Earnings per share 43.3p 58.3p * Restated to reflect changes in the Group’s segmental analysis following the introduction, in 2004, of the management of the Group’s distribution channels as profit centres and other changes in internal pricing arrangements.
Total capital ratio 10.0 per cent, tier 1 capital ratio 8.9 per cent.
The building blocks of attracting, retaining and developing customer relationships in all areas of our business are the foundations of profitable franchise development and sustainable earnings growth. With this in mind Lloyds TSB has spent much of the last few years putting our customers at the heart of our strategy, ensuring that customer needs drive our business transformation. During 2004 we have continued to improve our product range, we have significantly enhanced our customer service levels, and we have made clear progress in improving the Group’s processing efficiency. As a result, customer satisfaction levels are higher than at any time during recent years and we are recruiting a higher number of quality customer relationships.
This is a relatively benign economic outlook and operating environment for Lloyds TSB.
The work that we have done to allocate our capital more efficiently, as well as the management of our quality and costs, has allowed us to maintain high returns whilst we focused the organisation on delivering growth. Pleasingly, we are starting to demonstrate better growth across all of our divisions and key businesses.
In Insurance and Investments, our new business contribution in Scottish Widows increased by 21 per cent as we successfully focused on more profitable, and more capital efficient, business lines. The sales of life and pensions products in the branches were encouraging, although we lagged in unit trust sales. During 2004, supported by the launch of a simplified suite of bancassurance products in the second half of the year, we increased our market share of non-IFA life and pensions sales from 7.8 per cent to 8.9 per cent. Overall, life and pensions product sales increased by 9 per cent. In Lloyds TSB Insurance, increased investment resulted in strong growth in sales through direct channels and we maintained our market leading position in home insurance distribution.
In addition to the considerable progress in the divisions, we also used the year to enhance the effectiveness of the Corporate Centre, with the appointment of new directors in the Risk, Audit, Human Resources and Finance functions. This has enabled us to strengthen the operating disciplines across the Group, which provide the framework for us to grow in a sustained fashion.
We are only just beginning to unlock the growth potential of the Lloyds TSB franchise. During 2004, customer satisfaction ratings reached record levels, employee engagement scores rose to their highest level ever, credit quality remained strong and our financial disciplines guided the Group to exceed expectations in terms of financial performance. This gives us a solid underpinning for the future. We still have much to do in terms of improving our execution but I believe we can continue to deliver income growth in a controlled and sustainable way, due to the progress made by the divisions and improvements in our operating processes achieved during 2004.
People are our greatest asset and we are committed to becoming a world-class organisation in the way we manage and develop them.
We know that corporate responsibility is a factor in the perception that our staff have of Lloyds TSB as an employer and plays a key part in their engagement and satisfaction in working for the Group. We can demonstrate a direct relationship between employee satisfaction, customer satisfaction and, ultimately, shareholder satisfaction.
We are committed to improving the diversity of our workforce in terms of the representation of women, ethnic minority employees and disabled employees at all levels in our organisation. We encourage all employees to develop a balance between their personal and professional lives through our Work Options policy. This provides staff with the opportunity to adopt any one of a number of flexible working practices such as job sharing, variable and compressed hours and term-time working. As a result 34 per cent of our workforce currently work flexibly.
Lloyds TSB is a significant presence in every community. The customers we serve and the staff that serve them are drawn from those same communities. We have one of the largest community investment programmes in the UK, supporting our customers and staff, and making a significant contribution to improving the social fabric of the local environment in which our business operates.
Wholesale and International Banking Wholesale and International Banking provides banking and related services for major UK and multinational corporates and financial institutions, and small and medium-sized UK businesses. It also provides asset finance and share registration services to personal and corporate customers, manages Lloyds TSB Group’s activities in financial markets through its treasury function and provides banking and financial services overseas.
Summary of Group results In 2004 the Group’s statutory profit before tax was £3,493 million, a decrease of £855 million compared to £4,348 million in 2003. This decrease was attributable to the impact in 2003 of the profit on the sale and trading results of a number of overseas businesses, which contributed £1,183 million. For the same reason, profit attributable to shareholders decreased by £833 million, or 26 per cent, to £2,421 million and earnings per share decreased by 26 per cent to 43.3p.
Strong growth in loans and advances to customers and banks, partly offset by a reduction in debt securities, led to an 11 per cent increase in total assets to £280 billion. The Group’s strategy to increase retail lending, particularly in mortgages, credit cards and personal loans, was reflected in a 14 per cent increase in loans and advances to customers to £154 billion. Customer deposits increased by £6 billion, or 5 per cent, to £122 billion, largely as a result of strong growth in current account credit balances which was supported by further progress in the take-up of added value current accounts.
Much of the Group’s new retail lending during 2004 has been to existing customers where the Group has a better understanding of each individual customer’s total financial position and this, in conjunction with a relatively benign economic environment and increased corporate liquidity, has led to credit quality remaining strong throughout the Group. Notwithstanding substantial growth in loans and advances to customers, the provisions charge for bad and doubtful debts within the Group’s continuing operations was 2 per cent lower than in 2003 and, as a result, the Group’s provisions charge expressed as a percentage of average lending improved to 0.59 per cent, compared to 0.66 per cent in 2003. Non-performing lending was £1,240 million representing 0.8 per cent of total lending, down from 0.9 per cent at 31 December 2003.
