated liabilities
6.0884% Undated Subordinated Notes callable 2015 (£732 million)
6.369% Undated Subordinated Notes callable 2015 (£597 million)
5.92% Undated Subordinated Notes callable 2015 (US$378 million)
6.267% Undated Subordinated Notes callable 2016 (US$466 million)
6.3673% Undated Subordinated Notes callable 2019 (£331 million)
6.475% Undated Subordinated Notes callable 2024 (£102 million)
6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million)
6.413% Undated Subordinated Notes callable 2035 (US$375 million)
6.657% Undated Subordinated Notes callable 2037 (US$316 million)
Total undated subordinated liabilities
Dated subordinated liabilities
9.125% Subordinated Bonds 2011 (£150 million)
5.875% Subordinated Guaranteed Bonds 2014 (€750 million)
Total dated subordinated liabilities
Total subordinated liabilities
Note
a
a
a
a
a
a
a
a
a
a
a
a
b
2011
£m
–
170
83
10
124
306
2
38
114
131
266
54
2010
£m
–
119
57
9
110
279
2
34
98
115
239
49
1,298
1,111
642
533
188
227
291
87
11
171
143
578
480
164
198
266
80
11
155
130
2,293
2,062
–
717
717
4,308
152
749
901
4,074
a Further information regarding these issues can be found in note 46 to the consolidated financial statements.
b In certain circumstances, these bonds would acquire the characteristics of preference share capital. They are accounted for as liabilities as coupon payments are mandatory as a consequence of
the terms of the 6 per cent non-cumulative redeemable preference shares. At the callable date the coupon on these bonds will be reset by reference to the applicable five year benchmark gilt
rate. Further information regarding this can be found in note 46 to the consolidated financial statements.
351
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 8: Debt securities in issue
These comprise US$862.5 million 7.75% Public Income Notes due 2050 issued by the Company in July 2010.
Note 9: Related party transactions
In January 2009 HM Treasury became a related party of the Company and has remained so during 2010 and 2011. From 1 January 2011, in
accordance with IAS 24 (Revised), UK Government-controlled entities also became related parties of the Group. Further information on the
relationship and transactions with HM Treasury and UK Government-controlled entities is given in note 53 to the consolidated financial statements.
Key management personnel
The key management personnel of the Group and the Company are the same. The relevant disclosures are given in note 53 to the consolidated
financial statements.
The Company has no employees (2010: nil).
As discussed in note 52 to the consolidated financial statements, the Group provides share-based compensation to employees through a number
of schemes; these are all in relation to shares in the Company and the cost of providing those benefits is recharged to the employing companies in
the Group on a cash basis.
Investment in subsidiaries
At 1 January
Capital injections into Lloyds TSB Bank plc
Transfer of HBOS to Lloyds TSB Bank plc
At 31 December
2011
£m
38,194
2,340
–
40,534
2010
£m
32,584
27,005
(21,395)
38,194
As part of a reorganisation of the Lloyds Banking Group on 1 January 2010, the Company transferred its direct investment in 100 per cent of the
issued ordinary share capital of HBOS plc to its subsidiary, Lloyds TSB Bank plc. The consideration for this transfer was the issue of 21.4 million
shares by Lloyds TSB Bank plc to the Company for a total value of £21,395 million.
The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of
Lloyds Banking Group plc, are:
Lloyds TSB Bank plc
Scottish Widows plc
HBOS plc
Bank of Scotland plc
St. Andrew’s Insurance plc
Clerical Medical Investment Group Limited
Clerical Medical Managed Funds Limited
1
Indirect interest.
Country of
registration/
incorporation
England
Scotland
Scotland
Scotland
England
England
England
Percentage
of equity
share capital
and voting
rights held
100%
100%1
100%1
100%1
100%1
100%1
100%1
Nature of business
Banking and financial services
Life assurance
Holding company
Banking and financial services
General insurance
Life assurance
Life assurance
The principal area of operation for each of the above subsidiaries is the United Kingdom.
352
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 9: Related party transactions (continued)
In November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received by the Group,
Lloyds Banking Group agreed to suspend the payment of coupons and dividends on certain of the Group’s preference shares and preferred
securities for the two year period from 31 January 2010 to 31 January 2012. The Group has also agreed to temporarily suspend and/or waive
dividend payments on certain preference shares which have been issued intra-group. Consequently, in accordance with the terms of some of these
instruments, subsidiaries may be prevented from making dividend payments on ordinary shares during this period. In addition, certain subsidiary
companies currently have insufficient distributable reserves to make dividend payments.
Subject to the foregoing, there were no further significant restrictions on any of the Company’s subsidiaries in paying dividends or repaying loans
and advances. All regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may
impact those subsidiaries’ ability to make distributions.
Loans to subsidiaries
At 1 January
Exchange and other adjustments
Amounts advanced
Redemptions
At 31 December
2011
£m
8,332
(46)
–
–
8,286
2010
£m
7,466
291
1,425
(850)
8,332
In addition the Company carried out banking activities through its subsidiary, Lloyds TSB Bank plc. At 31 December 2011, the Company held
deposits of £1,105 million with Lloyds TSB Bank plc (2010: £375 million). Given the volume of transactions flowing through the account, it is not
meaningful to provide gross inflow and outflow information. Included within subordinated liabilities is £2,287 million (2010: £2,073 million) and
within other liabilities is £10,261 million (2010: £7,988 million) due to subsidiary undertakings. In addition, at 31 December 2011 the Company had
interest rate and currency swaps with Lloyds TSB Bank plc with an aggregate notional principal amount of £2,338 million and a net positive fair
value of £1,660 million (2010: notional principal amount of £2,504 million and a net positive fair value of £1,664 million), of which contracts with an
aggregate notional principal amount of £1,349 million and a net positive fair value of £314 million (2010: notional principal amount of £1,754 million
and a net positive fair value of £330 million) were designated as fair value hedges to manage the Company’s issuance of subordinated liabilities
and debt securities in issue.
