20-F 1 c65657_20-f.htm


 

As filed with the Securities and Exchange Commission on 13 May 2011

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 20-F

 

o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended 31 December 2010

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-15246

LLOYDS BANKING GROUP plc

(previously Lloyds TSB Group plc)

(Exact name of Registrant as Specified in Its Charter)

 

Scotland

(Jurisdiction of Incorporation or Organization)

 

25 Gresham Street

London EC2V 7HN

United Kingdom

(Address of Principal Executive Offices)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:


 

 

Title of each class

Name of each exchange on which registered

   

Ordinary shares of nominal value 10 pence each, represented by American Depositary Shares

The New York Stock Exchange

7.75% Public Income Notes due 2050

The New York Stock Exchange

4.875% Senior Notes due 2016

The New York Stock Exchange

6.375% Senior Notes due 2021

The New York Stock Exchange

Floating Rate Notes due 2014

The New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

The number of outstanding shares of each of Lloyds Banking Group plc’s classes of capital or common stock as of 31 December 2010 was:

 

 

 

Ordinary shares, nominal value 10 pence each

 

68,074,129,454

Limited voting shares, nominal value 10 pence each

 

80,921,051

Preference shares, nominal value 25 pence each

 

412,215,065

Preference shares, nominal value 25 cents each

 

1,917,280

Preference shares, nominal value 25 euro cents each

 

173,350

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x No o

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Yes o No x

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x   Accelerated filer o   Non-Accelerated filer o

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements including in this filing:

U.S. GAAP o   International Financial Reporting Standards as issued by the International Accounting Standards Board x
Other o

If ‘Other’ has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 o Item 18 o

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x



TABLE OF CONTENTS

 

 

   

Presentation of information

1

   

Business overview

2

   

Selected consolidated financial data

3

   

Exchange rates

4

   

Business

4

   

Operating and financial review and prospects

12

   

Management and employees

116

   

Compensation

119

   

Corporate governance

135

   

Major shareholders and related party transactions

140

   

Regulation

143

   

Listing information

145

   

Dividends

148

   

Memorandum and articles of association

149

   

Exchange controls

153

   

Taxation

154

   

Where you can find more information

157

   

Enforceability of civil liabilities

157

   

Risk factors

158

   

Forward looking statements

167

   

Lloyds Banking Group structure

168

   

Index to consolidated financial statements

F-1

   

Glossary

169

   

Form 20-F cross-reference sheet

171

   

Exhibit index

173

   

Signatures

174

   

PRESENTATION OF INFORMATION

In this annual report, references to the ‘Company’ are to Lloyds Banking Group plc; references to ‘Lloyds Banking Group’, ‘Lloyds’ or the ‘Group’ are to Lloyds Banking Group plc and its subsidiary and associated undertakings; references to ‘Lloyds TSB Bank’ are to Lloyds TSB Bank plc; and references to the ‘consolidated financial statements’ or ‘financial statements’ are to Lloyds Banking Group’s consolidated financial statements included in this annual report. References to the ‘Financial Services Authority’ or ‘FSA’ are to the United Kingdom (the UK) Financial Services Authority.

On 16 January 2009 the Company acquired 100 per cent of the ordinary share capital of HBOS plc and changed the Company’s name to Lloyds Banking Group plc. Accordingly, where this annual report provides information for dates prior to 16 January 2009, unless otherwise indicated, such information relates to the Lloyds Banking Group prior to the acquisition of HBOS plc. References to ‘HBOS’ or the ‘HBOS Group’ are to HBOS plc and its subsidiary and associated undertakings.

The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).

In this annual report, amounts described as ‘statutory’ refer to amounts included within the Group’s consolidated financial statements.

Lloyds Banking Group publishes its consolidated financial statements expressed in British pounds (‘pounds sterling’, ‘sterling’ or ‘£’), the lawful currency of the UK. In this annual report, references to ‘pence’ and ‘p’ are to one-hundredth of one pound sterling; references to ‘US dollars’, ‘US$’ or ‘$’ are to the lawful currency of the United States (the US); references to ‘cent’ or ‘c’ are to one-hundredth of one US dollar; references to ‘euro’ or ‘e’ are to the lawful currency of the member states of the European Union that have adopted a single currency in accordance with the Treaty establishing the European Communities, as amended by the Treaty of European Union; references to ‘euro cent’ are to one-hundredth of one euro; and references to ‘Japanese yen’, ‘Japanese ¥’ or ‘¥’ are to the lawful currency of Japan. Solely for the convenience of the reader, this annual report contains translations of certain pounds sterling amounts into US dollars at specified rates. These translations should not be construed as representations by Lloyds Banking Group that the pounds sterling amounts actually represent such US dollar amounts or could be converted into US dollars at the rate indicated or at any other rate. Unless otherwise stated, the translations of pounds sterling into US dollars have been made at the noon buying rate in New York City for cable transfers in pounds sterling as certified for customs purposes by the Federal Reserve Bank of New York (the Noon Buying Rate) in effect on 31 December 2010, which was $1.5392 = £1.00. The Noon Buying Rate on 31 December 2010 differs from certain of the actual rates used in the preparation of the consolidated financial statements, which are expressed in pounds sterling, and therefore US dollar amounts appearing in this annual report may differ significantly from actual US dollar amounts which were translated into pounds sterling in the preparation of the consolidated financial statements in accordance with IFRS.

1


BUSINESS OVERVIEW

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. At 31 December 2010, total Lloyds Banking Group assets were £992,438 million and Lloyds Banking Group had some 104,230 employees (on a full-time equivalent basis). Lloyds Banking Group plc’s market capitalisation at that date was some £44,725 million. The Group reported a loss before tax for the 12 months to 31 December 2010 of £2,919 million, as a result of a provision of £3,200 million in relation to payment protection insurance, and the capital ratios as at that date were 14.5 per cent for total capital, 11.0 per cent for tier 1 capital and 9.6 per cent for core tier 1 capital.

Set out below is the Group’s summarised income statement for the last three years:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

 

 

20081
£m

 

                     

Net interest income

 

 

12,546

 

 

9,026

 

 

7,718

 

Other income

 

 

30,921

 

 

36,271

 

 

(709

)

                     

Total income

 

 

43,467

 

 

45,297

 

 

7,009

 

Insurance claims

 

 

(18,511

)

 

(22,019

)

 

2,859

 

                     

Total income, net of insurance claims

 

 

24,956

 

 

23,278

 

 

9,868

 

Operating expenses

 

 

(16,470

)

 

(15,984

)

 

(6,100

)

                     

Trading surplus

 

 

8,486

 

 

7,294

 

 

3,768

 

Impairment

 

 

(10,952

)

 

(16,673

)

 

(3,012

)

Share of results of joint ventures and associates

 

 

(88

)

 

(752

)

 

4

 

Gain on acquisition

 

 

 

 

11,173

 

 

 

Loss on disposal of businesses

 

 

(365

)

 

 

 

 

                     

Loss (profit) before tax

 

 

(2,919

)

 

1,042

 

 

760

 

                     

 

 

1

Restated in 2009 for IFRS 2 (Revised).

Lloyds Banking Group was formed in January 2009 following the acquisition of HBOS and the Group’s main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. Services are offered through a number of well recognised brands including Lloyds TSB, Halifax, Bank of Scotland, Scottish Widows, Clerical Medical and Cheltenham & Gloucester, and a range of distribution channels including the largest branch network in the UK. The Group also operates an international banking business with a global footprint in over 30 countries.

Since the acquisition of HBOS in January 2009 there have been four primary operating divisions, which constitute the Group’s reporting segments: Retail, Wholesale, Wealth and International, and Insurance. Retail provides banking, mortgages and other financial services to personal customers in the UK. Wholesale provides banking and related services for major UK and multinational corporates and financial institutions, and small and medium-sized UK businesses. It also provides asset finance to personal and corporate customers and manages Lloyds Banking Group’s activities in financial markets through its treasury function. Wealth and International provides private banking, wealth and asset management in the UK and overseas and corporate, commercial and retail banking services outside the UK. Insurance offers life assurance, pensions and investment products in the UK and Europe and provides general insurance to personal customers in the UK.

The acquisition of HBOS plc on 16 January 2009 had a significant effect on the comparability of the Group’s financial position and results with prior periods. Profit before tax is analysed further on pages 13 to 26 on a statutory basis and, in order to provide a more comparable representation of business performance of the Group’s segments, on pages 28 to 46 on a combined businesses basis. The key principles adopted in the preparation of the combined businesses basis of reporting are described on page 28. The Group Executive Committee, which is the chief operating decision maker for the Group, reviews the Group’s internal reporting based around these segments (which reflect the Group’s organisational and management structures) in order to assess performance and allocate resources; this reporting is on a combined businesses basis, which the Group Executive Committee feel best represents the underlying performance of the Group. These combined businesses segmental results for 2010, 2009 and 2008 are therefore presented in compliance with IFRS 8 but the aggregated total of the combined businesses segmental results constitutes a non-GAAP measure as defined in the SEC’s Regulation G and a reconciliation of this aggregated total to the statutory income statement is therefore provided on page 47. The following table shows the results of Lloyds Banking Group’s Retail, Wholesale, Wealth and International, and Insurance segments and Group Operations and Central items in the last three fiscal years, and their aggregation.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

 

 

2008
£m

 

 

                     

Retail

 

 

4,716

 

 

 

1,382

 

 

 

2,542

 

 

Wholesale

 

 

3,257

 

 

 

(4,703

)

 

 

(10,479

)

 

Wealth and International

 

 

(4,824

)

 

 

(2,356

)

 

 

277

 

 

Insurance

 

 

1,102

 

 

 

975

 

 

 

1,540

 

 

Group Operations and Central items:

 

 

 

 

 

 

 

 

 

 

 

 

 

Group Operations

 

 

(63

)

 

 

(149

)

 

 

(76

)

 

Central items

 

 

(1,976

)

 

 

(1,449

)

 

 

(517

)

 

 

 

 

(2,039

)

 

 

(1,598

)

 

 

(593

)

 

                           

Profit (loss) before tax – Combined businesses basis

 

 

2,212

 

 

 

(6,300

)

 

 

(6,713

)

 

                           

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, United Kingdom, telephone number + 44 (0) 20 7626 1500.

2


SELECTED CONSOLIDATED FINANCIAL DATA

The financial information set out in the tables below has been derived from the annual reports and accounts of Lloyds Banking Group plc for each of the past five years adjusted for subsequent changes in accounting policy and presentation. The financial statements for each of the years shown have been audited by PricewaterhouseCoopers LLP, independent accountants.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                                 

 

 

 

2010

 

 

2009

 

 

2008

1

 

2007

1

 

2006

1

                                 

Income statement data for the year ended 31 December (£m)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total income, net of insurance claims

 

 

24,956

 

 

23,278

 

 

9,868

 

 

10,696

 

 

11,098

 

Operating expenses

 

 

(16,470

)

 

(15,984

)

 

(6,100

)

 

(5,568

)

 

(5,300

)

Trading surplus

 

 

8,486

 

 

7,294

 

 

3,768

 

 

5,128

 

 

5,798

 

Impairment losses

 

 

(10,952

)

 

(16,673

)

 

(3,012

)

 

(1,796

)

 

(1,555

)

Gain on acquisition

 

 

 

 

11,173

 

 

 

 

 

 

 

(Loss) profit before tax

 

 

(2,919

)

 

1,042

 

 

760

 

 

3,999

 

 

4,249

 

(Loss) profit for the year

 

 

(2,594

)

 

2,953

 

 

798

 

 

3,320

 

 

2,908

 

(Loss) profit for the year attributable to equity shareholders

 

 

(2,656

)

 

2,827

 

 

772

 

 

3,288

 

 

2,804

 

Total dividend for the year2

 

 

 

 

 

 

648

 

 

2,026

 

 

1,928

 

                                 

Balance sheet data at 31 December (£m)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share capital

 

 

6,815

 

 

10,472

 

 

1,513

 

 

1,432

 

 

1,429

 

Shareholders’ equity

 

 

43,725

 

 

43,278

 

 

9,393

 

 

12,141

 

 

11,155

 

Customer deposits

 

 

393,633

 

 

406,741

 

 

170,938

 

 

156,555

 

 

139,342

 

Subordinated liabilities

 

 

36,232

 

 

34,727

 

 

17,256

 

 

11,958

 

 

12,072

 

Loans and advances to customers

 

 

592,597

 

 

626,969

 

 

240,344

 

 

209,814

 

 

188,285

 

Total assets

 

 

992,438

 

 

1,027,255

 

 

436,033

 

 

353,346

 

 

343,598

 

                                 

Share information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per ordinary share3

 

 

(4.0)p

 

 

7.5p

 

 

6.7p

 

 

28.9p

 

 

24.8p

 

Diluted earnings per ordinary share3

 

 

(4.0)p

 

 

7.5p

 

 

6.6p

 

 

28.7p

 

 

24.5p

 

Net asset value per ordinary share

 

 

64p

 

 

68p

 

 

155p

 

 

212p

 

 

195p

 

Total dividend per ordinary share2

 

 

 

 

 

 

11.4p

 

 

35.9p

 

 

34.2p

 

Equivalent cents per share2,4

 

 

 

 

 

 

20.3c

 

 

71.0c

 

 

67.0c

 

Market price per ordinary share (year end)

 

 

65.7p

 

 

50.7p

 

 

126.0p

 

 

472.0p

 

 

571.5p

 

Number of shareholders (thousands)

 

 

2,798

 

 

2,834

 

 

824

 

 

814

 

 

870

 

Number of ordinary shares in issue (millions)5

 

 

68,074

 

 

63,775

 

 

5,973

 

 

5,648

 

 

5,638

 

                                 

Financial ratios (%)6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividend payout ratio

 

 

 

 

 

 

83.9

 

 

61.6

 

 

68.7

 

Post-tax return on average shareholders’ equity

 

 

(5.8

)

 

8.8

 

 

7.0

 

 

28.1

 

 

26.6

 

Post-tax return on average assets

 

 

(0.25

)

 

0.28

 

 

0.21

 

 

0.94

 

 

0.88

 

Average shareholders’ equity to average assets

 

 

4.5

 

 

3.0

 

 

2.9

 

 

3.3

 

 

3.2

 

Cost:income ratio7

 

 

66.0

 

 

68.7

 

 

61.8

 

 

52.1

 

 

47.8

 

                                 

Capital ratios (%)8,9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital

 

 

14.5

 

 

12.4

 

 

11.1

 

 

11.0

 

 

10.7

 

Tier 1 capital

 

 

11.0

 

 

9.6

 

 

7.9

 

 

8.1

 

 

8.2

 

                                 

 

 

1

Restated in 2009 for IFRS 2 (Revised) (see note 1 on page F-11).

 

 

2

Annual dividends comprise both interim and final dividend payments. The total dividend for the year represents the interim dividend paid during the year and the final dividend, which is paid and accounted for in the following year.

 

 

3

Earnings per share calculations for 2008 and earlier years have also been restated for the impact of the bonus element of the share issues in 2009.

 

 

4

Translated into US dollars at the Noon Buying Rate on the date each payment was made.

 

 

5

This figure excludes the limited voting ordinary shares owned by the Lloyds TSB Foundations.

 

 

6

Averages are calculated on a monthly basis from the consolidated financial data of Lloyds Banking Group.

 

 

7

The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims).

 

 

8

Capital ratios are in accordance with Basel II requirements other than the ratios for 2007 and 2006 which reflect Basel I.

 

 

9

Capital ratios for 2008 and 2009 were restated in 2010 to reflect a prior year adjustment to available-for-sale revaluation reserves (see note 1 on page F-11).

3


EXCHANGE RATES

In this annual report, unless otherwise indicated, all amounts are expressed in pounds sterling. For the months shown the US dollar high and low Noon Buying Rates per pound sterling were:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2011
April

 

2011
March

 

2011
February

 

2011
January

 

2010
December

 

2010
November

 

                           

US dollars per pound sterling:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

High

 

 

1.67

 

 

1.64

 

 

1.62

 

 

1.60

 

 

1.59

 

 

1.63

 

Low

 

 

1.61

 

 

1.60

 

 

1.60

 

 

1.55

 

 

1.54

 

 

1.56

 

                                       

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For each of the years shown, the average of the US dollar Noon Buying Rates per pound sterling on the last day of each month was:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

 

2009

 

 

2008

 

 

2007

 

 

2006

 

                                       

US dollars per pound sterling:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

1.54

 

 

1.57

 

 

1.84

 

 

2.01

 

 

1.86

 

                                       

On 6 May 2011, the latest practicable date, the US dollar Noon Buying Rate was $1.6417 = £1.00. Lloyds Banking Group makes no representation that amounts in pounds sterling have been, could have been or could be converted into US dollars at that rate or at any of the above rates.

BUSINESS

HISTORY AND DEVELOPMENT OF LLOYDS BANKING GROUP

The history of the Group can be traced back to the 18th century when the banking partnership of Taylors and Lloyds was established in Birmingham, England. Lloyds Bank Plc was incorporated in 1865 and during the late 19th and early 20th centuries entered into a number of acquisitions and mergers, significantly increasing the number of banking offices in the UK. In 1995, it continued to expand with the acquisition of the Cheltenham and Gloucester Building Society (C&G).

TSB Group plc became operational in 1986 when, following UK Government legislation, the operations of four Trustee Savings Banks and other related companies were transferred to TSB Group plc and its new banking subsidiaries. By 1995, the TSB Group had, either through organic growth or acquisition, developed life and general insurance operations, investment management activities, and a motor vehicle hire purchase and leasing operation to supplement its retail banking activities.

In 1995, TSB Group plc merged with Lloyds Bank Plc. Under the terms of the merger, the TSB and Lloyds Bank groups were combined under TSB Group plc, which was re-named Lloyds TSB Group plc with Lloyds Bank Plc, which was subsequently re-named Lloyds TSB Bank plc, the principal subsidiary. In 1999, the businesses, assets and liabilities of TSB Bank plc, the principal banking subsidiary of the TSB Group prior to the merger, and its subsidiary Hill Samuel Bank Limited were vested in Lloyds TSB Bank plc, and in 2000, Lloyds TSB Group acquired Scottish Widows. In addition to already being one of the leading providers of banking services in the UK, this transaction also positioned Lloyds TSB Group as one of the leading suppliers of long-term savings and protection products in the UK.

On 18 September 2008, with the support of the UK Government, the boards of Lloyds TSB Group plc and HBOS plc announced that they had reached agreement on the terms of a recommended acquisition by Lloyds TSB Group plc of HBOS plc. The shareholders of Lloyds TSB Group plc approved the acquisition at the Company’s general meeting on 19 November 2008. On 16 January 2009, the acquisition was completed and Lloyds TSB Group plc changed its name to Lloyds Banking Group plc.

Pursuant to two placing and open offers which were completed by the Company in January and June 2009 and the Rights Issue completed in December 2009, the UK Government acquired 43.4 per cent of the Company’s issued ordinary share capital. Following further issues of ordinary shares, the UK Government’s holding has been reduced to approximately 40.6 per cent.

STRATEGY OF LLOYDS BANKING GROUP

The Group’s corporate strategy supports its vision of being recognised as the best financial services company in the UK by customers, colleagues and shareholders. The strategy is focused on being a conservative, ‘through the cycle’ relationship-based business.

The main focus for the Group remains the financial services markets in the UK and the Group’s strategic position was strengthened through the acquisition of HBOS in January 2009. The Group is a well diversified UK financial services group and the largest retail financial services provider in the UK. The Group has leading positions in many of the markets in which it participates, a comprehensive distribution capability, well recognised brands and a large customer base. The Group continues to invest in products and services, systems and training that combined will offer improved choice and service to the Group’s customers.

The Group’s corporate strategy is focused on:

DEVELOPING STRONG CUSTOMER FRANCHISES THAT ARE BASED ON DEEP CUSTOMER RELATIONSHIPS

The Group’s core businesses are focused on extending customer relationships, whilst enhancing product capabilities to build competitive advantage. Striving to understand and effectively meet the needs of the Group’s customers from basic banking products to the more specialist services such as insurance, wealth management or corporate banking is at the heart of the Group’s business and is fundamental to ensuring that the Group is developing long-lasting customer relationships.

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BUILDING A HIGH PERFORMANCE ORGANISATION

In building a high performance organisation the Group is focused on improving its cost efficiency and utilising its capital more effectively whilst maintaining a prudent approach to risk.

 

 

The Group aspires to have one of the lowest cost:income ratios amongst UK financial institutions and further improving the Group’s processing efficiency and effectiveness will remain a priority. The effective integration of the HBOS business and the anticipated synergies arising from the acquisition will be key to further improving the Group’s efficiency.

 

 

Utilising capital more effectively is increasingly important in the current environment and capital will continue to be rigorously allocated across the Group’s portfolio of businesses to support core business growth.

 

 

The prudent Lloyds TSB ‘through the cycle’ approach to risk has been applied to the enlarged Group. The Group’s conservative and prudent approach to risk is core to the business model and the ‘through the cycle’ approach means that the Group will continue to support its customers throughout the economic cycle. The risk structures and frameworks that have been implemented are the foundation for good business management.

MANAGING THE GROUP’S MOST VALUABLE RESOURCE, PEOPLE

Central to executing the Group’s strategy effectively will be building strong and long lasting customer relationships; this will only be possible through the efforts of its people. Therefore the Group’s employees are its most valuable resource and it must ensure that their objectives and deliverables are aligned to the Group’s corporate strategy. In driving a high performance culture it is important to encourage, manage and develop staff whilst creating a great place to work. By creating a great place to work the Group believes it will be able to retain and attract the highest performers.

SUMMARY

The Group believes that the successful execution of its strategy to focus on core markets, customer and cost leadership, balance sheet efficiency, a prudent risk appetite and the effective management of its most valuable resource, its people, will bring the Group closer to achieving its vision of being recognised as the best financial services company in the UK.

Following the appointment of António Horta-Osório as Group Chief Executive of Lloyds Banking Group on 1 March 2011, the Group has also announced the launch of a Strategic Review of its Medium Term Plan (see Recent developments – Lloyds Banking Group moves ahead with Project Verde). The conclusions of the Strategic Review will be announced around the end of the first half of 2011. The Strategic Review will cover all aspects of the business and will focus on ensuring that customers will be at the heart of the Group’s future strategy by supporting UK households and businesses.

BUSINESS AND ACTIVITIES OF LLOYDS BANKING GROUP

The Group is organised into four segments: Retail; Wholesale; Wealth and International; and Insurance; see note 4 to the consolidated financial statements.

Further information on the Group’s segments is set out on pages 33 to 44.

MATERIAL CONTRACTS

The Company and its subsidiaries are party to various contracts in the ordinary course of business.

In 2009, the Company entered into a placing and compensatory open offer agreement with Her Majesty’s Treasury (HM Treasury) (as amended and restated on 20 March 2009 between the Company, HM Treasury, Citigroup Global Markets U.K. Equity Limited, J.P. Morgan Cazenove Limited and UBS Limited and further amended and restated between the same parties on 18 May 2009). In addition, the Company entered into a registration rights agreement with HM Treasury on 12 January 2009 (as amended with effect from 11 June 2009). The Company also entered into a resale rights agreement with HM Treasury pursuant to its obligations under the 2009 placing and compensatory open offer agreement. In addition, in connection with the Rights Issue completed in 2009 and the Group’s withdrawal from its proposed participation in the Government Asset Protection Scheme, the Company entered into a GAPS withdrawal deed with HM Treasury as well as the HMT undertaking to subscribe and the cost reimbursement deed. For further details on each of the 2009 agreements described above, see Major shareholders and related party transactions – Information about Lloyds Banking Group’s Relationship with the UK Government.

In addition to those agreements discussed above, the Company entered into the following agreements, which it considers to be material:

RIGHTS ISSUE UNDERWRITING AGREEMENT

Pursuant to an underwriting agreement dated 3 November 2009 (entered into in relation to the Rights Issue between the Company, the banks, the senior co-lead managers, the co-lead managers and the co-bookrunner (all as named therein)), new shares in the Company were issued at a price of 37 pence per share. Sufficient new shares were issued to ensure that the gross proceeds of the Rights Issue receivable by the Company, including pursuant to the HMT Undertaking to Subscribe, were not less than £13.5 billion.

HM Treasury undertook to subscribe for its pro rata entitlement under the Rights Issue and the new shares that were the subject of the HMT Undertaking to Subscribe were not underwritten pursuant to the Rights Issue Underwriting Agreement. Further details of the HMT Undertaking to Subscribe are set out in Major Shareholders and Related Party Transactions – Information about Lloyds Banking Group’s Relationship with the UK Government.

In consideration of their services under the Rights Issue Underwriting Agreement, (i) the underwriters (as named in the Rights Issue Underwriting Agreement) were paid an aggregate base fee of 2.25 per cent. of the issue price multiplied by the aggregate number of new shares issued (excluding the new shares that were subscribed for by HMT), and (ii) the joint bookrunners (as named in the Rights Issue Underwriting Agreement) were paid additional performance-based discretionary fees. Out of such fees (to the extent received by the joint global coordinators (as named in the Rights Issue Underwriting Agreement), the joint global coordinators were to pay any sub-underwriting commissions (to the extent that sub-underwriters were procured). The joint global coordinators had the ability to arrange sub-underwriting in respect of some, all or none of the new shares issued (other than the new shares to be subscribed by HM Treasury).

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The Company agreed to pay all costs and expenses of, or in connection with, the Rights Issue, the general meeting of the Company convened to approve the Rights Issue, the related subdivision of the Company’s shares, the allotment and issue of the new shares and the Rights Issue Underwriting Agreement, including (but not limited to) the UK Listing Authority and the London Stock Exchange listing and trading fees, other regulatory fees and expenses, printing and advertising costs, postage, Equiniti Limited’s charges (as registrar), its own and the banks’, the senior co-lead managers’ and the co-lead managers’ properly incurred legal and other out of-pocket expenses, all accountancy and other professional fees, properly incurred public relations fees and expenses and all stamp duty and stamp duty reserve tax (if any) and other duties and taxes (other than corporation tax incurred by any of the banks, the senior co-lead managers and the co-lead managers on the commissions payable to them).

The obligations of the banks, the senior co-lead managers and the co-lead managers under the Rights Issue Underwriting Agreement were subject to certain limited conditions which were satisfied.

