Expand from strength • look to leverage our financial strength and enhanced capabilities • new product, customer and geographical markets
Our group Lloyds TSB is a leading UK based financial services group providing a wide range of banking and financial services, primarily in the UK, to personal and corporate customers. Our main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. The Group has a large and diversified customer base and services are offered through a number of well recognised brands (Lloyds TSB, Cheltenham & Gloucester, Scottish Widows), and via a unique distribution capability comprising one of the largest branch networks in the UK and intermediary channels.
Factors that could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by Lloyds TSB Group or on Lloyds TSB Group’s behalf include, but are not limited to, general economic conditions in the UK and internationally; inflation, deflation, policies of the Bank of England and other G7 central banks, interest rate, exchange rate, market and monetary fluctuations; changing demographic developments including consumer spending, saving and borrowing habits, technological changes, natural and other disasters, adverse weather and similar contingencies outside the Lloyds TSB Group’s control; inadequate or failed internal or external processes, people and systems; terrorist acts and other acts of war or hostility and responses to those acts; changes in laws, regulations, taxation, government policies or accounting standards or practices; exposure to regulatory scrutiny, legal proceedings or complaints; changes in competition and pricing environments; the inability to hedge certain risks economically; the adequacy of loss reserves; the ability to secure new customers and develop more business from existing customers; the ability to achieve value-creating mergers and/or acquisitions at the appropriate time and prices and the success of the Lloyds TSB Group in managing the risks of the foregoing.
• Strong underlying profit momentum. Profit before tax up 6 per cent to £3,919 million notwithstanding impact of global financial markets turbulence. Excluding the impact of £280 million market dislocation, profit before tax increased by 13 per cent to £4,199 million.
Presentation of information In order to provide a more comparable representation of underlying business performance, insurance and policyholder interests volatility have been separately analysed for the Group’s insurance businesses. Further information on these items is shown on pages 30 and 31. In addition, the profit on the sale of businesses and the settlement of overdraft claims in 2007 and the impact in 2006 of the one-off pension schemes related credit have been separately analysed in the Group’s results. A reconciliation of this basis of presentation to the statutory profit is shown on page 10. Certain commentaries also separately analyse the impact in 2007 of market dislocation.
• Good income growth. Income growth of 5 per cent, reflecting the strength and resilience of the Group’s revenue base. Excluding the impact of market dislocation and insurance grossing, income increased by 6 per cent.
• Excellent capital management. Robust capital ratios maintained. Satisfactory transition to Basel II, with tier 1 capital ratio increasing to 9.5 per cent. Over £3.6 billion of capital repatriated from Scottish Widows over the last 3 years.
“We have a strong capital position from which we can continue to grow the business.”
Corporate governance While the board of any company must ensure that a robust governance structure is in place, we are equally committed to fostering a culture throughout the organisation that values exemplary ethical standards, personal and corporate identity, teamwork, taking personal responsibility and respect for others. Our approach to governance is predicated on the belief that there is a link between high quality governance and the creation of shareholder value.
Mike Fairey, Deputy Group Chief Executive, will retire in June, following a wonderful career with the Group spanning 17 years. Mike joined the TSB group in 1991, became a director of Lloyds TSB in 1997 and became Deputy Group Chief Executive in 1998. He has given both loyal service and wise counsel during these years and I will personally miss his contribution. I would like to thank Mike for all of his input over the years and wish him well for the future.
Key to supporting our relationship-focused strategy is the efficient management of costs and capital, allowing us to continue to invest in the franchise and drive future growth. Once again we have delivered a strong performance in these areas.
High quality sustainable business Key to sustaining our strong momentum in future years are the relationships we are building with our customers, understanding their needs and developing the products and services to meet those needs.
We estimate that we currently only have a 10 per cent share of the economic profit pool, and so we have significant potential within our existing franchise to grow by meeting more of our customers’ needs as well as through adding new customers to our franchise.
Outlook As we look forward to 2008, we do so against a backdrop of turbulent markets and slowing global economic growth. Despite these challenges, we are well positioned to deliver further growth and to take advantage of the opportunities that the current environment offers.
“We are well positioned to deliver further growth and to take advantage of the opportunities that the current environment offers.”
Group net interest income, excluding insurance grossing, increased by £349 million, or 7 per cent, to £5,631 million. Customer deposits increased by 12 per cent to £157 billion, supported by strong growth in savings balances in the retail bank, where bank savings increased by 15 per cent and wealth management balances by 12 per cent. Customer deposits in our Corporate Markets, Commercial and International businesses increased by 18 per cent.
Strong levels of customer lending growth in Commercial Banking and Corporate Markets, and good growth in mortgages and retail deposits, more than offset the marketwide experience of lower unsecured personal lending balances. Total assets increased by 3 per cent to £353 billion, with an 11 per cent increase in loans and advances to customers.
The net interest margin from our banking businesses decreased by 9 basis points, to 2.79 per cent, with broadly stable product margins but an adverse mix effect. Stronger growth in finer margin mortgages and flat wider margin unsecured consumer lending contributed to the negative mix effect which accounted for 9 basis points of margin decline. Overall product margins were 2 basis points lower, reflecting competitive pressures in the mortgage and asset finance businesses and a move to finer margin secured lending in Commercial Banking. Funding costs improved the margin by 2 basis points. During the second half of 2007, product margins have started to show signs of improving, with increased new business margins becoming evident in mortgages and corporate lending reflecting a marketwide trend towards more appropriate pricing for risk.
Other income, net of insurance claims and excluding insurance grossing, increased by £133 million, or 2 per cent, to £5,530 million. This reflected higher fees and commissions receivable as a result of strong growth in added value current accounts and higher insurance commissions in the retail bank. In addition, good levels of growth were achieved in fee based product sales to corporate and commercial banking customers.
“Overall income growth of 5 per cent reflects good progress in delivering our divisional strategies.”
“Lloyds TSB’s strategy to build strong customer franchises and grow our business by realising the considerable potential within those franchises continues to deliver strong results.”
Structured Investment Vehicle (SIV) Capital Notes At 30 June 2007 the Group’s exposure to SIV Capital Notes totalled £100 million. During the second half of 2007 the Group wrote down the value of these assets by £22 million, leaving a residual exposure at 31 December 2007 of £78 million. Additionally, at 31 December 2007 the Group had commercial paper back up liquidity facilities totalling £370 million, of which £98 million had been drawn. All of these liquidity lines are senior facilities. Since the year end, these facilities have been reduced to £208 million, of which £115 million has been drawn. The Group has no SIV-Lite exposure.
The Group’s investment in Cancara, our hybrid Asset Backed Commercial Paper conduit, was £12.0 billion at 31 December 2007, comprising £8.3 billion ABS and £3.7 billion client receivables transactions. Cancara, which is fully consolidated in the Group’s accounts, is managed in a very conservative manner, which is demonstrated by the quality and ratings stability of its underlying asset portfolio. At 31 December 2007, the ABS bonds in Cancara were 100 per cent Aaa/AAA rated by Moody’s and Standard & Poor’s respectively, and there was no exposure either directly or indirectly to sub-prime US mortgages within the ABS portfolio. Since the year end, ABS totalling £67 million have been downgraded. At 31 December 2007 the client receivables portfolio included £115 million of US sub-prime mortgage exposure.
Scottish Widows has no exposure to US sub-prime ABS either directly or indirectly through CDOs. The Group holds £25 million of short-dated SIV commercial paper through Scottish Widows.
Scottish Widows remains strongly capitalised and, at the end of December 2007, the working capital ratio of the Scottish Widows Long Term Fund was an estimated 19.2 per cent (page 54). During 2007, further capital repatriation totalling £1.9 billion was made to the Group, bringing the total capital repatriation since the beginning of 2005 to over £3.6 billion. On 5 December 2007 Standard & Poor’s announced that it had re-affirmed its Scottish Widows ‘AA-’ debt rating and placed it on positive outlook.
Substantial profit on sale of non-core businesses During 2007 the Group sold a number of non-core businesses realising profits on the disposal totalling £657 million. This has further strengthened the Group’s capital ratios and improved capital flexibility.
