Lloyds TSB Group is quoted on the London Stock Exchange and is one of the largest companies within the FTSE 100, with a market capitalisation of £26.7 billion on 31 December 2007. At the end of 2007 total group assets were £353 billion and the Group has nearly 70,000 employees. Total income for the 12 months to 31 December 2007 was £18 billion with profit before tax totalling £4 billion.
Lloyds TSB Group plc may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the US Securities and Exchange Commission, Lloyds TSB Group plc’s annual review, half-year announcement, proxy statements, offering circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of Lloyds TSB Group plc to third parties, including financial analysts. The forward looking statements contained in this annual report are made as of the date hereof, and Lloyds TSB Group undertakes no obligation to update any of its forward looking statements.
i Lloyds TSB Group Annual Report and Accounts 2007 2007 highlights • Strong financial performance with statutory earnings per share increased by 17 per cent to 58.3p. Economic profit increased by 21 per cent. Statutory profit before tax was 6 per cent lower at £4,000 million, largely reflecting adverse policyholder interests volatility.
• High returns maintained, with return on equity of 25.2 per cent. Improved return on risk-weighted assets, and return on Embedded Value increased to 9.9 per cent.
• Excellent cost management. Cost growth of only 1 per cent, delivering wide positive jaws. Cost:income ratio improved by 1.8 percentage points to 49.0 per cent. Groupwide productivity programme exceeded 2007 expectations, and remains on track to deliver benefits of £250 million in 2008.
• Satisfactory credit quality. Retail impairment charge lower than in 2006. Based on current trends, we do not expect a significant change in the retail impairment charge in the first half of 2008, compared to the first half of 2007. Corporate asset quality remains good.
Lloyds TSB Group was formed in 1995 following the merger of Lloyds Bank and TSB and now comprises the Lloyds TSB brand along with Cheltenham & Gloucester, one of the largest mortgage providers in the UK and Scottish Widows, one of the UK’s largest providers of life, pensions and unit trust products.
Earnings per share 58.3p 49.9p * Excluding volatility, profit on sale of businesses, the settlement of overdraft claims in 2007 and the pension schemes related credit in 2006.
† Excluding volatility, profit on sale of businesses, the settlement of overdraft claims in 2007, the pension schemes related credit in 2006, and customer redress provisions and the strengthening of reserves for mortality in 2005.
Lloyds TSB has a very clear vision to be the best financial services organisation in the UK. In achieving this we aim to be a great place for our customers to do business; a great place for our people to work; and to generate good returns for our shareholders. Underlying these aims we also want to be valued by the communities where we operate through high ethical standards, respect for our stakeholders, community involvement and a commitment to corporate responsibility. I am very pleased to be able to report significant progress on our journey towards achieving this vision during 2007.
Our major focus for support is through the four Lloyds TSB Foundations in England and Wales, Northern Ireland, Scotland and the Channel Islands. Our commitment is to provide 1 per cent of the Group’s pre-tax profits to the Foundations and in 2007 we gave £37 million to support their work. A further £37 million will be donated in 2008 bringing our total contributions since the Lloyds TSB merger to over £360 million, making Lloyds TSB one of the largest charitable donors in the UK. I would strongly encourage you to visit the website for the Lloyds TSB Foundations at www.lloydstsbfoundations.org.uk to look at some of the programmes we support and to see the difference we can make in helping disadvantaged people to live a fuller life in communities across the UK.
In March 2007 we were the first organisation to become a domestic partner of the 2012 Olympic and Paralympic Games. This places Lloyds TSB at the heart of the most exciting world event to take place in the UK for many decades. Our vision for our partnership with London 2012 is ‘to inspire and support young people, communities and businesses all over Britain on their journey to the Olympic and Paralympic Games and beyond.’
Our Group Chief Executive, Eric Daniels, has given real leadership to the Group. He and his executive have driven financial and operational success within a strong culture of teamwork and integrity. It is this work that has created the results that we have seen through 2007 and will ensure our continued success in future years.
Given this strong performance and confidence in our future earnings capacity, the board has decided to increase the final dividend by 5 per cent to 24.7 pence per share. This brings the full year dividend to 35.9 pence per share, an increase of 5 per cent over that paid for 2006. Going forward, the board expects to grow the dividend over time, whilst continuing to build dividend cover.
In the Retail Bank, we attracted over one million new current accounts and we delivered strong flows of new business, with sales volumes rising 17 per cent. We are now the number one provider of current accounts, cards and personal loans. In Insurance and Investments, we have seen good progress in the sale of bancassurance products to our franchise customers and sales volumes rose by 20 per cent, with particular success in the sale of protection products through the branch network.
Our capital position is strong. We manage our capital to support efficient growth, directing capital to our higher growth and higher return business lines. We continued the capital efficiency programmes in Scottish Widows, with a further £1.9 billion repatriated to the Group during the year.
We believe there remains significant opportunity for organic growth and as we successfully grow the business and develop our skills and capabilities, we will look to expand from a solid foundation of strength. This is likely to be through leveraging our financial strength and enhanced capabilities in new product, customer and geographic markets.
Profit before tax 4,000 4,248 * Excluding volatility, profit on sale of businesses, the settlement of overdraft claims in 2007 and the pension schemes related credit in 2006.
To enable meaningful comparisons to be made with 2006, the income statement commentaries below exclude insurance related volatility, the profit on sale of businesses, settlement of overdraft claims in 2007 and the pension schemes related credit in 2006.
Continued momentum throughout the business Profit before tax increased by £209 million, or 6 per cent, to £3,919 million, underpinned by good relationship banking momentum, notwithstanding the impact of the £280 million market dislocation in Corporate Markets. Revenue growth of 5 per cent exceeded cost growth of 1 per cent, with each division delivering stronger revenue growth than cost growth. Earnings per share increased by 8 per cent to 50.8p and economic profit increased by 9 per cent to £1,842 million. Excluding the impact of market dislocation, Group profit before tax increased by 13 per cent to £4,199 million.
The Group’s programme of productivity initiatives has continued to deliver significant benefits, improving underlying cost efficiency and creating greater headroom for further investment in the business. During 2007 the programme delivered net cost reductions of £145 million, exceeding the previously indicated net benefits of approximately £125 million, with gross benefits of £248 million and reinvestment in further programme initiatives of £103 million. The Group remains on track to deliver net benefits of approximately £250 million in 2008.
In UK Retail Banking, impairment losses decreased by £14 million, or 1 per cent, to £1,224 million. During 2007, we have seen a reduction in the level of customer insolvencies, improvements in the Group’s collections procedures and better than assumed recoveries. The quality of new unsecured lending has continued to be strong and our arrears and delinquency trends have improved during the year. In addition, the asset quality of our mortgage portfolio has remained excellent. Whilst the uncertain UK macroeconomic environment and customer insolvency trends remain key factors in the outlook for retail impairment, our current lead indicators are good, we are continuing to enhance our underwriting and collections procedures and the quality of new business remains strong. As a result, based on current trends, we do not expect a significant change in the retail impairment charge in the first half of 2008, compared to the first half of 2007.
Limited exposure to assets affected by current capital markets uncertainties Whilst no bank has been immune to the impact of the turbulence in global financial markets in the second half of 2007, Lloyds TSB’s high quality business model means that the Group has relatively limited exposure to assets affected by current capital markets uncertainties.
US sub-prime Asset Backed Securities (ABS) and ABS Collateralised Debt Obligations (CDOs) Lloyds TSB has no direct exposure to US sub-prime ABS and limited indirect exposure through ABS CDOs. During the second half of 2007, the market value of our holdings in ABS CDOs reduced and, as a result, the Group has taken an income statement charge of £114 million, leaving a residual investment of £130 million, net of hedges. The write-down largely reflects junior tranches of CDOs which have been written down to the expected interest payments to be received within the next 12 months. The Group has no exposure to mezzanine ABS CDOs. The Group’s residual investment of £130 million is stated net of credit default swap (CDS) protection totalling £470 million purchased from a ‘triple A’ rated monoline Financial Guarantor. At 31 December 2007, the underlying assets supported by this protection had fallen in value, leaving a reliance on the CDS protection totalling £155 million. In addition, we have £1,861 million of ABS CDOs which are fully cash collateralised by major global financial institutions.
