We expect economic growth in the UK to strengthen in 2004, helped by a recovery in the global economy. The UK’s manufacturing sector has had a difficult last few years but is now emerging from recession and that should continue this year, boosting the overall UK economy. This, we believe, will create a better balance to UK economic growth, which has been led by consumer spending for some years. The recent buoyant growth in mortgage and consumer credit markets may ease back to more normal levels in 2004 as the combined effect of higher interest rates and slower growth in personal disposable incomes lowers demand. The expected overall strengthening in UK economic growth is likely to lead to higher interest rates but, whilst inflation remains low, only a modest increase is expected. Over the next few years the financial services industry will face significant challenges as a result of the continuing burden of European and UK regulation. Some of this is potentially very damaging to the competitiveness of the UK financial services sector.
Introduction and development Lloyds TSB Group is a leading UK-based financial services group, which was created in 1995 following the merger of the TSB Group and the Lloyds Bank Group, the history of which can be traced back to the 18th century when the banking partnership of Taylor and Lloyds was established in the UK. Its businesses provide a wide range of banking and financial services in the UK and overseas, principally through branches of Lloyds TSB Bank and its wholly owned subsidiaries, Cheltenham & Gloucester and Lloyds TSB Scotland. In 2000, Lloyds TSB Group acquired Scottish Widows; this transaction positioned Lloyds TSB Group as one of the leading suppliers of long-term savings and protection products in the UK.
The accounting policies that are deemed critical to the Lloyds TSB Group’s results and financial position, based upon materiality and significant judgements and estimates, are discussed below.
Dealing profits decreased by £45 million, or 19 per cent, compared with 2001 as a result of a reduction of £60 million in gains from securities trading; there were reduced opportunities for the Lloyds TSB Group’s London treasury department, due to less favourable market conditions, and losses resulting from the economic turmoil in Brazil. Foreign exchange trading income improved by £15 million as a result of an improved performance from Lloyds TSB Group’s UK operations.
• Existing business: this comprises the following elements: – the expected return arising from the unwinding of the discount applied to the expected cash flows at the beginning of a year; – experience variances caused by differences between the actual experience during the year and the expected experience; – the effects of changes in assumptions, other than economic assumptions, and other items; and – provisions for customer redress.
• Development costs: these costs represent the investment made during the year in Sandler products and depolarisation developments, and the development of e-commerce relationships with IFAs.
Existing business earnings fell by 61 per cent to £145 million, from £369 million in 2001. The expected return from existing business was £34 million lower at £273 million reflecting the lower value of in-force business at the beginning of 2002, caused by the effect of lower stock markets on annual management charges. In addition, there was a reduction of £55 million in benefits from experience variances and actuarial assumption changes, largely reflecting the implementation of revised actuarial mortality assumptions. There was a £30 million reduction in provisions for redress to past purchasers of pension policies, although this was more than offset by a £165 million provision for possible redress to past purchasers of endowment policies.
The resulting risk oversight responsibilities of the board, audit committee and risk oversight committee are shown in the corporate governance section on page 75, whilst further key risk oversight roles are described below.
Group Risk Management facilitated executive risk workshops in many Lloyds TSB Group businesses during 2003 to enhance risk awareness, assist the identification and mitigation of key risks to achievement of business objectives, and to establish or further refine their risk appetite.
During 2003, Lloyds TSB Group revised its code of business conduct, which applies to the group chief executive, the deputy group chief executive, who is acting as the group finance director and principal accounting officer, and all other employees. It seeks to ensure that employees act with integrity and endeavour to deliver high levels of customer service. It promotes a working environment free from discrimination, harassment, bullying or victimisation of any kind. Employees are encouraged and expected to alert management to suspected misconduct, fraud or other serious malpractice. The code as amended from time to time is available to the public on the Lloyds TSB Group’s website at www.lloydstsb.com.
Credit derivatives. These are a method of transferring credit risk from one counterparty to another and of managing exposure to selected counterparties. Credit derivatives include credit swaps, credit spread options and credit linked notes. Lloyds TSB Group has limited exposure to such instruments.
In the US, it is the normal practice to stop accruing interest when payments are 90 days or more past due or when recovery of both principal and interest is doubtful. When the loans are transferred to non-accrual status, accrued interest is reversed from income and no further interest is recognised until it becomes probable that the principal and interest will be repaid in full. Loans on which interest has been accrued but suspended would be included in risk elements as loans accounted for on a non-accrual basis.
