• Improved profitability. Life, pensions and OEICs new business profit increased by 36 per cent. Good improvement in new business margin.
• Continued strong trading momentum. Substantial increase in trading surplus, up 14 per cent, to £1,948 million.
• Impairment up 20 per cent; overall credit quality remains satisfactory.
Wholesale and International Banking 1,640 1,524 Central group items - Before pension schemes related credit (449) (424) - Pension schemes related credit 128 –
• Strong sales growth in each key distribution channel; overall product sales up 16 per cent.
• Excellent sales performance. 24 per cent increase in Scottish Widows’ present value of new business premiums.
• Strong income growth, up 8 per cent, supported by a 46 per cent increase in cross-selling income.
I am delighted to be able to report that the Group has delivered another strong performance – building on the improved earnings momentum that has been achieved over the last few years.
LLOYDS TSB GROUP 5 2006 was another strong year for the Group as we continued to make progress against our strategic plan and delivered both good growth and high returns. We are reporting† a growth in profits of 8 per cent and a 25.1 per cent return on equity, building on the momentum established in recent years. We also achieved a total return for shareholders of 24.8 per cent, which compares very favourably to our peers.
Scottish Widows remains very well capitalised and in addition to the payment of a £206 million regular dividend to the Group in March 2006, a further £540 million distribution was made in December 2006. We continue to explore a number of opportunities to repatriate further surplus capital from Scottish Widows in 2007.
†To enable meaningful comparisons to be made with 2005, the commentaries in this statement exclude volatility, the 2006 pension schemes related credit and, in 2005, profit on sale and closure of businesses, customer redress provisions and the strengthening of reserves for annuitant mortality.
Summary of Group results In 2006, statutory profit before tax was £4,248 million, an increase of £428 million, or 11 per cent, compared to £3,820 million in 2005. Profit attributable to equity shareholders increased by £310 million, or 12 per cent, to £2,803 million and earnings per share increased by 12 per cent to 49.9p.
Impairment losses on loans and advances increased by 20 per cent to £1,555 million. Our impairment charge expressed as a percentage of average lending was 0.83 per cent, compared to 0.76 per cent in 2005. Impaired assets were 3 per cent lower at £4,006 million, and now represent 2.0 per cent of total lending, down from 2.3 per cent at 31 December 2005.
As expected, the Wholesale and International Banking charge for impairment losses on loans and advances increased by £120 million to £308 million, reflecting lower levels of releases and recoveries in Corporate Markets than in 2005, and a higher level of consumer finance lending impairment in the Asset Finance business. Overall asset quality remains good and the level of new corporate provisions remained at a low level in 2006, although we expect a return to more normal levels of impairment over time.
At the end of December 2006, the total capital ratio was 10.7 per cent and the tier 1 ratio 8.2 per cent. During the year, risk-weighted assets increased by 8 per cent to £156.0 billion, as strong growth in our mortgage and Corporate Markets businesses was partly offset by the impact of the Group’s new securitisation programme. The board has decided to maintain the final dividend at 23.5p per share, to make a total for the year of 34.2p. This represents a dividend yield for shareholders of 6 per cent, calculated using the 31 December 2006 share price of 571.5p.
Over the last 12 months, we have significantly improved our capital flexibility through the initiation of our securitisation programme and the repatriation of further capital from Scottish Widows to the Group. We have also increased the variety and flexibility of our capital raising programme, with the issuance of both sterling and US dollar preference shares, resulting in a more balanced capital structure. During 2006, we completed two mortgage securitisation transactions totalling over £10 billion as well as a £1 billion synthetic securitisation of commercial banking loans. Over the next few years, we expect to expand our securitisation programme to include a broader range of asset classes.
Under IFRS, only insurance policies and discretionary participating investment business are accounted for on an embedded value basis. In 2006, this basis has been revised to be consistent with relevant EEV Principles. Although there is no impact on the 2005 income statement, the impact on the 2006 income statement is to reduce profit before tax, excluding volatility, by £18 million. In line with industry best practice, the Group has introduced supplementary disclosures which show life, pension and OEIC products accounted for on an EEV basis, as we believe that EEV reporting provides for increased clarity, transparency and comparability of financial information.
In 2006, the Group reached agreement with the Trustees of the Group’s two principal pension schemes to fund the schemes’ actuarial funding deficits of approximately £1.5 billion, as at 30 June 2005, over a period of ten years. The Group also indicated that it expected to continue making additional voluntary contributions to the schemes. Further interim actuarial valuations of the schemes were carried out on behalf of the schemes’ Trustees as at 30 June 2006; these valuations showed a significant reduction in the deficits to approximately £0.3 billion.
Internet banking. Internet banking provides online banking facilities for personal customers. Some 4.4 million customers have registered to use Lloyds TSB Group’s internet banking services. At the end of 2006, these customers were conducting more than 57 million transactions per month online, a 24 per cent increase on 2005.
Cards. Lloyds TSB Group provides a range of card-based products and services, including credit and debit cards and card transaction processing services for retailers. Lloyds TSB Group is a member of both the VISA and MasterCard payment systems and has access to the American Express payment system. The Group had a 12.4 per cent share of outstanding card balances at 31 December 2006.
Registrars. Lloyds TSB Registrars is the UK’s leading provider of share registration services and employee share plans. It acts for over 650 client companies, including around 60 per cent of the FTSE 100.
Asset Finance. Lloyds TSB Group’s asset finance businesses provide individuals and companies with finance through leasing, hire purchase and contract hire packages. Through its invoice discounting and factoring subsidiary, Lloyds TSB Commercial Finance, Lloyds TSB Group provides working capital finance for its customers. Specialist personal lending, store credit and the Dutton-Forshaw motor dealerships complete this group of businesses. Altogether, Asset Finance has over 1.7 million individual customers and relationships with some 40,000 companies and small businesses.
Offshore banking. Lloyds TSB Group’s offshore banking operations comprise offices in the UK, the Channel Islands, the Isle of Man, Hong Kong, Singapore, Malaysia and overseas representative offices in Europe, the Middle East, Africa, Asia and the Americas. The business provides a wide range of retail banking, wealth management and expatriate services to local island residents, UK expatriates, foreign nationals and to other customers requiring offshore financial services.
UK Insurance and Central excluding Retail and International group insurance Insurance
Banking Investments** Banking items gross up gross up** Group 2006 £m £m £m £m £m £m £m
Total income, net of insurance claims 5,263 1,596 4,212 (389) 10,682 15 10,697
Impairment losses on loans and advances (1,238) – (308) (9) (1,555) – (1,555)
Trading surplus 2,787 2,535 Impairment losses on loans and advances (1,238) (1,065)
Profit before tax, before provisions for customer redress 1,549 1,470 Provisions for customer redress – (150)
Product net interest banking margins remained broadly stable as lower personal loan margins were offset by improved deposit and credit card margins. The adverse mix effect of finer margin mortgages growing faster than unsecured personal lending led to a slight overall reduction in the divisional margin.