Related party information in respect of other related party transactions is given in note 53 to the consolidated financial statements.
353
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 10: Financial instruments
Measurement basis of financial assets and liabilities
The accounting policies in note 2 to the consolidated financial statements describe how different classes of financial instruments are measured,
and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the
Company’s financial assets and liabilities by category and by balance sheet heading.
Derivatives designated as
hedging instruments, held
at fair value through
profit or loss
£m
Held for
trading at fair
value through
profit or loss
£m
Loans and
receivables
£m
Held at
amortised
cost
£m
At 31 December 2011
Financial assets:
Cash and cash equivalents
Derivative financial instruments
Loans to subsidiaries
Amounts due from subsidiaries
Total financial assets
Financial liabilities:
Debt securities in issue
Subordinated liabilities
Total financial liabilities
At 31 December 2010
Financial assets:
Cash and cash equivalents
Derivative financial instruments
Loans to subsidiaries
Amounts due from subsidiaries
Total financial assets
Financial liabilities:
Debt securities in issue
Subordinated liabilities
Total financial liabilities
–
314
–
–
314
–
–
–
–
330
–
–
330
–
–
–
–
1,346
–
–
1,346
–
–
–
–
1,334
–
–
1,334
–
–
–
–
–
8,286
212
8,498
–
–
–
–
–
8,332
217
8,549
–
–
–
Total
£m
1,105
1,660
8,286
212
1,105
–
–
–
1,105
11,263
555
4,308
4,863
375
–
–
–
555
4,308
4,863
375
1,664
8,332
217
375
10,588
549
4,074
4,623
549
4,074
4,623
Note 55 to the consolidated financial statements outlines the valuation hierarchy into which financial instruments measured at fair value
are categorised.
The derivative assets designated as hedging instruments represent level 2 portfolios. Of derivative assets classified as held for trading (not being
designated as hedging instruments) shown above, £174 million (31 December 2010: £157 million) represents level 2 portfolios and £1,172 million
(31 December 2010: £1,177 million) represents level 3 portfolios. The level 3 derivatives reflect the value of the equity conversion feature of
the Enhanced Capital Notes issued in December 2009 as part of Lloyds Banking Group’s recapitalisation and exit from the Government Asset
Protection Scheme.
The following reconciliation shows the movements in derivative financial instrument assets within level 3 portfolios:
At 1 January
Losses recognised in the income statement
At 31 December
2011
£m
1,177
(5)
1,172
2010
£m
1,797
(620)
1,177
Interest rate risk and currency risk
The Company is exposed to interest rate risk and currency risk on its debt securities in issue and its subordinated debt.
As discussed in note 9, the Company has entered into interest rate and currency swaps with its subsidiary, Lloyds TSB Bank plc, to manage
these risks.
354
Annual Report and Accounts 2011
NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS
Note 10: Financial instruments (continued)
Credit risk
The majority of the Company’s credit risk arises from amounts due from its wholly owned subsidiary, Lloyds TSB Bank plc, and subsidiaries of that
company.
Liquidity risk
The table below analyses financial instrument liabilities of the Company, on an undiscounted future cash flow basis according to contractual
maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in
the over 5 years category.
At 31 December 2011
Debt securities in issue
Subordinated liabilities
Total financial instrument liabilities
At 31 December 2010
Debt securities in issue
Subordinated liabilities
Total financial instrument liabilities
Up to
1 month
£m
1-3
months
£m
3-12
months
£m
1-5
years
£m
Over 5
years
£m
11
–
11
11
–
11
–
2
2
–
–
–
32
165
197
32
202
234
688
1,934
2,622
728
4,024
4,752
–
946
946
–
2,380
2,380
Total
£m
731
3,047
3,778
771
6,606
7,377
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of
approximately £303 million (2010: £302 million) per annum which is payable in respect of those instruments for as long as they remain in issue is not
included beyond 5 years.
10 Financial instruments
Fair values of financial assets and liabilities
The valuation techniques for the Company’s financial instruments are as discussed in note 55 to the consolidated financial statements.
Financial assets:
Cash and cash equivalents
Derivative financial instruments
Loans to subsidiaries
Amounts due from subsidiaries
Financial liabilities:
Debt securities in issue
Subordinated liabilities
2011
2010
Carrying
value
£m
Fair
value
£m
Carrying
value
£m
1,105
1,660
8,286
212
555
4,308
1,105
1,660
8,291
212
555
3,370
375
1,664
8,332
217
549
4,074
Fair
value
£m
375
1,664
8,713
217
549
4,207
Note 11: Approval of the financial statements and other information
The parent company financial statements were approved by the directors of Lloyds Banking Group plc on 27 February 2012.
Lloyds Banking Group plc was incorporated as a public limited company and registered in Scotland under the UK Companies Act 1985 on
21 October 1985 with the registered number 95000. Lloyds Banking Group plc’s registered office is The Mound, Edinburgh EH1 1YZ, Scotland, and
its principal executive offices in the UK are located at 25 Gresham Street, London EC2V 7HN.
355
Annual Report and Accounts 2011
Shareholder information 356Forward looking statements 358Glossary 359Abbreviations 364Index to annual report 365other information 356
Annual Report and Accounts 2011
SHAREHOLDER INFORMATION
Annual general meeting
The annual general meeting will be held at 11.30am on Thursday 17 May 2012 at the Edinburgh International Conference Centre, The
Exchange, Edinburgh, EH3 8EE. Further details about the meeting, including the proposed resolutions, can be found in our Notice of annual
general meeting which is sent to all shareholders who have requested paper copy documents. It is also available on our website
www.lloydsbankinggroup.com
Shareholder enquiries
The Company’s share register and the Lloyds Banking Group Shareholder Account are maintained by Equiniti Limited. Contact them using the
details below if you have enquiries about your shareholding, including:
– Change of name or address
– Loss of share certificate
– Dividend information, including loss of dividend warrant or tax voucher.
