Profit attributable to shareholders increased by £1,464 million, or 82 per cent, to £3,254 million.
Final dividend of 23.5p per share, making a total of 34.2p for the year (2002: 34.2p).
Market share the Group has improved its market share in many key product areas, including credit cards, bank savings, and life, pensions and long-term savings.
Excluding changes in economic assumptions, investment variance and profit on sale of businesses: Profit before tax decreased by £126 million, or 4 per cent, to £3,380 million.
The quality of our delivery is also vital. Excellent execution is one of the key attributes that distinguishes successful companies over time and high quality delivery will ensure we improve our relationships with our customers. By ensuring that we put our customers at the heart of everything that we do, we can create better and deeper long-term relationships and ensure that our future growth is profitable and sustainable, thereby maximising value for our shareholders.
Scottish Widows’ share of the UK life and pensions market grew to 5.7 per cent in 2003
When viewing our trading performance for the year, a number of other factors need to be taken into account to allow for a better understanding and comparison with 2002.
• to position the Group to deliver profitable growth from within our retail and corporate customer franchises.
In our life assurance business, we continue to keep close control over earnings risk and have put plans in place to deliver capital efficient growth.
We have also put in place new sales management processes and incentive plans designed to guide the organisation to build deep, long-term customer relationships, and to underpin our commitment to treating our customers fairly. We are determined to avoid future lapses in our sales processes which, in the first half of 2003, required us to raise a £300 million provision to provide redress to customers.
In 2003, we established an increased focus on economic capital management, supported by the introduction of a more rigorous, Basel 2 compliant, equity attribution model. This has changed the way we allocate capital, and has been reflected in the mix of our balance sheet growth during 2003. We have seen good growth in consumer lending and a reduction in our portfolio of finer margin loans and debt securities. The improvement in our mix of assets has supported an increase in the Group’s net interest margin in the fourth quarter of the year.
In line with our plans to maximise the use of our capital resources, we have reviewed the performance of our life, pensions and investments product portfolio. The new business margin rose from 19.3 per cent to 21.6 per cent whilst growing market share from 5.2 per cent to 5.7 per cent. Scottish Widows remains one of the most strongly capitalised life assurance companies in the UK and is on track to pay a 2004 dividend to Lloyds TSB. During the year Scottish Widows’ free asset ratio, a key measure of life assurance companies’ financial strength, increased to an estimated 13.5 per cent, from 12.2 per cent in 2002.
Cost control continues to have high priority throughout the Lloyds TSB Group. The increasing use of straight through processing, and our introduction of a Sigma approach to quality, currently covering almost 30 per cent of our transactions, has started to improve our cost effectiveness and customer service levels. We intend to extend this programme over the next year. We have also embarked on a programme of outsourcing a number of our processing and back office operations.
Credit card balances grew by 36 per cent to £6.7 billion
Is the website worth a visit? LloydsTSB.com is one of the most visited financial websites in Europe (2.4 million registered customers) There has been strong balance growth in many key areas, particularly credit cards, up 18 per cent, and personal loans, up 9 per cent, excluding the Goldfish acquisition, retail banking current accounts, savings and investments, up 10 per cent, and mortgages, up 13 per cent. Over 1.8 million customers have benefited from the roll out of enhanced relationship management offers, Premier and Privilege, that have begun to have a positive impact on income generation and customer loyalty.
In our mortgage business, we increased our outstanding balances but our share of net new lending fell in the second half of 2003, given the uneconomic nature of some products. Product sales via the internet distribution channel continue to grow rapidly with an average of more than 70,000 product sales per month, up 80 per cent on 2002.
In Wholesale and International Banking, positive results are emerging from the improved co-ordination between our Corporate and Financial Markets businesses. There was an uplift in foreign exchange and interest rate management product sales to Corporate customers in the second half of 2003, and the pipeline for new business continues to expand.
Finally, I would like to extend my thanks to our staff for their commitment and support and, in particular, their desire to serve our customers.
The positive way in which they have embraced the change programme lends further confidence to my belief that we will grow our business in line with our expectations.
Foundations’ broad grant-giving criteria. And over £1 million was raised for Help the Hospices, our charity of the year. Ten winners of the Lloyds TSB Group’s 2003 Community Awards scheme each received a £1,000 cheque for their nominated organisation.
During 2003, the Lloyds TSB Group disposed of a number of its overseas operations, as part of the process of managing its portfolio of businesses to focus on its core markets. The sale of the Lloyds TSB Group’s French fund management and private banking businesses completed on 30 June 2003; the sale of The National Bank of New Zealand completed on 1 December 2003; and the sale of substantially all of the Lloyds TSB Group’s Brazilian businesses completed on 15 December 2003. In addition, on 1 December 2003 the Lloyds TSB Group announced the disposal of its businesses in Guatemala, Honduras and Panama; these transactions are still subject to regulatory approval but are expected to complete during 2004. These disposals have resulted in a significant reduction in the size of the Lloyds TSB Group’s international business.
£1,021 million. In September 2003, Lloyds TSB Group acquired the credit card and personal loan portfolios of Goldfish Bank, which amounted to some £1.0 billion.
Personal loans. Lloyds TSB Bank and Lloyds TSB Scotland offer a range of personal loans through their branch networks and directly to the customer via the internet and telephone.
Life assurance, pensions and investments. Scottish Widows is Lloyds TSB Group’s specialist provider of life assurance, pensions and investment products, which are distributed through Lloyds TSB Bank’s branch network, through independent financial advisors and directly via the telephone and the internet. The Scottish Widows brand is the sole brand for new sales of Lloyds TSB Group’s life, pensions, unit trust and other long-term savings products.
The profit before tax of Wholesale in 2003 was £890 million.
Financial Markets. Lloyds TSB Group is a leading participant in the sterling money market. It is also active in currency money markets, foreign exchange markets and in certain derivatives markets, primarily to meet the needs of customers. It also plays a central role in the funding, cash and liquidity management of Lloyds TSB Group.
Following the disposal of the Lloyds TSB Group’s operations in New Zealand, Brazil and France during 2003, the extent of the activities of International Banking has been significantly reduced. The profit before tax of International Banking in 2003 was £1,305 million, including a profit on the disposal of businesses of £865 million. These businesses contributed £318 million to profit in 2003.
Europe. Lloyds TSB Group has private banking operations for wealthy individuals outside their country of residence. The business is conducted through branches of Lloyds TSB Bank located in Switzerland, Luxembourg, Monaco and Gibraltar. There are also private and corporate banking operations in Belgium, Netherlands and Spain.
In 1998, the UK government commissioned an investigation into competition in the banking industry whose findings were published in March 2000. The investigation specifically examined the levels of innovation, competition and efficiency in various sub-markets within the industry. The investigation found that the small and medium-sized business market was not sufficiently competitive, with barriers to entry existing for new players. The provision of banking services to this sector was referred to the UK Competition Commission under the Fair Trading Act 1973 for a full competition inquiry.
The OFT has also recommended changes to the banking codes with regard to payments. In particular, it recommends that the banking system should no longer have an interest-free float while certain electronic payments are cleared: customers should receive relevant interest. And the OFT also recommends there should be greater clarity for customers about clearing times for payments and receipts of funds.
Lloyds TSB Group’s businesses are subject to inherent risks regarding borrower credit quality as well as general UK economic conditions. Each of these can change the level of demand for, and supply of, Lloyds TSB Group’s products and services. Changes in the credit quality of Lloyds TSB Group’s UK and/or international borrowers and counterparties could reduce the value of Lloyds TSB Group’s assets, and increase provisions for bad and doubtful debts. In addition, changes in economic conditions may result in a deterioration in the value of security held against lending exposures and increase the risk of loss in the event of borrower default. Any significant increase in the UK unemployment rate would reduce profits from the insurance business. Furthermore, a general deterioration in the UK economy would also reduce Lloyds TSB Group’s profit from both its UK banking and financial services businesses. A general deterioration in any other major world economy could also adversely impact Lloyds TSB Group’s profitability.
Adverse experience in the operational risks inherent in Lloyds TSB Group’s businesses could have a negative impact on its results of operations.
Terrorist acts, and other acts of war or hostility and responses to those acts, may create economic and political uncertainties, which could have a negative impact on UK and international economic conditions generally, and more specifically on the business and results of operations of Lloyds TSB Group in ways that cannot be predicted.
Lloyds TSB Group seeks to achieve further organic growth by securing new customers and developing more business from existing customers. Lloyds TSB Group is currently expending significant resources and effort to bring about this growth, particularly with respect to its UK retail financial services business. If these expenditures and efforts do not meet with success, its operating results would grow more slowly or decline.
In addition to its important strategy of organic growth, one of Lloyds TSB Group’s aims is to remain alert for opportunities to participate in the further consolidation of the financial services industry, both in the UK and overseas. Management believes that under current conditions Lloyds TSB Group may find it difficult to make a significant acquisition in the UK in any business line where it already has a significant market share. Lloyds TSB Group’s ability to generate an appropriate return for its shareholders over the long term may depend upon whether management is able to achieve value-creating mergers and/or acquisitions at the appropriate times and prices. Lloyds TSB Group cannot be sure that it will ultimately be able to make any such mergers or acquisitions.
Overseas, much of the growth in profitability during 2003 was attributable to the performance of The National Bank of New Zealand which was disposed of at the beginning of December. There was a reduction in the loss incurred by the Lloyds TSB Group’s operations in Argentina as economic conditions in that country have stabilised although the outlook remains uncertain. The Lloyds TSB Group’s exposure to Latin America has been reduced during 2003 following the disposal of substantially all of its operations in Brazil and will be further reduced following, subject to regulatory approval, the completion of the sale of its operations in Guatemala, Honduras and Panama in 2004.
For the Lloyds TSB Group’s other lending portfolios, provisions are calculated on a case-by-case basis having regard to expected future cash flows including those arising from the realisation of collateral. The determination of these provisions often requires the exercise of considerable judgment by management involving matters such as future economic conditions and the resulting trading performance of the customer and the value of collateral, for which there may not be a readily accessible market. As a result these provisions can be subject to significant variation as time progresses and the circumstances of the customer become clearer.
Future surpluses will depend on experience in a number of areas such as investment returns, lapse rates, mortality and investment expenses. Surpluses are projected by making assumptions about future experience, having regard to both actual experience and forecast long-term economic trends. Changes to these assumptions may cause the present value of future surpluses to differ from those assumed at the balance sheet date and could significantly affect the value attributed to the in-force business. In note 30 to the financial statements the effect of illustrative changes in the principal economic assumptions upon the embedded value included in the balance sheet and new business income is set out.
Net interest income 5,255 5,171 4,922 Other finance income 34 165 307
Share of results of joint ventures (22) (11) (10) Profit on sale of businesses 865 – 39
Profit on ordinary activities after tax 3,323 1,852 2,290 Minority interests: Profit attributable to shareholders 3,254 1,790 2,233 1 Lloyds TSB Group defines economic profit as the earnings on the equity invested in the business less a notional charge for the cost of the equity invested in that business. See ‘Operating and financial review and prospects – Economic profit’.
At the end of 2003, the total capital ratio increased to 11.3 per cent principally as a result of profit retentions and the effect of a £4,679 million, or 4 per cent, reduction in risk-weighted assets to £117,732 million, from £122,411 million at the end of 2002. The effect of growth in personal lending, partly as a result of the acquisition of the personal loan and credit card portfolios of Goldfish Bank, and mortgage lending was more than offset by a reduction of £10,110 million as a result of disposals. Balance sheet assets decreased by £549 million to £252,012 million; the effect of the disposals during 2003 reduced total assets by £14,602 million and there was therefore an underlying increase of £14,053 million. This underlying increase is largely attributable to growth in loans and advances to customers with higher period end UK mortgage and personal lending balances.
