Lloyds Banking Group PLC Annual Report 2004

Plain-text annual report

Annual Report and Accounts 2004 Forward looking statements This annual report includes certain forward looking statements with respect to the business, strategy and plans of Lloyds TSB Group and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Lloyds TSB Group’s or management’s beliefs and expectations, are forward looking statements. Words such as ‘believes’, ‘anticipates’, ‘estimates’, ‘expects’, ‘intends’, ‘aims’, ‘potential’, ‘will’, ‘could’, ‘considered’, ‘likely’, ‘estimate’ and variations of these words and similar expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will occur in the future. Examples of such forward looking statements include, but are not limited to, projections or expectations of profit attributable to shareholders, provisions, economic profit, dividends, capital structure or any other financial items or ratios; statements of plans, objectives or goals of Lloyds TSB Group or its management; statements about the future trends in interest rates, stock market levels and demographic trends and any impact on Lloyds TSB Group; statements concerning any future UK or other economic environment or performance including in particular any such statements included in this annual report; statements about strategic goals, competition, regulation, dispositions and consolidation or technological developments in the financial services industry and statements of assumptions underlying such statements. Factors that could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by Lloyds TSB Group or on Lloyds TSB Group’s behalf include, but are not limited to, general economic conditions in the UK and internationally; inflation, interest rate, exchange rate, market and monetary fluctuations; changing demographic developments, adverse weather and similar contingencies outside the Lloyds TSB Group’s control; inadequate or failed internal or external processes, people and systems; terrorist acts and other acts of war or hostility and responses to those acts; changes in laws, regulations or taxation; changes in competition and pricing environments; the ability to secure new customers and develop more business from existing customers; the ability to achieve value-creating mergers and/or acquisitions at the appropriate time and prices and the success of the Lloyds TSB Group in managing the risks of the foregoing. Lloyds TSB Group plc may also make or disclose written and/or oral forward looking statements in reports filed with or furnished to the Securities and Exchange Commission (‘SEC’), Lloyds TSB Group plc’s annual review, proxy statements, offering circulars, prospectuses, press releases and other written materials and in oral statements made by the directors, officers or employees of Lloyds TSB Group plc to third parties, including financial analysts. The forward looking statements contained in this annual report are made as of the date hereof, and Lloyds TSB Group undertakes no obligation to update any of its forward looking statements. Contents Forward looking statements 2004 highlights Chairman’s statement Group chief executive’s review The community and our business The businesses of Lloyds TSB Operating and financial review and prospects Five year financial summary The board Directors’ report Corporate governance Directors’ remuneration report Report of the independent auditors Primary financial statements Notes to the accounts Information for shareholders 3 5 7 9 10 12 39 40 42 43 47 58 59 65 113 LLOYDS TSB GROUP 1 Delivering earnings growth across all major business areas 2004 highlights Profit before tax Results By division Profit before tax decreased by £855 million, or 20 per cent, to £3,493 million, reflecting the impact of businesses disposed of in 2003 which contributed £1,183 million last year. Profit attributable to shareholders decreased by £833 million, or 26 per cent, to £2,421 million. Earnings per share decreased by 26 per cent to 43.3p. Post-tax return on average shareholders’ equity 24.3 per cent. Total capital ratio 10.0 per cent, tier 1 capital ratio 8.9 per cent. Dividend maintained. Final dividend of 23.5p per share, making a total of 34.2p for the year (2003: 34.2p). Results – continuing operations excluding investment variance, changes in economic assumptions and profit/loss on sale of businesses. Profit before tax increased by £301 million, or 10 per cent, to £3,363 million. Earnings per share increased by 12 per cent to 41.8p. Economic profit increased by 9 per cent to £1,442 million. Post-tax return on average shareholders’ equity 23.5 per cent. Post-tax return on average risk-weighted assets increased from 1.87 per cent to 1.95 per cent. 2004 £ million 2003* £ million UK Retail Banking Insurance and Investments Wholesale and International Banking Central group items 1,651 773 1,272 (333) Profit before tax from continuing operations** 3,363 Changes in economic assumptions† Investment variance† Loss on sale of businesses in 2004† Discontinued operations in 2003† Profit before tax Earnings per share (2) 147 (15) – 3,493 43.3p 1,471 565 1,038 (12) 3,062 (22) 125 – 1,183 4,348 58.3p * Restated to reflect changes in the Group’s segmental analysis following the introduction, in 2004, of the management of the Group’s distribution channels as profit centres and other changes in internal pricing arrangements. ** Excluding changes in economic assumptions, investment variance and (loss) profit on sale of businesses. † Changes in economic assumptions and investment variance relate to Insurance and Investments, loss on sale of businesses in 2004 and discontinued operations in 2003 relate to Wholesale and International Banking. Presentation of information Dividends In order to provide a clearer representation of the underlying performance of the Group, the results of the Group’s life and pensions, and general insurance businesses include investment earnings calculated using longer-term investment rates of return. 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, the profit/loss on the sale of a number of overseas businesses in 2003 and 2004 and the trading results of businesses sold in 2003 have been separately analysed and a reconciliation to the Group’s profit before tax is shown on this page. Dividends per share (pence) 30.6 33.7 34.2 34.2 34.2 0 0 0 2 1 0 0 2 2 0 0 2 3 0 0 2 4 0 0 2 LLOYDS TSB GROUP 3 Profitably growing our retail and corporate franchises Chairman’s statement Lloyds TSB has a clearly articulated organic growth strategy that is focused on improving and deepening relationships with our personal and business customers. During 2004 this strategy has started to gain traction, with good progress being made in each of our business units. The successful delivery of profitable franchise growth has been central to the Group’s return to positive earnings momentum during 2004. The building blocks of attracting, retaining and developing customer relationships in all areas of our business are the foundations of profitable franchise development and sustainable earnings growth. With this in mind Lloyds TSB has spent much of the last few years putting our customers at the heart of our strategy, ensuring that customer needs drive our business transformation. During 2004 we have continued to improve our product range, we have significantly enhanced our customer service levels, and we have made clear progress in improving the Group’s processing efficiency. As a result, customer satisfaction levels are higher than at any time during recent years and we are recruiting a higher number of quality customer relationships. This focus on our customers, however, has not come at the expense of other stakeholders. We are constantly striving to make Lloyds TSB a great place to work and a great investment opportunity for shareholders. Throughout 2004 I have continued to be impressed by the drive, commitment and enthusiasm of our staff and, particularly, their desire to keep improving all aspects of our business. For shareholders, Lloyds TSB delivered a total shareholder return (share price appreciation plus dividends) of 15 per cent during 2004, a significantly better performance than both the FTSE Bank Index and the FTSE 100 Index. So, 2004 has been a year of good progress for customers, staff and shareholders all of whom are linked by a common desire – the successful delivery of Lloyds TSB’s business and financial strategies. Financial results During a year when a great deal of management focus has been on positioning the Group to deliver sustainable earnings growth, I am delighted with the 10 per cent growth in profit before tax from the Group’s continuing operations, excluding investment variance, changes in economic assumptions and disposal gains/losses. Each division delivered revenue growth in excess of cost growth, credit quality has remained strong and profitability has improved. Economic outlook Looking at the UK economy, it is likely that economic growth will continue, with many commentators believing growth in 2005 will remain above 2.5 per cent. Whilst there are downside risks to these expectations, from a possible slowdown in the housing market, there is upside potential as well, such as from higher business investment spending. We expect unemployment and inflation to remain low, and interest rates to peak during 2005. This is a relatively benign economic outlook and operating environment for Lloyds TSB. Increasing levels of regulation, from both the UK and overseas, have already become a significant burden on all UK financial companies. With the adoption of international financial reporting standards in 2005, this burden is unlikely to ease and the financial services industry in the UK is likely to continue to face significant challenges in the arena of accounting and regulatory change. Whilst Lloyds TSB is well prepared for these challenges, the ongoing cost of compliance will remain considerable. Maarten van den Bergh Our enhanced risk governance framework is now well embedded throughout the Group and risk is a key part of all executive decision making. Reporting and risk aggregation has been enhanced and through our better understanding of risk in the business, we are well placed to take advantage of opportunities to continue to grow our business profitably and safely. Capital and dividend During 2004 Lloyds TSB has continued to maintain satisfactory capital ratios, largely as a result of high cash flows generated throughout the business. The Group’s post-tax return on equity at 24.3 per cent remains one of the highest amongst the major banks of the world and the board is satisfied with the Group’s capital position. In addition, Scottish Widows continues to be one of the most strongly capitalised life assurance companies in the UK. In line with the rest of the UK banking industry, the Group has now adopted international financial reporting standards and will in future report earnings on the basis of these new standards. Current indications are that this change will not have a material impact on either the earnings of the Group or its regulatory capital position, although some ongoing earnings volatility may arise. The board has decided to maintain the final dividend at 23.5p per share, making a total for the year of 34.2p (2003: 34.2p). This represents a dividend yield of 7.2 per cent, calculated using the 31 December 2004 share price of 473p. Board changes Since the annual general meeting last year, we have welcomed two new directors to the board. Truett Tate was appointed as Group Executive Director, Wholesale and International Banking in August 2004 and Sir Julian Horn-Smith joined us, as a non-executive director, in January 2005. Two executive directors, Steve Targett and Peter Ayliffe, left the board in April 2004 and January 2005 respectively, and Sir Tom McKillop retired at the end of his term as a non-executive director in December 2004. David Pritchard and Chris Gibson-Smith will also be retiring at the annual general meeting. All the departing directors leave with our sincere thanks for their contribution to the Group. Staff The successful implementation of the Group’s strategy is the responsibility of all 70,000 staff employed by the Group. It is their approach to making Lloyds TSB a high performing organisation that has enabled the Group to make such good progress in 2004 and will ensure further progress over the next few years. We have a real opportunity to meet an increasing number of our customers’ needs and it is our staff who will make that happen. They are the day-to-day face of the Bank, the heart of all we do and the key to future success. I thank them for their efforts in 2004 and their continuing commitment. Lloyds TSB Group remains one of the UK’s largest corporate givers, principally through the excellent work of the independent Lloyds TSB Foundations who made grants to charities of over £27 million in 2004. Looking forward Our focus on delivering profitable franchise growth, against a backdrop of significant regulatory and competitive pressure, has led to a good track record of earnings growth. Despite an expected slowdown in consumer lending growth in the UK, I am confident that the delivery of revenue growth in excess of cost growth, combined with strong risk management throughout the organisation, will enable the Group to achieve a continuing high return on equity and sustainable economic profit growth. Maarten van den Bergh Chairman 3 March 2005 LLOYDS TSB GROUP 5 Continuing to improve service quality and processing efficiency Group chief executive’s review 2004 was a good year for Lloyds TSB and, in many respects, marks the closing of one chapter and the opening of another. During the past two years, we worked on a three point plan: • to enhance the quality, and decrease the