TOP UP ISSUES UNDERWRITING AGREEMENT

Pursuant to the Top Up Issues Underwriting Agreement dated 3 November 2009 among the Company, LBG Capital No.2 plc (as issuer), Lloyds TSB Bank plc (as guarantor) and the joint bookrunners (as named therein), in the event that the two exchange offers announced by the Group on 3 November 2009 (the Exchange Offers) did not generate or were not expected to generate prior to 30 April 2010, or such other date as the Company and the joint global bookrunners (as named therein) might agree, £7.5 billion or more of core tier 1 and/or nominal value of contingent core tier 1 capital, the joint bookrunners severally agreed to underwrite one or more further issues of enhanced capital notes in an aggregate amount sufficient to reduce such shortfall to zero by such date.

In consideration of their underwriting services under the Top Up Issues Underwriting Agreement, and subject to their obligations under the Top Up Issues Underwriting Agreement having become unconditional and the Top Up Issues Underwriting Agreement not having been terminated, the joint bookrunners were paid an aggregate underwriting fee of £75 million and additional performance-based discretionary fees.

The obligations of the joint bookrunners under the Top Up Issues Underwriting Agreement and, in relation to each issue of additional enhanced capital notes, the obligations of the joint bookrunners under the Top Up Issues Underwriting Agreement were subject to certain conditions which were satisfied.

Each of the Company, the issuer and the guarantor gave certain customary representations, warranties, undertakings and indemnities to the joint bookrunners, all of which have now expired.

In addition to the fees described above, the joint bookrunners and their affiliates were paid pursuant to the Rights Issue Underwriting Agreement and the Top Up Issues Underwriting Agreement:

 

 

(i)

an aggregate transaction praecipuum of 0.088 per cent of £15.1 billion (being the aggregate of the underwriting commitments of the underwriters and the joint bookrunners), or of a sum in excess thereof dependent on the notional amount of the securities submitted in the Exchange Offers; and

 

 

(ii)

a further discretionary aggregate transaction praecipuum (to be paid at the sole discretion of the Company, as to payment and allocation) of 0.088 per cent. of £15.1 billion (being the aggregate of the underwriting commitments of the underwriters and the joint bookrunners), or of a sum in excess thereof dependent on the notional amount of the securities submitted in the Exchange Offers.

ENVIRONMENTAL MATTERS

The Group believes that it has an important role to play in facilitating and financing the transition to a low carbon, resource efficient economy. The Group’s vision is to be recognised by its stakeholders as a leading environmentally responsible organisation.

The Group is already one of the leading global financers of renewable energy (by debt underwriting capability). In 2010, Lloyds Banking Group was rated the top UK bank in the new FTSE Carbon Disclosure Project (CDP) Carbon Strategy Index Series, recognising its performance in managing climate risks and grasping the emerging opportunities.

GOVERNANCE

The Group strengthened its governance framework in 2010, establishing Board representatives for key strands of its Corporate Responsibility agenda, including environmental management. Truett Tate, Group Executive Director, Wholesale, is Executive Sponsor for Climate Change and Environmental Issues. The Group also established a new Environmental Steering Group, chaired by the Group Property Director. With senior representation from across the Group, this drives the environmental strategy, targets and performance.

MANAGING ENVIRONMENTAL RISKS IN LENDING

The Group has introduced policies and procedures to reduce the environmental impact of its lending activities. The groupwide Environmental Risk Policy requires all business loans to be assessed for material environmental risks as part of the credit sanctioning process. The Group’s policy is supported by a robust process which ensures that there is a consistent approach to identifying, assessing, mitigating and reporting environmental risks. Lending officers are responsible for ensuring that environmental risks are assessed and that action is taken where a risk is identified. Employees are trained in environmental risk management as part of the Group’s standard credit risk training course and have access to relevant guidance documents. In 2011, the Group will further strengthen its risk management process with the implementation of an online environmental risk screening tool.

PROJECT FINANCE: EQUATOR PRINCIPLES

Lloyds Banking Group is a signatory to the Equator Principles to support its approach to assessing and managing environmental and social issues in project finance. Lending officers are responsible for undertaking initial classification of transactions that qualify under the Equator Principles. Their assessments are subject to further review by the Group’s Equator Principles Review Group, comprising experts from both the Risk and Project Finance teams, to ensure that each transaction is compliant and is consistent with the Group’s Environmental Risk Policy. The Group trained over 100 employees in its Equator Principle Procedures in 2010.

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Equator Principles reporting January to December 2010:

DEALS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CATEGORY1

 

 

A

 

 

B

 

 

C

 

 

Total

 

                           

Completed

 

 

 

 

8

 

 

10

 

 

18

 

In progress

 

 

 

 

4

 

 

 

 

4

 

Not completed

 

 

 

 

5

 

 

2

 

 

7

 

                           

Total

 

 

 

 

17

 

 

12

 

 

29

 

                           

 

GEOGRAPHY OF COMPLETED TRANSACTIONS

 

 

 

 

 

 

 

 

 

 

 

 

 

US

 

 

 

 

3

 

 

2

 

 

5

 

Europe

 

 

 

 

5

 

 

8

 

 

13

 

Rest of World

 

 

 

 

 

 

 

 

 

                           

Total

 

 

 

 

8

 

 

10

 

 

18

 

                           

 

INDUSTRY OF COMPLETED TRANSACTIONS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number

 

 

£m

 

                           

Renewables

 

 

 

 

 

 

 

 

8

 

 

391

 

Infrastructure

 

 

 

 

 

 

 

 

8

 

 

699

 

Energy and utilities

 

 

 

 

 

 

 

 

2

 

 

78

 

                           

Total

 

 

 

 

 

 

 

 

18

 

 

1,168

 

                           

 

 

1

Category A is higher risk; category B is medium risk; category C is lower risk.

RESOURCE EFFICIENCY

Reducing the Group’s own use of resources helps the Group minimise its impact on the environment as well as keeping costs under control. In 2010, the Group launched Smart & Responsible, its new targeted environmental action plan. It aims to deliver significant environmental and cost savings, as well as improving colleagues’ work-life balance.

The Group also registered for the Carbon Reduction Commitment Energy Efficiency Scheme in 2010 and will now be required to purchase allowances for each tonne of energy-related CO2 that it emits. This has significant cost implications for the Group which provides a further incentive to reduce carbon emissions. The Group is already working towards achieving the Carbon Trust Standard – this standard recognises organisations that are genuinely measuring and reducing CO2 emissions. The Group’s goal is to reduce its energy consumption by 30 per cent by 2020.

ENGAGING OUR EMPLOYEES

Employees play a key role in delivering the Group’s environmental agenda. One of the main areas where colleagues can have a real impact is in business travel. There is a common travel policy in place across the Group which supports a focus on reducing travel. This has helped to increase the volume of teleconferences by 73 per cent in 2010 compared with 2009.

The Group has strengthened its approach in 2010 with the introduction of TRAVELwise, part of the Smart & Responsible programme. The Group has set a TRAVELwise target to avoid 1 in 5 business flights by 2015.

CO2 EMISSIONS (TONNES)

 

 

 

 

 

 

 

 

 

 

2010

 

2009

 

           

Total UK CO2 emissions

 

 

442,535

 

 

449,207

 

Scope 1 emissions

 

 

73,182

 

 

76,387

 

Scope 2 emissions

 

 

333,315

 

 

343,693

 

Scope 3 emissions

 

 

36,038

 

 

29,127

 

               

For 2009, the Group has reported emissions for January to December. For 2010 and future years, the Group will report annual emissions from October to September. The Group’s CO2 emissions have been independently verified by environmental consultants, RPS Group.

PROPERTIES

As at 31 December 2010, Lloyds Banking Group occupied 3,231 properties in the UK. Of these, 928 were held as freeholds, 91 as long-term leaseholds and 2,212 as short-term leaseholds. The majority of these properties are retail branches, widely distributed throughout England, Scotland and Wales. Other buildings include the Lloyds Banking Group’s head office in the City of London with other customer service and support centres located to suit business needs but clustered largely in eight core geographic conurbations – London, Edinburgh, Glasgow, Midlands (Birmingham), Northwest (Chester and Manchester), West Yorkshire (Halifax and Leeds), South (Brighton and Andover) and Southwest (Bristol and Cardiff).

In addition, there are 498 properties which are either sub-let or vacant. There are also a number of ATM units situated throughout the UK, the majority of which are held as short-term leasehold. The Group also has business operations elsewhere in the world, primarily holding property on a leasehold basis, principally in North America, Europe and Asia.

LEGAL ACTIONS AND REGULATORY MATTERS

During the ordinary course of business the Group is subject to threatened or actual legal proceedings and regulatory challenge both in the UK and overseas.

UNARRANGED OVERDRAFT CHARGES

In April 2007, the Office of Fair Trading (OFT) commenced an investigation into the fairness of personal current accounts and unarranged overdraft charges. At the same time, it commenced a market study into wider questions about competition and price transparency in the provision of personal current accounts.

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The Supreme Court of the United Kingdom published its judgment in respect of the fairness of unarranged overdraft charges on personal current accounts on 25 November 2009, finding in favour of the litigant banks. On 22 December 2009, the OFT announced that it will not continue its investigation into the fairness of these charges. The Group is working with the regulators to ensure that outstanding customer complaints are concluded as quickly as possible and anticipates that most cases in the county courts will be discontinued. The Group expects that some customers will argue that despite the test case ruling they are entitled to a refund of unarranged overdraft charges on the basis of other legal arguments or challenges. It is not practicable to quantify the claims at this time. The Group is robustly defending any such complaints or claims and does not expect any such complaints or claims to have a material effect on the Group.

The OFT however continued to discuss its concerns in relation to the personal current account market with the banks, consumer groups and other organisations under the auspices of its Market Study into personal current accounts. In October 2009, the OFT published voluntary initiatives agreed with the industry and consumer groups to improve transparency of the costs and benefits of personal current accounts and improvements to the switching process. On 16 March 2010 the OFT published a further update announcing several further voluntary industry wide initiatives to improve a customer’s ability to control whether they use an unarranged overdraft and to assist those in financial difficulty. However, in light of the progress it noted in the unarranged overdraft market since July 2007 and the progress it expects to see over the next two years, it has decided to take no further action at this time and will review the unarranged overdraft market again in 2012.

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 issuers charged a uniform fallback interchange fee 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 fee 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 a uniform fallback interchange fee are compatible with European Union competition laws. MasterCard has announced that it has reached an understanding with the European Commission on a new methodology for calculating intra European Economic Area multi-lateral interchange fees on an interim basis pending the outcome of the appeal. Meanwhile, the European Commission and the UK’s OFT are pursuing investigations with a view to deciding whether arrangements adopted by other payment card schemes for the levying of uniform fallback interchange fees in respect of domestic and/or crossborder payment transactions also infringe European Union and/or UK competition laws. As part of this initiative, the OFT will also intervene in the General Court appeal supporting the European Commission position and Visa reached an agreement with the European Commission to reduce the level of interchange for crossborder debit card transactions to the interim levels agreed by MasterCard. The ultimate impact of the investigations on the Group can only be known at the conclusion of these investigations and any relevant appeal proceedings.

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.

Subsequent to the year end, 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.

Since publication of the judgment, the Group has been in 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 income statement for the year ended 31 December 2010 of £3,200 million in respect of the anticipated costs of such contact and/or redress, including administration expenses. 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 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.

US SANCTIONS

In January 2009 Lloyds TSB Bank plc announced the settlement it had reached with the US Department of Justice and the New York County District Attorney’s Office in relation to their investigations into historic US dollar payment practices involving countries, persons or entities subject to the economic sanctions administered by the US Office of Foreign Assets Control (OFAC). On 22 December 2009 OFAC announced the settlement it had reached with Lloyds TSB Bank plc in relation to its investigation and confirmed that the settlement sum due to OFAC had been fully satisfied by

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Lloyds TSB Bank plc’s payment to the Department of Justice and the New York County District Attorney’s Office. No further enforcement actions are expected in relation to the matters set out in the settlement agreements.

On 26 February 2009, a purported shareholder filed a derivative civil action in the Supreme Court of New York, Nassau County against certain current and former directors, and nominally against Lloyds TSB Bank plc and Lloyds Banking Group plc, seeking various forms of relief. The derivative action is at an early stage and settlement is being discussed, and the ultimate outcome is not expected to have a material impact on the Group.

CUSTOMER GOODWILL PAYMENTS

The Group has been in discussions with the FSA regarding the application of an interest variation clause in certain Bank of Scotland plc variable rate mortgage contracts where the wording in the offer documents received by certain customers had the potential to cause confusion. The relevant mortgages were written between 2004 and 2007 by Bank of Scotland plc under the ‘Halifax’ brand. In February 2011, the Group reached agreement with the FSA in relation to initiating a customer review and contact programme and making goodwill payments to affected customers. In order to make these goodwill payments, Bank of Scotland plc applied for a Voluntary Variation of Permission to carry out the customer review and contact programme to bring it within section 404F (7) of FSMA 2000. The Group has made a provision of £500 million within its 2010 accounts which is expected to fully cover the payments under this contact programme.

INTERBANK OFFERED RATE SETTING INVESTIGATIONS

Various regulators in the UK, US and overseas, including the US Commodity Futures Trading Commission, the SEC and 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 in a number of jurisdictions. The Group has received requests from some regulators for information and is co-operating with their investigations. In addition recently the Group has been named in private purported class action suits in the US with regard to the setting of London interbank offered rates (LIBOR) by members of the LIBOR setting panel. It is currently not possible to predict the scope and ultimate outcome of the various regulatory investigations or purported private class action suits, including the timing and scale of the potential impact of any investigations and class action suits on the Group.

OTHER LEGAL ACTIONS AND 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, product terms and sales processes. The Group is keen to ensure that any regulatory concerns regarding the Group’s processes, product governance, sales processes or contract terms are understood and addressed. The ultimate impact on the Group of these discussions can only be known at the conclusion of such discussions.

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, arising out of regulatory investigations or otherwise), 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.

COMPETITIVE ENVIRONMENT

The Group provides financial services to personal and corporate customers, predominantly in the UK but also overseas. The main business activities of the Group are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision.

In the retail banking market, the Group competes with banks and building societies, major retailers and internet-only providers. In the mortgage market, competitors include the traditional banks and building societies and specialist mortgage providers. The Group competes with both UK and foreign financial institutions in the wholesale banking markets and with bancassurance, life assurance and general insurance companies in the UK insurance market.

RECENT DEVELOPMENTS

LLOYDS BANKING GROUP MOVES AHEAD WITH PROJECT VERDE

On 1 March 2011, the Group made the following announcement with respect to Project Verde:

In order to meet its obligations under the state aid commitments and to ensure the Group maintains the maximum flexibility in its options, Lloyds Banking Group is accelerating the start of the disposal of the business described in more detail within Major shareholders and related party transactions – Information about the Lloyds Banking Group’s relationship with the UK government – Other related party transactions with the UK government – State aid.

Moving ahead with the disposal follows the excellent progress the bank has made on integration.

Following the appointment of António Horta-Osório as Group Chief Executive of Lloyds Banking Group on 1 March 2011, the Group has also announced the launch of a Strategic Review of its Medium Term Plan. The conclusions of the Strategic Review will be announced around the end of the first half of 2011.

The Strategic Review will cover all aspects of the business and will focus on ensuring that customers will be at the heart of the Group’s future strategy by supporting UK households and businesses.

To support this commitment, the Group will place a moratorium on announcing further UK branch closures until the end of 2011 and pending the Strategic Review.

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LLOYDS BANKING GROUP ANNOUNCES BOARD AND MANAGEMENT TEAM CHANGES

On 9 March 2011, the Group announced changes to the Group Board and management team.

Mr Archie Kane, Group Executive Director for Insurance and Scotland will not seek re-election as a Director at the Group’s Annual General Meeting on 18 May 2011.

The components of the Insurance division of the Group, Life, Pensions and Investments and General Insurance, will report directly to the Group Chief Executive António Horta-Osório.

In addition as a result of a restructure of the retail bank outlined below, Mrs Helen Weir, Group Executive Director for Retail, has decided to leave the Group and will consequently not seek re-election as a Director at the Group’s Annual General Meeting.

The Group’s Retail banking division will now be restructured as follows:

 

 

Retail Products and Marketing.

 

 

The Lloyds TSB and Bank of Scotland Community Banks.

 

 

The Halifax Community Bank.

All of which will report directly to the Group Chief Executive.

CONSOLIDATED FINANCIAL STATEMENTS SET OUT IN THE GROUP’S ANNUAL REPORT AND ACCOUNTS

The audited consolidated financial statements set forth in the Group’s Annual Report and Accounts published on 30 March 2011 were approved on 24 February 2011. As discussed in greater detail in note 59 on page F-124 of the audited consolidated financial statements included in this Annual Report on Form 20-F (which were approved on 13 May 2011 and which therefore include the impact of adjusting post balance sheet events up to this date), the Group has made a provision of £3,200 million in connection with the sale of payment protection insurance following a UK High Court judgment handed down on 20 April 2011, subsequent discussions with the FSA and analyses prepared by the Group.

LLOYDS BANKING GROUP RESPONDS TO THE INTERIM REPORT FROM THE INDEPENDENT COMMISSION ON BANKING

On 11 April 2011, the Group published the following response to the Interim Report from the Independent Commission on Banking (ICB):

The Group has reviewed the Interim Report from the ICB and will consider and respond to the options presented more fully in due course. The Group will continue to play a constructive role in the debate and to consult with the ICB during the coming months.

The Group notes the ICB’s desire to ensure the stability of the financial system through a form of subsidiarisation and strengthened capital. The Group will consider the financial and non-financial impact of these measures in order that the implications are fully understood.

The Group believes that the UK retail banking market is competitive and that the ICB should now seriously consider the importance of Independent Financial Advisers and of the internet channel as forces that promote competition. The Group welcomes the focus on improving switching and greater transparency that should be positive for customers of banks and is consistent with the Group’s submissions to the ICB.

The Group believes that the Interim Report’s option for an expansion of the divestiture of 600 branches as mandated by the European Union (‘Project Verde’) would not be in the interest of its customers and appears to be based on limited evidence and may significantly delay meeting the commitments agreed between the UK Government and the European Union.

Project Verde will result in the creation of the seventh largest retail bank in the UK. The European Union, working with the UK Government, structured Project Verde to ensure the divested entity would specifically be a strong and viable competitor. Moreover, the Group’s acceleration of the start of Project Verde is expected to identify a potential purchaser by the end of 2011.

FIRST QUARTER 2011 TRADING UPDATE

See the Group’s Form 6-K relating to its first quarter 2011 trading update filed with the Securities and Exchange Commission on 13 May 2011.

10


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The results discussed below are not necessarily indicative of Lloyds Banking Group’s results in future periods. The following information contains certain forward looking statements. For a discussion of certain cautionary statements relating to forward looking statements, see Forward looking statements.

The following discussion is based on and should be read in conjunction with the consolidated financial statements and the related notes thereto included elsewhere in this annual report. For a discussion of the accounting policies used in the preparation of the consolidated financial statements, see Accounting policies in note 2 to the consolidated financial statements.

TABLE OF CONTENTS

 

 

 

 

     

 

Overview and trend information

 

12

 

     

 

Critical accounting policies

 

13

 

     

 

Future accounting developments

 

13

 

     

 

Results of operations – 2010, 2009 and 2008

 

13

 

     

 

Economic profit

 

26

 

     

 

Integration

 

27

 

     

 

Line of business information

 

28

 

     

 

Average balance sheet and net interest income

 

50

 

     

 

Changes in net interest income – volume and rate analysis

 

54

 

     

 

Risk management

 

55

 

     

 

Business risk

 

62

 

     

 

Credit risk

 

63

 

     

 

Loan portfolio

 

79

 

     

 

Risk elements in the loan portfolio

 

85

 

     

 

Market risk

 

89

 

     

 

Insurance risk

 

91

 

     

 

Operational risk

 

92

 

     

 

Financial soundness

 

95

 

     

 

11


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OVERVIEW AND TREND INFORMATION

THE ECONOMY

The global economy has continued to recover from the deep recession of 2009, but the recovery is fairly weak by past standards and its continuation is not assured. Remaining vulnerabilities in the sustainability of public finances and the robustness of banking sectors across the US and Europe have meant that growth there has faltered during 2010 and required monetary policy to be kept highly accommodative for longer than expected at the start of the year. Ireland has required support from the IMF and EU, and other high deficit countries in the Eurozone may do so during 2011. The US has extended the Bush-era tax cuts, although it is unclear how much stimulus this will provide given the need to tighten fiscal policy significantly in the medium term.

First estimates suggest that the UK economy grew by 1.4 per cent in 2010, below the long-term average of 2.25 per cent. Growth peaked in the first half due to the initial boost from companies beginning to rebuild stocks, and has slowed during the second half. Consumer confidence has fallen back and house prices have recently reversed some of their 2009 rise. Nevertheless, employment has held up relatively well, falling by much less than in previous recessions and beginning to rise much earlier, although the recent trend is broadly flat. UK corporate liquidations have been on a gradually falling trend since Q3 2009, much earlier than in previous recoveries, and are now almost back to the level at the start of the recession. Related to that, commercial property prices have now risen by 16 per cent from the trough reached in July 2009. Even though house price rises have fallen back slightly recently, average prices are still 6 per cent above their trough of April 2009.

The Group’s central scenario is for the modest recovery in the UK to continue – the projection of slightly less than 2 per cent Gross Domestic Product (GDP) growth in 2011 and slightly less than 2.5 per cent in 2012 is close to consensus and the March 2011 forecasts from the Office for Budget Responsibility. Private and public sector deleveraging, which is expected to suppress economic growth, should be more than offset by a positive contribution from net external trade (reflecting the weakness of sterling), by further rebuilding of stocks by companies and by increased investment. Public spending cuts may increase unemployment slightly in 2011, but if the economy continues to grow, the private sector should be able to more than offset that impact from 2012. Similarly, further declines in corporate insolvencies are likely to be very slow, limited by the public spending cuts and the weakness of consumer spending. House prices and commercial property prices are expected to dip slightly in 2011 and then rise slowly. The US recovery is assumed to continue in 2011, and in the Eurozone there is expected to be a wide divergence in 2011 between recovery in the stronger low-deficit countries and the higher deficit countries that will struggle to grow at all. The Irish economy, to which the Group has exposure, is not expected to grow materially in 2011. House prices there are expected to fall a little further in 2011 before flattening in 2012; commercial property prices are expected to be flat over 2011 and 2012.

Downside risks around this scenario remain significant. Business and consumer confidence remains fragile, and the extent to which simultaneous fiscal tightening across Europe might undermine global and UK growth is unclear. Contagion from the Irish bail-out to other Eurozone economies could drive further fiscal tightening and worsen the outlook further. Rising oil and other commodity prices, driven by strong recovery in Asia and the unrest in the Middle East, might fuel a further increase in inflation in the West, prompting short-term interest rates to rise more quickly than anticipated. Since any shock to growth would also worsen the outlook for both public finances and bank capital and funding, a relatively small initial shock could throw economies onto a much weaker path as governments are forced to tighten fiscal policy even further or financial institutions are constrained in their ability to lend. A ‘double-dip’ scenario – a second shallower recession following closely the one that the economy is just emerging from – would result in further significant increases in corporate failures and unemployment during 2011-12. In addition, residential and commercial property would suffer a second period of falling prices, tenant defaults would increase and central banks would have limited ability to cushion the downturn.

IMPACT ON THE LLOYDS BANKING GROUP’S MARKETS

The weak economic recovery in the UK has kept growth in the Group’s core markets subdued.

On the retail side, net new mortgage lending (all new lending minus repayments) continued to weaken slightly after a 72 per cent fall in 2009, so outstanding market balances grew by just 0.4 per cent. Net new unsecured consumer lending improved in 2010 after turning negative in the second half of 2009, but at £2.5 billion was only 18 per cent of the 2007 level. Part of the weakness in lending is the natural result of some lenders having left the market, particularly in the higher risk segments of mortgages and personal loans, but we have also seen a continued desire from customers to repay debt early where they are able. Deposit market growth has also remained weak, with balances rising by 3 per cent through 2010, as deteriorating disposable incomes have squeezed savings flows.

Businesses also continue to reduce their indebtedness. Non-financial corporations shrunk their borrowings from banks and building societies by 3.9 per cent in 2010 after a 2.2 per cent reduction in 2009. Rising profits and weak investment spending boosted deposit growth in the latter part of 2009 and the first half of 2010, but deposit growth has since weakened to 1.6 per cent over 2010 as a whole, after 4.5 per cent in 2009.

Low interest rates have, however, been a key benefit to consumers and businesses throughout 2010. Arrears and defaults rose by much less during the recession than in previous recessions, and began to improve in 2010 despite the weakness of the recovery in the economy. The number of company liquidations in England and Wales fell by nearly 16 per cent in 2010 after a 23 per cent rise in 2009, reducing the rate of failure of active companies to 0.7 per cent from 0.9 per cent in 2009. The number of individual insolvencies rose by a further 0.7 per cent in 2010 after a 26 per cent rise in 2009, but insolvencies during the second half of 2010 were 8.7 per cent lower than a year earlier. The number of mortgages in arrears across the market fell by 10 per cent in 2010, and the share in arrears by more than three months fell to its lowest in two years by Q4 2010.

The Group’s customer data shows that a combination of low interest rates and declining indebtedness is beginning to strengthen households’ cashflow. This is positive news for both impairments and the near-term general economic outlook. Nevertheless, the Group expects that a continuation of weak economic recovery will be accompanied by a sustained period of weak growth in its markets. Consumers and businesses will continue to deleverage slowly. Deposit growth will be limited by the pressure on consumers’ disposable incomes from wage growth below inflation and cuts in welfare benefits, and from rising investment spend by companies. Arrears trends should continue to improve, but less quickly in the coming year than the experience through 2010.

In Ireland, the economy shrank by 1 per cent in 2010, the third year of decline in succession. The loan from the Eurozone Stability Fund is helping support the economy while the government implements its sharp fiscal consolidation, and is providing the funds to recapitalise the banking sector. Nevertheless, consumers are still adjusting to lower incomes and companies to reduced demand, and as a result property prices have fallen further during 2010 – house prices by 10.8 per cent and commercial property prices by 10.7 per cent. The economy is expected to flatten out in 2011 but the environment remains challenging, particularly for property prices which are likely to fall further in the near-term before recovery begins.

12


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates.

The accounting policies that are deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are discussed in note 3 to the consolidated financial statements.

FUTURE ACCOUNTING DEVELOPMENTS

Future developments in relation to the Group’s IFRS reporting are discussed in note 58 to the consolidated financial statements.