In 2002, Lloyds TSB Group’s profit before tax decreased by £549 million, or 17 per cent, to £2,618 million from £3,167 million in 2001. Profit attributable to shareholders was 20 per cent lower at £1,790 million and earnings per share decreased by 21 per cent to 32.1p. Shareholders’ equity decreased by £2,383 million to £7,943 million following a reduction of £2,331 million in the value of the Group’s pension schemes, largely caused by the significant fall in equity market values. The post-tax return on average shareholders’ equity was 16.8 per cent, compared to 18.1 per cent in 2001. Economic profit decreased by 26 per cent to £830 million. The post-tax return on average assets was 0.93 per cent, and the post-tax return on average risk-weighted assets was 1.62 per cent.
Other finance income, at £165 million, was down £142 million, or 46 per cent, from £307 million in 2001. The expected return on pension scheme assets was £27 million lower, reflecting the lower market value of scheme assets at the start of 2002, as a result of stock market conditions. The interest charge in respect of the unwinding of the discount on scheme liabilities was £115 million higher, due to the increased level of scheme liabilities at the start of 2002 mainly reflecting the greater longevity of the members of the schemes.
Other income was £108 million, or 3 per cent, lower at £3,551 million compared to £3,659 million in 2001. Income from long-term assurance business was £264 million lower, mainly as a result of the depressed stock market conditions reducing the returns from the investments supporting the life funds and the capitalised value of annual management charges, together with a £135 million increase in provisions for redress to past purchasers of endowment and pension products. There was also a charge of £57 million to reflect the implementation of revised mortality assumptions. Dealing profits were £45 million lower, largely as a result of less favourable market conditions. These factors more than offset an increase in net fees and commissions receivable which were £88 million higher. Growth in general insurance broking income and income from credit and debit cards was only partly offset by reduced levels of stock market related fees. General insurance premium income was £58 million higher and other operating income increased by £55 million as reductions in venture capital gains and profits from sale and leasebacks of premises were more that offset by increased operating lease rental income, mainly reflecting the impact of acquisitions during 2002.
Operating expenses were £144 million, or 3 per cent, higher at £4,913 million compared to £4,769 million in 2001. Administrative expenses were £7 million lower than in 2001. Staff costs reduced by £32 million as the benefits of reductions in staff numbers and lower levels of pension scheme augmentation costs more than offset the impact of acquisitions, the annual pay review and increased severance costs. Premises and equipment costs were £26 million higher as a result of increased rental costs and repairs and maintenance expenditure. Depreciation was £131 million higher, largely reflecting a £95 million increase in respect of operating lease assets as a result of acquisitions and organic growth in the Lloyds TSB Group’s existing businesses. Goodwill amortisation was £20 million higher. The efficiency ratio increased to 55.3 per cent from 53.7 per cent.
The charge for bad and doubtful debts was 38 per cent higher at £1,029 million compared with £747 million in 2001. In UK Retail Banking and Mortgages the provisions charge increased by £139 million, or 39 per cent, to £496 million, largely as a result of volume related asset growth in the personal loan and credit card portfolios, which grew by 15 per cent and 27 per cent respectively and the non-recurrence of one-off releases recognised in 2001. In Wholesale and International Banking the provisions charge increased by £144 million to £540 million. In Wholesale, provisions against the corporate lending portfolio increased by £145 million as a result of a small number of large provisions against certain US customers following the discovery of accounting or other operational irregularities and higher provisions against exposures in specific sectors of the UK economy which experienced a slowdown in activity. Within International Banking provisions fell mainly as a result of lower specific provisions in Losango, Lloyds TSB Group’s consumer finance business in Brazil, largely reflecting exchange rate movements. The general provision held against the Lloyds TSB Group’s exposure to Argentina was increased by £50 million, compared to a charge of £55 million in 2001.
The yields, spreads and margins in the table below are those relating to the banking business only.
Lloyds TSB Group Net interest income £m 5,255 5,171 4,922 Average interest-earning assets £m 172,896 161,818 144,945 Average rates: – Gross yield on interest-earning assets %1 5.87 6.52 7.84
2 Lloyds TSB Group interest spread is the difference between the rate of interest earned on total average interest-earning assets and the rate of interest paid on total average interest-bearing liabilities. The domestic interest spread is the difference between the rate of interest earned on domestic average interest-earning assets and the rate of interest paid on domestic average interest-bearing liabilities. The international interest spread is the difference between the rate of interest earned on international average interest-earning assets and the rate of interest paid on international average interest-bearing liabilities.
4 The analysis of net interest income by domestic and international operations shown above is based on the location of the office recording the transaction, except for lending by the international business booked in London.
Lloyds TSB Group net interest income increased by £84 million, or 2 per cent, to £5,255 million, representing 53 per cent of total income compared to 58 per cent in 2002; businesses disposed of during 2003 contributed £511 million of this total. Average interest-earning assets increased by £11,078 million, or 7 per cent, to £172,896 million, adding £284 million to net interest income. Within UK Retail Banking and Mortgages, continued strong growth led to increases of £2,173 million in average personal lending and credit card balances and £7,424 million in average mortgage balances. Within Wholesale and International Banking, average interest-earning assets increased by £2,010 million, reflecting growth in asset finance balances and the full year effect of structured finance transactions entered into during 2002 which have more than offset a reduction in balances within the Lloyds TSB Group’s treasury operations due to fewer market opportunities in 2003. Overseas, growth in balances in New Zealand, principally due to exchange rate movements, was partly offset by reductions in Latin America as the Lloyds TSB Group’s exposures to Brazil and Argentina have been further reduced. There was also a reduction of £1,207 million following the reclassification as trading assets and subsequent disposal of the Lloyds TSB Group’s portfolio of emerging markets debt securities.
The domestic net interest margin decreased by 17 basis points, reducing net interest income by £229 million. In UK Retail Banking and Mortgages there was a 19 basis point decrease in the net interest margin caused by finer margins being earned in the mortgages business as a result of competitive pressures and the effect of lower average interest rates reducing the benefit of low cost and interest-free funds. This was partly offset by improved margins on personal loans reflecting the lower funding cost. Within Wholesale the margin fell by 21 basis points as a result of the implementation of the Competition Commission’s SME report remedies. If this is excluded there was an increase of 5 basis points; an improved margin in the asset finance business offset the inclusion for a full year of the finer margin structured finance transactions entered into in 2002.
The net interest margin fell by 20 basis points to 3.20 per cent from 3.40 per cent in 2001, reducing net interest income by £290 million. Reductions in interest rates in the UK in the second half of 2001 resulted in a reduced benefit from Lloyds TSB Group’s low interest rate deposits and interest-free liabilities. There was also a continuing shift in the mix of average interest-earning assets towards high quality, but finer margin, corporate and wholesale lending. Adverse exchange rate movements, principally in Latin America, reduced net interest income by £116 million.
Fees and commissions receivable: – UK current account fees 623 579 573 – Other UK fees and commissions 1,173 1,163 1,220
Other income increased by £1,068 million, or 30 per cent, to £4,619 million; of this total businesses disposed of during 2003 accounted for £142 million.
Other UK fees and commissions increased by £10 million. Fees earned by the mortgages business rose by £20 million reflecting the growth in new mortgage lending during 2003 and an increase in the arrangement fee charged to customers. There was a £14 million increase in the fees charged in connection with the early settlement of personal loans following their introduction in the second half of 2002 and fees from large corporate and factoring activity increased by £16 million. There was also an increase in fees receivable within the asset finance business; acceptance fees were £7 million higher and collection fees grew by £8 million as a result of volume growth. This growth has been largely offset by a further reduction of £27 million in unit trust and asset management fees reflecting lower average fund values and the continued weakness of the long-term savings market. Fee income from stockbroking activities reduced reflecting lower transaction volumes in weak market conditions and income from the company registration business also fell as levels of corporate activity have remained subdued. Income from credit and debit card services increased by £46 million mainly as a result of a growth in interchange income, partly reflecting the acquisition of the Goldfish credit card portfolio during 2003, higher overseas use commissions and other fees.
Premium income from general insurance underwriting increased by £49 million, or 10 per cent, to £535 million, compared to £486 million in 2002. There was growth of £60 million in premiums from home insurance products, reflecting successful cross-selling to the Lloyds TSB Group’s mortgage customers and the continued strength of the UK housing market, partly offset by a £7 million increase in reinsurance premiums due to increased rates in the reinsurance market and higher underwritten premiums.
Other operating income decreased by £69 million to £694 million mainly due to the change in treatment of earnings from the emerging markets debt investments portfolio following the reclassification of the portfolio as a trading asset at the end of 2002. There was also a further £28 million reduction in profits from the sale and leaseback of premises, which in 2003 totalled £4 million. These factors more than offset the effect of the inclusion of income from the sale of cars by the Dutton-Forshaw Group following its acquisition in December 2002 which increased by £51 million and a £26 million increase in the gains on realisation of venture capital investments by Lloyds TSB Development Capital. There were also gains of £34 million following the sale of a number of leases by Lloyds TSB Leasing where the tax attributes could be used by the purchasers.
Other income decreased by £108 million, or 3 per cent, to £3,551 million although after adjusting for the effect of acquisitions made during 2002 there was a reduction of £221 million or 6 per cent.
Depreciation rose by £4 million. Operating lease depreciation increased by £19 million as an accelerated charge was recorded following the reassessment of the carrying value of a small number of big ticket operating lease assets; the effect of the acquisition of First National Vehicle Holdings during 2002 was largely offset by the reduction in the size of the existing portfolios. This was offset by a £15 million reduction in the charge on other fixed assets, mainly reflecting the accelerated write-off of certain software development costs in 2002. Goodwill amortisation was £8 million lower.
Other expenses reduced by £1 million. Communications and external data processing costs were £37 million lower as a result of reduced levels of expenditure on the development of the Lloyds TSB Group’s e-commerce and real-time banking systems. Other costs were £40 million higher, reflecting the impact of acquisitions and increased charges from iPSL.
The efficiency ratio in 2002 was 55.3 per cent compared to 53.7 per cent in 2001.
UK Retail Banking and Mortgages 594 496 357 Wholesale and International Banking 369 540 396 Central group items (13) (7) (6)
Foreign tax: – Current tax on profits for the year 144 216 179 – Adjustments in respect of prior years (15) (15) (17)
The effective rate of tax in 2002 was 29.3 per cent, slightly lower than the corporation tax rate of 30 per cent, compared to an effective rate of tax of 27.7 per cent in 2001. The higher effective rate of tax in 2002 is largely due to a lower level of tax relief on payments to the QUEST and a lower level of gains on the disposal of properties which were sheltered by capital losses. There was also a higher effective rate of tax in the Lloyds TSB Group’s life and pensions businesses because of increased losses on the investment portfolio.
Lloyds TSB Group believes that economic profit instils financial discipline in determining investment decisions throughout Lloyds TSB Group and that it enables Lloyds TSB Group to evaluate alternative strategies objectively, with a clear understanding of the value created by each strategy, and then to select the strategy which creates the greatest value. Awards to senior executives under Lloyds TSB Group’s annual bonus arrangements are partly determined by the achievement of economic profit targets.
Profit attributable to shareholders 3,254 1,790 2,233 Less: notional charge (761) (960) (1,110)
The notional charge has been calculated by multiplying average shareholders’ equity by the cost of equity.
In order to provide a clearer representation of the underlying performance, the results of the Insurance and Investments segment include investment earnings calculated using longer-term rates of return and annual management charges based on unsmoothed fund values. Management separately analyse the difference between these normalised earnings and the actual return (‘the investment variance’) together with the impact of changes in the economic assumptions used in the embedded value calculation. The results of the businesses are set out below: £m £m £m.
