Achieving the vision We have maintained strong business momentum through the year to deliver another good set of results with underlying profit before tax up 6 per cent in 2007 to £3,919 million. Against a turbulent backdrop, these results are achieved from a business that focuses tirelessly on the needs of customers and which, as a result, has a lower risk and a more predictable earnings stream. Our quality of earnings emerges from the strength of our three high quality businesses; our UK Retail Bank; our Wholesale and International Banking division; and our Insurance and Investments division which includes Scottish Widows.
We cannot eliminate all CO2 emissions so in 2007 we committed to become carbon neutral by offsetting those emissions that we cannot reduce. I am pleased to confirm that in 2007 we purchased sufficient carbon credits to achieve carbon neutrality.
The board’s ongoing renewal process has continued throughout the year and we are delighted to have appointed two new independent non-executive directors since the last annual general meeting. Philip Green was welcomed to the board on 10 May 2007. He brings valuable experience to the Group through a very successful business career across a number of different business sectors including his current role as Chief Executive of United Utilities and as the former Chief Executive of Royal P&O Nedlloyd. Sir David Manning will join us on 1 May 2008. Sir David has a long and distinguished career in the Foreign and Commonwealth Office where he was most recently Her Majesty’s Ambassador to the United States of America.
Strong momentum On an underlying basis, the Group increased profit before tax by 6 per cent to £3,919 million. Excluding the £280 million charge arising from the market dislocation, the Group grew profits by 13 per cent from £3,710 million to £4,199 million. Whilst we cannot overlook the impact of the dislocation on our results, these numbers are more reflective of the ongoing performance of the Group.
Operating expenses remained well controlled, increasing by 3 per cent, excluding the settlement of overdraft claims. Significant improvements have been made in the rationalisation of back office operations to improve efficiency and we continue to increase the proportion of front office to back office staff in the branch network.
“During 2007, the Group opened more than 1 million new current accounts.”
Scottish Widows life, pensions and OEICs Profit before tax increased by £183 million, or 26 per cent, to £884 million. The effect of surplus capital repatriation to the Group has been to reduce investment earnings by a total of £36 million in 2007. Adjusting 2006 for this, profit before tax increased by 33 per cent.
Results on a European Embedded Value (EEV) basis Lloyds TSB continues to report under IFRS, however, in line with industry best practice, the Group provides supplementary financial reporting for Scottish Widows on an EEV basis. The Group believes that EEV represents the most appropriate measure of long-term value creation in life assurance and investment businesses.
Divisional results 22 Lloyds TSB Group Annual Report and Accounts 2007
• Risk assurance and oversight: Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators. Risk assurance teams are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.
• Unit-linked liabilities are matched with the same assets that are used to define the liability but future fee income is dependent upon the performance of those assets.
Risk appetite Insurance risk appetite is defined as the quantum and composition of insurance risk that exists currently in the Group and the direction in which the Group wishes to manage this.
The Group mitigates the risk of a liquidity mismatch which is outside of its appetite by managing the liquidity profile of the balance sheet through both short-term liquidity management and long-term strategic funding.
The Group is able to raise funds by issuing subordinated liabilities or equity. As at 31 December 2007, the Group had £11,958 million of subordinated debt in issuance. The cost and availability of subordinated liability finance are influenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access. At 31 December 2007, the credit ratings of Lloyds TSB Bank, the primary issuer in the Group, were as follows: Senior debt
Changes in assumptions used to measure life assurance liabilities (104) (40) (144) – (144)
Profit for the year attributable to equity shareholders 3,289 2,803 2,493 2,392 2,421 3,254
Incentive awards for executive directors are based upon individual contribution and overall corporate results. Half of the bonus opportunity is driven by corporate performance based on the stretching budget relating to profit before tax and economic profit. The lower of profit before tax and economic profit will determine the extent to which the target has been met. The other half of the bonus opportunity is determined by divisional achievement driven through individual performance. Individual targets relevant to improving overall business performance are contained in a balanced scorecard and are grouped under the following headings: These targets are weighted differently for each of the executive directors, reflecting differing strategic priorities. The non-financial measures include key performance indicators relating to process efficiency, service quality and employee engagement.
