This focus on our customers, however, has not come at the expense of other stakeholders. We are constantly striving to make Lloyds TSB a great place to work and a great investment opportunity for shareholders. Throughout 2004 I have continued to be impressed by the drive, commitment and enthusiasm of our staff and, particularly, their desire to keep improving all aspects of our business. For shareholders, Lloyds TSB delivered a total shareholder return (share price appreciation plus dividends) of 15 per cent during 2004, a significantly better performance than both the FTSE Bank Index and the FTSE 100 Index. So, 2004 has been a year of good progress for customers, staff and shareholders all of whom are linked by a common desire – the successful delivery of Lloyds TSB’s business and financial strategies.
During 2004 Lloyds TSB has continued to maintain satisfactory capital ratios, largely as a result of high cash flows generated throughout the business. The Group’s post-tax return on equity at 24.3 per cent remains one of the highest amongst the major banks of the world and the board is satisfied with the Group’s capital position. In addition, Scottish Widows continues to be one of the most strongly capitalised life assurance companies in the UK.
Since the annual general meeting last year, we have welcomed two new directors to the board. Truett Tate was appointed as Group Executive Director, Wholesale and International Banking in August 2004 and Sir Julian Horn-Smith joined us, as a non-executive director, in January 2005. Two executive directors, Steve Targett and Peter Ayliffe, left the board in April 2004 and January 2005 respectively, and Sir Tom McKillop retired at the end of his term as a non-executive director in December 2004. David Pritchard and Chris Gibson-Smith will also be retiring at the annual general meeting. All the departing directors leave with our sincere thanks for their contribution to the Group.
Our focus on delivering profitable franchise growth, against a backdrop of significant regulatory and competitive pressure, has led to a good track record of earnings growth. Despite an expected slowdown in consumer lending growth in the UK, I am confident that the delivery of revenue growth in excess of cost growth, combined with strong risk management throughout the organisation, will enable the Group to achieve a continuing high return on equity and sustainable economic profit growth.
In the Retail Bank, income growth exceeded cost growth, we maintained or grew market share in most of the major product categories and we improved the depth of customer relationships. We used the year to put in place a more competitive product set and a new operating model, whereby we now manage the branch network on what we term a ‘local markets’ basis. In essence, we have returned the branch to being part of the local community and given branch managers greater authority to manage profitability and run their areas as businesses. We recognise that the needs of customers vary by community and, by organising in this way, we believe that we will be both more responsive and effective which will, in turn, result in faster growth. In our test markets, we achieved higher growth in quality customer recruitment and a greater improvement in customer satisfaction than in the rest of the branch network, and this is now starting to deliver an improved sales performance. The new model was extended to the entire branch network in the second half of 2004.
• to improve our efficiency, growing our top line whilst improving the productivity of our cost base, using the discipline of ‘positive jaws’. As our income grows, we will continue to increase our investment to improve our customer satisfaction ratings and our efficiency, through further development of our quality performance, automation, straight-through processing and the more effective leveraging of our group wide cost base.
We have a clear opportunity to help our customers achieve their goals
It is not just about having the right products at the right price, and a relentless pursuit of superior service and accessibility for customers. Having strong values, clear leadership and a responsible corporate culture are also critical if the business is to prosper over time. We want our business to be the first and natural choice for customers and investors.
In the UK, where we employ over 68,000 people, our employment policies are continually monitored and benchmarked against other companies to ensure that, as one of the UK’s largest employers, we remain at the leading edge of employment practice. Our workforce policies and programmes are focused on ensuring that all our employees believe that Lloyds TSB is a great place to work and an employer of choice.
Of course, cash giving is also important. Every year we support our staff ’s commitment to local communities through the matched giving scheme. In 2004 the Lloyds TSB Foundations set aside £1.25 million to match money raised for, and the time given to, charity by Lloyds TSB staff. More than 4,000 staff took part in the scheme, raising a total for charities of more than £3.4 million. One of our biggest group wide activities is our Charity of the Year fundraising. In 2004, staff raised over £1 million for NSPCC and Children 1ST.
The Lloyds TSB Foundations together receive one per cent of the Group’s pre-tax profits, averaged over three years, in lieu of their shareholder dividend. Since 1997, they have received £228 million to distribute to grassroots causes. In 2005, they will receive a further £31.2 million to distribute to community groups.
More information on these issues is available in the Group’s 2004 corporate responsibility report and there are details of how to obtain a copy of this document on page 113.
Internet banking. Internet banking provides online banking facilities for personal customers. Some 3 million customers have registered to use Lloyds TSB Group’s internet banking services.
Telephone banking. Telephone banking continues to grow and Lloyds TSB Group provides, in terms of customer numbers, one of the largest telephony services in Europe. At the end of 2004, some 4.8 million customers had registered to use the services of PhoneBank and the automated voice response service PhoneBank Express. Lloyds TSB Group’s telephone banking contact centres handled some 62 million calls during 2004.
UK Wealth Management. Private Banking provides a range of tailor-made wealth management services and products to individuals from 30 offices throughout the UK. In addition to asset management, these include tax and estate planning, executor and trustee services, deposit taking and lending, insurance and personal equity plan and individual savings account (ISA) products.
Life assurance, pensions and investments. Scottish Widows is Lloyds TSB Group’s specialist provider of life assurance, pensions and investment products, which are distributed through Lloyds TSB Bank’s branch network, through independent financial advisers and directly via the telephone and the internet. The Scottish Widows brand is the main brand for new sales of Lloyds TSB Group’s life, pensions, unit trust and other long-term savings products.
Wholesale 2004 has seen a further increase in our corporate activity with the tighter integration of the businesses within the Wholesale Bank.
Business Banking. Relationships with some 574,000 small businesses are managed by around 1,700 dedicated business managers based in over 500 locations throughout the UK supported by nearly 2,000 business customer advisers in branches. Lloyds TSB Group is one of the leading banks for new business start-ups with nearly a quarter of new businesses opening an account with Lloyds TSB. The main activity of the Agricultural Mortgage Corporation is to provide long-term finance to the agricultural sector.
The Group has continued to reshape its international network in 2004 as the sales of our businesses in Argentina, Colombia, Guatemala, Panama and Honduras were completed during the year.
Offshore banking. Lloyds TSB Group’s offshore banking operations comprise offices in the UK, the Channel Islands, the Isle of Man and overseas representative offices in the Middle East, Asia and the Americas. The business provides a wide range of retail banking, wealth management and expatriate services to local island residents, UK expatriates, foreign nationals and to other customers requiring offshore financial services.
Middle East and Asia. There are banking operations in Hong Kong, Singapore, Tokyo, Malaysia and Dubai.
The Group net interest margin from continuing operations decreased by 11 basis points to 2.89 per cent, after adjusting for the impact of a change in the middle of 2004 in the Group’s wholesale liquidity and funding strategy towards the use of more capital efficient reverse repurchase agreements, which have been excluded from the net interest margin calculation. This margin reduction reflected the impact of changes in business mix and lower margins in the Group’s credit card, personal lending and mortgages portfolios as a result of competitive pressures. During the second half of 2004, however, we started to see a slowdown in the rate of margin erosion in a number of retail product areas. There has also been further substitution of net interest income for fee income in certain product lines.
Income from long-term assurance business, excluding the impact of customer redress provisions, increased by 32 per cent to £590 million as a result of significantly improved profitability in the Scottish Widows life and pensions business. There was also a £50 million increase in gains on the sales of assets, largely the realisation of venture capital investments.
