HBOS PLC: Report and Accounts
HBOS PLC: Report and Accounts
Member of Lloyds Banking Group
HBOS plc
Contents
Directors’ report 2
Directors 5
Registered office: The Mound, Edinburgh, EH1 1YZ Registered in Scotland no 218813
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HBOS plc
Directors’ report
Results
The consolidated income statement on page 13 shows a profit attributable to equity shareholders for the year ended 31 December 2012 of £128 million.
Principal activities
HBOS plc (the Company) and its subsidiary undertakings (the Group) provide a wide range of banking and financial services through branches and offices in
the UK and overseas.
The Group’s revenue is earned through interest and fees on a broad range of financial services products including current and savings accounts, personal loans,
credit cards and mortgages within the retail market; loans and capital market products to commercial, corporate and asset finance customers; life, pensions and
investment products; and private banking and asset management.
Business review
For the year ended 31 December 2012, the Group recorded a profit before tax of £255 million compared with a loss before tax in 2011 of £3,894 million; the
improvement in profitability particularly reflecting a reduction in the impairment charge in 2012 and the loss on disposal of businesses in 2011.
Total income increased by £439 million, or 4 per cent, to £11,838 million in 2012 compared with £11,399 million in 2011, comprising a £1,927 million
increase in other income only partly offset by a decrease of £1,488 million in net interest income.
Net interest income was £6,910 million in 2012, a decrease of £1,488 million, or 18 per cent, compared to £8,398 million in 2011. This reduction reflected
a decrease in average interest-earning assets, mainly due to subdued lending demand and the disposal of assets outside of the Group’s risk appetite. It was also
driven by a decrease in net interest margin, which resulted from competitive deposit markets and elevated wholesale funding costs continuing into 2012, with
the average cost of new funding continuing to be higher than the average cost of maturing funds.
Other income was £1,927 million, or 64 per cent, higher at £4,928 million in 2012 compared to £3,001 million in 2011. Fee and commission income
was £155 million, or 9 per cent, lower at £1,659 million compared to £1,814 million in 2011. Fee and commission expense decreased by £191 million, or
26 per cent, to £536 million compared with £727 million in 2011. Net trading income increased by £4,386 million to £3,492 million in 2012 compared to
a deficit of £894 million in 2011; this increase reflected an improvement in gains on policyholder investments held within the Group’s remaining insurance
business, offset by a similar increase in the related claims expense. Insurance premium income was £1,621 million, or 98 per cent, lower at £36 million in
2012 compared with £1,657 million in 2011 reflecting the sale of the Group’s wholly owned insurance businesses during 2011. Other operating income was
£874 million, or 76 per cent, lower at £277 million in 2012 compared to £1,151 million in 2011 reflecting, in particular, the gains on capital transactions in
2011, not repeated in 2012.
Insurance claims expense was £2,010 million higher at £2,985 million in 2012 compared to £975 million in 2011; this increase in claims was matched by
a similar improvement in net trading income, reflecting the improved performance of policyholder investments.
Operating expenses decreased by £1,187 million, or 22 per cent, to £4,288 million in 2012 compared with £5,475 million in 2011. Both years included
significant charges in respect of regulatory provisions (2012: £1,039 million; 2011: £1,155 million); operating expenses excluding these provisions were
£1,071 million, or 25 per cent, lower at £3,249 million in 2012 compared with £4,320 million in 2011; this partly reflected the disposal of the Group’s
wholly‑owned insurance businesses during 2011. Staff costs were £709 million, or 32 per cent, lower at £1,510 million in 2012 compared with £2,219 million
in 2011. Excluding the past service pension credit in 2012, staff costs were £451 million, or 20 per cent, lower at £1,768 million compared with £2,219 million
in 2011 due to the impact of the sale of the Group’s wholly owned insurance businesses in 2011 and the ongoing impact of headcount reductions more than
offsetting the effect of annual pay rises. Premises and equipment costs were £91 million, or 20 per cent, lower at £369 million compared with £460 million in
2011. Other expenses (excluding the charges in respect of payment protection insurance and other regulatory provisions of £1,039 million from 2012 and
£1,155 million from 2011) were £108 million, or 9 per cent, lower at £1,113 million in 2012 compared with £1,221 million in 2011. Depreciation and
amortisation costs were £98 million, or 28 per cent, lower at £257 million in 2012 compared to £355 million in 2011. In 2011, there had been a charge of
£65 million in relation to the impairment of tangible fixed assets; there was no such charge in 2012.
Impairment losses decreased by £2,794 million, or 39 per cent, to £4,310 million in 2012 compared with £7,104 million in 2011. Impairment losses in
respect of loans and advances to customers were £2,709 million, or 39 per cent, lower at £4,252 million compared with £6,961 million in 2011. The overall
performance of the portfolio continues to improve and benefits from low interest rates and broadly stable UK residential property prices, partly offset by the
subdued UK economy, the weak commercial real estate market, and high, although improving, unemployment.
The impairment charge in respect of debt securities classified as loans and receivables was £43 million lower at £17 million in 2012 compared to a charge of
£60 million in 2011 and the impairment charge in respect of available-for-sale financial assets was £37 million, or 47 per cent, lower at £41 million in 2012
compared to £78 million in 2011.
In July 2011, the Lloyds Banking Group completed a restructuring of the legal ownership of its insurance businesses, as a result of which the Group’s subsidiary,
HBOS Insurance & Investment Group Limited, sold its wholly owned life, pensions and general insurance subsidiaries to Lloyds TSB General Insurance Holdings
Limited and Scottish Widows Financial Services Holdings Limited, which are also wholly owned by Lloyds TSB Bank plc. These transactions resulted in a
consolidated loss on disposal of £1,739 million during the year ended 31 December 2011.
In 2012, the Group recorded a tax charge of £86 million compared to a tax credit of £173 million in 2011. The tax charge of £86 million in 2012 arose on a
profit before tax of £255 million, an effective rate of 34 per cent reflecting the effect on the net deferred tax asset of the reduction in the UK corporation tax rate
to 23 per cent with effect from 1 April 2013 more than offsetting the benefit of non-taxable items.
Total assets at 31 December 2012 were £582,107 million, £14,108 million, or 2 per cent, higher compared to £567,999 million at 31 December 2011. This
increase reflects the greater levels of intercompany funding with other Lloyds Banking Group companies, which more than offset the reduction caused by the
continuing disposal of assets which are outside of the Group’s risk appetite, customer deleveraging and de-risking and subdued demand in lending markets.
Deposits from banks increased by £21,696 million, or 14 per cent, to £171,738 million compared to £150,042 million at 31 December 2011, but customer
deposits were little changed at £217,515 million.
Shareholders’ equity increased by £926 million, from £23,771 million to £24,697 million at 31 December 2012, as a result of positive movements in the
available-for-sale financial assets revaluation reserve and the cash flow hedging reserve.
As at 31 December 2012, the Group’s capital ratios had increased with a total capital ratio of 18.6 per cent (compared to 16.0 per cent at 31 December 2011);
a tier 1 capital ratio of 14.8 per cent (compared to 12.3 per cent at 31 December 2011) and a core tier 1 ratio of 13.0 per cent (compared to 10.8 per cent at
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HBOS plc
Directors’ report
31 December 2011). During 2012 risk-weighted assets decreased by £35,272 million to £164,052 million at 31 December 2012 compared with £199,324
million at 31 December 2011; this decrease reflected risk-weighted asset reductions across the business driven by reductions in assets outside of the Group’s
risk appetite, lower lending balances and strong management of risk.
Going concern
The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of
capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the foreseeable future, the Directors
have considered a number of key dependencies as discussed in the Principal risks and uncertainties section under Liquidity and funding on page 9 and
additionally have considered projections for the Group’s capital and funding position. Having considered these, the Directors consider that it is appropriate to
continue to adopt the going concern basis in preparing the accounts.
Directors
The names of the Directors of the Company are shown on page 5. Changes to the composition of the Board since 1 January 2012 up to the date of this report
are shown in the table below:
M A Scicluna and T T Ryan, Jr will retire from the Board on 31 March 2013 and 18 April 2013, respectively.
Directors’ interests
The Directors are also Directors of Lloyds Banking Group plc and their interests in shares in Lloyds Banking Group plc are shown in the report and accounts of
that company.
Directors’ indemnities
The Directors of the Company, including the former Directors who retired during the year and since the year end, have entered into individual deeds of indemnity
with Lloyds Banking Group plc which constituted ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ for the
purposes of the Companies Act 2006. In addition, Lloyds Banking Group plc has granted a deed of indemnity through deed poll which constituted ‘third party
indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ to the Directors of the Company’s subsidiary companies, including to former
Directors who retired during the year and since the year end. The deeds were in force during the whole of the financial year or from the date of appointment in
respect of the Directors who joined the Boards in 2012 and 2013. The indemnities remain in force for the duration of a Director’s period of office. The deeds
indemnify the Directors to the maximum extent permitted by law. Deeds for existing Directors are available for inspection at the Company’s registered office.
Share capital
Information about share capital and dividends is shown in notes 45 and 49 on pages 69 and 72 and is incorporated into this report by reference.
Employees
The Company, as part of Lloyds Banking Group is committed to providing employment practices and policies which recognise the diversity of our workforce. We
will not unfairly discriminate in our recruitment or employment practices on the basis of any factor which is not relevant to individuals’ performance including
sex, race, disability, age, sexual orientation or religious belief. We work hard to ensure Lloyds Banking Group is inclusive for all our colleagues.
To support us in this aim, Lloyds Banking Group belongs to a number of major UK employment equality campaign groups, including the Business Disability
Forum, The Age and Employment Network, Stonewall and Race for Opportunity. Our involvement with these organisations enables us to identify and implement
best practice for our staff. The Company, as part of Lloyds Banking Group, has a range of programmes to support colleagues who become disabled or acquire a
long-term health condition. These include a workplace adjustment programme to provide physical equipment or changes to the way a job is done. The Group
also runs residential Personal and Career Development Programmes to help colleagues deal positively with the impact of a disability and the colleague disability
network, Access, provides peer support.
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HBOS plc
Directors’ report
Employees are kept closely involved in major changes affecting them through such measures as team meetings, briefings, internal communications and opinion
surveys. There are well established procedures, including regular meetings with recognised unions, to ensure that the views of employees are taken into account
in reaching decisions.
Schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement in Lloyds Banking Group.
Lloyds Banking Group is committed to providing employees with comprehensive coverage of the economic and financial issues affecting the Group. We have
established a full suite of communication channels, including an extensive face-to-face briefing programme, which allows us to update our employees on our
performance and any financial issues throughout the year.
The Company’s policy is to agree terms of payment with suppliers and these normally provide for settlement within 30 days after the date of the invoice, except
where other arrangements have been negotiated. It is the policy of the Company to abide by the agreed terms of payment, provided the supplier performs
according to the terms of the contract.
The number of days required to be shown in this report, to comply with the provisions of the Companies Act 2006, is 13 (2011: 14 days). This bears the same
proportion to the number of days in the year as the aggregate of the amounts owed to trade creditors at 31 December 2012 bears to the aggregate of the amounts
invoiced by suppliers during the year.
Significant contracts
Details of related party transactions are set out in note 51 on pages 79 to 81.
Company law requires the Directors to prepare financial statements for each financial year. Under that law, the Directors have prepared the Group and Company
financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. Under company law, the
Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the
Company and of the profit or loss of the Company and Group for that period. In preparing these financial statements, the Directors are required to: select suitable
accounting policies and then apply them consistently; make judgements and accounting estimates that are reasonable and prudent; and state whether applicable
IFRSs as adopted by the European Union have been followed.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with
reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial statements comply with the
Companies Act 2006. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the
prevention and detection of fraud and other irregularities.
A copy of the financial statements is placed on the website www.lloydsbankinggroup.com. The Directors are responsible for the maintenance and integrity in
relation to the Company on that website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation
in other jurisdictions.
Each of the current Directors, whose names are shown on page 5 of this annual report, confirms that, to the best of his or her knowledge:
–– the financial statements, which have been prepared in accordance with IFRSs as adopted by the European Union, give a true and fair view of the assets,
liabilities and financial position of the Company and Group and the profit or loss of the Group;
–– the business review includes a fair review of the development and performance of the business and the position of the Company and Group; and
–– the principal risks and uncertainties faced by the Company and the Group are set out on pages 7 to 11.
A resolution will be proposed at the 2013 annual general meeting to reappoint PricewaterhouseCoopers LLP as auditors. The Company’s Audit Committee is
satisfied that the external auditors remain independent and effective.
Claire A Davies
Company Secretary
1 March 2013
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HBOS plc
Directors
Lord Blackwell
C J Fairbairn
A M Frew
D L Roberts
T T Ryan, Jr
M A Scicluna
A Watson CBE
S V Weller
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HBOS plc
This annual report includes certain forward looking statements within the meaning of the safe harbor provisions of the US Private Securities Litigation Reform
Act of 1995 with respect to the business, strategy and plans of HBOS plc and its current goals and expectations relating to its future financial condition and
performance. Statements that are not historical facts, including statements about HBOS plc or its directors’ and/or management’s beliefs and expectations, are
forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ’will’, ‘would’, ‘could’, ‘considered’, ‘likely’,
‘estimate’ and variations of these words and similar future or conditional expressions are intended to identify forward looking statements but are not the exclusive
means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon
circumstances that will occur in the future.
Examples of such forward looking statements include, but are not limited to: projections or expectations of the Group’s future financial position including profit
attributable to shareholders, provisions, economic profit, dividends, capital structure, expenditures or any other financial items or ratios; statements of plans,
objectives or goals of the Group or its management including in respect of certain synergy targets; statements about the future business and economic
environments in the United Kingdom (UK) and elsewhere including, but not limited to, future trends in interest rates, foreign exchange rates, credit and equity
market levels and demographic developments; statements about competition, regulation, disposals and consolidation or technological developments in the
financial services industry; and statements of assumptions underlying such statements.
Factors that could cause actual business, strategy, plans and/or results to differ materially from the plans, objectives, expectations, estimates and intentions
expressed in such forward looking statements made by the Group or on its behalf include, but are not limited to: general economic and business conditions in
the UK and internationally; inflation, deflation, interest rates and policies of the Bank of England, the European Central Bank and other G8 central banks;
fluctuations in exchange rates, stock markets and currencies; the ability to access sufficient funding to meet the Group’s liquidity needs; changes to the Group’s,
Lloyds Banking Group plc’s or Lloyds TSB Bank plc’s credit ratings; the ability to derive cost savings and other benefits including, without limitation, as a result
of the integration of HBOS into Lloyds Banking Group and the Group’s Simplification Programme; changing demographic developments including mortality and
changing customer behaviour including consumer spending, saving and borrowing habits; changes to borrower or counterparty credit quality; instability in the
global financial markets including Eurozone instability and the impact of any sovereign credit rating downgrade or other sovereign financial issues; technological
changes; natural and other disasters, adverse weather and similar contingencies outside the Group’s control; inadequate or failed internal or external processes,
people and systems; terrorist acts and other acts of war or hostility and responses to those acts, geopolitical, pandemic or other such events; changes in laws,
regulations, taxation, accounting standards or practices; regulatory capital or liquidity requirements and similar contingencies outside the Group’s control; the
policies and actions of governmental or regulatory authorities in the UK, the European Union (EU), the US or elsewhere; the implementation of the draft EU crisis
management framework directive and banking reform, following the recommendations made by the Independent Commission on Banking; the ability to attract
and retain senior management and other employees; requirements or limitations imposed on Lloyds Banking Group plc, Lloyds TSB Bank plc and the Group as
a result of HM Treasury’s investment in Lloyds Banking Group plc; the ability to complete satisfactorily the disposal of certain assets as part of the Lloyds Banking
Group plc’s EU State Aid obligations; the extent of any future impairment charges or write-downs caused by depressed asset valuations, market disruptions and
illiquid markets; market related trends and developments; exposure to regulatory scrutiny, legal proceedings, regulatory investigations or complaints; changes in
competition and pricing environments; the inability to hedge certain risks economically; the adequacy of loss reserves; the actions of competitors, including
non‑bank financial services and lending companies; and the success of the Group in managing the risks of the foregoing. Please refer to the latest Annual Report
on Form 20-F filed with the US Securities and Exchange Commission for a discussion of certain factors.
The Group may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the US Securities and Exchange
Commission, Group annual reviews, half-year announcements, proxy statements, offering circulars, prospectuses, press releases and other written materials and
in oral statements made by the directors, officers or employees of the Group to third parties, including financial analysts. Except as required by any applicable
law or regulation, the forward looking statements contained in this annual report are made as of the date hereof, and HBOS plc expressly disclaims any obligation
or undertaking to release publicly any updates or revisions to any forward looking statements contained in this annual report to reflect any change in HBOS plc’s
expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
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HBOS plc
CREDIT RISK
Definition
Credit risk is defined as the risk that parties with whom the Group has contracted fail to meet their obligations (both on or off balance sheet).
Principal risks
Arising mainly in the retail, commercial banking, and wealth, asset finance and international operations, reflecting the risks inherent in the Group’s lending
activities and, to a lesser extent in the Insurance operations in respect of investment holdings and exposures to reinsurers. Adverse changes in the credit quality
of the Group’s UK and/or international borrowers and counterparties, or in their behaviour, would be expected to reduce the value of the Group’s assets and
increase the Group’s write-downs and allowances for impairment losses. Credit risk can be affected by a range of macroeconomic environment and other factors,
including, inter alia, increased unemployment, reduced asset values, lower consumer spending, increased personal or corporate insolvency levels, reduced
corporate profits, increased interest rates and/or higher tenant defaults.
Over the last five years, the global banking crisis and economic downturn has driven cyclically high bad debt charges, especially in the Group’s legacy HBOS
portfolios, arising from the Group’s lending to both retail (including those in wealth, asset finance and international) and commercial customers (including those
in wealth, asset finance and international). Group portfolios will remain strongly linked to the economic environment, with inter alia house price falls,
unemployment increases, consumer over‑indebtedness and rising interest rates being possible impacts to the Group’s exposures. The Group has exposure to
commercial customers in both the UK and internationally, including Europe and Ireland, particularly related to commercial real estate lending, where the Group
has a high level of lending secured on secondary and tertiary assets. The possibility of further economic downside risk remains.
Mitigating actions
The Group takes many mitigating actions with respect to this principal risk. The Group manages its credit risk in a variety of ways such as:
–– through prudent and through the cycle credit risk appetite and policies;
–– clearly defined levels of authority (including, independently sanctioned and controlled credit limits for commercial customers and counterparties, sound credit
scoring models and credit policies for retail customers);
–– robust credit processes and controls; and
–– well-established Group and Divisional committees that ensure distressed and impaired loans are identified, considered, controlled and appropriately escalated
and appropriately impaired (taking account of the Group’s latest view of current and expected market conditions, as well as refinancing risk).
Reviews are undertaken at least quarterly and incorporate internal and external audit review and challenge.
CONDUCT RISK
Definition
Conduct risk is defined as the risk of customer detriment or censure and/or a reduction in earnings/value, through financial or reputational loss, from inappropriate
or poor customer treatment or business conduct.
Principal risks
Conduct risk and how Lloyds Banking Group manages its customer relationships affect all aspects of the Group’s operations and are closely aligned with
achievement of Lloyds Banking Group’s strategic vision to be the best bank for customers. As a provider of a wide range of financial services products distributed
through numerous channels to a broad and varied customer base, and as a participant in market activities the Group faces significant conduct risks, such as:
products or services not meeting the needs of its customers; sales processes which could result in selling products to customers which do not meet their needs;
failure to deal with a customer’s complaint effectively where the Group has got it wrong and not met customer expectations; behaviours which do not meet
market standards.
There remains a high level of scrutiny regarding financial institutions’ treatment of customers and business conduct from regulatory bodies, the media and
politicians. The FSA in particular continues to drive focus on conduct of business activities through its supervision activity.
There is a risk that certain aspects of the Group’s business may be determined by the FSA, other regulatory bodies or the courts as not being conducted in
accordance with applicable laws or regulations, or fair and reasonable treatment in their opinion. The Group may also be liable for damages to third parties
harmed by the conduct of its business.
Mitigating actions
The Group takes many mitigating actions with respect to this principal risk; key examples include:
–– The Group’s Conduct Strategy and supporting framework have been designed to support its vision and strategic aim to put the customer at the heart of
everything it does. The Group has developed and implemented a framework to enable it to deliver the right outcomes for its customers, which is supported by
policies and standards in key areas, including product governance, customer treatment, sales, responsible lending, customers in financial difficulties, claims
and complaints handling.
–– The Group actively engages with regulatory bodies and other stakeholders in developing its understanding of current customer treatment concerns. The Group
develops colleagues’ awareness of these and other expected standards of conduct through these and other policies and standards and codes of responsibility.
It also undertakes root cause analysis of complaints and makes use of technology and metrics to facilitate earlier detection and mitigation of conduct issues.
MARKET RISK
Definition
Market risk is defined as the risk that unfavourable market moves (including changes in and increased volatility of interest rates, market-implied inflation rates,
credit spreads and prices for bonds, foreign exchange rates, equity, property and commodity prices and other instruments), lead to reductions in earnings and/
or value.
Principal risks
The Group has a number of market risks, the principal ones being:
–– Interest rate risk: This risk to the Group’s banking income arises from competitive pressures on product terms in existing loans and deposits, which sometimes
restrict the Group in its ability to change interest rates applying to customers in response to changes in interbank and central bank rates. A further related risk arises
from the level of interest rates and the margin of interbank rates over central bank rates.
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HBOS plc
–– Equity risk: This risk arises from movements in equity market prices. The main equity market risks arise in the Insurance business and defined benefit pension
schemes.
–– Credit spread risk: This risk arises when the market perception of the creditworthiness of a particular counterparty changes. The main credit spread exposure
arises in the Insurance business, defined benefit pension schemes and banking businesses.
Mitigating actions
Market risk is managed within a Board approved framework using a range of metrics to monitor the Group’s profile against its stated appetite and potential market
conditions.
High level market risk exposure is reported regularly to appropriate committees for monitoring and oversight by senior management.
–– Sensitivity based measures (e.g. sensitivity to 1 basis point move in interest rates)
–– Percentile based measures (e.g. Value at Risk)
–– Scenario/stress based measures (e.g. single factor stresses, macroeconomic scenarios)
In addition, profit and loss triggers are used in the Trading Books in order to ensure that mitigating action is discussed if profit and loss becomes volatile.
–– Interest rate risk: Exposure arising from the different repricing characteristics of the Group’s non-trading assets and liabilities, and from the mismatch between
interest rate insensitive assets and interest rate sensitive liabilities, is managed centrally. Matching assets and liabilities are offset against each other and
interest rate swaps are also used to manage the residual exposure to within the non-traded market risk appetite. Exposure arising from the margin of interbank
rates over central bank rates is monitored and managed within the non-traded market risk appetite through appropriate hedging activity.
–– Equity and credit spread risk: The Group continues to liaise with defined benefit pension scheme Trustees with regard to appropriately de-risking their portfolio.
OPERATIONAL RISK
Definition
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
Principal risks
The principal operational risks currently facing the Group are:
–– IT systems and resilience: The risk of loss resulting from the failure to develop, deliver or maintain effective IT solutions. The resilience of IT in terms of its
availability to customers and colleagues is of paramount importance to the Group.
–– Information security: The risk of information leakage, loss or theft. The threat profile is rapidly changing; in particular increasingly sophisticated attacks by
cybercrime groups.
–– External fraud: The risk of loss to the Group and/or its customers resulting from an act of deception or omission.
–– Customer process: The risk of new issues, process weaknesses and control deficiencies within the Group’s customer facing processes as the business
continues to evolve.
Mitigating actions
The Group operates a robust control environment with regular review and investment. Contingency plans are maintained for a range of potential scenarios with
a regime of regular disaster recovery exercises, both Group specific and industry wide. Significant investment has been made in IT infrastructure and systems to
ensure their resilience and to enhance the services they support, in recognition of the importance of the ongoing availability of the Group’s services both to its
customers and to the wider UK financial infrastructure. The Group continues to invest in IT and information security control environments including user access
management and records management to address evolving threats.
