We serve our business customers in the UK with dedicated relationship managers in over 500 locations 2003 highlights Results
Profit before tax, excluding changes in economic assumptions, investment variance and profit on sale of businesses 3,380 3,506
Earnings per share 58.3p 32.1p * Restated to reflect a change in accounting policy following the issue of new accounting guidance in Urgent Issues Task Force Abstracts 37 ‘Purchases and sales of own shares’ and 38 ‘Accounting for ESOP trusts’, the reclassification of Business Banking earnings from UK Retail Banking and Mortgages to Wholesale and International Banking, and changes in internal transfer pricing arrangements. The Lloyds TSB Group has also changed its accounting policy relating to the deferral of certain expenses incurred in connection with the acquisition of new asset finance and unit trust business. These costs are now charged to the profit and loss account as incurred, rather than over the expected life of the related transactions.
† Changes in economic assumptions and investment variance relate to Insurance and Investments, profit on sale of businesses relates to Wholesale and International Banking.
In this report the terms ‘UK GAAP’ and ‘US GAAP’ refer to generally accepted accounting principles (‘GAAP’) in the UK and the US respectively.
2003 has been a year of considerable change for the Lloyds TSB Group. We have refocused our strategic direction, to concentrate on our core businesses, and put in place many of the building blocks for profitable franchise growth in 2004 and beyond. One of the significant challenges that we face is that growth in the financial services industry is expected to slow over the next couple of years. This means that for us to grow profitably we will need to win a greater share of new and existing customers’ business. To do this we are placing much greater emphasis on developing our relationship management skills in each of the Lloyds TSB Group’s businesses, so we better understand and meet our customers’ needs and create more value for them than our competitors can. At the same time, we continue to improve our products and services and build on the progress we have made in 2003.
The Lloyds TSB Group has delivered a satisfactory performance in 2003. This has been achieved as a result of growth in our income, through building stronger relationships with our customers whilst at
the same time maintaining strict cost control. A number of actions have also been taken to reduce risk and earnings volatility. We also made good progress in 2003 in enhancing overall customer service, supported by the introduction of new products and improved processes.
Lloyds TSB Group’s capital ratios improved significantly during 2003, partly as a result of gains on business disposals, and the Group continues to generate strong cash flows from its banking operations. Lloyds TSB Bank remains one of the most profitable major banks in the world and is one of only two large commercially owned banks in the world, and the only UK bank, to have a ‘triple A’ rating from Moody’s.
The board has decided to maintain the final dividend at 23.5p per share to make a total for the year of 34.2p (2002: 34.2p). The board continues to recognise the importance attached by shareholders to the Group’s dividend which in 2003 represented a dividend yield of 7.6 per cent, calculated using the 31 December 2003 share price of 448p.
Lloyds TSB continues to improve its products and services. Over 800,000 new customers joined the bank in 2003
In 2003, we implemented a new risk infrastructure across all our business units and maintained tight control over our risk positions and credit quality, which is in part reflected in our lower charge for bad and doubtful debts and reduced levels of non-performing lending.
The emphasis on developing the core franchise has resulted in a robust performance in UK Retail Banking and Mortgages in 2003, with profit before tax increasing by 21 per cent as revenues increased by 9 per cent whilst costs were held flat, excluding the customer redress provision of £200 million.
Over 4 million customers have chosen accounts from our added value current account range
Scottish Widows has made good market share gains in the UK life and pensions market, particularly through the Independent Financial Advisor distribution channel, with new business contribution up by 13 per cent and the margin on new business increasing significantly, following the focus on the distribution of more profitable and capital efficient products.
Work is also underway to improve the overall performance through our branch channels. Profitability from existing business fell, largely as a result of changes in actuarial assumptions. Our general insurance business continued to perform well with good income growth in the home insurance market.
Training and development are integral to improving the performance of our people. And we seek to recognise that performance with a competitive range of salaries and an innovative benefits package. Flavours is our response to changes in the rules governing taxable benefits for employees and comprises cash allowances, life and medical insurance, redemption vouchers, flexible benefits, an opportunity to share in the Lloyds TSB Group’s profit through share schemes and an ability to obtain free company shares. Over 84,000 products
In support of the community we serve as a business, the four independent Lloyds TSB Foundations will receive £31 million in 2004 to distribute to grassroots charities throughout the UK, which focus on improving the lives of disabled and disadvantaged people. The Foundations receive 1 per cent of the Group’s pre-tax profits adjusted for certain items, averaged over three years, instead of the dividend on their shareholding.
Thousands of our employees are committed to good causes. In 2003, £1.3 million was set aside by the trustees of the LloydsTSB Foundations to match money raised and time given by our employees to charities that meet the have now been selected by our employees and Flavours received Employee Benefits magazine’s most successful new benefits launch award in 2003.
By encouraging diversity in our workforce, we are better able to serve the community in which our business is rooted. With more women, ethnic minority and disabled employees, and their increasing representation at management level, we can ensure that we leverage the best available talent for our business.
• building a high-performance organisation focused on the right goals and the best possible execution of those strategies.
Even the best strategies will fail to deliver shareholder value if poorly executed. Lloyds TSB Group has restructured its businesses and reinvigorated its governance and performance management processes to link plans and budgets much more closely to the highest value strategy for each business, to ensure maximum clarity and accountability for execution within all levels of its management team, and to link reward much more closely to performance.
Lloyds TSB Group remains alert for opportunities to grow through acquisitions that complement its organic strategies and help provide new opportunities for profitable growth, both in the UK and overseas. Lloyds TSB Group’s strategy is to focus initially on improving performance in its core markets and by doing so build an advantaged platform for subsequent expansion into new markets.
Current accounts. The retail branches of Lloyds TSB Bank and Lloyds TSB Scotland offer a wide range of current accounts, including interest-bearing current accounts and a range of added value accounts.
Savings accounts. Lloyds TSB Bank and Lloyds TSB Scotland offer a wide range of savings accounts and Cheltenham & Gloucester provides retail investments through their branch networks and a postal investment centre.
Corporate. Lloyds TSB Group provides a relationship-based financial and advisory service to the corporate marketplace through dedicated offices in the UK and a number of locations overseas, including New York. Customers have access to our capital and expertise in a broad range of financial solutions, including correspondent banking and trade finance, foreign exchange and interest rate management instruments, short and long-term lending, structured asset finance including large value lease and other asset based finance, securitisation, acquisition finance, capital markets and share registration. Lloyds TSB Development Capital provides venture capital finance to developing companies.
Asset Finance. Lloyds TSB Group’s asset finance businesses provide individuals and companies with finance through leasing, hire purchase and contract hire packages. Hire purchase, or instalment credit, is a form of consumer financing where a customer takes possession of goods on payment of an initial deposit but the legal title to the goods does not pass to the customer until the agreed number of instalments have been paid and the option to purchase has been exercised. Through its invoice discounting and factoring subsidiary Lloyds TSB Commercial Finance, Lloyds TSB Group provides working capital finance for customers by releasing to the customer up to 90 per cent of the value of their unpaid invoices, with the balance payable, after deduction of a service fee, once the invoices have been settled. Invoice discounting differs to factoring in that the customer retains control of the debt collection and the credit risk. Specialist personal lending, store credit, small/medium ticket leasing and the Dutton-Forshaw motor dealership complete this group of businesses.
Business Banking. Relationships with some 560,000 small businesses are managed by around 1,700 dedicated business managers based in over 500 locations throughout the UK supported by nearly 2,000 business customer advisers in branches. Lloyds TSB Group is one of the leading banks for new business start-ups with around one in five opening accounts with Lloyds TSB Bank. Customers have access to Lloyds TSB Group’s unique business development programme RouteMap and a wide range of solutions to business problems such as Debtor Management service, providing legal support to help customers recover debts, and Prospect Finder, providing customers with a tailored list of potential customers for their business. The main activity of the Agricultural Mortgage Corporation is to provide long-term finance to the agricultural sector.
Offshore banking. The Lloyds TSB Group’s offshore banking operations comprise offices in the UK, the Channel Islands, the Isle of Man and overseas representative offices in the Middle East, Asia and the Americas. The business provides a wide range of retail banking, wealth management and expatriate services to local island residents, UK expatriates, foreign nationals and to other customers requiring offshore financial services.
Lloyds TSB Group operates in a marketplace which is continually changing. No organisation can successfully manage change without the support and commitment of its staff. The pace and scope of change will not diminish as competition in the financial services market continues to increase. Lloyds TSB Group recognises that it is the staff of the organisation who have delivered, and will continue to deliver, its success and considers that one of its greatest competitive advantages is the ability of its people to adapt to rapid and far reaching change. The knowledge and skills of Lloyds TSB Group’s employees are a key element in its success and therefore it invests significantly in training, ensuring that training is accessible by everyone in the organisation.
Lloyds TSB Group recognises that long-term success depends on the quality of its management. It is therefore committed to developing the potential of all managers; in particular ensuring that it has the succession management capability to meet future needs for top management. On 1 June 2003 Eric Daniels, formerly group executive director, UK Retail Banking, succeeded Peter Ellwood upon his retirement as group chief executive; Peter Ayliffe succeeded Eric Daniels as group executive director, UK Retail Banking. On 10 March 2003 Steve Targett joined the board and on 16 April 2003 he succeeded David Pritchard upon his retirement as group executive director, Wholesale and International Banking.
On 30 September 2003 Mike Ross, group executive director, Insurance and Investments, left the board and was replaced by Archie Kane, previously group executive director, IT and Operations. Chris Wiscarson, formerly managing director, International Banking, assumed the responsibilities of director of Group IT and Operations and joined the group executive committee but did not become a member of the board. On 12 January 2004 Philip Hampton, group finance director, left the board. Helen Weir, formerly group finance director of Kingfisher, has been appointed group finance director from 26 April 2004. In the meantime, the finance director’s duties are being carried out by Mike Fairey, deputy group chief executive. On 1 February 2004, Frans Hijkoop joined the Lloyds TSB Group as director of Group Human Resources and became a member of the group executive committee but did not become a member of the board. On 1 March 2004, Carol Sergeant, formerly managing director, Regulatory Process and Risks Directorate for the UK Financial Services Authority, joined the Lloyds TSB Group as chief risk director and also became a member of the group executive committee but did not become a member of the board.
At the same date, 44,478 people were employed in UK Retail Banking and Mortgages, 5,783 in Insurance and Investments, 19,414 in Wholesale and International Banking, and 1,934 in other functions. Lloyds TSB Group has gone through substantial changes in recent years; adjusting for the effect of acquisitions and disposals underlying staff numbers have reduced by 16,209 since 1995. However, during this time no material strikes or work stoppages have occurred.
Lloyds TSB Group expects competition within the industry to continue to be based on service and relationships as well as price, particularly for core banking services. Lloyds TSB Group has significant strengths, in its portfolio of strong brands, its existing customer franchises in both retail and corporate, commercial and business banking, its multi-channel distribution capability and its knowledge and understanding of its customers.
Lloyds TSB Group’s competitors include all the major financial services and fund management companies operating in the UK. De-mutualised building societies which have become banks and life assurers which have entered the banking market have become direct competitors in the provision of banking products.
In the distribution of life, pensions and investments products Lloyds TSB Group has seen increased competition from new market entrants, such as traditional retailers, primarily in specialist areas. The fragmented nature of the life, pensions and investments market in the UK has resulted in some consolidation within the sector; government regulations on product charges and competitive pressures are likely to drive further consolidation as providers seek to achieve the benefits of economies of scale. Proposed changes to the regulation of life, pensions and investment products are expected to favour distributors, including banks, rather than product providers.
In the general insurance sector, the market has seen significant consolidation amongst underwriters but continued fragmentation in distribution and an increasing number of new market entrants including both overseas insurers and direct operators.
In commercial and corporate markets, margins are typically finer than in retail, but probably under less downward pressure. Nevertheless, traditional forms of bank finance face increasing competition from market-based products as companies increasingly access those markets directly.
In the credit card market, the Office of Fair Trading (OFT) has recently reached a preliminary conclusion that an agreement between MasterCard’s UK members on transaction charges infringes the Competition Act 1998. In the absence of justification of the existing agreement from MasterCard, a decision is expected in March or April that will require MasterCard to cease its infringement of the Competition Act.
Set out below are certain risk factors which could affect the Lloyds TSB Group’s future results and cause them to be materially different from expected results. The factors discussed in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.
Lloyds TSB Group’s businesses are conducted in a marketplace that is consolidating and significant cross-border mergers and acquisitions may happen in the coming years. Lloyds TSB Group’s ability to generate an appropriate return for its shareholders over the long term may depend upon whether management is able or permitted by either regulatory bodies or its shareholders to achieve value-creating mergers and/or acquisitions at the appropriate times and prices.
The results of Lloyds TSB Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. The accounting policies used in the preparation of the financial statements are set out in note 1 to the financial statements. In preparing the accounts, the directors are required to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. Where UK GAAP allows a choice of policy, Financial Reporting Standard 18 ‘Accounting Policies’ requires Lloyds TSB Group to adopt those policies judged to be most appropriate to its particular circumstances for the purpose of giving a true and fair view.
Lloyds TSB Group accounts for the value of the shareholder’s interest in the long-term assurance business using the embedded value basis of accounting, which is UK GAAP for banking groups owning life assurance operations. The embedded value is comprised of the net tangible assets of the life assurance subsidiaries and the present value of the projected future surplus arising on the in-force business, which is calculated by projecting these surpluses and other net cash flows attributable to the shareholder arising from business written by the balance sheet date and discounting the result at a rate which reflects the shareholder’s overall risk premium.
The value of the in-force business could also be affected by unpredicted changes in investment market levels and other in-period variances between expected and actual experience. Investment market levels principally affect annual management charges and other fees levied on policyholders, which are reflected in the profit and loss account using unsmoothed fund values. In addition, to the extent that actual experience is different from that assumed, for example with respect to mortality or persistency, the effect will be recognised in the profit and loss account for the period. The effect of changes in the underlying assumptions and variations between actual and assumed experience on the results of the current and prior periods are disclosed in note 30 in the financial statements.