Equiniti Limited
Aspect House
Spencer Road
Lancing
West Sussex BN99 6DA
Telephone 0871 384 29901
Textphone 0871 384 2255
Overseas +44 (0)121 415 7066
Telephone lines are open 8.30am to 5.30pm, Monday to Friday.
1
Calls to 0871 numbers are charged at 8p per minute from a BT landline. The price of calls from mobiles and other networks may vary. Calls from
outside the United Kingdom are charged at applicable international rates. The call prices we have quoted were correct in February 2012.
Equiniti operates a web based enquiry and portfolio management service for you to receive shareholder communications electronically and to
register your proxy appointments or voting instructions online. You can also change your address or bank details either by telephone or online.
Visit www.shareview.co.uk for details.
Share price information
Shareholders can access both the latest and historical share prices via our website, www.lloydsbankinggroup.com, as well as listings in most
national newspapers. For a real time buying or selling price, you will need to contact a stockbroker, or you can contact the sharedealing providers
detailed below.
Share dealing facilities
Lloyds Banking Group offers shareholders a choice of two dealing services:
Lloyds TSB Share Dealing
– Internet dealing. Visit www.lloydstsbsharedealing.com
– Telephone dealing. Call 0845 60 60 560
Internet services are available 24/7 and telephone services are available between 8.00am and 6.00pm, Monday to Friday. Details of any dealing
costs are available when you log on to the share dealing website or when you call the above number. To open a Lloyds TSB Share Dealing Account
you must be 18 years of age or over and be resident in the UK, the Channel Islands or the Isle of Man. You can apply online or by post.
Halifax Share Dealing
– Internet dealing. Visit www.halifaxsharedealing.co.uk
– Telephone dealing. Call 08457 22 55 25
Internet services are available 24/7 and telephone services are available between 8.00am and 9.15pm, Monday to Friday, and 9.00am to 1.00pm,
Saturday. To open a Halifax Share Dealing Account you must be 18 years of age or over and be resident in the UK, Jersey, Guernsey or the Isle of Man.
Shareholders in the Lloyds Banking Group Shareholder Account can only trade by telephone through the Halifax Share Dealing Service.
Individual Savings Accounts (ISAs)
The Company provides a number of options for investing in Lloyds Banking Group shares through an ISA. For details contact: Lloyds TSB Share
Dealing, Halifax Share Dealing or Equiniti Limited.
357
Annual Report and Accounts 2011
SHAREHOLDER INFORMATION
American Depositary Receipts (ADRs)
Lloyds Banking Group shares are traded in the USA through an NYSE-listed sponsored ADR facility, with The Bank of New York Mellon as the
depositary. The ADRs are traded on the New York Stock Exchange under the symbol LYG. The CUSIP number is 539439109 and the ratio of ADRs
to ordinary shares is 1:4.
For details contact: The Bank of New York Mellon, PO Box 358516, Pittsburgh, Pennsylvania 15252-8516.
Telephone: 1-866-259-0336 (US toll free), international callers: +1 201-680-6825. Alternatively visit www.adrbnymellon.com or email
shrrelations@bnymellon.com
Analysis of shareholders
At 31 December 2011
Size of shareholding
1 – 99
100 – 499
500 – 999
1,000 – 4,999
5,000 – 9,999
10,000 – 49,999
50,000 – 99,999
100,000 – 999,999
1,000,000 and over
Shareholders
Number of ordinary shares
Number
156,887
1,641,748
449,386
403,203
55,675
54,424
4,674
2,610
977
%
5.66
59.28
16.23
14.56
2.01
1.96
0.17
0.09
0.04
2,769,584
100.00
Millions
6.1
374.4
309.9
821.7
388.1
1,078.3
313.0
600.7
64,834.4
68,726.6
%
0.01
0.54
0.45
1.20
0.56
1.57
0.46
0.87
94.34
100.00
Share sale fraud
Lloyds Banking Group have been made aware of an increasing number of share sale frauds being reported by listed companies. This involves
bogus stockbrokers, usually based overseas, cold calling people to:
– either pressure them into buying shares that promise high returns; or
– offer to buy their shares at an inflated price claiming that there is a ‘secret’ takeover or merger. This is followed by a request for an upfront cash
bond to commit to the deal.
In reality, the shares or secret information are either worthless or nonexistent and if you receive such a call, we strongly recommend that you seek
independent investment advice from an FSA authorised adviser before you take any action.
If you are concerned that you may have been targeted by such a scheme, please contact the FSA Consumer Helpline on 0845 606 1234,
www.fsa.gov.uk or Action Fraud on 0300 123 2040, www.actionfraud.org.uk for further advice.
358
Annual Report and Accounts 2011
FORWARD LOOKING STATEMENTS
This annual report includes certain forward looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995 with
respect to the business, strategy and plans of Lloyds Banking Group and its current goals and expectations relating to its future financial condition
and performance. Statements that are not historical facts, including statements about Lloyds Banking Group or its directors’ and/or management’s
beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’,
’will’, ‘would’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar future or conditional expressions are intended to
identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements
involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future.
Examples of such forward looking statements include, but are not limited to, projections or expectations of the Group’s future financial position
including profit attributable to shareholders, provisions, economic profit, dividends, capital structure, expenditures or any other financial items
or ratios; statements of plans, objectives or goals of the Group or its management including in respect of certain synergy targets; statements
about the future business and economic environments in the United Kingdom (UK) and elsewhere including future trends in interest rates, foreign
exchange rates, credit and equity market levels and demographic developments; statements about competition, regulation, disposals and
consolidation or technological developments in the financial services industry; and statements of assumptions underlying such statements.