Total income, net of insurance claims 5,263 1,596 4,212 (392) 10,679 15 10,694
** The Group’s income statement includes income and expenditure which are attributable to the policyholders of the Group’s long-term assurance funds. These items have no impact upon the profit attributable to equity shareholders. In order to provide a clearer representation of the underlying trends within the Insurance and Investments segment, these items are shown within a separate column in the segmental analysis above.
Summary of Group results 14 Lloyds TSB Group Annual Report and Accounts 2007
• Improved return on risk-weighted assets, reflecting the impact of double-digit profit growth exceeding the increase in risk-weighted assets.
Profit before tax from UK Retail Banking increased by £183 million, or 12 per cent, to £1,732 million, reflecting strong levels of franchise growth, excellent cost management and a slightly reduced impairment charge. Excluding the settlement of overdraft claims, profit before tax increased by 17 per cent to £1,808 million. Total income increased by £317 million, or 6 per cent, supported by higher income from current accounts, savings and personal lending.
Impairment levels slightly decreased Impairment losses on loans and advances decreased by £14 million, or 1 per cent, to £1,224 million, largely reflecting a reduction in the level of customer insolvencies and the quality of new lending. In addition, collections procedures continue to improve, a particularly important competitive advantage in a slowing consumer environment, and we achieved better than assumed recoveries. The impairment charge as a percentage of average lending improved to 1.10 per cent, compared to 1.18 per cent last year. Over 99 per cent of new personal loans and 89 per cent of new credit cards sold during 2007 were to existing customers, where the Group has a better understanding of an individual customer’s total financial position. The level of arrears in the personal loan and credit card portfolios reduced during 2007, whilst overdraft arrears remained stable.
The Scottish Widows brand is the main brand for new sales of Lloyds TSB Group’s life, pensions, Open Ended Investment Companies and other long-term savings products.
Scottish Widows Investment Partnership (SWIP) manages funds for Lloyds TSB Group’s retail life, pensions and investment products. Other key clients cover both the retail and institutional segments, with SWIP occupying a top 3 position in terms of retail funds under management. SWIP has close to £100 billion of funds under management.
• Improved returns. On an EEV basis, the post-tax return on embedded value increased to 9.9 per cent. New business margin was robust at 3.1 per cent.
• Increased weather related claims of £113 million, largely relating to the severe flooding in the UK in June and July, contributed to a 47 per cent reduction in profit before tax in General Insurance.
Life and pensions new business profit, on an IFRS basis and excluding volatility, reduced by 5 per cent to £163 million reflecting a change in the mix of investment products sold through the branch network towards non-embedded value accounted products. Total existing business profit grew by 43 per cent to £551 million, partly reflecting increased profits from the growing OEIC portfolio, improved cost management and a reduction in adverse assumption changes compared to 2006. The expected return on shareholders’ net assets increased by 43 per cent to £192 million as a result of a higher volume of free assets, driven by strong equity markets and the impact of regulatory changes in 2006, and a higher expected rate of return.
Profitably growing IFA sales Sales through the IFA distribution channel increased by 2 per cent, following record A-day related sales levels in 2006. Scottish Widows has continued to focus on the more profitable business areas within the IFA market. Sales of savings and investment products were lower as we chose not to compete in areas which deliver unsatisfactory returns, although this was partly offset by good growth in OEIC sales. Corporate pensions volumes remained strong following excellent growth last year and our managed fund business also showed good improvement.
Adjusting for the impact of capital repatriation, EEV profit before tax from the Group’s life, pensions and OEICs business increased by 11 per cent to £903 million.
New business profit fell by £20 million, or 6 per cent, to £326 million, largely reflecting the impact of a higher risk-free discount rate and changes in other economic assumptions applied to new business. This was however offset by a corresponding credit to the expected return on shareholders’ net assets.
Existing business profit increased by 9 per cent. Expected return decreased by 16 per cent to £337 million, primarily reflecting a lower shareholder benefit this year from the reduction in the value of realistic balance sheet liabilities and the impact of regulatory changes in 2006. Positive experience variances were driven by higher annuity profits from Abbey Life. Overall lapse experience was broadly in line with the Group’s expectations, as higher lapse experience in the life and pensions business was broadly offset by a favourable experience in OEICs. Assumption changes primarily reflect changes to the longer term lapse assumptions for both life and pensions business and OEICs. The expected return on shareholders’ net assets increased by £76 million, as a result of a higher volume of free assets, driven by strong equity markets and the impact of regulatory changes in 2006, and a higher expected rate of return.
Including assets under management within our UK Wealth Management and International Private Banking businesses, Groupwide funds under management decreased by 3 per cent to £122.8 billion.
Economic assumptions A bottom up approach is used to determine the economic assumptions for valuing the business in order to determine a market consistent valuation.
In sensitivities 4 to 7 assumptions have been flexed on the basis used to calculate the value of in-force business and the realistic and the statutory reserving bases. A change in risk discount rates is not relevant as the risk discount rate is not an input to a market consistent valuation.
8 Under a market consistent valuation, changes in assumed equity and property returns have no impact on the EEV.
Overall sales performance has been good with an 8 per cent increase in new business gross written premiums (GWP). Home insurance sales through the branch network continue to perform well with 14 per cent growth in new business GWP. We have, however, scaled back our participation in the distribution of home insurance through direct channels, as a result of the increasingly competitive pricing in that area of the market. During the year we continued to invest in product development, with loan protection and home insurance products both securing industry leading external quality ratings.
We use our strong product capabilities to support our new and existing customer relationships, with primary current focus being placed on the UK corporate segment in which energies and resource are directed to achieve gains in profitable market share thereby creating long term, sustainable relationships with our customers.
Key highlights • Overall profits impacted by turbulence in global financial markets. Whilst the division has limited exposure to assets affected by current capital market uncertainties, the impact of recent market dislocation has been to reduce profit before tax in 2007 by £280 million.
• Continued relationship banking momentum. Excluding the impact of market dislocation, profit before tax increased by 5 per cent.
Overall, the division’s profit before tax decreased by 12 per cent, to £1,437 million, reflecting the £280 million reduction in profits as a result of market dislocation. Excluding this impact, profit before tax increased by 5 per cent, with a continued strong performance in our relationship banking businesses. This has generated overall income growth of 6 per cent, driven by strong Corporate Markets and Commercial Banking income growth of 18 per cent and 8 per cent respectively. This exceeded cost growth of 1 per cent, leading to a reduction in the cost:income ratio to 50.9 per cent, from 53.8 per cent last year. Trading surplus, excluding the impact of market dislocation, increased by £249 million, or 13 per cent, to £2,197 million.
Profit before tax in Asset Finance decreased by 47 per cent to £60 million, largely reflecting continued tight credit criteria and a slowdown in demand in the consumer lending portfolio which has led to a reduction in the level of new business underwritten. As a result, income decreased by £89 million, or 10 per cent. Costs were 5 per cent lower and the impairment charge decreased by £11 million to £228 million, reflecting the recent tightening of credit criteria, improved collections procedures and lower balances outstanding, which offset an increase in arrears. Conditions in the Motor Finance business remain challenging. New business volumes have reduced, reflecting the marketwide slowdown in consumer demand, and we have sought to avoid the structural contraction in interest margins. In Personal Finance, new business volumes have risen modestly in a fiercely competitive market. Our Contract Hire business, Autolease, has performed well by continuing to leverage its strong market position and efficient operation.
During 2007, profit before tax included negative insurance volatility of £267 million, being a credit of £7 million to net interest income and a charge of £274 million to other income (2006: positive volatility of £84 million, being a credit of £2 million to net interest income and a credit of £82 million to other income). The effect of widening credit risk spreads and falling gilt values more than offset the favourable impact of a modest increase in equity values and changes in market consistent assumptions. During 2006 increases in equity values were partly offset by lower gilt values.
Divisional results 30 Lloyds TSB Group Annual Report and Accounts 2007
Policyholder interests volatility As a result of the requirement under IFRS to consolidate the Group’s life and pensions businesses on a line-by-line basis, the Group’s income statement includes amounts attributable to policyholders which affect profit before tax; the most significant of these items is policyholder tax.
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 set out below these amounts do not accrue to the equity holders, accordingly management believes a clearer representation of the underlying performance of the Group’s life and pensions businesses is presented by excluding policyholder interests volatility.