The Group adopts a risk based approach to external fraud management, reflecting the current and emerging external fraud risks within the market. This approach
drives an annual programme of enhancements to the Group’s technology, process and people related controls; with emphasis on preventative controls, supported
by real time detective controls – wherever feasible. The Group has developed a mature and robust fraud operating model with centralised accountability
established, discharged via Group-wide policies and operational control frameworks. The Group’s fraud awareness programme is a key component of its fraud
control environment; in 2012 a Group-wide awareness campaign was launched specifically addressing the emerging ‘cyber’ threats and the role that the Group’s
colleagues play in helping to keep its customers safe and secure.
Material operational risks are reported regularly to appropriate committees, attracting senior management visibility, and are managed via a range of strategies
– avoidance, mitigation, transfer (including insurance), and acceptance.
PEOPLE RISK
Definition
People risk is defined as the risk that the Group fails to lead, manage and enable colleagues to deliver to customers, shareholders and regulators leading to
reductions in earnings and/ or value.
Principal risks
Lloyds Banking Group has a strategic aim to be the best bank for customers; it is committed to addressing issues within the business that could contribute to
customers receiving unfair outcomes. The Group believes the quality, effectiveness and engagement of its people are fundamental to its successful delivery of
this strategy. This belief coincides with the increasing external focus on the culture which underpins the performance and behaviour of employees in the
development and delivery of fair outcomes to customers.
Consequently, the Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives. Over the coming twelve months
the Group’s ability to manage people risks successfully is likely to be affected by the following factors:
–– The developing and increasingly rigorous and intrusive regulatory environment may challenge the Group’s people strategy, remuneration practices and
retention; and
–– Negative political and media attention on banking sector culture, sales practices and ethical conduct may impact colleague engagement, investor sentiment
and the Group’s cost base.
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HBOS plc
Mitigating actions
The Group takes many mitigating actions with respect to people risk. Key examples include:
–– Focusing on strengthening the risk-based culture amongst colleagues by developing and delivering a number of initiatives that reinforce risk-based behaviours
to generate the best possible outcomes for customers and colleagues;
–– Continuing to ensure strong management of the impact of organisational change and consolidation on colleagues;
–– Embedding our Codes of Personal and Business Responsibility across the Group;
–– Reviewing and developing incentives continually to ensure they promote colleagues’ behaviours that meet customer needs and regulatory expectations;
–– Focusing on leadership and colleague engagement, through delivery of strategies to attract, retain and develop high calibre people together with implementation
of rigorous succession planning;
–– Maintaining focus on people risk management across the Group; and
–– Ensuring compliance with legal and regulatory requirements related to Approved Persons and the Remuneration Code, and embedding compliant and
appropriate colleague behaviours in line with Group policies, values and its people risk priorities.
Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.
Principal risks
Liquidity and funding continues to remain a key area of focus for Lloyds Banking Group and the industry as a whole. Like all major banks, the Group is
dependent on confidence in the short and long-term wholesale funding markets. Should the Group, due to exceptional circumstances, be unable to continue to
source sustainable funding, its ability to fund its financial obligations could be impacted. The key dependencies on successfully funding the Group’s balance
sheet include:
Mitigating actions
Liquidity and funding risk appetite for the banking businesses is set by the Board and this statement of the Group’s overall appetite for liquidity risk is reviewed
and approved annually by the Board.
–– The Group’s liquidity and funding position is underpinned by its significant customer deposit base, and has been supported by stable funding from the
wholesale markets with a reduced dependence on short-term wholesale funding;
–– Daily monitoring and control processes are in place to address regulatory liquidity requirements. The Group monitors a range of market and internal early
warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group;
–– The Group carries out stress testing of its liquidity position against a range of scenarios, including those prescribed by the FSA on an ongoing basis. The
Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics; and
–– The Group has a contingency funding plan embedded within the Group Liquidity Policy which has been designed to identify emerging liquidity concerns at
an early stage, so that mitigating actions can be taken to avoid a more serious crisis developing.
INSURANCE RISK
Definition
Insurance risk is defined as the risk of adverse developments in the timing, frequency and severity of claims for insured/underwritten events and in customer
behaviour, leading to reductions in earnings and/or value.
Principal risks
The major sources of insurance risk are within the Insurance business and the Group’s defined benefit pension schemes. Insurance risk is inherent in the
Insurance business and can be affected by customer behaviour. Insurance risks accepted relate primarily to mortality, longevity, morbidity, persistency, expenses,
property and unemployment. The primary insurance risk of the Group’s defined benefit pension schemes is related to longevity.
Insurance risk has the potential to significantly impact the earnings and capital position of the Insurance business of the Group. For the Group’s defined benefit
pension schemes, insurance risk could significantly increase the cost of pension provision and impact the balance sheet of the Group.
Mitigating actions
The Group takes many mitigating actions with respect to this principal risk, key examples include:
–– Actuarial assumptions are reviewed in line with experience and in-depth reviews are conducted regularly. Longevity assumptions for the Group’s defined
benefit pension schemes are reviewed annually together with other IFRS assumptions. Expert judgement is required; and
–– Insurance risk is controlled by robust processes including underwriting, pricing-to-risk, claims management, reinsurance and other risk mitigation techniques.
9
HBOS plc
Banking Group on a commercial basis without interference in day-to-day management decisions. There is a risk that a change in Government priorities could
result in the framework agreement currently in place being replaced leading to interference in the operations of the Group.
In addition, Lloyds Banking Group is subject to European State Aid obligations in line with the Restructuring Plan agreed with HM Treasury and the EU College
of Commissioners in November 2009, which is designed to support the long-term viability of the Group and remedy any distortion of competition and trade in
the European Union (EU) arising from the State Aid given to Lloyds Banking Group. This has placed a number of requirements on Lloyds Banking Group
including an asset reduction target from a defined pool of assets by the end of 2014, known as Project Atlantic, and the divestment of certain portions of its
Retail business by the end of November 2013, known as Project Verde. There is a risk that if the Group does not deliver its divestment commitments by
November 2013, a Divesture Trustee would be appointed to dispose of the divestment, which could be sold at a negative price.
Mitigating actions
Lloyds Banking Group has received no indications that the Government intends to change the existing operating arrangements with regard to the role of UKFI
and engagement with the Group.
Lloyds Banking Group continues to make good progress in respect to its State Aid commitments. In line with the strengthening of the balance sheet, the Group
has made excellent progress against its asset reduction commitment and reached the reduction total required in December 2012, two years ahead of the
mandated completion date. The Group is currently working with the European Commission to achieve formal release from this commitment.
On 19 July 2012 Lloyds Banking Group announced that it had agreed non-binding heads of terms with The Co‑operative Group (the Co-operative) for the disposal of
the Verde business. The Group continues to work with the Co‑operative to agree a sale and purchase agreement, with completion of the divestment expected by
the end of November 2013. The Group has also undertaken planning for an Initial Public Offering (IPO) of the Verde business, should this be required as a
fallback option. The Verde business will be rebranded and operating on a standalone basis within the Lloyds Banking Group during 2013 and available for sale
to another third party as a further fallback option.
The Group continues to work closely with the FSA, EU Commission, HM Treasury and the Monitoring Trustee appointed by the EU Commission to ensure the
successful implementation of the restructuring plan and mitigate customer impact.
EMERGING RISKS
The Group considers the following to be emerging risks that have the potential to increase in significance and affect the performance of the Group. These risks
are considered alongside Lloyds Banking Group’s five year operating plan.
Macroeconomic environment
The operating plan is challenging, with a focus on improving earnings while achieving the required regulatory improvements on capital and liquidity. Any adverse
movement in interest rates or deterioration in macroeconomic environment beyond the Group’s assumptions would delay improvement of the earnings and
return profile.
Mitigating actions
The Group is actively supporting sustainable growth in the UK economy through the focused range of products and services provided to business and personal
customers, as well as through partnerships with industry and Government. Capital, liquidity and credit risk are managed conservatively and non-core asset
reductions remain ahead of schedule ensuring the Group is better placed to address macroeconomic shocks.
Capital risk
Lloyds Banking Group has a strong capital position but remains exposed to the risks of lower than expected profitability, significant losses in a number of stress
scenarios or volatility through accounting standards and regulatory changes.
One such area of potential regulatory change relates to the Bank of England’s interim Financial Policy Committee (FPC) which published its Financial Stability
Report on 29 November 2012. The report recommended that the Financial Services Authority takes action to ensure that the capital of UK banks and building
societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights. The FSA is expected to
respond prior to the March FPC meeting.
Mitigating actions
The Group has made significant progress and continues to deliver on its strategy of strengthening the balance sheet, including its capital position, to improve the
resilience of the Group.
The Group has strong governance, processes and controls which, combined with our proactive management of risk, result in an appropriate level of capital. This
includes:
–– Rigorous stress testing exercises where the results are shared with the FSA
–– Prudent internal models, based on empirical data, that meet regulatory and stringent internal requirements.
Regulatory change
The Parliamentary Commission on Banking Standards (PCBS) was asked to conduct pre-legislative scrutiny on the draft Banking Reform Bill. The PCBS
published its initial report on 21 December 2012. The report contains the Commission’s consideration of the Government’s draft legislation which gives effect
to the recommendations of the Independent Commission on Banking. The PCBS looked at ‘Ring fencing’, one of the UK Government’s main proposals for
increasing financial stability.
Mitigating actions
Actions to respond to the proposals on ring fencing are being taken forward alongside planning for recovery and resolution as part of a programme of work with
senior executive sponsorship and robust governance arrangements.
Mitigating actions
Prudent provisioning policy – provisions for legacy conduct issues represent management’s best estimate of the anticipated costs of related customer contact
and/or redress, including administration expenses.
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HBOS plc
Group product governance controls – potential risks are monitored through product management information, new product approvals and annual product reviews
leading to identification and mitigation of risks at an early stage.
Accounting standards
A number of potential changes to accounting standards are under consultation. These standards are currently scheduled for implementation between 2015 and
2018 and have the potential to add substantial volatility to the Group’s reported results and capital.
Mitigating actions
The Group continues to monitor potential changes and where appropriate provide feedback.
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HBOS plc
This report, including the opinions, has been prepared for and only for the Company’s members as a body in accordance with Chapter 3 of Part 16 of the
Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person
to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
–– the financial statements give a true and fair view of the state of the Group’s and of the Company’s affairs as at 31 December 2012 and of the Group’s profit
and the Group’s and Company’s cash flows for the year then ended;
–– the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union;
–– the Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance
with the provisions of the Companies Act 2006; and
–– the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements,
Article 4 of the lAS Regulation.
–– adequate accounting records have not been kept by the Company, or returns adequate for our audit have not been received from branches not visited by us;
or
–– the Company financial statements are not in agreement with the accounting records and returns; or
–– certain disclosures of directors’ remuneration specified by law are not made; or
–– we have not received all the information and explanations we require for our audit.
Philip Rivett
Senior Statutory Auditor
for and on behalf of PricewaterhouseCoopers LLP
Chartered Accountants and Statutory Auditors
London
1 March 2013
(a) The maintenance and integrity of the Lloyds Banking Group plc website is the responsibility of the Group directors; the work carried out by the auditors does
not involve consideration of these matters and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial
statements since they were initially presented on the website.
(b) Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
12
HBOS plc
2012 2011
Note £ million £ million
13
HBOS plc
2012 2011
The Group £ million £ million
2012 2011
The Company £ million £ million
14
HBOS plc
2012 2011
Note £ million £ million
Assets
Cash and balances at central banks 6,112 3,075
Items in the course of collection from banks 416 379
Trading and other financial assets at fair value through profit or loss 16 62,358 45,347
Derivative financial instruments 17 35,855 36,253
Loans and receivables:
Loans and advances to banks 18 140,085 91,210
Loans and advances to customers 19 313,387 357,110
Debt securities 22 3,979 11,276
457,451 459,596
Available-for-sale financial assets 24 6,052 10,498
Investment properties 25 1,279 1,686
Goodwill 27 859 859
Value of in-force business 28 135 147
Other intangible assets 29 103 76
Tangible fixed assets 30 1,705 2,372
Current tax recoverable 576 338
Deferred tax assets 42 3,445 3,977
Retirement benefit assets 41 865 394
Other assets 31 4,896 3,002
Total assets 582,107 567,999
The accompanying notes are an integral part of the consolidated financial statements.
15
HBOS plc
2012 2011
Note £ million £ million
The accompanying notes are an integral part of the consolidated financial statements.
16
HBOS plc
Further details of movements in the Group’s share capital and reserves are provided in notes 45, 46, 47 and 48.
The accompanying notes are an integral part of the consolidated financial statements.
17
HBOS plc
2012 2011
Note £ million £ million
The accompanying notes are an integral part of the consolidated financial statements.
18
HBOS plc
2012 2011
Note £ million £ million
Assets
Amounts owed by Group entities 42,713 47,378
Derivative financial instruments 17 1,565 1,857
Retirement benefit assets 41 839 375
Other assets 31 17 17
Investments in subsidiary undertakings 26 23,000 23,000
Total assets 68,134 72,627
Liabilities
Amounts owed to Group entities 29,643 35,237
Derivative financial instruments 17 10 10
Other liabilities 40 469 457
Current tax liabilities 307 283
Retirement benefit obligations 41 110 107
Deferred tax liabilities 42 207 82
Subordinated liabilities 44 9,021 9,318
Total liabilities 39,767 45,494
Equity
Issued share capital 45 3,763 3,763
Share premium account 46 18,655 18,655
Other reserves 47 9,693 9,693
Retained profits 48 (3,744) (4,978)
Shareholders’ equity 28,367 27,133
Total equity and liabilities 68,134 72,627
Approved by the Board on 1 March 2013 and signed on its behalf by:
19
HBOS plc
Share
capital and Other Retained
premium reserves profits Total
£ million £ million £ million £ million
Balance at 1 January 2011 22,418 9,692 (4,681) 27,429
Comprehensive income
Loss for the year – – (297) (297)
Other comprehensive income
Movements in cash flow hedging reserves, net of tax – 1 – 1
Total comprehensive income – 1 (297) (296)
Balance at 31 December 2011 22,418 9,693 (4,978) 27,133
Comprehensive income1
Total comprehensive income – – 1,234 1,234
Balance at 31 December 2012 22,418 9,693 (3,744) 28,367
1Total comprehensive income in 2012 comprised only the profit for the year.
20
HBOS plc
2012 2011
£ million £ million
The accompanying notes are an integral part of the Company financial statements.
21
HBOS plc
1 Basis of preparation
The financial statements of HBOS plc have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European
Union (EU) as applied in accordance with the provisions of the Companies Act 2006. IFRS comprises accounting standards prefixed IFRS issued by the
International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the
International Financial Reporting Interpretations Committee (IFRIC) and its predecessor body. The EU endorsed version of IAS 39 Financial Instruments:
Recognition and Measurement relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is
no difference in application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB. The financial information has been prepared
under the historical cost convention, as modified by the revaluation of investment properties, available‑for-sale financial assets, trading securities and certain
other financial assets and liabilities at fair value through profit or loss and all derivative contracts.
The going concern of the Company and the Group is dependent on successfully funding their respective balance sheets and maintaining adequate levels of
capital. In order to satisfy themselves that the Company and the Group have adequate resources to continue to operate for the foreseeable future, the directors
have considered a number of key dependencies which are set out in the Principal risks and uncertainties section under Liquidity and funding on page 9 and
additionally have considered projections for the Group’s capital and funding position. Taking all of these factors into account, the directors consider that it is
appropriate to continue to adopt the going concern basis in preparing the financial statements.
As the Group’s share of results of joint ventures and associates is no longer significant, this is now included within other operating income and the related asset
reported within other assets; comparatives have been re-presented on a consistent basis.
The Group has adopted the following amendments to standards which became effective for financial years beginning on or after 1 January 2012. Neither of
these amendments has had a material impact on these financial statements.
(i) D
isclosures – Transfers of Financial Assets (Amendments to IFRS 7). Requires disclosures in respect of all transferred financial assets that are not
derecognised in their entirety and transferred assets that are derecognised in their entirety but with which there is continuing involvement. Disclosures in
connection with such transfers can be found in note 53.
(ii) D
eferred Tax: Recovery of Underlying Assets (Amendment to IAS 12). Introduces a rebuttable presumption that investment property measured at fair value
is recovered entirely through sale and that deferred tax in respect of such investment property is recognised on that basis.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2012 and which have not been applied
in preparing these financial statements are given in note 57.
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HBOS plc
2 Accounting policies
The accounting policies are set out below. These accounting policies have been applied consistently.
a Consolidation
The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts
made up to the reporting date. Group undertakings include subsidiaries, joint ventures and associates.
(1) Subsidiaries
Subsidiaries include entities over which the Group has the power to govern the financial and operating policies which generally accompanies a shareholding of
more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when
assessing whether the Group controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Group; they are
de‑consolidated from the date that control ceases. Details of the principal subsidiaries are given in note 26.
Investment vehicles, such as Open Ended Investment Companies (OEICs), where the Group has control are consolidated. Control arises when the Group
manages the funds and also has a majority beneficial interest. In circumstances where the Group holds a majority beneficial interest, but is not the fund manager,
the Group does not consolidate the entity as it does not have the fund manager’s decision-making powers over the investment activities of the OEIC necessary
to establish control. The interests of parties other than the Group are reported in other liabilities.
Special purpose entities (SPEs) are consolidated if, in substance, the Group controls the entity. A key indicator of such control, amongst others, is where the
Group is exposed to the risks and benefits of the SPE.
The treatment of transactions with non-controlling interests depends on whether, as a result of the transaction, the Group loses control of the subsidiary. Changes
in the parent’s ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions; any difference between the
amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed
to the owners of the parent entity. Where the group loses control of the subsidiary, at the date when control is lost the amount of any non-controlling interest in
that former subsidiary is derecognised and any investment retained in the former subsidiary is remeasured to its fair value; the gain or loss that is recognised in
profit or loss on the partial disposal of the subsidiary includes the gain or loss on the remeasurement of the retained interest.
Intercompany transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
The acquisition method of accounting is used to account for business combinations by the Group. The consideration for the acquisition of a subsidiary is the fair
value of the assets transferred, the liabilities incurred and the equity interests issued by the Group. The consideration includes the fair value of any asset or
liability resulting from a contingent consideration arrangement. Acquisition related costs are expensed as incurred except those relating to the issuance of debt
instruments (see 2e(4)) or share capital (see 2r(1)). Identifiable assets acquired and liabilities assumed in a business combination are measured initially at their
fair value at the acquisition date.
The Group utilises the venture capital exemption for investments where significant influence or joint control is present and the business unit operates as a venture
capital business. These investments are designated at initial recognition at fair value through profit or loss. Otherwise, the Group’s investments in joint ventures
and associates are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Group’s share of the
post-acquisition results of the joint venture or associate based on audited accounts which are coterminous with the Group or made up to a date which is not
more than three months before the Group’s reporting date. The share of any losses is restricted to a level that reflects an obligation to fund such losses.
b Goodwill
Goodwill arises on business combinations, including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and associates; goodwill
represents the excess of the cost of an acquisition over the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities acquired.
Where the fair value of the Group’s share of the identifiable assets, liabilities and contingent liabilities of the acquired entity is greater than the cost of acquisition,
the excess is recognised immediately in the income statement.
Goodwill is recognised as an asset at cost and is tested at least annually for impairment. If an impairment is identified the carrying value of the goodwill is written
down immediately through the income statement and is not subsequently reversed. Goodwill arising on acquisitions of associates and joint ventures is included
in the Group’s investment in joint ventures and associates. At the date of disposal of a subsidiary, the carrying value of attributable goodwill is included in the
calculation of the profit or loss on disposal except where it has been written off directly to reserves in the past.
d Revenue recognition
Interest income and expense are recognised in the income statement for all interest-bearing financial instruments, except for those classified at fair value through
profit or loss, using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and
of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts
23
HBOS plc
The effective interest rate is calculated on initial recognition of the financial asset or liability by estimating the future cash flows after considering all the
contractual terms of the instrument but not future credit losses. The calculation includes all amounts expected to be paid or received by the Group including
expected early redemption fees and related penalties and premiums and discounts that are an integral part of the overall return. Direct incremental transaction
costs related to the acquisition, issue or disposal of a financial instrument are also taken into account in the calculation. Once a financial asset or a group of
similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the
future cash flows for the purpose of measuring the impairment loss (see h below).
Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided. Loan commitment
fees for loans that are likely to be drawn down are deferred (together with related direct costs) and recognised as an adjustment to the effective interest rate on
the loan once drawn. Where it is unlikely that loan commitments will be drawn, loan commitment fees are recognised over the life of the facility. Loan syndication
fees are recognised as revenue when the syndication has been completed and the Group retains no part of the loan package for itself or retains a part at the
same effective interest rate for all interest-bearing financial instruments, including loans and advances, as for the other participants.
Revenue recognition policies specific to life insurance and general insurance business are detailed below (see o below); those relating to leases are set out in
k(2) below.
Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when the Group has transferred its contractual
right to receive the cash flows from the assets and either:
–– substantially all of the risks and rewards of ownership have been transferred; or
–– the Group has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.
Financial liabilities are derecognised when they are extinguished (ie when the obligation is discharged), cancelled or expire.
Trading securities are debt securities and equity shares acquired principally for the purpose of selling in the short term or which are part of a portfolio which is
managed for short-term gains. Such securities are classified as trading securities and recognised in the balance sheet at their fair value. Gains and losses arising
from changes in their fair value together with interest coupons and dividend income are recognised in the income statement within net trading income in the
period in which they occur.
Other financial assets and liabilities at fair value through profit or loss are designated as such by management upon initial recognition. Such assets and liabilities
are carried in the balance sheet at their fair value and gains and losses arising from changes in fair value together with interest coupons and dividend income
are recognised in the income statement within net trading income in the period in which they occur. Financial assets and liabilities are designated at fair value
through profit or loss on acquisition in the following circumstances:
–– it eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets and liabilities or recognising gains or
losses on different bases. The main type of financial assets designated by the Group at fair value through profit or loss are assets backing insurance contracts
and investment contracts issued by the Group’s life insurance businesses. Fair value designation allows changes in the fair value of these assets to be recorded
in the income statement along with the changes in the value of the associated liabilities, thereby significantly reducing the measurement inconsistency had
the assets been classified as available-for-sale financial assets.
–– the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk
management or investment strategy, with management information also prepared on this basis. As noted in a(2) above, certain of the Group’s investments
are managed as venture capital investments and evaluated on the basis of their fair value and these assets are designated at fair value through profit or loss.
–– where the assets and liabilities contain one or more embedded derivatives that significantly modify the cash flows arising under the contract and would
otherwise need to be separately accounted for.
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group
establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are
substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Refer to
note 3 (Critical accounting estimates and judgements: Valuation of financial instruments) and note 53 (3) (Financial instruments: Fair values of financial assets
and liabilities) for details of valuation techniques and significant inputs to valuation models.
The Group is permitted to reclassify, at fair value at the date of transfer, non-derivative financial assets (other than those designated at fair value through profit
or loss by the entity upon initial recognition) out of the trading category if they are no longer held for the purpose of being sold or repurchased in the near term,
as follows:
–– if the financial assets would have met the definition of loans and receivables (but for the fact that they had to be classified as held for trading at initial
recognition), they may be reclassified into loans and receivables where the Group has the intention and ability to hold the assets for the foreseeable future or
until maturity; or
–– if the financial assets would not have met the definition of loans and receivables, they may be reclassified out of the held for trading category into available-
for-sale financial assets in ‘rare circumstances’.
24
HBOS plc
The Group is permitted to transfer a financial asset from the available-for-sale category to the loans and receivables category where that asset would have met
the definition of loans and receivables at the time of reclassification (if the financial asset had not been designated as available‑for‑sale) and where there is both
the intention and ability to hold that financial asset for the foreseeable future. Reclassification of a financial asset from the available-for-sale category to the
held‑to‑maturity category is permitted when the Group has the ability and intent to hold that financial asset to maturity.
Reclassifications are made at fair value as of the reclassification date. Fair value becomes the new cost or amortised cost as applicable. Effective interest rates
for financial assets reclassified to the loans and receivables and held‑to‑maturity categories are determined at the reclassification date. Any previous gain or loss
on a transferred asset that has been recognised in equity is amortised to profit or loss over the remaining life of the investment using the effective interest method
or until the asset becomes impaired. Any difference between the new amortised cost and the expected cash flows is also amortised over the remaining life of
the asset using the effective interest method.