The Group’s capital position remains satisfactory. At the end of 2004, the total capital ratio was 10.0 per cent and the tier 1 capital ratio was 8.9 per cent. Risk-weighted assets increased by 12 per cent to £132.2 billion, reflecting strong growth in consumer lending and mortgages, higher lending in Corporate Markets and the acquisition of a UK corporate loan portfolio from Danske Bank which added risk-weighted assets of some £2.0 billion. The Group continues to plan for risk-weighted asset growth of mid-to-high single digits over the next few years, and expected profit retentions are sufficient to support this level of risk-weighted asset growth within the Group’s current capital management policy. Profit retentions for 2004 totalled £507 million.
Scottish Widows continues to be one of the most strongly capitalised life assurance companies in the UK. We remain satisfied with the overall capital position of Scottish Widows when calculated using the Financial Services Authority’s (FSA) new ‘realistic’ basis of balance sheet reporting, and the first Individual Capital Assessment under the new FSA regime has been completed and shows that our capital requirements are well covered. At the end of December 2004 the working capital ratio of the Scottish Widows Long-Term Fund, applying the FSA’s new realistic basis, was an estimated 19.0 per cent. The required risk capital margin was covered over nine times. Scottish Widows has also paid a 2004 dividend of £200 million to Lloyds TSB reflecting the start of an expected regular dividend stream.
Profit before tax from UK Retail Banking increased by £180 million, or 12 per cent, to £1,651 million, compared to £1,471 million in 2003, supported by continued strong growth in the Group’s consumer lending portfolios, partly offset by lower product margins, higher current account credit balances, improved current account fee income, tight cost control and a lower provision for customer redress. Excluding the impact of provisions for customer redress, profit before tax in UK Retail Banking increased by 5 per cent, with income growth of 4 per cent and cost growth of 1 per cent.
The bad debt provisions charge increased by £79 million, or 13 per cent, to £673 million. £37 million of this increase reflected the acquisition in September 2003 of the Goldfish credit card and personal lending portfolios with the remainder reflecting volume related asset growth in personal loan and credit card lending. The provisions charge as a percentage of average lending for personal loans and overdrafts fell to 4.20 per cent, from 4.25 per cent in 2003, while the charge in the credit card portfolio increased to 3.42 per cent, from 3.19 per cent in 2003. In the mortgages business, there was a net provision release of £42 million (2003: £18 million release), reflecting the continuing low level of losses in a climate of rising house prices and historically low interest rates. Overall, the provisions charge as a percentage of average lending was 0.71 per cent, compared to 0.72 per cent in 2003, and the arrears position remained satisfactory.
Customers are increasingly choosing to buy via direct channels and continued investment in our direct channel capabilities has supported good levels of business growth. Our internet bank now has 3 million registered users and, in 2004, 1.2 million product sales were achieved through the internet, an increase of 39 per cent compared to 2003. Over 400 million transactions were processed through internet banking, an increase of 60 per cent on 2003. Sales through direct channels now represent 50 per cent of total sales.
During 2004, there was a net charge of £80 million from changes in actuarial assumptions and experience variances, compared to a net charge of £91 million in 2003. Higher margins, lower distribution costs and an improved stock market performance led to a significant improvement in the profit before tax from unit trusts, despite a reduction in the level of unit trust sales.
In life and pensions, supported by growth in all channels, weighted sales increased by 9 per cent to £656.7 million, resulting in an increase in the Group’s market share to 7.5 per cent, from 7.0 per cent in 2003. Through the branch network and direct channels, the Group’s market share increased to 8.9 per cent, from 7.8 per cent in 2003, whilst the Group’s market share in the IFA market improved to 7.0 per cent, from 6.7 per cent in 2003.
Profit before tax, excluding investment variance, from our general insurance operations increased by £7 million, or 5 per cent, to £160 million.
Continued progress in improving levels of business retention and higher product margins led to premium income from underwriting increasing by £19 million, or 4 per cent. Home insurance income increased by 8 per cent. Insurance broking commission income decreased by £18 million as a £26 million increase in income from creditor insurance was offset by a £47 million reduction in other commissions, reflecting lower profit sharing income. There was a significant improvement in broking income from creditor insurance in the second half of the year, partly reflecting improvements in personal loan and credit card penetration rates.
The business strategy to increase investment in more cost efficient distribution through direct channels is starting to create a shift from face-to-face channels towards direct channels. As a result gross written premiums from new policies sold through direct channels increased by 12 per cent in 2004. Gross written premiums for new policies sold via the internet increased by 37 per cent.
Wholesale and International Banking profit before tax, excluding profit/loss on sale of businesses and trading results of discontinued operations, increased by £234 million, or 23 per cent, to £1,272 million, from £1,038 million in 2003. On the same basis income growth of 5 per cent exceeded cost growth of 2 per cent, leading to an improvement in the cost:income ratio to 57.9 per cent. Our focus on cross-selling and capital efficiency has led to an increase in the post-tax return on average risk-weighted assets to 1.42 per cent compared with 1.23 per cent in 2003. In Wholesale, there was strong profit growth in Corporate Markets, Business Banking and Asset Finance, in addition to a reduction in provisions for bad and doubtful debts.
The charge for provisions for bad and doubtful debts decreased by £113 million to £193 million. The charge in Wholesale fell by £68 million to £232 million, as a result of a decrease in provisions from the corporate lending portfolio, partially offset by higher charges in the Asset Finance business. In International Banking there was a credit of £39 million mainly reflecting a £30 million release from the general provision against the Group’s exposures in Argentina.
We continue to deepen customer relationships, and the creation of an integrated regional sales structure, bringing together product specialists with relationship managers, has already started to generate positive results, with a 59 per cent increase in cross-selling income within Corporate Markets including an 86 per cent increase in Financial Markets cross-selling income to £69 million in 2004. In Corporate Markets, which incorporates Corporate Banking, Structured Finance and Financial Markets, profit before tax grew by 25 per cent from £504 million in 2003 to £631 million, reflecting an increase in the contribution from both relationship and transactional business driven by a combination of higher income and a reduction in provisions.
The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly disabled and disadvantaged, to play a fuller role in society. The Foundations receive 1 per cent of the Lloyds TSB Group’s pre-tax profit after adjusting for gains and losses on the disposal of businesses and pre-tax minority interests, averaged over three years, instead of the dividend on their shareholdings. In 2004, the Group accrued £31 million for payment to the Lloyds TSB Foundations.
Lloyds TSB Group uses an enterprise-wide framework for the identification, assessment, measurement and management of risk, designed to meet its customers’ needs and maximise value for shareholders over time by aligning risk management with the corporate strategy; assessing the impact of emerging risks from new technologies or markets; and developing risk tolerances and mitigating strategies. The framework strengthens the Group’s ability to identify and assess risks; aggregate risks and define the corporate risk appetite; develop solutions for reducing or transferring risk, where appropriate; and exploit risks to gain competitive advantage, thereby seeking to increase shareholder value.
Risks which the business assumes are broken down into eleven common risk drivers (shown on page 21). Business and divisional risk functions use 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; seeking to ensure effective mitigating action is being taken where appropriate and also that the risk appetite allocated to them is profitability and prudently deployed. Divisional risk profile reports are reviewed by the group business risk committee to seek to ensure that group executive directors and the chief risk director are aware of risk exposures and are comfortable these are being effectively managed. During the year a new group consolidated risk report was developed and implemented to further support the identification and control of risk.