Trading portfolio In the second half of 2007, Corporate Markets also saw a reduction in profit before tax of approximately £144 million as a result of the impact of mark-to-market adjustments in the Group’s trading portfolio, to reflect the marketwide repricing of liquidity and credit. At 31 December 2007 the trading portfolio contained £181 million of indirect exposure to US sub-prime mortgages and ABS CDOs. This super senior exposure is protected by note subordination.
Available-for-sale assets At 31 December 2007, the Group’s portfolio of available-for-sale assets totalled £20,196 million (31 December 2006: £19,178 million). A significant proportion of these assets (£8.3 billion) related to the ABS in Cancara. The residual assets included £3.2 billion Student Loan ABS, predominantly guaranteed by the US Government, £4.6 billion Government bond and short-dated bank commercial paper and certificates of deposit and £4.1 billion major bank senior paper and high quality ABS. These available-for-sale assets are intended to be held to maturity however, under IFRS, they are marked-to-market through reserves. During 2007, a net £413 million reserves adjustment, which has no impact on the Group’s capital ratios, has been made to reflect a reduction in the value of these assets. These assets are not impaired and we expect to obtain full value for them upon maturity.
“We do not expect a significant change in the retail impairment charge in the first half of 2008, compared to the first half of 2007.”
Strong capital management disciplines Capital efficiency continued to improve throughout the Group, resulting in an increase in post-tax return on average shareholders’ equity to 25.2 per cent, and in the post-tax return on average risk-weighted assets to 1.76 per cent, from 1.72 per cent. In our life assurance and investment businesses, the post-tax return on embedded value, on a European Embedded Value (EEV) basis, increased to 9.9 per cent, from 9.3 per cent.
Significant reduction in the Group pension schemes’ deficit The Group’s defined benefit pension schemes’ gross deficit at 31 December 2007 improved by £1,416 million to £683 million, comprising net recognised liabilities of £2,033 million partly offset by unrecognised actuarial gains of £1,350 million. This improvement reflects an increase in the real discount rate used to value the schemes’ liabilities and Group contributions to the schemes, which exceeded the cost of accruing benefits.
In July 2007, the Group announced an agreement to sell Abbey Life Assurance Company Limited (Abbey Life) to Deutsche Bank AG. This transaction was also completed at the end of September 2007 and the Group has reported a profit before tax on the sale of this business of £272 million (tax: £nil). In addition, a pre-sale dividend of £175 million was paid to Group in June 2007.
• Excellent progress in growing the current account customer franchise, with over 1 million new current accounts opened, an increase of 17 per cent. New Added Value Accounts increased by 79 per cent. Lloyds TSB is now the UK market leader in new current account customer recruitment.
• Stabilisation in net interest margin, with net interest margin in the second half of 2007 1 basis point higher than in the first half of 2007.
• The quality of new lending continues to be strong. Arrears levels have continued to improve and the impairment charge in 2007 was lower than in 2006. Whilst the economic outlook for 2008 is uncertain, we do not expect to experience a significant change in the retail impairment charge in the first half of 2008, compared to the first half of 2007.
Overall sales increased by 17 per cent, with improvements over a broad range of products, especially current accounts, credit cards and bank savings products. Sales volumes were particularly strong in the branch network with an increase of 24 per cent. This continued strong sales growth has been driven from high levels of product innovation over the last twelve months with the successful launch of a number of enhanced savings products, an improved range of added value current accounts and the introduction of the innovative Lloyds TSB Duo Airmiles credit card offer. Customer deposits have increased strongly, by 8 per cent over the last twelve months, with particularly strong progress in growing our bank savings and wealth management deposit balances, with increases of 15 per cent and 12 per cent respectively.
The Group has delivered good levels of mortgage growth, focusing on prime mortgage business and seeking to maintain economic returns. However, as we have previously indicated, our market share of net new mortgage lending in the second half of the year was below our outstanding stock position, reflecting our continued focus on writing value-creating business. The Group continues to focus on those segments of the mortgage market where value can be created while adopting a conservative approach to credit risk. As a result of our focus on managing for value and the recent marketwide increase in interest spreads, new business net interest margins have strengthened. Recent levels of mortgage allocations have been stronger and we expect this to translate into robust balance growth as we move into 2008.
We have maintained our market leadership position in personal loans, despite tightened credit criteria and a slowdown in consumer demand. Unsecured consumer credit balances were broadly flat with personal loan balances outstanding at 31 December 2007 marginally higher at £11.2 billion, and credit card balances slightly lower at £6.6 billion.
Expanding the customer franchise In addition to the strong growth in product sales from existing customers, the Group has continued to make progress in expanding its customer franchise. Current account recruitment increased by 17 per cent, compared with last year, supported by the range of added value current accounts, in particular the Silver Account focusing on foreign nationals. During 2007, the Group opened more than 1 million new current accounts.
In Telephone Banking we have continued to invest in our market leading speech recognition technology which has supported significant growth in the number of customers using our automated service. This, combined with further improvements in the efficiency of our contact centre operations, has led to all customer service calls now being answered from UK based centres.
Mortgage credit quality remains excellent with the impairment charge remaining at a low level of £18 million, or 2 basis points of average mortgage lending. Arrears in the mortgage business have also fallen. In Cheltenham & Gloucester, the average indexed loan-to-value ratio on the mortgage portfolio was 43 per cent, and the average loan-to-value ratio for new mortgages and further advances written during 2007 was 63 per cent. At 31 December 2007, only 1.7 per cent of balances had an indexed loan-to-value ratio in excess of 95 per cent. We extensively stress-test our lending to changes in macroeconomic conditions and we remain very confident in the quality of our mortgage portfolio.
Lloyds TSB General Insurance is the leading distributor of home insurance in Britain, with products distributed through Lloyds TSB Group channels and strategic corporate partners.
Lloyds TSB General Insurance is targeting growing share in chosen customer segments, developing key insurance partnerships, improving margins by better customer management and improving service and efficiency.
• Good sales performance. 7 per cent increase in Scottish Widows’ present value of new business premiums. Strong progress in increasing bancassurance sales, up 20 per cent. Good performance in the sale of protection products, corporate pensions and retirement income products.
Total profit after tax, excluding profit on sale of Abbey Life 768 773
Breakdown of income statement between life and pensions, and OEICs Life and pensions OEICS Total 2007 £m £m £m
* Other items represent amounts not considered attributable to the underlying performance of the business.
Impact on new Impact business profit on EEV before tax £m £m 2007 EEV/new business profit before tax 5,365 326 100 basis points reduction in risk-free rate1 161 7 100 basis points increase in risk-free rate1 (115) (7)
5 This sensitivity shows the impact of reducing lapse and surrender rates to 90 per cent of the expected rate.
6 This sensitivity shows the impact on our annuity and deferred annuity business of reducing mortality rates to 95 per cent of the expected rate.
9 This sensitivity shows the impact of a 10 basis point increase in corporate bond yields and the corresponding reduction in market values. Government bond yields and the risk-free rate are assumed to be unchanged.
Net operating income decreased by £16 million, or 3 per cent, as growth in home and loan protection income was more than offset by lower motor insurance income, increased reinsurance costs and the run-off from the legacy health portfolio. Our continued focus on improving operational efficiency and improving the effectiveness of our marketing spend has resulted in a £3 million, or 2 per cent, reduction in operating costs, whilst also continuing to improve processing efficiency.
Wholesale and International Banking Our business Our businesses within the Wholesale and International Banking arena cover a broad scope, serving thousands of customers, ranging from start-ups and small enterprises to large organisations and global corporations. Combining the respective strengths of some 3,000 people in Corporate Banking and Products & Markets, Corporate Markets plays an integral role in leveraging and expanding the customer franchise and building deep, long-lasting relationships with around 17,000 corporate customers and was awarded with ‘Real Finance/CBI FDs’ Excellence Awards – Corporate Bank of the Year’ for the third year running. Commercial Banking is a growing business with some 5,500 people serving nearly one million customers across the UK from one-person start-ups to large, established enterprises. Lloyds TSB Group has a leading share of the new business start-up market, with some 120,000 new businesses opening an account in 2007. We also participate in specialist markets with a range of solutions including personal and international expatriate and private banking, motor and leisure finance and auto leasing.
Our strategy The Wholesale and International Banking strategic vision is to be the best UK mid-market focused wholesale bank and to compete successfully in selected, relevant global markets. Our key strategic priorities are to grow the Corporate Markets business; build on the growth momentum in Commercial Banking; and maintain strong asset quality.