General insurance claims (236) (229) (174) Provisions for bad and doubtful debts (950) (1,029) (747) Amounts written off fixed asset investments (44) (87) (60)
Other income was £1,068 million, or 30 per cent, higher at £4,619 million compared to £3,551 million in 2002. Income from long-term assurance business was £747 million higher, mainly as a result of improved returns from the investments supporting the life funds. Dealing profits were £372 million higher, as a result of increases of £55 million in foreign exchange income and £317 million in gains from securities trading reflecting earnings from the sale of Lloyds TSB’s portfolio of emerging markets debt investments. General insurance premiums were £49 million higher as a result of strong growth in home insurance products. However, net fees and commissions receivable fell by £31 million as a reduction in income from insurance broking and higher fees payable within the asset finance and mortgage businesses more than offset growth in income from current accounts and credit and debit cards. Other operating income decreased by £69 million, following the recognition of earnings on the emerging markets debt portfolio in 2003 in dealing profits following its reclassification to trading assets at the end of 2002, and a reduction of £28 million in profits on the sale and leaseback of premises. This more than offset the effect of the inclusion of a full year’s income from the Dutton-Forshaw Group which was acquired in December 2002, and higher disposal gains within the wholesale businesses.
Operating expenses were £260 million, or 5 per cent, higher at £5,173 million compared to £4,913 million in 2002, as a result of a £200 million provision for customer redress and the inclusion for a full year of the costs of businesses acquired in 2002 which increased operating expenses by £110 million in 2003. Administrative expenses were £264 million higher than in 2002. Staff costs increased by £71 million as the impact of acquisitions and the annual pay review more than offset the benefits of reductions in staff numbers and lower levels restructuring costs. Premises and equipment costs were £1 million higher and other expenses increased by £192 million reflecting the inclusion of the customer redress provision. The efficiency ratio improved to 52.2 per cent from 55.3 per cent.
General insurance claims increased by £55 million, or 32 per cent, to £229 million, reflecting volume related increases in property claims and a higher level of weather and flood related insurance claims.
Amounts written off fixed asset investments increased by £27 million, or 45 per cent, to £87 million in 2002, compared to £60 million in 2001. There was a £21 million write down following operating irregularities on one specific securitisation issue and a £21 million increase in the charge in respect of the venture capital business in the UK, reflecting portfolio growth. These increases were partly offset by a £15 million reduction in the charge in respect of Argentine government debt.
At the end of 2002, the total capital ratio increased to 9.6 per cent as new issues of tier 1 and tier 2 capital instruments during the year more than offset the effect of a £14,550 million, or 13 per cent, increase in risk-weighted assets to £122,411 million, from £107,861 million at the end of 2001. Balance sheet assets increased by £17,060 million, or 7 per cent, to £252,561 million. Loans and advances to customers increased by £11,539 million, mainly reflecting growth in UK mortgage and personal period end lending balances, which increased by £8,036 million, and growth of £2,012 million in New Zealand. Debt securities were £5,089 million higher due to further growth in the Lloyds TSB Group’s asset-backed portfolio.
Domestic net interest income increased by £223 million, or 5 per cent, to £4,425 million. This represented 86 per cent of consolidated net interest income. Average interest-earning assets increased by £13,658 million, or 11 per cent, to £134,902 million, adding £449 million to net interest income. Average personal lending and mortgage balances grew by £6,737 million and wholesale balances increased by £7,190 million.
Dealing profits increased substantially by £372 million compared with 2002 as a result of an increase of £55 million in foreign exchange income and an increase of £317 million in gains from securities trading, largely reflecting profits from the disposal of the Lloyds TSB Group’s portfolio of emerging markets debt investments which, at the end of 2002, was reclassified as a trading asset. In 2002, earnings from emerging markets debt investments were primarily reported within other operating income.
Income from long-term assurance business increased by £747 million reflecting the improved performance of stock markets during 2003 as the return on the investments held to support the long-term assurance funds grew by £934 million. Although there was only limited growth in overall product sales, new business contribution increased by £14 million largely reflecting an improved new business margin caused by a shift to more profitable regular premium products. Profits from existing business fell by £111 million mainly as a result of a £168 million reduction in benefits from experience variances and actuarial assumption changes, and the expected return reduced by £48 million; however, provisions for customer redress were £105 million lower. The benefits from economic assumption changes also reduced by £77 million.
Other operating income increased by £55 million, or 8 per cent, to £763 million. Increases of £25 million in earnings on the sale and restructuring of emerging markets debt investments and £111 million in operating lease rentals, largely as a result of the acquisition of First National Vehicle Holdings and Abbey National Vehicle Finance, were offset by a £35 million reduction in the realisation of venture capital gains by Lloyds TSB Development Capital and a reduction of £25 million in profits on the sale and leaseback of premises.
Other expenses: – Communications and external data processing 446 446 483 – Advertising and promotion 172 147 154
The efficiency ratio was 52.2 per cent, compared to 55.3 per cent in 2002.
Depreciation was £131 million, or 26 per cent, higher reflecting a £95 million increase in operating lease depreciation. Of this amount £33 million relates to the Lloyds TSB Group’s existing operations, reflecting both organic growth and the non-repetition of a one-off benefit of £23 million recognised in 2001 in respect of certain ship leases, and £62 million relates to the businesses acquired during 2002. The remaining increase in the charge reflects the accelerated write-off of certain software development costs and the ongoing impact of the significant investment in computers, software and other equipment made by the Lloyds TSB Group in recent years. Goodwill amortisation increased by £20 million, reflecting the acquisitions made in the year.
In Wholesale and International Banking the provisions charge fell by £171 million to £369 million. The charge within Wholesale fell by £78 million as the level of new provisions required against corporate customers reduced. In 2002 provisions totalling some £100 million were made against large US exposures which have not been repeated to the same extent during 2003. In the asset finance businesses the provisions charge was largely unchanged despite strong lending growth during 2003 as the high level of voluntary terminations experienced in 2002 were not repeated during 2003. Within International Banking the charge fell by £93 million mainly as a result of a reduction of £79 million in the new provisions required against the Lloyds TSB Group’s exposures in Argentina as the economic conditions in that country have started to stabilise. There has also been a reduction in the charge in other Latin American operations as specific cases requiring provisions in 2002 have not been repeated.
The total charge for bad and doubtful debts increased by £282 million, or 38 per cent, to £1,029 million from £747 million in 2001. In UK Retail Banking and Mortgages the provisions charge increased by £139 million, from £357 million in 2001, to £496 million, as a result of asset growth in the personal loan and credit card portfolios and a lower level of recoveries and releases, following the non-recurrence of the release of surplus provisions in 2001.
In Wholesale and International Banking the provisions charge increased by £144 million, or 36 per cent, to £540 million from £396 million in 2001. The charge in respect of corporate banking operations was £145 million higher partly as a result of provisions against the Group’s exposure to certain large US corporate customers which totalled some £100 million compared to £30 million in 2001. There was also an increase in the provisions charge against the UK corporate lending portfolio, reflecting the slowdown in activity in certain sectors of the UK economy. The charge in respect of the Lloyds TSB Group’s asset finance businesses increased by £11 million, mainly reflecting volume growth and a high level of voluntary terminations. There was a £27 million reduction in the specific provisions charge in Losango, the Lloyds TSB Group’s consumer finance business in Brazil, largely reflecting exchange rate movements. The general provision against the Lloyds TSB Group’s exposure to Argentina was increased by £50 million, compared to a charge of £55 million in 2001.
In Central group items there was a credit of £7 million, little changed from a credit of £6 million in 2001; these credits represent the release of provisions following the repayment of medium-term debt in the emerging markets portfolio.
The Group’s charge for bad and doubtful debts as a percentage of average lending increased to 0.77 per cent, compared to 0.62 per cent in 2001.
Provisions for bad and doubtful debts (594) (496) (357) Share of results of joint ventures (22) (11) (10)
Bad debt provisions increased by £98 million to £594 million as a result of an increase in the provisions required against the personal lending and credit card portfolios mainly reflecting volume growth during the year but also some deterioration in the arrears levels within the personal loan portfolio and an increase in fraud related losses. There was a net release of £18 million from the provisions held against the mortgage portfolio compared to a net release of £1 million in 2002, as the arrears position has improved and the value of the underlying security increased. The provisions charge as a percentage of average lending for personal loans and overdrafts increased to 4.25 per cent from 3.73 per cent in 2002, while the charge in the credit card portfolio decreased to 3.19 per cent from 3.52 per cent the previous year.
The Lloyds TSB Group’s share of the results of its joint venture operations in 2003 was a loss of £22 million compared to £11 million in 2002. Following the purchase by the Lloyds TSB Group of the personal loan and credit card portfolios of Goldfish Bank, the remaining business is being wound down resulting in increased losses from asset write-downs and closure provisions.
respectively and, within Retail Banking, balances on current accounts and savings and investment accounts grew by 10 per cent. Mortgage balances outstanding increased by 10 per cent to £62,467 million representing a market share of 9.3 per cent. Gross new mortgage lending increased by 36 per cent to £19,039 million, compared with £13,986 million a year ago. Net new lending increased to £5,889 million resulting in a market share of net new lending of 7.5 per cent; the Lloyds TSB Group’s market share of net new lending in the second half of 2002, at 8.8 per cent, was considerably better than in the first half of the year. Mortgages offer the Lloyds TSB Group the opportunity to sell a range of additional products and, during 2002, the Lloyds TSB Group’s key objective in the mortgage business was to achieve an appropriate balance between market share and profitability.
General insurance claims increased by £7 million to £236 million, as the effect of the increase in the size of the portfolio was largely offset by a reduction in claims caused by the generally mild weather conditions.
The operating profit from Insurance and Investments at £1,230 million, was £194 million, or 14 per cent, lower than 2001.
General insurance claims were £55 million, or 32 per cent, higher at £229 million compared to £174 million in 2001. The increase in claims reflects the significant growth in the size of the underwritten portfolio together with higher claims due to flood and storm damage during the early part of 2002.
The operating profit from life, pensions and unit trusts decreased by £105 million, or 22 per cent, to £372 million from £477 million in 2002. Operating profit at Scottish Widows was £211 million lower at £379 million compared to £590 million in 2002. Profit from existing business was £171 million lower reflecting a reduction of £174 million in benefits from experience variances and actuarial assumption changes; within the expected return a reduction of £39 million reflecting the lower value of in-force business and a lower discount rate was offset by lower restructuring costs. Normalised investment earnings fell by £56 million due to lower expected investment returns and £13 million of development costs were incurred. This more than offset an increase in new business contribution which grew by £15 million or 13 per cent as a result of an improved product mix. Profits from the unit trust business increased by £14 million, largely reflecting the absence of restructuring related costs in 2003.
The provisions charge in respect of customer redress payments was £105 million lower in 2003. In 2002 a charge of £165 million was made in respect of sales of mortgage endowment and other long-term savings products made by the Abbey Life sales force, between 1988 and the disposal of the sales force in early 2000. This provision was increased by some £20 million in 2003 as greater experience has allowed management to refine the underlying assumptions. A further provision of some £35 million has been made in respect of sales made by the Abbey Life sales force prior to 1988. In 2002 there was also a charge of £40 million to increase the provisions held in respect of redress payments to past purchasers of pension policies; in 2003 a further charge of some £45 million has been made as the review now nears completion. See ‘Operating and financial review and prospects – Customer remediation payments’.
Abbey Life’s operating profit reduced by £98 million to £92 million in 2002. This reduction in profitability principally reflected reduced expected return from existing business and investment earnings as a result of lower asset levels at the start of 2002 and a reduction in benefits from experience variances and actuarial assumption changes, which were £73 million lower, as a number of one-off benefits in 2001 were not repeated.
The revised assumptions have resulted in a net charge to the profit and loss account in 2003 of £22 million (2002: a credit of £55 million) of which £21 million is attributable to the increase in the rate of expenses inflation from 3.30 per cent to 3.80 per cent.
• Investment earnings: this represents the expected investment return on both the net tangible assets and the value of the shareholder’s interest in the long-term business account, based upon the economic assumptions made at the beginning of the year.
New business income 457 398 358 Life and pensions distribution costs (327) (283) (255) New business contribution 130 115 103 Existing business: – Assumption changes and other items (75) 78 95 – Provisions for customer redress (100) (205) (70)
The operating profit of the life, pensions and unit trust businesses in 2002 was £477 million, compared to £763 million in 2001, a decrease of £286 million, or 37 per cent.
Claims were £55 million, or 32 per cent, higher at £229 million compared to £174 million in 2001. The overall claims ratio at 45.7 per cent was higher than in 2001 (39.9 per cent) largely as a result of increased property claims, due to a 26 per cent growth in the home underwritten portfolio, and higher weather and flood related insurance claims.
Provisions for bad and doubtful debts (306) (63) (369) (540) (396) Amounts written off fixed asset investments (44) – (44) (57) (22)
The profit before tax of Wholesale and International Banking decreased by £188 million, or 13 per cent, to £1,264 million in 2002 from £1,452 million in 2001. The acquisition during the year of First National Vehicle Holdings, Abbey National Vehicle Finance and the Dutton-Forshaw Group had a significant impact on the trends in income and expenses within Wholesale and International Banking. In 2002 these acquisitions contributed £101 million of income, and £102 million of operating expenses, including goodwill amortisation of £3 million, resulting in a loss before tax of £1 million.
Total assets were £10,032 million, or 9 per cent, higher at £117,066 million. Of this increase, some £4,700 million resulted from a growth in debt securities within Wholesale, reflecting an increase in the Lloyds TSB Group’s portfolio of asset backed securities, most of which are triple A rated. The portfolio allows the Lloyds TSB Group to provide a securitised asset funding service for its corporate clients (see ‘Operating and financial review and prospects – Liquidity’), and to participate in structured deals with a limited number of global financial institutions. Customer lending balances increased by some £2,600 million with growth in lending to large corporates and asset finance balances as these businesses have sought to grow their balance sheets. There was an increase in interbank lending of some £2,400 million mainly as a result of deposits made by the Lloyds TSB Group’s Treasury department in London as part of its liquidity management activities. Within International Banking, total assets decreased by £109 million as strong growth in New Zealand, where total assets increased by £2,370 million in sterling terms, was offset by reductions in the Lloyds TSB Group’s exposure to Brazil and Argentina.