When an impairment loss is recognised in respect of available-for-sale assets transferred, the unamortised balance of any available‑for‑sale reserve that remains
in equity is transferred to the income statement and recorded as part of the impairment loss.
The Group has entered into securitisation and similar transactions to finance certain loans and advances to customers. In cases where the securitisation vehicles
are funded by the issue of debt, on terms whereby the majority of the risks and rewards of the portfolio of securitised lending are retained by the Group, these
loans and advances continue to be recognised by the Group, together with a corresponding liability for the funding.
(4) Borrowings
Borrowings (which include deposits from banks, customer deposits, debt securities in issue and subordinated liabilities) are recognised initially at fair value,
being their issue proceeds net of transaction costs incurred. These instruments are subsequently stated at amortised cost using the effective interest method.
Preference shares and other instruments which carry a mandatory coupon or are redeemable on a specific date are classified as financial liabilities. The coupon
on these instruments is recognised in the income statement as interest expense.
An exchange of financial liabilities on substantially different terms is accounted for as an extinguishment of the original financial liability and the recognition of
a new financial liability. The difference between the carrying amount of a financial liability extinguished and the new financial liability is recognised in profit or
loss together with any related costs or fees incurred.
When a financial liability is exchanged for an equity instrument, the new equity instrument is recognised at fair value and any difference between the original
carrying value of the liability and the fair value of the new equity is recognised in the profit or loss together with any related costs or fees incurred.
Securities lent to counterparties are retained in the financial statements. Securities borrowed are not recognised in the financial statements, unless these are sold
to third parties, in which case the obligation to return them is recorded at fair value as a trading liability.
Changes in the fair value of any derivative instrument that is not part of a hedging relationship are recognised immediately in the income statement.
Derivatives embedded in financial instruments and insurance contracts (unless the embedded derivative is itself an insurance contract) are treated as separate
derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value
through profit or loss. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. In accordance with
IFRS 4 Insurance Contracts, a policyholder’s option to surrender an insurance contract for a fixed amount is not treated as an embedded derivative.
The method of recognising the movements in the fair value of derivatives depends on whether they are designated as hedging instruments and, if so, the nature
of the item being hedged. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another
financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the hedge relationship, formal documentation is drawn up
specifying the hedging strategy, the hedged item and the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge
25
HBOS plc
The Group designates certain derivatives as either: (1) hedges of the fair value of the particular risks inherent in recognised assets or liabilities (fair value hedges);
(2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges); or (3) hedges of net investments in foreign
operations (net investment hedges). These are accounted for as follows:
g Offset
Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an
intention to settle on a net basis, or realise the asset and settle the liability simultaneously. In certain situations, even though master netting agreements exist,
the lack of management intention to settle on a net basis results in the financial assets and liabilities being reported gross on the balance sheet.
Where such an event has had an impact on the estimated future cash flows of the financial asset or group of financial assets, an impairment allowance is
recognised. The amount of impairment allowance is the difference between the asset’s carrying amount and the present value of estimated future cash flows
discounted at the asset’s original effective interest rate. If the asset has a variable rate of interest, the discount rate used for measuring the impairment allowance
is the current effective interest rate.
Subsequent to the recognition of an impairment loss on a financial asset or a group of financial assets, interest income continues to be recognised on an effective
interest rate basis, on the asset’s carrying value net of impairment provisions. If, in a subsequent period, the amount of the impairment loss decreases and the
decrease can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower’s credit rating, the
allowance is adjusted and the amount of the reversal is recognised in the income statement.
Impairment allowances are assessed individually for financial assets that are individually significant. Such individual assessment is used primarily for the Group’s
wholesale lending portfolios. Impairment allowances for portfolios of smaller balance homogenous loans such as most residential mortgages, personal loans and
credit card balances in the Group’s retail portfolios that are below the individual assessment thresholds, and for loan losses that have been incurred but not
separately identified at the balance sheet date, are determined on a collective basis.
Individual assessment
In respect of individually significant financial assets in the Group’s wholesale lending portfolios, assets are reviewed on a regular basis and those showing
potential or actual vulnerability are placed on a watch list where greater monitoring is undertaken and any adverse or potentially adverse impact on ability to
repay is used in assessing whether an asset should be transferred to a dedicated Business Support Unit. Specific examples of trigger events that would lead to
the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of additional impairment allowances) include (i)
trading losses, loss of business or major customer of a borrower; (ii) material breaches of the terms and conditions of a loan facility, including non-payment of
interest or principal, or a fall in the value of security such that it is no longer considered adequate; (iii) disappearance of an active market because of financial
difficulties; or (iv) restructuring a facility with preferential terms to aid recovery of the lending (such as a debt for equity swap).
For such individually identified financial assets, a review is undertaken of the expected future cash flows which requires significant management judgement as
to the amount and timing of such cash flows. Where the debt is secured, the assessment reflects the expected cash flows from the realisation of the security, net
of costs to realise, whether or not foreclosure or realisation of the collateral is probable.
For impaired debt instruments which are held at amortised cost, impairment losses are recognised in subsequent periods when it is determined that there has
been a further negative impact on expected future cash flows. A reduction in fair value caused by general widening of credit spreads would not, of itself, result
in additional impairment.
Collective assessment
Impairment is assessed on a collective basis for (1) homogenous groups of loans that are not considered individually impaired; and (2) to cover losses which
have been incurred but have not yet been identified on loans subject to individual impairment.
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HBOS plc
Generally, the impairment trigger used within the impairment calculation for a loan, or group of loans, is when they reach a pre-defined level of delinquency or
where the customer is bankrupt. Loans where the Group provides arrangements that forgive a portion of interest or principal are also deemed to be impaired and
loans that are originated to refinance currently impaired assets are also defined as impaired.
In respect of the Group’s secured mortgage portfolios, the impairment allowance is calculated based on a definition of impaired loans which are those six months
or more in arrears (or certain cases where the borrower is bankrupt or is in possession). The estimated cash flows are calculated based on historical experience
and are dependent on estimates of the expected value of collateral which takes into account expected future movements in house prices, less costs to sell.
For unsecured personal lending portfolios, the impairment trigger is generally when the balance is two or more instalments in arrears or where the customer has
exhibited one or more of the impairment characteristics set out above. While the trigger is based on the payment performance or circumstances of each individual
asset, the assessment of future cash flows uses historical experience of cohorts of similar portfolios such that the assessment is considered to be collective. Future
cash flows are estimated on the basis of the contractual cash flows of the assets in the cohort and historical loss experience for similar assets. Historical loss
experience is adjusted on the basis of current observable data about economic and credit conditions (including unemployment rates and borrowers’ behaviour)
to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions
in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group
to reduce any differences between loss estimates and actual loss experience.
Write offs
A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have
been received or there is no realistic prospect of recovery and the amount of the loss has been determined. Subsequent recoveries of amounts previously written
off decrease the amount of impairment losses recorded in the income statement. For both secured and unsecured retail balances, the write-off takes place only
once an extensive set of collections processes has been completed, or the status of the account reaches a point where policy dictates that forbearance is no
longer appropriate. For wholesale lending, a write-off occurs if the loan facility with the customer is restructured, the asset is under administration and the only
monies that can be received are the amounts estimated by the administrator, the underlying assets are disposed and a decision is made that no further settlement
monies will be received, or external evidence (for example, third party valuations) is available that there has been an irreversible decline in expected cash flows.
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HBOS plc
–– Freehold/long and short leasehold premises: shorter of 50 years and the remaining period of the lease.
–– Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease.
Equipment:
The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In the event that
an asset’s carrying amount is determined to be greater than its recoverable amount it is written down immediately. The recoverable amount is the higher of the
asset’s fair value less costs to sell and its value in use.
k Leases
(1) As lessee
The leases entered into by the Group are primarily operating leases. Operating lease rentals payable are charged to the income statement on a straight-line basis
over the period of the lease.
When an operating lease is terminated before the end of the lease period, any payment made to the lessor by way of penalty is recognised as an expense in the
period of termination.
(2) As lessor
Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all the risks and rewards of ownership to the lessee but
not necessarily legal title. All other leases are classified as operating leases. When assets are subject to finance leases, the present value of the lease payments,
together with any unguaranteed residual value, is recognised as a receivable, net of provisions, within loans and advances to banks and customers. The
difference between the gross receivable and the present value of the receivable is recognised as unearned finance lease income. Finance lease income is
recognised in interest income over the term of the lease using the net investment method (before tax) so as to give a constant rate of return on the net investment
in the leases. Unguaranteed residual values are reviewed regularly to identify any impairment.
Operating lease assets are included within tangible fixed assets at cost and depreciated over their estimated useful lives, which equates to the lives of the leases,
after taking into account anticipated residual values. Operating lease rental income is recognised on a straight-line basis over the life of the lease.
The Group evaluates non-lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then accounted for
separately.
Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening years; these
valuations are updated to 31 December each year by qualified independent actuaries. For the purposes of these annual updates scheme assets are included at
their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method adjusted for unrecognised actuarial gains and
losses. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the balance sheet date on high‑quality corporate bonds
that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability.
The Group’s income statement charge includes the current service cost of providing pension benefits, the expected return on the schemes’ assets, net of expected
administration costs, and the interest cost on the schemes’ liabilities. Actuarial gains and losses arising from experience adjustments and changes in actuarial
assumptions are not recognised unless the cumulative unrecognised gain or loss at the end of the previous reporting period exceeds the greater of 10 per cent
of the scheme assets or liabilities (‘the corridor approach’). In these circumstances the excess is charged or credited to the income statement over the employees’
expected average remaining working lives. Past service costs are charged immediately to the income statement, unless the charges are conditional on the
employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight-line basis over
the vesting period.
The Group’s balance sheet includes the net surplus or deficit, being the difference between the fair value of scheme assets and the discounted value of scheme
liabilities at the balance sheet date adjusted for any cumulative unrecognised actuarial gains or losses. Surpluses are only recognised to the extent that they are
recoverable through reduced contributions in the future or through refunds from the schemes.
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HBOS plc
The costs of the Group’s defined contribution plans are charged to the income statement in the period in which they fall due.
m Share-based compensation
Lloyds Banking Group operates a number of equity-settled, share-based compensation plans in respect of services received from certain of its employees. The
value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the
instruments. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity
instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of
grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model or a Monte Carlo simulation. The determination of
fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are
expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income
statement, together with a corresponding adjustment to equity. Cancellations by employees of contributions to the Group’s Save As You Earn plans are treated
as non-vesting conditions and the Group recognises, in the year of cancellation, the amount of the expense that would have otherwise been recognised over the
remainder of the vesting period. Modifications are assessed at the date of modification and any incremental charges are charged to the income statement.
n Taxation
Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.
For the Group’s long-term insurance businesses, the tax charge is analysed between tax that is payable in respect of policyholders’ returns and tax that is payable
on shareholders’ returns. This allocation is based on an assessment of the rates of tax which will be applied to the returns under current UK tax rules.
Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying
amounts in the consolidated financial statements. However, deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a
transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax is determined
using tax rates that have been enacted or substantively enacted by the balance sheet date which are expected to apply when the related deferred tax asset is
realised or the deferred tax liability is settled.
Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised. Income
tax payable on profits is recognised as an expense in the period in which those profits arise. The tax effects of losses available for carry forward are recognised
as an asset when it is probable that future taxable profits will be available against which these losses can be utilised. Deferred and current tax related to gains
and losses on the fair value re-measurement of available-for-sale investments and cash flow hedges, where these gains and losses are recognised in other
comprehensive income, is also recognised in other comprehensive income. Such tax is subsequently transferred to the income statement together with the gain
or loss.
Deferred and current tax assets and liabilities are offset when they arise in the same tax reporting group and where there is both a legal right of offset and the
intention to settle on a net basis or to realise the asset and settle the liability simultaneously.
o Insurance
The Group undertakes both life insurance and general insurance business. Insurance and participating investment contracts are accounted for under IFRS 4
Insurance Contracts, which permits (with certain exceptions) the continuation of accounting practices for measuring insurance and participating investment
contracts that applied prior to the adoption of IFRS. The Group, therefore, continues to account for these products using UK GAAP, including FRS 27 Life
Assurance and UK established practice.
Products sold by the life insurance business are classified into three categories:
–– Insurance contracts – these contracts transfer significant insurance risk and may also transfer financial risk. The Group defines significant insurance risk as
the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were
not to occur. These contracts may or may not include discretionary participation features.
–– Investment contracts containing a discretionary participation feature (‘participating investment contracts’) – these contracts do not transfer significant insurance
risk, but contain a contractual right which gives the holder the right to receive, in addition to the guaranteed benefits, further additional discretionary benefits
or bonuses that are likely to be a significant proportion of the total contractual benefits and the amount and timing of which is at the discretion of the Group,
within the constraints of the terms and conditions of the instrument and based upon the performance of specified assets.
–– Non-participating investment contracts – these contracts do not transfer significant insurance risk or contain a discretionary participation feature.
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HBOS plc
–– Insurance and participating investment contracts which are not unit-linked or in the Group’s with-profit funds
A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by
estimating the future cash flows over the duration of in-force policies and discounting them back to the valuation date allowing for probabilities of occurrence.
The liability will vary with movements in interest rates and with the cost of life insurance and annuity benefits where future mortality is uncertain.
Assumptions are made in respect of all material factors affecting future cash flows, including future interest rates, mortality and costs.
Changes in the value of these liabilities are recognised in the income statement through insurance claims.
Unallocated surplus
Any amounts in the with-profit funds not yet determined as being due to policyholders or shareholders are recognised as an unallocated surplus which is shown
separately from liabilities arising from insurance contracts and participating investment contracts.
Deposits and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the non-
participating investment contract liability.
The Group receives investment management fees in the form of an initial adjustment or charge to the amount invested. These fees are in respect of services
rendered in conjunction with the issue and management of investment contracts where the Group actively manages the consideration received from its
customers to fund a return that is based on the investment profile that the customer selected on origination of the contract. These services comprise an
indeterminate number of acts over the lives of the individual contracts and, therefore, the Group defers these fees and recognises them over the estimated lives
of the contracts, in line with the provision of investment management services.
Costs which are directly attributable and incremental to securing new non-participating investment contracts are deferred. This asset is subsequently amortised
over the period of the provision of investment management services and is reviewed for impairment in circumstances where its carrying amount may not be
recoverable. If the asset is greater than its recoverable amount it is written down immediately through fee and commission expense in the income statement. All
other costs are recognised as expenses when incurred.
The Group’s contractual rights to benefits from providing investment management services in relation to non-participating investment contracts acquired in
business combinations and portfolio transfers are measured at fair value at the date of acquisition. The resulting asset is amortised over the estimated lives of
the contracts. At each reporting date an assessment is made to determine if there is any indication of impairment. Where impairment exists, the carrying value
of the asset is reduced to its recoverable amount and the impairment loss recognised in the income statement.
The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet
date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into
account all known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take
into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical
techniques are used to determine the provision for claims incurred but not reported at the balance sheet date. Claims liabilities are not discounted.
30
HBOS plc
(4) Reinsurance
Contracts entered into by the Group with reinsurers under which the Group is compensated for benefits payable on one or more contracts issued by the Group are
recognised as assets arising from reinsurance contracts held. Where the underlying contracts issued by the Group are classified as insurance contracts and the
reinsurance contract transfers significant insurance risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as
insurance contracts. Where the underlying contracts issued by the Group are classified as non-participating investment contracts and the reinsurance contract
transfers financial risk on those contracts to the reinsurer, the assets arising from reinsurance contracts held are classified as non-participating investment contracts.
Assets arising from reinsurance contracts held – Classified as non-participating investment contracts
These contracts are accounted for as financial assets whose value is contractually linked to the fair values of financial assets within the reinsurers’ investment
funds. Investment returns (including movements in fair value and investment income) allocated to these contracts are recognised in insurance claims. Deposits
and withdrawals are not accounted for through the income statement but are accounted for directly in the balance sheet as adjustments to the assets arising
from reinsurance contracts held.
Foreign currency transactions are translated into the appropriate functional currency using the exchange rates prevailing at the dates of the transactions. Foreign
exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and
liabilities denominated in foreign currencies are recognised in the income statement, except when recognised in other comprehensive income as qualifying cash
flow or net investment hedges. Non-monetary assets that are measured at fair value are translated using the exchange rate at the date that the fair value was
determined. Translation differences on equities and similar non-monetary items held at fair value through profit and loss are recognised in profit or loss as part
of the fair value gain or loss. Translation differences on available-for-sale non-monetary financial assets, such as equity shares, are included in the fair value
reserve in equity unless the asset is a hedged item in a fair value hedge.
The results and financial position of all group entities that have a functional currency different from the presentation currency are translated into the presentation
currency as follows:
–– The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into
sterling at foreign exchange rates ruling at the balance sheet date.
–– The income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange
rates ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.
Foreign exchange differences arising on the translation of a foreign operation are recognised in other comprehensive income and accumulated in a separate
component of equity together with exchange differences arising from the translation of borrowings and other currency instruments designated as hedges of such
investments (see f(3) above). On disposal of a foreign operation, the cumulative amount of exchange differences relating to that foreign operation are reclassified
from equity and included in determining the profit or loss arising on disposal.
The Group recognises provisions in respect of vacant leasehold property where the unavoidable costs of the present obligations exceed anticipated rental income.
Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows
of resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are
remote.
r Share capital
(1) Share issue costs
Incremental costs directly attributable to the issue of new shares or options or to the acquisition of a business are shown in equity as a deduction, net of tax,
from the proceeds.
(2) Dividends
Dividends paid on the Group’s ordinary shares are recognised as a reduction in equity in the period in which they are paid.
t Investment in subsidiaries
Investments in subsidiaries are carried at historical cost, less any provisions for impairment.
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HBOS plc
The preparation of the Group’s financial statements in accordance with IFRS requires management to make judgements, estimates and assumptions in applying
the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual
results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually
evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the
circumstances.
The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty in these financial
statements, which together are deemed critical to the Group’s results and financial position, are as follows.
The allowance for impairment losses on loans and receivables is management’s best estimate of losses incurred in the portfolio at the balance sheet date.
Impairment allowances are made up of two components, those determined individually and those determined collectively.
Individual impairment allowances are generally established against the Group’s wholesale lending portfolios. The determination of individual impairment
allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions and the resulting trading
performance of the customer, and the value of the security held, for which there may not be a readily accessible market. In particular, significant judgement is
required by management in the current economic environment in assessing the borrower’s cash flows and debt servicing capability together with the realisable
value of real estate collateral. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes
of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the
customer become clearer.
Collective impairment allowances are generally established for smaller balance homogenous portfolios such as the retail portfolios. The collective impairment
allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including the interdependency of
house prices, unemployment rates, interest rates, borrowers’ behaviour, and consumer bankruptcy trends. It is, however, inherently difficult to estimate how
changes in one or more of these factors might impact the collective impairment allowance.
Given the relative size of the mortgage portfolio, a key variable is house prices which determine the collateral value supporting loans in such portfolios. The value
of this collateral is estimated by applying changes in house price indices to the original assessed value of the property. If average house prices were ten per cent
lower than those estimated at 31 December 2012, the impairment charge would increase by approximately £280 million in respect of UK mortgages and a
further £55 million in respect of Irish mortgages.
In addition, a collective unimpaired provision is made for loan losses that have been incurred but have not been separately identified at the balance sheet date.
This provision is sensitive to changes in the time between the loss event and the date the impairment is specifically identified. This period is known as the loss
emergence period. In the Group’s wholesale businesses, an increase of one month in the loss emergence period in respect of the loan portfolio assessed for
collective unimpaired provisions would result in an increase in the collective unimpaired provision of approximately £88 million (at 31 December 2011, a one
month increase in the loss emergence period would have increased the collective unimpaired provision by an estimated £135 million).
Valuation techniques for level 2 financial instruments use inputs that are largely based on observable market data. Level 3 financial instruments are those where
at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data. Determining the appropriate
assumptions to be used for level 3 financial instruments requires significant management judgement.
At 31 December 2012, the Group classified £763 million of financial assets and £68 million of financial liabilities as level 3. Further details of the Group’s level
3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair
value are set out in note 53.
The recoverability of the Group’s deferred tax assets in respect of carry forward losses is based on an assessment of future levels of taxable profit expected to
arise that can be offset against these losses. The Group’s expectations as to the level of future taxable profits take into account the Group’s long-term financial
and strategic plans, and anticipated future tax adjusting items.
In making this assessment account is taken of, business plans, the five year board approved operating plan and the following future risk factors:
–– The expected future economic outlook as set out in the Group Chief Executive’s Review contained in the Annual Report of Lloyds Banking Group.
–– The retail banking business disposal as required by the European Commission; and
–– Future regulatory change.
The Group’s total deferred tax asset includes £3,637 million (2011: £3,568 million) in respect of trading losses carried forward. The tax losses have arisen in
individual legal entities and will be used as future taxable profits arise in those legal entities, though substantially all of the unused tax losses for which a deferred
tax asset has been recognised arise in Bank of Scotland plc.
32
HBOS plc
As disclosed in note 42, deferred tax assets totalling £664 million (2011: £571 million) have not been recognised in respect of certain capital losses carried
forward, trading losses carried forward (mainly in certain overseas companies) and unrelieved foreign tax credits as there are no predicted future capital or
taxable profits against which these losses can be recognised.
The value of the Group’s defined benefit pension schemes’ liabilities requires management to make a number of assumptions. The key areas of estimation
uncertainty are the discount rate applied to future cash flows and the expected lifetime of the schemes’ members. The accounting surplus or deficit is sensitive
to changes in the discount rate, which is affected by market conditions and therefore potentially subject to significant variation. The cost of the benefits payable
by the schemes will also depend upon the longevity of the members. Assumptions are made regarding the expected lifetime of scheme members based upon
recent experience and extrapolate the improving trend, however given the rate of advance in medical science and increasing levels of obesity, it is uncertain
whether they will ultimately reflect actual experience.
The effect on the net accounting surplus or deficit and on the pension charge in the Group’s income statement of changes to the principal actuarial assumptions
is set out in note 41.
At 31 December 2012, the Group carried liabilities arising from insurance contracts and participating investment contracts of £423 million (2011: £385 million).
The methodology used to value these liabilities is described in note 2o(1). Elements of the liability valuations require assumptions to be made about future
investment returns, future mortality rates and future policyholder behaviour and are subject to significant management judgement and estimation uncertainty.
The key assumptions that have been made in determining the carrying value of these liabilities are set out in note 37.
The effect on the Group’s profit before tax and shareholders’ equity of changes in key assumptions used in determining the life insurance assets and liabilities is
set out in note 37.
Note 43 contains more detail on the nature of the assumptions that have been made and key sensitivities.
33
HBOS plc
4 Segmental analysis
IFRS 8 ’Operating Segments’ requires reporting of financial and descriptive information about operating segments which are based on how financial information
is reported and evaluated internally. The chief operating decision maker has been identified as the Group Executive Committee of Lloyds Banking Group. The
HBOS Group is managed on an entity basis and not by segment. The Group Executive Committee does not assess the HBOS Group’s performance and allocate
resources across any segments, accordingly no segmental information is provided. A brief overview of the Group’s sources of income is provided in this
document. The ultimate parent undertaking, Lloyds Banking Group plc, produces consolidated accounts which set out the basis of the segments through which
it manages performance and allocates resources across the consolidated Lloyds Banking Group.
Geographical areas
The Group’s activities are focused in the UK and the analyses of income and assets below are based on the location of the branch or entity recording the income
or assets.
2012 2011
UK Non-UK Total UK Non-UK Total
£m £m £m £m £m £m
There was no individual non-UK country contributing more than 5 per cent of total income or total assets.
Weighted average
effective interest rate
2012 2011 2012 2011
% % £m £m
Included within interest and similar income is £889 million (2011: £1,041 million) in respect of impaired financial assets. Net interest income also includes a
credit of £269 million (2011: a charge of £373 million) transferred from the cash flow hedging reserve (see note 47).
34
HBOS plc
2012 2011
£m £m
As discussed in note 2d, fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in note 5. Fees
and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown in note 7.
