Examples of such forward looking statements include, but are not limited to, projections or expectations of profit attributable to shareholders, provisions, economic profit, dividends, capital structure or any other financial items or ratios; statements of plans, objectives or goals of Lloyds TSB Group or its management; statements about the future trends in interest rates, stock market levels and demographic trends and any impact on Lloyds TSB Group; statements concerning any future UK or other economic environment or performance including in particular any such statements included in this annual report; statements about strategic goals, competition, regulation, dispositions and consolidation or technological developments in the financial services industry and statements of assumptions underlying such statements.
Profit before tax increased by £343 million, or 10 per cent, to £3,820 million.
Profit attributable to equity shareholders increased by £101 million, or 4 per cent, to £2,493 million.
Post-tax return on average shareholders’ equity increased to 25.6 per cent, from 22.8 per cent.
Results – comparable basis Profit before tax increased by £146 million, or 4 per cent, to £3,466 million.
– Before provisions for customer redress and strengthening of reserves for mortality 908 790
Earnings per share 44.6p 42.8p * Volatility relates to Insurance and Investments (2005: £749 million, 2004: £138 million) and Central group items (2005: £(124) million, 2004: nil).
** Other IFRS adjustments applied from 1 January 2005 relate to UK Retail Banking (£(213) million), Insurance and Investments (£(73) million), Wholesale and International Banking (£20 million) and Central group items (£(55) million).
†† Trading results of discontinued operations in 2004 relates to Wholesale and International Banking.
2005 was a successful year for the Lloyds TSB Group, as we continue to build our business and deliver good earnings momentum. Each division has again delivered revenue growth in excess of cost growth, costs have remained firmly under control and overall credit quality has remained satisfactory. Above all the Group has made substantial progress in the execution of its organic growth strategy focused on improving and deepening relationships with our personal and business customers.
Over the last two years the changes that have been introduced by the Group’s new management team have addressed the significant external challenges of competition and regulation and have substantially improved the outlook for the Group. There is plenty of scope for organic growth in our chosen markets and our aim is to attract more of the business that our customers have with other financial services companies. We want to be the most successful company in the UK financial services industry.
I am proud of what this Group has achieved in a very short space of time; wherever I go in the business we are making substantial progress.
Whilst the economic outlook for the UK remains dependent on events that unfold in the global economy, we expect economic growth to increase slightly in 2006 to just over 2 per cent. Interest rate changes are expected to remain modest. Consumer spending, which was the major factor behind the economic slowdown in the UK in 2005, is showing some signs of recovery, although we expect only a modest recovery during 2006. The mortgage market should remain reasonably healthy, although personal borrowers are expected to continue to cut back on unsecured borrowing.
During 2005 Lloyds TSB has continued to maintain robust capital ratios and remains one of the very few banks in the world with an ‘Aaa’ long-term debt rating from Moody’s, the credit rating agency. In addition, Scottish Widows remains one of the strongest capitalised life assurance companies in the UK, and the repatriation of £1 billion of surplus capital from Scottish Widows to the Group during 2005 shows the significant improvements that have been made in the capital management of Scottish Widows over the last few years.
Lloyds TSB remains one of the UK’s largest corporate givers, principally through the excellent work of the Lloyds TSB Foundations who made grants to charities of over £30 million in 2005.
The Lloyds TSB Group is all about people and in my five and a half years as chairman I have enjoyed meeting so many of them.
Throughout our businesses, our employees are the Group’s ambassadors – I am extremely proud of them all and am truly grateful for their continuing efforts, without which the Group could not have made such considerable recent progress. We are a service company and I am certain that improved levels of customer service will lead to improved sales performance.
As previously announced, I shall be retiring as chairman at the annual general meeting in May and I am delighted that Sir Victor Blank will be succeeding me. He will join the board in March as Deputy Chairman. The board carefully considered the provisions of the combined code on corporate governance when nominating Sir Victor as my successor.
LLOYDS TSB GROUP 7 2005 was a good year for the Group, both in terms of our financial performance and, as importantly, in making further progress in the development of our organic growth strategy.
We have significantly enhanced our productivity, as the quality programmes that we commenced in 2003 continue to show improving results. This is reflected in our cost:income ratio which, on a comparable basis and excluding customer redress provisions and the strengthening of reserves for mortality, improved to 52.7 per cent, from 54.3 per cent in 2004, and I am pleased that we have achieved this whilst continuing to invest substantially in the business. Our customer satisfaction scores hit record highs in 2005, again reflecting the improvement programmes established over the last couple of years, and we will continue to drive further improvements as we seek to differentiate our service performance against that of our competitors.
In the Retail Bank, income grew 4 per cent whilst costs rose by just 1 per cent, on a comparable basis and excluding customer redress provisions. This led to 7 per cent growth in the trading surplus which was offset by an increase in the charge for impaired lending, reflecting an increase in customers experiencing repayment difficulties. Profit before tax reduced by 3 per cent. To reflect the general slowdown in the consumer credit markets, a number of actions were taken over the course of the year to tighten credit underwriting.
Scottish Widows delivered a significant increase in sales as we focused on more profitable and more capital efficient business lines. This led to a 19 per cent increase in new business contribution. Bancassurance sales grew by 13 per cent despite a slowdown seen in the levels of mortgage related protection business. The sales of OEICs increased by 72 per cent, building on the launch of the simplified product suite that was introduced at the end of 2004.
In Business Banking, we have again reported strong franchise growth winning increasing numbers of new customers both through attracting profitable ‘switchers’ from other banks and by cementing our position as the leader in the business start-ups market with a share of 22 per cent. We have continued to build stronger relationships with our customers, as we satisfy more of their needs, and this has been reflected in good balance growth in both customer lending and deposits, as well as fee income.
Turning to 2006, our objective across each of the divisions is to continue to improve sales performance and deepen our customer relationships, which will result in market share growth. To support our efficiency and productivity objectives, we will continue to focus on the centralisation and industrialisation of our manufacturing capabilities, take the next steps in our procurement programme and further embed our quality approach throughout the Group.
We are committed to deepening relationships with our customers by understanding and meeting their needs. We measure our customers’ satisfaction with our service and track our progress through our ‘CARE Index’ which is based on information obtained from over 10,000 interviews with customers each month. The ‘CARE Index’ reached its highest ever level in 2005.
Staff performance is measured using a balanced scorecard that takes account of the needs of customers, employees and shareholders. All staff have objectives which, in addition to financial performance measures, include building the business in the longer term, customer service, risk management and people development. Where relevant, management remuneration and incentives are linked directly to specific areas of corporate responsibility, such as service quality.
We have been developing a management framework for corporate responsibility that ensures we have: • a clear and constant purpose, helping us to focus on the delivery of results; • a focus on customers and how we can create value by better meeting their needs; • a systematic application of processes and fact-based assessments to manage our business and to make our strategic decisions; • the ability to identify what we need to do to develop our people and maximise their potential; • the scope to derive value from meeting our responsibilities to the communities we serve.
We have adopted the European Foundation of Quality Management’s Corporate Responsibility Framework. This helps us align corporate responsibility with business strategy, and also with individual balanced scorecard priorities. As part of the process we conduct an annual self-assessment of our performance with independent oversight and assurance.
Through one of the largest community investment programmes in the UK, we are able to make a significant contribution to the local communities in which we operate. The majority of Lloyds TSB’s charitable giving is channelled through the four Lloyds TSB Foundations, which cover England and Wales, Scotland, Northern Ireland and the Channel Islands. Their mission is to improve the lives of people in local communities, especially those who are disadvantaged or disabled.
More information on all of the above issues is available in the Group’s 2005 corporate responsibility report and there are details of how to obtain a copy on page 129.