Provisions for bad and doubtful debts were £144 million, or 36 per cent, higher at £540 million compared to £396 million in 2001. The charge in respect of corporate banking operations was £145 million higher following a charge of some £100 million in respect of certain large US corporates, caused by accounting and operational irregularities, and an increased charge from the UK corporate lending portfolio reflecting the slowdown in activity in certain sectors of the UK economy. The charge in respect of the asset finance businesses increased by £11 million mainly as a result of volume growth and a high level of voluntary terminations. Within International Banking, the charge was £21 million lower as a result of lower specific provisions in Losango, the Lloyds TSB Group’s consumer finance business in Brazil, largely reflecting exchange rate movements. There was a general provision charge of £50 million in relation to the Lloyds TSB Group’s exposure to Argentina, compared to £55 million in 2001.
Amounts written off fixed asset investments were £35 million higher at £57 million. There was a £21 million charge following operating irregularities on one securitisation issue and a £21 million increase in the charge in respect of the Lloyds TSB Group’s development capital business, following the significant growth in the portfolio over recent years. These increases were partly offset by the non-repetition of a charge of £7 million incurred in 2001, in respect of Argentine government debt instruments held within International Banking.
Included within Central group items are the costs of Lloyds TSB Group support functions, the accrual for the annual payment to the Lloyds TSB Foundations, other finance income arising on the Lloyds TSB Group’s post-retirement defined benefit schemes together with the cost of any benefit augmentations in those schemes, the net earnings on that part of Lloyds TSB Group’s capital base which is not required to support the operations of the businesses together with earnings on the emerging markets debt investment portfolio, and other items of income and expenditure managed centrally.
UK compared with US GAAP Under US GAAP, Lloyds TSB Group’s net income for the year ended 31 December 2003 was £3,231 million (2002: £1,753 million) compared to £3,254 million (2002: £1,790 million) under UK GAAP. Reconciliations between the UK GAAP and US GAAP figures, together with detailed explanations of the accounting differences, are included in note 50 to the financial statements.
However, US GAAP net income is lower due to an amortisation charge in respect of customer related intangibles, the intangible assets representing the value of customer relationships associated with acquisitions, which are separately established under US GAAP.
Derivatives. Under UK GAAP, derivatives held for risk management purposes are accounted for on an accruals basis, in line with the underlying instruments being hedged. Under US GAAP, because Lloyds TSB Group has elected not to satisfy the more onerous hedging criteria of SFAS No. 133 ‘Accounting for Derivative Instruments and for Hedging Activities’ in respect of derivative contracts, these instruments are treated as being held for trading purposes, with the unrealised mark-to-market gains and losses taken to income as they arise and the resulting assets or liabilities recorded on the balance sheet. As Lloyds TSB Group will continue to hold a significant number of derivatives which are hedge accounted under UK GAAP this means that net income and shareholders’ equity under US GAAP will be subject to greater volatility.
Provisions for bad and doubtful debts (1,846) (1,623) (1,489) Non-interest earning assets: Total average assets and interest income 210,998 10,815 5.13 198,476 11,151 5.62 178,616 11,908 6.67
Loans and advances to banks and customers include non-performing loans. Interest receivable on such loans has only been included to the extent to which cash payments have been received, in accordance with Lloyds TSB Group’s policy on income recognition.
Enterprise-wide risk management (EWRM) is founded on four principal concepts: strong risk governance; empowerment; competitive advantage; and common risk language.
The group executive committee, assisted by its sub-committees the group business risk committee and the group asset and liability committee, supports the group chief executive in ensuring the development, implementation and effectiveness of the Lloyds TSB Group’s risk management framework, the clear articulation of the Lloyds TSB Group’s risk policies and reviews the Lloyds TSB Group’s aggregate risk exposures and concentrations of risk. The group executive committee’s duties are described more fully on page 75.
The chief risk director, a member of the group executive committee, oversees and promotes the development and implementation of a consistent global risk management framework and provides objective challenge to both the group executive committee and the risk oversight committee. Group Risk Management supports the chief risk director in performing the role.
The director of group audit provides the required independent assurance to the board and audit committee that risks within the Lloyds TSB Group are recognised, monitored and managed within acceptable parameters. Group Audit is fully independent of Group Risk Management, ensuring objective challenge to the effectiveness of the risk governance framework.
The model provides the Lloyds TSB Group with an effective mechanism for developing and promulgating risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also facilitates more effective communication on these matters across the Lloyds TSB Group. These arrangements will enable the Lloyds TSB Group better to anticipate and pre-empt risks, and to manage those risks which crystallise more effectively.
During 2003, Group Risk Management has reviewed internal governance procedures in many businesses to assess compliance with Lloyds TSB Group standards and achieve greater consistency in risk governance. Where appropriate, these have prompted the creation of business risk committees and dedicated risk management functions.
Reflecting the importance the Lloyds TSB Group places on risk management, risk is one of the five principal criteria that it includes in its balanced scorecard on which individual staff performance is judged. Business executives have specified risk management objectives, and incentive schemes take account of performance against these.
There is an annual control self assessment exercise under which businesses across the Lloyds TSB Group review specific controls and provide certification that these meet the requirements of the Lloyds TSB Group.
The Lloyds TSB Group is developing an improved quantification approach towards its risk appetite (defined as the extent and categories of risk which the board regards as appropriate and acceptable for the Lloyds TSB Group to bear). Adoption of the metrics under development has the objective of enabling the Lloyds TSB Group to improve its risk management processes. This work is ongoing.
Governance, people and organisation risk, operations risk, customer treatment risk, legal and regulatory risk, and change management risk are collectively managed as operational risks. A third level of risk language has been identified for these operational risks.
This is the risk of loss from poor corporate governance at Lloyds TSB Group and business level. It includes sub-optimal organisational structuring, or failure to recruit, manage and retain appropriately skilled staff to achieve business objectives. Lloyds TSB Group policy for managing governance, people and organisation risk is defined in the Group Policy Manual. It defines the way the Lloyds TSB Group is organised, the need for tight financial and operating controls, maintenance of a strong risk management and control culture, the need to benchmark against industry best practice and for businesses to conduct themselves with integrity, due skill, care and diligence.
The Lloyds TSB Group seeks to ensure that all employees understand their role, the purpose of the role and where it fits into the wider team and organisational context. It manages and measures employees’ performance and contribution to collective goals and recognises the contribution of individuals in the context of the pay market and the performance of the business in which they work, and rewards appropriately.
This comprises the risks arising from the adoption of the Lloyds TSB Group’s agreed strategy and its implementation at corporate or business level. At corporate and business level these risks are managed through a number of processes.
An annual strategic planning process is conducted at Lloyds TSB Group and business level and includes a quantitative and qualitative assessment of the risks in the Lloyds TSB Group plan.
To enhance further the ability to measure and predict future risk, the Lloyds TSB Group continues to develop new policies and risk management systems.
Concentration risk. Formulation of concentration limits on certain industries and sectors. Group Risk Management sets sector caps that reflect risk appetite, and monitors exposures to prevent excessive concentration of risk.
• Establishment and maintenance of the Lloyds TSB Group’s large exposure and provisioning policies, in accordance with regulatory reporting requirements.
• Monitoring and controlling residual value risk exposure. The Lloyds TSB Group’s appetite for such exposure is communicated to the business by a series of time referenced sector caps, seeking to ensure an acceptable distribution of risk.
Day-to-day credit management and asset quality within each business is primarily the responsibility of the relevant business director. Businesses have established credit policies and processes reflecting Lloyds TSB Group policy. Businesses’ lending authorities are delegated by officers holding divisional lending authority. All material authorities are advised to Group Risk Management.
Credit quality is supported by specialist units established within Lloyds TSB Group businesses to provide, for example: intensive management and control; security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector-specific expertise; and legal services applicable to the particular market place and product range offered by the business.
The following table analyses loans to banks and customers by geographical area and type of loan at 31 December for each of the five years listed.
Foreign Loans and advances to banks 1,894 2,239 2,489 2,131 2,628 Loans and advances to customers: – Financial, business and other services 1,866 3,196 2,631 2,174 2,553
Analysis of foreign loans by region Loans and advances to customers: Loans and advances to banks: The classification of lending as domestic or foreign is based on the location of the office recording the transaction, except for certain lending of the international business booked in London.
– Financial, business and other services (11) (53) (44) (28) (40)
Recoveries of advances written off: Domestic Loans and advances to customers: – Financial, business and other services 7 13 11 10 6
Provision for loan losses charged against income for the year: Domestic Loans and advances to customers: – Agriculture, forestry and fishing 8 – 3 (6) (4)
– Financial, business and other services 49 107 39 12 16
Ratio of net write-offs during the period to average loans outstanding during the period 0.7% 0.5% 0.6% 0.5% 0.6%
In most circumstances in the US, title to property securing residential real estate transfers to the lender upon foreclosure. The loan is written off and the property acquired in this way is reported in a separate balance sheet category with any recoveries recorded as an offset to the provision for loan losses recorded in the period. Upon sale of the acquired property, gains or losses are recorded in the income statement as a gain or loss on acquired property.
The following table analyses risk elements in the loan portfolio as at 31 December for the last five years.
Foreign lending Interest income that would have been recognised under original contract terms 8 Interest income included in profit (6)
The business of Lloyds TSB Group involves significant exposures in non-local currencies. These cross border outstandings comprise loans (including accrued interest), acceptances, interest-bearing deposits with other banks, other interest-bearing investments and any other monetary assets which are denominated in non-local currency. The following tables analyse, by type of borrower, foreign outstandings which individually represent in excess of 1 per cent of Lloyds TSB Group’s total assets.
Banks Governments and other Commercial, and official financial industrial and Total institutions institutions other
As at 31 December 2003: As at 31 December 2002: As at 31 December 2001: As at 31 December 2003, Germany had commitments of £1,086 million, Italy had commitments of £166 million, Belgium had commitments of £21 million, United States of America had commitments of £1,762 million and Netherlands had commitments of £450 million.
Measurement techniques – a variety of techniques are used to quantify the market risk arising from the Lloyds TSB Group’s banking and trading activities. These reflect the nature of the business activity, and include simple interest rate gapping, open exchange positions, sensitivity analysis and value at risk. Stress testing and scenario analysis are also used in certain portfolios, and at Lloyds TSB Group level, to simulate extreme conditions to supplement these core measures.
The following table shows closing, average, maximum and minimum VaR for the years ended 31 December 2003 and 2002.
• The use of a confidence limit does not convey any information about potential losses on occasions when the confidence limit is exceeded. In times of extreme market movements actual losses may be several times greater than the VaR number. Stress testing is used to supplement VaR to estimate the impact of extreme events.
• The VcV approach to VaR is not well suited to options positions. As a result these positions are controlled by additional sensitivity limits.
Interest rate exposures. Comprise those originating in treasury trading activities and structural interest rate exposures, which arise from the commercial and retail banking activities of Lloyds TSB Group.
Trading interest rate risk. The VaR relating to interest rate trading positions is set out in ‘Market risk – Measurement – Trading value at risk (VaR)’.
• those which are sensitive to interest rate movements, primarily savings deposits bearing interest rates which are varied at Lloyds TSB Group’s discretion (‘managed rate liabilities’) but which for competitive reasons generally reflect changes in the Bank of England’s base rate.
Most banking assets, with the exception of such non-interest earning items as premises, are sensitive to interest rate movements. There is a large volume of managed rate assets such as variable rate mortgage loans, and these may be considered as a natural offset to managed rate liabilities. However many assets, such as personal loans and fixed rate mortgages, bear interest which is contractually fixed for periods of up to five years or longer.
Structural interest rate risk can also arise from the wholesale banking books in the UK, where it is managed by the Lloyds TSB Group’s Financial Markets Division in London, and internationally, where it is managed by an authorised local treasury operation in each overseas centre. The levels of exposure within these books are controlled and monitored within approved limits locally and centrally as set out in ‘Market risk – Limits – Market risk limits’. Limits are issued to the international businesses on interest rate gaps or, where more appropriate, VaR.
The analysis above is subject to certain simplifying assumptions including, but not limited to, all rates of all maturities worldwide move simultaneously by the same amount; all positions in the wholesale books run to maturity; and there is no management action in response to movements in interest rates.
Trading foreign exchange. The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. These risks reside in the authorised trading centres who are allocated exposure limits as set out in ‘Market risk – Limits – Market risk limits’. The limits are monitored daily by the local centres and reported to Group Treasury. Group Treasury calculates the associated VaR as shown in the table in ‘Market risk – Measurement – Trading value at risk (VaR)’.
Structural foreign exchange. Risk arises from Lloyds TSB Group’s investments in its overseas operations. Lloyds TSB Group’s structural foreign currency exposure is represented by the net asset value of the holding company’s foreign currency exchange equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to retained earnings.
The structural position is managed by Lloyds TSB Group Capital Funds having regard to the currency composition of Lloyds TSB Group’s risk-weighted assets and reported to the group asset and liability committee on a monthly basis. The objective is to limit the effect of the exchange rate movements on the published risk asset ratio.
Lloyds TSB Group’s structural position at 31 December 2003 is set out in note 47d to the financial statements. The position implies that at 31 December 2003 a hypothetical increase of 10 per cent in the value of sterling against all other currencies would have led to an £85 million reduction in reserves, and vice versa. On this basis, there would have been no material impact on Lloyds TSB Group’s risk asset ratios.
Wholesale Banking. Market risk in the wholesale banking books is managed in the UK by the Lloyds TSB Group’s Financial Markets Division in London, and internationally by an authorised local treasury operation in each overseas centre. The levels of exposure within these books are controlled and monitored within approved limits, both locally and also centrally by Group Treasury. Active management of the book is necessary to meet customer requirements and changing market circumstances.
General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modelling, including that of the probable maximum loss under various catastrophe scenarios, supports the choice of reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses.
Investment strategy is determined by the term and nature of the underwriting liabilities, and asset/liability matching positions are actively monitored. The aim is to invest in assets such that the cash flows on the investments will match those on the projected future liabilities. Actuarial tools are used to project and match the cash flows. It is not possible to eliminate risk completely as the timing of mortality is uncertain, and bonds are not available at all of the required maturities. As a result the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.
