Factors that could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by Lloyds TSB Group or on Lloyds TSB Group’s behalf include, but are not limited to, general economic conditions in the UK and internationally; inflation, interest rate, exchange rate, market and monetary fluctuations; changing demographic developments, adverse weather and similar contingencies outside the Lloyds TSB Group’s control; inadequate or failed internal or external processes, people and systems; terrorist acts and other acts of war or hostility and responses to those acts; changes in laws, regulations or taxation; changes in competition and pricing environments; the ability to secure new customers and develop more business from existing customers; the ability to achieve value-creating mergers and/or acquisitions at the appropriate time and prices and the success of the Lloyds TSB Group in managing the risks of the foregoing.
Lloyds TSB Group plc may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the Securities and Exchange Commission (‘SEC’), Lloyds TSB Group plc’s annual review, proxy statements, offering circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of Lloyds TSB Group plc to third parties, including financial analysts. The forward looking statements contained in this annual report are made as of the date hereof, and Lloyds TSB Group undertakes no obligation to update any of its forward looking statements.
Income growth of 7 per cent exceeded cost growth of 4 per cent.
† Profit (loss) on sale and closure of businesses relates to UK Retail Banking (2005: £76 million, 2004: nil), Wholesale and International Banking (2005: £(6) million, 2004: £(21) million) and Central group items (2005: £(20) million, 2004: nil).
In Wholesale and International Banking we have streamlined our international portfolio of businesses to focus on leveraging our strong customer relationships with business and corporate customers. As a result we have delivered excellent levels of profit growth and made great progress in delivering our strategy to build an integrated wholesale bank.
Whilst we have made considerable progress, we are not resting on our laurels. We know we have to continue to produce good levels of earnings growth and strong results. Going forward, the main thrust of our strategy will be continuing to invest in our businesses to deliver revenue growth through gaining new customers, deepening our relationship with customers, and leveraging the strength of our brands and our multi-channel distribution capability, whilst at the same time continuing to improve the products and services that we offer to our customers. In addition we will further improve our processing efficiency and seek to reduce day-to-day operating costs.
By focusing on this clearly articulated strategy I believe the Group can continue to deliver a strong return on equity together with good levels of economic profit growth. Over the last few years we have substantially improved the quality of the Group’s earnings and have re-established satisfactory levels of earnings growth. As a result, during 2005 we delivered a total shareholder return (share price appreciation plus dividends) of 10.9 per cent.
The regulatory burden upon the UK financial services industry continues to be a major concern. The adoption of International Financial Reporting Standards, compliance with Sarbanes-Oxley and preparations for the introduction of the Basel capital adequacy regime have all been time consuming and expensive. We welcome signs that notice is at last being taken of the extent of this regulatory burden. We shall, however, wait to see whether de-regulation initiatives, announced by both the UK Government and the European Commission, have any material impact upon the significant burden faced by the industry. The UK financial services industry is one of the great success stories of the last 20 years and great care must be taken to ensure that the conditions remain in place for this success story to continue.
The board has decided to maintain the final dividend at 23.5p per share, making a total for the year of 34.2p (2004: 34.2p). This represents a yield of 7.0 per cent calculated using the 31 December 2005 share price of 488.5p.
Since the 2005 annual general meeting, we have welcomed three directors to the board. Terri Dial was appointed as Group Executive Director, UK Retail Banking in June and Jan du Plessis and Lord Leitch joined us as independent non-executive directors in October.
Target customer recruitment 000s * Comparable basis – excluding impact of volatility, other IFRS adjustments applied from 1 January 2005 and discontinued operations. Also excludes provisions for customer redress.
In Insurance and Investments our focus is on profitability and returns, combined with strong new business sales 6 LLOYDS TSB GROUP
Our employee engagement scores have also improved significantly during the year, indicating that our people understand and are committed to our strategy, and we have improved our performance management processes in support of the Group strategy. We also strengthened our senior management team, with the addition of key hires in the Retail Bank.
It is not in the interests of the individual customer or the Group to lend money to a customer who cannot afford to repay. The Group takes its responsibilities in this regard very seriously and has a responsible lending programme, to ensure we help our customers clearly understand the nature of the agreements they are entering into and we confirm affordability before agreeing to any borrowing requests. Where customers do experience repayment difficulties, our staff are trained to offer the necessary advice and support to manage their finances and we have a Customer Support Unit, whose role it is to identify customers who are showing early signs of financial difficulty so that we can provide early advice and support to them.
In Wholesale and International Banking, our results show excellent progress in our core businesses and the division delivered a 20 per cent improvement in profit before tax, on a comparable basis, at the same time as improving returns. The good results were achieved by the successful implementation of our strategies in Business Banking and Corporate Markets, and these businesses will continue to provide the platform for profitable growth in the division. We again maintained our management discipline of positive jaws, with the rate of growth in income increasing by 10 per cent whilst costs grew by 7 per cent, partly reflecting the increase in investment costs necessary to fund the ongoing development of the division.
In support of our customer objectives, we have set stretching customer satisfaction targets and will continue to develop our products, policies and procedures in line with those targets. Our strong risk and control infrastructure remains an important element of our growth strategy and will be further enhanced as we seek to develop risk into a differentiating competency. We will also continue to focus on the development of our staff, whilst aiming for even stronger engagement scores.
In summary, 2005 was a good year for the Group. We delivered on our short-term financial goals whilst also investing in the long-term health of the business, which is necessary to drive sustainable future earnings growth. This is our last set of results under the chairmanship of Maarten van den Bergh and
Finally, I would like to express my continued thanks to all of the staff who work for the Lloyds TSB Group. They remain committed to serving the needs of our customers and their wonderful efforts are the key element to our continued success.
* Comparable basis – excluding impact of volatility, other IFRS adjustments applied from 1 January 2005 and discontinued operations.
Our corporate responsibility strategy is to help achieve our corporate vision by building a great place for our people to work, a great place for our customers to do business, and generating great returns for our shareholders. In so doing, we believe we create value for all our stakeholders.
We have strong evidence that there is a clear link between employee satisfaction and customer satisfaction, which in turn leads to improved financial performance.
• creating a culture where people feel involved and understand how their work contributes to the Group’s overall success
• the extent to which the Group is seen as being socially and environmentally responsible and ethical in its operations
We have developed award-winning programmes in the areas of training and development, career management, work-life balance, diversity and community involvement.
Our corporate responsibility steering group is chaired by the deputy group chief executive and comprises senior executives from all business divisions and relevant group functions. The committee meets quarterly to recommend strategy and provide direction. The board reviews overall corporate responsibility performance annually and individual issues are subject to board discussion throughout the year.
This allows us to identify strengths and areas for improvement and to prioritise actions and objectives. It also provides a benchmark against which we can compare our performance both internally and externally.
The board believes that the systems in place to manage significant social, ethical and environmental (SEE) risks are effective and provide adequate information to identify and assess the short and long-term risks arising from SEE matters. The board is also satisfied that relevant SEE risks have been assessed during 2005 and that they have been managed in compliance with relevant policies and procedures.
During 2005, the Foundations distributed £31 million to community causes across the UK.
Lloyds TSB Group’s activities are organised into three divisions: UK Retail Banking, Insurance and Investments, and Wholesale and International Banking. The main activities of Lloyds TSB Group’s three divisions are described below.
Cash machines. Lloyds TSB Group has one of the largest cash machine networks of any leading banking group in the UK and, at 31 December 2005, personal customers of Lloyds TSB Bank and Lloyds TSB Scotland were able to withdraw cash and check balances through some 4,200 ATMs at branches and external locations around the country. In addition, our personal customers have access to a further 54,000 cash machines via LINK in the UK and to cash machines worldwide through the VISA and MasterCard networks.
