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Bank of Scotland Plc (63GF)

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Friday 01 March, 2013

Bank of Scotland Plc

Bank of Scotland 2012 Results

RNS Number : 0266Z
Bank of Scotland Plc
01 March 2013
 



 

Bank of Scotland plc

Results Announcement

 

For the year to 31 December 2012

 

 

 

 

 

Member of the Lloyds Banking Group



 

FORWARD LOOKING STATEMENTS

 

This announcement contains forward looking statements with respect to the business, strategy and plans of Bank of Scotland plc, its current goals and expectations relating to its future financial condition and performance.  Statements that are not historical facts, including statements about the Bank of Scotland Group or the Bank of Scotland Group's management's beliefs and expectations, are forward looking statements.  By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will or may occur in the future.  The Bank of Scotland Group's actual future business, strategy, plans and/or results may differ materially from those expressed or implied in these forward looking statements as a result of a variety of risks, uncertainties and other factors, including UK domestic and global economic and business conditions; the ability to derive cost savings and other benefits, including as a result of the Lloyds Banking Group's Simplification programme; the ability to access sufficient funding to meet the Bank of Scotland Group's liquidity needs; changes to Bank of Scotland plc's, HBOS plc's, Lloyds TSB Bank plc's or Lloyds Banking Group plc's credit ratings; risks concerning 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; changing demographic and market related trends; changes in customer preferences; changes to laws, regulation, accounting standards or taxation, including changes to regulatory capital or liquidity requirements; the policies and actions of governmental or regulatory authorities in the UK, the European Union, or jurisdictions outside the UK in which the Group operates, including other European countries and the US; 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 Bank of Scotland 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's EC state aid obligations; the extent of any future impairment charges or write-downs caused by depressed asset valuations, market disruptions and illiquid markets; the effects of competition and the actions of competitors, including non-bank financial services and lending companies; exposure to regulatory scrutiny, legal proceedings, regulatory investigations or complaints, and other factors.  Please refer to Lloyds Banking Group plc's latest Annual Report on Form 20-F filed with the US Securities and Exchange Commission for a discussion of certain factors together with examples of forward looking statements.  The forward looking statements contained in this announcement are made as at the date of this announcement, and the Bank of Scotland Group undertakes no obligation to update any of its forward looking statements.

 

 

CONTENTS

 


Page 

Financial review

Principal risks and uncertainties

Primary statements


Consolidated income statement

10 

Consolidated statement of comprehensive income

11 

Consolidated balance sheet

12 

Consolidated statement of changes in equity

14 

Consolidated cash flow statement

15 

Notes

16 

Contacts

32 

 


FINANCIAL REVIEW

 

Principal activities

Bank of Scotland plc (the Bank) and its subsidiaries (together, the Group) provide a wide range of banking and financial services in the UK and overseas.

 

During 2012, the Group earned revenue 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; and private banking.

 

Review of results

For the year ended 31 December 2012, the Group recorded a loss before tax of £1,239 million compared with a loss before tax in 2011 of £3,461 million; the improvement in profitability particularly reflecting a reduction in the impairment charge in 2012.

 

Total income decreased by £1,283 million, or 15 per cent, to £7,338 million in 2012 compared with £8,621 million in 2011, comprising a decrease of £1,125 million in net interest income and a £158 million decrease in other income.

 

Net interest income was £6,732 million in 2012; a decrease of £1,125 million, or 14 per cent, compared to £7,857 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 £158 million, or 21 per cent, lower at £606 million in 2012 compared to £764 million in 2011. Fee and commission income was £201 million, or 17 per cent, lower at £1,007 million compared to £1,208 million in 2011. Fee and commission expense increased by £25 million, or 9 per cent, to £311 million compared with £286 million in 2011. Net trading income improved by £428 million to a deficit of £218 million in 2012 compared to a deficit of £646 million in 2011.  Other operating income was £360 million, or 74 per cent, lower at £128 million in 2012 compared to £488 million in 2011 reflecting, in particular, losses on disposal of assets outside of the Group's risk appetite in 2012 and a reduction in operating lease rental income.

 

Operating expenses decreased by £711 million, or 14 per cent, to £4,267 million in 2012 compared with £4,978 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 £595 million, or 16 per cent, lower at £3,228 million in 2012 compared with £3,823 million in 2011.  Staff costs were £335 million, or 17 per cent, lower at £1,691 million in 2012 compared with £2,026 million in 2011 with the ongoing impact of headcount reductions more than offsetting the effect of annual pay rises.  Premises and equipment costs were £83 million, or 19 per cent, lower at £351 million compared with £434 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 £23 million, or 2 per cent, lower at £939 million in 2012 compared with £962 million in 2011.  Depreciation and amortisation costs were £89 million, or 26 per cent, lower at £247 million in 2012 compared to £336 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.



 

FINANCIAL REVIEW (continued)

 

In 2012, the Group recorded a tax credit of £160 million compared to a tax credit of £356 million in 2011. The tax credit of £160 million in 2012 arose on a loss before tax of £1,239 million, an effective tax rate of 13 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 £561,433 million, £3,290 million, or 1 per cent, higher compared to £558,143 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 £20,048 million, or 13 per cent, to £170,118 million compared to £150,070 million at 31 December 2011, but customer deposits were little changed at £235,051 million.