RESULTS OF OPERATIONS – 2010, 2009 AND 2008

 

 

 

 

 

 

 

 

 

 

 

SUMMARY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

1

                     

Net interest income

 

 

12,546

 

 

9,026

 

 

7,718

 

Other income

 

 

30,921

 

 

36,271

 

 

(709

)

                     

Total income

 

 

43,467

 

 

45,297

 

 

7,009

 

Insurance claims

 

 

(18,511

)

 

(22,019

)

 

2,859

 

                     

Total income, net of insurance claims

 

 

24,956

 

 

23,278

 

 

9,868

 

Operating expenses

 

 

(16,470

)

 

(15,984

)

 

(6,100

)

                     

Trading surplus

 

 

8,486

 

 

7,294

 

 

3,768

 

Impairment

 

 

(10,952

)

 

(16,673

)

 

(3,012

)

Share of results of joint ventures and associates

 

 

(88

)

 

(752

)

 

4

 

Gain on acquisition

 

 

 

 

11,173

 

 

 

Loss on disposal of businesses

 

 

(365

)

 

 

 

 

                     

(Loss) profit before tax

 

 

(2,919

)

 

1,042

 

 

760

 

Taxation

 

 

325

 

 

1,911

 

 

38

 

                     

(Loss) profit for the year

 

 

(2,594

)

 

2,953

 

 

798

 

                     

 

 

 

 

 

 

 

 

 

 

 

Profit attributable to non-controlling interests

 

 

62

 

 

126

 

 

26

 

(Loss) profit attributable to equity shareholders

 

 

(2,656

)

 

2,827

 

 

772

 

                     

(Loss) profit for the year

 

 

(2,594

)

 

2,953

 

 

798

 

                     

 

 

1

Restated in 2009 for IFRS 2 (Revised).

2010 COMPARED WITH 2009

The Group recorded a loss before tax of £2,919 million in 2010 compared to a profit of £1,042 million in 2009 as a result of the £3,200 million payment protection insurance provision (see page 32). The results in 2010 also included a pension curtailment gain of £910 million, largely offset by a customer goodwill payments provision of £500 million (see page 32) and a loss on disposal of businesses of £365 million. The profit in 2009 included a negative goodwill credit of £11,173 million in relation to the acquisition of HBOS plc by the Group and a fee of £2,500 million paid to the UK Government as part of the agreement for the Group not to enter into the Government Asset Protection Scheme. There were significant post-acquisition impairment losses in respect of the HBOS portfolios in both 2009 and 2010.

Total income decreased by £1,830 million, or 4 per cent, to £43,467 million in 2010 compared to £45,297 million in 2009; with a £3,520 million, or 39 per cent, increase in the Group’s net interest income only partly offsetting a £5,350 million, or 15 per cent, decrease in other income.

Net interest income was £3,520 million, or 39 per cent, higher at £12,546 million in 2010 compared to £9,026 million in 2009. Net interest income was increased as the benefit of higher asset pricing more than offset the impact of lower deposit margins. The Group’s net interest margin increased by 61 basis points to 1.67 per cent in 2010 compared to 1.06 per cent in 2009 with increases in both Retail, where margins improved as a result of improved asset pricing and decreases in the LIBOR to base rate spread, and in Wholesale, again as a result of higher asset pricing to reflect customer risk. There was, however, a reduced margin in Wealth and International as a result of lower base rates, a very competitive deposit environment and the impact of impaired lending balances.

Other income was £5,350 million, or 15 per cent, lower at £30,921 million in 2010 compared to £36,271 million in 2009. Fee and commission income was £161 million, or 4 per cent, higher at £4,415 million in 2010 compared to £4,254 million in 2009. Fee and commission expense was £165 million, or 11 per cent, higher at £1,682 million in 2010 compared to £1,517 million in 2009. Net trading income was £3,374 million lower at £15,724 million in 2010 compared to £19,098 million in 2009; this included a reduction of £2,551 million in gains on policyholder investments held in the Group’s insurance businesses (although this was largely offset by a decrease in the related claims expense, see below) as a result of relative market conditions over 2010, compared to 2009; in addition, a loss of £620 million, which was £193 million, or 45 per cent, higher than the loss of £427 million in 2009, arose from the change in fair value of the embedded equity conversion feature contained in the Enhanced Capital Notes issued by the Group in 2009. During 2010 the Group exchanged certain existing subordinated debt securities for new securities, these exchanges resulted in a gain on extinguishment of the existing liabilities of £423 million, being the difference between the carrying amount of the securities extinguished and the fair value of the new securities together with related fees and costs; this was £1,075 million, or 72 per cent, lower than the gains of £1,498 million realised on similar transactions in 2009.

13


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Insurance claims were £3,508 million lower at an expense of £18,511 million in 2010 compared to £22,019 million in 2009. The insurance claims expense in respect of life and pensions business was £3,413 million, or 16 per cent, lower at £17,972 million in 2010 compared to £21,385 million in 2009 as a result of the relative returns on policyholder investments in the long-term insurance business; this movement in claims was broadly matched by a decrease in net trading income reflecting the gains on those policyholder investments. Insurance claims in respect of general insurance business were £95 million, or 15 per cent, lower at £539 million in 2010 compared to £634 million in 2009, this was due primarily to lower payment protection insurance claims related to unemployment.

Operating expenses increased by £486 million, or 3 per cent, to £16,470 million in 2010 compared to £15,984 million in 2009, this increase principally reflects the £3,200 million payment protection insurance provision in 2010, more than offsetting the impact of the non-repetition of the £2,500 million fee paid to the UK Government in 2009 as part of the agreement for the Group not to enter into the Government Asset Protection Scheme. A pension curtailment gain of £910 million in 2010 was offset by a £557 million increase in integration costs and a £500 million customer goodwill payments provision. Staff costs were £1,206 million, or 18 per cent, lower at £5,469 million in 2010 compared to £6,675 million in 2009. Excluding the pension curtailment gain of £910 million in 2010, staff costs were £296 million, or 4 per cent, lower at £6,379 million in 2010 compared to £6,675 million in 2009, as decreased salary costs, reflecting head count reductions, and lower levels of staff restructuring costs were partly offset by increases in other staff costs (reflecting greater use of agency staff in relation to the integration programme). Premises and equipment costs were £69 million, or 6 per cent, higher at £1,225 million in 2010 compared to £1,156 million in 2009. Other expenses were £4,289 million higher at £7,142 million in 2010 compared to £2,853 million in 2009. This increase reflects the £3,200 million payment protection insurance provision and the £500 million customer goodwill payments provision, both in 2010, and increased communication costs, professional fees and other expenditure in relation to the ongoing integration of the Lloyds TSB and HBOS businesses. Depreciation and amortisation costs were £128 million lower at £2,432 million in 2010 compared to £2,560 million in 2009. In 2010 there was a charge of £202 million in respect of the impairment of tangible fixed assets; and in 2009 there was a charge of £240 million in respect of the impairment of goodwill attributable to the Group’s asset finance business.

Impairment losses decreased by £5,721 million, or 34 per cent, to £10,952 million in 2010 compared to £16,673 million in 2009. Impairment losses in respect of loans and advances to customers were £5,056 million, or 32 per cent, lower at £10,727 million in 2010 compared to £15,783 million in 2009. This reflects improved credit experience in both the Retail and Wholesale divisions as a result of the improving economic environment in the UK and the US; partly offset by increased charges in the International business, especially in Ireland and Australia. The Group’s ‘through the cycle’ credit policies and procedures, which focus on the development of enduring client relationships, have resulted in higher quality new business being originated across the UK and very little new origination took place outside the UK. The Group’s level of impairment is being managed in the current challenging economic environment by the Wholesale business support units and Retail collection and recovery units. The business support model has been expanded from Wholesale across Wealth and International division, with a central team established to manage the Group’s business support activity globally. The Group has also strengthened resources within Retail collections and recoveries to enable more timely engagement with customers experiencing difficulties to drive more effective customer outcomes.

The Group’s share of results of joint ventures and associates was a net loss of £88 million in 2010 compared to a net loss of £752 million in 2009; partly due to reduced losses in the joint venture vehicles and partly reflecting the fact that many of the investments are now substantially written-off.

On 16 January 2009, the Group acquired 100 per cent of the ordinary share capital of HBOS plc. As the fair value of the identifiable net assets acquired was greater than the total consideration paid, negative goodwill of £11,173 million 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. There was no such credit in 2010.

In 2010, the Group incurred a loss on disposal of businesses of £365 million (2009: nil). During 2009, the Group had acquired an oil drilling rig construction business through a previous lending relationship and, 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.

In 2010, the Group recorded a tax credit of £325 million compared to a tax credit of £1,911 million in 2009. The tax credit of £325 million in 2010 arose on a loss before tax of £2,919 million, an effective tax rate of 11 per cent compared to the standard UK corporation tax rate of 28 per cent. This lower rate reflects losses where no deferred tax is recognised together with the impact of the tax charge attributable to UK life insurance policyholders and the Group’s interests in Open Ended Investment Companies (OEICs), which is required to be included within the income tax charge, and a charge resulting from the change in the UK corporation tax rate being largely offset by overseas tax rate differences and other adjustments.

Total assets were £34,817 million lower at £992,438 million at 31 December 2010 compared to £1,027,255 million at 31 December 2009; loans and advances to customers were £34,372 million, or 5 per cent, lower at £592,597 million at 31 December 2010 compared to £626,969 million at 31 December 2009; and customer deposits were £13,108 million, or 3 per cent, lower at £393,633 million at 31 December 2010 compared to £406,741 million at 31 December 2009; total assets have reduced as the Group has continued its strategy to reduce assets associated with non-relationship lending and investments, including business which is outside the Group’s current risk appetite. During 2009, the Group had identified approximately £300 billion of such assets; and confirmed that it is the Group’s intention to manage these assets for value and that, given the current economic climate, the primary focus would be on running these assets down over time. Over the next several years, the Group expects to achieve a reduction in these assets of approximately £200 billion (customer lending approximately £140 billion; treasury assets £60 billion). The reduction in total assets was substantially driven by reductions in non-core lending portfolios across the three banking divisions, continued customer deleveraging and de-risking and subdued demand in lending markets.

The Group’s credit market exposures primarily relate to asset-backed security exposures held in the Wholesale division; on the balance sheet these exposures are classified as loans and receivables, available-for-sale or trading and other financial assets at fair value through profit or loss depending on the nature of the investment. A detailed analysis of these asset-backed security exposures is provided in note 56 to the consolidated financial statements. The Wholesale division’s total exposure to asset-backed securities has decreased by £8,139 million from £42,863 million at 31 December 2009 to £34,724 million at 31 December 2010 as these investments continue to run-off.

Mortgage-backed security exposures were £2,562 million lower at £15,656 million at 31 December 2010 compared to £18,218 million at 31 December 2009. Exposures to Alt-A US residential mortgage-backed securities were £267 million lower at £3,700 million at 31 December 2010 compared to £3,967 million at 31 December 2009; there is no exposure to sub-prime US residential mortgage-backed securities.

For credit market exposures the Group’s approach is to analyse the underlying transaction to determine whether it needs to place reliance on any protection provided by an insurer or guarantor. In note 56 to the consolidated financial statements the Group discloses its exposures where reliance is placed on monoline insurers, which are limited to a total of £254 million at 31 December 2010 (31 December 2009: £444 million); all of the exposure at 31 December 2010 is rated AA.

14


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

At the end of December 2010, the Group’s capital ratios increased with a total capital ratio on a Basel II basis of 14.5 per cent (compared to 12.4 per cent at 31 December 2009), a tier 1 ratio of 11.0 per cent (compared to 9.6 per cent at 31 December 2009) and a core tier 1 ratio of 9.6 per cent (compared to 8.1 per cent at 31 December 2009). During 2010, risk-weighted assets decreased by £86,935 million to £406,372 million at 31 December 2010 compared to £493,307 million at 31 December 2009; this decrease reflects balance sheet reductions across all banking divisions, a revised assessment of the Retail division’s secured lending risk-weighted assets following improvements in the economic outlook and changes introduced as a result of continuing the process of integrating the Lloyds TSB and HBOS regulatory capital approaches which have impacted particularly on the Wholesale division.

2009 COMPARED WITH 2008

Profit before tax was £282 million, or 37 per cent, higher at £1,042 million in 2009 compared to £760 million in 2008; however, the profit in 2009 included a negative goodwill credit of £11,173 million in relation to the acquisition of HBOS plc by the Group; a fee of £2,500 million paid to the UK Government as part of the agreement for the Group not to enter into the Government Asset Protection Scheme; and significant post-acquisition impairment losses in respect of the HBOS portfolios.

Total income increased by £38,288 million to £45,297 million in 2009 compared to £7,009 million in 2008. Excluding the total income of £23,240 million arising on the consolidation of HBOS’s post-acquisition results, total income was £15,048 million higher at £22,057 million in 2009 compared to £7,009 million in 2008; with a reduction in the Group’s net interest income being more than offset by a large increase in other income.

Net interest income was £1,308 million, or 17 per cent, higher at £9,026 million in 2009 compared to £7,718 million in 2008. Excluding the net interest income of £4,049 million arising on the consolidation of HBOS’s post-acquisition results, net interest income was £2,741 million, or 36 per cent, lower at £4,977 million in 2009 compared to £7,718 million in 2008. Excluding the interest flows arising on the consolidation of HBOS’s post-acquisition results, both interest income and interest expense fell in response to the historically low interest rate environment that prevailed throughout 2009; net interest income was reduced as the benefit of higher asset pricing was more than offset by the impact of lower deposit margins, reflecting the impact of falling base rates, and higher funding costs, which included the impact of the Group extending its wholesale funding maturity profile. The Group’s net interest margin decreased by 157 basis points to 1.06 per cent in 2009 compared to 2.63 per cent in 2008 with reductions across the Group’s businesses.

Other income was £36,980 million higher at £36,271 million in 2009 compared to a deficit of £709 million in 2008. Fee and commission income was £1,023 million, or 32 per cent, higher at £4,254 million in 2009 compared to £3,231 million in 2008. However, excluding the fee and commission income which arose on the consolidation of HBOS’s post-acquisition results, fee and commission income was £479 million, or 15 per cent, lower at £2,752 million in 2009 compared to £3,231 million in 2008, largely due to a £424 million reduction in insurance broking income as a result of a market-wide move to monthly premiums on payment protection products. Net trading income improved by £28,284 million to net income of £19,098 million in 2009 compared to a net loss of £9,186 million in 2008. Excluding net trading income of £12,093 million arising from the consolidation of the post-acquisition results of HBOS, net trading income improved by £16,191 million to net income of £7,005 million in 2009 compared to a net loss of £9,186 million in 2008. Trading income in 2008 in the Group’s banking operations was particularly impacted by market dislocation, leading to significant downwards valuations on a number of assets; this was not repeated in 2009. In addition there was an improvement of £14,179 million in gains on policyholder investments held in the Group’s insurance businesses (and largely offset by an increase in the claims expense, see below) as the improvement in market conditions had led to trading profits in 2009, compared to substantial losses in 2008. During 2009 the Group exchanged certain existing subordinated debt securities for new securities, these exchanges resulted in a gain on extinguishment of the existing liabilities of £1,498 million, being the difference between the carrying amount of the securities extinguished and the fair value of the new securities together with related fees and costs.

Insurance claims were £24,878 million higher at an expense of £22,019 million in 2009 compared to a credit of £2,859 million in 2008. Excluding the insurance claims expense of £12,385 million arising on the consolidation of HBOS’s post-acquisition results, insurance claims were £12,493 million higher at an expense of £9,634 million in 2009 compared to a credit of £2,859 million in 2008. The insurance claims amount in respect of life and pensions business in 2008 was a credit of £3,052 million as a result of the negative returns in that year on policyholder investments in the long-term insurance business which led to a reduction in insurance related liabilities and a credit to the insurance claims expense; positive returns in 2009 led to the return to an insurance claims expense with the movement in claims being broadly matched by an improvement in net trading income reflecting the gains on policyholder investments. Insurance claims in respect of general insurance business were £441 million higher at £634 million in 2009 compared to £193 million in 2008. Excluding the general insurance claims of £362 million arising on the consolidation of HBOS’s post-acquisition results, general insurance claims were £79 million, or 41 per cent, higher at £272 million in 2009 compared to £193 million in 2008, this was due primarily to higher payment protection insurance claims related to unemployment.

Operating expenses increased by £9,884 million, or 162 per cent, to £15,984 million in 2009 compared to £6,100 million in 2008. Excluding the operating expenses of £6,456 million arising on the consolidation of HBOS’s post-acquisition results, operating expenses were £3,428 million, or 56 per cent, higher at £9,528 million in 2009 compared to £6,100 million in 2008; this increase principally reflected the £2,500 million fee paid to the UK Government as part of the agreement for the Group not to enter into the Government Asset Protection Scheme, costs of £635 million borne within the Lloyds TSB businesses in respect of the integration of the enlarged group and an increased charge in respect of goodwill impairment, only partly offset by the fact that operating expenses in 2008 included a £180 million settlement in relation to certain historic US dollar payments which was not repeated in 2009. Staff costs were £3,697 million, or 124 per cent, higher at £6,675 million compared to £2,978 million in 2008. Excluding the staff costs of £3,014 million that arose on consolidation of the post-acquisition results of HBOS, staff costs were £683 million, or 23 per cent, higher at £3,661 million in 2009 compared to £2,978 million in 2008, with particular increases in restructuring costs and other staff costs (reflecting increased use of agency staff in relation to the integration programme). Premises and equipment costs were £506 million, or 78 per cent, higher at £1,156 million in 2009 compared to £650 million in 2008. Excluding the premises and equipment costs that arose on the consolidation of the post-acquisition results of HBOS, premises and equipment costs were £84 million, or 13 per cent, higher at £734 million in 2009 compared to £650 million in 2008. Other expenses were £1,167 million, or 69 per cent, higher at £2,853 million in 2009 compared to £1,686 million in 2008. Excluding the £1,185 million of costs that arose on consolidation of the post-acquisition results of HBOS, other expenses were £18 million, or 1 per cent, lower at £1,668 million in 2009 compared to £1,686 million in 2008; however other expenses in 2008 included the £180 million settlement in relation to certain historic US dollar payments and, excluding this, other expenses excluding HBOS in 2009 were £162 million, or 11 per cent, higher at £1,668 million compared to £1,506 million in 2008. Depreciation and amortisation costs were £1,874 million higher at £2,560 million compared to £686 million in 2008; £1,813 million of this increase reflected the impact of consolidation of the post-acquisition results of HBOS. A charge of £240 million (2008: £100 million) arose in respect of the impairment of goodwill attributable to the Group’s asset finance business.

15


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Impairment losses increased by £13,661 million to £16,673 million in 2009 compared to £3,012 million in 2008. Excluding the impairment losses of £12,257 million arising from the consolidation of HBOS’s post-acquisition results, impairment losses were £1,404 million, or 47 per cent, higher at £4,416 million in 2009 compared to £3,012 million in 2008; this increase included £1,664 million in respect of loans and advances to customers and reflected the substantial deterioration in the credit environment; partly offset by a reduction in the charge in respect of loans and advances to banks and other impairment provisions. During 2009, following the acquisition of HBOS, the Group experienced a significant rise in impairment levels in its lending portfolios. This largely represented falls in the value of commercial real estate and the impact of the economic deterioration during that year, including the effects of rising unemployment and reduced corporate cash flows. The Group spent a significant amount of time analysing and addressing the issues in the legacy HBOS portfolios, with the greatest attention paid to the over-concentration in real estate related lending and those portfolios that fell outside of the Lloyds TSB risk appetite; and, as a consequence, the Group took prudent and material impairment charges in the period following the acquisition.

The Group’s share of results of joint ventures and associates was a net loss of £752 million in 2009 compared to a net profit of £4 million in 2008. However, excluding the losses of £755 million arising on the consolidation of HBOS’s post-acquisition results, the share of results of joint ventures and associates was £1 million, or 25 per cent, lower at a profit of £3 million compared to a profit of £4 million in 2008.

On 16 January 2009, the Group acquired 100 per cent of the ordinary share capital of HBOS plc. The consideration for the acquisition of HBOS comprised the issue of 7,776 million ordinary shares in Lloyds Banking Group plc together with the costs of acquisition. In determining the fair value of the consideration, the Company used the share price of its equity securities quoted on the London Stock Exchange, as at the date of completion. As the fair value of the identifiable net assets acquired was greater than the total consideration paid, negative goodwill of £11,173 million 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.

The exercise to fair value the assets and liabilities of HBOS took into account prevailing market conditions at the time of completion and, where appropriate, the Group engaged independent external advisers. As the consideration paid was significantly less than the provisional fair value of the net assets acquired, the results of the fair value calculations were subject to additional challenge in accordance with the requirements of IFRS 3.

On the date that the acquisition was announced (18 September 2008) the implied goodwill was a small positive amount based on the share price of the Company and the originally announced conversion factor of 0.833 Lloyds Banking Group plc shares for each HBOS share. However, a number of factors led to negative goodwill being recognised on completion of the transaction. By the time of the recommended offer, it had become increasingly difficult for HBOS to raise funds in wholesale markets and HBOS faced an outflow of customer deposits, reflecting reduced investor and depositor confidence. Subsequent to the announcement of the offer, turbulence in the markets continued, fuelled by concerns about credit risk and worsening economic conditions. For HBOS, confidence continued to deteriorate amid ongoing funding difficulties and concerns over the extent of future credit losses. Measures by national authorities and central banks failed to stem this turbulence and the UK Government decided in October 2008 that it would be appropriate for the UK banking sector to increase its level of capitalisation. The capital raising, underwritten by the UK Government, was made available to HBOS on condition that the acquisition by the Company completed. As a consequence of the capital that HBOS was required to issue and the impact of market conditions on the future prospects of the new group, the terms of the final agreed offer were revised down to a ratio of 0.605. Additionally, the share price of the Company fell from 280p at the date of the announcement to 98.4p on 15 January 2009 reflecting both the dilutive impact of the capital that the Company raised and the turmoil in the banking sector and equity markets in general. These factors combined to reduce the value of the consideration for HBOS.

In 2009, the Group recorded a tax credit of £1,911 million compared to a tax credit of £38 million in 2008. The tax credit in 2009 on a profit before tax of £1,042 million reflected the fact that the gain on acquisition of £11,173 million was not taxable, partly offset by the impact of losses in joint ventures and associates, losses where no deferred tax was provided and the tax charge attributable to UK life insurance policyholders and the Group’s interests in Open Ended Investment Companies (OEICs), which is required to be included within the income tax credit.

Total assets were £591,222 million higher at £1,027,255 million at 31 December 2009 compared to £436,033 million at 31 December 2008; loans and advances to customers were £386,625 million higher at £626,969 million at 31 December 2009 compared to £240,344 million at 31 December 2008; and customer deposits were £235,803 million higher at £406,741 million at 31 December 2009 compared to £170,938 million at 31 December 2008. These increases reflected the impact of the HBOS acquisition and, after allowing for the acquisition, total assets had reduced as the Group commenced its announced strategy to reduce assets associated with non-relationship lending and investments, including business which was outside the Group’s current risk appetite. During 2009, this portfolio of assets reduced by some £60 billion. Subsequent to the HBOS acquisition, the Group’s loans and advances to customers decreased as a result of the alignment of heritage risk appetites in Retail, a reduction in wholesale lending in Corporate Markets and a reduction in Wealth and International; customer deposits also decreased as growth in Retail was offset by the planned reduction in higher interest paying term deposits elsewhere.

The Group’s credit market exposures primarily relate to asset-backed security exposures held in the Wholesale division; a detailed analysis of these asset-backed security exposures is provided in note 56 to the consolidated financial statements. The total exposure to asset-backed securities had increased by £29,769 million from £16,521 million at 31 December 2008 to £46,290 million at 31 December 2009; however £31,010 million of these assets arose within the heritage HBOS business and, excluding these, total exposure to asset-backed securities was £1,241 million lower at £15,280 million at 31 December 2009 compared to £16,521 million at 31 December 2008.

Mortgage-backed security exposures were £11,817 million higher at £18,218 million, although excluding the heritage HBOS exposures they were £1,303 million lower at £5,098 million compared to £6,401 million at 31 December 2008. Exposures to Alt-A US residential mortgage-backed securities were £3,479 million higher, although adjusting for the heritage HBOS assets they were £167 million lower at £321 million compared to £488 million at 31 December 2008; there was no exposure to sub-prime US residential mortgage-backed securities.

For credit market exposures the Group’s approach is to analyse the underlying transaction to determine whether it needs to place reliance on any protection provided by an insurer or guarantor. In note 56 to the consolidated financial statements the Group discloses its exposures where reliance is placed on monoline insurers, which were limited to a total of £444 million at 31 December 2009. Of this total exposure, £436 million was rated AA with the remaining £8 million being sub-investment grade.

At the end of December 2009, the Group’s capital ratios, following the capital raising in December 2009, increased with a total capital ratio on a Basel II basis of 12.4 per cent (compared to 11.2 per cent at 31 December 2008), a tier 1 ratio of 9.6 per cent (compared to 8.0 per cent at 31 December 2008) and a core tier 1 ratio of 8.1 per cent (compared to 5.6 per cent at 31 December 2008). During 2009, risk-weighted assets had increased by £322,817 million to £493,307 million compared to £170,490 million at 31 December 2008; this increase reflected the impact of the HBOS acquisition and, after allowing for the acquisition, there was a small decrease in risk-weighted assets as the effect of a reduction in balance sheet assets was partly offset by the procyclical impact of the weaker economic environment.

16


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

NET INTEREST INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

2009

 

2008

 

                     

Net interest income £m

 

 

12,546

 

 

9,026

 

 

7,718

 

Average interest-earning assets £m

 

 

753,415

 

 

849,534

 

 

293,967

 

Average rates:

 

 

 

 

 

 

 

 

 

 

– Gross yield on interest-earning assets%1

 

 

3.89

 

 

3.32

 

 

5.98

 

– Interest spread%2

 

 

1.62

 

 

1.02

 

 

2.37

 

– Net interest margin%3

 

 

1.67

 

 

1.06

 

 

2.63

 

                     

 

 

1

Gross yield is the rate of interest earned on average interest-earning assets.

 

 

2

Interest spread is the difference between the rate of interest earned on average interest-earning assets and the rate of interest paid on average interest-bearing liabilities.

 

 

3

The net interest margin represents the interest spread together with the contribution of interest-free liabilities. It is calculated by expressing net interest income as a percentage of average interest-earning assets.