The surplus in the long-term non-participating fund of Scottish Widows plc exists to provide the long-term funds with liquidity and working capital. The surplus also forms a capital reserve to support the investments managed on behalf of the with-profits policies which were transferred from Scottish Widows Fund and Life Assurance Society. With-profits business involves guaranteed benefits; in adverse market conditions the surplus could be called upon to support with-profits benefits. As a consequence this fund is currently invested in a mix of equities, investment properties, fixed interest investments and cash that takes into account the mix in the With-Profits Fund. This investment policy maintains the value of the reserve as a proportion of the underlying
Equity derivatives are used by the Lloyds TSB Group to match equivalent liabilities arising from some of its retail products. Derivatives may also be used for efficient portfolio management purposes in client funds where such activity is in accordance with approved policy and the customer mandate.
The Lloyds TSB Group has defined high-level operations risk policies to seek to ensure a wide-ranging and consistent approach to the identification and management of operations risk and a standard methodology to ensure consistency in the identification, assessment and management of operations risk.
Group Risk Management carries out formal risk reviews, covering specific risks, activities, business sectors or products, and ensuring that prompt and pre-emptive action is taken to address any actual or perceived risks that may emerge, whether specific to the Lloyds TSB Group or to the industry generally.
Businesses maintain a range of products to meet customers’ needs and the business strategy, are responsible for managing and controlling product risks and compliance with applicable regulations.
Where appropriate, technical advice/approval is sought from specialist functions. Only new products carrying the approval of Group Risk Management and the businesses involved in their manufacture/delivery are offered to customers.
The risk of financial failure arising from lack of capital or liquidity, poor management or poor quality/volatile earnings.
Liquidity policy. A policy is in place which requires a common methodology to measuring liquidity across the Lloyds TSB Group. The methodology derives a liquidity ratio calculated by taking the sum of liquid assets, five-day wholesale inflows and back-up lines, and then dividing this by the sum of five-day wholesale outflows and a percentage of retail maturities and contingent claims drawable over the next five days.
The Lloyds TSB Group and its regulated subsidiary banks have been allocated an Individual Capital Ratio by the Financial Services Authority, and the board has agreed a formal buffer to be maintained in addition to the Individual Capital Ratio. Actual or prospective breaches of the formal buffer must be notified to the Financial Services Authority, together with proposed remedial action; no such notifications have been made during 2003. Informally, a further buffer is maintained. In addition, the Board has agreed a maximum limit of the proportion of debt instruments in the capital base. Risk-weighted assets are monitored by businesses, while capital is controlled centrally.
The liquidity policy requires all authorised local treasury operations to maintain a liquidity ratio of over 100 per cent, in addition to ensuring compliance with local regulatory requirements.
Each business has a nominated individual with ‘compliance oversight’ responsibility under Financial Services Authority rules. The role of such individuals is to ensure that management has in place within the business a control structure which creates awareness of the rules and regulations to which the Lloyds TSB Group is subject, and to monitor and report on adherence to these rules and regulations.
The risk of financial loss or reputational damage arising from programmes or projects failing to deliver to requirements, budget or timescale; or failing to implement change effectively.
Liquidity Liquidity risk is defined as the risk of a loss arising from Lloyds TSB Group’s inability to meet its financial obligations as they fall due. These obligations include the repayment of deposits on demand or at their contractual maturity; the repayment of loan capital and other borrowings as they mature; the payment of insurance policy benefits, claims and surrenders; the payment of lease obligations as they become due; the payment of operating expenses and taxation; the payment of dividends to shareholders; the ability to fund new and existing loan commitments; and the ability to take advantage of new business opportunities. Lloyds TSB Group complies with the Financial Services Authority’s liquidity requirements, and with similar liquidity policies in place across all trading centres worldwide. Compliance is monitored by regular liquidity returns to Group Treasury. Work is ongoing to ensure Lloyds TSB Group’s compliance with the new liquidity framework being proposed by the Financial Services Authority.
The principal sources of liquidity for Lloyds TSB Group plc are dividends received from its directly owned subsidiary company, Lloyds TSB Bank, and loans from this and other Lloyds TSB Group companies. The ability of Lloyds TSB Bank to pay dividends, or for Lloyds TSB Bank or other Lloyds TSB Group companies to make loans to Lloyds TSB Group plc, depends on a number of factors, including their own regulatory capital requirements, distributable reserves and financial performance. For additional information see ‘Shareholder information – Dividends’.
Euro Medium Term Note programme 711 177 673 3,623 5,184 US$ commercial paper programme 579 – – – 579 Securitisation vehicles 3,046 – – – 3,046
Other purchase obligations includes amounts expected to be payable in respect of material contracts entered into by the Lloyds TSB Group for the provision of outsourced and other services. The cost of these services will be charged to the profit and loss account as it is incurred. The Lloyds TSB Group also has a constructive obligation to ensure that its defined post-retirement benefit schemes remain adequately funded. The amount and timing of the Lloyds TSB Group’s cash contributions to these schemes is uncertain and will be affected by factors such as future investment returns and demographic changes. Lloyds TSB Group expects to make cash contributions of approximately £375 million to these schemes in 2004. The table above also excludes details of future cash flows related to certain insurance liabilities due to uncertainty as to their amounts and timing.
Lloyds TSB Group’s banking businesses are also exposed to liquidity risk through the provision of securitisation facilities to certain corporate customers. Lloyds TSB Group currently offers securitisation facilities to its corporate clients through two conduit securitisation vehicles, Cancara and Obelisk. These are funded in the asset-backed commercial paper market. The main conduit sponsored by Lloyds TSB Bank plc was established in 2002 and commenced funding in 2003. The conduit, Cancara Asset Securitisation Limited, is divided into three subgroups of companies: a) the issuer companies, Cancara Asset Securitisation Limited (‘Cancara Limited’) and Cancara Asset Securitisation LLC (‘Cancara LLC’), which issue the commercial paper in the US and Euro asset backed commercial paper markets to third party investors and are bankruptcy remote special purpose limited liability companies. Cancara Limited is wholly owned by an independent charitable trust; Cancara Asset Securitisation LLC is a subsidiary of Cancara Limited; b) the purchasing companies, Gresham Receivables Nos. 1, 2 (UK) and 3 Limited, which purchase customer receivables and fund these via a secured loan or discounted note from Cancara Limited, are bankruptcy remote special purpose vehicles, each wholly owned by one or more independent charitable trusts; and c) the investment purchasing companies, Dragon Securities Nos. 1, 2, 3, 4, 5, 6 and 7 Limited, which purchase asset-backed securities (backed by third party assets) from the market and initially also from Lloyds TSB Group. As Lloyds TSB Bank plc acts as investment advisor to the investment purchasing companies and receives a performance related fee, the companies are consolidated by Lloyds TSB Group under the provisions of Financial Reporting Standard 5 as quasi-subsidiaries.
Other than certain third party asset backed securities mentioned above, Lloyds TSB Group does not sell its own assets to the other purchasing companies or issuer companies nor does it, or any of its subsidiaries or affiliates, have an affiliation through ownership control or otherwise to these companies. However, Lloyds TSB Group does provide liquidity facilities to the issuer, purchasing and investment purchasing companies to fund short-term cash deficits that may arise through timing differences between cash receipts from the receivables and cash payments to the holders of the commercial paper. As at 31 December 2003 Lloyds TSB Bank plc provided asset-backed commercial paper liquidity support facilities to the purchasing companies, investment purchasing companies and Cancara totalling approximately £3.8 billion. As of the same date total assets held by the purchasing companies, investment purchasing companies and Cancara totalled approximately £3.7 billion, of which £3.1 billion has been consolidated into the Lloyds TSB Group’s balance sheet.
TSB Group’s life assurance companies take account of anticipated cash flow requirements including by matching the cash inflows with projected liabilities where appropriate. Cash deposits and highly liquid government securities are available to provide liquidity to cover any higher than expected cash outflows.
The FSA carries out its supervision of the UK banking sector through the collection of information from a series of prudential returns covering sterling and non-sterling operations, meetings with the senior management of the banks and reports obtained from skilled persons. The regular reports include operating statements and returns covering (amongst other things) capital adequacy, liquidity, large single exposures and large exposures to related borrowers, lendings by industry sector and geographical area, maturity analyses and foreign exchange activities. A risk-based approach for the supervision of all banks was introduced in 1998; under this approach, the starting point for the FSA’s supervision of a bank is based on a systematic analysis of that bank’s risk profile. Having determined the level of inherent risk in the bank a minimum capital adequacy requirement is established, which a bank is required to meet at all times.
The Business Banking Code is a voluntary code agreed by UK banks which became effective at the end of March 2002, with a subsequent revision in 2003 and which has been adopted by Lloyds TSB Group. The Business Banking Code defines the responsibilities of the banks to their smaller business customers in connection with the operation of their accounts and sets out minimum standards of service that such customers can expect from institutions which subscribe to the Business Banking Code. Compliance with the Business Banking Code is monitored by the Banking Code Standards Board.
Under the FSMA a compulsory single, industry wide, investor’s compensation scheme, the Financial Services Compensation Scheme has been set up. The Scheme is financed by a levy system and the FSMA allows for the establishment of different funds for different kinds of business and for different maximum amounts of claim. The maximum award for compensation on investments is £48,000 (100 per cent of the first £30,000 and 90 per cent of the next £20,000).
• Require the separation of the long-term business assets of an insurance company from the assets attributable to shareholders.
• Require the maintenance of a prescribed solvency margin at all times. The amount of the solvency margin depends upon the amount and type of business an insurance company writes. Failure to maintain the required solvency margin gives the regulator grounds for intervention.
The Mortgage Code is a voluntary code followed by lenders and mortgage intermediaries dealing with customers in the UK who want a loan secured on their home. It sets standards of good mortgage practice, which are followed as a minimum standard by those subscribing to it. Compliance with the Mortgage Code is monitored by the Mortgage Code Compliance Board. The new mortgage regulation regime has been finalised by the FSA and will take effect from
The UK financial services industry will also be affected by a number of other initiatives currently being developed by the EU; work continues on the Financial Services Action Plan, which is intended to create a single market for financial services by 2005, and there are proposals for a new Consumer Credit Directive. The Lloyds TSB Group will continue to monitor the progress of these initiatives and assess the likely impact on its business.
With-profits options and guarantees In common with other organisations in the life assurance industry, prior to its demutualisation Scottish Widows wrote policies which contained potentially valuable options and guarantees, including guaranteed annuity option policies. A guaranteed annuity option policy is a pension policy that provides a cash benefit at retirement age, which can be converted into an annuity at a specified minimum rate. Under the terms of the transfer of the Scottish Widows business, a separate memorandum account was created within the with-profits fund called the Additional Account which is available to meet any additional costs of providing guaranteed benefits on transferred policies. The Additional Account had a value at 31 December 2003 of £1.4 billion (2002: £1.5 billion); to the extent that it is insufficient to provide these benefits any shortfall would be met by the Lloyds TSB Group.
Minority interests (equity and non-equity) 727 731 546 Called-up share capital 1,418 1,416 1,411 Share premium account 1,136 1,093 959
Lloyds TSB Group’s capital ratios improved significantly during 2003, partly as a result of gains on business disposals. Lloyds TSB Group’s capital management policy is focused on optimising value for shareholders. There is a clear focus on delivering organic growth and expected capital retentions are sufficient to support planned levels of growth. However, management also wishes to maintain the flexibility to make value enhancing ‘in market’ acquisitions and therefore, at this stage, there are no plans to return capital to shareholders other than by way of dividend payments (see ‘Shareholder information – Dividends’). Management will keep all options for the utilisation of capital under reveiw.
The free asset ratio is a common measure of financial strength in the UK for long-term businesses. It is the ratio of assets less liabilities (including actuarial reserves but before the required regulatory minimum solvency margin) expressed as a percentage of the liabilities. It is derived from annual insurance returns which will be completed in March 2004. At 31 December 2003 the free asset ratio for Scottish Widows plc was estimated as 13.5 per cent, compared with 12.2 per cent at 31 December 2002. This free asset ratio included some £195 million allowance for future profits (December 2002: £400 million). After adjusting for the required regulatory minimum solvency margin, the Scottish Widows plc ratio, expressed as a percentage of total assets, was an estimated 8.3 per cent at 31 December 2003, compared with 7.3 per cent at 31 December 2002. As part of the FSA’s Integrated Prudential Sourcebook developments realistic reporting will be introduced for the end of 2004. Based on the form of disclosure agreed between the Association of British Insurers and the FSA, management estimates that the risk capital margin is covered over three times.
The Lloyds TSB Group recognises that social, ethical and environmental (SEE) issues bring both risks and opportunities. The Lloyds TSB Group’s full response to such issues is detailed in its separate CSR report, The Community & our Business, (see page 185 for details).
During 2003 the Lloyds TSB Group has continued to roll out its balanced scorecard as a tool to support the business strategy and values and to provide a means to balance the needs of customers, staff and shareholders. The balanced scorecard seeks to ensure that staff performance is measured on customer service, building customer relationships, people management and assessment of risk as well as sales and financial measures. Where appropriate, management remuneration and incentives are linked directly to specific areas of CSR performance, for example service quality.
Other securities UK government securities – – – – 31 31 Securities of the US treasury and US government agencies 38 38 40 40 – –
The weighted average yield for each range of maturities is calculated by dividing the annualised interest income prevailing at 31December 2003 by the book value of securities held at that date.
Maturing after one Maturing after five Maturing within one year but within five years but within ten years Maturing after ten years
Other securities Securities of the US treasury and US government agencies – – – – 38 4.1 – –
Maturing after Maturing in one but within Maturing after one year or less five years five years Total £m £m £m £m
Deposits in domestic offices Non-interest bearing demand deposits 2,745 – 5,985 – 6,182 –
Over Over 3 months 6 months 3 months but within but within Over or less 6 months 12 months 12 months Total £m £m £m £m £m
Liabilities in respect of securities sold under repurchase agreements Balance at the period end 4,640 6,157 5,516 Average balance for the period 4,848 6,294 3,898 Maximum balance during the period 7,395 9,697 5,516 Average interest rate during the period 4.5% 4.7% 6.7% Interest rate at the period end 4.0% 4.6% 6.1%
Post-tax return on average shareholders’ equity 38.5 16.8 18.1 21.2 23.4 Post-tax return on average assets 1.57 0.93 1.28 1.68 1.60 Post-tax return on average risk-weighted assets 2.63 1.62 2.26 3.08 2.88 Average shareholders’ equity to average assets 4.0 5.4 6.9 7.8 6.8
Chairman Joined the Group in 2000 as deputy chairman and was appointed chairman in 2001. Joined the Royal Dutch/Shell Group of companies in 1968 and after a number of senior and general management appointments in that group, became group managing director in 1992. Appointed president of Royal Dutch Petroleum Company and vice chairman of the committee of managing directors of the Royal Dutch/Shell Group in 1998 and continued in these roles until 2000. A non-executive director of Royal Dutch Petroleum Company, BT Group and British Airways. Aged 61.
