annual report Lloyds TSB Group plc and accounts 2002 LLOYDS TSB GROUP 223 consumer up 17% credit to £14.9 billion Profit before tax Contents By main businesses Presentation of results 1 2002 highlights 2 Chairman’s statement 4 Group chief executive’s review 7 Our work in the community 8 The businesses of Lloyds TSB 10 Financial review 42 Five year financial summary 44 The board 46 Directors’ report 48 Directors’ remuneration 55 Corporate governance 57 Independent auditors’ report 58 Consolidated profit and loss account 59 Consolidated balance sheet 61 Company balance sheet 62 Other statements 63 Consolidated cash flow statement 64 Notes to the accounts 93 Information for shareholders UK Retail Banking and Mortgages Insurance and Investments Wholesale Markets International Banking Central group items Profit before tax, excluding changes in economic assumptions and investment variance Changes in economic assumptions Investment variance Profit before tax 2002 2001* £ million £ million 1,172 1,231 626 379 96 1,205 1,421 852 357 185 3,504 55 (952) 4,020 – (859) 2,607 3,161 * Restated to reflect the implementation of UITF33, ‘Obligations in capital instruments’, FRS17, ‘Retirement benefits’, FRS19, ‘Deferred tax’ and detailed guidance from the Association of British Insurers for best practice in the preparation of results using the achieved profits method of accounting. 2001 figures have been restated to incorporate efficiency programme related restructuring costs within business units, and the reclassification of emerging markets debt earnings from International Banking to Central group items. Our governing objective is to maximise shareholder value over time To meet our governing objective we aim: •To be a leader in our chosen markets •To be the first choice for our 16 million customers •To reduce day-to-day operating costs through increased effectiveness During 2002 the Group implemented a number of changes in accounting policies following the issue of new accounting standards and guidelines: Urgent Issues Task Force Abstract 33 – ‘Obligations in capital instruments’, FRS 17 – ‘Retirement benefits’, FRS 19 – ‘Deferred tax’, and detailed guidance from the Association of British Insurers (ABI) for best practice in the preparation of results using the achieved profits method of accounting. In accordance with the requirements of accounting standards, the Group has restated comparative figures to reflect these changes. In order to provide a clearer representation of the underlying performance, the results of the Group’s life and pensions business include investment earnings calculated using longer- term investment rates of return and annual management charges based on unsmoothed fund values. The difference between the normalised investment earnings and the actual return (‘the investment variance’) together with the impact of changes in the economic assumptions used in the embedded value calculation have been separately analysed and a reconciliation to the Group’s profit before tax is given on this page. Market leadership in personal finance During 2002, the Group increased its market share in both personal loans and credit card lending. Personal loan balances increased by 15 per cent to £8.6 billion, while more than 700,000 new credit cards were issued, leading to a growth of 27 per cent in credit card balances outstanding to £4.9 billion. 2002 highlights Results Total income decreased by £11 million to £8,878 million. Operating expenses increased by 3 per cent to £4,915 million. Trading surplus decreased by 4 per cent to £3,963 million. Profit before tax decreased by £554 million to £2,607 million. Profit attributable to shareholders decreased by 20 per cent to £1,781 million. Earnings per share decreased by 21 per cent to 32.0p. Economic profit decreased by 27 per cent to £821 million. Post-tax return on average shareholders’ equity 16.7 per cent. Total capital ratio 9.6 per cent, tier 1 capital ratio 7.8 per cent. Final dividend of 23.5p per share, making a total of 34.2p for the year, an increase of 1.5 per cent. Achievements in 2002 include Dividends per share (pence) 22.2 26.6 30.6 33.7 34.2 Excluding changes in economic assumptions and investment variance: Profit before tax decreased by £516 million, or 13 per cent, to £3,504 million. Post-tax return on average shareholders’ equity was 23.0 per cent. Total income adjusted for investment variance, acquisitions and other specified items (see page 31), increased by 2 per cent to £9,484 million. Operating expenses excluding the impact of acquisitions and the netting of operating lease depreciation (see page 31), were flat at £4,580 million. Customer lending grew by 9 per cent to £134.5 billion and customer deposits increased by 7 per cent to £116.3 billion. Significant repositioning of UK Retail Banking to support customer franchise development and growth. Improved market share in many key product areas, including personal lending, credit cards, life, pensions and long-term savings and, in the fourth quarter of 2002, mortgages. 8 9 9 1 9 9 9 1 0 0 0 2 1 0 0 2 2 0 0 2 LLOYDS TSB GROUP 1 customer deposit up 7% balances to £116.3 billion Chairman’s statement Maarten van den Bergh The turmoil surrounding the operating, regulatory and stockmarket environment in which we operate has been unprecedented in recent times. Whilst these issues have had a direct effect on the Group’s results for 2002, and are likely to continue to have an impact until some stability returns to global stockmarkets, they do not impact our long- term strategic goals, the fundamental strength of the Group or the way in which we run our business. In the UK, from where the Group derives the vast majority of its earnings, the slowdown in economic growth has partly been alleviated by the continued strength of the housing market and high levels of consumer spending. We expect levels of growth in 2 LLOYDS TSB GROUP the housing market and consumer spending to fall during 2003 although overall economic growth for the year is expected to be slightly higher than the 1.7 per cent growth experienced in 2002. Our strategic aims The Group remains totally committed to maximising shareholder value over time and our business units continue to be focused on the Group’s three strategic aims: to be a leader in our chosen markets, to be first choice for our customers and to drive down day-to-day operational costs to enable us to further invest in our business franchise. This is a strategy that is being well implemented and delivered, and ensures that the Group continues to seek the optimum balance between short-term profit growth and investment in the future of the business, to create sustainable long-term value for all our stakeholders. Our results Notwithstanding the slowdown in the UK and all major global economies, Lloyds TSB continues to trade satisfactorily, with strong market share performances in many of its key product areas, and good growth in customer lending and deposits. During the year the Group also achieved its target of an average 2.5 products per customer, whilst maintaining its strict control on operational expenses with costs in 2002, excluding acquisitions and growth in operating lease depreciation, held flat, in part as a result of the significant investment in efficiency programmes made over the last three years. Profit before tax for the year, however, fell by 18 per cent to £2,607 million, partly as a result of a significant increase in provisions for bad and doubtful debts but also as a result of a number of special items including additional provisions for redress to past purchasers of certain pension and endowment products and a higher negative investment variance of £952 million in our insurance businesses, reflecting the weakness of equity markets. The high level of government interference in all areas of our business has continued throughout 2002 and into 2003. The annual cost of responding to this government intervention is substantial and in 2003 the cost of implementing the findings of the Competition Commission’s ‘Report into the supply of banking services to small and medium-sized enterprises’ is alone likely to be in the region of £150 million. This industry is already immensely competitive. If the Government wishes to foster greater competition within financial services it should recognise that the level of returns available must be acceptable to both existing and new competitors. The Government’s interventions include the removal of dividend tax credits – increasing corporate pension contributions – the cost of the Universal Bank and the automation of benefits, as well as more specific price controls in both the banking and pensions businesses. If interference continues, there is a danger that one of the UK’s great success stories – the financial services industry – will be less able to compete on the world financial scene where the really strong players will dominate in the future. Market leadership in home insurance With over 9 million policies in force, Lloyds TSB Insurance is one of the largest distributors of personal lines general insurance in the UK, with market leadership in the distribution of home and creditor insurance. Dividend The Group continues to generate strong cashflows from its banking businesses and, excluding investment variance, the profit attributable to shareholders in 2002 was £2,496 million. The Board has decided to maintain the final dividend at 23.5p, to make a total for the year of 34.2p, an increase of 1.5 per cent. The Board is mindful of the level of dividend cover and, consequently, profit growth may not necessarily result in increases in dividend. The Board recognises the importance attached by shareholders to the Group’s dividend. Our people In all of my dealings with staff throughout the Group it never ceases to amaze me how professional and motivated the entire staff of the Group continues to be, in the face of very difficult circumstances. Lloyds TSB’s continuing success is underpinned by the significant contribution made by its entire staff and the Group’s people strategy will continue to be shaped around harnessing this superb commitment, creating a workplace where staff understand their roles and contribution, and continue to feel proud to work for Lloyds TSB. I know the management and staff remain as committed as ever to the future development of the Group and delivery of value to its shareholders. Board changes After more than 40 years in the banking industry and over 12 years of outstanding service and leadership to TSB and the Lloyds TSB Group, Peter Ellwood will retire on 31 May 2003. His tremendous contribution to the Group has included bringing together Lloyds Bank and TSB in a most effective combination. Our highest regards and warmest wishes go with him. I am delighted that Peter will be succeeded by Eric Daniels, who has exceptional financial services experience throughout the world, and who has already made a significant impact on the quality and positioning of our retail business. Peter Ayliffe will succeed Eric Daniels as Group Executive Director, UK Retail Banking, and join the Board on 1 June 2003. We shall also bid farewell to Kent Atkinson who retires, with our best wishes, at the annual general meeting after more than 38 years with the Group. He was succeeded as Group Finance Director by Philip Hampton, who joined the Board on 1 June 2002. Alan Moore, Deputy Chairman, will also be leaving the Board at the annual general meeting after 23 years of valuable service, including 14 as a member of the Board, and will be replaced by David Pritchard, who will retire as an executive director. Steve Targett will join the Board on 10 March 2003, and succeed David as Group Executive Director, Wholesale and International Banking, following the annual general meeting. Other non-executive directors leaving the Board at the annual general meeting are Clive Butler, who has served since 1993, and Sheila Forbes, who joined the Board in 1994. All the departing directors leave with our warm thanks for their contribution to the Group over many years. Our future The business environment in which we operate is characterised by increasing levels of competition, volatile equity markets and increasing government intervention in, and regulation of, the financial services industry. Against this backdrop, Lloyds TSB will continue to focus on its long standing principles of prudent and sustainable revenue growth from the creation of value for customers, tight management of its cost base and strong credit risk management. With a clear focus on these core strengths, and supported by a dedicated and resourceful team of people, Lloyds TSB is well positioned for future growth and the challenges ahead. Maarten van den Bergh Chairman 13 February 2003 LLOYDS TSB GROUP 3 current account up 12% balances to £27.9 billion Group chief executive’s review profit and loss account. The encouraging side of the story is the growth in market share in personal loans, credit cards, general insurance, and life and pensions, and the fact that we sold more products to more people than we have ever done before, with a record net increase in products of 1.6 million compared with 1.3 million last year. Our improved cross- selling ratio of 2.5 products per customer remains industry leading. Customer lending increased by 9 per cent and customer deposits increased by 7 per cent. Our efficiency programme delivered benefits in 2002 in line with our forecasts resulting in a significant improvement in our underlying efficiency. Excluding the impact of acquisitions and operating lease depreciation, operating costs were flat in comparison with 2001, and there was a reduction in our headcount of over 4,000. At the same time we have continued to invest heavily in improving our service to customers. All these factors augur well for future sustainable growth. However, we have also had to absorb a number of significant hits to our profit and loss account. During the year we have experienced a reduction in profit of £952 million as a result of the adverse investment variance following the 24 per cent fall in the FT All Share Index during 2002. We have increased the Group’s general provision by £50 million in respect of our business in Argentina and significantly increased our provisions in respect of certain US corporate customers as a result of their accounting and other irregularities. In addition, we have absorbed provisions totalling £205 million for redress to past purchasers of pensions and Abbey Life endowment and long-term savings products, much of which relates to policies written in the late 1980s and early 1990s. The Group has also experienced a reduction of £59 million in unit trust and asset management fees, largely as a result of stockmarket falls, a cost of £57 million to reflect the implementation of revised mortality assumptions in the Group’s life businesses, and a £142 million reduction in income as a result of lower other finance income, following the adoption of Financial Reporting Standard 17. The overall impact of these issues meant that the Group’s statutory pre-tax profits fell to £2,607 million from £3,161 million in 2001, and earnings per share fell by 21 per cent to 32.0p. Our post-tax return on equity was 16.7 per cent. Excluding changes in economic assumptions and investment variance, our post-tax return on equity was 23.0 per cent. Within our businesses, the performance of retail banking is now benefiting from the substantial investments we have made to reposition the business for profitable growth. Product sales were at an all time high during 2002 and the Group continues to grow its current account customer franchise in the light of intense competition. Scottish Widows, in line with the rest of the life assurance industry, has experienced difficult trading conditions as a result of the considerable fall in equity markets. However, we believe the long-term growth prospects for this sector of the market, and for Scottish Widows in particular, remain Peter Ellwood CBE The trading environment of 2002 has been a substantial challenge for both the financial services industry and, within it, Lloyds TSB. In order to prosper in such a challenging environment it remains essential that the Lloyds TSB Group has in place a clearly defined strategy. To this end we remain committed to maximising shareholder value over time through leveraging world class leadership and management of our people to achieve our three strategic aims. We have made progress in a number of areas. The year has been characterised by some encouraging features but also by a number of issues which have adversely affected the 4 LLOYDS TSB GROUP Market leadership in motor finance In 2002, Lloyds TSB strengthened its leading position in the motor finance market, growing its business by 17 per cent. Lloyds TSB is also the leading contract hire and fleet management company in the UK, now managing a fleet of some 150,000 vehicles. good. The long-term winners will be those with extensive customer franchises and distribution reach, augmented by economies of scale and strong brand power. We have these in abundance. Our market leading general insurance business has continued to prosper and delivered very strong profitable growth, with pre-tax profits increasing by 16 per cent, compared with 2001. In our wholesale markets and international banking businesses good growth has continued to be achieved in a number of our specialist businesses, although this growth has been offset by a significant increase in the level of corporate bad and doubtful debt provisions. Whilst overall credit quality continues to be robust, the Group does have a cautious outlook on a number of corporate sectors and exposures which has led to these higher levels of corporate provisioning. The economic situation in Argentina continues to be difficult and the outlook is likely to remain uncertain at least until after the new Argentine government takes office during 2003. During 2002 the Group increased its general provision for its exposure to Argentina by £50 million and the Group’s total exposure to Argentina at the end of the year had been reduced to £190 million, net of provisions and charges, compared to £610 million a year ago. Against the volatile background, it is essential that we are not swayed from the successful implementation of our vision and strategic aims. As a Group we have a unifying vision whereby our first strategic aim is to be first choice for our customers because we understand and meet their needs more effectively than any of our competitors. It is a vision of a business where we truly create value for our customers; where our customers trust us enough to give us the privilege of looking after more of their business. It is a vision of a business where our staff understand the Group’s strategy, understand what we are seeking to do, agree with it and know that what they do is vital to our future success. Our second strategic aim of being a leader in our chosen markets also links in to the customer. Market leaders earn higher returns and generate greater value, some of which can be passed on to the customer. Our third strategic aim of driving down day-to-day operational costs allows the Group to create headroom to invest for the future. Throughout the Group these three themes underpin the development of our businesses and in the last twelve months considerable progress has been made to meet these strategic aims and our world class aspirations. First choice for our customers The Group’s strategy of maximising shareholder value over time can only be sustainably achieved by putting our customers at the heart of everything we do. Lloyds TSB’s multi-channel banking infrastructure, including internet and telephony services, means that the Group can provide its customers with significant options in terms of both convenience and choice. The knowledge and expertise of our staff ensures that the Group provides comprehensive financial solutions to meet the needs of all of our customers. But the environment in which we work is changing rapidly as customer needs are evolving and as customers continue to seek greater value in terms of the benefits they receive from their products and services. Customers expect excellent customer service and error free operation of their banking arrangements. Those organisations that can develop a reputation for providing excellent customer service will retain existing customers and attract new ones. Over the last twelve months Lloyds TSB has made considerable progress in addressing customer service issues, and these improvements in customer service during 2002 have been a significant contributory factor to strong recruitment of new customers during the year and the improvement in the Group’s cross selling rates. A leader in our chosen markets The Group continues to strengthen its market position in many of its key product LLOYDS TSB GROUP 5 mortgage up 10% balances to £62.5 billion risk and cost. These are not easy times but we have three businesses, UK Retail Banking and Mortgages, Insurance and Investments, and Wholesale Markets and International Banking, all of which have considerable scope for sustainable profitable growth and which can build on the track record in income growth which the Group has seen over the last six years, with costs growing at a considerably slower pace. For any successful business to maintain and improve on such an excellent track record it is important to go forward with realism, confidence and excitement about the future. This, we do. Peter Ellwood CBE Group Chief Executive 13 February 2003 areas despite high levels of competition throughout our business. In retail banking we continue to grow our customer franchise and during 2002 saw income growth of 5 per cent from our retail banking business. Our personal loan and credit card portfolios grew by 15 per cent and by 27 per cent respectively, again showing significant improvements in our market share. In Scottish Widows the second half of the year showed a good improvement in market share notwithstanding the very difficult stockmarket environment. In our general insurance business the Group further enhanced its UK market leadership position in the distribution of home and creditor insurance to deliver growth in premium and commission income of 19 per cent. Within asset finance, the Group has acquired First National Vehicle Holdings, Abbey National Vehicle Finance and the Dutton-Forshaw Group. These acquisitions have further enhanced the Group’s leading position in UK motor finance. So, in most areas of our business, the Group continues to maintain and 6 LLOYDS TSB GROUP develop market leading positions to enable high levels of returns to be sustained, or improved. Driving down our day- to-day costs The Group is already amongst the leaders in cost efficiency. However, in a relatively low growth, low inflation and low interest rate macro-economic environment, cost control remains critically important. Augmented by our efficiency programmes the Group’s control and focus on costs has meant that in 2002 costs, excluding the impact of acquisitions and operating lease depreciation, were held flat. Overall Group staff numbers decreased by 4,191 to 79,537 during 2002, after adjusting for an increase of 2,328 from acquisitions during the year. The Group will, of course, continue its significant programme of investment in improved efficiency, to support business growth. On a personal note, we announced in December last year that I will retire as Group Chief Executive on 31 May 2003, shortly after my 60th birthday. I have thoroughly enjoyed my time at Lloyds TSB and it has been a great privilege to lead this organisation as Chief Executive for the last six years. I am delighted to hand over the mantle to Eric Daniels, who shares my passion for this organisation, and my drive to create value for our customers and shareholders by providing excellent products and superior service. He will be supported by a fantastic team of over 79,000 people across the Group to whom my heartfelt thanks go for their help and support over the years. Lloyds TSB is an extremely successful organisation with strong returns on shareholders’ equity and a first class efficiency ratio. However, the Group does operate in a world of greater competitive ferocity, greater regulation and a tough global economic environment, exacerbated by concerns over geo-political stability. The Group has continued to strive constantly to refresh existing and new revenue streams, build upon its financial and intellectual capital and optimally manage The leading corporate donor in the UK Since 1996, the Lloyds TSB Foundations have received over £200 million to distribute to local charities. Distribution to the Lloyds TSB Foundations (£m) 27 31 34 36 33 8 9 9 1 9 9 9 1 0 0 0 2 1 0 0 2 2 0 0 2 LLOYDS TSB GROUP 7 Our work in the community Lloyds TSB is committed to making a positive impact on local communities. As one of the UK’s leading financial services organisations we recognise the need to play our part in tackling some of the social issues that confront the communities in which our business is based. Our community programme was valued at £40 million in 2002 which makes us the UK’s largest corporate giver. The majority of our support is channelled through the independent Lloyds TSB Foundations which receive one per cent of the Group’s pre-tax profits, averaged over three years, instead of the dividend on their shareholdings. This year they will receive £33 million to distribute to grassroots causes which help to improve the quality of life for disabled and disadvantaged people. The Foundations also run a ‘Matched Giving Scheme’ for Lloyds TSB Group staff which matches money raised and time given to registered charities. In 2003 the Foundations have set aside £1.25 million to encourage staff to support local groups. We support national charities through our Charity of the Year campaign. In 2002 staff raised some £685,000 for the Royal National Institute for Deaf People to fund its Information and Tinnitus Helpline for one year. This year we aim to raise £750,000 for Help the Hospices, to support both adult and children’s hospices across the country. As well as providing charitable support, we also focus our resources on education and economic and social regeneration. Our Quality in Education programme promotes the use of a self-assessment and improvement tool which helps schools to drive their own efforts to raise standards. In 2002, the programme received a Business in the Community Impact Endorsement Mark in recognition of the results we have achieved. By working through local education authorities, professional teacher associations and in partnership with the Department for Education and Skills and the Cabinet Office, the programme has been introduced to over 4,000 schools so far. Business has an important role to play in neighbourhood renewal which is why we work with community based organisations to foster economic and social regeneration. Our programme focuses on creating access to finance in disadvantaged communities, providing backing for small business and encouraging entrepreneurship among young people. One of our main projects this year has been the development of the Wessex Reinvestment Trust (WRT) which will deliver loan services to develop enterprise and facilitate access to affordable housing and workspace. This is the first entirely rural community finance initiative which seeks to provide a springboard for rural regeneration in Devon, Dorset and Somerset. The businesses of Lloyds TSB Lloyds TSB is one of the leading UK-based financial services groups, whose businesses provide a comprehensive range of banking and financial services in the UK and overseas. At the end of 2002 total group assets were £253 billion and there were over 79,000 employees. Market capitalisation was £24.8 billion. The main businesses and activities of the Group during 2002 are described below: UK Retail Banking and Mortgages UK Retail Banking and Mortgages provides a full range of banking and financial services to some 15 million customers. With more than 2,200 branches of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester (C&G), the Group provides comprehensive geographic coverage in England, Scotland and Wales. • Current accounts, savings and investment accounts, and consumer lending. The retail branches of Lloyds TSB Bank offer a broad range of branded products and C&G provides retail investments through its branch network and a postal investment centre. • Card Services provides a range of card-based products and services, including credit and debit cards and card transaction processing services for retailers. The Group is a member of both the VISA and MasterCard payment systems and is the third largest credit card issuer in the UK. • Cash machines. The Group has one of the largest cash machine networks of any leading banking group in the UK and personal customers of Lloyds TSB Bank are able to withdraw cash, check balances and obtain mini statements through 4,210 cashpoint* machines at branches and external locations around the country. In addition, they have access to a further 37,000 cash machines via LINK in the UK and to cash machines worldwide through the VISA and MasterCard networks. • Telephone Banking. Telephone Banking continues to grow and the Group provides one of the largest telephony services in Europe. At the end of 2002 3.2 million customers had registered to use the services of PhoneBank and the automated voice response service PhoneBank Express. * cashpoint is a registered trade mark of Lloyds TSB Bank plc • Internet Banking. Internet Banking provides online banking facilities for personal and business customers and enables them to conduct their financial affairs without using the branch network. Over 1.9 million customers have registered to use the Group’s internet banking services. • Business Banking. Small businesses are served by dedicated business managers based in some 450 locations throughout the UK. Customers have access to a wide range of tailored business services ranging from traditional banking products through factoring, insurance and investments to non- financial solutions to their business problems such as Debtor Management service providing legal support to help customers recover debts and Prospect Finder providing customers with a tailored list of potential customers for their business. Lloyds TSB is one of the leading banks for new business start-ups with around one in five opening accounts with the Group. • UK Wealth Management. Private Banking provides a range of tailor-made wealth management services and products to individuals from 40 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 ISA products. At the end of 2002, client funds under management totalled some £10 billion. Lloyds TSB Stockbrokers undertakes retail stockbroking through its Sharedeal Direct telephone service. • Cheltenham & Gloucester is the Group’s specialist residential mortgage provider, selling its mortgages through branches of C&G and Lloyds TSB Bank in England and Wales, as well as through the telephone, internet and postal service, C&G TeleDirect. The Group is the third largest residential market lender in the UK, with a market share of 9.3 per cent, loans outstanding at the end of 2002 of £62.5 billion and over 980,000 borrowers. Insurance and Investments • Scottish Widows is the Group’s specialist provider of life assurance, pensions and investment products, which are distributed through the Lloyds TSB branch network, through independent financial advisors and directly to the consumer via the telephone, internet, and face-to-face. 8 LLOYDS TSB GROUP International Banking • The Americas. The Group has operated in The Americas for over 130 years and has offices in Brazil, Argentina, Colombia and 6 other countries. In addition there are private banking and investment operations in the United States. • New Zealand. The National Bank of New Zealand is the country’s second largest bank and provides a full range of banking services through some 160 outlets. • Europe. The Group has private banking operations for wealthy individuals outside their country of residence. The business is conducted through Switzerland and through four other countries overseas. There are additional corporate and private banking operations in Belgium, Netherlands, France and Spain. • Offshore Banking comprises all the Group’s offices in the Channel Islands and Isle of Man providing a full range of retail banking, private banking, trust and financial services to overseas residents and islanders, together with deposit services offshore for UK residents. • Middle East and Asia. There are banking operations in Hong Kong, Singapore, Tokyo, Malaysia and Dubai. The businesses of Lloyds TSB • General insurance. Lloyds TSB General Insurance provides general insurance and broking services through the retail branches of Lloyds TSB Bank and C&G, and through a direct telephone operation and the internet. The business is the market leader in the distribution of household insurance in the UK. • Scottish Widows Investment Partnership manages funds for the Group’s retail life, pensions and investment products. Clients also include corporate pension schemes, local authorities and other institutions in the UK and overseas. At the end of 2002 funds under management totalled some £70 billion. Wholesale Markets The Group’s relationships with major UK and multinational companies, banks and financial institutions, and medium- sized UK businesses, together with its activities in financial markets, are managed through dedicated offices in the UK and a number of locations overseas, including New York. • Treasury is a leading participant in the Sterling money market. It is active in currency money markets, foreign exchange markets and also in certain derivatives markets to meet the needs of customers, and as part of the Group’s trading activities, including liquidity management. • Corporate provides a wide range of banking and related services, including electronic banking, large value lease finance, share registration, venture capital, correspondent banking and capital markets services to major UK and multinational companies, financial institutions and, through a network of dedicated offices, to medium-sized businesses in the UK. • Asset Finance through the Lloyds TSB Commercial Finance, Alex Lawrie and autolease brands is a market leader in invoice discounting, factoring and contract hire. The Black Horse branded point of sale finance operation has leading positions in the motor, motorbike and caravan markets. Specialist personal lending, store credit, small/medium ticket leasing and the recently acquired Dutton-Forshaw motor dealership complete this group of businesses. LLOYDS TSB GROUP 9 Financial review Accounting policies and presentation Accounting policies are set out on pages 64 to 67. During 2002 the Group has made a number of changes in accounting policy to implement the requirements of new accounting standards and guidelines. Comparative figures have been restated. The effect of these changes in policy on the results for the year and the comparative period is set out below. Urgent Issues Task Force Abstract 33 (UITF 33) UITF 33 was issued in February 2002 and is effective for accounting periods ending on or after 23 March 2002. Following its implementation the Group has reclassified €750 million (£482 million) of Perpetual Capital Securities as undated loan capital and the related cost is included within interest expense. Previously these securities were included within minority interests in the balance sheet and the cost was treated as a minority interest deduction. Financial Reporting Standard 19 (FRS 19) – Deferred Tax FRS 19 was issued in December 2000 and is effective for accounting periods ending on or after 23 January 2002. Following its implementation, the Group makes full provision for deferred tax assets and liabilities arising from timing differences between the recognition of gains and losses in the financial statements and their recognition in a tax computation. Previously provision was only made where it was considered that there was a reasonable probability that a liability or asset would crystallise in the foreseeable future. An adjustment has been made increasing shareholders’ equity at 31 December 2001 by £40 million to reflect the revised policy. Financial Reporting Standard 17 (FRS 17) – Retirement Benefits FRS 17 replaces SSAP 24 and UITF 6 as the accounting standard dealing with post-retirement benefits. The Group has decided to implement the requirements of FRS 17 in 2002 to coincide with the triennial full actuarial valuations of the Group’s pension schemes and because of the significant impact that implementation has on the Group’s reported results. The new standard requires the Group to include the assets of its defined benefit schemes on its balance sheet together with the related liability to make benefit payments. The profit and loss account includes a charge in respect of the cost of accruing benefits for active employees, any benefit improvements and the cost of severances borne by the schemes; the expected return on the schemes’ assets is included as other finance income less a charge in respect of the unwinding of the discount applied to the schemes’ liabilities. Under SSAP 24 the profit and loss account included a charge in respect of the cost of accruing benefits for active employees offset by a credit representing the amortisation of the surplus in the Group’s defined benefit schemes; a pension prepayment was included in the Group’s balance sheet together with a provision in respect of post-retirement healthcare obligations. An adjustment has been made reducing shareholders’ equity at 31 December 2001 by £236 million to reflect the revised policy. The amounts included in the Group’s profit and loss account in 2002 are reflected in other finance income and administrative expenses, and are summarised below. Other finance income Expected return on scheme assets Interest cost of scheme liabilities Other finance income Administrative expenses Defined contribution schemes Defined benefit schemes Pension costs 2002 £m 817 (652) 165 2002 £m 25 293 318 2001 £m 844 (537) 307 2001 £m 18 329 347 At 31 December 2002 a net pension deficit of £2,077 million was included in the Group’s balance sheet, based upon actuarial valuations carried out at that date. This reflects a fall in the value of the schemes’ assets caused by the significant reduction in equity market values. The valuations were prepared in accordance with the requirements of the accounting standard which seek to place a market value on the schemes’ assets and liabilities at a point in time. As a result, these valuations are not indicative of the long-term funding position of the schemes which is assessed in the light of triennial formal actuarial valuations of the schemes. The last formal actuarial valuation of the Group’s principal schemes was performed at 30 June 2002 and, whilst these valuations have yet to be finalised, they disclosed that the schemes remained satisfactorily funded although it is probable that it will be necessary to recommence employer’s cash contributions shortly. These cash contributions, which are likely to be in the order of £150 million in 2003 and £300 million in 2004, do not affect the Group’s profit and loss account as normal pension costs are already, under FRS 17, included within the Group’s operating expenses. 10 LLOYDS TSB GROUP Financial review Accounting policies and presentation (continued) Investment variance In December 2001, the Association of British Insurers (ABI) published detailed guidance for the preparation of figures using the achieved profits method of accounting which are published as supplementary financial information accompanying the accounts of most listed insurance companies. The ABI guidance recommends the use of unsmoothed fund values to calculate the value of in-force business. To improve the comparability of the results of the Group’s insurance operations with the supplementary financial information published by listed insurers the Group has changed the basis of its embedded value calculations to use unsmoothed fund values; previously the effect of investment fluctuations had been amortised in the profit and loss account over a two year period. An adjustment has been made reducing shareholders’ equity at 31 December 2001 by £208 million to reflect the revised policy. The following tables show the impact of the changes in accounting policies: 2002 Net interest income Other finance income Other income Total income Operating expenses Trading surplus Provisions/claims Joint ventures Profit before tax Tax Profit after tax Minority interests Attributable profit 2001 Net interest income Other finance income Other income Total income Operating expenses Trading surplus Provisions/claims Joint ventures Profit on sale of businesses Profit before tax Tax Profit after tax Minority interests Attributable profit Original results £m 4,944 – 3,882 8,826 4,324 4,502 981 (10) 39 3,550 971 2,579 79 2,500 UITF 33 £m FRS 19 £m FRS 17 £m Investment variance £m Total adjustment £m (31) – – (31) – (31) – – (31) – (31) (31) – – – – – – – – – – (29) 29 – 29 – 165 – 165 323 (158) – – (158) (47) (111) – (111) – – (104) (104) – (104) – – (104) (31) (73) – (73) UITF 33 £m FRS 19 £m FRS 17 £m Investment variance £m (22) – – (22) – (22) – – – (22) – (22) (22) – – – – – – – – – – – 14 (14) – (14) – 307 – 307 452 (145) – – – (145) (43) (102) – (102) – – (222) (222) – (222) – – – (222) (67) (155) – (155) (31) 165 (104) 30 323 (293) – – (293) (107) (186) (31) (155) Restated results £m 4,922 307 3,660 8,889 4,776 4,113 981 (10) 39 3,161 875 2,286 57 2,229 Consequential adjustments have been made to the balance sheet to reflect these changes in accounting policy. Forward looking statements This document contains forward looking statements with respect to the business, strategy and plans of the Lloyds TSB Group, its current goals and expectations relating to its future financial condition and performance. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future. Lloyds TSB Group’s actual future results may differ materially from the results expressed or implied in these forward looking statements as a result of a variety of factors, including UK domestic and global economic and business conditions, risks concerning borrower credit quality, market related risks such as interest rate risk and exchange rate LLOYDS TSB GROUP 11 Financial review Forward looking statements (continued) risk in its banking business and equity risk in its insurance businesses, changing demographic trends, unexpected changes to regulation or regulatory actions, changes in customer preferences, competition and other factors. Please refer to the latest Annual Report on Form 20-F of Lloyds TSB Group filed with the US Securities and Exchange Commission for a discussion of such factors. Summary of group results In 2002 the Group’s profit before tax decreased by £554 million to £2,607 million from £3,161 million in 2001. Total income decreased by £11 million whilst operating expenses increased by £139 million, or 3 per cent. Excluding changes in economic assumptions, investment variance, endowment and pension related provisions, investment returns on the Group’s pension scheme assets, the netting of operating lease depreciation and the impact of acquisitions, total income increased by 2 per cent whilst total costs, excluding the impact of acquisitions and operating lease depreciation, were held flat (see page 31). Customer lending and deposits continue to grow well with further growth in market share being achieved in a number of our core markets. Customer lending grew by 9 per cent to £134.5 billion and customer deposits increased by 7 per cent to £116.3 billion. The Group net interest margin was 3.20 per cent, compared with 3.40 per cent in 2001. This reduction was more than compensated for by increased volumes, resulting in an increase of 5 per cent in net interest income. Profit attributable to shareholders was 20 per cent lower at £1,781 million and earnings per share decreased by 21 per cent to 32.0p. Shareholders’ equity decreased by £2,384 million to £7,972 million following a reduction of £2,331 million in the value of the Group’s pension schemes, largely caused by the significant reduction in equity market values. These pension scheme related movements are ignored for regulatory capital purposes and, excluding these market movements, shareholders’ equity decreased by £53 million. The post-tax return on average shareholders’ equity was 16.7 per cent, compared to 18.1 per cent in 2001. Excluding changes in economic assumptions and investment variance, post-tax return on average shareholders’ equity was 23.0 per cent. Economic profit decreased by 27 per cent to £821 million. The post- tax return on average assets was 0.93 per cent, and the post-tax return on average risk-weighted assets was 1.61 per cent. Pre-tax profit from UK Retail Banking and Mortgages decreased by £33 million to £1,172 million, compared to £1,205 million in 2001. Excluding the impact of a reduction of £57 million in profits from the sale and leaseback of premises and the non-recurrence of certain provision releases in 2001, profit before tax increased by £96 million, or 9 per cent. There was strong growth in personal loans, up 15 per cent, and in credit card lending, up 27 per cent. Current account and savings and investment account balances, within Retail Banking, increased by 10 per cent. Overall, retail banking product sales were 6 per cent higher than in 2001. Costs remained tightly controlled and asset quality generally remains satisfactory, notwithstanding the general slowdown in economic activity within the UK. Provisions for bad and doubtful debts increased by £148 million to £563 million, as a result of volume related asset growth in the personal loan and credit card portfolios and a lower level of recoveries and releases than in 2001. Overall the arrears position was stable. An improved arrears position in personal lending was offset by a slight deterioration in the credit card portfolio. In the Mortgages business, gross new lending increased by 36 per cent to a record £19.0 billion, compared with £14.0 billion a year ago. Net new lending was £5.9 billion, compared with £3.9 billion in 2001, resulting in a market share of net new lending of 7.5 per cent. The Group’s current mortgage pipeline is at record levels and its market share of net new lending in the second half of 2002, at 8.8 per cent, was considerably better than in the first half of the year. Net new lending in the second half of 2002 was £3.9 billion compared with £2.0 billion in the first half of the year. The Group’s market share of net new lending in the fourth quarter of 2002 was 10.0 per cent. Profit before tax, excluding changes in economic assumptions and investment variance, from Insurance and Investments decreased by £190 million, or 13 per cent, to £1,231 million, partly as a result of a £135 million increase in provisions for redress to past purchasers of endowment and pension products to £205 million, and a reduction of £55 million in benefits from experience variances and assumption changes, largely reflecting the implementation of revised actuarial mortality assumptions. Overall weighted sales in the Group’s life, pensions and unit trust businesses were £767.6 million compared to £754.7 million last year, an increase of 2 per cent. This increase in weighted sales reflected a 7 per cent increase in weighted sales from life and pensions, partly offset by a 13 per cent reduction in weighted sales from unit trusts, largely caused by the continuing stockmarket volatility which has significantly reduced customer demand for equity-based ISA products. In the second half of 2002, weighted sales of £394.9 million were 10 per cent higher than the £358.9 million in the second half of 2001, and 6 per cent higher than the £372.7 million in the first half of 2002. Weighted sales from independent financial advisors rose by 25 per cent. There was further strong profit growth from the Group’s general insurance operations. A 19 per cent growth in the combined premium income from underwriting and commissions from insurance broking led to an increase in profit before tax of £103 million, or 16 per cent, to £754 million. Wholesale Markets pre-tax profit decreased by £226 million, or 27 per cent, to £626 million, partly as a result of a substantial increase in provisions for bad and doubtful debts. Growth in customer lending, increased operating lease assets and the impact of acquisitions in the asset finance business resulted in a £174 million, or 9 per cent, increase in total income. Operating expenses increased by £202 million, again largely as a result of the asset finance acquisitions and higher operating lease depreciation. The provisions charge for bad and doubtful debts increased by £156 million. In 2002, provisions against Group loans and advances to certain large US corporate customers, caused by accounting and operational irregularities, totalled some £100 million. There was also an increase in provisions within the corporate lending portfolio, reflecting weak equity markets and the slowdown in economic activity in the UK. In the less favourable economic and trading environment, all the individual businesses continued to perform well. 12 LLOYDS TSB GROUP Financial review Summary of group results (continued) International Banking pre-tax profit was £22 million, or 6 per cent, higher at £379 million compared with 2001. Profits from New Zealand increased by 32 per cent to £218 million as a result of good growth in all core businesses. Our consumer finance business in Brazil, Losango Consumer Finance, performed well, notwithstanding difficult local economic circumstances, and increased pre-tax profits on a local currency basis by 14 per cent. After the impact of adverse exchange rate movements, which were partly hedged, Losango made a pre-tax profit of £40 million, compared with £43 million in 2001. The total Group charge for bad and doubtful debts was 38 per cent higher at £1,029 million, compared with £747 million in 2001. In UK Retail Banking the provisions charge increased by £125 million, or 28 per cent, to £564 million, largely as a result of volume related asset growth in the personal loan and credit card portfolios which grew by 15 per cent and 27 per cent respectively. In Wholesale Markets the provisions charge increased by £156 million to £311 million, reflecting the higher provisions against certain large US customers and an increase in the provisions charge from the corporate lending portfolio, reflecting weak equity markets and the slowdown in economic activity in the UK. International Banking provisions decreased to £162 million from £183 million, as a result of lower specific provisions in Losango, our consumer finance business in Brazil, largely reflecting exchange rate movements. The Group’s charge for bad and doubtful debts, expressed as a percentage of average lending, was 0.77 per cent compared to 0.62 per cent in 2001. At the end of the year provisions for bad and doubtful debts for the Group totalled £1,767 million, representing over 120 per cent of non-performing loans (2001: 120 per cent), and the level of non-performing loans increased to £1,414 million, compared with £1,222 million in December 2001, largely reflecting higher levels of non-performing lending in the corporate portfolio, and general portfolio growth throughout the Group. Importantly, non-performing lending as a percentage of total lending was unchanged at 1.0 per cent. The Group’s customer lending portfolio continues to be heavily infuenced by our high quality, relatively low risk, mortgage business and, as a result, the Group remains well positioned to withstand a continued economic slowdown. Since the October presidential election in Brazil the economic situation has somewhat stabilised. The Group reduced its total exposure to Brazil, net of provisions, to £1.9 billion during 2002, from £3.3 billion at the end of 2001, largely from not replacing maturing Government bonds. Economic activity in Brazil has remained reasonably robust and we believe this relative strength in the local economy, in conjunction with the significant International Monetary Fund support package which the newly elected president and incoming government have indicated they will support, should alleviate current concerns about the Brazilian economy. The economic situation in Argentina continues to be difficult and the outlook is likely to remain uncertain at least until after the new Argentine government takes office during 2003. In 2002 the Group increased its general provision relating to its exposure to Argentina by £50 million and the Group’s total exposure to Argentina at the end of the year was some £190 million, net of provisions and charges, compared with £610 million at the end of 2001. The Group has now provided for some 50 per cent of its total exposure to Argentina. In common with a number of companies in the life assurance industry, the Group has been carrying out a review of the past sales of certain endowment based and long-term savings products. As a result the Group has made a provision of £165 million to cover its liability for redress to policyholders in respect of past sales made, primarily in the late 1980s and early 1990s, by the Abbey Life salesforce prior to its disposal by the Group in February 2000. The adequacy of the provision for redress to past purchasers of pension policies has been reviewed as lower stockmarket levels have increased the expected remaining cost of redress. The Group has made a final provision for this purpose of £40 million. The Group is also carrying out, in conjunction with the regulator, an investigation into the appropriateness of sales of a stockmarket related investment product, the Extra Income & Growth Plan. This investigation is expected to be completed during 2003, when the Group will be in a position to estimate the financial effect. The total capital ratio was 9.6 per cent and the tier 1 capital ratio was 7.8 per cent. Balance sheet assets increased by £17 billion, or 7 per cent, to £253 billion from £236 billion at the end of 2001. Loans and advances to customers increased by £11.5 billion, or 9 per cent. Risk-weighted assets increased by 13 per cent to £122 billion, from £108 billion at the end of 2001. At the end of December 2002, the Scottish Widows free asset ratio was an estimated 10.0 per cent, compared to 11.5 per cent at the end of 2001. Scottish Widows’ investment policy for the with-profit fund is determined, in conjunction with the views of the fund’s investment advisors, taking into account the long-term commitments of the fund. From time to time investment policy necessitates the use of derivatives and other hedging instruments, and at the end of 2002 such instruments were held to provide some protection against the short-term volatility in the UK equity markets. The Group keeps its investment policy under review. The equity backing ratio for traditional with-profits policies at 31 December 2002 was 53 per cent (equities 40 per cent; property 13 per cent). Scottish Widows remains sufficiently well capitalised to be able to sustain further stockmarket falls without an injection of capital. During 2002 the Group has not needed to inject additional capital from outside the Group’s insurance businesses into Scottish Widows. Scottish Widows is, however, well positioned to participate in a rapidly changing market and to support business growth, as well as maintaining prudent financial management. The Group may inject some capital into Scottish Widows if the level of the FTSE 100 index falls to, and remains at, approximately 3,000. At this FTSE 100 level the capital injection is unlikely to exceed £300 million. To optimise the financial management of the Group’s life businesses Lloyds TSB Life was transferred into the ownership of Scottish Widows in December 2002. LLOYDS TSB GROUP 13 Financial review Profit before tax by main businesses Segmental analysis Year ended 31 December 2002 UK Retail Banking and Mortgages £m Insurance and Investments £m Wholesale Markets £m International Banking £m Central group items £m Net interest income Other finance income Other operating income Total income Operating expenses Trading surplus General insurance claims Bad debt provisions Amounts written off fixed asset investments Income from joint ventures Profit before tax* Changes in economic assumptions Investment variance Profit before tax 3,340 – 1,076 4,416 2,670 1,746 – 563 – (11) 1,172 – – 1,172 74 – 1,876 1,950 490 1,460 229 – – – 1,231 55 (952) 334 1,158 – 975 2,133 1,139 994 – 311 57 – 626 – – 626 745 – 374 1,119 578 541 – 162 – – 379 – – 379 (146) 165 138 157 38 119 – (7) 30 – 96 – – 96 Year ended 31 December 2001 UK Retail Banking and Mortgages £m Insurance and Investments £m Wholesale Markets £m International Banking £m Central group items £m Net interest income Other finance income Other operating income Total income Operating expenses Trading surplus General insurance claims Bad debt provisions Amounts written off fixed asset investments Income from joint ventures Profit on sale of businesses Profit before tax* Investment variance Profit before tax 3,102 – 1,135 4,237 2,607 1,630 – 415 – (10) – 1,205 – 1,205 80 – 2,006 2,086 491 1,595 174 – – – – 1,421 (859) 562 1,096 – 863 1,959 937 1,022 – 155 15 – – 852 – 852 * excluding investment variance and changes in economic assumptions Year end assets by main businesses UK Retail Banking Mortgages UK Retail Banking and Mortgages Insurance and Investments* Wholesale Markets International Banking Central group items Total assets* * excluding long-term assurance assets attributable to policyholders 14 LLOYDS TSB GROUP Total £m 5,171 165 4,439 9,775 4,915 4,860 229 1,029 87 (11) 3,504 55 (952) 2,607 Total £m 4,922 307 4,519 9,748 4,776 4,972 174 747 60 (10) 39 4,020 (859) 3,161 2001 £m 21,124 56,858 77,982 9,270 79,370 21,407 1,375 (105) 307 170 372 155 217 – (6) 38 – – 185 – 185 749 – 345 1,094 586 508 – 183 7 – 39 357 – 357 2002 £m 23,279 62,589 85,868 9,161 89,066 21,779 1,544 207,418 189,404 Financial review UK Retail Banking and Mortgages (covering the Group’s UK retail businesses, providing banking and financial services to personal and small business customers; mortgages; private banking and stockbroking) Net interest income Other income Total income Operating expenses Trading surplus Provisions for bad and doubtful debts Income from joint ventures Profit before tax Efficiency ratio Total assets (year-end) Total risk-weighted assets (year-end) 2002 £m 3,340 1,076 4,416 2,670 1,746 563 (11) 1,172 60.5% £85.9bn £54.2bn 2001 £m 3,102 1,135 4,237 2,607 1,630 415 (10) 1,205 61.5% £78.0bn £48.3bn Profit before tax from UK Retail Banking and Mortgages decreased by £33 million to £1,172 million, compared with £1,205 million in 2001. Strong growth in the Group’s consumer lending portfolios and a focus on cost control were offset by the impact of a number of special items. These included a reduction of £57 million in profits from the sale and leaseback of premises and, in the mortgage, personal lending and credit card portfolios, the non-recurrence of provision releases totalling £72 million in 2001. Excluding these items pre-tax profits increased by 9 per cent. Total income increased by £179 million, or 4 per cent, to £4,416 million. Excluding the 2001 profits from the sale and leaseback of premises, total income grew by 6 per cent. Net interest income increased by £238 million, or 8 per cent, to £3,340 million. Personal loans and credit card lending increased by 15 per cent and 27 per cent respectively and, within Retail Banking, balances on current accounts and savings and investment accounts grew by 10 per cent. Mortgage balances outstanding increased by 10 per cent to £62.5 billion. Other income decreased by £59 million to £1,076 million. There was an improvement in income earned from credit and debit cards, and increased income from added value current accounts, but this was offset by a higher level of fees and commissions payable and a reduction of £57 million in profits from the sale and leaseback of premises, as the Group’s strategy of converting much of its branch portfolio from freehold tenure to leasehold is almost complete. Operating expenses increased by £63 million, or 2 per cent, to £2,670 million during 2002, compared to £2,607 million in 2001. Staff numbers decreased by 3,329 to 47,895. The trading surplus increased by £116 million, or 7 per cent, to £1,746 million. Bad debt provisions increased by £148 million to £563 million, as a result of volume related asset growth in the personal loan and credit card portfolios and a lower level of recoveries and releases than in 2001. Excluding the impact of the non-recurrence of provision releases totalling £72 million in 2001, the provisions charge as a percentage of average lending for personal loans and overdrafts decreased to 3.73 per cent, from 3.88 per cent in 2001, and the charge in the credit card portfolio decreased to 3.52 per cent, from 3.60 per cent in 2001. Overall the arrears position remained stable. Provisions for bad and doubtful debts by product Charge as a percentage of average lending* Personal loans/overdrafts Credit cards Business Banking Mortgages 2002 % 3.73 3.52 1.22 0.00 2001 % 3.88 3.60 1.05 0.01 * excluding the impact of the non-recurrence of provision releases totalling £72 million in 2001 UK Retail Banking has the responsibility for managing the core relationship with our current account customers and, therefore, acts as the principal gateway for the cross-sale of our full range of bancassurance products and services. As such it contributes significantly to the profitability of other businesses. There were good market share gains, particularly in customer deposits, credit cards and personal lending, and greater unit cost efficiencies, offset by the higher level of provisions for bad and doubtful debts. The Group is now starting to see the benefit of recent investments made in the strategic repositioning of the retail bank, which is well positioned to capture the benefits of future customer franchise development and growth. LLOYDS TSB GROUP 15 Financial review UK Retail Banking and Mortgages (continued) We continue to offer a comprehensive multichannel distribution service to our customers. In addition to our network of over 2,000 branches, lloydstsb.com, our internet banking system, continues to grow and remains one of the most visited financial websites in Europe. Over 450,000 product sales were achieved via the internet in 2002, more than four times the number achieved in 2001. Our telephone banking operation, comprising PhoneBank and PhoneBank Express, is one of the largest in the UK with over 3 million registered customers. Our telephone banking contact centres handled some 46 million calls in 2002, making extensive use of interactive voice recognition technology to improve efficiency and service. The retail bank continued to develop its strategy of building deeper customer relationships, particularly with our higher value customers, which has resulted in good growth in customer lending and deposit balances. Our relationship offers will be extended further in 2003 with the launch of the Premier Service, which has been successfully piloted in 2002, and the extension of our existing Personal Choice programme. Results from both of these programmes have already shown improved business flows and enhanced customer loyalty as we seek to meet a greater share of our customers’ financial needs, supported by the application of our advanced customer relationship management tools. The recent launch of the Group’s new, market leading, credit interest current account reflects the Group’s continuing commitment to invest in developing its retail banking franchise by attracting new high quality customers, and rewarding both new and existing customers for using lower cost distribution channels. Business Banking continued to grow its customer franchise with customer deposits growing by 8 per cent to £9,412 million from £8,715 million in December 2001, and customer lending by 1 per cent to £5,487 million from £5,435 million in December 2001. Following the launch of the Group’s unique segmentation strategy for the Business Banking market in 2001, roll-out to all existing customers is complete with customers now migrated to their choice of relationship offer. Underpinning these offers, and central to ensuring that our customers continue to grow their businesses successfully, is RouteMap, a suite of diagnostic tools to help and support customers. Use of success4business.com, our small business portal, also continues to grow. In March 2002, the Competition Commission’s report, following its investigation into the supply of banking services to small and medium size enterprises (SMEs), was published by the Government. The Group has implemented the remedies suggested by the Competition Commission and, as a result, it is likely that the annualised impact on profit before tax will be a reduction of some £150 million, based on the Group’s forecast level of interest rates. Mortgages Gross new mortgage lending Market share of gross new mortgage lending Net new mortgage lending Market share of net new mortgage lending Mortgages outstanding (year-end) Market share of mortgages outstanding 2002 £19.0bn 8.7% £5.9bn 7.5% £62.5bn 9.3% 2001 £14.0bn 8.7% £3.9bn 7.2% £56.6bn 9.5% Gross new lending increased by 36 per cent to a record £19.0 billion, compared with £14.0 billion a year ago. Net new lending increased to £5.9 billion resulting in a market share of net new lending of 7.5 per cent. Mortgage balances outstanding increased by 10 per cent to £62.5 billion. Mortgages remain a key recruitment vehicle in support of the Group’s cross-sell targets and, during 2002, the Group’s key objective in the mortgage business has been to achieve an appropriate balance between growth in market share and profitability. Gross new mortgage lending of £19.0 billion in the year was a record for the Group, and the Group’s market share of net new lending in the second half of 2002, at 8.8 per cent, was considerably better than in the first half of the year. Net new lending in the second half of 2002 was £3.9 billion, compared with £2.0 billion in the first half of the year. The Group’s market share of net new lending in the fourth quarter of 2002 was 10.0 per cent. The Group continues to be one of the most efficient mortgage providers in the UK. C&G continues to benefit from mortgage sales distribution through the Lloyds TSB branch network, the IFA market and from the strength of the C&G brand. In addition C&G TeleDirect, its internet and telephone operation, continued to perform strongly. Business levels sourced from intermediaries remain strong and, for the eighth consecutive year, C&G received a 5-star award from the Association of Independent Financial Advisors, an achievement unequalled by any UK financial services provider. A slightly improved arrears position and the beneficial effect of house price increases have meant that bad debt provisions remained at low levels. New provisions were offset by releases and recoveries resulting in a £1 million net provisions release for the year, compared with a net release of £24 million in 2001 which resulted from a release of £32 million of the Group’s mortgage general provision. The quality of our mortgage lending continues to be satisfactory. The average indexed loan-to-value ratio on the C&G mortgage portfolio was 46 per cent and the average loan-to-value ratio for C&G mortgage business written during 2002 was 67 per cent. C&G has a policy of not exceeding a 95 per cent loan-to-value ratio on new lending. 16 LLOYDS TSB GROUP Financial review Insurance and Investments (the life, pensions and unit trust businesses of Scottish Widows and Abbey Life; general insurance underwriting and broking; and Scottish Widows Investment Partnership) Net interest income Other income Total income Operating expenses Trading surplus General insurance claims Profit before tax* Changes in economic assumptions Investment variance * excluding changes in economic assumptions and investment variance Life, pensions and unit trusts – Scottish Widows – Abbey Life General insurance Operating profit from Insurance Scottish Widows Investment Partnership Profit before tax* 2002 £m 74 1,876 1,950 490 1,460 229 1,231 55 (952) 2002 £m 573 (98) 475 754 1,229 2 1,231 2001 £m 80 2,006 2,086 491 1,595 174 1,421 – (859) 2001 £m 585 175 760 651 1,411 10 1,421 * excluding changes in economic assumptions and investment variance Profit before tax from Insurance and Investments, excluding changes in economic assumptions and investment variance, decreased by £190 million, or 13 per cent, to £1,231 million, from £1,421 million in 2001. On the same basis, profit before tax from our life, pensions and unit trust businesses decreased by £285 million, or 38 per cent, to £475 million, partly as a result of a £135 million increase in provisions for redress to past purchasers of endowment and pension products, but also following a reduction of £55 million in benefits from experience variances and actuarial assumption changes. The market for medium and long-term investments continued to be adversely affected by the continued volatility in global stockmarkets. Total sales from the Group’s life, pensions and unit trust businesses were £4,456.3 million, compared with £4,423.5 million in 2001, an increase of 1 per cent. Overall weighted sales were £767.6 million compared to £754.7 million last year, an increase of 2 per cent. This increase in weighted sales reflected a 7 per cent increase in weighted sales from life and pensions, partly offset by a 13 per cent reduction in weighted sales from unit trusts and equity-based ISAs, largely caused by the continuing volatility in global stockmarkets throughout 2002. In the second half of 2002, weighted sales of £394.9 million were 10 per cent higher than the £358.9 million in the second half of 2001, and 6 per cent higher than the £372.7 million in the first half of 2002. The Group’s market share of the life, pensions and unit trusts market to September 2002 was 5.3 per cent, with a market share in the third quarter of 2002 of 5.9 per cent. By distribution channel, weighted sales from independent financial advisors rose by 25 per cent as a result of strong life and pensions sales. This compares with an increase of 11 per cent in the first half of the year, compared with the first half of 2001. Our share of the IFA market to September 2002 was 4.5 per cent, a significant improvement on the 3.8 per cent market share in 2001. In the branch network weighted sales were 7 per cent lower, as a result of the substantial reduction in sales of unit trusts, in comparison to a 10 per cent reduction in the first half of the year, compared with the first half of 2001. Scottish Widows remains the leading equity-based ISA provider in the UK as confirmed by the Investment Management Association (IMA) and the Group remains well placed in this sector of the market. A major programme to convert our unit trust range of some 80 funds into a range of Open Ended Investment Companies (OEICs) has now been completed and the resulting simpler range of mutual funds means that the Group is well positioned to take advantage of the likely changes in the market place, in particular the proposals outlined in the recently published Sandler report. LLOYDS TSB GROUP 17 Financial review Insurance and Investments (continued) Total new business premium income Regular premiums: Life – mortgage related – non-mortgage related Pensions Health Total regular premiums Single premiums: Life Annuities Pensions Total single premiums External unit trust sales: Regular payments Single amounts Total external unit trust sales Weighted sales (regular + 1⁄10 single) Life and pensions Unit trusts Life, pensions and unit trusts Weighted sales by distribution channel: Branch network Independent financial advisors Direct Life, pensions and unit trusts Group funds under management Scottish Widows Investment Partnership UK Wealth Management International 2002 £m 35.0 32.7 212.7 5.9 286.3 1,531.8 497.0 1,060.2 3,089.0 71.5 1,009.5 1,081.0 595.2 172.4 767.6 350.6 348.5 68.5 767.6 £bn 70 10 18 98 2001 £m 24.7 19.9 232.8 4.6 282.0 1,684.2 338.6 718.2 2,741.0 65.0 1,335.5 1,400.5 556.1 198.6 754.7 376.2 279.8 98.7 754.7 £bn 78 11 20 109 Profit before tax from general insurance operations, excluding investment variance, rose by £103 million, or 16 per cent, to a record £754 million, mainly as a result of continued strong revenue growth from creditor and home insurance. With over 9 million general insurance policies in force, we estimate that the Group has market leadership positions in the distribution of home and creditor insurance. The principal focus of Scottish Widows Investment Partnership (SWIP) is the delivery of consistently superior investment performance. Pre-tax profits from SWIP for the year were £2 million compared with £10 million in 2001, the reduction in profitability being driven primarily by lower stockmarket levels and significant investment in new infrastructure to support future business growth. At the end of the year SWIP had £70 billion of funds under management, out of Groupwide funds under management totalling £98 billion. Overall fund management performance in 2002 showed a significant improvement. SWIP’s largest UK equity fund, the UK Growth Fund, has achieved a top quartile performance within its sector over six and twelve months. This improvement in performance is also reflected in each of SWIP’s mainstream, actively managed, UK equity funds which have all achieved top quartile performance, over a twelve month period, within their sector. In addition, SWIP now has a total of 14 funds rated A and above by Standard and Poor’s. A number of new products have been launched during the year, most notably the SWIP Global Liquidity Fund, one of the largest sterling Institutional Money Market Funds, and the UK Balanced Property Trust, an innovative closed-end commercial property fund. 18 LLOYDS TSB GROUP Financial review Insurance and Investments (continued) The Financial Services Authority has announced the abolition of the polarisation regime and the Group has been positioning itself to achieve competitive advantage in the new depolarised world. The Lloyds TSB Group has extensive interests in both the manufacture and distribution of long-term savings products. With Scottish Widows continuing to be the best recognised brand in the medium to long-term savings market and the actions already taken to improve choice by offering a range of externally managed funds alongside those offered by Scottish Widows Investment Partnership, the Group remains well placed to prosper in a depolarised world. In particular, Scottish Widows’ unique multi-manager partnership with Frank Russell has been well received both in the IFA market and by our own customers. Life, pensions and unit trusts New business income Existing business – expected return – experience variances – assumption changes and other items – pension provisions – Abbey Life endowment provision Investment earnings Life and pensions distribution costs Unit trusts Unit trust distribution costs Profit before tax* 2002 £m 398 273 (1) 78 (40) (165) 145 214 (283) 474 90 (89) 1 475 2001 £m 358 307 37 95 (70) – 369 247 (255) 719 141 (100) 41 760 New business margin (life and pensions) 19.3% 18.5% * excluding changes in economic assumptions and investment variance New business income increased by 11 per cent supported by a 7 per cent growth in weighted sales from life and pensions products, and an improved performance in the more profitable life products. The life and pensions new business margin, defined as new business income less distribution costs divided by weighted sales, increased to 19.3 per cent, from 18.5 per cent in 2001. The improvement largely arose from an improved product mix, particularly higher margin protection and regular premium life products. The new business margin improved in all distribution channels. Profit before tax from existing business fell by 61 per cent to £145 million, reflecting the £135 million increase in provisions for redress to past purchasers of endowment and pension products, and a reduction of £55 million in benefits from experience variances and actuarial assumption changes, largely reflecting the implementation of revised actuarial mortality assumptions. The expected return from existing business, which reflects the unwinding of the long-term discount rate applied to the expected cash flows from the Group’s portfolio of in-force business, decreased by £34 million, or 11 per cent, to £273 million. This reduction reflects the lower value of in-force business at the beginning of the year, caused by the effect of lower stockmarkets on annual management charges. The Group has, along with other companies in the life assurance industry, been reviewing the past sales of certain endowment based and long- term savings products. As a result the Group has made a provision of £165 million to cover its liability for redress to policyholders in respect of past sales made, primarily in the late 1980s and early 1990s, by the Abbey Life salesforce prior to its disposal by the Group in February 2000. The adequacy of the provision for redress to past purchasers of pension policies has been reviewed as lower stockmarket levels have increased the expected remaining cost of redress. The Group has made a final provision for this purpose of £40 million. The Group is also carrying out, in conjunction with the regulator, an investigation into the appropriateness of sales of a stockmarket related investment product, the Extra Income & Growth Plan. This investigation is expected to be completed during 2003, when the Group will be in a position to estimate the financial effect. LLOYDS TSB GROUP 19 Financial review Insurance and Investments (continued) General Insurance Premium income from underwriting: Creditor Home Health Re-insurance premiums Commissions from insurance broking: Creditor Home Health Other Profit before tax* * excluding investment variance 2002 £m 107 350 44 (15) 486 426 44 17 160 647 754 2001 £m 110 281 45 (8) 428 323 41 22 142 528 651 Profit before tax, excluding investment variance, from our general insurance operations, comprising both underwriting and broking activities, rose by £103 million, or 16 per cent, to £754 million. Total income increased to a record £1.1 billion. Premium income from underwriting increased by £58 million, or 14 per cent, largely as a result of higher home insurance income which increased by 25 per cent. Commissions from insurance broking increased by £119 million, or 23 per cent, largely as a result of higher levels of creditor insurance. New business sales of 2.8 million products were 6 per cent higher than last year with home, creditor and motor business all growing strongly, particularly through direct channels (direct mail, telephone, affinity and internet) where sales grew by 11 per cent. Overall income from creditor insurance increased by 23 per cent, reflecting higher personal sector loan and credit card volumes and an improved personal lending penetration rate. Home insurance income increased by 22 per cent, with sales volumes increasing by 7 per cent to 1.2 million policies. Claims were £55 million, or 32 per cent, higher at £229 million than in 2001. The overall claims ratio of 46 per cent was higher than in 2001 (40 per cent) largely as a result of increased property claims which reflected a 26 per cent growth in the home underwritten portfolio, and higher weather and flood related insurance claims. As a leading distributor of general insurance products, Lloyds TSB now has over 9 million policies in force and we estimate that the Group is a UK market leader in the distribution of home and creditor insurance. 20 LLOYDS TSB GROUP Financial review Wholesale Markets (banking, treasury, large value lease finance, long-term agricultural finance, share registration, venture capital, and other related services for major UK and multinational companies, banks and financial institutions, and medium-sized UK businesses; and Lloyds TSB Asset Finance) Net interest income Other income Total income Operating expenses Trading surplus Provisions for bad and doubtful debts Amounts written off fixed asset investments Profit before tax Efficiency ratio Total assets (period-end) Total risk-weighted assets (period-end) 2002 £m 1,158 975 2,133 1,139 994 311 57 626 53.4% £89.1bn £52.9bn 2001 £m 1,096 863 1,959 937 1,022 155 15 852 47.8% £79.4bn £45.4bn Wholesale Markets pre-tax profit decreased by £226 million, or 27 per cent, to £626 million. The acquisitions during the year of First National Vehicle Holdings, Abbey National Vehicle Finance and the Dutton-Forshaw Group had a significant impact on the figures within Wholesale Markets. In 2002 these acquisitions contributed £101 million of income, and £102 million of operating expenses, including goodwill amortisation of £3 million, resulting in a loss before tax of £1 million. The acquisitions are expected to achieve substantial synergies in 2003 and beyond. Net interest income increased by £62 million resulting primarily from asset growth. Other income increased by £112 million, as an increase in operating lease rentals of £111 million, largely as a result of the asset finance acquisitions, and a higher level of insurance commission and corporate banking fees, were offset by a reduction in the realisations of venture capital gains, after record gains in 2001. Operating expenses increased by £202 million of which £102 million reflected the asset finance acquisitions, and a further £33 million reflected an increase in operating lease depreciation. The charge for provisions for bad and doubtful debts in Wholesale Markets increased by £156 million. The charge relating to the Group’s corporate lending portfolio increased by £145 million largely as a result of provisions against the Group’s loans and advances to certain large US corporate customers, which totalled some £100 million, and an increase in the provisions charge against the corporate lending portfolio, reflecting weak equity markets and the slowdown in economic activity in the UK. Amounts written off fixed asset investments increased by £42 million, as a result of a £21 million write-down relating to operating irregularities on one specific securitisation issue, and portfolio growth related write-downs in the Lloyds TSB Development Capital investment portfolio. Assets grew by 12 per cent to £89 billion, an increase of £10 billion. Of this increase, some £5 billion resulted from a growth in debt securities, reflecting an increase in the Group’s portfolio of asset backed securities, most of which were triple A rated, and £2.6 billion from an increase in customer lending. The Group’s policy to grow its asset backed securities portfolio is conservative, only targeting high quality tranches of asset backed securities issues, concentrating on mainstream asset classes such as mortgages, credit cards, student loans and retail car loans. The portfolio allows the Group to provide a securitised asset funding service for its corporate clients and to participate in structured deals with a limited number of global financial institutions. The high level of recent growth in the portfolio largely reflects the development of the Group’s capability in this market and, having now achieved a meaningful presence in the market, it is not intended that recent rates of portfolio growth will continue into 2003 and beyond. Our Treasury operations had another good year, however, primarily as a result of less favourable trading conditions, pre-tax profits decreased by 16 per cent to £196 million, compared with a record £233 million in 2001. The Group’s risk-based activity in the derivatives markets continues to remain largely focused on straight cash based products in support of our customers’ transactions. Lloyds TSB Leasing maintained its position as the largest ‘big ticket’ leasing company in the UK and continued to develop its position as an established provider of operating leases within its chosen market sectors. Pre-tax profits were £60 million compared to £67 million in 2001. At the end of the year, Lloyds TSB Registrars’ registration market share of FTSE 100 companies was 57 per cent, and its market leadership in employee share administration services continued to strengthen, having achieved market leadership in the new Share Incentive Plan market. Lower transactional activity, however, led to a reduction in pre-tax profit to £48 million, from £54 million in 2001. LLOYDS TSB GROUP 21 Financial review Wholesale Markets (continued) Lloyds TSB Development Capital achieved record levels of venture capital investment, however, in a difficult market for disposals, realisations of venture capital gains were £35 million lower than in 2001. During the year, Lloyds TSB Development Capital was named Private Equity House of the Year for 2001. Pre-tax profits in Lloyds TSB Asset Finance, which incorporates the Group’s asset finance and receivables finance businesses, were £86 million, compared with £87 million in 2001. Lloyds TSB Commercial Finance and Alex Lawrie Factors continued to expand their customer base, including a new venture in Germany through an agreement with Bertelsmann Finanz. In April 2002 Lloyds TSB Asset Finance acquired First National Vehicle Holdings and Abbey National Vehicle Finance, both previously wholly owned subsidiaries of Abbey National plc, for a provisional cash consideration of £47 million. The premium on acquisition was £86 million. The businesses have been combined with Lloyds TSB autolease to create the leader in the UK contract hire and fleet management markets. In December 2002, the Group also acquired the Dutton-Forshaw Group, one of the leading motor dealer groups in the UK with 38 franchised dealerships representing 14 manufacturers, for a cash consideration of £49 million. Our CarSelect and Cars4Staff initiatives continue to expand rapidly through a range of channels, supplying new and used cars to Group staff, customers, and employees of our corporate customers. Over 5,000 cars were supplied during 2002. 