Profit before tax increased by £1,730 million, or 66 per cent, to £4,348 million.
Customer lending and deposits excluding the impact of disposals, customer lending grew by 10 per cent to £135 billion and customer deposits increased by 6 per cent to £116 billion.
Lloyds TSB Registrars’ share of the registration market for FTSE 100 companies in 2003 was 59 per cent
This report comprises the Report and Accounts of Lloyds TSB Group plc for the year ended 31 December 2003 and includes certain financial and other information that the company is required to provide to the Securities and Exchange Commission (‘SEC’) in the United States on Form 20-F. In this report, references to ‘Lloyds TSB Group’ are to Lloyds TSB Group plc and its subsidiary and associated undertakings; references to ‘company’ are to Lloyds TSB Group plc; and references to ‘Lloyds TSB Bank’ are to Lloyds TSB Bank plc.
Lloyds TSB Group publishes its financial statements in pounds sterling (‘sterling’ or ‘£’). The abbreviations ‘£m’ and ‘£bn’ represent millions and thousands of millions of pounds sterling respectively and references to ‘pence’ and ‘p’ are to one-hundredth of one pound sterling. References to ‘US dollars’, ‘US$’ or ‘$’ are to United States (‘US’) dollars. The abbreviations ‘$m’ and ‘$bn’ represent millions and thousands of millions of US dollars respectively and references to ‘cent’ are to one-hundredth of one US dollar. References to ‘euro’ or ‘c’ are to the European single currency and the abbreviations ‘cm’ and ‘cbn’ represent millions and thousands of millions of euros respectively.
We are a market leader in the distribution of household insurance in the UK
Scottish Widows is one of the most strongly capitalised life companies in the UK
Our cost performance reflected good progress in a number of efficiency related initiatives, together with a reduction of some 1,200 in total staffing, after allowing for the acquisition and disposal of businesses. Provisions for bad and doubtful debts reduced by 8 per cent, as a result of lower
charges in the corporate and international businesses. Asset quality across the Lloyds TSB Group remains strong and total non-performing lending reduced by 14 per cent during the year, partly as a result of business disposals. Our return on equity, excluding disposal gains, investment variance and changes in economic assumptions, was 27.4 per cent.
In 2003, the management team set a series of priorities to guide the Lloyds TSB Group and provide a framework to build the franchise. The three key themes are: • to actively manage the portfolio of businesses and to reduce risk and earnings volatility,
During the year, we reviewed the strategic options for a number of our businesses. The criteria used in our evaluation process were the strategic fit with the Lloyds TSB Group and the prospects for long-term economic profit growth. As a result of the review, we sold The National Bank of New Zealand, substantially all of our businesses in Brazil and our French operations. We have also announced the sale of our Central American businesses, pending approval from the regulatory authorities. Our emerging markets debt portfolio, which totalled £1.1 billion at the end of 2002, was also sold. We have removed significant earnings volatility and are now more focused on our core franchises, and are confident the quality of our future earnings will improve.
The community and our business As one of the UK’s leading financial services companies, Lloyds TSB believes that business success should go hand-in-hand with corporate citizenship. This commitment is demonstrated by our position as one of the UK’s largest corporate givers; our awardwinning policies in the fields of employee relations, training and development, diversity and financial inclusion; as well as our role in leading innovation in the management of change and environmental risk. However, our commitment also involves the day-to-day business of listening to and serving all our stakeholders, because good corporate citizenship is an essential part of building a successful business.
At 31 December 2003 total Lloyds TSB Group assets were £252 billion and Lloyds TSB Group had over 71,500 employees. Lloyds TSB Group plc’s market capitalisation at that date was some £25.1 billion. The profit on ordinary activities before tax for the 12 months to 31 December 2003 was £4,348 million and the risk asset ratios as at that date were 11.3 per cent for total capital and 9.5 per cent for tier 1 capital.
In an increasingly competitive financial services market, and with customers able to exercise choice amongst alternative providers, shareholder value creation is closely linked to customer value creation. Shareholder value can only be created by attracting and retaining customers and winning a greater share of their financial services business. This requires a focus on strategies which create the most value for customers, and convert more of that value into business value. Across its main businesses, Lloyds TSB Group has strong core banking franchises, but smaller market shares in associated product areas. The Lloyds TSB Group’s strategy is focused on being differentiated in the creation of customer value to win a bigger share of our customers’ total financial services spend.
Lloyds TSB Group continues to develop new strategies to leverage the strength of its brands and its multi-channel distribution capability, its enhanced understanding of what its customers want and its cost advantage to deliver greater value to customers.
Businesses and activities Lloyds TSB Group’s activities are organised into three businesses: UK Retail Banking and Mortgages, Insurance and Investments, and Wholesale and International Banking. The main activities of Lloyds TSB Group’s three businesses are described below.
Services provided by UK Retail Banking and Mortgages encompass the provision of banking and other financial services, private banking, stockbroking and mortgages to personal customers. During 2003 services were provided to some 15 million customers through a wide range of products and channels and with over 2,200 branches of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester at the end of 2003, Lloyds TSB Group provides widereaching geographic branch coverage in England, Scotland and Wales. The profit before tax of UK Retail Banking and Mortgages in 2003 was
Cash machines. Lloyds TSB Group has one of the largest cash machine networks of any leading banking group in the UK and, at 31 December 2003, personal customers of Lloyds TSB Bank were able to withdraw cash and check balances through some 4,200 ATMs at branches and external locations around the country. In addition, they have access to some further 43,000 cash machines via LINK in the UK and to cash machines worldwide through the VISA and MasterCard networks.
Mortgages. Cheltenham & Gloucester is Lloyds TSB Group’s specialist residential mortgage provider, offering a range of mortgage products to personal customers through its own branches and those of Lloyds TSB Bank in England and Wales, as well as through the telephone, internet and postal service, C&G TeleDirect. Lloyds TSB Group also provides mortgages through Lloyds TSB Scotland and Scottish Widows Bank. Lloyds TSB Group is the third largest residential mortgage lender in the UK on the basis of outstanding balances, with mortgages outstanding at 31 December 2003 of £70.8 billion, representing a market share of 9.2 per cent.
With-profits life and pensions products are written from the With-Profits sub-fund. The benefits accruing from these policies are designed to provide a smoothed return to policyholders who hold their policies to maturity through a mix of annual and final (or terminal) bonuses added to guaranteed basic benefits. The guarantees generally only apply on death or maturity. The actual bonuses declared will reflect the experience of the With-Profits sub-fund.
Scottish Widows Investment Partnership. Scottish Widows Investment Partnership manages funds for Lloyds TSB Group’s retail life, pensions and investment products. Clients also include corporate pension schemes, local authorities and other institutions in the UK and overseas. At 31 December 2003 funds under management amounted to some £77 billion.
The Americas. Following the disposal of substantially all of its Brazilian operations, the Lloyds TSB Group continues to have offices in Argentina, Colombia, Ecuador, Paraguay and Uruguay; the sales of branches in Guatemala, Honduras and Panama are expected to be completed in 2004 after receipt of the required regulatory approvals. In addition Lloyds TSB Group has private banking and investment operations in the US. In Argentina, where Lloyds TSB Bank has 36 branches, and Colombia, where Lloyds TSB Bank’s subsidiary Lloyds TSB Bank S.A. has 17 branches, Lloyds TSB Group provides corporate banking services, including trade finance, working capital loans, import finance, term deposits and money transmission. It also provides retail banking services through a network of branches, including current and savings accounts, credit cards, personal loans and mortgages.
Employees At 31 December 2003, Lloyds TSB Group employed 71,609 people (full-time equivalent), compared with 79,537 at 31 December 2002; the reduction in staff numbers during the year is largely as a result of the disposal of the Lloyds TSB Group’s businesses in New Zealand, France and Brazil. At 31 December 2003, 68,017 employees were located in the UK, 2,327 in the Americas, 962 in continental Europe and 303 in the rest of the world.
Globalisation and developments in technology continue to expand Lloyds TSB Group’s range of competitors. The rising intensity of competition is expected to put Lloyds TSB Group’s margins under further pressure with many products becoming increasingly commoditised. Wholesale markets are integrating more rapidly across the European Union than their retail counterparts, leading to a deeper, more liquid, and more competitive corporate securities market, and the gradual disintermediation of traditional bank lending.
On 14 March 2002, the Competition Commission’s report into the competitiveness of banking for small and medium-sized enterprises (SMEs) was published by the government. The Competition Commission concluded that a number of specific practices had the effect of restricting or distorting price competition between the main banks. The government has accepted in full the recommendations made by the Competition Commission, which include a requirement that banks should offer any SME customer either a current account that pays interest of at least the Bank of England Base Rate minus 2.5 per cent, or a current account free of money transmission charges, or a choice between the two. The principal behavioural remedies intended to reduce barriers to entry and expansion are measures to ensure fast error-free switching of accounts between banks. In addition, measures have been proposed limiting the bundling of services and improving market information and transparency.
• The Pickering Review of Pensions, published in July 2002, which focused on the simplification of the pensions framework. Core recommendations included a new Pensions Act to consolidate all existing pensions legislation; a new, more pro-active regulator; a more targeted approach to communicating with pension scheme members; and allowing employers to make membership of their occupational pension schemes a condition of employment.
Lloyds TSB Group also operates in other countries where it is exposed to different competitive pressures. During 2003, Lloyds TSB Group sold its businesses in New Zealand and substantially all of its business in Brazil; the disposals of its operations in Guatemala, Honduras and Panama are pending regulatory approvals. As a result of these disposals Lloyds TSB Group has significantly reduced its exposure to businesses outside the UK.
Lloyds TSB Group’s businesses are inherently subject to the risk of market fluctuations. The most significant market risks Lloyds TSB Group faces are interest rate risk and foreign exchange risk in its banking businesses and equity risk and matters arising from the treatment of with-profits options and guarantees in its insurance businesses. See ‘Operating and financial review and prospects – Risk management – Market risk’, ‘Operating and financial review and prospects – Risk management – Insurance risk’ and ‘Operating and financial review and prospects – With-profits options and guarantees’ for a discussion of these risks. The Lloyds TSB Group’s pension schemes are also subject to market risks, principally equity risk and interest rate risk; adverse market movements would have an effect upon the financial condition of the pension schemes which would be reflected in the Lloyds TSB Group’s financial statements.
Lloyds TSB Group’s insurance businesses are subject to inherent risks relating to changing demographic developments, adverse weather and similar contingencies outside its control. Development of adverse conditions could reduce profitability.
Lloyds TSB Group’s insurance businesses are subject to inherent risk relating to changing demographic developments, adverse weather and similar contingencies outside its control, both in the UK and overseas. Such contingencies can change the risk profile and profitability of such products and services.
Lloyds TSB Group runs the risk of misselling financial products, acting in breach of regulatory requirements and giving negligent advice, any of which could have a negative impact on its results or its relations with its customers.
Some of these issues involve the possibility of alleged misselling of pension and other life assurance policies, savings and other products. There is a risk that further provisions may be required as a result of these issues. See ‘Operating and financial review and prospects – Customer remediation payments’.
Lloyds TSB Group’s businesses are conducted in highly competitive environments. Creation of an appropriate return for shareholders depends upon management’s ability to respond effectively to competitive pressures.
Lloyds TSB Group is devoting considerable time and resources to securing new customers and developing more business from existing customers. If Lloyds TSB Group is unsuccessful, its organic growth prospects will decline.
Changes in net interest income – volume and rate analysis 41
Overview and trend information Lloyds TSB Group has operations in both the UK and overseas, however, its earnings are heavily dependent upon its domestic activities. In 2003, 81 per cent of Lloyds TSB Group’s operating profit was derived from its UK operations and, following the disposal in the second half of the year of its operations in New Zealand and substantially all of its business in Brazil, this proportion is likely to increase in 2004 and beyond. The state of the UK economy, therefore, has significant implications for the way in which the Lloyds TSB Group runs its business and its performance.
Exposure to the equity market continues to have a significant effect upon the Lloyds TSB Group’s insurance and investment businesses. Although the recovery in stock market values during 2003 has resulted in an increase in the value of the investments held to support the long-term assurance funds, partially reversing the losses of earlier years, consumer confidence in long-term savings products remains weak and sales, particularly through the branch network, continue to be subdued. Steps have been taken to reduce Lloyds TSB Group’s exposure to reductions in equity market levels; however, the future performance of this business is, to a certain extent, dependent upon a further recovery in these markets.
The Lloyds TSB Group also maintains a general provision to cover latent bad and doubtful debts which are present in any portfolio of advances but which have not been specifically identified; at 31December 2003, the general provision amounted to £382 million. The calculation of the general provision requires a significant amount of judgement to assess the level of losses inherent in the portfolio and is based upon factors such as the level of watchlist or potential problem debt, the propensity for such debt to become impaired and historic loss rates. The general provision is allocated to business units which are responsible for reviewing the balance on a regular basis to ensure that it remains appropriate in prevailing economic conditions and in the light of the perceived level of credit risk within their lending portfolios.
Profit on ordinary activities before tax 4,348 2,618 3,167 Tax on profit on ordinary activities (1,025) (766) (877)
In 2003, Lloyds TSB Group’s profit before tax increased by £1,730 million, or 66 per cent, to £4,348 million from £2,618 million in 2002; this increase in profitability largely reflects net gains of £865 million recognised in 2003 following the disposal of a number of businesses and a £934 million improvement in the return from the assets supporting the long-term assurance funds. Profit attributable to shareholders was 82 per cent higher at £3,254 million and earnings per share increased by 82 per cent to 58.3p. Shareholders’ equity increased by £1,681 million to £9,624 million. The post-tax return on average shareholders’ equity was 38.5 per cent, compared to 16.8 per cent in 2002. Economic profit increased by £1,663 million to £2,493 million; see ‘Operating and financial review and prospects – Economic profit’. The post-tax return on average assets was 1.57 per cent, and the post-tax return on average risk-weighted assets was 2.63 per cent.
General insurance claims increased by £7 million to £236 million, as the effect of the increase in the size of the portfolio was offset by the beneficial effect of generally mild weather conditions.