Operating expenses increased by 3 per cent to £632 million, reflecting further investment in people to support ongoing business growth. The trading surplus, excluding market dislocation, increased by 26 per cent. The impairment charge of £240 million includes £92 million from the impact of market dislocation and the £28 million one-off charge relating to the impact of the 2007 Finance Act on the division’s leasing business. Excluding these items, the underlying increase in the impairment charge reflects lower levels of releases and recoveries, recent strong growth in corporate customer lending and impairments relating to two special situations.
Following changes in age discrimination legislation in 2006, the Group ceased to augment the pension entitlement of employees taking early retirement; this change reduced the Group’s defined benefit pension liability at 31 December 2006 by £129 million (£1 million of which was unrecognised) and resulted in a one-off credit to the 2006 income statement of £128 million.
Insurance volatility The Group’s insurance businesses have liability products that are supported by substantial holdings of investments, including equities, property and fixed interest investments, all of which have a volatile fair value. The value of the liabilities does not move exactly in line with changes in the fair value of the investments, yet IFRS requires that the changes in both the value of the liabilities and investments be reflected within the income statement. As these investments are substantial and movements in their fair value can have a significant impact on the profitability of the Insurance and Investments division, management believes that it is appropriate to disclose the division’s results on the basis of an expected return in addition to the actual return. The difference between the actual return on these investments and the expected return based upon economic assumptions made at the beginning of the year is included within insurance volatility.
At Lloyds TSB, people are our most valuable resource. Managing our people effectively is fundamental to the success of the business and achieving our vision of being the best financial services organisation in the UK. Creating a great place to work is a core priority of the people strategy which seeks to enable Lloyds TSB to be recognised, both within the financial services sector, but also more generally in the UK employment market, as the best company to work for.
To achieve these goals we aim to create a high commitment, high performance organisation. We are clear about what we expect from our people. Our values guide us in all our dealings with colleagues, customers and the wider community. We have nearly 70,000 people working for the Company and whilst business units across the Group have developed values specific to their business needs. They are based on the core Group values of: • putting customers first; • acting with integrity and respect; • taking personal responsibility; • working as a team.
It’s not just about bringing in new people. Developing existing employees and succession planning are equally important to support our growth strategy. We have strong succession and development plans for all our senior leaders across the Group and we are retaining people for an average tenure across our business of 13 years.
Recognition Recognition and reward schemes are widely used throughout the organisation to celebrate team and individual achievement. While our emphasis is on providing recognition through line management, we also formally recognise those who have exceeded expectations and pushed boundaries in areas such as colleague support, customer service and building community profile.
Overall investment in people development has risen by 10 per cent in 2007, and we now deliver an average of 2.3 days formal learning per full time employee (FTE), an increase of 24 per cent on 2006. We continue to provide our people with a range of opportunities and have seen formal learning delivery increase during 2007 to 939,000 hours; an increase of 37 per cent
In addition to developing programmes internally the UfLTSB works with external companies to develop and deliver learning. Some programmes may be certificated by external organisations providing employees with performance benchmarks and portable qualifications. We also support a range of business focused and developmental professional qualifications; for example over 1,800 people received financial study support during the year.
Employee engagement Lloyds TSB has inspirational leaders who provide a clear direction for the organisation through our strategy and vision and values framework. The success of our vision is in its simplicity, clarity and re-enforcement in what our leaders do. We ensure our people are actively engaged through communication and participation in regular employee engagement surveys.
Communications To support this, the Group invests in a range of internal media, ensuring our people are informed and involved. These include a company intranet, print publications and increasingly e-zines and social networking technology. The essential communication relationship between managers and their teams is also supported with bespoke communications training.
Equality and diversity Equality and diversity is not just about complying with equality legislation. We believe that it is vital for achieving competitive advantage and in a tight employment market, we need to attract and retain talented people from all the UK’s diverse communities. We need to be close to our customers and provide them with the right products and services. By attracting and retaining a diverse workforce, we will better understand the needs of all our customers and be able to build lasting relationships.
We continue to make significant progress with our disability and sexual orientation programmes. In 2007 our disability programme was ranked first out of 116 organisations by the Employers’ Forum on Disability and we maintained our sixth place ranking in Stonewall’s† Index of the 100 best employers of lesbian, gay and bisexual people.
* †† Shows percentage of whole workforce although not all employees have supplied information on race, disability or sexual orientation.
† Stonewall is a campaigning organisation that works to achieve equality and justice for lesbians, gay men and bisexual people.
We have adopted the European Foundation of Quality Management’s Corporate Responsibility Framework to help us align corporate responsibility with business strategy and also with individual balanced scorecard priorities. As part of the process we have a network of approximately 60 representatives across all business divisions, through whom we conduct an annual self assessment of our performance with independent oversight and assurance. This allows us to identify strengths and areas for improvement and to prioritise actions and objectives. It also provides a benchmark against which we can compare our performance both internally and externally.
Climate change The UK Government has stated its belief that climate change is the greatest long-term challenge facing the world today. Measures to tackle climate change will have potential implications for regulation, taxation and public policy and will carry both risks and opportunities for companies and the public.
* 2006 travel figures have been restated to reflect the fact that C&G travel data is now included and to provide a more accurate comparison between
Board and committees The board, assisted by its committees, the risk oversight committee, the group executive committee, and the group audit committee, approves the Group’s overall risk management framework. The board also reviews the Group’s aggregate risk exposures and concentrations of risk to seek to ensure that these are consistent with the board’s appetite for risk. The role of the board, audit committee and risk oversight committee are shown in the corporate governance section on pages 61 and 62, and further key risk oversight roles are described on the next page.
These committees are further supported by a number of specialist risk committees covering the Group’s risk types in detail.
Group executive directors have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are required to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within the parameters set by the board, group executive committee and group risk. Compliance with policies and parameters is overseen by the risk oversight committee, the group business risk committee, the group asset and liability committee, group risk and the divisional risk officers.
Business risk management forms part of a tiered risk management model, as shown on page 36 with the divisional risk officers providing oversight and challenge, as described above, and the chief risk director and group committees establishing the group wide perspective.
Lloyds TSB Group business strategy and the desired outcomes for our key stakeholders are used to determine the Group’s high level risk principles and risk appetite measures and metrics for the primary risk types. A key focus in 2007 has been to develop earnings volatility measures to complement existing capital measures for risk appetite. Risk appetite is reviewed annually in line with the overall Group’s appetite and the reward potential of the relevant exposures. Risk appetite is defined, cascaded and monitored.
Group and divisional risk functions have responsibility for overseeing effective implementation of policy. Group audit provides independent assurance to the board about the effectiveness of the Group’s control framework and adherence to policy. Policies are reviewed at least annually to seek to ensure they remain fit for purpose.
At group level a consolidated risk report is produced which is reviewed and debated by the group business risk committee, group executive committee, risk oversight committee and the board to ensure senior management and the board are satisfied with the overall risk profile, risk accountabilities and mitigating actions. During the year the Group’s consolidated risk report was further enhanced to support the ongoing identification, control and effective management of risk.
Risk drivers The Group’s risk language is designed to capture the Group’s principal risks referred to as the ‘primary risk drivers’. A description of each risk, including definition, appetite, control and exposures is included in the detail to this report. These are further broken down into 25 more granular risk types to enable more detailed review and facilitate appropriate reporting and monitoring, as set out below.
• Market risk arising in Insurance and Investments division and the Group’s pension schemes, reflecting the exposure to a fall in equity markets and the consequent effect upon the value of assets held by either the insurance businesses or in the pension schemes. The value of the pension schemes liabilities is also exposed to changes in real interest rates. Both of these market risks could impact earnings adversely.
Measurement An annual business planning process is conducted at group and business unit level which includes a quantitative and qualitative assessment of the risks that could impact the Group’s plans. Within the planning round, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams. Over the last few years, the Group has made significant progress with embedding stress testing and scenario analysis into its risk management practice with the dual objectives of adding value to the business whilst also meeting regulatory requirements. The Group assesses a wide array of scenarios including economic recessions, regulatory action scenarios, pandemics and scenarios specific to the operations of each part of the business.
Credit risk appetite is described and reported through a suite of metrics derived from a combination of accounting and credit portfolio model parameters which in turn use the various credit risk rating systems as inputs. These metrics are supplemented by a variety of policies, sector caps and limits to manage concentration risk at an acceptable level.