volatility, of our earnings • to maintain our good returns, and • to achieve growth. I am pleased to report that we have made good progress on each of these priorities and, in doing so, we have also addressed many of the concerns of our shareholders, which centred on the adequacy of our capital, the sustainability of the dividend and the achievement of growth whilst continuing to deliver strong returns. Our results in 2004 reflect a higher quality of earnings. The five Latin American businesses that we sold had impacted adversely on our performance, incurring losses amounting to more than £200 million over the five years to 2003, equivalent to a negative return on equity of some 28 per cent. In addition, the earnings lost from the strategic sale of our businesses in New Zealand and Brazil were replaced within a year, as the Group’s organic growth strategy continued to deliver. The work that we have done to allocate our capital more efficiently, as well as the management of our quality and costs, has allowed us to maintain high returns whilst we focused the organisation on delivering growth. Pleasingly, we are starting to demonstrate better growth across all of our divisions and key businesses. In the Retail Bank, income growth exceeded cost growth, we maintained or grew market share in most of the major product categories and we improved the depth of customer relationships. We used the year to put in place a more competitive product set and a new operating model, whereby we now manage the branch network on what we term a ‘local markets’ basis. In essence, we have returned the branch to being part of the local community and given branch managers greater authority to manage profitability and run their areas as businesses. We recognise that the needs of customers vary by community and, by organising in this way, we believe that we will be both more responsive and effective which will, in turn, result in faster growth. In our test markets, we achieved higher growth in quality customer recruitment and a greater improvement in customer satisfaction than in the rest of the branch network, and this is now starting to deliver an improved sales performance. The new model was extended to the entire branch network in the second half of 2004. In Wholesale Banking, each of the major businesses made good progress in acquiring and deepening customer relationships and all delivered year-on-year profit improvements in excess of 20 per cent. The new management team strengthened our competitive position with enhanced product offerings and more proactive calling efforts. This renewed customer focus and better alignment of relationship and product managers resulted in a 25 per cent uplift in earnings in the Corporate Markets franchise. Business Banking and Asset Finance also performed strongly, supported by good income growth and strong cost control. In Insurance and Investments, our new business contribution in Scottish Widows increased by 21 per cent as we successfully focused on more profitable, and more capital efficient, business lines. The sales of life and pensions products in the branches were encouraging, although we lagged in unit trust sales. During 2004, supported by the launch of a simplified suite of bancassurance products in the second half of the year, we increased our market share of non-IFA life and pensions sales from 7.8 per cent to 8.9 per cent. Overall, life and pensions product sales increased by 9 per cent. In Lloyds TSB Insurance, increased investment resulted in strong growth in sales through direct channels and we maintained our market leading position in home insurance distribution. Eric Daniels In addition to the considerable progress in the divisions, we also used the year to enhance the effectiveness of the Corporate Centre, with the appointment of new directors in the Risk, Audit, Human Resources and Finance functions. This has enabled us to strengthen the operating disciplines across the Group, which provide the framework for us to grow in a sustained fashion. We are only just beginning to unlock the growth potential of the Lloyds TSB franchise. During 2004, customer satisfaction ratings reached record levels, employee engagement scores rose to their highest level ever, credit quality remained strong and our financial disciplines guided the Group to exceed expectations in terms of financial performance. This gives us a solid underpinning for the future. We still have much to do in terms of improving our execution but I believe we can continue to deliver income growth in a controlled and sustainable way, due to the progress made by the divisions and improvements in our operating processes achieved during 2004. As we look to the future, we are opening a new chapter focused primarily on growth. We will continue to focus our efforts on our core markets and build our skills to sustain superior performance. Our new priorities are designed to leverage our strengths in those markets and they are: • to materially deepen customer relationships, meeting more of our customers’ needs and winning a greater share of their business. In the last year and a half, we have put in place many of the pieces to build stronger relationships; across all of our divisions we have enhanced service performance and we have introduced improved product ranges. We have also introduced local markets in the Retail Bank and built up strong regional centres in the Wholesale Bank. Our task is now to integrate these pieces so that our customers enjoy better value and view us as the place to bring more of their business. • to improve our efficiency, growing our top line whilst improving the productivity of our cost base, using the discipline of ‘positive jaws’. As our income grows, we will continue to increase our investment to improve our customer satisfaction ratings and our efficiency, through further development of our quality performance, automation, straight-through processing and the more effective leveraging of our group wide cost base. • to continue to enhance the Group’s capabilities and processes to support faster growth. In Finance, we will further develop our capital management disciplines and our understanding of the key drivers of economic profit growth at a more granular level. In Risk, we will continue to build our skill base to enable us to grow with less volatility in our earnings and to take advantage of the strategic benefits of Basel II. In Human Resources, we are developing our people to perform to their full potential and to create the high performance organisation necessary to achieve our goals. Looking back on the year, we achieved our three point plan and are now making marked progress on the elements of the Group’s balanced scorecard. Our capital position is in good shape, with the impact of recent accounting changes incorporated into our plans, and we achieved growth and higher quality earnings. Our staff are engaged and the achievement of these favourable results is due to their commitment and dedication to serving our customers. I look forward to seeing continued growth and progress against our revised set of priorities in 2005 and beyond. J Eric Daniels Group Chief Executive 3 March 2005 LLOYDS TSB GROUP 7 We have a clear opportunity to help our customers achieve their goals The community and our business Our business Community involvement There is a business case for corporate responsibility. We know very clearly that companies which adopt and embrace corporate responsibility, and link it to their core business, are more likely to create wealth and shareholder value than those that do not. It is not just about having the right products at the right price, and a relentless pursuit of superior service and accessibility for customers. Having strong values, clear leadership and a responsible corporate culture are also critical if the business is to prosper over time. We want our business to be the first and natural choice for customers and investors. With some 2,200 branches, Lloyds TSB Group has one of the largest branch networks in the UK as well as being a leading internet and telephone banking provider. Our agreement with the Post Office allows our personal customers to use around 16,000 post offices for their banking needs. Lloyds TSB has also been at the forefront of developing alternative forms of financial provision and support for those communities where mainstream financial services have traditionally been considered inappropriate or inaccessible. We have been involved in a wide range of projects, on both a commercial and semi-commercial basis, providing capital for loan funds which in turn support individual debt-consolidation, housing improvement, business start-ups and social enterprise. People and the workplace People are our greatest asset and we are committed to becoming a world-class organisation in the way we manage and develop them. We know that corporate responsibility is a factor in the perception that our staff have of Lloyds TSB as an employer and plays a key part in their engagement and satisfaction in working for the Group. We can demonstrate a direct relationship between employee satisfaction, customer satisfaction and, ultimately, shareholder satisfaction. In the UK, where we employ over 68,000 people, our employment policies are continually monitored and benchmarked against other companies to ensure that, as one of the UK’s largest employers, we remain at the leading edge of employment practice. Our workforce policies and programmes are focused on ensuring that all our employees believe that Lloyds TSB is a great place to work and an employer of choice. Our commitment to Investors in People (IIP) is about promoting a culture of career-long learning and a need to equip our staff with the skills and knowledge that will help them to perform in the workplace. In 2004, 87 per cent of our employees worked for business units that are IIP accredited. Almost £42 million was invested in employee training and development across the Group in 2004. The University for Lloyds TSB provided over 67,000 face-to-face training days and in excess of 29,000 delegate places on residential training courses. We seek to use awards and qualifications as a means of benchmarking staff achievement against external standards. We are committed to improving the diversity of our workforce in terms of the representation of women, ethnic minority employees and disabled employees at all levels in our organisation. We encourage all employees to develop a balance between their personal and professional lives through our Work Options policy. This provides staff with the opportunity to adopt any one of a number of flexible working practices such as job sharing, variable and compressed hours and term-time working. As a result 34 per cent of our workforce currently work flexibly. Lloyds TSB is a significant presence in every community. The customers we serve and the staff that serve them are drawn from those same communities. We have one of the largest community investment programmes in the UK, supporting our customers and staff, and making a significant contribution to improving the social fabric of the local environment in which our business operates. Community investment is not just about giving money to good causes. It is also about the substantial time given by our staff in supporting the work of community organisations, whether raising money, providing business expertise or simply providing another willing pair of hands. The Group Community Awards scheme celebrates staff achievement and rewards them for their work in the local community. In 2004, nearly 150 nominations were received and each of the 10 winners was presented with a £1,000 cheque for their nominated organisations. Of course, cash giving is also important. Every year we support our staff’s commitment to local communities through the matched giving scheme. In 2004 the Lloyds TSB Foundations set aside £1.25 million to match money raised for, and the time given to, charity by Lloyds TSB staff. More than 4,000 staff took part in the scheme, raising a total for charities of more than £3.4 million. One of our biggest group wide activities is our Charity of the Year fundraising. In 2004, staff raised over £1 million for NSPCC and Children 1ST. The majority of Lloyds TSB’s charitable giving is channelled through the four independent Lloyds TSB Foundations, which cover England and Wales, Scotland, Northern Ireland and the Channel Islands. Their mission is to improve the lives of people in local communities, especially those who are disadvantaged or disabled. The Lloyds TSB Foundations together receive one per cent of the Group’s pre-tax profits, averaged over three years, in lieu of their shareholder dividend. Since 1997, they have received £228 million to distribute to grassroots causes. In 2005, they will receive a further £31.2 million to distribute to community groups. More information on these issues is available in the Group’s 2004 corporate responsibility report and there are details of how to obtain a copy of this document on page 113. LLOYDS TSB GROUP 9 The businesses of Lloyds TSB Lloyds TSB Group’s activities are organised into three divisions: UK Retail Banking, Insurance and Investments, and Wholesale and International Banking. The main activities of Lloyds TSB Group’s three divisions are described below. UK Retail Banking UK Retail Banking provides banking, ﬁnancial services, mortgages and private banking to some 15 million personal customers through our multi channel distribution capabilities. Branches. Lloyds TSB Group provides wide-reaching geographic branch coverage in England, Scotland and Wales, with some 2,200 branches of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester as at the end of 2004. Internet banking. Internet banking provides