Total income was £1 million lower at £8,887 million, compared to £8,888 million in 2001. Lloyds TSB Group’s net interest income increased by £249 million, or 5 per cent, to £5,171 million. Average interest-earning assets increased by £16,873 million, or 12 per cent, to £161,818 million, adding £655 million to net interest income. In the UK, average personal lending and mortgage balances increased by £6,737 million driven by the strong residential
housing market and the low interest rate environment; wholesale balances were £7,190 million higher with increased corporate term and money market lending and a number of new structured finance transactions. Average balances overseas increased by £3,215 million, with the majority of the growth being in New Zealand reflecting a strengthening exchange rate and increased mortgage and agricultural lending. The effect of this volume growth was partly offset by a 20 basis point fall in the net interest margin, reducing net interest income by £290 million, reflecting the reduced benefits accruing from the Lloyds TSB Group’s low interest and interest-free liabilities and a change in mix toward finer margin products. Adverse exchange movements reduced net interest income by £116 million.
Net interest income £m 4,556 4,425 4,202 Average interest-earning assets £m 146,700 134,902 121,244 Average rates: – Gross yield on interest-earning assets %1 5.79 6.10 7.38
Net interest income £m 699 746 720 Average interest-earning assets £m 26,196 26,916 23,701 Average rates: – Gross yield on interest-earning assets %1 6.33 8.63 10.19 1 Gross yield is the rate of interest earned on average interest-earning assets.
Net interest income from international operations decreased by £47 million, or 6 per cent, to £699 million, representing 13 per cent of consolidated net interest income. In sterling terms, average interest-earning assets fell by £720 million, or 3 per cent, to £26,196 million, reducing net interest income by £79 million. Balances in Latin America fell by £765 million as the Lloyds TSB Group has sought to reduce its exposure to this region and wholesale balances, principally in the US, fell by £456 million as growth in local currency terms was more than offset by movements in exchange rates. The reclassification to trading assets and subsequent disposal of the Lloyds TSB Group’s portfolio of emerging markets debt securities reduced average interest-earning assets by £1,207 million. This more than offset an increase in average balances in New Zealand of £1,974 million mainly reflecting positive exchange rate movements.
The net interest margin from international operations reduced by 10 basis points, leading to a fall of £27 million in net interest income largely as a result of the sale of the relatively higher margin portfolio of emerging markets debt securities.
Net interest income from international operations increased by £26 million, or 4 per cent, to £746 million, representing 14 per cent of consolidated net interest income. In sterling terms, average interest-earning assets increased by £3,215 million, or 14 per cent, to £26,916 million, adding £206 million to net interest income. Average balances in New Zealand increased by £2,420 million reflecting both organic growth and positive exchange rate movements; growth in US structured finance and government guaranteed export credit transactions increased average interest-earning assets by a further £1,277 million. Balances in Latin America fell by £841 million as modest growth in local currency terms, principally in the Brazilian consumer finance business, was more than offset by the effect of exchange rate movements.
The net interest margin from international operations reduced by 27 basis points, leading to a fall of £64 million in net interest income, as a result of lower margins in the Lloyds TSB Group’s Latin American and US structured finance businesses which more than offset an improved margin in New Zealand.
Income from long-term assurance business 453 (294) (30) General insurance premium income 535 486 428 Other operating income 694 763 708 * Figures for 2002 and 2001 have been restated to reflect changes in accounting policy adopted in 2003; for further details see note 1 to the financial statements.
Insurance broking commission income decreased by £43 million as a result of a £75 million fall in income from creditor insurance, reflecting a reduction in the level of sales achieved through the branch network and an increase in the allowance of £35 million in respect of the clawback of commissions relating to personal loans which are being settled early, which more than offset a £55 million increase in retrospective commissions. International fees and commissions reduced by £11 million mainly due to the disposal of the Lloyds TSB Group’s businesses in France and lower fund management fees in other locations.
Fees and commissions payable increased by £43 million, or 7 per cent, compared to 2001 as a result of higher reciprocity fees and an increase in package costs relating to a number of products. Commissions paid to motor dealers by the asset finance business also increased, in line with business volumes.
Premises and equipment: – Rent and rates 281 280 261 – Hire of equipment 18 18 18 – Repairs and maintenance 127 131 115
Amortisation of goodwill 51 59 39 * Figures for 2002 and 2001 have been restated to reflect changes in accounting policy adopted in 2003; for further details see note 1 to the financial statements.
Total operating expenses increased by £260 million, or 5 per cent, to £5,173 million; of this total, businesses disposed of during 2003 accounted for £272 million. The impact of acquisitions made in 2002 increased operating expenses during 2003 by £110 million, and there was a £200 million provision for customer redress.
Total operating expenses increased by £144 million, or 3 per cent, to £4,913 million compared to £4,769 million in 2001; acquisitions added £105 million to costs in 2002.
Administrative expenses of £4,212 million in 2002 were £7 million lower than in 2001. Staff costs reduced by £32 million or 1 per cent. Salaries and profit sharing were £18 million lower as the impact of the annual pay review and the effect of acquisitions during the year were more than offset by the effect of an underlying reduction of 4,191 staff (full time equivalent) and lower levels of accruals for bonuses and profit related payments. Pension costs were £29 million lower as an increased current service cost, reflecting the impact of changes in the mortality assumptions made at the end of 2001, and higher costs relating to staff taking early retirement, were more than offset by the non-repetition of costs of £82 million incurred in 2001 in relation to benefit improvements. Severance costs were £36 million higher at £105 million, but other staff costs were £15 million lower, reflecting a £22 million reduction in agency staff costs.
Premises and equipment costs were £26 million, or 5 per cent, higher as a result of higher rental costs on branch and head office premises, in part reflecting the sale and leaseback of a number of properties in 2001, and increased repairs and maintenance expenditure reflecting costs incurred in advance of vacating a number of central properties. This was partly offset by a reduction in other premises and equipment costs.
The total charge for bad and doubtful debts decreased by £79 million, or 8 per cent, to £950 million; businesses disposed of during 2003 accounted for £63 million of this charge. In UK Retail Banking and Mortgages the provisions charge increased to £594 million from £496 million in 2002. The charge within UK Retail Banking increased by £115 million mainly due to an increase in the provisions required against the personal loan and credit card portfolios. This is largely attributable to the growth in the size of these portfolios although there has also been some deterioration in arrears levels and an increase in fraud related losses within the personal lending portfolio. There was a net release from the provisions held against the mortgages portfolio of £18 million compared to a net release of £1 million in 2002, reflecting an improved arrears position and an increase in the value of the property held as security.
The Group’s charge for bad and doubtful debts as a percentage of average lending decreased to 0.66 per cent, compared to 0.77 per cent in 2002.
The rate of tax is influenced by the geographic and business mix of profits. In the absence of special factors, Lloyds TSB Group does not expect the tax rate to vary significantly from the average UK corporation tax rate.
The effective rate of tax in 2003 was 23.6 per cent, compared to an effective rate of tax of 29.3 per cent in 2002 and the corporation tax rate in 2003 of 30 per cent. The lower effective rate of tax in 2003 was primarily due to the gain on disposal of The National Bank of New Zealand, which was exempt from taxation and a reduction in the non-allowable element of foreign taxes paid creditable against the UK corporation tax charge. This was partly offset by the withdrawal of tax relief on payments to the Lloyds TSB Group qualifying share ownership trust (‘QUEST’) to satisfy Save As You Earn options. See note 9 to the financial statements.
Management changes its estimates of the cost of equity only to reflect significant changes in long-term interest rates and other external market factors which are considered sustainable. The principal factor in estimating the cost of equity is sustainable long-term interest rates. If long-term interest rates increase, management will consider raising its estimate of the cost of equity; if long-term interest rates fall, management will consider reducing its estimate of the cost
of equity. The principal other external market factors considered are equity risk premium and Lloyds TSB Group’s share price volatility relative to the UK stock market as a whole. Any change to the estimated cost of equity will be disclosed. For the last three years, management has used a cost of equity of 9 per cent to reflect the shareholders’ minimum required rate of return on equity invested.
* Figures for 2002 and 2001 have been restated to reflect changes in accounting policy adopted in 2003; for further details see note 1 to the financial statements.
Economic profit increased by £1,663 million from £830 million in 2002 to £2,493 million in 2003. Profit attributable to shareholders increased by £1,464 million, or 82 per cent, to £3,254 million; the notional charge on average equity was £199 million lower, as a result of a 21 per cent reduction in average equity to £8,460 million from £10,672 million in 2002.
UK Retail Banking and Mortgages 1,021 1,008 1,064 Insurance and Investments 1,094 1,230 1,424 Wholesale and International Banking 2,195 1,264 1,452 Central group items (65) 4 87
The UK retail businesses of Lloyds TSB Group provide banking and financial services to personal customers, private banking and stockbroking. Lloyds TSB Group’s UK mortgage business is conducted through Cheltenham & Gloucester, Lloyds TSB Bank, Lloyds TSB Scotland, Scottish Widows Bank and C&G TeleDirect.
Profit before tax from UK Retail Banking and Mortgages increased by £13 million, or 1 per cent, to £1,021 million, compared to £1,008 million in 2002. The results in 2003 have been adversely affected by a £200 million provision for remediation payments to customers in respect of past sales of mortgage endowment and long-term savings products, principally the Extra Income & Growth Plan. Adjusting for this provision there was a £213 million or 21 per cent growth in profit.
Profit before tax from UK Retail Banking and Mortgages decreased by £56 million, or 5 per cent, to £1,008 million, compared with £1,064 million in 2001.
Other income decreased by £74 million, or 8 per cent, to £837 million. There was an improvement in income earned from credit and debit cards, and increased income from added value current accounts, but this was offset by a higher level of fees and commissions payable and a reduction of £57 million in profits from the sale and leaseback of premises, as the Lloyds TSB Group’s strategy of converting much of its branch portfolio from freehold tenure to leasehold is almost complete.
Provisions for bad and doubtful debts were £139 million, or 39 per cent, higher at £496 million, compared to £357 million in 2001, as a result of volume related asset growth in the personal loan and credit card portfolios and a lower level of recoveries and releases following the non-recurrence of the release of surplus provisions of £72 million in 2001. Excluding these provision releases, the charge as a percentage of average lending for personal loans and overdrafts decreased to 3.73 per cent from 3.88 per cent in 2001, and the charge in the credit card portfolio decreased to 3.52 per cent from 3.60 per cent in 2001. Overall the arrears position remained stable.
Lloyds TSB Group’s insurance and investments activities comprise the life, pensions and unit trust businesses of Scottish Widows and Abbey Life, general insurance underwriting and broking, and Scottish Widows Investment Partnership.
Total income was £205 million, or 11 per cent lower, at £1,734 million as a £212 million fall in other income more than offset a modest improvement in net interest income of £7 million. Other income was £1,653 million compared to £1,865 million in 2002. Income from long-term assurance business, excluding the effects of changes in economic assumptions and the investment variance, was £177 million lower. Income from existing business was lower as the benefit from experience variances and actuarial assumption changes reduced by £168 million, reflecting updated assumptions in respect of staff costs to support existing business and benefits recognised in 2002 from changes in the assumed shareholder tax rate and from the valuation of unmodelled products which have not been repeated; the expected return reduced by £48 million reflecting a reduction in the value of business in-force and a lower discount rate. There was also a reduction of £61 million in normalised investment earnings reflecting lower market rates of return. This has been partly offset by a £105 million reduction in provisions for customer redress. See ‘Operating and financial review and prospects – Customer remediation payments’.
Operating expenses decreased by £76 million, or 16 per cent, to £404 million. There was a £42 million reduction in the costs related to the restructuring of the Scottish Widows business and the increased proportion of overall sales represented by life and pensions products has resulted in more of the cost base being accounted for within embedded value income. These factors have more than offset the effect of an increase in costs within the general insurance business to support expansion.
Net interest income was £6 million, or 8 per cent, lower at £74 million, compared to £80 million in 2001, largely reflecting the impact of lower interest rates on the cash balances held in the general insurance business.
Other income was £141 million, or 7 per cent, lower at £1,865 million, compared to £2,006 million in 2001. Income from the long-term assurance businesses, excluding the effects of changes in economic assumptions and the investment variance, was £245 million lower. New business income was £40 million higher, as a result of sales growth, but this was partly offset by a £28 million increase in distribution costs. The expected return on existing business reduced by £34 million, partly reflecting the lower average value of in-force business caused by the fall in the stock market in 2001, and investment earnings were £33 million lower, as a result of the reduction in the value of the investments supporting the long-term assurance funds. Following a review carried out in conjunction with the Financial Services Authority into past sales made by the Abbey Life sales force, a provision of £165 million was established in 2002 for the estimated cost of redress due to customers. In addition a further provision of £40 million was made in respect of compensation payable to past purchasers of pension policies, compared to £70 million in 2001. There was a reduction of £55 million in benefits from experience variances and actuarial assumption changes, largely reflecting the implementation of revised mortality assumptions which resulted in a one-off charge of £57 million. Fee income from the unit trust and asset management businesses fell by £59 million, reflecting the continued fall in the level of stock markets during 2002. This more than offset an increase in premium income from general insurance underwriting which was £58 million higher, as a result of strong growth in home products; commissions from insurance broking were £119 million higher, with continued growth in creditor insurance products.
Abbey Life’s operating profit increased by £1 million to £93 million. Profits from existing business were largely unchanged. A £6 million improvement in the benefit from experience variances and actuarial assumption changes offset a reduction in income from investments.
Lloyds TSB Group accounts for the value of the shareholder’s interest in the long-term assurance business using the embedded value basis of accounting. The embedded value comprises the net tangible assets of the life assurance subsidiaries and the present value of the in-force business. The present value of the in-force business is calculated by projecting future surpluses and other net cash flows attributable to the shareholder and discounting the result at a rate which reflects the shareholder’s overall risk premium.
In accordance with generally accepted accounting practice in the UK, it is Lloyds TSB Group’s accounting policy to carry the investments comprising the reserves held by its life companies at market value. The reserves held to support the with-profits business of Scottish Widows are substantial and changes in market values cause significant volatility in the Group’s embedded value earnings, which are beyond the control of management. Consequently, in order to provide a clearer representation of the underlying performance, the results of the life and pensions business are separately analysed to show an operating profit including investment earnings calculated using longer-term investment rates of return, and annual management charges based on unsmoothed fund values. The investment variance represents the difference between the actual investment return in the year on investments backing shareholder funds and the expected return based upon the economic assumptions made at the beginning of the year, and the effect of these fluctuations on the value of in-force business. The effects of other changes in economic circumstances beyond the control of management are also reflected in the investment variance. A similar approach has been adopted for Lloyds TSB Group’s general insurance business.
The operating profit of the life, pensions and unit trust businesses is analysed in the following table. The basis of this analysis is as follows: The life and pensions results are split into five elements: • New business income: this represents the value recognised at the end of each financial year from the new business written during that year after taking into account the cost of establishing technical provisions and reserves. This is shown before the significant costs of acquiring that new business, which are shown separately as ‘Distribution costs’.