Factors that could cause actual business, strategy, plans and/or results to differ materially from the plans, objectives, expectations, estimates and
intentions expressed in such forward looking statements made by the Group or on its behalf include, but are not limited to: general economic
and business conditions in the UK and internationally; inflation, deflation, interest rates and policies of the Bank of England, the European Central
Bank and other G8 central banks; fluctuations in exchange rates, stock markets and currencies; the ability to access sufficient funding to meet the
Group’s liquidity needs; changes to the Group’s credit ratings; the ability to derive cost savings and other benefits including, without limitation,
as a result of the integration of HBOS and the Group’s Simplification Programme; changing demographic developments including mortality and
changing customer behaviour including consumer spending, saving and borrowing habits; changes to borrower or counterparty credit quality;
instability in the global financial markets including Eurozone instability; technological changes; natural and other disasters, adverse weather and
similar contingencies outside the Group’s control; inadequate or failed internal or external processes, people and systems; terrorist acts and other
acts of war or hostility and responses to those acts, geopolitical, pandemic or other such events; changes in laws, regulations, taxation, accounting
standards or practices; regulatory capital or liquidity requirements and similar contingencies outside the Group’s control; the policies and
actions of governmental or regulatory authorities in the UK, the European Union (EU), the US or elsewhere; the ability to attract and retain senior
management and other employees; requirements or limitations imposed on the Group as a result of HM Treasury’s investment in the Group; the
ability to complete satisfactorily the disposal of certain assets as part of the Group’s EU State Aid obligations; the extent of any future impairment
charges or write-downs caused by depressed asset valuations; market related trends and developments; exposure to regulatory scrutiny, legal
proceedings or complaints; changes in competition and pricing environments; the inability to hedge certain risks economically; the adequacy of
loss reserves; the actions of competitors; and the success of the Group in managing the risks of the foregoing. Please refer to the latest Annual
Report on Form 20-F filed with the US Securities and Exchange Commission for a discussion of certain factors.
Lloyds Banking Group may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the
US Securities and Exchange Commission, Lloyds Banking Group annual reviews, half-year announcements, proxy statements, offering
circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of
Lloyds Banking Group to third parties, including financial analysts. Except as required by any applicable law or regulation, the forward looking
statements contained in this annual report are made as of the date hereof, and Lloyds Banking Group expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward looking statements contained in this annual report to reflect any change
in Lloyds Banking Group’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement
is based.
359
Annual Report and Accounts 2011
GLOSSARY
Asset-Backed Securities (ABS)
Asset-backed securities are securities that represent an interest in an underlying pool of referenced assets.
The referenced pool can comprise any assets which attract a set of associated cash flows but are commonly
pools of residential or commercial mortgages but could also include leases, credit card receivables, motor
vehicles, student loans. Further information on the Group’s investments in ABS is given in note 56.
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.
Alt-A
Arrears
Alt-A are mortgage loans regarded as lower risk than sub-prime, but they share higher risk characteristics
than lending under normal criteria. Further information on the Group’s exposure to Alt-A investments is
given in note 56.
A customer is in arrears when they are behind in fulfilling their obligations with the result that an outstanding
loan is unpaid or overdue. Such a customer is also said to be in a state of delinquency. When a customer is
in arrears, the entire outstanding balance is said to be delinquent, meaning that delinquent balances are the
total outstanding loans on which payments are overdue.
Asset-backed commercial paper
See Commercial Paper
Bank levy
Basel II
Basel III
Basis point
The levy that applies to certain UK banks, UK building societies and the UK operations of foreign banks from
1 January 2011. The levy is payable based on a percentage of the chargeable equity and liabilities of the
bank as at the balance sheet date.
The capital adequacy framework issued by the Basel Committee on Banking Supervision in June 2006 in the
form of the ‘International Convergence of Capital Measurement and Capital Standards’.
The capital reforms and introduction of a global liquidity standard proposed by the Basel Committee on
Banking Supervision in 2010 and due to be phased in from 1 January 2013 onwards.
One hundredth of a per cent (0.01 per cent). 100 basis points is 1 per cent. Used in quoting movements in
interest rates or yields on securities.
Buy-to-let mortgages
Buy-to-let mortgages are those mortgages offered to customers purchasing residential property as a rental
investment.
Collateralised Debt Obligation
(CDO)
A security issued by a third party which references ABSs or other assets purchased by the issuer. Lloyds
Banking Group has invested in instruments issued by other banking groups, including Collateralised Loan
Obligations and Commercial Real Estate CDOs. Details of these investments are given in note 56.
Collateralised Loan Obligation
(CLO)
A security backed by the repayments from a pool of commercial loans. CLOs are usually structured products
with different tranches whereby senior classes of holder receive repayment before other tranches are repaid.
Collectively assessed loan
impairment provision
A provision established following an impairment assessment on a collective basis for homogeneous groups
of loans, such as credit card receivables and personal loans, that are not considered individually significant
and for loan losses that have been incurred but not separately identified at the balance sheet date.
Commercial Mortgage-Backed
Securities
Commercial Mortgage-Backed Securities are securities that represent interests in a pool of commercial
mortgages. Investors in these securities have the right to cash received from mortgage repayments of
interest and principal. Further information on the Group’s investment in CMBS is given in note 56.
Commercial Paper
Commercial Real Estate
Conduits
Contractual maturities
Core tier 1 capital
Commercial paper is an unsecured promissory note issued to finance short-term credit needs. It specifies
the face amount paid to investors on the maturity date. Commercial Paper can be issued as an unsecured
obligation of the Group or, for example when issued by the Group’s conduits, as an asset-backed obligation.
(in such case it is referred to as asset-backed commercial paper). Commercial Paper is usually issued for
periods from as little as a week up to nine months.