online banking facilities for personal customers. Some 3 million customers have registered to use Lloyds TSB Group’s internet banking services. Telephone banking. Telephone banking continues to grow and Lloyds TSB Group provides, in terms of customer numbers, one of the largest telephony services in Europe. At the end of 2004, some 4.8 million customers had registered to use the services of PhoneBank and the automated voice response service PhoneBank Express. Lloyds TSB Group’s telephone banking contact centres handled some 62 million calls during 2004. Cash machines. Lloyds TSB Group has one of the largest cash machine networks of any leading banking group in the UK and, at 31 December 2004, personal customers of Lloyds TSB Bank and Lloyds TSB Scotland were able to withdraw cash and check balances through some 4,200 ATMs at branches and external locations around the country. In addition, our personal customers have access to a further 50,000 cash machines via LINK in the UK and to cash machines worldwide through the VISA and MasterCard networks. Current accounts. Lloyds TSB Bank and Lloyds TSB Scotland offer a wide range of current accounts, including interest-bearing current accounts and a range of added value accounts. Savings accounts. Lloyds TSB Bank and Lloyds TSB Scotland offer a wide range of savings accounts and Cheltenham & Gloucester provide retail investments through their branch networks and a postal investment centre. Personal loans. Lloyds TSB Bank and Lloyds TSB Scotland offer a range of personal loans through their branch networks and directly to the customer via the internet and telephone. Credit cards. Lloyds TSB Group provides a range of card-based products and services, including credit and debit cards and card transaction processing services for retailers. Lloyds TSB Group is a member of both the VISA and MasterCard payment systems and had a 12.7 per cent share of outstanding card balances at 31 December 2004. Mortgages. Cheltenham & Gloucester is Lloyds TSB Group’s specialist residential mortgage provider, offering a range of mortgage products to personal customers through its own branches and those of Lloyds TSB Bank in England and Wales, as well as through the telephone, internet and postal service, C&G TeleDirect. Lloyds TSB Group also provides mortgages through Lloyds TSB Scotland and Scottish Widows Bank. Lloyds TSB Group is the third largest residential mortgage lender in the UK on the basis of outstanding balances, with mortgages outstanding at 31 December 2004 of £80.1 billion, representing a market share of 9.1 per cent. UK Wealth Management. Private Banking provides a range of tailor-made wealth management services and products to individuals from 30 ofﬁces throughout the UK. In addition to asset management, these include tax and estate planning, executor and trustee services, deposit taking and lending, insurance and personal equity plan and individual savings account (ISA) products. Insurance and Investments Insurance and Investments offers life assurance, pensions and investment products, general insurance and fund management services. Life assurance, pensions and investments. Scottish Widows is Lloyds TSB Group’s specialist provider of life assurance, pensions and investment products, which are distributed through Lloyds TSB Bank’s branch network, through independent ﬁnancial advisers and directly via the telephone and the internet. The Scottish Widows brand is the main brand for new sales of Lloyds TSB Group’s life, pensions, unit trust and other long-term savings products. General insurance. Lloyds TSB General Insurance provides general insurance through the retail branches of Lloyds TSB Bank and Cheltenham & Gloucester, and through a direct telephone operation and the internet. Lloyds TSB General Insurance is one of the leading distributors of household insurance in the UK. Scottish Widows Investment Partnership. Scottish Widows Investment Partnership manages funds for Lloyds TSB Group’s retail life, pensions and investment products. Clients also include corporate pension schemes, local authorities and other institutions in the UK and overseas. At 31 December 2004 funds under management amounted to some £82 billion. 10 LLOYDS TSB GROUP The businesses of Lloyds TSB Wholesale and International Banking Wholesale and International Banking provides banking and related services for major UK and multinational corporates and ﬁnancial institutions, and small and medium-sized UK businesses. It also provides asset ﬁnance and share registration services to personal and corporate customers, manages Lloyds TSB Group’s activities in ﬁnancial markets through its treasury function and provides banking and ﬁnancial services overseas. Wholesale 2004 has seen a further increase in our corporate activity with the tighter integration of the businesses within the Wholesale Bank. Corporate Markets combining the respective strengths of Corporate Banking, Structured Finance and Financial Markets, plays an integral role in leveraging and expanding our customer franchise and building deep, long-lasting relationships. Corporate Banking manages the core franchise, providing a relationship-based ﬁnancial and advisory service to the corporate marketplace through dedicated regional teams throughout the UK and key strategic locations abroad, including New York. Customers have access to our capital and expertise in a broad range of ﬁnancial solutions. Our relationship managers act as a conduit to partners in the Wholesale Bank and other parts of the Group. Structured Finance comprises the private equity and leveraged debt businesses and other transactional lending businesses of the Wholesale Bank. Structured Finance executes transactions within the existing corporate franchise as well as building an avenue for new to bank relationships. Financial Markets is a leading participant in the sterling money market. It is also active in currency money markets, foreign exchange markets and in certain derivatives markets, primarily to meet the needs of customers. It also plays a central role in the funding, cash and liquidity management of Lloyds TSB Group. Asset Finance. Lloyds TSB Group’s asset ﬁnance businesses provide individuals and companies with ﬁnance through leasing, hire purchase and contract hire packages. Through its invoice discounting and factoring subsidiary, Lloyds TSB Commercial Finance, Lloyds TSB Group provides working capital ﬁnance for customers. Specialist personal lending, store credit and the Dutton-Forshaw motor dealership group complete this group of businesses. Business Banking. Relationships with some 574,000 small businesses are managed by around 1,700 dedicated business managers based in over 500 locations throughout the UK supported by nearly 2,000 business customer advisers in branches. Lloyds TSB Group is one of the leading banks for new business start-ups with nearly a quarter of new businesses opening an account with Lloyds TSB. The main activity of the Agricultural Mortgage Corporation is to provide long-term ﬁnance to the agricultural sector. International Banking The Group has continued to reshape its international network in 2004 as the sales of our businesses in Argentina, Colombia, Guatemala, Panama and Honduras were completed during the year. Europe. Lloyds TSB Group has private banking operations for wealthy individuals outside their country of residence. The business is conducted through branches of Lloyds TSB Bank located in Switzerland, Luxembourg, Monaco and Gibraltar. There are also personal and corporate banking operations in Belgium, The Netherlands and Spain. Offshore banking. Lloyds TSB Group’s offshore banking operations comprise ofﬁces in the UK, the Channel Islands, the Isle of Man and overseas representative ofﬁces in the Middle East, Asia and the Americas. The business provides a wide range of retail banking, wealth management and expatriate services to local island residents, UK expatriates, foreign nationals and to other customers requiring offshore ﬁnancial services. The Americas. Lloyds TSB Group continues to have ofﬁces in Ecuador, Paraguay and Uruguay which provide mainly corporate banking services. In addition, Lloyds TSB Group has private banking and investment operations in the US. Middle East and Asia. There are banking operations in Hong Kong, Singapore, Tokyo, Malaysia and Dubai. LLOYDS TSB GROUP 11 Operating and financial review and prospects Summary of Group results In 2004 the Group’s statutory proﬁt before tax was £3,493 million, a decrease of £855 million compared to £4,348 million in 2003. This decrease was attributable to the impact in 2003 of the proﬁt on the sale and trading results of a number of overseas businesses, which contributed £1,183 million. For the same reason, proﬁt attributable to shareholders decreased by £833 million, or 26 per cent, to £2,421 million and earnings per share decreased by 26 per cent to 43.3p. To enable meaningful comparisons with 2003, it is appropriate to exclude the impact of these 2003 disposals, together with the investment variance and changes in economic assumptions in the Group’s life assurance businesses. On this basis, as a result of earnings growth in each business unit, proﬁt before tax increased by £301 million, or 10 per cent, to £3,363 million. Earnings per share increased by 12 per cent to 41.8p and economic proﬁt increased by 9 per cent to £1,442 million. The post-tax return on average shareholders’ equity was 23.5 per cent and the post-tax return on average risk-weighted assets increased to 1.95 per cent, from 1.87 per cent in 2003. Group net interest income from continuing operations increased by £176 million, or 4 per cent, and average interest-earning assets increased by 8 per cent to £170 billion. Strong consumer lending growth led to increases of £2.6 billion in average personal lending and credit card balances and £8.9 billion in average mortgage balances. The Group net interest margin from continuing operations decreased by 11 basis points to 2.89 per cent, after adjusting for the impact of a change in the middle of 2004 in the Group’s wholesale liquidity and funding strategy towards the use of more capital efﬁcient reverse repurchase agreements, which have been excluded from the net interest margin calculation. This margin reduction reﬂected the impact of changes in business mix and lower margins in the Group’s credit card, personal lending and mortgages portfolios as a result of competitive pressures. During the second half of 2004, however, we started to see a slowdown in the rate of margin erosion in a number of retail product areas. There has also been further substitution of net interest income for fee income in certain product lines. Strong growth in loans and advances to customers and banks, partly offset by a reduction in debt securities, led to an 11 per cent increase in total assets to £280 billion. The Group’s strategy to increase retail lending, particularly in mortgages, credit cards and personal loans, was reﬂected in a 14 per cent increase in loans and advances to customers to £154 billion. Customer deposits increased by £6 billion, or 5 per cent, to £122 billion, largely as a result of strong growth in current account credit balances which was supported by further progress in the take-up of added value current accounts. Other income from continuing operations, excluding investment variance and changes in economic assumptions, increased by £89 million to £4,463 million. Prior year comparisons are, however, further distorted by the impact of the sale, in 2003, of the Group’s portfolio of emerging markets debt bonds and certain closed foreign exchange positions and customer redress provisions. Excluding these items, other income increased by 7 per cent. Fees and commissions receivable increased by 5 per cent to £3,124 million as a result of higher income from the strong volume growth in credit and debit card services, partly as a result of the acquisition of the Goldﬁsh credit card portfolio in September 2003, an increase in mortgage related fees, reﬂecting the growth in new mortgage lending during the year, and an increase in fees from large corporate business and asset-based lending, as a result of growing customer transaction volumes. Income from long-term assurance business, excluding the impact of customer redress provisions, increased by 32 per cent to £590 million as a result of signiﬁcantly improved proﬁtability in the Scottish Widows life and pensions business. There was also a £50 million increase in gains on the sales of assets, largely the realisation of venture capital investments. Operating expenses on a continuing operations basis, excluding the impact of customer redress provisions, continued to be tightly controlled and increased by only 2 per cent to £4,817 million. Signiﬁcant improvements have been made in processing and operational efﬁciency and the Group has continued to expand its programme of offshoring a number of its processing and back ofﬁce operations to India. As a result of this constant focus on day-to-day operating cost control, the Group’s cost:income ratio improved to 51.1 per cent, from 52.5 per cent in 2003. Revenue growth exceeded cost growth in each division and at Group level. Much of the Group’s new retail lending during 2004 has been to existing customers where the Group has a better understanding of each individual customer’s total ﬁnancial position and this, in conjunction with a relatively benign economic environment and increased corporate liquidity, has led to credit quality remaining strong throughout the Group. Notwithstanding substantial growth in loans and advances to customers, the provisions charge for bad and doubtful debts within the Group’s continuing operations was 2 per cent lower than in 2003 and, as a result, the Group’s provisions charge expressed as a percentage of average lending improved to 0.59 per cent, compared to 0.66 per cent in 2003. Non-performing lending was £1,240 million representing 0.8 per cent of total lending, down from 0.9 per cent at 31 December 2003. During 2004 there has been an increase in the level of complaints relating to past sales and performance of certain endowment based and long-term savings products. Whilst the Group maintains provisions for customer redress in respect of past product sales, the adequacy of these provisions has been reviewed in the light of ongoing experience. As a result, an additional provision of £112 million has been made. The Group’s capital position remains satisfactory. At the end of 2004, the total capital ratio was 10.0 per cent and the tier 1 capital ratio was 8.9 per cent. Risk-weighted assets increased by 12 per cent to £132.2 billion, reﬂecting strong growth in consumer lending and mortgages, higher lending in Corporate Markets and the acquisition of a UK corporate loan portfolio from Danske Bank which added risk-weighted assets of some £2.0 billion. The Group continues to plan for risk-weighted asset growth of mid-to-high single digits over the next few years, and expected proﬁt retentions are sufﬁcient to support this level of risk-weighted asset growth within the Group’s current capital management policy. Proﬁt retentions for 2004 totalled £507 million. 