Impairment losses on loans and advances increased by £173 million, or 16 per cent, to £1,238 million, reflecting the impact of more customers with higher levels of indebtedness experiencing repayment difficulties, and higher levels of bankruptcies and IVAs. The impairment charge as a percentage of average lending was 1.18 per cent, compared to 1.09 per cent last year. Over 99 per cent of new personal loans and 84 per cent of new credit cards sold during 2006 were to existing customers, where the Group has a better understanding of an individual customer’s total financial position. Mortgage credit quality remains good and, as a result, the impairment charge was £5 million lower at £8 million for the year.
Present Value of New Business Premiums (‘PVNBP’) 9,740 7,842 PNVBP new business margin (EEV basis) 3.6% 3.2%
Present Value of New Business Premiums (‘PVNBP’) 2006 2005 £m £m
In May 2004, the Chief Financial Officers’ Forum (‘CFO Forum’) published its EEV Principles and Guidance which set out a series of agreed standards for embedded value reporting. These EEV Principles establish a consistent treatment for the financial information provided for insurance and investment contracts and, in our view, allow a fuller recognition of the economic value being created. Compared with traditional embedded value, EEV Principles also provide a more appropriate valuation of in-force business which explicitly takes into account the cost of financial options and guarantees, and required capital, as well as non-market risks, such as mortality.
Life and Life and pensions OEICs Total pensions OEICs Total £m £m £m £m £m £m
Total value of in-force business 2,841 2,941 Shareholders’ net assets 3,572 3,445
During 2006, Scottish Widows adopted the FSA’s Policy Statement 06/14 which amends the reserving requirements for non with-profits business written by life companies. This has increased shareholders’ net assets and reduced the value of in-force business by approximately £400 million.
Total profit after tax (105) 670 565 Debt issued (560) 560 –
The table below shows the sensitivity of the EEV and the new business profit before tax to movements in some of the key assumptions. The impact of a change in the assumption has only been shown in one direction. The impact can be assumed to be reasonably symmetrical.
Operating income, net of claims 400 369 Operating expenses (157) (160)
Net operating income improved by £34 million, or 6 per cent, as 7 per cent growth in underwriting income was offset by a reduction in broking commissions, particularly relating to creditor insurance, and associated profit sharing commissions. The Group’s corporate partnering capability was further extended during 2006 with new distribution agreements secured with Argos and Pearl Group.
Trading surplus 1,948 1,712 Impairment losses on loans and advances (308) (188)
In Wholesale and International Banking, the Group has continued to make significant progress in its strategy to leverage the Group’s strong corporate and small business customer franchises and, in doing so, become the best UK mid-market focused wholesale bank. We have continued to develop new product revenue streams, particularly in areas such as securitisation, structured credit and credit loan trading which, coupled with a strong focus on targeted corporate customer segments and Corporate Markets’ cross-selling income growth remaining strong, has supported good levels of overall income growth. Revenue growth has continued to exceed cost growth notwithstanding significant investment being made in the enhancement of our product and distribution capabilities, particularly in the Corporate Markets business.
As expected, the charge for impairment losses on loans and advances increased by £120 million to £308 million, as a result of the high level of releases and recoveries in Corporate Markets in 2005 which were not repeated in 2006, and a higher level of consumer finance lending impairment in the Asset Finance business. Whilst overall corporate and small business asset quality remains strong and the level of new corporate provisions remained at a low level in 2006, we continue to expect some normalisation in the impairment charge over the next few years.
Trading surplus 1,092 919 Net impairment credit on loans and advances 13 57
Trading surplus 334 272 Impairment losses on loans and advances (87) (76)
Profit before tax in Business Banking grew by £51 million, or 26 per cent, reflecting strong growth in business volumes, further improvements in growing the Business Banking customer franchise and progress in improving operational efficiency. Strong income growth combined with tight cost control led to an improvement of over 5 percentage points in the cost:income ratio. Costs remain tightly controlled and were 2 per cent lower. Business Banking continued to develop and grow its customer franchise strongly, with customer recruitment of some 118,000 during 2006, reflecting a market leading position in the start-up market. Asset quality in the Business Banking portfolios remains strong. The impairment charge increased by £11 million to £87 million, largely reflecting a lower level of releases and recoveries than in 2005.
Lloyds TSB Foundations (37) (34) Funding cost of acquisitions less earnings on capital (378) (378) Central costs and other unallocated items (34) (12) Pension schemes related credit 128 –
Following recent changes in age discrimination legislation, the Group has ceased to augment the pension entitlement of employees taking early retirement. This change has reduced the Group’s defined benefit pension liability by £129 million (£1 million of which is unrecognised) and resulted in a one-off credit to the 2006 income statement of £128 million.
During 2006, profit before tax included positive insurance volatility of £84 million, being a credit of £2 million to net interest income and a credit of £82 million to other income (2005: £438 million, being a credit of £6 million to net interest income and a credit of £432 million to other income). Returns in 2005 benefited from rising stock markets and rising gilt values. Although equity values continued to rise in 2006, this was less marked than in 2005 and the effect was partly offset by falling gilt values and a charge following the change in the economic assumptions used to calculate the value of in-force business at 31 December 2006.
Under IFRS, tax on policyholder investment returns is required to be included in the Group’s tax charge rather than being offset against the related income, as it is in actual distributions made to policyholders. The impact is, therefore, to either increase or decrease profit before tax with a corresponding change in the tax charge. Other items classified within policyholder interests volatility include the effects of investment vehicles which are only majority owned by the long-term assurance funds. In the case of these vehicles, the Group’s profit for the year includes the minorities’ share of the profits earned. As these amounts do not accrue to the equity holders, management believes a clearer representation of the underlying performance of the Group’s life and pensions businesses is presented by excluding policyholder interests volatility.
Achieving our vision of being the best financial services company in the UK depends on our ability to create a high performance culture. We know that every high performance company needs committed and motivated staff.
To create a high performance company, we recognise that we need to provide all employees with the opportunity to learn, develop and to fulfil their potential. The University for Lloyds TSB is our centre of excellence for learning, providing an accessible, high quality service structured around the needs of both the business and the individual. In 2006, the University provided over 33,250 training days and over 17,000 delegate places in addition to online learning through a group wide network of 2,029 multimedia personal computers and 20 dedicated cyber-cafés.
While our direct carbon intensity is relatively low compared to other industry sectors, we still need to fully understand the potential financial impact of climate change on others that we may lend to or invest in, so that we can manage the risks and identify business opportunities.
More information on all of the above issues is available in the Group’s Corporate Responsibility Report and there are details of how to obtain a copy on page 128.
Customer service index** 68.0% 69.7% Complaints resolved within 8 weeks 86.0% 94.8% Service quality index† 4.02 4.30
* The employee engagement index is based on the results of a survey conducted quarterly, asking Lloyds TSB employees a series of questions which reflect both the drivers and outcomes of engagement. The data captures the percentage of total responses received which were favourable for each question, combined into a simple average overall score.