In the US, loans whose terms have been modified due to problems with the borrower are required to be separately disclosed. If the new terms were in line with market conditions at the time of the restructuring and the restructured loan remains current as to repayment of principal and interest then the disclosure can be discontinued at the end of the first year.
Domestic lending Interest income that would have been recognised under original contract terms 18 Interest income included in profit (19)
The Lloyds TSB Group applies appropriate new product review processes to provide assurance that risks inherent in new products have been identified and mitigated.
Businesses are required, prior to publication of any sales material, to seek confirmation that it complies with the regulatory and legal requirements of the jurisdiction in which the product is offered and marketed. Terms and conditions (to include mandates, agreements and other documentation) are approved by legal advisors and reviewed periodically.
At N2, a new Inter-Professionals Code (IPC) covering investment products succeeded the London Code of Conduct (LCC) for investment and non-investment products. Trading in the wholesale markets in Non-Investment Products (NIPs) that is sterling, foreign exchange and bullion wholesale deposit markets, and the spot and forward foreign exchange and bullion markets, is not covered by the IPC. There was however strong market support for a code to cover these markets, and in November 2002, a draft NIPs Code was published for consultation.
Robust internal audit systems are in place to review adherence to policies and procedures and environmental performance is subject to external independent verification. Overall, the board is satisfied that the company complies with its CSR related policies and procedures.
Gavin J N Gemmell CBE✠* Chairman of Scottish Widows Joined the board in 2002. A nonexecutive director of Scottish Widows, having been appointed to the board of that company before it became a member of the Lloyds TSB Group. Retired as senior partner of Baillie Gifford in 2001, after 37 years with that firm. A non-executive director of Archangel Informal Investment. Chairman of the court of Heriot-Watt University. Aged 62.
The effectiveness of the internal control system is reviewed regularly by the board and the audit committee, which also receives reports of reviews undertaken around the Lloyds TSB Group by its risk management function, including Group Compliance, and Group Audit. The audit committee receives reports from the company’s auditors, PricewaterhouseCoopers LLP, (which include details of significant internal control matters that they have identified) and has a discussion with the auditors at least once a year without executives present, to ensure that there are no unresolved issues of concern.
This is a report made by the board of Lloyds TSB Group plc, on recommendation of the remuneration committee. The role of the remuneration committee is shown on page 75.
l) The exercise period was shortened in accordance with the share option scheme rules when the director ceased to be an employee.
None of those who were directors at the end of the year had any other interest in the capital of Lloyds TSB Group plc or its subsidiaries.
We review whether the corporate governance statement on pages 74 to 77 reflects the company’s compliance with the seven provisions of the Combined Code issued in June 1998 specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the board’s statements on internal control cover all risks and controls, or to form an opinion on the effectiveness of the company’s or Group’s corporate governance procedures or its risk and control procedures.
Fixed assets Investments: – Shares in group undertakings 22 10,753 9,091 – Loans to group undertakings 22 1,723 1,723
9 Tax on profit on ordinary activities a Analysis of charge for the year 2003 2002* 2001* £m £m £m.
pence pence pence per share per share per share £m £m £m 12 Earnings per share 2003 2002* 2001*
Other public sector securities 106 106 112 112 Bank and building society certificates of deposit – – 340 340
Net tangible assets of life companies including surplus 3,602 3,309 Value of other shareholder’s interests in the long-term assurance business 2,879 2,904
The revised assumptions have resulted in a net charge to the profit and loss account of £22 million.
Income from long-term assurance business attributable to the shareholder after tax 296 (250) (41) (Increase) decrease in value-in-force taken to profit (2) (166) 111
Liabilities Shareholder’s funds 4,234 3,914 Fund for future appropriations 346 12 Long-term business provision† 23,730 23,217 Technical provision for linked liabilities† 25,023 20,996 Other creditors 1,176 1,115
Repayable on demand 90,539 87,918 Other customer accounts with agreed maturity dates or periods of notice by residual maturity repayable: 3 months or less 17,316 19,047 1 year or less but over 3 months 1,846 3,099 5 years or less but over 1 year 5,431 4,140
Mortgage endowments were sold to customers through the branch network of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester, and underwritten by life assurance companies within Lloyds TSB Group and also by third parties. The principal assumptions underlying the provision relate to the number of cases requiring redress and the estimated average cost per case. It is expected that the majority of the expenditure will be incurred over the next two years. Whilst the current provision has been calculated based on recent actual experience, uncertainty remains as to the ultimate cost and timing of the payments, which will be influenced by external factors beyond the control of management, such as regulatory actions and the performance of financial markets.