2010 COMPARED WITH 2009

Net interest income was £3,520 million, or 39 per cent, higher at £12,546 million in 2010 compared to £9,026 million in 2009. Interest and similar income was £1,102 million, or 4 per cent, higher at £29,340 million in 2010 compared to £28,238 million in 2009; and interest and similar expense was £2,418 million, or 13 per cent, lower at £16,794 million in 2010 compared to £19,212 million in 2009. In the Retail division, this reflects higher asset pricing (partly due to mortgage customers moving onto and staying on standard variable rates and lending being priced to more appropriately reflect risk and rising funding costs), in part offset by the impact on interest expense of lower LIBOR to base rate spreads although there has been a reduction in the more expensive deposit balances. In the Wholesale division, lending is also being re-priced to reflect customer risk profiles resulting in higher customer margins on new business and from re-pricing on renewals. Across the Group, there has been some increase in funding costs as a result of the Group’s improved funding profile but there has been a benefit from a £723 million reduction in the amounts payable to unit holders in those Open-Ended Investment Companies included in the consolidated results of the Group (although, since these are policyholder items, there is no impact on profit attributable to shareholders).

Average interest-earning assets were £96,119 million, or 11 per cent, lower at £753,415 million in 2010 compared to £849,534 million in 2009. This reduction reflects the successful removal of assets which are outside of the Group’s risk appetite from the Group’s balance sheet.

Average interest-earning assets in Retail were £11,175 million, or 3 per cent, lower at £373,108 million in 2010 compared to £384,283 million in 2009. Average personal mortgage balances were £7,141 million, or 2 per cent, lower at £342,731 million in 2010 compared to £349,872 million in 2009, in part reflecting a slight reduction in demand in the UK mortgage market in 2010; Retail has continued to focus on supporting the housing market with 70 per cent of new lending being for house purchases rather than re-mortgages. Average other personal lending balances were £4,034 million, or 12 per cent, lower at £30,377 million in 2010 compared to £34,411 million in 2009 as a result of reduced customer demand for credit and customers continuing to reduce their personal indebtedness, with reductions in both unsecured loan and credit card balances.

Average interest-earning assets across the rest of the Group were £84,944 million, or 18 per cent, lower at £380,307 million in 2010 compared to £465,251 million in 2009. Relationship lending and similar average interest-earning assets in Wholesale were £25,040 million, or 11 per cent, lower at £196,040 million in 2010 compared to £221,080 million in 2009 as demand for new corporate lending and refinancing of existing facilities was more than offset by the level of maturities, reflecting a continuing trend of subdued corporate lending and customer deleveraging. Such balances in Wealth and International were £645 million, or 1 per cent, lower at £68,238 million in 2010 compared to £68,883 million in 2009. The remainder of the Group’s average interest-earning assets, which include certain non-relationship and treasury-related balances in the Wholesale division and the bank deposits held in the insurance businesses, were £59,259 million, or 34 per cent, lower at £116,029 million in 2010 compared to £175,288 million in 2009; this reflects planned balance sheet reductions.

The Group’s net interest margin increased by 61 basis points to 1.67 per cent in 2010 compared to 1.06 per cent in 2009 with increases in Retail and Wholesale only partly offset by reduced margins in the Wealth and International business. Margins in Retail improved as a result of improved asset pricing and decreases in the LIBOR to base rate spread. In Wholesale margins were also improved, again as result of higher asset pricing to reflect customer risk. Declining margins in Wealth and International reflected reduced base rates, a very competitive deposit environment and the impact of impaired lending balances.

17


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2009 COMPARED WITH 2008

Net interest income was £1,308 million, or 17 per cent, higher at £9,026 million in 2009 compared to £7,718 million in 2008. Excluding the net interest income of £4,049 million arising on the consolidation of HBOS’s post-acquisition results, net interest income was £2,741 million, or 36 per cent, lower at £4,977 million in 2009 compared to £7,718 million in 2008.

Excluding the interest flows arising on the consolidation of HBOS’s post-acquisition results, both interest income and interest expense fell in response to the historically low interest rate environment that prevailed throughout 2009; net interest income was reduced as the benefit of higher asset pricing was more than offset by the impact of lower deposit margins, reflecting the impact of falling base rates, and higher funding costs, which included the impact of the Group extending its wholesale funding maturity profile.

Average interest-earning assets were £555,567 million higher at £849,534 million in 2009 compared to £293,967 million in 2008. Excluding the average interest-earning assets of £526,630 million arising on the consolidation of HBOS’s post-acquisition results, average interest-earning assets were £29,207 million, or 10 per cent, higher at £323,174 million in 2009 compared to £293,967 million in 2008.

Excluding the average interest-earning assets arising on the consolidation of HBOS’s post-acquisition results, average personal mortgage balances within Retail were £5,973 million, or 6 per cent, higher at £106,068 million in 2009 compared to £100,095 million in 2008 as a result of the full-year effect on average balances of mortgage growth during 2008; period end mortgage balances being little changed over 2009. Average other personal lending balances within Retail were flat as the full-year effect on average balances of lending growth during 2008 was offset by the impact of lower lending balances over 2009 as customers reduced their personal indebtedness and did not take on new financial commitments in the difficult economic environment. Average interest-earning assets in the Group’s other businesses were £23,312 million, or 14 per cent, higher at £190,591 million in 2009 compared to £167,279 million in 2008 as the full year benefit of lending growth over 2008 more than offset the asset reductions in 2009.

The Group’s net interest margin decreased by 157 basis points to 1.06 per cent in 2009 compared to 2.63 per cent in 2008 with reductions across the Group’s businesses. Margins in Retail declined as the impact of higher wholesale funding costs and lower deposit margins, in the low base rate environment, was only partly offset by the benefit of higher pricing on lending products. In Wholesale margins were also reduced, again as higher wholesale funding costs were only partly offset by higher asset pricing. Declining margins in Wealth and International reflected reducing base rates, a very competitive deposit environment and the increased funding costs.

18


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OTHER INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

 

Fee and commission income:

 

 

 

 

 

 

 

 

 

 

– Current account fees

 

 

1,086

 

 

 

1,088

 

 

 

707

 

– Credit and debit card fees

 

 

812

 

 

 

765

 

 

 

581

 

– Other

 

 

2,517

 

 

 

2,401

 

 

 

1,943

 

 

 

 

4,415

 

 

 

4,254

 

 

 

3,231

 

Fee and commission expense

 

 

(1,682

)

 

(1,517

)

 

(694

)

Net fee and commission income

 

 

2,733

 

 

2,737

 

 

2,537

 

Net trading income

 

 

15,724

 

 

19,098

 

 

(9,186

)

Insurance premium income

 

 

8,148

 

 

 

8,946

 

 

 

5,412

 

Gains on capital transactions

 

 

423

 

 

 

1,498

 

 

 

 

Other

 

 

3,893

 

 

 

3,992

 

 

 

528

 

Other operating income

 

 

4,316

 

 

 

5,490

 

 

 

528

 

Total other income

 

 

30,921

 

 

36,271

 

 

(709

)

2010 COMPARED WITH 2009

Other income was £5,350 million lower at £30,921 million in 2010 compared to £36,271 million in 2009, as a result of the factors discussed below.

Fee and commission income was £161 million, or 4 per cent, higher at £4,415 million in 2010 compared to £4,254 million in 2009. Current account fees were little changed at £1,086 million in 2010 compared to £1,088 million in 2009 but credit and debit card fees were £47 million, or 6 per cent, higher at £812 million in 2010 compared to £765 million in 2009. Other fee and commission income was £116 million, or 5 per cent, higher at £2,517 million in 2010 compared to £2,401 million in 2009.

Fee and commission expense was £165 million, or 11 per cent, higher at £1,682 million in 2010 compared to £1,517 million in 2009. There have been increases in fees payable related to added-value account packages and higher levels of card fees payable, as well as increased levels of fees payable in respect of the Group’s fund management activities.

Net trading income was £3,374 million lower at £15,724 million in 2010 compared to £19,098 million in 2009. Net trading income within the insurance businesses was £2,551 million, or 16 per cent, lower at £13,749 million in 2010 compared to £16,300 million in 2009 reflecting a more subdued market performance in 2010 (equity market values increased by 9 per cent in 2010 compared to 22 per cent in 2009) although this decrease and the reduction in long-term insurance premium income are largely offset by the decrease in the insurance claims expense. A loss of £620 million, which was £193 million, or 45 per cent, higher than the loss of £427 million in 2009, arose from the change in fair value of the embedded equity conversion feature contained in the Enhanced Capital Notes issued by the Group in 2009. Net trading income within the Group’s banking activities was £630 million, or 20 per cent, lower at £2,595 million in 2010 compared to £3,225 million in 2009 as the Group continues to reduce activities outside of its risk appetite.

Insurance premium income was £798 million, or 9 per cent, lower at £8,148 million in 2010 compared to £8,946 million in 2009. Earned premiums in respect of the Group’s long-term life and pensions business were £687 million, or 9 per cent lower at £6,773 million in 2010 compared to £7,460 million in 2009, this reflects reduced new business sales, mainly as a result of the withdrawal, during 2009, of certain HBOS legacy products with lower returns. General insurance earned premiums were £111 million lower at £1,375 million in 2010 compared to £1,486 million in 2009; this primarily reflects the Group’s withdrawal from the payment protection insurance market in July 2010.

During 2009 and 2010, as part of the Group’s management of capital, the Group exchanged certain existing subordinated debt securities for new subordinated debt securities and ordinary shares. These exchanges resulted in a gain on extinguishment of the existing liabilities of £423 million (2009: £1,498 million), being the difference between the carrying value 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.

Other operating income, excluding the gains on capital transactions, was £99 million lower at £3,893 million in 2010 compared to £3,992 million in 2009; increased gains on disposal of available-for-sale financial assets were more than offset by lower levels of operating lease rentals receivable and a reduction in the income arising from the movement in value of in-force business.

19


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2009 COMPARED WITH 2008

Other income was £36,980 million higher at £36,271 million in 2009 compared to a deficit of £709 million in 2008, as a result of the factors discussed below.

Fee and commission income was £1,023 million, or 32 per cent, higher at £4,254 million in 2009 compared to £3,231 million in 2008. However, excluding the fee and commission income that arose on the consolidation of HBOS’s post-acquisition results, fee and commission income was £479 million, or 15 per cent, lower at £2,752 million in 2009 compared to £3,231 million in 2008. The £479 million decrease in fee and commission income excluding the fee income in HBOS was largely due to a £424 million reduction in insurance broking income as a result of a market-wide move to monthly premiums on payment protection products, rather than up-front annual income.

Fee and commission expense was £823 million, or 119 per cent, higher at £1,517 million in 2009 compared to £694 million in 2008. Excluding fees payable of £862 million arising on the consolidation of the post-acquisition results of HBOS, fee and commission expense was £39 million, or 6 per cent, lower at £655 million in 2009 compared to £694 million in 2008 primarily as a result of volume-related reductions in asset management and other fees.

Net trading income improved by £28,284 million to net income of £19,098 million in 2009 compared to a net loss of £9,186 million in 2008. Excluding net trading income of £12,093 million arising from the consolidation of the post-acquisition results of HBOS, net trading income improved by £16,191 million to net income of £7,005 million in 2009 compared to a net loss of £9,186 million in 2008. Trading income in 2008 in the Group’s banking operations was particularly impacted by market dislocation, leading to significant downwards valuations on a number of assets; this was not repeated in 2009. In addition there was an improvement of £14,179 million in gains on policyholder investments held in the Group’s insurance businesses (and largely offset by an increase in the claims expense) as the improvement in market conditions led to trading profits in 2009, compared to substantial losses in 2008.

Insurance premium income was £3,534 million, or 65 per cent, higher at £8,946 million in 2009 compared to £5,412 million in 2008. Excluding the premium income of £4,718 million that arose on consolidation of the post-acquisition results of HBOS, insurance premium income was £1,184 million, or 22 per cent, lower at £4,228 million in 2009 compared to £5,412 million in 2008. Earned premiums in respect of the Group’s long-term life and pensions business were £2,660 million, or 55 per cent, higher at £7,460 million in 2009 compared to £4,800 million in 2008. The consolidation of the post-acquisition results of HBOS contributed £3,890 million and, excluding this, premiums were £1,230 million, or 26 per cent, lower at £3,570 million in 2009 compared to £4,800 million in 2008; this reflected reduced new business sales as a result of a general contraction in the UK market. General insurance earned premiums were £874 million higher at £1,486 million in 2009 compared to £612 million in 2008. Excluding premiums of £828 million arising from the consolidation of the post-acquisition results of HBOS, general insurance earned premiums were £46 million, or 8 per cent, higher at £658 million in 2009 compared to £612 million in 2008; this primarily reflected modest growth in home insurance income.

During 2009 the Group exchanged certain existing subordinated debt securities for new securities, these exchanges resulted in a gain on extinguishment of the existing liabilities of £1,498 million, being the difference between the carrying amount of the securities extinguished and the fair value of the new securities together with related fees and costs; this gain arose because the balance sheet carrying values of these investments were in excess of market valuations at the time. In the first half of 2009, undated subordinated notes issued by a number of Group companies were exchanged for innovative tier 1 securities and senior unsecured notes issued by Lloyds TSB Bank plc. These exchanges resulted in a gain of £745 million. In July 2009, dated and undated subordinated liabilities issued by Clerical Medical Finance plc were exchanged for senior unsecured notes 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 EC 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 the Government Asset Protection Scheme, certain preference shares, preferred securities and undated subordinated notes were exchanged for enhanced capital notes. These exchanges, together with the partial extinguishment of liabilities arising from the suspension of payments on coupons, resulted in a gain of £723 million.

Other operating income was £3,464 million higher at £3,992 million in 2009 compared to £528 million in 2008; excluding the income of £1,517 million that arose on the consolidation of the post-acquisition results of HBOS, other operating income was £1,947 million higher at £2,475 million in 2009 compared to £528 million in 2008, principally reflecting an improvement in the movement in value of in-force business.

20


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

 

 

2009
£m

 

 

 

 

20081
£m

 

 

Administrative expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Staff:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

– Salaries

 

 

4,220

 

 

 

 

4,369

 

 

 

 

2,230

 

 

– Social security costs

 

 

396

 

 

 

 

383

 

 

 

 

176

 

 

– Pensions and other post-retirement benefit schemes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Curtailment gain

 

 

(910

)

 

 

 

 

 

 

 

 

 

Other

 

 

628

 

 

 

 

744

 

 

 

 

235

 

 

 

 

 

(282

)

 

 

 

744

 

 

 

 

235

 

 

– Restructuring costs

 

 

119

 

 

 

 

412

 

 

 

 

14

 

 

– Other staff costs

 

 

1,016

 

 

 

 

767

 

 

 

 

323

 

 

 

 

 

5,469

 

 

 

 

6,675

 

 

 

 

2,978

 

 

Premises and equipment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

– Rent and rates

 

 

601

 

 

 

 

569

 

 

 

 

318

 

 

– Hire of equipment

 

 

18

 

 

 

 

20

 

 

 

 

16

 

 

– Repairs and maintenance

 

 

199

 

 

 

 

226

 

 

 

 

151

 

 

– Other

 

 

407

 

 

 

 

341

 

 

 

 

165

 

 

 

 

 

1,225

 

 

 

 

1,156

 

 

 

 

650

 

 

Other expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

– Communications and data processing

 

 

891

 

 

 

 

668

 

 

 

 

455

 

 

– Advertising and promotion

 

 

362

 

 

 

 

335

 

 

 

 

194

 

 

– Professional fees

 

 

742

 

 

 

 

540

 

 

 

 

229

 

 

– Payment protection insurance provision

 

 

3,200

 

 

 

 

 

 

 

 

 

 

– Customer goodwill payments provision

 

 

500

 

 

 

 

 

 

 

 

 

 

– Other

 

 

1,447

 

 

 

 

1,310

 

 

 

 

808

 

 

 

 

 

7,142

 

 

 

 

2,853

 

 

 

 

1,686

 

 

Depreciation and amortisation:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

– Depreciation of tangible fixed assets

 

 

1,635

 

 

 

 

1,716

 

 

 

 

648

 

 

– Amortisation of acquired value of in-force non-participating investment contracts

 

 

76

 

 

 

 

75

 

 

 

 

 

 

– Amortisation of other intangible assets

 

 

721

 

 

 

 

769

 

 

 

 

38

 

 

 

 

 

2,432

 

 

 

 

2,560

 

 

 

 

686

 

 

Impairment of tangible fixed assets2

 

 

202

 

 

 

 

 

 

 

 

 

 

Goodwill impairment

 

 

 

 

 

 

240

 

 

 

 

100

 

 

Total operating expenses, excluding Government Asset Protection Scheme fee

 

 

16,470

 

 

 

 

13,484

 

 

 

 

6,100

 

 

Government Asset Protection Scheme fee

 

 

 

 

 

 

2,500

 

 

 

 

 

 

Total operating expenses

 

 

16,470

 

 

 

 

15,984

 

 

 

 

6,100

 

 

Cost:income ratio (%)3

 

 

66.0

 

 

 

 

68.7

 

 

 

 

61.8

 

 

 

 

1

Restated in 2009 for IFRS 2 (Revised).

 

 

2

£52 million of the impairment of tangible fixed assets relates to integration activities.

 

 

3

Total operating expenses divided by total income, net of insurance claims.

21


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2010 COMPARED WITH 2009

Operating expenses increased by £486 million, or 3 per cent, to £16,470 million in 2010 compared to £15,984 million in 2009. This increase principally reflects the £3,200 million payment protection insurance provision in 2010, which more than offset the non-repetition of the £2,500 million fee paid in 2009 to the UK Government as part of the agreement for the Group not to enter into the Government Asset Protection Scheme.

Staff costs were £1,206 million, or 18 per cent, lower at £5,469 million in 2010 compared to £6,675 million in 2009. Staff costs in 2010 were reduced by a curtailment gain related to the Group’s pension schemes. Following changes by the Group to the terms of its 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 2010 there was also 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. Excluding the pension curtailment gain of £910 million in 2010, staff costs were £296 million, or 4 per cent, lower at £6,379 million in 2010 compared to £6,675 million in 2009. Salaries were £149 million, or 3 per cent, lower at £4,220 million in 2010 compared to £4,369 million in 2009 as the impact of annual pay rises has been more than offset by staff reductions; pension costs, excluding the curtailment gain, were £116 million, or 16 per cent, lower at £628 million in 2010 compared to £744 million in 2009, principally as a result of increased asset levels in the defined benefit schemes at the end of 2009 which led to a higher expected return; staff restructuring costs were £293 million, or 71 per cent, lower at £119 million in 2010 compared to £412 million in 2009 principally as the significant staff rationalisations as part of the Group integration programme in 2009 were not repeated in 2010; and other staff costs were £249 million, or 32 per cent higher at £1,016 million in 2010 compared to £767 million in 2009, largely reflecting increased use of agency staff in relation to the integration programme.

Premises and equipment costs were £69 million, or 6 per cent, higher at £1,225 million in 2010 compared to £1,156 million in 2009. Rent and rates were £32 million, or 6 per cent, higher at £601 million in 2010 compared to £569 million in 2009, largely as a result of rent reviews; and other premises and equipment costs were £66 million, or 19 per cent, higher at £407 million in 2010 compared to £341 million in 2009 largely reflecting integration-related expenditure.

Other expenses were £4,289 million higher at £7,142 million in 2010 compared to £2,853 million in 2009. This increase principally reflects the £3,200 million payment protection insurance provision in 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 was heard in January 2011 and on 20 April 2011 judgment was handed down by the High Court dismissing the BBA’s application. Since publication of the judgment, the Group has been in 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 income statement for the year ended 31 December 2010 of £3,200 million in respect of the anticipated costs of such contact and/or redress, including administration expenses. Other expenses in 2010 also include a £500 million customer goodwill payments provision. Lloyds Banking Group has been in discussions with the FSA regarding the application of an interest variation clause in certain Bank of Scotland plc variable rate mortgage contracts where the wording in the offer documents received by certain customers had the potential to cause confusion. The relevant mortgages were written between 2004 and 2007 by Bank of Scotland plc under the ‘Halifax’ brand. In February 2011, the Group reached agreement with the FSA in relation to initiating a customer review and contact programme and making goodwill payments to affected customers. In order to make these goodwill payments, Bank of Scotland plc has applied for a Voluntary Variation of Permission to carry out the customer review and contact programme to bring it within section 404F(7) of FSMA 2000.

Excluding the payment protection insurance provision and the customer goodwill payments provision, other expenses in 2010 were £589 million, or 21 per cent, higher at £3,442 million compared to £2,853 million in 2009. Communications and data processing costs were £223 million, or 33 per cent, higher at £891 million in 2010 compared to £668 million in 2009 and professional fees were £202 million, or 37 per cent, higher at £742 million in 2010 compared to £540 million in 2009; in both cases reflecting increased levels of integration-related expenditure.

Depreciation and amortisation costs were £128 million, or 5 per cent, lower at £2,432 million in 2010 compared to £2,560 million in 2009.

A charge of £202 million (2009: nil) arose in respect of the impairment of tangible fixed assets. During 2009, the Group had 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; during 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. A further £52 million impairment charge related to the write-off of certain tangible fixed assets as a result of integration activities.

In 2009, a charge of £240 million had arisen in respect of the impairment of goodwill; there was no impairment charge in respect of goodwill in 2010.

22


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2009 COMPARED WITH 2008

Operating expenses increased by £9,884 million, or 162 per cent, to £15,984 million in 2009 compared to £6,100 million in 2008. Excluding the operating expenses of £6,456 million arising on the consolidation of HBOS’s post-acquisition results, operating expenses were £3,428 million, or 56 per cent, higher at £9,528 million in 2009 compared to £6,100 million in 2008; this increase principally reflected the £2,500 million fee paid to the UK Government as part of the agreement for the Group not to enter into the Government Asset Protection Scheme, costs of £635 million borne within the Lloyds TSB businesses in respect of the integration of the enlarged Group and an increased charge in respect of goodwill impairment, only partly offset by the fact that operating expenses in 2008 had included a £180 million settlement in relation to certain historic US dollar payments which was not repeated in 2009.

Staff costs were £3,697 million, or 124 per cent, higher at £6,675 million compared to £2,978 million in 2008. Excluding the staff costs of £3,014 million that arose on consolidation of the post-acquisition results of HBOS, staff costs were £683 million, or 23 per cent, higher at £3,661 million in 2009 compared to £2,978 million in 2008. Excluding the costs within HBOS, salaries were £87 million, or 4 per cent, higher as the impact of annual pay rises more than offset staff reductions; pension costs were £128 million higher principally as a result of reduced asset levels in the defined benefit schemes at the end of 2008 which led to a lower expected return; restructuring costs were £209 million higher principally as a result of staff rationalisation as part of the Group’s integration programme; and other staff costs were £241 million higher, partly reflecting increased use of agency staff in relation to the integration programme.

Premises and equipment costs were £506 million, or 78 per cent, higher at £1,156 million in 2009 compared to £650 million in 2008. Excluding the premises and equipment costs that arose on the consolidation of the post-acquisition results of HBOS, premises and equipment costs were £84 million, or 13 per cent, higher at £734 million in 2009 compared to £650 million in 2008; rent and rates were £30 million higher, largely as a result of rent reviews, repairs and maintenance costs were £24 million higher and other premises and equipment costs were £36 million higher.

Other expenses were £1,167 million, or 69 per cent, higher at £2,853 million in 2009 compared to £1,686 million in 2008. Excluding the £1,185 million of costs that arose on consolidation of the post-acquisition results of HBOS, other expenses were £18 million, or 1 per cent, lower at £1,668 million in 2009 compared to £1,686 million in 2008; however other expenses in 2008 included the £180 million settlement in relation to certain historic US dollar payments and, excluding this, other expenses excluding HBOS in 2009 were £162 million, or 11 per cent, higher at £1,668 million compared to £1,506 million in 2008. On this basis, professional fees were higher as a result of consultancy and other costs incurred in relation to integration, the Group’s consideration of the Government Asset Protection Scheme and other strategic projects; there were also increases in communications and data processing costs.

Depreciation and amortisation costs were £1,874 million higher at £2,560 million compared to £686 million in 2008. Depreciation of tangible fixed assets was £1,068 million higher at £1,716 million compared to £648 million in 2008; £1,035 million of this increase reflected the impact of consolidation of the post-acquisition results of HBOS. Amortisation of £75 million in respect of the acquired value of in-force non-participating investment contracts and £703 million in respect of acquisition-related intangibles (brands, core deposit intangibles, purchased credit card relationships and other customer-related intangibles) arose from the acquisition of HBOS.

A charge of £240 million (2008: £100 million) arose in respect of the impairment of goodwill. The Group reviews goodwill held on its balance sheet for impairment at least annually or when events or changes in economic circumstances indicate that an impairment may have taken place. Goodwill attributable to the Group’s Asset Finance business, for which an impairment charge of £100 million was recognised in the Group’s financial statements for the year ended 31 December 2008, had been further reviewed for impairment in 2009 due to the continuing uncertainties over the short-term macroeconomic environment. As a consequence, the carrying value of the consumer finance cash generating unit in Asset Finance (within Wholesale division) was reassessed resulting in an additional goodwill impairment charge of £240 million in the year ended 31 December 2009.

The Group also paid a fee of £2,500 million to the UK Government in respect of the Group’s withdrawal from the Government Asset Protection Scheme (GAPS). The Group had entered into a pre-accession deed dated 7 March 2009 relating to the proposed participation in GAPS. However, following the rights issue in November 2009, the Group withdrew from its proposed participation and, on 3 November 2009, entered into a GAPS Withdrawal Deed with HM Treasury pursuant to which, among other matters, the Group agreed to pay HM Treasury an amount of £2,500 million in recognition of the benefits to the Group’s trading operations arising as a result of HM Treasury proposing to make GAPS available to the Group.

23


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

 

 

 

 

 

 

 

 

 

IMPAIRMENT

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

 

 

2008
£m

 

Impairment losses on loans and receivables:

 

 

 

 

 

 

 

 

 

 

Loans and advances to banks

 

 

(13

)

 

(3

)

 

135

 

Loans and advances to customers

 

 

10,727

 

 

15,783

 

 

2,584

 

Debt securities classified as loans and receivables

 

 

57

 

 

248

 

 

157

 

Total impairment losses on loans and receivables

 

 

10,771

 

 

16,028

 

 

2,876

 

Impairment of available-for-sale financial assets

 

 

106

 

 

602

 

 

130

 

Other credit risk provisions

 

 

75

 

 

43

 

 

6

 

Total impairment charged to the income statement

 

 

10,952

 

 

16,673

 

 

3,012

 

2010 COMPARED WITH 2009

Impairment losses decreased by £5,721 million, or 34 per cent, to £10,952 million in 2010 compared to £16,673 million in 2009.