Telephone banking. Telephone banking continues to grow and Lloyds TSB Group now provides one of the largest telephone banking services in Europe. At the end of 2005, some 4.2 million customers had registered to use the services of PhoneBank and the automated voice response service, PhoneBank Express. Lloyds TSB Group’s telephone banking centres handled some 69 million calls during 2005.
General insurance. Lloyds TSB General Insurance provides general insurance through the retail branches of Lloyds TSB Bank and Cheltenham & Gloucester, and through a direct telephone operation and the internet. Lloyds TSB General Insurance is one of the leading distributors of household insurance in the UK.
Asset Finance. Lloyds TSB Group’s asset finance businesses provide individuals and companies with finance through leasing, hire purchase and contract hire packages. Through its invoice discounting and factoring subsidiary, Lloyds TSB Commercial Finance, Lloyds TSB Group provides working capital finance for its customers. Specialist personal lending, store credit and the Dutton-Forshaw motor dealerships complete this group of businesses. Altogether Asset Finance has over 1.7 million individual customers and relationships with some 40,000 companies and small businesses.
On a comparable basis, profit before tax increased by £146 million, or 4 per cent, to £3,466 million (2004: £3,320 million). Excluding the impact of customer redress provisions and the strengthening of reserves for mortality, profit before tax increased by 9 per cent to £3,726 million. Income increased by 7 per cent whilst costs grew by only 4 per cent. Earnings per share increased by 11 per cent to 47.2p. The post-tax return on shareholders’ equity increased to 23.3 per cent (2004: 22.2 per cent) and economic profit rose by 14 per cent to £1,620 million.
This programme of efficiency improvement initiatives is expected to deliver gross benefits of £275 million per annum for an initial investment of less than £200 million, of which £40 million was charged in 2005. This will continue to improve the Group’s cost:income ratio whilst allowing substantial scope to re-invest in the business. From 2007 onwards we expect the Group’s profit before tax to be increased by approximately £100 – £150 million per annum as a result of this programme of cost saving initiatives.
We expect a further deterioration in the retail credit environment in the first half of 2006 however, as a result of the improved quality of new business written in the last 12 months, we expect greater stability in the second half of 2006. In Wholesale Markets, impairment levels have remained low throughout 2005 and the outlook for corporate lending remains good, although we expect a return to more normal levels of impairment over time.
Following the publication of revised annuitant mortality tables and consultation on future mortality projections by the actuarial profession’s Mortality Committee, the Group has reviewed the annuitant mortality assumptions used in its life assurance businesses. While the actuarial profession is still consulting on the adoption of the new projections, the Group has decided to strengthen its mortality related reserves by £155 million (£110 million on a comparable basis).
• Higher impairment charge reflecting marketwide deterioration in retail credit quality as a result of more customers, with higher levels of indebtedness, experiencing repayment difficulties.
Trading surplus 908 787 Impairment losses on loans and advances – credit – 3
Profit before tax, excluding customer redress provisions and strengthening of reserves for mortality 908 790 Provisions for customer redress – (12) Strengthening of reserves for mortality (110) –
* Excluding customer redress provisions and strengthening of reserves for mortality 18 LLOYDS TSB GROUP
Pre-tax profit, on a comparable basis, from Scottish Widows Investment Partnership (SWIP) increased to £16 million, compared with £8 million in 2004, reflecting improved market performance and increased revenues from new business. SWIP won £4.4 billion of gross new business in 2005, an increase of 110 per cent on 2004, and its assets under management increased by 16 per cent to £95 billion. Overall investment performance during 2005 has continued to improve. Group wide funds under management increased by 12 per cent to £121 billion.
Net operating income improved by £26 million, as growth in income from home and motor business was partly offset by reduced broking commission from loan protection insurance, reflecting the slowdown in unsecured consumer lending growth during 2005 and lower health premiums following the transfer of the Group’s private medical insurance business to BUPA during 2004. Good progress has also been made in building the Group’s corporate partnering capability with a new distribution agreement secured with MORE TH>N during 2005.
• Positive jaws. Income growth of 10 per cent exceeded cost growth of 7 per cent. Continued investment in people and systems to support new product capabilities.
• Low levels of impairment as a result of high corporate liquidity and a continued strong level of recoveries. Impairment charge reduced by 20 per cent.
• Good progress in delivering the strategy to build an integrated wholesale bank for corporate markets. 17 per cent increase in Corporate Markets’ trading surplus, and 31 per cent increase in profit before tax.
• Good new business growth in Asset Finance with trading surplus up 12 per cent. However, higher levels of retail impairment resulted in a fall of 9 per cent in profit before tax.
The charge for impairment losses on loans and advances decreased by £45 million, or 20 per cent, to £185 million, as a result of lower provisions and a good level of recoveries from the corporate lending portfolio, partially offset by higher charges in the Asset Finance business.
In Corporate Markets, profit before tax grew by 31 per cent, from £732 million in 2004, to £958 million, driven by a combination of higher income and a reduction in impairment losses. Income increased by 15 per cent, including higher levels of cross-selling income which increased by 27 per cent reflecting our increased customer focus and integration across the business. Income growth was strong in both relationship and transactional business. Customer relationships continue to be deepened, and there has been considerable investment in the business to broaden origination, distribution and portfolio management capabilities. This has included the build up of new credit structuring and loan trading teams and the launch of a variety of new products.
Profit before tax in Asset Finance decreased by 9 per cent to £219 million, largely reflecting higher impairment losses, which offset the continued development of the motor and leisure, and contract hire businesses. Income increased by £71 million, or 8 per cent, leading to a 12 per cent growth in the trading surplus. New business has increased by 7 per cent in the personal and retail finance business. Lloyds TSB Commercial Finance has continued to grow strongly with a 19 per cent market share, measured by client numbers, and the motor and leisure business continues to be the largest independent lender in the UK motor and leisure point of sale market with a market share of 18 per cent.
In International Banking, profit before tax increased by £13 million, or 11 per cent, to £133 million. This reflects a reduction in costs and lower impairment provisions which offset a £12 million, or 3 per cent, reduction in income as a result of lower earnings on retained capital following the repatriation of offshore capital to the Group.
Loss before tax (367) (350) Volatility (124) – Other IFRS adjustments applied from 1 January 2005 (55) – Loss on sale and closure of businesses (20) –
The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly disabled and disadvantaged, to play a fuller role in society. The Foundations receive 1 per cent of the Lloyds TSB Group’s pre-tax profit after adjusting for gains and losses on the disposal of businesses and pre-tax minority interests, averaged over three years, instead of a dividend on their shareholdings. In 2005, £34 million was accrued for payment to registered charities.
In accordance with IFRS, it is the Group’s policy to recognise all derivatives at fair value. The banking businesses manage their interest rate and other market risks primarily through the use of intra-Group derivatives, with the resulting net positions managed centrally using external derivatives. IFRS does not, however, permit the intra-Group derivatives to be used in a hedge relationship for reporting purposes. Although fair value accounting can have a significant impact on reported earnings, it does not impact on the business fundamentals or cash flows of the businesses. The Group has, therefore, implemented an internal pricing structure that allows divisions to transfer to central group items the volatility associated with marking to market derivatives held for risk management purposes. ‘Banking volatility’ is principally comprised of the difference between the result that would be recognised on an accrual accounting basis for derivatives held for risk management purposes and their mark to market value. The Group has set up a central hedging function to reduce the impact of this volatility by establishing, where possible, accounting hedge relationships for the external derivatives.