Wolfgang C G Berndt✠† Joined the board in 2003. Joined Procter and Gamble in 1967 and held a number of senior and general management appointments in Europe, South America and North America, before retiring in 2001. A nonexecutive director of Cadbury Schweppes and GfK AG. Chairman of the Institute for the Future. Aged 61.
The Earl of Selborne KBE FRS✠*§ (leaving on 21 May 2004) A director since 1995, having been a director of Lloyds Bank since 1994. Managing director of The Blackmoor Estate, his family business. Chancellor of Southampton University since 1996. President of the Royal Geographical Society from 1997 to 2000. Aged 63.
Peter G Ayliffe Group Executive Director, UK Retail Banking Joined the board in 2003 having previously been managing director Personal Banking since 2000. Held a number of senior and general management appointments in the Lloyds TSB Group since 1985, including three years as branch network director. A non-executive director of Investors in People UK, Visa International Limited and Visa European Union. Served with National Westminster Bank from 1974 to
Steve C Targett Group Executive Director, Wholesale and International Banking Joined the board in 2003. Served with National Australia Bank from 1997, where he held a number of senior and general management appointments in Australia and the UK before becoming chief executive officer, Europe, in 2002. Previously held a number of senior and general management appointments in Cargill, a commodity trading group, from 1980 to 1988, State Bank of South Australia from 1988 to 1991 and ANZ Bank from 1991 to 1997.
Ewan Brown Sir Tom McKillop Peter Ayliffe Helen WeirEric Daniels Michael FaireySteve TargettArchie Kane
Group structure During the year the Lloyds TSB Group sold a number of businesses overseas, including all of its New Zealand operations, its French fund management and private banking business and substantially all of its Brazilian business. Details of these disposals are given in the notes to the accounts.
Authority to purchase shares The authority for the company to purchase, in the market, up to 566 million of its shares, representing some 10 per cent of the issued ordinary share capital, expires at the annual general meeting. It was not used during the year and shareholders will be asked, at the annual general meeting, to give a similar authority, with minor adjustments to provide the flexibility afforded by the new regulations relating to the holding and sale of shares in treasury.
Directors Biographical details of directors are shown on pages 70 to 71. Particulars of their emoluments and interests in shares in the company are given on pages 78 to 87.
Also in accordance with the articles of association, Mr Brown, Mr Daniels, Mr Pritchard and Mr van den Bergh retire at the annual general meeting and offer themselves for re-election.
In the UK, the Lloyds TSB Group supports Opportunity Now and is represented on the board of Race for Opportunity, campaigns to improve opportunities for women and ethnic minorities in the work place. The Lloyds TSB Group is a gold card member of the Employers’ Forum on Disability in support of employment of people with disabilities. This recognises the need for ensuring fair employment practices in recruitment and selection, and the retention, training and career development of disabled staff.
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 annexed to the UK Listing Authority’s listing rules. The Group has complied with the provisions of the code, and has done so throughout the year regarding the provisions whose requirements are of a continuing nature.
The chairman, the group chief executive and the group finance director have meetings with representatives of major shareholders and all shareholders are encouraged to attend and participate in the Group’s annual general meeting.
The board evaluates its performance and that of its committees and individual directors. The process adopted affords directors the opportunity, through their membership of boards of other companies, in the UK and overseas, to draw on their experience to endeavour to ensure that the Group follows best practice. It also enables directors to suggest how the Group’s procedures may be improved; to assess strengths and weaknesses; and to address its balance of skills, knowledge and experience. The committees, themselves, assess their respective roles, performance and terms of reference and report accordingly to the board.
The committee also has specific powers delegated to it by the board from time to time and following the exercising of these powers, it reports at the next convenient board meeting.
The nomination committee, comprising Mr van den Bergh (chairman), Dr Julius and The Earl of Selborne, reviews the composition of the board, taking into account the skills, knowledge and experience of directors and considers and makes recommendations to the board on potential candidates for appointment as directors. The deputy chairman and group chief executive are invited to attend meetings of the committee. The committee also makes recommendations to the board concerning the re-appointment of any independent non-executive director by the board at the conclusion of his or her specified term; the re-election of any director by the shareholders under the retirement provisions of the articles of association; any matters relating to the continuation in office of a director; and the appointment of any director to executive or other office, other than the positions of chairman and group chief executive, the recommendation for which would be considered at a meeting of the non-executive directors regarding the position of group chief executive, and all the directors regarding the position of chairman.
All the non-executive directors receive the minutes of remuneration committee meetings and have the opportunity to comment and have their views taken into account before the committee’s decisions are implemented.
Going concern The directors are satisfied that the company and the Lloyds TSB Group have adequate resources to continue to operate for the foreseeable future and are financially sound. For this reason they continue to adopt the going concern basis in preparing the accounts.
Disclosure controls As of 31 December 2003, the Lloyds TSB Group, under the supervision and with the participation of the Lloyds TSB Group’s management, including the group chief executive and the deputy group chief executive, performed an evaluation of the effectiveness of the Lloyds TSB Group’s disclosure controls and procedures. Based on this evaluation, the group chief executive and deputy group chief executive concluded that the Lloyds TSB Group’s disclosure controls and procedures are effective for gathering, analysing and disclosing the information the Lloyds TSB Group is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms. The Lloyds TSB Group’s management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which by their nature can provide only reasonable assurance regarding management’s control objectives.
The companies have been chosen as a representative sample against which to measure the success of the Lloyds TSB Group’s strategy of organic growth within the UK.
Performance conditions are set when the grant of options is made and the options cannot normally be exercised unless the conditions have been met. For options granted in 2004, the performance conditions require the company’s ranking, based on the TSR over the relevant three year period, to be at least ninth within the comparator group.
The full grant of options for executive directors will only become exercisable if the company is ranked first within the comparator group.
Salary from 1 January 2004 (or later date of appointment) Date of service agreement
Mr Ayliffe £400,000 30 May 2003 Mr Daniels £750,000 19 October 2001 Mr Fairey £518,000 28 August 1991 Mr Kane £450,000 9 February 2000 Mr Pritchard £243,000 7 April 2003 Mr Targett £480,000 15 August 2003 Mr van den Bergh £442,500 28 July 2000 Mrs Weir £450,000 4 March 2004
Mr Ross’s pension entitlement at 31 December 2003 includes an additional 12 months’ service in respect of his notice period.
Mr Ellwood retired on 31 May 2003. At retirement he commuted a pension of £10,611 in return for a lump sum of £110,890. The value shown in the table is the pension payable at 31 December 2003 assuming he did not commute any pension.
Additional Accrued Accrued Transfer Transfer pension pension at pension at value at value at Change in earned to Transfer 31 December 31 December 31 December 31 December transfer 31 December value of the
k) The exercise periods were shortened in accordance with the rules of the relevant share option schemes, when the directors concerned left the board.
** These share options lapsed when Mr Ross left the board.
None of the other directors at 31 December 2003 had options to acquire shares in Lloyds TSB Group plc or its subsidiaries.
A further share plan has been established in connection with the recruitment of Mr Targett as an executive director.
The Lloyds TSB Group plc share plan 2003 was adopted in March 2003, specifically to facilitate the recruitment of Mr Targett, to compensate him for the value of the options he had with his previous employer, which lapsed when he left them to join the Lloyds TSB Group. Mr Targett is the only participant in the plan and he became eligible to participate in it when he joined Lloyds TSB Group on 10 March 2003. On 11March 2003, an option was granted to him under the plan to acquire 331,125 ordinary shares in Lloyds TSB Group plc (with a value of £1 million at the date of grant) for a total exercise price of £1. No further options may be granted to him under the plan.
As for March 1996 plus a further condition that the company’s ranking based on TSR over the relevant period should be in the top fifty companies of the FTSE 100.
To the members of Lloyds TSB Group plc We have audited the financial statements which comprise the consolidated profit and loss account, the consolidated balance sheet, the company balance sheet, the consolidated cash flow statement, the statement of total recognised gains and losses and the related notes which have been prepared under the accounting policies set out on pages 95 to 98. We have also audited the disclosures required by Part 3 of Schedule 7A to the Companies Act 1985 contained in the directors’ remuneration report under the headings directors’ emoluments, directors’ pensions and directors’ interests in share options (‘the auditable part’).
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report and the financial statements in accordance with applicable United Kingdom law and accounting standards are set out in the statement of directors’ responsibilities on page 76. The directors are also responsible for preparing the directors’ remuneration report.
We read the other information contained in the annual report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. The other information comprises only the directors’ report, the chairman’s statement, the group chief executive’s review, the operating and financial review and prospects, the remainder of the directors’ remuneration report and the corporate governance statement.
Basis of audit opinion We conducted our audit in accordance with auditing standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the auditable part of the directors’ remuneration report. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the company’s and the Group’s circumstances, consistently applied and adequately disclosed.
• those parts of the directors’ remuneration report required by Part 3 of Schedule 7A to the Companies Act 1985 have been properly prepared in accordance with the Companies Act 1985.
PricewaterhouseCoopers LLP Chartered Accountants and Registered Auditors Southampton, England 5March 2004
Interest receivable: Interest receivable and similar income arising from debt securities 389 63 452 567 530 Other interest receivable and similar income 8,484 1,213 9,697 9,982 10,834
Interests in joint ventures: 21 – Share of gross assets 85 336 – Share of gross liabilities (31) (291)
Memorandum items 46 Contingent liabilities: – Acceptances and endorsements 299 1,879 – Guarantees and assets pledged as collateral security 6,122 5,927 – Other contingent liabilities 2,604 2,540
at 31 December 2003 2003 2002* Note £ million £ million
Total assets less current liabilities 10,980 9,310 Creditors Amounts falling due after more than one year: Net assets 9,624 7,954
Other statements for the year ended 31 December 2003 2003 2002* 2001* £ million £ million £ million
Total gains and losses recognised during the year 3,339 (948) 385
Profit (loss) for the year 1,343 (118) 361 Currency translation differences on foreign currency net investments 118 (3) (86) Actuarial losses recognised in post-retirement benefit schemes (4) (2,331) (2,010) Issue of shares 45 139 379 Movements in relation to own shares (2) (70) (195) Goodwill written back on sale of businesses (note 6) 181 – –
Acquisitions and disposals: – Additions to interests in joint ventures (12) (21) (44) – Acquisition of group undertakings and businesses (note 49e) (1,106) (117) (180) – Disposal of group undertakings and businesses (note 49g) 2,382 – 40 Net cash inflow (outflow) from acquisitions and disposals 1,264 (138) (184)
The effect of this change in policy has been to increase profit before tax in 2003 by £10 million (2002: £2 million; 2001: £3 million); a prior year adjustment reducing shareholders’ funds at 1 January 2001 by £30 million has been made. The effect upon the Group’s balance sheet at 31 December 2003 has been to reduce total assets by £27 million (2002: £37 million) and reduce shareholders’ funds by £19 million (2002: £26 million).
Paragraph 28 of Schedule 9 to the Companies Act 1985 requires that all goodwill carried on the balance sheet should be amortised. In the case of the goodwill arising on the acquisition of Scottish Widows, the directors consider that it is appropriate to depart from this requirement in order to comply with the over-riding requirement for the accounts to show a true and fair view. If this goodwill was amortised over a period of 20 years, profit before tax for the year ended 31 December 2003 would be £93 million lower (2002: £93 million lower; 2001: £94 million lower), with a corresponding reduction in reserves of £358 million (2002: £265 million); intangible assets on the balance sheet would also be £358 million lower (2002: £265 million lower).
At the date of the disposal of group or associated undertakings, any unamortised goodwill, or goodwill taken directly to reserves prior to 1 January 1998, is included in the Group’s share of the net assets of the undertaking in the calculation of the profit or loss on disposal.
For the Group’s portfolios of smaller balance homogeneous loans, such as the residential mortgage, personal lending and credit card portfolios, specific provisions are calculated using a formulae driven approach. These formulae take into account factors such as the length of time that payments from the customer are overdue, the value of any collateral held and the level of past and expected losses, in order to derive an appropriate provision.
In those cases where the operation of the customer’s account has ceased and it has been transferred to a specialist recovery department, the advance is written down to its estimated realisable value and interest is no longer charged to the customer’s account as its recovery is considered unlikely. Interest is only taken to income if it is received.
Debt securities, apart from those held for dealing purposes and in the long-term assurance business (see o), are stated at cost as adjusted for the amortisation of any premiums and discounts arising on acquisition, which are amortised from purchase to maturity in equal annual instalments, less amounts written off for any permanent diminution in their value. Equity shares, apart from those held for dealing purposes and in the long-term assurance business (see o), are stated at cost less amounts written off for any permanent diminution in their value.
Debt securities and equity shares held for dealing purposes are included at market value. In circumstances where securities are transferred from dealing portfolios to investment portfolios or vice versa, the transfer is effected at an amount based on the market value at the date of transfer. Any resulting profit or loss is reflected in the profit and loss account.
The Group accounts for its interest in long-term assurance business using the embedded value basis of accounting, in common with other UK banks with insurance subsidiaries. The value of the shareholder’s interest in the long-term assurance business (‘the embedded value’) included in the Group’s balance sheet is an actuarially determined estimate of the economic value of the Group’s life assurance subsidiaries, excluding any value which may be attributed to future new business. The embedded value is comprised of the net tangible assets of the life assurance subsidiaries, including any surplus retained within the long-term business funds, which could be transferred to the shareholder, and the present value of the in-force business. The value of the in-force business is calculated by projecting the future surpluses and other net cash flows attributable to the shareholder arising from business written by the balance sheet date, using appropriate economic and actuarial assumptions, and discounting the result at a rate which reflects the shareholder’s overall risk premium attributable to this business.