Corporate Markets, combining the respective strengths of 2,700 people in Corporate Banking, Structured Finance and Financial Markets, plays an integral role in leveraging and expanding our customer franchise and building deep, long-lasting relationships with around 16,000 corporate customers.
Summary of Group results With effect from 1 January 2005, the Group has been using IFRS for financial reporting. Although IFRS significantly changes the timing of earnings recognition in financial results it has no impact on our business fundamentals and cash flows, the development of our organic growth strategies, or our capital management policies.
Details of the retrospective impact of the Group’s implementation of IFRS were published in our ‘Transition to IFRS’ announcement on 27 May 2005. The increased use in IFRS of fair values has, however, led to greater volatility in the earnings of the Group. In order to provide a more comparable representation of our business performance this earnings volatility, together with other IFRS related adjustments applied with effect from 1 January 2005 and the impact on the Group’s results of businesses sold in 2004, have been separately analysed to provide a comparable basis of presentation.
Group net interest income, on a comparable basis, increased by £423 million, or 8 per cent, compared with last year. Good levels of consumer lending growth increased average personal lending and credit card balances by £1.7 billion and average mortgage balances by £7.8 billion. Customer lending growth in our Business Banking and Corporate Markets franchises increased average interest-earning assets by £4.4 billion. The banking net interest margin decreased by 6 basis points to 2.78 per cent. Much of this margin decline has been caused by the impact of lower earnings on the Group’s capital and other interest-free liabilities and, excluding this funding impact, the margin was broadly stable year on year. The banking net interest margin in the second half of 2005 actually increased by 5 basis points to 2.80 per cent, compared with 2.75 per cent in the first half of 2005.
Operating expenses continued to be tightly controlled and on a comparable basis increased by 5 per cent to £5,506 million. Excluding the impact of customer redress provisions, operating expenses increased by only 4 per cent. Significant improvements continue to be made in processing and operational efficiency and we have continued to expand our programme of offshoring a number of our processing and back office operations to India. Staff numbers reduced by 3,652 to 69,778 during the year, improving group productivity. As a result of this constant focus on day-today operating cost control, the cost:income ratio, excluding customer redress provisions and the strengthening of reserves for mortality, improved to 52.7 per cent, from 54.3 per cent in 2004.
• transforming group wide procurement to enhance the way we manage suppliers and achieve the most efficient pricing available.
Following the introduction of time-barring, and the consequent increase in claims, the Group has also reviewed the estimated cost of redress payments to customers, principally relating to past sales of mortgage endowment policies through the branch network. This has led to an increased provision for customer redress of £150 million.
• Satisfactory income growth in a more challenging consumer environment, with good growth in income per customer and a 28 per cent increase in target customer current account recruitment.
• Tight cost control, with a clear focus on improving efficiency. Staff reductions of 2,713 during the year resulted in lower costs in the second half of the year.
During 2005, good levels of growth were achieved in all key product areas. Gross new mortgage lending for the Group totalled £26.0 billion (2004: £26.3 billion). Net new lending totalled £8.3 billion resulting in a market share of net new lending of 9.1 per cent, and mortgage balances outstanding increased by 10 per cent to £88.4 billion. Personal loan balances outstanding at the year end were £11.0 billion, an increase of 3 per cent and credit card balances totalled £7.2 billion, an increase of 9 per cent, adjusting to exclude the effect of the Goldfish disposal. Credit balances on current accounts and savings and investment accounts increased by 7 per cent. Income per customer continued to improve during the year.
Total income, net of insurance claims 1,547 1,397 Operating expenses (639) (610)
In January 2006, Scottish Widows announced a new partnership with Virgin to market life assurance and a new cancer insurance product under the Virgin Money brand. This supports Scottish Widows’ long-term strategy to secure a greater breadth of distribution for its products.
Commission receivable 681 672 Commission payable (695) (750) Underwriting income (net of reinsurance) 562 554 Other income 18 64
Claims fell by £17 million to £197 million and the claims ratio improved to 34 per cent (2004: 37 per cent), reflecting good progress in re-engineering the claims process and improvements in the cost effectiveness of the claims supply chain, as well as lower health claims as a result of the transfer of the Group’s private medical insurance business to BUPA. As a result, the combined ratio relating to the underwriting business improved to 80.8 per cent in 2005 (2004: 83.2 per cent).
Wholesale and International Banking profit before tax, on a comparable basis, increased by £251 million, or 20 per cent, to £1,504 million. Income growth of 10 per cent exceeded cost growth of 7 per cent, leading to a reduction in the cost:income ratio to 56.4 per cent. Trading surplus increased by £206 million, or 14 per cent, to £1,689 million. There was strong profit growth in Corporate Markets, Business Banking and International Banking while Asset Finance saw strong trading surplus growth before higher impairment losses. Overall growth in profit was ahead of growth in risk-weighted assets and has led to an increase in the post-tax return on average risk-weighted assets to 1.50 per cent, compared to 1.41 per cent in 2004.
Net interest income increased by £179 million, or 9 per cent, reflecting higher income from strong growth in customer lending in Corporate Markets, Business Banking and Asset Finance. Other income increased by £166 million, or 11 per cent. Strong growth in structured finance transactions, increased fee income from relationship business products and higher levels of cross-selling activity led to an increase of 18 per cent in other income from Corporate Markets. In addition, other income benefited from the impact of motor dealership acquisitions in Asset Finance and sustained customer growth in Business Banking. Costs were 7 per cent higher at £2,186 million, reflecting higher staff costs as a result of our increased investment in people, as we continue to build up our Corporate Markets product capability and expertise, and the impact of the motor dealership acquisitions within Asset Finance.
Lloyds TSB Foundations (34) (31) Funding cost of acquisitions less earnings on capital (325) (317) Central costs and other unallocated items (8) (2)
The Group’s insurance businesses have substantial holdings of investments which are accounted for at fair value with changes being reflected within the income statement. The difference between the actual return on these investments attributable to shareholders and the expected return based upon economic assumptions made at the beginning of the year is included within insurance volatility. In addition, the calculation of the value of in-force business makes assumptions about future investment returns; to the extent that actual experience is different the effect is also included within insurance volatility.
The main assumptions used in the calculation of the value of in-force business at 31December 2005 were as follows: 31 December 31 December
Changes in stock market performance also affect the realistic valuation of the guarantees and options embedded within products written in the Scottish Widows With-Profits Fund, which following the implementation of FRS 27 is now reflected in the Group’s balance sheet. Fluctuations in this valuation caused by market-related movements are also included within insurance volatility.
During 2005, profit before tax included positive insurance volatility of £438 million.
As a result of the requirement contained in IFRS to consolidate the Group’s life and pensions businesses on a line by line basis, the Group’s income statement includes amounts attributable to policyholders which affect profit before tax; the most significant of these items is policyholder tax. Under IFRS, tax on policyholder investment returns is included in the Group’s tax charge rather than being offset against the related income, either increasing or decreasing profit before tax with a corresponding change in the tax charge. In order to provide a clearer representation of the underlying performance of the Group’s life and pensions businesses the impact of these items upon pre-tax profit has been separately identified within volatility.
The maintenance of a strong control framework remains a priority and is the foundation for the delivery of effective risk management. Risk analysis and reporting have been further strengthened to identify opportunities as well as risks, to improve the Group’s ability to take an aggregate view of the overall risk portfolio and assign clear responsibilities and timescales at group and divisional level for risk mitigation strategies. Risk continues to be a key component of routine management information reporting and is embedded within staff objectives via balanced scorecards.