The changing regulatory environment faced by the Group’s businesses, and developments in best practice, prompted the Group during 2003 to extensively review its risk governance structures and deliver more effective risk management. The process of embedding these changes has progressed during 2004 and is now substantially complete. In addition, further enhancements were made during the year with a solid reporting line established between the divisional risk officers and the chief risk director.
The model seeks to provide the Group with an effective mechanism for developing and promulgating risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also facilitates more effective communication on these matters across the Group. These arrangements will enable the Group to better anticipate and pre-empt risks, and to manage more effectively those risks which crystallise.
This is the risk of loss arising from counterparty default subsequent to the provision of credit facilities (both on- and off-balance sheet). Lloyds TSB Group has dedicated standards, policies and procedures for the measurement, control and monitoring of credit and related risks.
Group rating system. All business units operate an authorised rating system complying with the Group’s standard methodology. The Group uses a ‘Master Scale’ rating structure with ratings corresponding to a range of probabilities of future default.
Portfolio analysis. With Group Risk, businesses identify and define portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by Group Risk.
To enhance further the ability to measure and predict future risk, the Group continues to develop new policies and risk management systems.
Credit derivatives. These are a method of transferring credit risk from one counterparty to another and of managing exposure to selected counterparties. Credit derivatives include credit swaps, credit spread options and credit linked notes. The Group has limited exposure to such instruments.
• Independent review of credit exposures at divisional and group level.
• Monitoring of scorecards. The Group uses statistically-based decisioning techniques (primarily credit scoring and performance scoring) for its principal consumer lending portfolios. Group Risk reviews and monitors new and material changes to scorecards.
Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers. Control is exercised over those exposures through a suitable combination of formal limits, credit policy parameters and high level committee oversight.
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 Group’s banking activities expose it to the risk of adverse movements in interest rates or exchange rates, with little or no exposure to equity or commodity risk. The Group’s insurance activities also expose it to market risk. The Group’s pension schemes are exposed to significant risks from the constituent parts of their assets, primarily equity and interest rate risk, and from the present value of their liabilities.
Limits to control market risk in respect of trading positions are recommended by the group asset and liability committee, subject to review by Group Risk, to the group executive committee and authorised in total by the board. A combination of position and sensitivity limits is used, depending on the nature of the business activity. The group asset and liability committee, through Group Treasury for trading centres, ensures appropriate delegation to businesses.
Limits to control interest rate risk within the 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 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. Some centres have, in addition, adopted benchmark profiles for investment of interest rate insensitive liabilities as approved by Group Treasury.
The group asset and liability committee liaises with the pension scheme trustees with regard to strategies for the overall mix of pension scheme assets.
The primary measure within the Group is the Value at Risk (VaR) 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 VaR for the years ended 31 December 2004 and 2003 based on the Group’s global trading positions was as detailed in the table below (the table also aggregates potential loss measures from options portfolios).
• The use of a confidence limit does not convey any information about potential losses on occasions when the confidence limit is exceeded. In times of extreme market movements actual losses may be significantly greater than the VaR number. Stress testing is used to supplement VaR to estimate the impact of extreme events.
It is estimated that a hypothetical immediate and sustained 100 basis point increase in interest rates on 1 January 2005 would decrease net interest income by £80.7 million for the 12 months to 31 December 2005, while a hypothetical immediate and sustained 100 basis point decrease in interest rates would increase net interest income by £76.3 million. An analysis by currency is shown below.
In the Group’s retail portfolios, including mortgages, and in the Group’s capital funds, exposure arises from the different repricing characteristics of the Group’s banking assets and liabilities and is managed by Group Balance Sheet Management under the direction of the group asset and liability committee.
There is a relatively small volume of naturally arising banking liabilities whose interest rate is contractually fixed typically for periods of up to two years.
The Group’s structural position at 31 December 2004 is set out in note 47d to the financial statements. The position implies that at 31 December 2004 a hypothetical increase of 10 per cent in the value of sterling against all other currencies would have led to an £82 million reduction in reserves, and vice versa. On this basis, there would have been no material impact on Lloyds TSB Group’s risk asset ratios.
The investment policy together with appropriate limits including the limit to be applied to the equity component are approved by the group asset and liability committee supported by Group Risk.
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’ on page 28).
Persistency rates are regularly assessed by reference to appropriate risk factors.
Businesses have primary responsibility for identifying and managing their operations risks. They employ internal control techniques to reduce their likelihood or impact to tolerable levels within the Group’s risk appetite. Where appropriate, risk is mitigated by way of insurance.
Group Risk provides general guidance on operations risk related issues, including regulatory changes and developments in the measurement and management of operations risk, to promote best practice throughout the Group. It keeps under continuous review and improvement all aspects of operations risk management to reflect developments in industry best practice and regulatory requirements.
Lloyds TSB Group is committed to the fair treatment of its customers. A range of management information measures is in place across the Group to support the tracking of key customer treatment indicators. Group Risk and Group Audit are required to report regularly on customer treatment risk, management information trends and on compliance with the Group’s standards.
The Group’s strategy and those of its constituent businesses are reviewed and approved by the board. Regular reports are provided to the group executive committee and the board on the progress of the Group’s key strategies and plans. Group Risk conducts oversight to ensure the business plans remain consistent with the Group’s strategy.
A common approach is applied across the Group to assess the creation of shareholder value. This is measured by economic profit (the profit attributable to shareholders, less a notional charge for the equity invested in the business). The focus on economic profit allows the Group to compare the returns being made on capital employed in each business. The use of risk-based economic capital and regulatory capital is closely monitored at business and Group level. The Group’s economic capital model covers credit, market, insurance, business and operational risks.
All advertising and marketing material is required to comply with the 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.
This is the risk of loss from poor corporate governance at Group and business level. It includes sub-optimal organisational structuring, or failure to recruit, manage and retain appropriately skilled staff to achieve business objectives. Group policy for managing governance, people and organisation risk is defined in the Group Policy Manual. It defines the way the Group is organised, the need for tight financial and operating controls, maintenance of a strong risk management and control culture, the need to benchmark against industry best practice and for businesses to conduct themselves with integrity, due skill, care and diligence.
The Group seeks to identify and classify risks in a timely manner. The likelihood of risks crystallising and the significance of the consequent impact on the business, the Group and its customers are evaluated. The Group’s business control environment seeks to ensure effective and efficient operational management; reliability, integrity and consistency of financial and other reporting; and compliance with governing laws and regulations. Business directors seek to ensure that material risks are reported to the relevant divisional risk officer, group executive director and to Group Risk.
Training and development. The 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.
At 31 December 2004, the risk asset ratios were 10.0 per cent for total capital and 8.9 per cent for tier 1 capital. The 8.9 per cent tier 1 capital ratio appears higher than would perhaps be expected and reflects the higher level of supervisory deductions resulting from the Group’s significant investment in its life assurance operations.
During 2004, total capital for regulatory purposes increased by £13 million to £13,273 million. Tier 1 capital increased by £502 million, mainly as a result of profit retentions. However, tier 2 capital decreased by £135 million largely due to the reduction in the Group’s general bad debt provision. There was an increase in supervisory deductions of £354 million, mainly as a result of an increase of £300 million in the long-term assurance business attributable to the shareholder to £6,781 million, from £6,481 million in December 2003.
Lloyds TSB Group has long recognised the importance of corporate responsibility (sometimes described as corporate social responsibility). 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 corporate responsibility indices, league tables and investor ratings.