The Group’s activities are organised into three businesses: UK Retail Banking and Mortgages, Insurance and Investments and Wholesale and International Banking. Services provided by UK Retail Banking and Mortgages encompass the provision of banking and other financial services, private banking, stockbroking and mortgages to personal customers. Insurance and Investments offers life assurance, pensions and savings products, general insurance and fund management services. Wholesale and International Banking provides banking and related services for major UK and multinational companies, banks and financial institutions, and small and medium-sized UK businesses. It also provides asset finance to personal and corporate customers; manages the Group’s activities in financial markets through its Treasury function and provides banking and financial services overseas.
Provisions for bad and doubtful debts (357) – – – (328) 6 (679) (68) (747) Amounts written off fixed asset investments – – – – (22) (38) (60) – (60) Share of results of joint ventures (10) – – – – – (10) – (10) Profit on sale of businesses – – – – – – – 39 39
Income from long-term assurance business (305) – (305) 11 (294) General insurance premium income 486 – 486 – 486
Income from long-term assurance business (42) – (42) 12 (30) General insurance premium income 428 – 428 – 428
Foreign exchange trading income 228 173 158 Securities and other gains 332 15 75
– Audit related regulatory reporting 0.9 0.9 0.8 – Further assurance services 3.3 1.7 5.0 Other audit related fees 4.2 2.6 5.8
During the year the auditors also earned fees of £0.6 million (2002: £0.8 million; 2001: £0.8 million) in respect of the audit of unit trusts and pension schemes managed by the Group.
Loss on sale of French fund management and private banking businesses (tax: nil) (15) – – Loss on sale of Brazilian businesses (after charging £161 million of goodwill previously written off to reserves) (tax: nil) (41) – – Profit on sale of New Zealand operations (after charging £20 million of goodwill previously written off to reserves) (tax: nil) 921 – – Profit on sale of Brazilian fund management and private banking businesses (tax: £11 million) – – 39
During 2003 the Group completed the following transactions: • The sale, announced on 16 May 2003 and completed on 30 June 2003, of its French fund management and private banking businesses, including its subsidiaries Lloyds Bank SA, Chaillot Assurances SA and Capucines Investissements SA.
During the year ended 31 December 2001 the Group sold its Brazilian fund management and private banking business, including its subsidiary, Lloyds TSB Asset Management S.A.
Net interest income 4,683 488 5,171 Other finance income 165 – 165 Other income: Fees and commissions receivable 2,942 111 3,053 Fees and commissions payable (614) (31) (645) Dealing profits (before expenses) 164 24 188 Income from long-term assurance business (305) 11 (294) General insurance premium income 486 – 486 Other operating income 759 4 763
7 Analysis of comparative profit and loss accounts (continued) Continuing Discontinued operations operations Total £m £m. £m.
UK corporation tax: – Current tax on profits for the year 1,079 786 769 – Adjustments in respect of prior years (72) 12 (14)
Current tax charge 913 870 830 Deferred tax: – Capital allowances in excess of depreciation 105 (7) 48 – Other timing differences 14 (99) (2) Associated undertakings and joint ventures (7) 2 1
The current tax charge includes a charge of £157 million (2002: credit of £44 million; 2001: charge of £11 million) in respect of notional tax on the shareholder’s interest in the movement in value of the long-term assurance business. Since this derives from the use of a combination of tax rates it can give rise to a higher or lower charge compared to an expected 30 per cent rate.
Certain disclosures necessary to meet US GAAP and SEC disclosure requirements in relation to the parent company are given in note 51 to these financial statements.
Lending to banks 2,292 2,212 Deposits placed with banks 13,273 15,318
Total loans and advances to customers 136,956 136,297 Provisions for bad and doubtful debts (1,677) (1,766) Interest held in suspense (28) (57)
Provisions for bad and doubtful debts (1,677) (1,766) Interest held in suspense (28) (57)
Equipment leased to customers, which is stated after deducting £4,907 million (2002: £5,603 million) of unearned charges, is repayable as follows: £m £m 3 months or less 91 127 1 year or less but over 3 months 345 407 5 years or less but over 1 year 1,465 1,669
Adjustments on acquisitions and disposals (49) (5) – 3 – – Transfer from general to specific provisions 50 (50) – – – – Advances written off (1,145) – (878) – (885) – Recoveries of advances written off in previous years 178 – 203 – 194 – Charge (release) to profit and loss account: In respect of: Loans and advances to banks 18 1 2 Loans and advances to customers 1,677 1,766 1,466 £m £m
Other public sector securities – – 1 1 Bank and building society certificates of deposit 2,515 2,515 3,147 3,148
Geographical analysis by issuer United Kingdom 5,232 5,569 Other European 15,949 13,254 North America and Caribbean 5,130 6,077 Latin America 98 1,231 Asia Pacific 1,994 2,763
Included in the Group’s balance sheet are assets subject to sale and repurchase agreements as follows: £m £m
Exchange and other adjustments 17 Additions 12 Share of losses (20)
In the year ended 31 December 2003 £25 million (2002: £31 million; 2001: £27 million) of fees payable to iPSL have been included in the Group’s administrative expenses and £3 million (2002: £6 million; 2001: £6 million) of charges to iPSL have been included in the Group’s income. The Group has also prepaid £13 million (2002: £6 million) of fees in respect of 2004 and this amount is included in prepayments and accrued income.
Included in the gross assets disclosed on the balance sheet is an investment of £3 million (2002: £8 million) in associated undertakings.
On an historical basis, shares in group undertakings would have been included at cost of £6,066 million (2002: £6,066 million). No deferred tax provision has been made against the liability which could arise if group undertakings were disposed of at their balance sheet carrying value because of surplus capital losses and the exemptions for disposal of substantial shareholding investments.
The principal group undertakings, 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 Country of equity share registration/ capital and incorporation voting rights held Nature of business
The country of registration/incorporation is also the principal area of operation for each of the above group undertakings except as follows: Lloyds TSB Bank plc operates principally in the UK but also through branches in Argentina, Belgium, Dubai, Ecuador, Gibraltar, Guatemala, Hong Kong, Honduras, Japan, Luxembourg, Malaysia, Monaco, Netherlands, Panama, Paraguay, Singapore, Spain, Switzerland, Uruguay and the USA.
Balance sheet Assets: Loans and advances to customers – – 345 329 Debt securities – – 3,718 – Tangible fixed assets 1,408 1,307 – – Other assets and prepayments 23 25 34 4
Balance sheet amount of premises comprises: Leaseholds 50 years and over unexpired 133 132 Leaseholds less than 50 years unexpired 274 273
Interest receivable 869 931 Deferred expenditure incurred under cash gift and discount mortgage schemes 128 201 Other debtors and prepayments 921 1,155 * restated (see note 1)
Income from long-term assurance business included in the profit and loss account can be divided into those items comprising the operating profit of the business and other items. Included within operating profit are the following items: New business income. This represents the value recognised at the end of the year from new business written during the year after taking into account the cost of establishing technical provisions and reserves.
Distribution costs. This represents the actual costs of acquiring new business during the year and includes commissions paid to independent financial advisors and other direct sales costs.
Contribution from existing business. This comprises the following elements: •The expected return arising from the unwinding of the discount applied to the expected cash flows at the beginning of the year; •Experience variances caused by the differences between the actual experience during the year and the expected experience; •The effects of changes in assumptions, other than economic assumptions, and other items; and
At 1 January 165 – – Accrual of interest on the provision 5 – – Charge for the year 56 165 – Compensation paid (77) – –
Details of the provisions held in respect of the estimated cost of making redress payments to customers in respect of past product sales by the Group’s banking operations are given in note 38.
The table below shows the effect on both the embedded value at 31December 2003 and the new business contribution for the year then ended of theoretical changes in the main economic assumptions.
The liabilities to policyholders comprise: Technical provisions: – Long-term business provision (net of reinsurance) 23,730 23,217 – Claims outstanding (net of reinsurance) 238 225 Technical provisions for linked liabilities 25,023 20,996 Fund for future appropriations 346 12 Other liabilities 863 890 * restated (see note 1)
Under the modified statutory solvency basis, the results of the Group’s long-term life and pensions businesses were as follows: 2003 2002* 2001* £m £m £m
Realised losses on investments (1,679) (1,790) (1,031) Unrealised losses on investments (22) (4,353) (4,432)
Profit (loss) on ordinary activities before tax 375 (561) (51) Tax on profit (loss) on ordinary activities (125) 177 94
Income from long-term assurance business after tax reconciles to the loss calculated on a modified statutory solvency basis as follows: 2003 2002* 2001* £m £m £m.
The value of long-term business attributable to the shareholder on an embedded value basis reconciles to the net assets of the Group’s life and pensions subsidiaries calculated on a modified statutory solvency basis as follows: 2003 2002* £m £m
Long-term assurance business attributable to the shareholder – embedded value basis 6,481 6,213 Value of in-force business (2,879) (2,904)
Net tangible assets of life operations: Modified statutory solvency basis 4,234 3,914 * restated (see note 1)
Liabilities: Denominated in sterling 153,769 142,566 Denominated in other currencies 48,165 64,777 * restated (see note 1)
Other debt securities by residual maturity repayable: 3 months or less 17,942 19,525 1 year or less but over 3 months 2,015 7,174 5 years or less but over 1 year 283 30
Debt securities in issue include certificates of deposit of £16,415 million (2002: £21,246 million) and commercial paper of £3,625 million (2002: £3,109 million). An amount of £5,184 million (2002: £2,364 million) relating to debt securities issued under the Group’s Euro Medium Term Note programme is included in these figures.
Balances arising from derivatives used for trading purposes (note 47a) 3,499 4,462 Balances arising from derivatives used for hedging purposes 503 611 Current tax 503 528
Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on an annual basis and will normally run off over the remaining life of the leases concerned, currently averaging five years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
Subordinated Floating Rate Notes 2004 a, i 100 100 – –
Subordinated Step-up Floating Rate Notes 2009 callable 2004 (US$500 million) a 279 310 – – Subordinated Fixed Rate Bonds 2010 (NZ$100 million) – 33 – – 61/4% Subordinated Notes 2010 (c400 million) 281 259 – – Subordinated Floating Rate Notes 2010 (US$400 million) a 223 248 – –
Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (c430 million)* 301 278 Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015** 248 248
† These securities constitute interests in European Financial Institution Investments Partnership, an English law general partnership in which the principal partner is Langbourn Holdings Limited, a wholly owned subsidiary of the Group. The minority interests are entitled to 90 per cent of the partnership’s profits. In the event of a winding-up, at least 90 per cent of the capital of the partnership would be returned to Langbourn Holdings Limited.
‡ These securities constitute interests in LM ABS Investment Partnership, an English law general partnership in which the principal partner is Lime Street (Funding) Limited, a wholly owned subsidiary of the Group. The minority interests are entitled to 95 per cent of the partnership’s profits. In the event of a winding-up, at least 85 per cent of the capital of the partnership would be returned to Lime Street (Funding) Limited.
Euro ccm cm cm 160 million Preference shares of c25 cents each 40 40 40
Number of shares in issue (millions): Ordinary shares of 25p each 5,594 5,583 5,564
At 31 December 2003, options to acquire 158 million Lloyds TSB Group ordinary shares of 25p each were outstanding under the executive share option schemes, the share retention plan, the Lloyds TSB Group plc share plan 2003, and the staff sharesave share option schemes exercisable up to 2013. These include the options, described on page 86, to acquire 216,763 shares and 331,125 shares under the share retention plan and the Lloyds TSB Group plc share plan 2003 respectively: otherwise the options are exercisable at prices ranging from 202p to 888p per share.
Profit and loss account (the Group): At 1 January – as previously reported 5,091 7,613 9,567 Prior year adjustment (note 1) – – (24)
Revaluation reserve (the Company): At 1 January 3,025 Increase in net tangible assets of subsidiary undertakings 1,662
At 1 January – restated 2,420 Movements in relation to own shares (note 43) (6) Loss for the year (31)
The pension costs included in administrative expenses are comprised as follows: £m £m £m
Rate of inflation 2.50 2.30 2.50 Rate of salary increases 4.04 3.83 4.04 Rate of increase for pensions in payment and deferred pensions 2.50 2.30 2.50
Notes to the accounts 45 Pensions and other post-retirement benefits (continued)
Included within other finance income is an interest cost of £5 million (2002: £4 million; 2001: £3 million) in respect of these defined benefit post-retirement healthcare schemes.
The pension and other post-retirement benefit cost in respect of defined benefit schemes comprises: £m £m £m.
Amount recognised in the statement of total recognised gains and losses (4) (2,331) (2,010)
The experience gains and losses recognised can also be interpreted as follows: £m £m £m.
Other: – Other items serving as direct credit substitutes 1,069 1,103 – Performance bonds and other transaction-related contingencies 1,534 1,436 – Other contingent liabilities 1 1
Unlike on-balance sheet instruments the principal amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group, should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure.
Exchange rate contracts: Interest rate contracts: Equity and other contracts: Total: Exchange rate contracts: Interest rate contracts: Equity contracts: Total: The notional principal amount does not represent the Group’s real exposure to credit risk, which is limited to the current cost of replacing contracts at current market rates should the counterparties default.
The table below summarises the repricing mismatches of the Group’s non-trading assets and liabilities. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date. The table does not take into account the effect of interest rate options used by the Group to hedge its exposure; details of options are given in note 47a.
Assets: Treasury bills and other eligible bills 408 48 65 6 3 – 9 539 Loans and advances to banks 10,686 1,311 463 746 86 366 1,889 15,547 Loans and advances to customers 88,298 4,680 5,549 30,777 6,171 (1,648) 1,424 135,251 Debt securities and equity shares 8,718 606 279 1,856 2,372 (55) 15,351 29,127
Assets: Treasury bills and other eligible bills 1,759 23 94 1 2 – 530 2,409 Loans and advances to banks 12,363 1,362 761 775 200 666 1,402 17,529 Loans and advances to customers 88,349 4,997 8,233 26,787 7,210 (1,732) 630 134,474 Debt securities and equity shares 6,093 1,049 312 1,972 2,516 (42) 17,620 29,520
The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities is estimated using quoted market prices.