Commercial real estate includes office buildings, industrial property, medical centres, hotels, malls, retail
stores, shopping centres, farm land, multifamily housing buildings, warehouses, garages, and industrial
properties.
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 23.
Contractual maturity refers to the final payment date of a loan or other financial instrument, at which point all
the remaining outstanding principal will be repaid and interest is due to be paid.
As defined by the FSA mainly comprising shareholders’ equity and equity non-controlling interests after
deducting goodwill, other intangible assets and other regulatory deductions. Further details are given in the
Capital Risk section on page 118.
360
Annual Report and Accounts 2011
GLOSSARY
Core tier 1 ratio
Core tier 1 capital as a percentage of risk weighted assets.
Cost:Income ratio
Operating expenses compared to total income net of insurance claims. The Group calculates this ratio using
the ‘reported basis’ which is the basis on which financial information is reported internally to management.
Coverage ratio
Impairment provisions as a percentage of impaired loans.
Covered mortgage bonds
Credit Default Swap
Credit derivatives
A bond backed by a pool of mortgage loans. The mortgages remain on the issuer’s balance sheet. The
issuing bank can change the make-up of the loan pool or the terms of the loans to preserve credit quality.
Covered bonds thus have a higher risk weighting than mortgage-backed securities because the holder is
exposed to both the non-payment of the mortgages and the financial health of the issuer. The Group issues
covered bonds as part of its funding activities. Further details are provided in note 22.
A credit default swap is also referred to as a credit derivative. It is an arrangement whereby the credit risk of
an asset (the reference asset) is transferred from the buyer to the seller of protection. A credit default swap is
a contract where the protection seller receives premium or interest-related payments in return for contracting
to make payments to the protection buyer upon a defined credit event. Credit events normally include
bankruptcy, payment default on a reference asset or assets, or downgrades by a rating agency.
A credit derivative is a financial instrument that derives its value from the credit rating of an underlying
instrument carrying the credit risk of the issuing entity. The principal type of credit derivatives are credit
default swaps, which are used by the Group as part of its trading activity and to manage its own exposure to
credit risk.
Credit Risk
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).
Credit risk spread (or credit
spread)
The credit spread is the yield spread between securities with the same currency and maturity structure
but with different associated credit risks, with the yield spread rising as the credit rating worsens. It is the
premium over the benchmark or risk-free rate required by the market to take on a lower credit quality.
Credit valuation adjustments
These are adjustments to the fair values of derivative assets to reflect the creditworthiness of the
counterparty. Further details are given in note 55.
Customer deposits
Debt restructuring
Money deposited by account holders. Such funds are recorded as liabilities of the Group. The Group
includes certain repos within customer deposits.
This is when the terms and provisions of outstanding debt agreements are changed. This is often done
in order to improve cash flow and the ability of the borrower to repay the debt. It can involve altering the
repayment schedule as well as reducing the debt or interest charged on the loan.
Debt securities
Debt securities are assets held by the Group representing certificates of indebtedness of credit institutions,
public bodies or other undertakings, excluding those issued by Central Banks.
Debt securities in issue
These are unsubordinated debt securities issued by the Group. They include commercial paper, certificates
of deposit, bonds and medium-term notes.
Delinquency
See Arrears.
Embedded equity conversion
feature
An embedded equity conversion feature is a derivative contained within the terms and conditions of a
debt instrument that enables or requires the instrument to be converted into equity under a particular
set of circumstances. The Group’s Enhanced Capital Notes (ECNs) contain such a feature whereby these
notes convert to ordinary shares in the event that the consolidated core tier 1 ratio of the Group falls
below 5 per cent.
Enhanced Capital Notes (ECNs)
The Group’s ECN’s are subordinated notes issued by the Group that contain an embedded equity
conversion feature. Further details of these are given in note 46.
Expected loss
This is the amount of loss that can be expected by the Group calculated in accordance with FSA rules. In
broad terms it is calculated by multiplying the Default Frequency by the Loss Given Default by the Exposure
at Default.
Exposure at Default
An estimate of the amount expected to be owed by a customer at the time of the customer’s default.
Fair value adjustment
First/Second Lien
Fair value adjustments arise on acquisition when assets and liabilities are acquired at fair values that are
different from the carrying values in the acquired company. In respect of the Group’s acquisition of HBOS
the principal adjustments were write-downs in respect of loans and advances to customers and debt issued.
A first lien gives the holder (usually the bank lending the funds) the first right to collect compensation from
the sale of the underlying collateral in the event of a default on the loan. A second lien may be issued against
the same collateral but in the case of default, compensation for this debt will only be received after the first
lien has been repaid.
361
Annual Report and Accounts 2011
GLOSSARY
Forbearance
Full time equivalent
A term generally applied to arrangements provided to support borrowers experiencing temporary financial
difficulty. Such arrangements include reduced or nil payments, term extensions, transfers to interest only and
the capitalisation of arrears.
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.
Funded/unfunded exposures
Exposures where the notional amount of the transaction is either funded or unfunded.
Guaranteed mortgages
Mortgages for which there is a guarantor to provide the lender a certain level of financial security in the event
of default of the borrower.
Home Loans
Impaired loans
Impairment allowances
Impairment losses
A loan to purchase a residential property which is then used as collateral to guarantee repayment of the loan.
The borrower gives the lender a lien against the property, and the lender can foreclose on the property if the
borrower does not repay the loan per the agreed terms.
Impaired loans are loans where the Group does not expect to collect all the contractual cash flows or to
collect them when they are contractually due.
Impairment allowances are a provision held on the balance sheet as a result of the raising of a charge against
profit for the incurred loss inherent in the lending book. An impairment allowance may either be individual
or collective.