Total income increased by £319 million, or 9 per cent, to £4,046 million. Net interest income increased by £247 million, or 9 per cent, to £3,137 million as continued growth in lending and deposit balances added £379 million to net interest income partly offset by a reduction of £132 million caused by a 19 basis point reduction in the net interest margin. There was good organic growth in the personal loan and credit card businesses with outstanding balances increasing by 9 per cent and 18 per cent respectively over the year; after taking account of the impact of the acquisition of the Goldfish Bank portfolios, outstanding personal loan balances had increased by 10 per cent and credit card balances by 36 per cent by the end of December 2003. Within UK Retail Banking balances on current and savings and investment accounts grew by 10 per cent reflecting the growth in the number of added value accounts and the success of new savings products launched during 2003. Over the last twelve months, mortgage balances outstanding have increased by 13 per cent to £70,750 million as net new lending increased to £8,283 million from £5,889 million; this represents an improved market share of 8.6 per cent although it remains below the Lloyds TSB Group’s market share of outstanding mortgages.
The net interest margin was 19 basis points lower. There has been margin contraction in the mortgages business as competitive pressures have caused a move to discounted and finer margin products; the margin on retail savings products has also fallen as the full effect of interest rate falls has not been passed on to customers and the benefit of low interest and interest-free current accounts has been reduced. This has been partly offset by an improved margin on personal loans, which has benefited from lower funding costs.
Other income increased by £72 million to £909 million. Fees earned from current account activity grew by £44 million reflecting increased volumes of added value accounts and higher monthly charges; returned cheque fees have also increased as the number of returned items has risen. There was also improved income from credit and debit card transactions, which increased by £46 million, mainly as a result of a growth in interchange income, higher overseas use commissions and other fees. This was partly offset by higher fees payable in respect of the credit card business, mainly reflecting volume growth and the cost of customer incentives, and increased package costs incurred on the added value account range as volumes have risen. A growth in fee income in the mortgages business as lending volumes have grown and charges increased, has been offset by the higher cost of customer incentives.
Operating expenses were £42 million, or 2 per cent, higher at £2,212 million compared to £2,170 million in 2001. Costs associated with the Lloyds TSB Group’s efficiency programme totalled £175 million compared to £134 million in 2001, an increase of £41 million, as the Lloyds TSB Group continues to invest in initiatives to enhance Retail Banking performance and rationalise software and systems. There were also increased staff costs particularly within the Mortgages business as additional staff were taken on in order to maintain customer service levels in the expanding portfolio. These increases and the effect of annual pay awards were partly offset by reduced headcount in the branch network and lower development costs in respect of internet banking and other initiatives. The efficiency ratio, however, improved to 59.4 per cent from 60.3 per cent in 2001.
Operating expenses, at £480 million, were down slightly from £488 million in 2001. Cost reductions resulting from lower levels of sales and marketing activities in the unit trust and asset management operations have been largely offset by higher client service costs and increased costs in the general insurance business, to manage the significant increase in volumes.
When projecting future surpluses and other net cash flows Lloyds TSB Group makes a series of assumptions about long-term economic conditions. Prior to 2002, these assumptions were only updated infrequently for changes that were considered sustainable. In order to achieve greater comparability with other listed insurers in the UK, in 2002 the Lloyds TSB Group changed its practice and now revises these assumptions at each reporting date.
• Distribution costs: the costs of acquiring the new business generated in the year. These comprise the cost of selling products through Lloyds TSB Bank’s branch network; the commissions paid to independent financial advisors and related costs of sales through this channel; and the costs of other direct sales channels.
Unit trust income is shown before the acquisition costs of new business which are separately disclosed.
The table below shows the level of new business premium income and unit trust sales. Management monitor these figures because they provide an indication of both the performance and the profitability of the business.
Weighted sales is a UK insurance industry standard which measures the new business volumes; the weighting is made towards regular premium policies to reflect the long-term nature of these contracts. There are four main distribution channels for the sale of Lloyds TSB Group’s life, pension and unit trust products and the table below shows the relative importance of each.
New business income from the life and pensions businesses was £40 million, or 11 per cent, higher at £398 million. This increase in profits reflects a 7 per cent increase in weighted sales from life and pensions products, and an improved performance in the more profitable life products. The life and pensions new business margin improved to 19.3 per cent from 18.5 per cent in 2001. The improvement largely arose from an improved product mix, as a result of the growth in sales of higher margin term assurance and regular premium life products. Distribution costs increased by £28 million, or 11 per cent, to £283 million from £255 million partly due to the growth in weighted sales but also because of the increasing proportion of sales made through independent financial advisors.
Life and pensions investment earnings, at £214 million, were £33 million, or 13 per cent, lower than in 2001. This fall reflected the lower asset level at the start of 2002, following poor stock market performance in the latter part of 2001.
Costs were £12 million higher. Operating expenses increased by £6 million as a growth in salary costs was partly offset by a reduction in advertising and severance related costs. There was also a £6 million increase in commissions payable reflecting the growth in premium income.
The operating profit of the general insurance broking business was £54 million, or 10 per cent lower, at £501 million compared to £555 million in 2002. Commission income fell by £43 million reflecting a £75 million reduction in income from creditor insurance products as personal loan sales volumes within the branch network have started to slow and an allowance of £35 million has been made against the clawback of commissions by the insurance underwriters as loans are settled early. Income from sales of home insurance products fell by £14 million due to more competitive offers from other market participants. These factors have been partly offset by a £47 million improvement in other commissions reflecting a significant increase in the level of retrospective commissions receivable from underwriters as the favourable economic conditions have improved the profitability of the policies written. There was a £4 million increase in operating expenses principally reflecting higher staff costs due to both the annual pay review and increased numbers to support new business volumes and other initiatives.
Operating expenses increased in line with sales, as more staff were taken on to deal with the increased business volumes, and commissions expense increased by £18 million as a result of increased sales volumes and, in particular, higher levels of affinity sales.
The operating profit of the general insurance broking business, at £555 million, was £118 million, or 27 per cent, higher than £437 million in 2001, principally reflecting a £119 million increase in broking commission income to £647 million in 2002. Creditor insurance commissions were £103 million higher at £426 million reflecting improved penetration into the Lloyds TSB Group’s personal credit portfolios, coupled with the benefit of higher volumes of personal loans and credit card outstandings. There has also been a benefit from the Lloyds TSB Group’s continuing shift towards broking more general insurance business. Other commission income was £18 million higher as increased commissions on motor and other smaller products, together with increased levels of retrospective commissions on a number of products, more than offset the impact of the non-repetition of a one-off benefit of £30 million in 2001 which resulted from a change in broking arrangements.
Amounts written off fixed asset investments fell by £13 million to £44 million reflecting lower charges against both corporate and venture capital investments.
In 2003, a profit of £865 million arose on the sale of The National Bank of New Zealand, substantially all of Lloyds TSB Group’s businesses in Brazil and its French fund management and private banking businesses.
Other income increased by £156 million, or 11 per cent, to £1,588 million. Operating lease rentals were £111 million higher; of this growth £83 million was due to the acquisitions made during the year, with the balance due to organic growth in the Lloyds UDT and Lloyds TSB Leasing portfolios. A higher level of insurance commission income within the asset finance business and a £20 million increase in corporate banking and factoring fees were offset by a £35 million reduction in the realisations of venture capital gains. Fee income in the company registration business was £6 million lower, as the exceptionally high levels of company transactions in 2001 were not repeated. Overseas, other income increased by £29 million mainly as a result of profits on the sale and leaseback of premises totalling £32 million.
Operating expenses increased by £225 million, or 11 per cent, to £2,185 million. Excluding the effect of acquisitions made during the year, the underlying increase was £123 million. Of this increase £33 million was due to increased operating lease depreciation as a result of organic growth in the Lloyds UDT and Lloyds TSB Leasing portfolios and the non-repetition of a one-off benefit of £23 million recognised in 2001 in respect of certain ship leases. There was increased investment spend in corporate and commercial banking activities to support business growth and increased staff and other costs in the UK asset finance and business banking businesses. Overseas, costs were little changed as increases in New Zealand, to support recent business growth, and the effect of annual pay awards and increased pension costs, were offset by favourable exchange movements.
Earnings on surplus capital and the emerging markets debt investment portfolio reflect earnings on capital held at the Group centre, less the funding cost of recent acquisitions, and profits from the Group’s investment portfolio of emerging markets debt securities. During the first half of 2003 improved secondary bond market conditions allowed the Group to sell its portfolio of emerging markets debt securities. Profits on bond sales, and certain closed foreign exchange positions, in 2003 totalled some £295 million compared to £212 million in 2002. The Group will not achieve any further contribution from the emerging markets debt portfolio. This benefit has been partly offset by lower earnings on the investment of the Lloyds TSB Group’s capital reflecting the reduction in average UK interest rates since 2002.
Information concerning other future accounting developments is provided in note 50 to the financial statements.
The most significant areas of difference between UK GAAP and US GAAP which affect net income are as follows: Insurance accounting. Under UK GAAP applicable to banking groups, life assurance activities are accounted for using the embedded value basis of accounting which requires the recognition of the discounted value of the projected future net cash flows attributable to the shareholder at the point of sale. UK GAAP therefore results in a substantial proportion of the net profit accruing on a portfolio of life assurance polices being recognised at their inception. Under US GAAP income is recognised in the profit and loss account in the period in which it is earned and expenses in the period in which they are incurred. This results in a more even recognition of profit over the life of the related policies.
Average Interest Average Interest Average Interest balance income Yield balance income Yield balance income Yield
Average interest-earning assets and net interest income: Net yield on interest-earning assets 190,518 5,255 2.76 177,336 5,171 2.92 157,197 4,922 3.13
Interest payable Deposits by banks: Liabilities to banks under sale and repurchase agreements: Customer accounts: Liabilities to customers under sale and repurchase agreements: – Foreign offices (1) – (1) – – – Debt securities in issue: Subordinated liabilities: Total banking book interest payable (484) 325 (809) (1,064) 572 (1,636) Total trading book interest payable 64 80 (16) 58 127 (69)
Risk management Lloyds TSB Group uses an enterprise-wide framework for the identification, assessment, measurement and management of risk, designed to meet its customers’ needs and maximise value for shareholders over time by aligning risk management with the corporate strategy; assessing the impact of emerging risks from new technologies or markets; and developing risk tolerances and mitigating strategies.
Directors of the Lloyds TSB Group’s businesses have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are empowered to establish control frameworks for their businesses that are consistent with the Lloyds TSB Group’s high level policies and within parameters set and overseen by Group Risk Management and the divisional risk officers.
Intranet based risk management training has been developed to help staff understand the principal risks faced by the Lloyds TSB Group and identify and manage effectively the risks that they face in their roles. The University for Lloyds TSB has validated the training to enable the awarding of internal qualifications to those staff completing it.
The Lloyds TSB Group seeks to identify and classify risks in a timely manner. The likelihood of risks crystallising and the significance of the consequent impact on the business, the Lloyds TSB Group and its customers are evaluated. The Lloyds TSB Group’s business control environment seeks to ensure effective and efficient operational management; reliability, integrity and consistency of financial and other reporting; and compliance with governing laws and regulations. Business directors seek to ensure that material risks are reported to the relevant divisional risk officer, group executive director and to Group Risk Management.
A common approach is applied across the Lloyds TSB Group to assess the creation of shareholder value. This is measured by economic profit (the profit attributable to shareholders, less a notional charge for the equity invested in the business). The focus on economic profit allows the Lloyds TSB Group to compare the returns being made on capital employed in each business. The use of risk-based economic capital and regulatory capital is closely monitored at business and Lloyds TSB Group level. The Lloyds TSB Group’s economic capital model covers credit, market, insurance, business and operational risks.