A key focus for 2005 has been the enhancement of this framework. The approach starts with a simple but clear articulation of the Group’s strategic vision and the desired outcomes for our key stakeholders (shareholders, customers, staff, debtholders and regulators). The risk implications are expressed in a risk vision and high level risk appetite measures, which are in turn translated into high level risk principles and risk appetite measures and metrics for the primary risk types (credit risk, market risk, insurance risk, operational risk, strategy risk and financial soundness). The degree of sophistication continues to evolve. An overview of each of the primary risk drivers is set out on pages 27 to 34. The more detailed articulation of the risk principles and distribution of the risk appetite measures amongst the divisions and businesses is subsequently agreed by the group chief executive, through consultation with the group executive committee and on the advice of the group business risk committee and the group asset and liability committee.
• Group policy – policy for the main EWRM risk types aligned to the risk drivers (agreed by the group chief executive)
Policies are reviewed regularly to seek to ensure accuracy and appropriateness.
At group level a consolidated risk report is produced which is reviewed and debated by group business risk committee, group executive committee, risk oversight committee and board to ensure senior management and the board are satisfied with the overall risk profile, risk accountabilities and any necessary mitigating actions. During the year the Group’s consolidated risk report was further enhanced to support the identification, control and effective management of risk.
An annual strategic planning process is conducted at group and business level which includes a quantitative and qualitative assessment of the risks in the Group’s plan. Within the planning round, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams.
Businesses have formal processes for reviewing the range of their product portfolios and subject all product development to rigorous assessment. The assessment includes seeking to ensure that the product meets clearly defined customer needs. Businesses have a defined channel distribution strategy for products, consistent with the Group’s distribution strategy. Businesses launching new products are responsible for ensuring compliance with all applicable regulations and that the proposed sales activity is appropriate for the type of customer and their attitude to risk.
Credit risk also arises from the use of derivatives. Note 17 shows the total notional principal amount of interest rate, exchange rate and equity and other contracts outstanding at 31 December 2005. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. 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.
Impairment provisions are provided for losses that have been incurred at the balance sheet date. Changes in general economic conditions in the UK or in interest rates could result in losses that are different from those provided for at the balance sheet date.
The following are the principal mechanisms through which the Group operates the credit risk framework set out above: Credit rating systems. All business units operate appropriate rating system(s) for their portfolio(s). All rating systems, which are authorised by executive management, comply with the Group’s standard methodology. The Group uses a ‘Master Scale’ rating structure with ratings corresponding to a range of probabilities of future default.
Portfolio monitoring and reporting. With Group Risk, businesses and divisions identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by Group Risk. Group Risk in turn produces an aggregated review of credit risk throughout the Group, which is presented to the group business risk committee.
Credit principles and policy. Group Risk sets out the group credit principles according to which credit risk is managed. These form the basis of the group credit policy, which in turn is the basis for divisional and business unit credit policy. Principles and policy are reviewed regularly and any changes are subject to a review and approval process.
Risk assurance and oversight. Divisional and group level oversight teams monitor credit performance trends, review and challenge exceptions to planned outcomes and test the adequacy of credit risk infrastructure and governance processes throughout the Group. This includes tracking portfolio performance against an agreed set of key risk indicators. Risk assurance teams and Group Audit are engaged where appropriate to conduct further credit reviews if a need for closer scrutiny is identified.
Lloyds TSB Group uses a range of approaches to mitigate credit risk. In the case of individual exposures, the Group makes use of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. The Group will also consider the sale of assets, where credit concerns exist. Securitisation is another credit mitigation technique which receives consideration as does the use of credit derivative-based approaches.
• Market risk in the Group’s retail portfolios and in the Group’s capital funds arises from the different repricing characteristics of the Group’s banking assets and liabilities. Interest rate risk arises from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets
The Group’s banking non-trading exposure is summarised in the form of an interest rate repricing table, as set out in note 51 to the financial statements. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date. However, the table does not take into account the effect of interest rate options used by the Group to hedge its exposure.
North Asia & Europe & Total Total UK America Australasia Middle East 2006 2005 £m £m £m £m £m £m
The Group has seven sub operational risk types: governance risk, legal and regulatory risk, customer treatment risk, process and resource risk, theft, fraud and other criminal acts risk, people risk and change-related risk each of which is described in further detail below.
Group functions (eg Group Human Resources, Group Risk, Group Finance, Group Strategy, Group Audit) are established to provide functional leadership (eg policy, strategy, and standards), challenge and support across the Group and ensure information is consolidated at group level.
Group Audit has unrestricted access to all functions, property, records and staff. It independently reviews adherence to the policies and processes that make up the control environment, disseminating best practices throughout the Group in the course of its monitoring and corrective action activities. The director of group audit reports to and meets regularly with the group chief executive and the audit committee chairman and periodically with the audit committee.
All compliance personnel also have a reporting line to the group compliance director who sets compliance standards across the Group and provides independent reporting and assessment to the board and business directors.
The Group has defined high-level process and resource risk policies to seek to ensure a wide-ranging and consistent approach to the identification and management of process and resource risk.
Group Security has primary responsibility for the security of the people, premises and assets, including identifying and developing countermeasures to minimise the impact of physical threats to the Group. Business unit management seek to ensure that the level of security risk applicable to each site they occupy is assessed, and that the appropriate security countermeasures are determined in order to protect people, premises and assets.
The risk of reductions in earnings and/or value, through financial or reputational loss, from inappropriate staff behaviour, industrial action or health and safety issues. Loss can also be incurred through failure to recruit, retain, train, reward and incentivise appropriately skilled staff to achieve business objectives and through failure to take appropriate action as a result of staff underperformance.
Standards of behaviour. The Group has a code of business conduct which applies to all employees. It seeks to ensure that employees act with integrity and endeavour to deliver high levels of customer service. It promotes a working environment free from discrimination, harassment, bullying or victimisation of any kind. Employees are encouraged and expected to alert management to suspected misconduct, fraud or other serious malpractice. We provide mechanisms to facilitate disclosure if an employee is unable to inform their direct line management and will thoroughly investigate any reports made in good faith. The code as amended from time to time is available to the public on the Group’s website at www.lloydstsb.com.
For non-linked funds investments are arranged to minimise the possibility of being a distressed seller whilst at the same time investing to meet policyholder obligations. For unit-linked business, deferral provisions are designed to give time to realise linked assets without being a forced seller.
The rating outlook from Moody’s for Lloyds TSB Bank is stable. The Standard & Poor’s rating outlook is negative. These credit ratings are not a recommendation to buy, hold or sell any security; and each rating should be evaluated independently of every other rating.
The ability to sell assets quickly is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of marketable debt securities which could be disposed of to provide additional funding should the need arise.
At 31 December 2005, the risk asset ratios were 10.9 per cent for total capital and 7.9 per cent for tier 1 capital. The 7.9 per cent tier 1 capital ratio appears higher than would perhaps be expected and reflects the higher level of supervisory deductions resulting from the Group’s significant investment in its life assurance operations.
There are strict limits imposed by the regulatory authorities as to the proportion of the Group’s regulatory capital base that can be made up of subordinated debt and preferred securities. The Group’s capacity to raise new debt capital for regulatory purposes increases as profits are retained; at 31 December 2005, the Group had capacity to raise approximately £1,000 million of tier 2 debt capital. The unpredictable nature of movements in the value of the investments supporting the long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate.
The following table provides more detail regarding the sources of capital in the life assurance business and reconciles those amounts to the Group’s balance sheet. The figures quoted are based on management’s current expectations regarding completion of the annual financial return to the FSA.