12 LLOYDS TSB GROUP Operating and financial review and prospects Scottish Widows continues to be one of the most strongly capitalised life assurance companies in the UK. We remain satisﬁed with the overall capital position of Scottish Widows when calculated using the Financial Services Authority’s (FSA) new ‘realistic’ basis of balance sheet reporting, and the ﬁrst Individual Capital Assessment under the new FSA regime has been completed and shows that our capital requirements are well covered. At the end of December 2004 the working capital ratio of the Scottish Widows Long-Term Fund, applying the FSA’s new realistic basis, was an estimated 19.0 per cent. The required risk capital margin was covered over nine times. Scottish Widows has also paid a 2004 dividend of £200 million to Lloyds TSB reﬂecting the start of an expected regular dividend stream. Recognising the Group’s high existing dividend payout ratio, and reﬂecting a desire to maintain capital ﬂexibility to continue making value enhancing acquisitions, such as the acquisition of Danske Bank’s UK corporate loan portfolio in December 2004, the board has decided to maintain the ﬁnal dividend at 23.5p per share to make a total for the year of 34.2p per share. This represents a dividend yield for shareholders of 7.2 per cent, calculated using the 31 December 2004 share price of 473p. LLOYDS TSB GROUP 13 Operating and financial review and prospects UK Retail Banking Net interest income Other income Total income Operating expenses Trading surplus Provisions for bad and doubtful debts Share of results of joint ventures Proﬁt before tax Proﬁt before tax, before provisions for customer redress Cost:income ratio, before provisions for customer redress Total assets (year-end) Total risk-weighted assets (year-end) † Restated, as explained on page 3. 2004 £m 3,198 1,639 4,837 (2,513) 2,324 (673) – 1,651 1,751 49.9% £101.6bn £60.5bn 2003† £m 3,137 1,533 4,670 (2,583) 2,087 (594) (22) 1,471 1,671 51.0% £90.5bn £54.1bn Proﬁt before tax from UK Retail Banking increased by £180 million, or 12 per cent, to £1,651 million, compared to £1,471 million in 2003, supported by continued strong growth in the Group’s consumer lending portfolios, partly offset by lower product margins, higher current account credit balances, improved current account fee income, tight cost control and a lower provision for customer redress. Excluding the impact of provisions for customer redress, proﬁt before tax in UK Retail Banking increased by 5 per cent, with income growth of 4 per cent and cost growth of 1 per cent. During 2004, we completed the restructure of our retail branch network through the establishment of 165 proﬁt centred local markets. Initially, we particularly focused on developing our business in the London and South East markets where Lloyds TSB is currently under represented. Good progress has been made and, in our test markets, we achieved higher growth in quality customer recruitment, and greater improvement in levels of customer satisfaction than elsewhere in the branch network, and this is now starting to deliver an improved sales performance. In 2004, market shares were increased or maintained in most key product areas including gross and net new mortgage lending, personal loans and credit cards. Income, proﬁt and economic proﬁt per customer all improved during 2004. Strong growth in volumes was achieved with personal loans outstanding at 31 December 2004 of £10.7 billion, an increase of 12 per cent during the year, and card balances of £7.5 billion, an increase of 12 per cent. Gross new mortgage lending increased by 9 per cent to a record £26.3 billion, compared with £24.2 billion in 2003. Net new lending increased to £9.3 billion resulting in a market share of net new lending of 9.2 per cent, and mortgage balances outstanding increased by 13 per cent to £80.1 billion. Credit balances on current accounts and savings and investment accounts increased by 7 per cent. Within personal loans, key initiatives have been the increased use of behavioural and risk-based pricing, leveraging our customer relationship management capabilities to enable the Group to deliver more competitive pricing to better quality customers and to price by distribution channel within our existing customer base. 99 per cent of new personal loans, and 75 per cent of new credit cards, sold during 2004 were to existing customers, where the Group has a better understanding of an individual customer’s total ﬁnancial proﬁle. The Group has also continued to avoid sub-prime lending. Dynamic delinquency measures, on a rolling 12 month basis, show an improving position for new business written. We have also continued to rationalise back ofﬁce operations to improve efﬁciency and levels of customer service and satisfaction. Operating expenses were well controlled throughout the business and as a result, excluding provisions for customer redress, increased by only £30 million, or 1 per cent, to £2,413 million compared with 4 per cent growth in income during the year. The bad debt provisions charge increased by £79 million, or 13 per cent, to £673 million. £37 million of this increase reﬂected the acquisition in September 2003 of the Goldﬁsh credit card and personal lending portfolios with the remainder reﬂecting volume related asset growth in personal loan and credit card lending. The provisions charge as a percentage of average lending for personal loans and overdrafts fell to 4.20 per cent, from 4.25 per cent in 2003, while the charge in the credit card portfolio increased to 3.42 per cent, from 3.19 per cent in 2003. In the mortgages business, there was a net provision release of £42 million (2003: £18 million release), reﬂecting the continuing low level of losses in a climate of rising house prices and historically low interest rates. Overall, the provisions charge as a percentage of average lending was 0.71 per cent, compared to 0.72 per cent in 2003, and the arrears position remained satisfactory. C&G continues to focus on prime lending market segments, and has maintained its policy of not exceeding a 95 per cent loan-to-value ratio on new lending. The average indexed loan-to-value ratio on the C&G mortgage portfolio was 41 per cent (31 December 2003: 43 per cent), and the average loan-to-value ratio for C&G new mortgages and further advances written during 2004 was 62 per cent (2003: 62 per cent). At 31 December 2004, 88 per cent of C&G mortgage balances had an indexed loan-to-value ratio of less than 80 per cent and only 0.3 per cent of balances had an indexed loan-to-value ratio in excess of 95 per cent. 14 LLOYDS TSB GROUP Operating and financial review and prospects Customers are increasingly choosing to buy via direct channels and continued investment in our direct channel capabilities has supported good levels of business growth. Our internet bank now has 3 million registered users and, in 2004, 1.2 million product sales were achieved through the internet, an increase of 39 per cent compared to 2003. Over 400 million transactions were processed through internet banking, an increase of 60 per cent on 2003. Sales through direct channels now represent 50 per cent of total sales. Lloyds TSB remains a leader in the added value current account market, with over 4 million customers. Quality customer current account recruitment increased by 20 per cent, compared with 2003, whilst quality current account attrition was 11 per cent lower, reﬂecting improvements made in levels of process quality, customer service and customer satisfaction. LLOYDS TSB GROUP 15 Operating and financial review and prospects Insurance and Investments Life and pensions new business income Life and pensions distribution costs New business contribution Existing business: Expected return Experience variances Assumption changes and other items Provisions for customer redress Development costs Investment earnings Proﬁt before tax (life and pensions)* Unit trusts Unit trust distribution costs Proﬁt before tax (unit trusts) Proﬁt before tax (life, pensions and unit trusts)* General insurance* Scottish Widows Investment Partnership Proﬁt before tax* 2004 £m 419 (231) 188 300 (41) (39) 220 (12) (11) 167 552 75 (22) 53 605 160 8 773 Proﬁt before tax, excluding provisions for customer redress* New business margin (life and pensions) 785 28.6% † Restated, as explained on page 3. * Excluding changes in economic assumptions and investment variance. 2003† £m 396 (241) 155 283 (16) (75) 192 (100) (13) 153 387 62 (38) 24 411 153 1 565 665 25.8% Proﬁt before tax from Insurance and Investments, excluding changes in economic assumptions, investment variance and customer redress provisions, increased by 18 per cent to £785 million, from £665 million in 2003. On the same basis, proﬁt before tax from our life, pensions and unit trust businesses increased by £106 million, or 21 per cent, to £617 million. The Group’s strategy to improve its proﬁt mix by focusing on more proﬁtable, less capital intensive, business whilst constantly seeking to improve process and distribution efﬁciency has led to a 21 per cent increase in new business contribution to £188 million. As a result of this improved capital efﬁciency, strong sales of pensions and single premium investments, and a reduced emphasis on certain lower return products such as stakeholder pensions, the life and pensions new business margin increased to 28.6 per cent, from 25.8 per cent in 2003. Proﬁt before tax from existing business, excluding provisions for customer redress, increased by £28 million, or 15 per cent, to £220 million. The expected return from existing business, which largely reﬂects the unwinding of the long-term discount rate applied to the expected cash ﬂows from the Group’s portfolio of in-force business, was £17 million, or 6 per cent, higher at £300 million. During 2004, there was a net charge of £80 million from changes in actuarial assumptions and experience variances, compared to a net charge of £91 million in 2003. Higher margins, lower distribution costs and an improved stock market performance led to a signiﬁcant improvement in the proﬁt before tax from unit trusts, despite a reduction in the level of unit trust sales. Pre-tax proﬁt from Scottish Widows Investment Partnership (‘SWIP’) increased to £8 million, compared with £1 million in 2003, reﬂecting improved market performance and increased revenues from new business. SWIP won a record £2.1 billion of gross new business in 2004 and increased its assets under management by 6 per cent to £82 billion. The investment performance of ﬁxed income and property remained strong in 2004. Corporate composite bonds outperformed the market in the three year period to 31 December 2004, and the principal property unit- linked funds have performed in the top quartile in each of the last three years. UK and European equity performance has shown steady improvement over 2004 and UK equities within SWIP’s largest institutional funds have been signiﬁcantly ahead of the benchmark in the second half of 2004. SWIP has introduced a new simpliﬁed fund range to support Lloyds TSB’s bancassurance offer. Overall, weighted sales in 2004 increased to £743.1 million, compared to £733.4 million in 2003 with 10 per cent growth in IFA sales to £431.6 million. Direct sales grew by 17 per cent to £72.2 million, while branch network sales were 14 per cent lower at £238.9 million largely reﬂecting the wider market trend of lower single premium unit trust sales. In life and pensions, supported by growth in all channels, weighted sales increased by 9 per cent to £656.7 million, resulting in an increase in the Group’s market share to 7.5 per cent, from 7.0 per cent in 2003. Through the branch network and direct channels, the Group’s market share increased to 8.9 per cent, from 7.8 per cent in 2003, whilst the Group’s market share in the IFA market improved to 7.0 per cent, from 6.7 per cent in 2003. 