22 LLOYDS TSB GROUP Financial review International Banking (banking and financial services overseas in three main areas: The Americas, New Zealand, and Europe and Offshore Banking) Net interest income Other income Total income Operating expenses Trading surplus Provisions for bad and doubtful debts Amounts written off fixed asset investments Profit on sale of Lloyds TSB Asset Management S.A. Profit before tax Efficiency ratio Total assets (year-end) Total risk-weighted assets (year-end) 2002 £m 745 374 1,119 578 541 162 – 379 – 379 51.7% £21.8bn £14.3bn 2001 £m 749 345 1,094 586 508 183 7 318 39 357 53.6% £21.4bn £13.2bn International Banking pre-tax profit was £22 million, or 6 per cent, higher at £379 million compared with 2001, despite a profit in 2001 of £39 million from the sale of the Group’s Brazilian fund management business. Net interest income decreased by £4 million to £745 million as volume growth in New Zealand and Brazil was offset by the impact of adverse exchange rate movements. Other income increased by £29 million, or 8 per cent, to £374 million, as a result of profits on the sale and leaseback of premises totalling £32 million. Operating expenses reduced by £8 million as increased local currency costs in New Zealand, which supported higher business volumes, and in Argentina, were more than offset by favourable exchange rate movements. Provisions for bad and doubtful debts were £21 million lower, as a result of lower specific provisions in Losango, our consumer finance business in Brazil, largely reflecting exchange rate movements. Pre-tax profits from The National Bank of New Zealand increased by 32 per cent to £218 million as a result of asset growth across all business sectors, growth in the number of personal customers and higher levels of retail deposits and residential mortgages. Our consumer finance business in Brazil, Losango Consumer Finance, performed well, notwithstanding difficult local economic circumstances, and increased pre-tax profits on a local currency basis by 14 per cent. After the impact of adverse exchange rate movements, which were partly hedged, Losango made a pre-tax profit of £40 million, compared with £43 million in 2001. The Group’s offshore banking operations increased their pre-tax profit by £3 million to £123 million. In Europe Private Banking, pre-tax profits were £24 million, compared to £20 million in 2001. Since the October presidential election in Brazil the economic situation has somewhat stabilised. The Group reduced its total exposure to Brazil, net of provisions, to £1.9 billion during 2002 (December 2001: £3.3 billion), largely from not replacing maturing Government bonds. Economic activity in Brazil has remained reasonably robust, and we believe this relative strength in the local economy, in conjunction with the significant International Monetary Fund support package which the newly elected president and incoming government have indicated they will support, should alleviate current concerns about the Brazilian economy. The economic situation in Argentina continues to be difficult and the outlook is likely to remain uncertain at least until after the new Argentine government takes office during 2003. In 2002 the Group increased its general provision relating to its exposure to Argentina by £50 million. The Group’s total exposure to Argentina at the end of the year was reduced to some £190 million net of provisions and charges, compared to £610 million at the end of 2001. The Group has now provided for some 50 per cent of its total exposure to Argentina. In October 2001, the Group sold its Brazilian fund management and private banking business, including its subsidiary Lloyds TSB Asset Management S.A., to Banco Itaú S.A., resulting in a profit on sale of £39 million. LLOYDS TSB GROUP 23 Financial review Central group items (earnings on surplus capital and the emerging markets debt investment portfolio, central costs and other unallocated items) Accrual for payment to Lloyds TSB Foundations Other finance income Pension scheme benefit augmentations Earnings on surplus capital and the emerging markets debt investment portfolio Abbey National offer costs Central costs and other unallocated items 2002 £m (33) 165 – 2 – (38) 96 2001 £m (36) 307 (82) 63 (16) (51) 185 The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly disabled and disadvantaged people, to play a fuller role in society. The Foundations receive 1 per cent of the Group’s pre-tax profit, averaged over three years, instead of the dividend on their shareholdings. In 2003 they will receive £33 million (2002: £36 million) to distribute to charities, making them in aggregate the largest independent grant giving body in the UK. Other finance income represents income from the expected return on the Group’s pension fund assets less the charge for unwinding the discount on the pension fund liabilities. The significant reduction in income in 2002 reflects the combined impact of a reduction in the expected return on lower pension scheme assets as a result of the continuing weakness in global equity markets, and increased pension fund liabilities caused by the expected greater lifespan of pension scheme members. Earnings on surplus capital and the emerging markets debt investment portfolio largely reflect earnings on capital held at the Group centre, less the funding cost of Scottish Widows, and profits from the Group’s investment portfolio of, largely, emerging markets debt securities. During the year the Group accelerated its disposal programme for these investments as a result of concerns over credit and liquidity risks, particularly in Latin America. Given the higher level of disposals the Group has decided to mark the portfolio to market in 2002 and in future reporting periods. This change had no profit impact in 2002. The Group does not expect to achieve similar levels of emerging markets debt portfolio contributions, which in 2002 totalled £103 million, in 2003 and beyond. Net interest income Group: Net interest income £m Average interest-earning assets £m Gross yield on interest-earning assets % Interest spread % Net interest margin % Domestic: Net interest income £m Average interest-earning assets £m Gross yield on interest-earning assets % Interest spread % Net interest margin % International: Net interest income £m Average interest-earning assets £m Gross yield on interest-earning assets % Interest spread % Net interest margin % 2002 5,171 161,818 6.52 2.94 3.20 4,425 134,902 6.10 3.08 3.28 746 26,916 8.63 2.12 2.77 2001 4,922 144,945 7.84 3.00 3.40 4,202 121,244 7.38 3.11 3.47 720 23,701 10.19 2.43 3.04 Notes: a) Gross yield is the rate of interest earned on average interest-earning assets. b) Interest spread is the difference between the rate of interest earned on average interest-earning assets and the rate of interest paid on average interest-bearing liabilities. c) Net interest margin is net interest income as a percentage of average interest-earning assets. d) The analysis of net interest income by domestic and international operations shown above is based on the location of the office recording the transaction, except for lending by the international business booked in London. 24 LLOYDS TSB GROUP Financial review Net interest income (continued) Group net interest income increased by £249 million, or 5 per cent, to £5,171 million, despite a reduction of £290 million caused by a 20 basis point reduction in the net interest margin. Average interest-earning assets increased by 12 per cent to £162 billion. The 20 basis points decrease in the overall net interest margin, to 3.20 per cent, reflected a lower contribution from interest-free liabilities, caused by the lower average interest rates, the continuing shift in the mix of average interest-earning assets towards high quality, but finer margin, corporate and wholesale lending, and the impact of adverse exchange rate movements on our higher margin Latin American businesses, which led to a 27 basis point reduction in the international net interest margin. The interest spread reduced by 6 basis points. Domestic net interest income increased by £223 million, or 5 per cent, to £4,425 million, notwithstanding a reduction of £226 million caused by a 19 basis point reduction in the net interest margin. This represents 86 per cent of total group net interest income. Average interest-earning assets increased by £13.7 billion, or 11 per cent to £134.9 billion. Average personal lending and mortgage balances grew by £6.7 billion and wholesale balances increased by £7.2 billion. The net interest margin decreased by 19 basis points reflecting a reduction in the contribution of interest-free liabilities and the continuing shift in the mix of average interest-earning assets towards high quality, but finer margin, corporate and wholesale lending. In UK Retail Banking and Mortgages there was a 4 basis point decrease in the net interest margin as continued gradual erosion of the mortgage margin was partly offset by a shift in the mix of retail business growth towards personal lending and credit cards. In Wholesale Markets there was an 18 basis point reduction caused by further growth in finer margin corporate lending. The interest spread reduced by only 3 basis points. Net interest income from international operations increased by £26 million, or 4 per cent, to £746 million. This represents 14 per cent of total group net interest income. Strong volume growth, particularly in New Zealand, was offset by the adverse effect of exchange rate movements. Average interest-earning assets on a local currency basis increased by 16 per cent but again this was partly offset by the adverse effect of exchange rate movements. The net interest margin reduced by 27 basis points as a result of lower margins in our Latin American businesses. In particular, the effect of adverse exchange rate movements had a significant impact on the contribution to the interest margin from our higher margin businesses in Brazil. Other income Fees and commissions receivable: UK current account fees Other UK fees and commissions Insurance broking Card services International fees and commissions Fees and commissions payable Dealing profits (before expenses): Foreign exchange trading income Securities and other gains Income from long-term assurance business General insurance premium income Other operating income Total other income 2002 £m 579 1,163 647 414 250 3,053 (645) 173 15 188 (303) 486 763 3,542 2001 £m 573 1,220 528 332 269 2,922 (602) 158 75 233 (29) 428 708 3,660 Other income decreased by £118 million, or 3 per cent, to £3,542 million, partly as a result of a £38 million reduction in income from the combined effect of changes in economic assumptions and the higher negative investment variance. Fees and commissions receivable increased by 4 per cent to £3,053 million, largely reflecting strong growth in income from insurance broking and card services. Other UK fees and commissions decreased by £57 million, or 5 per cent, from £1,220 million to £1,163 million as a result of a £59 million reduction in unit trust and asset management fees, which reflected the impact of the continued fall in the level of stockmarkets during 2002. There was also a £20 million increase in fees from large corporate and factoring activity reflecting increased transaction volumes. LLOYDS TSB GROUP 25 Financial review Other income (continued) Insurance broking commission income increased by £119 million, compared with 2001, with continued strong growth in creditor insurance products. Income from credit and debit card services increased by £82 million, mainly as a result of higher merchant service charges and fees. UK current account fee income rose by £6 million, reversing the downward trend experienced in recent years; a £37 million increase in fee income from added value current accounts more than offset a reduction in service charges and unauthorised borrowing and other fees. Fees and commissions payable increased by £43 million against last year as a result of higher reciprocity fees and an increase in package costs relating to a number of products. Dealing profits decreased by £45 million compared with 2001 as a result of a reduction of £60 million in gains from securities trading. Income from long-term assurance business decreased by £274 million however, excluding changes in economic assumptions, investment variance and the impact of a £135 million increase in provisions for redress to past purchasers of endowment and pension products, it was £115 million lower, partly reflecting a reduction of £55 million in benefits from experience variances and actuarial assumption changes. Other operating income increased by £55 million to £763 million. Increases of £25 million in earnings on the sale and restructuring of emerging markets debt investments and £111 million in operating lease rentals, largely as a result of the acquisition of First National Vehicle Holdings and Abbey National Vehicle Finance, were partly offset by a £35 million reduction in the realisation of venture capital gains by Lloyds TSB Development Capital and a reduction of £25 million in profits on the sale and leaseback of premises. Operating expenses Administrative expenses Staff: Salaries and profit sharing National insurance Pensions Restructuring Other staff costs Premises and equipment: Rent and rates Hire of equipment Repairs and maintenance Other Other expenses: Communications and external data processing Advertising and promotion Professional fees Other Administrative expenses Depreciation Amortisation of goodwill Total operating expenses Efficiency ratio Efficiency ratio, excluding changes in economic assumptions and investment variance 2002 £m 1,758 134 318 105 202 2,517 280 18 131 114 543 446 147 113 448 1,154 4,214 642 59 4,915 55.4% 50.3% 2001 £m 1,776 140 347 69 221 2,553 261 18 115 123 517 483 154 110 409 1,156 4,226 511 39 4,776 53.7% 49.0% Total operating expenses increased by £139 million, or 3 per cent, compared with 2001. Excluding the impact of acquisitions and operating lease depreciation, operating expenses were flat. Administrative expenses decreased by £12 million to £4,214 million. Staff costs fell by £36 million to £2,517 million and other expenses decreased by £2 million to £1,154 million. Depreciation rose by £131 million, reflecting an increase of £95 million in operating lease depreciation. Goodwill amortisation was £20 million higher. The efficiency ratio, excluding changes in economic assumptions and investment variance, was 50.3 per cent, compared to 49.0 per cent in 2001. 26 LLOYDS TSB GROUP Financial review Efficiency programme In February 2000 the Group announced the commencement of a substantial medium-term efficiency programme to improve the Group’s overall efficiency, to maintain our continuing focus on operating costs and to support increasing levels of investment in the Group’s businesses. The efficiency programme has been a major contributing factor to the net reduction in Group staff numbers of 4,191, after adjusting for an additional 2,328 staff following a number of acquisitions, against the targeted net reduction in staff numbers of 3,000 by the end of 2002. The Group remains committed to strict cost control and, largely as a result of the continuing efficiency initiatives, we expect that the Group’s operating expenses in 2003, excluding the impact of acquisitions and operating lease depreciation, will grow by no more than the rate of inflation. This focus on cost control will be continued notwithstanding further significant investment throughout the business in 2003, to support increased business volumes, further improvements in productivity, and increases in investment in mandatory projects. These include projects such as the Universal Banking Service, anti-money laundering financial crimes programmes, and preparation for the forthcoming introduction of the Basel 2 capital accord. Number of employees (full-time equivalent) Staff numbers decreased by 1,863 to 79,537 during the year, notwithstanding an increase of 2,328 from acquisitions made during the year. Excluding the impact of acquisitions, staff numbers decreased by 4,191. This is significantly in excess of the targeted net reduction of 3,000 staff. Within UK Retail Banking staff numbers decreased by 3,513 as increases from planned improvements to customer service and a substantial increase in our branch sales activities have been more than offset by reductions of staff numbers in back office operations as part of the Group’s efficiency programme. In Wholesale Markets staff numbers increased by 2,151 as a result of the asset finance acquisitions, but reduced by 114 on an underlying basis. In International Banking staff numbers decreased by 466. UK Retail Banking* Mortgages Insurance and Investments Wholesale Markets International Banking Other Total number of employees (full-time equivalent) 31 December 2002 31 December 2001 44,184 3,711 6,170 11,385 11,788 2,299 79,537 47,697 3,527 6,316 9,234 12,254 2,372 81,400 * although the costs of distributing mortgages and insurance through the Lloyds TSB network are allocated to the mortgage and insurance businesses, the number of employees involved in these activities in the network is included under UK Retail Banking LLOYDS TSB GROUP 27 Financial review Charge for bad and doubtful debts UK Retail Banking Mortgages Wholesale Markets International Banking Central group items Total charge Specific provisions General provisions Total charge Charge as % of average lending: Domestic International Total charge 2002 £m 564 (1) 311 162 (7) 1,029 965 64 1,029 % 0.70 1.28 0.77 2001 £m 439 (24) 155 183 (6) 747 736 11 747 % 0.54 1.10 0.62 The total charge for bad and doubtful debts increased to £1,029 million from £747 million. In UK Retail Banking the provisions charge increased by £125 million, from £439 million in 2001, to £564 million, as a result of volume related asset growth in the personal loan and credit card portfolios and a lower level of recoveries and releases. In Wholesale Markets the provisions charge increased by £156 million to £311 million from £155 million in 2001. Provisions against the Group’s exposure to certain large US corporate customers totalled some £100 million, and there was also an increase in the provision charge from the corporate lending portfolio, reflecting weak equity markets and the slowdown in economic activity in the UK. In International Banking provisions decreased by £21 million as a result of lower specific provisions in Losango, largely reflecting exchange rate movements. There was also an increase of £64 million in the Group’s overall general provision reflecting a £50 million general provision charge relating to the Group’s exposure to Argentina, and a more cautious outlook following the slowdown in economic growth in the UK. Non-performing loans increased to £1,414 million compared with £1,222 million in December 2001, largely reflecting higher levels of non- performing lending in the Group’s corporate portfolio and general portfolio growth throughout the Group. In UK Retail Banking and Mortgages the overall arrears position remained stable. An improved position in personal lending and mortgages was offset by a slight deterioration in the credit card portfolio, largely reflecting the slowdown in economic growth in the UK. Non-performing lending represented 1.0 per cent of total lending, compared with 1.0 per cent in December 2001. Our lending portfolio remains heavily influenced by our high quality, relatively low risk, mortgage business and, as a result, we remain relatively well positioned to withstand any continued economic slowdown. Total provisions for bad and doubtful debts Closing provisions as % of lending (excluding unapplied interest) 31 December 2002 % £m 31 December 2001 % £m Specific: – Domestic – International General 1,016 318 1,334 433 1,767 (0.8) (1.7) (1.0) (0.3) (1.3) 848 251 1,099 369 1,468 (0.8) (1.5) (0.9) (0.3) (1.2) At the end of December 2002 provisions for bad and doubtful debts totalled £1,767 million. This represented 1.3 per cent of total lending (December 2001: 1.2 per cent). Non-performing lending increased to £1,414 million from £1,222 million in December 2001, largely reflecting higher levels of non-performing lending in the Group’s corporate portfolio, and general portfolio growth throughout the Group. At the end of the year, total provisions represented over 120 per cent of non-performing loans (December 2001: 120 per cent). 28 LLOYDS TSB GROUP Financial review Capital ratios Capital: tier 1 : tier 2 Supervisory deductions Total capital Risk-weighted assets: UK Retail Banking Mortgages UK Retail Banking and Mortgages Insurance and Investments Wholesale Markets International Banking Central group items Total risk-weighted assets Risk asset ratios: total capital : tier 1 31 December 2002 £m 31 December 2001 £m 9,490 8,846 18,336 (6,588) 11,748 £bn 22.7 31.5 54.2 0.2 52.9 14.3 0.8 122.4 9.6% 7.8% 1.61% 8,408 7,831 16,239 (6,752) 9,487 £bn 19.6 28.7 48.3 0.2 45.4 13.2 0.8 107.9 8.8% 7.8% 2.26% Post-tax return on average risk-weighted assets Notes: a) Tier 1 capital comprises mainly shareholders’ funds, tier 1 capital instruments and minority interests. b) Tier 2 capital comprises loan capital and the general provision for bad and doubtful debts. c) Supervisory deductions comprise mainly the investment in the insurance businesses. At the end of December 2002 the risk asset ratios were 9.6 per cent for total capital and 7.8 per cent for tier 1 capital. During 2002, total capital for regulatory purposes increased by £2,261 million to £11,748 million. Tier 1 capital increased by £1,082 million, mainly from the issue of new tier 1 capital instruments. The total amount of embedded value earnings contained within the Group’s tier 1 capital is now some £2.2 billion. Tier 2 capital increased by £1,015 million and supervisory deductions decreased by £164 million, as a result of a decrease in the Group’s embedded value to £6,228 million, from £6,366 million in December 2001. Risk-weighted assets increased by 13 per cent to £122.4 billion and the post-tax return on average risk-weighted assets decreased to 1.61 per cent. Tax The effective rate of tax was 29.3 per cent (2001: 27.7 per cent). The lower effective rate of tax, compared with the standard tax rate of 30 per cent, is largely due to tax relief on payments to the QUEST to satisfy Save As You Earn options, non taxable gains on disposals of properties sheltered by capital losses, and tier 1 capital interest payments, partly offset by a higher effective rate of tax in the Group’s life and pensions businesses in 2002 (see note 8b, page 70). Free asset ratio The free asset ratio is a common measure of financial strength in the UK for long-term insurance businesses. It is the ratio of assets less liabilities (including actuarial reserves but before the required regulatory minimum solvency margin) expressed as a percentage of the liabilities. It is derived from annual insurance returns which are due to be completed in March 2003, and have yet to be finalised. However, based on current expectations, at 31 December 2002 the free asset ratio for Scottish Widows plc was an estimated 10.0 per cent, compared with 11.5 per cent at 31 December 2001. This free asset ratio included some £400 million allowance for future profits (December 2001: nil). After adjusting for the inclusion of the required regulatory minimum solvency margin within liabilities, the Scottish Widows plc ratio was an estimated 5.5 per cent at 31 December 2002, compared with 6.6 per cent at 31 December 2001. LLOYDS TSB GROUP 29 Financial review Economic profit In pursuit of our aim to maximise shareholder value, we use a system of value based management as a framework to identify and measure value in order to help us make better business decisions. Accounting profit is of limited use as a measure of value creation and performance as it ignores the cost of the equity capital that has to be invested to generate the profit. We choose economic profit as a measure of performance because it captures both growth in investment and return. Economic profit represents the difference between the earnings on the equity invested in a business and the cost of the equity. Our calculation of economic profit uses average equity for the year and is based on a cost of equity of 9 per cent (2001: 9 per cent). Economic profit instils a rigorous financial discipline in determining investment decisions throughout the Group. It enables us to evaluate alternative strategies objectively, with a clear understanding of the value created by each strategy, and then to select the strategy which creates the greatest value. Average shareholders’ equity Profit attributable to shareholders Less: notional charge Economic profit 2002 £m 10,672 1,781 (960) 821 2001 £m 12,338 2,229 (1,110) 1,119 The notional charge has been calculated by multiplying average shareholders’ equity by the cost of equity. Investment variance In accordance with generally accepted accounting practice in the UK, it is the Group’s accounting policy to carry the investments comprising the reserves held by its life companies at market value. The reserves held to support the with-profits business of Scottish Widows are substantial and changes in market values will result in significant volatility in the Group’s embedded value earnings, which is beyond the control of management. Consequently, in order to provide a clearer representation of the underlying performance, the results of the life and pensions business are separately analysed to include investment earnings calculated using longer-term investment rates of return, and annual management charges based on unsmoothed fund values. This investment variance represents the difference between the actual investment return in the year on investments backing shareholder funds and the expected return based upon the economic assumptions made at the beginning of the year, and the effect of these fluctuations on the value of in-force business. The effects of other changes in economic circumstances beyond the control of management are also reflected in the investment variance. The longer-term rates of return for the period are consistent with those used by the Group in the calculation of the embedded value at the beginning of the period, which were 8 per cent for equities and 5.25 per cent for gilts. Following changes in economic assumptions made at the end of 2002 the longer-term rates of return for 2003 have been revised to 7.10 per cent for equities and 4.50 per cent for gilts. Lloyds TSB General Insurance also holds investments to support its underwriting business; these are carried at market value and gains and losses included within dealing profits. Consistent with the approach adopted for the life and pensions business, an operating profit for the general insurance business is calculated including investment earnings normalised using the same long-term rates of return. During 2002 the FTSE All-Share index fell by 24 per cent and this created an adverse investment variance totalling £952 million. This adverse variance should not represent a permanent impairment to the value of the Group’s reserves which fluctuate as stockmarket values fluctuate. 30 LLOYDS TSB GROUP Financial review Income and expenses reconciliations To facilitate comparison of results, certain key financial information and commentaries have been considered excluding changes in economic assumptions, investment variance, pension and endowment provisions, the impact of investment returns of the Group’s pension scheme assets, operating lease depreciation, and the impact of acquisitions. Reconciliations are detailed below. Income, excluding changes in economic assumptions, investment variance, pension and endowment provisions, the impact of investment returns on the Group’s pension scheme assets, operating lease depreciation and the impact of acquisitions Changes in economic assumptions Investment variance Pension and endowment provisions Other finance income Netting of operating lease depreciation Acquisitions Total income Expenses, excluding operating lease depreciation and the impact of acquisitions Netting of operating lease depreciation Acquisitions Total operating expenses Enterprise-wide risk management 2002 £m 9,484 55 (952) (205) 165 230 101 8,878 2002 £m 4,580 230 105 4,915 2001 £m 9,314 – (859) (70) 307 197 – 8,889 2001 £m 4,579 197 – 4,776 Lloyds TSB has adopted an enterprise-wide framework for the identification, assessment and management of risk, designed to meet its customers’ needs and maximise shareholder value 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. Enterprise-wide risk management (EWRM) is founded on four principal concepts: strong risk governance; empowerment; competitive advantage and common risk language. Strong Risk Governance Common Risk Language Current and Emerging Risks Empowerment Competitive Advantage LLOYDS TSB GROUP 31 Financial review Strong risk governance The risk governance structure is designed to create a risk-aware culture in which the nature and size of risks are well understood, and business decisions strike a balance between risk and reward which is consistent with the Group’s risk appetite, whilst maximising shareholder value. The governance structure is based on the following elements: The Board is responsible for determining the long-term strategy of the business, the markets in which the Group will operate and the level of risk acceptable to the Group in each area of its business. As explained on page 55, it is assisted in this by the Chairman’s Committee and the Audit Committee. The Group Executive Committee is responsible to the Group Chief Executive for the development and implementation of strategy, operational plans, policies and budgets. It monitors operating and financial performance, assesses and controls risk, and prioritises and allocates resources. The Group Risk Committee is responsible to the Group Executive Committee for protecting shareholder value through assessment and control of the high level risks assumed by the Group; approving the Group’s high level policies; ensuring that the necessary culture, practices and systems are in place to enable the Group to meet its internal and external obligations; and reviewing the allocation and deployment of capital at risk, taking into account the Group’s risk appetite. The Director of Group Risk Management is responsible for the implementation of risk policy and the provision of independent assurance to the Audit Committee and Board, who receive regular reports on risk issues prepared by Group Risk Management. The Director of Group Risk Management reports to the Group Chief Executive and has access to the Chairman and members of senior management; he is also a member of the Group Risk Committee. These relationships are illustrated in the following diagram: Board Audit Committee Group Chief Executive Chairman’s Committee Group Risk Management Group Risk Committee Group Executive Committee External Auditors Regulators Business Units Empowerment The directors of the Group’s business units have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability. They are empowered to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within parameters set by Group Risk Management. Competitive advantage The EWRM model 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 increasing shareholder value. 32 LLOYDS TSB GROUP Financial review Common risk language The Group has adopted a risk language in which all risks are classified by one or more of the following 11 Risk Drivers: Governance, People and Organisation Strategy Credit Market Insurance Operational Product and Service Financial Customer Treatment Legal and Regulatory Change Management The Group’s high level policy and reporting to the Group Risk Committee, Audit Committee and Board have been aligned to the Risk Drivers. Roll- out of the risk language to the business has commenced and will be completed during 2003, ensuring a consistent approach to classifying and describing risks. 1 Governance, people and organisation Definition The risk of loss from poor corporate governance at Group and business unit level, sub-optimal organisational structuring, or failure to recruit, manage and retain appropriate skilled staff to achieve business objectives. Group Policy Manual The Group’s policy for managing Governance, People and Organisation risk is set out in the Group Policy Manual, which is approved by the Group Risk Committee. The salient elements of the policy are summarised below. Governance and Organisation The Group’s governance and organisation policy is to: – Organise itself into three principal business units (UK Retail Banking and Mortgages, Wholesale and International Banking, and Insurance and Investments) with a centralised IT and operational support function (Group IT and Operations). These units are run in a manner consistent with strategic direction from the Board, tight financial and operating controls and the prudent management of risk. – Develop and maintain a strong risk management and control culture across all businesses. – Follow industry best practice on corporate governance, and conduct business with integrity, due skill, care and diligence. Management of Risks The Group sets high standards for the conduct of its business and values its reputation. Responsibility for establishing an effective organisational structure is vested in Group and business unit management. Sound internal risk management practices are promoted through business unit directors who are responsible for identifying, measuring, monitoring and controlling the risks within their specific areas of accountability. 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 ensures effective and efficient operational management; reliability, integrity and consistency of financial and other reporting; and compliance with governing laws and regulations. Business unit directors ensure that material risks are reported to the relevant Group Executive Director and to Group Risk Management. Information and Communication The Board and senior management at both Group and business unit level receive relevant, reliable and timely management information in line with business objectives to ensure that activities are appropriately controlled, key risks are identified and monitored, decisions are implemented and regulatory obligations are met. LLOYDS TSB GROUP 33 Financial review 1 Governance, people and organisation (continued) Audit Responsibilities and Rights Group Audit independently reviews adherence to the policies and processes that make up the control environment, disseminating best practices throughout the Group in the course of its monitoring and corrective action activities. The Group Audit Director meets regularly with the Group Chief Executive and periodically with the Audit Committee. People The Group’s approach to people management is to employ skilled, committed staff, working as a team for the benefit of customers and shareholders, who are given the opportunity to fulfil their potential; employ the highest ethical standards of behaviour and best practice management principles; and recruit on the basis of ability and competence. Standards of Behaviour The Group seeks to ensure that its employees act with integrity and seek to deliver high levels of customer service. It promotes a working environment free from discrimination, harassment, bullying or victimisation of any kind. Employees are encouraged and expected to alert management to suspected misconduct, fraud or other serious malpractice. Performance and Reward Management The Group seeks to: – Ensure that all employees understand their role, the purpose of the role and where it fits into the wider team and organisational context. – Manage and measure employees’ performance and contribution to collective goals. – Recognise the contribution of individuals in the context of the pay market and the performance of the business in which they work, and reward appropriately. Training and Development The Group believes that: – Long term success depends on the quality and skills of its staff. – It has a joint responsibility with employees for their personal and career development to improve current performance and to enhance future prospects. 2 Strategy risk Definition The risk arising from the adoption of the Group’s agreed strategy and its implementation at corporate or business unit level. Processes The Group’s governing objective is to maximise value for its shareholders by: – Being first choice for its customers. – Being a leader in its chosen markets. – Driving down day-to-day costs to facilitate investment. The risks arising from the adoption of the Group’s strategy at corporate and business unit level are managed by a number of processes. 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 unit and Group level. The Group’s equity attribution model covers credit, market, insurance, business and operational risks. A rigorous annual strategic planning process is conducted at Group and business unit level and includes a quantitative and qualitative assessment of the risks in the Group plan. The Group’s strategy and those of its constituent business units 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. 34 LLOYDS TSB GROUP Financial review 2 Strategy risk (continued) Revenue and capital investment decisions require additional formal assessment and approval. Formal risk assessment is conducted as part of the financial approval process. Company mergers and acquisitions require specific approval by the Board. In addition to the standard due diligence conducted during a merger or acquisition, Group Risk Management conducts an independent risk assessment of the target company and its proposed integration into the Group. 3 Credit risk Definition The risk of loss arising from counterparty default subsequent to the provision of credit facilities (both on- and off-balance sheet). Measurement The Group has dedicated standards, policies and procedures to control and monitor credit and related risks. Examples of the way in which such risks are measured include: Group Rating System – all business units are required to operate an authorised rating system that complies with the Group’s standard methodology. The Group uses a ‘Master Scale’ rating structure with ratings corresponding to a range of probability of future default. Portfolio Analysis – in conjunction with Group Risk Management, Group 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 Management. To further enhance the ability to measure and predict future risk, the Group continues to develop new policies and risk management systems. Limits A number of tools, including Group-level credit policy where appropriate, are used to control the Group’s exposure to undue levels of credit risk: Counterparty Limits – exposure to individual counterparties, groups of counterparties or customer risk segments is controlled through a tiered hierarchy of delegated sanctioning authorities. Approval requirements for each decision are based on the transaction amount, the customer’s aggregate facilities, credit risk ratings and the nature and term of the risk. Regular reports on significant credit exposures are provided to the Group Executive Committee and Board. Bank Exposures – an in-house proprietary rating system is used to approve bank facilities, which are sanctioned on a Group-wide basis. Cross-border Exposures – country limits are authorised and managed by a dedicated unit, using an in-house rating system, which takes into account economic and political factors. Concentration Risk – formulation of concentration limits on certain industries and sectors. Group Risk Management sets Sector Caps that reflect risk appetite, and monitors exposures to prevent excessive concentration of risk. Credit Risk Arising from the Use of Derivatives – note 46 on page 87 shows the total notional principal amount of interest rate, exchange rate and equity contracts outstanding at 31 December 2002. The notional principal amount does not, however, represent the Group’s real exposure to credit risk, which is limited to the current cost of replacing contracts with a positive value to the Group, should the counterparty default. This replacement cost is also shown in note 46. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. 