Talent, recruitment and retention One of the highest people priorities for our leaders is recruitment, retention and development of talented people. Top performers are attracted to join Lloyds TSB because of our reputation, strong brand and values; together with top class reward and development. Last year, we successfully recruited over 9,500 people from the external market.
Alongside this we run a wide range of generalist and specialist development programmes to support career progression into management.
Meeting our customers’ needs is key to our business strategy. Our balanced scorecard aims to show employees how their actions impact their colleagues and customers and how this, in turn, translates into our overall performance. It ensures that people understand how their personal objectives relate to our strategy, and how their performance contributes to the Group’s performance.
Employee engagement survey Every quarter a comprehensive confidential employee survey is undertaken on-line to gauge employees viewpoints on key engagement issues. Our group chief executive personally agrees the content of our employee engagement survey, demonstrating our commitment and investment in understanding our employee’s view. Over the last three years the overall employee engagement index has increased to 75.3 per cent and response rates have been consistently above 70 per cent.
Responsible lending We are committed to being a responsible lender. It is in our interest to help customers borrow only those amounts they can manage to repay. We have a responsible lending programme with internal management reporting and accountability. Our employees are trained to offer the necessary advice and support to help customers manage their borrowing. Our Customer Support Unit provides help for customers who are in financial difficulties to find an appropriate solution through effective budgeting or rescheduling their borrowing. We also support independent money advice networks including the Money Advice Trust and the Consumer Credit Counselling Service. Payments totalling more than £3.4 million were made in 2007.
Combating financial crime We take protecting our customers and their assets extremely seriously and continue to invest in systems and activities to deter, detect and prevent fraud. These include transaction monitoring tools to identify suspicious account activity and the introduction of verification technology on our counters to secure withdrawals. We also work to ensure customers are aware of how to protect themselves including dedicating a section of our website to information on common internet fraud types and an annual campaign to raise awareness of the threat of identity theft.
Financial inclusion We continue to develop financial services especially tailored to tackle the problem of financial exclusion. These include basic bank accounts, support for community credit unions and other community finance initiatives and, loan and venture capital funds, which offer loans to individuals and businesses in some of the most deprived areas in the UK. Lloyds TSB currently has £14 million invested in the community finance sector in addition to its normal commercial lending to small businesses in these areas. Our alliance with the Post Office allows our customers access to the UK network of post offices as well as over 2,000 of our own branches and over 4,100 free ATMs. At the end of 2007 we had over 470,000 basic bank accounts.
From 2008 we will be introducing a new measure of customer advocacy, the Net Promoter Score, which measures the likelihood of customers recommending Lloyds TSB to friends, family and colleagues.
Number/amount of compensation payments 1 payment totalling £25 for late settlement
During 2007 we consulted with senior management across all Lloyds TSB Group businesses to identify key climate-related risks and opportunities and to develop a programme to engage our employees and customers on the environment. Following the consultation, we published a target to reduce our CO2 emissions by 30 per cent by 2012, based on 2002 levels. This is a stretching target and to achieve it we will need to manage our energy consumption and efficiency together with our business travel.
Of course, we cannot eliminate all CO2 emissions so in 2007 we also committed to become carbon neutral by offsetting those emissions that we cannot reduce. We can confirm that in 2007 we purchased carbon credits through our carbon trading desk to achieve carbon neutrality.
More information on all the above issues is available in the Group’s corporate responsibility report and there are details on how to obtain a copy on page 159.
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 support the identification of opportunities as well as risks and it provides an aggregate view of the overall risk portfolio. Responsibilities and timescales at group and divisional level are clearly assigned 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.
Functional reporting line to support the committees Reporting line Functional reporting line from BU risk officer or function to divisional risk officers
Divisional risk officers provide oversight of risk management activity within each of the Group’s divisions. Reporting directly to the group executive directors responsible for the divisions and the chief risk director, their day-to-day contact with business management, business operations and risk initiatives seeks to provide an effective risk oversight mechanism.
The risk appetite is proposed by the group chief executive and reviewed by various governance bodies including the group executive committee and the risk oversight committee. Responsibility for the approval of risk appetite rests with the board. The approved high level appetite and limits are delegated to individual group executive directors by the group chief executive.
Risk reporting is standardised through the use of consistent definitions when reporting, to enable risk aggregation. Divisions monitor their risk levels against their risk appetite seeking to ensure effective mitigating action has been taken where appropriate. Divisional risk reports are reviewed by divisional executive committees to ensure that respective senior management are satisfied with the overall risk profile, risk accountabilities and progress on any necessary mitigating actions. Reporting, including that of performance against relevant limits or policies, is in place at a detailed level appropriate to the exposures concerned and regular information is provided to group risk for review and aggregate reporting. Any significant issues identified in the monitoring process are appropriately reported, and an escalation process is in place to report significant losses to appropriate levels of management. Group risk reports on risk exposures and material issues quarterly to the group asset and liability committee, group business risk committee, group executive committee, risk oversight committee and the board.
Detailed policy and authorities – including metrics and qualitative measures 38 Lloyds TSB Group Annual Report and Accounts 2007
• external factors: economic, technological, political, social and ethical, environmental, legal and regulatory, market expectations, reputation and competitive behaviour.
Mitigation As part of the annual business planning process, the Group develops a set of management actions to prevent or mitigate the impact on earnings in the event that business risks materialise. Additionally, business risk monitoring, through regular reports and oversight, results in corrective actions to plans and reductions in exposures where necessary.
Monitoring The Group’s strategy is reviewed and approved by the board. Regular reports are provided to the group executive committee and the board on the progress of the Group’s key strategies and plans. Group risk conducts oversight to seek to ensure that business plans remain consistent with the Group’s strategy.
Credit risk can also arise from debt securities, derivatives and foreign exchange activities. Note 16 to the financial statements shows the total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2007. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 47 on page 136.
• Counterparty limits: Credit risk in wholesale portfolios is subject to individual credit assessments, which consider the strengths and weaknesses of individual transactions and the balance of risk and reward. Exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. The Group’s credit approval criteria for counterparty underwriting is the same as that for assets intended to be held over the period to maturity.
• Credit scoring: In its principal retail portfolios, the Group uses statistically-based decisioning techniques (primarily credit scoring). Divisional risk departments review scorecard effectiveness and approve changes, with material changes subject to group risk approval.
• Cross-border and cross-currency exposures: Country limits are authorised and managed by a dedicated unit taking into account economic and political factors.
• Daily settlement limits: Settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of all settlement risk arising from the Group’s market transactions on any single day.
The Group has implemented guidelines on the acceptability of specific classes of collateral. Collateral held as security for financial assets other than loans and advances is determined by the nature of the instrument. Debt securities, treasury and other eligible bills are generally unsecured, with the exception of asset-backed securities and similar instruments, which are secured by portfolios of financial instruments. Collateral is generally not held against loans and advances to financial institutions, except where securities are held as part of reverse repurchase or securities borrowing transactions or where a collateral agreement has been entered into under a master netting agreement.
Market risk Definition The risk of reductions in earnings and/or value, through financial or reputational loss, arising from unexpected changes in financial prices, including interest rates, exchange rates and prices for bonds, commodities, equities, property and other instruments. It arises in all areas of the Group’s activities and is managed by a variety of different techniques.
Exposures The Group’s banking activities expose it to the risk of adverse movements in interest rates, credit spreads, exchange rates and equity prices, with little or no exposure to commodity risk.
The Group’s market risk exposure in respect of insurance activities described above is measured using European Embedded Value (EEV) as a proxy for economic value. The pre-tax sensitivity of EEV to standardised market stresses is shown below for the years ended 31 December 2007 and 2006. Foreign exchange risk arises predominantly from overseas equity holdings. Impacts have only been shown in one direction but can be assumed to be reasonably symmetrical. Opening and closing numbers only have been provided as this data is not volatile or tracked on a daily basis. This disclosure has been amended to reflect internal reporting for market risk in the insurance portfolio, in accordance with IFRS7.
Interest rate risk arising from the different repricing characteristics of the Group’s non-trading assets and liabilities, and from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets, is managed centrally. Matching assets and liabilities are offset against each other and internal interest rate swaps are also used.