 

Shareholders' equity decreased by £283 million, from £18,397 million to £18,114 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 partly offsetting the loss for the year.

 

As at 31 December 2012, the Group's capital ratios had increased with a total capital ratio of 17.4 per cent (compared to 14.9 per cent at 31 December 2011); a tier 1 capital ratio of 10.2 per cent (compared to 8.7 per cent at 31 December 2011) and a core tier 1 ratio of 9.8 per cent (compared to 8.4 per cent at 31 December 2011). During 2012 risk-weighted assets decreased by £36,667 million to £162,582 million at 31 December 2012 compared with £199,249 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.

 

 

 

 

 

 

 

 

 

 

 



 

PRINCIPAL RISKS AND UNCERTAINTIES

 

At present the most significant risks faced by the Group are:

 

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.  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, 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.

 

 



 

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

 

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 one 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.

 



 

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

 

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.

 

A variety of risk measures are used such as:

 

-    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.

 

 

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

TheGroup 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.

 



 

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

 

The Group has on-going plans to improve the IT and Information security control environments.

 

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.

 

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.



 

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

 

LIQUIDITY AND FUNDING RISK

Definition

Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost.

 

Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.

 

Principal risks

Liquidity and funding continues to remain a key area of focus for 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:

 

-    Continued functioning of the money and capital markets.

-    The continuation of Lloyds Banking Group's strategy of right-sizing the balance sheet and development of the retail deposit base which has led to a significant reduction in the wholesale funding requirement over the past year.

-    Limited further deterioration in the UK's and the Group's credit rating. In June 2012 the Group experienced a one notch downgrade in its long-term rating from Moody's, following the agency's review of 114 European banks.  The impact that the Group experienced following the downgrade was not material and was consistent with the modelled outcomes based on the stress testing framework.  Similarly, the internal stress testing framework indicates that Moody's one notch downgrade of the UK's credit rating, announced on 22 February 2013, will not have a material impact on the Group's liquidity and funding positions; and

-    No significant or sudden withdrawal of customer deposits.

 

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.

 



 

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

 

STATE FUNDING AND STATE AID

Principal risks

HM Treasury currently holds 39.2 per cent of Lloyds Banking Group's ordinary share capital.  United Kingdom Financial Investments Limited (UKFI), as manager of HM Treasury's shareholding, continues to operate in line with the framework document between UKFI and HM Treasury, managing the investment in Lloyds 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.

 

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.

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

 

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.

 

Compliance and conduct

Significant legacy costs beyond current provisioning could have significant impact on capital ratios and credit ratings with consequent impact on liquidity risk.  There is inherent uncertainty in making estimates of provisions required.

 

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.

 

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.

 

Further information can be found under Note 18: Future accounting developments.

CONSOLIDATED INCOME STATEMENT

 




2012 


2011 


Note 


£ million 


£ million 







Interest and similar income



15,398 


16,748 

Interest and similar expense



(8,666)


(8,891)

Net interest income



6,732 


7,857 

Fee and commission income



1,007 


1,208 

Fee and commission expense



(311)


(286)

Net fee and commission income



696 


922 

Net trading income



(218)


(646)

Other operating income



128 


488 

Other income


606 


764 

Total income



7,338 


8,621 

Regulatory provisions

14 


(1,039)


(1,155)

Other operating expenses



(3,228)


(3,823)

Total operating expenses


(4,267)


(4,978)

Trading surplus



3,071 


3,643 

Impairment 


(4,310)


(7,104)

Loss before tax



(1,239)


(3,461)

Taxation


160 


356 

Loss for the year



(1,079)


(3,105)







Profit attributable to non-controlling interests




Loss attributable to equity shareholders



(1,082)


(3,105)

Loss for the year



(1,079)


(3,105)

 

 



 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

 



2012 


2011 



£ million 


£ million 






Loss for the year


(1,079)


(3,105)

Other comprehensive income:





Movements in revaluation reserve in respect of available-for-sale financial assets:





Change in fair value


360 


(90)

Income statement transfers in respect of disposals


(385)


(72)

Income statement transfers in respect of impairment


397 


749 

Other income statement transfers


121 


(76)

Taxation


(121)


(129)



372


382 

Movements in cash flow hedging reserve:





Effective portion of changes in fair value

729 


1,350 

Net income statement transfers


(269)


373 

Taxation


(83)


(447)



377 


1,276 

Currency translation differences (tax: nil)


50 


Other comprehensive income for the year, net of tax


799 


1,660 

Total comprehensive income for the year


(280)


(1,445)






Total comprehensive income attributable to non-controlling interests



Total comprehensive income attributable to equity shareholders


(283)


(1,445)

Total comprehensive income for the year


(280)


(1,445)

 

 



 

CONSOLIDATED BALANCE SHEET

 




As at 
31 Dec 
2012 


As at 
31 Dec 
2011 


Note 


£ million 


£ million 







Assets






Cash and balances at central banks



6,084 


3,070 

Items in course of collection from banks



416 


431 

Trading and other financial assets at fair value through profit or loss


32,585 


22,315 

Derivative financial instruments



35,863 


36,283 

Loans and receivables:






Loans and advances to banks



138,207 


89,490 

Loans and advances to customers


329,636 


376,355 

Debt securities



4,600 


11,886 




472,443 


477,731 

Available-for-sale financial assets



3,572 


8,288 

Investment properties



705 


1,185 

Goodwill



385 


385 

Other intangible assets



92 


69 

Tangible fixed assets



1,701 


2,367 

Current tax recoverable



873 


593 

Deferred tax assets



3,640 


4,050 

Other assets



3,074 


1,376 

Total assets



561,433 


558,143 

 

 



 

CONSOLIDATED BALANCE SHEET

 




As at 
31 Dec 
2012 


As at 
31 Dec 
2011 


Note 


£ million 


£ million 







Equity and liabilities






Liabilities






Deposits from banks



170,118 


150,070 

Customer deposits



235,051 


235,855 

Items in course of transmission to banks



518 


332 

Trading liabilities



33,610 


20,805 

Derivative financial instruments



33,272 


35,262 

Notes in circulation



1,198 


1,145 

Debt securities in issue

10 


49,508 


75,449 

Other liabilities



4,415 


4,539 

Current tax liabilities



59 


54 

Deferred tax liabilities




Other provisions



1,146 


1,063 

Subordinated liabilities

11 


14,404 


15,155 

Total liabilities



543,299 


539,730 







Equity






Share capital

12 


5,847 


5,847 

Share premium account

13 


27,479 


27,479 

Other reserves

13 


3,074 


2,275 

Retained profits

13 


(18,286)


(17,204)

Shareholders' equity



18,114 


18,397 

Non-controlling interests



20 


16 

Total equity



18,134 


18,413 

Total equity and liabilities



561,433 


558,143 

 

 



 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 



Attributable to equity shareholders





Share capital 

and 

premium 

Other 

reserves 


Retained 

profits 


Total 

Non- 
controlling 

interests 


Total 



£ million 

£ million 


£ million 


£ million 


£ million 


£ million 














Balance at 1 January 2011


33,326 


615 


(14,099)


19,842 


201 


20,043 

Comprehensive income













Loss for the year




(3,105)


(3,105)



(3,105)

Other comprehensive income













Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax



382 



382 



382 

Movements in cash flow hedging reserve, net of tax



1,276 



1,276 



1,276 

Currency translation differences (tax: nil)






Total other comprehensive income


1,660 



1,660 



1,660 

Total comprehensive income



1,660 


(3,105)


(1,445)



(1,445)

Transactions with owners













Change in non-controlling interests






(185)


(185)

Balance at 31 December 2011


33,326 


2,275 


(17,204)


18,397 


16 


18,413 

Comprehensive income













(Loss) profit for the year




(1,082)


(1,082)



(1,079)

Other comprehensive income













Movements in revaluation reserve in respect of available-for-sale financial assets, net of tax



372 



372 



372 

Movements in cash flow hedging reserve, net of tax



377 



377 



377 

Currency translation differences (tax: nil)


50 



50 



50 

Total other comprehensive income



799 



799 



799 

Total comprehensive income



799 


(1,082)


(283)



(280)

Transactions with owners













Dividends paid






(3)


(3)

Change in non-controlling interests







Total transactions with owners







Balance at 31 December 2012


33,326 


3,074 


(18,286)


18,114 


20 


18,134 

 



 

CONSOLIDATED CASH FLOW STATEMENT

 



2012 


2011 



£ million 


£ million 






Loss before tax


(1,239)


(3,461)

Adjustments for:





Change in operating assets


(1,763)


7,821 

Change in operating liabilities


4,362 


(14,304)

Non-cash and other items


(3,681)


1,912 

Tax received


38 


169 

Net cash used in operating activities


(2,283)


(7,863)






Cash flows from investing activities





Purchase of available-for-sale financial assets


(2,002)


(3,967)

Proceeds from sale and maturity of available-for-sale financial assets


6,950 


9,747 

Purchase of fixed assets


(319)


(391)

Proceeds from sale of fixed assets


1,316 


1,348 

Acquisition of businesses, net of cash acquired


(11)


(62)

Disposal of businesses, net of cash disposed


22 


298 

Net cash provided by investing activities


5,956 


6,973 






Cash flows from financing activities





Dividends paid to non-controlling interests


(3)


Change in non-controlling interests



Interest paid on subordinated liabilities


(490)


(481)

Repayment of subordinated liabilities


(649)


(94)

Net cash used in financing activities


(1,138)


(575)

Effects of exchange rate changes on cash and cash equivalents


(2)


Change in cash and cash equivalents


2,533 


(1,464)

Cash and cash equivalents at beginning of year


4,918 


6,382 

Cash and cash equivalents at end of year


7,451 


4,918 

 

Cash and cash equivalents comprise cash and balances at central banks (excluding mandatory deposits) and amounts due from banks with a maturity of less than three months.