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. Lloyds TSB has limited exposure to such instruments. LLOYDS TSB GROUP 35 Financial review 3 Credit risk (continued) Processes The processes by which Group Risk Management discharges its responsibilities in respect of credit risk include the following: – Formulation of high-level credit policies designed to ensure a balanced and managed approach to the identification and mitigation of credit risk. – Provision of lending guidelines. These define the responsibilities for lending officers and provide a disciplined and focused benchmark for credit decisions. – Establishment and maintenance of the Group’s Large Exposure and Provisioning policies, in accordance with regulatory reporting requirements. – Monitoring of scorecards. The Group utilises statistically-based decisioning techniques (primarily credit scoring and performance scoring) for its principal consumer lending portfolios. Group Risk Management reviews and monitors new and material changes to scorecards. – Maintenance of a facilities database. Group Risk Management operates a centralised database of large corporate, sovereign and bank facilities designed to ensure a consistent aggregation policy is maintained throughout the Group. – Monitoring and controlling residual value risk exposure. The Group’s appetite for such exposure is communicated to the business by a series of time referenced Sector Caps, ensuring an acceptable distribution of future risk. – Communication and provision of general guidance on all credit-related risk issues, including regulatory changes and environmental risk policy, to promote consistent and best practice throughout the Group. Day-to-day credit management and asset quality within each business unit is the primary responsibility of the relevant business unit director. Such responsibility is fulfilled by: – Each business unit having in place established credit processes which are consistent with the corresponding Group policies. – Authority to delegate lending authorities within business units resting with officers holding divisional delegated lending authority. All material authorities are advised to Group Risk Management. – Specialist units established within Group businesses to provide, for example: intensive management and control; security perfection, maintenance and retention; expertise in documentation for lending and associated products; sector-specific expertise; and legal services applicable to the particular market place and product range offered by the business unit. 4 Market risk Definition The risk of loss arising from unexpected changes in financial prices, including interest rates, exchange rates, bond, equity and commodity prices. 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 (see ‘Insurance Risk’ below). Measurement Measurement Techniques – a variety of techniques are used to quantify the market risk arising from the Group’s banking and trading activities. These reflect the nature of the business activity, and include simple interest rate gapping, open exchange positions, sensitivity analysis and Value at Risk (VaR). Stress testing and scenario analysis are also used in certain portfolios, and at Group level, to simulate extreme conditions to supplement these core measures. Trading Portfolios – market risk within the Group’s trading portfolios is calculated using various parameters to calculate the VaR on a given trading portfolio of positions, thus avoiding undue reliance on a single measure. Based on the commonly-quoted 95 per cent confidence level, assuming positions are held overnight and using observation periods with greater emphasis given to more recent data, during 2002 the VaR on the Group’s global trading averaged £1.26 million (2001: £1.17 million) with a maximum of £2.07 million (2001: £1.62 million) and a minimum of £0.93 million (2001: £0.78 million). The figure at 31 December 2002 was £1.02 million (2001: £1.62 million). Non-trading Portfolios – interest rate risk within the Group’s non-trading exposure is summarised in the form of an interest rate repricing table, as set out on page 89. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date. However, the table does not take into account the effect of interest rate options used by the Group to hedge its exposure. Structural Foreign Exchange Risk – this arises from the Group’s investments in its overseas operations. The structural position is managed after having regard to the currency composition of the Group’s risk-weighted assets, the objective being to limit the effect of exchange rate movements on the risk asset ratio. The Group’s structural position at 31 December 2002 is set out on page 90 in note 46d. The position implies that a hypothetical increase of 10 per cent in the value of sterling against all other currencies would lead to a £191 million reduction in reserves. There would be no material impact upon the Group’s risk asset ratio. 36 LLOYDS TSB GROUP Financial review 4 Market risk (continued) Limits Market Risk Limits – limits to control market risk in respect of trading positions, UK wholesale banking and overseas centres are set by Group Risk Management up to a total authorised by the Board. A combination of position and sensitivity limits is used, depending on the nature of the business activity. Retail Portfolios – limits to control interest rate risk within the Group’s UK retail portfolios are set out in the policy for Group Balance Sheet Management (GBSM), which is established by the Group Asset and Liability Committee (ALCO) and ratified by the 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. Overseas operations are managed within limits authorised by Group Risk Management, in addition to which some centres have adopted benchmark profiles for investment of interest rate insensitive liabilities as approved by Group Risk Management. Processes Wholesale Banking – market risk in the wholesale banking books is managed in the UK by Lloyds TSB Treasury, and internationally by an authorised local treasury operation in each overseas centre. The levels of exposure within these books are controlled and monitored within approved limits, both locally and also centrally by Group Risk Management. Active management of the book is necessary to meet customer requirements and changing market circumstances. Trading Activities – trading is restricted to a number of specialist centres, authorised by Group Risk Management, the most important centre being the Group’s principal Treasury department in London. The level of exposure is strictly controlled and monitored within approved limits locally and centrally by Group Risk Management. Most of the Group’s trading activity is undertaken to meet the requirements of customers for foreign exchange and interest rate products. However, some interest rate and exchange rate positions are taken out using derivatives (forward foreign exchange contracts, interest rate swaps and forward rate agreements) and on-balance sheet instruments (mainly debt securities), with the objective of earning a profit from favourable movements in market rates. Accordingly, these transactions are reflected in the accounts at their fair value and gains and losses shown in the profit and loss account as dealing profits. Retail Portfolios and Capital Funds – market risk in the Group’s retail portfolios, including mortgages, and in the Group’s capital funds arises from the different repricing characteristics of the Group’s banking assets and liabilities and is managed by GBSM, reporting to the ALCO. The simulation models used by GBSM include assumptions about the relationships between customer behaviour and the level of interest rates; the anticipated level of future business is also taken into account. The accuracy of these assumptions will impact the efficiency of hedging transactions. The assumptions are regularly updated and the projected exposure is actively managed in accordance with the policy. Derivatives – these are used to meet customers’ financial needs; as part of the Group’s trading activities; and to reduce the Group’s own exposure to fluctuations in interest and exchange rates. The principal derivatives used by the Group are interest rate contracts (including interest rate swaps, forward rate agreements and options) and exchange rate contracts (including forward foreign exchange contracts, currency swaps and options). Particular attention is paid to the liquidity of the markets and products in which the Group trades to ensure that there are no undue concentrations of activity and risk. 5 Insurance risk Definition The risk of loss arising from the sensitivity of profits to movements in claims experience and expectation; movements in the market value of invested assets which are not matched by similar movements in the value of insurance liabilities; the presence of options and guarantees in insurance products; and changes in the legal, regulatory and fiscal environment. Measurement Financial risks are measured through deterministic studies of the impact of different insurance and investment market scenarios on the future free assets of the business. Processes Insurance risks are both retained and reinsured with external underwriters. The retained risk level is carefully controlled and monitored, with close attention being paid to the analysis of underwriting experience, product design, policy wordings, adequacy of reserves, solvency management and regulatory requirements. LLOYDS TSB GROUP 37 Financial review 5 Insurance risk (continued) General insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modeling, including that of the Probable Maximum Loss under various catastrophe scenarios, supports the choice of reinsurance arrangements. Appropriate reinsurance arrangements also apply within the life and pensions businesses. Investment strategy is determined by the term and nature of the underwriting liabilities, and asset/liability matching positions are actively monitored. Investment strategy for surplus assets held in excess of liabilities takes account of the regulatory and internal business requirements for capital to be held to support the business now and in the future. Equity derivatives are used by the Group to match equivalent liabilities arising from some of its retail products. Derivatives may also be used for efficient portfolio management purposes in client funds where such activity is in accordance with Group approved policy and the customer mandate. With-profits life and pensions business involves guaranteed benefits that create a contingent market risk to the Group. Accordingly, in extreme investment market conditions the surplus assets in the life and pensions business could be called upon to support with-profits benefits. Options and guarantees are only incorporated in new insurance products after careful consideration of the risk management issues that they present. This occurs under the New Product Approval process (see ‘Product and Service Risk’ below). 6 Operational risk Definition The risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. For internal purposes, reputational impact is also included. Processes Business units have primary responsibility for identifying and managing their operational 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 Management’s responsibilities in relation to operational risk include: – Defining high-level operational risk policies to ensure a comprehensive and consistent approach to the identification and management of operational risk. – Implementation of a Group-wide standard methodology to ensure consistency in the identification, assessment and management of operational risk. – Communication and provision of general guidance on operational risk related issues, including regulatory changes and developments in the measurement and management of operational risk, to promote best practice throughout the Group. – Continuous review and improvement of all aspects of operational risk management to reflect developments in industry best practice and regulatory requirements, e.g. the New Basel Accord. – Approval from a risk perspective of all new products launched throughout the Group, to ensure their risks are understood by the business and managed appropriately (see ‘Product and Service Risk’ below). – Identification of risk through formal risk reviews, covering specific risks, activities, business sectors or products, and ensuring that prompt and pre-emptive action is taken to address any actual or perceived risks that may emerge, whether specific to the Group or to the industry generally. 7 Product and service risk Definition The risk of loss arising from the inherent characteristics, management or distribution of products or services, or from failure to meet or exceed customer expectations and competitor offerings. Processes For the Group to achieve its strategic aims of leadership in chosen markets and being first choice for customers, product life cycles must be effectively managed and new products developed to meet customer needs. Business units are responsible for maintaining a range of products which meets the needs of customers and the business strategy; managing and controlling product risks; and compliance with applicable regulations. 38 LLOYDS TSB GROUP Financial review 7 Product and service risk (continued) Product Planning and Development – business units have formal processes for reviewing the range of their product portfolios and subjecting all product development to rigorous assessment. They are also responsible for ensuring compliance with all relevant regulatory and legislative requirements. Product Pricing – business units have pricing objectives consistent with Group strategy. Product Promotion, Distribution and Sales – business units have a defined channel distribution strategy for products, consistent with the Group’s distribution strategy. Business units launching new products are responsible for ensuring that proposed sales activity within delivery channels is compliant with regulatory requirements. All advertising and marketing material complies with the Group’s governing policy on Business Conduct. Any statement of fact is substantiated through documentary evidence; any comparison is presented in a fair and balanced way; and any reference to past performance clearly states the basis of measurement. Business units are required, prior to the publication of any sales material, to seek confirmation that it complies with the regulatory and legal requirements of the jurisdiction in which the product is offered and marketed. Terms and conditions (to include mandates, agreements and other documentation) are approved by legal advisers and reviewed periodically. New Product Approval – the Group defines a New Product as a new or amended product that introduces a significantly different risk profile at Group or business unit level. In line with defined policy, business units provide Group Risk Management with details of New Products at an early stage of product or service development to ensure compliance with the Group’s risk appetite and strategy. Where appropriate, technical advice/approval is sought from specialist functions, e.g. Tax, Legal and Compliance. Only products carrying the approval of Group Risk Management and the business units involved in their manufacture/delivery are offered to customers. Product Performance – business units establish and monitor performance standards for all marketed products across a range of indicators, e.g. sales volumes, customer service, risk profile. Significant deviations from these standards are investigated and appropriate action taken. 8 Financial risk Definition The risk of financial failure arising from lack of capital or liquidity, poor management or poor quality/volatile earnings. Measurement The international standard for measuring capital adequacy is the risk asset ratio, which relates to on- and off-balance sheet exposures weighted according to broad categories of risk. The Group’s capital ratios, calculated in line with the requirements of the Financial Services Authority (FSA), are set out in detail within this report. Liquidity Policy – a Group Liquidity Policy is in place which requires a common methodology for measuring liquidity across the Group. The methodology derives a liquidity ratio calculated by taking the sum of liquid assets, five-day wholesale inflows and back-up lines, and then dividing this by the sum of five-day wholesale outflows and a percentage of retail maturities and contingent claims drawable over the next five days. Accounting Policies – the Group seeks to use appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates. Limits The Group and its regulated subsidiary banks have been allocated an Individual Capital Ratio by the FSA, and the Board has agreed a formal buffer to be maintained in addition to the Individual Capital Ratio. Actual or prospective breaches of the formal buffer must be notified to the FSA, together with proposed remedial action; no such notifications have been made during 2002. Informally, a further buffer is maintained. In addition, the Board has agreed a maximum limit for the proportion of debt instruments in the capital base. Risk-weighted assets are monitored by business unit, while capital is controlled centrally. The Liquidity Policy requires all authorised local treasury operations to maintain a liquidity ratio of over 100 per cent, in addition to ensuring compliance with local regulatory requirements. LLOYDS TSB GROUP 39 Financial review 8 Financial risk (continued) Processes Capital ratios are a key factor in the Group’s budgeting and planning processes, and updates of expected ratios are prepared regularly during the year. Capital raised takes account of expected growth and currency of risk assets, and also allows for the sensitivity of the Group’s capital to movements in equity markets. Each reporting entity within the Group has a finance function which is responsible for the production of financial, management and regulatory information. It is the responsibility of Group Finance to produce consolidated information for use internally and to meet external regulatory and statutory reporting requirements. In conjunction with directives laid down by Group Finance, business units or reporting entities: – Have formal month-end and quarter-end procedures in place for preparation of management and financial accounts respectively. – Review and formally approve management accounts at a determined level of detail, ensuring consistency with financial accounts. – Prepare forecasts and detailed annual budgets that are subject to formal review and approval. – Implement measures to monitor performance at local level to identify significant fluctuations or unusual activity. It is the responsibility of local line management to ensure that the Liquidity Policy is met, and the sources and maturities of assets and liabilities are continually managed and appropriately diversified to avoid any undue concentration as market conditions evolve. Compliance is monitored by regular liquidity returns to Group Risk Management. 9 Customer treatment risk Definition The risk of financial loss or reputational damage arising from inappropriate or poor customer treatment. Measurement Service improvements are monitored by customer satisfaction surveys. The results of the research are fed into the Group’s CARE Index, which measures ongoing performance against five principal objectives: customer understanding; accessibility; responsibility; expertise; and overall service quality improvement. Processes Trends across all the CARE Index categories are monitored and fed into a programme of continuous customer service improvement. Lloyds TSB also provides its staff with clear FSA-compliant guidelines and processes for dealing with customer complaints. 10 Legal and regulatory risk Definition The risk of financial loss or reputational damage arising from failing to comply with the laws, regulations or codes applicable to the financial services industry. Processes The Group’s business is regulated overall by the FSA, and additionally by local regulators in offshore and overseas jurisdictions. Each Group business has a nominated individual with ‘Compliance Oversight’ responsibility under FSA rules. The role of such individuals is to ensure that management have in place within the business a control structure which creates awareness of the rules and regulations to which the Group is subject, and to monitor and report on adherence to these rules and regulations. Group Compliance – all compliance personnel also have a reporting line to Group Compliance, which sets compliance standards across the Group and provides independent reporting and assessment to the Board and business unit directors. Financial Crime – Group Compliance includes a dedicated unit, led by the Group Financial Crime Director, which is responsible for ensuring that the Group has effective processes in place to identify and report on suspicious transactions and customers in support of the world-wide fight against financial crime. The Group Compliance Director has access to the Chairman, Group Chief Executive and members of senior management. 40 LLOYDS TSB GROUP Financial review 11 Change management risk Definition The risk of financial loss or reputational damage arising from programmes or projects failing to deliver to requirements, budget or timescale, or failing to implement change effectively. Processes To deliver the Group’s strategic aims, change must be managed in an effective, risk-aware and appropriately controlled manner throughout the organisation. The Group’s Change Management Standards provide consistency of approach across the Group’s project portfolio. In particular, the following control processes are in place: – The Group’s approach to change management is regularly benchmarked against other organisations around the world. – A specialist Group Project Services function provides a pool of experienced, professional project managers to be deployed on major projects across the Group. – An Investment Committee oversees the Group’s investment in projects, and is constituted as a sub-committee of the Group Executive Committee. – Changes that significantly impact customers or staff are managed as part of an overall Group Change Plan managed by the Change Implementation Review Committee (CIRC). The CIRC ensures that the aggregate impact of the implementation of change on customers, staff and systems is understood, managed and controlled. – A six-monthly update on the Group’s Aggregate Change Plan is provided to the Board. Corporate social responsibility Lloyds TSB adopts a responsible attitude to Social, Environmental and Ethical (SEE) issues, and publishes a separate annual information pack on its role in the community, its code of business conduct and its environmental performance: ‘the community and our business’ (see page 93 for details). The Group has a dedicated Environmental Risk unit which is responsible for the development of environmental policies and procedures, and provides practical advice and guidance on environmental issues to business units. Significant progress has been made in developing the Group’s environmental management system, and this is detailed in the environmental report forming part of ‘the community and our business’. During the year, the Group has reviewed its SEE performance and is of the opinion that it already complies with the majority of the guidelines published by the Association of British Insurers in 2001. The Group continues to develop its policies and procedures and will monitor its performance more rigorously in 2003. LLOYDS TSB GROUP 41 Five year financial summary Profit and loss account Net interest income Other finance income Other operating income Total income Operating expenses Trading surplus General insurance claims Provisions Income from joint ventures Profit (loss) on sale and closure of businesses 2002 £ million 2001 £ million 2000 £ million 1999 £ million 1998 £ million 5,171 165 3,542 8,878 (4,915) 3,963 (229) (1,116) (11) – 4,922 307 3,660 4,587 424 3,765 4,783 268 3,267 4,398 252 2,792 8,889 (4,776) 8,776 (4,279) 8,318 (3,884) 7,442 (3,876) 4,113 (174) (807) (10) 39 4,497 (142) (573) 3 – 4,434 (169) (622) 12 (126) 3,566 (146) (570) 14 84 Profit on ordinary activities before tax 2,607 3,161 3,785 3,529 2,948 Profit on ordinary activities after tax 1,843 2,286 2,703 2,445 2,086 Profit for the year attributable to shareholders 1,781 2,229 2,654 2,439 2,073 Economic profit 821 1,119 1,524 1,522 1,189 Note Figures for 2001 and earlier years have been restated to reflect the implementation of UITF33, ‘Obligations in capital instruments’, FRS 17, ‘Retirement benefits’, FRS 19, ‘Deferred tax’ and detailed guidance from the Association of British Insurers for best practice in the preparation of results using the achieved profits method of accounting. Quality of earnings UK Retail Banking and Mortgages 35% (2001: 32%) Insurance and Investments 36% (2001: 37%) Wholesale Markets 18% (2001: 22%) International Banking 11% (2001: 9%) Excluding central group items, changes in economic assumptions and investment variance 42 LLOYDS TSB GROUP Five year financial summary Balance sheet and capital ratios Loans and advances to banks and customers Investments Other assets 2002 £ million 2001 £ million 2000 £ million 1999 £ million 1998 £ million 152,003 29,565 25,850 138,159 24,489 26,756 129,722 14,861 25,004 119,196 15,125 18,851 113,706 13,324 19,445 Long-term assurance assets attributable to policyholders 207,418 45,340 189,404 46,389 169,587 51,085 153,172 26,542 146,475 23,692 Total assets 252,758 235,793 220,672 179,714 170,167 Deposits by banks and customers and debt securities in issue 172,032 16,515 Other liabilities 10,168 Subordinated liabilities (loan capital) 731 Minority interests (equity and non-equity) 7,972 Shareholders’ funds (equity) 157,846 12,548 8,108 546 10,356 136,623 13,001 7,510 552 11,901 123,668 11,218 6,493 33 11,760 119,389 13,690 4,021 42 9,333 Long-term assurance liabilities to policyholders 207,418 45,340 189,404 46,389 169,587 51,085 153,172 26,542 146,475 23,692 Total liabilities 252,758 235,793 220,672 179,714 170,167 Risk asset ratio : total capital : tier 1 capital Share information Earnings per share Dividends per share (net) Dividend cover (times) Market price (year-end) Net assets per share Number of shareholders (thousands) Average shares in issue (millions) Performance measures Post-tax return on average shareholders’ equity Post-tax return on average assets* Post-tax return on average risk-weighted assets* Efficiency ratio 9.6% 7.8% 32.0p 34.2p 0.9 446p 141p 973 5,570 16.7% 0.93% 1.61% 55.4% 8.8% 7.8% 40.3p 33.7p 1.2 746p 184p 981 5,533 18.1% 1.28% 2.26% 53.7% 8.7% 8.0% 14.9% 9.9% 11.2% 8.6% 48.4p 30.6p 1.6 708p 213p 1,026 5,487 21.1% 1.68% 3.07% 48.8% 44.8p 26.6p 1.7 774p 212p 1,024 5,445 23.9% 1.63% 2.94% 46.7% 38.4p 22.2p 1.7 855p 170p 1,028 5,400 23.5% 1.48% 2.62% 52.1% * Assets exclude long-term assurance assets attributable to policyholders. Note Figures for 2001 and earlier years have been restated to reflect the implementation of UITF33, ‘Obligations in capital instruments’, FRS 17, ‘Retirement benefits’, FRS 19, ‘Deferred tax’ and detailed guidance from the Association of British Insurers for best practice in the preparation of results using the achieved profits method of accounting. LLOYDS TSB GROUP 43 The board Non-executive directors Maarten A van den Bergh(cid:2) Chairman Joined the Group in 2000 as deputy chairman and was appointed chairman in 2001. Joined the Royal Dutch/Shell Group of companies in 1968 and after a number of senior and general management appointments in that group, became group managing director in 1992. Appointed president of Royal Dutch Petroleum Company and vice chairman of the committee of managing directors of the Royal Dutch/Shell Group in 1998 and continued in these roles until 2000. A non-executive director of Royal Dutch Petroleum Company, BT Group and British Airways. Aged 60. Alan E Moore CBE*§ Deputy Chairman (leaving on 16 April 2003) Joined Lloyds Bank International in 1980. Held a number of senior and general management appointments in that company and in Lloyds Bank before becoming a director of Lloyds Bank in 1989 and deputy chief executive and treasurer in 1994. Following the merger with TSB Group in 1995, became deputy group chief executive of Lloyds TSB Group and then deputy chairman in 1998. Joined Glyn Mills & Co in 1953, holding senior appointments there until his secondment, as director general, to the Bahrain Monetary Agency from 1974 to 1979. Aged 66. * Member of the audit committee ** Chairman of the audit committee † Member of the remuneration committee ‡ Chairman of the remuneration committee § Member of the nomination committee (cid:2) Chairman of the nomination committee ✠ Independent director (cid:4) Senior independent director 44 LLOYDS TSB GROUP M Kent Atkinson (leaving on 16 April 2003) Joined Bank of London & South America in 1964, which became a Lloyds Bank subsidiary in 1971, and held a number of senior and general management appointments, including positions in Latin America and the Middle East, before being appointed to the board in 1997 as group finance director. Became a non-executive director of the group in June 2002. A non-executive director of Coca-Cola HBC SA, Marconi and Marconi Corporation. Aged 57. Sheila M Forbes CBE✠† (leaving on 16 April 2003) A director of TSB Group since 1994. Chairs the board of governors of Thames Valley University and is a civil service commissioner. Head of personnel for Unigate from 1980 to 1988 and personnel director for Storehouse from 1988 to 1992. Director of human resources at Reed Elsevier (UK) from 1992 to 1996. A non-executive director of OCS Group. Aged 56. DeAnne S Julius CBE✠† Joined the board in 2001. Held a number of senior appointments in the UK and USA with the World Bank, Royal Dutch/Shell Group and British Airways, before membership of the Bank of England Monetary Policy Committee from 1997 to 2001. Chaired HM Treasury’s banking services consumer codes review group. A non-executive director of the Bank of England, BP, Serco Group and Roche Holdings SA. Aged 53. Ewan Brown CBE FRSE✠** Chairman of Lloyds TSB Scotland A director since 1999. A non- executive director of Lloyds TSB Scotland since 1997. Executive director of Noble Grossart since 1971. Chairman of Transport Initiatives Edinburgh. A non-executive director of John Wood Group and Stagecoach Holdings. Aged 60. Gavin J N Gemmell CBE✠* Chairman of Scottish Widows Joined the board in 2002. A non-executive director of Scottish Widows since 1984. Retired as senior partner of Baillie Gifford in 2001, after 37 years with that firm. A non-executive director of Archangel Informal Investment. Chairman of the court of Heriot-Watt University. Aged 61. Sir Tom McKillop✠*† ((cid:4) from 16 April 2003) A director since 1999. Joined ICI in 1969 and held a number of senior and general management appointments before the demerger in 1993, when Zeneca was created. Chief executive of Zeneca Pharmaceuticals from 1994 to 1999 and chief executive of AstraZeneca from 1999. Pro-chancellor of Leicester University. Aged 59. A Clive ButIer‡§(cid:4) (leaving on 16 April 2003) A director of TSB Group since 1993. Joined Unilever in 1970 and following a number of senior and general management appointments was appointed an executive director of Unilever in 1992. Aged 56. Christopher S Gibson-Smith✠† A director since 1999. Chairman of National Air Traffic Services. Managing director of BP from 1997 to 2001, having held senior and general management appointments in the UK, USA, Canada and Europe, since joining that company in 1970. A non-executive director of The British Land Company. Aged 57. The Earl of Selborne KBE FRS✠§ A director since 1995, having been a director of Lloyds Bank since 1994. Managing director of The Blackmoor Estate, his family business. Chancellor of Southampton University since 1996. President of the Royal Geographical Society from 1997 to 2000. Aged 62. Executive directors Peter B Ellwood CBE Group Chief Executive (until 31 May 2003) Joined TSB Bank in 1989 as chief executive, retail banking. Appointed a director of TSB Group in 1990 and became group chief executive in 1992. Following the merger with Lloyds Bank in 1995, became deputy group chief executive of Lloyds TSB Group and then group chief executive in 1997. Joined Barclays Bank in 1961 and held a number of senior and general management appointments, including chief executive of Barclaycard from 1985 to 1989. Chairman of the Work Foundation. Former chairman of Visa International. Aged 59. J Eric Daniels Group Executive Director, UK Retail Banking (Group Chief Executive from 1 June 2003) Joined the board in 2001. Served with Citibank from 1975 and held a number of senior and general management appointments in the USA, South America and Europe before becoming chief operating officer of Citibank Consumer Bank in 1998. Following the Citibank/Travelers merger in 1998, he was chairman and chief executive officer of Travelers Life and Annuity until 2000. Chairman and chief executive officer of Zona Financiera from 2000 to 2001. Aged 51. Archie G Kane Group Executive Director, IT and Operations Joined TSB Commercial Holdings in 1986 and held a number of senior and general management appointments in the Group before being appointed to the board in 2000. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as finance director in the UK from 1983 to 1985. Chairman of the council of the Association for Payment Clearing Services. Aged 50. Steve C Targett (Group Executive Director, Wholesale and International Banking from 16 April 2003) Joins the board on 10 March 2003. Served with National Australia Bank from 1997, where he held a number of senior and general management appointments in Australia and the UK before becoming chief executive officer, Europe, in 2002. Previously held a number of senior and general management appointments in Cargill, a commodity trading group, from 1980 to 1988, State Bank of South Australia from 1988 to 1991 and ANZ Bank from 1991 to 1997. His early career, between 1972 and 1980, was spent with National Australia Bank. Aged 47. Company Secretary Alastair J Michie FCIS FCIBS Michael E Fairey Deputy Group Chief Executive Joined TSB Group in 1991 and held a number of senior and general management appointments before being appointed to the board in 1997 and deputy group chief executive in 1998. Joined Barclays Bank in 1967 and held a number of senior and general management appointments, including managing director of Barclays Direct Lending Services from 1990 to 1991. Aged 54. Philip R Hampton Group Finance Director Joined the board in 2002. Previously, finance director of BT Group from 2000 to 2002, BG Group from 1996 to 2000 and British Steel from 1990 to 1996. Before that, he worked for Coopers & Lybrand from 1975 to 1980 and Lazard Brothers from 1981 to 1990. A non-executive director of RMC Group. Aged 49. David P Pritchard Group Executive Director, Wholesale and International Banking (Deputy Chairman from 16 April 2003) 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. 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 The London Clearing House. Aged 58. Michael D Ross CBE Deputy Group Chief Executive Joined the board in 2000. Joined Scottish Widows in 1964 and following a number of senior and general management appointments became group chief executive of that company in 1991. Chairman of the Association of British Insurers. Aged 56. LLOYDS TSB GROUP 45 Directors’ report Results and dividends Employees The group is committed to employment policies which follow best practice, based on equal opportunities for all employees irrespective of sex, race, national origin, religion, colour, disability, sexual orientation, age or marital status. In the UK, the group supports Opportunity Now and Race for Opportunity; campaigns to improve opportunities for women and ethnic minorities in the work place. The group is a 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. Employees are kept closely involved in major changes affecting them through such measures as team meetings, briefings, internal communications and opinion surveys. There are well established procedures, including regular meetings with recognised unions, to ensure that the views of employees are taken into account in reaching decisions. Schemes offering share options or the acquisition of shares are available for most staff, to encourage their financial involvement in the group. Donations The profit and loss account includes a charge for charitable donations totalling £33,403,000 (2001: £36,747,000), including £33,336,667 (2001: £36,376,667) under deeds of covenant to the four Lloyds TSB Foundations, which will be paid during 2003. No donations were made to political parties. The consolidated profit and loss account on page 58 shows a profit attributable to shareholders for the year ended 31 December 2002 of £1,781 million. An interim dividend of 10.7p per ordinary share was paid on 9 October 2002 and a final dividend of 23.5p per ordinary share will be paid on 7 May 2003. These dividends will absorb £1,908 million. Principal activities The company is a holding company and its subsidiaries provide a wide range of banking and financial services through branches and offices in the UK and overseas. Business review and future developments A review of the business and an indication of future developments are given on pages 2 to 41. Authority to purchase shares The authority for the company to purchase, in the market, up to 564 million of its shares, representing some 10 per cent of the issued ordinary share capital, expires at the annual general meeting. It was not used during the year and shareholders will be asked to give a similar authority at the annual general meeting. Details are contained in the accompanying notice of meeting. Directors Biographical details of directors are shown on pages 44 and 45. Particulars of their emoluments and interests in shares in the company are given on pages 48 to 54. Mr Urquhart left the board at the annual general meeting in 2002. Mr Atkinson, Mr Butler, Miss Forbes and Mr Moore will leave the board at the annual general meeting in 2003. Mr Gemmell became a director on 17 April 2002 and was elected at the annual general meeting on that day. Mr Hampton joined the board on 1 June 2002 and Mr Targett will join the board on 10 March 2003. Under the articles of association they offer themselves for election at the annual general meeting. Mr Kane and Mr Ross retire by rotation at the annual general meeting and offer themselves for re-election. No director had a material interest at any time during the year in any contract of significance with the company or its subsidiaries. 46 LLOYDS TSB GROUP Directors’ report Policy and practice on payment of creditors The company follows ‘The Better Payment Practice Code’ published by the Department of Trade and Industry regarding the making of payments to suppliers. Details of how to obtain a copy of the code and other related information is shown on page 93. The company’s policy is to agree terms of payment with suppliers and these normally provide for settlement within 30 days after the date of the invoice, except where other arrangements have been negotiated. It is the policy of the company to abide by the agreed terms of payment, provided the supplier performs according to the terms of the contract. As the company owed no amounts to trade creditors at 31 December 2002, the number of days required to be shown in this report, to comply with the provisions of the Companies Act 1985, is nil. The equivalent figure for the Lloyds TSB Group in the UK is 27. This bears the same proportion to the number of days in the year as the aggregate of the amounts owed to trade creditors at 31 December 2002 bears to the aggregate of the amounts invoiced by suppliers during the year. Auditors Following the transfer of substantially all of the business of the UK firm of PricewaterhouseCoopers, the company’s auditors, to a limited liability partnership on 1 January 2003, PricewaterhouseCoopers resigned and the directors appointed the new firm, PricewaterhouseCoopers LLP. Resolutions concerning the re-appointment of the auditors and authorising the directors to set their remuneration will be proposed at the annual general meeting. On behalf of the board A J Michie Secretary 13 February 2003 LLOYDS TSB GROUP 47 Directors’ remuneration The remuneration committee The remuneration committee, comprising Mr Butler (chairman), Miss Forbes, Dr Gibson-Smith, Dr Julius and Sir Tom McKillop, makes recommendations to the board on the framework of executive directors’ remuneration and its cost, and determines, on the board’s behalf, specific remuneration packages for each of the chairman, the deputy chairman and the executive directors. Additionally, all the non-executive directors receive the minutes of remuneration committee meetings and have the opportunity to comment and have their views taken into account before the committee’s decisions are implemented. Each year, with the help of external management consultants, the total remuneration package of the directors is reviewed, and in 2002 The Hay Group Management Limited were commissioned by the remuneration committee to conduct the review. The consultants have also provided services, such as salary survey information and job evaluation, to other parts of the Group. Mr van den Bergh, Mr Ellwood, Mr Fairey, Mr Mitchinson, Director of Group Human Resources, and Mr Wilson, Compensation and Benefits Director, assisted the committee in their deliberations but did not participate in any decision relating to their own remuneration. Directors’ remuneration policy The Group aims to ensure that the executive directors’ remuneration arrangements, in line with the Group’s overall practice on pay and benefits, are competitive and designed to attract, retain and motivate executive directors of the highest calibre, who are expected to perform to the highest standards. Account is taken of information, from internal and independent sources, on the remuneration for comparable positions in a wide range of FTSE 100 companies. The strategy for executive directors’ pay is for basic salaries to reflect the relevant market median; for benefits such as a company car, medical insurance and pension to reflect market practice; and for total direct compensation (basic salary, annual incentives and the value of long-term incentives) to be at the upper quartile of the market place, provided that performance justifies the amount. This strategy is consistent with the Group’s belief that performance should determine a significant proportion of the total remuneration package for executive directors. There are no plans to change the strategy. The fees of the non-executive directors are agreed by the board within a total amount determined by the shareholders. They are designed to recognise the significant responsibilities of directors and to attract individuals with the necessary experience and ability to make an important contribution to the Group’s affairs. The fees, which are neither performance related nor pensionable, are comparable with those paid by other companies. Reward package The current package for executive directors comprises the following elements: Basic salary The aim is to ensure that salaries are competitively set in relation to similar jobs in a wide range of FTSE 100 companies. Current salaries for the chairman, deputy chairman and executive directors, following the most recent salary review in December 2002 are: aaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa Mr Daniels Mr Ellwood Mr Fairey Mr Hampton Mr Kane Mr Moore Mr Pritchard Mr Ross £450,000 £700,000 £498,000 £483,000 £397,500 £215,250 £409,500 £443,000 Mr van den Bergh aaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa £422,500 Annual incentive The annual incentive scheme is designed to reflect specific goals linked to the performance of the business. In 2002, the group chief executive had a maximum incentive opportunity equal to 100 per cent of his salary as did Mr Daniels, whose bonus opportunity and payment for 2002 were agreed as part of his recruitment package. Each of the other executive directors could earn an incentive equal to 75 per cent of their salary. The awards were based on group performance and the attainment of predetermined targets relating to total income, profit before tax and economic profit. Each will receive an award equal to 4.7 per cent of salary based on achievement against the income target, which was met in part. No bonus has been earned for the other targets. In 2003, all the executive directors will have a maximum incentive opportunity equal to 100 per cent of their salaries. Awards will be based on group performance, with predetermined targets relating to profit before tax and economic profit. 