16 LLOYDS TSB GROUP Operating and financial review and prospects 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 advisers Direct Other, including International Life, pensions and unit trusts Group funds under management: Scottish Widows Investment Partnership UK Wealth Management International General insurance 2004 £m 656.7 86.4 743.1 238.9 431.6 72.2 0.4 743.1 2004 £bn 82 13 13 108 2003 £m 601.7 131.7 733.4 278.8 391.6 61.6 1.4 733.4 2003 £bn 77 11 15 103 Proﬁt before tax, excluding investment variance, from our general insurance operations increased by £7 million, or 5 per cent, to £160 million. Continued progress in improving levels of business retention and higher product margins led to premium income from underwriting increasing by £19 million, or 4 per cent. Home insurance income increased by 8 per cent. Insurance broking commission income decreased by £18 million as a £26 million increase in income from creditor insurance was offset by a £47 million reduction in other commissions, reﬂecting lower proﬁt sharing income. There was a signiﬁcant improvement in broking income from creditor insurance in the second half of the year, partly reﬂecting improvements in personal loan and credit card penetration rates. The business strategy to increase investment in more cost efﬁcient distribution through direct channels is starting to create a shift from face-to-face channels towards direct channels. As a result gross written premiums from new policies sold through direct channels increased by 12 per cent in 2004. Gross written premiums for new policies sold via the internet increased by 37 per cent. Claims fell by £12 million to £224 million, compared to 2003, and the claims ratio fell to 38 per cent compared with 42 per cent in 2003, reﬂecting benign weather conditions and improved leverage of the supply chain. The combined ratio relating to the underwriting business was 83.2 per cent in 2004. Premium income from underwriting: Creditor Home Health Reinsurance premiums Commissions from insurance broking: Creditor Home Health Other Proﬁt before tax* † Restated, as explained on page 3. * Excluding investment variance. 2004 £m 114 442 27 (29) 554 377 30 19 160 586 160 2003† £m 104 410 43 (22) 535 351 30 16 207 604 153 LLOYDS TSB GROUP 17 Operating and financial review and prospects Wholesale and International Banking Net interest income Other income Total income Operating expenses Trading surplus Provisions for bad and doubtful debts Amounts written off ﬁxed asset investments (Loss) proﬁt on sale of businesses Proﬁt before tax Cost:income ratio* Total assets (year-end) Total risk-weighted assets (year-end) † Restated, as explained on page 3. * Excluding trading results of discontinued operations. 2004 £m 1,966 1,641 3,607 (2,090) 1,517 (193) (52) 1,272 (15) 1,257 57.9% £113.0bn £71.1bn Continuing operations 2003† £m 1,875 1,561 3,436 (2,048) 1,388 (306) (44) 1,038 – 1,038 Discontinued operations 2003 £m 511 142 653 (272) 381 (63) – 318 865 1,183 Total 2003† £m 2,386 1,703 4,089 (2,320) 1,769 (369) (44) 1,356 865 2,221 59.6% £101.3bn £62.8bn Wholesale and International Banking proﬁt before tax, excluding proﬁt/loss on sale of businesses and trading results of discontinued operations, increased by £234 million, or 23 per cent, to £1,272 million, from £1,038 million in 2003. On the same basis income growth of 5 per cent exceeded cost growth of 2 per cent, leading to an improvement in the cost:income ratio to 57.9 per cent. Our focus on cross-selling and capital efﬁciency has led to an increase in the post-tax return on average risk-weighted assets to 1.42 per cent compared with 1.23 per cent in 2003. In Wholesale, there was strong proﬁt growth in Corporate Markets, Business Banking and Asset Finance, in addition to a reduction in provisions for bad and doubtful debts. Excluding the trading results of businesses sold in 2003 net interest income increased by £91 million, or 5 per cent, reﬂecting higher income from improved margins in Corporate Banking and the Asset Finance businesses, and strong growth in customer lending in Asset Finance. Other income increased by £80 million, partly as a result of a £50 million increase in gains on the sales of assets, largely the realisation of venture capital investments by Lloyds TSB Development Capital. Costs were tightly controlled, 2 per cent higher at £2,090 million, reﬂecting higher staff related costs and increased investment spend within Corporate Markets, partially offset by lower operating lease depreciation within Asset Finance. The charge for provisions for bad and doubtful debts decreased by £113 million to £193 million. The charge in Wholesale fell by £68 million to £232 million, as a result of a decrease in provisions from the corporate lending portfolio, partially offset by higher charges in the Asset Finance business. In International Banking there was a credit of £39 million mainly reﬂecting a £30 million release from the general provision against the Group’s exposures in Argentina. We continue to deepen customer relationships, and the creation of an integrated regional sales structure, bringing together product specialists with relationship managers, has already started to generate positive results, with a 59 per cent increase in cross-selling income within Corporate Markets including an 86 per cent increase in Financial Markets cross-selling income to £69 million in 2004. In Corporate Markets, which incorporates Corporate Banking, Structured Finance and Financial Markets, proﬁt before tax grew by 25 per cent from £504 million in 2003 to £631 million, reﬂecting an increase in the contribution from both relationship and transactional business driven by a combination of higher income and a reduction in provisions. In December 2004, we agreed the acquisition of a UK corporate loan portfolio from Danske Bank comprising some 110 relationships, with total assets of £1.2 billion and risk-weighted assets of some £2.0 billion. The transaction is expected to enable us to deepen the relationships we have with a number of our existing corporate customers and acquire some important new corporate relationships to support the growth within our Corporate Markets businesses. Proﬁt before tax in Business Banking grew by £23 million, or 22 per cent, to £126 million reﬂecting good growth in customer income and tight control of costs. Customer deposits rose by 3 per cent to £10.3 billion and customer lending increased by 9 per cent to £6.0 billion. Business Banking continued to grow its customer franchise, with net customer recruitment of some 12,000 during the year, regaining leadership in the start-up market with a share of 22 per cent in 2004. Proﬁt before tax in Lloyds TSB Asset Finance increased by 27 per cent to £202 million, compared with £159 million in 2003, largely reﬂecting the continued proﬁtable development of the motor and leisure, and contract hire businesses. In the personal and retail finance business, new business volumes have increased by some 9 per cent, increasing market share. Lloyds TSB Commercial Finance has retained market leadership, measured by client numbers, with a 19 per cent market share, and the motor and leisure business continues to be the largest independent lender in the UK motor and leisure point of sale market with a market share of 20 per cent. In International Banking, proﬁt before tax, excluding the proﬁt/loss on sale of businesses and trading results of discontinued operations, increased by £27 million, or 21 per cent, to £157 million, reﬂecting a £45 million reduction in provisions, including a £30 million general provision release in Argentina. During 2004, the Group completed the sale of its businesses in Panama, Guatemala, Honduras, Argentina and Colombia resulting in a net loss on disposal of £15 million. 18 LLOYDS TSB GROUP Operating and financial review and prospects Central group items Accrual for payment to Lloyds TSB Foundations Other ﬁnance income Funding cost of acquisitions less earnings on capital Proﬁt on sale of emerging markets debt portfolio and certain closed foreign exchange positions Central costs and other unallocated items 2004 £m (31) 39 (342) – 1 (333) 2003† £m (31) 34 (345) 295 35 (12) † Restated, as explained on page 3. The four independent Lloyds TSB Foundations support registered charities throughout the UK that enable people, particularly disabled and disadvantaged, to play a fuller role in society. The Foundations receive 1 per cent of the Lloyds TSB Group’s pre-tax proﬁt after adjusting for gains and losses on the disposal of businesses and pre-tax minority interests, averaged over three years, instead of the dividend on their shareholdings. In 2004, the Group accrued £31 million for payment to the Lloyds TSB Foundations. During 2003 improved secondary bond market conditions allowed the Group to sell its remaining portfolio of emerging markets debt securities. Proﬁts on these bond sales, and certain closed foreign exchange positions, in 2003 totalled £295 million. LLOYDS TSB GROUP 19 Operating and financial review and prospects Risk management Risk as a strategic differentiator Risk awareness has improved signiﬁcantly. The ground work of embedding the risk governance framework has been completed and the challenge and support provided by specialist risk functions has been located closer to business units, whilst maintaining independence. This is reﬂected in dual reporting lines to both the chief risk director and business managers. Risk analysis has been strengthened and a new reporting system has been developed and implemented which better identiﬁes opportunities as well as risks, improves the ability to take an aggregate view of the overall risk portfolio and assigns clear responsibilities and timetables at Group and divisional level for risk mitigation strategies. Risk continues to be a key component of all routine management information reporting and is embedded in the balanced scorecards, which are cascaded to every member of staff. The objective is to go beyond risk mitigation and control to developing risk capabilities as a key strategic differentiator for Lloyds TSB. s e i t i l i b a p a C Regulatory requirements Differentiating excellence in risk management Defining and promoting effective use of the Group’s risk capacity Risk control Effectiveness Risk proﬁle Having worked to reduce risk and earnings volatility during 2003 by tactically selling part of our portfolio of businesses, this year’s focus has been more on improving the understanding of risk. Our credit disciplines are strong, which will leave us well positioned, should there be any adverse change in the economic climate during 2005 and as we selectively seek to increase our lending portfolios. Allied to this there has been a much closer alignment between risk and the strategic planning round both in terms of identifying risks to the delivery of the plans and change in risk appetite arising from those plans. Risk management framework Lloyds TSB Group uses an enterprise-wide framework for the identiﬁcation, assessment, measurement and management of risk, designed to meet its customers’ needs and maximise value for shareholders over time by aligning risk management with the corporate strategy; assessing the impact of emerging risks from new technologies or markets; and developing risk tolerances and mitigating strategies. The framework strengthens the Group’s ability to identify and assess risks; aggregate risks and deﬁne the corporate risk appetite; develop solutions for reducing or transferring risk, where appropriate; and exploit risks to gain competitive advantage, thereby seeking to increase shareholder value. Risks which the business assumes are broken down into eleven common risk drivers (shown on page 21). Business and divisional risk functions use this format when reporting risks centrally, to enable risk aggregation, and assessing risk levels of new products, change initiatives or business plans. Business executive committees, with divisional oversight, monitor their risk levels against their risk appetite; seeking to ensure effective mitigating action is being taken where appropriate and also that the risk appetite allocated to them is proﬁtability and prudently deployed. Divisional risk proﬁle reports are reviewed by the group business risk committee to seek to ensure that group executive directors and the chief risk director are aware of risk exposures and are comfortable these are being effectively managed. During the year a new group consolidated risk report was developed and implemented to further support the identiﬁcation and control of risk. The Group is developing an improved approach towards its risk appetite (deﬁned as the extent and categories of risk which the board regards as appropriate and acceptable for the Group to bear). Adoption of the principles and metrics under development has the objective of deriving Lloyds TSB’s risk appetite and processes explicitly from its strategic objectives and the commitments it makes to all its stakeholders (customers, shareholders, staff, debt holders and regulators). This work is ongoing. 