Fund Fund Fund funds basis adjustments basis of capital adjustments total £m £m £m £m £m £m £m £m £m £m
Adjustments onto a regulatory basis: Life assurance business Unallocated surplus within insurance business 494 – 494 – 494 Adjustments to remove differences between IFRS and regulatory valuation of assets and liabilities – (456) (456) (767) (1,223) Adjustment to include estimated ‘realistic’ liabilities payable to the shareholder (729) – (729) – (729) Adjustment to replace ‘realistic’ liabilities with
Available capital resources – insurance business 2,302 2,663 4,965 1,307 6,272
Realistic value of assets of fund 19,018 23,242 17,814 22,012 Support arrangement assets (value of ‘Support Account’) 1,115 – 1,265 –
Realistic value of assets available to the fund 20,133 23,242 19,079 22,012 Realistic value of liabilities of fund (19,253) (19,102) (18,108) (17,827)
Scottish Widows continues to be well capitalised with the working capital ratios for the With-Profits Fund and the Long-Term Fund being an estimated 4.4 per cent (31 December 2004: 5.1 per cent) and 17.8 per cent (31 December 2004: 19.0 per cent) respectively. The decrease in the Long-Term Fund ratio is a result of the proposed transfers to the Shareholder Fund noted above.
Outside the With-Profits Fund, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are broadly matched. The most critical non-economic assumptions are mortality rates in respect of annuity business written (lower mortality rates are more onerous). The Group has reduced its exposure to deteriorating mortality rates in respect of life assurance contracts through its reinsurance arrangements. In addition, poor cost control would gradually depreciate the available capital and lead to an increase in the valuation of the liabilities (through an increased allowance for future costs).
As noted above, under the realistic capital regime of the FSA, the liabilities of the With-Profits Fund are valued using a market-consistent stochastic simulation model. This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
Abbey Life currently has a number of policies in-force which have a guaranteed annuity option. In total it holds traditional regulatory reserves of £332 million to cover this liability at 31 December 2005 (£288 million at 31 December 2004). These reserves have been determined using prudent future interest rate, mortality rate and rate of annuity option take-up assumptions and exceed the value that would be placed on them using a market-consistent stochastic model. It is estimated that a 0.5 per cent reduction in future interest rates would increase the liability by some £54 million.
The financial information set out in the table below has been derived from the annual reports and accounts of Lloyds TSB Group plc for each of the past five years. 2005 is the first year in which the annual report and accounts have been prepared under International Financial Reporting Standards (IFRS). 2004 and earlier years have been prepared under UK Generally Accepted Accounting Principles (UK GAAP) and earlier years have been adjusted for subsequent changes in accounting policy and presentation. To bridge the change in framework, 2004 figures have been presented under both IFRS and UK GAAP. Under IFRS, accounting standards dealing with financial instruments (IAS 32 and IAS 39) and insurance (IFRS 4 and FRS 27) have been applied only from 1 January 2005. The comparative IFRS balance sheet data is presented as at 1 January 2005; the 2005 and 2004 IFRS income statement data are not comparable. Details of changes to the Group’s 2004 figures arising from transition to IFRS and accounting changes under IFRS that are effective from 1 January 2005 and which do not affect 2004 IFRS comparatives are outlined in note 54 to the 2005 accounts and in the Group’s announcement setting out the effects of the implementation of IFRS and FRS 27 published on 27 May 2005. The financial statements for 2001 were audited by PricewaterhouseCoopers, independent accountants; the financial statements for each of the years 2002 to 2005 have been audited by their successor firm PricewaterhouseCoopers LLP, independent accountants.
Impairment losses on loans and advances (1,299) (866) (866) (950) (1,029) (747)
Net asset value per ordinary share 180p 167p 176p 170p 140p 183p
Loans and advances to customers 174,944 161,162 154,240 135,251 134,474 122,935
Five year financial summary 1 Annual dividends comprise both interim and final dividend payments. Under IFRS, the total dividend for the year represents the interim dividend paid during the year and the final dividend which will be paid and accounted for during the following year. Under UK GAAP, final dividends are included in the year to which they relate rather than in the year in which they are paid.
�� Chairman of the nomination committee † Member of the remuneration committee
†† Chairman of the remuneration committee + Member of the risk oversight committee
Archie G Kane Group Executive Director Insurance and Investments Joined TSB Commercial Holdings in 1986 and held a number of senior and general management appointments in Lloyds TSB Group before being appointed to the board in 2000, as group executive director, IT and operations. Appointed group executive director, insurance and investments in October 2003. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as finance director in the UK from 1983 to 1985. Aged 53.
Principal activities, business review, future developments and financial risk management objectives and policies The Company is a holding company and its subsidiaries provide a wide range of banking and financial services through branches and offices in the UK and overseas. A review of the business and an indication of future developments are given on pages 4 to 38. Information regarding the financial risk management objectives and policies of the Company and its subsidiary undertakings, in relation to the use of financial instruments, is given on pages 24 to 34 and in note 51 on pages 107 to 111.
Authority to purchase shares The authority for the Company to purchase, in the market, up to 567 million of its shares, representing some 10 per cent of the issued ordinary share capital, expires at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give a similar authority.
Employees Lloyds TSB Group is committed to employment policies which follow best practice, based on equal opportunities for all employees irrespective of sex, race, national origin, religion, colour, disability, sexual orientation, age or marital status.
Directors’ indemnities Directors’ service agreements or letters of appointment, which are available for inspection, contain indemnities as provided for in the Companies (Audit, Investigations and Community Enterprise) Act 2004.
The committee may have specific powers delegated to it by the board from time to time and following the exercising of these powers, it reports to the board. To comply with the Group’s articles of association, only committee members who are also directors of the Company participate in the exercising of any powers delegated by the board.
The attendance of directors at board meetings and at meetings of the audit, nomination, remuneration and risk oversight committees during 2005 was as follows: Audit Nomination Remuneration Risk oversight Board committee committee committee committee
Lord Leitch3 2 1 G T Tate 9 M A van den Bergh 9 3 4 H A Weir 9
LLOYDS TSB GROUP 45 1 Appointed to the nomination committee from 3 March 2005 2 Appointed to the board from 1 June 2005 3 Appointed to the board and audit committee from 1 October 2005 4 Appointed to the risk oversight committee from 3 March 2005 5 Left the board on 5 May 2005
• Increase executive director expected levels of personal shareholding in the Group.
We believe that these changes, which have the full support of the board, should even more firmly align executive director remuneration with shareholders’ interests as well as engaging them in pursuing long-term shareholder value. The remuneration committee unanimously recommends that the long-term incentive plan proposal and the wider remuneration report be approved.
• Dr Gibson-Smith (until 5 May 2005 when he left the board)
Regarding Mr Daniels’ 2006 bonus opportunity, an amount equal to 112.5 per cent of basic salary will continue to be available on the achievement of stretching targets contained in a balanced scorecard. However, his maximum bonus opportunity will be increased to 175 per cent of basic salary for the achievement of exceptional performance targets, bringing Mr Daniels’ bonus opportunity closer to comparator group levels. In line with the revised bonus arrangements for the executive directors, half of the bonus will be driven by corporate results and the other half by individual performance. Failure to achieve at least 90 per cent of the stretching budget target would result in no payment under the corporate half of the bonus.
If shareholders approve the policy proposal mentioned earlier, further grants under this scheme will not be awarded to directors after 2006. From 2007, therefore, awards under the annual incentive scheme will be in cash only. However, it is envisaged that the loss of the performance share dynamics under the current plan will be compensated for under the proposed new long-term incentive plan.
Under the performance share plan executives will be eligible for an award of free shares, known as performance shares, to match the bonus shares. The maximum match will be two performance shares for each bonus share, awarded at the end of the three year retention period. The number of performance shares actually awarded will depend on the Group’s TSR performance measured over the three year period ending December 2008, compared with the TSR of the other companies in the comparator group listed below. The maximum of two performance shares for each bonus share will be awarded only if the Group’s TSR performance places it first in the comparator group; one performance share will be awarded for each bonus share if the Group is placed fifth; and one performance share for every two bonus shares if the Group is placed eighth (median). Between first and fifth positions and fifth and eighth positions sliding scales will apply. If the TSR performance is below median no performance shares will be awarded. There will be no retest. Whilst income tax is deducted from the deferred bonus before the conversion to bonus shares, where a match of performance shares is justified, these shares will be awarded as if income tax had not been deducted. This maintains the original design of the plan prior to the issue of guidance from HM Revenue & Customs in December 2004.