The Lloyds TSB Group’s strategy and those of its constituent businesses are reviewed and approved by the board. Regular reports are provided to the group executive committee and the board on the progress of the Lloyds TSB Group’s key strategies and plans.
• Sector caps, encompassing both industry sectors and specific product types are established by Group Risk Management to communicate the Lloyds TSB Group’s risk appetite for specific types of business, primarily in the non-retail markets.
Total loans and advances net of provisions and interest held in suspense 150,798 152,003 138,159 129,722 119,196
In the UK, although a bank is entitled to enforce a first charge on a property held as security, it typically does so only to the extent of enforcing its power of sale. In accordance with UK GAAP and industry practice, Lloyds TSB Group takes control of a property held as collateral on a loan at repossession but title does not transfer to it. Loans subject to repossession continue to be reported as loans in the balance sheet although the accrual of interest is suspended. Any gains or losses on sale of the acquired property are recorded within the provision for loan losses during the reporting period.
The difference in practices has no effect on net income reported in the UK compared to that reported in the US but it does result in a difference in classification of losses and recoveries in the income statement. It also has the effect of causing UK banks to report an increased level of non-performing loans compared with US banks.
Accruing loans on which interest is still being accrued and taken to profit, and against which specific provisions have been made
Accruing loans on which interest is still being accrued and taken to profit, the lending is contractually past due 90 days or more as to principal or interest, but against which no provisions have been made
Total accruing loans against which no provisions have been made 875 810 730 553 521
In summary, although VaR is an important component of Lloyds TSB Group’s approach to managing trading market risk, it is supplemented by position and sensitivity limits and stress testing.
The financial assets and liabilities referred to above are acquired by way of internal transactions between Group Balance Sheet Management and the Lloyds TSB Group’s Financial Markets Division in London, typically in the form of interest rate swaps and loans or deposits.
It is estimated that a hypothetical immediate and sustained 100 basis point increase in interest rates on 1 January 2004 would decrease net interest income by £88.3 million for the 12 months to 31 December 2004, while a hypothetical immediate and sustained 100 basis point decrease in interest rates would increase net interest income by £84.0 million.
North Asia & Latin Europe & Total Total UK America Australasia America Middle East 2004 2003 £m £m £m £m £m £m £m
Change in net interest income from a +100 basis point shift in yield curves (56.4) (0.5) (1.3) (0.4) (29.7) (88.3) (37.9) Change in net interest income from a –100 basis point shift in yield curves 52.1 0.5 1.3 0.4 29.7 84.0 30.3
Retail portfolios and Capital Funds. Market risk in the Lloyds TSB Group’s retail portfolios and in the Lloyds TSB Group’s capital funds arises from the different repricing characteristics of the Lloyds TSB Group’s banking assets and liabilities and is managed by Group Balance Sheet Management. The simulation models used by Group Balance Sheet Management include assumptions about the relationships between customer behaviour and the level of interest rates; the anticipated level of future business is also taken into account. The accuracy of these assumptions will impact the efficiency of hedging transactions. The assumptions are regularly updated and the projected exposure is actively managed in accordance with the policy.
Derivatives. These are used to meet customers’ financial needs; as part of the Lloyds TSB Group’s trading activities; and to reduce the Lloyds TSB Group’s own exposure to fluctuations in interest and exchange rates. The principal derivatives used by the Lloyds TSB Group are interest rate contracts (including interest rate swaps, forward rate agreements and options) and exchange rate contracts (including forward foreign exchange contracts, currency swaps and options). Particular attention is paid to the liquidity of the markets and products in which the Lloyds TSB Group trades to ensure that there are no undue concentrations of activity and risk.
The composition, and value, of both the non-participating fund and the General Insurance portfolio are reported to Group Risk Management on a monthly basis and a VaR is calculated. Stress testing is also used to supplement the VaR models.
The risk of loss measured by the VaR model is the potential loss in earnings over a given time horizon. The VaR methodology used is a VcV approach which is the same in all respects to that used for the traded risk in banking activities, except that in the case of equity risk, the model maps the portfolio composition onto a series of appropriate indices by region and sector. The figures quoted below are the sum of the two portfolios with no allowance for diversification between portfolios or asset classes and represents the potential loss in earnings.
The General Insurance portfolio is invested in a mixture of assets: cash, bonds and equities. The investment policy together with appropriate limits including the limit to be applied to the equity component are approved by group asset and liability committee supported by Group Risk Management.
Businesses have primary responsibility for identifying and managing their operations risks. They employ internal control techniques to reduce their likelihood or impact to tolerable levels within the Lloyds TSB Group’s risk appetite. Where appropriate, risk is mitigated by way of insurance.
Group Risk Management provides general guidance on operations risk related issues, including regulatory changes and developments in the measurement and management of operations risk, to promote best practice throughout the Lloyds TSB Group. It keeps under continuous review and improvement all aspects of operations risk management to reflect developments in industry best practice and regulatory requirements.
The Lloyds TSB Group is committed to the fair treatment of its customers. This is embedded into the processes indicated below to ensure businesses have developed customer centric strategies for product and business development, marketing, selling and after sales service.
Capital ratios are a key factor in the Lloyds TSB Group’s budgeting and planning processes, and updates of expected ratios are prepared regularly during the year. Capital raised takes account of expected growth and currency of risk assets, and also allows for the sensitivity of the Lloyds TSB Group’s capital to movements in equity markets.
The Lloyds TSB Group’s business is regulated overall by the Financial Services Authority, and additionally by local regulators in offshore and overseas jurisdictions.
Lloyds TSB Group plc is also able to raise funds by issuing loan capital or equity, although in practice Lloyds TSB Group plc has never issued equity for this purpose and the majority of Lloyds TSB Group’s loan capital has been issued by Lloyds TSB Bank. As at 31 December 2003, Lloyds TSB Group plc had £1,356 million of subordinated debt in issuance compared with £10,454 million for the consolidated Lloyds TSB Group. The cost and availability of subordinated debt finance are influenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access. At 31 December 2003, the credit ratings of Lloyds TSB Bank were as follows: Senior debt
At 31 December 2003 Lloyds TSB Group also acted as sponsor to three additional conduit securitisation purchasing entities, Monument Asset Securitisation Company Limited (‘Monument’) and Obelisk Funding Limited and Obelisk Funding (No. 2) Limited (‘Obelisk’). These are wholly owned by independent trusts and administered by third parties. These off-balance sheet entities purchase securities or receivables from customers funded by secured lending from third parties, which in turn issue asset-backed commercial paper to investors. Lloyds TSB Group does not sell its own receivables to these entities, and the assets and obligations of Monument and Obelisk are not included in Lloyds TSB Group’s consolidated balance sheet. However, Lloyds TSB Group provides short-term asset-backed commercial paper liquidity support facilities on commercial terms to the issuers of the commercial paper, for use in the event of a market disturbance should they be unable to roll over maturing commercial paper or obtain alternative sources of funding.
The regulatory environments in which the different businesses within the Lloyds TSB Group operate are discussed below.
Capital adequacy returns are submitted on a periodic basis for all the authorised institutions within the Lloyds TSB Group. There are six UK authorised banks within the Lloyds TSB Group: Lloyds TSB Bank, Lloyds TSB Scotland, Cheltenham & Gloucester, Lloyds TSB Private Banking, Scottish Widows Bank and AMC Bank. Returns are also submitted on a consolidated basis for the Lloyds TSB Group as a whole.
The London Code of Conduct for Non-Investment Products will apply to both FSA authorised and non-FSA authorised institutions. Given the fact that some firms will operate both in the NIPs and investment product markets, the NIPs Code has been drafted with a view to making its provisions consistent where appropriate with the relevant parallel provisions in the FSA Handbook. The provisions of the NIPs Code are intended only as guidance on what is currently believed to constitute good practice in the NIPs wholesale markets. The code has no statutory underpinning except where it refers to existing legal requirements, although the FSA may take into account a firm’s compliance or otherwise with this and other codes when making decisions on authorisation.
• Prevent the use of the long-term business assets for purposes other than supporting long-term business.
The Financial Services Compensation Scheme also applies to general and long-term insurance business written by an insurer authorised by the FSA or by the UK branch of a European Economic Area firm carrying on ‘home state regulated activity’. The limit of compensation in respect of long-term insurance contracts is 90 per cent of the value of the contract with no maximum.
The General Insurance Standards Council (‘GISC’) is an independent, non-statutory organisation that was officially launched on 3 July 2000 to regulate the sales, advice and service standards of its members. GISC members may be insurers, intermediaries or others involved in general insurance such as claims handlers. Members’ obligations to individuals buying insurance for themselves and their families are explained fully in the GISC Private Customer Code, while the GISC Commercial Code explains members’ obligations in relation to businesses buying insurance. Members are monitored to make sure they follow the standards in the Code.
Whilst credit institutions such as those in Lloyds TSB Group are primarily regulated in their home state by a local regulator, the EU directives prescribe minimum criteria for the authorisation of credit institutions and the prudential supervision applicable to them. Investment firms are subject to a similar regulatory environment and can obtain a ‘passport’ under the Investment Services Directive or the UCITS Management Directive. Despite the application of the ‘passports’ a member state can impose certain requirements on the conduct of banking and investment activities in its boundaries, including conduct of business rules.
Credit institutions and investment firms are required to make adequate capital provisions for risks entered into: the directives set out the deemed quality and acceptable relative proportions of various types of capital. The directives also regulate permissible counterparty exposures, provide for the supervision of consolidated financial groups’ capital adequacy requirements and define permissible exposures to individual or linked counterparties.
Lloyds TSB Group operates in many countries around the world and its overseas branches and subsidiaries are subject to reporting and reserve requirements and controls imposed by the relevant central banks and regulatory authorities.
During the early 1990s, the UK government and regulatory authorities became concerned that customers who had been encouraged to set up private pension plans had been given poor advice and that they would, in fact, have been in a better position if they had remained in, or joined, employer sponsored pension schemes. The regulator of the UK pension industry (then the Securities and Investments Board, now the FSA) carried out an industry-wide investigation into the conduct of business involving the transfer of pensions. The conclusion of this investigation was that a large number of customers had been poorly advised by insurance companies and intermediaries across the industry. As a result, the regulator established an action plan requiring the UK pensions industry to review all cases of possible misselling and where appropriate pay compensation.
Concerns have also been expressed over the appropriateness of sales of certain stock market related savings products. In this regard, Lloyds TSB Group has carried out, in conjunction with the FSA, an investigation into sales made in 2000 and 2001 of the Extra Income & Growth Plan (‘EIGP’). The EIGP is a term investment providing a fixed return either by way of quarterly income, annual income or a single payment at maturity. The capital repayment at maturity is linked to the performance of a basket of shares, selected from the FTSE 100. The investigation was completed during 2003 and concluded that the Lloyds TSB Group did not have sufficiently rigorous systems and controls for considering all the issues surrounding the selling of the EIGP and in particular, did not provide sales staff with sufficiently in-depth training on how much of a customer’s available funds should be invested. As a result the product was sold to some customers for whom it was not suitable. The FSA fined Lloyds TSB Bank £1.9 million and required that compensation should be paid to those customers who invested in the EIGP when it was not appropriate. A charge of £130 million has been made to the profit and loss account in 2003 in respect of the costs of the investigation and to provide for the estimated cost of redress and the incremental costs expected to be incurred processing the payments to customers. A further charge of £5 million was made during 2003 in respect of remediation to customers who invested in other long-term savings products.
Since demutualisation in 2000, Scottish Widows continued to write policies containing similar features, although the volume of products written has since reduced and is now not significant. The Additional Account is not available to meet any additional cost of providing the benefits on these policies which would, to a large extent, have to be met by the Lloyds TSB Group.