Risk-adjusted discount rate (net of tax) 7.02 7.40 Return on equities (gross of tax) 6.72 7.17 Return on fixed interest securities (gross of tax) 4.12 4.57 Expenses inflation 3.79 3.76
The model seeks to provide the Group with an effective mechanism for developing and embedding risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also facilitates effective communication on these matters across the Group. These arrangements enable the Group to anticipate and pre-empt risks better, and to manage more effectively those risks which crystallise.
The Group has revised the risk language during the year such that all risks are classified within one of six primary risk drivers. These are further broken down into thirteen enterprise wide risk management (EWRM) risk types to enable more detailed review and facilitate appropriate reporting and analysis of root causes, as set out below.
• Detailed group policy – detailed policy that applies across the Group (agreed by the chief risk director)
The risk of reductions in earnings and/or value, through financial or reputational loss, as a result of the failure of the party with whom we have contracted to meet its obligations (both on and off balance sheet).
Credit portfolio model. The Group models portfolio credit risk based on defaults, using a statistically-based model which calculates the economic equity employed and credit value at risk for each portfolio.
Credit risk appetite is defined as the quantum and quality of the desired credit portfolio and the direction in which the Group wants to manage it, in order to achieve its short and long-term strategic goals.
The Group’s banking activities expose it to the risk of adverse movements in interest rates or exchange rates, with little or no exposure to equity or commodity risk.
• The management of with-profits funds leads to assets and liabilities that are mismatched with the aim of generating a higher rate of return to meet policyholders’ expectations
• Investment strategy for surplus assets held in excess of liabilities takes account of the regulatory and internal business requirements for capital to be held to support the business now and in the future
The risk of loss measured by the VaR model is the potential loss in earnings. The total and average trading VaR does not assume any diversification benefit across the three risk types. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported as a whole.
The composition, and value, of both the Scottish Widows plc Non-Profit Fund and the General Insurance portfolio are reported to Group Risk on a monthly basis and a VaR is calculated which is presented to the group asset and liability committee. The VaR methodology used is the same in all respects to that used for the traded risk in banking activities, except that in the case of equity risk, the model maps the portfolio composition onto a series of appropriate indices by region and sector. In addition the risks are calculated based on a 99 per cent confidence level and a ten day holding period. The figures quoted below are the sum of the two portfolios with no allowance for diversification between portfolios or asset classes and represents the potential loss in earnings.
The following table shows closing, average, maximum and minimum VaR for the years ended 31 December 2005 and 2004 on a 99 per cent confidence ten day basis.
Insurance risks are measured through deterministic studies of the impact of different insurance market scenarios on the future free assets of the business together with relevant stochastic modelling.
Group Compliance also provides leadership on compliance with money laundering and terrorist financing legislation and regulation across the Group. It sets group policy and standards on the topic and undertakes high level oversight of anti money laundering risks. A specialist team within Group Compliance provides a centre of excellence on the relevant legislation and regulation as well as interfacing with external public and private bodies in order to evolve the Group’s approach and seek to ensure greater effectiveness and focus on key risk areas. Its remit also includes compliance with financial sanctions.
Each business unit is responsible for complying with relevant laws and legal principles. Business units have access to legal advice both internal and external. The group chief legal adviser provides policies to assist business units identify areas where legal risk management procedures are necessary. Reports to the group chief legal adviser are required in relation to both significant litigation and also material legal issues.
A framework is in place to guide the consideration and documentation of customer treatment risk when developing policies and procedures. The Group has defined customer treatment principles and benchmark standards in all the key areas and enhanced its processes and procedures for a number of individual initiatives including the governance of responsible lending and complaints handling. The divisions are required to meet or exceed these standards, tailoring customer treatment to the needs of each customer segment.
Businesses have primary responsibility for identifying and managing their process and resource risks. They employ internal control techniques to reduce their likelihood or impact to tolerable levels within the Group’s risk appetite. Where appropriate, risk is mitigated by way of insurance.
To deliver the Group’s strategic aims, change must be managed in an effective, risk-aware and appropriately controlled manner throughout the organisation. The Group’s change management standards seek to ensure appropriate control across the project portfolio and the approach is regularly benchmarked against other leading institutions and practices. The Group’s change management committee reviews the overall change portfolio monthly, with particular focus on initiatives having a high impact on customers and staff. The committee ensures that the aggregate impact of the implementation of change on customers, staff and systems is understood, managed and controlled.
The international standard for measuring capital adequacy is the risk asset ratio, which relates to on- and off-balance sheet exposures weighted according to broad categories of risk. The Group’s capital ratios, calculated in line with the requirements of the FSA, are set out in detail on page 34.
Capital ratios are a key factor in the Group’s budgeting and planning processes and updates of expected ratios are prepared regularly during the year. Capital raised takes account of expected growth and currency of risk assets and also allows for the sensitivity of the Group’s capital to movements in equity markets.
The Group’s regulatory capital is divided into tiers defined by the European Community Banking Consolidation Directive as implemented in the UK by the FSA’s Interim Prudential Sourcebook for Banks. Tier 1 comprises mainly shareholders’ funds, tier 1 capital instruments and minority interests, after deducting goodwill and other intangible assets. Tier 2 comprises collective impairment provisions, and qualifying subordinated loan capital, with restrictions on the amount of collective impairment provisions and loan capital which may be included. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting investments in subsidiaries and associates which are not consolidated for regulatory purposes and investments in the capital of other credit/financial institutions. In the case of Lloyds TSB Group, this means that the net assets of its life assurance and general insurance businesses are deducted from the Group’s regulatory capital.
Statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. With the express permission of the FSA, an intangible asset can be recognised which represents the present value of future releases of prudent margins on business written. The liabilities are calculated using a projection of future cash flows after making prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the FSA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for with-profits policies that are at the discretion of the Company, but does include a value for policyholder options likely to be exercised.
‘Realistic’ basis. The FSA requires each life assurance company which contains a with-profits fund in excess of £500 million, including Scottish Widows plc (‘Scottish Widows’), to carry out a ‘realistic’ valuation of that fund. The word ‘realistic’ in this context reflects the terminology used for reporting to the FSA and is an assessment of the financial position of a with-profits fund calculated under a prescribed methodology.
The valuation of with-profits assets in the With-Profits Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-profits business written in the With-Profits Fund, it includes the present value of the anticipated future release of the prudent margins for adverse deviation. The realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above.
The realistic valuation of liabilities is carried out using a stochastic simulation model which values liabilities on a basis consistent with tradable market option contracts (a ‘market-consistent’ basis). The model takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reflect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given below in the section entitled ‘Options and guarantees’.
Non- Total Share- business on Other With-Profits Profit Long-Term holder’s Statutory Consolidation a Group sources Consolidation Group
Adjustment to remove the value of future profits recognised in respect of non-participating contracts written in the With-Profits Fund (43) – (43) – (43) Recognition of future profits for regulatory
Supervisory deductions Net investment in life assurance business (5,478) Other (682) Available capital resources – Group 15,765
Requirement to maintain a Support Account. The Scheme requires the maintenance of a ‘Support Account’ within the Non-Profit Fund. The quantum of the Support Account is calculated with reference to the value of assets backing current with-profits policies which also existed at the date of demutualisation and must be maintained until the value of these assets reaches a minimum level. Assets can only be transferred from the Non-Profit Fund if the value of the remaining assets in the fund exceeds the value of the Support Account. Scottish Widows has obtained from the FSA permission to include the value of the Support Account in assessing the realistic value of assets available to the With-Profits Fund. At 31 December 2005, the estimated value of surplus admissible assets in the Non-Profit Fund was £2,163 million (31 December 2004: £2,222 million) and the value of the Support Account was £1,115 million (31 December 2004: £1,265 million).