 



NOTES

 



Page 

1

Accounting policies, presentation and estimates

17 

2

Other income

18 

3

Operating expenses

18 

4

Impairment

18 

5

Taxation

19 

6

Trading and other financial assets at fair value through profit or loss

19 

7

Loans and advances to customers

20 

8

Allowance for impairment losses on loans and receivables

20 

9

Securitisations and covered bonds

21 

10

Debt securities in issue

22 

11

Subordinated liabilities

22 

12

Share capital

22 

13

Reserves

22 

14

Provisions for liabilities and charges

23 

15

Contingent liabilities and commitments

24 

16

Capital ratios

27 

17

Related party transactions

28 

18

Future accounting developments

30 

19

Ultimate parent undertaking

31 

20

Other information

31 

 



1.         Accounting policies, presentation and estimates

 

These financial statements as at and for the year to 31 December 2012 have been prepared in accordance with the Listing Rules of the Financial Services Authority (FSA) relating to Preliminary Results and comprise the results of Bank of Scotland plc (the Bank) together with its subsidiaries (the Group).  The Group's consolidated financial statements as at and for the year ended 31 December 2012 have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union.  Copies of the 2012 annual report and accounts will be published on the Lloyds Banking Group's website and will be available upon request from Investor Relations, Lloyds Banking Group plc, 25 Gresham Street, London EC2V 7HN.

 

The directors consider that it is appropriate to continue to adopt the going concern basis in preparing these financial statements.  In reaching this assessment, the directors have considered projections for the Group's capital and funding position and have had regard to the factors set out in Principal risks and uncertainties: Liquidity and funding risk on page 6.

 

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.

 

Accounting policies

The accounting policies are consistent with those applied by the Group in its 2011 annual report and accounts.

 

New accounting pronouncements

The Group has adopted the following amendments to standards which became effective for financial years beginning on or after 1 January 2012.  Neither of amendments has had a material impact on these financial statements.

 

(i)   Disclosures - 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.  The relevant disclosures have been made in the Group's financial statements for the year ended 31 December 2012.

 

(ii)  Deferred 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 will not be effective at 31 December 2012 and which have not been applied in preparing these financial statements are given in note 18.

 

Critical accounting estimates and judgements

The preparation of the Group's financial statements requires management to make judgements, estimates and assumptions that impact the application of accounting policies and the reported amounts of assets, liabilities, income and expenses.  Due to the inherent uncertainty in making estimates, actual results reported in future periods may include 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.  There have been no significant changes in the basis upon which estimates have been determined, compared to that applied at 31 December 2011.

 



 

2.         Other income



2012 


2011 



£m 


£m 






Fee and commission income:





Current account fees


281 


357 

Credit and debit card fees


262 


214 

Other fees and commissions


464 


637 



1,007 


1,208 

Fee and commission expense


(311)


(286)

Net fee and commission income


696 


922 

Net trading income


(218)


(646)

Other operating income


128 


488 

Total other income


606 


764 

 

 

3.         Operating expenses



2012 


2011 



£m 


£m 






Administrative expenses:





Staff


1,691 


2,026 

Premises and equipment


351 


434 

Other expenses


939 


962 



2,981 


3,422 

Depreciation and amortisation


247 


336 

Impairment of tangible fixed assets



65 

Total operating expenses, excluding regulatory provisions

3,228 


3,823 

Regulatory provisions (note 14)

1,039 


1,155 

Total operating expenses

4,267 


4,978 

 

 

4.         Impairment



2012 


2011 



£m 


£m 






Impairment losses on loans and receivables:





Loans and advances to customers


4,252 


6,961 

Debt securities classified as loans and receivables


17 


60 

Impairment losses on loans and receivables (note 8)


4,269 


7,021 

Impairment of available-for-sale financial assets


41 


78 

Other credit risk provisions



Total impairment charged to the income statement


4,310 


7,104 

 

 



 

5.         Taxation

 

A reconciliation of the tax credit that would result from applying the standard UK corporation tax rate to the loss before tax to the actual tax credit is given below:

 



2012 


2011 



£m 


£m 






Loss before tax


(1,239)


(3,461)






Tax credit thereon at UK corporation tax rate of 24.5 per cent (2011: 26.5 per cent)

304 


917 

Factors affecting tax credit:





UK corporation tax rate change


(325)


(350)

Disallowed and non-taxable items


61 


(48)

Overseas tax rate differences


75 


(8)

Gains exempted or covered by capital losses


(10)


60 

Losses surrendered for nil payment



(34)

Tax losses where no deferred tax recognised


(13)


(246)

Adjustments in respect of previous years


64 


20 

Deferred tax on tax losses not previously recognised



40 

Effect of results in joint ventures and associates



Other items


(5)


Tax credit


160 


356 

 

 

The Finance Act 2012 (the Act) was substantively enacted on 3 July 2012.  The Act further reduces the rate of corporation tax to 23 per cent with effect from 1 April 2013.  

 

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.