Profit and loss account 6,727 5,091 7,613 Shareholders’ funds (equity) 9,624 7,943 10,326
Undated loan capital 5,959 5,496 4,102 Dated loan capital 4,495 4,672 4,006
Lloyds TSB Group’s total capital resources increased by £1,963 million during 2003.
During 2003, total capital for regulatory purposes increased by £1,545 million to £13,260 million. Tier 1 capital increased by £1,781 million, mainly as a result of profit retentions and favourable exchange rate movements, and tier 2 capital increased by £89 million. This was partly offset by an increase in supervisory deductions of £325 million, reflecting an increase of £268 million in the long-term assurance business attributable to the shareholder to £6,481 million, from £6,213 million in December 2002.
The following table sets out the book value and valuation of Lloyds TSB Group’s investment securities and other securities at 31 December for each of the three years indicated.
Bank and building society certificates of deposit 2,515 2,515 3,147 3,148 4,670 4,677
Investment securities Bank and building society certificates of deposit 2,464 3.7 51 2.7 – – – –
Securities of the US treasury and US government agencies – – 414 1.6 1,112 1.8 98 1.6
Other asset backed securities – – 62 3.0 58 4.5 – –
The following table gives details of Lloyds TSB Group’s certificates of deposit issued and other time deposits as at 31 December 2003 individually in excess of US $100,000 (or equivalent in another currency) by time remaining to maturity.
The following table gives details of the significant short-term borrowings of Lloyds TSB Group for each of the past three years.
Provisions for bad and doubtful debts (950) (1,029) (747) (541) (615) Profit on ordinary activities before tax 4,348 2,618 3,167 3,791 3,477 Profit on ordinary activities after tax 3,323 1,852 2,290 2,707 2,394 Profit for the year attributable to shareholders 3,254 1,790 2,233 2,658 2,388
Number of ordinary shares in issue (millions)7 5,594 5,583 5,564 5,507 5,475
DeAnne S Julius CBE✠†§ Joined the board in 2001. Held a number of senior appointments in the UK and USA with the World Bank, Royal Dutch/Shell Group and British Airways, before membership of the Bank of England Monetary Policy Committee from 1997 to 2001. Chaired HM Treasury’s banking services consumer codes review group in 2000/1. Chairman of the Royal Institute of International Affairs. A non-executive director of the Bank of England, BP, Serco Group and Roche Holdings SA. Aged 54.
J Eric Daniels Group Chief Executive Joined the board in 2001 as group executive director, UK Retail Banking before his appointment as group chief executive in June 2003. Served with Citibank from 1975 and held a number of senior and general management appointments in the USA, South America and Europe before becoming chief operating officer of Citibank Consumer Bank in 1998. Following the Citibank/Travelers merger in 1998, he was chairman and chief executive officer of Travelers Life and Annuity until 2000. Chairman and chief executive officer of Zona Financiera from 2000 to 2001. Aged 52.
Executive directors * Member of the audit committee ** Chairman of the audit committee † Member of the remuneration committee ‡ Chairman of the remuneration committee § Member of the nomination committee ◆ Chairman of the nomination committee ✠ Independent director ▲ Senior independent director
Results and dividends The consolidated profit and loss account on page 89 shows a profit attributable to shareholders for the year ended 31 December 2003 of £3,254 million.
An interim dividend of 10.7p per ordinary share was paid on 8 October 2003 and a final dividend of 23.5p per ordinary share will be paid on 5 May 2004. These dividends will absorb £1,911 million.
Business review and future developments A review of the business and an indication of future developments are given on pages 4 to 67.
Mr Atkinson, Mr Butler, Miss Forbes and Mr Moore left the board at the annual general meeting in 2003. Mr Ellwood retired on 31 May 2003 and Mr Ross and Mr Hampton left the board on 30 September 2003 and 12 January 2004, respectively. The Earl of Selborne will retire at the annual general meeting in 2004.
Mr Targett joined the board on 10 March 2003 and was elected at the annual general meeting on 16 April 2003.
Employees The Lloyds TSB Group is committed to employment policies which follow best practice, based on equal opportunities for all employees irrespective of sex, race, national origin, religion, colour, disability, sexual orientation, age or marital status.
The board has determined that no member of the audit committee satisfies the strict definition of an ‘audit committee financial expert’ under the regulations issued by the Securities and Exchange Commission of the United States of America following the passing of the Sarbanes-Oxley Act of 2002. However, the directors are confident in the expertise and experience of each member of the committee and of the committee as a whole. The board believes that the collective experience of the members of the committee enables them, as a group, to act as an effective audit committee and that the audit committee has functioned and can continue to function effectively without a member who qualifies as an audit committee financial expert.
The committee also has specific powers delegated to it by the board from time to time and following the exercising of these powers, it reports at the next convenient board meeting. To comply with the Group’s articles of association, only committee members who are also directors of the company participate in the exercising of any powers delegated by the board.
During 2003, the risk oversight committee was established, comprising Mr Pritchard (chairman), Mr van den Bergh, Mr Daniels, Mr Fairey, Mr Brown and Sir Tom McKillop: all non-executive directors are 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 governance framework, risk appetite, risk strategy 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 Management division and the appointment of senior executives of that division. The risk oversight committee reports to the board on its deliberations after each meeting.
The directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of published policies and procedures and regular management briefings. Key business risks are identified, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. In addition, there is an annual control self assessment exercise under which businesses review specific controls and provide certification that these meet the requirements of the Lloyds TSB Group. As in previous years, this exercise was completed for the year ended 31 December 2003. There are well established budgeting and forecasting procedures in place and reports are presented regularly to the board detailing the results of each principal business, variances against budget and prior year, and other performance data. Internal controls contain procedures which assist the board in identifying new and emerging risks.
There has been no change in the Lloyds TSB Group’s internal control over financial reporting that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, the Lloyds TSB Group’s internal control over financial reporting.
For all executive directors, except Mr Fairey, approximately two thirds of their total remuneration is performance related. For Mr Fairey, the performance related element is approximately one half as a result of his pension arrangements outlined on page 81.
The other companies in the comparator group are: Abbey National ABN Amro Alliance & Leicester Aviva Barclays Citigroup Fortis HBOS HSBC Holdings ING Legal & General National Australia Bank Prudential Royal Bank of Scotland Royal & Sun Alliance Standard Chartered
As mentioned above, in 2004 the shareholders will be asked to approve the introduction of a performance share plan. The board is also recommending that, if the performance share plan is approved, the executive share option scheme rules should be amended so that with effect from the options granted in 2005, the maximum limit for the grant of options to an executive director in any one year will be equal to three times annual basic salary, but with no performance multiplier. This is a reduction from the current maximum equal to 1.5 times annual salary multiplied by a performance multiplier of 3.5, which amounts to 5.25 times annual salary in total. The 3 times salary limit may be exceeded but only in exceptional circumstances, for example on the recruitment of a new executive, to a maximum equal to 4 times basic salary.
During 2003, a former executive director received a fee of £35,000, which he retained, for serving as a non-executive director of another company.
Directors’ pensions The executive directors are members of one of the pension schemes provided by the Lloyds TSB Group with benefits either on a defined benefit or defined contribution basis. Those directors who joined the Lloyds TSB Group after 1 June 1989 and are members of a defined benefit scheme, have pensions provided on salary in excess of the earnings cap either through membership of a funded unapproved retirement benefits scheme ('FURBS’) or by an unfunded pension promise.
Mr Targett is a member of a defined contribution scheme. He joined the Lloyds TSB Group on 10 March 2003. The employer has made contributions to the defined contribution scheme in respect of him totalling £54,910.
Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2003 and 2002, respectively (ignoring the two-year requirement to qualify for a deferred pension).
At 31 December Former directors Granted 2003 (or earlier Exercise periods who served during Lapsed during date of leaving Exercise during 2003 At 1 January 2003 the year the year the board) price From To Notes a) Sharesave.
† During the year these share options lapsed, following termination of savings contracts linked to the staff sharesave option scheme, in accordance with the rules of the scheme.
Mr Daniels is the only participant in this plan and holds an option, granted to him on 2 November 2001, to acquire 216,763 ordinary shares in Lloyds TSB Group plc for a total price of £1. The option was granted as part of the remuneration package considered necessary to attract him from the USA and is designed to encourage him to remain with Lloyds TSB Group plc. The option is not subject to any performance condition but will normally become exercisable only if he remains an employee, and has not given notice of resignation, on 31 December 2004. Full details of the plan were set out in the 2002 annual report.
No new shares will be issued to satisfy the option under either of these plans.
Directors had non-beneficial interests as follows: Mr Ayliffe, Mr Daniels, Mr Fairey, Mr Hampton, Mr Kane, Mr Pritchard, Mr Targett and Mr van den Bergh, together with some 80,000 other employees, were potential beneficiaries in the 162,692 and 1,609,602 shares held at the end of the year by the Lloyds TSB qualifying employee share ownership trust and the Lloyds TSB Group employee share ownership trust respectively. 1,721,503 and 1,684,041 shares, respectively, were held by these trusts at the beginning of the year. These holdings were 1,364 and 1,471,150, respectively, on 5 March 2004. In addition, the above directors, with the exception of Mr van den Bergh, together with some 80,000 other employees, were potential participants in the Lloyds TSB Group shareplan and were, therefore, treated as interested in the 2,163,267 shares held at the end of the year by the trustee of the shareplan. No shares were held at the beginning of the year. This holding was 1,849,239 on 5 March 2004.
We report to you our opinion, as to whether the financial statements give a true and fair view and whether the financial statements and the auditable part of the directors’ remuneration report have been properly prepared in accordance with the Companies Act 1985. We also report to you if, in our opinion, the directors’ report is not consistent with the financial statements, if the company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and transactions is not disclosed.
Share of results of joint ventures 21 (22) – (22) (11) (10) Profit on sale of businesses 6 – 865 865 – 39
Intangible fixed assets 24 2,513 2,634 Tangible fixed assets 25 3,918 4,096
The accompanying notes are an integral part of the financial statements. * restated (see note 1)
Profit and loss account 42 6,727 5,091 Shareholders’ funds (equity) 9,624 7,943
Capital and reserves Called-up share capital 41 1,418 1,416 Share premium account 42 1,136 1,093
M A van den Bergh J E Daniels M E Fairey Chairman Group Chief Executive Deputy Group Chief Executive 92 LLOYDS TSB GROUP
Historical cost profits and losses for the year ended 31 December 2003
There has been no effect upon profit before tax in 2003 as a result of this change in policy (2002: increase of £9 million; 2001: increase of £3 million); a prior year adjustment increasing shareholders’ funds at 1 January 2001 by £6 million has been made. The effect upon the Group’s balance sheet at 31 December 2003 has been to reduce total assets by £164 million (2002: £160 million), to reduce accruals by £43 million, to increase deferred tax provisions by £7 million, to reduce shareholders’ funds by £6 million (2002: £3 million) and to reduce long-term assurance liabilities to policyholders by £122 million (2002: £122 million). The effect upon the Company’s balance sheet at 31 December 2003 has been to reduce total assets by £23 million (2002: £18 million) and to reduce shareholders’ funds by an equivalent amount. Comparative figures have been restated.