The comparator group is the same as that used for the performance share plan.
It is the Group’s policy that where compensation on early termination is due, it should be paid on a phased basis, mitigated in the event that alternative employment is secured, and that bonus payments should relate to the period of actual service, rather than the full notice period and will be determined on the basis of performance.
During 2005, Ms Dial and Mrs Weir received fees of $88,775 and £14,375 respectively, which were retained by them, for serving as non-executive directors of other companies.
Mr Ayliffe left the board on 31 January 2005. However, he remained with the Company until his employment was terminated on 31 March 2005 and was paid £71,442 for that period. Mr Hampton’s employment was terminated on 12 January 2004. Subsequently they both received payments in accordance with their contractual entitlement.
Additional Defined benefit scheme members Accrued Accrued Transfer Transfer pension pension at pension at Change in value at value at Change in earned to Transfer 31 December 31 December accrued 31 December 31 December transfer 31 December value of the
The interests, all beneficial, of those who were directors at 31 December 2005 in shares in Lloyds TSB Group were: At 1 January 2005 (or later date of At 31 December At 23 February
† The changes in beneficial interests between 31 December 2005 and 23 February 2006 related to ‘partnership’ and ‘matching’ shares acquired under the Lloyds TSB Group shareplan.
i) Market price on day of exercise was 497p. In that regard Mr Daniels made a gain of £1,077,312. This is the difference between the market price of the shares on the day on which the share option was exercised and the price paid for the shares.
j) These share options lapsed as the performance condition had not been met.
‡ Mr Ayliffe exercised this share option after he left the board. The date of exercise was 14 December 2005 and the market price of the shares on that day was 480.25p.
At the end of 2005 Lloyds TSB Group was ranked: 15th after four years of the performance period for options granted in 2002; 17th after three years of the performance period for options granted in 2003; and 8th after two years of the performance period for the options granted in 2004.
Mr Daniels was the only participant in this plan and held an option, granted to him on 2 November 2001, to acquire 216,763 ordinary shares in Lloyds TSB Group plc for a total price of £1. The option was granted as part of the remuneration package considered necessary to attract him from the USA and was designed to encourage him to remain with Lloyds TSB Group plc. The option was not subject to any performance condition and vested on 31 December 2004. Mr Daniels exercised this option on 4 March 2005. Full details of the plan were set out in the 2002 annual report.
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report and the consolidated financial statements in accordance with applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union are set out in the statement of directors’ responsibilities.
Profit attributable to minority interests 62 67 Profit attributable to equity shareholders 2,493 2,392
Maarten A van den Bergh J Eric Daniels Helen A Weir Chairman Group Chief Executive Group Finance Director 60 LLOYDS TSB GROUP
Adjustments on transition to IAS 32, IAS 39 and IFRS 4 (note 54) – 28 (1,586) (1,558) (550) (2,108)
Purchase/sale of treasury shares – – 18 18 – 18 Employee share option schemes: – value of employee services – – 47 47 – 47 – proceeds from shares issued 26 – – 26 – 26 Change in minority interests – – – – 329 329
Cash and cash equivalents comprise cash and balances at central banks (excluding mandatory deposits) and amounts due from banks with a maturity of less than three months.
Assets held for sale and discontinued The Group has no transactions prior to 1 January 2005 that are affected by the transitional requirements of IFRS 5. operations
Business combinations By electing to apply IFRS 3 on a prospective basis from 1 January 2004, the Group has not restated past acquisitions and mergers. Goodwill previously written off to reserves has not been reinstated and no additional intangible assets have been recognised in this regard.
Goodwill arising on acquisitions prior to 1 January 2004, the date of transition to IFRS, has been retained at the balance sheet amount at that date and has been tested for impairment at that date. Goodwill previously written off directly to reserves under UK GAAP has not been reinstated and will not be included in calculating any subsequent profit or loss on disposal.
Interest income and expense are recognised in the income statement for all interest-bearing financial instruments, including loans and advances, using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. The effective interest rate is calculated on initial recognition of the financial asset or liability, estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts paid or received by the Group that are an integral part of the overall return, direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument and all other premiums or discounts. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see i).
The Group receives investment management fees in respect of services rendered in conjunction with the issue and management of investment contracts where the Group actively manages the consideration received from its customers to fund a return that is based on the investment profile that the customer selected on origination of the instrument. These services comprise an indeterminate number of acts over the lives of the individual contracts and, therefore, the Group recognises these fees on a straight-line basis over the estimated lives of the contracts.
Securities sold subject to repurchase agreements (‘repos’) are reclassified in the financial statements as assets pledged when the transferee has the right by contract or custom to sell or repledge the collateral; the counterparty liability is included in deposits from banks or customer accounts, as appropriate. Securities purchased under agreements to resell (‘reverse repos’) are recorded as loans and advances to banks or customers, as appropriate. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method. Securities lent to counterparties are also retained in the financial statements.
The method of recognising the movements in the fair value of the derivatives depends on whether they are designated as hedging instruments, and if so, the nature of the item being hedged. Derivatives may only be designated as hedges provided certain strict criteria are met. At the inception of a hedge its terms must be clearly documented and there must be an expectation that the derivative will be highly effective in offsetting changes in the fair value or cash flow of the hedged risk. The effectiveness of the hedging relationship must be tested throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its objective the hedge relationship is terminated.
Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged risk are no longer recognised in the income statement; the adjustment that has been made to the carrying amount of a hedged item is amortised to the income statement over the period to maturity.
– life insurance contracts or participating investment contracts in the Group’s With-Profits Fund
A liability for contractual benefits that are expected to be incurred in the future is recorded when the premiums are recognised. The liability is calculated by estimating the future cash flows over the duration of in-force policies and discounting them back to the valuation date allowing for probabilities of occurrence. The liability will vary with movements in interest rates and with the cost of life assurance and annuity benefits where future mortality is uncertain. Assumptions are made in respect of all material factors affecting future cash flows, including future interest rates, mortality and costs.
Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when deferred in equity as qualifying cash flow hedges. Translation differences on non-monetary items, such as equities held at fair value through profit or loss, are reported as part of the fair value gain or loss. Translation differences on non-monetary items, such as equities classified as available-for-sale financial assets, are included in the fair value reserve in equity.
(iii) all resulting exchange differences are recognised as a separate component of equity.
The net liability recognised in the balance sheet in respect of the Group’s retirement benefit obligations represents the liabilities of the Group’s defined benefit pension schemes after deduction of the fair value of the related assets. The schemes’ liabilities are derived by estimating the ultimate cost of benefits payable by the schemes and reflecting the discounted value of the proportion accrued by the year end in the balance sheet. In order to arrive at this estimate a number of key financial and non-financial assumptions are made by management, changes to which could have a material impact upon the net deficit and also the net cost recognised in the income statement.
Lloyds TSB Group is a leading UK-based financial services group, whose businesses provide a wide range of banking and financial services in the UK and in certain locations overseas.
Year ended 31 December 2005 £m £m £m £m £m £m £m £m
Year ended 31 December 2004 £m £m £m £m £m £m £m £m
Total income, net of insurance claims 4,924 334 1,201 1,535 3,564 (362) – 9,661
4 Net interest income 2005 Average effective interest rate 2005 2004 % £m £m
Foreign exchange translation gains 13 22 Gains on foreign exchange trading transactions 150 152
The table below reflects the insurance premiums, substantially all of which relate to business written in the United Kingdom, broken down into life insurance and non-life insurance: £m £m
Operating lease rental income 433 422 Income from investment property 272 158 Other rents receivable 30 32 Gains less losses on disposal of available-for-sale financial assets, net of allowances for impairment 5 Gains less losses on disposal of investment securities, net of amounts written off 74 Movement in value of in-force insurance business (note 26) 162 16 Other income 238 155
Changes in non-life insurance policyholder liabilities: – Reinsurers’ share – –
Life insurance gross claims can also be analysed as follows: A non-life insurance claims development table is included in note 34.