An impairment loss is the reduction in value that arises following an impairment review of an asset that
determines that the asset’s value is lower than it’s carrying value. For impaired financial assets measured
at amortised cost, impairment losses are the difference between the carrying value and the present value
of estimated future cash flows, discounted at the asset’s original effective interest rate. Impairment losses
can be difficult to assess and the critical accounting estimates and judgements in note 3 detail the key
assessments made when determining impairment losses.
Individually/Collectively
Assessed
Impairment is measured individually for assets that are individually significant, and collectively where a
portfolio comprises homogenous assets and where appropriate statistical techniques are available.
Individually assessed loan
impairment provisions
Impairment loss provisions for individually significant impaired loans are assessed on a case-by-case basis,
taking into account the financial condition of the counterparty, any guarantor and the realisable value of any
collateral held.
Investment grade
This refers to the highest range of credit ratings, from ‘AAA’ to ‘BBB’ as measured by external credit
rating agencies.
ISDA (International swaps and
derivatives association) master
agreement
Leverage finance
Liquidity and Credit
enhancements
Loan to deposit ratio
Loan-to-value ratio (LTV)
A standardised contract developed by the ISDA which is used as an umbrella contract for bilateral derivative
contracts.
Funding provided for entities with higher than average indebtedness, which typically arises from
sub-investment grade acquisitions or event-driven financing.
Credit enhancement facilities are used to enhance the creditworthiness of financial obligations and cover
losses due to asset default. Two general types of credit enhancement are third-party loan guarantees (such
as guaranteed mortgages) and self-enhancement through overcollateralisation (in the case of covered
mortgage bonds). Liquidity enhancement makes funds available if required, for other reasons than asset
default, eg to ensure timely repayment of maturing commercial paper.
The ratio of loans and advances to customers net of allowance for impairment losses and excluding reverse
repurchase agreements divided by customer deposits excluding repurchase agreements.
The loan-to-value ratio is a mathematical calculation which expresses the amount of a mortgage balance
outstanding as a percentage of the total appraised value of the property. A high LTV indicates that there is
less value to protect the lender against house price falls or increases in the loan if repayments are not made
and interest is added to the outstanding balance of the loan.
Loans past due
Loans are past due when a counterparty has failed to make a payment when contractually due.
Loss emergence period
The loss emergence period is the estimated period between impairment occurring and the loss being
specifically identified and evidenced by the establishment of an appropriate impairment allowance.
Loss given default
The estimated loss that will arise if a customer defaults. It is calculated after taking account of credit risk
mitigation and includes the cost of recovery.
362
Annual Report and Accounts 2011
GLOSSARY
Medium Term Notes
Monolines
Medium term notes are a form of corporate borrowing covering maturity periods ranging from nine months
to 30 years. Details of the notes issued under the Group’s medium term notes programmes are given in
note 37.
A monoline insurer is defined as an entity which specialises in providing credit protection to the holders
of debt instruments in the event of default by the debt security counterparty. This protection is typically
provided in the form of derivatives such as credit default swaps referencing the underlying exposures held.
Mortgage-backed securities
See Residential and Commercial mortgage-backed securities.
Mortgage related assets
Assets which are referenced to underlying mortgages.
Mortgage vintage
The year the mortgage was issued.
Negative basis bonds
ABS held with a separately purchased matching credit default swaps to protect against the risk of default
of the security. The Group refers to ABS without the benefit of CDS protection as Uncovered ABS. Details of
the Group’s exposure to negative basis bonds is given in note 56.
Negative Equity Mortgages
Negative equity occurs when the value of the property purchased using the mortgage is below the balance
outstanding on the loan. Negative equity is the value of the asset less the outstanding balance on the loan.
Net asset value per ordinary
share
Shareholders' equity divided by the number of ordinary shares and limited voting ordinary shares in issue,
adjusted to exclude shares held under certain employee share ownership plans.
Net Interest Income
The difference between interest received on assets and interest paid on liabilities.
Net interest margin
Operational risk
Net interest margin is net interest income as a percentage of average interest-earning assets. Details of the
Group’s banking net interest margin are given on page 97.
The risk of reductions in earnings and/or value, through financial or reputational loss, from inadequate or
failed internal processes and systems, or from people-related or external events.
Over the counter derivatives
Over the counter derivatives are derivatives for which the terms and conditions can be freely negotiated by
the counterparties involved, unlike exchange traded derivatives which have standardised terms.
Prime
Prime mortgages are those granted to the most creditworthy category of borrower.
Private equity investments
Private equity is equity securities in operating companies not quoted on a public exchange. Investment in
private equity often involves the investment of capital in private companies or the acquisition of a public
company that results in the delisting of public equity. Capital for private equity investment is raised by retail
or institutional investors and used to fund investment strategies such as leveraged buyouts, venture capital,
growth capital, distressed investments and mezzanine capital.
Probability of default
The likelihood that a customer will default on their obligation within the next year.
Renegotiated loans
Loans and advances are generally renegotiated either as part of an ongoing customer relationship or in
response to an adverse change in the circumstances of the borrower. In the latter case renegotiation can
result in an extension of the due date of payment or repayment plans under which the Group offers a
concessionary rate of interest to genuinely distressed borrowers. This will result in the asset continuing to be
overdue and will be impaired where the renegotiated payments of interest and principal will not recover the
original carrying amount of the asset. In other cases, renegotiation will lead to a new agreement, which is
treated as a new loan.
Repurchase agreements
or ‘repos’
Short-term funding agreements which allow a borrower to sell a financial asset, such as ABS or Government
bonds as collateral for cash. As part of the agreement the borrower agrees to repurchase the security at
some later date, usually less than 30 days, repaying the proceeds of the loan.
Retail loans
Money loaned to individuals rather than institutions. These include both secured and unsecured loans such
as mortgages and credit card balances.