Operating profit of life, pensions and unit trusts 372 477 763
The operating profit of the life, pensions and unit trust businesses in 2003 fell by £105 million to £372 million.
the increase in the proportion of sales made through the comparatively more expensive independent financial advisor (‘IFA’) channel and also the higher levels of commission payable on sales of the more profitable products.
Unit trust sales were £132.7 million, or 12 per cent, lower at £948.3 million compared to £1,081.0 million in 2002 as consumers continue to view investments in equity-based products with caution.
Normalised investment earnings fell by £61 million, or 29 per cent, to £153 million from £214 million in 2002 reflecting a reduction in the expected rates of return in the low interest rate environment in the UK.
Unit trust profits were £17 million compared to £3 million in 2002. Income in the unit trust business is derived from both initial charges at the point of sale and annual management fees which are calculated as a percentage of the unit trust funds. During 2003 overall unit trust income fell by 23 per cent broadly in line with the reduction in weighted average sales, which were 24 per cent lower. However, new business income only fell by 10 per cent as a result of a shift in the mix of business towards higher margin products with the remainder of the reduction reflecting lower annual management charges as the depressed stock markets have caused fund values to reduce. Unit trust distribution costs have fallen by 39 per cent as a result of the fall in sales volumes and the absence of restructuring related costs in 2003.
Single premium sales were £348.0 million, or 13 per cent, higher at £3,089.0 million, compared to £2,741.0 million in 2001. Sales of single premium life products were £152.4 million lower, reflecting reduced sales of investment bond products which had been affected by low stock market levels and adverse press comment. Annuity sales, however, were £158.4 million higher; Scottish Widows had improved their position in the annuity market by maintaining rates, in the face of competitor reductions, and through the launch of a number of new products. Single premium pension sales increased by £342.0 million, benefiting from an increase in Department of Social Security rebates.
The following table shows premium income from underwriting and commission income from insurance broking.
Premium income from underwriting: Commissions from insurance broking: Profit before tax 733 693 605 2003 compared to 2002
The operating profit, calculated as explained under ‘Operating and financial review and prospects – Line of business information – Summary’ from general insurance was £720 million, a reduction of £33 million, or 4 per cent, compared to 2002. This comprised a profit of £219 million from the general insurance underwriting operations and £501 million from the broking operations.
The operating profit of the underwriting business, at £198 million, was down £16 million, or 7 per cent, from £214 million in 2001. Premium income increased by £58 million, or 14 per cent, to £486 million, principally driven by a £69 million increase in income from home protection products reflecting the strength of the housing market in the UK and success in cross-selling home insurance products to mortgage customers. Creditor insurance premiums were £3 million lower, due to the continuing impact of the outsourcing of the card protection book in 2000. Reinsurance premiums payable have increased by £7 million to £15 million, following a decision to mitigate the risks on policies with large sums assured.
The profit before tax of Wholesale and International Banking increased by £931 million to £2,195 million including a profit on the disposal of businesses in New Zealand, Brazil and France of £865 million. If this gain is excluded there was an underlying improvement in profit of £66 million to £1,330 million; of this amount the businesses which have now been disposed of contributed £318 million compared to £279 million in 2002.
Operating expenses increased by £115 million or 5 per cent. In Wholesale there was an increase of £121 million; the inclusion of the Dutton-Forshaw Group accounted for £44 million of this increase. Within Corporate Banking there was a £39 million increase in costs. 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 operating lease assets and there were higher staff and risk management costs, although this was partly offset by lower reorganisation costs. There were smaller increases in other areas of Wholesale principally relating to staff and consultancy costs to support a number of major projects. In International Banking operating expenses reduced by £6 million as higher costs in Brazil and New Zealand, mainly reflecting exchange rate movements, have been offset by lower costs in the European operations following the disposal of the Lloyds TSB Group’s businesses in France.
Total income increased by £255 million, or 7 per cent, to £4,046 million. Excluding the impact of acquisitions, total income was £154 million, or 4 per cent, higher. Net interest income was £99 million higher at £2,458 million. Growth in interest-earning assets more than offset a 24 basis point reduction in the net interest margin and the effect of adverse exchange rate movements, which reduced net interest income by £116 million.
(Loss) profit before tax (65) 4 87 2003 compared to 2002
Other finance income at £165 million was £142 million, or 46 per cent, lower than in 2001, as a result of a reduced expected return on the pension scheme assets following the fall in their value during 2001, together with an increased charge in respect of the unwinding of the discount on the scheme liabilities. Costs of £82 million in 2001 in respect of benefit augmentations in the Lloyds TSB Group’s main pension schemes were not repeated in 2002.
The IASB’s proposals in the area of insurance accounting are also likely to have an effect upon the Lloyds TSB Group’s financial statements. An exposure draft has been issued setting out a limited revision to the accounting framework pending the completion of a more wide-ranging review, which is not expected to be before 2007. The requirements in the exposure draft will result in some products, which are currently accounted for as insurance using the embedded value basis of accounting, being accounted for as financial instruments. The IASB is still considering the responses that it has received to the exposure draft and the eventual requirements of the resulting IFRS remain uncertain.
Average balance sheet and net interest income The following average balance sheet excludes the long-term assurance business assets and liabilities attributable to policyholders. The interest yields and costs for foreign office assets and liabilities are affected by Lloyds TSB Group’s operations in Latin America. The countries in which Lloyds TSB Group operates are periodically subject to comparatively high rates of interest, which in certain instances in the tables below has had the effect of producing unusually high yields and costs.
Assets Treasury bills and other eligible bills: Loans and advances to banks: Loans and advances to customers: Debt securities: Lease and hire purchase receivables: Total interest-earning assets of
Percentage of assets applicable to foreign activities (%) 13.8 14.8 14.3
Average Average Average interest Net Net interest Net Net interest Net Net earning interest interest earning interest interest earning interest interest assets income margin assets income margin assets income margin
Changes in net interest income – volume and rate analysis The following table allocates changes in net interest income between volume and rate for 2003 compared with 2002 and for 2002 compared with 2001. Where variances have arisen from both changes in volume and rate these are allocated to volume.
Total change Volume Rate Total change Volume Rate £m £m £m £m £m £m
Accountability of line management has also been reinforced in relation to the management of risks arising from its business and in developing the risk awareness and risk management capability of its staff. A key objective is to ensure that business decisions strike an appropriate balance between risk and reward, consistent with the Lloyds TSB Group’s risk appetite. As shown on page 43, business management forms part of a tiered risk management model, with the divisional risk officers providing oversight and challenge, as described above, and the chief risk director and group committees establishing the Group-wide perspective.
Greater consistency has been brought to the assessment and classification of risk through use of 11 common risk drivers (shown below). Business and divisional risk functions are increasingly using this format when reporting risks centrally to enable risk aggregation, and assessing risk levels of new products, change initiatives or business plans. Business executive committees, with divisional oversight, monitor their risk levels against their risk appetite; ensuring effective mitigating action is being taken where appropriate. Divisional risk profile reports are reviewed by the group business risk committee to ensure that group executive directors and the chief risk director are aware of risk exposures and are comfortable these are being effectively managed.
Functional reporting line for divisional risk officers to chief risk director
The Lloyds TSB Group’s high level policies and reporting to the group business risk committee, risk oversight committee, audit committee and board have been aligned to the risk drivers. Roll-out of the risk language to the business was completed during 2003 providing consistency in classifying and describing risks.
Group Audit has unrestricted access to all functions, property, records and staff. It independently reviews adherence to the policies and processes that make up the control environment, disseminating best practices throughout the Lloyds TSB Group in the course of its monitoring and corrective action activities. The director of group audit reports to and meets regularly with the group chief executive and periodically with the audit committee.
The Lloyds TSB Group believes that long-term success depends on the quality and skills of its staff and that it has a joint responsibility with employees for their personal and career development to improve current performance and to enhance future prospects.
This is the risk of loss arising from counterparty default subsequent to the provision of credit facilities (both on- and off-balance sheet). The Lloyds TSB Group has dedicated standards, policies and procedures for the measurement, control and monitoring of credit and related risks.
Credit risk arising from the use of derivatives. Note 47 on page 137 shows the total notional principal amount of interest rate, exchange rate and equity contracts outstanding at 31 December 2003. The notional principal amount does not, however, represent the Lloyds TSB Group’s real exposure to credit risk, which is limited to the current cost of replacing contracts with a positive value to the Lloyds TSB Group, should the counterparty default. This replacement cost is also shown in note 47. To reduce credit risk the Lloyds TSB Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure.
• Maintenance of a facilities database. Group Risk Management operates a centralised database of large corporate, sovereign and bank facilities designed to monitor aggregate exposure throughout the Lloyds TSB Group.
• Communication and provision of general guidance on all credit-related risk issues, including regulatory changes and environmental risk policy, to promote consistent and best practice throughout the Lloyds TSB Group.
Domestic Loans and advances to banks 13,671 15,291 12,737 13,165 14,341 Loans and advances to customers: – Financial, business and other services 9,652 8,352 8,736 9,295 6,614
The following table analyses the movements in the allowance for loan losses for each of the five years listed.
Acquisition and disposal of businesses (54) 3 – 49 – Advances written off: Domestic Loans and advances to customers: – Mortgages (1) (21) (23) (35) (30)
Percentage of Percentage of Percentage of Percentage of Percentage of loans in each loans in each loans in each loans in each loans in each category to category to category to category to category to Allowance total loans Allowance total loans Allowance total loans Allowance total loans Allowance total loans
In accordance with the UK British Bankers’ Association Statement of Recommended Practice on Advances, Lloyds TSB Group continues to accrue interest, where appropriate, on doubtful debts when there is a realistic prospect of recovery. This interest is charged to the customer’s account but it is not credited to income; it is placed on a suspense account and only taken to income if there ceases to be significant doubt about its being paid. Loans are transferred to non-accrual status where the operation of the customer’s account has ceased. This lending is managed by specialist recovery departments and is written down to its estimated realisable value. Interest is not added to the lending or placed on a suspense account as its recovery is considered unlikely; it is only taken to income if it is received.
Potential problem loans are loans where known information about possible credit problems causes management to have concern as to the borrowers’ ability to comply with the present loan repayment terms. Interest continues to be accrued to the profit and loss account until, in the opinion of management, its ultimate recoverability becomes doubtful.
The table below summarises the interest foregone on loans accounted for on a non-accrual basis and troubled debt restructurings.
In addition to the non-performing lending disclosed above, lendings which were current as to payment of interest and principal but where concerns existed about the ability of the borrowers to comply with loan repayment terms in the near future were as follows: £m £m £m £m £m
The figures shown for potential problem lending are not indicative of the losses that might arise should the credit quality of this lending deteriorate since they do not take into account security held.
As at 31 December 2003, the country with cross border outstandings of between 0.75 per cent and 1 per cent of assets, amounting to £1,828 million in total was France.
Market risk is the risk of loss arising from unexpected changes in financial prices, including interest rates, exchange rates and bond, commodity and equity prices. It arises in all areas of Lloyds TSB Group’s activities and is managed by a variety of different techniques. The Lloyds TSB Group’s banking activities expose it to the risk of adverse movements in interest rates or exchange rates, with little or no exposure to equity or commodity risk; this is covered in detail in this section. The Lloyds TSB Group’s insurance activities also expose it to market risk (see ‘Insurance risk’ below).
The predominant measure within Lloyds TSB Group is the variance/covariance (VcV) methodology, which incorporates the volatility of relevant market prices and the correlation of their movements. Based on the commonly used 95 per cent confidence level, assuming positions are held overnight and using observation periods of the preceding three years, the value at risk based on Lloyds TSB Group’s global trading positions was as detailed in the table below.
There are some limitations to the VcV methodology which are covered below: • The model assumes that changes in the underlying asset returns can be modelled by a normal distribution. This assumption is an approximation of reality that may not reflect all circumstances.
• Any model that forecasts the future based on historic data is implicitly assuming that the conditions that generated the data will remain true in the future. Stress testing and using more than one VaR methodology for some local markets form part of the wider market risk framework.
The simulation models used by Lloyds TSB Group include assumptions about the relationships between customer behaviour and the level of interest rates; the anticipated level of future business is also taken into account. The accuracy of these assumptions will impact the efficiency of hedging transactions. The assumptions are regularly updated and the projected exposure is actively managed in accordance with Lloyds TSB Group’s group asset and liability committee policy.
Foreign exchange risk. Exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in Lloyds TSB Group’s overseas operations.
Equity exposure. A small number of Lloyds TSB Group’s authorised centres can incur equity risk in dealings with their retail and commercial customers. Limits on these equity exposures are controlled and monitored by Group Treasury. Group Treasury calculates VaR on these equities positions as set out in the trading VaR table in ‘Market risk – Measurement – Trading value at risk (VaR)’.
Market risk limits (structural). Limits to control interest rate risk within the Lloyds TSB Group’s UK retail portfolios are set out in the policy for Group Balance Sheet Management, which is established by the group asset and liability committee and ratified by the Lloyds TSB Group board. The policy is to optimise the stability of future net interest income, and this is achieved by entering into hedging transactions using interest rate swaps and other financial instruments. Both short and long-term interest rate parameters are applied to management of the balance sheet. Limits to control market risk in respect of UK wholesale banking and overseas centres are recommended by the group asset and liability committee, subject to review by Group Risk Management, to the group executive committee and authorised in total by the board, as described above. Some centres have, in addition, adopted benchmark profiles for investment of interest rate insensitive liabilities as approved by Group Treasury.
The risk of loss arising from the sensitivity of profits to movements in claims experience and expectation; movements in the market value of invested assets which are not matched by similar movements in the value of insurance liabilities; the presence of options and guarantees in insurance products; and changes in the legal, regulatory and fiscal environment as applicable to the insurance businesses.
Financial risks are measured through deterministic studies of the impact of different insurance and investment market scenarios on the future free assets of the business as well as some stochastic modelling.
The following table shows closing, average, maximum and minimum VaR for the years ended 31 December 2003 and 2002 on a 95 per cent confidence one day basis.
Investment strategy for surplus assets held in excess of liabilities takes account of the regulatory and internal business requirements for capital to be held to support the business now and in the future. Surplus assets are held primarily in two portfolios: the surplus in the Scottish Widows non-participating fund and an investment portfolio within the General Insurance business.