The reduction in the Group’s impairment charge in 2010 reflected stabilisation of the wholesale portfolios and improved retail affordability and performance. Improvements in Wholesale and Retail more than offset increased impairment charges in Ireland and Australia, the latter caused by difficult market conditions. The Group’s ‘through the cycle’ credit policies and procedures, which focus on the development of enduring client relationships, have resulted in higher quality new business being originated across the UK and very little new origination took place outside the UK. The Group’s level of impairment is being managed in the current challenging economic environment by the Wholesale business support units and Retail collection and recovery units. The business support model has been expanded from Wholesale across Wealth and International division, with a central team established to manage the Group’s business support activity globally. The Group has also strengthened resources within Retail collections and recoveries to enable more timely engagement with customers experiencing difficulties to drive more effective customer outcomes. The Group has actively reduced limits to Portugal, Ireland, Italy, Greece and Spain over the last two years, with the associated country risk profile modest in the context of the Group’s asset base.

The impairment charge in respect of loans and advances to customers was £5,056 million, or 32 per cent, lower at £10,727 million in 2010 compared to £15,783 million in 2009. This improvement reflects reduced impairment charges in both Retail, as a result of the improved quality of new business and a slow recovery in the UK economy, and Wholesale, where stabilising economic conditions have led to lower impairment charges, particularly in the corporate real estate and real estate-related UK and US portfolios; only partly offset by increased impairment charges in Wealth and International as a result of difficult market conditions in a number of locations abroad, particularly Ireland and Australia, and especially in relation to the commercial real estate portfolios in those locations. The level of losses continues to be dominated by the economic environment in Ireland, and to a lesser extent has also been influenced by the performance of specific areas of the Australian economy.

In Retail, there was a lower secured impairment charge reflecting reduced impaired loan levels and improved arrears in the first half of 2010, although in the second half, and particularly in the last quarter, the Group saw some signs of strain, with fewer customers returning their accounts to order than was the case six months previously. Although house prices fell slightly over 2010, the proportion of the mortgage portfolio with an indexed loan-to-value of greater than 100 per cent was broadly stable at 13 per cent. The value of the portfolio with an indexed loan-to-value greater than 100 per cent and more than three months in arrears increased by £0.2 billion and at 31 December 2010 was £3.2 billion, representing 0.9 per cent of the portfolio. The number of mortgage customers new to arrears has also remained relatively stable in the last twelve months, and is now well below the peak experienced in the second half of 2008. There was a decrease in the unsecured impairment charge, reflecting continued improving portfolio trends resulting from application of the Group’s risk appetite, management actions taken over the past two years, and stable unemployment. Unsecured impaired loans decreased as a result of fewer cases going into arrears, improved quality of new business and increased write off of impaired loans.

The Wholesale impairment charge decreased as a result of the significant actions which were taken in the first half of 2009 on the heritage HBOS portfolios (including the identification of large impairments post the HBOS acquisition, especially in corporate real estate, real estate-related and Corporate (UK and US) portfolios), together with the stabilising UK and US economic environment in 2010, with a low interest rate environment helping to maintain defaults at a lower level and a number of write backs due to asset disposals.

The impairment charge in respect of loans and advances to banks improved by £10 million to a credit of £13 million compared to a credit of £3 million in 2009; this reflects releases in respect of a small number of specific exposures. The impairment charge in respect of debt securities classified as loans and receivables decreased by £191 million, or 77 per cent, to £57 million in 2010 compared to £248 million in 2009. Impairment losses in respect of available-for-sale financial assets were £496 million lower at £106 million in 2010 compared to £602 million in 2009. The charge in respect of other credit risk provisions was £32 million, or 74 per cent, higher at £75 million in 2010 compared to £43 million in 2009, as a result of a small number of specific new cases that arose in 2010.

24


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2009 COMPARED WITH 2008

Impairment losses increased by £13,661 million to £16,673 million in 2009 compared to £3,012 million in 2008. Excluding the impairment losses of £12,257 million arising on the consolidation of HBOS’s post-acquisition results, impairment losses were £1,404 million, or 47 per cent, higher at £4,416 million in 2009 compared to a £3,012 million in 2008; this increase included £1,664 million in respect of loans and advances to customers and reflected the substantial deterioration in the credit environment in 2009; partly offset by a reduction in the charge in respect of loans and advances to banks and other impairment provisions.

The impairment charge in respect of loans and advances to customers was £13,199 million higher at £15,783 million in 2009 compared to £2,584 million in 2008. Excluding the impairment losses of £11,535 million arising on the consolidation of HBOS’s post-acquisition results, impairment losses in respect of loans and advances to customers were £1,664 million, or 64 per cent, higher at £4,248 million in 2009 compared to £2,584 million in 2008. This reflected the substantial deterioration in the credit environment in 2009 leading to increased charges in respect of both unsecured personal lending, as rising UK unemployment impacted the charge in both the retail banking and asset finance operations, and non-personal lending. During 2009, following the acquisition of HBOS, the Group experienced a significant rise in impairment levels in its lending portfolios. This largely represented falls in the value of commercial real estate and the impact of the economic deterioration during 2009, including the effects of rising unemployment and reduced corporate cash flows. In Retail, impairment losses increased, particularly reflecting the impact of increases in UK unemployment during 2009 on the unsecured charge, which was partly offset by a lower secured impairment charge as house prices stabilised. The Wholesale charge increased significantly, reflecting the year-on-year decline in commercial property valuations and reduced levels of corporate cash flows; in particular, the real estate-related lending exposures in the heritage HBOS portfolios were more sensitive to the downturn in the economic environment. The Group spent a significant amount of time analysing and addressing the issues in the heritage HBOS portfolios, with the greatest attention paid to the over concentration in real estate related lending and those portfolios that fell outside of the Lloyds TSB risk appetite. As a result of this portfolio review, which applied prudent assumptions to real estate asset expectations, and with the deterioration in the economy translating into lower commercial property valuations, the Group took prudent and material impairment charges in the period following the acquisition. In the Wealth and International business the impairment charge reflected significant provisions against the Irish and Australian commercial real estate portfolios.

The impairment charge in respect of loans and advances to banks improved by £138 million to a credit of £3 million compared to a charge of £135 million in 2008; this reflected a small release in 2009 whereas 2008 included a number of specific charges as a result of the economic conditions faced by some banks at that time.

The impairment charge in respect of debt securities classified as loans and receivables increased by £91 million, or 58 per cent, to £248 million in 2009 compared to £157 million in 2008; £140 million arose from the consolidation of the post-acquisition results of HBOS and there was a reduction of £49 million in respect of heritage Lloyds TSB businesses.

Impairment losses in respect of available-for-sale financial assets were £472 million higher at £602 million in 2009 compared to £130 million in 2008. This increase was principally due to the charge of £577 million arising on the consolidation of the post-acquisition results of HBOS and reflects impairment of certain debt securities taken on as part of the acquisition.

The charge in respect of other credit risk provisions was £43 million in 2009 compared to £6 million in 2008; £5 million of the charge in 2009 relates to the post-acquisition results of HBOS.

25


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

 

 

 

 

 

 

 

 

 

 

 

TAXATION

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

 

2009
£m

 

 

 

2008
£m

 

UK corporation tax:

 

 

 

 

 

 

 

 

 

 

 

 

– Current tax on profits for the year

 

 

(146

)

 

 

(227

)

 

 

(667

)

– Adjustments in respect of prior years

 

 

310

 

 

 

(310

)

 

 

(19

)

 

 

 

164

 

 

 

(537

)

 

 

(686

)

Double taxation relief

 

 

1

 

 

 

10

 

 

 

91

 

 

 

 

165

 

 

 

(527

)

 

 

(595

)

Foreign tax:

 

 

 

 

 

 

 

 

 

 

 

 

– Current tax on profits for the year

 

 

(82

)

 

 

(221

)

 

 

(144

)

– Adjustments in respect of prior years

 

 

49

 

 

 

40

 

 

 

4

 

 

 

 

(33

)

 

 

(181

)

 

 

(140

)

Current tax credit (charge)

 

 

132

 

 

 

(708

)

 

 

(735

)

Deferred tax

 

 

193

 

 

 

2,619

 

 

 

773

 

Taxation credit

 

 

325

 

 

 

1,911

 

 

 

38

 

2010 COMPARED WITH 2009

The rate of tax is influenced by the geographic and business mix of profits. In 2010, a tax credit of £325 million arose on a loss before tax of £2,919 million and in 2009 a tax credit of £1,911 million arose on a profit before tax of £1,042 million. The statutory corporation tax rate was 28 per cent in both years. The Group’s tax charge or credit is distorted, in particular, by the requirement to include, within income tax in the income statement, the tax attributable to UK life insurance policyholder earnings and the Group’s interests in Open Ended Investment Companies, being a tax charge of £315 million for 2010 compared to a charge of £410 million in 2009. The tax position in 2009 was also particularly distorted by the gain on acquisition of £11,173 million, which did not attract a tax charge. In both 2010 and 2009, there was also an impact from tax losses, mostly in overseas jurisdictions, where deferred tax assets have not been recognised, leading to an additional charge of £487 million in 2010 (2009: £332 million). The remainder of the variation in effective tax rates reflects normal fluctuations in disallowed and non-taxable items. The Group does not expect the tax rate, excluding the impact of policyholders’ tax and Open Ended Investment Companies, to vary significantly from the average UK corporation tax rate.

2009 COMPARED WITH 2008

The effective rate of tax was negative in both 2009 and 2008 as tax credits arose on the profits in both years; the statutory corporation tax rates were 28 per cent in 2009 and 28.5 per cent in 2008. The tax credit was distorted, in particular, by both the gain on acquisition of £11,173 million in 2009, which did not attract a tax charge, and the goodwill impairment charges of £240 million in 2009 and £100 million in 2008 on which no tax relief could be taken. The effective tax rate was also distorted by the requirement to include, within income tax in the income statement, the tax attributable to UK life insurance policyholder earnings and the Group’s interests in Open Ended Investment Companies, being a tax charge of £410 million for 2009 compared to a tax credit of £461 million in 2008. Excluding these items the effective tax rate in 2009 was 22.5 per cent compared to 32.0 per cent in 2008. Of this 9.5 per cent decrease in the effective rate, 7.3 per cent was attributable to the impact in 2009 of losses arising in certain subsidiaries resident in Ireland, for which a deferred tax asset could not be recognised, and the statutory tax rate is 12.5 per cent; the remainder of the decrease in the effective tax rate in 2009 on this adjusted basis reflected normal fluctuations in disallowed and non-taxable items.

ECONOMIC PROFIT

In pursuit of its aim to maximise shareholder value over time, the Group has for a number of years used a system of value based management as a framework to identify and measure value creation and has used economic profit, a non-GAAP measure, as a measure of performance. The Group continues to believe that economic profit provides important information, because it captures both growth in investment and return and informs management decision making.

26


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

INTEGRATION

The Group remains on target to deliver annualised cost savings from synergies and other operating efficiencies of £2 billion by the end of 2011.

The sustainable run-rate synergies achieved as at 31 December 2010 totalled £1,379 million excluding a number of one-off savings. The table below analyses the run-rate synergies as at 31 December 2010 and the 2011 target run-rate of £2 billion by division.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

2011

 

 

 

Synergy
run-rate as at
31 December
2010
£m

 

Allocation
of Group
Operations
run-rate to
divisions
£m

 

Run-rate
by market
facing
division
£m

 

Target
run-rate
by market
facing
division
£m

 

Retail

 

 

301

 

 

228

 

 

529

 

 

867

 

Wholesale

 

 

248

 

 

111

 

 

359

 

 

532

 

Wealth and International

 

 

233

 

 

7

 

 

240

 

 

242

 

Insurance

 

 

167

 

 

30

 

 

197

 

 

239

 

Group Operations

 

 

393

 

 

(393

)

 

 

 

 

Central items

 

 

37

 

 

17

 

 

54

 

 

120

 

Total

 

 

1,379

 

 

 

 

1,379

 

 

2,000

 

Savings to date continue to be driven largely from role reductions resulting from deployment of the new Group organisation design adopting the Lloyds TSB approach. The overwhelming majority of role reductions have been achieved through re-deployment, natural turnover and voluntary redundancy. In addition the Group has exited 79 non-branch properties during 2010, bringing the total to 162 since the start of the integration programme.

Procurement benefits in 2010 were also significant at £236 million and supplier negotiations resulted in over 90 per cent of Group expenditure being consolidated within our top 1,000 suppliers.

The software build of the Integrated IT Platform was completed in the first half of 2010 and, following extensive testing, largely implemented by the end of 2010 and is now live and operational for most Lloyds TSB processes and transactions. Roll out of the Lloyds TSB counter system across Halifax and Bank of Scotland branches commenced in late 2010 and will complete during the first half of 2011. Similarly HBOS ATMs are being migrated and the Group’s target mortgage sales platform rolled out to mortgage sales advisers creating a single platform for mortgage sales.

Product and channel systems are being integrated and harmonised where required and this will continue through the first half of 2011 in parallel with a detailed and rigorous programme of testing in preparation for customer data migration from HBOS systems to the single IT platform by the end of 2011.

Integration activities have continued at pace over 2010 with delivery being wide ranging and spanning Group activities. Examples include the rollout of the Lloyds TSB model of day time cash deliveries to Halifax and Bank of Scotland branches; implementation of an improved online mortgage application process for mortgage brokers; delivery of a single scalable secure Internet Banking platform; launch of an integrated product proposition for our market leading Bancassurance business; migration of Asset Finance Lex customer and Bank of Scotland dealer finance books onto a single platform; and harmonisation of our loss notification and loss adjusting service processes for household insurance within our General Insurance business.

Total cost reductions from synergies of £1,361 million achieved in the year against the integration baseline and in line with target include other operating efficiencies and one-off savings which are excluded from the reported run rate synergies. The total cost reductions relate primarily to reductions in colleague numbers, procurement and IT savings.

Integration costs of £1,653 million were incurred in 2010 which have been excluded from the combined businesses results. This brings the total integration costs since the HBOS acquisition to £2,749 million. The integration costs relate to severance, IT and business costs of implementation. The severance provisions are for 26,000 role reductions announced to the end of 2010 of which 22,000 have been achieved to date.

27


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

LINE OF BUSINESS INFORMATION

The requirements for IFRS segmental reporting are set out in IFRS 8 ‘Operating Segments’ which mandates that an entity’s segmental reporting should reflect the way in which its operations are viewed and judged by its chief operating decision maker. As a consequence, the Group’s statutory segmental reporting follows the combined businesses basis as explained below (see also note 4 to the consolidated financial statements).

The Group Executive Committee (GEC) has been determined to be the chief operating decision maker for the Group. The Group’s operating segments reflect its organisational and management structures. GEC 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.

The Group’s activities are organised into four financial reporting segments: Retail, Wholesale, Wealth and International and Insurance. The segmental results and comparatives are presented on the basis reviewed by the chief operating decision maker and as a consequence include the pre-acquisition results of HBOS for 2008 and the period from 1 January 2009 to 16 January 2009.

Comparisons of results on a historical consolidated statutory basis are dominated by the impact of the acquisition of HBOS as the 2009 statutory results include the results of HBOS from 16 January 2009, together with the effects of the unwind of fair value adjustments made to the HBOS balance sheet on acquisition, and the 2008 statutory results do not include any results of HBOS. 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 following adjustments have been made:

 

 

 

 

the 2008 results include the results of HBOS as if it had been acquired on 1 January 2008;

 

 

 

 

the 2009 results assume HBOS had been owned throughout that year;

 

 

 

 

the gain on acquisition of HBOS (in 2009) and amortisation of purchased intangible assets have been excluded; and

 

 

 

 

the unwind of acquisition-related fair value adjustments is shown as one line in the 2010 and 2009 combined businesses income statements and has not been back-dated to 2008.

 

 

 

In order to better present business performance the following items, not related to acquisition accounting, have also been excluded:

 

 

 

 

the results of BankWest and St. Andrews, sold in December 2008, and the related loss on disposal; and the loss on disposal of businesses in 2010;

 

 

 

 

integration costs;

 

 

 

 

insurance and policyholder interests volatility;

 

 

 

 

the Government Asset Protection Scheme (GAPS) fee paid in December 2009;

 

 

 

 

goodwill impairment;

 

 

 

 

the curtailment gain in 2010 in respect of the Group’s defined benefit pension schemes;

 

 

 

 

the payment protection insurance provision; and

 

 

 

 

the customer goodwill payments provision.

Readers should be aware that the combined businesses basis has been presented for comparative purposes only and is not intended to provide proforma information or show the results of the Group as if the acquisition of HBOS had taken place at an earlier date. Readers should also note that HBOS was not managed by the current management of Lloyds Banking Group in 2008.

The results of the businesses are set out below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

 

2009
£m

 

 

 

2008
£m

 

Retail

 

 

4,716

 

 

 

1,382

 

 

 

2,542

 

Wholesale

 

 

3,257

 

 

 

(4,703

)

 

 

(10,479

)

Wealth and International

 

 

(4,824

)

 

 

(2,356

)

 

 

277

 

Insurance

 

 

1,102

 

 

 

975

 

 

 

1,540

 

Group Operations and Central items:

 

 

 

 

 

 

 

 

 

 

 

 

Group Operations

 

 

(63

)

 

 

(149

)

 

 

(76

)

Central items

 

 

(1,976

)

 

 

(1,449

)

 

 

(517

)

 

 

 

(2,039

)

 

 

(1,598

)

 

 

(593

)

Profit (loss) before tax – combined businesses

 

 

2,212

 

 

 

(6,300

)

 

 

(6,713

)

The aggregate total of the combined businesses basis segmental results is a non-GAAP measure; further discussion of this measure is set out on page 47.

28


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RECONCILIATION OF COMBINED BUSINESSES PROFIT (LOSS) BEFORE TAX TO STATUTORY PROFIT BEFORE TAX FOR THE YEAR

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note

 

 

2010
£m

 

 

2009
£m

 

 

2008
£m

 

Profit (loss) before tax – combined businesses

 

 

 

 

 

2,212

 

 

(6,300

)

 

(6,713

)

Integration costs

 

 

1

 

 

(1,653

)

 

(1,096

)

 

 

Volatility arising in insurance businesses

 

 

2

 

 

306

 

 

478

 

 

(2,349

)

Government Asset Protection Scheme fee

 

 

3

 

 

 

 

(2,500

)

 

 

Negative goodwill credit

 

 

4

 

 

 

 

11,173

 

 

 

Amortisation of purchased intangibles and goodwill impairment

 

 

5

 

 

(629

)

 

(993

)

 

(258

)

Curtailment gain in respect of defined benefit pension schemes

 

 

6

 

 

910

 

 

 

 

 

Pre-acquisition results of HBOS plc

 

 

7

 

 

 

 

280

 

 

10,825

 

Insurance grossing adjustment

 

 

8

 

 

 

 

 

 

10

 

Results of BankWest and St. Andrews

 

 

9

 

 

 

 

 

 

90

 

Payment protection insurance provision

 

 

10

 

 

(3,200

)

 

 

 

 

Customer goodwill payments provision

 

 

11

 

 

(500

)

 

 

 

 

Loss on disposal of businesses

 

 

12

 

 

(365

)

 

 

 

(845

)

(Loss) profit before tax – statutory

 

 

 

 

 

(2,919

)

 

1,042

 

 

760

 


 

 

1.

Integration costs

Integration costs of £1,653 million were incurred in 2010 and £1,096 million in 2009; these relate to severance, IT and other costs of implementation. The severance provisions relate to some 26,000 role reductions announced by 31 December 2010, of which some 22,000 had been delivered by the end of 2010. The overwhelming majority of role reductions were achieved through re-deployment, natural turnover and voluntary redundancy.

 

 

2.

Volatility arising in insurance businesses

The Group’s statutory profit 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.

During 2010, the Group’s statutory profit before tax included positive insurance and policyholder interests volatility of £306 million compared to positive volatility of £478 million in 2009 and negative volatility of £2,349 million in 2008. The volatility in 2010 reflects the strong performance of equity markets, partly offset by lower than expected returns on cash and fixed interest assets; this compares to more significant improvements in financial markets in 2009. The negative volatility of £2,349 million in 2008 primarily reflects the far less favourable financial markets in that year.

Volatility comprises the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

 

 

2008
£m

 

Insurance volatility

 

 

100

 

 

237

 

 

(1,425

)

Policyholder interests volatility

 

 

216

 

 

298

 

 

(924

)

Insurance hedging arrangements

 

 

(10

)

 

(57

)

 

 

Total

 

 

306

 

 

478

 

 

(2,349

)

Management believes that excluding volatility from profit before tax on a combined businesses basis provides useful information for investors on the performance of the business as it excludes amounts included within profit before tax which do not accrue to the Group’s equity holders and excludes the impact of changes in market variables which are beyond the control of management.

The most significant limitations associated with excluding volatility from the combined businesses results are:

 

 

(i)

Insurance volatility requires an assumption to be made for the normalised return on equities and other investments; and

 

 

(ii)

Insurance volatility impacts on the Group’s regulatory capital position, even though it is not included within profit before tax on a combined businesses basis.

 

 

Management compensates for the limitations above by:

 

 

(i)

Monitoring closely the assumptions used to calculate the normalised return used within the calculation of insurance volatility; these assumptions are disclosed below; and

 

 

(ii)

Producing separate reports on the Group’s current and forecast capital ratios.

29


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Insurance volatility

The Group’s insurance businesses have 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 the value of both the liabilities and the 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 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)

 

 

2011
%

 

 

2010
%

 

 

2009
%

 

 

2008
%

 

Gilt yields (gross)

 

 

3.99

 

 

4.45

 

 

3.74

 

 

4.55

 

Equity returns (gross)

 

 

6.99

 

 

7.45

 

 

6.74

 

 

7.55

 

Dividend yield

 

 

3.00

 

 

3.00

 

 

3.00

 

 

3.00

 

Property return (gross)

 

 

6.99

 

 

7.45

 

 

6.74

 

 

7.55

 

Corporate bonds in unit-linked and with-profit funds (gross)

 

 

4.59

 

 

5.05

 

 

4.34

 

 

5.15

 

Fixed interest investments backing annuity liabilities (gross)

 

 

4.78

 

 

5.30

 

 

5.72

 

 

5.52

 

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 liabilities in respect of the Group’s annuity business are matched by a portfolio of fixed interest securities, which includes a large proportion of corporate bonds. In accordance with the approach adopted in previous years, the value of in-force business for the annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of these corporate bond holdings. The illiquidity premium is estimated to have remained at 75 basis points as at 31 December 2010 (31 December 2009: 75 basis points; 31 December 2008: 154 basis points). The insurance businesses experienced positive volatility of £100 million during 2010, compared to positive volatility of £237 million in 2009 and negative volatility of £1,425 million in 2008. The positive volatility of £100 million in 2010 was primarily driven by strong performance of equity and property investments relative to the expected return. During 2010, equity market values increased by 9 per cent and property returns reached 19 per cent. Partly offsetting this were lower than expected returns on cash and fixed interest assets. This benefit is lower than the £237 million positive volatility reported in 2009, as 2009 included significant benefits from reductions in corporate bond spreads, which did not occur in 2010, and greater out-performance of equity markets (during 2009, equities recovered by 22 per cent); these increases in 2009 being only partly offset by a reduction in gilts, reflecting an increase in yields and a reduction in property values of 6.6 per cent. The improvement in returns in 2009, however, was in contrast to the situation in 2008, when a 33 per cent reduction in equities was the main driver of the £1,425 million of negative volatility.

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 the combined businesses results. 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.

During the year ended 31 December 2010, the statutory profit before tax included credits to other income of £216 million which related to the policyholder interests volatility tax charge (2009: credits of £298 million in other income which related to the policyholder interests volatility tax charge; 2008: charge of £924 million in other income which related to the policyholder interests volatility tax credit). Strong market conditions in the latter part of 2010 resulted in increased policyholder tax liabilities and led to a policyholder tax charge of £315 million (2009: charge of £410 million; 2008: credit of £461 million) for the year in the Group’s tax charge. The market recovery in 2009 had increased policyholder tax liabilities and led to a policyholder tax charge during that year in the Group’s tax charge; although this was partly offset by a credit relating to differences in the expected levels of policyholder tax provisions and charges. This compared to 2008 when substantial policyholder tax losses were generated as a result of the fall in property, bond and equity values.

Group hedging arrangements

The statutory results for the year ended 31 December 2010 also include a charge in relation to the Group’s insurance hedging arrangements of £10 million (2009: £57 million; 2008: nil). 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 2009. These expired in January 2010. The charge for these options in the year ended 31 December 2010 was £7 million (2009: £57 million). New protection against significant market falls, using option contracts, was acquired by the Group, financed by selling some upside potential from equity market movements. There was no initial cost associated with these hedging arrangements. On a mark-to-market valuation basis a loss of £3 million was recognised in relation to these new contracts in the year ended 31 December 2010. Subsequent to the year end, these 2010 option contracts were replaced by the Group in January 2011 with fresh contracts to provide further protection against significant market falls. Again this was financed, at no initial cost, by selling some upside potential from equity market movements.

30


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

3.

Government Asset Protection Scheme fee

The Group entered into an agreement in March 2009 relating to its proposed participation in the Government Asset Protection Scheme (GAPS). However, following its rights issue in November 2009, the Group withdrew from its proposed participation and agreed to pay HM Treasury £2,500 million in recognition of the benefits to the Group’s trading operations arising as a result of HM Treasury proposing to make GAPS available to the Group; this fee was paid in December 2009 (see Major shareholders and related party transactions – Information about the Lloyds Banking Group’s relationship with the UK Government – Other related party transactions with the UK Government – GAPS withdrawal deed).

 

 

4.

Negative goodwill credit

On 16 January 2009, the Group acquired 100 per cent of the ordinary share capital of HBOS plc. The consideration for the acquisition of HBOS comprised the issue of 7,776 million ordinary shares in Lloyds Banking Group plc together with the costs of acquisition. In determining the fair value of the consideration, the Company used the share price of its equity securities quoted on the London Stock Exchange, as at the date of completion.

As the fair value of the identifiable net assets acquired was greater than the total consideration paid, negative goodwill of £11,173 million 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.