Recognising the Group’s high existing dividend payout ratio, and reflecting a desire to maintain capital flexibility to continue making value enhancing acquisitions, such as the acquisition of Danske Bank’s UK corporate loan portfolio in December 2004, the board has decided to maintain the final dividend at 23.5p per share to make a total for the year of 34.2p per share. This represents a dividend yield for shareholders of 7.2 per cent, calculated using the 31 December 2004 share price of 473p.
C&G continues to focus on prime lending market segments, and has maintained its policy of not exceeding a 95 per cent loan-to-value ratio on new lending. The average indexed loan-to-value ratio on the C&G mortgage portfolio was 41 per cent (31 December 2003: 43 per cent), and the average loan-to-value ratio for C&G new mortgages and further advances written during 2004 was 62 per cent (2003: 62 per cent). At 31 December 2004, 88 per cent of C&G mortgage balances had an indexed loan-to-value ratio of less than 80 per cent and only 0.3 per cent of balances had an indexed loan-to-value ratio in excess of 95 per cent.
Lloyds TSB remains a leader in the added value current account market, with over 4 million customers. Quality customer current account recruitment increased by 20 per cent, compared with 2003, whilst quality current account attrition was 11 per cent lower, reflecting improvements made in levels of process quality, customer service and customer satisfaction.
Profit before tax from existing business, excluding provisions for customer redress, increased by £28 million, or 15 per cent, to £220 million. The expected return from existing business, which largely reflects the unwinding of the long-term discount rate applied to the expected cash flows from the Group’s portfolio of in-force business, was £17 million, or 6 per cent, higher at £300 million.
Overall, weighted sales in 2004 increased to £743.1 million, compared to £733.4 million in 2003 with 10 per cent growth in IFA sales to £431.6 million. Direct sales grew by 17 per cent to £72.2 million, while branch network sales were 14 per cent lower at £238.9 million largely reflecting the wider market trend of lower single premium unit trust sales.
Wholesale and International Banking Continuing Discontinued operations operations Total £m £m £m £m
Excluding the trading results of businesses sold in 2003 net interest income increased by £91 million, or 5 per cent, reflecting higher income from improved margins in Corporate Banking and the Asset Finance businesses, and strong growth in customer lending in Asset Finance. Other income increased by £80 million, partly as a result of a £50 million increase in gains on the sales of assets, largely the realisation of venture capital investments by Lloyds TSB Development Capital. Costs were tightly controlled, 2 per cent higher at £2,090 million, reflecting higher staff related costs and increased investment spend within Corporate Markets, partially offset by lower operating lease depreciation within Asset Finance.
Profit before tax in Lloyds TSB Asset Finance increased by 27 per cent to £202 million, compared with £159 million in 2003, largely reflecting the continued profitable development of the motor and leisure, and contract hire businesses. In the personal and retail finance business, new business volumes have increased by some 9 per cent, increasing market share. Lloyds TSB Commercial Finance has retained market leadership, measured by client numbers, with a 19 per cent market share, 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 20 per cent.
Having worked to reduce risk and earnings volatility during 2003 by tactically selling part of our portfolio of businesses, this year’s focus has been more on improving the understanding of risk. Our credit disciplines are strong, which will leave us well positioned, should there be any adverse change in the economic climate during 2005 and as we selectively seek to increase our lending portfolios. Allied to this there has been a much closer alignment between risk and the strategic planning round both in terms of identifying risks to the delivery of the plans and change in risk appetite arising from those plans.
The Group is developing an improved approach towards its risk appetite (defined as the extent and categories of risk which the board regards as appropriate and acceptable for the Group to bear). Adoption of the principles and metrics under development has the objective of deriving Lloyds TSB’s risk appetite and processes explicitly from its strategic objectives and the commitments it makes to all its stakeholders (customers, shareholders, staff, debt holders and regulators). This work is ongoing.
Lloyds TSB Group has a risk language in which all risks are classified within one or more of the eleven risk drivers set out below.
The risk oversight responsibilities of the board, audit committee and risk oversight committee are shown in the corporate governance section on pages 43 and 44, whilst further key risk oversight roles are described below.
Divisional risk officers provide oversight of risk management activity within each of the Group’s operating divisions. Reporting directly to the group executive directors responsible for the divisions, their day-to-day contact with business management, business operations and risk initiatives, provides an effective risk oversight mechanism. They meet regularly with the chief risk director to enable best practice to be shared and to provide a wide ranging and current perspective on material risks facing the Group.
The Capital Requirements Directive will come into force for all European banks at the start of 2007, although the final rules to be applied in the UK are only likely to be published in 2006. These will be subject to further consultation, and the Lloyds TSB Group has been playing a full part with the regulatory authorities in attempting to shape them. The Group aspires to an Internal Ratings Based approach to credit risk and an Advanced Measurement Approach to operational risk. Accordingly, a considerable investment is being made in order to meet the standards required for these more advanced approaches. As well as meeting the compliance imperative, benefits to the Group will accrue through further enhancement of our risk management and capital allocation capabilities.
Cross-border and cross-currency exposures. Country limits are authorised and managed by a dedicated unit taking into account economic and political factors.
Credit risk arising from the use of derivatives. Note 47 shows the total notional principal amount of interest rate, exchange rate and equity and other contracts outstanding at 31 December 2004. The notional principal amount does not, however, represent the Group’s real exposure to credit risk, which is limited to the current cost of replacing contracts with a positive value to the Group, should the counterparty default. This replacement cost is also shown in note 47. 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.