2012 2011
£m £m
Securities and other gains (losses) comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows:
2012 2011
£m £m
Net income (expense) arising on assets held at fair value through profit or loss:
Debt securities, loans and advances 501 504
Equity shares 2,857 (1,038)
Total net income (expense) arising on assets held at fair value through profit or loss 3,358 (534)
Net gains (losses) on financial instruments held for trading 190 (857)
Securities and other gains (losses) 3,548 (1,391)
35
HBOS plc
2012 2011
£m £m
Life insurance
Gross premiums 61 1,441
Ceded reinsurance premiums (25) (104)
Net earned premiums 36 1,337
Non-life insurance
Gross written premiums – 320
Ceded reinsurance premiums – (3)
Net written premiums – 317
Change in provision for unearned premiums (note 36(2)) – 16
Change in provision for ceded unearned premiums (note 36(2)) – (13)
Net earned premiums – 320
Total net earned premiums 36 1,657
2012 2011
£m £m
2012 2011
£m £m
Credit protection – 74
Home – 246
Gross written premiums – 320
2012 2011
£m £m
During December 2011, the Lloyds Banking Group completed the exchange of certain subordinated debt securities issued by Lloyds TSB Bank plc and the
Company for new subordinated debt securities issued by Lloyds TSB Bank plc by undertaking an exchange offer on certain securities which were eligible for call
before 31 December 2012. This exchange resulted in a gain for the Group on extinguishment of the existing securities of £610 million being the difference
between the carrying amount of the securities extinguished and the fair value of the new securities issued together with related fees and costs.
36
HBOS plc
2012 2011
£m £m
Non-life insurance
Claims and claims paid:
Gross – 158
Reinsurers’ share – (3)
– 155
Change in liabilities (note 36(2)):
Gross – (42)
Reinsurers’ share – 8
– (34)
Total non-life insurance – 121
Total insurance claims 2,985 975
Life insurance and participating investment contract gross claims can also be analysed as follows:
Deaths 10 239
Maturities 7 244
Surrenders 20 1,689
Annuities – 89
Other 11 134
Total life insurance gross claims 48 2,395
37
HBOS plc
2012 2011
£m £m
Staff costs:
Salaries 1,360 1,723
Social security costs 128 162
Pensions and other post-retirement benefit schemes (note 41):
Past service credits and curtailment gain1 (258) –
Other 184 182
(74) 182
Restructuring costs – 62
Other staff costs 96 90
1,510 2,219
Premises and equipment:
Rent and rates 196 264
Hire of equipment 2 3
Repairs and maintenance 29 37
Other 142 156
369 460
Other expenses:
Communications and data processing 245 263
Advertising and promotion 106 159
Professional fees 31 88
Financial services compensation scheme levy (note 52) 104 86
Other 627 625
1,113 1,221
Depreciation and amortisation:
Depreciation of tangible fixed assets (note 30) 236 326
Amortisation of acquired value of in-force non-participating investment contracts (note 28) 7 11
Amortisation of other intangible assets (note 29) 14 18
257 355
Impairment of tangible fixed assets (note 30) – 65
Total operating expenses, excluding regulatory provisions 3,249 4,320
Regulatory provisions:
Payment protection insurance provision (note 43) 850 1,155
Other regulatory provisions (note 43) 189 –
1,039 1,155
Total operating expenses 4,288 5,475
1Following
a review of policy in respect of discretionary pension increases in relation to the Group’s defined benefit pension schemes, increases in certain schemes are now linked to the
Consumer Price Index rather than the Retail Price Index. The impact of this change is a reduction in the Group’s defined benefit obligation of £258 million, recognised in the Group’s
income statement in 2012.
38
HBOS plc
2012 2011
UK 45,716 50,340
Overseas 1,104 1,689
Total 46,820 52,029
2012 2011
£m £m
Fees payable for the audit of the Company’s current year annual report 0.6 0.6
Fees payable for other services:
Audit of the Company’s subsidiaries pursuant to legislation 6.0 8.2
Other services supplied pursuant to legislation 0.7 1.0
Other services – audit related fees 0.1 0.4
Taxation compliance services – 0.1
All other taxation advisory services 0.1 0.5
Services relating to corporate finance transactions – 0.5
All other services 0.2 0.5
Total fees payable to the Company’s auditors by the Group 7.7 11.8
During the year, the auditors also earned fees payable by entities outside the consolidated Group in respect of the following:
2012 2011
£m £m
12 Impairment
2012 2011
£m £m
39
HBOS plc
The Group’s share of results of and investments in joint ventures and associates comprises:
During 2012, the Group recognised a net £10 million (2011: £8 million) of losses of associates not previously recognised. The Group’s unrecognised share of
losses of joint ventures is £126 million in 2012 (2011: £85 million in respect of joint ventures and £8 million in respect of associates). For entities making
losses, subsequent profits earned are not recognised until previously unrecognised losses are extinguished. The Group’s unrecognised share of losses net of
unrecognised profits on a cumulative basis of associates is £31 million (2011: £56 million) and of joint ventures is £329 million (2011: £299 million).
The Group’s principal joint venture investment at 31 December 2012 was in Sainsbury’s Bank plc; the Group owns 50 per cent of the ordinary share capital of
Sainsbury’s Bank plc, whose business is banking and principal area of operation is the UK. Sainsbury’s Bank plc is incorporated in the UK and the Group’s
interest is held by a subsidiary.
Where entities have statutory accounts drawn up to a date other than 31 December management accounts are used when accounting for them by the Group.
In July 2011, the Lloyds Banking Group completed a restructuring of the legal ownership of its insurance businesses, as a result of which the Group's subsidiary,
HBOS Insurance & Investment Group Limited, sold its wholly owned life, pensions and general insurance subsidiaries to Lloyds TSB General Insurance Holdings
Limited and Scottish Widows Financial Services Holdings Limited, which are also wholly owned by Lloyds TSB Bank plc for a total consideration of £3,013 million.
This resulted in a consolidated loss on disposal of £1,739 million in the year ended 31 December 2011.
40
HBOS plc
15 Taxation
UK corporation tax:
Current tax on profit (loss) for the year 157 322
Adjustments in respect of prior years 170 (95)
327 227
Foreign tax:
Current tax on profit (loss) for the year (25) (23)
Adjustments in respect of prior years (7) 19
(32) (4)
Current tax credit 295 223
The tax (charge) credit for 2012 is based on a UK corporation tax rate of 24.5 per cent (2011: 26.5 per cent).
2012 2011
£m £m
41
HBOS plc
16 Trading and other financial assets at fair value through profit or loss of the Group
2012 2011
£m £m
2012 2011
Other financial Other financial
assets at fair value assets at fair value
through profit through profit
Trading assets or loss Trading assets or loss
£m £m £m £m
At 31 December 2012 £38,591 million (2011: £28,113 million) of trading and other financial assets at fair value through profit or loss had a contractual
residual maturity of greater than one year.
Other financial assets at fair value through profit or loss include financial assets backing insurance contracts and investment contracts of £29,765 million
(2011: £23,474 million) which are so designated because the related liabilities either have cash flows that are contractually based on the performance of the
assets or are contracts whose measurement takes account of current market conditions and where significant measurement inconsistencies would otherwise
arise.
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £28,993 million for the Group
(2011: £18,729 million). Collateral is held with a fair value of £33,946 million for the Group (2011: £23,655 million), all of which the Group is able to
repledge. At 31 December 2012, £30,191 million had been repledged by the Group (2011: £20,055 million).
For amounts included above which are subject to repurchase agreements see note 54.
–– Customer driven, where derivatives are held as part of the provision of risk management products to Group customers;
–– To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by
the Group is to utilise a combination of fair value and cash flow hedge approaches as described in note 54; and
–– Derivatives held in policyholders funds as permitted by the investment strategies of those funds.
Derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under IAS 39. Derivatives are held at fair
value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using
reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 53.
–– Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to
exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts.
Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal
amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of
interest on a future loan or deposit, for a specified period and commencing on a specified future date.
42
HBOS plc
The fair values and notional amounts of derivative instruments are set out in the following table:
2012 2011
Contract/ Contract/
notional Fair value Fair value notional Fair value Fair value
amount assets liabilities amount assets liabilities
Group £m £m £m £m £m £m
Trading
Exchange rate contracts:
Spot, forwards and futures 543 36 44 1,294 112 55
Currency swaps 35,785 828 806 55,004 1,595 996
Options purchased 139 3 – 56 1 –
Options written 51 – – 138 – 4
36,518 867 850 56,492 1,708 1,055
Interest rate contracts:
Interest rate swaps 454,087 23,293 24,646 496,685 23,026 23,666
Forward rate agreements 9,902 12 14 203,645 80 66
Options purchased 8,866 764 – 11,629 823 –
Options written 11,268 – 889 14,143 – 1,002
Futures 44,548 – 1 113,213 – –
528,671 24,069 25,550 839,315 23,929 24,734
Credit derivatives 435 – 57 204 10 75
Equity and other contracts 7,241 996 766 6,890 1,018 811
Total derivative assets/liabilities held for trading 572,865 25,932 27,223 902,901 26,665 26,675
Hedging
Derivatives designated as fair value hedges:
Interest rate swaps 42,602 4,713 491 35,757 4,165 581
Cross currency swaps 27,299 450 219 19,100 557 138
69,901 5,163 710 54,857 4,722 719
Derivatives designated as cash flow hedges:
Interest rate swaps 111,889 4,745 3,745 161,463 4,690 5,901
Cross currency swaps 2,704 14 32 25,732 176 90
Options – – – – – –
Futures 49,527 1 – 103,467 – –
164,120 4,760 3,777 290,662 4,866 5,991
Derivatives designated as net investment hedges:
Cross currency swaps – – – – – –
Total derivative assets/liabilities held
for hedging 234,021 9,923 4,487 345,519 9,588 6,710
Total recognised derivative assets/liabilities 806,886 35,855 31,710 1,248,420 36,253 33,385
43
HBOS plc
0-1 years 1-2 years 2-3 years 3-4 years 4-5 years 5-10 years 10-20 years Over 20 years Total
2012 £m £m £m £m £m £m £m £m £m
Hedged forecast cash flows
expected to occur:
Forecast receivable cash flows 73 123 248 206 88 243 76 119 1,176
Forecast payable cash flows (101) (60) (42) (53) (57) (405) (456) (30) (1,204)
0-1 years 1-2 years 2-3 years 3-4 years 4-5 years 5-10 years 10-20 years Over 20 years Total
2011 £m £m £m £m £m £m £m £m £m
Hedged forecast cash flows
expected to occur:
Forecast receivable cash flows 52 140 377 277 136 260 5 28 1,275
Forecast payable cash flows (154) (173) (94) (65) (28) (119) (409) (55) (1,097)
There were no transactions for which cash flow hedge accounting had to be ceased in 2012 or 2011 as a result of the highly probable cash flows no longer
being expected to occur.
At 31 December 2012 £31,907 million of total recognised derivative assets of the Group and £29,447 million of total recognised derivative liabilities of the
Group (2011: £32,892 million of assets and £30,209 million of liabilities) had a contractual residual maturity of greater than one year.
2012 2011
Contract/ Contract/
notional Fair value Fair value notional Fair value Fair value
amount assets liabilities amount assets liabilities
Company £m £m £m £m £m £m
Hedging
Derivatives designated as fair value hedges:
Currency swaps 6,478 1,430 – 5,600 1,715 10
Interest rate swaps 597 135 10 508 142 –
Total recognised derivative assets/liabilities,
held for hedging 7,075 1,565 10 6,108 1,857 10
At 31 December 2012 £1,564 million of total recognised derivative assets of the Company and £nil of total recognised derivative liabilities of the Company
(2011: £1,687 million of assets and £nil of liabilities) had a contractual residual maturity of greater than one year.
The principal amount of a contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a
positive value to the Group and the Company should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques
such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 54.
2012 2011
£m £m
No allowance for impaired loans was carried against these exposures at 31 December 2012 or 31 December 2011.
44
HBOS plc
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £83 million
(2011: £2,950 million). Collateral is held with a fair value of £83 million (2011: £2,950 million), all of which the Group is able to repledge.
2012 2011
£m £m
At 31 December 2012 £276,042 million (2011: £290,167 million) of loans and advances to customers had a contractual residual maturity of greater than
one year.
Included in the amounts reported above are reverse repurchase agreements treated as collateralised loans with a carrying value of £nil (2011: £14,250 million).
Collateral is held with a fair value of £nil (2011: £14,254 million), all of which the Group is able to repledge.
Included in the amounts reported above are collateral balances in the form of cash provided in respect of reverse repurchase agreements amounting to £2 million
(2011: £34 million).
Loans and advances to customers include finance lease receivables, which may be analysed as follows:
2012 2011
£m £m
2012 2011
£m £m
45
HBOS plc
The unguaranteed residual values included in finance lease receivables were as follows:
2012 2011
£m £m
Securitisation programmes
Loans and advances to customers and debt securities classified as loans and receivables include loans securitised under the Group’s securitisation programmes,
the majority of which have been sold by subsidiary companies to bankruptcy remote special purpose entities (SPEs). As the SPEs are funded by the issue of
debt on terms whereby the majority of the risks and rewards of the portfolio are retained by the subsidiary, the SPEs are consolidated fully and all of these loans
are retained on the Group’s balance sheet, with the related notes in issue included within debt securities in issue. In addition to the SPEs described below, the
Group sponsors a conduit programme, Grampian (note 21).
The Group’s principal securitisation and covered bond programmes, together with the balances of the advances subject to these arrangements and the carrying
value on the notes in issue at 31 December, are listed below. The notes in issue are reported in note 35.
2012 2011
Loans and Loans and
advances Notes advances Notes
securitised in issue securitised in issue
£m £m £m £m
Securitisation programmes
UK residential mortgages 44,647 32,201 91,246 68,425
US residential mortgage-backed securities 3,909 5,237 4,659 6,351
Irish residential mortgages 5,194 3,509 5,531 5,661
Credit card receivables 7,001 3,794 6,792 4,810
Dutch residential mortgages 4,551 4,692 4,960 4,817
Commercial loans 675 675 680 631
Motor vehicle loans 1,039 1,086 1,573 1,341
67,016 51,194 115,441 92,036
Less held by the Group (33,570) (65,118)
Total securitisation programmes (note 35) 17,624 26,918
Cash deposits of £12,710 million (2011: £13,381 million) held by the Group are restricted in use to repayment of the debt securities issued by the SPEs,
covered bonds issued by Bank of Scotland plc and other legal obligations.
46
HBOS plc
In addition to the SPEs discussed in note 20, which are used for securitisation and covered bond programmes, the Group sponsors an asset-backed conduit,
Grampian, which invests in debt securities. All the external assets in this conduit are consolidated in the Group's financial statements. The total consolidated
exposures in this conduit are set out in the table below:
2012 2011
£m £m
2012 2011
£m £m
Asset-backed securities:
Mortgage-backed securities 4,280 7,258
Other asset-backed securities 416 4,738
Corporate and other debt securities 271 428
Total debt securities classified as loans and receivables before allowance for impairment losses 4,967 12,424
Allowance for impairment losses (note 23) (988) (1,148)
Total debt securities classified as loans and receivables 3,979 11,276
At 31 December 2012, £3,872 million (2011: £11,065 million) of debt securities classified as loans and receivables of the Group had a contractual residual
maturity of greater than one year.
For amounts included above which are subject to repurchase agreements see note 54.
Loans and
advances to
customers Debt securities Total
£m £m £m
Balance at 1 January 2011 25,316 1,291 26,607
Exchange and other adjustments (385) 11 (374)
Advances written off (8,428) (222) (8,650)
Recoveries of advances written off in previous years 58 8 66
Unwinding of discount (171) – (171)
Charge to the income statement (note 12) 6,961 60 7,021
At 31 December 2011 23,351 1,148 24,499
Exchange and other adjustments (305) (41) (346)
Advances written off (9,572) (151) (9,723)
Recoveries of advances written off in previous years 484 15 499
Unwinding of discount (329) – (329)
Charge to the income statement (note 12) 4,252 17 4,269
At 31 December 2012 17,881 988 18,869
Of the Group’s total allowance in respect of loans and advances to customers, £16,726 million (2011: £21,876 million) related to lending that had been
determined to be impaired (either individually or on a collective basis) at the reporting date. Of the total allowance in respect of loans and advances to customers,
£3,724 million (2011: £4,075 million) was assessed on a collective basis.
47
HBOS plc
2012 2011
£m £m
Debt securities:
Government securities 113 163
Bank and building society certificates of deposit 25 32
Asset-backed securities:
Mortgage-backed securities 882 789
Other asset-backed securities 306 83
Corporate and other debt securities 4,256 7,550
5,582 8,617
Equity shares 470 1,881
Total available-for-sale financial assets 6,052 10,498
At 31 December 2012 £4,997 million (2011: £8,457 million) of available-for-sale financial assets had a contractual residual maturity of greater than one year.
For amounts included above which are subject to repurchase agreements see note 54.
All assets have been individually assessed for impairment. The criteria used to determine whether an impairment loss has been incurred are disclosed in note
2h(2). At 31 December 2012 no available-for-sale debt securities have been individually determined to be impaired (2011: gross amount before impairment
allowances £2 million, in respect of which no collateral was held).
2012 2011
£m £m
The investment properties are valued at least annually at open-market value, by independent, professionally qualified valuers, who have recent experience in
the location and categories of the investment properties being valued.
In addition, the following amounts have been recognised in the income statement:
2012 2011
£m £m
Capital expenditure contracted for at the balance sheet date but not recognised in the financial statements – 6
48
HBOS plc
2012 2011
£m £m
The principal group undertakings, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of
HBOS plc, are:
Company’s interest in
Share ordinary share capital
class and voting rights Country of incorporation Principal business
Bank of Scotland plc Ordinary 100% UK Banking, financial and related services
HBOS Insurance & Investment Group Limited Ordinary 100% UK Investment holding
The principal area of operation for each of the above group undertakings is the United Kingdom.
In November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received, Lloyds Banking Group plc
agreed to suspend the payment of coupons and dividends on certain Group preference shares and preferred securities for the two year period from 31 January 2010
to 31 January 2012. Lloyds Banking Group plc also agreed to temporarily suspend and/or waive dividend payments on certain preference shares which have
been issued intra-group. Consequently, in accordance with the terms of some of these instruments, subsidiaries could have been prevented from making
dividend payments on ordinary shares during this period. In addition, certain subsidiary companies currently have insufficient distributable reserves to make
dividend distributions.
Subject to the foregoing, there were no further significant restrictions on any of the Company’s subsidiaries in paying dividends or repaying loans and advances.
All regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may impact those subsidiaries’ ability
to make payments.
27 Goodwill
2012 2011
£m £m
1For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. This compares the recoverable amount, being the higher of a
cash‑generating unit’s fair value less costs to sell and its value in use, with the carrying value. When this indicates that the carrying value is not recoverable it
is written down through the income statement as goodwill impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash
generating unit; of the total balance of £859 million (2011: £859 million), £478 million (or 55 per cent of the total) has been allocated to insurance and
investment businesses and £356 million (or 41 per cent of the total) to retail banking activities.
The recoverable amount of goodwill carried at 31 December 2012 has been based upon value in use. This calculation uses cash flow projections based upon
the five year business plan where the main assumptions used for planning purposes relate to the current economic outlook and opinions in respect of economic
growth, unemployment, property markets, interest rates and credit quality. Cash flows for the period subsequent to the term of the business plan are not
considered for the purposes of impairment testing. The discount rate used in discounting the projected cash flows is 11 per cent (post-tax) reflecting, inter alia,
the perceived risks within those businesses. Management believes that any reasonably possible change in the key assumptions would not cause the recoverable
amount to fall below the balance sheet carrying value.
49
HBOS plc
The gross value of in-force business asset in the consolidated balance sheet is as follows:
2012 2011
£m £m
The movement in the acquired value of in-force non-participating investment contracts over the year is as follows:
2012 2011
£m £m
The movement in the value of in-force insurance and participating investment contracts over the year is as follows:
2012 2011
£m £m
At 1 January 42 3,035
Exchange and other adjustments – 48
New business – 108
Existing business:
Expected return (5) (168)
Experience variances – (30)
Non-economic assumption changes – 51
Economic variance – 48
Movement in the value of in-force business taken to income statement (note 9) (5) 9
Disposal of businesses (note 14) – (3,050)
At 31 December 37 42
This breakdown shows the movement in the value of in-force business only, and does not represent the full contribution that each item in the breakdown
contributes to profit before tax. This will also contain changes in the other assets and liabilities, including the effects of changes in assumptions used to value
liabilities, of the relevant businesses. Economic variance is the element of earnings which is generated from changes to economic experience in the period and
to economic assumptions over time. The presentation of economic variance includes the impact of financial market conditions being different at the end of the
reporting period from those included in assumptions used to calculate new and existing business returns.
The principal features of the methodology and process used for determining key assumptions used in the calculation of the value of in-force business are set
out below:
Economic assumptions
Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets. In practice, to achieve the same result,
where the cash flows are either independent of or move linearly with market movements, a method has been applied known as the ‘certainty equivalent’
approach whereby it is assumed that all assets earn a risk-free rate and all cash flows are discounted at a risk-free rate.
A market-consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to
be consistent with the market price of relevant options at each valuation date. The risk-free rate used for the value of financial options and guarantees is defined
as the spot yield derived from the relevant government bond yield curve in line with FSA realistic balance sheet assumptions.
The risk-free rate assumed in valuing the non-annuity in-force business is the 15 year government bond yield for the appropriate territory.
50
HBOS plc
2012 2011
% %
Non-market risk
An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected
financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk, reinsurer default and
the with-profit funds there are asymmetries in the range of potential outcomes for which an explicit allowance is made.
Non-economic assumptions
Future mortality, morbidity, expenses, lapse and paid-up rate assumptions are reviewed each year and are based on an analysis of past experience and on
management’s view of likely future experience.
Maintenance expenses
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs. Explicit
allowance is made for future expense inflation.
These assumptions are intended to represent a best estimate of future experience, and further information about the effect of changes in key assumptions is
given in note 37.
51
HBOS plc
Capitalised
software
Brands enhancements Total
Group £m £m £m
Cost:
At 1 January 2011 24 303 327
Exchange and other adjustments – 6 6
Additions – 35 35
Disposals – (12) (12)
Disposal of businesses (note 14) – (30) (30)
At 31 December 2011 24 302 326
Additions – 45 45
Disposals – (76) (76)
At 31 December 2012 24 271 295
Accumulated amortisation:
At 1 January 2011 24 229 253
Exchange and other adjustments – (1) (1)
Charge for the year (note 11) – 18 18
Disposals – (12) (12)
Disposal of businesses (note 14) – (8) (8)
At 31 December 2011 24 226 250
Exchange and other adjustments – 4 4
Charge for the year (note 11) – 14 14
Disposals – (76) (76)
At 31 December 2012 24 168 192
Balance sheet amount at 31 December 2012 – 103 103
Balance sheet amount at 31 December 2011 – 76 76
Brands
Company £m
Cost:
At 1 January 2011 10
At 31 December 2011 10
At 31 December 2012 10
Accumulated amortisation:
At 1 January 2011 10
At 31 December 2011 10
At 31 December 2012 10
Balance sheet amount at 31 December 2012 –
Balance sheet amount at 31 December 2011 –
Capitalised software enhancements principally comprise identifiable and directly associated internal staff and other costs.
52
HBOS plc
At 31 December the future minimum rentals receivable by the Group under non-cancellable operating leases were as follows:
2012 2011
£m £m
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2012 and 2011 no contingent rentals in
respect of operating leases were recognised in the income statement.
In addition, total future minimum sub-lease income of £nil at 31 December 2012 (2011: £nil) is expected to be received under non-cancellable sub-leases of
the Group’s premises.
53
HBOS plc
Group Company
2012 2011 2012 2011
£m £m £m £m
2012 2011
Deferred acquisition costs of the Group: £m £m
2012 2011
£m £m
At 31 December 2012 £146,769 million (2011: £120,160 million) of deposits from banks had a contractual residual maturity of greater than one year.
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £15,845 million (2011: £28,040 million)
and a fair value of £14,427 million (2011: £28,180 million).