20 LLOYDS TSB GROUP Operating and financial review and prospects Risk language Lloyds TSB Group has a risk language in which all risks are classiﬁed within one or more of the eleven risk drivers set out below. Governance, people and organisation Strategy Credit Market Insurance Operations Product and service Financial Customer treatment Legal and regulatory Change management Sub-risks have been developed for these high level risks to further reﬁne the identiﬁcation and classiﬁcation of risk and enable risk events to be accurately categorised to facilitate analysis of root causes. Governance, people and organisation risk, operations risk, customer treatment risk, legal and regulatory risk, and change management risk are collectively managed as operational risks. A more detailed language has been identiﬁed for these operational risks. The Group’s high level policies and reporting to the group business risk committee, risk oversight committee, audit committee and board are aligned to the risk drivers. Risk governance The changing regulatory environment faced by the Group’s businesses, and developments in best practice, prompted the Group during 2003 to extensively review its risk governance structures and deliver more effective risk management. The process of embedding these changes has progressed during 2004 and is now substantially complete. In addition, further enhancements were made during the year with a solid reporting line established between the divisional risk ofﬁcers and the chief risk director. Board and committees Lloyds TSB board Audit committee Risk oversight committee Group executive committee Group chief executive Group executive directors Chief risk director Group asset and liability committee Group business risk committee Risk management oversight Business risk management Director of group audit Divisional risk officers Group Risk Business risk functions Board and board committees Direct reporting line Management committees Functional reporting line to support committees Personnel Functions The risk oversight responsibilities of the board, audit committee and risk oversight committee are shown in the corporate governance section on pages 43 and 44, whilst further key risk oversight roles are described below. The group executive committee, assisted by its sub-committees the group business risk committee and the group asset and liability committee, supports the group chief executive in ensuring the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, and reviews the Group’s aggregate risk exposures and concentrations of risk. The group executive committee’s duties are described more fully on page 44. LLOYDS TSB GROUP 21 Operating and financial review and prospects Directors of the Group’s businesses have primary responsibility for measuring, monitoring and controlling risks within their areas of accountability and are empowered to establish control frameworks for their businesses that are consistent with the Group’s high level policies and within the parameters set by the board, group executive committee, Group Risk and the divisional risk ofﬁcers. The policies and parameters are overseen by the risk oversight committee, the group business risk committee, the group asset and liability committee, Group Risk and the divisional risk ofﬁcers. The chief risk director, a member of the group executive committee, oversees and promotes the development and implementation of a consistent group wide risk management framework and provides objective challenge to the group executive committee. Group Risk supports the chief risk director in performing the role. Divisional risk ofﬁcers provide oversight of risk management activity within each of the Group’s operating divisions. Reporting directly to the group executive directors responsible for the divisions, their day-to-day contact with business management, business operations and risk initiatives, provides an effective risk oversight mechanism. They meet regularly with the chief risk director to enable best practice to be shared and to provide a wide ranging and current perspective on material risks facing the Group. The director of group audit provides the required independent assurance to the board and audit committee that risks within the Group are recognised, monitored and managed within acceptable parameters. Group Audit is fully independent of Group Risk, ensuring objective challenge to the effectiveness of the risk governance framework. Accountability of line management has also been reinforced in relation to the management of risks arising from its business and in developing the risk awareness and risk management capability of its staff. A key objective is to ensure that business decisions strike an appropriate balance between risk and reward, consistent with the Group’s risk appetite. As shown on page 21, business management forms part of a tiered risk management model, with the divisional risk ofﬁcers providing oversight and challenge, as described above, and the chief risk director and Group committees establishing the group wide perspective. The model seeks to provide the Group with an effective mechanism for developing and promulgating risk policies and risk management strategies which are aligned with the risks faced by its businesses. It also facilitates more effective communication on these matters across the Group. These arrangements will enable the Group to better anticipate and pre-empt risks, and to manage more effectively those risks which crystallise. Reﬂecting the importance the Group places on risk management, risk is one of the ﬁve principal criteria that it includes in its balanced scorecard on which individual staff performance is judged. Business executives have speciﬁed risk management objectives, and incentive schemes take account of performance against these. There is an annual control self-assessment exercise under which key businesses and head ofﬁce functions across the Group review speciﬁc controls and certify the accuracy of their assessments. Basel The Capital Requirements Directive will come into force for all European banks at the start of 2007, although the ﬁnal rules to be applied in the UK are only likely to be published in 2006. These will be subject to further consultation, and the Lloyds TSB Group has been playing a full part with the regulatory authorities in attempting to shape them. The Group aspires to an Internal Ratings Based approach to credit risk and an Advanced Measurement Approach to operational risk. Accordingly, a considerable investment is being made in order to meet the standards required for these more advanced approaches. As well as meeting the compliance imperative, beneﬁts to the Group will accrue through further enhancement of our risk management and capital allocation capabilities. 22 LLOYDS TSB GROUP Operating and financial review and prospects Credit risk Deﬁntion This is the risk of loss arising from counterparty default subsequent to the provision of credit facilities (both on- and off-balance sheet). Lloyds TSB Group has dedicated standards, policies and procedures for the measurement, control and monitoring of credit and related risks. Control Group rating system. All business units operate an authorised rating system complying with the Group’s standard methodology. The Group uses a ‘Master Scale’ rating structure with ratings corresponding to a range of probabilities of future default. Portfolio analysis. With Group Risk, businesses identify and deﬁne portfolios of credit and related risk exposures and the key benchmarks, behaviours and characteristics by which those portfolios are managed in terms of credit risk exposure. This entails the production and analysis of regular portfolio monitoring reports for review by Group Risk. To enhance further the ability to measure and predict future risk, the Group continues to develop new policies and risk management systems. 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. Cross-border and cross-currency exposures. Country limits are authorised and managed by a dedicated unit taking into account economic and political factors. Concentration risk. The formulation of concentration limits on certain industries and sectors. Group Risk sets sector caps that reﬂect risk appetite, and monitors exposures to prevent excessive concentration of risk. Credit derivatives. These are a method of transferring credit risk from one counterparty to another and of managing exposure to selected counterparties. Credit derivatives include credit swaps, credit spread options and credit linked notes. The Group has limited exposure to such instruments. Credit risk arising from the use of derivatives. Note 47 shows the total notional principal amount of interest rate, exchange rate and equity and other contracts outstanding at 31 December 2004. 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 47. 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. 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: • High-level credit policies designed to ensure a balanced and managed approach to the identiﬁcation and mitigation of credit risk. • Lending guidelines deﬁning the responsibilities of lending ofﬁcers seek to provide a disciplined and focused benchmark for credit decisions. • Independent review of credit exposures at divisional and group level. • Sector caps, encompassing both industry sectors and speciﬁc product types are established by Group Risk to communicate the Group’s risk appetite for speciﬁc types of business, primarily in the non-retail markets. • Establishment and maintenance of the Group’s large exposure and provisioning policies, in accordance with regulatory reporting requirements. • Monitoring of scorecards. The Group uses statistically-based decisioning techniques (primarily credit scoring and performance scoring) for its principal consumer lending portfolios. Group Risk reviews and monitors new and material changes to scorecards. • Maintenance of a facilities database. Group Risk operates a centralised database of large corporate, sovereign and bank facilities designed to monitor aggregate exposure 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, seeking to ensure an acceptable distribution of 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 is primarily the responsibility of the relevant business director. Businesses have established credit policies and processes reﬂecting Group policy. Businesses’ lending authorities are delegated by ofﬁcers holding divisional lending authority. All material authorities are advised to Group Risk. Credit quality is supported by specialist units established within the 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. Credit risk exposures in the insurance businesses arise primarily from holding investments and from exposure to reinsurers. Control is exercised over those exposures through a suitable combination of formal limits, credit policy parameters and high level committee oversight. LLOYDS TSB GROUP 23 Operating and financial review and prospects Market risk Deﬁnition Market risk is the risk of loss arising from unexpected changes in ﬁnancial prices, including interest rates, exchange rates and bond, commodity and equity prices. It arises in all areas of Lloyds TSB Group’s activities and is managed by a variety of different techniques. The Group’s banking activities expose it to the risk of adverse movements in interest rates or exchange rates, with little or no exposure to equity or commodity risk. The Group’s insurance activities also expose it to market risk. The Group’s pension schemes are exposed to signiﬁcant risks from the constituent parts of their assets, primarily equity and interest rate risk, and from the present value of their liabilities. Control Limits to control market risk in respect of trading positions are recommended by the group asset and liability committee, subject to review by Group Risk, to the group executive committee and authorised in total by the board. A combination of position and sensitivity limits is used, depending on the nature of the business activity. The group asset and liability committee, through Group Treasury for trading centres, ensures appropriate delegation to businesses. Trading is restricted to a number of specialist centres, authorised by Group Treasury, the most important centre being Financial Markets in London. The level of exposure is strictly controlled and monitored within approved limits by Group Treasury. 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 (including 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 are shown in the proﬁt and loss account as dealing proﬁts and losses. Market risk in the wholesale banking books is managed in the UK by Financial Markets in London, 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 Treasury. Active management of the book is necessary to meet customer requirements and changing market circumstances. Market risk in the Group’s retail portfolios 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 Group Balance Sheet Management. Limits to control interest rate risk within the Group’s UK retail portfolios are set out in the policy for group balance sheet management, which is established by the group asset and liability committee and ratiﬁed by the Group board. The policy is to optimise the stability of future net interest income, and this is achieved by entering into hedging transactions using interest rate swaps and other ﬁnancial instruments. Both short and long-term interest rate parameters are applied to management of the balance sheet. Some centres have, in addition, adopted benchmark proﬁles for investment of interest rate insensitive liabilities as approved by Group Treasury. Derivatives 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 seek to ensure that there are no undue concentrations of activity and risk. Market risk exposures from the insurance businesses are controlled via approved investment policies consistent with the Group’s overall risk appetite and regularly reviewed by the group asset and liability committee. The group asset and liability committee liaises with the pension scheme trustees with regard to strategies for the overall mix of pension scheme assets. Trading risk exposures from banking activities The primary measure within the Group is the Value at Risk (VaR) methodology, which incorporates the volatility of relevant market prices and the correlation of their movements. Based on the commonly used 95 per cent conﬁdence level, assuming positions are held overnight and using observation periods of the preceding three years, the VaR for the years ended 31 December 2004 and 2003 based on the Group’s global trading positions was as detailed in the table below (the table also aggregates potential loss measures from options portfolios). Interest rate risk Foreign exchange risk Equity risk Total VaR (no diversiﬁcation) 31 December 2004 31 December 2003 Closing £m Average £m Maximum £m Minimum £m Closing £m Average £m Maximum £m Minimum £m 0.7 0.2 0.0 0.9 0.9 0.3 0.0 1.3 1.7 0.6 0.0 2.0 0.5 0.2 0.0 0.8 0.7 0.3 0.0 1.0 0.8 0.7 0.0 1.5 1.8 1.0 0.1 2.6 0.3 0.3 0.0 0.9 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. Stress testing and scenario analysis are also used in certain portfolios, and at Group level, to simulate extreme conditions to supplement these core measures. The risk of loss measured by the VaR model is the potential loss in earnings. The total and average trading VaR does not assume any diversiﬁcation beneﬁt across the three risk types. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported as a whole. There are some limitations to the VaR methodology: • The model assumes that changes in the underlying asset returns can be modelled by a normal distribution. This assumption is an approximation of reality that may not reﬂect all circumstances. • The use of a conﬁdence limit does not convey any information about potential losses on occasions when the conﬁdence limit is exceeded. In times of extreme market movements actual losses may be signiﬁcantly greater than the VaR number. Stress testing is used to supplement VaR to estimate the impact of extreme events. • Any model that forecasts the future based on historic data is implicitly assuming that the conditions that generated the data will remain true in the future. Stress testing and using more than one VaR methodology for some local markets form part of the wider market risk framework. 24 LLOYDS TSB GROUP Operating and financial review and prospects • Periods of severe market illiquidity, both in terms of the extent of the illiquidity and the time that it lasts, could mean that it might not be possible to hedge, or close, all positions in the timescales assumed in the VaR model. • VaR is calculated at the close of business each day, which excludes the proﬁt and loss impact of intra-day trading. • VaR is not well suited to options positions. As a result these positions are controlled by additional sensitivity limits. In summary, although VaR is an important component of the Group’s approach to managing trading market risk, it is supplemented by position and sensitivity limits and stress testing. Structural interest risk exposures from banking activities The Group’s non-trading exposure is summarised in the form of an interest rate repricing table, as set out in note 47b to the ﬁnancial statements. 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. The simulation models used by the Group include assumptions about the relationships between customer behaviour and the level of interest rates; the anticipated level of future business is also taken into account. The accuracy of these assumptions will impact the efﬁciency of hedging transactions. The assumptions are regularly updated and the projected exposure is actively managed in accordance with group asset and liability committee policy. It is estimated that a hypothetical immediate and sustained 100 basis point increase in interest rates on 1 January 2005 would decrease net interest income by £80.7 million for the 12 months to 31 December 2005, while a hypothetical immediate and sustained 100 basis point decrease in interest rates would increase net interest income by £76.3 million. An analysis by currency is shown below. UK £m North America £m Asia & Europe & Australasia Middle East £m £m Total 2005 £m Total 2004 £m Change in net interest income from a +100 basis point shift in yield curves Change in net interest income from a –100 basis point shift in yield curves (48.7) 3.5 (1.0) (34.5) (80.7) (88.3) 44.3 (3.5) 1.0 34.5 76.3 84.0 The analysis above is subject to certain simplifying assumptions including, but not limited to, all rates of all maturities worldwide move simultaneously by the same amount; all positions in the wholesale books run to maturity; and there is no management action in response to movements in interest rates, in particular no changes to product margins. In practice, positions in both the retail and wholesale books are actively managed and actual impact on net interest income may be different to the model. In the Group’s retail portfolios, including mortgages, and in the Group’s capital funds, exposure arises from the different repricing characteristics of the Group’s banking assets and liabilities and is managed by Group Balance Sheet Management under the direction of the group asset and liability committee. Liabilities arising in the course of business from the Group’s retail banking business fall into two broad categories: • those which are insensitive to interest rate movements, non-interest bearing liabilities such as shareholders’ funds and interest-free or very low interest current account deposits; and • those which are sensitive to interest rate movements, primarily savings deposits bearing interest rates which are varied at the Group’s discretion (‘managed rate liabilities’) but which for competitive reasons generally reﬂect changes in the Bank of England’s base rate. There is a relatively small volume of naturally arising banking liabilities whose interest rate is contractually ﬁxed typically for periods of up to two years. Most banking assets, with the exception of such non-interest earning items as premises, are sensitive to interest rate movements. There is a large volume of managed rate assets such as variable rate mortgage loans and these may be considered as a natural offset to managed rate liabilities. However many assets, such as personal loans and ﬁxed rate mortgages, bear interest which is contractually ﬁxed for periods of up to ﬁve years or longer. Interest rate risk arises from the mismatch between interest rate insensitive liabilities and interest rate sensitive assets, and between the differing contractual periods for which interest rates are ﬁxed on interest rate sensitive assets and liabilities. Group Balance Sheet Management manages this risk centrally by offsetting against each other any matching interest rate sensitive assets and liabilities; acquiring new ﬁnancial assets and liabilities as matching hedges against net balances of mismatched interest rate sensitive banking liabilities and assets, respectively; and acquiring new ﬁnancial assets with interest rates contractually ﬁxed for a range of periods up to ﬁve years as hedges for net balances of interest rate insensitive liabilities. The ﬁnancial assets and liabilities referred to above are acquired by way of internal transactions between Group Balance Sheet Management and Financial Markets in London, typically in the form of interest rate swaps and loans or deposits. Structural interest rate risk can also arise from the wholesale banking books in the UK, where it is managed by Financial Markets in London, and internationally, where it is managed by an authorised local treasury operation in each overseas centre. The levels of exposure within these books are controlled and monitored within approved limits locally and centrally. Limits are issued to the international businesses on interest rate gaps or, where more appropriate, VaR. Foreign exchange exposures from banking activities Foreign exchange exposures comprise those originating in treasury trading activities and structural foreign exchange exposures, which arise from investment in the Group’s overseas operations. The corporate and retail businesses incur foreign exchange risk in the course of providing services to their customers. These risks reside in the authorised trading centres who are allocated exposure limits. The limits are monitored daily by the local centres and reported to Group Treasury. Group Treasury calculates the associated VaR as shown in the table on the previous page. Risk arises from the Group’s investments in its overseas operations. The Group’s structural foreign currency exposure is represented by the net asset value of the holding company’s foreign currency exchange equity and subordinated debt investments in its subsidiaries and branches. Gains or losses on structural foreign currency exposures are taken to retained earnings. LLOYDS TSB GROUP 25 Operating and financial review and prospects The structural position is managed by Lloyds TSB Group Capital Funds having regard to the currency composition of the Group’s risk-weighted assets and reported to the group asset and liability committee on a monthly basis. The objective is to limit the effect of exchange rate movements on the published risk asset ratio. The Group’s structural position at 31 December 2004 is set out in note 47d to the ﬁnancial statements. The position implies that at 31 December 2004 a hypothetical increase of 10 per cent in the value of sterling against all other currencies would have led to an £82 million reduction in reserves, and vice versa. On this basis, there would have been no material impact on Lloyds TSB Group’s risk asset ratios. Market risk exposures in the insurance businesses Market risk exposure depends upon the nature of the funds in question: • With-proﬁts funds are managed in accordance with the relevant fund’s Principles and Practices of Financial Management. This leads to assets and liabilities that are mismatched with the aim of generating a higher rate of return to meet policyholders’ expectations. • Unit-linked liabilities are matched with the same assets that are used to deﬁne the liability but future fee income is dependent upon the performance of these assets. • For other insurance liabilities the investment strategy is determined by the term and nature of the underlying liabilities and asset/liability matching positions are actively monitored. The aim is to invest in assets such that the cash ﬂows on the investments will match those on the projected future liabilities. Actuarial tools are used to project and match the cash ﬂows. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result the cash ﬂows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch. • Investment strategy for surplus assets held in excess of liabilities takes account of the regulatory and internal business requirements for capital to be held to support the business now and in the future. Surplus assets are held primarily in three portfolios: the surplus in the non-participating fund within the Long-Term Fund of Scottish Widows plc, assets in shareholder funds of life assurance companies and an investment portfolio within the General Insurance business. Market risks are monitored using stochastic modelling. The surplus in the Non-Participating Fund of Scottish Widows plc exists to provide the Long-Term Fund with liquidity and working capital. The surplus also forms a capital reserve to support the investments managed on behalf of the With-Proﬁts Fund of Scottish Widows plc. With-proﬁts business involves guaranteed beneﬁts; in adverse market conditions the surplus could be called upon to support with-proﬁts beneﬁts. As a consequence this fund is currently invested in a mix of equities, investment properties, ﬁxed interest investments and cash that takes into account the mix in the With-Proﬁts Fund. This investment policy helps maintain the value of the reserve as a proportion of the underlying With-Proﬁts Fund. The existence and investment mix of the surplus in the Non-Participating Fund can therefore be considered as structural rather than as a traded portfolio. Under UK GAAP the portfolio is shown at market value and gains and losses are recognised in the proﬁt and loss account. Assets held in shareholder funds are invested in money market funds, gilts and investment grade bonds so as to reduce the risk of statutory insolvency in the event of market crashes. The General Insurance portfolio is invested in a mixture of assets: cash, bonds and equities. The investment policy together with appropriate limits including the limit to be applied to the equity component are approved by the group asset and liability committee supported by Group Risk. Investment holdings are diversiﬁed across markets and, within markets, across sectors. Holdings of individual assets are diversiﬁed to minimise speciﬁc risk and large individual exposures are monitored closely. For assets held outside unit-linked funds, investments are only permitted in countries and markets which are sufﬁciently regulated and liquid. 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 approved policy and the customer mandate. Options and guarantees are incorporated in new insurance products only after careful consideration of the risk management issues that they present. This occurs as part of the new product approval process (see ‘Product and service risk’ on page 28). The composition, and value, of both the Scottish Widows plc Non-Participating Fund and the General Insurance portfolio are reported to Group Risk on a monthly basis and a VaR is calculated which is presented to the group asset and liability committee. The risk of loss measured by the VaR model is the potential loss in earnings over a given time horizon. The VaR methodology used is the same in all respects to that used for the traded risk in banking activities, except that in the case of equity risk, the model maps the portfolio composition onto a series of appropriate indices by region and sector. In addition the risks are calculated based on a 99 per cent conﬁdence level and a ten day holding period. The ﬁgures quoted below are the sum of the two portfolios with no allowance for diversiﬁcation between portfolios or asset classes and represents the potential loss in earnings. The following table shows closing, average, maximum and minimum VaR for the years ended 31 December 2004 and 2003 on a 99 per cent conﬁdence ten day basis. 