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 and is managed by Group Balance Sheet Management.
Market risk exposures from the insurance businesses are controlled via approved investment policies consistent with the Group’s overall risk appetite and regularly reviewed by the group asset and liability committee.
There are some limitations to the VaR methodology: • The model assumes that changes in the underlying asset returns can be modelled by a normal distribution. This assumption is an approximation of reality that may not reflect all circumstances.
• VaR is calculated at the close of business each day, which excludes the profit and loss impact of intra-day trading.
The simulation models used by the Group include assumptions about the relationships between customer behaviour and the level of interest rates; the anticipated level of future business is also taken into account. The accuracy of these assumptions will impact the efficiency of hedging transactions. The assumptions are regularly updated and the projected exposure is actively managed in accordance with group asset and liability committee policy.
The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to Group Treasury. Group Treasury calculates the associated VaR as shown in the table on the previous page.
Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the holding company’s foreign currency exchange equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to retained earnings.
General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modelling, including that of the probable maximum loss under various catastrophe scenarios, supports the choice of reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses with significant mortality risk and morbidity risk being transferred to our chosen reinsurers.
The risk of financial loss or reputational damage arising from inappropriate or poor customer treatment or failure to treat customers fairly.
The Group is committed to the fair treatment of its customers. This is embedded into the processes indicated below to ensure businesses have developed customer centric strategies for product and business development, marketing, selling and after sales service.
Product promotion, distribution and sales. 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.
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 ensure appropriate control across the project portfolio and the approach is regularly benchmarked against other organisations around the world.
Management of risks. The Group sets high standards for the conduct of its business and values its reputation. Responsibility for establishing an effective organisational structure is vested in Group and business management. Sound internal risk management practices are promoted through business directors who are ultimately responsible for identifying, measuring, monitoring and controlling the risks within their specific areas of accountability.
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 2004, the Group had capacity to raise approximately £2,900 million of tier 2 debt capital, compared to approximately £2,300 million at 31 December 2003. This increase reflects the effects of retained profits and favourable exchange rate movements. 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 board believes that the systems in place to manage significant SEE risks are effective and provide adequate information to identify and assess the short and long-term risks arising from SEE matters. One of the most significant risks is that posed by climate change, which affects the whole business of insurance – claims, regulation, investment returns and operating costs. Storm and flood damage claims in the UK have doubled to £6 billion since 1998. Lloyds TSB Insurance recognises this risk and is working with the Association of British Insurers and the government to prevent further building on flood plains. In addition it offers advice to homeowners on how to protect their properties against extreme weather conditions. These measures have ensured that Lloyds TSB Insurance is currently able to continue offering cover to renewing customers in areas considered prone to flooding, while managing its exposure through pricing and underwriting controls.
As a 2005 first-time adopter of IFRS, the Group is required to prepare an opening balance sheet as at 1 January 2004. Most accounting policy adjustments to apply IFRS retrospectively will be made against retained earnings in this opening balance sheet. However, transitional adjustments relating to those standards for which comparatives are not required to be restated will be made on 1 January 2005. Restated comparatives are not required for IAS 32 Financial Instruments: Disclosure and Presentation, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 4 Insurance Contracts.
The overall impact on net assets and earnings up to 1 January 2005 is not expected to be significant. From 1 January 2005 there will be impacts arising from changes in the fair values of financial assets and liabilities, and volatility arising from ineffective hedges. The future impact for fee income, lease accounting and accounting for insurance business will depend on the mix of business and the rate of new business growth. The following areas have been identified as having the greatest impact upon the Group.
Netting IFRS prohibits financial assets and financial liabilities from being offset unless there is a legal right of set-off and the asset and liability are normally settled on a net basis. In the banking business, this will result in the grossing-up on the balance sheet of assets and liabilities subject to set-off arrangements that are presented net under UK GAAP. In the case of insurance business, insurance liabilities will be presented without offsetting them against related reinsurance assets.
Depreciation In addition to the impact for depreciation of operating lease assets outlined below, IFRS requires property, plant and equipment to be depreciated since the date of acquisition. Under UK GAAP, long leasehold and freehold properties have been depreciated only since 1 January 2000. There will be no effect upon the Group’s income statement until the properties concerned are disposed of at which point any gain on sale will increase or any loss will be reduced.
Dividends Under IFRS equity dividends declared after the balance sheet date may not be included as a liability at the balance sheet date. Consequently, the 2003 final dividend will be adjusted against opening retained earnings at
Share-based payments IFRS requires that a cost be recognised in the financial statements for all options granted under executive and employee Save-As-You-Earn share option schemes. The total cost recognised represents the fair value of the options (as determined using an option valuation model) at the grant date, as adjusted for the expected number of forfeitures and, for executive schemes, the probability that the performance target will not be met. This total cost is spread over the period to vesting. This will result in an increase in the costs recognised in the Group’s income statement as under UK GAAP only the intrinsic value of executive share options is charged to the profit and loss account.
In December 2004 the UK Accounting Standards Board (‘ASB’) issued FRS 27 Life Assurance setting out changes to the way in which life assurance business should be accounted for and requiring certain additional disclosures; this standard is effective for accounting years ending on or after 23 December 2005. Although technically not applicable to those reporting under International Financial Reporting Standards in 2005, under the terms of a Memorandum of Understanding entered into between leading members of the life assurance and bancassurance sectors and the Association of British Insurers and the ASB, the Group has committed to implementing the requirements of FRS 27 in 2005 and providing additional disclosures in its 2004 accounts. These disclosures are set out below.