The second graph illustrates the performance of the Group measured by TSR against a ‘broad equity market index’ over the past five years. The Group has been a constituent of the FTSE 100 index throughout this five year period.
PerformanceSalaries / related 2007 2006 fees Cash Non cash payments Total Total
Directors’ interests The interests, all beneficial, of those who were directors at 31 December 2007 in shares in Lloyds TSB Group were: At 1 January 2007 (or later date of At 31 December At 21 February
Share capital Other Retained Minority and premium reserves profits Total interests Total £ million £ million £ million £ million £ million £ million
(1) As lessee The leases entered into by the Group are primarily operating leases. Operating lease rentals are charged to the income statement on a straight-line basis over the period of the lease.
(1) Life assurance business (i) Accounting for insurance and participating investment contracts
(2) General insurance business The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods are deferred and only credited to the income statement when earned. Broking commission is recognised when the underwriter accepts the risk of providing insurance cover to the customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience.
The average number of persons on a headcount basis employed by the Group during the year was as follows: During the year the auditors earned the following fees: 2007 2006 £m £m
(b) Factors affecting the tax charge for the year A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the tax charge for the year is given below: £m £m
Derivatives designated as cash flow hedges: Interest rate swaps 630 1 24
The CDSs are accounted for as derivatives and are included in derivative financial instruments (see note 16) and the external funding is shown in debt securities in issue (see note 30).
24 Other intangible assets Customer Software lists enhancements Total £m £m £m
Assumptions The principal actuarial and financial assumptions used in valuations of the defined benefit pension schemes were as follows: Discount rate 5.80 5.10
An analysis of the impact of a reasonable change in these assumptions is provided in note 2.
Executive schemes The executive share option schemes were long-term incentive schemes available to certain senior executives of the Group, with grants usually made annually. Options were granted within limits set by the rules of the schemes relating to the number of shares under option and the price payable on the exercise of options. The last grant of executive options was made in August 2005. These options were granted without a performance multiplier and the maximum limit for the grant of options in normal circumstances was three times annual salary. Between April 2001 and August 2004, the aggregate value of the award based upon the market price at the date of grant could not exceed four times the executive’s annual remuneration and, normally, the limit for the grant of options to an executive in any one year would be equal to 1.5 times annual salary with a maximum performance multiplier of 3.5. Prior to 18 April 2001, the normal limit was equal to one year’s remuneration and no performance multiplier was applied.
Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year original maturity: Mortgage offers made 4,639 4,071
Other commitments 52,791 49,731 1 year or over original maturity 32,165 28,477
Items in the course of collection from banks – – – – – 1,242 – 1,242
As at 31 December 2006 £m £m £m £m £m £m £m
Liquidity risk The table below analyses financial instrument liabilities of the Group, excluding those arising from insurance and participating investment contracts, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
Liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by IFRS 4, as follows: 1 month months months years years Total £m £m £m £m £m £m
Less: amounts with a maturity of three months or more (6,946) (16,798)
Requires interest and other costs incurred in connection with the borrowing of funds to be recognised as an expense excepting that those which are directly attributable to the acquisition, construction or production of assets that take a substantial period of time to get ready for their intended use or sale must be capitalised as part of the cost of those assets.
1 At the date of this report, these pronouncements are awaiting EU endorsement. 2 Subject to any EU endorsement, the Group has not yet made a final decision as to whether it will apply these pronouncements in the 2008 financial statements.
• the information given in the directors’ report is consistent with the parent company financial statements.
Details of the Company’s dividends are as set out in note 43 to the consolidated financial statements.
Fair values of financial assets and liabilities The valuation techniques for the Company’s financial instruments are as discussed in note 47 to the consolidated financial statements.
Impairment Accounting policy 84 Critical accounting estimates and judgements 89 Notes to the group accounts 97, 104
Life assurance businesses Accounting policy 87 Basis of determining regulatory capital 52 Capital sensitivities 55 Capital statement 52 Critical accounting estimates and judgements 90 Financial information calculated on a ‘realistic’ basis 54 Options and guarantees 55
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