** The customer service index is computed based on the results of a customer satisfaction survey performed monthly for Lloyds TSB by an external agency. Customers in each of six business units are asked to rate the service they receive on fives bases – overall satisfaction, understanding of the customer’s needs, accessibility of the service, and the responsiveness and expertise of the service provider. These scores are weighted to produce a Group score based on the proportion of total Group income each business unit represents.
The maintenance of a strong control framework remains a priority and is the foundation for the delivery of effective risk management. Risk analysis and reporting capabilities continue to evolve to identify opportunities as well as risks, to improve the Group’s ability to take an aggregate view of the overall risk portfolio and assign clear responsibilities and timescales at group and divisional level for risk mitigation strategies. Risk continues to be a key component of routine management information reporting and is embedded within staff objectives via balanced scorecards.
The chief risk director, a member of the group executive committee and reporting directly to the group chief executive, oversees and promotes the development and implementation of a consistent group wide risk management framework. The chief risk director, supported by Group Risk, provides objective challenge to the Group’s senior management.
Accountability of line management has been further reinforced in relation to the management of risks arising from the Group’s business and in developing the risk awareness and risk management capability of the Group’s staff. A key objective is to ensure that business decisions strike an appropriate balance between risk and reward, consistent with the Group’s risk appetite. The senior executive team and Board received regular briefings and guidance from the chief risk director to ensure awareness of the overarching risk model and a clear understanding of their accountabilities for risk and internal control.
Business management forms part of a tiered risk management model, as shown on page 28, with the divisional risk officers providing oversight and challenge, as described above, and the chief risk director and group committees establishing the group wide perspective.
Reflecting the importance the Group places on risk management, risk is one of the five principal criteria that it includes in its balanced scorecard on which individual staff performance is judged. Business executives have specified risk management objectives, and incentive schemes take account of performance against these.
The more detailed articulation of the risk principles and distribution of the risk appetite measures amongst the divisions and businesses is subsequently agreed by the group chief executive, through consultation with the group executive committee and on the advice of the group business risk committee and the group asset and liability committee.
The Group seeks to achieve further organic growth by securing new customers and developing more business from existing customers. Lloyds TSB is currently expending significant resources and effort to bring about this growth, particularly with respect to its UK retail financial services business. If these expenditures and efforts did not meet with success, its operating results would grow more slowly or decline.
The Group’s businesses are conducted in a market place that is consolidating and significant cross-border mergers and acquisitions may happen in the coming years. Lloyds TSB’s ability to generate an appropriate return for its shareholders over the long term may depend upon whether management is able to achieve value creating acquisitions and/or mergers at the appropriate times and prices. Lloyds TSB cannot be sure that it will ultimately be able to make such mergers or acquisitions or that, if it does, such mergers or acquisitions will be integrated successfully or realise anticipated benefits.
• Concentration risk. Credit risk management sets portfolio controls on certain industries, sectors and product lines that reflect risk appetite, and monitors exposures to prevent excessive concentration of risk. These concentration risk controls are not necessarily in the form of a maximum limit on lending but may instead require new business in concentrated sectors to fulfil additional hurdle requirements. Amongst these controls is a series of sector caps to manage residual value risk exposure, seeking to ensure an acceptable distribution of risk. The Group’s large exposures are managed in accordance with regulatory reporting requirements.
• Impairment process. The maintenance of adequate impairment allowances is considered a key issue from a credit control perspective. Impairment methodology is set out in credit policy and is subject to a rigorous governance process, including the preparation of a regular impairment review paper to executive management, consideration by dedicated business unit and divisional impairment review committees and the reporting to the group executive committee of material individual counterparty impairment charges.
• Stress testing and scenario analysis. The credit portfolio model is also used in stress-testing, to simulate a scenario and calculate its impact. Our modelling capabilities are currently subject to further development. Events are modelled both at a group wide level, at divisional and business unit level and by portfolio, for example, for a specific industry sector.
• 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 and Group Audit are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.
• Surplus assets are held primarily in three portfolios: the surplus in the non-profit fund within the Long Term Fund of Scottish Widows plc, assets in shareholder funds of life assurance companies and an investment portfolio within the general insurance business
Non-trading: The Group’s banking non-trading exposure is summarised in the form of an interest rate repricing table, as set out in note 47 to the financial statements. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date. However, the table does not take into account the effect of interest rate options used by the Group to hedge its exposure.
The table below shows closing, average, maximum and minimum VaR for surplus assets held in excess of liabilities in the Group’s insurance businesses for the years ended 31 December 2006 and 2005 on a 99 per cent confidence ten day basis.
• With-profits funds are managed in accordance with the relevant fund’s Principles and Practices of Financial Management
The Group discusses strategies for the overall mix of pension assets with the pension scheme trustees.
The risk of reductions in earnings and/or value, through financial or reputational loss, due to fluctuations in the timing, frequency and severity of insured/underwritten events and to fluctuations in the timing and amount of claim settlements. This includes fluctuations in profits due to customer behaviour.
A key element of the control framework is the consideration of insurance risk by a suitable combination of high level committees/boards. For the life assurance businesses the key control body is the board of Scottish Widows Group Limited with the more significant risks also being subject to approval by the Lloyds TSB group executive committee and/or the Lloyds TSB Group board. For the general insurance businesses the key control body is the Lloyds TSB Insurance executive committee with the more significant risks again being subject to Lloyds TSB group executive committee and/or Lloyds TSB Group board approval. All group pension scheme issues are covered by the group asset and liability committee.
New insurance proposals are underwritten to ensure an appropriate premium is charged for the risk or the risk is declined.
Operational risk appetite is defined as the quantum and composition of operational risk that exists in the Group and the direction in which the Group wishes to manage it.
The Group has developed an impact on earnings approach to operational risk appetite. This involves looking at how much the Group could lose due to operational risk losses at various levels of severity. In setting operational risk appetite, the Group looks at both impact on solvency and the Group’s reputation, including customer service requirements.