Included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting to £4 million
(2011: £nil).
2012 2011
£m £m
Non-interest bearing current accounts 11,955 11,204
Interest bearing current accounts 19,788 26,093
Savings and investment accounts 161,059 147,004
Liabilities in respect of securities sold under repurchase agreements – 3,662
Other customer deposits 24,713 29,085
Total customer deposits 217,515 217,048
At 31 December 2012 £53,284 million (2011: £41,670 million) of customer deposits had a contractual residual maturity of greater than one year.
Included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £262 million (2011: £5,306 million) and
a fair value of £268 million (2011: £5,655 million).
Included in the amounts reported above are collateral balances in the form of cash provided in respect of repurchase agreements amounting to £192 million
(2011: £323 million).
54
HBOS plc
2012 2011
£m £m
At 31 December 2012 £7,848 million (2011: £5,937 million) of trading liabilities had a contractual residual maturity of greater than one year.
2012 2011
£m £m
At 31 December 2012 £39,895 million (2011: £59,830 million) of debt securities in issue had a contractual residual maturity of greater than one year.
36 Liabilities arising from insurance contracts and participating investment contracts
The movement in these life insurance contract and participating investment contract liabilities over the year can be analysed as follows:
Participating
Insurance investment
contracts contracts Gross Reinsurance Net
£m £m £m £m £m
At 1 January 2011 34,440 4,984 39,424 (1,546) 37,878
Exchange and other adjustments (15) (2) (17) 2 (15)
New business 803 4 807 (164) 643
Changes in existing business (1,185) (459) (1,644) (23) (1,667)
Change in liabilities charged to the income statement (note 10) (382) (455) (837) (187) (1,024)
Disposal of business (note 14) (33,658) (4,527) (38,185) 1,693 (36,492)
At 31 December 2011 385 – 385 (38) 347
Exchange and other adjustments
New business – – – – –
Changes in existing business 38 – 38 (4) 34
Change in liabilities charged to the income statement (note 10) 38 – 38 (4) 34
At 31 December 2012 423 – 423 (42) 381
Liabilities for life insurance contracts and participating investment contracts at 31 December 2011 and 2012 related to non-profit fund liabilities, accounted for
using a prospective actuarial discounted cash flow methodology, as follows:
Unit-linked business – This includes unit-linked pensions and unit-linked bonds, the primary purpose of which is to provide an investment vehicle where the
policyholder is also insured against death.
Life insurance – The policyholder is insured against death or permanent disability, usually for predetermined amounts. Such business includes whole of life and
term assurance and long-term creditor policies.
55
HBOS plc
36 Liabilities arising from insurance contracts and participating investment contracts (continued)
(ii) Method of calculation of liabilities
The non-profit fund liabilities are determined on the basis of recognised actuarial methods and consistent with the approach required by regulatory rules.
The methods used involve estimating future policy cash flows over the duration of the in-force book of policies, and discounting the cash flows back to the
valuation date allowing for probabilities of occurrence.
(iii) Assumptions
Generally, assumptions used to value non-profit fund liabilities are prudent in nature and therefore contain a margin for adverse deviation. This margin for adverse
deviation is based on management’s judgement and reflects management’s views on the inherent level of uncertainty. The key assumptions used in the
measurement of non-profit fund liabilities are:
Interest rates
The rates used are derived in accordance with the guidelines set by local regulatory bodies. These limit the rates of interest that can be used by reference to a
number of factors including the redemption yields on fixed interest assets at the valuation date.
Margins for risk are allowed for in the assumed interest rates. These are derived from the limits in the guidelines set by local regulatory bodies, including
reductions made to the available yields to allow for default risk based upon the credit rating of the securities allocated to the insurance liability.
Mortality and morbidity
The mortality and morbidity assumptions, are set with regard to the Group’s actual experience where this provides a reliable basis, and relevant industry data
otherwise, and include a margin for adverse deviation.
Lapse rates (persistency)
Lapse rates are allowed for on some non-profit fund contracts. Lapse rates refer to the rate of policy termination or the rate at which policyholders stop paying
regular premiums due under the contract.
Historical persistency experience is analysed using statistical techniques. As experience can vary considerably between different product types and for contracts
that have been in force for different periods, the data is broken down into broadly homogenous groups for the purpose of this analysis.
The most recent experience is considered along with the results of previous analyses and management’s views on future experience, taking into consideration
potential changes in future experience that may result from guarantees and options becoming more valuable under adverse market conditions, in order to
determine a ‘best estimate’ view of what persistency will be. In determining this best estimate view a number of factors are considered, including the credibility
of the results (which will be affected by the volume of data available), any exceptional events that have occurred during the period under consideration, any
known or expected trends in underlying data and relevant published market data. Prudent scenario is assumed by the inclusion of a margin for adverse deviation
within the non-profit fund liabilities.
Maintenance expenses
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs plus a
margin for adverse deviation. Explicit allowance is made for future expense inflation.
Key changes in assumptions
A detailed review of the Group’s assumptions in 2011 resulted in no significant impacts on profit before tax. This takes into account the impacts of movements
in liabilities and the value of in-force business in respect of insurance contracts and participating investment contracts.
With-profit fund realistic liabilities
In July 2011 the Group disposed of its with-profit fund within Clerical Medical Investment Group Limited.
(2) Non-life insurance
The Group’s non-life insurance contract liabilities all arose in businesses sold in 2011 (see note 14).
The movements in non-life insurance contract liabilities and reinsurance assets over 2011 were as follows:
Gross Reinsurance Net
£m £m £m
Claims outstanding
At 1 January 2011 323 (13) 310
Cash paid for claims settled in the year (161) 24 (137)
Increase (decrease) in liabilities:
Arising from current year claims 123 (13) 110
Arising from prior year claims (4) (3) (7)
Change in liabilities charged to income statement (note 10) (42) 8 (34)
Disposal of businesses (note 14) (281) 5 (276)
At 31 December 2011 – – –
56
HBOS plc
The following table demonstrates the effect of changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that
the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include
movements in assets, liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts. The impact is
shown in one direction but can be assumed to be reasonably symmetrical.
Following the sale of the Group’s wholly-owned life and pensions subsidiaries in 2011 (see note 14) the Group’s insurance activities are no longer significant.
Increase
(reduction) Increase
in profit (reduction)
before tax in equity
31 December 2012 Change in variable £m £m
Non-annuitant mortality 1
5% reduction – –
Lapse rates2 10% reduction – –
Future maintenance and investment expenses3 10% reduction – –
Risk-free rate4 0.25% reduction – –
Increase
(reduction) Increase
in profit (reduction)
before tax in equity
31 December 2011 Change in variable £m £m
Non-annuitant mortality1 5% reduction 1 1
Lapse rates 2
10% reduction (3) (2)
Future maintenance and investment expenses3 10% reduction – –
Risk-free rate4 0.25% reduction (1) (1)
Assumptions have been flexed on the basis used to calculate the value of in-force business and the realistic and statutory reserving bases.
1This sensitivity shows the impact on the annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
2This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.
3This sensitivity shows the impact of reducing maintenance expenses and investment expenses to 90 per cent of the expected rate.
4This
sensitivity shows the impact on the value of in-force business, financial options and guarantee costs, statutory reserves and asset values of reducing the risk-free rate by
25 basis points.
The movement in liabilities arising from non-participating investment contracts may be analysed as follows:
57
HBOS plc
The movement in the unallocated surplus within long-term insurance businesses, which all arose in businesses sold in 2011 (see note 14), over 2011 was
analysed as follows:
2012 2011
£m £m
At 1 January – 321
Exchange and other adjustments – 2
Change in unallocated surplus recognised in the income statement (note 10) – 41
Disposal of businesses (note 14) – (364)
At 31 December – –
Group Company
2012 2011 2012 2011
£m £m £m £m
2012 2011
£m £m
1In2012, there was a credit of £258 million following the Group’s decision to link discretionary pension increases in the HBOS Final Salary Pension Scheme to the Consumer Price
Index (see note 11).
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
58
HBOS plc
The latest full valuation of the HFSPS was carried out as at 30 June 2011; the results have been updated to 31 December 2012 by qualified independent
actuaries. The last full valuations of other Group schemes were carried out on a number of different dates by qualified independent actuaries.
The Group’s obligations in respect of its defined benefit schemes are funded.
The Group currently expects to pay contributions of approximately £300 million to its defined benefit schemes in 2013.
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
59
HBOS plc
2012 2011
Years Years
The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted
in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 as at 31 December 2012 is assumed to live for,
on average, 26.9 years for a male and 29.4 years for a female. In practice there will be much variation between individual members but these assumptions are
expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the
expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement
assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
Sensitivity analysis
The effect of changes in key assumptions on the pension charge in the Group’s income statement and on the net defined benefit pension scheme asset is set
out below:
Inflation1:
Increase of 0.2 per cent 3 3 (267) (284)
Decrease of 0.2 per cent – (3) 216 274
Discount rate : 2
1At 31 December 2012, the assumed rate of inflation is 2.90 per cent (2011: 3.00 per cent)
2At 31 December 2012, the assumed discount rate is 4.60 per cent (2011: 5.00 per cent)
60
HBOS plc
The expected return on scheme assets in 2013 will be calculated using the following assumptions:
2013
%
With effect from 1 January 2013 the Group will adopt amendments to IAS 19 Employee Benefits. These amendments will change the calculation of the Group’s
defined benefit schemes’ income statement expense, replacing expected return on plan assets and interest cost with a net interest amount that is calculated by
applying the discount rate to the net defined benefit liability (asset) (see note 57 on page 112). The above expected return on plan assets will be used in
determining the effect of this new accounting policy on the Group’s 2013 income statement expense.
Group Company
2012 2011 2012 2011
£m £m £m £m
The assets of all the funded plans are held independently of the Group’s assets in separate trustee administered funds.
The expected return on plan assets was determined by considering the expected returns available on the assets underlying the current investment policy.
Expected yields on fixed interest investments are based on gross redemption yields at the balance sheet date at a term and credit rating broadly appropriate for
the bonds held. Expected returns on equity and property investment are long-term rates based on the views of the plan’s independent investment consultants.
The expected return on equities allows for the different expected returns from the private equity, infrastructure and hedge fund investments held by some of the
funded plans. Some of the funded plans also invest in certain money market instruments and the expected return on these investments has been assumed to
be the same as cash.
Experience adjustments history for the HFSPS and other schemes (since the date of adoption of IAS 19):
Present value of defined benefit obligation (9,881) (8,999) (8,382) (8,276) (6,709) (7,623)
Fair value of scheme assets 10,498 9,881 8,483 7,442 7,241 7,329
Surplus (deficit) 617 882 101 (834) 532 (294)
Experience (losses) gains on scheme liabilities 797 (19) (32) 38 (22) (95)
Experience gains (losses) on scheme assets 96 823 330 (176) (615) 76
61
HBOS plc
2012 2011
£m £m
Following a review of policy in respect of discretionary pension increases in relation to the Group’s defined benefit pension schemes, increases in the HFSPS are
now linked to the Consumer Price Index rather than the Retail Price Index. The impact of this change is a reduction in the Group’s defined benefit obligation of
£258 million, recognised in the Group’s income statement in 2012.
During the year ended 31 December 2012 the charge to the income statement in respect of defined contribution schemes was £76 million (2011: £101 million),
representing the contributions payable by the employer in accordance with each scheme’s rules.
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 4 November 2009; this valuation has been
updated to 31 December 2012 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in
healthcare premiums has been assumed at 4.60 per cent (2011: 5.00 per cent).
62
HBOS plc
Group Company
2012 2011 2012 2011
The movement in the net deferred tax balance is as follows: £m £m £m £m
The statutory position reflects the deferred tax assets and liabilities as disclosed in the consolidated balance sheet and takes account of the inability to offset
assets and liabilities where there is no legally enforceable right of offset. The tax disclosure of deferred tax assets and liabilities ties to the amounts outlined in
the table below which splits the deferred tax assets and liabilities by type.
Group Company
2012 2011 2012 2011
£m £m £m £m
Statutory position
Deferred tax asset 3,445 3,977 – –
Deferred tax liability (69) (1) (207) (82)
Net deferred tax asset (liability) 3,376 3,976 (207) (82)
Tax disclosure
Deferred tax asset 4,386 4,668 1 –
Deferred tax liability (1,010) (692) (208) (82)
Net deferred tax asset (liability) 3,376 3,976 (207) (82)
The deferred tax charge in the consolidated income statement comprises the following temporary differences:
2012 2011
£m £m
63
HBOS plc
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
On 21 March 2012, the Government announced that the corporation tax rate applicable from 1 April 2012 would be 24 per cent. This change passed into
legislation on 26 March 2012. In addition, the Finance Act 2012, which was substantively enacted on 3 July 2012, included legislation to reduce the main
rate of corporation tax from 24 per cent to 23 per cent with effect from 1 April 2013. The change in the main rate of corporation tax from 25 per cent to
23 per cent has resulted in a reduction in the Group’s net deferred tax asset at 31 December 2012 of £268 million, comprising the £300 million charge included
in the income statement and a £32 million credit included in equity.
The proposed further reduction in the rate of corporation tax by 2 per cent to 21 per cent by 1 April 2014 is expected to be enacted during 2013. The effect of
this further change upon the Group’s deferred tax balances and leasing business cannot be reliably quantified at this stage.
Deferred tax assets of £131 million for the Group and £nil for the Company (2011: £43 million for the Group and £nil for the Company) have not been
recognised in respect of capital losses carried forward as there are no predicted future capital profits to offset them. Capital losses can be carried forward
indefinitely.
Deferred tax assets of £493 million for the Group and £nil for the Company (2011: £488 million for the Group and £nil for the Company) have not been
recognised in respect of trading losses carried forward, arising in overseas companies, as there are limited predicted future trading profits to offset them. Trading
losses can be carried forward indefinitely except for losses in the USA which expire after 20 years.
In addition, deferred tax assets have not been recognised in respect of unrelieved foreign tax carried forward as at 31 December 2012 of £40 million for the
Group and £nil for the Company (2011: £40 million for the Group and £nil for the Company), as there are no predicted future taxable profits against which the
unrelieved foreign tax credits can be utilised. These tax credits can be carried forward indefinitely.
64
HBOS plc
Vacant
Payment Other leasehold
Provisions for protection regulatory property
commitments insurance provisions and other Total
£m £m £m £m £m
During the first half of 2012 there was an increase in the volume of complaints being received and, although the level of complaints has declined during
the second half of 2012, they are higher than had been anticipated at 31 December 2011. As a consequence, the Group believes that it is appropriate to
increase its provision by a further £850 million at 31 December 2012. This increases the total estimated cost of redress, including administration expenses, to
£2,005 million; redress payments made and expenses incurred on the some 300,000 claims paid to the end of December 2012 amounted to £1,254 million.
However, there are still a number of uncertainties as to the eventual redress costs, in particular the total number of complaints and the activities of claims
management companies and regulatory bodies.
The Group has calculated the provision by making a number of assumptions based upon current and expected experience. The principal sensitivities are
as follows:
–– the number of claims received: an increase of 100,000 from the level assumed would increase the provision for redress costs by £43 million;
–– uphold rate of claims reviewed: an increase of one percentage point in this assumption would increase the provision by £6 million;
–– average future redress payment: an increase of £100 in this assumption would increase the provision by £21 million.
The Group will reassess the continued appropriateness of the assumptions underlying its analysis at each reporting date in the light of current experience and
other relevant evidence.
Following the completion of a pilot review of IRHP sales to small and medium-sized businesses and agreement reached with the FSA on 30 January 2013 on
the principles to be adopted during the course of the wider review, the Group has provided £139 million for the estimated cost of redress and related
administration costs. At 31 December 2012, £10 million of the provision had been utilised. A number of uncertainties remain as to the eventual costs given the
inherent difficulties in determining the number of customers within the scope of the review and the average compensation to customers.
65
HBOS plc
Group Company
2012 2011 2012 2011
£m £m £m £m
Preference shares – – – –
Preferred securities 3,374 3,472 – –
Undated subordinated liabilities 673 759 1,997 2,071
Dated subordinated liabilities 8,444 9,382 7,024 7,247
Total subordinated liabilities 12,491 13,613 9,021 9,318
Group Company
2012 2011 2012 2011
The movement in subordinated liabilities during the year was as follows: £m £m £m £m
These securities will, in the event of the winding-up of the issuer, be subordinated to the claims of the depositors and all other creditors of the issuer, other than
creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of the specific subordinated
liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are
generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of the holders of the dated subordinated liabilities.
Neither the Group nor the Company has had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the year
(2011: none).
Group Company
2012 2011 2012 2011
Preference shares £m £m £m £m
Since 2009, the Company has had in issue 100 6% non-cumulative preference shares of £1 each. The shares are redeemable at the option of the Company
at any time, carry the rights to a fixed rate non-cumulative preferential dividend of 6% per annum; no dividend shall be paid in the event that the directors
determine that prudential capital ratios would not be maintained if the dividend were paid. Upon winding up the shares rank equally with any other preference
shares issued by the Company. The holder of the shares waived its right to payment for the period from 1 March 2010 to 1 March 2012.
Group
2012 2011
Preferred securities Note £m £m
66
HBOS plc
Group Company
2012 2011 2012 2011
Undated subordinated liabilities Note £m £m £m £m
5.625% Cumulative Callable Fixed to Floating Rate Undated
Subordinated Notes callable 2019 (£500 million) a 4 4 4 4
6.071% Undated Subordinated Fixed to Floating Rate Instruments
(US$750 million) – – 464 484
4.875% Undated Subordinated Fixed to Floating Rate Instruments
(€750 million) a 81 90 81 90
Floating Rate Undated Subordinated Notes (€500 million) a 49 53 49 53
5.375% Undated Fixed to Floating Rate Subordinated Notes
(US$1,000 million) a 9 11 9 11
5.125% Undated Subordinated Fixed to Floating Notes
(€750 million) a 59 67 59 67
5.75% Undated Subordinated Step-up Notes (£600 million) 4 4 4 4
6.85% Undated Subordinated Notes (US$1,000 million) – – 611 640
Fixed to Floating Rate Undated Subordinated Notes (£600 million) – – 604 603
6.05% Fixed to Floating Rate Undated Subordinated Notes
(€500 million) b, e 21 22 21 22
7.5% Undated Subordinated Step-up Notes (£300 million) 4 6 4 6
8.625% Perpetual Subordinated Notes (£200 million) a 23 26 – –
Floating Rate Undated Subordinated Step-up Notes (€300 million) b 32 33 32 33
Floating Rate Primary Capital Notes (US$250 million) 111 118 – –
7.375% Subordinated Undated Instruments (£150 million) a 74 78 – –
4.25% Instruments (¥17 billion) 138 174 – –
10.25% Subordinated Undated Instruments (£100 million) a 1 1 – –
12% Perpetual Subordinated Bonds (£100 million) a 22 26 – –
8.75% Perpetual Subordinated Bonds (£100 million) a 5 5 – –
13.625% Perpetual Subordinated Bonds (£75 million) a 14 17 – –
9.375% Perpetual Subordinated Bonds (£50 million) a 15 18 – –
5.75% Undated Subordinated Step-up Notes (£500 million) 7 6 7 6
4.939% Undated Fixed to Floating Rate Subordinated Notes
(€750 million) – – 34 34
Undated Perpetual Preferred Securities (£750 million) – – 14 14
Total undated subordinated liabilities 673 759 1,997 2,071
67
HBOS plc
Group Company
2012 2011 2012 2011
Dated subordinated liabilities Note £m £m £m £m
a) In November 2009, as part of the state aid restructuring plan, the Group agreed to suspend the payment of coupons on these instruments for the two year period from
31 January 2010 to 31 January 2012.
b) These securities are callable at specific dates as per the terms of the securities at the option of the issuer and with approval from the FSA. In November 2009, as part of the state
aid restructuring plan, the Group agreed not to exercise any call options on these instruments for the two year period from 31 January 2010 to 31 January 2012.
c) The fixed rate on this security was reset from 8.117 per cent to 6.059 per cent with effect from 31 May 2010.
d) The fixed rate on this security was reset from 7.627 per cent to 3 months Euribor plus 2.875 per cent with effect from 9 December 2011.
e) The fixed rate on this security was reset from 6.05 per cent to 3 months Euribor plus 2.25 per cent with effect from 23 November 2011.
f) The floating interest rate payable on these securities reset during 2012.
At 31 December 2012 £11,581 million (2011: £12,947 million) of subordinated liabilities of the Group and £8,400 million (2011: £9,318 million) of the
Company has a contractual residual maturity of greater than one year.
68
HBOS plc
Sterling
Ordinary shares of 25p 15,139,999,999 15,139,999,999 3,785 3,785
6.125% non-cumulative redeemable preference shares of £1 200,000,000 200,000,000 200 200
8.117% non-cumulative perpetual preference shares class ‘A’ of £10 each 250,000 250,000 3 3
7.754% non-cumulative perpetual preference shares class ‘B’ of £10 each 150,000 150,000 2 2
Preference shares of £1 each 2,596,834,398 2,596,834,398 2,597 2,597
6,587 6,587
69
HBOS plc
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
70
HBOS plc
Group
2012 2011
£m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
Group Company
2012 2011 2012 2011
£m £m £m £m
71
HBOS plc
Group Company
2012 2011 2012 2011
£m £m £m £m
1No income statement has been prepared for the Company as permitted by section 408 of the Companies Act 2006.
49 Dividends
In November 2009, as part of the restructuring plan that was a requirement for European Commission approval of state aid received by the Lloyds Banking
Group, Lloyds Banking Group plc agreed to suspend the payment of coupons and dividends on certain preference shares and preferred securities for the two
year period from 31 January 2010 to 31 January 2012. Lloyds Banking Group plc also agreed to temporarily suspend and/or waive dividend payments on
certain preference shares which have been issued intra-group. Consequently, in accordance with the terms of some of these instruments, the Company was
prevented from making dividend payments on its ordinary shares during this period.
The amount charged to the Group’s income statement in respect of Lloyds Banking Group share-based payment schemes, and which is included within staff
costs (note 11), was £114 million (2011: £155 million).
The performance condition was measured over a three year period which commenced at the end of the financial year preceding the grant of the option and
continued until the end of the third subsequent year. If the performance condition was not then met, it was measured at the end of the fourth financial year.
If the condition was not then met, the options would lapse.
To meet the performance conditions, the Group’s ranking against the comparator group was required to be at least ninth. The full grant of options only became
exercisable if the Group was ranked first. A performance multiplier (of between nil and 100 per cent) was applied below this level to calculate the number of
shares in respect of which options granted to Executive Directors would become exercisable, and were calculated on a sliding scale. If Lloyds Banking Group
plc was ranked below median the options would not be exercisable.
Options granted to senior executives other than Executive Directors were not so highly leveraged and, as a result, different performance multipliers were
applied to their options. For the majority of executives, options were granted with the performance condition but with no performance multiplier.
Options granted in 2004 became exercisable as the performance condition was met on the re-test. The performance condition vested at 14 per cent for
Executive Directors, 24 per cent for Managing Directors, and 100 per cent for all other executives.
72
HBOS plc
Movements in the number of share options outstanding under the executive share option schemes during 2011 and 2012 are set out below:
2012 2011
Weighted average Weighted average
Number of exercise price Number of exercise price
options (pence) options (pence)
No options were exercised during 2012 or 2011. The weighted average remaining contractual life of options outstanding at the end of the year was 1.9 years
(2011: 2.9 years). The fair values of the executive share options have been determined using a standard Black-Scholes model.
Save-As-You-Earn schemes
Eligible employees may enter into contracts through the Save-As-You-Earn schemes to save up to £250 per month and, at the expiry of a fixed term of three,
five or seven years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a discounted price
of no less than 80 per cent of the market price at the start of the invitation.
Movements in the number of share options outstanding under the SAYE schemes are set out below:
2012 2011
Weighted average Weighted average
Number of exercise price Number of exercise price
options (pence) options (pence)
No options were exercised in 2012. The weighted average share price at the time that the options were exercised during 2011 was £0.54. The weighted
average remaining contractual life of options outstanding at the end of the year was 0.8 years (2011: 1.7 years).
No SAYE options were granted in 2012 or 2011. The fair values of the SAYE options have been determined using a standard Black-Scholes model.