Exposures The principal sources of credit risk within the Group arise from loans and advances to retail customers, financial institutions and corporate clients. The credit risk exposures of the Group are set out in note 47 to the financial statements.
• Concentration risk: Credit risk management includes portfolio controls on certain industries, sectors and product lines that reflect risk appetite. Credit policy is aligned to our risk appetite and restricts exposure to certain high risk and more vulnerable sectors. Note 18 to the accounts provides an analysis of loans and advances to customers by industry (for wholesale) and product (for retail). Exposures are monitored to prevent excessive concentration of risk. These
The principal collateral types for loans and advances are: • Mortgages over residential properties; • Charges over business assets such as premises, inventory and accounts receivable; • Charges over financial instruments such as debt securities and equities; • Guarantees received from third parties.
• Surplus assets are held primarily in three portfolios: the surplus in the non-profit fund within the long term fund of Scottish Widows plc, assets in shareholder funds of life assurance companies and an investment portfolio within the general insurance business.
Based on the commonly used 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding 300 business days, the VaR for the years ended 31 December 2007 and 2006 based on the Group’s global trading positions was as detailed in the table below (the table also aggregates potential loss measures from options portfolios). VaR is calculated daily for trading and other fair valued portfolios in the products and markets business.
Mitigation Various mitigation activities are undertaken across the Group to manage portfolios and ensure they remain within approved limits.
• 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.
Insurance risk is primarily controlled via the following processes: • Underwriting (the process to ensure that new insurance proposals are properly assessed)
Monitoring Ongoing monitoring is in place to track the progression of insurance risks. This normally involves monitoring relevant experiences against expectations (for example claims experience, option take up rates, persistency experience, expenses, non-disclosure at the point of sale), as well as evaluating the effectiveness of controls put in place to manage insurance risk.
The Group has developed an impact on earnings approach to operational risk appetite. This involves looking at how much the Group could lose due to operational risk losses at various levels of certainty. In setting operational risk appetite, the Group looks at both impact on solvency and the Group’s reputation, including customer service requirements.
Integral to this operational risk management framework is a hybrid approach to calculating capital to support unexpected losses. The capital model calculations are driven by internal data which captures past losses, and forward looking scenarios which value potential future risk events. External industry wide data is collected to help with validating scenarios.
• Evaluation of the effectiveness of the control framework covering each of the key risks to which the business area is exposed.
The risk of reputational damage, loss of investor confidence and/or financial loss arising from, the adoption of inappropriate accounting policies, ineffective controls over financial, prudential regulatory and tax reporting and the failure to disclose information on a timely basis about the legal constitution of the Group.
Liquidity exposure represents the amount of potential outflows in any future period less committed inflows in that period such that the Group is unable to meet its financial obligations as they fall due, or can only secure them at excessive cost. Liquidity is considered from both an internal and regulatory perspective.
Capital exposure arises should the Group have insufficient regulatory capital resources to support its strategic objectives and plans, and meet external stakeholder requirements and expectations.
An analysis of financial instrument liabilities of the Group, excluding those arising from insurance contracts, on an undiscounted future cash flow basis according to contractual maturity into relevant maturity groupings based on the remaining period at the balance sheet date is shown in note 47 to the accounts. An analysis of insurance contracts on a behavioural basis is also shown in note 47 to the accounts.
*A firm is permitted to include innovative tier 1 capital in its tier 1 capital resources for the purposes of GENPRU1.2 (adequacy of financial resources) but is required to exclude these amounts from tier 1 for the purposes of meeting the main BIPRU firm Pillar 1 rules. Accordingly, the Group has provided its tier 1 capital ratio both including and excluding these amounts.
Capital is actively managed at an appropriate level of frequency and regulatory ratios are a key factor in the Group’s budgeting and planning processes with updates of expected ratios reviewed regularly during the year by GALCO. Capital raised takes account of expected growth and currency of risk assets. Capital policies and procedures are subject to independent oversight.
Total regulatory capital 18,877 15,675 31 December 31 December £bn £bn
The principal movements are: • a reduction of tier 1 capital resources primarily arising from a deduction of 50 per cent of the difference between expected loss and accounting impairment provisions partially offset by related notional tax relief.
• a reduction of tier 2 capital resources primarily arising from a deduction of 50 per cent of the difference between expected loss and accounting impairment provisions, together with the removal of collective impairment provisions which no longer qualify as tier 2 capital under the Basel II rules.
• a reduction in supervisory deduction reflecting derecognition for capital adequacy purposes of mortgage securitisation.
• a reduction in total risk-weighted assets, reflecting the application of the IRB approach to the majority of the Group’s credit portfolios, offset, in part, by the introduction of a specific charge for operational risk.
The above comparison is set out using the risk asset ratio framework, which, as explained above, remains the international standard for measuring capital adequacy. The FSA’s approach to such measurement under Basel II is now based primarily on monitoring the relationship of the Capital Resources Requirement (CRR – broadly equivalent to 8 per cent of risk-weighted assets and thus representing the capital required under Pillar 1 of Basel II) to available capital resources. Notwithstanding this new approach, the Group will continue to report ratios both internally and externally. The FSA is also setting Individual Capital Guidance (ICG) for each UK bank, calibrated by reference to its CRR. A key input to the FSA’s ICG setting process (which addresses the requirements of Pillar 2 under Basel II) is each bank’s Internal Capital Adequacy Assessment Process (ICAAP). The Group submitted its ICAAP document to the FSA in April 2007. The FSA has made it clear that each ICG remains a confidential matter between each bank and the FSA.
Available capital resources represent the excess of assets over liabilities calculated in accordance with detailed regulatory rules issued by the FSA. Different rules apply depending on the nature of the fund, as detailed below.
‘Realistic’ basis. The FSA requires each life assurance company which contains a with-profits fund in excess of £500 million, including 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 determination of realistic liabilities of the With Profit Fund in respect of Scottish Widows includes the value of internal transfers expected to be made from the With Profit Fund to the Non-Participating Fund of Scottish Widows. These internal transfers include charges on policies where the associated costs are borne by the Non-Participating Fund. The With-Profits Insurance Capital Component is reduced by the value, calculated in the stress test scenario, of these internal transfers, but only to the extent that credit has not been taken for the value of these charges in deriving actuarial reserves for the Non-Participating Fund.
Assets attributable to the shareholder held outside the long-term funds – – – 946 946
Adjustments to remove differences between IFRS and regulatory valuation of assets and liabilities – (431) (431) (600) (1,031)
Adjustment to remove the value of future profits recognised in respect of non-participating contracts written in the With Profit Fund (23) – (23) – (23)
Assets attributable to the shareholder held within the long-term funds – 2,225 2,225 – 2,225
Adjustments to remove differences between IFRS and regulatory valuation of assets and liabilities – (263) (263) (810) (1,073)
Adjustment to replace ‘realistic’ liabilities with statutory liabilities 3,783 – 3,783 – 3,783
The primary reasons for the movement in total available capital resources during the year are as follows: With Profit Fund
Recognition of future profits allowable for ‘realistic’ capital purposes – 2,064 – 1,896 54 Lloyds TSB Group Annual Report and Accounts 2007
The most significant economic assumptions included in the model are: • Risk-free yield. The risk-free yield is defined as 0.1 per cent higher than spot yields derived from the UK gilt yield curve.
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 £65 million (31 December 2006: £98 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 £3 million. If yields were 0.5 per cent lower than assumed, the liability would increase by some £12 million.
Risk management Audited information 56 Lloyds TSB Group Annual Report and Accounts 2007
Basic earnings per ordinary share 58.3p 49.9p 44.6p 42.8p 43.3p 58.3p
Sir Victor Blank◆◆†++ Chairman Joined the board in 2006 as deputy chairman and became chairman in May 2006. Former partner in Clifford-Turner (now Clifford Chance) from 1969 to 1981 and chairman and chief executive of Charterhouse until 1997. Director of The Royal Bank of Scotland from 1985 to 1993 and of GUS from 1993 to 2006 (chairman from 2000). Chairman of Trinity Mirror from 1999 to 2006. A member of the Financial Reporting Council from 2002 to 2007 and a member of the Council of Oxford University from 2000 to 2007. A senior adviser to the Texas Pacific Group. Chairs two charities, WellBeing of Women and UJS Hillel, as well as the Council of University College School. Aged 65.
† Member of the remuneration committee †† Chairman of the remuneration committee + Member of the risk oversight committee
Michael E Fairey Deputy Group Chief Executive (retiring on 30 June 2008) 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. A non-executive director of The Energy Saving Trust and VTX Bidco. President of The British Quality Foundation and chairman of Race for Opportunity. Aged 59.