The Group’s governance arrangements are based upon the following core principles: • the interests of shareholders and other stakeholders are protected by ensuring that excessive powers are not delegated to individuals; • decisions taken by management are consistent with the Group’s strategic objectives and risk appetite, which are approved by the board; • managers are accountable for the management of risk, including internal controls, in their business; • risk management arrangements and risk exposures (including material transactions, financial positions or portfolios) are subject to independent oversight; • business is conducted in line with authorities and accountabilities ultimately delegated by the board; these are described within specific policies; • clear accountabilities are delegated by management to people who have the right level of skills, competencies and experience; • managers are required to safeguard against conflicts of interest; • every member of staff is responsible for understanding and managing the risk they take on behalf of the Group and for ensuring that they act within the authorities and accountabilities delegated to them; and
Lloyds TSB Group plc is also able to raise funds by issuing loan capital or equity, although in practice the majority of Lloyds TSB Group’s loan capital has been issued by Lloyds TSB Bank. As at 31 December 2006, Lloyds TSB Group plc had £2,297 million of subordinated debt in issuance compared with £12,072 million for the consolidated Lloyds TSB Group. The cost and availability of subordinated debt finance are influenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access. At 31 December 2006, the credit ratings of Lloyds TSB Bank were as follows: Senior debt
A significant part of the liquidity of the Lloyds TSB Group’s banking businesses arises from their ability to generate customer deposits. A substantial proportion of the customer deposit base is made up of current and savings accounts which, although repayable on demand, have traditionally provided a stable source of funding. During 2006, amounts deposited by customers increased by £8,272 million from £131,070 million at 31 December 2005 to £139,342 million at 31 December 2006. These customer deposits are supplemented by the issue of subordinated loan capital and wholesale funding sources in the capital markets, as well as from direct customer contracts. Wholesale funding sources include deposits taken on the inter-bank market, certificates of deposit, sale and repurchase agreements, a Euro Medium-Term Note programme, of which £6,806 million had been utilised for senior funding at 31 December 2006, and commercial paper programmes, under which £2,343 million had been utilised at 31 December 2006. The Group has also raised wholesale funding via the issuance of Residential Mortgage Backed Securities; £10,048 million was outstanding at 31 December 2006.
The ability to sell assets quickly is also an important source of liquidity for the Lloyds TSB Group’s banking businesses. The Lloyds TSB Group holds sizeable balances of marketable debt securities which could be disposed of to provide additional funding should the need arise.
Group regulatory capital ratios: The international standard for measuring capital adequacy is the risk asset ratio, which relates regulatory capital to balance sheet assets and off-balance sheet exposures weighted according to broad categories of risk.
There are strict limits imposed by the regulatory authorities as to the proportion of the Lloyds TSB Group’s regulatory capital base that can be made up of subordinated debt and preferred securities. The unpredictable nature of movements in the value of the investments supporting the long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Lloyds TSB Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate.
Capital ratios are a key factor in the Group’s budgeting and planning processes and updates of expected ratios are prepared regularly during the year. Capital raised takes account of expected growth and currency of risk assets.
The determination of realistic liabilities of the With Profit Fund in respect of Scottish Widows includes the value of internal transfers expected to be made from the With Profit Fund to the Non-Participating Fund of Scottish Widows. These internal transfers include charges on policies where the associated costs are borne by the Non-Participating Fund. The With Profit Insurance Capital Component is reduced by the value, calculated in the stress test scenario, of these internal transfers, but only to the extent that credit has not been taken for the value of these charges in deriving actuarial reserves for the Non-Participating Fund.
The comparative position as at 31 December 2005 was as follows (again, relating to Scottish Widows plc only): Non- Total
Adjustments onto a regulatory basis: Life assurance business Unallocated surplus within insurance business 494 – 494 – 494 Adjustments to remove differences between IFRS and regulatory valuation of assets and liabilities – (456) (456) (767) (1,223) Adjustment to include estimated ‘realistic’ liabilities payable to the shareholder (729) – (729) – (729) Adjustment to replace ‘realistic’ liabilities with statutory liabilities 2,580 – 2,580 – 2,580 Adjustment to remove the value of future profits recognised in respect of non-participating contracts written in the With Profit Fund (43) – (43) – (43) Recognition of future profits for regulatory capital purposes – 500 500 – 500 Qualifying loan capital – – – 561 561
Changes in assumptions used to measure life assurance liabilities 208 (29) 179 – 179 Dividends and capital transfers – (750) (750) 499 (251) Changes in regulatory requirements – 155 155 26 181 New business and other factors 1,117 169 1,286 (215) 1,071
The primary reasons for the movement in total available capital resources during the year are as follows: With Profit Fund: Available capital in the With Profit Fund has increased from £2,302 million at 31 December 2005 to an estimated £3,627 million at 31 December 2006 primarily as a result of strong investment market performance.
Support arrangement assets 1,174 – 1,115 – Adjustments to replace statutory liabilities with ‘realistic’ liabilities (3,721) (3,544) (2,580) (2,291) Adjustments to include the value of future profits recognised in respect of Non-Participating business written in the With Profit Fund 32 32 43 43 Removal of future profits allowable for regulatory capital purposes – – – (500) Recognition of future profits allowable for ‘realistic’ capital purposes – 1,896 – 1,923 1 Subsequent to publication of the 2005 results, Scottish Widows obtained from the FSA permission to include the value of additional support assets in respect of policies written since demutualisation in assessing the realistic value of assets available to the With Profit Fund. The actual year end working capital ratios for the With Profit Fund and the Long Term Fund based on information from the final FSA returns were 5.5 per cent and 17.7 per cent respectively.
Analysis of policyholder liabilities in respect of the Group’s life assurance business: Scottish Widows plc With Profit Fund
Insurance and participating investment contract liabilities 17,827 23,031 40,858 Non-participating investment contract liabilities – 24,370 24,370
Options and guarantees outside the With Profit Fund of Scottish Widows
Abbey Life currently has a number of policies in force which have a guaranteed annuity option. It holds traditional regulatory reserves of £257 million to cover this liability at 31 December 2006 (£332 million at 31 December 2005). These reserves have been determined using prudent future interest rate, mortality rate and rate of annuity option take-up assumptions and exceed the value that would be placed on them using a market-consistent stochastic model. It is estimated that a 0.5 per cent reduction in future interest rates would increase the liability by some £27 million.
Under some of Abbey Life’s older contracts, the maturity value or the surrender value at the end of the selected period is guaranteed to be not less than total premiums paid or sums assured. The total provision for these options was £4 million at 31 December 2006 (£5 million at 31 December 2005) and was established using stochastic techniques after making prudent assumptions.
The financial information set out in the table below has been derived from the annual reports and accounts of Lloyds TSB Group plc for each of the past five years. 2005 was the first year in which the annual report and accounts were prepared under International Financial Reporting Standards (IFRS). 2004 and earlier years had been prepared under UK Generally Accepted Accounting Principles (UK GAAP) and earlier years had been adjusted for subsequent changes in accounting policy and presentation. To bridge the change in framework, 2004 figures have been presented under both IFRS and UK GAAP. Under IFRS, accounting standards dealing with financial instruments (IAS 32 and IAS 39) and insurance (IFRS 4 and FRS 27) were applied only from 1 January 2005. To aid comparison, IFRS balance sheet data is presented as at 1 January 2005 rather than 31 December 2004; the 2004 IFRS income statement data is not comparable to the data for 2005 and 2006. The financial statements for each of the years presented have been audited by PricewaterhouseCoopers LLP, independent accountants.