For the HBOS sharesave plan, no options were exercised during 2012 or 2011. The options outstanding at 31 December 2012 had an exercise price of £1.8066
(2011: £1.8066) and a weighted average remaining contractual life of 2.1 years (2011: 2.0 years).
Participants are not entitled to any dividends paid during the vesting period.
2012 2011
Weighted average Weighted average
Number of exercise price Number of exercise price
options (pence) options (pence)
The weighted average fair value of options granted in the year was £0.30 (2011: £0.46). The fair values of options granted have been determined
using a standard Black-Scholes model. The weighted average share price at the time that the options were exercised during 2012 was £0.33
(2011: £0.51). The weighted average remaining contractual life of options outstanding at the end of the year was 3.7 years (2011: 2.1 years).
73
HBOS plc
The awards were granted in recognition that the Executives’ outstanding awards over shares in their previous employing company lapsed on accepting
employment with the Group.
2012 2011
Weighted average Weighted average
Number of exercise price Number of exercise price
options (pence) options (pence)
No options were granted or exercised in 2012. The weighted average fair value of options granted during 2011 was £0.38. The weighted average share price
at the time that the options were exercised during 2011 was £0.54. The weighted average remaining contractual life of options outstanding at the end of the
year was 8.6 years (2011: 9.6 years).
Participants are entitled to any dividends paid during the vesting period. This amount will be paid in cash unless the Remuneration Committee decides it will
be paid in shares.
The fair values of the majority of options granted have been determined using a standard Black-Scholes model. The fair values of the remaining options have
been determined by Monte Carlo simulation.
Participants are not entitled to any dividends paid during the vesting period.
2012 2011
Weighted average Weighted average
Number of exercise price Number of exercise price
options (pence) options (pence)
No options were exercised during 2012 or 2011. The options outstanding under the HBOS Share Option Plan and St James’s Place Share Option Plan at
31 December 2012 had exercise prices in the range of £0.5183 to £5.80 (2011: £0.5183 to £8.7189) and a weighted average remaining contractual life
of 1.1 years (2011: 2.0 years).
Participants may be entitled to any dividends paid during the vesting period if the performance conditions are met. An amount equal in value to any dividends
paid between the award date and the date the Remuneration Committee determine that the performance conditions were met may be paid, based on the
number of shares that vest. The Remuneration Committee will determine if any dividends are to be paid in cash or in shares.
The performance conditions for awards made in April, May and September 2009 were as follows:
(i) E
arnings per share (EPS): relevant to 50 per cent of the award. Performance was measured based on EPS growth over a three-year period from the
baseline EPS of 2008.
If the growth in EPS reached 26 per cent, 25 per cent of this element of the award, being the threshold, would vest. If growth in EPS reached 36 per cent,
100 per cent of this element would vest.
74
HBOS plc
If the absolute improvement in adjusted EP reached 100 per cent, 25 per cent of this element of the award, being the threshold, would vest. If the absolute
improvement in adjusted EP reached 202 per cent, 100 per cent of this element would vest.
The EPS and EP performance measures applying to this 2009 LTIP award were set on the basis that the Group would enter into the Government Asset
Protection Scheme. As the Group did not participate in the Government Asset Protection Scheme, in June 2010 the Remuneration Committee approved restated
performance measures on a basis consistent with the EPS and EP measures used for the 2010 LTIP awards. At the end of the relevant period, neither of the
performance conditions had been met and the awards lapsed.
An additional discretionary award was made in April, May and September 2009. The performance conditions for those awards were as follows:
Synergy Savings: The release of 50 per cent of the shares was dependent on the achievement of target run‑rate synergy savings in 2009 and 2010 as
(i)
well as the achievement of sustainable synergy savings of at least £1.5 billion by the end of 2011. The award was broken down into three equally
weighted annual tranches. Performance was assessed at the end of each year against annual performance targets based on a trajectory to meet the 2011
target. The extent to which targets were achieved determined the proportion of shares to be banked each year. Any release of shares was subject to the
Remuneration Committee judging the overall success of the delivery of the integration programme.
Integration Balanced Scorecard: The release of the remaining 50 per cent of the shares was dependent on the outcome of a Balanced Scorecard of
(ii)
non-financial measures of the success of the integration in each of 2009, 2010 and 2011. The Balanced Scorecard element was broken down into three
equally weighted tranches. The tranches were crystallised and banked for each year of the performance cycle subject to separate annual performance
targets across the four measurement categories of Building the Business, Customer, Risk and People and Organisation Development.
The performance conditions were met and, as a consequence, the share awards vested in full in March 2012 for all participants, with the exception of current
and former Executive Directors.
The performance conditions for awards made in March and August 2010 were as follows:
EPS: relevant to 50 per cent of the award. Performance was measured based on EPS growth over a three-year period from the baseline
(i)
EPS of 2009.
If the absolute improvement in adjusted EPS reached 158 per cent, 25 per cent of this element of the award, being the threshold, would vest. If absolute
improvement in adjusted EPS reached 180 per cent, 100 per cent of this element would vest.
EP: relevant to 50 per cent of the award. Performance was measured based on the compound annual growth rate of adjusted EP over the three financial
(ii)
years starting on 1 January 2010 relative to an adjusted 2009 EP base.
If the compounded annual growth rate of adjusted EP reached 57 per cent per annum, 25 per cent of this element of the award, being the threshold,
would vest. If the compounded annual growth rate of adjusted EP reached 77 per cent per annum, 100 per cent of this element would vest.
For awards made to Executive Directors, a third performance condition was set, relating to Absolute Share Price, relevant to 28 per cent of the award.
Performance will be measured based on the Absolute Share Price on 26 March 2013, being the third anniversary of the award date. If the share price at the
end of the performance period is 75 pence or less, none of this element of the award will vest. If the share price is 114 pence or higher, 100 per cent of this
element will vest. Vesting between threshold and maximum will be on a straight line basis, provided that shares comprised in the Absolute Share Price element
may only be released if both the EPS and EP performance measures have been satisfied at the threshold level or above. The EPS and EP performance
conditions each relate to 36 per cent of the total award.
At the end of the performance period for the EPS and EP measures, it has been assessed that neither of the performance conditions has been met and,
therefore, the awards will not vest.
The performance conditions for awards made in March and September 2011 are as follows:
(i) EPS: relevant to 50 per cent of the award. The performance target is based on 2013 adjusted EPS outcome.
If the adjusted EPS reaches 6.4p, 25 per cent of this element of the award, being the threshold, will vest.
(ii) EP: relevant to 50 per cent of the award. The performance target is based on 2013 adjusted EP outcome.
If the adjusted EP reaches £567 million, 25 per cent of this element of the award, being the threshold, will vest. If the adjusted EP reaches £1,234 million,
100 per cent of this element will vest.
For awards made to Executive Directors, a third performance condition was set, relating to Absolute Total Shareholder Return, relevant to one third of the
award. Performance will be measured based on the annualised Absolute Total Shareholder Return over the three year performance period. If the annualised
Absolute Total Shareholder Return at the end of the performance period is less than 8 per cent, none of this element of the award will vest. If the Absolute
Total Shareholder Return is 8 per cent, 25 per cent of this element of the award, being the threshold, will vest. If the Absolute Total Shareholder Return is
14 per cent or higher, 100 per cent of this element will vest. Vesting between threshold and maximum will be on a straight line basis. The EPS and EP
performance conditions will each relate to 33.3 per cent of the total award.
75
HBOS plc
EP: relevant to 30 per cent of the award. The performance target is based on 2014 adjusted EP outcome.
(i)
If the adjusted EP reaches £160 million, 25 per cent of this element of the award, being the threshold, will vest.
If the adjusted EP reaches £1,653 million, 100 per cent of this element will vest.
(ii) A
bsolute Total Shareholder Return (ATSR): relevant to 30 per cent of the award. Performance will be measured against the annualised return over the
three year period ending 31 December 2014.
If the ATSR reaches 12 per cent per annum, 25 per cent of this element of the award, being the threshold, will vest.
If the ATSR reaches 30 per cent per annum, 100 per cent of this element will vest.
(iii) Short-term funding as a percentage of total funding: relevant to 10 per cent of the award. Performance will be measured relative to 2014 targets.
If the average percentage reaches 20 per cent, 25 per cent of this element of the award, being the threshold, will vest.
If the average percentage reaches 15 per cent, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
Non-core assets at the end of 2014: relevant to 10 per cent of the award. Performance will be measured by reference to balance sheet non‑core assets
(iv)
at 31 December 2014.
If non-core assets amount to £95 billion or less, 25 per cent of this element of the award, being the threshold, will vest.
If non-core assets amount to £80 billion or less, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
Net simplification benefits: relevant to 10 per cent of the award. Performance will be measured by reference to the run rate achieved by the end of 2014.
(v)
If a run rate of net simplification benefits of £1.5 billion is achieved, 25 per cent of this element of the award, being the threshold, will vest.
If a run rate of net simplification benefits of £1.8 billion is achieved, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
Customer satisfaction: relevant to 10 per cent of the award. Performance will be measured by reference to the total number of FSA reportable complaints
(vi)
per 1,000 customers over the three year period to 31 December 2014.
If complaints per 1,000 customers average 1.5 per annum or less over three years, 25 per cent of this element of the award, being the threshold, will vest.
If complaints per 1,000 customers average 1.3 per annum or less over three years, 100 per cent of this element will vest.
Vesting between threshold and maximum will be on a straight line basis.
2012 2011
Number of shares Number of shares
The weighted average fair value of the share awards granted in 2012 was £0.24 (2011: £0.54). The fair values of the majority of share awards granted have
been determined using a standard Black-Scholes model. The fair values of the remaining share awards have been determined by Monte Carlo simulation.
Scottish Widows Investment Partnership Long-Term Incentive Plan
The Scottish Widows Investment Partnership (SWIP) Long-Term Incentive Plan applicable to senior executives and employees of SWIP, which had previously
been a cash-only scheme, was amended in May 2012 for awards granted on or after that date. The amendment introduced the receipt of shares in Lloyds
Banking Group plc as an element of the total award. The other element will continue to be cash based, with the split between cash based and share based
determined by the Remuneration Committee. The amendment is aimed at delivering shareholder value by linking the receipt of shares to an improvement in
the performance of SWIP over a three year period. Awards are made within limits set by the rules of the Plan, with the maximum limits for combined cash
and shares awarded equating to 3.5 times annual salary. In exceptional circumstances this may increase to 4 times annual salary.
The performance conditions for share-based awards made in June 2012 are as follows:
(i) Profitability: relevant to 40 per cent of the award. The performance target is based on a cumulative 3 year profit before tax. If cumulative profit before tax
reaches a specified target level, 100 per cent of this element will vest. If cumulative profit before tax reaches 90 per cent of the target level, 25 per cent of
this element of the award, being the threshold, will vest. If cumulative profit before tax reaches 110 per cent of the target level, 200 per cent of this element
of the award, being the maximum, will vest.
No award will be made where performance is below the threshold. Vesting between threshold and target and between target and maximum will be on a
straight line basis.
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HBOS plc
No award will be made where performance is below the threshold. Vesting between threshold and target and between target and maximum will be on a
straight line basis.
(iii) Funds under management (FUM) growth: relevant to 20 per cent of the award. The performance target is based on growth in the value of third party
assets managed by SWIP by the end of the 3 year period. If third party FUM reaches a specified target level, 100 per cent of this element of the award will
vest. If third party FUM reaches 80 per cent of the target level, 25 per cent of this element, being the threshold, will vest. If third party FUM reaches 120 per
cent of the target level, 200 per cent of this element of the award, being the maximum, will vest.
No award will be made where performance is below the threshold. Vesting between threshold and target and between target and maximum will be on a
straight line basis.
For awards made to SWIP’s Code Staff (as defined by FSA), a fourth performance condition was set, relating to an internal measure of operational risk. This
additional measure is relevant to 15 per cent of the award for these individuals, with a corresponding 5 per cent reduction in each of the weightings for the
other three measures described above. As with the other measures, this performance condition has a target value at which 100 per cent of the award will
vest, a maximum value at which 200 per cent of the award will vest, and a threshold value at which 25 per cent of the award will vest.
No award will be made where performance is below the threshold. Vesting between threshold and target and between target and maximum will be on a
straight line basis.
The relevant period commenced on 1 January 2012 and ends on 31 December 2014.
2012 2011
Number of Number of
shares shares
Outstanding at 1 January – –
Granted 5,452,877 –
Outstanding at 31 December 5,452,877 –
The fair value of the share awards granted in 2012 was £0.27. The fair values of share awards granted have been determined using a standard
Black-Scholes model.
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding for the option
schemes were as follows:
Executive schemes SAYE schemes Other share option plans
Weighted Weighted Weighted Weighted Weighted Weighted
average average average average average average
exercise price remaining life Number of exercise price remaining life Number of exercise price remaining life Number of
(pence) (years) options (pence) (years) options (pence) (years) options
At 31 December 2012
Exercise price range
£0 to £1 – – – 46.79 0.8 311,648,405 5.43 4.9 74,766,919
£1 to £2 199.91 1.6 233,714 178.14 1.8 2,923,618 – – –
£2 to £3 225.69 1.9 7,811,182 – – – – – –
£3 to £4 – – – – – – – – –
£5 to £6 – – – – – – 566.89 0.9 12,026,160
Executive schemes SAYE schemes Other share option plans
Weighted Weighted Weighted Weighted Weighted Weighted
average average average average average average
exercise price remaining life Number of exercise price remaining life Number of exercise price remaining life Number of
(pence) (years) options (pence) (years) options (pence) (years) options
At 31 December 2011
Exercise price range
£0 to £1 – – – 47.94 1.7 446,965,447 4.94 4.1 82,152,838
£1 to £2 199.91 2.6 233,714 179.16 2.0 5,563,072 – – –
£2 to £3 225.74 2.9 9,941,155 214.16 0.9 490,513 – – –
£3 to £4 – – – – – – – – –
£5 to £6 – – – – – – 582.82 1.8 14,227,020
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HBOS plc
Executive
Share Plan Share Buy SWIP
2003 LTIP Out Awards LTIP
Expected volatility is a measure of the amount by which the Group’s shares are expected to fluctuate during the life of an option. The expected volatility is
estimated based on the historical volatility of the closing daily share price over the most recent period that is commensurate with the expected life of the
option. The historical volatility is compared to the implied volatility generated from market traded options in the Group’s shares to assess the reasonableness
of the historical volatility and adjustments made where appropriate.
Matching shares
The Group undertakes to match shares purchased by employees up to the value of £30 per month; these matching shares are held in trust for a mandatory
period of three years on the employee’s behalf, during which period the employee is entitled to any dividends paid on such shares. The award is subject to a
non-market based condition: if an employee leaves within this three year period for other than a ‘good’ reason, 100 per cent of the matching shares are
forfeited. Similarly if the employees sell their purchased shares within three years, their matching shares are forfeited.
The number of shares awarded relating to matching shares in 2012 was 36,158,343 (2011: 30,999,387), with an average fair value of £0.34 (2011:
£0.42), based on market prices at the date of award.
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HBOS plc
The table below details, on an aggregated basis, key management personnel compensation. The compensation of key management personnel has been allocated
to the Company on an estimated basis.
2012 2011
£m £m
Compensation
Salaries and other short-term benefits 6 6
Share-based payments 7 6
Total compensation 13 12
The aggregate of the emoluments of the directors was £3.8 million (2011: £4.3 million). The total for the highest paid director (António Horta-Osório) was
£1,699,000, (2011: (António Horta‑Osório) £2,061,000).
2012 2011
million million
2012 2011
million million
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to
other transactions between the Lloyds Banking Group and its key management personnel:
2012 2011
£m £m
Loans
At 1 January 3 3
Advanced (includes loans of appointed key management personnel) 3 1
Repayments (includes loans of former key management personnel) (4) (1)
At 31 December 2 3
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 2.5 per cent and
29.95 per cent in 2012 (2011: 1.09 per cent and 27.5 per cent).
No provisions have been recognised in respect of loans given to key management personnel (2011: £nil).
2012 2011
£m £m
Deposits
At 1 January 6 4
Placed (includes deposits of appointed key management personnel) 39 17
Withdrawn (includes deposits of former key management personnel) (35) (15)
At 31 December 10 6
Deposits placed by key management personnel attracted interest rates of up to 3.8 per cent in 2012 (2011: 5 per cent).
At 31 December 2012, the Group did not provide any guarantees in respect of key management personnel (2011: none).
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HBOS plc
The Company has a significant number of transactions with various of its subsidiary undertakings; these are included on the balance sheet of the Company as follows:
2012 2011
£m £m
Due to the size and volume of transactions passing through these accounts, it is neither practical nor meaningful to disclose information on gross inflows and
outflows. During 2012 the Company earned interest income on the above asset balances of £1,189 million (2011: £1,539 million) and incurred interest
expense on the above liability balances of £297 million (2011: £654 million).
Balances and transactions with Lloyds Banking Group plc and fellow subsidiaries of the Lloyds Banking Group
The Company and its subsidiaries have balances due to and from the Company’s ultimate parent company, Lloyds Banking Group plc, and fellow subsidiaries
of the Lloyds Banking Group. These are included on the balance sheet as follows:
Group Company
These balances include Lloyds Banking Group plc’s banking arrangements and, due to the size and volume of transactions passing through these accounts, it
is neither practical nor meaningful to disclose information on gross inflows and outflows. During 2012 the Group earned £1,427 million and the Company
earned £153 million of interest income on the above asset balances (2011: Group £920 million; Company £103 million); the Group incurred £2,549 million
and the Company incurred £335 million of interest expense on the above liability balances (2011: Group £1,974 million; Company £200 million).
In July 2011, as a result of a restructuring of the insurance operations of the Lloyds Banking Group, the life, pensions and general insurance subsidiaries of the
Group were sold to fellow subsidiaries of the Lloyds Banking Group. Further details are provided in note 14.
UK Government
In January 2009, the UK Government through HM Treasury became a related party of Lloyds Banking Group plc, the Bank’s ultimate parent company, following
its subscription for ordinary shares issued under a placing and open offer. As at 31 December 2012, HM Treasury held a 39.2 per cent (31 December
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HBOS plc
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HBOS plc
Interchange fees
On 24 May 2012, the General Court of the European Union upheld the European Commission’s 2007 decision that an infringement of EU competition law had
arisen from arrangements whereby MasterCard issuers charged a uniform fallback interchange fee (MIFs) in respect of cross border transactions in relation to
the use of a MasterCard or Maestro branded payment card.
MasterCard has appealed the General Court’s judgment to the Court of Justice of the European Union. MasterCard is supported by several card issuers, including
Lloyds Banking Group. Judgment is not expected until late 2013 or later.
In parallel:
–– the European Commission is also considering further action, including introducing legislation to regulate interchange fees, following its 2012 Green Paper
(Towards an integrated European market for cards, internet and mobile payments) consultation;
–– the European Commission is pursuing an investigation with a view to deciding whether arrangements adopted by VISA for the levying of the MIF in respect of
cross-border credit card payment transactions also infringe European Union competition laws. In this regard VISA reached an agreement (which expires in
2014) with the European Commission to reduce the level of interchange fee for cross-border debit card transactions to the interim levels agreed by MasterCard;
and
–– the Office of Fair Trading (OFT) may decide to renew its ongoing examination of whether the levels of interchange fees paid by retailers in respect of MasterCard
and VISA credit cards, debit cards and charge cards in the UK infringe competition law. The OFT had placed the investigation on hold pending the outcome
of the MasterCard appeal to the General Court.
The ultimate impact of the investigations and any regulatory developments on the Lloyds Banking Group can only be known at the conclusion of these
investigations and any relevant appeal proceedings and once regulatory proposals are more certain.
Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those
firms. The interest rate on the borrowings with HM Treasury, which total circa £20 billion, increased from 12 month LIBOR plus 30 basis points to 12 month
LIBOR plus 100 basis points on 1 April 2012. Each deposit-taking institution contributes towards the FSCS levies in proportion to their share of total protected
deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March.
In determining an appropriate accrual in respect of the management expenses levy, certain assumptions have been made including the proportion of total
protected deposits held by the Lloyds Banking Group, the level and timing of repayments to be made by the FSCS to HM Treasury and the interest rate to be
charged by HM Treasury. For the year ended 31 December 2012, the Group has charged £53 million (2011: £86 million;) to the income statement in respect
of the management expenses levy.
The substantial majority of the principal balance of the £20 billion loan between the FSCS and HM Treasury will be repaid from funds the FSCS receives from
asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted. In March 2012, the FSCS confirmed that it expects a shortfall
of approximately £802 million and that it expects to recover that amount by raising compensation levies on all deposit-taking participants over a three year
period. In addition to the management expenses levy detailed above, the Group has also charged £51 million (2011: £nil) to the income statement in respect
of compensation levies. The amount of future compensation levies payable by the Group depends on a number of factors including participation in the market
at 31 December, the level of protected deposits and the population of deposit-taking participants.
Shareholder complaints
In November 2011 the Lloyds Banking Group and two former members of the Lloyds Banking Group’s Board of Directors were named as defendants in a
purported securities class action filed in the United States District Court for the Southern District of New York. The complaint asserted claims under the Securities
Exchange Act of 1934 in connection with alleged material omissions from statements made in 2008 in connection with the acquisition of HBOS. No quantum
is specified. In October 2012 the court dismissed the complaint. An appeal against this decision has been filed. The Lloyds Banking Group continues to consider
that the allegations are without merit.
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HBOS plc
Other items serving as direct credit substitutes include standby letters of credit, or other irrevocable obligations, where the Group has an irrevocable obligation
to pay a third party beneficiary if the customer fails to repay an outstanding commitment; they also include acceptances drawn under letters of credit or similar
facilities where the acceptor does not have specific title to an identifiable underlying shipment of goods.
Performance bonds and other transaction-related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs & Excise bonds
and standby letters of credit relating to a particular contract or non-financial transaction) are undertakings where the requirement to make payment under the
guarantee depends on the outcome of a future event.
The Group’s maximum exposure to loss is represented by the contractual nominal amount detailed in the table below. Consideration has not been taken of any
possible recoveries from customers for payments made in respect of such guarantees under recourse provisions or from collateral held.
Group
2012 2011
£m £m
Contingent liabilities
Acceptances and endorsements 2 3
Other:
Other items serving as direct credit substitutes 28 110
Performance bonds and other transaction-related contingencies 565 674
593 784
Total contingent liabilities 595 787
The contingent liabilities of the Group, as detailed above, arise in the normal course of its banking business and it is not practicable to quantify their future
financial effect.
Group
2012 2011
£m £m
Commitments
Documentary credits and other short-term trade-related transactions 4 8
Undrawn formal standby facilities, credit lines and other commitments to lend: – –
Less than 1 year original maturity:
Mortgage offers made 6,346 6,311
Other commitments 20,828 22,851
27,174 29,162
1 year or over original maturity 7,664 16,442
Total commitments 34,842 45,612
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend, £12,922 million (2011: £15,087 million)
was irrevocable.