Professional fees 216 222 Provisions for customer remediation (note 40) 150 112
The average number of persons on a headcount basis employed by the Group during the year was as follows: During the year the auditors earned the following fees: 2005 2004 £m £m
The auditors’ remuneration for the holding company was £57,000 (2004: £51,500).
11 Impairment losses on loans and advances 2005 2004 £m £m
12 Profit (loss) on sale and closure of businesses 2005 2004 £m £m
The businesses sold in 2004 and 2005 were not material to the Group, and consequently they have not been treated as discontinued operations.
Tax charge thereon at UK corporation tax rate of 30% 1,146 1,043 Factors affecting charge: Disallowed and non-taxable items (47) (32) Overseas tax rate differences (1) (14) Net tax effect of disposals and unrealised gains (59) (2) Tax deductible coupons on non-equity minority interests – (12) Policyholder tax and Open Ended Investment Companies 223 33 Other items 3 2
Profit attributable to equity shareholders £2,493m £2,392m Weighted average number of ordinary shares in issue 5,595m 5,590m Basic earnings per share 44.6p 42.8p
LLOYDS TSB GROUP 79 15 Treasury bills and other eligible bills
Balance sheet carrying value – treasury bills and other eligible bills 92
Derivatives designated as cash flow hedges: Interest rate swaps 648 5 23
At 31 December 2004, the fair value amounts shown above were included on the balance sheet within other assets and other liabilities (see notes 30 and 37). The maturity of the notional principal amounts and replacement cost of trading instruments entered into with third parties was: Under 1 year 1 to 5 years Over 5 years Total £m £m £m £m
Total 18 Loans and advances to banks 2005 2004 £m £m
The Group holds collateral with a fair value of £6,381 million, which it is permitted to sell or repledge, of which £5,550 million was repledged or sold to third parties for periods not exceeding three months from the transfer.
Allowance for impairment losses (note 20) (2,072) (1,662) Interest held in suspense (21)
The Group holds collateral with a fair value of £1,018 million, which it is permitted to sell or repledge, of which £741 million was repledged or sold to third parties for periods not exceeding three months from the transfer.
Unearned future finance income on finance leases (2,954) (4,021) Rentals received in advance (200) (338) Commitments for expenditure in respect of equipment to be leased (117) (196)
Restated balance at 1 January 1,919 Exchange and other adjustments 1 (8) (3) (11) Reclassifications 43 – – – Adjustments on acquisitions and disposals (27) (21) (12) (33) Advances written off (1,236) (1,028) – (1,028) Recoveries of advances written off in previous years 158 174 – 174 Effect of unwinding of discount recognised through interest income (87) Charge (release) to the income statement 1,302 953 (87) 866
As at 31 December 2004 (prior to the implementation of IAS 32 and IAS 39 on 1 January 2005) debt securities were shown separately on the balance sheet. This balance sheet caption comprised both investment securities and other securities. Investment securities were those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. At 31 December 2005, debt securities are categorised as either trading securities and other financial assets at fair value through profit or loss (note 16) or available-for-sale financial assets (note 23).
As at 31 December 2004 (prior to the implementation of IAS 32 and IAS 39 on 1 January 2005) equity shares were shown separately on the balance sheet. This balance sheet caption comprised both investment securities and other securities. Investment securities were those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. At 31 December 2005, equity shares are categorised as either trading securities and other financial assets at fair value through profit or loss (note 16) or available-for-sale financial assets (note 23).
The movement in available-for-sale financial assets is summarised as follows: Carrying value Balance sheet before provisions Provisions value £m £m £m
Capital expenditure in respect of investment properties: 2005 2004 £m £m
The goodwill held in the Group’s balance sheet is tested at least annually for impairment. For the purposes of impairment testing the goodwill is allocated to the appropriate cash generating unit; of the total balance of £2,373 million (2004: £2,469 milllion), £1,836 million (or 77 per cent of the total) has been allocated to Scottish Widows and £517 million (or 22 per cent of the total) to Asset Finance.
Further information on the Group’s life assurance businesses, including its available capital resources and regulatory capital requirements, the realistic value of its assets and liabilities and its capital sensitivities is given in note 34 and on pages 35 to 38.
* For acquisitions made prior to 1 January 2004, the date of transition to IFRS, cost is included net of amounts amortised up to 31 December 2003.
The process for determining the key assumptions used in the calculations of the value of in-force business is set out below.
Accumulated depreciation: Charge for the year 18 22 Disposals – (5)
Balance sheet amount at 31 December 2005 820 871 2,600 4,291
The breakdown of deposits from banks between the domestic and international offices of the Group is set out below: £m £m
International: Non-interest bearing 24 31 Interest bearing 6,691 6,498 £m £m
The Group’s With-Profits Fund contains life insurance contracts and participating investment contracts. The calculation of With-Profits realistic liabilities uses best estimate assumptions for mortality and morbidity, persistency rates and expenses. These are calculated in a similar manner to those used for the value of the in-force business as discussed in note 26.
Investment volatility is derived from derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. For example, as at 31 December 2005, the 10 year equity-implied at-the-money assumption was set at 20.0 per cent (31 December 2004: 18.0 per cent). The long-term at-the-money assumptions for property and fixed interest stocks were 15.0 per cent (31 December 2004: 15.0 per cent) and 13.5 per cent (31 December 2004: 13.0 per cent) respectively.
The following table demonstrates the effect of changes in key assumptions on profit before tax assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts: Reduction (increase)
Change in before tax (Participating in profit variable (Insurance) Investment) before tax
Non-life insurance contract liabilities are analysed by line of business as follows: 2005 2004 £m £m
Claims and loss adjustment expenses Gross Reinsurance Net £m £m £m
Cash paid for claims settled in the year (221) – (221) Increase in liabilities: – arising from current year claims 239 – 239 – arising from prior year claims (12) – (12)
– two years later 184 228 223 – – – three years later 181 224 – – – – four years later 179 – – – –
Liability recognised in the balance sheet 7 3 17 17 88 132
The movement in liabilities arising from gross non-participating investment contracts may be analysed as follows: £m
At 31 December 2004 Adjustments to reflect the implementation of IAS 32, IAS 39 and IFRS 4 16,361
The movement in the unallocated surplus within long-term insurance business over the year can be analysed as follows: £m
Adjustments to reflect the implementation of IAS 39 and FRS 27 (936)
Settlement balances 779 134 Unitholders’ interest in OEICs 3,296 2,680 Derivative financial instruments (see note 17) 5,943 Other creditors and accruals 5,768 5,700 38 Retirement benefit obligations
The principal financial assumptions used in the scheme valuations were as follows: 2005 2004
Rate of inflation 2.70 2.60 Rate of salary increases 3.98 4.14 Rate of increase for pensions in payment and deferred pensions 2.50 2.60 Discount rate 4.80 5.30
Life expectancy for member aged 60, 15 years after the valuation date
The amounts recognised in the balance sheet are as follows: 2005 2004 £m £m
The amounts recognised in the income statement are as follows: 2005 2004 £m £m
Current service cost 292 280 Interest cost 775 728 Expected return on scheme assets (839) (757) Past service cost 15 17
Equities 8.0 UK fixed interest gilts 4.1 UK index linked gilts 3.9 Sterling non-government bonds 4.8 Property 6.4 Cash 3.7
Deferred tax assets of £526 million (2004: £527 million) have not been recognised in respect of capital losses carried forward as there are no predicted future capital profits. Capital losses can be carried forward indefinitely.