Available capital in the With-Profits Fund has increased from £1,351 million at 31 December 2004 to an estimated £2,302 million at 31 December 2005 primarily as a result of strong investment market performance.
The financial information calculated on a ‘realistic’ basis reconciles to the Capital Statement as follows: 31 December 2005
With-Profits Fund (in accordance Non-Profit Total long- Other long- Total life with FRS 27) Fund term fund term funds business £m £m £m £m £m
With-Profits Fund liabilities 18,720 – 18,720 133 18,853 Unit-linked business (excluding those accounted for as investment contracts) – 8,041 8,041 2,738 10,779 Other life assurance business – 8,671 8,671 1,653 10,324
The most significant options and guarantees provided from within the With-Profits Fund are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies. For those policies written pre-demutualisation containing potentially valuable options and guarantees, under the terms of the Scheme a separate memorandum account was set up within the With-Profits Fund of Scottish Widows called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits in respect of those policies. The Additional Account had a value at 31 December 2005 of £1.7 billion (2004: £1.4 billion). The eventual cost of providing benefits on policies written both pre and post demutualisation is dependent upon a large number of variables, including future interest rates and equity values, demographic factors, such as persistency and mortality, and the proportion of policyholders who seek to exercise their options. The ultimate cost will therefore not be known for many years.
The most significant economic assumptions included in the model are: • Risk-free yield curve. This is derived from the yield on UK gilts, with an additional 0.1 per cent yield assumed to be risk-free; • Investment volatility. This 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.
Profit for the year attributable to equity shareholders 2,493 2,392 2,421 3,254 1,790 2,233 Total dividend for the year1 1,915 1,914 1,914 1,911 1,908 1,872 31 December 1 January 31 December 31 December 31 December 31 December
Post-tax return on average shareholders’ equity 25.6 22.8 24.3 38.5 16.8 18.1 Post-tax return on average risk-weighted assets 1.81 1.99 2.01 2.63 1.62 2.26 31 December 1 January 31 December 31 December 31 December 31 December
2 This figure excludes 79 million limited voting ordinary shares. 3 Averages are calculated on a monthly basis from the consolidated financial data of Lloyds TSB Group. 4 The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims for the IFRS numbers in 2004 and 2005).
Chairman (retiring at the annual general meeting on 11 May 2006) Joined the board 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 Shell, BT Group and British Airways, and a member of the supervisory board of Akzo Nobel. Aged 63.
Chairman of Lloyds TSB Scotland Joined the board in 1999. A non-executive director of Lloyds TSB Scotland since 1997. Joined Noble Grossart in 1969 and was an executive director of that company until December 2003. Chairman of Transport Initiatives Edinburgh. A non-executive director of John Wood Group, Noble Grossart and Stagecoach Group. Aged 63.
Joined the board in 2001. Held a number of senior appointments in the UK and USA with the World Bank, Royal Dutch/Shell Group and British Airways, before membership of the Bank of England Monetary Policy Committee from 1997 to 2001. Chaired HM Treasury’s banking services consumer codes review group in 2000/1. Chairman of the Royal Institute of International Affairs. A non-executive director of BP, Serco Group and Roche Holdings SA. Aged 56.
G Truett Tate Group Executive Director Wholesale and International Banking Joined the Group in 2003 as managing director, corporate banking before being appointed to the board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was president and chief executive officer of eCharge Corporation from 1999 to 2001 and co-founder and vice chairman of the board of Chase Cost Management Inc from 1996 to 2003. Aged 55.
Helen A Weir Group Finance Director Joined the board in 2004. Group finance director of Kingfisher from 2000 to 2004. Previously finance director of B&Q from 1997, having joined that company in 1995, and held a senior position at McKinsey & Co from 1990 to 1995. Began her career at Unilever in 1983. A nonexecutive director of Royal Mail Holdings and a member of the Accounting Standards Board. Aged 43.
Michael E Fairey Deputy Group Chief Executive Joined TSB Group in 1991 and held a number of senior and general management appointments before being appointed to the board in 1997 and deputy group chief executive in 1998. Joined Barclays Bank in 1967 and held a number of senior and general management appointments, including managing director of Barclays Direct Lending Services from 1990 to 1991. President of The British Quality Foundation. Aged 57.
An interim dividend of 10.7p per ordinary share was paid on 5 October 2005 and a final dividend of 23.5p per ordinary share will be paid on 3 May 2006. These dividends will absorb £1,915 million.
Directors Biographical details of directors are shown on pages 40 and 41. Particulars of their emoluments and interests in shares in the Company are given on pages 46 to 57.
Dr Gibson-Smith and Mr Pritchard left the board at the annual general meeting in 2005. Mr Ayliffe left the board on 31 January 2005.
In the UK, 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. 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.
As the Company owed no amounts to trade creditors at 31 December 2005, the number of days required to be shown in this report, to comply with the provisions of the Companies Act 1985, is nil.
There is an induction programme for all new directors, which is tailored to their specific requirements and includes visits to individual businesses and meetings with senior management. Additional training and updates on particular issues are arranged as appropriate.
During the year, the committee recommended the appointment of one executive director and two non-executive directors. In that regard, detailed role specifications were drawn up, external search consultants were engaged and candidates were interviewed by committee members and the other directors.
Lloyds TSB Group acknowledges Sir Victor’s responsibilities as chairman of two FTSE 100 companies for a transitional period but the board feels that his experience will enable him to discharge his duties fully during that time. The senior independent non-executive director, Mr Brown, also recognises the importance of his role in being available to shareholders, especially during this transitional period.
In addition, we will be recommending to shareholders the adoption of a new long-term incentive plan which will replace the current executive share option scheme.
Mr van den Bergh, Mr Daniels, Mr Hijkoop (Group Human Resources Director) and Mr Farley (Group Compensation & Benefits Director) provided guidance to the committee (other than for their own remuneration).
• The long-term rewards are aligned to shareholder interests, which is achieved by taking account of measures that reflect shareholder interests, and by expecting executive directors to build a shareholding in the Group equivalent to 1 times the director’s base pay over a period of four years. This has now increased to 1.5 times (2 times for the group chief executive), with the executives being expected to retain at least 50 per cent of all net vested equity until the guideline is met.
As a consequence of the proposed changes in policy, the composition of the remuneration package in 2006 will be as follows: In 2006, approximately 67 per cent (69 per cent for the group chief executive) of an executive director’s potential direct remuneration (salary, annual bonus and long-term incentives) will be performance related. The value of long-term incentives is the expected value calculated by using a ‘binomial’ model, which is a widely accepted methodology for this purpose.
The fees of the independent non-executive directors are agreed by the board within a total amount determined by the shareholders. An increase in the total amount that can be paid is being proposed at the annual general meeting. Directors may also receive fees, agreed by the board, for membership of board committees. The fees are designed to recognise the various responsibilities of a non-executive director’s role and to attract individuals with relevant skills, knowledge and experience. The fees are neither performance related nor pensionable and are comparable with those paid by other companies. The annual fees are listed below: Board £50,000 Audit committee chairmanship £40,000 Audit committee membership £15,000 Nomination committee membership £5,000 Remuneration committee chairmanship £20,000 Remuneration committee membership £15,000 Risk oversight committee membership £15,000
Independent non-executive directors who serve on the boards of subsidiary companies may also receive fees from the subsidiaries. These are included in the table shown on page 51.