The exercise to fair value the assets and liabilities of HBOS took into account prevailing market conditions at the time of completion and, where appropriate, the Group engaged independent external advisers. As the consideration paid was significantly less than the provisional fair value of the net assets acquired, the results of the fair value calculations were subject to additional challenge in accordance with the requirements of IFRS 3.

On the date that the acquisition was announced (18 September 2008) the implied goodwill was a small positive amount based on the share price of the Company and the originally announced conversion factor of 0.833 Lloyds Banking Group plc shares for each HBOS share. However, a number of factors led to negative goodwill being recognised on completion of the transaction.

By the time of the recommended offer, it had become increasingly difficult for HBOS to raise funds in wholesale markets and HBOS faced an outflow of customer deposits, reflecting reduced investor and depositor confidence. Subsequent to the announcement of the offer, turbulence in the markets continued, fuelled by concerns about credit risk and worsening economic conditions. For HBOS, confidence continued to deteriorate amid ongoing funding difficulties and concerns over the extent of future credit losses. Measures by national authorities and central banks failed to stem this turbulence and the UK Government decided in October 2008 that it would be appropriate for the UK banking sector to increase its level of capitalisation. The capital raising, underwritten by the UK Government, was made available to HBOS on condition that the acquisition by the Company completed. As a consequence of the capital that HBOS was required to issue and the impact of market conditions on the future prospects of the new group, the terms of the final agreed offer were revised down to a ratio of 0.605. Additionally, the share price of the Company fell from 280p at the date of the announcement to 98.4p on 15 January 2009 reflecting both the dilutive impact of the capital that the Company raised and the turmoil in the banking sector and equity markets in general. These factors combined to reduce the value of the consideration for HBOS.

 

 

5.

Amortisation of purchased intangibles and goodwill impairment

A total of £4,650 million of customer-related intangibles, brands, core deposit intangibles and purchased credit card relationships were recognised on the acquisition of HBOS in 2009 and these are being amortised over their estimated useful lives, where this has been determined to be finite. This has resulted in a charge of £629 million in the year ended 31 December 2010 (2009: £753 million).

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.

The Group reviews goodwill held on its balance sheet for impairment at least annually or when events or changes in economic circumstances indicate that an impairment may have taken place. Goodwill attributable to the Group’s asset finance business, for which an impairment charge of £100 million was recognised in the Group’s financial statements for the year ended 31 December 2008, was again reviewed for impairment in 2009 due to the continuing uncertainties over the short-term macroeconomic environment. As a consequence, the carrying value of the consumer finance cash generating unit within Asset Finance was reassessed resulting in an additional goodwill impairment charge of £240 million in the year ended 31 December 2009.

The charge in 2008 of £258 million comprised impairment of goodwill, principally in relation to the heritage Lloyds TSB asset finance operations, the ICC business banking division in Ireland and a specialist area of the HBOS UK credit card business.

 

 

6.

Curtailment gain in respect of defined benefit pension schemes

Following changes by the Group to the terms of its 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 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 the year ended 31 December 2010 and an equivalent reduction in the balance sheet liability.

 

 

7.

Pre-acquisition results of HBOS plc

The acquisition of HBOS plc on 16 January 2009 had a significant effect on the comparability of the Group’s financial position and results, as a consequence, the combined businesses basis results are prepared as if HBOS had been owned by the Group for the full year 2009 and throughout 2008.

31


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

8.

Insurance grossing adjustment

The Group’s insurance businesses’ income statements include income and expenditure which are attributable to the policyholders of the Group’s long-term assurance funds. These items have no impact upon the profit attributable to equity shareholders and, in order to provide a clearer representation of the underlying trends within the business, these items are shown net on a separate line.

 

 

9.

Results of BankWest and St. Andrews

As explained below, HBOS sold part of its Australian operations in December 2008, the trading results of these businesses up to the date of sale have been excluded from the combined businesses basis results for 2008.

 

 

10.

Payment protection insurance provision

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 was heard in January 2011 and on 20 April 2011 judgment was handed down by the High Court dismissing the BBA’s application. Since publication of the judgment, the Group has been in 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 income statement for the year ended 31 December 2010 of £3,200 million in respect of the anticipated costs of such contact and/or redress, including administration expenses.

 

 

11.

Customer goodwill payments provision

Lloyds Banking Group has been in discussions with the FSA regarding the application of an interest variation clause in certain Bank of Scotland plc variable rate mortgage contracts where the wording in the offer documents received by certain customers had the potential to cause confusion. The relevant mortgages were written between 2004 and 2007 by Bank of Scotland plc under the ‘Halifax’ brand. In February 2011, the Group reached agreement with the FSA in relation to initiating a customer review and contact programme and making goodwill payments to affected customers. In order to make these goodwill payments, Bank of Scotland plc has applied for a Voluntary Variation of Permission to carry out the customer review and contact programme to bring it within section 404F(7) of FSMA 2000. The Group made a provision of £500 million in relation to this programme during the year ended 31 December 2010.

 

 

12.

Loss on disposal of businesses

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. The Group extended vendor financing, on normal commercial terms and negotiated on an arms length basis, 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.

On 19 December 2008, HBOS completed the sale of part of its Australian operations, principally Bank of Western Australia Limited and St. Andrews Australia Pty Limited, to Commonwealth Bank of Australia Limited; this resulted in a pre-tax loss on disposal of £845 million.

32


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

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 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 has over 22 million current account customers and provides social banking to over four million people through basic banking or social banking accounts. It is also the largest provider of personal loans in the UK, as well as being the UK’s leading credit card issuer. Retail provides over one in five new residential mortgages making it one of the leading UK mortgage lenders and provided over 50,000 mortgages to help first time buyers in 2010. 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.

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

 

               

Net interest income

 

 

9,378

 

 

7,970

 

 

8,454

 

Other income

 

 

1,607

 

 

1,804

 

 

2,739

 

                     

Total income

 

 

10,985

 

 

9,774

 

 

11,193

 

Operating expenses

 

 

(4,644

)

 

(4,566

)

 

(4,963

)

                     

Trading surplus

 

 

6,341

 

 

5,208

 

 

6,230

 

Impairment

 

 

(2,747

)

 

(4,227

)

 

(3,695

)

Share of results of joint ventures and associates

 

 

17

 

 

(6

)

 

7

 

                     

Profit before tax and fair value unwind

 

 

3,611

 

 

975

 

 

2,542

 

Fair value unwind

 

 

1,105

 

 

407

 

 

 

                     

Profit before tax

 

 

4,716

 

 

1,382

 

 

2,542

 

                     

2010 COMPARED WITH 2009

Profit before tax from Retail was £3,334 million higher at £4,716 million compared to £1,382 million in 2009; profit in 2010 included £1,105 million in respect of the unwinding of the fair value adjustments arising on the acquisition of HBOS plc by the Group compared with £407 million in 2009.

Profit before tax and fair value unwind increased by £2,636 million to £3,611 million in 2010 compared to £975 million in 2009. This increase in profit was driven by higher income and a significant reduction in impairment losses, in the context of a stabilising economy, partly offset by an increase in operating expenses.

Total income increased by £1,211 million, or 12 per cent, to £10,985 million compared with £9,774 million in 2009 reflecting an increase in net interest income of £1,408 million, partially offset by a reduction in other income of £197 million.

Net interest income increased by 18 per cent. The net interest margin was 2.46 per cent compared with 1.97 per cent in 2009. The asset margins expanded in 2010 from 1.18 per cent to 1.93 per cent as a result of decreases in the LIBOR to base rate spread and stable customer interest rates. The asset margin also widened partly as a result of mortgage customers continuing to move onto, and staying on, standard variable rates and assets being priced to more appropriately reflect risk, offset by rising funding costs. The liability margin, on the other hand, has reduced from 1.41 per cent to 0.87 per cent as the effect of lower LIBOR to base rate spreads was partially offset by the reduction of expensive deposit balances.

Lending to customers in Retail, net of impairment provisions and fair value adjustments, was £7,327 million, or 2 per cent, lower at £363,731 million in 2010 compared with £371,058 million in 2009. This reflected reduced customer demand for credit and customers continuing to reduce their personal indebtedness.

Retail’s gross new mortgage lending was £30,113 million in 2010 representing a market share of 22.1 per cent. New mortgage lending continued to be focused on supporting the housing market, with 70 per cent of the lending being for house purchase rather than re-mortgaging. Retail remains the largest lender to first time buyers in the market helping over 50,000 customers to buy their first home. It also continues to be an industry leader in its support for shared equity and shared ownership schemes. Average loan-to-value on new mortgage lending in 2010 was 60.9 per cent compared with 59.3 per cent in 2009, whilst average indexed loan-to-value on the mortgage portfolio was 55.6 per cent at 31 December 2010 compared with 54.8 per cent at 31 December 2009 and reflected the net fall in house prices in the year.

Total customer deposits were £11,442 million, or 5 per cent, higher at £235,591 million in 2010 compared with £224,149 million in 2009. The growth was predominantly from instant access and tax free cash ISA accounts, rather than more expensive term deposits. Retail continued to perform well in the savings market, with a strong stable of savings brands which can be tailored to customer demands.

Other income decreased by 11 per cent in 2010 to £1,607 million from £1,804 million in 2009 largely as a result of changes to current account overdraft charges. Retail continues to focus on having fees and rates that customers understand. It is believed that this will result in stronger customer relationships as well as supporting the deepening of these relationships. An example of this focus is the changes to the overdraft charging structure for Halifax and Bank of Scotland personal current accounts at the end of 2009, which delivers a more suitable product proposition and an improved customer experience and resulted in a reduction in other income of approximately £90 million. Similarly, the changes to the Lloyds TSB current account pricing model, which became effective at the end of 2010, provide a simpler, more sustainable proposition for customers, resulting in an overall reduction in the cost of overdraft usage.

33


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Total income is analysed as follows and reflects the trends discussed above:

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

           

Mortgages and Savings

 

 

4,739

 

 

3,667

 

Consumer Banking

 

 

6,246

 

 

6,107

 

               

Total income

 

 

10,985

 

 

9,774

 

               

Operating expenses increased by £78 million, or 2 per cent, to £4,644 million compared with £4,566 million in 2009. This was against a background of an increase in total income of 12 per cent and reflected ongoing cost control and synergies from the integration. The cost:income ratio for the year was 42.3 per cent compared to 46.7 per cent in 2009.

Impairment losses decreased by £1,480 million, or 35 per cent, to £2,747 million in 2010 compared with £4,227 million in 2009. Impairment losses as a percentage of average loans and advances to customers were 0.74 per cent in 2010 compared with 1.11 per cent in 2009. This reduction was driven primarily by the improved quality of new business and effective portfolio management, combined with the continued slow recovery of the economy. Across Retail in 2010, there were fewer cases going into arrears.

Unsecured impairment losses reduced by £983 million to £2,455 million compared with £3,438 million in 2009. This reflected a continuation of the improving portfolio trends resulting from the Group’s prudent risk appetite, with a focus on lending towards existing customers, combined with stable unemployment. Secured impairment losses of £292 million, compared with £789 million in 2009, reflected a reduction in impaired loans and improved arrears in 2010, together with the stabilising economy, more stable house prices, low interest rates and prudent lending criteria.

Impaired loans in the unsecured portfolio decreased by £838 million to £2,981 million which represented 10.7 per cent of closing loans and advances to customers at 31 December 2010, compared with 11.9 per cent at 31 December 2009. The movement in impaired loans is consistent with the trends seen in both the flow of accounts to arrears and arrears balances, both of which have fallen across all unsecured products during 2010. This is a result of tightening credit policy across the credit lifecycle, including stronger controls on customer affordability, set against a stable economic environment. Retail’s exposure to revolving credit products has been actively managed to ensure that it is appropriate to customers’ changing financial circumstances. The portfolios’ results are supported by pre-recessionary levels of early arrears for accounts acquired in the last two years, highlighting an underlying improvement in the risk profile of the business. Impairment provisions decreased by £606 million, compared with 31 December 2009, to £1,507 million. Impairment provisions, as a percentage of impaired loans, decreased to 50.6 per cent at 31 December 2010 from 55.3 per cent at 31 December 2009, largely driven by more stringent criteria for new and existing unsecured collections repayment plans resulting in highly provided assets being written off.

Impaired loans in the secured portfolio decreased by £427 million to £6,769 million at 31 December 2010 and, as a percentage of closing loans and advances to customers, reduced to 2.0 per cent from 2.1 per cent at 31 December 2009. The reduction in impaired loans reflects the continued ability of customers to afford their mortgage payments in a low interest rate environment. The number of customers going into arrears remained stable throughout 2010. In the second half of 2010 fewer accounts in arrears returned to order resulting in higher early arrears balances for 31 December 2010 compared to 30 June 2010. As reported at the 2009 year end, Specialist lending remains closed to new business and this book is in run-off.

The fair value unwind was a net credit of £1,105 million compared with a net credit of £407 million in 2009. The net fair value unwind was larger in 2010 than in 2009 and reflected a smaller charge related to the fixed rate mortgage portfolios as mortgages reached the end of their fixed term and borrowers moved to standard variable products. This was partially offset by a reduction in the credit attributed to the fixed rate savings portfolio as fixed rate term deposits, existing prior to acquisition, matured.

2009 COMPARED WITH 2008

Profit before tax from Retail was £1,160 million, or 46 per cent, lower at £1,382 million in 2009 compared to £2,542 million in 2008; profit in 2009 included a credit of £407 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Profit before tax and fair value unwind decreased by £1,567 million, or 62 per cent, to £975 million in 2009 compared to £2,542 million in 2008. This decrease was driven by higher impairment losses and lower income, partly offset by a reduction in operating expenses.

Total income decreased by £1,419 million, or 13 per cent, to £9,774 million in 2009 compared to £11,193 million in 2008, reflecting a reduction in margins, lower payment protection income and non-recurring one-off income in 2008. Total income was analysed as follows:

 

 

 

 

 

 

 

 

 

 

2009
£m

 

2008
£m

 

           

Mortgages and Savings

 

 

3,667

 

 

5,009

 

Consumer Banking

 

 

6,107

 

 

6,184

 

               

Total income

 

 

9,774

 

 

11,193

 

               

Total income in Mortgages and Savings decreased by £1,342 million, or 27 per cent, to £3,667 million in 2009 compared to £5,009 million in 2008. The reduction in Mortgage income reflected increased wholesale money market funding costs, which were partly offset by higher asset pricing. Lower income in Savings was the result of margin pressures arising from lower base rates and the competitive environment, the impact of which was partly offset by higher customer deposits.

Income within Consumer Banking (where the principal products are current accounts and unsecured lending) was £77 million, or 1 per cent, lower at £6,107 million in 2009 compared to £6,184 million in 2008. On 1 January 2009 Retail introduced a monthly premium payment protection product and ceased selling single premium products. This new product offers customers the benefit of monthly payments and income is recognised over the life of the loan rather than all being recognised in the first year. This reduction in income, together with the effect of lower loan volumes, was broadly offset by an improved performance across the rest of Consumer Banking, including benefits from asset re-pricing.

Lending to customers in Retail, net of impairment provisions and fair value adjustments arising from the acquisition of HBOS plc by the Group, was £6,019 million, or 2 per cent, lower at £371,058 million in 2009 compared to £377,077 million in 2008; this reflected the impact of customers reducing their personal indebtedness and not taking on new financial commitments in the difficult economic environment.

34


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Retail continued to build its mortgage business in a contracting market by focusing on the prime mortgage market, particularly through the branch network rather than intermediaries, whilst maintaining a prudent approach to risk. Gross new mortgage lending totalled £34,666 million during 2009, compared to £78,058 million in 2008, representing a market share of 24 per cent. Retail maintained its commitment to the housing market and first time buyers, with more than 60 per cent of new lending in 2009 being for house purchase rather than for re-mortgage. The average loan-to-value ratio at the end of 2009 was 54.8 per cent compared with 54.9 per cent at the end of 2008, whilst the average loan-to-value ratio on new residential lending in 2009 was 59.3 per cent compared with 63.1 per cent in 2008. Specialist lending balances (self-certified and sub-prime) decreased slowly following the decision, at the start of 2009, to withdraw from this market. New buy-to-let lending remained broadly flat at 13 per cent of total new mortgage lending; however, redemptions in this book were low.

Buy-to-let mortgage balances increased by £2,872 million in 2009. Retail continued to carefully assess the risks of such lending and as a result the average loan-to-value on new lending in the buy-to-let portfolio fell to 65.6 per cent at the end of 2009 compared to 73.1 per cent at the end of 2008.

Customer deposits were £7,867 million, or 4 per cent, higher at £224,149 million in 2009 compared to £216,282 million in 2008 despite the high level of term deposits maturing during 2009, as a result of Halifax and Bank of Scotland deposit gathering activities in the first half of 2008. Current account balances increased by 15 per cent over 2009 resulting from growth in the number of current accounts and a low interest rate environment.

Retail’s net interest margin decreased by 18 basis points to 1.97 per cent in 2009 compared to 2.15 per cent in 2008, reflecting higher wholesale funding costs and reduced margins on savings products due to the low base rate environment, partly offset by higher asset pricing which led to a stronger margin in the second half of 2009.

Operating expenses decreased by £397 million, or 8 per cent, to £4,566 million in 2009 compared to £4,963 million in 2008. This decrease was driven primarily by a focus on cost control, cost savings resulting from integrating the two businesses and the benefit of a lower Financial Services Compensation Scheme levy. The reduction in operating expenses resulting from integrating the Lloyds TSB and HBOS retail businesses was delivered through streamlining management structures, consolidating the number of mortgage operational sites, integrating and simplifying the mortgage operating model, procurement savings from the rationalisation of suppliers and property savings through the consolidation of sites.

Impairment losses on loans and advances increased by £532 million, or 14 per cent, to £4,227 million in 2009 compared to £3,695 million in 2008. Impairment losses as a percentage of average advances were 1.11 per cent in 2009 compared to 0.97 per cent in 2008. Higher unemployment and the weak economy drove a significant increase in unsecured impairments which was partly offset by a lower secured impairment charge as house prices stabilised. Unsecured impairment losses are sensitive to economic conditions, particularly unemployment levels; consequently the 2009 impairment charge increased by £1,038 million to £3,438 million. The stabilisation of the housing market, in combination with lower interest rates and prudent risk management, resulted in the secured impairment charge decreasing in 2009 by £506 million to £789 million.

Arrears levels in the secured portfolios in 2009 were higher than 2008 but improved in the second half of 2009, and remained below the industry average. The percentage of mortgage cases more than three months in arrears increased to 2.3 per cent at 31 December 2009 compared to 1.8 per cent as at 31 December 2008. The stock of repossessed properties reduced by 32 per cent to 2,720 properties compared to 4,011 properties at the end of 2008 and, as a proportion of total accounts, remained lower than the industry average.

Impaired loans in the unsecured lending portfolio, as at 31 December 2009, totalled £3,819 million, or 11.9 per cent of closing advances (after writing off some £2,100 million of loans provided against in earlier years). This compared with £5,350 million, or 14.7 per cent of closing advances at 31 December 2008; however, on an equivalent basis (adjusting for the write-off in 2009) impaired loans at 31 December 2008 totalled some £3,250 million, or 8.9 per cent of advances. The underlying increase in impaired loans which occurred in 2009 reflected the weak economy, particularly rising unemployment. During 2009 a number of actions were taken which improved delinquency rates on new business.

35


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

WHOLESALE

The Wholesale division serves in excess of a million businesses, ranging from start-ups and small enterprises to global corporations, with a range of propositions fully segmented according to customer need. The division comprises Corporate Markets, Treasury and Trading and Asset Finance.

Corporate Markets comprises Commercial, Corporate, Wholesale Markets, Wholesale Equity and Corporate Real Estate Business Support Unit. Commercial and Corporate provide relationship-based banking, risk management and advisory services to business customers, principally in the UK. Wholesale Markets provides risk management solutions, specialised lending, access to capital markets and multi-product financing solutions to its customers, whilst managing the Group’s own portfolio of structured credit investments and treasury assets. Wholesale Equity manages the division’s equity investment holdings (including Lloyds Development Capital). Corporate Real Estate Business Support Unit manages relationships with commercial real estate customers facing financial difficulties.

Treasury and Trading’s role is to provide access to financial markets in order to meet the Group’s balance sheet management requirements, and it provides trading infrastructure to support execution of customer-driven risk management transactions, whilst operating within a well controlled and conservative risk appetite.

Asset Finance consists of a number of leasing and speciality lending businesses including Contract Hire (Lex Autolease and Hill Hire) and Consumer Finance (Black Horse Motor and Personal Finance).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

 

 

2008
£m

 

                   

Net interest income

 

 

4,426

 

 

 

4,710

 

 

 

5,752

 

Other income

 

 

4,136

 

 

 

4,199

 

 

 

(302

)

                         

Total income

 

 

8,562

 

 

 

8,909

 

 

 

5,450

 

Costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     

 

     

 

     

– Operating expenses

 

 

(3,744

)

 

 

(4,106

)

 

 

(4,591

)

– Impairment of tangible fixed assets

 

 

(150

)

 

 

 

 

 

 

 

 

     

 

     

 

     

 

 

 

(3,894

)

 

 

(4,106

)

 

 

(4,591

)

                         

Trading surplus

 

 

4,668

 

 

 

4,803

 

 

 

859

 

Impairment

 

 

(4,446

)

 

 

(15,683

)

 

 

(10,394

)

Share of results of joint ventures and associates

 

 

(95

)

 

 

(720

)

 

 

(944

)

                         

Profit (loss) before tax and fair value unwind

 

 

127

 

 

 

(11,600

)

 

 

(10,479

)

Fair value unwind

 

 

3,130

 

 

 

6,897

 

 

 

 

                         

Profit (loss) before tax

 

 

3,257

 

 

 

(4,703

)

 

 

(10,479

)

                         

2010 COMPARED WITH 2009

Profit before tax from Wholesale improved by £7,960 million to a profit of £3,257 million compared to a loss of £4,703 million in 2009. The improvement of £7,960 million includes a credit of £3,130 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc, which were reduced by £3,767 million compared to £6,897 million in 2009.

Profit before tax and fair value unwind of £127 million improved by £11,727 million from a loss of £11,600 million in 2009. The improvement was driven by a decrease in the impairment charge, a decrease in the negative share of results of joint ventures and associates and a decrease in costs, only partially offset by lower income.

Total income decreased by £347 million, or 4 per cent, to £8,562 million in 2010 due to lower net interest income and other income.

Net interest income was £284 million, or 6 per cent, lower at £4,426 million in 2010 compared to £4,710 million in 2009. The decline in net interest income primarily reflects lower interest-earning asset balances in line with the Group’s targeted balance sheet reduction, mainly in loans and advances to customers, debt securities and available-for-sale positions. Net interest income was affected by higher funding costs and lower lending volumes, partly offset by higher customer margins on new business and from re-pricing on renewals.

Banking net interest income, which excludes trading activity, increased by £330 million, to £3,683 million, as lending business continued to be re-priced to reflect customer risk profiles, with lending margins increasing by 26 basis points. Deposit margins increased moderately, by 13 basis points, reflecting favourable internal liquidity rates, which were partially offset by the impact of lower LIBOR to base rate spreads. As a result, the banking net interest margin increased by 36 basis points to 1.88 per cent in 2010. The impact of re-pricing was only partially offset by a decrease in average interest-earning assets and liability balances.

Other income was £63 million, or 2 per cent, lower at £4,136 million in 2010 compared to £4,199 million in 2009. This deterioration primarily reflects higher levels of market volatility in 2009 which resulted in mark-to-market gains in Wholesale Markets, whilst 2010 experienced losses on sale of assets in targeted balance sheet reductions and lower operating lease income. Other income in 2010, however, benefited from investment gains in Wholesale Equity as a result of stabilisation in market conditions and improved fund investment performance, strong fee income across structuring and capital markets and more favourable performance in Treasury and Trading.

Operating expenses decreased by £362 million, or 9 per cent, to £3,744 million in 2010 compared to £4,106 million in 2009. The decrease reflected reduced levels of operating lease depreciation and cost savings attributable to the integration programme. This was partially offset by additional costs in the Business Support Unit and continued investment in customer facing resources and systems.

The impairment charge decreased by £11,237 million to £4,446 million in December 2010 compared to £15,683 million in 2009. The impairment charge on loans and advances as a percentage of average loans and advances to customers improved to 2.08 per cent in 2010 compared to 5.92 per cent in 2009. The decrease reflects reductions, notably in the heritage HBOS corporate real estate and real estate-related portfolios and heritage HBOS Corporate (UK and US) portfolios, and write backs from asset disposals, due to the stabilising economic environment, low interest rates which helped to maintain defaults at reduced levels, the stabilisation of UK real estate prices and provisioning against base case assumptions undertaken on the acquired heritage HBOS portfolios in the first half of 2009.

36


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The share of losses from joint ventures and associates comprises a small loss for the year of £95 million, a decrease of £625 million. This represents a net reduction in both the value and size of the portfolio compared to the prior year. The majority of the portfolio is now valued at nil with a remaining portfolio carrying value of approximately £128 million.

Wholesale’s fair value unwind credit of £3,130 million decreased by £3,767 million in 2010 from £6,897 million in 2009 due to lower impairments in 2010 relating to the HBOS assets that were fair valued on acquisition, partially offset by charges relating to the expected losses on acquired debt securities and by fair value releases on sales.

2009 COMPARED WITH 2008

Loss before tax from Wholesale improved by £5,776 million to a loss of £4,703 million in 2009 compared to a loss of £10,479 million in 2008; however, the loss in 2009 included a credit of £6,897 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Loss before tax and fair value unwind deteriorated by £1,121 million to a loss of £11,600 million in 2009 compared to a loss of £10,479 million in 2008. This deterioration was driven by higher impairment losses, only partly offset by an increase in other operating income and a decrease in operating expenses.

Total income increased by £3,459 million, or 63 per cent, to £8,909 million in 2009 compared to £5,450 million in 2008, driven by a large increase in other income.

Lending to customers in Wholesale, net of impairment provisions and fair value adjustments arising from the acquisition of HBOS plc by the Group, was £42,754 million, or 18 per cent, lower at £191,808 million in 2009 compared to £234,562 million in 2008. Customer deposits were £4,552 million, or 3 per cent, lower at £153,389 million in 2009 compared to £157,941 million in 2008.

Net interest income was £1,042 million, or 18 per cent, lower at £4,710 million in 2009 compared to £5,752 million in 2008. The net interest margin, adjusted to exclude products where either the funding costs or the related revenues are recognised in other income, declined by 33 basis points to 1.52 per cent in 2009 compared to 1.85 per cent in 2008. This reduction in income and margin reflected higher wholesale funding costs partly offset by higher asset pricing.