Net asset value per ordinary share 195p 180p 167p 176p 170p 140p
Post-tax return on average shareholders’ equity 26.6 25.6 22.8 24.3 38.5 16.8 Post-tax return on average risk-weighted assets 1.89 1.81 1.99 2.01 2.63 1.62 31 December 31 December 1 January 31 December 31 December 31 December
Joined the board in 2005. Chairman of British American Tobacco and RHM. Held a number of senior and general management appointments in Rembrandt Group from 1981, before joining Compagnie Financière Richemont as group finance director in 1988, a position he held until 2004. From 1990 to 1995 he was also the group finance director of Rothmans International. Aged 53.
G Truett Tate Group Executive Director, Wholesale and International Banking Joined the group in 2003 as managing director, corporate banking before being appointed to the board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was president and chief executive officer of eCharge Corporation from 1999 to 2001 and co-founder and vice chairman of the board of Chase Cost Management Inc from 1996 to 2003. Aged 56.
An interim dividend of 10.7p per ordinary share was paid on 4 October 2006 and a final dividend of 23.5p per ordinary share will be paid on 2 May 2007. These dividends will absorb £1,927 million.
Authority to purchase shares The authority for the Company to purchase, in the market, up to 568 million of its shares, representing some 10 per cent of the issued ordinary share capital, expires at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give a similar authority.
Compliance with the combined code The board considers that good governance is central to achieving the Group’s governing objective of maximising shareholder value over time. That has been uppermost in directors’ minds when applying the principles contained in the corporate governance code issued by the Financial Reporting Council. Sir Victor Blank, who was considered to be independent on appointment as chairman of the company, was appointed as an additional member of the remuneration committee in August 2006, as permitted by the new code issued in June 2006. Otherwise, the Group has complied with the provisions of the previous code, which was relevant for the 2006 financial year, and has done so throughout the year regarding the provisions where the requirements are of a continuing nature.
All directors have access to the services of the company secretary, and independent professional advice is available to the directors at the Group’s expense, where they judge it necessary to discharge their duties as directors.
In January 2006, it was announced that Mr van den Bergh had decided to retire as chairman and Sir Victor Blank, who became deputy chairman on 1 March, succeeded him as chairman of the company at the conclusion of the annual general meeting in May. The selection process relating to Sir Victor’s appointment was described fully in the annual report for 2005.
Number of meetings during the year 12 6 4 7 5
A copy of the financial statements of the Company is placed on the website of Lloyds TSB Group plc. The directors are responsible for the maintenance and integrity of statutory and audited information on the Company’s website. Information published on the internet is accessible in many countries with different legal requirements. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
This is a report made by the board of Lloyds TSB Group plc, on the recommendation of the remuneration committee. It covers the current and proposed components of the remuneration policy and details the remuneration for each serving director during 2006.
Statement from Wolfgang Berndt To ensure that our remuneration framework remains both cost effective and competitive, and following a comprehensive and independent policy review in 2005, a number of significant policy changes were implemented in 2006. An important change was the introduction of a new long-term incentive plan, which was implemented following shareholder approval and used for all long-term awards made during the year. I am confident that this plan will continue to underpin our primary objective of attracting, retaining and motivating executives of the highest calibre.
The committee met on seven occasions during 2006, and although not proposing any significant changes to the Group’s executive remuneration framework, the committee recommended that the competitive market positioning of our package should continue to be measured against the FTSE 20, and at the same time take closer account of the remuneration practice of our direct competitors, namely the major UK banks. It is typically against these organisations that we are competing for high calibre talent.
Following detailed independent market analysis and review, it is apparent that certain levels of basic salary as well as our annual maximum bonus opportunity, including the level of award for on-target performance achievement, are behind the market, particularly when compared with our main competitors in the financial services sector. As a result, the salary adjustments implemented from 1 January 2007 have been designed to bring base pay levels closer in line with the competitive market place. In addition, from 2007 the maximum bonus opportunity for executive directors will be increased to 200 per cent (225 per cent for Mr Daniels). However, although the underlying structure of the scheme will remain unchanged, with half of the maximum opportunity being triggered for on-target performance achievement, significantly more stretching targets will need to be met to qualify for maximum payment. In addition, and notwithstanding Mr Daniels’ increase in bonus opportunity from 2007, the level of bonus award for on-target achievement will remain 112.5 per cent of basic salary payable on the achievement of stretching targets contained in a balanced scorecard. Any payout will continue to reflect actual achievements linked explicitly to individual and organisational performance.
We believe that the remuneration framework which is set out below is entirely consistent with our policy to align executive director remuneration firmly with shareholders’ interests as well as engaging the executive directors in pursuing long-term shareholder value. The remuneration committee unanimously recommends that the remuneration report be approved.
Remuneration committee membership The remuneration committee is comprised of the following independent non-executive directors: • Dr Berndt (chairman)
Directors’ remuneration policy The Group’s remuneration policy is to ensure that individual rewards are aligned with the Group’s performance and the interests of its shareholders, and that cost effective packages are provided which attract and retain executive directors and senior management of the highest calibre and motivate them to perform to the highest standards. The main principles are: • FTSE 20 adopted as the comparator group used to benchmark overall competitiveness of the remuneration package whilst taking particular account of the remuneration practice of our direct competitors, namely the major UK banks. The FTSE 20 is regarded as providing a realistic and relevant comparison in terms of company size and sector, as well as being a key market for talent.
Regarding Mr Daniels’ incentive award, and in line with the arrangements for the executive directors, half of his bonus is driven by corporate results and the other half by individual performance. His maximum bonus opportunity is 175 per cent (225 per cent from 2007) of basic salary for the achievement of exceptional performance targets. An amount equal to 112.5 per cent of basic salary is available on the achievement of a range of financial and non-financial measures contained in a balanced scorecard. The non-financial measures include key performance indicators relating to customer service, process efficiency, service quality, risk and employees (e.g. employee engagement). Failure to achieve at least 90 per cent of the stretching budget target would result in no payment under the corporate half of the bonus.
Mr Brown waived fees payable to him as a director and chairman of Lloyds TSB Group Pension Trust (No.1) Limited and Lloyds TSB Group Pension Trust (No.2) Limited, which totalled £14,750 in 2006 (2005: £14,000 waived).
The amount shown for Mr Ayliffe reflects payments he received in accordance with his contractual entitlement.
Defined benefit scheme members Additional Accrued Accrued Transfer Transfer pension pension at pension at Change in value at value at Change in earned to Transfer 31 December 31 December accrued 31 December 31 December transfer 31 December value of the
March 2000 – March 2001 As for March 1997 – August 1999 except that there must have been growth in the earnings per share equal to the change in the retail price index plus three percentage points for each complete year of the relevant period.
Options granted in 2002 lapsed as the performance condition had not been met.
At the end of 2006 Lloyds TSB Group was ranked: 11th after two years of the performance period for options granted in 2005.
The following are conditional share awards available under the plan. The share price for the award was 520p. Further information regarding this plan can be found on page 54.