During 2004 the Group further embedded its balanced scorecard as a tool to support the business strategy and values and to provide a means to balance the needs of customers, staff and shareholders. The balanced scorecard seeks to ensure that staff performance is measured on customer service, building customer relationships, people management and assessment of risk as well as sales and financial measures. Where appropriate, management remuneration and incentives are linked directly to specific areas of corporate responsibility performance: for example service quality.
From 1 January 2005, the Group is using International Financial Reporting Standards (‘IFRS’) as its primary financial reporting framework. The Group will report IFRS results for the first time in its interim report for the six months to 30 June 2005 and in its 2005 annual report. Comparative information in these reports will be fully reconciled to reported UK GAAP numbers.
Loan impairment IFRS adopts an incurred loss model for impairment losses on loans and provides guidance on the measurement of impairment. An allowance is raised for losses in respect of exposures that are known to be impaired. The required allowance is computed by comparing the book value of the loans with the net present value of the expected future cash flows from the loans discounted at their effective interest rates or, as a practical expedient for variable rate loans, using observable market prices. Exposures found not to be impaired are placed into pools of similar assets with similar risk characteristics to be collectively assessed for losses that have been incurred, but not yet identified. For such exposures, the required allowance is estimated on the basis of historical loss experience for assets with credit risk characteristics similar to those in the collective pool. The historical loss experience is adjusted based on current observable data. These more prescriptive requirements are expected to lead to increased volatility in the charge made to the income statement.
Equity to debt reclassification The classification of the majority of the Group’s capital and subordinated debt instruments will continue to follow their current treatment. However, the limited voting ordinary shares of Lloyds TSB Group plc will be reclassified as debt. In addition, the Group’s preferred securities, which are treated as non-equity minority interests under UK GAAP, will be reclassified as debt. Distributions on these securities will be shown as interest expense rather than as minority interests.
Fee income Revised rules governing the accounting for fee income will result in more fees being deferred on initial receipt, and recognised either as an adjustment to yield or over the period of service. Fees required to be treated as an adjustment to yield will be recognised in interest income rather than fee income. On initial application, certain fees that have previously been credited to the profit and loss account under UK GAAP will be recognised in the balance sheet, with a corresponding reduction in retained earnings.
IFRS requires line-by-line consolidation for all subsidiaries. Consequently, the Group is no longer permitted to report the results and balances of the life assurance business on one line; instead these amounts must be broken down into their constituent parts and allocated to the appropriate line items. IFRS will also require consolidation of several entities that the Group was not required to consolidate under UK GAAP. These relate to the entities supporting the Group’s securitisation conduits, which facilitate customers’ own securitisations, and to Open Ended Investment Companies (OEICs) where the Group, through the Scottish Widows life funds, has an interest. This will have the effect of grossing-up the balances reported in the income statement and on the balance sheet.
Capitalisation of software Currently only software costs relating to separable new systems are capitalised. Under IFRS, costs relating to enhancements that lead to additional system functionality will also be capitalised. The impact on the Group’s income statement will depend on the level of IT expenditure and whether it meets the criteria for capitalisation.
The exclusion of future investment margins will result in an adjustment to retained earnings as at 1 January 2004 and will lead to increased volatility in the reported income from long-term assurance business.
‘Realistic’ basis. The FSA requires each life assurance company which contains a with-profits fund in excess of £500 million, including Scottish Widows, to carry out a ‘realistic’ valuation of that fund. The word ‘realistic’ in this context reflects the terminology used for reporting to the FSA and is an assessment of the financial position of a with-profits fund calculated under a prescribed methodology. The methodology has the effect of limiting the assumed average future investment return to the risk free rate and represents a best estimate of a theoretical market value of the liabilities.
Each life assurance company must retain sufficient capital to meet the regulatory capital requirements mandated by the FSA; the basis of calculating the regulatory capital requirement is given below. For the companies described above, with the exception of Scottish Widows, the regulatory capital requirement is a combination of amounts held in respect of actuarial reserves and sums at risk (the Long-Term Insurance Capital Requirement) and amounts required to cover various stress tests. The regulatory capital requirement is deducted from the available capital resources to give ‘statutory excess capital’.
The estimated financial position of the With-Profits Fund of Scottish Widows at 31 December 2004, calculated on a ‘realistic’ basis, is given in the following table, in the form that the information will be reported to the FSA. As a result of the capital support arrangements, it is considered appropriate to also disclose the ‘realistic’ financial position of the Long-Term Fund of Scottish Widows as a whole, which consists of both the With-Profits Fund and the Non-Participating Fund.
Realistic value of assets available to the fund 19,079 22,012 Realistic value of liabilities of fund (18,108) (17,827)
The realistic liabilities of the With-Profits Fund disclosed above include amounts payable from the With-Profits Fund to the Non-Participating Fund of Scottish Widows in respect of the shareholders’ share of future bonuses and other charges due as a result of the Scheme. The value of the liabilities excluding the shareholders’ share of future bonuses is £17,988 million. The value of the liabilities excluding the value placed on all interfund transfers is £17,353 million, and the value of excess assets in the With-Profits Fund after eliminating those amounts (excluding the value of the Support Account) is £461 million.
Excess assets in the Long-Term Fund of Scottish Widows on a realistic basis 4,185 * A reconciliation of the total shareholders’ funds on a modified statutory solvency basis (£4,581 million) to the amount included in the Group’s balance sheet on an embedded value basis (£6,781 million) is included in note 29(h) to the financial statements.
Scottish Widows has a formal arrangement with one of its subsidiary undertakings, Scottish Widows Unit Funds Limited, whereby the subsidiary company can draw down capital from Scottish Widows to finance new business which is reinsured from the parent to its subsidiary. Scottish Widows has also provided subordinated loans to its fellow group undertakings, Scottish Widows Annuities Limited and Scottish Widows Bank plc.
The most significant options and guarantees provided from within the With-Profits Fund are in respect of guaranteed minimum cash benefits on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies. As noted above, under the realistic capital regime of the FSA, the liabilities of the With-Profits Fund are valued using a market-consistent stochastic simulation model. This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
Abbey Life currently has a number of policies in-force which have a guaranteed annuity option. In total it holds statutory reserves of £288 million to cover this liability at 31 December 2004. These reserves have been determined using prudent future interest rate, mortality rate and rate of annuity option take-up assumptions and exceed the value that would be placed on them using a market-consistent stochastic model. It is estimated that a 0.5 per cent reduction in future interest rates would increase the liability by some £45 million.
Under some of Abbey Life’s older contracts, the maturity value or the surrender value at the end of the selected period is guaranteed to be not less than total premiums paid or sums assured. The total provision for these options was £11 million at 31 December 2004 and was established using stochastic techniques after making prudent assumptions.
Profit and loss account data for the year ended 31 December (£m)1
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 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.
Deputy Chairman (leaving on 5 May 2005) 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. Aged 60.
Wolfgang C G Berndt✠†† Joined the board in 2003. Joined Procter and Gamble in 1967 and held a number of senior and general management appointments in Europe, South America and North America, before retiring in 2001. A non-executive director of Cadbury Schweppes and GfK AG. Board member of the Institute for the Future. Aged 62.
Joined the board in 2001. Held a number of senior appointments in the UK and USA with the World Bank, Royal Dutch/Shell Group and British Airways, before membership of the Bank of England Monetary Policy Committee from 1997 to 2001. Chaired HM Treasury’s banking services consumer codes review group in 2000/1. Chairman of the Royal Institute of International Affairs. A non-executive director of BP, Serco Group and Roche Holdings SA. Aged 55.