Archie G Kane Group Executive Director, Insurance and Investments Joined TSB Commercial Holdings in 1986 and held a number of senior and general management appointments in Lloyds TSB Group before being appointed to the board in 2000, as group executive director, IT and operations. Appointed group executive director, insurance and investments in October 2003. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as finance director in the UK from 1983 to 1985. Chairman of the Association of British Insurers. Aged 55.
Dr DeAnne S Julius and Mr G J N Gemmell left the board on 9 May 2007 and 30 September 2007, respectively.
Mr P N Green joined the board on 10 May 2007 and Sir David Manning has been appointed a director from 1 May 2008. In accordance with the articles of association, they offer themselves for election at the annual general meeting.
In the UK, the Lloyds TSB Group belongs to the major employer groups campaigning for equality for the above groups of staff, including Employers’ Forum on Disability, Employers’ Forum on Age and Stonewall. The Group is also represented on the Board of Race for Opportunity and the Equal Opportunities Commission. Our involvement with these organisations enables us to identify and implement best practice for our staff.
Auditors and audit information Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no relevant audit information of which the Company’s auditors are unaware and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 234ZA of the Companies Act 1985.
The roles of the chairman, the group chief executive and the board and its governance arrangements, including the schedule of matters specifically reserved to the board for decision, are reviewed annually. The matters reserved to the board for decision include the approval of the annual report and accounts and any other financial statements; the payment of dividends; the long term objectives of the Group; the strategies necessary to achieve these objectives; the Group’s budgets and plans; significant capital expenditure items; significant investments and disposals; the basis of allocation of capital within the Group; the organisation structure of the Group; the arrangements for ensuring that the Group manages risks effectively; any significant change in accounting policies or practices; the appointment of the Company’s main professional advisers and their fees; and the appointment of senior executives within the organisation and related succession planning.
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. Major shareholders are also offered the opportunity to meet new non-executive directors. Additional training and updates on particular issues are arranged as appropriate.
The nomination committee, comprising Sir Victor Blank (chairman), Dr Berndt, Mr du Plessis, Sir Julian Horn-Smith and Lord Leitch, reviews the structure, size and composition of the board, taking into account the skills, knowledge and experience of directors and considers and makes recommendations to the board on potential candidates for appointment as directors. The committee also makes recommendations to the board concerning the re-appointment of any independent non-executive director by the board at the conclusion of his or her specified term; the re-election of any director by the shareholders under the retirement provisions of the articles of association; any matters relating to the continuation in office of a director; and the appointment of any director to executive or other office in the company, although the chairman of the company would not chair the committee when it was dealing with the appointment of a successor to the chairmanship of the company.
The committee’s terms of reference are available from the company secretary and are displayed on our website www.lloydstsb.com.
The risk oversight committee comprises Sir Victor Blank (chairman), Mr Brown, Sir Julian Horn-Smith and Lord Leitch. All non-executive directors are also invited to attend meetings if they wish. The risk oversight committee’s duties include overseeing the development, implementation and maintenance of the Group’s overall risk management framework, and its risk appetite, strategy, principles and policies, to ensure they are in line with emerging regulatory, corporate governance and industry best practice. The committee also oversees the Group’s risk exposures; facilitates the involvement of non-executive directors in risk issues and aids their understanding of these issues; oversees adherence to Group risk policies and standards and considers any material amendments to them; and reviews the work of the Group Risk division.
1 Appointed to the board and remuneration committee from 10 May 2007 and the audit committee from 14 December 2007. A member of the risk oversight committee from 1 July 2007 to 14 December 2007.
This is a report made by the board of Lloyds TSB Group plc, on the recommendation of the remuneration committee. It covers the current and proposed components of the remuneration policy and details the remuneration for each serving director during 2007.
In 2005, we conducted a comprehensive and independent review of remuneration policy for our most senior executives which led to a number of important policy changes, including the introduction of a new long-term incentive plan. This plan has been used for all long-term awards made since its introduction and we believe that this plan will continue to underpin our primary objective of attracting, retaining and motivating executives of the highest calibre.
In terms of changes to the committee’s membership, Mr Green joined the committee in May, replacing Dr Julius. In addition to welcoming Mr Green, I am extremely grateful to Dr Julius for her contribution to the work of the committee.
• Dr Julius (until 9 May when she left the board)
Composition of directors’ remuneration In 2007 the total compensation of the executive directors consisted of components in the following proportions: Note: Salary and benefits are the actual amounts received during 2007; pension for those directors in the defined benefits scheme (Messrs Daniels, Fairey and Kane) is the increase in actual transfer value for 2007; pension for those in the defined contribution scheme (Mr Tate and Mrs Weir) is the sum of the employer’s contribution and any cash pension supplement; pension for Ms Dial is the cash salary supplement she receives for choosing not to join the pension scheme; performance bonus is that payable in respect of 2007 and includes the value of any award made under the Group’s ‘shareplan’; and the value of the LTIP awarded in 2007 is the expected value calculated by using a ‘binominal’ model, which is a widely accepted methodology for this purpose.
Chairman’s remuneration The chairman’s remuneration comprises salary and benefits which are broadly similar to those extended to the executive directors. However, he does not participate in the annual bonus and long-term incentive arrangements, nor is he entitled to pension benefits.
Independent non-executive directors who serve on the boards of subsidiary companies may also receive fees from the subsidiaries. The fees paid in 2007 to the current non-executive directors are shown in the table below: Lloyds TSB Scottish 2007 non-executive directors’ fees Lloyds TSB Group Scotland Widows
Audit Remuneration Nomination Risk oversight 2007 Board committee committee committee committee Board Board Total fees
Awards under the annual incentive scheme are made in cash only.
Other key achievements within the three commercial divisions of the Group, which impact on the individual balanced score card elements of bonus awards made to Ms Dial, Mr Tate and Mr Kane, were: • Profit before tax from UK Retail Banking, excluding settlement of overdraft claims, increased by 17 per cent reflecting strong levels of franchise growth, excellent cost management and a slightly reduced impairment charge.
*To enable meaningful profit before tax comparisons to be made with 2006, the figures quoted above exclude insurance related volatility, the profit on sale of businesses, settlement of overdraft claims in 2007 and the pension schemes related credit in 2006.
Long-term incentive plan The aim of the long-term incentive plan is to deliver shareholder value through linking the receipt of shares to an improvement in the performance of the Group over a three year period.
17.5 per cent of the TSR Award (8.75 per cent of the total award) will vest where the Company’s TSR is equal to median and vesting will occur on a straight line basis in between these points. Where the Company’s TSR is below the median of the comparator group, the TSR Award will lapse.
Other companies in the comparator group: Alliance & Leicester Aviva Banco Santander Barclays
EPS is the Group’s normalised earnings per ordinary share as shown in the Group’s report and accounts, adjusted if necessary for consistency. Details of the Group’s basic earnings per share are shown in the consolidated income statement on page 77.
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2007 and 2006, respectively (ignoring the two-year requirement to qualify for a deferred pension).
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2007 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme in accordance with actuarial guidance note GN11. The basic method used to arrive at the factors has not changed during the year, but the underlying basis has been strengthened to allow for mortality improvements and a reduction in the long-term post-retirement investment return.
i) These share options lapsed as the performance condition had not been met.
None of the other directors at 31 December 2007 had options to acquire shares in Lloyds TSB Group plc or its subsidiaries.
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) 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.
The following table contains information on the performance conditions for awards made under the long-term incentive plan. The remuneration committee chose the relevant performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
For the other 50 per cent of the award (the ‘TSR Award’) – it will be necessary for the Company’s TSR to exceed the median of a comparator group (14 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award will vest where the Company’s TSR is equal to median and vesting will occur on a straight line basis in between these points. Where the Company’s TSR is below the median of the comparator group, the TSR Award will lapse. The relevant period commenced on 1 January 2006 and ends on 31 December 2008.
Alithos Limited provided information for the testing of the TSR performance conditions for the Group’s long-term incentive schemes. EPS is the Group’s normalised earnings per share as shown in the Group’s report and accounts, subject to such adjustments as the remuneration committee regard as necessary for consistency.
We have reported separately on the parent company financial statements of Lloyds TSB Group plc for the year ended 31 December 2007 and on the information in the directors’ remuneration report that is described as having been audited.