For the other 50 per cent of the award (the ‘TSR Award’) - it will be necessary for the Group’s TSR to exceed the median of a comparator group (14 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award will vest where the Group’s TSR is equal to median and vesting will occur on a straight line basis in between these points. Where the Group’s TSR is below the median of the comparator group, the TSR Award will lapse.
We read other information contained in the annual report and consider whether it is consistent with the audited consolidated financial statements. The other information comprises only the Group key performance indicators, the chairman’s statement, the group chief executive’s review, the business review, the five year financial summary, the directors’ report, the corporate governance disclosures, the unaudited part of the directors’ remuneration report and the information for shareholders. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the consolidated financial statements. Our responsibilities do not extend to any other information.
Interest and similar income 14,316 12,589 Interest and similar expense (8,779) (6,918)
Total income, net of insurance claims 11,104 10,540 Operating expenses 10 (5,301) (5,471)
Sir Victor Blank J Eric Daniels Helen A Weir Chairman Group Chief Executive Group Finance Director 64 LLOYDS TSB GROUP
Retirement benefit obligations 35 2,462 2,910 Current tax liabilities 817 552 Deferred tax liabilities 36 1,416 1,145
Profit before tax 4,248 3,820 Adjustments for: Change in operating assets 49(a) (31,995) (17,158) Change in operating liabilities 49(b) 33,069 10,039 Non-cash and other items 49(c) 1,555 4,364 Tax paid (798) (708)
Change in cash and cash equivalents (1,315) (1,443) Cash and cash equivalents at beginning of year 26,753 28,196
The Group has entered into securitisation and similar transactions to finance certain loans and advances to customers. Such financial assets continue to be recognised by the Group, together with a corresponding liability for the funding except in those cases where substantially all of the risks and rewards associated with the assets have been transferred or a significant proportion but not all of the risks and rewards have been transferred and the transferee has the ability to sell the assets when the assets are derecognised in full. If a fully proportional share of all, or of specifically identified, cash flows have been transferred, then that proportion of the assets is derecognised.
The Group assesses at each balance sheet date whether there is objective evidence that an available-for-sale financial asset is impaired. In addition to the factors set out above, a significant or prolonged decline in the fair value of the asset below its cost is considered in determining whether an impairment loss has been incurred. If an impairment loss has been incurred, the cumulative loss measured as the difference between the original cost and the current fair value, less any impairment loss on that asset previously recognised, is removed from equity and recognised in the income statement. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised, the impairment loss is reversed through the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.
Tangible fixed assets are included at cost less accumulated depreciation. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows: Premises (excluding land): • Freehold/long and short leasehold premises: shorter of 50 years or the remaining period of the lease
The Group evaluates non-lease arrangements such as outsourcing and similar contracts to determine if they contain a lease which is then separately accounted for.
The Group operates a number of equity-settled, share-based compensation plans. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting period, together with a corresponding adjustment to equity.
– insurance or participating investment contracts which are not unit-linked or in the Group’s With Profit Fund
The Group recognises as an asset the value of in-force business in respect of life insurance and participating investment contracts. The asset represents the present value of the shareholders’ interest in the profits expected to emerge from those contracts written at the balance sheet date determined using appropriate economic and actuarial assumptions, after making allowance for the realistic value of financial options and guarantees. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
The net liability recognised in the balance sheet at 31 December 2006 in respect of the Group’s retirement benefit obligations was £2,462 million (2005: £2,910 million) of which £2,362 million (2005: £2,809 million) related to defined benefit pension schemes. This liability excludes actuarial gains of £263 million (2005: losses of £485 million) which the Group is permitted to leave unrecognised. The defined benefit pension schemes’ gross deficit totalled £2,099 million (2005: £3,294 million) representing the difference between the schemes’ liabilities and the fair value of the related assets at the balance sheet date.
Under the Group’s transfer pricing arrangements, inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds. In addition, for those derivative contracts entered into by business units for risk management purposes, the difference between the result that would have been recognised on an accruals accounting basis and the actual result calculated using fair values is charged or credited to the central segment where the resulting volatility is managed.
Other income (net of fee and commission expense) 1,621 594 9,893 10,487 1,827 201 – 14,136
Impairment losses on loans and advances (1,238) – – – (308) (9) – (1,555)
Total income, net of insurance claims 5,126 397 1,671 2,068 3,893 (547) – 10,540
Other segment items: Customer remediation provision 150 – – – – – – 150
Included within interest receivable is £297 million (2005: £209 million) in respect of impaired financial assets.
Total foreign exchange 130 163 Investment property gains (note 21) 631 430 Securities and other gains 5,580 8,705
Net premiums 591 553 Change in provision for unearned premiums 9 9 Net earned premiums 600 562
Credit protection 203 173 8 Other operating income 2006 2005 £m £m
Operating lease rental income 422 433 Rental income from investment property 313 272 Other rents receivable 28 30 Gains less losses on disposal of available-for-sale financial assets 22 5 Movement in value of in-force business (note 23) (199) 162 Other income 220 238 80 LLOYDS TSB GROUP
Non-life insurance Claims and claims paid: Gross 198 195 Reinsurers’ share – (1)
Changes in non-life insurance policyholder liabilities: Gross 2 3 Reinsurers’ share – –
11 Impairment losses on loans and advances 2006 2005 £m £m
Impairment losses on loans and advances (note 19) 1,560 1,302 Other credit risk provisions (note 37) (5) (3)
Basic earnings per share are calculated by dividing the net profit attributable to shareholders by the weighted average number of ordinary shares in issue during the year, which has been calculated after deducting 5 million (2005: 5 million) ordinary shares representing the Group’s holdings of own shares in respect of employee share schemes. 2006 2005
Profit attributable to equity shareholders £2,803m £2,493m Weighted average number of ordinary shares in issue 5,616m 5,595m Basic earnings per share 49.9p 44.6p
Trading value through Trading value through assets profit or loss assets profit or loss £m £m £m £m
Hedging Derivatives designated as fair value hedges: Cross currency interest rate swaps 80 10 – Interest rate swaps (including swap options) 37,298 333 453
Derivatives designated as cash flow hedges: Interest rate swaps 569 5 13 Derivatives designated as net investment hedges: Cross currency swaps 2,589 139 –
Credit derivatives 562 3 – Equity and other contracts 4,787 607 84
Total recognised derivative assets/liabilities 5,878 6,396 17 Loans and advances to banks 2006 2005 £m £m
Lending to banks 5,966 2,510 Money market placements with banks 34,673 29,146
The Group holds collateral with a fair value of £6,837 million (2005: £6,381 million), which it is permitted to sell or repledge, of which £6,209 million (2005: £5,550 million) was repledged or sold to third parties for periods not exceeding three months from the transfer.
Agriculture, forestry and fishing 2,905 2,451 Energy and water supply 2,024 1,592
Loans and advances to customers include balances that have been securitised but not derecognised, comprising both residential mortgages and commercial loans.