The disclosures in this note cover all on-balance sheet financial instruments; fair values of all derivative instruments are disclosed in note 47a.
Information about the management of market risk in the Group’s trading activities is given on pages 53 to 55.
On 1 August 2003, the Group announced the acquisition of the credit card and personal loan businesses of Goldfish Bank Limited, together with the Goldfish brand and loyalty programme. The acquisition became effective on 30 September 2003 with the transfer of the portfolios to the Group’s subsidiary, Lloyds TSB Bank plc, for a consideration of £1,096 million, settled in cash. The premium arising of £96 million from the effective payment to the majority shareholder has been capitalised and will be written off to the profit and loss account over its estimated useful life of 10 years. No significant fair value adjustments were made. The results of these businesses have been consolidated in full from the date of acquisition; the effect on the results of the Group is not material.
Decrease (increase) in prepayments and accrued income 147 (21) (285) (Decrease) increase in accruals and deferred income (226) 113 (439) Provisions for bad and doubtful debts 950 1,029 747 Net advances written off (967) (675) (691)
Net cash (outflow) inflow before adjustments for the effect of foreign exchange movements (487) 1,766 (100) Effect of foreign exchange movements (3) 4 (38)
Exchange and other adjustments (1) (1) – Minority share of profit after tax 22 19 17 Dividends paid to minority shareholders (14) (18) (17)
Cash consideration paid (see f) 1,096 103 1 Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 14 14 179 Cash consideration refunded in respect of acquisition in 2002 (5) – – Deferred consideration in respect of acquisition in 2002 1 – –
Tangible fixed assets 2 384 – Deposits by banks, customer accounts and other liabilities (13) (590) (13)
Cash 52 – – Loans and advances to banks 1,035 – – Loans and advances to customers 13,770 – – Debt securities 852 – – Intangible assets 189 – – Deposits by banks (519) – – Customer accounts (8,372) – – Debt securities in issue (5,108) – – Subordinated liabilities (206) – – Other net assets (305) – 1 Goodwill written back on sale of businesses 181 – –
SFAS No. 87 ‘Employers’ Accounting for Pensions’ prescribes a similar method but allows that a certain portion of actuarial gains and losses be deferred and allocated in equal amounts over the average remaining service lives of the current employees. In addition, if the fair value of plan assets falls below the accumulated benefit obligation (which is the current value of accrued benefits without allowance for future salary increases) an additional minimum liability must be recognised. An equal amount should be recognised as an intangible asset up to the amount of any unrecognised prior service cost. Any amount not recognised as an intangible asset is reported in other comprehensive income, net of deferred tax.
US GAAP also requires a transition adjustment for pension schemes in place before the introduction of SFAS No. 87. The difference between the funded status of the schemes and the total amount of accrued or prepaid pension cost, at the date of transition, is amortised over the average remaining service lives of employees at that date.
Following the implementation of Financial Reporting Standard (FRS) 10 ‘Goodwill and intangible assets’ in 1998 goodwill arising on acquisitions of or by group and associated undertakings is capitalised and amortised over its estimated life. There is a presumption that the estimated life is limited to 20 years or less, although this may be rebutted and a longer or indefinite useful life considered. Goodwill is written off when judged to be irrecoverable. For acquisitions prior to 1January 1998 goodwill was charged directly against reserves as permitted by Statement of Standard Accounting Practice 22. This goodwill was not reinstated following the implementation of FRS 10, but in the event of a subsequent disposal it will be written back and included in the calculation of the profit or loss on disposal.
UK GAAP permits merger accounting for business combinations where all of the following criteria are met: (1) no party is either portrayed as acquirer or acquired; (2) all parties participate in establishing the management structure; (3) one party does not dominate by virtue of its relative size; (4) consideration received by the equity shareholders of each party, in relation to their equity shareholding, comprises primarily equity shares in the combined entity; and (5) no equity shareholder retains any material interest in only part of the combined entity. Business combinations that do not satisfy all these criteria must be accounted for using acquisition accounting.
SFAS No. 133 ‘Accounting for Derivative Instruments and for Hedging Activities’ requires that all derivatives be recognised on-balance sheet at fair value. Changes in the fair value of derivatives that are not hedges are reported in the income statement. For derivatives which are hedges, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognised in other comprehensive income until the hedged item is recognised in earnings. The ineffective portion of a hedge’s change in fair value is immediately recognised in earnings. A derivative will only be classified as a hedge providing an entity meets stringent qualifying criteria in respect of documentation and hedge effectiveness.
The application of SFAS No. 13 ‘Accounting for Leases’ gives rise to a level rate of return on the investment in the lease, but without taking into account tax payments and receipts. This results in income being recognised in different periods than under UK GAAP.
Following the adoption of SFAS No. 150 ‘Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity’ from 1 January 2003, certain trust-preferred securities are classified as liabilities rather than equity.
FIN 46-R requires the consolidation of variable interest entities (VIEs) for which Lloyds TSB Group is deemed to be the primary beneficiary. A more detailed discussion of VIEs can be found on pages 170 to 171.
FIN 46 was issued in January 2003, was revised in December 2003 and has been interpreted in various FASB staff positions. It is effective immediately for all variable interests in variable interest entities (VIE) created after 31 January 2003. For VIEs created before that date, the requirements are effective for Lloyds TSB Group from 1 January 2004. FIN 46 requires certain transitional disclosures to be made immediately if it is reasonably possible that an entity will consolidate or disclose information about VIEs when FIN 46 becomes effective. FIN 46 defines a VIE as an entity where either the total equity investment at risk is not sufficient to permit the entity to finance its activities, without additional subordinated financial support; or the equity investors lack any one of the following: (1) the ability to make decisions about an entity’s activities; (2) the obligation to absorb losses of the entity; or (3) the right to receive residual returns of the entity. VIEs are required to be consolidated by the primary beneficiary, which is the party that absorbs the majority of the entity’s expected losses, expected gains, or both. The required transitional disclosures have been made within this annual report; the impact on Lloyds TSB Group’s US GAAP financial statements is discussed further on page 170.
SFAS 150 – Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
AICPA Statement of Position (SOP) 03-1 – Accounting and Reporting by Insurance Enterprises for Certain Non-Traditional Long-Duration Contracts and for Separate Accounts
AICPA Statement of Position 03-3 – Accounting for Certain Loans or Debt Securities Acquired in a Transfer
EITF 03-1 – The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments
Additional information on the differences between the UK and US accounting for insurance activities is provided within the Insurance section of this note on pages 172 to 174.
Reconciliation of movements in shareholders’ equity under US GAAP 2003 2002* 2001* £m £m £m
Income before tax from continuing operations 3,013 2,067 1,949 Provision for income taxes (continuing operations)** 832 495 448 Minority interests, net of income taxes 26 62 57 Discontinued operations: – Income from discontinued operations 354 311 233 – Profit on sale of businesses 853 – 39 – Provision for income taxes (89) (81) (81)
Loans, net of provisions 134,043 134,202 Tangible fixed assets 3,842 4,085 Intangible fixed assets: – Customer related intangibles 535 589 – Value of long-term assurance business acquired 2,094 2,282 – Pension liability related intangible 231 221 Deferred acquisition costs 1,048 846 Separate account assets 22,494 18,945 Other assets 4,713 7,354
Trading account liabilities 3,500 5,583 Debt securities in issue 25,922 29,133 Policyholder liabilities 25,080 23,763 Undistributed policyholder allocations 1,772 1,890 Commitments and contingencies 216 192 Deferred tax 1,444 1,422 Long-term debt 11,003 10,168 Separate account liabilities 22,494 18,945 Other liabilities 7,330 10,584 Minority interests 54 731
Condensed Consolidated statement of cash flows in accordance with SFAS No. 95 2003 2002* 2001* £m £m £m
Cash flows from operating activities Net income before minority interests and effect of accounting changes 3,299 1,802 1,692 Adjustments required to reconcile net income to net cash provided by operating activities: Amortisation of intangible fixed assets 338 918 772 Depreciation of tangible fixed assets 726 761 625 Provision for bad and doubtful debts, net of write-offs (17) 354 56 Change in trading account assets 4,309 (3,176) (2,004) Change in trading account liabilities (2,083) 2,107 174 Change in deferred acquisition costs (202) (51) (97) Change in other assets 1,760 (91) (2,776) Change in policyholder liabilities 1,365 (97) 583 Change in undistributed policyholder allocations (118) (1,588) (2,427) Change in other liabilities (2,779) (266) 100 Net gain on sale of investment securities (89) (163) (183) Profit on disposal of businesses (853) – (39) Profit on disposal of tangible fixed assets (43) (47) (67)
Cash flows from financing activities Dividends paid – equity (1,908) (1,903) (1,738) Dividends paid to minorities – equity (14) (18) (17) Dividends paid to minorities – non-equity (38) (43) (40) Cash proceeds from issue of ordinary share capital and sale of treasury stock 32 77 194 Issue of long-term debt 533 2,120 742 Redemption of long-term debt (75) (55) (131) Minority investment in subsidiaries – 167 – Change in deposits 6,388 7,925 16,458 Change in short-term borrowings 1,807 5,969 6,326
Certain classification differences exist in financial reporting under UK GAAP and US GAAP. For the Group, such differences primarily arise in the balance sheet and the following comparison lists the line items in which such differences occur.
Cash and balances at central banks Cash and due from banks Items in course of collection from banks Cash and due from banks Treasury bills and other eligible bills Classified as ‘Trading account assets’ where appropriate Loans and advances to banks Loans to banks due on demand classified as ‘Cash and due from banks’; Reverse repos classified as ‘Securities purchased under resale agreements’ Loans and advances to customers Reverse repos classified as ‘Securities purchased under resale agreements’ Debt securities Classified as ‘Trading account assets’ and ‘Investments’ where appropriate Equity shares Classified as ‘Trading account assets’ and ‘Investments’ where appropriate Other assets Classified as ‘Trading account assets’ where appropriate Prepayments and accrued income Other assets Items in course of transmission to banks Cash and due from banks Debt securities in issue Classified as ‘Trading account liabilities’ where appropriate Other liabilities Classified as ‘Trading account liabilities’ where appropriate Accruals and deferred income Other liabilities Other provisions for liabilities and charges Commitments and contingencies Subordinated liabilities Long-term debt Merger reserve Classified as ‘Additional paid-in capital’ Long-term assurance business Classifications are discussed on pages 172 to 174
For the purposes of SFAS No. 95, the Group’s cash and cash equivalents of £9,364 million (2002: £8,547 million; 2001: £7,388 million) comprise items reported under the following UK balance sheet categories: cash and balances at central banks; items in the course of collection from banks; loans and advances to banks repayable on demand and items in the course of transmission to banks. Under UK GAAP the results, assets and liabilities of the long-term assurance business are presented on a one-line basis and accordingly movements in cash flows are aggregated into one line within the reconciliation of operating profit. Under US GAAP, the insurance activities have been disaggregated and accordingly the cash flows have been allocated to the appropriate line items within the cash flow statement. Cash attributable to the long-term assurance business is included within cash and cash equivalents above.
Net change in loans and advances, including lease financing Operating activities Investing activities Net change in deposits and debt securities in issue Operating activities Financing activities Dividends paid to equity and non-equity minority interests Returns on investments and servicing of finance Financing activities Tax paid Taxation Operating activities Capital expenditure and financial investment Capital expenditure and financial investment Investing activities Purchases/proceeds from disposal of subsidiary and associated undertakings Acquisitions and disposals Investing activities Dividends paid – equity Equity dividends paid Financing activities
In 1988, Lloyds Bank Plc transferred a minority interest in five businesses to Abbey Life Group plc, a life insurance company, in return for a majority interest in the enlarged Abbey Life Group. Under UK GAAP, this transaction was accounted for as a merger. Under US GAAP, the same transaction would be accounted for as an acquisition. Accordingly the net assets of Abbey Life Group plc (later renamed Lloyds Abbey Life plc) have been fair valued in accordance with US GAAP and a purchase price determined based on the fair value of the minority interest transferred. In 1996, Lloyds TSB Group plc acquired the remaining minority interest in Lloyds Abbey Life plc. Under UK and US GAAP the transaction is treated as an acquisition. However, certain differences arise under US GAAP regarding the determination of fair value of life insurance companies and accordingly an adjustment has been made for the items affected.
The movement in US GAAP goodwill is summarised as follows: UK US GAAP US UK US GAAP US GAAP adjustment GAAP GAAP adjustment GAAP
Under UK GAAP, upon disposal of a business or undertaking, goodwill written off directly against reserves prior to the implementation of FRS 10 ‘Goodwill and Intangible Assets’, is included in the Group’s share of the net assets of the business or undertaking in the calculation of the profit or loss on disposal.
Differences in the net book value of goodwill (89) Other UK/US GAAP accounting differences (6) Exchange adjustments 107
The following is a summary of the US GAAP assets and liabilities of the discontinued operations as at the date of disposal.
Other post-retirement costs include a liability of £87 million (2002: £83 million) in respect of post-retirement healthcare.
Expected return on plan assets (797) (817) (778) Net amortisation and deferral 3 (79) (89)
Change in projected benefit obligation Projected benefit obligation as at 1 January 12,183 11,020 Exchange and other movements (99) – Service cost 267 256 Interest cost 670 655
The expected return for each asset class reflects a combination of historical performance analysis, the forward looking views of the financial markets (as suggested by the yields available) and the views of investment organisations. Consideration is also given to the rate of return expected to be available for reinvestment.
Prior to March 1996 None March 1996 – August 1999 That Lloyds TSB Group plc’s ranking based on shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be in the top fifty companies of the FTSE 100 and that there must have been growth in earnings per share which is equal to the aggregate percentage change in the Retail Price Index plus two percentage points for each complete year of the relevant period.
March 2000 – March 2001 As for March 1996 – August 1999 except that there must have been growth in the earnings per share equal to the change in the Retail Price Index plus three percentage points for each complete year of the relevant period.
As at 31 December 2003, no options granted under the Executive share scheme have lapsed as a result of a failure to satisfy the performance conditions.
Weighted Weighted Weighted average average average Number of exercise price Number of exercise price Number of exercise price
The weighted average remaining vesting period as at 31 December 2003 was 1 year.