2012 2011
£m £m
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HBOS plc
Capital commitments
Excluding commitments of the Group in respect of investment property (see note 25), there was no capital expenditure contracted but not provided for at
31 December 2012 (2011: £nil).
At fair value
through profit or loss
Derivatives
designated Designated Held at
as hedging Held for upon initial Available- Loans and amortised Insurance
instruments trading recognition for-sale receivables cost contracts Total
Group £m £m £m £m £m £m £m £m
At 31 December 2012
Financial assets
Cash and balances at central banks – – – – – 6,112 – 6,112
Items in the course of collection from banks – – – – – 416 – 416
Trading and other financial assets at fair value
through profit or loss – 32,201 30,157 – – – – 62,358
Derivative financial instruments 9,923 25,932 – – – – – 35,855
Loans and receivables:
Loans and advances to banks – – – – 140,085 – – 140,085
Loans and advances to customers – – – – 313,387 – – 313,387
Debt securities – – – – 3,979 – – 3,979
– – – – 457,451 – – 457,451
Available-for-sale financial assets – – – 6,052 – – – 6,052
Total financial assets 9,923 58,133 30,157 6,052 457,451 6,528 – 568,244
Financial liabilities
Deposits from banks – – – – – 171,738 – 171,738
Customer deposits – – – – – 217,515 – 217,515
Items in course of transmission to banks – – – – – 518 – 518
Trading liabilities – 33,610 – – – – – 33,610
Derivative financial instruments 4,487 27,223 – – – – – 31,710
Notes in circulation – – – – – 1,198 – 1,198
Debt securities in issue – – – – – 49,521 – 49,521
Liabilities arising from insurance contracts and
participating investment contracts – – – – – – 423 423
Liabilities arising from non-participating
investment contracts – – – – – – 27,166 27,166
Financial guarantees – – 14 – – – – 14
Subordinated liabilities – – – – – 12,491 – 12,491
Total financial liabilities 4,487 60,833 14 – – 452,981 27,589 545,904
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At fair value
through profit or loss
Derivatives
designated Designated Held at
as hedging Held for upon initial Available- Loans and amortised Insurance
instruments trading recognition for-sale receivables cost contracts Total
Group £m £m £m £m £m £m £m £m
At 31 December 2011
Financial assets
Cash and balances at central banks – – – – – 3,075 – 3,075
Items in the course of collection from banks – – – – – 379 – 379
Trading and other financial assets at fair value
through profit or loss – 21,840 23,507 – – – – 45,347
Derivative financial instruments 9,588 26,665 – – – – – 36,253
Loans and receivables:
Loans and advances to banks – – – – 91,210 – – 91,210
Loans and advances to customers – – – – 357,110 – – 357,110
Debt securities – – – – 11,276 – – 11,276
– – – – 459,596 – – 459,596
Available-for-sale financial assets – – – 10,498 – – – 10,498
Total financial assets 9,588 48,505 23,507 10,498 459,596 3,454 – 555,148
Financial liabilities
Deposits from banks – – – – – 150,042 – 150,042
Customer deposits – – – – – 217,048 – 217,048
Items in course of transmission to banks – – – – – 332 – 332
Trading liabilities – 20,805 – – – – – 20,805
Derivative financial instruments 6,710 26,675 – – – – – 33,385
Notes in circulation – – – – – 1,145 – 1,145
Debt securities in issue – – – – – 75,457 – 75,457
Liabilities arising from insurance contracts and
participating investment contracts – – – – – – 385 385
Liabilities arising from non-participating
investment contracts – – – – – – 22,207 22,207
Financial guarantees – – 17 – – – – 17
Subordinated liabilities – – – – – 13,613 – 13,613
Total financial liabilities 6,710 47,480 17 – – 457,637 22,592 534,436
Derivatives
designated Held at
as hedging Loans and amortised
instruments receivables cost Total
Company £m £m £m £m
At 31 December 2012
Financial assets
Derivative financial instruments 1,565 – – 1,565
Loans and receivables:
Amounts due from fellow Lloyds Banking Group undertakings – 42,713 – 42,713
Total financial assets 1,565 42,713 – 44,278
Financial liabilities
Derivative financial instruments 10 – – 10
Subordinated liabilities – – 9,021 9,021
Total financial liabilities 10 – 9,021 9,031
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HBOS plc
Derivatives
designated Held at
as hedging Loans and amortised
instruments receivables cost Total
Company £m £m £m £m
At 31 December 2011
Financial assets
Derivative financial instruments 1,857 – – 1,857
Loans and receivables:
Amounts due from fellow Lloyds Banking Group undertakings – 47,378 – 47,378
Total financial assets 1,857 47,378 – 49,235
Financial liabilities
Derivative financial instruments 10 – – 10
Subordinated liabilities – – 9,318 9,318
Total financial liabilities 10 – 9,318 9,328
The Company has entered into interest rate and currency swaps with its subsidiary, Bank of Scotland plc, to manage these risks.
Credit risk
The majority of the Company’s credit risk arises from amounts due from its wholly owned subsidiary and subsidiaries of that company.
In accordance with the amendment to IAS 39 that became applicable during 2008, the Group reviewed the categorisation of its financial assets classified as
held for trading and available-for-sale. On the basis that there was no longer an active market for some of those assets, which are therefore more appropriately
managed as loans, the Group reclassified the following financial assets:
–– In January 2009, the Group reclassified £1,825 million of debt securities classified as held for trading to debt securities classified as loans and receivables.
–– In addition, the Group reclassified £649 million of securities classified as available-for-sale to debt securities classified as loans and receivables.
–– With effect from 1 July 2008, the Group transferred £12,210 million of assets previously classified as held for trading into available-for-sale financial assets.
–– With effect from 1 November 2008, the Group transferred £35,446 million of assets previously classified as available-for-sale financial assets into loans and
receivables.
At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity. As at the date of reclassification,
the weighted average effective interest rate of the assets transferred was 0.7 per cent to 9.5 per cent with the estimated recoverable cash flows of £56,743 million.
During the year ended 31 December 2012, the carrying value of reclassified assets decreased by £7,861 million due to sales and maturities of £7,732 million,
foreign exchange and other movements of £221 million less accretion of discount of £92 million.
No financial assets have been reclassified in accordance with the amendment to IAS 39 since 2009; the following disclosures relate to those assets which were
reclassified in 2008 and 2009.
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HBOS plc
From held for trading to available-for-sale financial assets 285 26 136 904 981
From available-for-sale financial assets to loans and receivables 724 130 (134) 1,147 708
Total additional fair value gains 1,009 156 2 2,051 1,689
For assets reclassified from held for trading to loans and receivables in 2009
For assets reclassified from held for trading to available-for-sale financial assets in 2008
For assets reclassified from available-for-sale financial assets to loans and receivables in 2009
For assets reclassified from available-for-sale financial assets to loans and receivables in 2008
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HBOS plc
2012 2011
Carrying value Fair value Carrying value Fair value
Group £m £m £m £m
Financial assets
Cash and balances at central banks 6,112 6,112 3,075 3,075
Items in the course of collection from banks 416 416 379 379
Trading and other financial assets at fair value through profit or loss 62,358 62,358 45,347 45,347
Derivative financial instruments 35,855 35,855 36,253 36,253
Loans and receivables:
Loans and advances to banks 140,085 140,086 91,210 91,172
Loans and advances to customers 313,387 303,987 357,110 344,150
Debt securities 3,979 4,163 11,276 9,479
Available-for-sale financial assets 6,052 6,052 10,498 10,498
Financial liabilities
Deposits from banks 171,738 171,812 150,042 150,140
Customer deposits 217,515 219,106 217,048 217,860
Items in course of transmission to banks 518 518 332 332
Trading liabilities 33,610 33,610 20,805 20,805
Derivative financial instruments 31,710 31,710 33,385 33,385
Notes in circulation 1,198 1,198 1,145 1,145
Debt securities in issue 49,521 50,028 75,457 73,167
Liabilities arising from non-participating investment contracts 27,166 27,166 22,207 22,207
Financial guarantees 14 14 17 17
Subordinated liabilities 12,491 10,585 13,613 8,447
Financial assets
Derivative financial instruments 1,565 1,565 1,857 1,857
Amounts due from subsidiaries 42,713 42,713 47,378 47,378
Financial liabilities
Derivative financial instruments 10 10 10 10
Subordinated liabilities 9,021 8,375 9,318 7,516
Valuation methodology
Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, or are
unreliable because of poor liquidity, fair values have been determined using valuation techniques which, to the extent possible, use market observable inputs.
Valuation techniques used include discounted cash flow analysis and pricing models and, where appropriate, comparison to instruments with characteristics
either identical or similar to those of the instruments held by the Group. These estimation techniques are necessarily subjective in nature and involve several
assumptions.
Fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets, premises,
equipment, and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent
the underlying value of the Group.
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Notes in circulation
The fair value of notes in circulation which are payable on demand is considered to be equal to their carrying value.
Level 1 portfolios
Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities. Products classified as level
1 predominantly comprise equity shares, treasury bills and other government securities.
Level 2 portfolios
Level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not considered to be
active or valuation techniques are used to determine fair value and where these techniques use inputs that are based significantly on observable market data.
Examples of such financial instruments include most over-the-counter derivatives, financial institution issued securities, certificates of deposit and certain asset-
backed securities.
Level 3 portfolios
Level 3 portfolios are those where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data.
Such instruments would include the Group’s venture capital and unlisted equity investments which are valued using various valuation techniques that require
significant management judgement in determining appropriate assumptions, including earnings multiples and estimated future cash flows. Certain of the Group’s
asset-backed securities and derivatives, principally where there is no trading activity in such securities, are also classified as level 3.
Model validation covers both qualitative and quantitative elements relating to new models. In respect of new products, a product implementation review is
conducted pre- and post-trading. Pre-trade testing ensures that the new model is integrated into the Group’s systems and that the profit and loss and risk
reporting are consistent throughout the trade life cycle. Post-trade testing examines the explanatory power of the implemented model, actively monitoring model
parameters and comparing in-house pricing to external sources. Independent price verification procedures cover financial instruments carried at fair value. The
frequency of the review is matched to the availability of independent data, monthly being the minimum. Valuation differences in breach of established thresholds
are escalated to senior management. The results from independent pricing and valuation reserves are reviewed monthly by senior management
Formal committees, consisting of senior risk, finance and business management, meet at least quarterly to discuss and approve valuations in more judgemental
areas, in particular for unquoted equities, structured credit, over-the-counter options and the Credit Valuation Adjustment (CVA) reserve.
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Valuation hierarchy
Level 1 Level 2 Level 3 Total
£m £m £m £m
At 31 December 2012
Trading and other financial assets at fair value through profit or loss
Loans and advances to customers – 28,372 – 28,372
Loans and advances to banks – 729 – 729
Debt securities:
Government securities 184 2,002 – 2,186
Other public sector securities – 154 – 154
Bank and building society certificates of deposit – 2,399 – 2,399
Asset-backed securities:
Mortgage-backed securities – 18 – 18
Other asset-backed securities – 4 – 4
Corporate and other debt securities – 4,372 14 4,386
184 8,949 14 9,147
Equity shares 23,676 – 149 23,825
Treasury and other bills 285 – – 285
Total trading and other financial assets at fair value through profit or loss 24,145 38,050 163 62,358
Available-for-sale financial assets
Debt securities:
Government securities 113 – – 113
Bank and building society certificates of deposit – 25 – 25
Asset-backed securities:
Mortgage-backed securities – 882 – 882
Other asset-backed securities – 285 21 306
Corporate and other debt securities 22 4,234 – 4,256
135 5,426 21 5,582
Equity shares 16 47 407 470
Total available-for-sale financial assets 151 5,473 428 6,052
Derivative financial instruments – 35,683 172 35,855
Total financial assets carried at fair value 24,296 79,206 763 104,265
Trading liabilities:
Liabilities in respect of securities sold under repurchase agreements – 32,449 – 32,449
Short positions in securities 1,146 – – 1,146
Other 15 – – 15
Total trading liabilities 1,161 32,449 – 33,610
Derivative financial instruments – 31,656 54 31,710
Financial guarantees – – 14 14
Total financial liabilities carried at fair value 1,161 64,105 68 65,334
There were no significant transfers between level 1 and level 2 during the year.
90
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91
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Depending on the business sector and the circumstances of the investment, unlisted equity valuations are based on earnings multiples, net asset values or
discounted cash flows.
–– A number of earnings multiples are used in valuing the portfolio including price earnings, earnings before interest and tax and earnings before interest, tax,
depreciation and amortisation. The particular multiple selected being appropriate for the type of business being valued and is derived by reference to the
current market-based multiple. Consideration is given to the risk attributes, growth prospects and financial gearing of comparable businesses when selecting
an appropriate multiple.
–– Discounted cash flow valuations use estimated future cash flows, usually based on management forecasts, with the application of appropriate exit yields or
terminal multiples and discounted using rates appropriate to the specific investment, business sector or recent economic rates of return. Recent transactions
involving the sale of similar businesses may sometimes be used as a frame of reference in deriving an appropriate multiple.
–– For fund investments the most recent capital account value calculated by the fund manager is used as the basis for the valuation and adjusted, if necessary,
to align valuation techniques with the Group’s valuation policy.
Derivatives
Where the Group’s derivative assets and liabilities are not traded on an exchange, they are valued using valuation techniques, including discounted cash flow
and options pricing models, as appropriate. The types of derivatives classified as level 2 and the valuation techniques used include:
–– Interest rate swaps which are valued using discounted cash flow models; the most significant inputs into those models are interest rate yield curves which are
developed from publicly quoted rates.
–– Foreign exchange derivatives that do not contain options which are priced using rates available from publicly quoted sources.
–– Credit derivatives, except for the items classified as level 3, which are valued using publicly available yield and credit default swap (CDS) curves are valued
using standard models with observable inputs.
–– Less complex interest rate and foreign exchange option products which are valued using volatility surfaces developed from publicly available interest rate cap,
interest rate swaption and other option volatilities; option volatility skew information is derived from a market standard consensus pricing service. For more
complex option products, the Group calibrates its models using observable at-the-money data; where necessary, the Group adjusts for out-of-the-money
positions using a market standard consensus pricing service.
Complex interest rate and foreign exchange products where there is significant dispersion of consensus pricing or where implied funding costs are material and
unobservable are classified as level 3.
Where credit protection, usually in the form of credit default swaps, has been purchased or written on asset-backed securities, the security is referred to as a
negative basis asset-backed security and the resulting derivative assets or liabilities have been classified as either level 2 or level 3 according to the classification
of the underlying asset-backed security.
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HBOS plc
The table below analyses movements in the level 3 financial liabilities portfolio:
Transfers out of the level 3 portfolio arise when inputs that could have a significant impact on the instrument’s valuation become market observable after
previously having been non-market observable. In the case of asset-backed securities this can arise if more than one consistent independent source of data
becomes available. Conversely transfers into the portfolio arise when consistent sources of data cease to be available.
Included within the gains (losses) recognised in the income statement are losses of £237 million (2011: gains of £122 million) related to financial instruments
that are held in the level 3 portfolio at the year end. These amounts are included in other operating income.
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HBOS plc
Level 3 portfolio
Sensitivity of level 3 valuations
At 31 December 2012 At 31 December 2011
Trading and other financial assets at fair value through profit or loss
Asset-backed securities Lead manager or Use of single pricing – – – 203 1 (1)
broker quote/ source
consensus pricing
from market data
provider
Equity and venture Various valuation Earnings, net asset 163 29 (8) 229 16 (19)
capital investments techniques value and earnings
multiples, forecast
cash flows
Unlisted equities and Third party valuations n/a – – – – – –
property partnerships in
the life funds
163 432
Available-for-sale financial assets
Equity and venture Various valuation Earnings, net asset 428 36 (11) 1,825 183 (88)
capital investments techniques value, underlying
asset values, property
prices, forecast cash
flows
Derivative financial assets
Industry standard Prepayment rates, 172 27 (19) 351 58 (23)
model/consensus probability of default,
pricing from market loss given default and
data provider yield curves
Financial assets 763 2,608
Asset-backed securities
Reasonably possible alternative valuations have been calculated for asset-backed securities by using alternative pricing sources and calculating an absolute
difference. The pricing difference is defined as the absolute difference between the actual price used and the closest, alternative price available.
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At 31 December 2012
Repurchase and securities lending transactions
Trading and other financial assets at fair value through profit or loss 703 189
Available-for-sale financial assets 2,439 464
Loans and receivables:
Loans and advances to customers 44,451 5,300
Debt securities classified as loans and receivables 493 403
Securitisation programmes
Loans and receivables:
Loans and advances to customers1 67,016 17,6242
1 Includes US residential mortage-backed securities and associated liabilities whose carrying values were £185 million and £221 million respectively; the associated liabilities have
recourse only to the securities transferred and, at 31 December 2012, the fair values of the securities and the associated liabilities were £244 million and £311 million respectively, a
difference of £67 million.
2 Excludes securitisation notes held by the Group (£33,570 million).
At 31 December 2012
Debt securities 199 – 237 1991
Liquidity facilities 56 – 55 561
Fund investments – 70 70 1002
Total 255 70 362 355
1 Amount represents the carrying amount of the asset.
2 Amount represents the carrying amount of the asset plus undrawn commitments of £30 million.
Debt securities shown in the table above are notes held in non-controlled securitisation vehicles representing the Group’s ongoing involvement in financial assets
transferred into those securitisation vehicles in prior years. The debt securities, which benefit from significant credit enhancement, are classified as available-for-
sale financial assets and are managed on a similar basis to the Group’s other non-traded asset backed securities.
Fund investments shown in the table above are equity and debt interests in an investment fund representing the Group’s ongoing involvement in financial assets
transferred into the fund in a prior year. The fund investments were designated at fair value through profit or loss and are managed on a similar basis to the
Group’s trading assets.
Liquidity facilities are to asset-backed conduits of Lloyds TSB Bank plc which include assets previously recognised by the Group.
The Group has no obligation or option to repurchase any of the assets transferred.
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HBOS plc
In respect of fund investments shown above, an amount of £3 million was recognised during the year (£55 million cumulatively since derecognition) within net
trading income.
Financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant
component of the risks faced by the Group.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and currency risk; and
liquidity risk. Qualitative and quantitative information about the Group’s management of these risks is given below.
Group
2012 2011
£m £m
96
HBOS plc
Loans and
advances
designated
Loans and advances to customers
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m
31 December 2012
Neither past due nor impaired 4,769 219,939 12,703 39,811 272,453 14,340
Past due but not impaired – 10,554 391 1,147 12,092 –
Impaired – no provision required – 409 635 965 2,009 –
Impaired – provision held – 6,564 424 27,961 34,949 –
Gross 4,769 237,466 14,153 69,884 321,503 14,340
Allowance for impairment losses (note 23) – (2,542) (371) (14,968) (17,881) –
Net 4,769 234,924 13,782 54,916 303,622 14,340
Due from fellow Lloyds Banking Group
undertakings 135,316 9,765 14,761
140,085 313,387 29,101
31 December 2011
Neither past due nor impaired 5,404 226,256 12,715 68,006 306,977 11,051
Past due but not impaired – 10,329 439 1,821 12,589 –
Impaired – no provision required 6 940 689 2,935 4,564 –
– provision held – 5,697 533 38,403 44,633 –
Gross 5,410 243,222 14,376 111,165 368,763 11,051
Allowance for impairment losses (note 23) – (2,432) (499) (20,420) (23,351) –
Net 5,410 240,790 13,877 90,745 345,412 11,051
Due from fellow Lloyds Banking Group
undertakings 85,800 11,698 7,739
91,210 357,110 18,790
The criteria that the Group uses to determine that there is objective evidence of an impairment loss are disclosed in note 2(h). All impaired loans which exceed
certain thresholds, principally within the Group’s wholesale and corporate businesses, are individually assessed for impairment by reviewing expected future
cash flows including those that could arise from the realisation of security. Included in loans and receivables are advances individually determined to be impaired
with a gross amount before impairment allowances of £28,970 million (2011: £41,984 million).
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HBOS plc
Loans and
advances
Loans and advances to customers designated
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m
31 December 2012
Good quality 4,737 214,017 8,820 10,949 14,306
Satisfactory quality 24 4,227 3,248 11,972 25
Lower quality – 542 282 12,473 6
Below standard, but not impaired 8 1,153 353 4,417 3
Total loans and advances which are neither
past due nor impaired 4,769 219,939 12,703 39,811 272,453 14,340
31 December 2011
Good quality 5,319 219,014 7,823 25,630 11,047
Satisfactory quality 38 5,035 3,858 17,560 4
Lower quality – 951 410 17,777 –
Below standard, but not impaired 47 1,256 624 7,039 –
Total loans and advances which are neither past
due nor impaired 5,404 226,256 12,715 68,006 306,977 11,051
The definitions of good quality, satisfactory quality, lower quality and below standard, but not impaired applying to retail and wholesale are not the same,
reflecting the different characteristics of these exposures and the way they are managed internally, and consequently totals are not provided. Wholesale lending
has been classified using internal probability of default rating models mapped so that they are comparable to external credit ratings. Good quality lending
comprises the lower assessed default probabilities, with other classifications reflecting progressively higher default risk. Classifications of retail lending incorporate
expected recovery levels for mortgages, as well as probabilities of default assessed using internal rating models.
Loans and advances which are past due but not impaired
Loans and
advances
Loans and advances to customers designated
Loans and at fair value
advances Retail – Retail – through
to banks mortgages other Wholesale Total profit or loss
£m £m £m £m £m £m
31 December 2012
0-30 days – 4,902 297 654 5,853 –
30-60 days – 2,166 67 107 2,340 –
60-90 days – 1,460 21 281 1,762 –
90-180 days – 2,026 5 18 2,049 –
Over 180 days – – 1 87 88 –
Total loans and advances which are past due
but not impaired – 10,554 391 1,147 12,092 –
31 December 2011
0-30 days – 4,746 324 974 6,044 –
30-60 days – 2,120 91 386 2,597 –
60-90 days – 1,524 19 151 1,694 –
90-180 days – 1,939 4 114 2,057 –
Over 180 days – – 1 196 197 –
Total loans and advances which are past due but
not impaired – 10,329 439 1,821 12,589 –
A financial asset is ‘past due’ if a counterparty has failed to make a payment when contractually due.
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HBOS plc
Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m
At 31 December 2012
Asset-backed securities:
Mortgage-backed securities 600 943 646 704 312 909 4,114
Other asset-backed securities 120 – 167 – 128 1 416
720 943 813 704 440 910 4,530
Corporate and other debt securities – – – – – 271 271
720 943 813 704 440 1,181 4,801
Due from fellow Group undertakings:
Mortgage-backed securities 166
Total debt securities classified as loans and receivables 4,967
At 31 December 2011
Asset-backed securities:
Mortgage-backed securities 1,770 2,043 1,087 909 307 918 7,034
Other asset-backed securities 3,603 374 331 126 304 – 4,738
5,373 2,417 1,418 1,035 611 918 11,772
Corporate and other debt securities – – 25 – – 403 428
5,373 2,417 1,443 1,035 611 1,321 12,200
Due from fellow Group undertakings:
Mortgage-backed securities 224
Total debt securities classified as loans and receivables 12,424
99
HBOS plc
Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m
At 31 December 2012
Debt securities:
Government securities 113 – – – – – 113
Bank and building society certificates of deposit – – 25 – – – 25
Asset-backed securities:
Mortgage-backed securities 796 43 – – 43 – 882
Other asset-backed securities 285 21 – – – – 306
1,081 64 – – 43 – 1,188
Corporate and other debt securities 272 211 568 599 85 22 1,757
1,466 275 593 599 128 22 3,083
Due from fellow Group undertakings:
Corporate and other debt securities 2,499
Total held as available-for-sale financial assets 5,582
At 31 December 2011
Debt securities:
Government securities 89 74 – – – – 163
Bank and building society certificates of deposit – – 32 – – – 32
Asset-backed securities:
Mortgage-backed securities 469 121 116 83 – – 789
Other asset-backed securities 83 – – – – – 83
552 121 116 83 – – 872
Corporate and other debt securities 1,591 856 2,315 303 – 67 5,132
2,232 1,051 2,463 386 – 67 6,199
Treasury and other bills – – – – – – –
2,232 1,051 2,463 386 – 67 6,199
Due from fellow Group undertakings:
Corporate and other debt securities 2,418
Total held as available-for-sale financial assets 8,617
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HBOS plc
Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m
At 31 December 2012
Debt securities, treasury and other bills held at fair value
through profit or loss
Trading assets
Government securities 184 – – – – – 184
Bank and building society certificates of deposit – 1,636 603 – – – 2,239
Other asset-backed securities – – 4 – – – 4
Corporate and other debt securities 320 90 – – – – 410
Total debt securities held as trading assets 504 1,726 607 – – – 2,837
Treasury and other bills 285 – – – – – 285
Total held as trading assets 789 1,726 607 – – – 3,122
Other assets held at fair value through profit or loss
Government securities 1,469 359 – 174 – – 2,002
Other public sector securities 119 26 3 6 – – 154
Bank and building society certificates of deposit – 26 134 – – – 160
Asset-backed securities
Mortgage-backed securities – – 18 – – – 18
Other asset-backed securities – – – – – – –
– – 18 – – – 18
Corporate and other debt securities 192 673 764 483 1,584 64 3,760
Total other assets held at fair value through profit or loss 1,780 1,084 919 663 1,584 64 6,094
2,569 2,810 1,526 663 1,584 64 9,216
Due from fellow Group undertakings:
Corporate and other debt securities 216
Total held at fair value through profit or loss 9,432
At 31 December 2011
Debt securities, treasury and other bills held at fair value
through profit or loss
Trading assets
Government securities 992 – – – – – 992
Bank and building society certificates of deposit – 1,062 322 – – – 1,384
Other asset-backed securities – 151 52 – – – 203
Corporate and other debt securities 201 – – 100 – – 301
Total debt securities held as trading assets 1,193 1,213 374 100 – – 2,880
Treasury and other bills 224 – – – – – 224
Total held as trading assets 1,417 1,213 374 100 – – 3,104
Other assets held at fair value through profit or loss
Government securities 1,386 39 44 2 – – 1,471
Other public sector securities 97 86 2 – – – 185
Bank and building society certificates of deposit – 62 30 – – – 92
Asset-backed securities
Mortgage-backed securities 7 – 2 – – – 9
Corporate and other debt securities 341 550 437 433 692 90 2,543
Total other assets held at fair value through profit or loss 1,831 737 515 435 692 90 4,300
Total held at fair value through profit or loss 3,248 1,950 889 535 692 90 7,404
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Derivative assets
An analysis of derivative assets is given in note 17. The Group reduces exposure to credit risk by using master netting agreements and by obtaining collateral in
the form of cash or highly liquid securities. In respect of the Group’s maximum credit risk relating to derivative assets of £15,122 million (2011: £13,437 million),
cash collateral of £2,638 million (2011: £2,249 million) was held and a further £439 million was due from OECD banks (2011: £1,303 million).