Exposures The major sources of insurance risk within the Group are the insurance businesses and the Group’s defined benefit pension schemes. The nature of insurance business involves the accepting of insurance risks which relate primarily to mortality, morbidity, persistency, expenses, property damage and unemployment. The prime insurance risk carried by the Group’s pension schemes is related to mortality.
Measurement Insurance risks are measured using a variety of techniques including stress and scenario testing; and, where appropriate, stochastic modelling.
Mitigation 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 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 group executive committee and/or Lloyds TSB Group board approval. All group pension schemes issues are covered by the group asset and liability committee and the group business risk committee.
The overall insurance risk is mitigated through pooling and through diversification across large numbers of uncorrelated individuals, geographical areas, and different types of risk exposure.
• Pricing-to-risk (new insurance proposals would usually be priced in accordance with the underwriting assessment)
The intention is to extend the same methodology to the insurance businesses within the Group where regulatory capital is currently determined under the ICA requirements.
• For each of the material risks identified, an estimate of the exposure to financial losses that could result within the coming financial year, together with a ‘worst case’ stressed estimate.
A series of measures are used across the Group to monitor both short and long term liquidity including ratios, cash outflow triggers and stress test survival period triggers.
The Group’s regulatory capital is divided into tiers defined by the European Community Banking Consolidation Directive as implemented in the UK by the FSA’s General Prudential Sourcebook. Tier 1 comprises mainly shareholders’ equity, tier 1 capital instruments and minority interests, after deducting goodwill and other intangible assets. Tier 2 comprises collective impairment provisions, and qualifying subordinated loan capital, with restrictions on the amount of collective impairment provisions and loan capital which may be included. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting investments in subsidiaries and associates which are not consolidated for regulatory purposes and investments in the capital of other credit/financial institutions. In the case of Lloyds TSB Group, this means that the net assets of its life assurance and general insurance businesses are deducted from its regulatory capital.
Lloyds TSB Group and its regulated subsidiary banks have been allocated an Individual Capital Ratio by the FSA, and the board has agreed a formal buffer to be maintained in addition to this ratio. Any breaches of the formal buffer must be notified to the FSA, together with proposed remedial action. No such notifications have been made during 2007.
With effect from 1 January 2008 the Group moved onto the Basel II framework and maintained satisfactory capital ratios throughout the transition as set out in further detail on page 51.
The Group has developed procedures to ensure that compliance with both current and potential future requirements are understood and that policies are aligned to its risk appetite.
Short-term liquidity management is considered from two perspectives; business as usual and crisis liquidity, both of which relate to funding in the less than one year time horizon.
The Group’s funding and liquidity management is fundamentally based on a significant retail deposit base, accompanied by appropriate funding from the wholesale markets. A substantial proportion of the retail deposit base is made up of customer’s current and savings accounts which, although repayable on demand, have traditionally in aggregate provided a stable source of funding. Additionally, the Group accesses the short-term wholesale markets to provide inter-bank deposits and to issue certificates of deposit and commercial paper to meet short-term obligations. The Group’s short-term money market funding is based on an analysis of the market’s capacity for the Group’s credit, based on quantitative data. The Group has developed strong relationships with certain wholesale market segments, for example central banks and corporate customers, to supplement its retail deposit base.
Within the insurance businesses, non-linked funds investments are arranged to minimise the possibility of being a distressed seller whilst at the same time investing to meet policyholder obligations. For unit-linked business, deferral provisions are designed to give time to realise linked assets without being a forced seller.
The Group maintains a system of internal controls, consistently applied, providing reasonable assurance that transactions are recorded and undertaken in accordance with delegated authorities that permit the preparation and disclosure of financial statements, prudential regulatory reporting and tax returns in accordance with IFRS, statutory and regulatory requirements.
Future changes to regulatory capital rules The regulatory capital regime is subject to ongoing review and development by the regulator. The Group continues to work with the regulator to assess the impact on the Group’s regulatory capital requirements and resources.
Basis of determining regulatory capital of the life assurance businesses Available capital resources
Capital statement The following table provides more detail regarding the sources of capital in the life assurance business. The figures quoted are based on management’s current expectations pending completion of the annual financial return to the FSA. The figures allow for an anticipated transfer of £300 million from the Long Term Fund to the Shareholder Fund as at 31 December 2007. Non- Total
Assets attributable to the shareholder held within the long-term funds – 2,346 2,346 – 2,346
Adjustment to replace ‘realistic’ liabilities with statutory liabilities 3,696 – 3,696 – 3,696
The comparative position as at 31 December 2006 was as follows (again, relating to Scottish Widows plc only): Non- Total
Assets attributable to the shareholder held outside the long-term funds – – – 1,947 1,947
Adjustment to remove the value of future profits recognised in respect of non-participating contracts written in the With Profit Fund (32) – (32) – (32)
Available capital in the With Profit Fund has decreased from £3,686 million at 31 December 2006 to an estimated £3,608 million at 31 December 2007. The key driver is investment market performance, which was broadly neutral over 2007.
Available capital in the Non-Participating Fund has decreased from £1,962 million at 31 December 2006 to an estimated £1,915 million at 31 December 2007. This is primarily a result of the anticipated transfer from the Non-Participating Fund to the Shareholder Fund at the year end of £300 million, offset by the return generated from the business.
Financial information calculated on a ‘realistic’ basis The estimated financial position of the With Profit Fund of Scottish Widows at 31 December 2007, calculated on a ‘realistic’ basis, is given in the following table, in the form reported to the FSA. As a result of the capital support arrangements, it is considered appropriate to also disclose the estimated ‘realistic’ financial position of the Long Term Fund of Scottish Widows as a whole, which consists of both the With Profit Fund and the Non-Participating Fund.
With Profit Fund (in accordance Other long- Total life with FRS 27) term funds business £m £m £m
The most significant options and guarantees provided from within the With Profit Fund are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies. For those policies written pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up within the With Profit Fund of Scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2007 of £1.7 billion (2006: £1.8 billion). The eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
Loans and advances to customers 209,814 188,285 174,944 161,162 154,240 135,251
Diluted earnings per ordinary share 57.9p 49.5p 44.2p 42.5p 43.0p 58.1p
Total dividend per ordinary share1 35.9p 34.2p 34.2p 34.2p 34.2p 34.2p
Number of ordinary shares in issue (millions)2 5,648 5,638 5,603 5,596 5,596 5,594
1 Annual dividends comprise both interim and estimated final dividend payments. Under IFRS, the total dividend for the year represents the interim dividend paid during the year and the final dividend which will be paid and accounted for during the following year. Under UK GAAP, final dividends are included in the year to which they relate rather than in the year in which they are paid.
2 This figure excludes 79 million limited voting ordinary shares. 3 Averages are calculated on a monthly basis from the consolidated financial data of Lloyds TSB Group. 4 The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims for the IFRS numbers in 2004 and later years).
Philip N Green✠†* Joined the board in May 2007. Appointed chief executive of United Utilities in 2006. Former chief executive of Royal P&O Nedlloyd from 2003 to 2005. Previously held senior positions in DHL from 1990 to 1999, becoming chief operating officer for Europe and Africa in 1994, and the Reuters Group from 1999 to 2003, becoming chief operating officer in 2001. A director of Business in the Community, a member of the UK Commission for Employment and Skills and a trustee of the Philharmonia Orchestra. Aged 54.
Sir Julian Horn-Smith✠◆†+ Joined the board in 2005. Held a number of senior and general management appointments in Vodafone from 1984 to 2006 including a directorship of that company from 1996 and of deputy chief executive officer from 2005. Previously held positions in Rediffusion from 1972 to 1978, Philips from 1978 to 1982 and Mars GB from 1982 to 1984. A non-executive director of Digicel Group, a member of the Altimo International advisory board and a senior adviser to UBS in relation to the global telecommunications sector. A former chairman of The Sage Group. Aged 59.
Sir David Manning GCMG CVO✠ Joins the board on 1 May 2008. Entered the Foreign and Commonwealth Office in 1972 and held senior appointments, including HM ambassador to Israel between 1995 and 1998, foreign policy adviser to the Prime Minister from 2001 to 2003 and HM ambassador to the USA from 2003 to 2007. Aged 58.