Basic salaries are reviewed annually, usually in December, taking into account individual performance and market information (which is provided by Towers Perrin) and then adjusted from 1 January of the following year. Basic salary increases for other employees across the Group will be generally in the range of 0-10 per cent, and the salary increase awarded to executive directors are consistent with this policy. Salaries payable from 1 January 2006 are as follows: Name J E Daniels M E Fairey T A Dial A G Kane G T Tate H A Weir
The maximum annual bonus opportunity for 2005 for Mr Daniels was also set at 150 per cent of basic salary for exceptional performance. An amount equal to 112.5 per cent of basic salary is available on the achievement of stretching budget targets relating to profit before tax and economic profit; failure to achieve at least 90 per cent of these performance targets would result in no bonus payment. The actual level of bonus award made takes account of Mr Daniels’ individual performance and contribution.
PricewaterhouseCoopers LLP check the calculation of the annual incentive payments for executive directors based on the achievement of performance against targets set. In respect of performance in 2005, the bonus percentages awarded to the directors are shown in the table below.
In 2005, options were granted to executive directors and senior executives within the scheme limits. These limits relate to the number of shares under option and the price payable on exercise. The maximum limit for the grant of options to an executive director in any one year is equal to 3 times annual basic salary, although in exceptional circumstances, for example on the recruitment of a new executive director, that could be increased to 4 times annual basic salary.
A performance condition was set when the grant of options was made and the options will not normally be exercisable unless the condition is met. The performance condition requires the Group’s ranking, based on TSR over the relevant (three year) period, to be at least eighth within the comparator group.
The following table illustrates the percentage of the grant which would be exercisable depending on the Group’s TSR ranking within the comparator group set out above.
Pensions Executive directors are either entitled to participate in the Group’s defined benefit pension schemes (based on salary and length of service, with a maximum pension of two thirds of final salary), or the Group’s defined contribution scheme (under which their final entitlement will depend on their contributions and the final value of their fund). The defined benefit schemes are closed to new entrants on recruitment.
Salaries/ related for loss of 2005 2004 fees Cash Non cash payments office Total Total
Retirement pensions accrue at rates of between 1/60 and 1/30 of basic salary per annum.
Mr Tate is a member of a defined contribution scheme. During the year to 31 December 2005, the employer has made contributions to the defined contribution scheme in respect of him totalling £62,937.
Mrs Weir is a member of a defined contribution scheme. During the year to 31 December 2005, the employer has made contributions to the defined contribution scheme in respect of her totalling £40,375.
The disclosures in columns (e) and (f) are as required by the UK Listing Authority listing rules. The requirements of the listing rules differ from those of the Companies Act. The listing rules require the additional pension earned over the year to be calculated as the difference between the pension accrued at the end of the financial year and the pension accrued at the start of the financial year less the increase in the pension earned over the year solely due to inflation. The transfer value in column (f) can differ significantly from the change in transfer value as required by the Companies Act because the additional pension accrued over the year calculated in accordance with the listing rules makes allowance for inflation and the change in the transfer value required by the Companies Act will be significantly influenced by changes in the assumptions underlying the transfer value calculation at the beginning and end of the financial year.
Directors had non-beneficial interests as follows: Mr Daniels, Mr Fairey, Ms Dial, Mr Kane, Mr Tate, Mr van den Bergh and Mrs Weir, together with some 77,000 other employees, were potential beneficiaries in the 1,364 and 1,237,191 shares held at the end of the year by the Lloyds TSB qualifying employee share ownership trust and the Lloyds TSB Group employee share ownership trust respectively. 1,364 and 1,467,422 shares, respectively, were held by these trusts at the beginning of the year. These holdings were 1,364 and 1,224,846 respectively on 23 February 2006. In addition, the above directors, with the exception of Mr van den Bergh, together with some 77,000 other employees, were potential participants in shareplan and were, therefore, treated as interested in the 582,462 shares held at the end of the year by the trustee of the shareplan. 471,989 shares were held by the trustee at the beginning of the year. This holding was 729,451 on 23 February 2006.
At 31 December Former directors Granted Exercised/ 2005 (or earlier Exercise periods who served during lapsed during date of leaving Exercise during 2005 At 1 January 2005 the year the year the board) price From To Notes
The following bonus and performance shares relating to the bonus award for 2004 are available under the plan. Further information is given on page 48.
At Purchased At At award during At performance 1 January during 31 December 1 January the year 31 December Award share 2005 the year 2005 2005 (maximum) 2005 price award date
The market price for a share in the Company at 1 January 2005 and 31 December 2005 was 473p and 488.5p, respectively. The range of prices between 1 January 2005 and 31 December 2005 was 439.5p to 509p.
August 2001 – August 2004 That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international financial services companies including Lloyds TSB Group) must be at least ninth, when 14 per cent of the option will be exercisable. If the company is ranked first in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met.
March 2005 – August 2005 That the Company’s ranking based on TSR over the relevant period against a comparator group (15 companies including Lloyds TSB Group) must be at least eighth, when 30 per cent of the option will be exercisable. If the company is ranked first to fourth position in the group, then 100 per cent of the option will be exercisable and if ranked ninth or below the performance condition is not met.
At the end of 2005 Lloyds TSB Group was ranked 10th after one year of the performance period.
Our responsibility is to audit the consolidated financial statements in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). This report, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with Section 235 of the Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.
We report to you our opinion as to whether the consolidated financial statements give a true and fair view and whether the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation. We also report to you if, in our opinion, the directors’ report is not consistent with the consolidated financial statements, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and other transactions is not disclosed.
We read other information contained in the annual report and consider whether it is consistent with the audited consolidated financial statements. The other information comprises only the directors’ report, the 2005 highlights, the chairman’s statement, the Group chief executive’s review, the operating and financial review and prospects, the five year financial summary, the unaudited part of the directors’ remuneration report and the corporate governance statement. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the consolidated financial statements. Our responsibilities do not extend to any other information.
Opinion In our opinion: • the consolidated financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union, of the state of the Group’s affairs as at 31 December 2005 and of its profit and cash flows for the year then ended; • the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation.
Net fees and commission income 5 2,148 2,210 Net trading income 6 9,298 5,036 Insurance premium income 7 4,469 6,070 Other operating income 8 1,140 857 Other income 17,055 14,173
Trading surplus 5,069 4,364 Impairment losses on loans and advances 11 (1,299) (866) Profit (loss) on sale and closure of businesses 12 50 (21)
Change in cash and cash equivalents (1,443) 8,763 Cash and cash equivalents at beginning of year 28,196 19,433
Hedge accounting IFRS compliant hedge accounting is applied by the Group from 1 January 2005.
Insurance contracts The Group has chosen not to restate its comparatives for IFRS 4 but to reflect the impact of this standard through adjustments to shareholders’ equity at 1 January 2005. The Group has applied UK GAAP for its 2004 comparatives.
(d) Trading securities, other financial assets at fair value through profit or loss, and available-for-sale financial assets
The Group designates certain derivatives as either: (1) hedges of the fair value of the interest rate risk inherent in recognised assets or liabilities (fair value hedges); or (2) hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges). These are accounted for as follows: (1) Fair value hedges
If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower’s credit rating, the provision is adjusted and the amount of the reversal is recognised in the income statement.
Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax is determined using tax rates that have been enacted or substantially enacted by the balance sheet date which are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
Premiums received in respect of life insurance contracts and participating investment contracts are recognised as revenue when due and are shown before deduction of commission.
Liabilities of the Group’s With-Profits Fund, including guarantees and options embedded within products written by that fund, are stated at their realistic values in accordance with the Financial Services Authority’s realistic capital regime.
– life insurance contracts or participating investment contracts which are not unit-linked or in the Group’s With-Profits Fund
Directly incremental commissions that vary with and are related to either securing new or renewing existing non-participating investment contracts are deferred; all other costs are recognised as expenses when incurred. This asset is subsequently amortised over the period of the provision of investment management services and is reviewed for impairment in circumstances where its carrying amount may not be recoverable. If the asset is greater than its recoverable amount it is written down immediately.