With-Profits Fund. The existence and investment mix of the surplus in the non-participating fund can therefore be considered as structural rather than as a traded portfolio. Under UK GAAP the portfolio is shown at market value and gains and losses are recognised in the profit and loss account.
With-profits life and pensions business involves guaranteed benefits that create a contingent market risk to the Lloyds TSB Group. Accordingly, in adverse investment market conditions the surplus assets in the life and pensions business could be called upon to support with-profits benefits. Options and guarantees are incorporated in new insurance products only after careful consideration of the risk management issues that they present. This occurs as part of the new product approval process (see ‘Product and Service risk’ below).
The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. For internal purposes, reputational impact is also included.
In response to the ongoing threat of external fraud, Lloyds TSB Group established a central fraud unit during 2003. This supports businesses in combating fraud by providing data mining expertise and fraud intelligence; investigating pan Lloyds TSB Group fraud cases; coordinating the development of fraud detection and prevention software; and acting as an interface to law enforcement agencies and industry bodies. Group Risk Management retains responsibility for oversight of fraud management.
All advertising and marketing material is required to comply with the Lloyds TSB Group’s governing policy on business conduct. Businesses are required to have procedures in place to ensure that the material is fair, clear and not misleading bearing in mind the knowledge and sophistication of the customer. Any statement of fact should be substantiated through documentary evidence; any comparison should be made in a fair and balanced way; and any reference to past performance should clearly state the basis of measurement.
Product performance. Businesses establish and monitor performance standards for all marketed products across a range of indicators, for example sales volumes, customer service and risk profile. Significant deviations from these standards are investigated and appropriate action taken.
The international standard for measuring capital adequacy is the risk asset ratio, which relates to on- and off-balance sheet exposures weighted according to broad categories of risk. The Lloyds TSB Group’s capital ratios, calculated in line with the requirements of the Financial Services Authority, are set out in detail on page 64.
It is the responsibility of local line management to ensure that the liquidity policy is met, and the sources and maturities of assets and liabilities are continually managed and appropriately diversified to avoid any undue concentration as market conditions evolve. Compliance is monitored by regular liquidity returns to Group Risk Management.
A framework is in place to guide the consideration and documentation of customer treatment risk when developing policies and procedures. The Lloyds TSB Group has defined benchmark standards in all the key areas. The divisions are required to meet or exceed these standards.
Financial crime. Group Compliance includes a dedicated unit, led by the group financial crime director, which is responsible for ensuring that the Lloyds TSB Group has effective processes in place to identify and report on suspicious transactions and customers, in support of the worldwide fight against financial crime.
To deliver the Lloyds TSB Group’s strategic aims, change must be managed in an effective, risk-aware and appropriately controlled manner throughout the organisation. The Lloyds TSB Group’s Change Management Standards provide consistency of approach across its project portfolio, and the approach is regularly benchmarked against other organisations around the world.
Changes that significantly impact customers or staff are managed as part of an overall change plan managed by the Lloyds TSB Group change management committee. The committee ensures that the aggregate impact of the implementation of change on customers, staff and systems is understood, managed and controlled.
A significant part of the liquidity of Lloyds TSB Group’s banking businesses arises from their ability to generate customer deposits. A substantial proportion of the customer deposit base is made up of current and savings accounts which, although repayable on demand, have traditionally provided a stable source of funding. During 2003, amounts deposited by customers increased by £162 million from £116,334 million at 31 December 2002 to £116,496 million at 31 December 2003, although excluding the effect of disposals made during the year there was an underlying growth of £6,798 million. These customer deposits are supplemented by the issue of subordinated loan capital and wholesale funding sources in the capital markets, as well as from direct customer contracts. Wholesale funding sources include deposits taken on the inter-bank market, certificates of deposit, sale and repurchase agreements, a Euro Medium Term Note programme, of which £5,184 million had been utilised for senior funding at 31 December 2003, and a US$5,000 million commercial paper programme, of which US$1,037 million had been utilised at 31 December 2003.
The ability to sell assets quickly is also an important source of liquidity for Lloyds TSB Group’s banking businesses. Lloyds TSB Group holds sizeable balances of marketable treasury and other eligible bills and debt securities which could be disposed of to provide additional funding should the need arise.
The following table sets out the amounts and maturities of Lloyds TSB Group’s contractual cash obligations at 31 December 2003.
The following table sets out the amounts and maturities of Lloyds TSB Group’s other commercial commitments at 31December 2003. These commitments are not included in Lloyds TSB Group’s consolidated balance sheet.
Within One to Three to Over one year three years five years five years Total £m £m £m £m £m
Lending commitments are agreements to lend to customers in accordance with contractual provisions; these are either for a specified period or, as in the case of credit cards and overdrafts, represent a revolving credit facility which can be drawn down at any time, provided that the agreement has not been terminated. The total amounts of unused commitments do not necessarily represent future cash requirements, in that commitments often expire without being drawn upon.
In respect of Obelisk as at 31 December 2003 it held assets of approximately £0.6 billion, primarily loans and investments. The assets are generally of investment grade quality and are typically secured. Lloyds TSB Bank plc provided asset-backed commercial paper liquidity support facilities of approximately £0.6 billion. In the future it is intended that much of the business funded by Obelisk will be transferred to the Cancara conduit structure. At 31 December 2003, Monument had no assets and there are no remaining commitments to Monument as this vehicle is in the process of being closed. During 2003, fee income earned by Lloyds TSB Group in relation to the Cancara, Monument and Obelisk transactions totalled approximately £7.80 million.
Based upon the levels of resources within the banking and insurance and investments businesses and the ability of Lloyds TSB Group to access the wholesale money markets or issue debt securities should the need arise, Lloyds TSB Group believes that its overall liquidity is sufficient to meet current obligations to customers, policyholders and debt holders, support expectations for future changes in asset and liability levels and carry on normal operations.
The cornerstone of the regulatory regime in the UK is the Financial Services and Markets Act 2000 (‘FSMA’) which came into force on 1 December 2001 (a date known as N2) and replaced much of the previous legislation under which banks, insurance companies and investment businesses had been authorised and supervised. In accordance with the provisions of the FMSA on 30 November 2002, the Financial Services Authority (‘FSA’) completed the process of assuming responsibility for the regulation and oversight of a wide range of financial services activities in the UK. The FSA’s Integrated Prudential Sourcebook (due to be implemented by the end of 2004) will bring together their main prudential requirements organised by risk (for example, credit risk, market risk, insurance risk etc) replacing the existing Interim Prudential Sourcebooks, which are organised by types of business. Much of the Integrated Prudential Sourcebook is based on European Union (‘EU’) directives and other international standards, many of which are currently being revised.
Any individual who carries out what is known as a ‘controlled function’ in a financial services firm needs to be approved by the FSA. Controlled functions include those of directors, the finance officer, risk management, compliance, anti-money laundering and internal audit. The FSA has established a Code of Practice for Approved Persons; shortfalls in their conduct can lead to sanctions against the individual by the FSA.
Depositors (who are eligible claimants) in the UK are provided with protection for their deposits with authorised institutions. Depositors with an institution which has been declared insolvent are entitled to receive 100 per cent of the first £2,000 and 90 per cent of the next £33,000 of their protected deposits from the Financial Services Compensation Scheme, subject to a maximum amount of £31,700, including both principal and accrued interest. All authorised institutions are required to be members of the Financial Services Compensation Scheme and are subject to a levy in proportion to their deposit base, which includes deposits in sterling, other European Economic Area currencies and euro, to finance the Compensation Scheme.
The Banking Code (the ‘Code’) is a voluntary code agreed by UK banks and building societies which became effective in 1992, with subsequent revisions in 1994, 1998, 2001 and 2003, and which has been adopted by Lloyds TSB Group. The Code defines the responsibilities of the banks and building societies to their personal customers in connection with the operation of their UK accounts and sets out minimum standards of service that these customers can expect from institutions which subscribe to the Code. Compliance with the Code is monitored by the Banking Code Standards Board.
The FSA’s regulatory approach aims to focus and reinforce the responsibility of the management of each approved person to ensure that it takes reasonable care to organise and control its affairs responsibly and effectively and that it develops and maintains adequate risk management systems. The FSA Handbook of Rules and Guidance (‘the Handbook’) sets out 11 Principles for Businesses and the rules to which investment businesses are required to adhere.
With the introduction of the Integrated Prudential Sourcebook in 2004, the rules governing the appointment and roles of actuaries and the minimum capital requirements relating to long-term insurance business are set to change, particularly in relation to with-profits business.
During 2004 the European Commission will be issuing a draft risk based capital directive for banks and investment firms. This is based on the revised Basel Capital Accord, which is being developed by the Basel Committee on banking supervision. This is likely to result in comprehensive changes to the capital adequacy regulations applicable to Lloyds TSB Group. The proposals for the new framework cover three main areas: • Minimum capital requirements and methodologies for allocation of regulatory capital for credit and other risks.
• A supervisory review process, including the setting of capital ratios by bank supervisors.
In common with a number of other banks and insurance companies, in January 1997 Lloyds TSB Bank was fined £325,000 by the Investment Management Regulatory Organisation Limited for regulatory breaches and failings in connection with the sale of personal pensions between April 1988 and July 1993. Lloyds TSB Group does not expect any further fines or regulatory investigations in connection with the regulator’s action plan for reviewing cases of possible misselling. However, the principal cost incurred by the Lloyds TSB Group as a result of this matter relates to the compensation paid to past purchasers of pensions. As the review of pension cases has progressed, provisions have been established in respect of the anticipated cost of these payments.
The provisions have been calculated by making assumptions about the number of cases requiring compensation and the estimated cost of the resulting payment. As the review has progressed greater experience has enabled management to refine these assumptions. 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 levels which have resulted in an increase in the cost of restitution into company pension schemes as personal pension fund values and the trustees’ expectation of future returns reduce. These factors have resulted in additional charges being made to the Lloyds TSB Group’s profit and loss account of £70 million in 2001, £40 million in 2002 and £44 million in 2003. Following normal actuarial practice, each year the provision has also been increased to recognise the interest accruing upon the assets held to match the liability. This increase in the provision amounted to some £2 million in 2003, £17 million in 2002 and £20 million in 2001, although there was no net effect on Lloyds TSB Group’s profit and loss account. At 31 December 2003 the provisions held amounted to £25 million. See note 30d to the financial statements.
During 2002, a review was carried out in conjunction with the FSA into sales of mortgage endowment and other long-term savings products made by the Abbey Life sales force between 1988 and its disposal by the Lloyds TSB Group in February 2000. As a result of this review, in December 2002 the FSA fined Abbey Life £1 million for mortgage endowment misselling and other deficiencies in its compliance procedures and controls. A provision of £165 million was established, in the year ended 31 December 2002, for the cost of compensation due to customers based upon assumptions as to the number of cases requiring redress and the estimated average cost; this provision was increased by £22 million in 2003 as greater experience has enabled management to refine the underlying assumptions. In addition, there has been an increase in complaints in respect of products sold by the Abbey Life sales force prior to 1988; a provision of £34 million has been established in 2003 to cover the estimated cost of redress.
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
Capital resources The total capital resources of Lloyds TSB Group are set out below: 31 December 31 December 31 December.
The international standard for measuring capital adequacy is the risk asset ratio, which relates regulatory capital to balance sheet assets and off-balance sheet exposures weighted according to broad categories of risk.
Banking operations are categorised as either banking book or trading book (broadly, activities which are accounted for on a mark-to-market basis). Risk-weighted assets are determined according to a broad categorisation of the nature of each asset or exposure and counterparty and, for the trading book, by taking into account market-related risks.
Post-tax return on average risk-weighted assets 2.63% 1.62% 2.26% Risk asset ratios: At 31 December 2003, the risk asset ratios were 11.3 per cent for total capital and 9.5 per cent for tier 1 capital. The 9.5 per cent tier 1 capital ratio appears higher than would perhaps be expected and reflects the higher level of supervisory deductions resulting from Lloyds TSB Group’s significant investment in its life assurance operations.
There are strict limits imposed by the regulatory authorities as to the proportion of Lloyds TSB Group’s regulatory capital base that can be made up of subordinated debt and preferred securities. Lloyds TSB Group’s capacity to raise new debt capital for regulatory purposes increases as profits are retained; at 31 December 2003, Lloyds TSB Group had capacity to raise approximately £2,300 million of tier 2 debt capital, compared to approximately £600 million at 31 December 2002. This increase reflects the effects of retained profits and favourable exchange rate movements. The unpredictable nature of movements in the value of the investments supporting the long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Lloyds TSB Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate.
Corporate social responsibility The Lloyds TSB Group has long recognised the importance of corporate social responsibility (CSR). It is one of the UK’s largest corporate givers; it has award winning policies in equality and diversity, employee relations and training and development; and, it has leading edge systems for the assessment of environmental risks in lending. This track record is reflected in sector leading performance in a variety of CSR indices, league tables and investor ratings.
Investment portfolio, maturities, deposits, short-term borrowings Investment securities and other securities
The following table analyses the maturity profile and interest rate sensitivity of loans by type on a contractual repayment basis as at 31 December 2003. All amounts are before deduction of provisions and interest in suspense. Demand loans are included in the ‘maturing in one year or less’ category.
The following table shows the details of Lloyds TSB Group’s average customer deposits in each of the past three years.
Deposits in foreign offices Non-interest bearing demand deposits 845 – 789 – 595 –
The financial information set out in the table below has been derived from the annual reports and accounts of Lloyds TSB Group plc for each of the past five years adjusted for subsequent changes in accounting policy and presentation. The financial statements for each of the years 1999 to 2001 have been audited by PricewaterhouseCoopers, independent accountants; the financial statements for 2002 and 2003 were audited by their successor firm PricewaterhouseCoopers LLP, independent accountants.
Basic earnings per ordinary share 58.3p 32.1p 40.4p 48.4p 43.9p Diluted earnings per ordinary share 58.1p 32.0p 40.0p 47.9p 43.1p Net asset value per ordinary share 170p 140p 183p 213p 212p
Capital ratios (%)1 1 Figures for 2002 and earlier years have been restated to reflect the implementation of UITF 37, ‘Purchases and sales of own shares’. UITF 38, ‘Accounting for ESOP trusts’, FRS 15, ‘Tangible Fixed Assets’, FRS 18, ‘Accounting Policies’, FRS 17, ‘Retirement Benefits’, FRS 19 ‘Deferred Tax’, UITF 33 ‘Obligations in Capital Instruments’, detailed guidance from the Association of British Insurers for best practice in the preparation of results using the achieved profits method of accounting and other minor adjustments.