The consolidated accounts are prepared under the historical cost convention as modified by the revaluation of debt securities and equity shares held for dealing purposes (see g) and assets held in the long-term assurance business (see o), in compliance with Section 255A, Schedule 9 and other requirements of the Companies Act 1985 except as described below (see c), in accordance with applicable accounting standards, pronouncements of the Urgent Issues Task Force and with the Statements of Recommended Practice issued by the British Bankers’ Association and the Finance & Leasing Association. The Group’s methodology for calculating embedded value follows the guidance published by the Association of British Insurers for the preparation of figures using the achieved profits method of accounting except that tangible assets attributable to the shareholder are valued at market value. The guidance would require those assets backing capital requirements to be discounted to reflect the cost of encumbered capital, but such a treatment would be inconsistent with the treatment of capital supporting the Group’s banking operations. If this treatment had been followed income from long-term assurance business before tax in 2003 would have been slightly reduced and embedded value would have been some 8 per cent lower given the size of the shareholder capital required to be retained within Scottish Widows under the terms of the demutualisation.
As a result, the Scottish Widows goodwill is not being amortised through the profit and loss account; however, it is subjected to annual impairment reviews in accordance with Financial Reporting Standard 11, ‘Impairment of Fixed Assets and Goodwill’. Impairment of the goodwill is evaluated by comparing the present value of the expected future cash flows, excluding financing and tax (the ‘value-in-use’), to the carrying value of the underlying net assets and goodwill. If the net assets and goodwill were to exceed the value-in-use, an impairment would be deemed to have occurred and the resulting write-down in the goodwill would be charged to the profit and loss account immediately.
The Group operates a number of defined benefit pension and post-retirement healthcare schemes, and a number of employees are members of defined contribution pension schemes.
Year ended 31December 2003 £m £m £m £m £m £m £m £m £m
Other finance income – – – – 34 34 – 34 Income from long-term assurance business – – 436 436 – – 436 17 453
** The geographical distribution of gross income sources, profit on ordinary activities before tax and assets by domestic and international operations is based on the location of the office recording the transaction, except for lending by the international business booked in London.
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. Following a change in policy in 2002, the auditors are no longer permitted to provide management consultancy services to the Group.
During 2003, the Group revised its procedures for audit committee pre-approval of fees for audit and non-audit services in order to comply with rules issued by the SEC which seek to ensure the independence of the auditors. Certain de minimis limits for non-audit fees have been established, for particular detailed types of service. All non-audit assignments where the fee falls below the relevant limit have been approved in advance by the audit committee. All statutory audit work, and non-audit assignments where the fee is expected to exceed the relevant limit, are subject to individual pre-approval by the audit committee. Since these revised procedures were introduced in April 2003, 62% of the fees incurred by the Group for non-audit services were individually approved in advance by the audit committee. In addition, on a quarterly basis, the audit committee receives a report detailing all pre-approved services and amounts paid to the auditors for such pre-approved services.
5 Amounts written off fixed asset investments 2003 2002 2001 £m £m £m.
• The sale, announced on 23 October 2003 and completed on 1 December 2003, of its subsidiary, NBNZ Holdings Limited, comprising the Group’s New Zealand banking and insurance operations.
The analysis of the profit and loss accounts for comparative periods between continuing and discontinued operations is set out below. Discontinued operations comprise the operations in France, New Zealand and Brazil sold in 2003 and 2001; for further details see note 6.
Interest receivable: – Interest receivable and similar income arising from debt securities 523 44 567 – Other interest receivable and similar income 8,285 1,697 9,982
Associated undertakings and joint ventures (7) 2 1 * restated (see note 1)
†† The weighted average number of shares for the year has been calculated after deducting 8 million (2002: 5 million; 2001: 15 million) ordinary shares representing the Group’s holdings of own shares (note 43).
Geographical analysis by issuer: United Kingdom 336 1,726 Latin America 70 567
Bills sold or matured (24,803) (61) (24,864) Amortisation of premiums and discounts – 59 59
Total loans and advances to banks 15,565 17,530 Provisions for bad and doubtful debts (18) (1)
Lending to customers 125,785 124,655 Hire purchase debtors 4,701 4,342 Equipment leased to customers 6,470 7,300
Other asset backed securities 120 120 1,191 1,191 Other debt securities – – 94 94
Treasury bills and other eligible bills 136 588 Debt securities 4,503 5,651
The Group’s principal investments are in two joint ventures: Group interest Nature of business iPSL 19.5% of issued ordinary share capital Cheque processing Goldfish Holdings Limited 25.0% of issued ordinary share capital Financial services
Depreciation: Exchange and other adjustments – 10 (2) Adjustments on disposal (14) (74) – Charge for the year 65 270 311
Amounts payable in 1 year or less – 1 27 Capital commitments
The embedded value included in the consolidated balance sheet comprises: 2003 2002*
Movements in the embedded value balance have been as follows: 2003 2002*
Development costs. This represents investments in strategic developments primarily relating to Sandler products, depolarisation and e-commerce.
A review of the adequacy of the provision has been carried out at each year end and greater experience has lead to the refinement of the underlying assumptions about the number of cases requiring compensation and the estimated cost per case. The size of the provision has also been affected by periodic revisions to the actuarial guidelines issued by the FSA for the calculation of redress payments and lower stock market values which have resulted in an increase in the cost of restitution into company pension schemes as personal pension fund values and the trustees’ expectations of future returns reduce. These factors have lead to additional provisions being made of £70 million in 2001, £40 million in 2002 and £44 million in 2003.
The eventual cost of providing benefits on the policies written both pre and post demutualisation is dependent upon a large number of variables, including in particular: • future interest rate and equity market trends; •demographic factors, such as future persistency and mortality; and
The principal economic assumptions have been revised at 31December 2003 as follows: Risk-adjusted discount rate (net of tax) 7.60 7.35 Return on equities (gross of tax) 7.45 7.10 Return on fixed interest securities (gross of tax) 4.85 4.50 Expenses inflation 3.80 3.30
•The value of the in-force business does not allow for future premiums under recurring single premium business or non-contractual increments, which are included in new business when the premium is received. Department of Social Security rebates have been treated as recurring single premiums.
As published 6,481 477 Effect of a 1% increase in the discount rate (190) (33) Effect of a 1% reduction in the discount rate 199 31 Effect of a 1% reduction in the return on equities (80) (18)
Investments shown above comprise: Fixed interest securities 15,947 14,779 Stocks, shares and unit trusts 27,590 24,128 Investment properties 3,540 3,623 Other properties 121 121 Mortgages and loans 65 53
A summarised balance sheet on a modified statutory solvency basis was as follows: 2003 2002*
Other differences: Deferred acquisition costs 496 430 Tax adjustment 145 205 Other adjustments (9) (30)
31 Assets and liabilities denominated in foreign currencies 2003 2002* £m £m
Assets: Denominated in sterling 153,775 142,586 Denominated in other currencies 48,159 64,757
Bonds and medium-term notes by residual maturity repayable: 1 year or less 711 437 2 years or less but over 1 year 81 443 5 years or less but over 2 years 1,099 746
Settlement balances 40 49 Other liabilities 1,148 1,323 * restated (see note 1)
Short-term timing differences (229) (357) Accelerated depreciation allowances 1,605 1,670 * restated (see note 1) £m
At 1 January 2003 – as previously reported 1,317 Prior year adjustment (note 1) (4)
At 1 January 2003 – restated 1,313 Exchange and other adjustments 64 Adjustments on acquisitions and disposals (120) Tax provided 119
Deferred tax is recognised in respect of the retained earnings of overseas subsidiaries and associates only to the extent that, at the balance sheet date, dividends have been accrued as receivable or a binding agreement to distribute past earnings in the future has been entered into. Deferred tax balances have not been discounted.
Exchange and other adjustments – (11) – (11) Adjustments on disposal – – (3) (3)
The Group’s general insurance subsidiary maintains provisions for outstanding claims which represent the ultimate cost of settling all claims arising from events which have occurred up to the balance sheet date and these include provisions for the cost of claims notified but not settled and for claims incurred but not yet reported. In addition, in line with the requirements of the Insurance Companies (Reserves) Act 1995, claims equalisation provisions are maintained in relation to property, credit and suretyship business. The majority of provisions in respect of claims will be settled in the following year, although new provisions will then be required in respect of claims arising from that year. The level of the claims equalisation provision will be adjusted annually, taking into account the guidelines contained in the legislation, and such provisions will be held for as long as the Group continues to write the relevant types of general insurance business.
Undated loan capital* Primary Capital Undated Floating Rate Notes: a Series 1 (US$750 million) 419 466 – – Series 2 (US$500 million) 279 311 – – Series 3 (US$600 million) 335 373 – – 113/4% Perpetual Subordinated Bonds 100 100 – – 6.625% Perpetual Capital Securities (c750 million) b 523 482 – – 6.90% Perpetual Capital Securities callable 2007 (US$1,000 million) c 550 610 – – 55/8% Undated Subordinated Step-up Notes callable
Undated Step-up Floating Rate Notes 65/8% Undated Subordinated Step-up Notes callable 2010 f 407 406 – – 6.35% Step-up Perpetual Capital Securities 5.57% Undated Subordinated Step-up Coupon Notes callable 2015 (¥20,000 million) h 104 104 – – 5.125% Undated Subordinated Step-up Notes callable 2016 j 496 – – – 61/2% Undated Subordinated Step-up Notes callable 2019 f 267 267 – – 8% Undated Subordinated Step-up Notes callable 2023 f 199 199 – – 61/2% Undated Subordinated Step-up Notes callable 2029 f 455 455 – – 6% Undated Subordinated Step-up
Subordinated Floating Rate Notes 2020 (c100 million) a 70 65 – –
Dated subordinated liabilities are repayable as follows: Group Group Company Company £m £m £m £m 2 years or less but over 1 year – 505 – – 5 years or less but over 2 years 917 548 249 249 40 Non-equity minority interests
Capital instruments 549 526 European Financial Institution Investments Partnership† 100 123 LM ABS Investment Partnership‡ 34 45 * These securities constitute limited partnership interests in Lloyds TSB Capital 1 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. Non-cumulative income distributions accrue at a fixed rate of 7.375 per cent per annum up to 7 February 2012; thereafter they will accrue at a rate of 2.33 per cent above EURIBOR, to be set annually.
US dollars US$m US$m US$m 160 million Preference shares of US25 cents each 40 40 40
Lloyds TSB Group plc has entered into deeds of covenant with the Lloyds TSB Foundations, under the terms of which the Company makes annual donations to the foundations equal, in total, to 1 per cent of the Group’s pre-tax profits (after certain adjustments) averaged over three years. The deeds of covenant can be cancelled by the Company at nine years’ notice.
Own shares held in relation to employee shares schemes* 22 26 33
In addition, a further 0.4 million ordinary shares were held by Lloyds TSB Group Holdings (Jersey) Limited at 31 December 2003 (2002: 0.4 million; 2001: 0.5 million). These shares, on which the dividend entitlement has been waived, were gifted to the Group some years ago at nil cost and are used to satisfy outstanding options or to meet commitments arising under other employee share schemes. These shares have a market value of £2 million (2002: £2 million; 2001: £4 million).
44 Related party transactions a Transactions, arrangements and agreements involving directors and others
Loans and credit card transactions: Directors and connected persons 6 3,199 4 3,334
The latest full valuations of the schemes were carried out as at 30 June 2002; these have been updated to 31 December 2003 by qualified independent actuaries. The last full valuations of other group schemes were carried out on a number of different dates; these have been updated to 31 December 2003 by qualified independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows.
Expected return on scheme assets 696 817 844 Interest cost of scheme liabilities (662) (652) (537)
Actuarial losses recognised (6) (3,299) (2,873) Deferred tax thereon 2 968 863
Actual return less expected return on scheme assets: Percentage of scheme assets at balance sheet date 7.6% 28.4% 18.1% Experience gains and losses arising on scheme liabilities: Percentage of scheme liabilities at balance sheet date 0.7% 2.0% 0.7% Total amount recognised in the statement of total recognised gains and losses: Percentage of scheme liabilities at balance sheet date 0.0% 27.5% 26.9%
Market value of assets 10,603 9,083 Present value of scheme liabilities (13,658) (12,014)
The movements in the (deficit) surplus in the schemes over the last two years have been as follows: £m £m
Performance bonds and other transaction related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs & Excise bonds and standby letters of credit relating to a particular contract or non-financial transaction) are undertakings where the requirement to make payment under the guarantee depends on the outcome of a future event.