Trading and other financial assets at fair value through profit or loss 15 57,911 67,695
– transferred to income statement in respect of disposals – (5) – (5) – (5)
Employee share option schemes: – value of employee services – – 16 16 – 16
(c) Other intangible assets Other intangible assets comprise capitalised software enhancements and customer lists. Capitalised software enhancements are amortised over periods not exceeding five years, being their estimated useful lives, using the straight-line method. Customer lists are amortised over periods not exceeding 15 years, being their estimated useful lives, in line with the income expected to arise from those customers and are subject to annual reassessment. All other intangible assets are reviewed for impairment whenever events or any changes in circumstances indicate that the carrying amount may not be recoverable. In the event that an asset’s carrying amount is determined to be greater than its recoverable amount, it is written down immediately.
(e) Trading securities, other financial assets and liabilities at fair value through profit or loss, and available-for-sale financial assets
The fair values of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market is not active the Group establishes a fair value by using valuation techniques. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants.
Debt securities and equity shares, other than those classified as trading securities or at fair value through profit or loss, are classified as available-for-sale and recognised in the balance sheet at their fair value; available-for-sale investments are those intended to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of investments classified as available-for-sale are recognised directly in equity, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in equity is recognised in the income statement. Interest calculated using the effective interest method is recognised in the income statement.
(2) Cash flow hedges The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in equity. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement.
overnance Financial Statem ents Shareholder Inform ation 1 Accounting policies continued
(3) Renegotiated loans Loans that are either subject to collective impairment assessment or individually significant and whose terms have been renegotiated are no longer considered to be past due but are treated as new loans. In subsequent years, the asset is considered to be past due and disclosed only if further renegotiated.
(p) Share-based compensation The Group operates a number of equity-settled, share-based compensation plans. The value of the employee services received in exchange for equity instruments granted under these plans is recognised as an expense over the vesting period of the instruments, with a corresponding increase in equity. This expense is determined by reference to the fair value of the number of equity instruments that are expected to vest. The fair value of equity instruments granted is based on market prices, if available, at the date of grant. In the absence of market prices, the fair value of the instruments at the date of grant is estimated using an appropriate valuation technique, such as a Black-Scholes option pricing model. The determination of fair values excludes the impact of any non-market vesting conditions, which are included in the assumptions used to estimate the number of options that are expected to vest. At each balance sheet date, this estimate is reassessed and if necessary revised. Any revision of the original estimate is recognised in the income statement over the remaining vesting period, together with a corresponding adjustment to equity.
Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate.
Loan impairment allowances The Group regularly reviews its loan portfolios to assess for impairment. Impairment allowances are established to recognise incurred impairment losses in its loan portfolios carried at amortised cost. In determining whether an impairment has occurred at the balance sheet date the Group considers whether there is any observable data indicating that there has been a measurable decrease in the estimated future cash flows or 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 loan repayment obligations. Where this is the case, the impairment loss is the difference between the carrying value of the loan and the present value of the estimated future cash flows discounted at the loan’s original effective interest rate.
The schemes’ liabilities are calculated using the projected unit credit method, which takes into account projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. The resulting estimated cash flows are discounted at a rate equivalent to the market yield at the balance sheet date on high quality bonds with a similar duration and currency to the schemes’ liabilities. In order to estimate the future cash flows, a number of financial and non-financial assumptions are made by management, changes to which could have a material impact upon the overall deficit or the net cost recognised in the income statement.
At 31 December 2007 the Group also carried substantial liabilities to holders of life insurance policies in its balance sheet. The methodology used to value the liabilities is described in note 1 (r) (1). Liabilities arising from insurance contracts and participating investment contracts were £22,526 million and £14,874 million respectively (2006: £25,763 million and £15,095 million) and those arising from non-participating investment contracts totalled £18,197 million (2006: £24,370 million). Elements of the liabilities require assumptions about future investment returns, future mortality rates and future policyholder behaviour. The process for determining the key assumptions that have been made at 31 December 2007 and the impact on profit before tax of changes in key assumptions is detailed in note 31.
General insurance business At 31 December 2007 the Group held a provision of £207 million (2006: £149 million) in respect of 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.
Taxation Significant judgement is required in determining the Group’s income tax liabilities. In arriving at the current tax liability of £484 million and deferred tax liability of £948 million at 31 December 2007 (2006: current tax liability of £817 million and deferred tax liability of £1,416 million), the Group has taken account of tax issues that are subject to ongoing discussions with HM Revenue & Customs and other tax authorities. Calculations of these liabilities have been based on management’s assessment of legal and professional advice, case law and other relevant guidance. In these situations, the various risks are categorised and approximate weightings applied in arriving at the assessment of the expected liability. Where the expected tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred tax amounts in the period in which such determination is made.
3 Segmental analysis Lloyds TSB Group is a leading financial services group, whose businesses provide a wide range of banking and financial services predominantly in the UK.
Under the Group’s transfer pricing arrangements, inter-segment services are generally recharged at cost, with the exception of the internal commission arrangements between the UK branch and other distribution networks and the insurance product manufacturing businesses within the Group, where a profit margin is also charged. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.
For those derivative contracts entered into by business units for risk management purposes, the business unit retains the amount that would have been recognised on an accrual accounting basis (an amount equal to the interest element of the next payment on the swap) and transfers the remainder of the fair value of the swap to the central group segment where the resulting accounting volatility is managed though the establishment of hedge accounting relationships. Any change in fair value of the hedged instrument attributable to the hedged risk is also recorded within the central group segment. This allocation of the fair value of the swap and change in fair value of the hedged instrument attributable to the hedged risk avoids accounting asymmetry in segmental results, records volatility where it is managed and provides a fair presentation of the segments’ operating performance. It is the basis on which the segments are managed and measured internally and is the basis of the Group’s internal segmental reporting to the board.
Included within interest receivable is £395 million (2006: £297 million) in respect of impaired financial assets. Net interest income also includes a credit of £1 million (2006: charge of £1 million) transferred from the cash flow hedging reserve (note 41).
As discussed in note 1(d), fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in note 4. Fees and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown in note 6.
Net income arising on assets held at fair value through profit or loss: Loans and advances to banks and customers 23 29
Total net gains arising on assets and liabilities held at fair value through profit or loss 2,965 5,277
Securities and other gains 3,251 5,580 7 Insurance premium income 2007 2006 £m £m
Notes to the group accounts 94 Lloyds TSB Group Annual Report and Accounts 2007
Non-life insurance gross written premiums can be further analysed as follows: 2007 2006 £m £m
Other non-audit fees: Services relating to corporate finance transactions 0.7 1.0
Notes to the group accounts 96 Lloyds TSB Group Annual Report and Accounts 2007
Audits of the unconsolidated Open Ended Investment Companies managed by the Group 0.4 0.4
Other services supplied pursuant to legislation relate primarily to the costs associated with the Sarbanes-Oxley Act audit requirements together with the cost of the audit of the Group’s Form 20-F filing.
It is the Group’s policy to use the auditors on assignments in cases where their knowledge of the Group means that it is neither efficient nor cost effective to employ another firm of accountants. Such assignments typically relate to the provision of advice on tax issues, assistance in transactions involving the acquisition and disposal of businesses and accounting advice. The auditors are not permitted to provide management consultancy services to the Group.
Total impairment charged to the income statement 1,796 1,555 12 Profit on sale of businesses 2007 2006 £m £m
Other, including adjustments in respect of businesses sold in prior years (22) –
98 Lloyds TSB Group Annual Report and Accounts 2007 13 Taxation
The charge for tax on the profit for the year is based on a UK corporation tax rate of 30 per cent (2006: 30 per cent).
The effective tax rate of the Group excluding the gross policyholder and Open Ended Investment Company interests from profit before tax and the tax charge and, in 2007, the profit on disposal of businesses from profit before tax and the impact on the year end deferred tax position of the UK corporation tax rate change was 28.3 per cent (2006: 28.0 per cent).
Equity shares: At 31 December 2007 £55,729 million (2006: £65,122 million) of trading and other financial assets at fair value through profit or loss had a contractual residual maturity of greater than one year.
The carrying value of assets that are subject to stock lending arrangements was £1,450 million at 31 December 2007 (2006: £1,781 million) all of which the secured party is permitted by contract or custom to sell or repledge.