The benefits to which the Group is entitled under its reinsurance contracts held are recognised as reinsurance assets. These assets consist of short-term balances due from reinsurers as well as longer term receivables that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts. Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured insurance contracts and in accordance with the terms of each reinsurance contract. Reinsurance liabilities are primarily premiums payable for reinsurance contracts and are recognised as an expense when due.
Dividends on ordinary shares are recognised in equity in the period in which they are paid.
The Group regularly reviews its loan portfolios to assess for impairment. In determining whether an impairment has occurred the Group considers whether there is any observable data indicating that there has been a measurable decrease in the estimated future cash flows and their timings; such observable data includes whether there has been an adverse change in the payment status of borrowers or changes in economic conditions that correlate with defaults on assets in the Group.
The methodology used to calculate the required provision varies according to the type of lending portfolio. For portfolios of smaller balance homogenous loans, such as residential mortgages, personal loans and credit card balances, impairment provisions are calculated collectively using formulae which take into account factors such as the length of time that the customer’s account has been delinquent, historical loss rates and the value of any collateral held in order to determine expected future cash flows. The variables used in the formulae are kept under regular review to ensure that as far as possible they reflect the current economic circumstances, although actual experience may differ from that assumed.
Calculation of the value of in-force life assurance business assets and life assurance business policy liabilities are dependent on assumptions made regarding future experience. If actual experience differs from that assumed, this could significantly affect the value attributed to these items. Any profit or loss arising from such changes would be recognised in the income statement in that period. The key assumptions upon which these items are dependent are described in notes 26 and 34, along with the impact on profit before tax which would occur if they were to change.
A provision is made for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for claims incurred but not reported at the balance sheet date.
The Group’s activities are organised into three segments: UK Retail Banking, Insurance and Investments and Wholesale and International Banking. Services provided by UK Retail Banking encompass the provision of banking and other financial services to personal customers, private banking, stockbroking and mortgages. Insurance and Investments offers life assurance, pensions and savings products, general insurance and asset 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.
UK Retail General and asset and International Central Inter-segment Banking insurance management Investments Banking group items eliminations Total
Included within interest income in 2005 is £209 million in respect of impaired financial assets.
Net fees and commission income 2,148 2,210 6 Net trading income 2005 2004 £m £m
Net profit (loss) on disposal of businesses 74 (21) Adjustment to consideration received in respect of prior period disposals (4) – Provision for costs in respect of the closure of businesses (20) –
UK corporation tax: Current tax on profits for the year 862 759 Adjustments in respect of prior years (20) (69)
b Factors affecting the tax charge for the year A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the tax charge for the year is given below: £m £m
For the calculation of diluted earnings per share the weighted average number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The Company has dilutive potential ordinary shares in respect of share options granted to employees. The number of shares that could have been acquired at market price (determined as the average annual share price of the Company’s shares) based on the monetary value of the subscription rights attached to outstanding share options is determined; the residual bonus shares are added to the weighted average number of ordinary shares in issue, but no adjustment is made to the profit attributable to equity shareholders.
Details of the balance sheet carrying value of the treasury bills and other eligible bills held at 31 December 2004 were as follows: £m
Hedging Derivatives designated as fair value hedges: Cross currency interest rate swaps 69 12 – Interest rate swaps (including swap options) 39,499 473 730
17 Derivative financial instruments and other trading liabilities (continued) Contract/notional Fair value Fair value amount assets liabilities
Total loans and advances to banks 31,656 31,849 Allowance for impairment losses (note 20) (1) (1)
Gross investment in finance leases, receivable: Not later than 1 year 673 603 Later than 1 year and not later than 5 years 2,388 2,698 Later than 5 years 6,025 7,481
Equipment leased to customers under finance leases primarily relates to structured financing transactions to fund the purchase of aircraft, ships and other ‘big ticket’ items. The allowance for uncollectable finance lease receivables included in the allowance for impairment losses is £4 million (2004: £10 million).
In respect of: Loans and advances to banks (note 18) 1 1 Loans and advances to customers (note 19) 2,072 1,662 21 Debt securities
Details of the balance sheet carrying value of the debt securities held at 31 December 2004 were as follows: £m
Details of the balance sheet carrying value of the equity shares held at 31 December 2004 were as follows: £m
Treasury bills and other eligible bills: Treasury bills and similar securities 70 Other eligible bills 17
Fair value movements 430 329 Additions to investment properties 807 351 Disposals of investment properties (753) (455)
In addition, the following amounts have been recognised in the income statement: 2005 2004 £m £m
Acquisition adjustment – (34) Acquisitions of businesses (note 52) 3 – Adjustments on disposal of businesses (93) (10) Impairment charge (6) –
Adjustments on the adoption of FRS27 (386) Adjustments on the adoption of IFRS4 and IAS39 (1,217)
The assumption for future investment returns for fixed (or index linked) investments reflects the actual portfolio. Projected returns from fixed and index linked investments are based on risk-free (gilt-edged) returns and are reduced for the risk of default but not adjusted for liquidity. Where an assumption on future equity or property returns is required, this is based on such returns having an equity or property yield margin over the corresponding risk-free (gilt-edged) return assumed.
The RDR is set to remove investment risk margins, including those assumed to be generated by equities, whilst retaining a margin for other, non-investment, risks.
Persistency rates refer to the rate of policy termination and the rate at which policies cease to pay regular premiums. These rates are based on a combination of historical experience and management’s views on future experience.
Accumulated depreciation and impairment: Exchange and other adjustments – 2 (3) (1) Adjustments on acquisition and disposal of businesses (4) (8) – (12) Charge for the year 68 267 281 616
Euro medium-term note programme 6,683 5,097 Other bonds and medium-term notes 141 266 Certificates of deposit issued 22,101 15,226 Commercial paper 10,421 8,026 Other marketable paper – 155
Adjustments to reflect the implementation of IAS 32, IAS 39, IFRS 4 and FRS 27 (28,033)
The realistic capital regime dictates that With-Profits Fund liabilities are valued on a market consistent basis. This is achieved by setting assumed investment returns and discount rates equal to a risk-free yield, defined as 0.1 per cent higher than the yield on UK gilts.
Allowance is made for future policy costs explicitly. Expenses are determined by reference to an internal analysis of current and expected future costs plus a margin for adverse deviations. Explicit allowance is made for future expense inflation.
Changes in certain key assumptions were made during 2005 with the following impacts on profit before tax. These amounts include movements in liabilities and value of the in-force business in respect of insurance contracts and participating investment contracts: Reduction in profit before tax £m
Mortality1 10% adverse 414 11 425 Lapse rates 20% increase 21 32 53 Maintenance expenses 10% increase 40 29 69 Interest rates2 1% addition 242 (18) 224 Guaranteed annuity option take up 5% increase 81 – 81
For non-life insurance contracts, the methodology and assumptions used in relation to determining the bases of the earned premium and claims provisioning levels are derived for each individual underwritten product. Assumptions are intended to be neutral estimates of the most likely or expected outcome. A margin is placed on these best estimate claims reserves to provide confidence in being able to achieve this objective and varies according to product class. A relatively small margin was used for most products where sufficient past experience has been accumulated. An additional margin was used to allow for reserve uncertainty of claims where there is less experience and the introduction of claims re-engineering processes, which will affect how claims are being reported for household and domestic all risks products.