In addition, deferred tax assets have not been recognised in respect of Eligible Unrelieved Foreign Tax (‘EUFT’) and other foreign tax credits carried forward as at 31 December 2005 of £88 million (2004: £32 million), as there are no predicted future taxable profits against which the unrelieved foreign tax credits can be utilised. EUFT can be carried forward indefinitely.
* In certain circumstances, these notes, bonds and securities would acquire the characteristics of preference share capital. Any repayments of undated loan capital would require the prior consent of the Financial Services Authority. They are accounted for as liabilities as coupon payments are mandatory as a consequence of the terms of certain preference shares.
d) In certain circumstances the interest payments on these securities can be deferred although in this case Scottish Widows plc cannot declare or pay a dividend until any deferred payments have been made.
e) Issued by a group undertaking under the Company’s subordinated guarantee.
f) At the callable date the coupon on these notes will be reset by reference to the applicable five year benchmark gilt rate.
US dollars US$m 160 million Preference shares of US$25 cents each* 40
Japanese yen ¥m 50 million Preference shares of ¥25 each* 1,250
k) At 31 December 2004, prior to the implementation of the prospective standards IAS 32 and IAS 39 from 1 January 2005, these instruments were classified as minority interests (see note 48).
Cash flow hedging reserve At 1 January 2005 (following implementation of IAS 32 and IAS 39) – Change in fair value of hedging derivatives 4 Deferred tax thereon (1)
Restatement on implementation of IAS 32, IAS 39 and IFRS 4 (1,586)
The directors have proposed a final dividend of 23.5 pence per share (2004: 23.5 pence per share) representing a total cost of £1,316 million (2004: 1,315 million) which will be paid on 3 May 2006.
March 1997 – August 1999 As for March 1996, plus a further condition 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.
In 2001, the Group adopted the Lloyds TSB Group plc Share Retention Plan. Options granted under this scheme are not subject to any conditions other than to remain employed by the Group for three years.
The weighted average fair value of options granted in the year was £4.18 (2004: £3.69). No options outstanding at 31December were exercisable. The weighted average remaining contractual life of options outstanding at the end of the year was 1.9 years (2004: 3.0 years).
Outstanding at 1 January – – Granted during the year 242,825 Nil
Outstanding at 1 January – Granted during the year 854,116 Forfeited (27,678)
Risk-free interest rate 4.73% 4.61% 4.41% Expected life 4.8 years 4.1 years 2.8 years
The charge to the income statement is set out below: 2005 2004 £m £m
Euro Step-up Non-voting Non-cumulative Preferred Securities callable 2012 (c430 million)* 302 Sterling Step-up Non-voting Non-cumulative Preferred Securities callable 2015** 248
Granted (including options of appointed directors) 3 5 Exercised/lapsed (including options of retired directors) (3) (3)
The loans are on both a secured and unsecured basis and are expected to be settled in cash. The loans attracted interest rates of between 4.6 per cent and 17.9 per cent in 2005 (2004: 5.4 per cent and 17.9 per cent).
No provisions have been recognised in respect of loans given to key management personnel (2004: nil).
Deposits placed by key management personnel attracted interest rates of up to 4.5 per cent (2004: 4.8 per cent).
Details of the principal subsidiaries are given in note 7 to the parent company financial statements. In accordance with IAS 27 transactions and balances with subsidiaries that have been eliminated on consolidation are not reported.
The Group manages 86 (2004: 76) Open Ended Investment Companies (‘OEICs’), and of these 36 (2004: 47) are consolidated. The Group invested £345 million (2004: £131 million) and redeemed £265 milllion (2004: £164 million) in the unconsolidated OEICs during the year and had investments, at fair value, of £2,074 million (2004: £1,415 million) at 31 December. The Group earned fees of £85 million from the unconsolidated OEICs (2004: £78 million). The company held no investments in OEICs at any time during 2004 or 2005.
The Group has a number of venture capital associates that it accounts for at fair value through profit or loss. At 31 December 2005, these companies had total assets of approximately £1,194 million (2004: £1,095 million), total liabilities of approximately £1,072 million (2004: £968 million) and for the year ended 31 December 2005 had turnover of £1,782 million (2004: £1,551 million) and made a net profit of approximately £36 million (2004: £42 million). In addition, the Group has provided £363 million (2004: £335 million) of financing to these companies on which it received £19 million (2004: £13 million) of interest income in the year.
Commitments Documentary credits and other short-term trade-related transactions 283 431 Forward asset purchases and forward deposits placed 277 1,654 Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year maturity 55,310 59,085 1 year or over maturity 24,123 20,009
Operating lease payments represent rental payable by the Group for certain of its properties. Some of these operating lease arrangements have renewal options and rent escalation clauses, although the effect of these are not material. No arrangements have been entered into for contingent rental payments.
The Group uses financial instruments (including derivatives) to meet the financial needs of its customers, as part of its trading activities and to reduce its own exposure to fluctuations in interest and exchange rates.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group’s management of these risks is given on pages 24 to 34, with further disclosure provided below.
The table below summarises the repricing mismatches of the Group’s financial assets and liabilities. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date.
As at 31 December 2005 Assets Trading securities and other financial assets at fair value through profit or loss 1,734 2,418 1,035 3,796 17,886 33,505 60,374 Derivative financial instruments* – – – – – 5,878 5,878 Loans and advances to banks 25,107 2,483 2,923 370 57 715 31,655 Loans and advances to customers 72,912 17,048 20,327 51,044 13,594 19 174,944 Available-for-sale financial assets 1,695 8,674 1,221 1,497 1,678 175 14,940
Derivative financial instruments which are exposed to interest rate risk are carried in the balance sheet at fair value and for the purposes of this analysis have been treated as non-interest bearing.
51 Financial risk management (continued) 3 months 1 year 5 years or less or less or less Non1 month but over but over but over Over interest or less 1month 3 months 1 year 5 years bearing Total £m £m £m £m £m £m £m
At 31 December 2005, the maximum credit risk exposure of the Group in the event of other parties failing to perform their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss is considered to be the instruments’ balance sheet carrying amount or, for non-derivative off-balance sheet transactions, their contractual nominal amounts. 2005 £m
Trading securities and other financial assets at fair value through profit or loss 26,869
Deposit amount available for offset and amounts available for offset under master netting arrangements do not meet the criteria under IAS 32 to enable loans and advances and derivative assets respectively to be presented net of these balances in the financial statements.
See note 50 – Contingent liabilities and commitments for further information.
Liabilities arising from insurance and investment contracts 1,030 359 1,263 9,502 50,753 62,907
Fair values represent open-market values determined by an independent, professionally qualified valuer.
Financial assets Treasury bills and other eligible bills – investment securities 88 90
– other securities 29,117 29,117 Equity shares – investment securities 41 65
Derivative financial instruments and other trading liabilities 6,396 6,396 Debt securities in issue 39,346 28,770 39,352 28,477 Liabilities arising from non-participating investment contracts 21,839 21,839 52 Acquisitions
c Analysis of changes in cash and cash equivalents during the year 2005 2004 £m £m
Net cash (outflow) inflow before adjustments for the effect of foreign exchange movements (1,423) 8,777 Effect of foreign exchange movements (20) (14)
The amounts shown as cash inflows from financing include proceeds in respect of the above issues of share capital together with a net cash inflow in 2004 of £1 million relating to transactions in own shares held in respect of employee share schemes.
Net cash outflow from acquisitions in the year* 16 – Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 11 15 Deferred consideration in respect of acquisition in 2002 – 1
The consideration of £16 million in respect of these acquisitions was settled in cash in 2005 (see note 52).