Beneficial interests in residential mortgages were transferred during the year to special purpose entities which issued floating rate debt securities. Neither the Group nor any entities in the Group are obliged to support any losses that may be suffered by the note holders and do not intend to offer such support. The floating rate note holders only receive payments of interest and principal to the extent that the special purpose entities have received sufficient funds from the transferred mortgages and after certain expenses have been met. In the event of a deficiency, they have no recourse whatsoever to the Group.
The Group participates in the securitisation through the provision of administration and other services, the provision of interest rate and currency swaps and in the form of unsecured loan financing which is subordinate to the interests of the floating rate note holders.
In addition the Group completed a £961 million synthetic securitisation of its commercial banking loans during the year (2005: £nil) utilising credit default swaps (‘CDSs’). The CDSs are accounted for as derivatives and are included in derivative financial instruments (note 16).
19 Allowance for impairment losses on loans and advances 2006 2005 £m £m
At 1 January 2,073 1,919 Exchange and other adjustments (13) 1 Reclassifications – 43 Adjustments on disposal of businesses and portfolios (27) (27) Advances written off (1,489) (1,236) Recoveries of advances written off in previous years 190 158 Unwinding of discount (100) (87) Charge to the income statement 1,560 1,302
An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk and the with-profits fund there are asymmetries in the range of potential outcomes for which an explicit allowance is made.
At 31 December 2005 601 1,796 361 2,758 Exchange and other adjustments (1) (1) (63) (65) Charge for the year 82 248 272 602
Equipment leased to customers under operating leases primarily relates to vehicle contract hire arrangements. During 2006 and 2005 no contingent rentals in respect of operating leases were recognised in the income statement.
International: Non-interest bearing 31 24 Interest bearing 7,869 6,691 £m £m
29 Trading and other liabilities at fair value through profit or loss 2006 2005 £m £m
Insurance contract liabilities 26,350 26,482 Participating investment contract liabilities 15,095 14,068
Investment volatility is derived from derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2006, the 10 year equity-implied at-the-money assumption was set at 20 per cent (31 December 2005: 20 per cent). The long-term at-the-money assumptions for property and fixed interest stocks were 15 per cent (31 December 2005: 15 per cent) and 13 per cent (31 December 2005: 13.5 per cent) respectively.
Lapse rates1 (114) Modelling of options and guarantees in the With-Profits Fund2 66 FSA rule changes under PS06/143 4
Non-life insurance contract liabilities are analysed by line of business as follows: 2006 2005 £m £m
3 Changes brought in by the FSA under PS06/14 have brought significant reductions to the reserves required to be held. There has been a large offsetting reduction in the value of in-force business, as explained in note 23.
Claims and loss adjustment expenses Gross Reinsurance* Net £m £m £m
Total defined benefit schemes 109 259 Defined contribution pension schemes 56 49
Defined benefit pension schemes 2,362 2,809 Other post-retirement benefit schemes 100 101
* In 2006 this amount is shown net of a credit of £128 million following the Group’s decision to cease augmenting the pension entitlement of employees taking early retirement.
The Group’s obligations in respect of its defined benefit schemes are funded. The Group expects to pay contributions of approximately £530 million to its defined benefit schemes in 2007.
Movements in the other post-retirement benefits obligation: 2006 2005 £m £m
At 1 January 1,145 925 Exchange and other adjustments (3) (2)
Amount charged (credited) to equity: Available-for-sale financial assets – (2) Cash flow hedges – 1 Share based compensation (19) (16)
Deferred tax assets and liabilities are comprised as follows: 2006 2005 £m £m
Tax losses carried forward (326) (322) Other temporary differences (255) (270)
Deferred tax liabilities: Accelerated capital allowances 1,252 1,358 Investment reserve 149 90 Unrealised gains 500 338 Tax on value of in-force business 875 934 Other temporary differences 303 250
Deferred tax assets of £567 million (2005: £526 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
The Group has established provisions for the estimated cost of making redress payments to customers in respect of past product sales, in those cases where the original sales processes have been found to be deficient. During 2006 management have reviewed the adequacy of the provisions held having regard to current complaint volumes and the level of payments being made and are satisfied that no additional charge is required (in 2005 a charge of £150 million was made).
Euro cccm cm 160 million Preference shares of e25 cents each 40 40
d) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until any deferred payments have been made. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares.
f) In certain circumstances the interest payments on these securities can be deferred although in this case Scottish Widows plc cannot declare or pay a dividend until any deferred payments have been made.
g) Issued by a group undertaking under the Company’s subordinated guarantee.
h) At the callable date the coupon on these notes will be reset by reference to the applicable five year benchmark gilt rate.
l) 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 margin of 3.50 per cent over a rate based on the yield of specified UK government stock. This issue was made under the limited subordinated guarantee of Lloyds TSB Bank plc. In certain circumstances these preferred securities will be mandatorily exchanged for preference shares in Lloyds TSB Group plc. Lloyds TSB Group plc has entered into an agreement whereby dividends may only be paid on its ordinary shares if sufficient distributable profits are available for distributions due in the financial year on these preferred securities.
Throughout 2005 and 2006, the Company has had in issue 400 6 per cent non-cumulative redeemable preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a fixed rate non-cumulative preferential dividend at a rate of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company. In accordance with IFRS, these shares are reported within liabilities.
Other reserves comprise: Merger reserve 343 343 Revaluation reserve in respect of available-for-sale financial assets – 29 Cash flow hedging reserve 12 11
Revaluation reserve in respect of available-for-sale financial assets At 1 January 29 28 Exchange and other adjustments 2 (7) Change in fair value of available-for-sale financial assets (10) 11 Deferred tax – 2
– 3 Income statement transfer 1 12 Deferred tax – (4)
Retained profits are stated after deducting £87 million (2005: £73 million) representing 15 million (2005: 14 million) treasury shares held.
The movements over the year in the cumulative amount of foreign exchange differences taken directly to retained profits are as follows: £m £m
The directors have proposed a final dividend of 23.5 pence per share (2005: 23.5 pence per share) representing a total cost of £1,324 million (2005: £1,316 million) which will be paid on 2 May 2007.
Movements in the number of share options outstanding under the Executive share option schemes during 2005 and 2006 are set out below: Weighted average Weighted average Number of exercise price Number of exercise price options (pence) options (pence)
The plan was adopted in December 2003 and under the plan share options may be granted to senior employees, who may also be directors of Lloyds TSB Group. Options granted to date under this scheme were granted specifically to facilitate recruitment. Options granted under this plan are not subject to any performance conditions. 2006 2005
This plan was adopted by the Group in 2005, specifically to facilitate the recruitment of Ms Dial. Ms Dial is the only participant in the plan. Options granted under this plan are not subject to any performance conditions and will normally become exercisable only if Ms Dial remains as an employee, and has not given notice of resignation, on 31 May 2008. The option will also be exercisable if Ms Dial ceases to be an employee before that date in certain circumstances described in her service agreement, in which case the options will be exercisable for six months and then lapse.