Principal activities, business review, future developments and financial risk management objectives and policies The Company is a holding company and its subsidiary undertakings provide a wide range of banking and financial services through branches and offices in the UK and overseas. A review of the development and performance of the business during the financial year and an indication of the likely future developments are given on pages 2 to 56. Key performance indicators are shown on page i. Information regarding the financial risk management objectives and policies of the Company and its subsidiary undertakings, in relation to the use of financial instruments, is given on pages 36 to 56 and in note 47 on pages 134 to 142.
Directors Biographical details of directors are shown on pages 58 and 59. Particulars of their emoluments and interests in shares in the Company are given on pages 64 to 75.
Mr M E Fairey, Sir Julian Horn-Smith and Mr G T Tate retire at the annual general meeting and offer themselves for re-election. Mr Ewan Brown, whom the board has asked to remain as a director for a further year, also seeks re-election as stated in the corporate governance report on page 62.
Directors’ indemnities The directors, including two former directors who left during the year, entered into individual contracts of indemnity with the Company which constituted ‘qualifying third party indemnity provisions’ for the purposes of the Companies Act 1985. These contracts were in force during the whole of the financial year or from the date of appointment in respect of the director who joined the board on 10 May 2007. Since the end of the year following the introduction of relevant sections of the Companies Act 2006, revised contracts of indemnity were entered into with the directors which constitute ‘qualifying third party indemnity provisions’ and ‘qualifying pension scheme indemnity provisions’ and these remain in force and are available for inspection at the Company’s registered office.
Share capital and control Information about share capital and control is shown in note 39 on pages 122 to 124; in note 6 of the parent company accounts, included within this document, on page 153; in the corporate governance report on pages 61 to 63; and in the directors’ remuneration report on pages 64 to 75.
Directors’ report 60 Lloyds TSB Group Annual Report and Accounts 2007
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 combined code on corporate governance issued by the Financial Reporting Council. The Group has complied with the provisions of the code and has done so throughout the year regarding the provisions where the requirements are of a continuing nature.
The resolutions to be considered at the annual general meeting in 2008 will also be decided on a poll. Details of the results will be announced following the meeting and will be displayed on our website, www.lloydstsb.com. They will also be available from the company secretary.
Information about the remuneration committee’s membership and work is given in the directors’ remuneration report on pages 64 to 75 and its terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com.
Corporate governance 62 Lloyds TSB Group Annual Report and Accounts 2007
Number of meetings during the year 14 6 4 4 4
As detailed in last year’s report and given strong endorsement by shareholders who voted on the Directors’ Remuneration Report at our 2006 AGM, we made some changes to the annual incentive scheme for 2007, with an increase in the maximum bonus opportunity for executive directors to 200 per cent of salary (225 per cent for Mr Daniels) to ensure that the individual elements and the totality of our reward offering is competitive. We believe that a policy of positioning basic salaries at the median of the market combined with the substantial proportion of total reward opportunity being at risk through our short and long-term incentive schemes, underpinned by demanding performance conditions, provides strong levels of alignment with shareholders’ interests as well as engaging the executive directors in pursuing long-term shareholder value.
Looking forward, Lloyds TSB’s remuneration policy remains unchanged and, following further independent review, we intend to maintain the short and long-term incentive schemes in their current form. We believe that it is essential for the positioning of our package to be highly competitive against the external market; and in setting appropriate pay levels we will continue to consider remuneration practice of FTSE 20, and at the same time take close account of our direct competitors, namely the major UK banks, with whom we typically compete for high calibre talent.
• considering the level of Group performance and the correlation with outcomes under our previous long-term incentive awards
We have made a number of changes to this year’s report which are intended to demonstrate our commitment to the highest levels of clarity and comprehensive disclosure. Given our stated aim of ensuring a strong level of alignment between overall performance and reward outcomes, I believe that the actual levels of reward disclosed in the report which follows are entirely consistent with Lloyds TSB’s performance in 2007.
Role of remuneration committee The committee reviews the remuneration policy for the top management group, to ensure that members of the executive management are provided with appropriate incentives to encourage them to enhance the performance of the Group and that they are rewarded for their individual contribution to the success of the organisation. It advises on major changes of employee benefits schemes and it also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated power for settling remuneration for the chairman, the group executive directors, the company secretary and any group employee whose salary exceeds a specified amount.
The committee’s terms of reference are available from the company secretary and are displayed on the Group’s website www.lloydstsb.com.
• Mr Green (from 10 May when he joined the board)
In addition, in 2007, Alithos Limited provided information on behalf of the committee for the testing of the total shareholder return (TSR) (calculated by reference to both dividends and growth in share price) performance conditions for the Group’s long-term incentive schemes.
• The majority of total compensation is linked to the achievement of stretching performance targets.
In 2007, the Group performed strongly against the backdrop of significant turbulence in global financial markets. The 80 per cent of opportunity awarded for the corporate half of the bonus plan was deemed by the remuneration committee to be the appropriate level to recognise this performance and the marked progress made by the Group against its key performance indicators. The profit before tax* increased by 6 per cent to £3,919 million and the economic profit increased by 9 per cent to £1,842 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. While we cannot overlook the impact of the dislocation on our results, these numbers are more reflective of the ongoing performance of the Group.
The other 50 per cent of any award granted (the ‘EPS Award’) will be based on earnings per share (EPS) growth calculated on a compound annualised basis. In order for the EPS Award to vest in full, the EPS growth over the performance period must be at least equivalent to an average of the Retail Price Index (RPI) plus 6 per cent per annum. 17.5 per cent of the EPS Award (8.75 per cent of the total award) will vest where EPS growth is an average of the RPI plus 3 per cent per annum and vesting will occur on a straight line basis in between these points. Where the EPS growth is less than an average of the RPI plus 3 per cent per annum, the EPS Award will lapse.
Details of previous long-term incentive plans are shown on pages 74 and 75.
Performance graphs The first graph compares the Company’s TSR with the median TSR of the comparator group detailed on page 68. This is the comparator group used for the TSR performance conditions for executive share awards since 2005 (ie executive share options in 2005, performance share plan in 2005/06 and the long-term incentive plan since 2006).
Column (d) is the equivalent transfer value, but calculated as at 31 December 2006 on the assumption that the director left service at that date.
Members of the Lloyds TSB Group’s pension schemes have the option to pay additional voluntary contributions: neither the contributions nor the resulting benefits are included in the above table.
Options granted in 2003 lapsed as the performance condition had not been met.
At the end of 2007 Lloyds TSB Group was ranked 5th after the three year performance period for options granted in 2005.
Lloyds TSB long-term incentive plan The following are conditional share awards available under the plan. The share price for the 2007 award was 539p. Further information regarding this plan can be found on page 68.
At Awarded At 1 January during the 31 December Year of 2007 year 2007 vesting
We review whether the corporate governance statement reflects the Company’s compliance with the nine provisions of the Combined Code (2006) 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 form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures.
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 Overview, the unaudited part of the Business Review, the directors’ report, the corporate governance disclosures, the unaudited part of the directors’ remuneration report and the shareholder information. 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.
The directors approved the consolidated financial statements on 21 February 2008.
Movement in available-for-sale financial assets, net of tax: – change in fair value – (10) – (10) – (10)
– transferred to income statement in respect of disposals – (21) – (21) – (21)
Employee share option schemes: – value of employee services – – 65 65 – 65
– transferred to income statement in respect of impairment – 49 – 49 – 49
Proceeds from sale and maturity of available-for-sale financial assets 19,468 18,106
Cash and cash equivalents at end of year 49(d) 31,891 25,438
1 Accounting policies The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU). IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 ‘Financial Instruments: Recognition and Measurement’ relaxes some of the hedge accounting requirements; the Group has not taken advantage of this relaxation, and therefore there is no difference in application to the Group between IFRS as adopted by the EU and IFRS as issued by the IASB.
(a) Consolidation The assets, liabilities and results of Group undertakings (including special purpose entities) are included in the financial statements on the basis of accounts made up to the reporting date. Group undertakings include all entities over which the Group has the power to govern the financial and operating policies which generally accompanies a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Group controls another entity. Group undertakings are fully consolidated from the date on which control is transferred to the Group; they are de-consolidated from the date that control ceases. Open Ended Investment Companies (OEICs) where the Group, through the Group’s life funds, has a controlling interest are consolidated; the unit holders’ interest is reported in other liabilities. Intra-Group transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated.