Scottish Widows was created following the demutualisation of Scottish Widows Fund and Life Assurance Society in 2000. The terms of the demutualisation are governed by a Court-approved Scheme of Transfer (the ‘Scheme’) which, inter alia, created a With-Profits Fund and a Non-Participating Fund and established protected capital support for the with-profits policyholders in existence at the date of demutualisation. Much of that capital support is held in the Non-Participating Fund and, as such, the capital held in that fund is subject to the constraints noted below.
Further Support Account. The Further Support Account is an extra tier of capital support for the with-profits policies in existence at the date of demutualisation. The Scheme requires that assets can only be transferred from the Non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the Support Account and Further Support Account. Unlike the Support Account test, the economic value used for this test includes both admissible assets and the present value of future profits of business written in the Non-Participating Fund or by any subsidiaries of that fund. The balance of the Further Support Account is expected to reduce to nil by the year 2030. At 31 December 2004, the net economic value of the Non-Participating Fund and its subsidiaries for the purposes of this test was £4,185 million and the combined value of the Support Account and Further Support Account was £2,704 million.
Total shareholders’ funds on a modified statutory solvency basis* (note 29) 4,581 Adjustments to restate amounts onto an FSA statutory basis (502)
Available capital resources on an FSA statutory basis excluding the With-Profits Fund 4,079 Fund for future appropriations** 1,354
** The fund for future appropriations included in the table relates to the With-Profits Fund of Scottish Widows only; the figure disclosed in note 29(h) to the financial statements (£1,379 million) includes £25 million in respect of the other life funds of the Group.
In both Abbey Life and Scottish Widows, certain personal pension policyholders, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other benefits will correspond in value to the benefits of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £89 million in respect of those guarantees. If future salary growth were 0.5 per cent per annum greater than assumed, the liability would increase by some £6 million. If yields were 0.5 per cent lower than assumed, the liability would increase by some £15 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 adjusted for subsequent changes in accounting policy and presentation. The financial statements for each of the years 2000 and 2001 were audited by PricewaterhouseCoopers, independent accountants; the financial statements for each of the years 2002 to 2004 have been audited by their successor firm PricewaterhouseCoopers LLP, independent accountants.
Provisions for bad and doubtful debts (866) (950) (1,029) (747) (541) Profit on ordinary activities before tax 3,493 4,348 2,618 3,167 3,791 Profit on ordinary activities after tax 2,489 3,323 1,852 2,290 2,707 Profit for the year attributable to shareholders 2,421 3,254 1,790 2,233 2,658
Number of ordinary shares in issue (millions)6 5,596 5,594 5,583 5,564 5,507
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.
(leaving on 5 May 2005) A director since 1999. Chairman of National Air Traffic Services and the London Stock Exchange. Joined BP in 1970, serving as managing director from 1997 to 2001, having held senior and general management appointments in the UK, USA, Canada and Europe.
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 54.
Principal activities, business review and future developments 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 5 to 38.
Donations The profit and loss account includes a charge for charitable donations totalling £31,571,000 (2003: £31,712,000) including £31,230,000 (2003: £31,450,000) under deeds of covenant to the four Lloyds TSB Foundations, which will be paid during 2005.
As the Company owed no amounts to trade creditors at 31 December 2004, the number of days required to be shown in this report, to comply with the provisions of the Companies Act 1985, is nil.
The board and its committees The Group is led by a board comprising executive and non-executive directors with wide experience. The appointment of directors is considered by the board and, following the provisions in the articles of association, they must stand for election by the shareholders at the first annual general meeting following their appointment and must retire, and may stand for re-election by the shareholders, at least every three years. Executive directors normally retire at age 60, as required by their service agreements. Independent non-executive directors are appointed for three-year renewable terms, which may be terminated without notice or payment of compensation.
The chairman’s performance is evaluated by the non-executive directors, led by the senior independent director, taking account of the views of executive directors.
The chairman, the group chief executive and the group finance director also have meetings with representatives of major shareholders and the senior independent director and the chairman of the audit committee attend some of these meetings. In addition, all directors are invited to attend investment analysts’ and stockbrokers’ briefings on the financial results.
The resolutions to be considered at the annual general meeting in 2005 will also be decided on a poll. Details of the results will be announced on our website, www.lloydstsb.com and will also be available from the company secretary.
During the year, the committee met three times and recommended the appointment of two executive directors and one non-executive director. In that regard, detailed role specifications were drawn up, external search consultants were engaged and candidates were interviewed by committee members and other directors.
The remuneration committee, which comprises Dr Berndt (chairman), Dr Gibson-Smith, Sir Julian Horn-Smith and Dr Julius, reviews the remuneration policy for the top management group, to ensure that members of the executive management are provided with appropriate incentives to encourage them to enhance the performance of the Group and that they are rewarded for their individual contribution to the success of the organisation. It is made aware of, and advises on, major changes to employee benefit schemes and it also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated powers for setting remuneration for the chairman, the deputy chairman, the group executive directors, the company secretary and any Group employee whose salary exceeds a specified amount.