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 and the Port of London Authority. Aged 54.
◆◆ Chairman of the nomination committee † Member of the remuneration committee
Archie G Kane Group Executive Director, Insurance and Investments Joined TSB Commercial Holdings in 1986 and held a number of senior and general management appointments in Lloyds TSB Group before being appointed to the board in 2000, as group executive director, IT and Operations. Appointed group executive director, Insurance and Investments in October 2003. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as finance director in the UK from
Helen A Weir Group Finance Director Joined the board in 2004. Group finance director of Kingfisher from 2000 to 2004. Previously finance director of B&Q from 1997, having joined that company in 1995, and held a senior position at McKinsey & Co from 1990 to 1995. Began her career at Unilever in 1983. A non-executive director of The City of London Investment Trust. Aged 42.
An interim dividend of 10.7p per ordinary share was paid on 6 October 2004 and a final dividend of 23.5p per ordinary share will be paid on 4 May 2005. These dividends will absorb £1,914 million.
Mrs Weir joined the board on 26 April 2004 and was elected at the annual general meeting on 21 May 2004.
In the UK, the Lloyds TSB Group supports Opportunity Now and is represented on the board of Race for Opportunity; campaigns to improve opportunities for women and ethnic minorities in the work place. The Lloyds TSB Group is a gold card member of the Employers’ Forum on Disability, in support of employment of people with disabilities. This recognises the need for ensuring fair employment practices in recruitment and selection, and the retention, training and career development of disabled staff.
Each resolution considered at the annual general meeting in 2004 was decided on a poll. Votes representing some 50 per cent of the total number of shares in issue were cast and each resolution was passed by a substantial majority. Details of the poll results are available from the company secretary.
compliance with financial services legislation and regulations (more information about which is given in the note about internal control on page 46); procedures by which staff may raise concerns in confidence; the results of the external audit and its cost effectiveness; reports from the external auditors on audit planning and their findings on accounting and internal control systems; and the committee’s own role and performance. The committee also had a meeting with the auditors, without executives present, and a meeting with the head of internal audit alone.
The risk oversight committee comprises Mr Pritchard (chairman), Mr van den Bergh, Mr Brown and Sir Julian Horn-Smith. All non-executive directors are invited to attend meetings if they wish. The risk oversight committee’s duties include overseeing the development, implementation and maintenance of the Group’s overall risk governance framework, risk appetite, risk strategy and policies, to ensure they are in line with emerging regulatory, corporate governance and industry best practice. The committee also oversees the Group’s risk exposures; facilitates the involvement of non-executive directors in risk issues and aids their understanding of these issues; oversees adherence to Group risk policies and standards and considers any material amendments to them; and reviews the work of the Group Risk division. The risk oversight committee reports to the board on its deliberations after each meeting.
The attendance of directors at board meetings and at meetings of the audit, nomination, remuneration and risk oversight committees during 2004 was as follows: Audit Nomination Remuneration Risk oversight Board committee committee committee committee
• The long-term rewards are aligned to shareholders’ interests and executive directors are expected to build a shareholding in the Group over a period of four years equivalent to the value of one times the director’s annual basic salary.
Executive directors’ remuneration is made up of basic salary, annual bonus, long-term incentives, pensions and other benefits. In 2005, approximately 75 per cent (82 per cent for the group chief executive) of an executive director’s potential direct remuneration (salary, annual bonus and long-term incentives) will be performance related (see illustrative charts below). The value of long-term incentives is the expected value calculated by using a ‘binomial’ model, which is a widely accepted methodology for this purpose.
Remuneration committee membership £15,000 £10,000 Risk oversight committee membership £15,000 –
Basic salaries are reviewed annually, usually in December, taking into account individual performance and market information (which is provided by TPFC) and then adjusted from 1 January of the following year. Basic salary increases for other employees across the Group will be in the range of 0-10 per cent, and the salary increases awarded to executive directors are consistent with this policy. Details of salaries payable to executive directors in 2005 are shown on page 50.
Under the performance share plan agreed at the annual general meeting in May 2004, executive directors are required to defer 50 per cent of any bonus payable into shares in the Company, known as bonus shares. The bonus shares will be held on behalf of the executive for a period of three years before release. The amounts deferred into bonus shares in respect of the 2004 bonus, before the deduction of income tax, will be: Name J E Daniels M E Fairey A G Kane G T Tate H A Weir
Under the new plan, executives will be eligible for an award of free shares, to be known as performance shares, to match the bonus shares. The maximum match will be two performance shares for each bonus share, awarded at the end of the three year retention period. The number of performance shares actually awarded will depend on the Company’s TSR performance measured over the three year period ending 31 December 2007, compared with the TSR of the other companies in the comparator group listed below. The maximum of two performance shares for each bonus share will be awarded only if the Company’s TSR performance places it first in the comparator group; one performance share will be awarded for each bonus share if the Company is placed fifth; and one performance share for every two bonus shares if the Company is placed eighth (median). Between first and fifth positions and fifth and eighth positions a sliding scale will apply. If the TSR performance is below median no performance shares will be awarded. There will be no retest. In December 2004, the Inland Revenue issued new guidance which will require income tax to be deducted before the deferral into bonus shares. This is a change that effectively would alter the balance under the long-term arrangements, and as a result would reduce any performance related match. Therefore, to avoid this inbalance, where a match with performance shares is justified it will be made on a notional deferral as if income tax had not been deducted at the outset. This maintains the intention of the original design of the plan.
The remuneration committee believes that the out-performance of Lloyds TSB Group’s TSR compared with that of the companies in the comparator group will demonstrate the success of the Group’s strategy.
In 2004, options were granted to executive directors and senior executives within the scheme limits. These limits relate to the number of shares under option and the price payable on exercise. The maximum limit for the grant of options to an executive director in any one year was one and a half times annual basic salary multiplied by a performance multiplier of 3.5 (although in exceptional circumstances, for example on the recruitment of a new executive, that could be increased to four times annual basic salary multiplied by 3.5). The table on pages 55 and 56 gives the number of options granted.
During 2004, one of the current executive directors received a fee of £11,300, which was retained, for serving as a non-executive director of another company.
Salaries/ Other benefits related for loss of 2004 fees Cash Non cash payments office Total 2003
Directors have a normal retirement age of 60. In the event of death in service, a lump sum of four times salary is payable plus, for members of a defined benefit scheme, a spouse’s pension of two-thirds of the member’s prospective pension. On death in retirement, a spouse’s pension of two-thirds of the member’s pension is payable. The defined benefit schemes are non-contributory. Members of defined contribution schemes are required to contribute.
Additional Defined benefit scheme members Accrued Accrued Transfer Transfer pension pension at pension at Change in value at value at Change in earned to Transfer 31December 31 December accrued 31December 31 December transfer 31December value of the
† The changes in beneficial interests between 31 December 2004 and 3 March 2005 related to ‘partnership’ and ‘matching’ shares acquired under shareplan.
At 31 December Former directors Granted Exercised/ 2004 (or earlier Exercise periods who served during lapsed during date of leaving Exercise during 2004 At 1 January 2004 the year the year the board) price From To Notes
Share plan 2003 S C Targett 331,125 331,125§ – (see page 57)
h) Not exercisable as the option has not been held for the period required by the relevant scheme.
i) Market price of shares is below the share option exercise price.
§ These share options lapsed when Mr Hampton and Mr Targett left the board on 12 January 2004 and 30 April 2004, respectively.