– the assets and liabilities are part of a group which is managed, and its performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy with management information also prepared on this basis, or
(1) Fair value hedges Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value attributable to the hedged risk are no longer recognised in the income statement; the adjustment that has been made to the carrying amount of a hedged item is amortised to the income statement over the period to maturity.
(3) Net investment hedges Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in equity; the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of.
(i) Offset Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right of set-off and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.
The estimated period between a loss occurring and its identification is determined by local management for each identified portfolio. In general, the periods used vary between three months and nine months.
(o) Pensions and other post-retirement benefits The Group operates a number of post-retirement benefit schemes for its employees including both defined benefit and defined contribution pension plans. A defined benefit scheme is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, dependent on one or more factors such as age, years of service and salary. A defined contribution plan is a pension plan into which the Group pays fixed contributions; there is no legal or constructive obligation to pay further contributions.
For accounting purposes the life assurance business issues three types of contract: Insurance contracts – these contracts contain significant insurance risk, which the Group defines as the possibility of having to pay benefits on the occurrence of an insured event which are significantly more than the benefits payable if the insured event were not to occur.
Liabilities of the Group’s With Profit Fund, including guarantees and options embedded within products written by that fund, are stated at their realistic values in accordance with the Financial Services Authority’s realistic capital regime. Further details on the realistic capital regime are given on page 54.
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. This is determined using appropriate allowance for economic conditions and appropriate assumptions for future mortality rates and future persistency rates, making allowance for the realistic value of financial options and guarantees. Each cash flow is valued using the discount rate consistent with that applied to such a cash flow in the capital markets, including an explicit allowance for non-market risk. 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.
(3) Liability adequacy test At each balance sheet date liability adequacy tests are performed to ensure the adequacy of insurance and participating investment contract liabilities net of related deferred tax assets and acquired value of in-force business. In performing these tests current best estimates of discounted future contractual cash flows and claims handling and administration expenses, as well as investment income from the assets backing such liabilities, are used. Any deficiency is immediately charged to profit or loss by establishing a provision for losses arising from liability adequacy tests.
(t) Provisions Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the obligations and they can be reliably estimated.
(u) Dividends Dividends on ordinary shares are recognised in equity in the period in which they are paid.
(v) Cash and cash equivalents For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non-mandatory balances with central banks and amounts due from banks with a maturity of less than three months.
At 31 December 2007 gross loans and advances to customers and banks totalled £247,067 million (2006: £231,117 million) against which impairment allowances of £2,408 million (2006: £2,194 million) had been made.
Valuation of financial instruments Trading securities, other financial assets and liabilities at fair value through profit or loss, derivatives and available-for-sale financial assets are stated at fair value. The fair value of these financial instruments is the amount for which an asset could be exchanged or a liability settled between willing parties in arm’s length transactions. The fair values of financial instruments are determined by reference to observable market prices where these are available and the market is active. Where market prices are not available or are unreliable because of poor liquidity, fair values are determined using valuation techniques including cash flow models which, to the extent possible, use observable market parameters. The process of calculating the fair value using valuation techniques may necessitate the estimation of certain pricing parameters, assumptions or model characteristics. Changes in assumptions about these factors could affect reported fair values of financial instruments. The fair value movement on assets and liabilities held at fair value through profit or loss and gains in respect of instruments held for trading are disclosed in note 6. Movements in respect of available-for-sale financial assets, including those arising from changes in their fair value, are disclosed in note 20. The fair values of the Group’s financial assets and liabilities are disclosed within note 47 on pages 141 and 142 together with an indication of the valuation technique used for each major asset or liability category.
Interest receivable: Loans and advances to customers 6.89 6.21 13,209 10,853
Fee and commission income: Credit and debit card fees 536 493
Life insurance gross written premiums can be further analysed as follows: 2007 2006 £m £m
Other income 389 220 9 Insurance claims Insurance claims comprise: 2007 2006 £m £m
Fees payable for the audit of the Company’s current year annual report 6.8 6.0
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 2.5 2.9
• The sale, announced on 31 July 2007, of Abbey Life Assurance Company Limited, a UK life operation which has been closed to new business since 2000.
In addition, provision has been made for payments under an indemnity given in relation to a business sold in an earlier year.
(a) Analysis of charge for the year 2007 2006 £m £m
Foreign tax: Current tax on profit for the year 98 83
In addition to the income statement current tax charge, a total of £131 million of current tax has been credited to equity (2006: a total of £17 million charged to equity); a credit of £3 million (2006: a credit of £15 million) in respect of share based payments, a credit of £103 million (2006: a charge of £33 million) in respect of foreign exchange differences and a net credit of £25 million (2006: a net credit of £1 million) in respect of the revaluation of available-for-sale financial assets.
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Company has dilutive potential ordinary shares in respect of share options and awards granted to employees. The number of shares that could have been acquired at market price (determined as the average annual share price of the Company’s shares) based on the monetary value of the subscription rights attached to outstanding share options and awards is determined; the residual bonus shares are added to the weighted average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.
Weighted average number of ordinary shares for diluted earnings per share 5,683m 5,667m
Notes to the group accounts 100 Lloyds TSB Group Annual Report and Accounts 2007
Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. As discussed in note 18, the Group also uses credit default swaps to synthetically securitise £1,572 million (2006: £961 million) of commercial banking loans, and, in combination with external funding, to securitise a further £2,753 million (2006: £nil) of commercial banking loans.
At 31 December 2007 £3,573 million of total recognised derivative assets and £4,112 million of total recognised derivative liabilities (2006: £3,068 million of assets and £3,412 million of liabilities) had a contractual residual maturity of greater than one year.
Derivatives designated as fair value hedges: Cross currency interest rate swaps 80 10 –
Derivatives designated as cash flow hedges: Derivatives designated as net investment hedges: Cross currency swaps 2,589 139 –
At 31 December 2007 £5,773 million (2006: £15,259 million) of loans and advances to banks had a contractual residual maturity of greater than one year.
Notes to the group accounts 102 Lloyds TSB Group Annual Report and Accounts 2007
The net investment in finance leases represents amounts recoverable as follows: 2007 2006 £m £m
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other large individual value items. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £16 million (2006: £7 million). The unguaranteed residual values included in finance lease receivables were as follows: Not later than 1 year – –
Loans and Retail – Retail – advances to mortgages other Wholesale Total banks Total £m £m £m £m £m £m
Adjustments on disposal of businesses and portfolios – (27) – (27) – (27)
Charge to the income statement 12 1,558 (10) 1,560 – 1,560
The movement in available-for-sale financial assets is summarised as follows: Carrying value before allowances Allowances for Balance sheet for impairment impairment value £m £m £m
23 Value of in-force business The asset in the consolidated balance sheet and movement recognised in the income statement are as follows: Gross value of in-force insurance and participating investment business 2007 2006 £m £m
Notes to the group accounts 106 Lloyds TSB Group Annual Report and Accounts 2007
Non-economic assumptions Future maintenance expenses, mortality, morbidity, lapse and paid-up rate assumptions are based on an analysis of past experience and represent management’s best estimate of likely future experience.
overnance Financial Statem ents Shareholder Inform ation 26 Other assets continued
Liabilities held at fair value through profit or loss (debt securities) 3,107 1,156
Debt securities in issue at 31 December 2007 included £12,403 million (2006: £10,048 million) in respect of the securitisation of mortgages and £98 million (2006: £nil) in respect of the securitisation of commercial banking loans (see note 18).
The mortality assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this is significant, and relevant industry data otherwise.
The mortality and morbidity assumptions, including allowances for improvements in longevity for annuitants, are set with regard to the Group’s actual experience where this provides a reliable basis, and relevant industry data otherwise, and include a margin for adverse deviation.
Key changes in assumptions During 2007, following a detailed review of the Group’s current and expected experience, there has been a change in the key assumption in respect of lapse rates. The impact of this change has been to decrease profit before tax by £52 million; this amount includes movements in liabilities and value of the in-force business in respect of insurance contracts and participating investment contracts.