Number of meetings during the year 9 5 3 5 4
G T Tate3 3 M A van den Bergh 9 3 1 H A Weir4 6
Former directors who served during 2004 P G Ayliffe5 9 Sir Tom McKillop6 7 4 2
S C Targett8 3 1 Appointed to the nomination committee from 3 March 2005 2 Appointed to the nomination committee from 21 May 2004 3 Appointed to the board from 1 August 2004 4 Appointed to the board from 26 April 2004 5 Left the board on 31 January 2005 6 Left the board on 31 December 2004 7 Left the board on 21 May 2004 8 Left the board on 30 April 2004
Internal control The board of directors is responsible for the establishment and review of the Lloyds TSB Group’s system of internal control, which is designed to ensure effective and efficient operations, quality of internal and external reporting, internal control, and compliance with laws and regulations. It should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control the directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss.
Going concern The directors are satisfied that the Company and the Lloyds TSB Group have adequate resources to continue to operate for the foreseeable future and are financially sound. For this reason they continue to adopt the going concern basis in preparing the accounts.
The remuneration committee The members of the remuneration committee during 2004 were Sir Tom McKillop (chairman until 31 December 2004), Dr Berndt, Dr Gibson-Smith, and Dr Julius. From 1 January 2005, Dr Berndt became chairman and Sir Julian Horn-Smith joined the committee.
In addition, in 2004, Alithos Limited provided information for the testing of the total shareholder return (TSR) (calculated by reference to both dividends and growth in share price) performance conditions for the Company’s executive share option schemes.
Directors’ remuneration policy Lloyds TSB Group’s remuneration policy is to ensure that individual rewards are aligned with Lloyds TSB Group’s performance and the interests of its shareholders, and that packages are provided which attract and retain executive directors and senior management of the highest calibre and motivate them to perform to the highest standards. The main principles are: • Basic salary reflects the market median of companies in the FTSE 30 and total compensation should be at the market upper quartile providing performance is at that level.
The chairman and deputy chairman receive remuneration which comprises basic salary and benefits which are broadly similar to the executive directors, but they do not participate in the annual bonus and long-term incentive arrangements. The deputy chairman has pension benefits which accrued during his service as an executive director and pension benefits are accruing for the chairman as described on page 53.
The fees of the independent non-executive directors are agreed by the board within a total amount determined by the shareholders. They may also receive fees, agreed by the board, for membership of board committees. The fees are designed to recognise the responsibilities of the 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: Annual fees from 1 April 2005 Annual fees pre-April 2005
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 Company’s ranking, based on TSR over the relevant (three year) period, to be at least ninth within the comparator group.
The full grant of options for executive directors will only become exercisable if the Company is ranked first within the comparator group.
A performance condition is set when the grant of options is made and the options cannot normally be exercised unless the condition has been met.
Ranking position within comparator group Per cent of option which may be exercised 9 or below Nil – options not exercisable
The remuneration committee believes that the out-performance of Lloyds TSB Group’s TSR compared with those of the companies in the comparator group will demonstrate the success of the Group’s strategy. The Company uses data provided by Alithos Limited to assess the Company’s performance against the comparator group for the purposes of the executive share option scheme and the performance share plan, and PricewaterhouseCoopers LLP check the results of the testing of the performance condition.
The executive directors, the chairman and the deputy chairman are also eligible to participate in the Lloyds TSB Group ‘sharesave’ scheme and the Lloyds TSB Group ’shareplan’. These are ‘all-employee’ share schemes and, therefore, performance conditions do not apply.
The following charts illustrate the available dilution capacity for the Company’s share schemes.
Executive directors are entitled to participate either 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.
It is now the Group’s policy (subject to existing contractual arrangements) that where compensation on early termination is due, it should be restricted to basic salary and bonus to the extent earned. Payments will be on a phased basis and mitigated in the event that alternative employment is secured. 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.
Lloyds TSB Group recognises that executive directors may be invited to become non-executive directors of other publicly quoted companies and that these appointments may broaden their knowledge and experience, to the benefit of the Lloyds TSB Group. Fees are normally retained by the individual directors as the post entails personal responsibility. Executive directors are generally allowed to accept one non-executive directorship.
Dilution capacity – all schemes (10% in any consecutive 10 years)
Dilution capacity – executive schemes (5% in any consecutive 10 years)
The graph illustrates the performance of Lloyds TSB Group plc measured by TSR against a ‘broad equity market index’ over the past five years. As Lloyds TSB Group plc has been a constituent of the FTSE 100 index throughout this five-year period, that index is considered to be the most appropriate benchmark.
The amount shown for Mr Ross reflects payments he received in accordance with his contractual entitlement.
Directors’ pensions The executive directors are members of one of the pension schemes provided by the Lloyds TSB Group with benefits either on a defined benefit or defined contribution basis. Those directors who joined the Lloyds TSB Group after 1 June 1989 and are members of a defined benefit scheme, have pensions provided on salary in excess of the earnings cap either through membership of a funded unapproved retirement benefits scheme (‘FURBS’) or by an unfunded pension promise.
Mr Tate is a member of a defined contribution scheme. He joined the Lloyds TSB Group on 4 August 2003. During the year to 31 December 2004, the employer has made contributions to the defined contribution scheme in respect of him totalling £47,760 of which £24,843 related to the period since his appointment as a director.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2004 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme in accordance with actuarial guidance note GN11. The underlying bases used to arrive at the factors have not changed during the year.
Column (d) is the equivalent transfer value, but calculated as at 31 December 2003 on the assumption that the director left service at that date.