75 per cent of the award will be payable on achievement of profit before tax and economic profit relating to the Group’s stretching budget for 2003 and the remuneration committee has set a higher target for the maximum award. The threshold performance levels, below which no bonus will be payable, have also been set by the remuneration committee at higher figures than those achieved in 2002. 48 LLOYDS TSB GROUP Directors’ remuneration The remuneration committee reviewed the attainment of targets in 2002 and agreed the incentive payments, and the auditors confirmed the calculations. These payments are not pensionable. Long-term rewards Executive share option schemes The Group is committed to the governing objective of maximising shareholder value over time. The board believes that the executive share option schemes for senior executives, approved by the shareholders at the annual general meeting in 1997 and amended at the annual general meeting in 2001, provide an effective method of giving executives an incentive to achieve that objective. Performance conditions are set when the grant of options is made and the options cannot normally be exercised unless the conditions have been met. To meet the performance conditions, the company’s ranking, based on total shareholder return (calculated by reference to both dividends and growth in share price) over the relevant (three year) period, within the comparator group, must be at least ninth. Hoare Govett independently provides the information on total shareholder return and the company’s ranking and the auditors are also involved before the remuneration committee confirms whether the conditions have been met. In 2002, 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 is equal to 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 full grant of options for executive directors will only become exercisable if the company is ranked first within the comparator group. The following table illustrates the percentage of the grant which would be exercisable depending on the ranking within the comparator group. At the end of 2002 Lloyds TSB Group was ranked: 6th after two years of the performance period for options granted in 2001; and 11th after one year of the performance period for options granted in 2002. Any awards made to executive directors in 2003 will be subject to the same scheme limits and performance conditions as outlined above. Ranking position within comparator group aaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa % of option which may be exercised 1 2 3 4 5 6 7 8 9 100 86 71 57 43 29 23 17 14 10 or below aaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa Nil – options not exercisable The current constituents of the comparator group are: Abbey National ABN Amro Alliance and Leicester Aviva Fortis ING Barclays HBOS Citigroup HSBC Holdings Legal and General National Australia Bank Prudential Royal Bank of Scotland Royal & Sun Alliance Standard Chartered In addition, share options have been granted in previous years in accordance with the relevant scheme rules and market practice at that time. The table on page 53 includes options granted under these previous schemes. Options granted aaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa Performance conditions Prior to March 1996 None March 1996-August 1999 March 2000-March 2001 That the company’s ranking based on shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be in the top fifty companies of the FTSE 100 and that there must have been growth in earnings per share which is equal to the aggregate percentage change in the Retail Price Index plus two percentage points for each complete year of the relevant period. As for March 1996 – August 1999 except that there must have been growth in the earnings per share equal to the change in the Retail Price Index plus three percentage points for each complete year of the relevant period. aaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaa The remuneration committee chose the relevant performance condition, where applicable, because it was felt to be challenging, aligned to shareholder interests and appropriate at the time. At the annual general meeting in April 2003, shareholders will be asked to approve an amendment to the rules of the executive share option schemes. Under the existing rules, a share option may not be granted to any person who, at the date of grant, is within 2 years of retirement. It is proposed to amend the rules of the schemes to allow share options to be granted to executives up to six months before retirement. LLOYDS TSB GROUP 49 Directors’ remuneration Since the introduction of the new performance condition in 2001, the exercise of options after retirement would still require the condition to be satisfied over the original performance period. Also, if the optionholder retired within 3 years of the date of grant, the number of shares which could be acquired on exercise would be reduced according to the length of time the optionholder was employed between the date of grant and the date of retirement. Other share plans The executive directors, the chairman and the deputy chairman may participate in the Group’s ‘sharesave’ scheme and ‘shareplan’ on the same basis as other employees. Pensions Executive directors are entitled to pensions based on salary and length of service with the Group, with a maximum pension of two thirds of final salary. Service agreements The general group policy is for executive directors to have service agreements with notice periods of no greater than one year, to reflect current corporate governance best practice. Executive directors are required to give the Group six months’ notice if they wish to leave. The Association of British Insurers and the National Association of Pension Funds published a joint statement of best practice on executive contracts and severance in December 2002 and, during 2003, the remuneration committee will consider what changes would be desirable in respect of service agreements. Mr Fairey, Mr Kane and Mr Hampton each has a service agreement which the company may terminate by giving one year’s notice. Mr Ross’s service agreement, entered into in connection with the arrangements for the transfer of the business of Scottish Widows to the Group in March 2000, provided for two years’ notice for the first two years, but since March 2002 the notice period has decreased by one month for each month of service, to one year’s notice. From March 2003, therefore, Mr Ross’s agreement may be terminated on one year’s notice. Mr Daniels’ service agreement provides for two years’ notice for the first eighteen months (from November 2001): after that, the notice period reduces to one year. His contract also provides that if, within eighteen months of the commencement of his employment, there were to be a change of circumstances of the company (as defined in the agreement) so that there was, in his reasonable judgement, a materially adverse effect on his prospects or a material diminution in his status, he would be entitled to serve notice terminating his 160 140 120 100 80 60 40 20 0 50 LLOYDS TSB GROUP employment and appropriate compensation would be payable to him. None of the other directors has a service agreement with a notice period of one year or more. The remuneration committee has considered the provisions of the UK listing authority’s corporate governance code and the recent ABI/NAPF joint statement mentioned above, relating to compensation in the event of early termination of directors’ service agreements and a departing director’s duty to mitigate his or her loss. The Group will have regard to that duty on a case by case basis when assessing the appropriate level of compensation which may be payable. It is the Group’s policy that where compensation on early termination is due, in appropriate circumstances it should be paid on a phased basis. Non-executive directors do not have service agreements and, in accordance with the articles of association, their appointment may be terminated at any time without compensation. External appointments Lloyds TSB recognises that executive directors may be invited to become non-executive directors of other companies and that such appointments can broaden their knowledge and experience, to the benefit of the Group. Fees are normally retained by the individual director, as the post entails personal responsibility on their part. Directors are generally allowed to accept one such appointment. Performance graph As required by recent legislation regarding the directors’ remuneration report, this graph illustrates the performance of Lloyds TSB Group plc measured by total shareholder return (share price growth plus dividends paid) against a ‘broad equity market index’ over the past five years. As Lloyds TSB Group plc has been a constituent of the FTSE 100 index throughout this five-year period, that index is considered to be the most appropriate benchmark. Comparative total shareholder return 31 Dec 1997 31 Dec 1998 31 Dec 1999 31 Dec 2000 31 Dec 2001 31 Dec 2002 Source: Datastream Rebased to 100 on 1 January 1998 Lloyds TSB Group plc FTSE 100 index Directors’ remuneration Directors’ emoluments Current directors who served during 2002: M K Atkinson (service agreement dated 2 February 1999) Ewan Brown A C Butler J E Daniels (service agreement dated 19 October 2001) P B Ellwood (service agreement dated 19 June 1989) M E Fairey (service agreement dated 28 August 1991) S M Forbes G J N Gemmell C S Gibson-Smith P R Hampton (service agreement dated 30 May 2002) D S Julius A G Kane (service agreement dated 9 February 2000) Sir Tom McKillop A E Moore D P Pritchard (service agreement dated 13 February 1998) M D Ross (service agreement dated 7 March 2000) Lord Selborne M A van den Bergh Former director who served during 2002: L M Urquhart Former directors who served during 2001 Salaries/fees £000 Other benefits £000 Performance- related payments £000 Shareplan £000 370 18 450 31 22 13 18 18 20 349 22 137 9 14 11 17 15 15 5 14 20 14 8 11 6 12 13 174 60 40 450 660 470 38 68 38 268 38 375 45 210 390 430 33 400 25 2002 Total £000 567 60 40 1,263 733 643 38 68 38 298 38 418 45 227 437 478 33 415 25 2001 £000 588 59 40 192 1,001 791 38 – 38 – 9 548 45 229 588 650 43 406 93 391 4,212 959 590 103 5,864 5,749 ‘Other benefits’ include the use of a car, private medical insurance, life insurance cover and payments to a former executive director on termination of his service contract (see below). Allowances for relocation, housing and legal advice arising from Mr Daniels’ service agreement, and an additional payment in respect of the contribution to the separate fund relating to Mr Fairey’s pension, are also included. The separate fund, which was mentioned in previous annual reports, was established to cover pension obligations of those who joined the Group after 1 June 1989 and who are subject to the Inland Revenue earnings cap relating to pensions, introduced by the Finance Act 1989. £348,637 included in ‘other benefits’ for Mr Atkinson represents the amount to which he was contractually entitled when his employment was terminated on 31 May 2002. This included 12 months’ salary from which he elected to pay £318,637 to purchase additional pension from Lloyds TSB Group Pension Scheme No. 1. As part of his termination package, he is also entitled to a bonus reflecting what he would have received during his notice period. He became entitled to a pension of £273,514 immediately when his employment terminated, which took into account the additional 12 months’ service for the notice period. He also continues to receive beneficial rights to medical insurance and use of a car for 12 months after departure. His outstanding share options are exercisable either up to 12 months after departure or, for those options granted after August 2001, at the later appropriate time providing the performance condition has been met. Performance-related payments These payments relate solely to cash bonuses earned in 2002 under the annual incentive scheme. They do not include any amounts relating to the former medium-term incentive plan, approved by shareholders in 2000, which ended in 2002 without any payments being made, as the relevant performance targets were not met. Shareplan Amounts shown are those receivable by directors in respect of the Group’s ‘shareplan’. Under the scheme, employees received an award equal to 3 per cent of salary in 2002. A maximum of £3,000 is receivable in shares for those eligible, with any balance paid in cash. LLOYDS TSB GROUP 51 Directors’ remuneration Directors’ pensions The executive directors are all members of one of the defined benefit schemes provided by the Lloyds TSB Group. Those directors who joined the Group after 1 June 1989 have pensions provided on salary in excess of the earnings cap either through membership of a Funded Unapproved Retirement Benefits Scheme (‘FURBS’) or by an unfunded pension promise. Retirement pensions accrue at rates of between 1/60 and 1/30 of basic salary. With the exception of Mr Pritchard, directors have a normal retirement age of 60. Mr Pritchard’s retirement date is 16 April 2003. In the event of death in service, a lump sum of 4 times salary is payable plus a spouse’s pension of 2/3 of the member’s prospective pension. On death in retirement, a spouse’s pension of 2/3 of the member’s pension is payable. The schemes are non-contributory. Mr Pritchard has a deferred cash entitlement of £71,310 from his membership of the defined contribution section of the Group’s FURBS. Accrued pension at Accrued pension at Transfer value at 31 December 2002 31 December 2001 31 December 2002 31 December 2001 (d) Transfer value at (b) (a) (c) Change in Additional pension earned to transfer value 31 December 2002 (e) (c) - (d) M K Atkinson J E Daniels P B Ellwood M E Fairey P R Hampton A G Kane D P Pritchard M D Ross 273,514 31,250 393,875 155,805 5,963 144,353 38,974 274,125 227,274 23,750 336,441 127,183 – 118,599 30,582 245,229 4,632,189 346,555 7,093,775 2,075,301 58,631 1,514,190 656,073 4,395,896 3,455,667 312,504 5,943,051 1,862,642 – 1,503,489 518,412 3,564,387 1,176,522 34,051 1,150,724 212,659 58,631 10,701 137,661 831,509 42,376 7,096 51,715 26,460 5,963 23,737 7,872 24,727 Transfer value of the increase (f) 717,673 78,693 931,398 352,443 58,631 248,989 132,514 392,853 In addition, the following unfunded benefits have accrued for Mr van den Bergh instead of a salary increase in 2002: M A van den Bergh 36,160 36,160 3,378 – – 3,378 36,160 The disclosures in columns (a) to (d) are as required by the Companies Act 1985 Schedule 7A. Columns (a) and (b) represent the deferred pension to which the directors would have been entitled had they left the Group on 31 December 2002 and 2001, respectively (ignoring the two-year requirement to qualify for a deferred pension). Column (c) is the transfer value of the deferred pension in column (a) calculated as at 31 December 2002 based on factors supplied by the actuary of the relevant Group pension scheme in accordance with actuarial guidance note GN11. Column (d) is the equivalent transfer value, but calculated as at 31 December 2001 on the assumption that the director left service at that date. Mr Hampton joined the Group on 1 June 2002 and previous years’ figures are not shown. Column (e) is the increase in pension built up during the year, recognising (i) the accrual rate for the additional service based on the pensionable salary in force at the year end, and (ii) where appropriate the effect of pay changes in ‘real’ (inflation adjusted) terms on the pension already earned at the start of the year. Column (f) is the capital value of the pension in column (e). The disclosures in columns (e) and (f) are as required by the UK listing authority’s listing rules. The requirements of the listing rules differ from those of the Companies Act. The listing rules require the additional pension earned over the year to be calculated as the difference between the pension accrued at the end of the financial year and the pension accrued at the start of the financial year less the increase in the pension earned over the year solely due to inflation. The change in the transfer value required by the Companies Act will also be significantly influenced by the assumptions underlying the calculation at the beginning and the end of the financial year and market conditions. Members of the Group’s pension schemes have the option to pay additional voluntary contributions: neither the contributions nor the resulting benefits are included in the above table. Directors’ interests The directors’ interests, all beneficial, in shares in Lloyds TSB Group were: Shares M K Atkinson Ewan Brown A C Butler J E Daniels P B Ellwood M E Fairey S M Forbes G J N Gemmell C S Gibson-Smith At 1 January 2002 (or date of At 31 December 2002 appointment if later) 93,394 3,548 2,000 1,029 183,999 75,425 2,000 50,000 3,151 124,815 3,402 2,000 1,000 178,751 74,158 2,000 30,000 3,151 52 LLOYDS TSB GROUP At 1 January 2002 (or date of At 31 December 2002 appointment if later) P R Hampton D S Julius A G Kane Sir Tom McKillop A E Moore D P Pritchard M D Ross Lord Selborne M A van den Bergh 6,021 2,000 81,248 1,000 1,108,475 4,446 2,500 3,372 5,079 – 2,000 80,120 1,000 1,107,396 3,367 2,500 3,372 4,000 Directors’ remuneration Directors’ interests (continued) Options to acquire shares: At 1 January 2002 (or date of appointment if later) Granted during the year Exercise Weighted average price of exercise share options granted, price at exercised during the 31 December 31 December or lapsed 2002 Exercised/ lapsed 2002 year At M K Atkinson Exercisable Not exercisable Exercisable* Not exercisable* 147,600 253,155 – 92,000 97,600 – 92,000 232,122 259p – 670p 676p 275,349 916† 1,245† 91,817† 252,404† J E Daniels Exercisable Not exercisable Exercisable* Not exercisable* – 907,780 – – – – – 1,238,597 4,146 P B Ellwood** M E Fairey P R Hampton A G Kane** D P Pritchard M D Ross Exercisable Not exercisable Exercisable* Not exercisable* 321,340 276,725 – 165,000 Exercisable Not exercisable Exercisable* Not exercisable* 54,000 288,329 – 105,809 Exercisable Not exercisable Exercisable* Not exercisable* – – – – Exercisable Not exercisable Exercisable* Not exercisable* 171,547 233,721 – 77,000 Exercisable Not exercisable Exercisable* Not exercisable* – 250,096 – 90,000 Exercisable Not exercisable Exercisable* Not exercisable* – 440,549 – – 330,419 398 345,104 797 326,351 275,349 286,363 315,734 Gain made by Dennis Holt, who left the board on 31 August 2001 Gain made by A E Moore, who no longer holds share options 211,340 – 190,000 357,579 – – 102,809 691,230 – – – 326,351 131,547 4,157 90,000 531,913 – 4,687 50,000 571,772 – – – 756,283 – – – 700p 280p – 657p 663p – – 675p 701p – – – 740p 252p 442p 716p 701p – 416p 860p 700p – – – 657p 715p 442p 591p 733p 715p 715p 474p 715p 474p 740p 715p 715p 715p Share retention plan J E Daniels Not exercisable 216,763 216,763 (see page 54) Market price at date of exercise Amount of gain on exercise*** 2002 £000 2001 £000 – 577 416p 632.5p 9 – – 882 – – 9 53 281 1,793 LLOYDS TSB GROUP 53 Directors’ remuneration Directors’ interests (continued) Options may be exercised between 2003 and 2012. Options were not exercisable because they had not been held for the period required by the relevant scheme or the performance conditions had not been met. * Market price of shares is below the share option exercise price. ** These directors will receive additional Lloyds TSB Group shares on exercising share options held on 28 December 1995. These shares will compensate them for the special dividend of 68.3p per share which was paid to former TSB Group shareholders in 1996 following the merger with Lloyds Bank, but which was not paid to optionholders. *** This is the difference between the market price of the shares on the day on which the share option was exercised and the price paid for the shares, and includes the value of shares issued to compensate directors for the special dividend mentioned above. † These share options lapsed following termination of Mr Atkinson’s service contract. The market price for a share in the Company at 1 January 2002 and 31 December 2002 was 746p and 446p respectively. The range of prices between 1 January 2002 and 31 December 2002 was 427.5p to 817p. None of the other directors at 31 December 2002 had options to acquire shares in the Company or its subsidiaries. Share retention plan Mr Daniels is the only participant in the share retention plan, which was adopted in 2001 as part of the remuneration package considered necessary to attract him from the USA to the UK. An option was granted to him under the plan on 2 November 2001 to acquire 216,763 ordinary shares in the Company (with a value of £1.5 million at the date of grant) for a total price of £1. The option is designed to encourage him to remain with the Company and, accordingly, is not subject to any performance condition but will normally become exercisable only if he remains an employee, and has not given notice of resignation, on 31 December 2004. However, the option will become exercisable if before that date Mr Daniels becomes entitled to terminate his service agreement by way of breach (including circumstances treated as breach) or if, following a reconstruction or takeover of the Company, the remuneration committee so decides. The option will lapse if before 31 December 2004 Mr Daniels dies, or ceases to be an employee or resigns, except in the circumstances described in the preceding paragraph. Otherwise, the option will become exercisable between 1 January 2005 and 30 June 2005. The benefits conferred by the option are not pensionable and the option is not transferable. Scottish Widows loan capital At the end of the year, Mr Ross had an interest in £28,394 of Scottish Widows Group Limited floating rate unsecured loan notes 2008 (2001: £43,194). Non-beneficial interests Directors had non-beneficial interests as follows: 1. Mr Daniels, Mr Ellwood, Mr Fairey, Mr Hampton, Mr Kane, Mr Moore, Mr Pritchard, Mr Ross and Mr van den Bergh together with some 80,000 other employees, were potential beneficiaries in the 1,721,503 and 1,684,041 shares held at the end of the year by the Lloyds TSB qualifying employee share ownership trust and the Lloyds TSB Group employee share ownership trust, respectively. 2,417,245 and 1,952,179 shares, respectively, were held by these trusts at the beginning of the year. These holdings were 1,487,696 and 1,677,280, respectively, on 13 February 2003. 2. At the beginning and end of the year, Mr Ellwood also had a non-beneficial interest in 7,000 shares held in another trust. None of those who were directors at the end of the year had any other interest in the capital of the Company or its subsidiaries and there were no changes in their beneficial interests between 31 December 2002 and 13 February 2003. The register of directors’ interests, which is open to inspection, contains full particulars of directors’ shareholdings and options to acquire shares in the Company. On behalf of the board A J Michie Secretary 13 February 2003 54 LLOYDS TSB GROUP Corporate governance The UK listing authority’s rules require companies to make statements on corporate governance in their annual reports. The following comments are, therefore, included to comply with these rules. The chairman, the group chief executive and the group finance director have meetings with representatives of institutional shareholders and all shareholders are encouraged to participate in the Company’s annual general meeting. Corporate governance principles Compliance with the code The board considers that good governance is central to achieving the Group’s governing objective of maximising shareholder value. That has been uppermost in directors’ minds when applying the governance principles contained in the code annexed to the UK listing authority’s listing rules. The following remarks demonstrate how the board has applied these principles. The information on pages 44 and 45 shows that the Company is led and controlled by a board comprising executive and non-executive directors with wide experience. The appointment of directors is considered by the board and, following the provisions in the articles of association, they must retire by rotation, and may stand for re-election by the shareholders, at least every three years. The board meets nine times a year and a programme is prepared and agreed each year, which ensures that the directors are able regularly to review corporate strategy and the operations and results of the business units in the Group and to discharge their other duties. The roles of the chairman, the group chief executive and the board and its governance arrangements are reviewed annually. The board has a chairman’s committee, comprising the chairman, the deputy chairman, the group chief executive and his deputy. The chairman’s committee meets to discuss current issues and strategy, examine and test proposals and prepare for board meetings. It also has specific powers delegated to it by the board from time to time. The board has audit, nomination and remuneration committees which comply with the provisions of the code. Information about directors’ remuneration is given in the directors’ remuneration report on pages 48 to 54 and details of how the board reviews financial and operational controls and risk management generally are shown on page 56 and in the financial review on pages 10 to 41. The directors believe that the Company complies with the provisions of the code and that it has complied throughout the year with the provisions where the requirements are of a continuing nature. Directors’ responsibilities The directors are required by the Companies Act 1985 to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the Company and the Group as at the end of the year and of the profit or loss for the year. Following discussions with the auditors, the directors consider that in preparing the financial statements on pages 58 to 92, the Company has used appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates, and that all accounting standards which they consider applicable have been followed. The directors have responsibility for ensuring that the Company keeps accounting records which disclose with reasonable accuracy the financial position of the Company and which enable them to ensure that the financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. Going concern The directors are satisfied that the Company and the Group have adequate resources to continue to operate for the foreseeable future and are financially sound. For this reason, they continue to adopt the going concern basis in preparing the accounts. LLOYDS TSB GROUP 55 Corporate governance Internal control The board of directors is responsible for the Group’s system of internal control, which is designed to ensure effective and efficient operations, internal control, including financial reporting, and compliance with laws and regulations. It should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control the directors have regard to the materiality of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss. The directors and senior management of the Group are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of procedures manuals and regular management briefings. Key business risks are identified, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. There are well established budgeting and forecasting procedures in place and reports are presented regularly to the board detailing the results of each principal business unit, variances against budget and prior year, and other performance data. Internal controls contain procedures which assist the board in identifying new and emerging risks. The effectiveness of the internal control system is reviewed regularly by the board and the audit committee, which also receives reports of reviews undertaken around the Group by the Group’s risk management function, including Group Audit and Group Compliance. The audit committee receives reports from the Company’s auditors, PricewaterhouseCoopers LLP, (which include details of significant internal control matters that they have identified) and has a discussion with the auditors at least once a year without executives present, to ensure that there are no unresolved issues of concern. The audit committee reviews the objectivity and independence of the auditors and monitors any non-audit work undertaken by them. Steps have also been taken to ensure that the auditors do not perform any management consultancy work for the Group. However, in certain circumstances, PricewaterhouseCoopers LLP undertake work which is not specifically related to the statutory or regulatory audits, but only where there is clear evidence that their experience with the Group would be key and valuable and in these cases any significant engagement is subject to approval by the audit committee. 56 LLOYDS TSB GROUP Independent auditors’ report To the members of Lloyds TSB Group plc We have audited the financial statements which comprise the consolidated profit and loss account, the consolidated balance sheet, the Company balance sheet, the consolidated cash flow statement, the statement of total recognised gains and losses and the related notes which have been prepared under the accounting policies set out on pages 64 to 67. We have also audited the disclosures required by Part 3 of Schedule 7A to the Companies Act 1985 contained in the directors’ remuneration report under the headings reward package, directors’ emoluments, directors’ pensions and directors’ interests (‘the auditable part’). 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 55. 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. Our 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. We report to you our opinion, as to whether the financial statements give a true and fair view and are properly prepared in accordance with the United Kingdom Companies Act 1985. We also report to you if, in our opinion, the directors’ report is not consistent with the financial statements, if the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and transactions is not disclosed. We read the other information contained in the annual report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. The other information comprises only the directors’ report, the chairman’s statement, the group chief executive’s review, the financial review, the remainder of the directors’ remuneration report and the corporate governance statement. We review whether the corporate governance statement on pages 55 and 56 reflects the Company’s compliance with the seven provisions of the Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the board’s statements on internal control cover all risks and controls, or to form an opinion on the effectiveness of the Company’s or Group’s corporate governance procedures or its risk and control procedures. 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: (cid:127) the financial statements give a true and fair view of the state of affairs of the Company and the Group as at 31 December 2002 and of the profit and cash flows of the Group for the year then ended; (cid:127) the financial statements have been properly prepared in accordance with the Companies Act 1985; and (cid:127) those parts of the directors’ remuneration report required by Part 3 of Schedule 7A to the Companies Act 1985 have been properly prepared in accordance with the Companies Act 1985. PricewaterhouseCoopers LLP Chartered Accountants and Registered Auditors Southampton 13 February 2003 LLOYDS TSB GROUP 57 Consolidated profit and loss account for the year ended 31 December 2002 Interest receivable: Interest receivable and similar income arising from debt securities Other interest receivable and similar income Interest payable Net interest income Other finance income Other income Fees and commissions receivable Fees and commissions payable Dealing profits (before expenses) Income from long-term assurance business General insurance premium income Other operating income Total income Operating expenses Administrative expenses Depreciation Amortisation of goodwill Depreciation and amortisation Total operating expenses Trading surplus General insurance claims Provisions for bad and doubtful debts Specific General Amounts written off fixed asset investments Operating profit Income from joint ventures Profit on sale of businesses Profit on ordinary activities before tax Tax on profit on ordinary activities Profit on ordinary activities after tax Minority interests: equity : non-equity Profit for the year attributable to shareholders Dividends (Loss) profit for the year Earnings per share Diluted earnings per share * restated (see note 1) 58 LLOYDS TSB GROUP Note 2002 £ million 2001* £ million 567 9,982 5,378 5,171 165 3,053 (645) 188 (303) 486 763 3,542 8,878 530 10,834 6,442 4,922 307 2,922 (602) 233 (29) 428 708 3,660 8,889 4,214 4,226 642 59 701 4,915 3,963 229 965 64 1,029 87 2,618 (11) – 2,607 764 1,843 19 43 1,781 1,908 (127) 32.0p 31.8p 511 39 550 4,776 4,113 174 736 11 747 60 3,132 (10) 39 3,161 875 2,286 17 40 2,229 1,872 357 40.3p 39.9p 44 3 30 4 24 23 15 5 20 6 7 8 40 9 10 42 11 11 Consolidated balance sheet at 31 December 2002 Assets Cash and balances at central banks Items in course of collection from banks Treasury bills and other eligible bills Loans and advances to banks Loans and advances to customers Non-returnable finance Debt securities Equity shares Interests in joint ventures: – share of gross assets – share of gross liabilities Intangible fixed assets Tangible fixed assets Own shares Other assets Prepayments and accrued income Post-retirement benefit asset Long-term assurance business attributable to the shareholder Long-term assurance assets attributable to policyholders Total assets * restated (see note 1) The directors approved the accounts on 13 February 2003. 2002 2001* Note £ million £ million 1,140 1,757 2,409 1,240 1,664 4,412 17,529 15,224 134,498 123,059 (24) (124) 134,474 122,935 29,314 24,225 206 225 336 (291) 45 2,634 4,096 18 5,263 2,305 – 6,228 281 (242) 39 2,566 3,365 23 4,468 2,296 356 6,366 207,418 189,404 45,340 46,389 252,758 235,793 12 13 14 17 18 20 23 24 27 28 29 44 30 30 M A van den Bergh Chairman P B Ellwood CBE Group Chief Executive P R Hampton Group Finance Director LLOYDS TSB GROUP 59 Consolidated balance sheet Liabilities Deposits by banks Customer accounts Items in course of transmission to banks Debt securities in issue Other liabilities Accruals and deferred income Post-retirement benefit liability Provisions for liabilities and charges: Deferred tax Other provisions for liabilities and charges Subordinated liabilities: Undated loan capital Dated loan capital Minority interests: Equity Non-equity Called-up share capital Share premium account Merger reserve Profit and loss account Shareholders’ funds (equity) Note 2002 £ million 2001* £ million 32 33 34 35 36 44 37 38 39 39 40 41 42 42 42 25,443 24,310 116,334 109,116 775 534 30,255 24,420 8,289 3,696 2,077 1,317 361 5,496 4,672 37 694 731 1,416 1,093 343 5,120 7,972 6,673 3,563 75 1,411 292 4,102 4,006 37 509 546 1,411 959 343 7,643 10,356 Long-term assurance liabilities to policyholders 30 45,340 46,389 207,418 189,404 Total liabilities Memorandum items Contingent liabilities: Acceptances and endorsements Guarantees and assets pledged as collateral security Other contingent liabilities Commitments * restated (see note 1) 252,758 235,793 45 1,879 5,927 2,540 10,346 2,243 3,789 1,931 7,963 64,504 53,342 60 LLOYDS TSB GROUP Company balance sheet at 31 December 2002 Fixed assets Investments: Shares in group undertakings Loans to group undertakings Own shares Current assets Debtors falling due within one year: Amounts owed by group undertakings Other debtors Tax recoverable Cash balances with group undertakings Current liabilities Amounts falling due within one year: Amounts owed to group undertakings Other creditors Dividend payable Loan capital Net current liabilities Total assets less current liabilities Creditors Amounts falling due after more than one year: Loan capital Net assets Capital and reserves Called-up share capital Share premium account Revaluation reserve Profit and loss account Shareholders’ funds (equity) Note 2002 £ million 2001 £ million 21 21 27 9,091 1,723 18 11,960 759 23 10,832 12,742 1,375 1,369 89 11 250 47 29 114 1,725 1,559 1,801 103 1,311 14 3,229 1,760 62 1,306 – 3,128 (1,504) (1,569) 9,328 11,173 1,356 7,972 1,416 1,093 3,025 2,438 7,972 413 10,760 1,411 959 5,894 2,496 10,760 39 39 41 42 42 42 The directors approved the accounts on 13 February 2003. M A van den Bergh Chairman P B Ellwood CBE Group Chief Executive P R Hampton Group Finance Director LLOYDS TSB GROUP 61 Other statements Statement of total recognised gains and losses for the year ended 31 December 2002 Profit attributable to shareholders Currency translation differences on foreign currency net investments 2002 £ million 1,781 (3) 2001* £ million 2,229 (86) Actuarial losses recognised in post-retirement benefit schemes (note 44) (3,299) (2,873) Deferred tax thereon (note 44) Total recognised gains and losses relating to the year Prior year adjustment at 1 January 2002 in respect of current year changes in accounting policy (note 1) Prior year adjustment in respect of the adoption of FRS 18 Total gains and losses recognised during the year * restated (see note 1) 968 863 (2,331) (2,010) (553) (404) – (957) 133 – 248 381 Historical cost profits and losses for the year ended 31 December 2002 There was no material difference between the results as reported and the results that would have been reported on an unmodified historical cost basis. Accordingly, no note of historical cost profits and losses has been included. Reconciliation of movements in shareholders’ funds for the year ended 31 December 2002 Profit attributable to shareholders Dividends (Loss) profit for the year Currency translation differences on foreign currency net investments 2002 £ million 1,781 (1,908) (127) (3) 2001* £ million 2,229 (1,872) 357 (86) Actuarial losses recognised in post-retirement benefit schemes (2,331) (2,010) Issue of shares Net decrease in shareholders’ funds Shareholders’ funds at beginning of year Prior year adjustment at 1 January 2001 (note 1) Shareholders’ funds at end of year * restated (see note 1) 77 194 (2,384) 10,356 – 7,972 (1,545) 10,024 1,877 10,356 62 LLOYDS TSB GROUP Consolidated cash flow statement for the year ended 31 December 2002 Net cash inflow from operating activities (note 48a) Dividends received from associated undertakings Returns on investments and servicing of finance: Dividends paid to equity minority interests Payments made to non-equity minority interests Interest paid on subordinated liabilities (loan capital) Interest element of finance lease rental payments Net cash outflow from returns on investments and servicing of finance Taxation: UK corporation tax Overseas tax Total taxation Capital expenditure and financial investment: Additions to fixed asset investments Disposals of fixed asset investments Additions to tangible fixed assets Disposals of tangible fixed assets Capital injections to life fund Net cash outflow from capital expenditure and financial investment Acquisitions and disposals: Additions to interests in joint ventures Acquisition of group undertakings (note 48e) Disposal of group undertakings and businesses (note 48g) Net cash outflow from acquisitions and disposals Equity dividends paid Net cash outflow before financing Financing: Issue of subordinated liabilities (loan capital) Issue of ordinary share capital net of £62 million (2001: £185 million) charge in respect of the QUEST (note 27) Repayments of subordinated liabilities (loan capital) Minority investment in subsidiaries Capital element of finance lease rental payments Net cash inflow from financing Increase (decrease) in cash (note 48c) * restated (see note 1) 2002 £ million 5,394 2 (18) (43) (463) – 2001* £ million 9,927 2 (17) (40) (514) (1) (524) (572) (758) (193) (951) (682) (147) (829) (46,830) (47,049) 45,507 (1,315) 359 (140) 40,530 (1,157) 285 (100) (2,419) (7,491) (21) (117) – (138) (1,903) (539) (44) (180) 40 (184) (1,738) (885) 2,120 742 77 (55) 167 (4) 2,305 1,766 194 (131) – (20) 785 (100) LLOYDS TSB GROUP 63 Notes to the accounts 1 Accounting policies Accounting policies are unchanged from 2001, except that: (i) The Group has implemented the requirements of the Urgent Issues Task Force’s Abstract 33 ‘Obligations in capital instruments’. Following its implementation the Group has reclassified €750 million of Perpetual Capital Securities as undated loan capital and the related cost is included within interest expense. Previously these securities were included within minority interests in the balance sheet and the cost was treated as a minority interest deduction. The effect of this change on the profit and loss account for the year ended 31 December 2002 has been to increase interest payable and reduce non-equity minority interests by £31 million (2001: £22 million); there has been no effect on attributable profit. The effect on the Group’s balance sheet at 31 December 2002 has been to increase undated loan capital and reduce non-equity minority interests by £482 million (2001: £451 million). (ii) The Group has implemented the requirements of Financial Reporting Standard 19 (‘FRS 19’) ‘Deferred Tax’. Following its implementation, the Group makes full provision for deferred tax assets and liabilities arising from timing differences between the recognition of gains and losses in the financial statements and their recognition in a tax computation. Previously provision was only made where it was considered that there was a reasonable probability that a liability or asset would crystallise in the foreseeable future. A prior year adjustment has been made increasing shareholders’ funds by £54 million to reflect the revised policy. The effect of this change on the profit and loss account for the year ended 31 December 2002 has been to reduce the tax charge by £29 million (2001: increase the tax charge by £14 million). The effect on the Group’s balance sheet at 31 December 2002 has been to reduce the deferred tax liability and increase shareholders’ funds by £69 million (2001: £40 million). (iii) The Group has adopted fully the accounting requirements of Financial Reporting Standard 17 (‘FRS 17’) ‘Retirement Benefits’. FRS 17 replaces Statement of Standard Accounting Practice 24 and the Urgent Issues Task Force’s Abstract 6 as the accounting standard dealing with post-retirement benefits. The Group has decided to implement the requirements of FRS 17 in 2002 to coincide with the triennial full actuarial valuations of the Group’s pension schemes and because of the significant impact that implementation has on the Group’s reported results. FRS 17 requires the assets of post-retirement defined benefit schemes to be included on the balance sheet together with the related liability to make benefit payments. The profit and loss account includes a charge in respect of the cost of accruing benefits for active employees, benefit improvements and the cost of severances borne by the schemes; the expected return on the schemes’ assets is included within other finance income net of a charge in respect of the unwinding of the discount applied to the schemes’ liabilities. It also includes a charge in respect of post-retirement healthcare obligations. Under Statement of Standard Accounting Practice 24 the profit and loss account included a charge in respect of the cost of accruing benefits for active employees offset by a credit representing the amortisation of the surplus in the Group’s defined benefit pension schemes; a pension prepayment was included in the Group’s balance sheet, together with a provision in respect of post-retirement healthcare obligations. A prior year adjustment has been made increasing shareholders’ funds by £1,876 million to reflect the revised policy. The effect of this change on the profit and loss account for the year ended 31 December 2002 has been to introduce other finance income of £165 million (2001: £307 million), and to increase administrative expenses by £323 million (2001: £452 million). Profit before tax has been reduced by £158 million (2001: £145 million). The effect on the Group’s balance sheet at 31 December 2002 has been to reflect a net post- retirement benefit liability of £2,077 million (2001: a net post-retirement benefit asset of £356 million and a post-retirement benefit liability of £75 million), to reduce prepayments and accrued income by £928 million (2001: £894 million), to reduce the deferred tax liability by £251 million (2001: £268 million), to reduce other provisions for liabilities and charges by £76 million (2001: £109 million) and to reduce shareholders’ funds by £2,678 million (2001: £236 million). 