Other intangible assets – 9 Deposits by banks – (42) Customer accounts – (327) Debt securities in issue – (111) Other net assets and liabilities (946) 9
Net cash outflow from disposals in the year – (25) Adjustment to consideration received in respect of prior period disposals (4) –
IFRS requires income from finance leases to be credited to the income statement to give a constant pre-tax rate of return on the net investment in the lease; UK GAAP required a constant post-tax rate of return. In addition, IFRS requires depreciation on operating lease assets to be charged on the same basis as for other tangible fixed assets, which for the Group is a straight-line basis. Under UK GAAP depreciation was charged so as to give a constant rate of return on the leased asset.
Under IFRS the Group moved from immediate recognition of up-front fees received for investment management services to recognising them on a straight-line basis over the estimated lives of the investment contracts.
Under UK GAAP the Group’s accounting policy was to amortise goodwill arising on acquisitions after 1 January 1998, with the exception of goodwill which arose on the acquisition of Scottish Widows. Under IFRS all goodwill recognised in the UK GAAP balance sheet at 1 January 2004 is carried forward without adjustment in the balance sheet and is now subject to impairment testing annually, or more frequently if events or circumstances indicate that it might be impaired.
Under IFRS equity dividends declared after the balance sheet date may not be included as a liability at the balance sheet date.
IFRS adopts an incurred loss model for impairment losses on loans and provides guidance on the measurement of impairment. Any provision required is calculated by comparing the book value of the loans with the net present value of the expected future cash flows from the loans discounted at their effective interest rates or, as a practical expedient for variable rate loans, using observable market prices. The impairment principles under IFRS are similar to those followed by the Group under UK GAAP, with the exception of the requirements to discount the expected cash flows at the original effective interest rate when determining the provisioning requirement.
LLOYDS TSB GROUP 115 54 Adoption of International Financial Reporting Standards (continued)
IFRS 4 applies to contracts under which the insurer agrees to compensate the policyholder if a specified uncertain future event adversely affects the policyholder as well as to investment contracts which entitle the holder to receive additional discretionary benefits depending on performance. For contracts within the scope of IFRS 4, accounting practices are largely unchanged except for the modifications introduced by FRS 27 which is dealt with separately below.
Changes to reconciliations published on 27 May 2005: Except as noted below, the accounting policies adopted in the preparation of the 2005 results are unchanged from those disclosed in the Group’s announcement setting out the effects of the implementation of IFRS and FRS 27 published on 27 May 2005.
Subordinated liabilities 10,454 – – – – – – – – – 10,454 Long-term assurance liabilities to policyholders 50,078 (50,078) – – – – – – – – –
Share capital 1,418 – – – – – – – – – 1,418
Share premium account 1,136 – – – – – – – – – 1,136
Restated consolidated balance sheet (reconciliation of equity) at 31 December 2004 (excludes effects of IAS 32, IAS 39 and IFRS 4)
Items in the course of collection from banks 1,462 – – – – – – – – – 1,462
Loans and advances to banks 23,565 5,836 2,447 – – – – – – – 31,848
Loans and advances to customers 154,240 (99) 1,339 (162) – – – – – – 155,318
Equity and liabilities £m £m £m £m £m £m £m £m £m £m £m
Insurance contract liabilities – 52,350 – – – – – – – (61) 52,289
Long-term assurance liabilities to policyholders 54,764 (54,764) – – – – – – – – –
Insurance premium income 554 5,516 – – – – – – – 6,070
Total income, net of insurance claims 9,343 372 15 (19) (39) – 31 – (42) 9,661
Depreciation of property, plant and equipment (589) (12) – (15) – (22) – – – (638)
Impairment losses on loans and advances (866) – – – – – – – – (866)
Amounts written off fixed asset investments (52) – – – – – – – 52 –
Treasury bills and other eligible bills 92 (92) – – – – – – – –
Loans and advances to banks 31,848 – 3 – – – – – – – 31,851
Loans and advances to customers 155,318 (337) 108 (314) 6,287 95 – – – 5 161,162
Equity shares 27,310 (27,310) – – – – – – – –
Available-for-sale financial assets 14,385 – – – 175 33 – – – 14,593
Fixed assets 4,180 – – – – – – – – – 4,180
Deposits from banks 39,723 – – – – – – – – – 39,723
Liabilities to customers under investment contracts 16,354 – – – – – 7 – – 16,361
The following pronouncements will be relevant to the Group but were not effective at 31 December 2005 and have not been applied in preparing these financial statements.
Amendment to IAS 39 Financial Instruments: Recognition and Measurement – The Fair Value Option
Consolidates the current financial instruments disclosures into a single standard and requires more detailed qualitative and quantitative disclosures about exposure to risks arising from financial instruments.
To the members of Lloyds TSB Group plc We have audited the parent company financial statements of Lloyds TSB Group plc for the year ended 31 December 2005 which comprise the balance sheet, the cash flow statement, the statement of changes in equity and the related notes. These parent company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the directors’ remuneration report on pages 46 to 57 that is described as having been audited.
Opinion In our opinion: • the parent company financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union as applied in accordance with the provisions of the Companies Act 1985, of the state of the parent company’s affairs as at 31 December 2005 and cash flows for the year then ended; and
• the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation.
Non-current liabilities: Current liabilities: Current tax liabilities 5 7 Amounts owed to subsidiaries 1,692 1,741 Other liabilities 79 100
The directors approved the parent company accounts on 23 February 2006.
Employee share option schemes: – value of employee services – 19 19
Adjustments on transition to IAS 32 and IAS 39 – 30 30
Profit before tax 1,882 1,894 Profit on disposal of subsidiary – (1) Dividend income (1,913) (1,913) Fair value adjustment 9 – Change in other assets (72) – Change in other liabilities (44) (24) Tax paid 12 (122)
With effect from 1 January 2005 the Company implemented the requirements of IAS 39 ‘Financial instruments: Recognition and Measurement’. As a result, certain financial assets and liabilities valued at amortised cost are now carried at fair value with a consequential adjustment being made to the deferred tax balance.
Profit for the year 1,928 Dividends (1,913) Purchase/sale of treasury shares 9 Employee share option schemes: value of employee services 19
Notes to the parent company accounts 8 Adoption of International Financial Reporting Standards
The impact for the parent company in respect of the accounting for dividends, derivatives and hedging instruments is the same as for the Group, as set out in note 54 to the consolidated accounts.
Set out below are explanations and reconciliations showing the effect of the adoption of IFRS upon the parent company’s previously published financial information.
Restated parent company balance sheet (reconciliation of equity) at 1 January 2004 (excludes the effect of IAS 32 and IAS 39)
Investment in subsidiaries 11,080 – (5,491) – – 5,589 Loans to subsidiaries 1,723 – – – – 1,723 Deferred tax assets – 9 – – 6 15
Share capital 1,419 – 1,419 Share premium account 1,145 – 1,145
The parent company financial statements were approved by the directors of Lloyds TSB Group plc on 23 February 2006.
In addition to listings in the financial pages of the press, the latest price of Lloyds TSB shares on the London Stock Exchange can be obtained by telephoning 0906 877 1515. These telephone calls are charged at 55p per minute, including VAT. Visit www.londonstockexchange.com for details.
For postal dealing, the current rate for both purchases and sales is 0.75%: no minimum. For full details, contact Lloyds TSB Registrars on: American Depositary Receipts (ADRs)
The Company provides a facility for investing in Lloyds TSB shares through an ISA. For details contact Retail Investor Operations, Lloyds TSB Registrars, The Causeway, Worthing, West Sussex BN99 6UY. Telephone 0870 242 4244.
Contact them if you have enquiries about your Lloyds TSB shareholding, including those concerning the following matters: • change of name or address
Final date for joining or leaving the dividend reinvestment plan for the final dividend 3 May
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