Directors had non-beneficial interests as follows: Mr Ayliffe, Mr Daniels, Mr Fairey, Mr Kane, Mr Pritchard, Mr Tate, Mr van den Bergh and Mrs Weir, together with some 77,000 other employees, were potential beneficiaries in the 1,364 and 1,467,422 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. 162,692 and 1,609,602 shares, respectively, were held by these trusts at the beginning of the year. These holdings were 1,364 and 1,453,954 respectively on 3 March 2005. 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 471,989 shares held at the end of the year by the trustee of the shareplan. 2,163,267 shares were held by the trustee at the beginning of the year. This holding was 582,350 on
Share retention plan J E Daniels 216,763 216,763 (see page 57) 1/1/2005 30/6/2005
We review whether the corporate governance statement on pages 43 to 46 reflects the Company’s compliance with the nine provisions of the 2003 Financial Reporting Council’s Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the board’s statements on internal control cover all risks and controls, or to form an opinion on the effectiveness of the Company’s or Group’s corporate governance procedures or its risk and control procedures.
Other income Fees and commissions receivable 3,124 2,987 112 3,099 Fees and commissions payable (744) (688) (34) (722)
Intangible fixed assets 23 2,425 2,513 Tangible fixed assets 24 4,181 3,918
Maarten A van den Bergh J Eric Daniels Helen A Weir Chairman Group Chief Executive Group Finance Director
Items in course of transmission to banks 631 626 Debt securities in issue 33 27,217 25,922
Memorandum items 46 Contingent liabilities: Acceptances and endorsements 71 299 Guarantees and assets pledged as collateral security 6,786 6,122 Other contingent liabilities 1,669 2,604
Total recognised gains and losses relating to the year 2,244 3,368 Prior year adjustments in respect of changes in accounting policy in 2003 – (29)
Historical cost profits and losses for the year ended 31 December 2004
Profit for the year 507 1,343 Currency translation differences on foreign currency net investments (11) 118 Actuarial losses recognised in post-retirement benefit schemes 45 (166) (4) Issue of shares 40,41 10 45 Movements in relation to own shares 43 10 (2) Goodwill written back on sale of businesses 6 3 181
Capital expenditure and financial investment: – Additions to fixed asset investments (10,088) (35,420) – Disposals and maturities of fixed asset investments 9,732 36,281 – Additions to tangible fixed assets (1,183) (778) – Disposals of tangible fixed assets 243 287 Net cash (outflow) inflow from capital expenditure and financial investment (1,296) 370
The useful economic life of the goodwill arising on each acquisition is determined at the time of the acquisition. The directors consider that it is appropriate to assign an indefinite life to the goodwill which arose on the acquisition of Scottish Widows during 2000 in view of the strength of the Scottish Widows brand, developed through over 185 years of trading, and the position of the business as one of the leading providers of life, pensions, unit trust and fund management products. Both of these attributes are deemed to have indefinite durability, which has been determined based on the following factors: the nature of the business; the typical life spans of the products; the extent to which the acquisition overcomes market entry barriers; and the expected future impact of competition on the business.
General provisions are raised to cover latent bad and doubtful debts which are present in any portfolio of advances but have not been specifically identified. The Group has general provisions, held against each of its principal lending portfolios, which are calculated after having regard to a number of factors; in particular, the level of watchlist or potential problem debt, the observed propensity for such debt to deteriorate and become impaired and prior period loss rates. The level of general provision held is reviewed on a regular basis to ensure that it remains appropriate in the context of the perceived risk inherent in the related portfolio and the prevailing economic climate.
Equipment is depreciated by equal annual instalments over the estimated useful lives of the assets, which for fixtures and furnishings are 10-20 years and for computer hardware, operating software and application software and the related development costs relating to separable new systems, motor vehicles and other equipment are 3-8 years.
Assets, liabilities and results in foreign currencies are expressed in sterling at the rates of exchange ruling on the dates of the respective balance sheets. Exchange adjustments on the translation of opening net assets held overseas are taken direct to reserves. All foreign exchange gains and losses, which arise from normal trading activities, are included in the profit and loss account.
Income from long-term assurance business 715 – 715 436 – 436 17 453
Social security costs 140 143 Other pension costs (note 45) 338 353
During the year the auditors also earned fees of £0.6 million (2003: £0.6 million) in respect of the audit of unit trusts and pension schemes managed by the Group.
During 2004 the Group completed the sale, announced on 19 July 2004 and completed on 19 November 2004, of the business of the branch of Lloyds TSB Bank plc in Argentina; the sale, announced on 19 July 2004 and completed on 30 November 2004 of the Group’s principal businesses in Colombia comprising its interests in Lloyds TSB Bank S.A. and in Lloyds Trust S.A. and certain offshore assets; and the sales, announced on 1 December 2003, of substantially all of the businesses of the branches of Lloyds TSB Bank plc in Panama, Guatemala and Honduras which were completed on 30 April 2004, 4 June 2004 and 1 October 2004 respectively.
8 Tax on profit on ordinary activities a Analysis of charge for the year 2004 2003 £m £m
Foreign tax: – Current tax on profits for the year 119 144 – Adjustments in respect of prior years (5) (15)
Current tax charge 859 913 Deferred tax 146 119 Associated undertakings and joint ventures (1) (7)
In addition to the tax charge in the profit and loss account detailed above, £71 million (2003: £2 million) of deferred tax has been credited to the statement of total recognised gains and losses in respect of actuarial losses recognised in post-retirement benefit schemes (note 45).