Residential Mortgaged-Backed
Securities
Residential Mortgage-Backed Securities are a category of ABS. They are securities that represent interests
in a group of residential mortgages. Investors in these securities have the right to cash received from future
mortgage payments (interest and/or principal).
Risk-weighted assets
A measure of a bank’s assets adjusted for their associated risks. Risk weightings are established in
accordance with the Basel Capital Accord as implemented by the FSA.
363
Annual Report and Accounts 2011
GLOSSARY
Securitisation
Special Purpose Entities (SPEs)
Securitisation is a process by which a group of assets, usually loans, are aggregated into a pool, which is used
to back the issuance of new securities. Securitisation is the process by which ABS are created. A company
sells assets to a special purpose entity which then issues securities backed by the assets. This allows the
credit quality of the assets to be separated from the credit rating of the original company and transfers risk to
external investors. Assets used in securitisations include mortgages to create mortgage-backed securities or
Residential Mortgage-Backed Securities as well as commercial mortgage-backed securities. The Group has
established several securitisation structures as part of its funding and capital management activities. These
generally use mortgages, corporate loans and credit cards as asset pools. A listing of these programmes with
the amounts secured and associated funding raised is given in note 22.
SPEs are entities that are created to accomplish a narrow and well defined objective. There are often specific
restrictions or limits around their ongoing activities. The Group uses a number of SPEs, including those set-
up under securitisation programmes, and as conduits. Where the Group has control of these entities or
retains the risks and rewards relating to them they are consolidated within the Group’s results.
Specialist mortgages
Specialist mortgages include those mortgage loans provided to customers who have self-certified their
income (normally as a consequence of being self-employed) or who are otherwise regarded as a sub-prime
credit risk. New mortgage lending of this type has not been offered by the Group since early 2009.
Student loan related assets
Assets which are referenced to underlying student loans (see note 56).
Sub-investment grade
Subordinated liabilities
This refers to credit ratings issued by external credit rating agencies that are below ‘BBB’ grade or its
equivalent.
Liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of
depositors and other creditors of the issuer. Details of the Group’s subordinated liabilities are set out in
note 46.
Sub-Prime
Synthetic CDO
Tier 1 capital
Sub-prime is defined as loans to borrowers typically having weakened credit histories that include payment
delinquencies and potentially more severe problems such as court judgements and bankruptcies. They may
also display reduced repayment capacity as measured by credit scores, high debt-to-income ratios, or other
criteria indicating heightened risk of default.
A security that is similar in structure to a CDO whereby the pool of referenced assets is created synthetically
usually by credit default swaps.
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.
Tier 1 capital ratio
Tier 1 capital as a percentage of risk-weighted assets.
Tier 2 capital
Uncovered ABS
Value at Risk
A component of regulatory capital defined by the FSA, mainly comprising qualifying subordinated loan
capital, certain non-controlling interests and eligible collective impairment allowances. Further details are
given in the Capital Risk section on page 118.
ABS held without the benefit of separately purchased matching credit default swaps to protect against the
risk of default of the security. Details of the Group’s uncovered ABS are given in note 56.
Value at Risk is an estimate of the potential loss in earnings which might arise from market movements
under normal market conditions, if the current positions were to be held unchanged for one business day,
measured to a confidence level of 95 per cent.
Wrapped loans and bonds
If a loan or bond (usually an ABS security) is originally issued with a credit default swap already attached, the
package is called a ‘wrapped bond’ or ‘wrapped loan’. The Group’s exposure to wrapped loans and bonds is
set out in note 56.
Write Downs
The depreciation or lowering of the value of an asset in the books to reflect a decline in their value, or
expected cash flows.
364
Annual Report and Accounts 2011
ABBREVIATIONS
ABS
ADRs
AQR
ATMs
BBA
BSU
CDO
CDS
CLO
Asset-Backed Securities
American Depositary Receipts
Asset Quality Ratio
Automated Teller Machines
British Bankers’ Association
Business Support Unit
Collateralised Debt Obligation
Credit Default Swap
Collateralised Loan Obligation
CMIG
Clerical Medical Investment Group Limited
CRA
CRD
CRR
CVA
DVA
Credit Reference Agency
Capital Requirements Directive
Capital Resources Requirement
Credit Valuation Adjustment
Debit Valuation Adjustment
ECNs
Enhanced Capital Notes
EEI
EEV
EP
EPS
EU
FCA
FOS
FSA
Employee Engagement Index
European Embedded Value
Economic Profit
Earnings Per Share
European Union
Financial Conduct Authority
Financial Ombudsman Service
Financial Services Authority
FSCS
Financial Services Compensation Scheme
HMRC
Her Majesty’s Revenue & Customs
IAS
IASB
ICB
ICG
IFAs
IFRIC
IFRS
ISA
International Accounting Standard
International Accounting Standards Board
Independent Commission on Banking
Individual Capital Guidance
Independent Financial Advisers
International Financial Reporting
Interpretations Committee
International Financial Reporting Standards
Individual Savings Account
KPIs
LCR
LGD
Key Performance Indicators
Liquidity Coverage Ratio
Loss Given Default
LIBOR
London Inter-Bank Offered Rate
LTIP
LTV
MIF
NSFR
OEICs
OFAC
PCA
PEI
PFI
PPI
PPP
PRA
Long Term Incentive Plan
Loan-to-value
Multilateral Interchange Fee
Net Stable Funding Ratio
Open Ended Investment Companies
Office of Foreign Assets Control
Personal Current Account
Performance Excellence Index
Private Finance Initiative
Payment Protection Insurance
Public Private Partnership
Prudential Regulatory Authority
PVNBP
Present Value of New Business Premiums
RDR
SAYE
SMEs
SPE
SWIP
TSR
UK
UKFI
US
VaR
VVOP
WBM
Retail Distribution Review