Market values of scheme assets: UK fixed interest gilts 946 550 UK index linked gilts 920 561 Sterling non-government bonds 1,415 938
Exchange and other adjustments 4 2 Net charge to the income statement 243 268 Contributions paid (419) (369)
The expected return on scheme assets has been calculated using the following assumptions: 2005 2004
UK fixed interest gilts 4.6 4.8 UK index linked gilts 4.3 4.4 Sterling non-government bonds 5.3 5.4
The movements in the amounts recognised in the balance sheet are as follows: 2005 2004 £m £m
The deferred tax charge in the income statement comprises the following temporary differences: 2005 2004 £m £m
Deferred tax liabilities have not been recognised for tax that may be payable if earnings of certain subsidiaries were remitted to the UK. Such amounts are either permanently reinvested or can be remitted free of tax. Unremitted earnings totalled £609 million (2004: £639 million).
Future transfers from Scottish Widows plc’s long-term business funds to its Shareholder Fund will be subject to a shareholder tax charge. Under IAS 12, no provision is required to be made to the extent that the timing of such transfers is under Scottish Widows plc’s control. Accordingly, deferred tax liabilities of £110 million (2004: £230 million) have not been recognised.
Adjustments to reflect the implementation of IAS 32, IAS 39 and IFRS 4 49 – 10 59
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 period of under-recovery of the leases concerned, currently averaging four years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
Undated subordinated loan capital* Primary Capital Undated Floating Rate Notes: a Series 1 (US$750 million) 436 389 Series 2 (US$500 million) 291 259 Series 3 (US$600 million) 349 311 113/4% Perpetual Subordinated Bonds (£100 million) 100 100 6.625% Perpetual Capital Securities (c750 million) callable 2006 b 518 526 6.90% Perpetual Capital Securities callable 2007 (US$1,000 million) c 553 512 55/8% Undated Subordinated Step-up Notes callable 2009 (c1,250 million) g 892 877 Undated Step-up Floating Rate Notes callable 2009 (c150 million) a 103 105 65/8% Undated Subordinated Step-up Notes callable 2010 (£410 million) f 407 407 Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (c430 million) i,k 337 ■■■■ 6.35% Step-up Perpetual Capital Securities callable 2013 (c500 million) b,g 371 350 5.125% Step-up Perpetual Subordinated Notes callable 2015 (£560 million) d,l 553 – 5.57% Undated Subordinated Step-up Coupon Notes callable 2015 (¥20,000 million) h 127 101 Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015 (£250 million) j,k 248 ■■■■ 5.125% Undated Subordinated Step-up Notes callable 2016 (£500 million) 501 497 4.385% Step-up Perpetual Capital Securities callable 2017 (c750 million) b,g,l 522 – 61/2% Undated Subordinated Step-up Notes callable 2019 (£270 million) f 269 267 8% Undated Subordinated Step-up Notes callable 2023 (£200 million) f 202 199 61/2% Undated Subordinated Step-up Notes callable 2029 (£450 million) f 457 455 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million) f 497 497
Subordinated Step-up Floating Rate Notes 2016 callable 2011 (£300 million) a,l 300 – Subordinated Step-up Floating Rate Notes 2016 callable 2011 (c500 million) a 343 353 Subordinated Floating Rate Notes 2020 (c100 million) a 68 70 5.75% Subordinated Step-up Notes 2025 callable 2020 (£350 million) 346 346
The merger reserve arose on the combination of Lloyds Bank Plc and TSB Group plc in 1995, as permitted by UK GAAP at the time. In accordance with the transitional provisions of IFRS 1, the accounting treatment of this combination was not revisited when the Lloyds TSB Group adopted International Financial Reporting Standards on 1 January 2004.
Revaluation reserve in respect of available-for-sale financial assets At 1 January 2005 (following implementation of IAS 32 and IAS 39) 28 Exchange and other adjustments (7) Change in fair value of available-for-sale financial assets 11 Deferred tax thereon 2
At 1 January – restated 6,554 Currency translation differences 24 (12) Profit for the year 2,493 2,392
To meet the performance conditions, the Group’s ranking against the comparator group must be at least ninth. The full grant of options will only become exercisable if the Group is ranked first. A performance multiplier (of between nil and 100 per cent) will be applied below this level to calculate the number of shares in respect of which options granted to executive directors will become exercisable, and will be calculated on a sliding scale. If Lloyds TSB Group plc is ranked below median the options will not be exercisable.
In 2003, the Group adopted the Lloyds TSB Group plc Share Plan 2003. Options granted under this scheme were not subject to any performance conditions. An option was granted in 2003 specifically to facilitate the recruitment of one executive director, this option had a total exercise price of £1, and would have been exercisable in the six month period beginning 31 December 2005; however this option lapsed during 2004 following the executive director’s resignation.
The plan was adopted in December 2003 and under the plan share options may be granted to senior employees, who may also be directors of Lloyds TSB Group. Options granted to date under this scheme were granted specificially to facilitate recruitment. Options granted under this plan are not subject to any performance condiitions.
This plan was adopted by the Group in 2005, specificially to facilitate the recruitment of Ms Dial. Ms Dial is the only participant in the plan. Options granted under this plan are not subject to any performance conditions and will normally become exercisable only if Ms Dial remains as an employee, and has not given notice of resignation, on 31 May 2008. The option will also be exercisable if Ms Dial ceases to be an employee before that date in certain circumstances described in her service agreement, in which case the options will be exercisable for six months and then lapse.
Under the performance share plan, introduced during 2005, executive directors will be eligible for an award of free shares, known as performance shares, to match the bonus shares awarded as part of their 2004 bonus. The maximum match will be two performance shares for each bonus share, awarded at the end of a three year period. The actual number of shares awarded will depend on the Group’s TSR performance measured over a three year period, compared to other companies in the comparator group. 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 for each bonus share will be granted 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, and fifth and eighth, 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 bonus before deferral into the plan, where a match of performance shares is justified, these shares will be awarded as if income tax had not been deducted.
The number of shares awarded relating to free shares in 2005 was 8,748,521 (2004: 8,903,125), with an average fair value of £4.57 (2004: £4.27), based on the market price at the date of award. The number of shares awarded relating to matching shares in 2005 was 2,296,575 (2004: 2,431,305), with an average fair value of £4.73 (2004: £4.28), based on market prices at the date of award.
These securities constitute limited partnership interests in Lloyds TSB Capital 2 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. Non-cumulative income distributions accrue at a fixed rate of 7.834 per cent per annum up to 7 February 2015; thereafter they will accrue at a rate of 350 basis points above a rate based on the yield of specified UK government stock.
Other: Other items serving as direct credit substitutes 550 345 Performance bonds and other transaction-related contingencies 1,737 1,324
Not later than 1 year 216 211 Later than 1 year and not later than 5 years 784 783 Later than 5 years 1,016 980
Finance lease payments relate to leases of certain premises and equipment. No arrangements have been entered into for contingent rental payments. The fair value of these finance lease obligations approximates their carrying amount at 31 December 2005 and 2004.
The Group establishes two types of hedge accounting relationships; fair value hedges and cash flow hedges. The Group is exposed to fair value interest rate risk on its fixed rate customer loans, its fixed rate customer deposits and the majority of its subordinated debt, and to cash flow interest rate risk on its variable rate loans and deposits together with its floating rate subordinated debt. The majority of the Group’s hedge accounting relationships are fair value hedges where interest rate swaps are used to hedge the interest rate risk inherent in the fixed rate mortgage portfolio. At 31 December 2005 the aggregate notional principal of interest rate swaps designated as fair value hedges was £39,568 million with a net fair value (liability) of £245 million (see note 17). In addition the Group has a small number of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. These cash flows are expected to occur over the next seven years and will be reported in the income statement as they take place. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2005 was £648 million with a net fair value (liability) of £18 million (see note 17).