2 Assets exclude long-term assurance assets attributable to policyholders. 3 Annual dividends are comprised of both interim and final dividend payments. Final dividends (which are always paid in the following year) are included in the year to which they relate rather than in the year in which they are paid.
5 Averages are calculated on a monthly basis from the consolidated financial data of Lloyds TSB Group. 6 The efficiency ratio is calculated as total operating expenses as a percentage of total income. 7 This figure excludes 79 million limited voting ordinary shares.
Amounts in accordance with US GAAP 2003 2002 2001 2000 1999
Total revenues, net of interest expense 14,139 10,498 9,335 10,380 9,493 Policyholder benefits and claims expense (3,036) (1,565) (2,228) (1,735) (936) Provision for bad and doubtful debts (950) (1,029) (747) (541) (615)
David P Pritchard Deputy Chairman Joined TSB Group in 1995 as group treasurer. Seconded to the Securities and Investments Board as head of supervision & standards, markets & exchanges, from 1996 to 1998. Appointed to the board in 1998, as group executive director, Wholesale and International Banking. Retired from executive duties in 2003, when he was appointed deputy chairman. Held senior and general management appointments with Citicorp from 1978 to 1986 and Royal Bank of Canada from 1986 to 1995. A non-executive director of LCH. Clearnet Group.
Angela A Knight ✠* Joined the board in 2003. Deputy chairman of Scottish Widows, having been appointed to the board of that company before it became a member of the Lloyds TSB Group. A member of parliament from 1992 to 1997 and Economic Secretary to the Treasury from 1995 to 1997. Chief Executive of the Association of Private Client Investment Managers and Stockbrokers. A non-executive director of LogicaCMG, South East Water and the Port of London Authority. Aged 53.
Christopher Gibson-Smith Angela Knight David PritchardThe Earl of Selborne Gavin Gemmell Maarten van den Bergh DeAnne Julius Wolfgang Berndt
Helen A Weir Group Finance Director designate Joins the board on 26 April 2004. Group finance director of Kingfisher from 2000 to 2004. Previously finance director of B&Q from 1997, having joined that company in 1995, and held a senior position at McKinsey & Co from 1990 to 1995. Began her career at Unilever in 1983. A nonexecutive director of The City of London Investment Trust. Aged 41.
Dr Berndt and Mrs Knight joined the board on 1 May 2003, Mr Ayliffe’s appointment was effective from 1 June 2003 and Mrs Weir joins the board on 26 April 2004. In accordance with the articles of association, they offer themselves for election at the annual general meeting.
Donations The profit and loss account includes a charge for charitable donations totalling £31,712,000 (2002: £33,403,000) including £31,450,000 (2002: £33,336,667) under deeds of covenant to the four Lloyds TSB Foundations, which will be paid during 2004. No donations were made to political parties.
Policy and practice on payment of creditors The company follows 'The Better Payment Practice Code' published by the Department of Trade and Industry, regarding the making of payments to suppliers. A copy of the code and information about it may be obtained from the Department of Trade and Industry as shown on page 185.
The board and its committees The Group is led by a board comprising executive and non-executive directors with wide experience. The appointment of directors is considered by the board and, following the provisions in the articles of association, they must stand for election by the shareholders at the first annual general meeting following their appointment and must retire, and may stand for re-election by the shareholders, at least every three years. Executive directors normally retire at age 60, as required by their service agreements. Independent non-executive directors are appointed for specified terms which, previously, would not exceed five years and could be renewed, but now do not exceed three years and may be renewed.
The board has delegated to management the power to make decisions on operational matters, including those relating to credit, liquidity and market risk, within an agreed framework.
The audit committee comprises Mr Brown (chairman), Mr Gemmell, Mrs Knight and The Earl of Selborne. The deputy chairman is invited to attend meetings of the committee. The committee’s terms of reference are available from the company secretary and are displayed on the company’s website www.lloydstsb.com.
The committee’s terms of reference are available from the company secretary and are displayed on the company’s website www.lloydstsb.com.
M D Ross10 7 1 Appointed to the board from 1 June 2003 2 Appointed to the board and remuneration committee from 1 May 2003 3 Appointed to the nomination committee from 16 April 2003 4 Appointed to the board and audit committee from 1 May 2003 5 Left the audit committee on 16 May 2003 6 Appointed to the audit committee from 16 May 2003 7 Appointed to the board from 10 March 2003 8 Left the board on 16 April 2003 9 Left the board on 31 May 2003 10 Left the board on 30 September 2003
The directors have responsibility for ensuring that the company keeps accounting records which disclose with reasonable accuracy the financial position of the company and which enable them to ensure that the financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Lloyds TSB Group and to prevent and detect fraud and other irregularities.
Internal control The board of directors is responsible for the establishment and review of the Lloyds TSB Group’s system of internal control, which is designed to ensure effective and efficient operations, quality of internal and external reporting, internal control, and compliance with applicable laws and regulations. It should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control the directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss.
The remuneration committee The members of the remuneration committee during 2003 were Sir Tom McKillop (chairman), Dr Gibson-Smith, Dr Julius, Dr Berndt from 1 May 2003, Mr Butler until 16 April 2003 and Miss Forbes until 16 April 2003.
Towers, Perrin, Forster & Crosby, Inc. (TPFC) were appointed by the committee to advise it on matters relating to executive remuneration. TPFC also provide the management of the company with competitive market data relating to other employees and administrative services for the company’s flexible benefits plan for its employees.
Mr van den Bergh, Mr Daniels, Mr Ellwood, Mr Fairey, Mr Mitchinson (Director of Group Human Resources) and Mr Wilson (Compensation & Benefits Director) provided guidance to the committee (other than for their own remuneration).
The following table illustrates the percentage of the grant which would be exercisable depending on the company’s TSR ranking within the comparator group set out below.
Service agreements Lloyds TSB Group policy is for executive directors to have service agreements with notice periods of no more than one year. All current executive directors are entitled to receive 12 months’ notice from the company, but would be required to give six months’ notice if they wished to leave. As the chairman and deputy chairman are regarded as employees, they are entitled to receive up to eight weeks’ notice.
Lloyds TSB Group recognises that executive directors may be invited to become non-executive directors of other companies and that these appointments may broaden their knowledge and experience, to the benefit of the Lloyds TSB Group. Fees are normally retained by the individual directors as the posts entail personal responsibility. Directors are generally allowed to accept one non-executive directorship.
Directors, with the exception of Mr Pritchard, have a normal retirement age of 60. Mr Pritchard’s retirement date was 16 April 2003. In the event of death in service, a lump sum of 4 times salary is payable plus a spouse’s pension of 2/3 of the member’s prospective pension. On death in retirement, a spouse’s pension of 2/3 of the member’s pension is payable. The defined benefit schemes are non-contributory. Members of defined contribution schemes are required to contribute.
Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2003 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme in accordance with actuarial guidance note GN11. The underlying bases used to arrive at the factors were changed during the year by the Actuary to comply with guidance from the Institute of Actuaries. The resulting transfer values are higher than those arrived at using the previous bases.
Former executive director * The interests at 31 December 2003 include 732 shares allocated on 28 April 2003 at 409.4p per share under the terms of the Lloyds TSB Group shareplan, the Lloyds TSB Group’s all employee share incentive plan. All eligible employees were entitled to receive an award, up to a maximum of £3,000 in shares, equal to 3 per cent of their 2002 salary. A similar award will be made in 2004.
In addition, under shareplan, employees have the opportunity to purchase shares, known as partnership shares, up to a maximum of £125 per month. Under the terms of the scheme employees who purchased partnership shares received additional shares free, known as matching shares, on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share. Any shares purchased or awarded under this scheme are included in the figures above.
† The changes in beneficial interests between 31 December 2003 and 5 March 2004 related to ‘partnership’ and ‘matching’ shares acquired under the Lloyds TSB Group shareplan.
Current directors At 1 January 2003 Granted Exercised/ Exercise periods who served (or later date of during lapsed during At 31 December Exercise during 2003 appointment) the year the year 2003 price From To Notes
j) Market price on day of exercise was 447p. In that regard Mr Kane made a gain of £294,672. This is the difference between the market price of the shares on the day on which the share option was exercised and the price paid for the shares, and includes the value of shares issued to compensate directors for the special dividend mentioned below.
* Mr Kane was entitled to receive additional Lloyds TSB Group shares on exercising share options held on 28 December 1995. These shares were to compensate him for the special dividend of 68.3p per share which was paid to former TSB Group shareholders in 1996 following the merger with Lloyds Bank, but which was not paid to optionholders. In that regard he received 6,994, 3,339 and 5,130 additional shares when he exercised the 48,192, 23,008 and 35,347 share options shown above. Following these exercises, he no longer holds any share options over which these arrangements apply.
‡ Mr Atkinson exercised this share option after he left the board. The date of exercise was 29 May 2003 and the market price of the shares on that day was 454.5p.
That the company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international financial services companies including Lloyds TSB) must be at least ninth, when 14 per cent of the option will be exercisable. If the company is ranked first in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met.
At the end of 2003 Lloyds TSB Group was ranked: 10th after three years of the performance period for options granted in 2001; 11th after two years of the performance period for options granted in 2002; and 17th after one year of the performance period for options granted in 2003.
Our responsibility is to audit the financial statements and the auditable part of the directors’ remuneration report in accordance with relevant legal and regulatory requirements and United Kingdom Auditing Standards issued by the Auditing Practices Board. This report, including the opinion, has been prepared for and only for the company’s members as a body in accordance with Section 235 of the United Kingdom Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or in to whose hands it may come save where expressly agreed by our prior consent in writing.
Note £ million £ million £ million £ million £ million
Profit on ordinary activities before tax 8 3,165 1,183 4,348 2,618 3,167 Tax on profit on ordinary activities 9 1,025 766 877
Profit on ordinary activities after tax 3,323 1,852 2,290 Minority interests: Profit for the year attributable to shareholders 10 3,254 1,790 2,233
The accompanying notes are an integral part of the financial statements. * restated (see note 1) † An analysis of the results for the years ended 31 December 2002 and 2001 between continuing and discontinued operations is given in note 7.
Assets Cash and balances at central banks 1,195 1,140 Items in course of collection from banks 1,447 1,757 Treasury bills and other eligible bills 13 539 2,409 Loans and advances to banks 14 15,547 17,529 Loans and advances to customers 15 135,251 134,474
Consolidated balance sheet at 31 December 2003 2003 2002* Note £ million £ million
Accruals and deferred income 36 3,206 3,659 Post-retirement benefit liability 45 2,139 2,077 Provisions for liabilities and charges: – Other provisions for liabilities and charges 38 402 361 Subordinated liabilities: – Undated loan capital 39 5,959 5,496 – Dated loan capital 39 4,495 4,672 Minority interests: Called-up share capital 41 1,418 1,416 Share premium account 42 1,136 1,093
Current assets Debtors falling due within one year: – Amounts owed by group undertakings 1,387 1,375 – Other debtors 88 89 – Tax recoverable – 11 Cash balances with group undertakings 362 250
Current liabilities Amounts falling due within one year: – Amounts owed to group undertakings 1,913 1,801 – Other creditors 106 103 – Dividend payable 1,314 1,311 – Loan capital 39 – 14
Net increase (decrease) in shareholders’ funds 1,681 (2,383) (1,551) Shareholders’ funds at beginning of year 7,943 10,326 11,901 Prior year adjustment at 1 January 2001 (note 1) – – (24)
Net cash inflow from operating activities (note 49a) 772 5,394 9,927
Financing: – Issue of subordinated liabilities (loan capital) 533 2,120 742 – Cash proceeds from issue of ordinary share capital and sale of own shares – held in respect of employee share schemes 32 77 194 – Repayments of subordinated liabilities (loan capital) (75) (55) (131) – Minority investment in subsidiaries (note 49d) – 167 – – Capital element of finance lease rental payments (1) (4) (20) Net cash inflow from financing 489 2,305 785
An advance becomes classified as non-performing when interest ceases to be credited to the profit and loss account. There are two types of non-performing lending which are discussed further below.
Land is not depreciated. Leasehold premises with unexpired lease terms of 50 years or less are depreciated by equal annual instalments over the remaining period of the lease. Freehold and long leasehold buildings are depreciated over 50 years. The costs of adapting premises for the use of the Group are separately identified and depreciated over 10 years, or over the term of the lease if less; such costs are included within premises in the balance sheet total of tangible fixed assets.
Other finance income – – – – – 165 165 – 165 Income from long-term assurance business – – (305) (305) – – (305) 11 (294)
Other finance income – – – – – 307 307 – 307 Income from long-term assurance business – – (42) (42) – – (42) 12 (30)
2 Segmental analysis (continued) Continuing Discontinued††† Domestic International operations operations Total
Profit on ordinary activities before tax 2,810 355 3,165 1,183 4,348
Profit on ordinary activities before tax 2,122 217 2,339 279 2,618
Profit on ordinary activities before tax 2,601 283 2,884 283 3,167
Class of business UK Retail Banking and Mortgages 2,555 2,242 90,272 79,629 Insurance and Investments: – Life, pensions, unit trusts and asset management 6,531 6,461 8,835 8,333
Discontinued operations††† – 1,352 – 14,602 * Figures for 2001 and 2002 have been restated to take account of the changes in accounting policy explained in note 1 and to reflect the transfer of Business Banking from UK Retail Banking and Mortgages to Wholesale and International Banking, together with changes in internal transfer pricing arrangements. Under the Group’s transfer pricing arrangements, inter-segment services are generally recharged at cost. Inter-segment lending and deposits are generally entered into at market rates, except that non-interest bearing balances are priced at a rate that reflects the external yield that could be earned on such funds.
† Net assets represent shareholders’ funds plus equity minority interests. Disclosure of information on net assets is an accounting standard requirement (SSAP 25); it is not appropriate to relate it directly to the segmental profits above because the business is not managed by the allocation of net assets to business units.
††† Discontinued operations relate to the Wholesale and International Banking segment.
3 Dealing profits (before expenses) 2003 2002 2001 £m £m £m.
Social security costs 143 134 140 Other pension costs (note 45) 353 318 347
Other administrative expenses 1,888 1,695 1,670 * restated (see note 1)
Details of directors’ emoluments, pensions and interests are given on pages 81 to 87.
Included in ‘Other audit related fees’ are the costs of the audit of the Group’s Form 20-F filing with the SEC and, in 2001, work in relation to the Group’s initial registration. Also included in this category is advice in relation to preparations for the implementation of International Financial Reporting Standards; internal control reviews; and work on a number of projects within the Group’s insurance and investments businesses including the audit of the conversion of unit trusts to open ended investment companies.