None of the other directors at 31 December 2004 had options to acquire shares in Lloyds TSB Group plc or its subsidiaries.
The following table contains information on the performance conditions for executive options granted since 1996. The remuneration committee chose the relevant performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time.
As for March 1996 plus a further condition that the Company’s ranking based on TSR over the relevant period should be in the top fifty companies of the FTSE 100.
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report and the financial statements in accordance with applicable United Kingdom law and accounting standards are set out in the statement of directors’ responsibilities on page 45. The directors are also responsible for preparing the directors’ remuneration report.
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.
Basis of audit opinion We conducted our audit in accordance with auditing standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the auditable part of the directors’ remuneration report. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Company’s and the Group’s circumstances, consistently applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements and the auditable part of the directors’ remuneration report are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements.
Opinion In our opinion: • the financial statements give a true and fair view of the state of affairs of the Company and the Group as at 31 December 2004 and of the profit and cash flows of the Group for the year then ended; • the financial statements have been properly prepared in accordance with the Companies Act 1985; and
Income from long-term assurance business 29 715 436 17 453 General insurance premium income 554 535 – 535
Amounts written off fixed asset investments 5 52 44 – 44
Share of results of joint ventures 20 – (22) – (22) (Loss) profit on sale of businesses 6 (15) – 865 865
Current liabilities Amounts falling due within one year: Amounts owed to group undertakings 1,741 1,913 Other creditors 107 106 Dividend payable 1,315 1,314
Profit attributable to shareholders 2,421 3,254 Currency translation differences on foreign currency net investments (11) 118 Actuarial losses recognised in post-retirement benefit schemes (237) (6) Deferred tax thereon 71 2
Taxation: – UK corporation tax (656) (598) – Overseas tax (107) (186) Total taxation (763) (784)
Acquisitions and disposals: – Additions to interests in joint ventures – (12) – Acquisition of group undertakings and businesses 49e (16) (1,106) – Disposal of group undertakings and businesses 49g (25) 2,382 Net cash (outflow) inflow from acquisitions and disposals (41) 1,264
In December 2004, the Accounting Standards Board (‘ASB’) issued Financial Reporting Standard 27 ‘Life Assurance’. The Group will implement the requirements of this standard in its 2005 accounts; however, in accordance with the Memorandum of Understanding entered into by leading members of the life assurance and bancassurance sectors and the Association of British Insurers with the ASB, certain additional disclosures have been given in ‘Operating and financial review and prospects’ attached to these accounts.
As a result, the Scottish Widows goodwill is not being amortised through the profit and loss account; however, it is subjected to annual impairment reviews in accordance with Financial Reporting Standard 11, ‘Impairment of Fixed Assets and Goodwill’. Impairment of the goodwill is evaluated by comparing the present value of the expected future cash flows, excluding financing and tax, (the ‘value-in-use’) to the carrying value of the underlying net assets and goodwill. If the net assets and goodwill were to exceed the value-in-use, an impairment would be deemed to have occurred and the resulting write-down in the goodwill would be charged to the profit and loss account immediately.
For the Group’s other lending portfolios, specific provisions are calculated on a case-by-case basis. In establishing an appropriate provision, factors such as the financial condition of the customer, the nature and value of any collateral held and the costs associated with obtaining repayment and realisation of the collateral are taken into consideration.
In those cases where the operation of the customer’s account has ceased and it has been transferred to a specialist recovery department, the advance is written down to its expected net realisable value and interest is no longer charged to the customer’s account as the likelihood of its recovery is considered remote. Interest is only taken to income if it is received.
Payments made under cash gift and discount mortgage schemes, which are recoverable from the customer in the event of early redemption, are amortised as an adjustment to net interest income over the early redemption charge period. Payments cease to be deferred and are charged to the profit and loss account in the event that the related loan is redeemed or becomes impaired.
Shares in group undertakings are stated in the balance sheet of the Company at its share of net assets, with the exception of the life assurance group undertakings which are stated on the basis described in o. Attributable goodwill is included, where this has not been written-off directly to reserves.
When a leasehold property ceases to be used in the business or a commitment is entered into which would cause this to occur, provision is made to the extent that the recoverable amount of the interest in the property is expected to be insufficient to cover future obligations relating to the lease.
Assets leased to customers are classified as finance leases if the lease agreements transfer substantially all of the risks and rewards of ownership to the lessee; all other leases are classified as operating leases.
The Group operates both defined benefit and defined contribution post-retirement benefit schemes.
The costs of the Group’s defined contribution pension schemes are charged to the profit and loss account in the period in which they fall due.
The Group accounts for its interest in long-term assurance business using the embedded value basis of accounting. The value of the shareholder’s interest in the long-term assurance business (‘the embedded value’) included in the Group’s balance sheet is an actuarially determined estimate of the economic value of the Group’s life assurance subsidiaries, excluding any value which may be attributed to future new business. The embedded value is comprised of the net tangible assets of the life assurance subsidiaries, including any surplus retained within the long-term business funds, which could be transferred to the shareholder, and the present value of the in-force business. The present value of the in-force business is calculated by projecting the future surpluses and other net cash flows attributable to the shareholder arising from business written by the balance sheet date, using appropriate economic and actuarial assumptions, and discounting the result at a rate which reflects the shareholder’s overall risk premium attributable to this business.
Securities which have been sold with an agreement to repurchase continue to be shown on the balance sheet and the sale proceeds recorded within deposits by banks or customer accounts as appropriate. Securities acquired in reverse sale and repurchase transactions are not recognised on the balance sheet and the purchase price is recorded within loans and advances. The difference between the sale price and repurchase price is accrued evenly over the life of the transaction and charged or credited to the profit and loss account as interest payable or receivable.
The Group’s activities are organised into three businesses: UK Retail Banking, Insurance and Investments and Wholesale and International Banking. Services provided by UK Retail Banking encompass the provision of banking and other financial services, private banking and mortgages to personal customers. Insurance and Investments offers life assurance, pensions and savings products, general insurance and fund management services. Wholesale and International Banking provides banking and related services for major UK and multinational companies, banks and financial institutions, and small and medium-sized UK businesses. It also provides asset finance to personal and corporate customers, manages the Group’s activities in financial markets through its Treasury function and provides banking and financial services overseas.
Other finance income – – – – – 39 39 – 39
Other finance income – – – – – 34 34 – 34
* From the beginning of 2004 the Group changed its UK branch and other distribution networks from cost centres to profit centres and, consequently, amended the internal commission arrangements between these networks and the insurance product manufacturing businesses within the Group. The effect of this change has been to redistribute income from the insurance segments to UK Retail Banking and, to a lesser extent, to Wholesale. In addition, certain costs previously included in Central group items were reallocated to the operating segments. The 2003 segmental analysis has been restated to reflect these changes on a consistent basis.
Foreign exchange trading income 178 228 Securities and other gains 93 332
Statutory audit 5.2 5.5 Other audit related fees: – Audit related regulatory reporting 0.9 0.9 – Further assurance services 6.4 3.3 Total other audit related fees 7.3 4.2
Included in ’Other audit related fees’ are the costs of the advice provided in relation to the Group’s preparations for the implementation of International Financial Reporting Standards and the requirements of the Sarbanes-Oxley Act together with the costs of the audit of the Group’s Form 20-F filing.