64 LLOYDS TSB GROUP (iv) In December 2001, the Association of British Insurers (ABI) published detailed guidance for the preparation of figures using the achieved profits method of accounting which are published as supplementary financial information accompanying the accounts of most listed insurance companies. The ABI guidance recommends the use of unsmoothed fund values to calculate the value of in-force business. To improve the comparability of the results of the Group’s insurance operations with the supplementary financial information published by listed insurers the Group has changed the basis of its embedded value calculations to use unsmoothed fund values; previously the effect of investment fluctuations had been amortised to the profit and loss account over a two year period. A prior year adjustment has been made reducing shareholders’ funds by £53 million, to reflect the revised policy. The effect of this change on the profit and loss account for the year ended 31 December 2002 has been to reduce income from long-term assurance business before tax by £104 million (2001: £222 million). The effect on the Group’s balance sheet at 31 December 2002 has been to reduce the value of the long-term assurance business attributable to the shareholder by £281 million (2001: £208 million) and to reduce shareholders’ funds by the same amount. Comparative figures for 2001 have been restated in respect of all of the above changes. The prior year adjustments in respect of these changes can be summarised as follows: Actuarial losses recognised in post- retirement Impact on attributable profit for year ended Adjustment to shareholders’ funds at benefit Adjustment to schemes for shareholders’ funds at year ended 1 January 31 December 31 December 31 December 2001 £m 2001 £m 2001 £m 2001 £m FRS 19 Deferred tax (ii) FRS 17 Retirement benefits (iii) ABI guidance (iv) 54 (14) – 40 1,876 (53) (102) (155) (2,010) – (236) (208) Total 1,877 (271) (2,010) (404) a Accounting convention The consolidated accounts are prepared under the historical cost convention as modified by the revaluation of debt securities and equity shares held for dealing purposes (see g) and assets held in the long-term assurance business (see o), in compliance with Section 255A, Schedule 9 and other requirements of the Companies Act 1985 except as described below (see c), in accordance with applicable accounting standards, pronouncements of the Urgent Issues Task Force and with the Statements of Recommended Practice issued by the British Bankers’ Association and the Finance & Leasing Association. The Group’s methodology for calculating embedded value follows the guidance published by the Association of British Insurers for the preparation of figures using the achieved profits method of accounting except that tangible assets attributable to the shareholder are valued at market value. The guidance would require those assets backing capital requirements to be discounted to reflect the cost of encumbered capital, but such a treatment would be inconsistent with the treatment of capital supporting the Group’s banking operations. If this treatment had been followed income from long-term assurance business before tax in 2002 would have been slightly improved. Conversely, embedded value would have been some 8 per cent lower given the size of the shareholder capital required to be retained within Scottish Widows under the terms of the demutualisation. The accounts of the Company are prepared under the historical cost convention as modified by the revaluation of shares in group undertakings (see h), in compliance with Section 226, Schedule 4 and other requirements of the Companies Act 1985 and in accordance with applicable accounting standards and pronouncements of the Urgent Issues Task Force. Notes to the accounts 1 Accounting policies (continued) a Accounting convention (continued) The Group continues to take advantage of the dispensation in the Urgent Issues Task Force’s Abstract 17 ‘Employee Share Schemes’ not to apply that Abstract to the Group’s Inland Revenue approved SAYE schemes. b Basis of consolidation Assets, liabilities and results of group undertakings and joint ventures are included in the consolidated accounts on the basis of accounts made up to 31 December. Entities that do not meet the legal definition of a subsidiary but which give rise to benefits that are in substance no different to those that would arise from subsidiaries are also included in the consolidated accounts. In order to reflect the different nature of the shareholder’s and policyholders’ interests in the long-term assurance business, the value of long-term assurance business attributable to the shareholder and the assets and liabilities attributable to policyholders are classified under separate headings in the consolidated balance sheet. Details of transactions entered into by the Group which are not eliminated on consolidation are given in note 43. c Goodwill Goodwill arising on acquisitions of or by group undertakings is capitalised. For acquisitions prior to 1 January 1998, goodwill was taken direct to reserves in the year of acquisition. As permitted by the transitional arrangements of Financial Reporting Standard 10, this goodwill was not reinstated when the Group adopted the standard in 1998. The useful economic life of the goodwill arising on each acquisition is determined at the time of the acquisition. The directors consider that it is appropriate to assign an indefinite life to the goodwill which arose on the acquisition of Scottish Widows during 2000 in view of the strength of the Scottish Widows brand, developed through over 185 years of trading, and the position of the business as one of the leading providers of life, pensions, unit trust and fund management products. Both of these attributes are deemed to have indefinite durability, which has been determined based on the following factors: the nature of the business; the typical lifespans of the products; the extent to which the acquisition overcomes market entry barriers; and the expected future impact of competition on the business. 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 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. Paragraph 28 of Schedule 9 to the Companies Act 1985 requires that all goodwill carried on the balance sheet should be amortised. In the case of the goodwill arising on the acquisition of Scottish Widows, the directors consider that it is appropriate to depart from this requirement in order to comply with the over-riding requirement for the accounts to show a true and fair view. If this goodwill was amortised over a period of 20 years, profit before tax for the year ended 31 December 2002 would be £93 million lower (2001: £94 million lower), with a corresponding reduction in reserves of £265 million (2001: £172 million); intangible assets on the balance sheet would also be £265 million lower (2001: £172 million lower). Goodwill arising on all other acquisitions after 1 January 1998 is amortised on a straight line basis over its estimated useful economic life, which does not exceed 20 years. At the date of the disposal of group or associated undertakings, any unamortised goodwill, or goodwill taken directly to reserves prior to 1 January 1998, is included in the Group’s share of the net assets of the undertaking in the calculation of the profit or loss on disposal. d Income recognition Interest income is recognised in the profit and loss account as it accrues, with the exception of interest on non-performing lending which is taken to income either when it is received or when there ceases to be any significant doubt about its ultimate receipt (see e). Fees and commissions receivable from customers to reimburse the Group for costs incurred are taken to income when due. Fees and commissions relating to the ongoing provision of a service or risk borne for a customer are taken to income in proportion to the service provided or risk borne in each accounting period. Fees and commissions charged in lieu of interest are taken to income on a level yield basis over the period of the loan. Other fees and commissions receivable are accounted for as they fall due. e Provisions for bad and doubtful debts and non-performing lending Provisions for bad and doubtful debts It is the Group’s policy to make provisions for bad and doubtful debts, by way of a charge to the profit and loss account, to reflect the losses inherent in the loan portfolio at the balance sheet date. There are two types of provision, specific and general, and these are discussed further below. Specific provisions Specific provisions relate to identified risk advances and are raised when the Group considers that recovery of the whole of the outstanding balance is in serious doubt. The amount of the provision is equivalent to the amount necessary to reduce the carrying value of the advance to its expected ultimate net realisable value. For the Group’s portfolios of smaller balance homogeneous loans, such as the residential mortgage, personal lending and credit card portfolios, specific provisions are calculated using a formulae driven approach. These formulae take into account factors such as the length of time that payments from the customer are overdue, the value of any collateral held and the level of past and expected losses, in order to derive an appropriate provision. 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. General provisions General provisions are raised to cover latent bad and doubtful debts which are present in any portfolio of advances but have not been specifically identified. The Group holds general provisions against each of its principal lending portfolios, which are calculated after having regard to a number of factors; in particular, the level of watchlist or potential problem debt, the observed propensity for such debt to deteriorate and become impaired and prior period loss rates. The level of general provision held is reviewed on a regular basis to ensure that it remains appropriate in the context of the perceived risk inherent in the related portfolio and the prevailing economic climate. Non-performing lending An advance becomes non-performing when interest ceases to be credited to the profit and loss account. There are two types of non-performing lending which are discussed further below. Accruing loans on which interest is being placed in suspense Where the customer continues to operate the account, but where there is doubt about the payment of interest, interest continues to be charged to the customer’s account, but it is not applied to income. Interest is placed on a suspense account and only taken to income if there ceases to be significant doubt about its being paid. Loans accounted for on a non-accrual basis In those cases where the operation of the customer’s account has ceased and it has been transferred to a specialist recovery department, the LLOYDS TSB GROUP 65 Notes to the accounts 1 Accounting policies (continued) e Provisions for bad and doubtful debts and non-performing lending (continued) advance is written down to its estimated realisable value and interest is no longer charged to the customer’s account as its recovery is considered unlikely. Interest is only taken to income if it is received. f Mortgage incentives 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. g Debt securities and equity shares Debt securities, apart from those held for dealing purposes, are stated at cost as adjusted for the amortisation of any premiums and discounts arising on acquisition, which are amortised from purchase to maturity in equal annual instalments, less amounts written off for any permanent diminution in their value. Equity shares, apart from those held for dealing purposes, are stated at cost less amounts written off for any permanent diminution in their value. Debt securities and equity shares held for dealing purposes are included at market value. In rare circumstances where securities are transferred from dealing portfolios to investment portfolios or vice versa, the transfer is effected at an amount based on the market value at the date of transfer. Any resulting profit or loss is reflected in the profit and loss account. h Shares in group undertakings 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. i Tangible fixed assets Tangible fixed assets are included at cost less depreciation. Land is not depreciated. Leasehold premises with unexpired lease terms of 50 years or less are depreciated by equal annual instalments over the remaining period of the lease. Freehold and long leasehold buildings are depreciated over 50 years. The costs of adapting premises for the use of the Group are separately identified and depreciated over 10 years, or over the term of the lease if less; such costs are included within premises in the balance sheet total of tangible fixed assets. Equipment is depreciated by equal annual instalments over the estimated useful lives of the assets, which for fixtures and furnishings are 10-20 years and for computer hardware, operating software and application software and the related development costs relating to separable new systems, motor vehicles and other equipment are 3-8 years. Premises and equipment held for letting to customers under operating leases are depreciated over the life of the lease to give a constant rate of return on the net investment, taking into account anticipated residual values. Anticipated residual values are reviewed regularly and any impairments identified are charged to the profit and loss account. j Vacant leasehold property 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. k Leasing and instalment credit transactions 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. 66 LLOYDS TSB GROUP Income from both finance and operating leases is credited to the profit and loss account in proportion to the net cash invested so as to give a constant rate of return over each period after taking account of tax. Income from instalment credit transactions is credited to the profit and loss account using the sum of the digits method. In those cases where the Group is the lessee, operating lease costs are charged to the profit and loss account in equal annual instalments over the life of the lease. l Deferred tax Full provision is made for deferred tax liabilities arising from timing differences between the recognition of gains and losses in the financial statements and their recognition in a tax computation. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying timing differences can be deducted, or where they can be offset against deferred tax liabilities. Deferred tax is measured at the average tax rates that are expected to apply in the periods in which the timing differences are expected to reverse, based on tax rates and laws that have been enacted or substantively enacted by the balance sheet date. m Pensions and other post-retirement benefits The Group operates a number of defined benefit pension and post- retirement healthcare schemes, and a number of employees are members of defined contribution pension schemes. Full actuarial valuations of the Group’s main defined benefit schemes are carried out every three years with interim reviews in the intervening years; these valuations are updated to 31 December each year by qualified independent actuaries. For the purposes of these annual updates, scheme assets are included at market value and scheme liabilities are measured on an actuarial basis using the projected unit method; these liabilities are discounted at the current rate of return on a high quality corporate bond of equivalent currency and term. The post-retirement benefit surplus or deficit is included on the Group’s balance sheet, net of the related amount of deferred tax. Surpluses are only included to the extent that they are recoverable through reduced contributions in the future or through refunds from the schemes. The current service cost and any past service costs are included in the profit and loss account within operating expenses and the expected return on the schemes’ assets, net of the impact of the unwinding of the discount on scheme liabilities, is included within other finance income. Actuarial gains and losses, including differences between the expected and actual return on scheme assets, are recognised, net of the related deferred tax, in the statement of total recognised gains and losses. 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. n Foreign currency translation Assets, liabilities and results in foreign currencies are expressed in sterling at the rates of exchange ruling on the dates of the respective balance sheets. Exchange adjustments on the translation of opening net assets held overseas are taken direct to reserves. All other exchange profits or losses, which arise from normal trading activities, are included in the profit and loss account. o Long-term assurance business A number of the Group’s subsidiary undertakings are engaged in writing long-term assurance business, including the provision of life assurance, pensions, annuities and permanent health insurance contracts. In common with other life assurance companies in the UK, these companies are structured into one or more long-term business funds, depending upon the nature of the products being written, and a shareholder’s fund. All premiums received, investment returns, claims and expenses, and changes in liabilities to policyholders are accounted for within the related long-term business fund. Any surplus, which is determined annually by the Appointed Actuary after taking account of these items, may either be distributed between the shareholder and the policyholders according to a predetermined formula or retained within the long-term business fund. The shareholder will also levy investment management and administration charges upon the long-term business fund. Notes to the accounts 1 Accounting policies (continued) o Long-term assurance business (continued) The Group accounts for its interest in long-term assurance business using the embedded value basis of accounting, in common with other UK banks with insurance subsidiaries. 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 shareholder, and the present value of the in-force business. The 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. Changes in the embedded value, which are determined on a post-tax basis, are included in the profit and loss account. For the purpose of presentation, the change in this value is grossed up at the underlying rate of corporation tax. The assets held within the long-term business funds are legally owned by the life assurance companies, however the shareholder will only benefit from ownership of these assets to the extent that surpluses are declared or from other cash flows attributable to the shareholder. Reflecting the different nature of these assets, they are classified separately on the Group’s balance sheet as ‘Long-term assurance assets attributable to policyholders’, with a corresponding liability to the policyholders also shown. Investments held within the long-term business funds are included on the following basis: equity shares, debt securities and unit trusts held for unit linked funds are valued in accordance with policy conditions at market prices; other equity shares and debt securities are valued at middle market price and other unit trusts at bid price; investment properties are included at valuation by independent valuers at existing use value at the balance sheet date, and mortgages and loans are at cost less amounts written off. p General insurance business The Group both underwrites and acts as intermediary in the sale of general insurance products. Underwriting premiums are included, net of refunds, in the period in which insurance cover is provided to the customer; premiums received relating to future periods are deferred and only credited to the profit and loss account when earned. Where the Group acts as intermediary, commission income is included in the profit and loss account at the time that the underwriter accepts the risk of providing insurance cover to the customer. Where appropriate, provision is made for the effect of future policy terminations based upon past experience. The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. In those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. Similar statistical techniques are used to determine the provision for claims incurred but not reported at the balance sheet date. Claims equalisation provisions are calculated in accordance with the relevant legislative requirements. q Derivatives Derivatives are used in the Group’s trading activities to meet the financial needs of customers, for proprietary purposes and to manage risk in the Group’s trading portfolios. Such instruments include exchange rate forwards and futures, currency swaps and options together with interest rate swaps, forward rate agreements, interest rate options and futures. These derivatives are carried at fair value and all changes in fair value are reported within dealing profits in the profit and loss account. Fair values are normally determined by reference to quoted market prices; internal models are used to determine fair value in instances where no market price is available. The unrealised gains and losses on trading derivatives are included within other assets and other liabilities respectively. These items are reported gross except in instances where the Group has entered into legally binding netting agreements, where the Group has a right to insist on net settlement that would survive the insolvency of the counterparty; in these cases the positive and negative fair values of trading derivatives with the relevant counterparties are offset within the balance sheet totals. Derivatives used in the Group’s non-trading activities are taken out to reduce exposures to fluctuations in interest and exchange rates and include exchange rate forwards and futures, currency swaps together with interest rate swaps, forward rate agreements and options. These derivatives are accounted for in the same way as the underlying items which they are hedging. Interest receipts and payments on hedging interest derivatives are included in the profit and loss account so as to match the interest payable or receivable on the hedged item. A derivative will only be classified as a hedge in circumstances where there was evidence of the intention to hedge at the outset of the transaction and the derivative substantially matches or eliminates the risk associated with the exposure being hedged. Where a hedge transaction is superseded, ceases to be effective or is terminated early the derivative is measured at fair value. Any profit or loss arising is then amortised to the profit and loss account over the remaining life of the item which it was originally hedging. When the underlying asset, liability or position that was being hedged is terminated, the hedging derivative is measured at fair value and any profit or loss arising is recognised immediately. LLOYDS TSB GROUP 67 Notes to the accounts 2 Segmental analysis Class of business: UK Retail Banking and Mortgages Insurance and Investments Operating profit Changes in economic assumptions Investment variance Wholesale Markets and International Banking Central group items Profit on ordinary activities before tax 2001* 2002 £m £m 1,172 1,205 1,231 55 (952) 334 1,005 96 1,421 – (859) 562 1,209 185 2,607 3,161 Interest receivable Other finance income Fees and commissions receivable Dealing profits (before expenses) Income from long-term assurance business General insurance premium income Other operating income Domestic 2001* £m 8,950 307 2,636 138 (41) 428 538 Inter- national 2001 £m 2,414 – 286 95 12 – 170 Total 2001* £m 11,364 307 2,922 233 (29) 428 708 Total gross income 12,956 2,977 15,933 Profit on ordinary activities before tax 2,595 566 3,161 Net assets† Assets‡ 2002 £m 2001* £m 2002 £m 2001* £m 2,541 6,936 2,437 85,868 9,161 6,811 77,982 9,270 4,925 (6,393) 4,405 110,845 100,777 1,375 1,544 (3,260) 8,009 10,393 207,418 189,404 6,634 1,375 9,319 177,702 160,796 28,608 1,074 29,716 8,009 10,393 207,418 189,404 Operating profit from Insurance and Investments is further analysed as follows: Life and pensions Unit trusts General insurance Asset management 2002 £m 474 1 754 2 2001* £m 719 41 651 10 1,231 1,421 Class of business: UK Retail Banking and Mortgages Insurance and Investments Wholesale Markets and International Banking Central group items The operating profit for the life and pensions business shown above reconciles to the income from long-term assurance business shown in the profit and loss account as follows: Life and pensions segmental profit Changes in economic assumptions Investment variance relating to the life and pensions business Other items 2002 £m 474 55 (892) 60 2001* £m 719 – (813) 65 Income from long-term assurance business (303) (29) Geographical area:** Domestic 2002 £m Inter- national 2002 £m Total 2002 £m Interest receivable Other finance income Fees and commissions receivable Dealing profits (before expenses) Income from long-term assurance business General insurance premium income Other operating income 8,226 165 2,773 125 (314) 486 552 2,323 10,549 165 3,053 188 (303) 486 763 – 280 63 11 – 211 Geographical area:** Domestic International *2001 figures have been restated to take account of the changes in accounting policy explained in note 1 and the reclassification of emerging markets debt earnings from Wholesale Markets and International Banking to Central group items. ** The geographical distribution of gross income sources, profit on ordinary activities before tax and assets by domestic and international operations is based on the location of the office recording the transaction, except for lending by the international business booked in London. †Net assets represent shareholders’ funds plus equity minority interests. Disclosure of information on net assets is an accounting standard requirement (SSAP25); it is not appropriate to relate it directly to the segmental profits above because the business is not managed by the allocation of net assets to business units. ‡Assets exclude long-term assurance assets attributable to policyholders. As the business of the Group is mainly that of banking and insurance, no segmental analysis of turnover is given. Total gross income 12,013 2,888 14,901 3 Dealing profits (before expenses) Profit on ordinary activities before tax 2,111 496 2,607 Foreign exchange trading income Securities and other gains 2002 £m 173 15 188 2001 £m 158 75 233 Dealing profits include the profits and losses arising both on the purchase and sale of trading instruments and from the year-end revaluation to market value, together with the interest income earned from these instruments and the related funding cost. 68 LLOYDS TSB GROUP Notes to the accounts 4 Administrative expenses Salaries and profit sharing Social security costs Other pension costs (note 44) Staff costs Other administrative expenses 2002 £m 2,065 134 318 2,517 1,697 2,066 140 347 2,553 1,673 *restated (see note 1) The average number of persons on a headcount basis employed by the Group during the year was as follows: 4,214 4,226 UK Overseas 2002 2001 71,134 11,491 71,184 11,768 82,625 82,952 The above staff numbers exclude 5,870 (2001: 5,450) staff employed in the long-term assurance business. Costs of £209 million (2001: £168 million) in relation to those staff are reflected in the valuation of the long-term assurance business. Details of directors’ emoluments, pensions and interests are given on pages 51 to 54. During the year the auditors earned the following fees: Statutory audit Other audit fees including regulatory reporting Due diligence Internal control reviews Other Audit related fees Audit and audit related fees Tax fees Management consultancy fees Other fees 2002 £m 2001 £m 4.8 2.6 0.8 0.3 0.2 1.3 8.7 0.7 0.1 1.0 4.0 5.5 5.7 0.2 0.5 6.4 15.9 0.4 3.5 1.3 2001* £m 5 Amounts written off fixed asset investments 2002 £m 2001 £m Debt securities Equity shares 84 3 87 58 2 60 6 Profit before tax on sale of businesses On 3 October 2001 the Group announced the sale of its Brazilian fund management and private banking business, including its subsidiary, Lloyds TSB Asset Management S.A. This resulted in a profit on sale of £39 million (tax: £11 million). 7 Profit on ordinary activities before tax Profit on ordinary activities before tax is stated after taking account of: 2002 £m 2001* £m Income from: Aggregate amounts receivable, including capital repayments, in respect of assets leased to customers and banks under: Finance leases and hire purchase contracts Operating leases Profit less losses on disposal of investment securities 3,290 440 160 3,250 329 160 Charges: Rental of premises Hire of equipment Interest on subordinated liabilities (loan capital) 220 18 537 203 18 515 *restated (see note 1) 8 Tax on profit on ordinary activities a Analysis of charge for the year UK corporation tax Current tax on profits for the year Adjustments in respect of prior years Total fees 10.5 21.1 Double taxation relief The auditors’ remuneration for the holding company was £50,000 (2001: £50,000). It is the Group’s policy to employ the auditors on assignments additional to their statutory audit duties, where their expertise and experience with the Group are important, principally relating to tax advice and due diligence reporting on acquisitions and disposals. Following a change in policy earlier this year, the auditors are no longer permitted to perform management consultancy work on behalf of the Group. Foreign tax Current tax on profits for the year Adjustments in respect of prior years Current tax charge Deferred tax Associated undertakings and joint ventures 2002 £m 2001* £m 784 12 796 (129) 769 (14) 755 (87) 667 668 216 (15) 201 868 (106) 2 764 179 (17) 162 830 44 1 875 *restated (see note 1) The charge for tax on the profit for the year is based on a UK corporation tax rate of 30 per cent (2001: 30 per cent). In addition to the tax charge in the profit and loss account detailed above, £968 million (2001: £863 million) of deferred tax has been credited to the statement of total recognised gains and losses in respect of actuarial losses recognised in post-retirement benefit schemes (note 44). LLOYDS TSB GROUP 69 Notes to the accounts 8 Tax on profit on ordinary activities (continued) b Factors affecting the tax charge for the year A reconciliation of the charge that would result from applying the standard UK corporation tax rate to profit before tax to the current tax charge and total tax charge for the year is given below: Profit on ordinary activities before tax Tax charge thereon at UK corporation tax rate of 30% Factors affecting charge: Goodwill amortisation Overseas tax rate differences Non-allowable and non-taxable items Gains exempted or covered by capital losses Tax deductible coupons on non-equity minority interests Payments to employee trust Capital allowances in excess of depreciation Other timing differences Life companies rate differences Other items Current tax charge Deferred tax – capital allowances in excess of depreciation – other timing differences Associated undertakings and joint ventures 2002 £m 2001 £m 2,607 3,161 9 24 (28) (23) (12) (20) 7 99 44 (14) 8 12 8 (39) (12) (60) (48) 4 21 (12) 868 830 (7) (99) 2 48 (4) 1 782 948 11 Earnings per share 10 Ordinary dividends Interim: paid Final: proposed 2002 pence per share 2001 pence per share 2002 2001 £m £m 10.7 23.5 10.2 23.5 597 1,311 566 1,306 34.2 33.7 1,908 1,872 Profit attributable to shareholders† Weighted average number of ordinary shares in issue during the year†† Dilutive effect of options outstanding Diluted weighted average number of ordinary shares in issue during the year Earnings per share Diluted earnings per share *restated (see note 1) 2002 2001* £1,781m £2,229m 5,570m 5,533m 50m 27m 5,597m 5,583m 40.3p 39.9p 32.0p 31.8p †No adjustment was made to profit attributable to shareholders in calculating diluted earnings per share. ††The weighted average number of shares for the year has been calculated after deducting 5 million (2001: 15 million) ordinary shares held by Lloyds TSB Group Holdings (Jersey) Limited and the trustees of the TSB Group Employee Trust, the Lloyds TSB Group Employee Share Ownership Trust and the Lloyds TSB Qualifying Employee Share Ownership Trust, on which dividends have been waived (note 27). Tax on profit on ordinary activities 764 875 Effective rate 29.3% 27.7% 12 Treasury bills and other eligible bills c Factors that may affect the future tax charge The current tax charge includes a credit of £46 million (2001: charge of £11 million) in respect of notional tax on the shareholder’s interest in the movement in value of the long-term assurance business. Since this derives from the use of a combination of tax rates it can give rise to a higher or lower charge compared to an expected 30 per cent rate, depending upon the reported investment returns. Following Government changes recently announced in respect of employee benefit trusts the future benefit to the tax charge from this source will be less. In December 2002 the Inland Revenue announced its intention to introduce legislation which may affect the tax treatment of certain transfers from Scottish Widows plc’s long term business fund to its shareholder’s fund. The precise impact of these proposals is yet to be determined, however it is possible that these transfers will be subject to a higher tax charge than was previously anticipated. Factors that may affect the future deferred tax charge are dealt with in Note 37. Investment securities: Treasury bills and similar securities Other eligible bills Other securities: Treasury bills and similar securities Geographical analysis by issuer: United Kingdom Latin America Other 9 Profit for the financial year attributable to shareholders The profit attributable to shareholders includes a profit of £1,912 million (2001: £1,893 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. Included above: Unamortised discounts net of premiums on investment securities 2002 Balance 2002 sheet Valuation £m £m 2001 Balance sheet £m 2001 Valuation £m 257 1,622 258 1,620 748 2,034 748 2,032 1,879 1,878 2,782 2,780 530 2,409 1,726 567 116 2,409 1,630 4,412 2,620 1,412 380 4,412 5 6 70 LLOYDS TSB GROUP Notes to the accounts 12 Treasury bills and other eligible bills (continued) Movements in investment securities comprise: Premiums and discounts £m Cost £m Total £m At 1 January 2002 Exchange and other adjustments Additions Bills sold or matured Amortisation of premiums and discounts 2,777 (3) 30,402 (31,301) – 2,782 5 (3) – – 30,402 (76) (31,377) 75 75 At 31 December 2002 1,875 4 1,879 Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. The difference between the cost of other securities and market value, where the market value is higher than the cost, is not disclosed as its determination is not practicable. It is expected that tax of £1 million (2001: £1 million) would be recoverable if the investment securities were sold at their year end valuation. 13 Loans and advances to banks Lending to banks Deposits placed with banks Total loans and advances to banks Provisions for bad and doubtful debts Repayable on demand Other loans and advances by residual maturity repayable: 3 months or less 1 year or less but over 3 months 5 years or less but over 1 year Over 5 years Provisions for bad and doubtful debts 14 Loans and advances to customers Lending to customers Hire purchase debtors Equipment leased to customers Total loans and advances to customers Provisions for bad and doubtful debts Interest held in suspense Loans and advances by residual maturity repayable: 3 months or less 1 year or less but over 3 months 5 years or less but over 1 year Over 5 years Provisions for bad and doubtful debts Interest held in suspense 2002 £m 2001 £m 2,212 15,318 1,616 13,610 17,530 (1) 15,226 (2) 17,529 15,224 4,313 2,443 8,512 2,624 1,700 381 (1) 8,995 2,698 708 382 (2) 17,529 15,224 2002 £m 2001 £m 123,007 111,541 5,345 7,585 5,990 7,300 136,297 124,471 (1,466) (70) (1,766) (57) 134,474 122,935 23,989 10,357 30,637 71,314 (1,766) (57) 21,393 8,867 27,910 66,301 (1,466) (70) 134,474 122,935 Of which repayable on demand or at short notice 11,852 10,116 The cost of assets acquired during the year for letting to customers under finance leases and hire purchase contracts amounted to £3,752 million (2001: £3,166 million). Securitisations Certain instalment credit receivables have been securitised and are subject to non-returnable financing arrangements. In accordance with Financial Reporting Standard 5, these items have been shown under the linked presentation method. The Group’s subsidiary, Black Horse Limited (formerly Chartered Trust plc), entered into transactions whereby it disposed of its interest in portfolios of motor vehicle and caravan instalment credit agreements for a total of £980 million to Cardiff Automobile Receivables Securitisation (UK) No 4 plc (CARS 4). CARS Trustee (UK) No 4 Limited is responsible for the collection and onward payment of all amounts falling due under the terms of the receivables sold to CARS 4. Principal receipts up to 10 December 2000 were used to purchase further receivables; subsequent to this date they are being used to redeem floating rate notes. Income receipts are applied in the following order of priority: interest due on the floating rate notes; credit manager fees; payments under swaps; amounts due to third parties; dividends; and residual income to Black Horse Limited. Black Horse Limited has been appointed by CARS Trustee (UK) No 4 Limited as credit manager and receives a fee for fulfilling this function. It has no liability to the noteholders or any creditor of CARS 4 or CARS Trustee (UK) No 4 Limited other than through failure to meet its obligations as credit manager or for breach of warranties given. Black Horse Limited has no interest in the share capital of CARS 4 or CARS Trustee (UK) No 4 Limited. Black Horse Limited and CARS 4 have also entered into interest rate swaps in respect of this transaction, the interest rates payable and receivable under these swaps are set by reference to market rates of interest on an arm’s length basis. At 31 December 2002 CARS 4 held £24 million (2001: £124 million) of receivables, matched by non-returnable finance of the same amount. 