Rated BB
AAA AA A BBB or lower Not rated Total
£m £m £m £m £m £m £m
The Group holds collateral in respect of loans and advances to banks and customers as set out below. The Group does not hold collateral against debt securities,
comprising asset-backed securities and corporate and other debt securities, which are classified as loans and receivables.
There were reverse repurchase agreements which are accounted for as collateralised loans within loans and advances to banks with a carrying value of
£83 million (2011: £2,950 million), against which the Group held collateral with a fair value of £83 million (2011: £2,950 million), all of which the Group is
able to repledge.
These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.
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Neither
past due Past due but
nor impaired not impaired Impaired Gross
£m £m £m £m
31 December 2012
Less than 70 per cent 81,549 2,491 1,152 85,192
70 per cent to 80 per cent 44,178 1,620 713 46,511
80 per cent to 90 per cent 38,670 1,950 951 41,571
90 per cent to 100 per cent 26,631 1,737 969 29,337
Greater than 100 per cent 28,911 2,756 3,188 34,855
Total 219,939 10,554 6,973 237,466
Neither
past due Past due but
nor impaired not impaired Impaired Gross
£m £m £m £m
31 December 2011
Less than 70 per cent 85,775 2,382 1,055 89,212
70 per cent to 80 per cent 42,089 1,532 672 44,293
80 per cent to 90 per cent 38,666 1,874 890 41,430
90 per cent to 100 per cent 29,329 1,798 972 32,099
Greater than 100 per cent 30,397 2,743 3,048 36,188
Total 226,256 10,329 6,637 243,222
Other
No collateral is held in respect of retail credit cards or overdrafts, or unsecured personal loans. For non-mortgage retail lending to small businesses, collateral
will often include second charges over residential property and the assignment of life cover.
The majority of non-mortgage retail lending is unsecured. At 31 December 2012, impaired non-mortgage lending amounted to £688 million, net of an
impairment allowance of £371 million (2011: £723 million net of an impairment allowance of £499 million). The fair value of the collateral held in respect of
this lending was £8 million (2011: £9 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of realisation
and the value of collateral for each loan has been limited to the principal amount of the outstanding advance in order to eliminate the effects of any
over‑collateralisation and to provide a clearer representation of the Group’s exposure.
Unimpaired non-mortgage retail lending amounted to £13,094 million (2011: £13,154 million). Lending decisions are predominantly based on an obligor’s
ability to repay from normal business operations rather than reliance on the disposal of any security provided. Collateral values are rigorously assessed at the
time of loan origination and are monitored throughout the credit lifecycle in accordance with business unit credit policy.
The Group credit risk disclosures for unimpaired non-mortgage retail lending report assets gross of collateral and therefore disclose the maximum loss exposure.
The Group believes that this approach is appropriate as collateral values at origination and during a period of good performance may not be representative of the
value of collateral if the obligor enters a distressed state. The value of collateral is re-evaluated and its legal soundness re-assessed if there is observable evidence
of distress of the borrower. Unimpaired non-mortgage retail lending, including any associated collateral, is managed on a customer-by-customer basis rather
than a portfolio basis. Key management personnel review collateral information on a case-by-case basis; no aggregated collateral information for the entire
unimpaired non-mortgage retail lending portfolio is provided to key management personnel.
Wholesale lending
Reverse repurchase transactions
There were reverse repurchase agreements which are accounted for as collateralised loans with a carrying value of £nil (2011: £14,250 million), against which
the Group held collateral with a fair value of £nil (2011: £14,254 million), all of which the Group is able to repledge. Included in these amounts are collateral
balances in the form of cash provided in respect of reverse repurchase agreements amounting to £2 million (2011: £34 million). These transactions were
generally conducted under terms that are usual and customary for standard secured lending activities.
At 31 December 2012, impaired secured wholesale lending amounted to £14,531 million, net of an impairment allowance of £13,291 million
(2011: £20,490 million, net of an impairment allowance of £18,576 million). The fair value of the collateral held in respect of impaired secured wholesale
lending was £7,379 million (2011: £12,301 million). In determining the fair value of collateral, no specific amounts have been attributed to the costs of
realisation. For the purposes of determining the total collateral held by the Group in respect of impaired secured wholesale lending, the value of collateral for
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HBOS plc
Impaired secured wholesale lending and associated collateral relates to lending to property companies and to customers in the financial, business and other
services; transport, distribution and hotels; and construction industries.
The extent to which collateral values are actively managed will depend on the credit quality and other circumstances of the obligor. Although lending decisions
are predominantly based on expected cash flows, any collateral provided may impact the pricing and other terms of a loan or facility granted; this will have a
financial impact on the amount of net interest income recognised and on internal loss-given-default estimates that contribute to the determination of asset quality.
For unimpaired secured wholesale lending, the Group reports assets gross of collateral and therefore discloses the maximum loss exposure. The Group believes
that this approach is appropriate as collateral values at origination and during a period of good performance may not be representative of the value of collateral
if the obligor enters a distressed state.
Unimpaired secured wholesale lending is predominantly managed on a cash flow basis. On occasion, it may include an assessment of underlying collateral,
although, for impaired lending, this will not always involve assessing it on a fair value basis. No aggregated collateral information for the entire unimpaired
secured wholesale lending portfolio is provided to key management personnel.
Trading and other financial assets at fair value through profit or loss (excluding equity shares)
In respect of trading and other financial assets at fair value through profit or loss, the fair value of collateral accepted under reverse repurchase transactions which
are accounted for as collateralised loans that the Group is permitted by contract or custom to sell or repledge was £33,946 million (2011: £23,655 million).
Of this, £30,191 million was sold or repledged (2011: £20,055 million).
In addition, securities held as collateral in the form of stock borrowed amounted to £44,181 million (2011: £53,395 million). Of this amount, £43,246 million
(2011: £44,896 million) had been resold or repledged as collateral for the Group’s own transactions.
These transactions were generally conducted under terms that are usual and customary for standard secured lending activities.
Lending decisions in respect of irrevocable loan commitments are based on the obligor’s ability to repay from normal business operations rather than reliance
on the disposal of any security provided. For wholesale unimpaired lending, it is the Group’s practice to request sufficient collateral for secured irrevocable loan
commitments. For retail mortgage commitments, the majority are for mortgages with a loan‑to‑value ratio of less than 100 per cent. Aggregated collateral
information covering the entire balance of irrevocable loan commitments over which security will be taken is not provided to key management personnel.
The fair value of collateral pledged in respect of repurchase transactions, accounted for as secured borrowings, where the secured party is permitted by contract
or custom to repledge was £52,226 million (2011: £57,892 million). In addition, the following financial assets on the balance sheet have been pledged as
collateral as part of securities lending transactions:
Assets pledged
2012 2011
£m £m
Trading and other financial assets at fair value through profit or loss 513 1,550
Loans and advances to customers 38,434 47,400
Debt securities classified as loans and receivables 63 1,071
Available-for-sale financial assets 1,903 1,733
40,913 51,754
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HBOS plc
E. Collateral repossessed
2012 2011
£m £m
In respect of retail portfolios, the Group does not take physical possession of properties or other assets held as collateral and uses external agents to realise the
value as soon as practicable, generally at auction, to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in
accordance with appropriate insolvency regulations. In certain circumstances the Group takes physical possession of assets held as collateral against wholesale
lending. In such cases, the assets are carried on the Group’s balance sheet and are classified according to the Group’s accounting policies.
Many banking assets are sensitive to interest rate movements; there is a large volume of managed rate assets such as variable rate mortgages which may be
considered as a natural offset to the interest rate risk arising from the managed rate liabilities. However a significant proportion of the Group’s lending assets, for
example personal loans and mortgages, bear interest rates which are contractually fixed for periods of up to five years or longer.
The Group establishes two types of hedge accounting relationships for interest rate risk: fair value hedges and cash flow hedges. The Group is exposed to fair
value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate
risk on its variable rate loans and deposits together with its floating rate subordinated debt. The majority of the Group’s hedge accounting relationships are fair
value hedges where interest rate swaps are used to hedge the interest rate risk inherent in the fixed rate capital issuances.
At 31 December 2012 the aggregate notional principal of interest rate swaps designated as fair value hedges was £42,602 million (2011: £35,757 million)
with a net fair value asset of £4,222 million (2011: £3,584 million) (see note 17). The losses on the hedging instruments were £16 million (2011: gains of
£873 million). The gains on the hedged items attributable to the hedged risk were £17 million (2011: losses of £875 million).
In addition the Group has a small number of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale
business. These cash flows are expected to occur over the next five years and the hedge accounting adjustments will be reported in the income statement as the
cash flows arise. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2012 was £111,889 million (2011:
£161,463 million) with a net fair value asset of £1,000 million (2011: liability of £1,211 million) (see note 17). In 2012, ineffectiveness recognised in the
income statement that arises from cash flow hedges was a gain of £6 million (2011: loss of £13 million).
Currency risk
Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in
the Group’s overseas operations.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange
exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres
who are allocated exposure limits. The limits are monitored daily by the local centres and reported to the central market risk function.
Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the
foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken
to reserves.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using cross currency borrowings.
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HBOS plc
Group
2012 2011
£m £m
The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an
undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date;
balances with no fixed maturity are included in the over 5 years category. Certain balances, included in the table below on the basis of their residual maturity,
are repayable on demand upon payment of a penalty.
At 31 December 2012
Deposits from banks 98,379 5,871 3,636 35,959 29,646 173,491
Customer deposits 145,878 7,085 22,197 43,429 6,520 225,109
Trading liabilities 12,132 5,100 9,855 3,303 3,280 33,670
Debt securities in issue 4,956 647 7,522 32,411 8,685 54,221
Liabilities arising from non-participating
investment contracts – – – – 27,166 27,166
Subordinated liabilities 14 317 102 4,830 9,226 14,489
Total non-derivative financial liabilities 261,359 19,020 43,312 119,932 84,523 528,146
Derivative financial liabilities:
Gross settled derivative – outflow 5,622 1,324 3,271 21,335 18,703 50,255
Gross settled derivative – inflow (5,428) (1,119) (3,106) (20,292) (17,484) (47,429)
Gross settled derivative – netflow 194 205 165 1,043 1,219 2,826
Net settled derivative liabilities 25,750 193 1,017 2,861 686 30,507
Total derivative financial liabilities 25,944 398 1,182 3,904 1,905 33,333
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HBOS plc
At 31 December 2011
Deposits from banks 1,218 71,230 5,365 49,210 62,652 189,675
Customer deposits 201,470 36,820 23,216 57,719 41,485 360,710
Trading liabilities 10,574 2,338 2,979 2,442 2,486 20,819
Debt securities in issue 116,648 12,562 8,322 40,880 9,391 187,803
Liabilities arising from non-participating
investment contracts – – – – 22,207 22,207
Subordinated liabilities 30 449 2,883 7,794 19,362 30,518
Total non-derivative financial liabilities 329,940 123,399 42,765 158,045 157,583 811,732
At 31 December 2012
Amounts owed to fellow Group undertakings 1,619 – – – 28,024 29,643
Subordinated liabilities – – – 3,542 5,479 9,021
Total non-derivative financial liabilities 1,619 – – 3,542 33,503 38,664
At 31 December 2011
Amounts owed to fellow Group undertakings 606 24,162 359 6,682 8,422 40,231
Subordinated liabilities – – 1,167 4,759 10,159 16,085
Total non-derivative financial liabilities 606 24,162 1,526 11,441 18,581 56,316
The Group’s financial guarantee contracts are accounted for as financial instruments and measured at fair value on the balance sheet. The majority of the Group’s
financial guarantee contracts are callable on demand, were the guaranteed party to fail to meet its obligations. It is, however, expected that most guarantees will
expire unused. The contractual nominal amounts of these guarantees totalled £5,330 million at 31 December 2012 (2011: £6,011 million) with £2,019 million
expiring within one year; £784 million between one and three years; £560 million between three and five years; and £1,967 million over five years
(2011: £727 million expiring within one year; £2,070 million between one and three years; £870 million between three and five years; and £2,344 million
over five years).
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately
£16 million (2011: £16 million) for the Group and £nil (2011: £11 million) for the Company per annum which is payable in respect of those instruments for
as long as they remain in issue is not included beyond five years.
The majority of the Group’s non-participating investment contract liabilities are unit-lined. These unit-lined products are invested in accordance with unit fund
mandates. Classes are included in policyholder contracts to permit the deferral of sales, where necessary, so that linked assets can be released without being a
forced seller.
Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows:
For insurance and participating investment contracts which are neither unit-linked nor in the Group’s with-profit funds, in particular annuity liabilites, the aim is
to invest in assets such that the cash flows on investments match those on the projected future liabilities.
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HBOS plc
31 December 2012
Acceptances and endorsements 2 – – – 2
Other contingent liabilities 380 140 57 16 593
Total contingent liabilities 382 140 57 16 595
Lending commitments 27,959 2,987 2,052 1,840 34,838
Other commitments 4 – – – 4
Total commitments 27,963 2,987 2,052 1,840 34,842
Total contingents and commitments 28,345 3,127 2,109 1,856 35,437
The Group’s appetite for solvency and earnings in insurance entities is reviewed and approved annually by the Board. Insurance risks are measured using a
variety of techniques including stress and scenario testing, and, where appropriate, stochastic modelling. Ongoing monitoring is in place to track the progression
of insurance risks. This normally involves monitoring relevant experiences against expectations, as well as evaluating the effectiveness of controls put in place
to manage insurance risk.
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HBOS plc
55 Capital
Capital is actively managed at an appropriate level of frequency and regulatory ratios are a key factor in the Group’s budgeting and planning processes with
updates of expected ratios reviewed regularly during the year by the Lloyds Banking Group Asset and Liability Committee. Capital raised takes account of
expected growth and currency of risk assets. Capital policies and procedures are subject to independent oversight.
The Group’s regulatory capital is divided into tiers depending on level of subordination and ability to absorb losses. Core tier 1 capital as defined in the FSA letter
to the British Bankers’ Association in May 2009, comprises mainly shareholders’ equity and non-controlling interests, after deducting goodwill, other intangible
assets and 50 per cent of the net excess of expected loss over accounting provisions and certain securitisation positions. Accounting equity is adjusted in
accordance with FSA requirements, particularly in respect of pensions and Available‑for‑Sale assets. Tier 1 capital, as defined by the European Community
Banking Consolidation Directive as implemented in the UK by the FSA’s General Prudential Sourcebook (GENPRU), is core tier 1 capital plus tier 1 capital
securities less 50 per cent of material holdings in financial companies. Tier 2 capital, defined by GENPRU, comprises qualifying subordinated debt and some
additional Provisions and reserves after deducting 50 per cent of the excess of expected loss over accounting provisions, and certain securitisation positions and
material holdings in financial companies. Total capital is the sum of tier 1 and tier 2 capital after deducting investments in subsidiaries and associates that are
not consolidated for regulatory purposes. In the case of the Group, this means that the net assets of its life assurance and general insurance businesses are
excluded from its total regulatory capital.
2012 2011
£m £m
A number of limits are imposed by the FSA on the proportion of the regulatory capital base that can be made up of subordinated debt and preferred securities;
for example the amount of qualifying tier 2 capital cannot exceed that of tier 1 capital.
The minimum total capital required under Pillar 1 of the Basel II framework is the Capital Resources Requirement (CRR) calculated as 8 per cent of risk weighted
assets. In addition to the minimum requirements for total capital, the FSA has made statements to explain it also operates a framework of targets and expected
buffers for core tier 1 and tier 1 capital.
In order to address the requirements of Pillar 2 of the Basel II framework, the FSA currently sets additional minimum requirements through the issuance of
Individual Capital Guidance (ICG) for each UK bank calibrated by reference to the CRR. A key input into the FSA’s ICG setting process is each bank’s Internal
Capital Adequacy Assessment Process. The Group has been given an ICG by the FSA. The FSA has made it clear, however, that ICG remains a confidential matter
between each bank and the FSA.
The Group maintains its own buffer to ensure that the regulatory minimum requirements and regulatory targets and buffers are met at all times.
During the course of the year there have been a number of significant regulatory reform developments:
Until the Basel III reforms for an enhanced global capital accord are introduced in the EU through the implementation of the new Capital Requirements Directive
and Regulation (CRDIV), the regulatory capital will continue to be based upon the Basel II framework. The impact of the reforms will be gradually phased in as
they are subject to a long transition period through to 2022. This allows time for the Group to further strengthen its capital position as necessary through
business performance and mitigating actions.
Many of the details of the way these reforms will be integrated within the UK are still to be finalised. In the meantime the Group continues to monitor their
development very closely and to analyse their potential impact whilst ensuring that the Group continues to have a strong loss absorption capacity exceeding
regulatory requirements as currently formulated.
During the year, the individual entities within the Group and the Group complied with all of the externally imposed capital requirements to which they are subject.
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HBOS plc
Group
2012 2011
£m £m
Group
2012 2011
£m £m
Group
2012 2011
£m £m
1These OEICs (Open-ended investment companies) are mutual funds which are consolidated if the Group manages the funds and also has a majority beneficial interest. The population of
OEICs to be consolidated varies at each reporting date as external investors acquire and divest holdings in the various funds. The consolidation of these funds is effected by the inclusion
of the fund investments and a matching liability to the unit holders, and changes in funds consolidated represent a non-cash movement on the balance sheet.
2When considering the movement on each line of the balance sheet, the impact of foreign exchange rate movements is removed in order to show the underlying cash impact.
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HBOS plc
Group
2012 2011
£m £m
1Mandatory reserve deposits are held with local central banks in accordance with statutory requirements; these deposits are not available to finance the Group’s day-to-day operations.
2012 2011
£m £m
Derivatives, trading and other financial assets at fair value through profit or loss – 56,359
Loans and advances to banks – 2,318
Loans and advances to customers 15 –
Debt securities – 6
Tangible fixed assets – 185
Insurance and investment contract liabilities – (52,371)
Other net assets and liabilities 29 (1,592)
44 4,905
(Loss) profit on sale of businesses (7) (1,760)
Net cash inflow from disposals 37 3,145
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HBOS plc
The following pronouncements may have a significant effect on the Group’s financial statements but are not applicable for the year ending 31 December 2012
and have not been applied in preparing these financial statements. Save as disclosed the full impact of these accounting changes is being assessed by the Group.
Amendments to IAS 1 Presentation of Financial Requires entities to group items presented in other comprehensive Annual periods beginning on or
Statements – ‘Presentation of Items of Other income on the basis of whether they are potentially reclassified after 1 July 2012.
Comprehensive Income’ to profit or loss subsequently.
Amendments to IFRS 7 Financial Instruments: Requires an entity to disclose information to enable users of its Annual and interim periods
Disclosures – Disclosures-Offsetting Financial financial statements to evaluate the effect or potential effect of beginning on or after 1 January
Assets and Financial Liabilities’ netting arrangements on the entity’s balance sheet. 2013.
IFRS 10 Consolidated Financial Statements Supersedes IAS 27 Consolidated and Separate Financial Annual periods beginning on or
Statements and SIC-12 Consolidation – Special Purpose Entities after 1 January 2013.
and establishes the principles for when the Group controls another
entity and therefore is required to consolidate the other entity in the
Group’s financial statements. The implementation of IFRS 10 will
result in the Group consolidating certain entities that were previously
not consolidated, and deconsolidating certain entities which were
previously consolidated. The effect of applying IFRS 10 in 2012
would have been to recognise an increase in total assets and total
liabilities at 31 December 2012 of approximately £1.5 billion
resulting in no change to shareholders’ equity. There would have
been no impact on the result for the year to 31 December 2012.
IFRS 12 Disclosure of Interests in Other Entities Requires an entity to disclose information that enables users of Annual periods beginning on or
financial statements to evaluate the nature of, and risks associated after 1 January 2013.
with, its interests in other entities and the effects of those interests
on its financial position, financial performance and cash flows.
IFRS 13 Fair Value Measurement Defines fair value, sets out a framework for measuring fair value Annual and interim periods
and requires disclosures about fair value measurements. It beginning on or after 1 January
applies to IFRSs that require or permit fair value measurements 2013.
or disclosures about fair value measurements.
Amendments to IAS 19 Employee Benefits Prescribes the accounting and disclosure by employers for employee Annual periods beginning on or
benefits. The main change is that actuarial gains and losses after 1 January 2013.
(remeasurements) in respect of defined benefit pension schemes are
no longer permitted to be deferred using the corridor approach and
must be recognised immediately in other comprehensive income. In
addition, revised IAS 19 also replaces interest cost and expected
return on plan assets with a net interest amount that is calculated by
applying the discount rate to the net defined benefit liability (asset).
Had the Group adopted these changes in 2012, profit after tax for
the year to 31 December 2012 would have been approximately
£2 million lower and other comprehensive income net of tax some
£570 million lower. As at 31 December 2012, unrecognised
actuarial losses of some £220 million and deferred tax assets of
£50 million would have been recognised and shareholders’ equity
would have been £170 million lower.
Amendments to IAS 32 Financial Instruments: Inserts application guidance to address inconsistencies Annual periods beginning on or
Presentation – ‘Offsetting Financial Assets and identified in applying the offsetting criteria used in the standard. after 1 January 2014.
Financial Liabilities’ Some gross settlement systems may qualify for offsetting where
they exhibit certain characteristics akin to net settlement.
IFRS 9 Financial Instruments1,2 Replaces those parts of IAS 39 Financial Instruments: Recognition Annual periods beginning on or
and Measurement relating to the classification, measurement and after 1 January 2015.
derecognition of financial assets and liabilities. IFRS 9 requires
financial assets to be classified into two measurement categories,
fair value and amortised cost, on the basis of the objectives of the
entity’s business model for managing its financial assets and the
contractual cash flow characteristics of the instruments and
eliminates the available‑for‑sale financial asset and held-to-maturity
investment categories in IAS 39. The requirements for derecognition
are broadly unchanged from IAS 39. The standard also retains
most of the IAS 39 requirements for financial liabilities, except for
those designated at fair value through profit or loss where that part
of the fair value change attributable to an entity’s own credit risk is
recorded in other comprehensive income.
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HBOS plc
The consolidated financial statements were approved by the directors of HBOS plc on 1 March 2013.
HBOS plc and its subsidiaries form a leading UK-based financial services group, whose businesses provide a wide range of banking and financial services in
the UK and in certain locations overseas.
HBOS plc’s ultimate parent undertaking and controlling party is Lloyds Banking Group plc which is incorporated in Scotland. Copies of the consolidated annual
report and accounts of Lloyds Banking Group plc may be obtained from Lloyds Banking Group’s head office at 25 Gresham Street, London EC2V 7HN or
downloaded via www.lloydsbankinggroup.com.
113
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