Details of options outstanding in respect of stock compensation plans operated prior to 1 January 1995 are as follows: Weighted Number of average shares as Weighted option to which Number Number average Number of price at options were of options of options exercise options at 31 December exercisable at lapsed exercised price 2003 31 December (pence) 31 December during year during year (pence)
Basic earnings per share under US GAAP differ from UK GAAP (see note 12) only to the extent that income calculated under US GAAP differs from UK GAAP.
For the purposes of US GAAP, the Group believes that derivatives that are hedges under UK GAAP do not qualify for hedge accounting under the provisions of SFAS No. 133; prior to the adoption of SFAS No. 133, such exposures did not qualify for hedge accounting under US GAAP either and therefore there was no transition adjustment in respect of SFAS No. 133. Accordingly these exposures have been marked to market, with the resulting gains and losses taken directly to income. In addition, an adjustment to measure embedded derivatives that are not deemed to be clearly and closely related to the underlying host contract at their fair value has been included within unrecognised gains and losses during the year. The movement in the US GAAP adjustment arising is summarised below: £m £m £m.
These activities are discussed more fully on pages 53 to 55 and in note 47 on page 137.
Under UK GAAP investment securities are held at amortised cost except within the long-term insurance businesses where the securities are held at market value, with unrealised gains and losses taken to the income statement in the period to which they relate.
Proceeds from sales and maturities of available-for-sale investment debt securities and equity shares 14,448 15,502 Gross realised gains (136) (197) Gross realised losses 47 34
Of which: At 31 December 2003, the aggregate amount of unrealised losses outstanding for less than 12 months was £40 million, and related to investment securities with a fair value of £651 million; the aggregate amount of unrealised losses outstanding for more than 12 months was £18 million, and related to investment securities with a fair value of £206 million. These are generally corporate and government securities and the changes in fair value are primarily caused by movements in interest rates rather than movements in credit ratings. Accordingly, Lloyds TSB Group considers that these unrealised losses are temporary in nature and accordingly no charge has been made for other-than-temporary impairment. The amortised cost includes provisions of £105 million that have been raised under UK GAAP; these provisions are considered as permanent under US GAAP and no further provisions are deemed necessary.
Notes to the accounts 50 Differences between UK GAAP and US GAAP (continued) Gross Gross
Available-for-sale investment securities: Securities of the US treasury and US government agencies 1,740 3 (7) 1,736 European governments 106 – – 106
Other public sector securities 70 3 – 73 Bank and building society certificates of deposit 3,147 1 – 3,148
Mortgage backed securities 893 – (1) 892 Other asset backed securities 2,817 12 (9) 2,820
Additional own shares held of £154 million at 31 December 2003 (2002: £166 million) have been netted off against Additional Paid-in Capital within Shareholders’ equity in accordance with ARB No. 51. This relates to the amount of Lloyds TSB Group plc shares held within the long-term assurance funds that have not been deducted from equity under UK GAAP.
In accordance with the provisions of SFAS No. 109, the US GAAP deferred tax liability is: £m £m
US GAAP Profit and loss tax charge for continuing operations 832 495 448 £m £m
At 31 December 2003, the Group estimated that there was no difference between the carrying value of its loan portfolio on the basis of SFAS No. 114 and its value in the UK GAAP financial statements. Impaired loans are those reported as non-performing on page 110, less those loans which are outside the scope of SFAS No. 114, and amounted to £678 million (2002: £629 million). The impairment reserve in respect of these loans estimated in accordance with the provisions of SFAS No. 114 was £462 million (2002: £412 million). During the year ended 31 December 2003, impaired loans, including those excluded from SFAS No. 114, averaged £1,424 million (2002: £1,247 million) and interest income recognised on these loans was £25 million k Significant Group concentrations of credit risk
The Group enters into reverse repo transactions which are accounted for as collateralised loans. It is the Group’s policy to seek collateral which is at least equal to the amount loaned. At 31 December 2003, the fair value of collateral accepted under reverse repo transactions that the Group is permitted by contract or custom to sell or repledge was £2,077 million (2002: £1,295 million). Of this, £255 million (2002: £139 million) was sold or repledged as at 31 December 2003. The remainder has been held for continuing use within the business. The Group also enters into repos which are accounted for as secured borrowings. As at 31 December 2003, the carrying value of assets that have been pledged as collateral under repo transactions where the secured party is permitted by contract or custom to sell or repledge was £1,714 million (2002: £1,552 million).
The provisions of FIN 46-R have been applied immediately by Lloyds TSB Group to VIEs created on or after 1 February 2003; for VIEs created before that date, FIN 46-R becomes effective in 2004. The implementation of FIN 46-R has resulted in the consolidation of VIEs increasing total assets by £86 million.
These vehicles are investment-purchasing companies which purchase asset-backed securities (which are backed by third party assets) from the market and initially from Lloyds TSB Group. These vehicles form part of Lloyds TSB Group’s overall securitisation conduit and are consolidated under UK GAAP as these are considered to be directly controlled by Lloyds TSB Group.
Under UK GAAP applicable to banking groups, the Group accounts for its life assurance operations using the embedded value basis of accounting. An embedded value is an actuarially determined estimate of the economic value of a life assurance company, excluding any value which may be attributed to future new business. The embedded value is the sum of the net assets of the life assurance company and the present value of the in-force business. The value of the in-force business is calculated by projecting future net cash flows using appropriate economic and actuarial assumptions and the result discounted at a rate which reflects the shareholders’ overall risk premium. The change in the embedded value during any reporting period adjusted for any dividends declared or capital injected, and grossed up at the underlying rate of corporation tax, is reflected in the Group’s profit and loss account as income from long-term assurance business.
US GAAP requires that results of the life assurance business should be reported on a gross basis and reflected in appropriate captions in the income statement. Premiums from conventional with-profits policies and other protection-type life insurance policies are recognised as revenue when due from the policyholder. Premiums from unitised with-profits life insurance policies and investment contracts, which have minimal mortality risk, are reported as increases in policyholder account balances when received. Revenues derived from these policies consist of mortality charges, policy administration charges, investment management fees and surrender charges that are deducted from policyholders’ accounts and are disclosed within other income.
Over the next 5 years the amount of VOBA expected to be amortised prior to interest accruals is: 2004: £153 million 2005: £165 million 2006: £160 million 2007: £152 million 2008: £141 million iii) Balance sheet
For those securities classified as available-for-sale, the disclosures required under SFAS No. 115 are presented in aggregate with the banking business on pages 167 and 168.
Under UK GAAP applicable to banking groups, the cost of acquiring new and renewal life assurance business is recognised in the embedded value calculation as incurred.
Under US GAAP a liability is established for undistributed policyholder allocations. The excess of assets over liabilities in the with-profits fund is allocated to the policyholders and shareholders in accordance with the proportions prescribed by the contracts. The remaining liability comprises the obligation of the insurance company to the policyholders.
Profit on ordinary activities before tax 1,892 1,884 1,818 Taxation (charge) credit (12) 28 75
Net cash inflow (outflow) before financing 94 (899) (49) Financing: – Cash proceeds from issue of ordinary share capital and sale of own shares held in respect of employee share schemes 32 77 197 – Issue of subordinated liabilities (loan capital) – 958 – – Repayments of subordinated liabilities (loan capital) (14) – (100) Net cash inflow from financing 18 1,035 97
Shareholders’ funds (UK GAAP) 9,624 7,954 Dividends receivable (1,314) (1,311) Dividends payable 1,314 1,311 Revaluation of shares in group undertakings 2,268 2,236
On 4 March 2004, the closing price of shares on the London Stock Exchange was 456 pence, equivalent to $8.32 per share translated at the Noon Buying Rate of $1.825 per £1.00 on 4 March 2004.
Price per share (in US dollars) Price per share (in US dollars) High Low
The following table shows the reported high and low closing prices for ADSs on the New York Stock Exchange.
The UK Inland Revenue is the UK government department responsible for assessing and collecting UK tax revenues. The discussion is intended as a general guide and only applies to persons who are the beneficial owners of their ordinary shares or ADSs. References below to a US holder are to that term as defined, and subject to the exclusions described in the introduction, below under ‘US federal income tax considerations’. It may not apply to certain shareholders or ADS holders, such as dealers in securities.
A US holder who is an individual and who has, on or after 17 March 1998, ceased to be resident or ordinarily resident for tax purposes in the UK for a period of less than five years of assessment and who disposes of ordinary shares or ADSs during that period may be liable, on return to the UK, to UK taxation on chargeable gains arising during the period of absence, subject to any available exemption, relief and/or foreign tax credit.
Subject to the provisions set out above under ‘Individuals, other than US holders, temporarily non-resident in the UK’, shareholders or ADS holders who are neither resident nor ordinarily resident in the UK will not normally be liable for UK tax on chargeable gains unless they carry on a trade, profession or vocation in the UK through a branch or agency and the ordinary shares or ADSs are or have been used or held by or for the purposes of the branch or agency, in which case such shareholder or ADS holder might, depending on individual circumstances, be liable to UK tax on chargeable gains on any disposition of ordinary shares or ADSs. An individual holder of ordinary shares or ADSs who is only temporarily not resident in the UK may, under anti-avoidance legislation, still be liable for UK tax on chargeable gains realised, subject to any available exemption, relief and/or foreign tax credit.
Lloyds TSB Group will not be required to withhold tax at source when paying a dividend on the ordinary shares or ADSs.
There will be no payment of the tax credit or any part of it to an individual whose liability to income tax on the dividend and the related tax credit is less than the tax credit, except where the individual holds the relevant shares through a personal equity plan or individual savings account and the dividend is received into such plan or account on or before 5 April 2004.
The UK does not currently apply a withholding tax on dividends under its domestic laws. Were such withholding imposed as permitted under the New Treaty, the UK generally will be entitled in certain circumstances to impose a withholding tax at a rate of 15% on dividends paid to US holders. A US holder who is subject to such withholding should be entitled to a credit for such withholding tax, subject to applicable limitations, against the US holder's US federal income tax liability.
Lloyds TSB Group will not be required to withhold tax at source when paying a dividend on the ordinary shares or ADSs to a holder, other than a US holder, who is not resident for tax purposes in the UK.
No liability to UK stamp duty or SDRT will arise on a transfer of ADSs provided that any document that effects such transfer is not executed in the UK and that it remains at all subsequent times outside the UK. An agreement to transfer ADSs will not give rise to a liability to SDRT.
To the extent paid out of current or accumulated earnings and profits of Lloyds TSB Group plc (as determined in accordance with US federal income tax principles), distributions made with respect to ADSs or ordinary shares (other than certain distributions of capital stock of Lloyds TSB Group plc or rights to subscribe for shares of capital stock of Lloyds TSB Group plc) will be includible in the income of a US holder as ordinary dividend income from non-US sources. Such dividends will not be eligible for the ‘dividends received deduction’ generally allowed to corporations under the Code.
Subject to applicable limitations that may vary depending upon a holder’s individual circumstances, dividends paid to non-corporate US holders in taxable years beginning before 1 January 2009 should be taxable at a maximum tax rate of 15 per cent. Non-corporate US holders should consult their own tax advisors to determine whether they are subject to any special rules that limit their ability to be taxed at this favourable rate.
Dividends paid on ADSs or ordinary shares to a US holder may be subject to information reporting requirements of the Code. Such dividends may also be subject to backup withholding unless the US holder: • is a corporation or comes within certain other exempt categories and, when required, demonstrates this fact, or
Lloyds TSB Commercial England 100%* Credit factoring Beaumont House Finance Limited Beaumont Road, Banbury
Abbey Life Assurance Company England 100%* Life assurance 80 Holdenhurst Road Limited Bournemouth BH8 8ZQ
Scottish Widows Annuities Limited Scotland 100%* Life assurance 69 Morrison Street Edinburgh EH3 8YF
In addition, those directors held, as at 31 December 2003, options to acquire 8,342,025 shares, all of which were granted pursuant to the executive share option schemes, sharesave share option schemes, share retention plan and share plan.
Lloyds TSB Group plc is not owned or controlled directly or indirectly by another corporation or by any government and Lloyds TSB Group plc is unaware of any arrangements which might result in a change in control.
Exchange rates In this annual report, unless otherwise indicated, all amounts are expressed in pounds sterling. For the months shown the US dollar high and low Noon Buying Rates per pound sterling were: February January December November October September
Exchange controls There are no UK laws, decrees or regulations that restrict Lloyds TSB Group plc's export or import of capital, including the availability of cash and cash equivalents for use by Lloyds TSB Group, or that affect the remittance of dividends or other shareholder payments to non-UK holders of Lloyds TSB Group plc shares, except as otherwise set out in ‘Taxation’.
Legal actions Lloyds TSB Group is periodically subject to threatened or filed legal actions in the ordinary course of business. Lloyds TSB Group does not expect the final outcome of any legal proceedings currently known to it to have a material adverse effect on its consolidated results of operations or financial condition.
Memorandum and articles of association A summary of the material provisions of Lloyds TSB Group plc's memorandum and articles of association was incorporated into Lloyds TSB Group plc's registration statement filed with the SEC on 25 September 2001 and is therefore incorporated into this annual report by reference to that statement.
Economic profit See definition under ‘Operating and financial review and prospects – Economic profit’.
Guaranteed annuity option See ‘Operating and financial review and prospects – With-profits options and guarantees’.
Hire purchase See ‘Description of business – Business and activities – Wholesale and International Banking – Asset finance’.
Lien Under UK law, a right to retain possession pending payment.
National Insurance A form of taxation payable in the UK by employees, employers and the self-employed, used to fund benefits at the national level including state pensions, medical benefits through the National Health Service (NHS), unemployment and maternity. It is part of the UK's national social security system and ultimately controlled by the Department of Social Security.
Regular premium Premiums which are payable throughout the duration of a policy or for some shorter fixed period.
Single premium A premium in relation to an insurance policy payable once at the commencement of the policy.
VaR Value at Risk, see definition under ‘Operating and financial review and prospects – Risk management – Market risk – Measurement – Trading value at risk (VaR)’.
Share price information In addition to information published in the financial pages of the press, the latest price of Lloyds TSB shares on the London Stock Exchange can be obtained by telephoning 0906 8771515. These telephone calls are charged at 60p per minute, including VAT, or visit www.londonstockexchange.com for details.