‘Other non-audit fees’ in 2003 principally relate to work in connection with the disposal of The National Bank of New Zealand and the Group’s operations in Brazil.
Notes to the accounts 6 Profit before tax on sale of businesses 2003 2002 2001 £m £m £m.
On 1December 2003, the Group also announced the sale of its operations in Guatemala, Honduras and Panama; these sales are expected to be completed in 2004.
Operating expenses: Amortisation of goodwill 33 26 59 Depreciation and amortisation 663 38 701 Total operating expenses 4,636 277 4,913
Net interest income 4,468 454 4,922 Other finance income 307 – 307 Other income: Fees and commissions receivable 2,821 101 2,922 Fees and commissions payable (576) (26) (602) Dealing profits (before expenses) 208 25 233 Income from long-term assurance business (42) 12 (30) General insurance premium income 428 – 428 Other operating income 700 8 708
Operating expenses: Amortisation of goodwill 28 11 39 Depreciation and amortisation 526 24 550 Total operating expenses 4,507 262 4,769
Share of results of joint ventures (10) – (10) Profit on sale of business – 39 39
Profit on ordinary activities before tax 2,884 283 3,167 8 Profit on ordinary activities before tax 2003 2002 2001 £m £m £m.
Profits less losses on disposal of investment securities 47 160 160 Charges: Rental of premises 220 220 203 Hire of equipment 18 18 18 Interest on subordinated liabilities (loan capital) 622 537 515
In addition to the tax charge in the profit and loss account detailed above, £2 million (2002: £968 million; 2001: £863 million) of deferred tax has been credited to the statement of total recognised gains and losses in respect of actuarial losses recognised in post-retirement benefit schemes (note 45).
A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the current tax charge and total tax charge for the year is given below: 2003 2002* 2001* £m £m £m
Tax charge thereon at UK corporation tax rate of 30% 1,304 785 950 Factors affecting charge: – Overseas tax rate differences (9) 24 12 – Non-allowable and non-taxable items (10) (28) 8 – Gains exempted or covered by capital losses (276) (23) (39) – Tax deductible coupons on non-equity minority interests (12) (12) (12) – Payments to employee trust – (20) (60) – Capital allowances in excess of depreciation (105) 7 (48) – Other timing differences (14) 99 2 – Life companies rate differences 16 43 21
Tax on profit on ordinary activities 1,025 766 877 * restated (see note 1)
The Finance Act 2003 introduced legislation which will potentially affect the tax treatment of certain transfers from Scottish Widows plc’s long-term business fund to its shareholder’s fund; it is possible that these transfers will be subject to a higher tax charge than was previously anticipated. The potential deferred liability not recognised on the balance sheet is approximately £110 million.
Profit attributable to shareholders† £3,254m £1,790m £2,233m Weighted average number of ordinary shares in issue during the year†† 5,581m 5,570m 5,533m Dilutive effect of options outstanding 18m 27m 50m Diluted weighted average number of ordinary shares in issue during the year 5,599m 5,597m 5,583m Earnings per share 58.3p 32.1p 40.4p Diluted earnings per share 58.1p 32.0p 40.0p * restated (see note 1)
Investment securities: Treasury bills and similar securities 308 305 257 258
Of which repayable on demand or at short notice 13,365 11,852
The cost of assets acquired during the year for letting to customers under finance leases and hire purchase contracts amounted to £4,478 million (2002: £3,752 million).
Non-performing lending comprises: Accruing loans on which interest is being placed in suspense 633 752 Loans accounted for on a non-accrual basis 585 662
Transport, distribution and hotels 4,741 4,696 Property companies 4,577 4,008 Financial, business and other services 9,652 8,352 Personal: – Mortgages 70,750 62,467
Provisions for bad and doubtful debts* (1,677) (1,766) Interest held in suspense* (28) (57)
Transfers from other securities relate to debt securities that have been transferred into the Group’s new conduit securitisation vehicle, Cancara Asset Securitisation Limited. These securities were previously held within the Group’s trading portfolios but have been reclassified as investment securities since the intention is now to hold them for the longer term.
Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. If the investment securities were sold at their year end valuation no tax is expected to be payable as any such gains would be covered by available capital losses.
In the year ended 31 December 2003 £7 million (2002: £25 million; 2001: £1 million) of interest receivable from Goldfish Bank Limited (a wholly owned subsidiary of Goldfish Holdings Limited) and £6 million (2002: £12 million; 2001: £22 million) of charges to Goldfish Bank Limited in respect of administrative costs have been included in the Group’s income. At 31December 2002 Goldfish Bank Limited owed £430 million to the Group, which was included in loans and advances to banks; in addition, as at 31 December 2002, the Group had made facilities available for Goldfish Bank Limited to borrow a further £420 million; this facility was cancelled during 2003 and Goldfish Bank no longer owes any significant amounts to the Group.
On 30 September 2003 the Group completed the purchase of the credit card and personal loan businesses of Goldfish Bank Limited (see note 48).
Lloyds TSB Bank plc England 100% Banking and financial services Cheltenham & Gloucester plc England 100%† Mortgage lending and retail investments Lloyds TSB Commercial Finance Limited England 100%† Credit factoring Lloyds TSB Leasing Limited England 100%† Financial leasing Lloyds TSB Private Banking Limited England 100%† Private banking The Agricultural Mortgage Corporation PLC England 100%† Long-term agricultural finance Lloyds TSB Bank (Jersey) Limited Jersey 100%† Banking and financial services Lloyds TSB Scotland plc Scotland 100%† Banking and financial services Lloyds TSB General Insurance Limited England 100%† General insurance Scottish Widows Investment Partnership Group Limited England 100%† Investment management Abbey Life Assurance Company Limited England 100%† Life assurance Lloyds TSB Insurance Services Limited England 100%† Insurance broking Lloyds TSB Life Assurance Company Limited England 100%† Life assurance and other financial services Lloyds TSB Asset Finance Division Limited England 100%† Consumer credit, leasing and related services Black Horse Limited England 100%† Consumer credit, leasing and related services Scottish Widows plc Scotland 100%† Life assurance Scottish Widows Annuities Limited Scotland 100%† Life assurance
The primary financial statements of these entities can be summarised as follows: Equipment leasing vehicles Structured finance vehicles £m £m £m £m £m £m.
(Loss) profit on ordinary activities before taxation (2) 1 9 28 8 – Tax on (loss) profit on ordinary activities 6 5 (6) (2) – –
Liabilities: Deposits by banks 1,309 1,245 672 – Debt securities in issue – – 3,123 73 Other liabilities and accruals 108 77 18 2
Balance sheet amount at 31December 2002 819 920 2,357 £m £m
Residual value expected to be recovered in: 1 year or less 181 272 2 years or less but over 1 year 330 173 5 years or less but over 2 years 505 542
At 31December 2003, the Group was committed to various non-cancellable operating leases, which require aggregate future rental payments as follows: Premises £m
Leases on which the commitment is due to expire in: 5 years or less but over 1 year 29 – 29 1
Balances arising from derivatives used for trading purposes (note 47a) 2,489 3,428 Balances arising from derivatives used for hedging purposes 475 778 Settlement balances 54 76 Other assets 926 957 * restated (see note 1)
At 1 January – restated 6,213 6,344 Exchange and other adjustments 12 (14) Profit (loss) after tax 296 (250) Capital injections – 140 Adjustments on disposal (38) –
Operating profit is adjusted by the following items to arrive at income from long-term assurance business: Investment variance: this represents (a) the difference between the actual investment return in the year on investments backing shareholder funds and the expected return based upon the economic assumptions made at the beginning of the year; (b) the effect of these fluctuations on the value of in-force business; and (c) other effects of changes in extraneous economic circumstances beyond the control of management.
Changes in economic assumptions: this represents the effect of changes in the economic assumptions referred to in f.
* In some cases, rather than pay cash compensation directly into the customer’s personal pension plan, the Group has guaranteed to ‘top-up’ the customer’s pension income, on retirement, to the level that they would have received under the relevant occupational scheme.
The review is now nearing completion and management do not expect any further material changes in the provisioning requirement. However, the cases that are still to be settled are generally large and complex and there is therefore a risk that the assumptions made in determining the provision may prove to be inaccurate.
In common with other organisations in the life assurance industry, prior to its demutualisation Scottish Widows wrote policies which contained potentially valuable options and guarantees, including guaranteed annuity option policies. Under the terms of the transfer of the Scottish Widows business, a separate memorandum account was created within the with-profits fund called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed benefits on transferred policies; the Additional Account had a value at 31December 2003 of £1.4 billion (2002: £1.5 billion). To the extent that the Additional Account is insufficient to provide these benefits any shortfall would be met by the Lloyds TSB Group.
• the proportion of policyholders who seek to exercise their options.
In accordance with the Association of British Insurers’ detailed guidance for the preparation of figures using the achieved profits method of accounting, the Group has reviewed the economic assumptions used in the embedded value calculations. The guidance requires that the assumptions should be reviewed at each reporting date.
•Current tax legislation and rates have been assumed to continue unaltered, except where future changes have been announced. The UK corporation tax rate used for grossing up was 30 per cent (2002: 30 per cent; 2001: 30 per cent). The normalised investment earnings have been grossed up at a composite longer term tax rate of 17 per cent (2002: 17 per cent; 2001: 17 per cent).
•Future bonus rates on with-profits business are set at levels which would fully utilise the assets supporting the with-profits business. The proportion of profits derived from with-profits business allocated to the shareholder has been assumed to continue at the current rate of one-ninth of the cost of the eligible bonus, in accordance with the terms of the transfer of the Scottish Widows business.
Tax attributable to long-term business (41) 200 280 Transfer (to) from the fund for future appropriations (414) (84) 1,249
Balance on the technical account – long-term business 229 (405) 14 Tax attributable to balance on the technical account – long-term business 112 (190) (103) Income in shareholder fund 34 35 38 Expenses in shareholder fund – (1) –
Profit (loss) for the financial year 250 (384) 43 * restated (see note 1)
Profit (loss) for the financial year: Modified statutory solvency basis 250 (384) 43 * restated (see note 1)
Assets and liabilities exclude long-term assurance assets attributable to policyholders and liabilities to policyholders.
Repayable on demand 7,455 8,500 Other deposits by banks with agreed maturity dates or periods of notice by residual maturity repayable: 3 months or less 15,002 14,692 1 year or less but over 3 months 1,197 1,634 5 years or less but over 1 year 69 487
International: Non-interest bearing 61 82 Interest bearing 5,035 5,784 £m £m
38 Other provisions for liabilities and charges Customer Vacant remediation Insurance leasehold property provisions provisions and other Total £m £m £m £m
The provision in respect of long-term savings predominantly relates to redress payments in respect of the Extra Income and Growth Plan (‘EIGP’) product. During the year the Group has completed an investigation, in conjunction with the FSA, into sales of this product made in 2000 and 2001 and as a result has agreed to pay compensation to those customers who invested in the EIGP when it was not appropriate. The provision reflects the costs of this investigation, the estimated cost of redress payments to customers who qualify for compensation calculated using the criteria agreed with the FSA, and the incremental costs expected to be incurred processing the payments to customers. The compensation exercise is in progress and is expected to be completed during 2004.
Notes to the accounts 39 Subordinated liabilities Group Group Company Company
Dated loan capital Eurocurrency Zero Coupon Bonds 2003 (¥3,045 million) – 14 – 14 Subordinated Fixed Rate Bonds 2003 (NZ$151 million) – 48 – – Subordinated Floating Rate Notes 2004 a 5 10 – –
i) Exchangeable at the election of the Group for further subordinated floating rate notes.
Japanese yen ¥m ¥m ¥m 50 million Preference shares of ¥25 each 1,250 1,250 1,250 £m £m £m
Issued to the QUEST (note 43) (6 million shares; 2002: 18 million shares; Issued under employee share schemes (5 million shares; 2002: 1 million shares; Limited voting ordinary shares of 25p each
Share premium account (the Group and the Company): Premium arising on issue of shares 43 134 364
The profit and loss account reserves of the Group at 31December 2003 include £1,258 million (2002: £1,310 million; 2001: £1,222 million) not presently available for distribution representing the Group’s share of the value of long-term assurance business in force and the surplus retained within the long-term assurance funds. The Group’s profit and loss account reserves at 31 December 2002 are stated after including a deficit of £2,139 million relating to the Group’s post-retirement defined benefit schemes (2002: deficit of £2,077 million; 2001: surplus of £281 million) and after deducting £39 million (2002: £43 million; 2001: £50 million) in respect of own shares held (see note 43).
The amounts deducted from profit and loss account reserves in respect of own shares, which are held at cost, are comprised as follows: £m £m £m
The Group has also established the Lloyds TSB Qualifying Employee Share Ownership Trust (‘the QUEST’) for the purpose of providing shares on the exercise of options under certain of the Group’s Save As You Earn (SAYE) share option schemes. During 2003, Lloyds TSB Group plc made no contributions (2002: £66 million; 2001: £200 million) to the QUEST, and the trustees subscribed for 6 million (2002: 18 million; 2001: 47 million) shares in the Company for a consideration of £26 million (2002: £136 million; 2001: £316 million). At 31 December 2003, 0.2 million shares were held by the QUEST with a cost of £1 million (2002: 1.7 million shares with a cost of £13 million; 2001: 2.4 million shares with a cost of £18 million). Under the terms of the QUEST’s trust deed, the trustees have waived all but a nominal dividend on the shares they hold.
Movements in the amount deducted from reserves in respect of own shares have been as follows: £m £m £m
Purchases of, and subscriptions for, shares 74 185 374 Use of shares on exercise of employee options and for other employee share plans (78) (192) (371)
At 31 December 2003, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons and with officers included: 2003 2003 2002 2002
During the year one officer purchased a car from the Group for a consideration of £27,000 (2002: three officers, total consideration £37,000).
In addition, the Group operates a number of schemes which provide post-retirement healthcare benefits to certain employees, retired employees and their dependent relatives. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post-retirement healthcare for all eligible former employees (and their dependents) who retired prior to 1 January 1996. For retirements subsequent to this date, the Group will meet a reducing proportion of the cost until 31 December 2004, after which date the only obligation will be in respect of the pre 1 January 1996 retirements.
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 2000; this valuation has been updated to 31 December 2003 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 5.58 per cent.