 

6.         Trading and other financial assets at fair value through profit or loss



2012 


2011 



£m 


£m 






Trading assets


32,201 


21,840 






Other financial assets at fair value through profit or loss:





Loans and advances to customers


22 


54 

Debt securities


15 


135 

Equity shares


347 


286 



384 


475 

Total trading and other financial assets at fair value through profit or loss


32,585 


22,315 

 

 



 

7.         Loans and advances to customers



2012 


2011 



£m 


£m 






Agriculture, forestry and fishing


501 


588 

Energy and water supply


1,200 


1,670 

Manufacturing


1,842 


2,946 

Construction


3,956 


6,818 

Transport, distribution and hotels


14,898 


20,135 

Postal and communications


297 


357 

Property companies


30,163 


42,418 

Financial, business and other services


14,419 


33,077 

Personal:





Mortgages


237,466 


243,222 

Other


13,302 


12,920 

Lease financing


2,953 


3,840 

Hire purchase


506 


772 

Due from fellow Group undertakings


26,014 


30,943 



347,517 


399,706 

Allowance for impairment losses on loans and advances (note 8)


(17,881)


(23,351)

Total loans and advances to customers


329,636 


376,355 

 

Loans and advances to customers include advances securitised under the Group's securitisation and covered bond programmes.  Further details are given in note 9.

 

 

8.         Allowance for impairment losses on loans and receivables



2012 


2011 



£m 


£m 






At 1 January


24,499 


26,607 

Exchange and other adjustments


(346)


(374)

Advances written off


(9,723)


(8,650)

Recoveries of advances written off in previous years


499 


66 

Unwinding of discount (note 4)


(329)


(171)

Charge to the income statement


4,269 


7,021 

At 31 December


18,869 


24,499 

 





In respect of:





Loans and advances to customers (note 7)


17,881 


23,351 

Debt securities


988 


1,148 

At 31 December


18,869 


24,499 

 

 



9.         Securitisations and covered bonds

 

The Group's principal securitisation and covered bond programmes, together with the balances of the loans subject to these arrangements and the carrying value of the notes in issue, are listed in the table below.

 



2012


2011










Loans and 
advances 

securitised 


Notes in 

issue 


Loans and 
advances 

securitised 


Notes 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 10)




17,624 




26,918 










Covered bond programmes









Residential mortgage-backed


46,311 


33,414 


48,521 


38,882 

Social housing loan-backed


2,934 


2,400 


3,370 


2,605 



49,245 


35,814 


51,891 


41,487 

Less held by the Group




(10,226)




(13,515)

Total covered bond programmes (note 10)




25,588 




27,972 

Total securitisation and covered bond programmes


43,212 




54,890 

 

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 detailed above, the Group sponsors a conduit programme, Grampian.

 

Covered bond programmes

Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security to issues of covered bonds by the Group.  The Group retains all of the risks and rewards associated with these loans and the partnerships are consolidated fully with the loans retained on the Group's balance sheet, and the related covered bonds in issue included within debt securities in issue.

 

Cash deposits of £12,710 million (31 December 2011: £13,381 million) held by the Group are restricted in use to repayment of the debt securities issued by the SPEs and other legal obligations.



10.       Debt securities in issue



2012 


2011 



£m 


£m 






Medium-term notes issued


5,611 


12,491 

Covered bonds (note 9)


25,588 


27,972 

Certificates of deposit


29 


350 

Securitisation notes (note 9)


17,624 


26,918 

Commercial paper


121 


6,159 



48,973 


73,890 

Amounts due to fellow Group undertakings


535 


1,559 

Total debt securities in issue


49,508 


75,449 

 

 

11.       Subordinated liabilities

 

The movement in subordinated liabilities during the year was as follows:



2012 


2011 



£m 


£m 






At 1 January


15,155 


15,236 

Repurchases and redemptions during the year


(649)


(94)

Foreign exchange and other movements


(102)


13 

At 31 December


14,404 


15,155 

 

 

12.       Share capital

 

Ordinary share capital in issue is as follows:

Ordinary shares of 25 pence each


Number of 
shares 
(millions) 


£m 






At 1 January and 31 December 2012


23,388 


5,847 

 

 

13.       Reserves






Other reserves





Share 
premium 



Available- 
for-sale 


Cash flow 
hedging 


Merger 
and other 



Total 


Retained 
profits 



£m 



£m 


£m 


£m 



£m 


£m 
















At 1 January 2012


27,479 



(517)


861 


1,931 



2,275 


(17,204)

Loss for the year









(1,082)

Change in fair value of available-for-sale assets (net of tax)




282 





282 


Change in fair value of hedging derivatives
(net of tax)





584 




584 


Transfers to income statement (net of tax)




90 


(207)




(117)


Exchange and other adjustments






50 



50 


At 31 December 2012


27,479 



(145)


1,238 


1,981 



3,074 


(18,286)


















14.       Provision for liabilities and charges

 

Payment protection insurance

Following the unsuccessful legal challenge by the British Bankers' Association against the FSA and the Financial Ombudsman Service, the Lloyds Banking Group held  discussions with the FSA with a view to seeking clarity around the detailed implementation of the FSA Policy Statement which set out evidential provisions and guidance on the fair assessment of a complaint and the calculation of redress in respect of payment protection insurance sales standards, As a result, the Lloyds Banking Group concluded that there are certain circumstances where customer redress will be appropriate.  Accordingly the Group made a provision in its income statement for the year ended 31 December 2011 of £1,155 million in respect of the anticipated costs of such redress, including administration expenses.