During 2003 the Group completed the sales of its French fund management and private banking businesses, including its subsidiaries Lloyds Bank SA, Chaillot Assurances SA and Capucines Investissements SA; its Brazilian subsidiaries Banco Lloyds TSB S.A. and Losango Promotora de Vendas Ltda, together with substantially all of the business of the Brazilian branch of Lloyds TSB Bank plc and certain offshore Brazilian assets; and its subsidiary, NBNZ Holdings Limited, comprising the Group’s New Zealand banking and insurance operations.
UK corporation tax: – Current tax on profits for the year 841 1,079 – Adjustments in respect of prior years (38) (72)
Future transfers from Scottish Widows plc’s long-term business fund to its shareholder’s fund will be subject to a shareholder tax charge. Under FRS 19, no provision is required to be made since the timing of such transfers is under Scottish Widows plc’s control. The potential deferred tax liability (undiscounted) not recognised on the balance sheet is approximately £230 million (2003: £110 million).
The profit attributable to shareholders includes a profit of £1,921 million (2003: £1,880 million) dealt with in the accounts of the parent company for which no profit and loss account is shown as permitted by Section 230 of the Companies Act 1985.
Profit attributable to shareholders† £2,421m £3,254m Weighted average number of ordinary shares in issue during the year‡ 5,590m 5,581m Dilutive effect of options outstanding 35m 18m Diluted weighted average number of ordinary shares in issue during the year 5,625m 5,599m Earnings per share 43.3p 58.3p Diluted earnings per share 43.0p 58.1p
† No adjustment was made to profit attributable to shareholders in calculating diluted earnings per share.
Geographical analysis by issuer: United Kingdom – 336 Latin America 18 70
Included above: Unamortised discounts net of premiums on investment securities – 2
Bills sold or matured (830) (5) (835) Adjustments on disposal of businesses (37) – (37) Amortisation of premiums and discounts – 3 3
Total loans and advances to banks 23,566 15,565 Provisions for bad and doubtful debts (1) (18)
Total loans and advances to customers 155,923 136,956 Provisions for bad and doubtful debts (1,662) (1,677) Interest held in suspense (21) (28)
Exchange and other adjustments (11) – (1) – Adjustments on acquisitions and disposals (21) (12) (49) (5) Transfer from general to specific provisions 3 (3) 50 (50) Advances written off (1,028) – (1,145) – Recoveries of advances written off in previous years 174 – 178 – Charge (release) to profit and loss account: New and additional provisions 1,571 12 1,552 9
Non-performing lending comprises: Accruing loans on which interest is being placed in suspense 567 633 Loans accounted for on a non-accrual basis 673 585
Loans and advances to customers Domestic Agriculture, forestry and fishing 2,076 2,025
Due within 1 year 4,090 5,045 Due 1 year and over 21,104 23,624
Movements in investment securities: Exchange and other adjustments (484) – (2) (482)
19 Assets transferred under sale and repurchase transactions 2004 2003 £m £m
GF One Limited (formerly Goldfish Bank Limited, a wholly owned subsidiary of GF Two Limited) has lent £44 million (2003: nil) to the Group and this amount is included in customer accounts. Interest payable to GF One Limited of £1 million (2003: nil) has been charged to the Group’s profit and loss account and capitalised in this balance.
Balance sheet Assets: Loans and advances to customers – – 410 345 Debt securities – – 3,770 3,718 Tangible fixed assets 1,742 1,408 – – Other assets and prepayments 49 23 36 34
Cash flow statement Net cash inflow from operating activities 388 132 52 1,173 23 Intangible fixed assets Cost Amortisation Net book value £m £m £m
Balance sheet amount at 31 December 2003 776 890 2,252 £m £m
Balance sheet amount of premises comprises: Leaseholds 50 years and over unexpired 140 133 Leaseholds less than 50 years unexpired 275 274
Residual value expected to be recovered in: 1 year or less 378 181 2 years or less but over 1 year 128 330 5 years or less but over 2 years 647 505
Obligations under finance leases were: Premises Equipment Premises Equipment £m £m £m £m
Interest receivable 1,075 869 Deferred expenditure incurred under cash gift and discount mortgage schemes 78 128 Other debtors and prepayments 1,420 921
29 Long-term assurance business a Analysis of embedded value 2004 2003 £m £m
The embedded value included in the consolidated balance sheet comprises: Net tangible assets of life companies including surplus 3,842 3,602 Value of other shareholder’s interests in the long-term assurance business 2,939 2,879 £m £m
Operating profit 578 363 Investment variance 139 112 Changes in economic assumptions (see e) (2) (22)
Income from long-term assurance business before tax 715 453 Attributed tax (199) (157)
The revised assumptions have resulted in a net charge to the profit and loss account of £2 million.
Other assumptions used to derive the embedded value are as follows: • Assumed rates of mortality and morbidity are taken from published tables adjusted for demographic differences. Assumptions in respect of lapse rates take into account both the effects of recent actual experience and future expectations of the companies concerned.
For the purposes of consolidating the long-term assurance policyholder assets and liabilities into the Group’s balance sheet a deduction has been made of £130 million (2003: £122 million) for own shares held within the with-profit funds.
Under the modified statutory solvency basis, the results of the Group’s long-term life and pensions businesses were as follows: £m £m
Balance on the technical account – long-term business 456 229 Tax attributable to balance on the technical account – long-term business 155 112 Income in shareholder fund 55 34
Profit on ordinary activities before tax 666 375 Tax on profit on ordinary activities (170) (125)
Profit on ordinary activities after tax 496 250 Dividends proposed (200) –
Other differences: Movement in deferred acquisition costs 89 66 Tax adjustment 7 (60)
Assets held to cover linked liabilities 28,256 25,023 Other assets 1,992 2,018
Assets Denominated in sterling 171,704 153,775 Denominated in other currencies 53,375 48,159
Repayable on demand 93,846 90,539 Other customer accounts with agreed maturity dates or periods of notice by residual maturity repayable: 3 months or less 18,938 17,316 1 year or less but over 3 months 2,442 1,846 5 years or less but over 1 year 5,632 5,431
37 Other provisions for liabilities and charges Customer Vacant remediation Insurance leasehold property provisions provisions and other Total £m £m £m £m
The Group’s general insurance subsidiary maintains provisions for outstanding claims which represent the ultimate cost of settling all claims arising from events which have occurred up to the balance sheet date and these include provisions for the cost of claims notified but not settled and for claims incurred but not yet reported. In addition, in line with the requirements of the Insurance Companies (Reserves) Act 1995, a claims equalisation provision is maintained in relation to property business. The majority of provisions in respect of claims will be settled in the following year, although new provisions will then be required in respect of claims arising from that year. The level of the claims equalisation provision will be adjusted annually, taking into account the guidelines contained in the legislation, and such provisions will be held for as long as the Group continues to write the relevant types of general insurance business.
Dated loan capital Subordinated Floating Rate Notes 2004 – 5 – – 73/8% Subordinated Bonds 2004 – 400 – – Subordinated Floating Rate Notes 2004 – 100 – –
51/4% Subordinated Notes 2008 (DM 750 million) 270 269 – – 105/8% Guaranteed Subordinated Loan Stock 2008 e 100 100 – –
Subordinated Step-up Floating Rate Notes 2009 callable 2004 (US$500 million) – 279 – – 61/4% Subordinated Notes 2010 (c400 million) 281 281 – – Subordinated Floating Rate Notes 2010 (US$400 million) a 207 223 – –
5.75% Subordinated Step-up Notes 2025 callable 2020 i 346 – – –
a) These notes bear interest at rates fixed periodically in advance based on London Interbank rates.
g) In the event that these Notes are not redeemed at the callable date, the coupon will be reset to a floating rate.
Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (c430 million)* 302 301 Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015** 248 248
Authorised: Sterling £m £m 6,911 million Ordinary shares of 25p each 1,728 1,728 79 million Limited voting ordinary shares of 25p each 20 20 175 million Preference shares of 25p each 44 44
Euro ccm cm 160 million Preference shares of c25 cents each 40 40
Issued and fully paid: Ordinary shares of 25p each At 1 January 1,398 Issued under employee share schemes (3 million shares) 1
Merger reserve (the Group): At 1 January and 31 December 2004 343
Profit and loss account (the Company): Movements in relation to own shares (note 43) 8 Transfer from revaluation reserve 1 Profit for the year 7
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
In addition, a further 0.2 million ordinary shares were held by Lloyds TSB Group Holdings (Jersey) Limited at 31 December 2004 (2003: 0.4 million shares). These shares, on which the dividend entitlement has been waived, were gifted to Lloyds TSB Group some years ago at nil cost and are used to satisfy outstanding options or to meet commitments arising under other employee share schemes.
Purchases of, and subscriptions for, shares 57 Use of shares on exercise of employee options and for other employee share plans (67) Shares forfeited in the year 2
At 31 December 2004, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons and with officers included: 2004 2004 2003 2003
Loans and credit card transactions: Directors and connected persons 4 3,217 6 3,199
The Group enters into transactions with its long-term assurance businesses, which cannot be eliminated in the consolidated accounts because of the basis of accounting used for the Group’s long-term assurance businesses. After taking into account legally enforceable netting agreements, at 31 December 2004 Group entities owed £2,254 million (2003: £1,995 million) and were owed £97 million (2003: £136 million); these amounts are included in customer accounts and loans and advances to customers respectively. Furthermore Scottish Widows plc has provided £50 million (2003: £30 million) of subordinated loan capital to Scottish Widows Bank plc, which is included in other liabilities. In addition, fees of £201 million (2003: £107 million) were received, and fees of £49 million (2003: £71 million) were paid, in respect of distribution, asset management and other services.
The majority of the Group’s employees are members of the defined benefit sections of Lloyds TSB Group Pension Schemes No’s 1 and 2. During 2003 and 2004, no contributions have been made to the Lloyds TSB Group Pension Scheme No. 2. However, with effect from 1 July 2003 the Group recommenced contributions to the Lloyds TSB Group Pension Scheme No. 1 at a rate of 31.7 per cent of pensionable salary; this was increased to 56.5 per cent of pensionable salary with effect from 1 January 2004. Since the defined benefit sections of these schemes are now closed to new members and the age profile of the active members is increasing, under the projected unit method, the current service cost will increase as the members of the schemes approach retirement.
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 postretirement healthcare for all eligible former employees (and their dependents) who retired prior to 1 January 1996. For retirements subsequent to this date, the Group also met a reducing proportion of the cost until 31 December 2004, since which date the only obligation is in respect of the pre 1 January 1996 retirements.
Included within other finance income is an interest cost of £4 million (2003: £5 million) in respect of these defined benefit post-retirement healthcare schemes.
The pension and other post-retirement benefit cost in respect of defined benefit schemes comprises: £m £m
Amount recognised in the statement of total recognised gains and losses (166) (4)
The experience gains and losses recognised can also be analysed as follows: £m £m £m £m
Actual return less expected return on scheme assets: Percentage of scheme assets at balance sheet date 3.2% 7.6% 28.4% 18.1% Experience gains and losses arising on scheme liabilities: Percentage of scheme liabilities at balance sheet date 0.8% 0.7% 2.0% 0.7% Total amount recognised in the statement of total recognised gains and losses: Percentage of scheme liabilities at balance sheet date 1.6% 0.0% 27.5% 26.9%
Deficit in the schemes (3,187) (3,055) Related deferred tax asset 956 916
Deficit at beginning of year (3,055) (2,931) Exchange and other adjustments (2) (4) Other finance income 39 34 Current service costs (289) (269)
Past service costs (17) (51) Actuarial loss (237) (6) Adjustments on disposal of businesses – 34
Lloyds TSB Group’s maximum exposure to loss is represented by the contractual nominal amount detailed in the table below. Consideration has not been taken of any possible recoveries from customers for payments made in respect of such guarantees under recourse provisions or from collateral held or pledged.
Commitments Documentary credits and other short-term trade-related transactions 431 368 Forward asset purchases and forward deposits placed 1,654 546 Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year maturity 63,196 62,440 1 year or over maturity 20,009 15,981 47 Derivatives and other financial instruments
Derivative contracts expose the Group to both market risk and credit risk. Only a few highly specialist trading centres within the Group are permitted to enter into derivative contracts and the level of exposure to interest rate and exchange rate movements and other market variables is strictly controlled and monitored within approved limits.
Cumulative interest rate repricing gap (20,052) (21,144) (18,119) 5,902 7,341 – – –
US dollar 271 255 Swiss franc 58 104 Other non-sterling 202 200
At 31 December 2004, the unrecognised gains on financial instruments used for hedging were £272 million (2003: £303 million) and unrecognised losses were £424 million (2003: £219 million).
Of the net losses of £152 million at 31 December 2004, £49 million of net losses are expected to be recognised in the year ending 31 December 2005 and £103 million of net losses in later years.
During the year ended 31 December 2003, the Group completed the acquisition of the credit card and personal loan businesses of Goldfish Bank Limited, together with the Goldfish brand and loyalty programme, for a consideration of £1,096 million, settled in cash. The premium arising of £96 million from the effective payment to the majority shareholder was capitalised and is being written off to the profit and loss account over its estimated useful life of 10 years. No significant fair value adjustments were made.
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 the shareholder 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 the shareholder (see note 29) as adjusted for dividends. 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 2004 2003 £m £m
Net cash inflow from operating activities 3,469 772 b Analysis of cash as shown in the balance sheet 2004 2003 £m £m
Cash and balances with central banks 1,078 1,195 Loans and advances to banks repayable on demand 2,477 3,768
The Group is required to maintain balances with the Bank of England which, at 31 December 2004, amounted to £187 million (2003: £177 million).
Net cash outflow before adjustments for the effect of foreign exchange movements (1,403) (487) Effect of foreign exchange movements (5) (3)
The amounts shown as cash inflows from financing include proceeds in respect of the above issues of share capital together with a net cash inflow of £1 million (2003: outflow of £13 million) relating to transactions in own shares held in respect of employee share schemes.
Equity minority interests: Exchange and other adjustments – (1) Minority share of profit after tax 26 22 Dividends paid to minority shareholders (24) (14)
Cash consideration refunded in respect of acquisition in 2002 – (5) Deferred consideration in respect of acquisition in 2002 1 1
Substantial shareholdings At the date of this report notifications had been received that Legal & General Investment Management Limited and The Capital Group Companies had interests of 3% and 5.75%, 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.
Share price information In addition to information published in the financial pages of the press, the latest price of Lloyds TSB shares on the London Stock Exchange can be obtained
For internet dealing the current rate of commission for both purchases and sales is 0.5%, minimum £17.50. Visit www.shareview.co.uk/dealing for full details.
For details please contact The Bank of New York, Investor Services, PO Box 11258, Church Street Station, New York, NY 10286-1258. Telephone (1) 888 BNY ADRS (US toll free), international callers visit www.adrbny.com or email shareowners@bankofny.com
• to obtain a form for dividends to be paid directly to your bank or building society account (tax vouchers will still be sent to your registered address unless you request otherwise)
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