15 Provisions for bad and doubtful debts and non-performing lending At 1 January Exchange and other adjustments Adjustments on acquisition Advances written off Recoveries of advances written off in previous years Charge to profit and loss account: New and additional provisions Releases and recoveries 2002 Specific £m 2002 General £m 1,099 (55) – (878) 369 (3) 3 – 2001 Specific £m 1,069 (15) – (885) 2001 General £m 357 1 – – 203 – 194 – 1,544 (579) 965 64 – 64 1,310 (574) 736 64 (53) 11 At 31 December 1,334 433 1,099 369 In respect of: Loans and advances to banks Loans and advances to customers 1,767 1,468 1 1,766 1,767 2 1,466 1,468 LLOYDS TSB GROUP 71 Notes to the accounts 15 Provisions for bad and doubtful debts and non-performing lending (continued) Non-performing lending comprises: Accruing loans on which interest is being placed in suspense Loans accounted for on a non-accrual basis Provisions Interest held in suspense 16 Concentrations of exposure Loans and advances to customers: Domestic: Agriculture, forestry and fishing Manufacturing Construction Transport, distribution and hotels Property companies Financial, business and other services Personal: mortgages : other Lease financing Hire purchase Other Total domestic International: Latin America New Zealand Rest of the world Total international Provisions for bad and doubtful debts* Interest held in suspense* 2002 £m 2001 £m 752 662 843 379 1,414 (992) (57) 1,222 (829) (70) 365 323 2002 £m 2001 £m 2,076 3,373 1,482 4,696 4,008 8,352 62,467 14,931 7,285 5,990 3,397 2,074 3,321 1,309 4,440 2,907 8,736 56,578 12,784 7,552 5,345 2,992 118,057 108,038 1,591 10,447 6,202 2,347 8,435 5,651 18,240 16,433 136,297 124,471 (1,466) (70) (1,766) (57) 134,474 122,935 *Figures exclude provisions and interest held in suspense relating to loans and advances to banks. The classification of lending as domestic or international is based on the location of the office recording the transaction, except for certain lending of the international business booked in London. 72 LLOYDS TSB GROUP 17 Debt securities Investment securities: Government securities Other public sector securities Bank and building society certificates of deposit Corporate debt securities Mortgage backed securities Other asset backed securities Other debt securities Other securities: Government securities Other public sector securities Bank and building society certificates of deposit Corporate debt securities Mortgage backed securities Other asset backed securities Other debt securities Due within 1 year Due 1 year and over Geographical analysis by issuer: United Kingdom Other European North America and Caribbean Latin America Asia Pacific Other 2002 Balance 2002 sheet Valuation £m £m 2001 Balance sheet £m 2001 Valuation £m 2,140 1 2,141 1 2,781 – 2,976 – 3,147 1,495 893 2,817 1,369 3,148 1,496 892 2,820 1,367 4,670 613 521 1,193 1,211 4,677 616 527 1,198 1,209 11,862 11,865 10,989 11,203 6,035 112 6,035 112 4,103 151 4,103 151 340 7,842 1,838 1,191 94 340 7,842 1,838 1,191 94 234 7,102 1,054 592 – 234 7,102 1,054 592 – 29,314 29,317 24,225 24,439 6,412 22,902 29,314 5,569 13,254 6,077 1,231 2,763 420 29,314 6,745 17,480 24,225 5,947 9,920 4,708 1,290 1,921 439 24,225 622 Unamortised discounts net of premiums on investment securities 337 Investment securities: Listed Unlisted Other securities: Listed Unlisted 6,102 5,760 6,101 5,764 5,544 5,445 5,751 5,452 11,862 11,865 10,989 11,203 16,034 16,034 1,418 1,418 12,139 1,097 12,139 1,097 17,452 17,452 13,236 13,236 Notes to the accounts 17 Debt securities (continued) Movements in investment securities comprise: At 1 January 2002 Exchange and other adjustments Additions Transfers to other securities Securities sold or matured Charge for the year Amortisation of premiums and discounts Premiums and Cost £m discounts Provisions £m £m Total £m 10,553 519 83 10,989 (479) 16,418 (694) (13,913) – – (28) – (451) (61) – 87 66 (4) (503) – 16,418 (63) (1,082) (11) (13,963) (84) 84 – 87 19 Assets transferred under sale and repurchase transactions Included in the Group’s balance sheet are assets subject to sale and repurchase agreements as follows: Treasury bills and other eligible bills Debt securities 2002 £m 588 5,651 2001 £m 1,036 4,498 6,239 5,534 These investments have been sold to third parties but, since the Group is committed to reacquire them at a future date and at a predetermined price, they are shown in the balance sheet. At 31 December 2002 11,885 89 11,862 20 Interests in joint ventures Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. Transfers to other securities mainly relates to the reclassification of the Group’s portfolio of emerging market securities, following the decision to accelerate the disposal programme for these investments. The difference between the cost of other securities and market value, where the market value is higher than the cost, is not disclosed as its determination is not practicable. At 1 January 2002 Additions Share of losses At 31 December 2002 The Group’s principal investments are in two joint ventures: £m 39 21 (15) 45 It is expected that tax of £4 million (2001: £60 million) would be payable if the investment securities were sold at their year end valuation. iPSL Group interest Nature of business 19.5% of issued ordinary share capital Cheque processing 18 Equity shares Investment securities: Listed Unlisted Other securities: Listed 2002 Balance 2002 sheet Valuation £m £m 2001 Balance sheet £m 2001 Valuation £m Goldfish Holdings Limited 25.0% of issued Financial services ordinary share capital During 2002 the Group contributed a further £21 million of capital to Goldfish Holdings Limited. 5 33 38 168 206 5 62 67 4 34 38 187 225 14 52 66 In the year ended 31 December 2002 £31 million (2001: £27 million) of fees payable to iPSL have been included in the Group’s administrative expenses and £6 million (2001: £6 million) of charges to iPSL have been included in the Group’s income. The Group has also prepaid £6 million (2001: £8 million) of fees in respect of 2003 and this amount is included in prepayments and accrued income. Movements in investment securities comprise: At 1 January 2002 Additions Disposals Charge for the year At 31 December 2002 Cost Provisions £m £m Total £m 50 10 (9) – 51 12 – (2) 3 13 38 10 (7) (3) 38 Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. The difference between the cost of other securities and market value, where the market value is higher than the cost, is not disclosed as its determination is not practicable. If investment securities were sold at their year end valuation no tax is expected to be payable as any such gains would be covered by available capital losses. In the year ended 31 December 2002 £25 million (2001: £1 million) of interest receivable from Goldfish Bank Limited and £12 million (2001: £22 million) of charges to Goldfish Bank Limited in respect of administrative costs have been included in the Group’s income. At 31 December 2002 Goldfish Bank Limited owed £430 million (2001: £611 million) to the Group, which is included in loans and advances to banks. In addition, at 31 December 2002, the Group had made facilities available for Goldfish Bank Limited to borrow a further £420 million (2001: £239 million); these facilities are included in undrawn commitments (note 45). Included in the gross assets disclosed on the balance sheet is an investment of £8 million (2001: £5 million) in associated undertakings. LLOYDS TSB GROUP 73 The country of registration/incorporation is also the principal area of operation for each of the above group undertakings except as follows: Lloyds TSB Bank plc operates principally in the UK but also through branches in Argentina, Belgium, Brazil, Dubai, Ecuador, Gibraltar, Guatemala, Hong Kong, Honduras, Japan, Luxembourg, Malaysia, Monaco, Netherlands, Panama, Paraguay, Singapore, Spain, Switzerland, Uruguay, the USA and a representative office in Iran. The National Bank of New Zealand Limited also operates through representative offices in the UK and Hong Kong. 22 Quasi-subsidiaries The Group has interests in a number of entities which, although they do not meet the legal definition of a subsidiary, give rise to benefits that are in substance no different from those that would arise if those entities were subsidiaries. As a consequence, these entities are consolidated in the same way as if they were subsidiaries. The primary financial statements of these entities can be summarised as follows: Equipment leasing vehicles 2002 £m 2001 £m Structured finance vehicles 2002 £m 2001 £m Profit and loss account Interest receivable Interest payable Other operating income Total income Operating expenses Profit on ordinary activities before taxation Tax on profit on ordinary activities Retained profit Balance sheet Assets Loans and advances to customers Tangible fixed assets Other assets and prepayments Total assets Liabilities Deposits by banks Debt securities in issue Other liabilities and accruals Shareholders’ funds Total liabilities Cash flow statement Net cash inflow (outflow) from operating activities – (55) 80 25 (24) 1 5 6 – 1,307 25 1,332 1,245 – 77 10 1,332 – (41) 58 17 (8) 9 (6) 3 – 911 45 956 923 – 29 4 956 12 (4) – 8 – 8 – 8 329 – 4 333 – 73 2 258 333 422 391 (250) – – – – – – – – – – – – – – – – – – Notes to the accounts 21 Interests in group undertakings Company At 1 January 2002 Amounts advanced Revaluation At 31 December 2002 Shares in banks Shares in other group undertakings Total – all unlisted Shares £m 11,960 – (2,869) Loans £m 759 964 – 9,091 1,723 2002 £m 2001 £m 9,093 (2) 11,960 – 9,091 11,960 On an historical cost basis, shares in group undertakings would have been included at cost of £6,066 million (2001: £6,066 million). No deferred tax provision has been made against the liability which could arise if group undertakings were disposed of at their balance sheet carrying value because of surplus capital losses and the exemptions for disposals of substantial shareholding investments. The principal group undertakings, all of which have prepared accounts to 31 December and whose results are included in the consolidated accounts of Lloyds TSB Group plc, are: Percentage of equity share capital registration / and voting incorporation rights held Nature of business Country of Lloyds TSB Bank plc England 100% Banking and financial services Cheltenham & Gloucester plc England †100% Mortgage lending and England Lloyds TSB Commercial Finance Limited Lloyds TSB Leasing Limited England Lloyds TSB Private Banking England Limited The Agricultural Mortgage Corporation PLC The National Bank of New Zealand Limited Lloyds TSB Bank (Jersey) Limited Lloyds TSB Scotland plc New Zealand Scotland England Jersey England England Lloyds TSB General Insurance Limited Scottish Widows Investment England Partnership Group Limited Abbey Life Assurance Company Limited Lloyds TSB Insurance Services Limited Lloyds TSB Life Assurance Company Limited Lloyds TSB Asset Finance Division Limited Black Horse Limited England England England England retail investments †100% Credit factoring †100% Financial leasing †100% Private banking †100% Long-term agricultural finance †100% Banking and financial services †100% Banking and financial services †100% Banking and financial services †100% General insurance †100% Investment management †100% Life assurance †100% Insurance broking †100% Life assurance and other financial services †100% Consumer credit, leasing and related services †100% Consumer credit, leasing and related services Scotland Scotland †100% Life assurance †100% Life assurance Scottish Widows plc Scottish Widows Annuities Limited †Indirect interest. 74 LLOYDS TSB GROUP Notes to the accounts 23 Intangible fixed assets Goodwill At 1 January 2002 Exchange and other adjustments Acquisitions (note 47) Charge for the year Net Cost Amortisation book value £m £m £m 2,640 28 103 – 74 4 – 59 2,566 24 103 (59) At 31 December 2002 2,771 137 2,634 24 Tangible fixed assets Cost: At 1 January 2002 Exchange and other adjustments Adjustments on acquisition Additions Disposals Premises Equipment £m £m Operating lease assets £m 1,074 (1) 31 174 (82) 2,270 (7) 2 260 (210) 1,771 (3) 351 881 (428) At 31 December 2002 1,196 2,315 2,572 Depreciation: At 1 January 2002 Exchange and other adjustments Charge for the year Disposals 334 (2) 64 (19) 1,278 1 286 (170) 138 – 292 (215) At 31 December 2002 377 1,395 215 Balance sheet amount at 31 December 2002 Balance sheet amount at 31 December 2001 Balance sheet amount of premises comprises: Freeholds Leaseholds 50 years and over unexpired Leaseholds less than 50 years unexpired 819 920 2,357 4,096 740 992 1,633 3,365 2002 £m 414 132 273 819 2001 £m 436 36 268 740 Land and buildings occupied for own activities 749 664 The Group’s residual value exposure in respect of operating lease assets, all of which are expected to be disposed of at the end of the lease terms, was as follows: Residual value expected to be recovered in: 1 year or less 2 years or less but over 1 year 5 years or less but over 2 years Over 5 years Total exposure 2002 £m 2001 £m 272 173 542 617 156 119 388 482 1,604 1,145 25 Lease commitments Annual commitments under non-cancellable operating leases were: 2002 2002 Premises Equipment £m £m 2001 2001 Premises Equipment £m £m Leases on which the commitment is due to expire in: 1 year or less 5 years or less but over 1 year Over 5 years 10 29 188 227 2 1 – 3 7 33 181 221 5 3 – 8 Obligations under finance leases were: 2002 Equipment £m Amounts payable in 1 year or less 1 2001 Equipment £m 3 26 Capital commitments Capital expenditure contracted but not provided for at 31 December 2002 amounted to £117 million (2001: £137 million), of which £107 million (2001: £125 million) relates to assets to be leased to customers under operating leases. 27 Own shares Lloyds TSB Group plc sponsors the Lloyds TSB Group Employee Share Ownership Trust, a discretionary trust for the benefit of employees and former employees of the Lloyds TSB Group. The Company has lent £21 million to the trustees, interest free, to enable them to purchase Lloyds TSB Group plc ordinary shares, which are used to satisfy options granted by the Company or to meet commitments arising under other employee share schemes. Under the terms of the trust, the trustees have waived all but a nominal dividend on the shares they hold. The cost of providing these shares is charged to the profit and loss account on a systematic basis over the period that the employees are expected to benefit. At 31 December 2002, 2 million shares were held by the trustees with a book value of £13 million and a market value of £7 million. (2001: 2 million shares with a book value of £15 million and a market value of £15 million). The Group has also established the Lloyds TSB Qualifying Employee Share Ownership Trust (‘the QUEST’) for the purpose of providing shares on the exercise of options under certain of the Group’s Save As You Earn (SAYE) share option schemes. During 2002, Lloyds TSB Group plc contributed £66 million to the QUEST, and the trustees subscribed for 18 million shares in the Company for a consideration of £136 million. During 2001, Lloyds TSB Group plc contributed £200 million and the trustees subscribed for 47 million shares for a consideration of £316 million. At 31 December 2002, 2 million shares were held by the QUEST with a book value of £5 million (2001: 2 million shares with a book value of £8 million) reflecting the exercise price of the options the shares are expected to be used to satisfy. Under the terms of the QUEST’s trust deed, the trustees have waived all but a nominal dividend on the shares they hold. The difference between the amount contributed by the Company and the movement in the book value of the shares and cash held by the QUEST has been charged to profit and loss account reserves. LLOYDS TSB GROUP 75 Notes to the accounts 27 Own shares (continued) b Analysis of embedded value In addition, a further 0.4 million ordinary shares were held by Lloyds TSB Group Holdings (Jersey) Limited at 31 December 2002 (2001: 0.5 million shares). These shares, on which the dividend entitlement has been waived, were gifted to the Group some years ago at nil cost and are used to satisfy outstanding options or to meet commitments arising under other employee share schemes. 28 Other assets Balances arising from derivatives used for trading purposes (note 46a) Balances arising from derivatives used for hedging purposes Settlement balances Other assets 29 Prepayments and accrued income Interest receivable Deferred expenditure incurred under cash gift and discount mortgage schemes Other debtors and prepayments *restated (see note 1) 30 Long-term assurance business a Methodology 2002 £m 2001 £m 3,428 2,090 778 76 981 931 570 877 5,263 4,468 2002 £m 931 2001* £m 843 201 1,173 256 1,197 2,305 2,296 For the purposes of the Group’s consolidated accounts, the value of the shareholder’s interest in the long-term assurance business is calculated on an embedded value basis. The embedded value is comprised of the net tangible assets of the life assurance subsidiaries, including any surplus retained in the long-term business funds, which could be transferred to shareholders, and the present value of the in-force business. The value of the in-force business is calculated by projecting future surpluses and other net cash flows attributable to the shareholder arising from business written by the balance sheet date and discounting the result at a rate which reflects the shareholder’s overall risk premium attributable to this business. Surpluses arise following annual actuarial valuations of the long-term business funds, which are carried out in accordance with the statutory requirements designed to ensure and demonstrate the solvency of the funds. Future surpluses will depend upon experience in a number of areas such as investment returns, lapse rates, mortality and administrative expenses. Surpluses can be projected by making realistic assumptions about future experience, having regard to both actual experience and forecast long-term economic trends. Other net cash flows principally comprise annual management charges and other fees levied upon the policyholders by the life assurance subsidiaries. Changes in the embedded value, which are determined on a post-tax basis, are included in the profit and loss account and described as income from long-term assurance business. For the purpose of presentation the change in this value is grossed up at the underlying rate of corporation tax. The embedded value included in the consolidated balance sheet comprises: Net tangible assets of life companies including surplus Value of other shareholder’s interests in the long-term assurance business 2002 £m 2001* £m 3,324 3,628 2,904 2,738 6,228 6,366 Movements in the embedded value balance have been as follows: At 1 January – as previously reported Prior year adjustment (note 1) At 1 January – restated Exchange and other adjustments Loss after tax Capital injection Dividends At 31 December *restated (see note 1) 2002 £m 6,366 – 6,366 (14) (257) 140 (7) 2001* £m 6,549 (53) 6,496 (35) (40) 100 (155) 6,228 6,366 c Analysis of income from long-term assurance business Income from long-term assurance business included in the profit and loss account can be divided into those items comprising the operating profit of the business and other items. Included within operating profit are the following items: New business contribution: this represents the value recognised at the end of the year from new business written during the year after taking into account the cost of establishing technical provisions and reserves. Contribution from existing business: this comprises the following elements: • The expected return arising from the unwinding of the discount applied to the expected cash flows at the beginning of the year; • Experience variances caused by the differences between the actual experience during the year and the expected experience; • The effects of changes in assumptions, other than economic assumptions, and other items; • Pension provisions (see d); and • Endowment provision (see e). Investment earnings: this represents the expected investment return on both the net tangible assets and the value of the shareholder’s interest in the long-term business account, based upon the economic assumptions made at the beginning of the year. Distribution costs: this represents the actual costs of acquiring new business during the year and includes commissions paid to independent financial advisors and other direct sales costs. Operating profit is adjusted by the following items to arrive at income from long-term assurance business: Investment variance: this represents (a) the difference between the actual investment return in the year on investments backing shareholder funds and the expected return based upon the economic assumptions made at the beginning of the year; (b) the effect of these fluctuations on the value of in-force business; and (c) other effects of changes in extraneous economic circumstances beyond the control of management. 76 LLOYDS TSB GROUP Notes to the accounts 30 Long-term assurance business (continued) c Analysis of income from long-term assurance business (continued) Changes in economic assumptions: this represents the effect of changes in the economic assumptions referred to in g. The adequacy of the provision has again been reviewed at 31 December 2002, in the light of final experience as to the amount of compensation to be paid. Lower stockmarket levels have increased the final cost of redress and a further provision of £40 million has been made in the year ended 31 December 2002. Income from long-term assurance business is set out below: e Endowment provision New business contribution Contribution from existing business – expected return – experience variances – changes in assumptions and other items – pension provisions (see d) – endowment provision (see e) Investment earnings Distribution costs Operating profit Investment variance Changes in economic assumptions (see g) Income from long-term assurance business before tax Attributed tax 2002 £m 413 312 (1) 78 (40) (165) 214 (277) 534 (892) 55 (303) 46 Income from long-term assurance business after tax (257) *restated (see note 1) d Pension provisions 2001* £m 374 348 37 95 (70) – 247 (247) 784 (813) – (29) (11) (40) During the early 1990s, there was increasing concern that many customers had been given poor advice when they were advised to set up their own personal pension plan and that they would, in fact, have been in a better position if they had remained in, or joined, employer sponsored pension schemes. The regulator of the pension industry (now the responsibility of the Financial Services Authority) carried out an industry wide investigation into the conduct of business involving the transfer of pensions. The conclusion of this investigation was that a large number of customers had been poorly advised, by insurance companies and intermediaries across the industry. As a result of this investigation the regulator established an action plan for the pensions industry to follow in reviewing all cases of possible misselling and determining the necessary compensation. As the review of pension cases in the Group has progressed, provisions have been established for the estimated cost of compensation. Movements in the provision over the last two years have been as follows: At 1 January Accrual of interest on the provision Charge for the year Compensation paid Guarantees* 2002 £m 203 17 40 (223) – 2001 £m 352 20 70 (238) (1) At 31 December 37 203 *In some cases, rather than pay cash compensation directly into the customer’s personal pension plan, the Group has guaranteed to ‘top-up’ the customer’s pension income, on retirement, to the level that they would have received under the relevant occupational scheme. A review of the adequacy of the provision was carried out as at 31 December 2001. Lower stock market levels had had a significant impact on total redress costs as the cost of restitution into company pension schemes rose as personal pension fund values reduced. As a result of this and the fact that there was greater certainty as to the number and size of compensation claims to be paid, an additional provision of £70 million was made in the Group’s results for the year ended 31 December 2001. In common with a number of companies in the life assurance industry, Abbey Life Assurance Company Limited (‘Abbey Life’), one of the Group’s life assurance subsidiaries, has been carrying out a review of the past sales of certain endowment based and long-term savings products made, primarily in the late 1980s and early 1990s, by the Abbey Life sales force prior to its disposal by the Group in February 2000. The Group has assessed the likely implications for redress to policyholders and as a result a provision of £165 million has been raised. f Guaranteed annuity options After an extensive review of its existing practices, carried out in the light of the judgement of the House of Lords in the guaranteed annuities case Equitable Life vs Hyman, it was announced that Scottish Widows was revising the way it calculates benefits for guaranteed annuity policies with effect from 1 February 2002. As a result of this change, the terminal bonuses for guaranteed annuity option policies were increased. Under the terms of the transfer of the Scottish Widows business, a separate memorandum account was created within the With Profits Fund called the Additional Account. This Account had a value at 31 December 2002 of approximately £1.5 billion (2001: £1.7 billion) and is available to meet any additional costs of providing guaranteed benefits on transferred policies, including guaranteed annuity option policies. The assets allocated to the Additional Account include certain hedge assets, to provide protection to the With Profits Fund against the consequences of a future fall in interest rates. The eventual costs of providing the enhanced benefits is dependent upon a number of factors, including in particular: • The proportion of policyholders with a guaranteed annuity option policy who choose to exercise their options; • The effect of future interest rate and mortality trends on the cost of annuities; and • The future investment performance of the With Profits Funds. Having considered a range of possible outcomes, the Group currently expects that the most likely outcome is that the balance in the Additional Account available for this purpose will be sufficient to meet the cost of the enhanced benefits payable to the guaranteed annuity option policyholders, as well as other contingencies. The cost of enhanced benefits, currently estimated to be approximately £1.1 billion (2001: £1.4 billion) on a net present value basis, will be paid out over many years as policies mature. In the event that the amount in the Additional Account proves, over time, to be insufficient, the shortfall will be met by the Group. At this time, no provision is considered necessary for such risk. g Assumptions Following the publication, in December 2001, of the Association of British Insurers’ detailed guidance for the preparation of figures using the achieved profits method of accounting the Group has reviewed the way in which economic assumptions are set for the purposes of the embedded value calculations. The guidance requires that the assumptions should be reviewed at each reporting date. In order to comply with this guidance, and achieve greater comparability with other major insurers, the Group has adopted this approach. LLOYDS TSB GROUP 77 Notes to the accounts 30 Long-term assurance business (continued) Investments shown above comprise: g Assumptions (continued) The principal economic assumptions have been revised at 31 December 2002 as follows: Risk-adjusted discount rate (net of tax) Return on equities (gross of tax) Return on fixed interest securities (gross of tax) Expenses inflation 2002 % 7.35 7.10 4.50 3.30 2001 % 8.50 8.00 5.25 3.00 Fixed interest securities Stocks, shares and unit trusts Investment properties Other properties Mortgages and loans Deposits The revised assumptions have resulted in a net credit to the profit and loss account of £55 million. The liabilities to policyholders comprise: Technical provisions: 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 reflect the recent actual experience of the companies concerned. • Current tax legislation and rates have been assumed to continue unaltered, except where future changes have been announced. The UK corporation tax rate used for grossing up was 30 per cent (2001: 30 per cent). The normalised investment earnings have been grossed up at a composite longer term tax rate of 17 per cent (2001: 17 per cent). • The value of the in-force business does not allow for future premiums under recurring single premium business or non-contractual increments, which are included in new business when the premium is received. Department of Social Security rebates have been treated as recurring single premiums. • Future bonus rates on with-profits business are set at levels which would fully utilise the assets supporting the with-profits business. The proportion of profits derived from with-profits business allocated to the shareholder has been assumed to continue at the current rate of one-ninth of the cost of the bonus. h Sensitivities The table below shows the effect on both the embedded value at 31 December 2002 and the new business contribution for the year then ended of theoretical changes in the main economic assumptions. Embedded New business value contribution £m £m As published Effect of a 1% increase in the discount rate Effect of a 1% reduction in the discount rate Effect of a 1% reduction in the return on equities 6,228 (152) 166 (70) 413 (27) 32 (12) i Balance sheet The long-term assurance assets attributable to policyholders comprise: Long-term business provision (net of reinsurance) Claims outstanding (net of reinsurance) Technical provisions for linked liabilities Fund for future appropriations Other liabilities *restated (see note 1) j Disclosures on a modified statutory solvency basis The individual statutory accounts of the Group’s life assurance subsidiaries are prepared under the modified statutory solvency basis, in the same way as the statutory accounts of listed insurance groups in the UK. The principal difference between the modified statutory solvency basis and the embedded value basis used for the preparation of the Group’s accounts is that accounts prepared under the modified statutory solvency basis do not reflect the value of in-force business. Under the modified statutory solvency basis, the results of the Group’s long-term life and pensions businesses were as follows: Premiums Investment income Other income Claims Change in technical provisions Expenses Realised losses on investments Unrealised losses on investments Other charges Tax attributable to long-term business Transfer from the fund for future appropriations Investments Premises and equipment Other assets 2002 £m 2001* £m 47,151 45 1,468 47,910 16 2,091 Balance on the technical account – long-term business Tax credit attributable to balance on the technical account – long-term business Income in shareholder fund Expenses in shareholder fund Net tangible assets of life companies including surplus 48,664 (3,324) 50,017 (3,628) (Loss) profit on ordinary activities before tax Tax on (loss) profit on ordinary activities 45,340 46,389 (Loss) profit for the financial year (327) 168 78 LLOYDS TSB GROUP 2002 £m 2001* £m 14,779 24,143 3,623 121 53 4,432 12,642 27,018 3,722 121 102 4,305 47,151 47,910 23,217 225 20,996 12 890 24,129 211 21,098 75 876 45,340 46,389 2002 £m 5,524 1,942 33 7,499 (5,031) 3,877 (720) (1,790) (4,445) (3) 200 63 2001 £m 4,854 1,832 93 6,779 (4,957) 2,759 (625) (1,031) (4,423) (8) 280 1,365 (350) 139 (190) 35 (1) (506) 179 (103) 38 – 74 94 Notes to the accounts 30 Long-term assurance business (continued) j Disclosures on a modified statutory solvency basis (continued) 31 Assets and liabilities denominated in foreign currencies Income from long-term assurance business after tax reconciles to the loss calculated on a modified statutory solvency basis as follows: 2002 £m 2001 £m Assets: denominated in sterling : denominated in other currencies Income from long-term assurance business attributable to the shareholder after tax (Increase) decrease in value-in-force Other differences: – movement in deferred acquisition costs – tax adjustment – other (Loss) profit for the financial year – modified statutory solvency basis (257) (166) (40) 111 (423) 71 45 55 (4) (79) 150 26 (327) 168 2002 £m 2001* £m 142,661 132,812 56,592 64,757 207,418 189,404 142,641 132,915 56,489 64,777 207,418 189,404 Liabilities: denominated in sterling : denominated in other currencies *restated (see note 1) Assets and liabilities exclude long-term assurance assets attributable to policyholders and liabilities to policyholders. A summarised balance sheet on a modified statutory solvency basis was as follows: 32 Deposits by banks Assets Investments Assets held to cover linked liabilities Other assets Total assets Liabilities Shareholder’s funds Fund for future appropriations Long-term business provision† Technical provision for linked liabilities† Other creditors Total liabilities 2002 £m 2001 £m 26,555 20,996 1,718 27,204 21,098 2,210 49,269 50,512 3,929 12 23,217 20,996 1,115 4,123 75 24,129 21,098 1,087 49,269 50,512 †Net of reinsurers’ share of technical provisions The value of long-term business attributable to the shareholder on an embedded value basis reconciles to the net assets of the Group’s life and pensions subsidiaries calculated on a modified statutory solvency basis as follows: Repayable on demand Other deposits by banks with agreed maturity dates or periods of notice by residual maturity repayable: 3 months or less 1 year or less but over 3 months 5 years or less but over 1 year Over 5 years 33 Customer accounts Repayable on demand Other customer accounts with agreed maturity dates or periods of notice by residual maturity repayable: 3 months or less 1 year or less but over 3 months 5 years or less but over 1 year Over 5 years 2002 £m 2001 £m 34 Debt securities in issue Long-term assurance business attributable to the shareholder – embedded value basis Value of in-force business Other differences: – deferred acquisition costs – tax adjustment – other adjustments Net tangible assets of life operations – modified statutory solvency basis 6,228 (2,904) 6,366 (2,738) 3,324 3,628 430 205 (30) 385 150 (40) 3,929 4,123 Bonds and medium-term notes by residual maturity repayable: 1 year or less 2 years or less but over 1 year 5 years or less but over 2 years Over 5 years Other debt securities by residual maturity repayable: 3 months or less 1 year or less but over 3 months 5 years or less but over 1 year Over 5 years 2002 £m 2001 £m 8,500 6,634 14,692 1,634 487 130 14,227 2,529 751 169 25,443 24,310 2002 £m 2001 £m 87,918 80,635 19,047 3,099 4,140 2,130 19,902 2,889 3,369 2,321 116,334 109,116 2002 £m 2001 £m 437 443 746 1,659 589 178 405 928 3,285 2,100 19,525 7,174 30 241 17,070 4,931 104 215 26,970 22,320 30,255 24,420 LLOYDS TSB GROUP 79 Notes to the accounts 35 Other liabilities Balances arising from derivatives used for trading purposes (note 46a) Balances arising from derivatives used for hedging purposes Current tax Dividends Settlement balances Other liabilities 36 Accruals and deferred income Interest payable Other creditors and accruals 37 Deferred tax Short-term timing differences Accelerated depreciation allowances At 1 January 2002 – as previously reported Prior year adjustment (note 1) At 1 January 2002 – restated Exchange and other adjustments Adjustments on acquisition Tax provided At 31 December 2002 *restated (see note 1) 2002 £m 2001 £m 4,462 2,288 611 528 1,311 49 1,328 475 598 1,306 542 1,464 8,289 6,673 2002 £m 1,385 2,311 2001 £m 1,310 2,253 3,696 3,563 2002 £m 2001* £m (353) 1,670 (271) 1,682 1,317 1,411 £m 1,719 (308) 1,411 25 (13) (106) 1,317 Deferred tax is recognised in respect of the retained earnings of overseas subsidiaries and associates only to the extent that, at the balance sheet date, dividends have been accrued as receivable or a binding agreement to distribute past earnings in future has been entered into. Deferred tax balances have not been discounted. The deferred tax balance at 31 December 2002 does not include any amounts in respect of the Group’s post-retirement benefit liability which is shown on the balance sheet after deduction of a deferred tax asset of £854 million (2001: a net post-retirement benefit asset of £281 million after deduction of a deferred tax liability of £152 million) (note 44). 80 LLOYDS TSB GROUP Notes to the accounts 38 Other provisions for liabilities and charges At 1 January 2002 – as previously reported Prior year adjustment (note 1) At 1 January 2002 – restated Exchange and other adjustments Provisions applied Charge for the year At 31 December 2002 Pension obligations £m 34 (34) – – – – – Insurance provisions £m Post- retirement healthcare £m Vacant leasehold property and other £m 204 – 204 (2) (210) 233 225 75 (75) – – – – – 88 – 88 – (40) 88 136 Total £m 401 (109) 292 (2) (250) 321 361 Insurance provisions The Group’s general insurance subsidiary maintains provisions for outstanding claims which represent the ultimate cost of settling all claims arising from events which have occurred up to the balance sheet date and these include provisions for the cost of claims notified but not settled and for claims incurred but not yet reported. In addition, in line with the requirements of the Insurance Companies (Reserves) Act 1995, claims equalisation provisions are maintained in relation to property, credit and suretyship business. The majority of provisions in respect of claims will be settled in the following year, although new provisions will then be required in respect of claims arising from that year. The level of the claims equalisation provision will be adjusted annually, taking into account the guidelines contained in the legislation, and such provisions will be held for as long as the Group continues to write the relevant types of general insurance business. The Group also carries provisions in respect of its obligations relating to UIC Insurance Company Limited (‘UIC’), which is partly owned by the Group. The Group has indemnified a third party against losses in the event that UIC does not honour its obligations under a re-insurance contract, which is subject to asbestosis and pollution claims in the US. The ultimate exposure to claims in respect of the insurance business of UIC is uncertain. Accordingly, the provision has been based upon an actuarial estimate of prospective claims, taking account of re-insurance arrangements protecting UIC and UIC’s available assets. Given the long-term nature of many of the claims to which UIC is exposed, it is expected to be many years before the Group’s ultimate liability can be assessed with certainty. Vacant leasehold property and other Vacant leasehold property provisions are made by reference to a prudent estimate of expected sub-let income and the possibility of disposing of the Group’s interest in the lease, taking into account conditions in the property market. These provisions are reassessed on an annual basis and will normally run off over the remaining life of the leases concerned, currently averaging five years; where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released. 39 Subordinated liabilities Undated loan capital (see below) Dated loan capital (see below) Total subordinated liabilities **Undated loan capital: Primary Capital Undated Floating Rate Notes: Series 1 (US$750 million) Series 2 (US$500 million) Series 3 (US$600 million) 113⁄4% Perpetual Subordinated Bonds 6.625% Perpetual Capital Securities (€750 million) 6.90% Perpetual Capital Securities callable 2007 (US$1,000 million) 55⁄8% Undated Subordinated Step-up Notes callable 2009 (€1,250 million) Undated Step-up Floating Rate Notes callable 2009 (€150 million) 65⁄8% Undated Subordinated Step-up Notes callable 2010 6.35% Step-up Perpetual Capital Securities callable 2013 (€500 million) 5.57% Undated Subordinated Step-up Coupon Notes callable 2015 (¥20 billion) 61⁄2% Undated Subordinated Step-up Notes callable 2019 8% Undated Subordinated Step-up Notes callable 2023 61⁄2% Undated Subordinated Step-up Notes callable 2029 6% Undated Subordinated Step-up Guaranteed Bonds callable 2032 *restated (see note 1) Notes a b c, k h a f d, h, k i f f f f, k Group 2002 £m 5,496 4,672 2001* £m 4,102 4,006 10,168 8,108 Company 2002 £m 497 873 1,370 2001 £m – 413 413 466 311 373 100 482 610 807 97 406 322 104 267 199 455 497 516 344 412 100 451 – 757 91 406 – 105 266 199 455 – 5,496 4,102 – – – – – – – – – – – – – – 497 497 – – – – – – – – – – – – – – – – LLOYDS TSB GROUP 81 Notes to the accounts 39 Subordinated liabilities (continued) Dated loan capital: Eurocurrency Zero Coupon Bonds 2003 (¥3 billion) Subordinated Fixed Rate Bonds 2003 (NZ$151 million) Subordinated Floating Rate Notes 2004 73⁄8% Subordinated Bonds 2004 Subordinated Floating Rate Notes 2004 81⁄2% Subordinated Bonds 2006 73⁄4% Subordinated Bonds 2007 Subordinated Fixed Rate Bonds 2007 (NZ$150 million) 51⁄4% Subordinated Notes 2008 (DM750 million) 105⁄8% Guaranteed Subordinated Loan Stock 2008 91⁄2% Subordinated Bonds 2009 Subordinated Step-up Floating Rate Notes 2009 callable 2004 (US$500 million) Subordinated Fixed Rate Bonds 2010 (NZ$100 million) 61⁄4% Subordinated Notes 2010 (€400 million) Subordinated Floating Rate Notes 2010 (US$400 million) 12% Guaranteed Subordinated Bonds 2011 91⁄8% Subordinated Bonds 2011 43⁄4% Subordinated Notes 2011 (€850 million) Subordinated Fixed Rate Bonds 2011 (NZ$100 million) Subordinated Fixed Rate Bonds 2012 (NZ$125 million) Subordinated Fixed Rate Bonds 2012 (NZ$125 million) 57⁄8% Subordinated Guaranteed Bonds 2014 (€750 million) 57⁄8% Subordinated Notes 2014 65⁄8% Subordinated Notes 2015 Subordinated Floating Rate Notes 2020 (€100 million) 95⁄8% Subordinated Bonds 2023 Notes e g a a, j g e a g a e g g, k g, k k k a Group 2002 £m 2001 £m Company 2002 £m 2001 £m 14 48 10 400 100 249 299 – 249 100 99 310 33 259 248 100 149 532 33 41 41 461 148 344 65 340 15 43 15 399 100 249 299 43 234 100 99 343 29 244 274 100 149 498 28 – – – – 343 61 341 4,672 4,006 14 – – – – 249 – – – – – – – – – – 149 – – – – 461 – – – – 873 15 – – – – 249 – – – – – – – – – – 149 – – – – – – – – – 413 These liabilities will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer. **In certain circumstances, these notes and bonds would acquire the characteristics of preference share capital. a) These notes bear interest at rates fixed periodically in advance based on London Interbank rates. b) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until any deferred payments have been made. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares. The securities can be redeemed at par at the option of Lloyds TSB Bank plc on or after 25 October 2006. c) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until payments are resumed. Any deferred payments will be made good on redemption of the securities. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares. The securities can be redeemed at par at the option of Lloyds TSB Bank plc on or after 22 November 2007. d) In certain circumstances the interest payments on these securities can be deferred although in this case neither Lloyds TSB Bank plc nor Lloyds TSB Group plc can declare or pay a dividend until any deferred payments have been made. In the event of a winding up of Lloyds TSB Bank plc, these securities will acquire the characteristics of preference shares. The securities can be redeemed at par at the option of Lloyds TSB Bank plc on or after 25 February 2013. e) Issued by a group undertaking under the Company’s subordinated guarantee and, in the case of the Eurocurrency Zero Coupon Bonds 2003, on-lent to the Company on a subordinated basis. f) At the callable date the coupon on these Notes will be reset by reference to the applicable five year benchmark gilt rate. g) These bonds bear interest, to be reset 5 years before redemption date, at a fixed margin over New Zealand Government stocks. h) In the event that these Notes are not redeemed at the callable date, the coupon will be reset to a floating rate. i) In the event that these Notes are not redeemed at the callable date, the coupon will be reset to a fixed margin over the then 5 year Yen swap rate. j) Exchangeable at the election of the Group for further subordinated floating rate notes. k) Issued during 2002 primarily to finance the general business of the Group. 82 LLOYDS TSB GROUP Notes to the accounts 39 Subordinated liabilities (continued) Dated subordinated liabilities are repayable as follows: 41 Called-up share capital 1 year or less 2 years or less but over 1 year 5 years or less but over 2 years Over 5 years Group Company 2002 £m 67 505 548 3,552 2001 £m 5 63 753 3,185 4,672 4,006 2002 £m 14 – 249 610 873 2001 £m – 15 249 149 413 Authorised: Sterling Ordinary shares of 25p each Limited voting ordinary shares of 25p each Preference shares of 25p each US dollars Preference shares of US25 cents each 2002 £m 2001* £m Euro Preference shares of €25 cents each 278 261 Japanese yen Preference shares of ¥25 each 40 Non-equity minority interests Non-equity minority interests comprise: Euro Step-up Non-Voting Non-Cumulative Preferred Securities (€430 million) callable 2012** Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015† Capital instruments European Financial Institution Investments Partnership• LM ABS Investment Partnership 248 526 123 45 694 248 509 – – 509 *restated (see note 1) **These securities constitute limited partnership interests in Lloyds TSB Capital 1 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. Non- cumulative income distributions accrue at a fixed rate of 7.375 per cent per annum up to 7 February 2012; thereafter they will accrue at a rate of 2.33 per cent above EURIBOR, to be set annually. †These securities constitute limited partnership interests in Lloyds TSB Capital 2 L.P., a Jersey limited partnership in which Lloyds TSB (General Partner) Limited, a wholly owned subsidiary, is the general partner. Non- cumulative income distributions accrue at a fixed rate of 7.834 per cent per annum up to 7 February 2015; thereafter they will accrue at a rate of 3.50 per cent above a rate based on the yield of specified UK government stock. Both of the above issues were made under the limited subordinated guarantee of Lloyds TSB Bank plc. In certain circumstances these preferred securities will be mandatorily exchanged for preference shares in Lloyds TSB Group plc. Lloyds TSB Group plc has entered into an agreement whereby dividends may only be paid on its ordinary shares if sufficient distributable profits are available for distributions due in the financial year on these preferred securities. •These securities constitute interests in European Financial Institution Investments Partnership, an English law general partnership in which the principal partner is Langbourn Holdings Limited, a wholly owned subsidiary of the Group. The minority interests are entitled to 90 per cent of the partnership’s profits. In the event of a winding-up, at least 90 per cent of the capital of the partnership would be returned to Langbourn Holdings Limited. These securities constitute interests in LM ABS Investment Partnership, an English law general partnership in which the principal partner is Lime Street Holdings Limited, a wholly owned subsidiary of the Group. The minority interests are entitled to 95 per cent of the partnership’s profits. In the event of a winding-up, at least 85 per cent of the capital of the partnership would be returned to Lime Street Holdings Limited. 2002 £m 2001 £m 1,728 20 44 1,728 20 44 1,792 1,792 US$m 40 US$m 40 €m 40 €m 40 ¥m 1,250 ¥m 1,250 Limited voting ordinary shares of 25p each £m 20 – 20 Ordinary shares of 25p each £m 1,391 5 1,396 Total £m 1,411 5 1,416 Issued and fully paid: At 1 January 2002 Issued to the QUEST (note 27) At 31 December 2002 The limited voting ordinary shares are held by the Lloyds TSB Foundations. These shares carry no rights to dividends but rank pari passu with the ordinary shares in respect of other distributions and in the event of winding up. These shares do not have any right to vote at general meetings other than on resolutions concerning acquisitions or disposals of such importance that they require shareholder consent, or for the winding up of the Company, or for a variation in the class rights of the limited voting ordinary shares. Lloyds TSB Group plc has entered into deeds of covenant with the Lloyds TSB Foundations, under the terms of which the Company makes annual donations to the foundations equal, in total, to 1 per cent of the Group’s pre-tax profits (after certain adjustments) averaged over three years. The deeds of covenant can be cancelled by the Company at nine years’ notice. At 31 December 2002, options to acquire 126 million Lloyds TSB Group ordinary shares of 25p each were outstanding under the executive share option schemes, the share retention plan, and the staff sharesave share option schemes exercisable up to 2012. These include the option, described on page 54, to acquire 216,763 shares under the share retention plan: otherwise the options are exercisable at prices ranging from 160p to 888p per share. LLOYDS TSB GROUP 83 Group £m Company £m 959 134 959 134 1,093 1,093 43 Related party transactions a Transactions, arrangements and agreements involving directors and others At 31 December 2002, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons and with officers included: 5,894 (2,869) 3,025 2002 Number of persons 2002 2001 Total Number of persons £000 2001 Total £000 Loans and credit card transactions: Directors and connected persons Officers 4 31 3,334 3,930 7 28 1,343 4,113 During the year three officers purchased cars from the Group for a total consideration of £37,000. 343 – b Group undertakings Details of the principal group undertakings are given in note 21. In accordance with FRS 8, transactions or balances with group entities that have been eliminated on consolidation are not reported. c Joint ventures Details of the Group’s joint ventures are provided in note 20. Information relating to transactions entered into between Group undertakings and the joint ventures and details of outstanding balances at 31 December 2002 are also shown in note 20. d Long-term assurance business The Group enters into certain 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 2002 Group entities owed £1,372 million (2001: £1,186 million) and were owed £145 million (2001: £299 million); these amounts are included in customer accounts and loans and advances to customers respectively. In addition, fees of £76 million (2001: £62 million) were received, and fees of £35 million (2001: £28 million) were paid, in respect of asset management services. Certain administrative properties used by Scottish Widows are owned by the long-term assurance funds. During 2002 Scottish Widows paid rent to the long-term assurance funds amounting to £5 million (2001: £4 million). In addition, at 31 December 2002, the long-term assurance funds owned 31 million ordinary shares in the Company (2001: 31 million shares). e Pension funds Group entities provide a number of banking and other services to the Group’s pension funds, which are conducted on similar terms to third party transactions. At 31 December 2002, the Group’s pension funds had call deposits with Lloyds TSB Bank plc amounting to £89 million (2001: £572 million). Notes to the accounts 42 Reserves Share premium account: At 1 January 2002 Premium arising on issue of shares At 31 December 2002 Revaluation reserve: At 1 January 2002 Decrease in net tangible assets of subsidiary undertakings At 31 December 2002 Merger reserve: At 1 January 2002 and 31 December 2002 Profit and loss account: At 1 January 2002 – as previously reported Prior year adjustment (note 1) At 1 January 2002 – restated Exchange and other adjustments Actuarial losses recognised in post-retirement benefit schemes (note 44) Charge in respect of the QUEST (note 27) (Loss) profit for the year 8,047 (404) 7,643 (3) (2,331) (62) (127) 2,496 – 2,496 – – (62) 4 At 31 December 2002 5,120 2,438 The Group profit and loss account reserves at 31 December 2002 include £1,310 million (2001: £1,222 million) not presently available for distribution representing the Group’s share of the value of long-term assurance business in force and the surplus retained within the long-term assurance funds. The Group profit and loss account reserves at 31 December 2002 are stated after including a deficit of £2,077 million relating to the Group’s post-retirement defined benefit schemes (2001: surplus of £281 million). The cumulative amount of premiums on acquisitions written off against reserves during previous years amounts to £2,271 million of which £1,823 million was within the last 10 years. 84 LLOYDS TSB GROUP Notes to the accounts 44 Pensions and other post-retirement benefits The pension costs included in administrative expenses are comprised as follows: Defined contribution schemes Defined benefit schemes 2002 £m 25 293 318 2001 £m 18 329 347 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 the years ended 31 December 2001 and 2002, the Group made no contributions to these schemes. 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. The latest full valuations of the schemes were carried out as at 30 June 2002; these have been updated to 31 December 2002 by qualified independent actuaries. The last full valuations of other group schemes were carried out on a number of different dates; these have been updated to 31 December 2002 by qualified independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows. The principal assumptions used in the scheme valuations were as follows: Rate of inflation Rate of salary increases Rate of increase for pensions in payment and deferred pensions Discount rate 31 December 31 December 2001 % 2002 % 2.30 3.83 2.30 5.60 2.50 4.04 2.50 6.00 In addition, the Group operates a number of schemes which provide post- retirement healthcare benefits to certain employees, retired employees and their dependent relatives. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post-retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. For retirements subsequent to this date, the Group will meet a reducing proportion of the cost until 31 December 2004, after which date the only obligation will be in respect of the pre 1 January 1996 retirements. Included within other finance income is an interest cost of £4 million (2001: £3 million) in respect of these defined benefit post-retirement healthcare schemes. For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 2000; this valuation has been updated to 31 December 2002 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 4.86 per cent. The assets of the Group’s defined benefit schemes and the expected rates of return are summarised as follows: Fair value at Expected long-term rate of return at 31 December 31 December 2002 % 2002 £m Fair value at Expected long-term rate of return at 31 December 31 December 2001 % 2001 £m Market values of scheme assets: Equities Fixed interest securities Property Other 7,175 557 791 560 8.4 4.5 6.9 5.4 7,779 1,835 798 714 8.0 5.1 7.1 4.1 Total fair value of scheme assets 9,083 11,126 Other finance income is comprised of: Expected return on scheme assets Interest cost of scheme liabilities 2002 £m 817 (652) 2001 £m 844 (537) 165 307 The pension and other post-retirement benefit cost in respect of defined benefit schemes is comprised of: Current service cost Past service costs Defined benefit costs 2002 £m 244 49 293 2001 £m 212 117 329 The amounts recognised in the statement of total recognised gains and losses are comprised of: Actual return less expected return on scheme assets Experience gains and losses arising on scheme liabilities Effect of changes in demographic and financial assumptions Actuarial losses recognised Deferred tax thereon Amount recognised in the statement of total recognised gains and losses 2002 £m 2001 £m (2,582) (2,015) (240) (71) (477) (787) (3,299) 968 (2,873) 863 (2,331) (2,010) LLOYDS TSB GROUP 85 Notes to the accounts 44 Pensions and other post-retirement benefits (continued) The experience gains and losses recognised can also be interpreted as follows: 2002 £m 2001 £m Actual return less expected return on scheme assets Amount Percentage of scheme assets at balance sheet date Experience gains and losses arising on scheme liabilities Amount Percentage of scheme liabilities at balance sheet date Total amount recognised in the statement of total recognised gains and losses Amount Percentage of scheme liabilities at balance sheet date (2,015) (2,582) 28.4% 18.1% (240) 2.0% (71) 0.7% (3,299) (2,873) 27.5% 26.9% The amounts reported on the Group’s balance sheet are comprised as follows: Market value of assets Present value of scheme liabilities (Deficit) surplus in the schemes Related deferred tax asset (liability) 2002 £m 2001 £m 9,083 11,126 (12,014) (10,693) (2,931) 854 433 (152) Net post-retirement benefit (liability) asset (2,077) 281 Disclosed in the accounts as follows: Post-retirement benefit asset Post-retirement benefit liability – (2,077) 356 (75) (2,077) 281 The movements in the (deficit) surplus in the schemes over the year have been as follows: Surplus at beginning of year Exchange and other adjustments Other finance income Current service costs Contributions Past service costs Actuarial loss 2002 £m 2001 £m 433 26 165 (244) 37 (49) (3,299) 3,325 – 307 (212) 3 (117) (2,873) (Deficit) surplus at end of year (2,931) 433 86 LLOYDS TSB GROUP 45 Contingent liabilities and commitments a Contingent liabilities and commitments arising out of banking transactions Contingent liabilities: Acceptances and endorsements Guarantees Other: Other items serving as direct credit substitutes Performance bonds and other transaction-related contingencies Other contingent liabilities Commitments: Documentary credits and other short-term trade-related transactions Forward asset purchases and forward forward deposits placed Undrawn note issuing and revolving underwriting facilities Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year maturity 1 year or over maturity 2002 £m 2001 £m 1,879 5,927 2,243 3,789 1,103 460 1,436 1 1,469 2 2,540 1,931 10,346 7,963 289 394 354 783 32 35 49,417 14,372 42,594 9,576 64,504 53,342 b Contingent liabilities arising out of past sales of savings and investment products In common with other companies providing savings and investment products to retail consumers, matters arise from time to time as a result of customer complaints or investigations by the regulator requiring remedial action to be taken, which may include the payment of compensation. One such matter relates to the sale of life assurance products related to the repayment of residential mortgages. Falling investment returns have led to increased concern that the value of some of these policies will be less than the amount required to repay the mortgage. Certain customers have complained that this risk was not properly explained to them at the time of sale. Following a review of past sales made by Abbey Life a provision of £165 million has been made for the estimated cost of redress (note 30e). Other complaints, including those related to the sale of life assurance products, are dealt with on a case by case basis and where appropriate compensation is paid. Provision has been made, based upon the level of complaints for the estimated cost of redress which is not significant. If the position changes, further provisions may be required. Concerns have also been expressed over the appropriateness of certain sales of stockmarket related savings products. In this regard the Group is carrying out, in conjunction with the regulator, an investigation into the sales of the Extra Income & Growth Plan. This investigation is expected to be completed during 2003 when the Group will be in a position to estimate the financial effect. 111,577 2,383 3,150 Effect of netting Notes to the accounts 46 Derivatives and other financial instruments Information about the Group’s use of financial instruments and management of the associated risks is given on pages 31 to 41 in the financial review. a Derivatives The Group uses derivatives as part of its trading activities and to reduce its own exposure to fluctuations in interest and exchange rates. Trading The notional principal amounts and fair values (which, after netting, are the carrying values) of trading instruments entered into with third parties were as follows: 31 December 2002 Exchange rate contracts: Spot, forwards and futures Currency swaps Options purchased Options written Interest rate contracts: Interest rate swaps Forward rate agreements Options purchased Options written Futures Equity contracts Effect of netting Balances arising from off-balance sheet financial instruments 31 December 2001 Exchange rate contracts: Spot, forwards and futures Currency swaps Options purchased Options written Interest rate contracts: Interest rate swaps Forward rate agreements Options purchased Options written Futures Equity contracts Effect of netting Balances arising from off-balance sheet financial instruments Notional principal amount £m 94,250 8,556 4,468 4,303 Fair values Assets £m Liabilities £m 2,064 232 87 – 2,735 304 8 103 258,523 41,768 8,248 4,899 18,963 5,473 35 105 – – 5,808 37 – 152 – 332,401 5,613 5,997 5,662 608 491 (5,176) (5,176) 3,428 4,462 Fair values Assets £m Liabilities £m 1,035 223 11 – 1,038 152 – 9 Notional principal amount £m 95,895 6,737 3,825 3,492 109,949 1,269 1,199 286,617 54,171 8,887 3,993 35,112 4,085 78 73 – – 4,535 84 – 58 – 388,780 4,236 4,677 4,580 428 255 (3,843) (3,843) 2,090 2,288 Non-trading Through intra company and intra group transactions, Group companies establish non-trading derivatives positions with the Group’s independent trading operations, which then enter into similar positions with third parties. The notional principal amounts and fair values of non-trading instruments entered into with third parties were as follows: 31 December 2002 Exchange rate contracts: Spot, forwards and futures Currency swaps Interest rate contracts: Interest rate swaps Forward rate agreements Options written 31 December 2001 Exchange rate contracts: Spot, forwards and futures Currency swaps Interest rate contracts: Interest rate swaps Forward rate agreements Effect of netting Notional principal amount £m Fair values Positive £m Negative £m 146 59 205 17,261 1,279 41 18,581 Notional principal amount £m 146 70 216 2,919 62 2,981 16 4 20 129 2 – 131 4 1 5 223 2 1 226 (36) (36) 115 195 Fair values Positive £m Negative £m 3 9 12 164 – 164 1 1 2 68 – 68 (39) (39) 137 31 The Company held non-trading derivatives with a notional principal amount of £1,852 million (2001: £400 million). The aggregate carrying value of non-trading derivatives with a positive fair value was an asset of £54 million (2001: an asset of £18 million) and with a negative fair value was an asset of £9 million (2001: an asset of £1 million). LLOYDS TSB GROUP 87 Notes to the accounts 46 Derivatives and other financial instruments (continued) a Derivatives (continued) The maturity of the notional principal amounts and replacement cost of both trading and non-trading instruments entered into with third parties was: Under 1 year £m 1 to 5 years £m Over 5 years £m Total £m 31 December 2002 Exchange rate contracts: Notional principal amount Replacement cost Interest rate contracts: Notional principal amount Replacement cost Equity contracts: Notional principal amount Replacement cost Total: Notional principal amount Replacement cost 31 December 2001 Exchange rate contracts: Notional principal amount Replacement cost Interest rate contracts: Notional principal amount Replacement cost Equity contracts: Notional principal amount Replacement cost Total: Notional principal amount Replacement cost 102,559 2,209 6,888 108 2,335 111,782 2,403 86 150,883 149,381 50,718 350,982 5,744 2,682 2,212 850 1,130 3 3,714 531 818 74 5,662 608 254,572 159,983 53,871 468,426 8,755 3,321 2,372 3,062 102,130 1,087 6,260 152 1,775 110,165 1,281 42 187,570 155,079 1,796 1,300 49,112 391,761 4,400 1,304 738 75 3,394 330 448 23 4,580 428 290,438 164,733 2,278 2,462 51,335 506,506 6,109 1,369 The notional principal amount does not represent the Group’s real exposure to credit risk, which is limited to the current cost of replacing contracts at current market rates should the counterparties default. Net replacement cost represents the total positive fair value of all derivative contracts at the balance sheet date, after allowing for the offset of all negative fair values where the Group has a legal right of set-off with the counterparty concerned. An analysis of the net replacement cost of both trading and non-trading instruments entered into with third parties by counterparty type is set out below; the Group’s exposure is further reduced by qualifying collateral held. OECD banks Other Net replacement cost Qualifying collateral held Potential credit risk exposure 2002 £m 1,939 1,604 2001 £m 1,425 802 3,543 (521) 2,227 (339) 3,022 1,888 88 LLOYDS TSB GROUP Notes to the accounts 46 Derivatives and other financial instruments (continued) b Interest rate sensitivity gap analysis for the non-trading book The table below summarises the repricing mismatches of the Group’s non-trading assets and liabilities. Items are allocated to time bands by reference to the earlier of the next contractual interest rate repricing date and the maturity date. As at 31 December 2002 Assets: Treasury bills and other eligible bills Loans and advances to banks Loans and advances to customers Debt securities and equity shares Other assets 3 months or less £m 1,759 12,363 88,349 6,093 130 6 months or less but over 3 months £m 1 year or less but over 6 months £m 23 1,362 4,997 1,049 25 94 761 8,233 312 25 5 years or less but over 1 year £m 1 775 26,787 1,972 243 Over 5 years £m 2 200 7,210 2,516 48 Non- interest bearing £m – 666 (1,732) (42) 16,536 Trading book £m 530 1,402 630 17,620 6,479 Total £m 2,409 17,529 134,474 29,520 23,486 Total assets 108,694 7,456 9,425 29,778 9,976 15,428 26,661 207,418 Liabilities: Deposits by banks Customer accounts Debt securities in issue Other liabilities Subordinated liabilities – loan capital Minority interests and shareholders’ funds Internal funding of trading business 21,572 103,996 19,169 353 2,692 – (7,973) 817 1,318 5,526 – 1,140 – (198) 240 1,193 2,002 6 12 – (1,545) 377 3,829 1,212 – 1,183 – (5,148) 112 2,008 1,224 – 5,141 – (880) 248 3,140 – 9,136 – 8,855 – 2,077 850 1,122 7,020 – (152) 15,744 25,443 116,334 30,255 16,515 10,168 8,703 – Total liabilities 139,809 8,603 1,908 1,453 7,605 21,379 26,661 207,418 Off-balance sheet items 10,942 5,939 (10,082) (8,830) 2,031 – Interest rate repricing gap (20,173) 4,792 (2,565) 19,495 4,402 (5,951) Cumulative interest rate repricing gap (20,173) (15,381) (17,946) 1,549 5,951 – As at 31 December 2001* Assets: Treasury bills and other eligible bills Loans and advances to banks Loans and advances to customers Debt securities and equity shares Other assets 3 months or less £m 2,709 11,311 74,361 2,545 154 6 months or less but over 3 months £m 1 year or less but over 6 months £m 37 1,621 5,252 1,662 9 26 1,076 8,798 718 8 5 years or less but over 1 year £m 4 142 28,497 1,940 4 Over 5 years £m 6 289 7,108 4,168 15 Non- interest bearing £m – 452 (1,353) (6) 16,545 – – – Trading book £m 1,630 333 272 13,423 5,648 – – – Total £m 4,412 15,224 122,935 24,450 22,383 Total assets 91,080 8,581 10,626 30,587 11,586 15,638 21,306 189,404 Liabilities: Deposits by banks Customer accounts Debt securities in issue Other liabilities Subordinated liabilities – loan capital Minority interests and shareholders’ funds Internal funding of trading business 19,226 92,834 16,453 350 1,069 – (3,736) 1,859 1,644 3,957 – 714 – (741) 666 1,172 1,333 3 – – (1,171) 512 3,228 600 – 641 – (6,051) 90 2,299 890 5 5,684 – (1,384) 681 7,633 – 6,838 – 10,800 – 1,276 306 1,187 5,352 – 102 13,083 24,310 109,116 24,420 12,548 8,108 10,902 – Total liabilities 126,196 7,433 2,003 (1,070) 7,584 25,952 21,306 189,404 Off-balance sheet items 21,937 (10,861) (7,509) (2,896) (671) – Interest rate repricing gap (13,179) (9,713) 1,114 28,761 3,331 (10,314) Cumulative interest rate repricing gap (13,179) (22,892) (21,778) 6,983 10,314 – – – – – – – The table above does not take into account the effect of interest rate options used by the Group to hedge its exposure; details of options are given in note 46a. *restated (see note 1) LLOYDS TSB GROUP 89 Notes to the accounts 46 Derivatives and other financial instruments (continued) d Currency exposures c Fair value analysis The table below shows a comparison by category of book values and fair values of the Group’s on-balance sheet financial assets and liabilities. Structural currency exposures The Group’s main overseas operations are in New Zealand, the Americas and Europe. Details of the Group’s structural foreign currency exposures are as follows: As at 31 December 2002 Assets: Treasury bills and other eligible bills Loans and advances to banks and customers Debt securities and equity shares Liabilities: Deposits by banks and customers Debt securities in issue Subordinated liabilities As at 31 December 2001* Assets: Treasury bills and other eligible bills Loans and advances to banks and customers Debt securities and equity shares Liabilities: Deposits by banks and customers Debt securities in issue Subordinated liabilities *restated (see note 1) Trading book Book value £m Fair value £m Non-trading book Fair Book value value £m £m 530 530 1,879 1,878 2,032 2,032 149,971 151,526 17,620 17,620 11,900 11,932 2,927 1,122 – 2,927 138,850 138,428 1,122 29,133 29,005 – 10,168 11,156 Trading book Book value £m Fair value £m Non-trading book Fair Book value value £m £m 1,630 1,630 2,782 2,780 605 605 137,554 138,287 13,423 13,423 11,027 11,269 Functional currency of Group operation New Zealand dollar Euro US dollar Swiss franc Other non-sterling 2002 £m 2001 £m 921 304 259 100 323 748 286 147 104 438 1,907 1,723 Non-structural currency exposures All foreign exchange exposures in the non-trading book are transferred to the trading area where they are monitored and controlled. Information about the management of market risk in the Group’s trading activities is given on pages 36 and 37 in the financial review. e Unrecognised gains and losses on hedging instruments The Group uses a variety of financial instruments to hedge exposures in its banking book; these hedges are accounted for on an accruals basis, in line with the underlying instruments being hedged. Any gains or losses that would occur if these instruments were carried at market value are therefore not recognised. At 31 December 2002, the unrecognised gains on financial instruments used for hedging were £518 million (2001: £242 million) and unrecognised losses were £744 million (2001: £820 million). The net losses arising in 2001 and earlier years and recognised in 2002 amounted to £344 million. Net losses of £6 million arose in 2002 but were not recognised in the year. 1,582 1,187 – 1,582 131,844 131,813 23,266 23,233 1,187 8,544 8,108 – Of the net losses of £226 million at 31 December 2002, £38 million of net losses are expected to be recognised in the year ending 31 December 2003 and £188 million of net losses in later years. f Value at risk in trading activities Details of value at risk in the Group’s global trading activities are given on page 36 in the financial review. The disclosures in this note cover all on-balance sheet financial instruments; fair values of all derivative instruments are disclosed in note 46a. Fair values are determined by reference to quoted market prices or, where no market price is available, using internal models which discount expected future cashflows at prevailing interest rates. Fair values have not been calculated for sundry debtors and creditors in the trading book. 90 LLOYDS TSB GROUP Notes to the accounts 47 Acquisitions a) On 18 April 2002 the Group’s subsidiary, Lloyds TSB Asset Finance Division Limited, completed the acquisition of First National Vehicle Holdings and Abbey National Vehicle Finance, both previously wholly owned subsidiaries of Abbey National plc operating in the UK contract hire and fleet management market; the results of these businesses have been consolidated in full from that date, the effect on the results of the Group is not material. The premium on acquisition of £86 million has been capitalised and will be written off to the profit and loss account over its estimated useful life of 20 years. A summarised profit and loss account for First National Vehicle Holdings and Abbey National Vehicle Finance for the period from 1 January 2002 to 17 April 2002 is set out below: Net interest income Other income Total income Operating expenses Provisions for bad and doubtful debts Loss on ordinary activities before tax Tax Loss after tax for the period to 17 April 2002 Profit after tax for the year ended 31 December 2001 £m 6 25 31 38 1 (8) 2 (6) – All recognised gains and losses are included in the profit and loss account. The combined balance sheet of First National Vehicle Holdings and Abbey National Vehicle Finance at 18 April 2002 was as follows: Book value at 18 April Fair Fair value at value 2002 adjustments acquisition £m £m £m Loans and advances to customers Tangible fixed assets Other assets and prepayments Deposits by banks Other liabilities and accruals 64 355 63 (405) (107) – (8) – – (6) 64 347 63 (405) (113) Net liabilities acquired (30) (14) (44) Goodwill Consideration 86 42 An initial cash payment of £47 million has been made, however following the preparation of the completion accounts it is believed that this should be subject to a downward adjustment of £5 million. Accordingly a receivable of this amount has been recognised in the Group’s balance sheet. The fair value adjustments principally reflect adjustments to the carrying value of operating lease assets and related taxation. Negotiations regarding the completion of this acquisition are still ongoing and, whilst no further significant adjustments to consideration or fair value adjustments are expected, in accordance with the requirements of paragraph 27 of Financial Reporting Standard 6, it is noted that the fair value of the net assets of the acquired businesses and the goodwill arising shown above are provisional. b) On 17 October 2002 the Group’s subsidiary, Lloyds TSB Bank (No. 5) Limited, completed the purchase of the business of Accucard, a credit card technology development and marketing company. The consideration for the purchase was £9 million, of which £7 million was settled in cash with a further £1 million payable in 2003 and £1 million payable in 2004. The premium on acquisition of £7 million has been capitalised and will be written off to the profit and loss account over its estimated useful life of 5 years. There were no fair value adjustments made to the assets acquired. The results of this business have been consolidated in full from the date of acquisition, the effect on the results of the Group is not material. c) On 16 December 2002 the Group’s subsidiary, Lloyds TSB Asset Finance Division Limited, completed the purchase of the business of the Dutton-Forshaw Group, a motor dealer which has a network of 38 franchised dealerships representing 14 motor vehicle manufacturers. The consideration for the purchase was £49 million which was settled in cash. The premium on acquisition of £10 million has been capitalised and will be written off to the profit and loss account over its estimated useful life of 20 years. Fair value adjustments were made to the carrying value of tangible fixed assets and in respect of certain liabilities. Negotiations regarding the completion of this acquisition are still ongoing and, whilst no further significant adjustments to consideration or fair value adjustments are expected, in accordance with the requirements of paragraph 27 of Financial Reporting Standard 6, it is noted that the goodwill arising stated above is provisional. The results of this business have been consolidated in full from the date of acquisition, the effect on the results of the Group is not material. 48 Consolidated cash flow statement a Reconciliation of operating profit to net cash inflow from operating activities Operating profit Increase in prepayments and accrued income Increase (decrease) in accruals and deferred income Provisions for bad and doubtful debts Net advances written off Insurance claims Insurance claims paid Amounts written off fixed asset investments Income from long-term assurance business Transfer from long-term assurance business Interest on subordinated liabilities (loan capital) Interest element of finance lease rental payments Depreciation and amortisation Other non-cash movements 2002 £m 2001* £m 2,618 (21) 113 1,029 (675) 233 (210) 87 303 – 537 – 701 (189) 3,132 (285) (439) 747 (691) 174 (178) 60 29 155 515 1 550 (376) Net cash inflow from trading activities 4,526 3,394 Net increase in loans and advances Net increase in investments other than investment securities Net increase in other assets Net increase in deposits by banks Net increase in customer accounts Net increase in debt securities in issue Net increase in other liabilities Net decrease (increase) in items in course of collection/transmission Other non-cash movements (11,970) (9,340) (2,494) (683) 1,018 6,900 5,904 1,511 (5,664) (327) 7,689 7,525 6,557 109 147 535 (17) 1 Net cash inflow from operating activities 5,394 9,927 b Analysis of cash as shown in the balance sheet Cash and balances with central banks Loans and advances to banks repayable on demand 2002 £m 1,140 4,313 2001 £m 1,240 2,443 5,453 3,683 The Group is required to maintain balances with the Bank of England which, at 31 December 2002, amounted to £165 million (2001: £156 million). LLOYDS TSB GROUP 91 Notes to the accounts 48 Consolidated cash flow statement (continued) f Acquisition of group undertakings 2002 £m 2001 £m 66 137 384 (590) (3) 103 100 (5) – 2 103 100 2002 £m – – – – 15 – (13) 2 8 10 – 9 – 1 10 2001 £m 1 39 40 2002 £m 2001 £m 3,683 3,821 1,766 4 (100) (38) 5,453 3,683 Net assets acquired: Loans and advances Other assets Tangible fixed assets Deposits by banks and other liabilities Goodwill arising on consolidation Satisfied by: Amounts receivable Issue of loan notes Deferred consideration Cash g Disposal of group undertakings and businesses Sundry net assets disposed of Profit on sale Cash consideration received *restated (see note 1) Share capital (including premium and merger reserve) 2001 £m 2002 £m 2,713 139 2,334 379 2,852 2,713 Capital securities issued by subsidiary undertakings 2001* £m 2002 £m 509 17 526 515 (6) 509 Minority investment in subsidiaries 2001 £m 2002 £m – 167 1 168 – – – – Subordinated liabilities and finance leases 2001* 2002 £m £m 8,111 (5) 2,065 (4) 2 7,533 (13) 611 (20) – 10,169 8,111 2002 £m 103 14 117 2001 £m 1 179 180 c Analysis of changes in cash during the year At 1 January Net cash inflow (outflow) before adjustments for the effect of foreign exchange movements Effect of foreign exchange movements At 31 December d Analysis of changes in financing during the year At 1 January Cash inflow from financing At 31 December At 1 January Effect of foreign exchange movements At 31 December At 1 January Cash inflow from financing Retained profit At 31 December At 1 January Effect of foreign exchange movements Cash inflow from financing Capital repayments Adjustments on acquisition At 31 December e Analysis of the net cash outflow in respect of the acquisition of group undertakings Cash consideration paid (see f) Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 Net cash outflow 92 LLOYDS TSB GROUP Information for shareholders Analysis of shareholders at 31 December 2002 Size of shareholding 1 – 99 100 – 499 500 – 999 1,000 – 4,999 5,000 – 9,999 10,000 – 49,999 50,000 – 99,999 100,000 – 999,999 1,000,000 and over Number 68,103 448,759 295,111 126,484 18,626 13,647 843 1,289 506 973,368 Shareholders Number of ordinary shares % 7.00 46.10 30.32 12.99 1.91 1.41 0.09 0.13 0.05 Millions 2.3 150.7 186.8 244.8 127.8 247.3 57.0 409.3 4,157.1 % 0.04 2.70 3.35 4.38 2.29 4.43 1.02 7.33 74.46 100.00 5,583.1* 100.00 *Includes 710 million shares (12.7%) registered in the names of some 864,000 individuals. 203 million shares (3.6%) are held by over 67,000 staff and Group pensioners, or on their behalf by the trustee of the staff profit sharing schemes. American Depositary Receipts (ADRs) Lloyds TSB shares are traded in the USA through an NYSE-listed sponsored ADR facility, with The Bank of New York as the depositary. The ADRs are traded on the New York Stock Exchange under the symbol LYG. The CUSIP number is 539439109 and the ratio of ADRs to ordinary shares is 1:4. For details please contact The Bank of New York, Investor Relations, PO Box 11258, Church Street Station, New York, NY 10286- 1258. Telephone (1) 888 BNY ADRS (US toll free), international callers (1) 610 312 5315. Visit www.adrbny.com or email shareowner–svcs@bankofny.com Individual Savings Accounts (ISAs) The Company provides a facility for investing in Lloyds TSB shares through an ISA. For details please contact Lloyds TSB Private Banking ISAs, Freepost, PO Box 149, Haywards Heath, West Sussex RH16 3BR. Telephone 0845 7418418. The community and our business Information about the Group’s role in the community and copies of the Group’s code of business conduct and its environmental report may be obtained by writing to Public Affairs, Lloyds TSB Group plc, 71 Lombard Street, London EC3P 3BS. This information is also available on the Group’s website (see below). The Better Payment Practice Code A copy of the code and information about it may be obtained from the DTI Publications Orderline 0870 1502500, quoting ref URN 01/621. Shareholder enquiries The Company’s share register is maintained by Lloyds TSB Registrars, The Causeway, Worthing, West Sussex BN99 6DA. Telephone 0870 6003990; textphone 0870 6003950. Please contact them if you have enquiries about your Lloyds TSB shareholding, including those concerning the following matters: • change of name or address • loss of share certificate, dividend warrant or tax voucher • to obtain a form for dividends to be paid directly to your bank or building society account (tax vouchers will still be sent to your registered address unless you request otherwise) • to obtain details of the dividend reinvestment plan which enables you to use your cash dividends to buy Lloyds TSB shares in the market • request for copies of the report and accounts in alternative formats for shareholders with disabilities. Lloyds TSB Registrars operates a web based enquiry and portfolio management service for shareholders. Visit www.shareview.co.uk for details. Substantial shareholdings At the date of this report notification had been received that Legal & General Investment Management Limited has an interest in 3% 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 by telephoning 0906 8771515. These telephone calls are charged at 60p per minute, including VAT, or visit www.londonstockexchange.com. Share dealing facilities The Company provides a low cost, execution only, postal dealing service for the purchase and sale of Lloyds TSB shares through Lloyds TSB Registrars. The current rate of commission is 0.75%, for both purchases and sales, no minimum. For full details please contact Lloyds TSB Registrars. Telephone 0870 2424244. The Company also provides a telephone dealing service through Lloyds TSB Stockbrokers for the purchase and sale of Lloyds TSB shares on preferential commission terms. The current rate for both purchases and sales is 0.75%, minimum £18.50 maximum £75, for transactions up to £75,000. For full details please contact Lloyds TSB Stockbrokers. Telephone 0845 7888100. The information about Lloyds TSB Stockbrokers’ services is approved by Lloyds TSB Stockbrokers Limited. Lloyds TSB Stockbrokers is a member of the London Stock Exchange and is regulated by the FSA. Designed by Starling Design/The Team. Printed in the UK by St Ives Burrups. This document is printed on paper produced from sustainable managed forests using an elemental chlorine free process and an Environmentally Responsible Approach (ERA). Financial calendar 2003 14 February Results for 2002 announced 26 February Ex-dividend date for 2002 final dividend 28 February Record date for final dividend 9 April Final date for joining or leaving the dividend reinvestment plan for the final dividend 16 April Annual general meeting in Glasgow 7 May Final dividend paid 1 August Results for half-year to 30 June 2003 announced 13 August Ex-dividend date for 2003 interim dividend 15 August Record date for interim dividend 10 September Final date for joining or leaving the dividend reinvestment plan for the interim dividend 8 October Interim dividend paid Head office 71 Lombard Street London EC3P 3BS (from 28 March, 2003) 25 Gresham Street London EC2V 7HN Registered office Henry Duncan House 120 George Street Edinburgh EH2 4LH Registered in Scotland no 95000 Registrar Lloyds TSB Registrars The Causeway Worthing West Sussex BN99 6DA Internet www.lloydstsb.com LLOYDS TSB GROUP 93 222 LLOYDS TSB GROUP