 

During the first half of 2012 there was an increase in the volume of complaints being received, although other assumptions continued to be broadly in line with expectations, and as a result the Group increased its provision by a further £240 million in the six months to 30 June 2012 to cover the anticipated redress in relation to these increased volumes.  Whilst the level of complaints received declined during the second half of 2012 in comparison to the previous six months, they are higher than had been anticipated at the time of the Group's half year results.  As a consequence, the Group believes that it is appropriate to increase its provision by a further £610 million during the second half of 2012, resulting in a charge of £850 million for the year.  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 assumptions 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.

 

Other regulatory provisions

 

Interest rate hedging products

In June 2012, a number of banks, including the Lloyds Banking Group, reached agreement with the FSA to carry out a thorough assessment of sales made since 1 December 2001 of interest rate hedging products (IRHP) to certain small and medium-sized businesses.  The Lloyds Banking Group agreed that on conclusion of this review it would provide redress to any of these customers where appropriate.

 

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.

 

Other regulatory matters

In the course of its business, the Lloyds Banking Group is engaged in discussions with the FSA or other regulators in relation to a range of matters.  In 2012 a provision of £50 million was made in respect of certain UK retail and other matters; however, the ultimate impact on the Group of these discussions can only be known at the conclusion of such discussions.

15.       Contingent liabilities and commitments

 

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 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.

 

Interbank offered rate setting investigations

A number of government agencies in the UK, US and elsewhere, including the UK Financial Services Authority, the US Commodity Futures Trading Commission, the US Securities and Exchange Commission, the US Department of Justice and a number of State Attorneys General, as well as the European Commission, are conducting investigations into submissions made by panel members to the bodies that set various interbank offered rates including the BBA London Interbank Offered Rates (LIBOR) and the European Banking Federation's Euribor. Certain Lloyds Banking Group companies were (at the relevant times) and remain members of various panels whose members make submissions to these bodies including the BBA LIBOR panels.  No Lloyds Banking Group company is or was a member of the Euribor panel.  Certain Lloyds Banking Group companies have received subpoenas and requests for information from certain government agencies and the Lloyds Banking Group is co-operating with their investigations.  In addition certain Lloyds Banking Group companies, together with other panel banks, have been named as defendants in private lawsuits, including purported class action suits in the US with regard to the setting of LIBOR.  It is currently not possible to predict the scope and ultimate outcome of the various regulatory investigations or private lawsuits, including the timing and scale of the potential impact of any investigations and private lawsuits on the Lloyds Banking Group.

 



 

15.       Contingent liabilities and commitments (continued)

 

Financial Services Compensation Scheme

The Financial Services Compensation Scheme(FSCS) is the UK's independent statutory compensation fund for customers of authorised financial services firms and pays compensation if a firm is unable to pay claims against it.  The FSCS is funded by levies on the industry (and recoveries and borrowings where appropriate).  The levies raised comprise both management expenses levies and, where necessary, compensation levies on authorised firms.

 

Following the default of a number of deposit takers in 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. The 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: £81 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.  

 

FSA investigation into Bank of Scotland and report on HBOS

In 2009, the FSA commenced a supervisory review into HBOS.  The supervisory review was superseded when the FSA commenced an enforcement investigation into the Bank in relation to its Corporate Division between 2006 and 2008.  These proceedings have now concluded.  The FSA published its Final Notice on 9 March 2012.  No financial penalty was imposed on the Group or the Bank.  The FSA has committed to producing a public interest report on HBOS.  The FSA has indicated that the report is expected to be published in the summer.

 

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.

 



 

15.       Contingent liabilities and commitments (continued)

 

Other legal actions and regulatory matters

In addition, during the ordinary course of business the Lloyds Banking Group is subject to other threatened and actual legal proceedings (which may include class action lawsuits brought on behalf of customers, shareholders or other third parties), regulatory investigations, regulatory challenges and enforcement actions, both in the UK and overseas.  All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of the Lloyds Banking Group incurring a liability.  In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management's best estimate of the amount required to settle the obligation at the relevant balance sheet date.  In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed properly to assess the merits of the case and no provisions are held against such matters.  However the Lloyds Banking Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.

 

Contingent liabilities and commitments arising from the banking business

 



2012 


2011 



£m 


£m 






Contingent liabilities





Acceptances and endorsements


2 


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 






Commitments





Documentary credits and other short-term trade-related transactions


4


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 

 



 

16.       Capital ratios

 

 

Capital resources


2012 


2011 



£m 


£m 






Core tier 1





Shareholders' equity per balance sheet


18,114 


18,397 

Non-controlling interests per balance sheet


20 


16 

Regulatory adjustments:





Regulatory adjustments to non-controlling interests



12 

Unrealised reserve on available-for-sale debt securities


178 


859 

Unrealised reserve on available-for-sale equity investments


(33)


(342)

Cash flow hedging reserve


(1,238)


(861)

Other items



(16)



17,048


18,065 

Less: deductions from core tier 1





Goodwill


(374)


(416)

Intangible assets


(92)


(69)

50 per cent excess of expected losses over impairment provisions


(550)