16 Derivative financial instruments The principal derivatives used by the Group are interest rate and exchange rate contracts; particular attention is paid to the liquidity of the markets and products in which the Group trades to ensure that there are no undue concentrations of activity and risk.
At 31 December 2007 £153,302 million (2006: £141,247 million) of loans and advances to customers had a contractual residual maturity of greater than one year.
Gross investment in finance leases, receivable: Not later than 1 year 620 637
Beneficial interests in certain residential mortgages have been transferred to special purpose entities which issue floating rate debt securities. Neither the Group nor any entities in the Group are obliged to support any losses that may be suffered by the note holders and do not intend to offer such support. The floating rate note holders only receive payments of interest and principal to the extent that the special purpose entities have received sufficient funds from the transferred mortgages and after certain expenses have been met. In the event of a deficiency, they have no recourse whatsoever to the Group.
In addition the Group has entered into two securitisations of its commercial banking loans as follows: – a synthetic securitisation of £1,572 million (2006: £961 million) utilising credit default swaps (CDSs); – a securitisation of £2,753 million (2006: £nil) utilising a combination of CDSs and £98 million (2006: £nil) of external funding.
19 Allowance for impairment losses on loans and advances Loans and advances to customers
Recoveries of advances written off in previous years 2 170 18 190 – 190
Charge to the income statement 18 1,518 186 1,722 (1) 1,721
Notes to the group accounts 104 Lloyds TSB Group Annual Report and Accounts 2007
Equity shares: Treasury bills and other bills: Treasury bills and similar securities 1,608 1,743
Direct operating expenses arising from investment properties that generate rental income 24 24
Capital expenditure in respect of investment properties: 2007 2006 £m £m
Capital expenditure contracted for at the balance sheet date but not recognised in the financial statements 111 85 £m £m
The risk-free rate assumed in valuing in-force business is 10 basis points over the 15-year gilt yield. In valuing financial options and guarantees the risk-free rate is derived from gilt yields plus 10 basis points, in line with Scottish Widows’ FSA realistic balance sheet assumptions. The table below shows the range of resulting yields and other key assumptions at 31 December: Risk-free rate (value of in-force) 4.65 4.72
Non-market risk An allowance for non-market risk is made through the choice of best estimate assumptions based upon experience, which generally will give the mean expected financial outcome for shareholders and hence no further allowance for non-market risk is required. However, in the case of operational risk and the with-profits fund there are asymmetries in the range of potential outcomes for which an explicit allowance is made.
Notes to the group accounts 108 Lloyds TSB Group Annual Report and Accounts 2007
At 31 December 2007 £1,781 million (2006: £1,521 million) of other assets had a contractual residual maturity of greater than one year.
Acquisition costs deferred, net of amounts amortised to the income statement (22) 14
27 Deposits from banks The breakdown of deposits from banks between the domestic and international offices of the Group is set out below: £m £m
The amount contractually payable on maturity of the debt securities held at fair value through profit or loss at 31 December 2007 was £3,131 million, which was £24 million higher than the balance sheet carrying value (2006: £1,200 million, which was £44 million higher than the balance sheet carrying value). There was an £8 million (2006: £nil) decrease in the fair value of these liabilities attributable to changes in credit spread risk; this is determined by reference to the quoted credit spreads of Lloyds TSB Bank plc, the issuing entity within the Group.
Liabilities held at fair value through profit or loss represent designated debt securities in issue which contain substantive embedded derivatives which would otherwise need to be recognised and measured at fair value separately from the related debt securities.
At 31 December 2007 £35,603 million (2006: £38,297 million) of liabilities arising from insurance contracts and participating investment contracts had a contractual residual maturity of greater than one year.
Notes to the group accounts 110 Lloyds TSB Group Annual Report and Accounts 2007
The realistic capital regime dictates that With Profit Fund liabilities are valued on a market-consistent basis. This is achieved by the use of a valuation model which values liabilities on a basis calibrated to tradable market option contracts and other observable market data. The With Profit Fund financial options and guarantees are valued using a stochastic simulation model where all assets are assumed to earn, on average, the risk-free yield and all cash flows are discounted using the risk-free yield. The risk-free yield is defined as 0.1 per cent higher than the spot yields derived from the UK gilt yield curve.
Sensitivity analysis The following table demonstrates the effect of changes in key assumptions on profit before tax disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
Cash paid for claims settled in the year (223) – (223)
Notes to the group accounts 114 Lloyds TSB Group Annual Report and Accounts 2007
At 31 December 2007 £4,427 million (2006: £6,398 million) of other liabilities had a contractual residual maturity of greater than one year.
Defined benefit schemes The Group has established a number of defined benefit pension schemes in the UK and overseas. The majority of the Group’s employees are members of the defined benefit sections of the Lloyds TSB Group Pension Schemes No’s 1 and 2. These schemes provide retirement benefits calculated as a percentage of final salary depending upon the length of service; the minimum retirement age under the rules of the schemes is 50.
Life expectancy for member aged 60, on the valuation date: Life expectancy for member aged 60, 15 years after the valuation date: The mortality assumptions used in the scheme valuations are based on standard tables published by the Institute and Faculty of Actuaries which were adjusted in line with the actual experience of the relevant schemes. The table shows that a member retiring at age 60 as at 31 December 2007 is assumed to live for, on average, 25.9 years for a male and 27.9 years for a female. In practice there will be much variation between individual members but these assumptions are expected to be appropriate across all members. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 45 now, when they retire in 15 years time at age 60.
Movements in the other post-retirement benefits obligation: 2007 2006 £m £m
Notes to the group accounts 118 Lloyds TSB Group Annual Report and Accounts 2007
The 2007 Finance Act reduction in corporation tax rate from 30 per cent to 28 per cent resulted in a decrease in the Group’s provision for deferred tax at 31 December 2007 of £110 million.
37 Other provisions Provisions for Vacant contingent Customer leasehold liabilities and remediation property commitments provisions and other Total £m £m £m £m
Vacant leasehold property and other Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income, compared to the head rent, 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 two years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released.
Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (e430 million) d, m 335 312 6.35% Step-up Perpetual Capital Securities callable 2013 (e500 million) d, f, k 365 345
Primary Capital Undated Floating Rate Notes: d, e 113/4% Perpetual Subordinated Bonds (£100 million) 100 100 55/8% Undated Subordinated Step-up Notes callable 2009 (e1,250 million) d, k 915 845
g) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until payments are resumed. Any deferred payments will be made good on redemption of the securities. The securities can be redeemed at par at the option of Lloyds TSB Bank plc on any coupon date.
i) Issued by a group undertaking under the Company’s subordinated guarantee.
n) 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 margin of 3.50 per cent over a rate based on the yield of specified UK government stock. This issue was made under the limited subordinated guarantee of Lloyds TSB Bank plc. In certain circumstances these preferred securities will be mandatorily exchanged for preference shares in Lloyds TSB Group plc. Lloyds TSB Group plc has entered into an agreement whereby dividends may only be paid on its ordinary shares if sufficient distributable profits are available for distributions due in the financial year on these preferred securities.
o) Throughout 2007 and 2006, the Company has had in issue 400 6 per cent non-cumulative preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a fixed rate non-cumulative preferential dividend of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company.
Issued and fully paid ordinary shares 2007 2006 2007 2006 Number of shares Number of shares £m £m
Share capital and control There are no restrictions on the transfer of shares in the Company other than as set out in the articles of association and: • certain restrictions which may from time to time be imposed by law and regulations (for example, insider trading laws); and
• pursuant to the rules of some of the Company’s employee share plans where certain restrictions may apply while the shares are subject to the plans.
In addition, during 2006 the Company issued 600,000 Fixed/Floating Rate Non-Cumulative Callable Preference Shares of 25 pence each with a liquidation preference of £1,000 per share and 1,000,000 Fixed/Floating Rate Non-Cumulative Callable Preference Shares of 25 cents each with a liquidation preference of US$1,000 per share. Both issues of preference shares are perpetual, although the two issues can be redeemed at the option of the Company on or after 25 August 2015 and 14 November 2016 respectively and carry the right to non-cumulative dividends which are fixed until those first redemption dates. The terms of these two issues of preference shares are such that the Company cannot declare and pay a dividend on any other junior class of share (including the mandatory dividend on the 400 6 per cent non-cumulative redeemable preference shares mentioned above) until the coupon has been paid on these preference shares. As the Company is effectively committed to the payment of a coupon on these shares they are classified as liabilities on the balance sheet in accordance with IFRS (see note 38). The holders of the fixed/floating rate non-cumulative callable preference shares, who held less than 0.1 per cent of the total share capital as at 31 December 2007, do not have the right to receive notice of, attend, speak or vote at any general meetings other than on resolutions relating to the variation or abrogation of any of the rights or restrictions attached to the preference shares or the winding up or dissolution of the Company or if, at the date of the notice of meeting, the dividend payable at the immediately preceding dividend payment date has failed to be declared and paid in full. Upon winding up, the fixed/floating rate non-cumulative callable preference shares shall rank equally with the most senior class of preference shares and any other class of shares which are expressed to rank equally.