The number of shares awarded relating to matching shares in 2006 was 2,036,423 (2005: 2,296,575), with an average fair value of £5.40 (2005: £4.73), based on market prices at the date of award.
Compensation Salaries and other short-term benefits 14 11 Post-employment benefits 3 3 Termination benefits – – Share based payments 3 2 million million
At 31 December 2006, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £2 million with four directors and four connected persons (2005: £3 million with four directors and three connected persons).
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend £51,288 million (2005: £43,094 million) was irrevocable.
Where a Group company is the lessee the future obligations payable under finance leases are as follows: £m £m
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group’s management of these risks is given on pages 28 to 39, with further disclosure provided below.
The table below summarises the repricing mismatches of the Group’s financial assets and liabilities. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date: 3 months 1 year 5 years or less or less or less Non1 month but over but over but over Over interest or less 1 month 3 months 1 year 5 years bearing Total £m £m £m £m £m £m £m
As at 31 December 2006 Assets Trading and other financial assets at fair value through profit or loss 1,455 867 1,012 5,177 21,057 38,127 67,695 Derivative financial instruments* – – – – – 5,565 5,565 Loans and advances to banks 24,652 1,561 1,561 7,449 5,346 69 40,638 Loans and advances to customers 71,041 17,711 19,572 60,845 19,110 6 188,285 Available-for-sale financial assets 5,525 10,732 1,594 1,174 138 15 19,178
3 months 1 year 5 years or less or less or less Non1 month but over but over but over Over interest or less 1 month 3 months 1 year 5 years bearing Total £m £m £m £m £m £m £m
Derivative financial instruments, trading and other liabilities at fair value through profit or loss* – – – – – 6,396 6,396
The structural position is managed by Lloyds TSB Group Capital Funds having regard to the currency composition of the Group’s risk-weighted assets and reported to the group asset and liability committee on a monthly basis. The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures are as follows: £m £m
A substantial proportion of the customer deposit base is made up of current and savings accounts which, although repayable on demand, have traditionally provided a stable source of funding. During 2006, amounts deposited by customers increased by £8,272 million from £131,070 million at 31 December 2005 to £139,342 million at 31 December 2006. These customer deposits are supplemented by the issue of subordinated loan capital and wholesale funding sources in the capital markets, as well as from direct customer contracts. Wholesale funding sources include deposits taken on the inter-bank market, certificates of deposit, sale and repurchase agreements, a Euro Medium-Term Note programme and commercial paper programmes. The Group has also raised wholesale funding via the issuance of Residential Mortgage Backed Securities; £10,048 million was outstanding at 31 December 2006.
Liabilities arising from insurance and investment contracts 945 832 2,292 12,474 49,955 66,498
Fair value information is not provided for items that do not meet the definition of a financial instrument. These items include intangible assets, such as the value of the Group’s branch network, the long-term relationships with depositors and credit card relationships; premises and equipment; and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.
The valuation technique for each major category of financial instrument is discussed below.
Trading and other liabilities at fair value through profit or loss
Financial guarantees are valued on the basis of cash premiums receivable. The Group considers that it is not meaningful to provide an estimate of the fair value of other contingent liabilities and financial commitments, given the lack of an established market, the diversity of fee structures and the difficulty of separating the value of the instruments from the value of the overall transaction. Therefore only financial guarantees are included in the following table.
Debt securities in issue 54,118 39,346 54,070 39,352 Liabilities arising from non-participating investment contracts 24,370 21,839 24,370 21,839 Financial guarantees 49 – 49 –
In 2005 the Group, through its subsidiary The Dutton-Forshaw Motor Company Limited, completed the purchases of the assets and trade of three separate motor dealership businesses for a total consideration of £16 million, settled in cash. Goodwill of £3 million arose on these acquisitions; no significant fair value adjustments were made.
Total non-cash items 854 3,731 Interest expense on subordinated liabilities 744 698 Profit on disposal of businesses – (50)
Loans and advances to banks 40,638 31,655 Less: amounts with a maturity of three months or more (16,798) (5,770)
(e) Analysis of changes in financing during the year 2006 2005 £m £m
Share capital (including share premium account): At 1 January 2,590 2,564 Issue of share capital 105 26 £m £m
(g) Disposal and closure of group undertakings and businesses 2006 2005 £m £m
To the members of Lloyds TSB Group plc We have audited the parent company financial statements of Lloyds TSB Group plc for the year ended 31 December 2006 which comprise the balance sheet, the statement of changes in equity, the cash flow statement and the related notes. These parent company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the directors’ remuneration report on pages 52 to 61 that is described as having been audited.
We have reported separately on the consolidated financial statements of Lloyds TSB Group plc for the year ended 31 December 2006.
Current assets: Derivative financial instruments 114 188 Other assets 146 131 Amounts due from subsidiaries 3 203 164 Cash and cash equivalents 1,213 107
Non-current liabilities: Current liabilities: Current tax liabilities 43 5 Amounts owed to subsidiaries 1,850 1,692 Other liabilities 77 79
The directors approved the parent company financial statements on 22 February 2007.
Purchase/sale of treasury shares – (20) (20) Employee share option schemes: Value of employee services – 33 33 Proceeds from shares issued 105 – 105 * No income statement has been shown for the parent company, as permitted by section 230 of the Companies Act 1985.
Profit for the year 1,898 Dividends (1,914) Purchase/sale of treasury shares (2) Employee share option schemes: value of employee services 47
Preferred securities Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2015 (£600 million)† 587 – Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2016 (US$ 1,000 million)† 504 – 6% Non-cumulative Redeemable Preference Shares – – Undated subordinated liabilities 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million)* 497 497 Dated subordinated liabilities 81/2% Subordinated Bonds 2006 (£250 million) – 250 57/8% Subordinated Guaranteed Bonds 2014 (e750 million) 560 606
In addition the parent company carried out all of its banking activities through its subsidiary, Lloyds TSB Bank plc. At 31 December 2006, the parent company held deposits of £1,213 million with the bank (2005: £107 million). Given the volume of transactions flowing through the account, it is not meaningful to provide gross inflow and outflow information. In addition, at 31 December 2006 the parent company had interest rate and currency swaps with Lloyds TSB Bank plc with an aggregate notional principal amount of £2,228 million and a positive fair value of £114 million (2005: notional principal amount of £1,379 million and a positive fair value of £188 million), designated as fair value hedges to manage the interest rate risk in the Company’s issuance of subordinated liabilities .
Share price information In addition to listings in the financial pages of the press, the latest price of Lloyds TSB shares on the London Stock Exchange can be obtained by telephoning 0906 877 1515. These telephone calls are charged at 55p per minute, including VAT. Visit www.londonstockexchange.com for details.
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