Our vision To be the best financial services organisation in the UK
Wholesale and International Banking • grow the Corporate Markets business • build on the growth momentum in Commercial Banking • maintain strong asset quality
Our confidence in our business model and its ability to increase earnings throughout the economic cycle led to our decision to increase the dividend by 5 per cent year on year. This is the first year in five that we have increased our dividend and supports our long term shareholder proposition; going forward, we expect to continue to grow our dividend whilst continuing to build dividend cover.
Our lower risk strategy limited the impact of the abrupt change in the markets and, consequently, our charge was relatively modest in comparison to our balance sheet size, our earnings, and the charges taken by many other organisations. This is in large part due to the conscious choice to focus the Group’s strategy on building deep, long-lasting relationships with our customers in order to deliver high quality, sustainable results over time.
Building strong customer relationships Lloyds TSB’s strategy to build strong customer franchises and grow our business by realising the considerable potential within those franchises continues to deliver strong results. We have continued to extend the reach and depth of our customer relationships, achieving good sales growth, whilst also improving productivity and efficiency. The underlying performance of the business remains strong with revenue growth remaining well ahead of cost growth.
“Throughout the recent market-wide liquidity turmoil, Lloyds TSB has maintained a strong liquidity position.”
Key highlights • Excellent profit performance. Profit before tax increased by 17 per cent to £1,808 million, excluding the settlement of overdraft claims.
“Overall sales increased by 17 per cent, with improvements over a broad range of products, especially current accounts, credit cards and bank savings products.”
Within Scottish Widows this will be achieved by developing strong and enduring relationships, developing market-led propositions and being easy to do business with. Scottish Widows products are distributed through Lloyds TSB Group channels, independent financial advisers and other intermediaries. Scottish Widows was voted Best Individual Pensions Provider by IFAs and is the most trusted choice for pensions amongst UK consumers.
2 The reduction in market values is assumed to have no corresponding impact on dividend yields.
Total reward As well as our competitive salary packages we differentiate our reward through bonus schemes, and various reward and incentive programmes. This helps drive a high commitment, high performance culture where individuals strive for stretching goals.
Learning and development We remain committed to investing in our people through providing efficient and effective learning and development that helps our people to deliver great service and achieve great results. Our focus remains on providing our people with the knowledge and skills they need for their jobs today while continuing to develop the capabilities we will need to be successful in the future.
All business units, divisions and group functions complete a control self-assessment annually (described on page 63), reviewing the effectiveness of their internal controls and putting in place enhancements where appropriate. Managing directors and group executive directors certify the accuracy of their assessment.
Risk appetite Business risk appetite is encapsulated in the Group’s budget and medium-term plan, which are sanctioned by the board on an annual basis. Divisions and business units subsequently align their plans to the Group’s overall business risk appetite.
Where it is efficient and likely to be effective (generally with counterparties with which it undertakes a significant volume of transactions), the Group enters into master netting agreements. Although master netting agreements do not generally result in an offset of balance sheet assets and liabilities, as transactions are usually settled on a gross basis, they do reduce the credit risk to the extent that, if an event of default occurs, all amounts with the counterparty are terminated and settled on a net basis. The Group’s overall exposure to credit risk on derivative instruments subject to master netting agreements can change substantially within a short period since it is affected by each transaction subject to the agreement.
Banking – trading and other financial assets at fair value through profit or loss
Close Average Maximum Minimum Close Average Maximum Minimum £m £m £m £m £m £m £m £m
Market risk in the Group’s retail portfolios and in the Group’s capital and funding activities is managed within limits defined in the detailed group policy for interest rate risk in the banking book, which is reviewed and approved annually.
The capital model outputs are used to determine the internal capital charge for the Group which is then allocated to the businesses within the Group. Following review and approval of the operational risk management framework and capital model the FSA has granted the banking businesses within the Group an Advanced Measurement Approach (AMA) Waiver which recognises the embedding of the operational risk framework across the Group. The waiver allows the Group to calculate its own regulatory capital charge for operational risk from its capital model with effect from 1 January 2008.
Exposure represents the sufficiency of our policies and procedures to maintain adequate books and records to support statutory, regulatory and tax reporting, to present and detect financial reporting fraud and to manage the Group’s tax exposure.
The figures shown above for available capital resources within the insurance business relate to Scottish Widows plc only. The estimated total additional resources relating to the other life assurance subsidiaries within the Group are £330 million.
Adjustments to replace statutory liabilities with ‘realistic’ liabilities (3,696) (3,582) (3,783) (3,614)
The sale of Abbey Life Assurance Company Limited during 2007 reduced total policyholder liabilities by £11,632 million.