Profit on ordinary activities before tax 3,493 4,348 Tax charge thereon at UK corporation tax rate of 30% 1,048 1,304 Factors affecting charge: – Goodwill amortisation 9 9 – Overseas tax rate differences (14) (9) – Specifically allowable, unallowable and non-taxable items (5) (10) – Net tax effect of disposals (12) (276) – Tax deductible coupons on non-equity minority interests (12) (12) – Capital allowances in excess of depreciation (86) (105) – Other timing differences (60) (14) – Life companies rate differences (16) 16 – Other items 7 10
Current tax charge 859 913 Deferred tax: – Capital allowances in excess of depreciation 86 105 – Other timing differences 60 14 Associated undertakings and joint ventures (1) (7)
12 Treasury bills and other eligible bills 2004 2004 2003 2003 Balance sheet Valuation Balance sheet Valuation £m £m £m £m
Repayable on demand 2,477 3,768 Other loans and advances by residual maturity repayable: – 3 months or less 16,763 7,637 – 1 year or less but over 3 months 2,243 2,329 – 5 years or less but over 1 year 1,422 1,496
Lending to customers 144,708 125,785 Hire purchase debtors 4,828 4,701 Equipment leased to customers 6,387 6,470
Loans and advances by residual maturity repayable: – 3 months or less 28,748 23,284 – 1 year or less but over 3 months 9,878 9,458 – 5 years or less but over 1 year 35,301 31,384
Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. If the investment securities were sold at their year end valuation no tax is expected to be payable as any such gains would be exempt or covered by available capital losses.
These investments have been sold to third parties but the Group is committed to reacquire them at a future date and at a predetermined price. At 31 December 2004 the Group held £12,783 million (2003: £2,643 million) of securities as collateral under reverse repurchase agreements. The above disclosure includes assets held through these agreements and subsequently resold as collateral for the Group’s own transactions.
The Group’s largest investments are in two joint ventures: Group interest Nature of business iPSL 19.5% of issued ordinary share capital Cheque processing GF Two Limited (formerly Goldfish Holdings Limited) 25.0% of issued ordinary share capital No longer trading
In the year ended 31 December 2003 £7 million of interest receivable from GF One Limited and £6 million of charges to GF One Limited in respect of administrative costs were included in the Group’s income.
Included in the gross assets disclosed on the balance sheet is an investment of £3 million (2003: £3 million) in associated undertakings.
Shares in banks 11,080 10,752 Shares in other group undertakings – 1
The primary financial statements of these entities can be summarised as follows: Equipment leasing vehicles Structured finance vehicles £m £m £m £m
(Loss) profit on ordinary activities before taxation (15) (2) 41 28 Tax on (loss) profit on ordinary activities 5 6 (5) (2)
Cost: Exchange and other adjustments – (1) (46) Adjustments on disposal of businesses (10) (13) –
Depreciation: Exchange and other adjustments – (1) (4) Adjustments on disposal of businesses (4) (8) – Charge for the year (£589 million in total; 2003: £646 million) 66 257 266
Annual commitments under non-cancellable operating lease agreements were: Premises Equipment Premises Equipment £m £m £m £m
Leases on which the commitment is due to expire in: 1 year or less 6 – 7 – 5 years or less but over 1 year 26 – 29 –
Amounts payable in: 1 year or less 1 1 – – 5 years or less but over 1 year 3 1 – –
Capital expenditure contracted but not provided for at 31 December 2004 amounted to £150 million (2003: £77 million) of which £146 million (2003: £71 million) relates to assets to be leased to customers under operating leases.
Movements in the embedded value balance: Exchange and other adjustments (16) 12 Profit after tax 516 296 Adjustments on disposal of businesses – (38)
Contribution from existing business. This comprises the following elements: • The expected return arising from the unwinding of the discount applied to the expected cash flows at the beginning of the year; • Experience variances caused by the differences between the actual experience during the year and the expected experience; • The effects of changes in assumptions, other than economic assumptions, and other items; and
Income from long-term assurance business: New business contribution 225 150 Existing business: Expected return 289 264 Experience variances (41) (16) Assumption changes and other items (39) (75) Customer remediation provisions (see c) (12) (100)
Following an industry wide investigation in the 1990’s it was concluded that a large number of customers who had purchased personal pension products had been poorly advised by insurance companies and intermediaries; an action plan was established requiring the UK pensions industry to review all cases of possible misselling and, where appropriate, pay compensation. As the review of pension cases in the Group has progressed, provisions have been established for the estimated cost of compensation.
• Future bonus rates on with-profits business are set at levels which would fully utilise the assets supporting the with-profits business. The proportion of profits derived from with-profits business allocated to the shareholder has been assumed to continue at the current rate of one-ninth of the cost of the eligible bonus, in accordance with the terms of the transfer of the Scottish Widows business.
Investments shown above comprise: Fixed interest securities 15,985 15,947 Stocks, shares and unit trusts 31,896 27,590 Investment properties 3,150 3,540 Other properties 120 121 Mortgages and loans 76 65
Realised gains (losses) on investments 244 (1,679) Unrealised losses on investments – (22) Other charges – (4) Tax attributable to long-term business (110) (41) Transfer to the fund for future appropriations (1,084) (414)
Income from long-term assurance business after tax reconciles to the profit calculated on a modified statutory solvency basis as follows: £m £m
Income from long-term assurance business attributable to the shareholder after tax 516 296 Increase in value-in-force taken to profit (60) (2)
Bonds and medium-term notes by residual maturity repayable: 1 year or less 167 711 2 years or less but over 1 year 144 81 5 years or less but over 2 years 1,053 1,099
The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales, where the original sales processes are found to have been deficient. During 2004 management have again reviewed the adequacy of the provisions held having regard to current complaint volumes and the level of payments being made and as a result an additional charge of £100 million (2003: £200 million) has been made.