The assets of the Group’s defined benefit schemes and the expected rates of return are summarised as follows: Expected Expected Expected long-term rate long-term rate long-term rate
Market values of scheme assets: UK index linked gilts 545 4.4 – – 126 5.0 Sterling non-government bonds 1,033 5.4 491 5.6 – –
Actual return less expected return on scheme assets 802 (2,582) (2,015) Experience gains and losses arising on scheme liabilities 94 (240) (71) Effect of changes in demographic and financial assumptions (902) (477) (787)
The amounts reported on the Group’s balance sheet are comprised as follows: £m £m
The maturity of the notional principal amounts and replacement cost of both trading and non-trading instruments entered into with third parties was: Under 1 to 5 Over 5 1 year years years Total £m £m £m £m
Liabilities: Minority interests and shareholders’ funds – – – – – 10,333 18 10,351 Internal funding of trading business (11,528) (810) (412) (3,217) (820) – 16,787 –
6 months 1 year 5 years or less or less or less Non3 months but over but over but over Over interest Trading or less 3 months 6 months 1 year 5 years bearing book Total 31December 2002* £m £m £m £m £m £m £m £m
Liabilities: Minority interests and shareholders’ funds – – – – – 8,826 (152) 8,674 Internal funding of trading business (7,973) (198) (1,545) (5,148) (880) – 15,744 –
Financial instruments include both financial assets and financial liabilities and also derivatives. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, fair values have been estimated using quoted values for instruments with characteristics either identical or similar to those of the instruments held by the Group. In certain cases, where no ready markets currently exist, various techniques have been developed to estimate what the approximate fair value of such instruments might be. These estimation techniques are necessarily subjective in nature and involve several assumptions.
At 31 December 2003, the unrecognised gains on financial instruments used for hedging were £303 million (2002: £418 million) and unrecognised losses were £219 million (2002: £516 million).
The net losses arising in 2002 and earlier years and recognised in 2003 amounted to £150 million. Net gains of £30 million arose in 2003 but were not recognised in the year.
Of the net gains of £84 million at 31 December 2003, £63 million of net gains are expected to be recognised in the year ending 31 December 2004 and £21 million of net gains in later years.
During the year ended 31 December 2001, the Group completed the acquisition of CashFriday Limited, a provider of funding and payroll services to the UK temporary recruitment sector. The consideration was £10 million, of which £1 million was settled in cash in the year ended 31 December 2001 and £9 million was satisfied by the issue of short-term loan notes. The premium on acquisition of £8 million was capitalised and is being written off to the profit and loss account over its estimated useful life.
The cash flow statement reflects cash flows attributable to the banking, life and general insurance businesses. Cash flows from long-term assurance business attributable to shareholders include the surplus emerging from the life and pension businesses; ‘Income from long-term assurance business’ reflects the movement in the value of long-term assurance business attributable to shareholders (see note 30) as adjusted for capital injections and acquisitions, which are reflected within the ‘Capital expenditure and financial investment’ and ‘Acquisitions and disposals’ sections of the cash flow statement. Cash flows relating to the long-term assurance business attributable to policyholders are not reflected within this statement.
a Reconciliation of operating profit to net cash inflow from operating activities 2003 2002* 2001* £m £m £m
Insurance claims paid (231) (210) (178) Customer remediation provision 200 – – Customer remediation paid (119) – – Amounts written off fixed asset investments 44 87 60 Income from long-term assurance business (453) 294 30 Transfer from long-term assurance business – – 155 Interest on subordinated liabilities (loan capital) 622 537 515 Interest element of finance lease rental payments – – 1 Depreciation and amortisation 697 701 550 Other non-cash movements (30) (189) (376)
Net cash inflow from operating activities 772 5,394 9,927 * restated (see note 1)
The Group is required to maintain balances with the Bank of England which, at 31 December 2003, amounted to £177 million (2002: £165 million; 2001: £156 million).
c Analysis of changes in cash during the year 2003 2002 2001 £m £m £m
Included in the amounts shown above in respect of the issue of share capital are non-cash movements of £13 million (2002: £62 million; 2001: £185 million).
Exchange and other adjustments 34 (5) (13) Cash inflow from financing 458 2,065 611
f Acquisition of group undertakings 2003 2002 2001 £m £m £m
Satisfied by: Amounts receivable – (5) – Issue of loan notes – – 9 Deferred consideration – 2 –
The accounts presented in this report have been prepared in accordance with accounting principles generally accepted in the United Kingdom (UK GAAP). These differ in significant respects to the accounting principles generally accepted in the United States (US GAAP). The following is a summary of significant differences applicable to the Group.
Derivatives used in the Group’s trading activities are carried at fair value and all changes in fair value are reported within dealing profits in the profit and loss account. Derivatives used in the Group’s non-trading activities are accounted for on an accruals basis, in line with the treatment of the underlying items which they are hedging. A derivative will only be classified as a hedge in circumstances where there was adequate evidence of the intention to hedge at the outset of the transaction and the derivative substantially matches or eliminates the exposure being hedged. Derivatives embedded within financial instruments are not required to be separately analysed.
SFAS No. 133 further requires a derivative that is embedded within a financial instrument to be separated from the host contract and fair valued if it is not deemed to be clearly and closely related to the host. If the derivative cannot be reliably separated, SFAS No. 133 requires the entire instrument to be fair valued.
All computer software costs are expensed as incurred except for operating software and application software relating to separable new systems, which are capitalised and depreciated over their estimated useful lives. All enhancements are expensed as incurred.
The American Institute of Certified Public Accountants (AICPA) Statement of Position 98-1 ‘Accounting for the costs of computer software developed or obtained for internal use’ requires certain costs incurred from 1January 1999 in respect of software developed for internal use to be capitalised and subsequently amortised. This includes enhancements to existing systems which add additional functionality.
Depreciation is charged on the cost of freehold and long leasehold properties over their estimated useful economic lives. Following the adoption of FRS 15, the Group reassessed the useful economic lives and residual values of its freehold and long leasehold premises and, with effect from 1January 2000, the cost of these properties, after deducting the value of the land, is being depreciated over 50 years. Previously it was considered that the residual values were such that depreciation was not significant.
Freehold and long leasehold properties are included in the balance sheet at historical cost and depreciated over their estimated useful economic lives from the date of acquisition.
Operating lease assets are depreciated such that rentals less depreciation are recognised at a constant periodic rate of return on the net cash invested in that asset.
Profits or losses arising on sale and leasebacks are taken to profit as they arise.
Operating lease assets are depreciated such that the depreciation charge is at least equal to that which would arise on a straight line basis.
Under SFAS No. 28 ‘Accounting for Sales with Leasebacks’ profits or losses arising on a sale and leaseback are deferred and amortised. For leasebacks resulting in a finance lease, the amounts are amortised in proportion to the amortisation of the leased asset; for leasebacks resulting in an operating lease, the amounts are amortised in proportion to the gross rental charged to expense over the lease term.
Deferred tax is provided for all timing differences between the recognition of gains and losses in the financial statements and their recognition in a tax computation. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying timing differences can be deducted. Deferred tax is provided based on the rates that have been enacted or have been substantially enacted.
Dividends declared after the period end are recorded in the period to which they relate.
Debt securities and equity shares intended for use on a continuing basis by the Group are treated as investment securities and included in the balance sheet at cost as adjusted for the amortisation of any premiums and discounts arising upon acquisition, less provision for any permanent diminution in value.
FASB Interpretation Number (FIN) 46 (revised December 2003) – Consolidation of Variable Interest Entities
SFAS No. 150 was issued in May 2003. The statement amends the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that these instruments be classified as liabilities in statements of financial position. This statement is effective prospectively for financial instruments entered into or modified after 31 May 2003 and otherwise is effective at the beginning of the first interim period beginning after 15 June 2003. This statement shall be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. Following adoption of this statement, certain financial instruments have been reclassified from minority interests to liabilities.
SOP 03-3 was issued in December 2003, and provides guidance on the accounting for differences between contractual and expected cash flows from a purchaser’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable to credit quality. SOP 03-3 becomes effective for loans and debt securities acquired in years beginning after 15 December 2004. Adoption of this SOP is not expected to have a material impact on Lloyds TSB Group’s US GAAP financial statements.
The shareholder’s interest in the long-term assurance fund is valued at the net present value of the profits inherent in such policies.
Insurance activities, before tax p (66) (59) Banking and Group activities: – Customer related intangibles a 535 589 – Pension costs c 971 840
– Net unrealised gain on available-for-sale securities g 109 32 – Dividend payable 1,314 1,311 – Own shares h (195) (166) Total banking and Group activities, before tax 3,604 3,491 Taxation: – Deferred taxation i (39) (60) – Deferred taxation on GAAP differences i (1,231) (1,151) Total taxation (1,270) (1,211)
Exchange translation differences (158) (321) (321) Additional minimum pension liability (3,224) (3,277) – Available-for-sale securities: – Net unrealised gains – insurance activities 182 245 49 – Related amortisation of deferred acquisition costs (125) (197) (23) – Net unrealised gains – banking activities 109 32 242
The following table provides a condensed profit and loss account for the Group, incorporating the US GAAP adjustments arising.
Loan interest, including fees 8,341 7,937 8,707 Other interest and dividends 1,771 2,035 2,077
Amortisation of intangible fixed assets: – Goodwill – – 236 – Customer related intangibles 150 193 219 – Value of long-term assurance business acquired 188 725 305
The following table provides a condensed balance sheet for the Group, incorporating the US GAAP adjustments arising.
Net cash provided by (used in) operating activities 6,497 615 (4,350)
Cash and cash equivalents at end of period 9,364 8,547 7,388
Cash paid during the year for income taxes 784 951 829 Cash paid during the year for interest 5,066 5,321 6,755 Non-cash investing and financing activities: Loan notes issued in respect of acquisitions – – 9 * restated (see note 1)
FRS 1 (Revised) defines cash as cash in hand and repayable on demand. Under SFAS No. 95, cash and cash equivalents are defined as short-term, highly liquid investments that are both readily convertible to known amounts of cash; and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
Under FRS 1 (Revised), transactions designated as hedges are reported under the same heading as the related assets or liabilities. The restrictions in respect of cash and balances at central banks are disclosed on page 145.
The Group has performed the required impairment tests under UK and US GAAP and no impairments were recorded against goodwill during 2002 or 2003.
Under UK and US GAAP, the purchase of the business of Cheltenham & Gloucester Building Society by Lloyds Bank Plc in August 1995 is treated as an acquisition. Certain differences arise under US GAAP regarding the fair value of the net assets. In addition, the net assets acquired include £521 million relating to customer related intangibles, which has been amortised over 7 years.
The business combination of Lloyds Bank Plc and TSB Group plc in December 1995 was accounted for as a merger as permitted under UK GAAP at that time, although legally TSB Group plc was deemed to have acquired Lloyds Bank Plc. Under US GAAP, the same transaction would have been accounted for as an acquisition of TSB Group plc by Lloyds Bank Plc. Accordingly, for US GAAP, the net assets of TSB Group plc have been fair valued as at the date of the business combination and a purchase price determined based on the value of TSB Group plc shares at that time. The net assets include £1,596 million relating to customer related intangibles, which is being amortised over 11 years.
The movement in goodwill by segment is as follows: Balance at Exchange Balance at 1 January movements Disposals 31 December £m £m £m £m
UK Retail Banking and Mortgages 660 – – 660 Insurance and Investments 2,194 – – 2,194 Wholesale and International Banking 1,127 31 (281) 877
Under US GAAP, the intangible asset representing the value of customer relationships associated with an acquisition is capitalised separately and amortised in the consolidated income statement over the estimated average life of the customer relationships. At 31 December 2003, the weighted average remaining life of those relationships is estimated as 4 years.
Over the next 5 years, estimated amortisation is expected to be: 2004: £157 million 2005: £157 million 2006: £156 million 2007: £11 million 2008: £10 million
Summarised financial information, prepared in accordance with US GAAP, is as follows: £m £m £m
Income from discontinued operations 354 311 233 Profit on sale of businesses 853 – 39 Provision for income tax (89) (81) (81)
Cash 52 Investments 110 Trading assets 744 Loans 14,805 Goodwill 281 Other assets 1,077
The components of the defined benefit pension expense which arise under US GAAP are estimated as: £m £m £m
Change in plan assets Plan assets at fair value as at 1 January 9,095 11,335 Exchange and other movements (65) – Actual return on plan assets 1,838 (1,905) Employer contributions 138 37 Benefits paid (398) (372)
Projected benefit obligation 13,168 11,881 Accumulated benefit obligation 12,468 11,170 Fair value of plan assets 10,227 8,933
The pension schemes’ asset allocation at 2003 and 2002 and the target allocation for 2004 is as follows: Fair value of Fair value of Target plan assets at plan assets at allocation
The principal investment objective is to hold suitable assets of appropriate liquidity which will generate income and capital growth to meet, together with new contributions from members and the employer, the cost of current and future benefits which the scheme provides.
The trustees have taken advice from the Scheme Actuary and investment consultant to ensure that this target allocation is suitable for the schemes given their liability profiles. A number of investment managers have been employed to manage the schemes’ assets and each has been given a specific benchmark and performance objective.
The approach taken by the trustees of Lloyds TSB Group Pension Schemes No’s. 1 and 2 is similar to that taken by the trustees of the other Lloyds TSB Group pension schemes.
Charge for options granted in year (17) (9) (9) Charge for options granted in prior years (96) (35) (37)
Options are normally exercisable between three and ten years from the date of grant. However, the exercise of the options is subject to the satisfaction of the following performance conditions: For options granted after March 2001
To meet the performance conditions, the Group’s ranking against the comparator group must be at least ninth. The full grant of options will only become exercisable if the Group is ranked first. A performance multiplier will be applied below this level to calculate the number of shares in respect of which options granted to executive directors will become exercisable, and will be calculated on a sliding scale. If Lloyds TSB Group plc is ranked below median the options will not become exercisable.
The weighted average fair value of options granted in the year was £0.62 (2002: £1.41; 2001: £1.50). Of the options outstanding at 31 December 2003 6,930,536 were exercisable (2002: 4,409,916; 2001: 3,789,890) and had a weighted average exercise price of £6.24
The weighted average remaining vesting period as at 31 December 2003 was 2 years.
The weighted average fair value of options granted in the year was £0.85 (2002: £1.75; 2001: £2.24). Of the options outstanding at 31December 2003 3,422,122 were exercisable (2002: 3,923,030; 2001: 1,411,511) and had a weighted average exercise price of £5.60 (2002: £5.87; 2001 £3.81). In 2003 cancellations of approximately 56 million shares (2002: approximately 14 million; 2001: approximately 6 million) are included in the above amounts.