In addition, the directors agreed with the committee’s recommendation that Mr Brown be asked to remain on the board for a further year. This would enable the group to continue to benefit from his wide experience and maintain an appropriate balance of skills and experience on the board, as part of the plans for orderly succession for appointments. His continuing membership of the audit committee and understanding of the Group’s activities will be particularly helpful to the new chairman of that committee. Mr Brown remains the senior independent director and both the nomination committee and the board considered the matter very carefully and concluded that Mr Brown was independent in character and there were no relationships or circumstances which were likely to affect, or could appear to affect, the director’s judgement. As stated in the directors’ report, Mr Brown will stand for re-election at the annual general meeting, in accordance with the provisions of the combined code on corporate governance issued by the Financial Reporting Council which apply to independent non-executive directors who have served on the board for more than nine years from the date of their first election.
The directors have responsibility for ensuring that the Company and the Group keep proper accounting records which disclose with reasonable accuracy the financial position of the Company and the Group and which enable them to ensure that the financial statements and the directors’ remuneration report comply with the Companies Act 1985 and, as regards the consolidated financial statements, Article 4 of the IAS Regulation. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and the Group and to prevent and detect fraud and other irregularities.
(d) Revenue recognition Interest income and expense are recognised in the income statement for all interest-bearing financial instruments, except for those classified at fair value through profit or loss, using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. The effective interest rate is calculated on initial recognition of the financial asset or liability, estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts paid or received by the Group including expected early redemptions and related penalties and premiums and discounts that are an integral part of the overall return as well as direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument. Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see j).
2 Critical accounting estimates and judgements The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to the Group’s results and financial position, based upon materiality and significant judgements and estimates, are discussed below.
There are two components of the Group’s loan impairment allowances: individual and collective. All impaired loans which exceed a certain threshold, principally within the Group’s corporate banking business, are individually assessed for impairment having regard to expected future cash flows including those that could arise from the realisation of security. The determination of these allowances often requires the exercise of considerable judgement by management involving matters such as local economic conditions and the resulting trading performance of the customer and the value of the security held, for which there may not be a readily accessible market. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.
Other income (net of fee and commission expense) 1,621 594 9,893 10,487 2,035 201 – 14,344
Credit protection 212 203 8 Other operating income 2007 2006 £m £m
The following types of services are included in the categories listed above: Audit fees: This category includes fees in respect of the audit of the Group’s annual financial statements and other services in connection with regulatory filings. Audit related fees: This category includes fees in respect of services for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements.
Debt securities: Other public sector securities – – – 44 Bank and building society certificates of deposit – 811 – 573
The Group holds collateral with a fair value of £9,109 million (2006: £6,837 million), which it is permitted to sell or repledge, of which £8,482 million (2006: £6,209 million) was repledged or sold to third parties for periods not exceeding three months from the transfer.
Later than 1 year and not later than 5 years 1,917 2,358
Commitments for expenditure in respect of equipment to be leased (184) (443)
Later than 1 year and not later than 5 years 17 –
Insurance contract liabilities Insurance contract liabilities, substantially all of which relate to business written in the United Kingdom, are comprised as follows: Gross Reinsurance* Net Gross Reinsurance* Net £m £m £m £m £m £m
Margins for risk are allowed for in the assumed interest rates. These are derived from the limits in the FSA Rules, including reductions made to the available yields to allow for default risk based upon the credit rating of each stock.
• pursuant to the UK Listing Authority’s listing rules where directors and certain employees of the Company require the approval of the Company to deal in the Company’s shares; and
Value of employee services includes a credit of £30 million (2006: £31 million) reflecting the income statement charge in respect of SAYE and executive options, together with a related tax charge of £14 million (2006: tax credit £34 million). Purchase/sale of treasury shares includes a credit of £29 million (2006: £27 million) relating to the cost of other share scheme awards.
The performance conditions for awards made in March and August 2007 are as follows: (i) For 50 per cent of the award (the ‘EPS Award’) – the performance condition is as described for May 2006 with the relevant performance period commencing on 1 January 2007 and ending on 31 December 2009.
No provisions have been recognised in respect of loans given to key management personnel (2006: £nil).
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk and the Group’s management of capital can be found on pages 36 to 56. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.
In addition the Group has a small number of cash flow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. These cash flows are expected to occur over the next six years and the hedge accounting adjustments will be reported in the income statement as the cash flows arise. The notional principal of the interest rate swaps designated as cash flow hedges at 31 December 2007 was £630 million (2006: £569 million) with a net fair value liability of £23 million (2006: £8 million) (see note 16). In 2007, there is no ineffectiveness recognised in the income statement that arises from cash flow hedges (2006: nil). There were no transactions for which cash flow hedge accounting had to be ceased in 2007 or 2006 as a result of the highly probable cash flows no longer being expected to occur.
The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures, after net investment hedges, are as follows: £m £m
Allowance for impairment losses (note 19) (37) (2,029) (342) (2,408) – –
Trading and other financial assets at fair value through profit or loss 57,911 67,695 57,911 67,695
The directors approved the parent company financial statements on 21 February 2008.
Derivative financial instruments Accounting policy 83 Notes to the group accounts 101
Tangible fixed assets Accounting policy 85 Notes to the group accounts 108