Commitments Documentary credits and other short-term trade-related transactions 368 289 Forward asset purchases and forward deposits placed 546 394 Undrawn note issuing and revolving underwriting facilities – 32 Undrawn formal standby facilities, credit lines and other commitments to lend: – Less than 1 year maturity 62,440 49,417 – 1 year or over maturity 15,981 14,372 47 Derivatives and other financial instruments
Derivatives contracts expose the Group to both market risk and credit risk. Only a few highly specialist trading centres within the Group are permitted to enter into derivative contracts and the level of exposure to interest rate and exchange rate movements and other market variables is strictly controlled and monitored within approved limits.
Interest rate contracts: Interest rate swaps 258,523 5,473 5,808 Forward rate agreements 41,768 35 37 Options purchased 8,248 105 – Options written 4,899 – 152 Futures 18,963 – –
The aggregate carrying value of non-trading derivatives with a positive fair value was an asset of £132 million (2002: an asset of £54 million) and with a negative fair value was a liability of £71 million (2002: a liability of £9 million).
Cumulative interest rate repricing gap (20,584) (18,427) (17,870) 8,511 7,611 – – –
Fair value information is not provided for items that do not meet the definitions of a financial instrument. These items include intangible assets, such as the value of the Group’s branch network, the long-term relationships with depositors and credit card relationships, premises and equipment and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group.
Assets: – Treasury bills and other eligible bills 9 9 530 523 – Loans and advances to banks and customers 3,313 3,313 147,485 148,870 – Debt securities and equity shares 15,351 15,351 13,776 13,885 Liabilities: – Deposits by banks and customers 807 807 139,644 139,695 – Debt securities in issue – – 25,922 26,254 – Subordinated liabilities – – 10,454 11,684
47 Derivatives and other financial instruments (continued) Trading book Trading book Non-trading book Non-trading book Book value Fair value Book value Fair value 31December 2002 £m £m £m £m
Adjustments on acquisition – 2 – Adjustments on disposal (206) – –
e Acquisition of group undertakings and businesses 2003 2002 2001 £m £m £m
Costs in relation to defined contribution schemes are charged to the profit and loss account in the period in which they fall due.
Following the implementation in full of SFAS No. 142 ‘Goodwill and Other Intangible Assets’ on 1 January 2002, goodwill arising on all acquisitions by group and associated undertakings is capitalised but no longer amortised and is subject to regular review for impairment. Prior to the adoption of SFAS No. 142, the Group accounted for goodwill under the provisions of APB No. 17 ‘Intangible Assets’ which required that all goodwill be capitalised and amortised over its estimated useful life, which should not exceed 40 years; the Group amortised goodwill over periods of up to 20 years. Goodwill amortised prior to the adoption of SFAS No. 142 is not permitted to be reinstated.
For acquisitions occurring on or after 1 July 2001, SFAS No. 141 requires that, when assessing the value of the assets of an acquired entity, certain identifiable intangible assets must be recognised. Such identifiable intangible assets include the asset representing the value of customer relationships, which is capitalised separately and amortised through the income statement over the estimated average life of the customer relationships. Prior to 1 July 2001, the Group applied the provisions contained within SFAS No. 72 ‘Accounting for Certain Transactions of Bank and Thrift Institutions’ in assessing the value of assets of an acquired financial institution.
Following the implementation of Statement of Financial Accounting Standards (SFAS) No. 141 ‘Business Combinations’, which supersedes Accounting Principles Board (APB) Opinion No. 16 ‘Business Combinations’, the purchase method must be used for all business combinations initiated after 30 June 2001. For business combinations initiated before 1 July 2001, APB Opinion No. 16 required that a business combination be accounted for as a pooling-of-interests if two previously independent entities combined as a result of one entity issuing common stock in exchange for substantially all the common stock of the second entity. However, whilst the offer may include provisions to distribute cash for fractional shares or shares held by dissenting shareholders, it may not include a pro-rata distribution of cash or other consideration. In addition, no changes in the equity interests of the common stock may be made prior to the pooling in contemplation of the transaction and neither may the ratio of the interest of the individual common stockholder to those of other common stockholders in a combining company change as a result of the exchange of stock.
No cost is recognised for the Group’s Save-As-You-Earn schemes as these are exempt under UITF17. For other share schemes, the difference between the market price and exercise price at the date of grant is charged to the profit and loss account on a systematic basis over the period that the employees are expected to benefit.
Under UK GAAP, trust-preferred securities are treated as equity rather than debt.
Under SFAS No. 52 ‘Foreign Currency Translation’, foreign currency assets and liabilities are translated at the year-end rate; however, results are translated at the average rate for the year.
SOP 03-1 was issued in July 2003 and provides guidance on accounting and reporting by insurance enterprises for certain non-traditional long-duration contracts and for separate accounts. The SOP is effective for financial statements for fiscal years beginning after 15 December 2003, with earlier adoption encouraged. Lloyds TSB Group intends to adopt this SOP prospectively from 1 January 2004 and the SOP may not be applied retrospectively to prior years’ financial statements. Lloyds TSB Group is currently analysing the impact of this SOP but expects that it will require various determinations, such as qualification for separate account treatment, treatment of investments in separate account arrangements not meeting the criteria in this SOP and adjustments to contract holder liabilities, including consideration of certain guarantees.
Profit for the year attributable to shareholders under UK GAAP 3,254 1,790 2,233
– Property depreciation – 4 3 – Share compensation schemes d (113) (44) (46) – Internal software costs (17) 6 16
– Foreign currency translation differences (4) 12 (4) Total banking and Group activities, before tax 33 166 (618) Taxation: – Deferred taxation on GAAP differences i 83 165 296
Policyholder benefits and claims expense 3,036 1,565 2,228 Movement in undistributed earnings to policyholders (100) (1,518) (2,427) Provisions for bad and doubtful debts 887 978 679 Amounts written off fixed asset investments 44 87 60 Total benefits, claims and provisions 3,867 1,112 540 Non-insurance compensation and benefits 2,306 2,418 2,014 Insurance underwriting, operating and acquisition expenses 578 766 511 Other operating expenses 2,619 1,828 2,362
Earnings per share (pence) 57.9p 31.5p 29.5p Diluted earnings per share (pence) 57.7p 31.3p 29.2p * restated (see note 1)
Assets Cash and due from banks 9,364 8,547 Deposits at interest with banks 10,219 11,678 Securities purchased under resale agreements 2,642 1,696 Treasury bills and other eligible bills 530 1,879 Trading account assets 36,627 41,412
Total liabilities and shareholders’ equity 251,158 254,352 * restated (see note 1)
Cash flows from investing activities Change in deposits at interest with banks 1,587 102 (986) Change in securities purchased under resale agreements (946) (313) 3,554 Change in loans and advances to customers (12,342) (11,743) (12,211) Purchases of investment securities (40,763) (47,885) (48,842) Proceeds from sale and maturity of investment securities 39,312 46,880 42,282 Purchases of tangible fixed assets (799) (1,352) (1,140) Proceeds from sale of tangible fixed assets 330 359 293 Additions to interests in joint ventures (12) (21) (44) Acquisition of subsidiary undertakings and businesses (1,106) (117) (180) Disposal of subsidiary undertakings and businesses 2,382 – 40
Change in cash and cash equivalents 817 1,159 910 Cash and cash equivalents at beginning of period 8,547 7,388 6,478
Under UK GAAP on 1 January 1998, the Group adopted FRS 10, ‘Goodwill and Intangible Assets’. In respect of acquisitions since 1 January 1998, goodwill is included in the consolidated balance sheet under intangible fixed assets and amortised over its estimated useful economic life on a straight-line basis. Prior to 1 January 1998, the Group charged goodwill directly against reserves. In the case of the acquisition of Scottish Widows in 2000, in view of the strength of the Scottish Widows brand and the position of the business as one of the leading providers of life, pensions, unit trust and fund management products, the directors consider that it is appropriate to assign an indefinite life to the goodwill. This goodwill is not being amortised through the profit and loss account; however it is subjected to annual impairment reviews in accordance with FRS 11 ‘Impairment of Fixed Assets and Goodwill’. Should any impairment be identified, it would be charged to the profit and loss account immediately.
The treatment of the Group’s major acquisitions is detailed below: Abbey Life
In March 2000, the Group acquired the business of Scottish Widows’ Fund and Life Assurance Society, a life insurance and pensions provider. Under UK and US GAAP, the purchase is treated as an acquisition. However certain differences arise under US GAAP regarding the determination of fair value of the life insurance business, and certain other differences between UK and US GAAP such as the treatment of pensions and own shares, for which adjustments have been made.
In 2002, the unamortised deferred credit of £13 million in respect of negative goodwill was, under the transitional provisions of SFAS No. 141, written off and recognised in the income statement as the effect of a change in accounting principle.
Under US GAAP, all goodwill is capitalised and, up to 31 December 2002, amortised over its estimated useful life. From 1 January 2003, goodwill is no longer amortised but instead subject to impairment testing. Upon disposal of a business or undertaking, the goodwill is included in the calculation of the profit or loss on disposal. Compared to the treatment under UK GAAP, the effect of this is to increase the profits, or reduce the losses, arising on the sale of those businesses before the implementation of FRS 10.
Deposits 8,891 Debt securities in issue 5,108 Long-term debt 206 Other liabilities 1,390 Shareholders’ equity 1,474
Net pension charge (credit) 143 15 (110) Net charge recognised under UK GAAP 286 128 22
Accrued benefit cost, net of intangible asset recognised under US GAAP (2,084) (2,091) Accrued liability recognised under UK GAAP 3,055 2,931
The accumulated benefit obligations for all defined benefit pension schemes were £12,924 million at 31 December 2003 (2002: £11,407 million).
The assets of the pension schemes are invested primarily in equities and fixed interest securities. In accordance with SFAS No. 87, the excess of the plan assets over the projected benefit obligation at the transition date (1 January 1998) is recognised as a reduction to pension expense on a prospective basis over approximately 15 years, which was the average remaining service period of employees expected to receive benefits under the plans.
Following an asset-liability modelling study conducted in 2002, the trustees of Lloyds TSB Group Pension Schemes No’s. 1 and 2 considered the target asset allocation in the table above to be appropriate for the purposes of meeting this long-term objective. In determining this allocation, the trustees had regard to the benefits of diversification, the historical rates of return earned, their expected future returns and the expected short-term volatility of each asset class.
During the period from 1 January 1995 to 31 December 2003 the Group operated the following stock compensation plans: Executive scheme
The Executive share option schemes are long-term incentive schemes and are available to certain senior executives of the Group, with grants usually made annually. Options are granted within limits set by the rules of the schemes. These limits relate to the number of shares under option and the price payable on the exercise of options. From 18 April 2001, the aggregate value of the award based upon the market price at the date of grant must not exceed four times the executive’s annual remuneration and, normally, the limit for the grant of options to an executive in any one year would be equal to 1.5 times annual salary with a maximum performance multiplier of 3.5. Prior to 18 April 2001, the normal limit was equal to one year’s remuneration and no performance multiplier was applied.
In respect of options granted between March 1996 and March 2001, the relevant period for the performance conditions begins at the end of the financial year of the date of grant and will continue until the end of the third financial year following commencement or, if not met, the end of such later year in which the conditions are met. Once the conditions have been satisfied the options will remain exercisable without further conditions. If they are not satisfied by the tenth anniversary of the grant the option will lapse.