Notes to the group accounts 112 Lloyds TSB Group Annual Report and Accounts 2007
overnance Financial Statem ents Shareholder Inform ation 31 Liabilities arising from insurance contracts and participating investment contracts continued Increase
Current estimate of cumulative claims 220 206 204 206 317 1,153
The liability of £197 million shown in the above table excludes £10 million of unallocated claims handling expenses.
Change in unallocated surplus recognised in the income statement (note 9) (114) 165
35 Retirement benefit obligations Charge to the income statement 2007 2006 £m £m
Experience adjustments history (since the date of adoption of IAS 19): 2007 2006 2005 2004 £m £m £m £m
The expense recognised in the income statement for the year ended 31 December comprises: 2007 2006 £m £m
overnance Financial Statem ents Shareholder Inform ation 36 Deferred tax The movement in the net deferred tax balance is as follows: 2007 2006 £m £m
Income statement (credit) charge: Due to change in UK corporation tax rate (110) –
Deferred tax assets and liabilities are comprised as follows: 2007 2006 £m £m
Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2015 (£600 million) a, b 593 587
Fixed/Floating Rate Non-Cumulative Callable Preference Shares callable 2016 (US$1,000 million) a, c 515 504 6% Non-cumulative Redeemable Preference Shares o – –
Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015 (£250 million) d, n 248 248 4.385% Step-up Perpetual Capital Securities callable 2017 (e750 million) d, f, k 504 478
Subordinated Step-up Floating Rate Notes 2016 callable 2011 (£300 million) e 300 300
Notes to the group accounts 38 Subordinated liabilities continued a) Any repayment of preference shares would require prior notification to the Financial Services Authority. In certain circumstances, the shares may be mandatorily exchanged for qualifying non-innovative tier 1 securities. The Company may declare no dividend or a partial dividend on these preference shares. Dividends may be reduced if the distributable profits of the Company are insufficient to cover the payment in full of the dividends and also the payment in full of all other dividends on shares issued by the Company.
c) Dividends will accrue at a rate of 6.267 per cent per annum up to 13 November 2016 and, unless redeemed, at a rate reset quarterly equal to 1.035 per cent per annum above the London interbank offered rate for three-month sterling deposits thereafter. These preference shares can be redeemed at the option of the Company on 14 November 2016 or every 10 years thereafter.
d) In certain circumstances, these notes, bonds and securities would acquire the characteristics of preference share capital. Any repayments of undated subordinated liabilities would require prior notification to the Financial Services Authority. They are accounted for as liabilities since coupon payments are mandatory as a consequence of the terms of the 6% Non-cumulative Redeemable Preference Shares.
US dollars US$m US$m 160 million Preference shares of 25 cents each 40 40
Japanese yen ¥m ¥m 50 million Preference shares of ¥25 each 1,250 1,250
Information regarding significant direct or indirect holdings of shares in the Company can be found on page 159.
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary shares in accordance with the articles of association. The authority for the Company to purchase, in the market, 571,750,770 of its shares, representing some 10 per cent of the issued share capital, expires at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
Subject to any rights or restrictions attached to any shares, on a show of hands at a general meeting of the Company every holder of shares present in person or by proxy and entitled to vote has one vote and on a poll every member present and entitled to vote has one vote for every share held. Further details regarding voting at the annual general meeting can be found in the notes to the notice of the annual general meeting.
Limited voting ordinary shares The limited voting ordinary shares are held by the Lloyds TSB Foundations (‘the Foundations’). The holders of the limited voting ordinary shares, who held 1.38 per cent of the total share capital as at 31 December 2007, are entitled to receive copies of every circular or other document sent out by the Company to the holders of other ordinary shares. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. In the event of an offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting ordinary share will convert into an ordinary share and shall rank equally with the ordinary shares in all respects from the date of conversion. Lloyds TSB Group plc has entered into deeds of covenant with the Foundations, under the terms of which the Company makes annual donations to the Foundations equal, in total, to 1 per cent of the Group’s pre-tax profits (after certain adjustments) averaged over three years. The deeds of covenant can be cancelled by the Company at nine years’ notice. This donation is payable on or before the last day of February in each year (‘the payment date’). In the event of conversion of the limited voting ordinary shares, the Foundations shall be entitled to receive a donation, on the same basis as set out above, on the payment date following conversion.
Premium arising on issue of shares under share option schemes 32 96 £m £m
Retained profits are stated after deducting £75 million (2006: £87 million) representing 15 million (2006: 15 million) treasury shares held.
Final dividend for previous year paid during the current year 23.5 23.5 1,325 1,316
The directors have proposed a final dividend of 24.7 pence per share (2006: 23.5 pence per share) representing a total cost of £1,394 million (2006: £1,325 million) which will be paid on 7 May 2008.
Charge to the income statement The charge to the income statement is set out below: 2007 2006 £m £m
For options granted from August 2001 to August 2004 The performance condition is linked to the performance of Lloyds TSB Group plc’s total shareholder return (calculated by reference to both dividends and growth in share price) against a comparator group of 17 companies including Lloyds TSB Group plc.
– the full grant of options becomes exercisable only if the Group is ranked in the top four places of the comparator group. A sliding scale applies between fourth and eighth positions. If Lloyds TSB Group is ranked below the median (ninth or below) the options will not be exercisable and will lapse.
The weighted average fair value of options granted in the year was £5.27 (2006: £4.58). The weighted average share price at the time that the options were exercised during 2007 was 539.77 pence (2006: 557.25 pence). No options outstanding at 31 December were exercisable. The weighted average remaining contractual life of options outstanding at the end of the year was 1.8 years (2006: 2.0 years).
Lloyds TSB Group executive share plan 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, or if Ms Dial ceases to be an employee before that date in certain circumstances described in her service agreement: in both cases the options will be exercisable for six months and then lapse.
Outstanding at 1 January and 31 December 242,825 Nil 242,825 Nil
(ii) For the other 50 per cent of the award (the ‘TSR Award’) – it will be necessary for the Group’s total shareholder return (calculated by reference to both dividends and growth in share price) 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 total shareholder return is equal to median and vesting will occur on a straight line basis in between these points. Where the Group’s total shareholder return is below the median of the comparator group, the TSR Award will lapse. The relevant period commenced on 1 January 2006 and ends on 31 December 2008.
overnance Financial Statem ents Shareholder Inform ation 45 Related party transactions
Key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of an entity; the Group’s key management personnel are the members of the Lloyds TSB Group plc group executive committee together with its non-executive directors.
Deposits placed by key management personnel attracted interest rates of up to 8.0 per cent (2006: 5.2 per cent).
The Group manages 107 (2006: 89) Open Ended Investment Companies (OEICs), and of these 40 (2006: 38) are consolidated. The Group invested £1,961 million (2006: £372 million) and redeemed £1,526 million (2006: £237 million) in the unconsolidated OEICs during the year and had investments, at fair value, of £2,233 million (2006: £1,746 million) at 31 December. The Group earned fees of £200 million from the unconsolidated OEICs (2006: £149 million). The Company held no investments in OEICs at any time during 2006 or 2007.
The Group has a number of associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2007, these companies had total assets of approximately £3,184 million (2006: £1,625 million), total liabilities of approximately £3,182 million (2006: £1,609 million) and for the year ended 31 December 2007 had turnover of £2,136 million (2006: £2,409 million) and made a net profit of approximately £9 million (2006: net loss of £5 million). In addition, the Group has provided £609 million (2006: £460 million) of financing to these companies on which it received £23 million (2006: £20 million) of interest income in the year.
On 27 July 2007, following agreement between the UK Office of Fair Trading (OFT) and a number of UK financial institutions, the OFT issued High Court legal proceedings against those institutions, including Lloyds TSB Bank plc, to determine the legal status and enforceability of certain of the charges applied to their personal customers in relation to requests for unplanned overdrafts. A preliminary issues hearing has now taken place and judgement is currently awaited. It is likely that further hearings will be required and, if appeals are pursued, the proceedings may take a number of years to conclude. Pending resolution, the Financial Services Authority has agreed, subject to certain conditions, that the handling of customer complaints on this issue can be suspended until the proceedings are concluded unless in the light of prevailing circumstances this would be inappropriate. The Group intends strongly to defend its position. Accordingly, no provision in relation to the outcome of this litigation has been made. Depending on the Court’s determinations, a range of outcomes is possible, some of which could have a significant financial impact on the Group. The ultimate impact of the litigation on the Group can only be known at its conclusion.