43/4% Subordinated Notes 2011 (c850 million) 578 532 – – Subordinated Fixed Rate Bonds 2011 (NZ $100 million) – 33 – – Subordinated Fixed Rate Bonds 2012 (NZ $125 million) – 41 – – Subordinated Fixed Rate Bonds 2012 (NZ $125 million) – 41 – –
** These securities constitute limited partnership interests in Lloyds TSB Capital 2 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. Non-cumulative income distributions accrue at a fixed rate of 7.834 per cent per annum up to 7 February 2015; thereafter they will accrue at a rate of 3.50 per cent above a rate based on the yield of specified UK government stock.
Fair value at of return at Fair value at of return at Fair value at of return at 31 December 31 December 31 December 31 December 31 December 31 December
(Deficit) surplus at beginning of year (2,931) 433 Exchange and other adjustments (4) 26 Other finance income 34 165 Current service costs (269) (244)
Net cash inflow from trading activities 4,375 4,528 3,401 Net increase in loans and advances (11,710) (11,970) (9,340) Net decrease (increase) in investments other than investment securities 248 (2,494) (5,664) Net decrease (increase) in other assets 816 (685) (334) Net (decrease) increase in deposits by banks (1,000) 1,018 7,689 Net increase in customer accounts 7,658 6,900 7,525 Net increase in debt securities in issue 685 5,904 6,557 Net (decrease) increase in other liabilities (645) 1,511 109 Net decrease (increase) in items in course of collection/transmission 169 147 (17) Other non-cash movements 176 535 1
Insurance activities, before tax p (160) (393) (328) Banking and Group activities: – Reduction in profit on sale of businesses b (12) – – – Amortisation of customer related intangibles a (150) (193) (219)
Net income under US GAAP 3,231 1,753 1,635 Exchange translation and other differences 163 – (98) Minimum pension liability 53 (3,277) – Available-for-sale securities: – Net unrealised (losses) gains – insurance activities (63) 196 (49) – Related amortisation of deferred acquisition costs 72 (174) (16) – Net unrealised gains (losses) – banking activities 77 (210) (238)
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding at 31 December 2003 for the Executive and SAYE schemes are as follows: Executive scheme SAYE scheme
These entities have predominantly pre-determined activities, the nature of which are primarily lending and investments and are undertaken in order to improve the efficiency of Lloyds TSB Group’s normal lending and deposit taking activities. In determining whether to enter into these structures, careful consideration has been given to ensure the structures meet Lloyds TSB Group’s risk management and control requirements.
Net interest income 24 15 6 Dividends received from group undertakings 1,911 1,908 1,872
Dividends Lloyds TSB Group plc has paid an interim and final dividend each year since the merger of TSB Group plc and Lloyds Bank Plc in 1995. Dividends are paid in May and October and the record date for the purpose of determining the shareholders who will be entitled to a dividend is established a number of weeks before the dividend payment date. TSB Group plc, which was re-named Lloyds TSB Group plc after the merger, has paid an interim and final dividend every year since its flotation on the London Stock Exchange in September 1986, with the exception of 1986 when no final dividend was paid. Lloyds TSB Bank has paid a dividend every year since its incorporation as Lloyds Banking Company Limited in 1865.
A disposal (or deemed disposal) of ordinary shares or ADSs by a shareholder or holder of ADSs resident or (in the case of an individual) ordinarily resident for tax purposes in the UK may, depending on the shareholder's or ADS holder's particular circumstances, and subject to any available exemption or relief, give rise to a chargeable gain or an allowable loss for the purposes of UK taxation on chargeable gains.
In addition, Lloyds TSB Group owns, leases or uses under licence properties for business operations elsewhere in the world, principally in Argentina, Spain and Switzerland.
Demutualisation Process by which a mutual institution is converted into a public limited company.