Other income was £4,501 million higher at £4,199 million in 2009 compared to a deficit of £302 million in 2008. Other income in 2008 had been significantly reduced due to the effect of the dislocation in credit markets which resulted in investment valuation write-downs in the Wholesale business; these factors were not repeated in 2009. Other income in 2009 also benefited from good transaction volumes in capital markets and strong flows of client-driven derivative transactions at improved spreads.

Operating expenses decreased by £485 million, or 11 per cent, to £4,106 million in 2009 compared to £4,591 million in 2008. Operating expenses in 2008 included a £180 million settlement in relation to certain historic US dollar payments; excluding this item from 2008, operating expenses decreased by £305 million, or 7 per cent, to £4,106 million in 2009 compared to £4,411 million in 2008. This decrease reflected reduced levels of operating lease business and cost savings achieved from the integration programme, partly offset by increased investment in Wholesale’s customer focused business support functions.

Impairment losses increased by £5,289 million to £15,683 million in 2009 compared to £10,394 million in 2008. Impairment losses on loans and advances as a percentage of average loans and advances to customers were 5.92 per cent in 2009 compared to 3.32 per cent in 2008. These increased impairment losses reflected the continued weak economic climate, higher levels of corporate failures, and application of the Lloyds Banking Group provisioning policy, notably in HBOS Corporate Real Estate and HBOS Corporate (UK and US) transactions.

Wholesale’s share of results of joint ventures and associates improved by £224 million, or 24 per cent, to a loss of £720 million in 2009 compared to a loss of £944 million in 2008; there were lower levels of write-offs in 2009 as the majority of the book was fully written-off.

37


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

WEALTH AND INTERNATIONAL

Wealth and International was formed in 2009 to give increased focus and momentum to the private banking and asset management businesses and to manage the Group’s international businesses.

The Wealth business comprises private banking, wealth management and asset management. Wealth’s global private banking and wealth management 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. The private banking and wealth management business operates under the Lloyds TSB and Bank of Scotland brands. The 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 and a 55 per cent stake in Invista Real Estate.

The International business comprises the Group’s other 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, Ireland and Continental Europe and retail businesses in Germany and the Netherlands.

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

 

               

Net interest income

 

 

1,176

 

 

1,217

 

 

1,314

 

Other income

 

 

1,160

 

 

1,128

 

 

1,191

 

                     

Total Income

 

 

2,336

 

 

2,345

 

 

2,505

 

Operating expenses

 

 

(1,536

)

 

(1,544

)

 

(1,476

)

                     

Trading surplus

 

 

800

 

 

801

 

 

1,029

 

Impairment

 

 

(5,988

)

 

(4,078

)

 

(731

)

Share of results of joint ventures and associates

 

 

(8

)

 

(21

)

 

(21

)

                     

(Loss) profit before tax and fair value unwind

 

 

(5,196

)

 

(3,298

)

 

277

 

Fair value unwind

 

 

372

 

 

942

 

 

 

                     

(Loss) profit before tax

 

 

(4,824

)

 

(2,356

)

 

277

 

                     

Wealth

 

 

269

 

 

198

 

 

369

 

International

 

 

(5,465

)

 

(3,496

)

 

(92

)

                     

(Loss) profit before tax and fair value unwind

 

 

(5,196

)

 

(3,298

)

 

277

 

                     

2010 COMPARED WITH 2009

The results of Wealth and International deteriorated by £2,468 million, or 105 per cent, to a loss before tax of £4,824 million in 2010 compared to a loss of £2,356 million in 2009.

Loss before tax and fair value unwind deteriorated by £1,898 million, or 58 per cent, to £5,196 million compared to a loss of £3,298 million in 2009, due, in particular, to a higher impairment charge, predominantly in Ireland. An improvement in profits in the Wealth business was more than offset by the increased losses in the International business.

Net interest income decreased by £41 million, or 3 per cent, to £1,176 million in 2010 compared to £1,217 million in 2009, as an 8 basis points decline in the banking net interest margin more than offset the favourable impact of foreign currency movements, particularly the Australian dollar, and the income on the £7 billion European loan portfolio transferred in from the Wholesale division in the second half of 2009.

Other income was £32 million, or 3 per cent, higher at £1,160 million in 2010 compared to £1,128 million in 2009. This increase reflects favourable foreign exchange movements and restrained growth in the Wealth business, despite lower asset management fee income following the sale of the external fund management business of Insight Investment in November 2009.

Operating expenses decreased by £8 million, or 1 per cent, to £1,536 million in 2010 compared to £1,544 million in 2009, with cost savings achieved from integration, particularly in the asset management businesses in Wealth, partly offset by investment in International’s German deposit taking operation, increased risk management resources to manage impaired asset portfolios in Ireland and Australia and costs associated with the closure of the Irish business, and the effect of stronger foreign currency rates.

The impairment charge was £1,910 million, or 47 per cent, higher at £5,988 million in 2010, compared to £4,078 million in 2009, reflecting the material deterioration in the economic environment in Ireland in the last quarter of 2010 that resulted in EU-IMF financial support in late November 2010 and the tightening of liquidity in the second half of 2010 in regional Australian property markets to which the Group is exposed.

The impairment charge is summarised by key geography in the following table.

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

           

Ireland

 

 

4,264

 

 

2,949

 

Australia

 

 

1,362

 

 

849

 

Wholesale Europe

 

 

210

 

 

129

 

Latin America/Middle East

 

 

97

 

 

69

 

Netherlands

 

 

9

 

 

11

 

               

International

 

 

5,942

 

 

4,007

 

Wealth

 

 

46

 

 

71

 

               

Wealth and International

 

 

5,988

 

 

4,078

 

               

38


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Loans and advances to customers decreased by £8,191 million, or 13 per cent, to £55,357 million at 31 December 2010 compared to £63,548 million at the end of 2009, reflecting net repayments of some £4.1 billion, and additional impairment provisions in the International businesses, partly offset by foreign exchange movements of some £1.1 billion.

Customer deposits increased by £3,747 million, or 13 per cent, to £32,784 million at 31 December 2010 compared to £29,037 million at the end of 2009, due to strong inflows in UK Private Banking and Bank of Scotland Germany, partly offset by outflows in Ireland following the closure of the Irish retail branch network.

2009 COMPARED WITH 2008

Profit before tax from Wealth and International was £2,633 million lower at a loss of £2,356 million in 2009 compared to a profit of £277 million in 2008; the loss in 2009 included a credit of £942 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Profit before tax and fair value unwind decreased by £3,575 million to a loss of £3,298 million in 2009 compared to a profit of £277 million in 2008. This deterioration was driven by higher impairment losses.

Total income decreased by £160 million, or 6 per cent, to £2,345 million in 2009 compared to £2,505 million in 2008. This decrease reflected lower net interest margins, and the impact of lower global stock markets particularly in the first half of the year, partly offset by favourable foreign exchange movements.

Lending to customers in Wealth and International, net of impairment provisions and fair value adjustments arising from the acquisition of HBOS plc by the Group, was £1,005 million, or 2 per cent, lower at £63,548 million in 2009 compared to £64,553 million in 2008 as net repayments and increased impairment provisions in the International businesses were offset by the transfer of a European loan portfolio of some £7,000 million from Wholesale division.

Customer deposits were £5,058 million, or 15 per cent, lower at £29,037 million in 2009 compared to £34,095 million in 2008 primarily due to outflows in Ireland reflecting aggressive pricing from competitors who benefited from the Irish Government deposit guarantee.

Net interest income was £97 million, or 7 per cent, lower at £1,217 million in 2009 compared to £1,314 million in 2008. The net interest margin, adjusted to exclude earnings on policyholder funds and products where either the funding costs or the related revenues are recognised in other income, declined by 35 basis points to 1.71 per cent in 2009 compared to 2.06 per cent in 2008. This margin reduction reflected higher wholesale funding costs and lower deposit margins in the low base rate environment, partly offset by the impact of strong portfolio management in International and higher asset pricing leading to higher margins.

Other income was £63 million, or 5 per cent, lower at £1,128 million in 2009 compared to £1,191 million in 2008. This decrease was driven by falls in global stock markets, particularly in the first half of 2009, impacting sales volumes and fee income across all Wealth businesses; partly offset by favourable exchange movements in the International operations.

Operating expenses increased by £68 million, or 5 per cent, to £1,544 million in 2009 compared to £1,476 million in 2008. Adverse foreign exchange movements increased operating expenses in both the Wealth and the International businesses and additional costs resulted from investments to increase distribution capacity in Private Banking to support future growth plans, additional costs associated with the transitional services following the disposal by HBOS of BankWest and St. Andrews Australia in December 2008, the development of International’s deposit taking operation in Germany and increased risk management resources to manage impaired asset portfolios in Ireland and Australia. These increases in costs were partly offset by cost savings from integration, particularly in the Asset Management business.

Impairment losses increased by £3,347 million to £4,078 million in 2009 compared to £731 million in 2008. This reflected the significant deterioration in the credit risk environment in Ireland and Australia as well as the impact of the economic environment on the UK Private Banking and Expatriate lending portfolios. Of the total impairment losses in 2009, £2,949 million arose in Ireland which experienced a significant deterioration in asset values driven by the collapse in liquidity and severe decline in the property sector where commercial real estate values fell by over 50 per cent and house prices by over 25 per cent from their peak. A further £849 million of the total impairment losses in 2009 arose in Australia, driven by concentrations in property and in other sectors such as media, printing and transport which were hardest hit by the downturn. Business Support Units were established in both Ireland and Australia, supplemented by a divisional sanctioning process, to provide independent divisional oversight and control of the portfolios.

39


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

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

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 using the Lloyds TSB, Halifax, Bank of Scotland and Scottish Widows brands.

In common with other life assurance companies in the UK, the life and pensions business of each of the life assurance companies in the Lloyds Banking Group is written in a long-term business fund. The main long-term business funds are divided into one or both of With Profit and Non-Profit sub funds.

With-profits life and pensions products are written from the respective With Profit sub-funds in the Group. The benefits accruing from these policies are designed to provide a smoothed return to policyholders who hold their policies to maturity through a mix of annual and final (or terminal) bonuses added to guaranteed basic benefits. The guarantees generally only apply on death or maturity. The actual bonuses declared will reflect the experience of the With Profit sub-fund.

Other life and pensions products are generally written from Non-Profit sub-funds.

Examples include unit-linked policies, annuities, term assurances and health insurance (under which a predetermined amount of benefit is payable in the event of an insured event such as being unable to work through sickness). The benefits provided by linked policies are wholly or partly determined by reference to a specific portfolio of assets known as unit-linked funds.

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 significant brokerage operations for personal and commercial insurances. It operates primarily under the Lloyds TSB, Halifax and Bank of Scotland brands.

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

 

               

Net interest income

 

 

(263

)

 

(287

)

 

(345

)

Other income

 

 

2,814

 

 

2,944

 

 

3,493

 

                     

Total income

 

 

2,551

 

 

2,657

 

 

3,148

 

Insurance claims

 

 

(542

)

 

(637

)

 

(481

)

                     

Total income, net of insurance claims

 

 

2,009

 

 

2,020

 

 

2,667

 

Operating expenses

 

 

(854

)

 

(974

)

 

(1,129

)

Share of results of joint ventures and associates

 

 

(10

)

 

(22

)

 

2

 

                     

Profit before tax and fair value unwind

 

 

1,145

 

 

1,024

 

 

1,540

 

Fair value unwind

 

 

(43

)

 

(49

)

 

 

                     

Profit before tax

 

 

1,102

 

 

975

 

 

1,540

 

                     

 

 

 

 

 

 

 

 

 

 

 

Profit before tax and fair value unwind – before impact of PPI new business closure

 

 

1,215

 

 

1,024

 

 

1,540

 

Other income – impact of PPI new business closure

 

 

(70

)

 

 

 

 

                     

Profit before tax and fair value unwind

 

 

1,145

 

 

1,024

 

 

1,540

 

                     

 

 

 

 

 

 

 

 

 

 

 

Profit before tax and fair value unwind by business unit

 

 

 

 

 

 

 

 

 

 

Life, Pensions and Investments:

 

 

 

 

 

 

 

 

 

 

– Before impact of PPI new business closure

 

 

753

 

 

617

 

 

826

 

– PPI new business closure

 

 

(70

)

 

 

 

 

                     

UK business

 

 

683

 

 

617

 

 

826

 

European business

 

 

110

 

 

75

 

 

149

 

General Insurance

 

 

372

 

 

367

 

 

537

 

Other

 

 

(20

)

 

(35

)

 

28

 

                     

Profit before tax and fair value unwind

 

 

1,145

 

 

1,024

 

 

1,540

 

                     

40


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

2010 COMPARED WITH 2009

Profit before tax from Insurance was £127 million higher at £1,102 million compared to £975 million in 2009. Profit before tax and fair value unwind was £121 million higher at £1,145 million compared to £1,024 million in 2009.

Net interest income was £24 million, or 8 per cent, better at a deficit of £263 million in 2010 compared to a deficit of £287 million in 2009.

Other income decreased by £130 million, or 4 per cent, to £2,814 million in 2010 compared to £2,944 million in 2009 largely resulting from the decrease in PPI income as a result of the Group’s decision to cease writing payment protection business, partially off-set by improved new business income and the higher than expected return from improved investment markets.

Total income, net of insurance claims decreased by £11 million, or 1 per cent, to £2,009 million in 2010 compared to £2,020 million in 2009, primarily reflecting lower PPI income and claims arising from the freeze events in 2010, which are offset by reduced payment protection insurance claims and improved investment markets.

Insurance claims were £95 million, 15 per cent, lower at £542 million in 2010 compared to £637 million in 2009 reflecting improved unemployment claims experience. The home book has been particularly affected by the freeze events experienced in January and December 2010. This has been partly offset by the benefits of ongoing claims processing improvements and integration.

Operating expenses decreased by £120 million, or 12 per cent, to £854 million in 2010 compared to £974 million in 2009 due to a continued focus on cost management and delivery of integration synergies.

2009 COMPARED WITH 2008

Profit before tax from Insurance was £565 million lower at £975 million in 2009 compared to £1,540 million in 2008. The profit in 2009 included a charge of £49 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Profit before tax and fair value unwind was £516 million lower at £1,024 million in 2009 compared to £1,540 million in 2008. This deterioration in profits followed a reduction in income and an increase in claims, due to factors including demanding market conditions, partly offset by a decrease in operating expenses.

Total income decreased by £491 million, or 16 per cent, to £2,657 million in 2009 compared to £3,148 million in 2008 due to the non-recurrence of £334 million of HBOS legacy one-off benefits, principally in Life, Pensions and Investments, enjoyed in 2008 and the impact of challenging economic conditions driving lower sales and returns, partially offset by significantly lower charges for policyholder lapses.

Net interest income was £58 million, or 17 per cent, better at a deficit of £287 million in 2009 compared to a deficit of £345 million in 2008.

Other income was £549 million, or 16 per cent, lower at £2,944 million in 2009 compared to £3,493 million in 2008. Within the life and pensions activities, new business profit was significantly impacted by the general contraction in the life, savings and investments market and the reduction also reflected the integration of the intermediary sales forces and the withdrawal of a number of legacy HBOS products with poor returns. Existing business profit within the UK life and pensions activities reduced by 10 per cent, this included a reduction in expected return, reflecting lower asset values resulting from adverse investment markets in 2008, a lower assumed rate of return and the non-recurrence of one-off benefits enjoyed by HBOS in 2008. These impacts were partly offset by a significant reduction in charges for policyholder lapses in 2009. Within the general insurance activities, income was lower principally due to payment protection insurance income decreasing as a result of the market-wide move to monthly premiums on payment protection, partly offset by lower distribution commission payable to the Retail division.

Insurance claims were £156 million, or 32 per cent, higher at £637 million in 2009 compared to £481 million in 2008, primarily due to higher payment protection insurance claims related to unemployment. Whilst property claims were impacted by flooding and freeze claims in the final quarter of 2009, benefits from ongoing investments in claims processes continued to be realised.

Operating expenses decreased by £155 million, or 14 per cent, to £974 million in 2009 compared to £1,129 million in 2008; this was mainly due to continued focus on cost management and delivering integration synergies.

Insurance’s share of results of joint ventures and associates deteriorated to a loss of £22 million in 2009 compared to a profit of £2 million in 2008.

41


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

 

 

 

 

 

 

 

 

 

LIFE, PENSIONS AND INVESTMENTS
UK BUSINESS

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

 

               

Net interest income

 

 

(227

)

 

(273

)

 

(282

)

Other income

 

 

1,408

 

 

1,474

 

 

1,758

 

                     

Total income

 

 

1,181

 

 

1,201

 

 

1,476

 

Operating expenses

 

 

(498

)

 

(584

)

 

(650

)

                     

Profit before tax and fair value unwind

 

 

683

 

 

617

 

 

826

 

                     

 

 

 

 

 

 

 

 

 

 

 

Profit before tax and fair value unwind – before impact of PPI new business closure

 

 

753

 

 

617

 

 

826

 

Other income – impact of PPI new business closure

 

 

(70

)

 

 

 

 

                     

Profit before tax and fair value unwind

 

 

683

 

 

617

 

 

826

 

                     

 

 

 

 

 

 

 

 

 

 

 

Profit before tax and fair value unwind analysis

 

 

 

 

 

 

 

 

 

 

New business profit – insurance business1

 

 

332

 

 

328

 

 

465

 

– investment business1

 

 

(65

)

 

(196

)

 

(247

)

                     

Total new business profit

 

 

267

 

 

132

 

 

218

 

Existing business profit2

 

 

464

 

 

431

 

 

637

 

Experience and assumption changes

 

 

22

 

 

54

 

 

(29

)

                     

Profit before tax and fair value unwind – before impact of PPI new business closure

 

 

753

 

 

617

 

 

826

 

Other income – impact of PPI new business closure

 

 

(70

)

 

 

 

 

                     

Profit before tax and fair value unwind

 

 

683

 

 

617

 

 

826

 

                     

 

 

1

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 initial income and expenses. Consequently the recognition of profit for investment contracts is deferred relative to insurance contracts.

 

 

2

The disclosure of existing business profit has been changed to better reflect the performance of the business. Existing business profit includes the expected return on shareholder’s net assets and experience and assumption changes are disclosed separately.

2010 COMPARED WITH 2009

Profit before tax and fair value unwind increased by £66 million, or 11 per cent, to £683 million in 2010 compared to £617 million in 2009. New business profit increased by £135 million, or 102 per cent, to £267 million. The increase primarily reflects a reduction in initial commission on OEICs sold through the branch network and cost reductions through integration across our sales channels in addition to progress made on product participation choices.

Existing business profit increased by £33 million, or 8 per cent, to £464 million in 2010 compared to £431 million in 2009. This predominantly reflects higher asset values and a higher assumed rate of return following improved market conditions in the second half of 2009.

Profits arising from experience and assumption changes decreased by £32 million to £22 million mainly reflecting the non-recurrence of benefits recognised in 2009, including a liability management gain of £30 million. During 2010 a review was undertaken into the charging between the funds of Clerical Medical prior to the acquisition of HBOS, giving rise to a charge of £132 million. Additionally assumptions regarding future maintenance expenses within the Clerical Medical business were aligned to reflect the heritage Lloyds TSB approach, giving rise to a charge of £119 million. These charges relate to pre-acquisition matters and were largely offset by the release of fair value provisions.

2009 COMPARED WITH 2008

Profit before tax and fair value unwind decreased by £209 million, or 25 per cent, to £617 million in 2009 compared to £826 million in 2008. New business profit was significantly impacted by the general contraction in the life, savings and investments market but the reduction also reflected the integration of the intermediary sales forces and the withdrawal of a number of legacy HBOS products with poor returns.

Existing business profit reduced by £51 million, or 10 per cent, to £483 million in 2009 compared to £534 million in 2008. This reflected a reduction in expected return, reflecting lower asset values resulting from adverse investment markets in 2008, a lower assumed rate of return and the non-recurrence of one-off benefits in HBOS in 2008, principally relating to a move to a more market consistent basis of embedded value and enhancements to the bond proposition. Those impacts were partly offset by a significant reduction in charges for policyholder lapses in 2009.

Expected returns on shareholders’ net assets were impacted both by a lower assumed rate of return and by reduced asset values as a result of severe market falls in 2008.

42


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

EUROPEAN BUSINESS

2010 COMPARED WITH 2009

Profit before tax and fair value unwind increased by £35 million, or 47 per cent, to £110 million in 2010 compared to £75 million in 2009 driven largely by experience and assumption changes. New business sales reflect difficult economic and market conditions in Germany, our main European market.

2009 COMPARED WITH 2008

Profit before tax and fair value unwind decreased by £74 million, or 50 per cent to £75 million in 2009 compared to £149 million in 2008. New business profits reduced by £32 million driven by lower sales, reflecting economic and market conditions. Existing business profits decreased, primarily due to lower expected returns. In 2008, as a result of moving to a more market consistent basis of embedded value in HBOS, a one-off benefit of £123 million arose. The impact of this was largely offset by a significant reduction in charges for policyholder lapses in 2009.

NEW BUSINESS

The table below provides an analysis of the present value of new business premiums (PVNBP) for business written by the Insurance division, split between the UK and European Life, Pensions and Investments businesses. PVNBP is the measure of new business premiums for the life and pensions business and OEIC sales that management monitors because it provides an indication of the performance of the business – this is calculated as the value of single premiums plus the discounted present value of future expected regular premiums.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

UK
£m

 

2010
Europe
£m

 

Total
£m

 

UK
£m

 

2009
Europe
£m

 

Total
£m

 

UK
£m

 

2008
Europe
£m

 

Total
£m

 

                                       

Protection

 

 

574

 

 

56

 

 

630

 

 

519

 

 

49

 

 

568

 

 

492

 

 

51

 

 

543

 

Payment protection

 

 

70

 

 

 

 

70

 

 

153

 

 

 

 

153

 

 

679

 

 

 

 

679

 

Savings and investments

 

 

1,617

 

 

315

 

 

1,932

 

 

2,689

 

 

312

 

 

3,001

 

 

4,149

 

 

372

 

 

4,521

 

Individual pensions

 

 

1,606

 

 

141

 

 

1,747

 

 

2,275

 

 

185

 

 

2,460

 

 

4,216

 

 

306

 

 

4,522

 

Corporate and other pensions

 

 

2,750

 

 

 

 

2,750

 

 

2,600

 

 

 

 

2,600

 

 

2,940

 

 

 

 

2,940

 

Retirement income

 

 

889

 

 

 

 

889

 

 

887

 

 

 

 

887

 

 

1,451

 

 

 

 

1,451

 

Managed fund business

 

 

177

 

 

 

 

177

 

 

146

 

 

 

 

146

 

 

216

 

 

 

 

216

 

                                                         

Life and pensions

 

 

7,683

 

 

512

 

 

8,195

 

 

9,269

 

 

546

 

 

9,815

 

 

14,143

 

 

729

 

 

14,872

 

OEICs

 

 

2,633

 

 

 

 

2,633

 

 

3,704

 

 

 

 

3,704

 

 

3,303

 

 

 

 

3,303

 

                                                         

Total

 

 

10,316

 

 

512

 

 

10,828

 

 

12,973

 

 

546

 

 

13,519

 

 

17,446

 

 

729

 

 

18,175

 

                                                         

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Analysis by channel

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bancassurance

 

 

4,432

 

 

 

 

4,432

 

 

6,997

 

 

 

 

6,997

 

 

8,356

 

 

 

 

8,356

 

Intermediary

 

 

5,365

 

 

512

 

 

5,877

 

 

5,639

 

 

546

 

 

6,185

 

 

8,704

 

 

729

 

 

9,433

 

Direct

 

 

519

 

 

 

 

519

 

 

337

 

 

 

 

337

 

 

386

 

 

 

 

386

 

                                                         

Total

 

 

10,316

 

 

512

 

 

10,828

 

 

12,973

 

 

546

 

 

13,519

 

 

17,446

 

 

729

 

 

18,175

 

                                                         

2010 COMPARED WITH 2009

The present value of new business premiums reduced by £2,691 million, or 20 per cent, to £10,828 million in 2010 compared to £13,519 million in 2009. This largely reflects the withdrawal in 2009 of certain HBOS legacy products with lower returns.

In the Bancassurance channel the reduction reflects the removal from sale of an HBOS guaranteed investment plan sold in 2009 and, since the integrated Bancassurance proposition was launched in June 2010, a change in mix away from savings products towards more profitable protection business in line with the legacy Lloyds TSB strategy. Sales of OEICs have been further adversely affected by a reduction in the volume of capital protected products given improved investment markets. However, sales of protection products have increased by 11 per cent and the aggregate new business margin has increased.

Within the Intermediary channel the reduction in volumes primarily reflects the withdrawal of low returning HBOS individual pension products, partly offset by an increase in sales of the on-going Retirement Account pension product and strong sales of corporate pensions.

2009 COMPARED WITH 2008

The present value of new business premiums reduced by £4,656 million, or 26 per cent, to £13,519 million in 2009 compared to £18,175 million in 2008 reflecting both a general contraction in the UK and European markets as well as the re-positioning of the UK intermediary product range. Sales through the intermediary channel were significantly impacted as the UK intermediary sales forces were integrated and a number of legacy HBOS products with poor returns were withdrawn. As a result, sales in the intermediary channel reduced by 34 per cent. Sales through the Bancassurance channel, excluding payment protection, continued to perform relatively robustly with a reduction of 11 per cent. This included Scottish Widows sales through the Bancassurance network which showed growth of 18 per cent. Sales of OEIC products were strong with an increase of 12 per cent in 2009.