The Group also carries provisions in respect of its obligations relating to UIC Insurance Company Limited (‘UIC’), which is partly owned by the Group. The Group has indemnified a third party against losses in the event that UIC does not honour its obligations under a re-insurance contract, which is subject to asbestosis and pollution claims in the US. The ultimate exposure to claims in respect of the insurance business of UIC is uncertain. Accordingly, the provision has been based upon an actuarial estimate of prospective claims, taking account of re-insurance arrangements protecting UIC and UIC’s available assets. Given the long-term nature of many of the claims to which UIC is exposed, it is expected to be many years before the Group’s ultimate liability can be assessed with certainty.
* In certain circumstances, these notes and bonds would acquire the characteristics of preference share capital.
i) Issued during 2004 primarily to finance the general business of the Group. Group Group Company Company £m £m £m £m
** 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.
‡ These securities constituted interests in LM ABS Investment Partnership, an English law general partnership in which the principal partner was Lime Street (Funding) Limited, a wholly owned subsidiary of the Group. During 2004 the partnership was dissolved and the capital returned to the partners.
At 31 December 2004, options to acquire 162 million Lloyds TSB Group ordinary shares of 25p each were outstanding under the executive share option schemes, the share retention plan and the staff sharesave share option schemes exercisable up to 2014. These include the option, described on page 57, to acquire 216,763 shares under the share retention plan: otherwise the options are exercisable at prices ranging from 243p to 888p per share.
Own shares – the Company 14 22 Lloyds TSB Group interest in shares held by the long-term assurance funds† 17 17
The Lloyds TSB Group Shareplan (‘Shareplan’) has been established for the purpose of providing an enhanced remuneration package for employees. The shares are used to provide shares awarded to employees for no consideration, as a percentage of salaries by reference to the profits of Lloyds TSB Group, together with partnership shares which are acquired by employees via monthly contributions; and matching shares, which are additional shares awarded for no consideration to employees acquiring partnership shares. At 31 December 2004, 0.5 million shares (2003: 2.2 million shares) were held but not allocated to individual employees by the Shareplan trustees with a cost to the Group of £2.3 million (2003: £9.2 million). The trustees have waived all but a nominal dividend on the shares they hold.
The credit of £8 million to the Company’s profit and loss account reserves represents the net reduction in the cost of own shares.
Details of the Group’s joint ventures are provided in note 20. Information relating to transactions entered into between Group undertakings and the joint ventures and details of outstanding balances at 31 December 2004 are also shown in note 20.
The principal assumptions used in the scheme valuations were as follows: 31December 31 December 31 December
Fair value at of return at Fair value at of return at Fair value at of return at 31December 31December 31December 31December 31December 31December
Actual return less expected return on scheme assets 369 802 Experience gains and losses arising on scheme liabilities (114) 94 Effect of changes in demographic and financial assumptions (492) (902)
Other: Other items serving as direct credit substitutes 345 1,069 Performance bonds and other transaction-related contingencies 1,324 1,534 Other contingent liabilities – 1
Information about the Group’s use of financial instruments and management of the associated risks is given on pages 24 to 26.
Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell a specified amount of currency at an agreed rate of exchange on or before a specified future date.
The notional principal amounts and fair values (which, after netting, are the carrying values) of trading instruments entered into with third parties were as follows: Notional principal Fair value Fair value amount assets liabilities
Interest rate contracts: Interest rate swaps 275,547 3,118 3,631 Forward rate agreements 62,797 28 24 Options purchased 9,679 78 – Options written 7,430 – 163 Futures 48,278 – –
The aggregate carrying value of non-trading derivatives with a positive fair value was an asset of £96 million (2003: an asset of £132 million) and with a negative fair value was a liability of £35 million (2003: a liability of £71 million).
The Company held non-trading derivatives with a notional principal amount of £1,393 million (2003: £1,892 million).
The maturity of the notional principal amounts and replacement cost of both trading and non-trading instruments entered into with third parties was: Under 1 year 1 to 5 years Over 5 years Total £m £m £m £m
6 months 1 year 5 years or less or less or less Non3 months but over but over but over Over interest Trading or less 3 months 6 months 1 year 5 years bearing book Total
Trading book Trading book Non-trading book Non-trading book Book value Fair value Book value Fair value
The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures are as follows: Functional currency of Group operations £m £m
The net gains arising in 2003 and earlier years and recognised in 2004 amounted to £3 million. Net losses of £228 million arose in 2004 but were not recognised in the year.
Details of value at risk in the Group’s global trading activities are given on page 24.
c Analysis of changes in cash during the year 2004 2003 £m £m
d Analysis of changes in financing during the year 2004 2003 £m £m
Share capital (including premium and merger reserve): Issue of share capital 10 45
Individual Savings Accounts (ISAs) The Company provides a facility for investing in Lloyds TSB shares through an ISA. For details please contact Lloyds TSB Private Banking ISAs, Freepost, PO Box 249, Haywards Heath, West Sussex RH16 3ZU.
The Better Payment Practice Code A copy of the code and information about it may be obtained from the DTI Publications Orderline ref URN 04/606. Alternatively, log on to www.payontime.co.uk for details.