There has been increased scrutiny of the financial institutions sector, especially in the US, with respect to combating money laundering and terrorist financing and enforcing compliance with economic sanctions. The Office of Foreign Assets Control (OFAC) administers US laws and regulations in relation to US economic sanctions against designated foreign countries, nationals and others and the Group has been conducting a review of its conduct with respect to historic US dollar payments involving countries, persons or entities subject to those sanctions. The Group has provided information relating to its review of such historic payments to a number of authorities including OFAC, the US Department of Justice and the New York County District Attorney’s office which, along with other authorities, have been reported to be conducting a broader review of sanctions compliance by non-US financial institutions. The Group is involved in ongoing discussions with these authorities with respect to agreeing a resolution of their investigations. No provision has been made in respect of this matter. The Group does not expect the final outcome to have a material adverse effect on its financial position.
The contingent liabilities of the Group, as detailed above, arise in the normal course of its banking business and it is not practicable to quantify their future financial effect.
Of the amounts shown above in respect of undrawn formal standby facilities, credit lines and other commitments to lend £53,036 million (2006: £51,288 million) was irrevocable.
Capital commitments Excluding commitments in respect of investment property (see note 21), capital expenditure contracted but not provided for at 31 December 2007 amounted to £102 million (2006: £75 million). Of this amount, £96 million (2006: £74 million) related to assets to be leased to customers under operating leases. The Group’s management is confident that future net revenues and funding will be sufficient to cover these commitments.
Available-for-sale financial assets – – – 20,196 – – – 20,196
Loans and advances to customers – – – – 188,285 – – 188,285
Items in course of transmission to banks – – – – – 781 – 781
Derivative financial instruments 466 5,297 – – – – – 5,763
Unallocated surplus within insurance businesses – – – – – – 683 683
Interest rate risk In the Group’s retail banking business interest rate risk arises from the different repricing characteristics of the assets and liabilities. Liabilities are either insensitive to interest rate movements, for example interest free or very low interest customer deposits, or are sensitive to interest rate changes but bear rates which may be varied at the Group’s discretion and that for competitive reasons generally reflect changes in the Bank of England’s base rate. There are a relatively small volume of deposits whose rate is contractually fixed for their term to maturity.
Currency risk Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the Group’s overseas operations.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. All non-structural foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to Wholesale and International Banking Market and Liquidity Risk. Associated VaR and the closing, average, maximum and minimum for 2006 and 2007 are disclosed on page 43.
Neither past due nor impaired 92,873 29,364 60,005 182,242 835 40,638
Collateral held against retail mortgage lending is principally comprised of residential properties; their fair value has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in the Halifax House Price Index, after making allowance for indexation error and dilapidations. The resulting valuation has been limited to the principal amount of the outstanding advance in order to provide a clearer representation of the Group’s credit exposure.
Debt securities: Other public sector securities – – – – – 5 5
Rated BB AAA AA A BBB or lower Not rated Total
Debt securities: Other public sector securities 189 – – – – – 189
Derivative financial instruments, trading and other liabilities at fair value through profit or loss 8,928 2,037 2,600 663 887 15,115
Fair values of financial assets and liabilities Financial instruments include financial assets, financial liabilities and derivatives. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
overnance Financial Statem ents Shareholder Inform ation 48 Acquisitions During 2006, the Group, through its Asset Finance subsidiaries, acquired two businesses engaged in consumer finance for a total consideration of £16 million, settled in cash in that year. Goodwill of £4 million arose on those acquisitions; no significant fair value adjustments were made.
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss 3,840 556
Notes to the group accounts 49 Consolidated cash flow statement continued
overnance Financial Statem ents Shareholder Inform ation 49 Consolidated cash flow statement continued
50 Future developments The following pronouncements will be relevant to the Group but were not effective at 31 December 2007 and have not been applied in preparing these financial statements. The full impact of these accounting changes is being assessed by the Group, however, the initial view is that none of these pronouncements are expected to cause any material adjustments to reported numbers in the financial statements.
Provides guidance on the availability of refunds or reductions in future contributions for retirement plans and specifies how a minimum funding requirement might either affect the availability of reductions in future contributions or give rise to a liability.
IFRIC 14 IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirement and their Interaction 1
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report, the directors’ remuneration report and the parent company financial statements in accordance with applicable law and International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union are set out in the statement of directors’ responsibilities on page 63.
We read other information contained in the annual report and consider whether it is consistent with the audited parent company financial statements. The other information comprises only the chairman’s statement, the group chief executive’s review, the Business Review, the directors’ report, the corporate governance disclosures, the unaudited part of the directors’ remuneration report and the shareholder information. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the parent company financial statements. Our responsibilities do not extend to any other information.
overnance Financial Statem ents Shareholder Inform ation at 31 December 2007
Proceeds from shares issued 35 – 35 * No income statement has been shown for the parent company, as permitted by section 230 of the Companies Act 1985.
The accompanying notes are an integral part of the parent company financial statements.
1 Accounting policies The parent company has applied International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) in its financial statements for the year ended 31 December 2007. IFRS comprises accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB’s predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee and its predecessor body. The EU endorsed version of IAS 39 ‘Financial Instruments: Recognition and Measurement’ relaxes some of the hedge accounting requirements; the Company has not taken advantage of this relaxation, and therefore there is no difference in application to the Company between IFRS as adopted by the EU and IFRS as issued by the IASB.
2 Deferred tax assets The movement in the net deferred tax asset is as follows: 2007 2006 £m £m
7 Debt securities in issue These comprise the US$1,400 million Thirteen-Month Extendible Short-Term Notes and the US$1,725 million Thirteen-Month Extendible Short-Term Notes issued by the Company in May 2007.
* In certain circumstances, these bonds would acquire the characteristics of preference share capital. Any repayments of undated loan capital would require the prior consent of the Financial Services Authority. They are accounted for as liabilities as coupon payments are mandatory as a consequence of the terms of certain preference shares. At the callable date the coupon on these bonds will be reset by reference to the applicable five year benchmark gilt rate.
The principal subsidiaries, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of Lloyds TSB Group plc, are: Percentage of equity
Information for shareholders Analysis of shareholders 159 Financial calendar 2008 160 Shareholder enquiries 159
Investment property Accounting policy 85 Notes to the group accounts 105
Pensions Accounting policy 86 Critical accounting estimates and judgements 89 Directors’ 71 Notes to the group accounts 115
Risk management framework Business risk 40 Credit risk 41 Financial soundness 48 Insurance risk 45 Market risk 43 Principal risks 39 Operational risk 46 Risk drivers 39 Risk governance structures 36
Segmental reporting Central group items 30 Insurance and Investments 18 Notes to the group accounts 91 Summarised segmental analysis 14 UK Retail Banking 15 Wholesale and International Banking 26
Value of in-force business Accounting policy 87 Notes to the group accounts 106
• obtaining a form for dividends to be paid directly to your bank or building society account (tax vouchers will still be sent to your registered address unless you request otherwise)
Calls to 09058, 0871 and 0845 numbers are charged at 55p, 8p and 5p per minute, respectively, from a BT landline. Charges for calls from mobiles and other networks may vary.
* Includes 887 million shares (15.7%) registered in the names of some 783,000 individuals. 274 million shares (4.8%) are held by over 61,000 staff and Group pensioners, or on their behalf by the trustee of the staff shareplan scheme.
22 February Results for 2007 announced 5 March Ex-dividend date for 2007 final dividend 7 March Record date for final dividend 9 April Final date for joining or leaving the dividend reinvestment plan for the final dividend 7 May Final dividend paid 8 May Annual general meeting in Glasgow 30 July Results for half-year to 30 June 2008 announced 6 August Ex-dividend date for 2008 interim dividend 8 August Record date for interim dividend 3 September Final date for joining or leaving the dividend reinvestment plan for the interim dividend 1 October Interim dividend paid