43


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

GENERAL INSURANCE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

 

 

2008
£m

 

Home insurance

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting income (net of reinsurance)

 

 

922

 

 

 

897

 

 

 

885

 

Commission receivable

 

 

75

 

 

 

71

 

 

 

50

 

Commission payable

 

 

(135

)

 

 

(94

)

 

 

(70

)

 

 

 

862

 

 

 

874

 

 

 

865

 

Payment protection insurance

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting income (net of reinsurance)

 

 

544

 

 

 

731

 

 

 

860

 

Commission receivable

 

 

27

 

 

 

13

 

 

 

428

 

Commission payable

 

 

(318

)

 

 

(395

)

 

 

(923

)

 

 

 

253

 

 

 

349

 

 

 

365

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting income (net of reinsurance)

 

 

6

 

 

 

8

 

 

 

20

 

Commission receivable

 

 

50

 

 

 

69

 

 

 

71

 

Commission payable

 

 

(15

)

 

 

(28

)

 

 

(36

)

Other (including investment income)

 

 

(34

)

 

 

(6

)

 

 

93

 

 

 

 

7

 

 

 

43

 

 

 

148

 

Net operating income

 

 

1,122

 

 

 

1,266

 

 

 

1,378

 

Claims paid on insurance contracts (net of reinsurance)

 

 

(542

)

 

 

(637

)

 

 

(481

)

Operating income, net of claims

 

 

580

 

 

 

629

 

 

 

897

 

Operating expenses

 

 

(208

)

 

 

(262

)

 

 

(360

)

Profit before tax and fair value unwind

 

 

372

 

 

 

367

 

 

 

537

 

2010 COMPARED WITH 2009

Profit before tax and fair value unwind from General Insurance increased by £5 million, or 1 per cent, to £372 million in 2010 compared to £367 million in 2009, due primarily to improved unemployment claims experience plus integration synergies after taking account of lower income resulting from ceasing to write new PPI business and freeze related claims.

Underwriting income for home insurance showed modest growth of £25 million, or 3 per cent, to £922 million in 2010 compared to £897 million in 2009. Home commission payable was adversely affected by the alignment of commission arrangements between the legacy businesses during the year.

PPI underwriting income decreased by £187 million, or 26 per cent, to £544 million in 2010 compared to £731 million in 2009 reflecting the continued impact on new business volumes from the market wide move to monthly premiums in 2009 and the Group’s withdrawal from the payment protection market on 23 July 2010. Changes in commission payable reflect lower volumes of PPI written during the year.

Claims were £95 million, or 15 per cent, lower at £542 million in 2010 compared to £637 million in 2009 reflecting lower unemployment claims experience. The home book has been particularly affected by the freeze events experienced in January and December 2010. This has been partly offset by the benefits of ongoing claims processing improvements and integration.

Operating expenses decreased by £54 million, or 21 per cent, to £208 million in 2010 compared to £262 million in 2009 primarily as a result of the alignment of commission arrangements on home insurance, the delivery of integration savings and a continued focus on cost management.

2009 COMPARED WITH 2008

Profit before tax and fair value unwind from General Insurance decreased by £170 million, or 32 per cent, to £367 million in 2009 compared to £537 million in 2008.

Claims were £156 million, or 32 per cent, higher at £637 million compared to £481 million in 2008, primarily due to higher payment protection insurance claims related to unemployment. Whilst property claims were impacted by flooding and freeze claims in the final quarter of 2009, benefits from ongoing investments in claims processes continued to be realised.

Against the background of a particularly competitive market in which the general insurance business has a leading position, home insurance income generated modest growth of £9 million, or 1 per cent to £874 million in 2009 compared to £865 million in 2008. Payment protection insurance income decreased by £16 million, or 4 per cent, to £349 million in 2009 compared to £365 million in 2008 as a result of the market-wide move to monthly premiums on payment protection, partly offset by lower distribution commission payable to the Retail division.

Other income reduced, primarily reflecting lower interest rates and the allocation of certain charges.

Operating expenses decreased by £98 million, or 27 per cent, to £262 million in 2009 compared to £360 million in 2008. Adjusting for the reclassification of claims handling expenses into claims paid and non-recurring marketing spend in 2008, costs improved by 10 per cent year-on-year, reflecting continued focus on cost management and cost savings achieved through the integration.

44


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

GROUP OPERATIONS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

 

2009
£m

1

 

2008
£m

1

Net interest income

 

 

(72

)

 

 

(69

)

 

 

(59

)

Other income

 

 

49

 

 

 

20

 

 

 

35

 

Total income

 

 

(23

)

 

 

(49

)

 

 

(24

)

Direct costs:

 

 

 

 

 

 

 

 

 

 

 

 

Information technology

 

 

(1,209

)

 

 

(1,254

)

 

 

(1,336

)

Operations

 

 

(628

)

 

 

(672

)

 

 

(660

)

Property

 

 

(968

)

 

 

(983

)

 

 

(1,021

)

Procurement

 

 

(56

)

 

 

(57

)

 

 

(50

)

Support functions

 

 

(112

)

 

 

(116

)

 

 

(104

)

 

 

 

(2,973

)

 

 

(3,082

)

 

 

(3,171

)

Result before recharges to divisions

 

 

(2,996

)

 

 

(3,131

)

 

 

(3,195

)

Total net recharges to divisions

 

 

2,930

 

 

 

2,957

 

 

 

3,115

 

Share of results of joint ventures and associates

 

 

3

 

 

 

3

 

 

 

4

 

Loss before tax and fair value unwind

 

 

(63

)

 

 

(171

)

 

 

(76

)

Fair value unwind

 

 

 

 

 

22

 

 

 

 

Loss before tax

 

 

(63

)

 

 

(149

)

 

 

(76

)


 

 

1

2009 and 2008 comparative figures have been amended to reflect the impact of centralising operations across the Group as part of the integration programme. To ensure a fair comparison of 2010 performance, 2009 and 2008 direct costs have been increased with an equivalent offsetting increase in recharges to divisions.

2010 COMPARED WITH 2009

Loss before tax from Group Operations improved by £86 million to £63 million in 2010 compared to £149 million in 2009. The loss in 2009 included a credit of £22 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Loss before tax and fair value unwind improved by £108m to £63 million in 2010 compared to £171 million in 2009.

Total income, excluding recharges to divisions, improved by £26 million, to a deficit of £23 million in 2010 compared to a deficit of £49 million in 2009. Net interest income was £3 million, or 4 per cent, lower at a net expense of £72 million in 2010 compared to a net expense of £69 million in 2009. Other income was £29 million, or 145 per cent, higher at £49 million in 2010 compared to £20 million in 2009.

Direct costs were £109 million, or 4 per cent, lower at £2,973 million in 2010 compared to £3,082 million in 2009; this reflected the continued focus on cost management and the delivery of integration savings.

Information Technology costs decreased by 4 per cent primarily due to the further impact of integration benefits; Operations costs decreased by 7 per cent due to the continuing rationalisation of the major Operations functions and lower charges in respect of joint ventures; Group Property costs decreased by 2 per cent due to the continuing consolidation of the heritage property portfolios helping to deliver further integration benefits.

Recharges to divisions were £27 million, or 1 per cent, lower at £2,930 million in 2010 compared to £2,957 million in 2009.

2009 COMPARED WITH 2008

Loss before tax from Group Operations deteriorated by £73 million to £149 million in 2009 compared to £76 million in 2008. The loss in 2009 included a credit of £22 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Loss before tax and fair value unwind deteriorated by £95 million to £171 million in 2009 compared to £76 million in 2008.

Total income, excluding recharges to divisions, decreased by £25 million, to a deficit of £49 million in 2009 compared to a deficit of £24 million in 2008. Net interest income was £10 million, or 17 per cent, lower at a net expense of £69 million in 2009 compared to a net expense of £59 million in 2008. Other income was £15 million, or 43 per cent, lower at £20 million in 2009 compared to £35 million in 2008.

Direct costs were £89 million, or 3 per cent, lower at £3,082 million in 2009 compared to £3,171 million in 2008; this reflected the impact of integration savings and a continued focus on cost management.

Information Technology costs decreased by 6 per cent due to the early realisation of integration savings following the consolidation of IT operations across the Group in addition to lower investment spend as project activity was rationalised and replaced by integration activity; Group Property costs were also lower by 4 per cent which was primarily due to integration savings and the consolidation of premises (achieved at a faster rate than originally anticipated).

Recharges to divisions were £158 million, or 5 per cent, lower at £2,957 million in 2009 compared to £3,115 million in 2008.

45


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

CENTRAL ITEMS

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
£m

 

2009
£m

 

2008
£m

 

               

Net interest expense

 

 

(823

)

 

(815

)

 

(213

)

Other income

 

 

398

 

 

1,780

 

 

(223

)

                     

Total income

 

 

(425

)

 

965

 

 

(436

)

Operating expenses

 

 

(107

)

 

(294

)

 

(21

)

                     

Trading (deficit) surplus

 

 

(532

)

 

671

 

 

(457

)

Impairment

 

 

 

 

 

 

(60

)

Share of results of joint ventures and associates

 

 

2

 

 

(1

)

 

 

                     

(Loss) profit before tax and fair value unwind

 

 

(530

)

 

670

 

 

(517

)

Fair value unwind

 

 

(1,446

)

 

(2,119

)

 

 

                     

Loss before tax

 

 

(1,976

)

 

(1,449

)

 

(517

)

                     

Central items are comprised of three main elements:

 

 

 

1

The residual net interest position arising from the Group’s processes to allocate the following elements of net interest income to the divisions:

 

 

 

interest on the Group’s equity position;

 

 

 

 

net interest margin cost resulting from central capital activities, primarily arising on the management of senior and subordinated debt and preference shares; and

 

 

 

 

cost to the Group of funding wholesale and liquidity balances.

 

 

 

2

The charge for payments to the charitable foundations: the four independent Lloyds TSB Foundations and the independent Bank of Scotland Foundation support registered charities throughout the UK that enable people, particularly the disabled and disadvantaged, to play a fuller role in society.

 

 

3

Central costs and other unallocated items: these relate to the on-going costs of central group activities including those of group corporate treasury (including the central hedge function), group internal audit, group risk, group compliance, group finance and group IT and operations.

2010 COMPARED WITH 2009

Total income decreased by £1,390 million to £(425) million primarily due to a £1,045 million reduction in liability management gains, together with a £193 million increase in the mark-to-market losses arising from the equity conversion feature of the Group’s Enhanced Capital Notes and a £131 million reduction in the gain on other derivatives which cannot be mitigated through hedge accounting.

Liability management gains arose on transactions undertaken in both 2009 and 2010 as part of the Group’s management of capital which exchanged certain debt securities for ordinary shares or other debt instruments. These transactions resulted in a gain of £423 million in 2010 compared to a gain of £1,498 million in 2009 (of which £1,468 million is reflected in Central items). The fair value of the equity conversion feature of the Group’s Enhanced Capital Notes decreased by £620 million in 2010 compared to a decrease of £427 million in 2009.

Net interest expense was broadly unchanged at £823 million, but included higher capital and wholesale liquidity funding costs of £601 million (2009: £260 million) not recovered from the divisions, with the increase primarily due to higher wholesale market funding spreads and the Group’s decision to accelerate its wholesale funding in 2010. This has been offset by improved net interest from interest rate risk management activities compared to 2009.

Operating expenses reduced by £187 million to £107 million due to lower professional fees and other costs associated with capital transactions and projects.

Fair value unwind improved by £673 million to (£1,446) million primarily due to the effect of the liability management transactions leading to a reduced amortisation rate. Gains on liability management transactions included accelerated fair value amortisations.

2009 COMPARED WITH 2008

Loss before tax from Central items deteriorated by £932 million to £1,449 million in 2009 compared to £517 million in 2008. The loss in 2009 included a charge of £2,119 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Profit before tax and fair value unwind was £670 million in 2009 compared to a loss of £517 million in 2008.

Total income increased by £1,401 million, to £965 million in 2009 compared to a deficit of £436 million in 2008. Net interest income was £602 million lower at a net expense of £815 million in 2009 compared to a net expense of £213 million in 2008. Other income was £2,003 million higher at £1,780 million in 2009 compared to a deficit of £223 million in 2008; this was primarily as a result of gains arising when the Group exchanged certain existing subordinated debt securities for new securities. These exchanges resulted in a gain on extinguishment of the existing liability of £1,498 million (of which £1,468 million was reflected in Central items), being the difference between the carrying amount of the securities extinguished and the fair value of the new securities together with related fees and costs.

Operating expenses were £273 million higher at £294 million in 2009 compared to £21 million in 2008; this was due in part to higher professional fees and other costs associated with a number of group-wide projects, including the proposed participation in the Government Asset Protection Scheme, and an increase in the amount of pension costs held centrally.

46


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

COMBINED BUSINESSES BASIS SUMMARY

Readers should be aware that the combined businesses basis has been presented for comparative purposes only and is neither intended to provide proforma information nor to show the results of the Group as if the acquisition of HBOS had taken place at an earlier date. Readers should also note that HBOS was not managed by the current management of Lloyds Banking Group in 2008.

As noted on page 2, the combined businesses basis segmental results are presented in accordance with IFRS. However, the aggregated total of the combined businesses segmental results constitutes a non-GAAP measure as defined by the SEC.

The acquisition of HBOS plc on 16 January 2009 had a significant impact on the results of the Group. Comparisons of the Group’s performance on a statutory basis are, therefore, dominated by the impact of the acquisition of HBOS; the 2009 statutory results include the results of HBOS from 16 January 2009, together with the effects of the unwind of fair value adjustments made to the HBOS balance sheet on acquisition, and the 2008 statutory results do not include any results of HBOS.

Management uses the aggregated total of the combined businesses segmental results, a non-GAAP measure, as a measure of performance, and believes that it provides important information for investors, because it is a comparable representation of the Group’s performance. Profit before tax is the comparable GAAP measure to profit before tax on a combined businesses basis; a reconciliation of the Group’s statutory income statement to its combined businesses income statement is shown below. Readers should be aware that the combined businesses basis excludes certain items, as indicated in the tables below, reflected in the Group’s statutory results and includes certain items, also indicated in the tables below, not reflected in the Group’s statutory results. The Group refers readers to the discussion of its statutory results on pages 13 to 26.

Set out below is a reconciliation from the Group’s statutory results to the combined businesses basis, together with a brief commentary.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Removal of:

 

 

 

 

2010

 

Lloyds Banking
Group
statutory
£m

 

 

Acquisition
related items,
including pension
curtailment gain1
£m

 

 

Volatility
arising in
insurance
businesses
£m

 

 

Insurance
gross up
£m

 

 

Payment
protection
insurance provision,
customer goodwill
payments
provision and loss
on disposal of
businesses2
£m

 

 

Fair value
unwind
£m

 

 

Combined
businesses
£m

 

Net interest income

 

 

12,546

 

 

 

 

 

 

26

 

 

 

949

 

 

 

 

 

 

301

 

 

 

13,822

 

Other income

 

 

30,921

 

 

 

 

 

 

(332

)

 

 

(19,162

)

 

 

 

 

 

(1,263

)

 

 

10,164

 

Total income

 

 

43,467

 

 

 

 

 

 

(306

)

 

 

(18,213

)

 

 

 

 

 

(962

)

 

 

23,986

 

Insurance claims

 

 

(18,511

)

 

 

 

 

 

 

 

 

17,967

 

 

 

 

 

 

2

 

 

 

(542

)

Total income, net of insurance claims

 

 

24,956

 

 

 

 

 

 

(306

)

 

 

(246

)

 

 

 

 

 

(960

)

 

 

23,444

 

Costs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

(16,268

)

 

 

1,320

 

 

 

 

 

 

246

 

 

 

3,700

 

 

 

74

 

 

 

(10,928

)

Impairment of tangible fixed assets

 

 

(202

)

 

 

52

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(150

)

 

 

 

(16,470

)

 

 

1,372

 

 

 

 

 

 

246

 

 

 

3,700

 

 

 

74

 

 

 

(11,078

)

Trading surplus (deficit)

 

 

8,486

 

 

 

1,372

 

 

 

(306

)

 

 

 

 

 

3,700

 

 

 

(886

)

 

 

12,366

 

Impairment

 

 

(10,952

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,229

)

 

 

(13,181

)

Share of results of joint ventures and associates

 

 

(88

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3

)

 

 

(91

)

Loss of disposal of businesses

 

 

(365

)

 

 

 

 

 

 

 

 

 

 

 

365

 

 

 

 

 

 

 

Fair value unwind

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,118

 

 

 

3,118

 

(Loss) profit before tax

 

 

(2,919

)

 

 

1,372

 

 

 

(306

)

 

 

 

 

 

4,065

 

 

 

 

 

 

2,212

 


 

 

1

Comprises the pension curtailment gain (£910 million), integration costs (£1,653 million) and the amortisation of purchased intangibles (£629 million).

 

 

2

Comprises the payment protection insurance provision (£3,200 million), the customer goodwill payments provision (£500 million) and the loss on disposal of businesses (£365 million).

47


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Removal of:

 

 

 

 

 

 

 

 

 

 

 

2009

 

Lloyds Banking
Group
statutory
£m

 

Pre-acquisition
results of HBOS
£m

 

GAPS fee and
acquisition
related items1
£m

 

Volatility in
insurance
businesses
£m

 

Insurance
gross up
£m

 

Fair value
unwind
£m

 

Combined
businesses
£m

 

                               

Net interest income

 

 

9,026

 

 

243

 

 

 

 

11

 

 

1,280

 

 

2,166

 

 

12,726

 

Other income

 

 

36,271

 

 

(1,123

)

 

 

 

(479

)

 

(21,659

)

 

(1,135

)

 

11,875

 

                                             

Total income

 

 

45,297

 

 

(880

)

 

 

 

(468

)

 

(20,379

)

 

1,031

 

 

24,601

 

Insurance claims

 

 

(22,019

)

 

1,349

 

 

 

 

 

 

20,318

 

 

(285

)

 

(637

)

                                             

Total income, net of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

insurance claims

 

 

23,278

 

 

469

 

 

 

 

(468

)

 

(61

)

 

746

 

 

23,964

 

Operating expenses

 

 

(15,984

)

 

(293

)

 

4,589

 

 

 

 

61

 

 

18

 

 

(11,609

)

                                             

Trading surplus (deficit)

 

 

7,294

 

 

176

 

 

4,589

 

 

(468

)

 

 

 

764

 

 

12,355

 

Impairment

 

 

(16,673

)

 

(456

)

 

 

 

 

 

 

 

(6,859

)

 

(23,988

)

Share of results of joint ventures and associates

 

 

(752

)

 

 

 

 

 

(10

)

 

 

 

(5

)

 

(767

)

Gain on acquisition

 

 

11,173

 

 

 

 

(11,173

)

 

 

 

 

 

 

 

 

Fair value unwind

 

 

 

 

 

 

 

 

 

 

 

 

 

6,100

 

 

6,100

 

                                             

Profit (loss) before tax

 

 

1,042

 

 

(280

)

 

(6,584

)

 

(478

)

 

 

 

 

 

(6,300

)

                                             

 

 

1

Comprises 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 gain on acquisition (£11,173 million).


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Removal of:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

Lloyds TSB
statutory1
£m

 

HBOS
statutory
£m

 

Reclass-
ifications
£m

 

BankWest
and
St. Andrews
£m

 

Volatility in
insurance
businesses
£m

 

Goodwill
impairment
£m

 

Insurance
gross up
£m

 

Combined
businesses
£m

 

                                   

Net interest income

 

 

7,718

 

 

8,171

 

 

1,906

 

 

(524

)

 

(9

)

 

 

 

(2,359

)

 

14,903

 

Other income

 

 

(709

)

 

(4,559

)

 

(234

)

 

(148

)

 

2,358

 

 

 

 

10,225

 

 

6,933

 

                                                   

Total income

 

 

7,009

 

 

3,612

 

 

1,672

 

 

(672

)

 

2,349

 

 

 

 

7,866

 

 

21,836

 

Insurance claims

 

 

2,859

 

 

6,192

 

 

(1,570

)

 

 

 

 

 

 

 

(7,962

)

 

(481

)

                                                   

Total income, net of insurance claims

 

 

9,868

 

 

9,804

 

 

102

 

 

(672

)

 

2,349

 

 

 

 

(96

)

 

21,355

 

Operating expenses

 

 

(6,100

)

 

(6,880

)

 

 

 

400

 

 

 

 

258

 

 

86

 

 

(12,236

)

                                                   

Trading surplus

 

 

3,768

 

 

2,924

 

 

102

 

 

(272

)

 

2,349

 

 

258

 

 

(10

)

 

9,119

 

Impairment

 

 

(3,012

)

 

(12,050

)

 

 

 

182

 

 

 

 

 

 

 

 

(14,880

)

Share of results of joint ventures and associates

 

 

4

 

 

(956

)

 

 

 

 

 

 

 

 

 

 

 

(952

)

Non-operating income

 

 

 

 

(743

)

 

(102

)

 

845

 

 

 

 

 

 

 

 

 

                                                   

Profit (loss) before tax

 

 

760

 

 

(10,825

)

 

 

 

755

 

 

2,349

 

 

258

 

 

(10

)

 

(6,713

)

                                                   

 

 

1

Restated in 2009 for IFRS 2 (Revised).

2010 COMPARED WITH 2009

Profit before tax on a combined businesses basis improved by £8,512 million to a profit of £2,212 million in 2010 compared to a loss of £6,300 million in 2009; however, the profit in 2010 included a credit of £3,118 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group whereas the loss in 2009 was after a fair value unwind credit of £6,100 million. Loss before tax and fair value unwind improved by £11,494 million to a loss of £906 million in 2010 compared to a loss of £12,400 million in 2009; this improvement was driven by lower impairment losses.

Total income decreased by £615 million, or 2 per cent, to £23,986 million in 2010 compared to £24,601 million in 2009.

Lending to customers, net of impairment provisions and fair value adjustments arising from the acquisition of HBOS plc by the Group in 2009, was £34,372 million, or 5 per cent, lower at £592,597 million in 2010 compared to £626,969 million in 2009; customer deposits were £13,108 million, or 3 per cent, lower at £393,633 million in 2010 compared to £406,741 million in 2009. These balance sheet decreases reflected reductions in lending portfolios which are outside of the Group’s appetite, continued customer deleveraging and de-risking and subdued demand in lending markets.

Net interest income was £1,096 million, or 9 per cent, higher at £13,822 million in 2010 compared to £12,726 million in 2009. The net interest margin, adjusted to exclude products where either the funding costs or the related revenues are recognised in other income, increased by 33 basis points to 2.10 per cent in 2010 compared to 1.77 per cent in 2009. Higher asset pricing and reduction in the average spread between base rate and LIBOR more than offset lower deposit margins and increasing wholesale funding spreads.

Other income was £1,711 million, or 14 per cent, lower at £10,164 million in 2010 compared to £11,875 million in 2009. This reduction primarily reflects a £1,075 million reduction in gains on capital transactions and a £193 million increase in the charge to income related to the fair value of the equity conversion feature of the Enhanced Capital Notes issued in 2009 as well as a reduction in payment protection insurance income and overdraft charges.

48


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Costs decreased by £531 million, or 5 per cent, to £11,078 million in 2010 compared to £11,609 million in 2009. Savings related to the integration of the Lloyds TSB and HBOS business and lower levels of operating lease depreciation more than offset a charge of £150 million in respect of the impairment of tangible fixed assets.

Impairment losses decreased by £10,807 million, or 45 per cent, to £13,181 million in 2010 compared to £23,988 million in 2009. Impairment losses on loans and advances to customers as a percentage of average loans and advances to customers were 2.01 per cent in 2010 compared to 3.25 per cent in 2009. The decrease arose particularly in the Wholesale division, where a reduction of £11,237 million in the impairment charge reflects the actions which were taken in the first half of 2009 on the heritage HBOS portfolios (including the identification of large impairments post the HBOS acquisition, especially in the corporate real estate, real estate-related and Corporate (UK and US) portfolios), together with the stabilising UK and US economic environment in 2010, a low interest rate environment helping to maintain defaults at a lower level and a number of write backs due to asset disposals. The impairment charge within the Retail division was £1,480 million lower following improvements in impairment levels and arrears. In the Wealth and International division, however, impairment charges totalled £5,988 million, up 47 per cent on £4,078 million in 2009, reflecting increasing impairment charges in relation to corporate and real estate exposures in Ireland and Australia. The level of losses continues to be dominated by the economic environment in Ireland, and to a lesser extent has also been influenced by the performance of specific areas of the Australian economy.

The Group’s share of results of joint ventures and associates improved by £676 million, or 88 per cent, to a loss of £91 million in 2010 compared to a loss of £767 million in 2009.

2009 COMPARED WITH 2008

Profit before tax on a combined businesses basis improved by £413 million to a loss of £6,300 million in 2009 compared to a loss of £6,713 million in 2008; however, the loss in 2009 included a credit of £6,100 million in relation to the unwinding of fair value adjustments arising from the acquisition of HBOS plc by the Group. Loss before tax and fair value unwind deteriorated by £5,687 million to a loss of £12,400 million in 2009 compared to a loss of £6,713 million in 2008. This deterioration was driven by higher impairment losses, only partly offset by an increase in other operating income and a decrease in operating expenses.

Total income increased by £2,765 million, or 13 per cent, to £24,601 million in 2009 compared to £21,836 million in 2008, driven by a large increase in other income.

Lending to customers, net of impairment provisions and fair value adjustments arising from the acquisition of HBOS plc by the Group, was £50,277 million, or 7 per cent, lower at £626,969 million in 2009 compared to £677,246 million in 2008.

Customer deposits were £2,421 million lower at £406,741 million in 2009 compared to £409,162 million in 2008.

Net interest income was £2,177 million, or 15 per cent, lower at £12,726 million in 2009 compared to £14,903 million in 2008. The net interest margin, adjusted to exclude products where either the funding costs or the related revenues are recognised in other income, declined by 24 basis points to 1.77 per cent in 2009 compared to 2.01 per cent in 2008.

Other income was £4,942 million, or 71 per cent, higher at £11,875 million in 2009 compared to £6,933 million in 2008. Other income in 2008 had been significantly reduced due to the effect of the dislocation in credit markets which resulted in investment valuation write-downs of £3,452 million in the Wholesale business; these factors were not repeated in 2009.

Operating expenses decreased by £627 million, or 5 per cent, to £11,609 million in 2009 compared to £12,236 million in 2008. Operating expenses in 2008 included a £180 million settlement in relation to certain historic US dollar payments; excluding this item from 2008, operating expenses decreased by £447 million, or 4 per cent, to £11,609 million in 2009 compared to £12,056 million in 2008.

Impairment losses increased by £9,108 million, or 61 per cent, to £23,988 million in 2009 compared to £14,880 million in 2008. Impairment losses on loans and advances to customers as a percentage of average loans and advances to customers were 3.25 per cent in 2009 compared to 1.81 per cent in 2008.

The Group’s share of results of joint ventures and associates improved by £185 million, or 19 per cent, to a loss of £767 million in 2009 compared to a loss of £952 million in 2008; there were lower levels of write-offs in 2009 as the majority of the book was fully written-off.

49


OPERATING AND FINANCIAL REVIEW AND PROSPECTS

AVERAGE BALANCE SHEET AND NET INTEREST INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2010
Average
balance
£m