Save-As-You-Earn
Small and Medium sized enterprises
Special Purpose Entity
Scottish Widows Investment Partnership
Total Shareholder Return
United Kingdom of Great Britain and
Northern Ireland
United Kingdom Financial Investment Limited
United States of America
Value-at-Risk
Voluntary Variation of Permission
Wholesale Banking and Markets
365
Annual Report and Accounts 2011
INDEX TO ANNUAL REPORT
Click on the index number below to link to the page
Accounting
Accounting policies
Critical accounting estimates and judgements
Future accounting developments
Approval of financial statements
Consolidated
Parent company
Auditors
Report on the consolidated financial statements
Report on the parent company financial statements
Fees
Available-for-sale financial assets
Accounting policies
Notes to the consolidated financial statements
Valuation
Balance sheet
Consolidated
Parent company
Business Model and Strategy
Capital adequacy
Capital ratios
Cash flow statement
Consolidated
Notes to the consolidated financial statements
Parent company
Chairman’s statement
Charitable donations
Contingent liabilities and commitments
Credit market exposures
Debt securities in issue
Consolidated
Parent company
Valuation
Delivering our Action Plan
Deposits
Customer deposits
Deposits from banks
Valuation
Derivative financial instruments
Accounting policy
Notes to the consolidated financial statements
Valuation
217
228
343
343
354
206
344
243
Directors
Attendance at board and committee meetings
Biographies
Directors’ report
Emoluments
Interests
Remuneration policy
Service agreements
Dividends
Earnings per share
Employees
Diversity and inclusion
219, 223
Colleagues
258
312
Financial risk management
Credit risk
Currency risk
210, 211
Fair values of financial assets and liabilities
345
24
120
215
340
347
10
175
305
335
266
351
312
26
265
265
312
220
251
312
Insurance risk
Interest rate risk
Liquidity and funding risk
Market risk
Measurement basis of financial assets and liabilities
Five year financial summary
Forward looking statements
Going concern
Basis of preparation
Directors’ report
Goodwill
Accounting policy
Notes to the consolidated financial statements
Governance
Compliance with the UK Corporate Governance Code
Risk management
Board Committees
Group chief executive’s review
Held at fair value through profit or loss
Accounting policy
Notes to the consolidated financial statements
Valuation
Impairment
Accounting policy
Critical accounting estimates and judgements
Notes to the consolidated financial statements
182
172
174
196
198, 204
190
195
11, 18, 295
249
37
34
129, 322, 354
321, 353
311, 354
169
320, 353
106, 112
110, 164
308, 353
98
358
216
174
217
260
177
99
183
14
218
250, 266
312
221
228
244
366
Annual Report and Accounts 2011
INDEX TO ANNUAL REPORT
Click on the index number below to link to the page
Income statement
Consolidated
Information for shareholders
Analysis of shareholders
Shareholder enquiries
Insurance businesses
Accounting policy
Basis of determining regulatory capital
Capital sensitivities
Capital statement
Critical accounting estimates and judgements
Financial information calculated on a ‘realistic’ basis
Liabilities arising from insurance contracts and
participating investment contracts
Liabilities arising from non-participating investment contracts
Life insurance sensitivity analysis
Options and guarantees
Unallocated surplus within insurance businesses
Value of in-force business
Volatility arising in insurance businesses
Insurance claims
Insurance premium income
Intangible assets
Accounting policy
Notes to the consolidated financial statements
Investment property
Accounting policy
Notes to the consolidated financial statements
Key performance indicators
Loans and advances
Loans and advances to banks
Loans and advances to customers
Valuation
Marketplace trends
Regulation
The economy
Impact on our markets
Net fee and commission income
Net interest income
Net trading income
Operating expenses
Other operating income
208
357
356
225
123
126
123
229
123
266
274
273
127
274
260
94
241
239
218
263
223
259
Other financial information
Banking net interest margin
Core and non-core business
Integration costs and benefits
Liability management gains
Simplification costs and benefits
Volatility arising in insurance businesses
Pensions
Accounting policy
Critical accounting estimates and judgements
97
86
96
95
96
94
224
229
Directors’ pensions
191, 193, 197
Notes to the consolidated financial statements
Principal subsidiaries
Presentation of information
Provisions
Accounting policy
Notes to the consolidated financial statements
275
351
5
227
282
Related party transactions
302, 351
Relationships and responsibilities
Risk management framework
Business risk
Credit risk
Exposures to Eurozone countries
Financial soundness
Insurance risk
Market risk
Principal risks and uncertainties
Operational risk
6
Risk governance
Risk management
254
255
312
21
22
23
State funding and state aid
Risk-weighted assets
Securitisations and covered bonds
Segmental reporting
Central items
Combined businesses segmental analysis
Commercial
238
Group Operations
237
238
Insurance
Notes to the consolidated financial statements
Retail
242
Wealth and International
Wholesale
240
30
170
129
156
112
169
164
106
167
102
99
102
121
256
85
52, 53
66
84
77
231
54
70
59
367
Annual Report and Accounts 2011
INDEX TO ANNUAL REPORT
Click on the index number below to link to the page
Share-based payments
Accounting policy
Notes to the consolidated financial statements
Share capital
Statement of changes in equity
Consolidated
Parent company
Subordinated liabilities
Consolidated
Parent company
Valuation
Summary of Group results
Tangible fixed assets
Accounting policy
Notes to the consolidated financial statements
Taxation
Accounting policy
Critical accounting estimates and judgements
224
295
290
212
346
284
350
312
44
223
264
224
229
Notes to the consolidated financial statements
248, 280
Value at Risk (VaR)
Value of in-force business
Accounting policy
Notes to the consolidated financial statements
Volatility
Insurance
Policyholder interests
165
226
260
94
95
Annual Report and Accounts 2011
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Directors’ portraits – Marcus Ginns
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Annual Report and Accounts 2011
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