Weighted average remaining life (years) 7.8 3.5 7.7 2.8 7.9 2.8
Risk-free interest rate 3.80% 3.86% Expected life 5 years 3 or 5 years Expected volatility 38% 38% Expected dividend yield 6.40% 6.40%
Lloyds TSB Group plc Executive Share Option Scheme (1989) – – – – 48,680 162.50 Lloyds TSB Group plc Executive Share Option Scheme 87,889 282.50 87,889 – 23,008 – Lloyds Bank Plc Senior Executives’ UK Share Option Scheme 1987 52,728 200.70 52,728 – 35,152 201.60
Lloyds TSB Group Staff Share Save Scheme – – – 28,086 37,869 161.0 Lloyds TSB Group plc Executive Share Option Scheme (1989) 48,680 207.0 48,680 – 40,566 141.7 Lloyds TSB Group plc Executive Share Option Scheme 110,897 282.5 110,897 – 26,671 282.5 Lloyds Bank Plc Senior Executives’ UK Share Option Scheme 1987 87,880 200.7 87,880 – 35,152 200.6 Lloyds TSB Group Rollover Scheme (formerly Lloyds Abbey Life) – – – – 18,678 146.6
Basic Net income (US GAAP) £3,231m £1,753m £1,635m Weighted average number of ordinary shares in issue 5,581m 5,570m 5,533m Earnings per share 57.9p 31.5p 29.5p
Diluted Net income (US GAAP) £3,231m £1,753m £1,635m Weighted average number of ordinary shares in issue 5,600m 5,600m 5,595m Earnings per share 57.7p 31.3p 29.2p
Under UK GAAP, the Group uses a variety of financial instruments to hedge exposures in its banking book; these hedges are accounted for on an accruals basis, in line with the underlying instruments being hedged. Any gains or losses that would arise if these instruments were carried at market value are therefore not recognised.
Exchange and other adjustments (10) 14 (6) Net losses recognised in the year 150 396 230 Unrecognised gains (losses) arising during the year 22 (91) (390)
Gross Gross Amortised unrealised unrealised Carrying cost gains losses value 2003 £m £m £m £m
Other public sector securities 75 1 (2) 74 Bank and building society certificates of deposit 2,515 – – 2,515
Specific loan loss allowance (22) (67) Pension schemes (508) (602) Unrealised losses on trading securities (15) (20)
A further valuation allowance of £246 million (2002: £222 million) has been established against other tax losses which are not expected to be utilised in the foreseeable future. Under UK tax legislation, certain capital losses may only be offset against taxable gains of a particular type and consequently the associated deferred tax assets are less certain of realisation. Assessments have been made as to the likelihood of gains arising that can be offset against these losses and, to the extent that it is more likely than not that these losses will not be realised, appropriate valuation allowances have been established. In relation to other tax losses, the pattern of utilisation of losses over previous years has been reviewed together with gains that may be realised in the foreseeable future and an appropriate valuation allowance established to the extent that it is more likely than not that these losses will not be realised.
SFAS No. 107 ‘Disclosure about Fair Value of Financial Instruments’ states that concentrations of credit risk exist if a number of counterparties are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Group’s exposure to credit risk is concentrated in the United Kingdom where the majority of the Group’s activities are conducted and is detailed further in note 17.
In January 2003, the FASB released FIN 46 ‘Consolidation of Variable Interest Entities’ and subsequently issued a revised version, FIN 46-R, in December 2003. FIN 46-R changes the method of determining whether certain entities should be included in the Group’s consolidated financial statements. An entity is called a variable interest entity (VIE) and is subject to the requirements of FIN 46-R if it has: • equity that is insufficient to permit the entity to finance its activities without additional subordinated support; or
• equity investors that cannot make significant decisions about the entity’s operations, or that do not absorb the expected losses or receive the majority of the expected gains.
A VIE is consolidated by its primary beneficiary, which is the party involved with the VIE that has a majority of the expected losses or a majority of the expected returns or both.
The total assets of consolidated VIEs is attributable to the following types of vehicles: Currently VIEs created after consolidated VIEs 1 February 2003 Total
Financing vehicles 4,707 – 4,707 Leasing partnerships 1,431 – 1,431 Securitisation conduit vehicles 3,053 – 3,053 Venture capital enterprises – 86 86
The following table shows the total assets and maximum exposure to loss, as at 31 December 2003, for those entities where Lloyds TSB Group has a significant variable interest in a VIE but is not determined to be the primary beneficiary: Maximum Total assets exposure to loss £m £m
The FASB continues to provide additional guidance on implementing FIN 46-R through FASB Staff Positions. As this guidance is issued, the Group will continue to review the status of VIEs it is involved with and as a result of any changes in guidance additional VIEs may ultimately be required to be consolidated.
Following the application of SFAS No. 150, the trust-preferred securities that were previously classified as minority interests have been reclassified as debt in Lloyds TSB Group’s US GAAP financial statements. At 31 December 2003, these amounted to £549 million and further details of these securities can be found in note 40. The amount that previously would have been classified as minority interests in the US GAAP income statement has been reclassified as an effect of changes in accounting principle and amounted to £42 million, net of tax. In future years this will be included within interest expense.
Profit and loss account Note £m £m £m £m £m £m £m £m £m.
Income from long-term assurance business i (453) – (453) 294 – 294 30 – 30
Policyholder benefits and claims expense i (2,814) – (2,814) (1,394) – (1,394) (2,033) – (2,033) Movement in undistributed policyholder allocations 118 – 118 1,588 – 1,588 2,427 – 2,427 Insurance underwriting, operating and acquisition expenses i (676) 2 (674) (760) 2 (758) (697) (4) (701)
Amortisation of value of long-term assurance business acquired ii (188) – (188) (725) – (725) (305) – (305)
Under US GAAP, premiums and policy charges received that relate to future periods are deferred until the period to which they relate. For limited payment annuities, the excess of the gross premium over the US GAAP net benefit premium is deferred and amortised in relation to the expected future benefit payments. For investment contracts, policy charges that benefit future periods are deferred and amortised in relation to expected gross profits.
Under UK GAAP applicable to banking groups, debt securities and equity shares held within the long-term assurance funds are included in the Group’s balance sheet at market value; investment properties are included at existing use value.
Deferred acquisition costs for conventional with-profits life insurance and other protection type insurance policies are amortised in relation to premium income using assumptions consistent with those used in computing policyholder benefits provisions. Investment, universal life, and separate account contracts are amortised in proportion to the estimated gross profits arising from the contracts.
The contract for conventional with-profits business written into the with-profits fund provides that approximately 90 per cent of the surplus arising from the net assets of the fund is allocated to policyholders in the form of annual bonuses. For unitised with-profits business written into the with-profits fund all of the surplus is allocated to policyholders as bonus.
b Company cash flow statement 2003 2002 2001 £m £m £m
Net cash inflow (outflow) from operating activities 71 20 (68) Returns on investments and servicing of finance: – Dividends received from group undertakings 1,908 1,903 1,736 – Interest paid on subordinated liabilities (loan capital) (96) (34) (41)
Increase in cash 112 136 48 c Reconciliation to US GAAP 2003 2002* £m £m
Lloyds TSB Group plc's ability to pay dividends is restricted under UK company law. Dividends may only be paid if distributable profits are available for that purpose. In the case of a public limited company, a dividend may only be paid if the amount of net assets is not less than the aggregate of the called-up share capital and undistributable reserves and if the payment of the dividend will not reduce the amount of the net assets to less than that aggregate. In addition, a company cannot pay a dividend if any of its UK insurance subsidiaries is insolvent on a regulatory valuation basis or in the case of regulated entities, if the payment of a dividend results in regulatory capital requirements not being met. Similar restrictions exist over the ability of Lloyds TSB Group plc's subsidiary companies to pay dividends to their immediate parent companies. Furthermore, in the case of Lloyds TSB Group plc, dividends may only be paid if sufficient distributable profits are available for distributions due in the financial year on certain preferred securities. The board has the discretion to decide whether to pay a dividend and the amount of any dividend. In making this decision, the board is mindful of the level of dividend cover and, consequently, profit growth may not necessarily result in increases in the dividend. The board recognises the importance attached by shareholders to the Lloyds TSB Group’s dividend. In the case of American Depositary Shares (‘ADSs’), dividends are paid through The Bank of New York which acts as paying and transfer agent.
Fourth quarter 591.00 427.50 Third quarter 665.00 456.50 Second quarter 817.00 624.00 First quarter 775.00 680.00 Monthly prices:
Annual prices: Quarterly prices: Fourth quarter (to 26 November 2001) 43.88 38.25 Third quarter 44.00 35.50 Second quarter 43.94 38.94 First quarter 46.00 34.75
The New Treaty for the avoidance of double taxation with respect to taxes on income entered into force following the exchange of instruments of ratification by the UK Parliament and the US Senate on 31 March 2003.
Tax can be complicated and individual circumstances may need to be considered in more detail. Any person who is in any doubt as to his tax position should consult his own professional adviser.
A shareholder or ADS holder who is an individual and who has, on or after 17 March 1998, ceased to be resident and ordinarily resident for tax purposes in the UK for a period of less than five years of assessment and who disposes of ordinary shares or ADSs during that period may be liable, on return to the UK, to UK taxation on chargeable gains arising during the period of absence, subject to any available exemption, relief and/or foreign tax credit.
UK resident shareholders or ADS holders who are not liable to UK tax on dividends, including pension funds and charities, will not be entitled to claim the tax credits in respect of dividends although charities will be entitled to a payment by the UK Inland Revenue of a specified proportion of any dividend paid by us to the charities on or before 5 April 2004, that proportion declining on a year by year basis.
Lloyds TSB Group will not be required to withhold tax at source when paying a dividend on the ordinary shares or ADSs to a US holder.
The New Treaty does not provide for any such entitlement and a US holder will not be able to claim any payment from the UK Inland Revenue in respect of a dividend from Lloyds TSB Group.
Any conveyance or transfer on sale of ordinary shares (whether effected using the CREST settlement system or not) will be subject to UK stamp duty or stamp duty reserve tax (‘SDRT’). The transfer on sale of ordinary shares will be liable to ad valorem UK stamp duty or SDRT, generally at the rate of 0.5 per cent of the consideration paid (rounded up to the next multiple of £5 in the case of stamp duty). Stamp duty is usually the liability of the purchaser or transferee of the ordinary shares. An unconditional agreement to transfer such ordinary shares will be liable to SDRT, generally at the rate of 0.5 per cent of the consideration paid, but such liability will be cancelled, or, if already paid, refunded, if the agreement is completed by a duly stamped transfer within six years of the agreement having become unconditional. SDRT is normally the liability of the purchaser or transferee of the ordinary shares.
US federal income tax considerations The following summary describes certain US federal income tax consequences of the acquisition, ownership and disposition of ADSs or ordinary shares, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a decision to acquire such securities. The summary applies only to holders that hold ADSs or ordinary shares as capital assets and does not address special classes of holders, such as: • certain financial institutions; • insurance companies; • dealers in securities or foreign currencies; • holders holding ADSs or ordinary shares as part of a hedge, straddle or other conversion transaction; • holders whose ‘functional currency’ is not the US dollar; • holders liable for alternative minimum tax; • partnerships or other entities classified as partnerships for US federal income tax purposes; or
• a holder that owns 10 per cent or more of the voting shares of Lloyds TSB Group plc.
Gain or loss realised by a US holder on (i) the sale or exchange of ADSs or ordinary shares or (ii) the Depositary's sale or exchange of ordinary shares received as distributions on the ADSs will be subject to US federal income tax as a capital gain or loss in an amount equal to the difference between the US holder's tax basis in the ADSs or ordinary shares and the amount realised on the disposition. Gains or losses, if any, will be US source.
Deposits and withdrawals of ordinary shares in exchange for ADSs will not result in taxable gain or loss for US federal income tax purposes.
• provides a taxpayer identification number on a properly completed Form W-9 or a substitute form and certifies that no loss of exemption from backup withholding has occurred and that such holder is a US person.
Group structure The following is a list of the principal subsidiaries of Lloyds TSB Group plc at 31 December 2003. The audited consolidated accounts of Lloyds TSB Group plc for the year ended 31 December 2003 include the audited accounts of each of these companies.
Lloyds TSB Leasing Limited England 100%* Financial leasing 25 Gresham Street London EC2V 7HN
Lloyds TSB Private Banking England 100%* Private banking 25 Gresham Street Limited London EC2V 7HN
The Agricultural Mortgage England 100%* Long-term agricultural finance AMC House Corporation PLC Chantry Street, Andover
Lloyds TSB Scotland plc Scotland 100%* Banking and financial services Henry Duncan House 120 George Street Edinburgh EH2 4LH
Lloyds TSB General Insurance England 100%* General insurance 25 Gresham Street Limited London EC2V 7HN
Lloyds TSB Insurance Services England 100%* Insurance broking 25 Gresham Street Limited London EC2V 7HN
Black Horse Limited England 100%* Consumer credit, leasing and 25 Gresham Street related services London EC2V 7HN
Endowment mortgage An interest-only mortgage to be repaid by the proceeds of an endowment insurance policy which is assigned to the lender providing the mortgage. The sum insured, which is payable on maturity or upon the death of the policyholder, is used to repay the mortgage.
Reinsurance The insuring again by an insurer of the whole or part of a risk that it has already insured with another insurer called a reinsurer.
VcV Variance/covariance methodology, see definition under ‘Operating and financial review and prospects – Risk management – Market risk – Measurement – Trading value at risk (VaR)’.
Substantial shareholdings At the date of this report notifications had been received that Legal & General Investment Management Limited and Barclays PLC had interests of 3% and 3.03%, respectively, of the nominal value of the issued share capital. No other notification has been received that anyone has an interest in 3% or more of the nominal value of the issued share capital.
An internet sales service is available through Lloyds TSB Registrars. The current rate for sales is 0.5%, minimum £17.50. Log on to www.shareview.co.uk/dealing for full details.
• to obtain details of the dividend reinvestment plan which enables you to use your cash dividends to buy Lloyds TSB shares in the market
The information about Lloyds TSB Stockbrokers’ services is approved by Lloyds TSB Stockbrokers Limited, which is a member of the London Stock Exchange and is authorised and regulated by the Financial Service Authority.
* Includes 741 million shares (13.3%) registered in the names of some 867,000 individuals. 216 million shares (3.86%) are held by over 65,000 staff and Group pensioners, or on their behalf by the trustee of the staff profit sharing schemes or by the trustee of the staff incentive plan.