(684)

50 per cent of securitisation positions


(113)


(84)

Core tier 1 capital


15,919 


16,812 






Preferred securities1


700 


700 

Less: deductions from tier 1





50 per cent of material holdings


(3)


(80)

Total tier 1 capital


16,616 


17,432 






Tier 2





Undated subordinated debt


4,776 


4,812 

Dated subordinated debt


7,530 


7,639 

Unrealised gains on available for sale equity investments


33 


342 

Eligible provisions


942 


1,203 

Less: deductions from tier 2





50 per cent excess of expected losses over impairment provisions


(550)


(684)

50 per cent of securitisation positions


(113)


(84)

50 per cent of material holdings


(3)


(80)

Total tier 2 capital


12,615 


13,148 






Supervisory deductions





Unconsolidated investments


(919)


(983)

Total supervisory deductions


(919)


(983)

Total capital resources


28,312 


29,597 






Risk-weighted assets


162,582 


199,249 

Core tier 1 capital ratio


9.8% 


8.4% 

Tier 1 capital ratio


10.2% 


8.7% 

Total capital ratio


17.4% 


14.9% 

 

1

Covered by grandfathering provisions issued by FSA.

 

 

 

 



17.       Related party transactions

 

Balances and transactions with Lloyds Banking Group plc and fellow Group undertakings

The Bank and its subsidiaries have balances due to and from the Bank's ultimate parent company, Lloyds Banking Group plc, and fellow Group undertakings of the Bank.  These are included on the balance sheet as follows:

 



2012 


2011 



£m 


£m 






Assets





Derivative financial instruments


6,811 


4,226 

Loans and advances to banks


135,316 


85,800 

Loans and advances to customers


26,014 


30,943 

Trading and other financial assets at fair value through profit or loss


14,761 


7,739 

Other


1,574 


1,171 






Liabilities





Deposits from banks


163,005 


144,502 

Customer deposits


29,782 


35,267 

Trading liabilities


8,479 


6,690 

Derivative financial instruments


9,165 


8,562 

Debt securities in issue


535 


1,559 

Subordinated liabilities


11,140 


11,151 

Other


27 


 

During the year ended 31 December 2012 the Group earned £1,277 million (2011: £853 million) of interest income and incurred £2,356 million (2011: £2,296 million) of interest expense on balances and transactions with Lloyds Banking Group plc and fellow Group undertakings.

 

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 (2011: 40.2 per cent) interest in Lloyds Banking Group plc's ordinary share capital and consequently HM Treasury remained a related party of Lloyds Banking Group plc, and therefore of the Group, during the year ended 31 December 2012.

 

From 1 January 2011, in accordance with IAS 24, UK Government-controlled entities became related parties of the Group.  The Group regards the Bank of England and entities controlled by the UK Government, including The Royal Bank of Scotland Group plc, Northern Rock (Asset Management) plc and Bradford & Bingley plc, as related parties.

 

The Lloyds Banking Group has participated in a number of schemes operated by the UK Government and central banks and made available to eligible banks and building societies.

 

Credit guarantee scheme

HM Treasury launched the Credit Guarantee Scheme in October 2008.  The drawdown window for the Credit Guarantee Scheme closed for new issuance at the end of February 2010.  At 31 December 2011, the Lloyds Banking Group had £23.5 billion of debt in issue under the Credit Guarantee Scheme. During the year ended 31 December 2012, fees of £59 million paid to HM Treasury in respect of guaranteed funding were included in the Lloyds Banking Group's income statement (2011: £291 million). At 31 December 2012, the Lloyds Banking Group had fully repaid all debt issued under the Credit Guarantee Scheme.

 



 

17.          Related party transactions (continued)

 

National Loan Guarantee Scheme

The Lloyds Banking Group is participating in the UK Government's National Loan Guarantee Scheme, which was launched on 20 March 2012.  Through the scheme, the Lloyds Banking Group expects to provide eligible UK businesses with discounted funding over the next two years, subject to continuation of the scheme and its financial benefits, and based on the Lloyds Banking Group's existing lending criteria.  Eligible businesses who take up the funding will benefit from a 1 per cent discount on their funding rate for a certain period of time.

 

Business Growth Fund

In May 2011 the Lloyds Banking Group agreed, together with The Royal Bank of Scotland plc (and three other non-related parties), to commit up to £300 million of equity investment by subscribing for shares in the Business Growth Fund plc which is the company created to fulfil the role of the Business Growth Fund as set out in the British Bankers' Association's Business Taskforce Report of October 2010.  As at 31 December 2012, the Lloyds Banking Group had invested £50 million (2011: £20 million) in the Business Growth Fund and carried the investment at a fair value of £44 million (2011: £16 million).

 

Big Society Capital

In January 2012 the Lloyds Banking Group agreed, together with The Royal Bank of Scotland plc (and two other non-related parties), to commit up to £50 million each of equity investment into the Big Society Capital Fund.  The Fund, which was created as part of the Project Merlin arrangements, is a UK social investment fund.  The Fund was officially launched on 3 April 2012 and the Lloyds Banking Group invested £12 million in the Fund during 2012.