The ranges of exercise prices, weighted average fair values and weighted average contractual life for the options granted under the Executive and SAYE schemes outstanding at 31December 2001, 2002 and 2003 are shown in the table below: Executive SAYE Executive SAYE Executive. SAYE.
The weighted average number of anti-dilutive shares excluded from the calculation of diluted earnings per share was 71 million at 31 December 2003 (2002: 17 million; 2001: 9 million).
Available-for-sale investment securities: Securities of the US treasury and US government agencies 1,624 13 (11) 1,626
Amortised unrealised unrealised Carrying cost gains losses value 2002 £m £m £m £m
Deferred tax liabilities Assets used in the business 10 (21) Assets leased to customers 1,593 1,696 Transfers from long-term business fund (see note 9) 110 – Value of business acquired 496 543 Deferred acquisition costs 267 209 Pension profit recognition 50 167
Loan loss allowance (122) (104) Tax losses: – Pensions business (1,353) (1,362)
A deferred tax asset of £315 million (2002: £335 million) has been recognised as a result of the different accounting and tax treatments for goodwill arising upon acquisition of companies and businesses. There is currently no expectation that these businesses will be disposed of and therefore in the opinion of management it is more likely than not that these losses will not be realised. Accordingly, a full valuation allowance has been established against this balance.
Trading losses 1,741 1,340 Capital losses 1,082 786 Pensions business 3,800 3,900
These relate to limited partnerships which have been created with a third party investor to acquire significant capital items which are then leased out to third parties, typically on an operating lease.
These relate to start-up entities which typically have minimal equity investment, with the bulk of the financing provided by the Group in the form of subordinated lending. Without this lending, the entities would not have sufficient capital to finance their activities.
Under US GAAP the value of the long-term assurance business acquired (‘VOBA’) is calculated at acquisition by discounting future earnings to a present value. In subsequent years the VOBA is amortised over the premium recognition period for with-profits life insurance and other protection-type insurance policies using assumptions consistent with those used in computing policyholder benefit provisions. VOBA for investment-type policies and unitised insurance policies is amortised in relation to expected gross profits. Expected gross profits are evaluated regularly against actual experience and revisions made to allow for the effect of any changes.
Balance at 1 January 2,282 3,007 Interest accrued on unamortised balance 255 (108)
Under US GAAP the constituent parts of the shareholder’s and policyholders’ interests in the long-term assurance business are separately disclosed. Significant differences also arise regarding the valuation of the constituent assets and liabilities, which are discussed further in the notes which follow.
Under US GAAP, debt securities are classified as trading, available-for-sale or held-to-maturity; equity shares may only be classified as trading or availablefor -sale. Securities classified as trading are carried at current market value. Securities classified as available-for-sale are carried at current market value, and unrealised gains and losses arising are held as a separate component of shareholders’ equity. Securities classified as held-to-maturity are carried at amortised cost. In addition, US GAAP requires that all freehold and long leasehold properties should be carried at depreciated historic cost.
With-profits policies entitle the policyholder to participate in the surplus within the with-profits life fund of the insurance company which issued the policy. Regular bonuses are determined annually by the issuing company’s Appointed Actuary and its board of directors. The bonuses that may be declared are highly correlated to the overall performance of the underlying assets and liabilities of the fund in which the contracts participate and are the subject of normal variability and volatility. Terminal bonuses are paid on maturity of the contract and are designed to provide policyholders with a share of the total performance of the issuing company during the period of the contract.
Under UK GAAP all amounts in the with-profits fund not yet allocated to policyholders or shareholders are recorded in the liabilities attributable to policyholders on the Group’s balance sheet.
Net cash inflow from returns on investments and servicing of finance 1,812 1,869 1,695 Taxation: – UK corporation tax received 119 79 62 Capital expenditure and financial investment: – Capital lending to subsidiaries – (964) (100) – Repayments of capital lending by subsidiaries – – 100 Net cash outflow from capital expenditure and financial investment – (964) – Equity dividends paid (1,908) (1,903) (1,738)
Trading market for shares The ordinary shares of Lloyds TSB Group plc are listed and traded on the London Stock Exchange under the symbol ‘LLOY.L’. The prices for shares as quoted in the official list of the London Stock Exchange are in pounds sterling. The following table shows the reported high and low closing prices for the ordinary shares on the London Stock Exchange. This information has been extracted from publicly available documents from various sources, including officially prepared materials from the London Stock Exchange, and has not been prepared or independently verified by the Lloyds TSB Group.
Annual prices: Quarterly prices: Fourth quarter 448.00 396.00 Third quarter 483.00 413.75 Second quarter 476.75 326.00 First quarter 459.00 295.75
Lloyds TSB Group plc's American Depositary Receipts (‘ADRs’) have been traded on the over-the-counter market in the US under the symbol ‘LLDTY’ since March 2000. Since 27 November 2001 Lloyds TSB Group plc ADSs have been listed on The New York Stock Exchange under the symbol ‘LYG’. The prices for Lloyds TSB Group plc's ADRs, as quoted below, are in US dollars. Each ADS represents four ordinary shares. The following table shows the reported high and low closing prices for the ADRs in the over-the-counter market in the US.
UK taxation The following discussion is intended only as a general guide to current UK tax legislation, what is understood to be current UK Inland Revenue practice and the terms of the current UK/US income tax treaty (the ‘New Treaty’) and the former UK/US income tax treaty (the ‘Old Treaty’), all of which are subject to change at any time, possibly with retroactive effect.
An individual shareholder or ADS holder who is resident in the UK for tax purposes will be entitled to a tax credit in respect of any dividend received from the Lloyds TSB Group and will be taxable on the gross dividend, which is the aggregate of the dividend received and related tax credit. The value of the tax credit will be equal to one-ninth of the dividend received (and, therefore, 10 per cent of the gross dividend). The gross dividend will be treated as an individual's marginal taxable income. The tax credit will, however, be treated as discharging the individual's liability to income tax in respect of the gross dividend, unless and except to the extent that the gross dividend falls above the threshold for the higher rate of income tax. A UK resident individual shareholder or ADS holder who is liable to income tax at the higher rate (currently 40 per cent) will be subject to tax at the rate applicable to dividends for such shareholders or ADS holders (currently 32.5 per cent) on the gross dividend. The tax credit will be set against but will not fully discharge such shareholders’ or ADS holders’ tax liability on the gross dividend and they will have to pay additional tax equal to 22.5 per cent of the gross dividend, being 25 per cent of the dividend received, to the extent that such sum, when treated as marginal income, falls above the threshold for the higher rate of income tax.
Stamp duty and stamp duty reserve tax UK residents, US holders and other non-UK resident persons
A liability to stamp duty at the fixed rate of £5 will arise as a result of the cancellation of any ADSs with the ordinary shares that they represent being transferred to the ADS holder.
• a trust subject to the control of one or more US persons and the primary supervision of a US court.
The amount of the distribution will equal the US dollar value of the pounds sterling received, calculated by reference to the exchange rate in effect on the date such distribution is received (which, for holders of ADSs, will be the date such distribution is received by the Depositary), whether or not the Depositary or US holder in fact converts any pounds sterling received into US dollars at that time. If the pounds sterling received as a dividend are not converted into US dollars on the date of receipt, then the US holder's tax basis in the pounds sterling received will equal such dollar amount and the US holder may realise an exchange gain or loss on the subsequent conversion into US dollars. Any gains or losses resulting from the conversion of pounds sterling into US dollars will be treated as ordinary income or loss, as the case may be, of the US holder and will be US source.
A US holder may, under the Old Treaty, elect to claim a foreign tax credit in respect of the Tax Credit Amount. A US holder who so elects must include the Tax Credit Amount in income. Under the New Treaty no such election is available on or after 1 May 2003 (or 1 May 2004 in the case of a holder who effectively elects to extend the applicability of the Old Treaty).
The rules relating to foreign tax credits are complex and it is recommended that US holders consult their tax advisors to determine whether and to what extent a foreign tax credit might be available in connection with dividends on the ADSs or ordinary shares.
Any amount withheld under these rules will be creditable against the US holder's federal income tax liability. A US holder who does not provide a correct taxpayer identification number may be subject to certain penalties.
Name of subsidiary undertaking incorporation voting rights held Nature of business Registered office
Lloyds TSB Bank plc England 100% Banking and financial 25 Gresham Street services London EC2V 7HN
Lloyds TSB Bank (Jersey) Jersey 100%* Banking and financial services 25 New Street Limited St. Helier
Lloyds TSB Life Assurance England 100%* Life assurance and other 25 Gresham Street Company Limited financial services London EC2V 7HN
Scottish Widows plc Scotland 100%* Life assurance 69 Morrison Street Edinburgh EH3 8YF
Lloyds TSB Group, as at 31 December 2003, had related party transactions with 6 directors and 30 officers. See Note 44a to the financial statements. The transactions in question were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavourable features.
US dollars per pound sterling: For the years shown the averages of the US dollar Noon Buying Rates per pound sterling on the last day of each month were: US dollars per pound sterling: On 4 March 2004, the latest practicable date, the US dollar Noon Buying Rate was $1.825 = £1.00. Lloyds TSB Group makes no representation that amounts in pounds sterling have been, could have been or could be converted into US dollars at that rate or at any of the above rates.
Properties As at 31 December 2003, Lloyds TSB Group occupied 3,468 properties in the UK. Of these, 730 were held as freeholds, 84 as long-term leaseholds and 2,654 as short-term leaseholds. The majority of these properties are retail branches, widely distributed throughout England, Scotland and Wales. Other buildings include the Lloyds TSB Group's head office in the City of London, and customer service and support properties located to suit business needs, but clustered largely in London, Birmingham, Bristol (in England), Edinburgh (in Scotland) and Cardiff and Newport (in Wales).
Registered office and principal executive offices Lloyds TSB Group plc was incorporated as a public limited company and registered in Scotland under the UK Companies Act 1985 on 21 October 1985 with the registered number 95000. Lloyds TSB Group plc's registered office is Henry Duncan House, 120 George Street, Edinburgh EH2 4LH, and its principal executive offices in the UK are located at 25 Gresham Street, London, EC2V 7HN, telephone number + 44 (0) 20 7626 1500.
Building society A building society is a mutual institution set up to lend money to its members for house purchases. See also ‘Demutualisation’.
Interchange System allowing customers of different Automatic Teller Machine (ATM) operators to use any ATM that is part of the system.
Leasehold Land or property which is rented from the owner for a specified term under a lease. At the expiry of the term the land or property reverts back to the owner.
Share dealing facilities The company provides a range of share dealing facilities for the purchase and sale of Lloyds TSB shares.
A telephone dealing service is available through Lloyds TSB Stockbrokers. The current rate for both purchases and sales is 0.75% minimum £18.50, maximum £75 for transactions up to £75,000. For full details please contact Lloyds TSB Stockbrokers.
Telephone (1) 888 BNY ADRS (US toll free), international callers www.adrbny.com or email shareowners@bankofny.com for details.
The Better Payment Practice Code A copy of the code and information about it may be obtained from the DTI Publications Orderline 0870 1502500, quoting ref URN 04/606. Alternatively, log on to www.payontime.co.uk for details.
Shareholder enquiries The company’s share register is maintained by Lloyds TSB Registrars, The Causeway, Worthing, West Sussex BN99 6DA. Telephone 0870 6003990; textphone 0870 6003950. Please contact them if you have enquiries about your Lloyds TSB shareholding, including those concerning the following matters: • change of name or address • loss of share certificate, dividend warrant or tax voucher • to obtain a form for dividends to be paid directly to your bank or building society account (tax vouchers will still be sent to your registered address unless you request otherwise)