Movements in other reserves were as follows: 2007 2006 £m £m
overnance Financial Statem ents Shareholder Inform ation 41 Other reserves continued 2007 2006 £m £m
Employee share option schemes – value of employee services 16 65
Executive and SAYE schemes: Options granted in the year 6 6
Movements in the number of share options outstanding under the Executive share option schemes during 2006 and 2007 are set out below: Weighted average Weighted average Number of exercise price Number of exercise price options (pence) options (pence)
Save-As-You-Earn schemes Eligible employees may enter into contracts through the Save-As-You-Earn (SAYE) schemes to save up to £250 per month and, at the expiry of a fixed term of three or five years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a price equal to 80 per cent of the market price at the date the options were granted. Grants in periods up to 31 December 2001 also had options exercising after seven years.
No options outstanding at 31 December were exercisable. The weighted average remaining contractual life of options outstanding at the end of the year was 0.9 years (2006: 1.9 years).
Long-Term Incentive Plan The Long-Term Incentive Plan introduced in 2006 is a long-term incentive scheme aimed at delivering shareholder value by linking the receipt of shares to an improvement in the performance of the Group over a three year period. Awards are made within limits set by the rules of the plan, with the limits determining the maximum number of shares that can be awarded equating to three times annual salary, in exceptional circumstances this may increase up to four times annual salary.
(ii) For the other 50 per cent of the award (the ‘TSR Award’) – the performance condition is as described for May 2006 with the relevant performance period commencing on 8 March 2007 (the date of award) and ending on 7 March 2010.
The fair value of the share awards granted in 2007 was £3.13 (2006: £2.96).
Performance share plan Under the performance share plan, introduced during 2005, participating executives will be eligible for an award of free shares, known as performance shares, to match the bonus shares awarded as part of their 2004 and 2005 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 total shareholder return 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 total shareholder return 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 position, and fifth and eighth position, sliding scales will apply. If the total shareholder return 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.
At 31 December 2007, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £2 million with five directors and three connected persons (2006: £2 million with four directors and four connected persons).
Other related party disclosures At 31 December 2007, the Group’s pension funds had call deposits with Lloyds TSB Bank plc amounting to £23 million (2006: £19 million).
Other items serving as direct credit substitutes include standby letters of credit, or other irrevocable obligations, where the Lloyds TSB Group has an irrevocable obligation to pay a third party beneficiary if the customer fails to repay an outstanding commitment; they also include acceptances drawn under letters of credit or similar facilities where the acceptor does not have specific title to an identifiable underlying shipment of goods.
Items in course of transmission to banks – – – – – 668 – 668
Trading and other financial assets at fair value through profit or loss – 5,756 61,939 – – – – 67,695
Derivative financial instruments 487 5,078 – – – – – 5,565
Loans and advances to banks – – – – 40,638 – – 40,638
Available-for-sale financial assets – – – 19,178 – – – 19,178
Trading and other liabilities at fair value through profit or loss – 28 1,156 – – – – 1,184
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 foreign currency equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to retained earnings.
The Group hedges part of the currency translation risk of the net investment in certain foreign operations using cross currency swaps. At 31 December 2007 the aggregate notional principal of these cross currency swaps was £5,302 million (2006: £2,589 million) with a net fair value liability of £316 million (2006: asset of £139 million) (see note 16) and they were designated on an after-tax basis as hedges of net investments in foreign operations. In 2007, there is no ineffectiveness recognised in the income statement that arises from net investment hedges (2006: nil).
Impaired – no provision required 658 92 158 908 – –
Debt securities, treasury and other bills – analysis by credit rating Rated BB
The principal amount for undated subordinated liabilities with no redemption option is included within the over 5 years column; interest of approximately £223 million per annum which is payable in respect of those instruments for as long as they remain in issue is not included beyond 5 years.
Trading and other liabilities at fair value through profit or loss The fair values of financial instruments quoted in active markets are based on quoted prices. The fair values of financial instruments that are not quoted in active markets are determined using valuation techniques including cash flow models which, to the extent practical, use observable market inputs such as interest rate yield curves, equities and commodities prices, option volatilities and currency rates that are either directly observable or are implied from instrument prices.
(d) Analysis of cash and cash equivalents as shown in the balance sheet £m £m
(e) Analysis of changes in financing during the year 2007 2006 £m £m
(g) Disposal and closure of group undertakings and businesses 2007 2006 £m £m
Liabilities arising from insurance contracts and participating investment contracts (4,349) –
The amendment restricts the definition of vesting conditions to include only service conditions and performance conditions and deals with the accounting consequences of a failure to meet a condition other than a vesting condition including how to deal with cancellations by the counterparty and circumstances where neither the entity nor the counterparty is in a position to choose whether or not to meet a vesting condition.
Replaces IAS 14 Segment Reporting and requires reporting of financial and descriptive information about operating segments which are based on how financial information is reported and evaluated internally.
overnance Financial Statem ents Shareholder Inform ation 50 Future developments continued 51 Approval of financial statements The consolidated financial statements were approved by the directors of Lloyds TSB Group plc on 21 February 2008.
We report to you our opinion as to whether the parent company financial statements give a true and fair view and whether the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985. We also report to you whether, in our opinion, the information given in the directors’ report is consistent with the parent company financial statements. The information given in the directors’ report includes that specific information presented in the Overview and the Business Review that is cross referred from the principal activities, business review, future developments and financial risk management objectives and policies section of the directors’ report.
Opinion In our opinion: • the parent company financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union as applied in accordance with the provisions of the Companies Act 1985, of the state of the parent company’s affairs as at 31 December 2007 and cash flows for the year then ended; • the parent company financial statements and the part of the directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985; and
Report of the independent auditors on the parent company financial statements
Share capital Retained and premium profits Total £ million £ million £ million
Employee share option schemes: Value of employee services – 33 33
4 Share capital and share premium Details of the Company’s share capital and share premium account are as set out in notes 39 and 40 to the consolidated financial statements.
Undated subordinated liabilities 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 (£500 million)* 497 497
Key management personnel The key management personnel of the Group and parent company are the same. The relevant disclosures are given in note 45 to the consolidated financial statements.
As discussed in note 44 to the consolidated financial statements, the Group provides share based compensation to employees through a number of schemes; these are all in relation to shares in the Company and the cost of providing those benefits is recharged to the employing companies in the Group on a cash basis.
Country of share capital registration/ and voting Incorporation rights held Nature of business
None of the parent company’s subsidiaries has experienced any significant restrictions in paying dividends or repaying loans and advances. All regulated banking and insurance subsidiaries are required to maintain capital at levels agreed with the regulators; this may impact those subsidiaries’ ability to make distributions.
Interest rate risk and currency risk The Company is exposed to interest rate risk and currency risk on its debt securities in issue and its subordinated debt.
Liquidity risk The table below analyses financial instrument liabilities of the Company, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date, balances with no fixed maturity are included in the over 5 years category.
Accounting Critical estimates and judgements 89 Future developments 146 Policies 82
Cash flow statement Consolidated 81 Parent company 151 Notes to the group accounts 143
Liabilities Arising from insurance contracts and participating investment contracts 110 Arising from non-participating investment contracts 115 Other 115
A full range of dealing services is available through Lloyds TSB.
For details contact: The Bank of New York, Investor Services, PO Box 11258, Church Street Station, New York, NY 10286-1258. Telephone: 888 BNY ADRS (US toll free), international callers: +1 212 815 3700. Alternatively visit www.adrbny.com or email shareowners@bankofny.com
Our strategy Build customer franchises • extending reach and depth of customer relationships • enhancing product capabilities to build competitive advantage • improving processing efficiency • working capital harder
Insurance and Investments • maximise bancassurance success • profitably grow the IFA distribution channel • continue to improve operational efficiency and cost management • optimise capital management