 

Funding for Lending

In August 2012 the Lloyds Banking Group announced its support for the UK Government's Funding for Lending Scheme and confirmed its intention to participate in the scheme.  The Funding for Lending Scheme represents a further source of cost effective secured term funding available to the Lloyds Banking Group.  The initiative supports a broad range of UK-based customers, providing householders with more affordable housing finance and businesses with cheaper finance to invest and grow.  The Lloyds Banking Group drew down £3.0 billion during 2012.

 

Central bank facilities

In the ordinary course of business, the Lloyds Banking Group may from time to time access market-wide facilities provided by central banks.

 

Other government-related entities

There were no significant transactions with other UK Government-controlled entities (including UK Government-controlled banks) during the period that were not made in the ordinary course of business or that were unusual in their nature or conditions.

 

Other related party transactions

Other related party transactions for 2012 are similar in nature to those for the year ended 31 December 2011.

 



 

18.       Future accounting developments

 

The following pronouncements may have a significant effect on the Group's financial statements but are not applicable for the year ending 31 December 2012 and have not been applied in preparing these financial statements.  Save as disclosed below, the full impact of these accounting changes is being assessed by the Group.

 

Pronouncement

Nature of change

IASB effective date

Amendments to IAS 1 Presentation of Financial Statements - 'Presentation of Items of Other Comprehensive Income'

Requires entities to group items presented in other comprehensive income on the basis of whether they are potentially reclassified to profit or loss subsequently.

Annual periods beginning on or after 1 July 2012.

Amendments to IFRS 7 Financial Instruments: Disclosures - 'Disclosures-Offsetting Financial Assets and Financial Liabilities'

Requires an entity to disclose information to enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on the entity's balance sheet.

Annual and interim periods beginning on or after 1 January 2013.

IFRS 10 Consolidated Financial Statements

Supersedes IAS 27 Consolidated and Separate Financial Statements and SIC-12 Consolidation - Special Purpose Entities 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 is not expected to have a material impact on the Group.

Annual periods beginning on or after 1 January 2013.

IFRS 12 Disclosure of Interests in Other Entities

Requires an entity to disclose information that enables users of financial statements to evaluate the nature of, and risks associated with, its interests in other entities and the effects of those interests on its financial position, financial performance and cash flows.

Annual periods beginning on or after 1 January 2013.

IFRS 13 Fair Value Measurement

Defines fair value, sets out a framework for measuring fair value and requires disclosures about fair value measurements.  It applies to IFRSs that require or permit fair value measurements or disclosures about fair value measurements.

Annual and interim periods beginning on or after 1 January 2013.

Amendments to IAS 32 Financial Instruments: Presentation - 'Offsetting Financial Assets and Financial Liabilities'

Inserts application guidance to address inconsistencies identified in applying the offsetting criteria used in the standard.  Some gross settlement systems may qualify for offsetting where they exhibit certain characteristics akin to net settlement.

Annual periods beginning on or after 1 January 2014.

IFRS 9 Financial Instruments1,2

Replaces those parts of IAS 39 Financial Instruments: Recognition and Measurement relating to the classification, measurement and 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.

Annual periods beginning on or after 1 January 2015.

 

1

As at 1 March 2013, this pronouncement is awaiting EU endorsement.

2

IFRS 9 is the initial stage of the project to replace IAS 39.  Future stages are expected to result in amendments to IFRS 9 to deal with changes to the impairment of financial assets measured at amortised cost and hedge accounting, as well as a reconsideration of classification and measurement.  Until all stages of the replacement project are complete, it is not possible to determine the overall impact on the financial statements of the replacement of IAS 39.



 

19.       Ultimate parent undertaking

 

Bank of Scotland plc's ultimate parent undertaking and controlling party is Lloyds Banking Group plc which is incorporated in Scotland.  Lloyds Banking Group plc has published consolidated accounts for the year to 31 December 2011 and copies may be obtained from Investor Relations, Lloyds Banking Group, 25 Gresham Street, London EC2V 7HN and available for download from www.lloydsbankinggroup.com

 

 

20.       Other information

 

The financial information included in these financial statements does not constitute statutory accounts within the meaning of section 434 of the Companies Act 2006.  Statutory accounts for the year ended 31 December 2012 were approved by the directors on 1 March 2013 and will be delivered to the Registrar of Companies following publication in March 2013.  The auditors' report on those accounts was unqualified and did not include a statement under sections 498(2) (accounting records or returns inadequate or accounts not agreeing with records and returns) or 498(3) (failure to obtain necessary information and explanations) of the Companies Act 2006.

 

 



 

 

 

 

 

 

CONTACTS

 

 

 

For further information please contact:

 

INVESTORS AND ANALYSTS

Charles King

Investor Relations Director

020 7356 3537

[email protected]

 

 

CORPORATE AFFAIRS

Matthew Young

Group Corporate Affairs Director

020 7356 2231

[email protected]

 

Ed Petter
Group Media Relations Director

020 8936 5655

[email protected]

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Registered office: Bank of Scotland plc, The Mound, Edinburgh EH1 1YZ

Registered in Scotland no. SC327000

 


This information is provided by RNS
The company news service from the London Stock Exchange
 
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