As at 31 December 2004 Assets Treasury bills and other eligible bills 21 25 41 5 – – 92 Loans and advances to banks 21,979 5,561 2,984 629 81 614 31,848 Loans and advances to customers 82,251 18,302 13,565 36,681 6,198 (1,679) 155,318 Debt securities and equity shares 1,967 10,788 2,724 6,444 21,643 27,229 70,795
Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the Group’s overseas operations.
Available for sale debt securities and treasury bills 14,894 Contingent liabilities 11,695 Undrawn irrevocable formal standby facilities, credit lines and other commitments to lend2 43,094 Derivative assets, before netting 5,878 Amounts available for offset under master netting arrangements1 (3,235)
The Group is exposed to daily calls on its cash resources from current account and other amounts repayable on demand, overnight and other maturing deposits, loan draw-downs and cash-settled derivative instruments.
As at 31 December 2005 Assets Trading securities and other financial assets at fair value through profit or loss 520 818 1,051 6,271 51,714 60,374
Loans and advances to banks 24,372 1,513 3,955 1,357 458 31,655 Loans and advances to customers 22,999 7,696 10,859 39,132 94,258 174,944 Available-for-sale financial assets 130 1,092 1,839 6,638 5,241 14,940
Listed investment securities are valued at quoted market prices. Unlisted investment securities are valued based on discounted cash flows, market prices of similar securities and other appropriate valuation techniques. Trading securities are valued using market prices.
IFRS differs in certain respects from the Group’s previous accounting policies, which complied with UK Generally Accepted Accounting Principles (‘UK GAAP’). Set out below are explanations and reconciliations showing the effect of the adoption of IFRS and FRS 27 upon the Group’s previously published financial information.
IFRS requires line-by-line consolidation for all items of income and expenditure; consequently, the Group no longer reports the results and balances of the life assurance business as one line items.
The Group has elected to apply the corridor approach to determine the treatment of actuarial gains and losses arising during the year as permitted under IAS 19. The effect of this has been to derecognise the actuarial losses charged to reserves in 2004 under UK GAAP in the restated figures.
Fees and commissions that are an integral part of the effective yield on a financial instrument, and direct incremental costs associated with its origination, are included in the calculation of the effective interest rate and recognised over the expected life of the instrument, or a shorter period if appropriate. As a result the recognition of up-front fees and costs that were recognised when received, or incurred, under UK GAAP, for example those related to loan origination, are now deferred and the recognition of fee income typically charged at the end of an agreement, for example early redemption charges on mortgages, brought forward.
The Group enters into derivative contracts for both trading purposes and to hedge exposures arising from within the banking book. Under UK GAAP trading derivatives were carried at fair value but hedging derivatives were accounted for on the same basis as the underlying hedged item, mainly on an accruals basis. IAS 39 requires that all derivative contracts are carried at fair value on the Group’s balance sheet and movements in their fair value are reflected in the income statement except where cash flow hedging is applied; this results in a mismatch between the accounting and the underlying economics where the Group has hedged its economic risk resulting from the different treatment of the derivative and the underlying hedged position.
The Group has not changed the way it hedges its economic exposures as a result of the implementation of IFRS, but the Group seeks to mitigate the resulting income statement volatility by the application of hedge accounting. Although the Group intends to mitigate the volatility arising from the requirement to fair value all derivatives as far as possible, this will be a source of increased volatility in the income statement in 2005 and beyond.
IAS 39 permits financial assets to be designated at the time of initial recognition as being held at fair value, with unrecognised gains or losses reported in the income statement. Certain loans and advances and debt securities previously carried at amortised cost under UK GAAP have been designated as held at fair value through profit or loss on adoption of IAS 39 and have been valued at their fair value at 1 January 2005.
Comparative figures have also been restated to allow for deferred tax on properties acquired as part of a business combination and for the reclassification of certain balance sheet items following revised interpretations of the requirements of IFRS. This has resulted in a reduction in shareholders’ equity although there is no effect upon the Group’s income statement.
Restated consolidated balance sheet (reconciliation of equity) at 1January 2004 (excludes effects of IAS 32, IAS 39 and IFRS 4)
Value of in-force business – 4,347 – – – – – – – – 4,347 Intangible assets – – – – – 41 – – – – 41
Liabilities Deposits from banks 23,955 – – – – – – – – (8) 23,947
Long-term assurance business attributable to the shareholder 6,781 (6,781) – – – – – – – – –
Debt securities in issue 27,217 208 1,345 – – – – – – – 28,770
Accruals and deferred income 3,866 – – – – – – – – (3,866) –
UK Insurance New Employee Unit GAAP business entities Leasing benefits Software trusts Goodwill Other IFRS
Net fee and commission income 2,380 (111) (62) (33) – – 31 – 5 2,210
Increase in value of long-term assurance business 715 (715) – – – – – – – –
Profit and loss on disposal of businesses (15) – – – – – – – (6) (21)
Profit attributable to equity shareholders 2,421 (43) – (27) (13) (8) 22 41 (1) 2,392
Debt securities in issue 28,770 – – – – (42) – – – – 28,728
The full impact of these accounting changes is being assessed by the Group; none of these pronouncements are expected to cause any material adjustments to the financial statements. The Group has not yet made a final decision as to whether it will apply in the 2006 financial statements those pronouncements marked (*) in the table above.
The consolidated financial statements were approved by the directors of Lloyds TSB Group plc on 23 February 2006.
Amendment to IAS 19 Employee Benefits – Actuarial Gains and Losses, Group Plans and Disclosures
Restricts the fair value option for financial instruments to certain situations, including when doing so results in more relevant information because it eliminates or reduces a measurement or recognition inconsistency or where a group of financial instruments is managed and evaluated on a fair value basis in accordance with a documented strategy.
Amendment to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 4 Insurance Contracts – Financial Guarantee Contracts
Parent company cash flow statement for the year ended 31December 2005 £ million £ million
Cash flows from financing activities: Dividends received from subsidiaries 1,913 1,913 Dividends paid to equity shareholders (1,914) (1,913) Proceeds from issue of ordinary shares and transactions in own shares held in respect of employee share schemes 26 11
Change in cash and cash equivalents (101) (154) Cash and cash equivalents at beginning of year 208 362
The parent company has applied International Financial Reporting Standards (‘IFRS’) as adopted by the European Union (EU) in its financial statements for the year ended 31 December 2005.
The movement in the net deferred tax asset is as follows: 2005 2004 £m £m
Related party information in respect of other related party transactions is given in note 49 to the consolidated financial statements.
Amounts owed to subsidiaries 1,913 – – – – 1,913 Dividend payable 1,314 – – (1,314) – –
Amounts due from subsidiaries 1,390 – – (1,314) – 76 Cash and cash equivalents 208 – – – – 208
Amounts owed to subsidiaries 1,741 – – – – 1,741 Dividend payable 1,315 – – (1,315) – –
Investment in subsidiaries 5,589 – 5,589 Loans to subsidiaries 1,723 – 1,723 Deferred tax assets 15 (12) 3 Derivative financial instruments – 208 208
Lloyds TSB shares are traded in the USA through an NYSE-listed sponsored ADR facility, with The Bank of New York as the depositary. The ADRs are traded on the New York Stock Exchange under the symbol LYG. The CUSIP number is 539439109 and the ratio of ADRs to ordinary shares is 1:4.
* Includes 698 million shares (12.46%) registered in the names of some 812,000 individuals. 227 million shares (4.05%) are held by over 78,000 staff and Group pensioners, or on their behalf by the trustee of the staff shareplan scheme.