31 December 2004 31 December 2003 Closing £m Average £m Maximum £m Minimum £m Closing £m Average £m Maximum £m Minimum £m 15.5 2.4 55.2 73.1 16.1 2.7 54.2 73.0 17.9 3.4 56.4 75.9 11.2 2.2 51.6 67.1 15.1 3.6 52.1 70.8 16.3 4.0 63.0 83.3 24.3 4.6 80.0 107.5 13.2 3.3 51.8 70.8 Interest rate risk Foreign exchange risk Equity risk Total VaR 26 LLOYDS TSB GROUP Operating and financial review and prospects Insurance risk Deﬁnition The risk of loss arising from the sensitivity of proﬁts to movements in insurance claims, expenses and persistency experience and expectation. It also covers the risk of inadequate underwriting and/or reinsurance of insured risks and movements in the cost of providing beneﬁts from the Group’s pension schemes that result from social and demographic factors. Control Control is exercised primarily through a suitable combination of high level committees/boards. For the life assurance businesses the key control body is the Scottish Widows plc board with the more signiﬁcant risks also being subject to approval by the Lloyds TSB group executive committee and/or the Lloyds TSB Group board. For the general insurance businesses the key control body is Lloyds TSB Insurance executive committee with the more signiﬁcant risks again being subject to Lloyds TSB group executive committee and/or Lloyds TSB Group board approval. All Group pension scheme issues are covered by the group asset and liability committee. Insurance risks are measured through deterministic studies of the impact of different insurance market scenarios on the future free assets of the business together with relevant stochastic modelling. Limits are used as a control mechanism for insurance risk at policy level. Insurance risk exposures Some insurance risks are retained while others are reinsured with external underwriters. The retained risk level is carefully controlled and monitored, with close attention being paid to the analysis of underwriting experience, claims management, product design, policy wordings, adequacy of reserves, solvency management and regulatory requirements. General Insurance exposure to accumulations of risk and possible catastrophes is mitigated by reinsurance arrangements which are broadly spread over different reinsurers. Detailed modelling, 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 with signiﬁcant mortality risk and morbidity risk being transferred to our chosen reinsurers. Options and guarantees are incorporated in new insurance products only after careful consideration of the risk management issues that they present. This occurs as part of the new product approval process (see ‘Product and service risk’ on page 28). Expenses are monitored by an analysis of the Group’s experience relative to budget. Reasons for any signiﬁcant divergence from expectation are investigated and remedial action taken. Persistency rates are regularly assessed by reference to appropriate risk factors. Operations risk Deﬁnition The risk of loss resulting from inadequate or failed internal processes and systems, or from people related or external events. For internal purposes, reputational impact is also included. Control Businesses have primary responsibility for identifying and managing their operations risks. They employ internal control techniques to reduce their likelihood or impact to tolerable levels within the Group’s risk appetite. Where appropriate, risk is mitigated by way of insurance. The Group has deﬁned high-level operations risk policies to seek to ensure a wide-ranging and consistent approach to the identiﬁcation and management of operations risk and a standard methodology to ensure consistency in the identiﬁcation, assessment and management of operations risk. Group Risk provides general guidance on operations risk related issues, including regulatory changes and developments in the measurement and management of operations risk, to promote best practice throughout the Group. It keeps under continuous review and improvement all aspects of operations risk management to reﬂect developments in industry best practice and regulatory requirements. The Group applies appropriate new product review processes to provide assurance that risks inherent in new products have been identiﬁed and mitigated. 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. The Group’s business is regulated overall by the Financial Services Authority (’FSA’), and additionally by local regulators in offshore and overseas jurisdictions. Control Each business has a nominated individual with ‘compliance oversight’ responsibility under FSA rules. The role of such individuals is to ensure that management has 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. All compliance personnel also have a reporting line to the group compliance director, who sets compliance standards across the Group and provides independent reporting and assessment to the board and business directors. 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 worldwide ﬁght against ﬁnancial crime. The group compliance director has access to the chairman, group chief executive and members of senior management. LLOYDS TSB GROUP 27 Operating and financial review and prospects Customer treatment risk Deﬁnition The risk of ﬁnancial loss or reputational damage arising from inappropriate or poor customer treatment or failure to treat customers fairly. Control Lloyds TSB Group is committed to the fair treatment of its customers. A range of management information measures is in place across the Group to support the tracking of key customer treatment indicators. Group Risk and Group Audit are required to report regularly on customer treatment risk, management information trends and on compliance with the Group’s standards. 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. A framework is in place to guide the consideration and documentation of customer treatment risk when developing policies and procedures. The Group has deﬁned benchmark standards in all the key areas. The divisions are required to meet or exceed these standards. Trends across all the CARE Index categories are monitored and fed into a programme of continuous customer service improvement. The Group also provides its staff with clear FSA compliant guidelines and processes for dealing with customer complaints. Strategy risk Deﬁnition This comprises the risks arising from the adoption of the Group’s agreed strategy and its implementation at corporate or business level. At corporate and business level these risks are managed through a number of processes. Control An annual strategic planning process is conducted at Lloyds TSB Group and business level and includes a quantitative and qualitative assessment of the risks in the Group’s plan. The Group’s strategy and those of its constituent businesses are reviewed and approved by the board. Regular reports are provided to the group executive committee and the board on the progress of the Group’s key strategies and plans. Group Risk conducts oversight to ensure the business plans remain consistent with the Group’s strategy. Revenue and capital investment decisions require additional formal assessment and approval. Formal risk assessment is conducted as part of the ﬁnancial approval process. Signiﬁcant 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 conducts, where appropriate, an independent risk assessment of the target company and its proposed integration into the Lloyds TSB Group. A common approach is applied across the Group to assess the creation of shareholder value. This is measured by economic proﬁt (the proﬁt attributable to shareholders, less a notional charge for the equity invested in the business). The focus on economic proﬁt allows the Group to compare the returns being made on capital employed in each business. The use of risk-based economic capital and regulatory capital is closely monitored at business and Group level. The Group’s economic capital model covers credit, market, insurance, business and operational risks. 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. For the Group to achieve its objective to maximise value for shareholders over time, product life cycles must be effectively managed and new products developed to meet customer needs. Control The Group is committed to the fair treatment of its customers. This is embedded into the processes indicated below to ensure businesses have developed customer centric strategies for product and business development, marketing, selling and after sales service. Businesses maintain a range of products to meet customers’ needs and the business strategy and are responsible for managing and controlling product risks and compliance with applicable regulations. Product planning and development. Businesses have formal processes for reviewing the range of their product portfolios and subject all product development to rigorous assessment. The assessment includes seeking to ensure that the product meets clearly deﬁned customer needs. Product promotion, distribution and sales. Businesses have a deﬁned channel distribution strategy for products, consistent with the Group’s distribution strategy. Businesses launching new products are responsible for ensuring compliance with all applicable regulations and that the proposed sales activity is appropriate for the type of customer and their attitude to risk. All advertising and marketing material is required to comply with the Group’s governing policy on business conduct. Businesses are required to have procedures in place to ensure that the material is fair, clear and not misleading bearing in mind the knowledge and sophistication of the customer. Any statement of fact should be substantiated through documentary evidence; any comparison should be made in a fair and balanced way; and any reference to past performance should clearly state the basis of measurement. Businesses are required, prior to 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. Procedures require that terms and conditions (to include mandates, agreements and other documentation) are approved by legal advisers and reviewed periodically. 28 LLOYDS TSB GROUP Operating and financial review and prospects 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 level. In line with deﬁned policy, businesses provide divsional 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. Businesses are required to demonstrate that new products meet clearly deﬁned customer needs and that the sales process mitigates the risks of unsuitable sales. Where appropriate, technical advice/approval is sought from specialist functions. Only new products carrying the approval of divisional risk management and the businesses involved in their manufacture/delivery are offered to customers. Product performance. Businesses establish and monitor performance standards for all marketed products across a range of indicators, for example sales volumes, customer service and risk proﬁle. Signiﬁcant deviations from these standards are investigated and appropriate action taken. 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. Control 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 ensure appropriate control across the project portfolio and the approach is regularly benchmarked against other organisations around the world. Changes that signiﬁcantly impact customers or staff are managed as part of an overall change plan managed by the Group’s change management committee. The committee ensures that the aggregate impact of the implementation of change on customers, staff and systems is understood, managed and controlled. Governance, people and organisation Deﬁnition This is the risk of loss from poor corporate governance at Group and business level. It includes sub-optimal organisational structuring, or failure to recruit, manage and retain appropriately skilled staff to achieve business objectives. Group policy for managing governance, people and organisation risk is deﬁned in the Group Policy Manual. It deﬁnes the way the Group is organised, the need for tight ﬁnancial and operating controls, maintenance of a strong risk management and control culture, the need to benchmark against industry best practice and for businesses to conduct themselves with integrity, due skill, care and diligence. Control 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 management. Sound internal risk management practices are promoted through business directors who are ultimately 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 seeks to ensure effective and efﬁcient operational management; reliability, integrity and consistency of ﬁnancial and other reporting; and compliance with governing laws and regulations. Business directors seek to ensure that material risks are reported to the relevant divisional risk ofﬁcer, group executive director and to Group Risk. Information and communication. It is the Group’s policy for the board and senior management at both Group and business level to receive relevant, reliable and timely management information in line with business objectives to seek to ensure that activities are appropriately controlled, key risks are identiﬁed and monitored, decisions are implemented and regulatory obligations are met. Audit responsibilities and rights. Group Audit has unrestricted access to all functions, property, records and staff. It independently reviews adherence to the policies and processes that make up the control environment, disseminating best practices throughout the Group in the course of its monitoring and corrective action activities. The director of group audit reports to and meets regularly with the group chief executive and periodically with the audit committee. 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 has a code of business conduct, which applies to the group chief executive, the group ﬁnance director, and all other employees. It seeks to ensure that employees act with integrity and endeavour 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. The code as amended from time to time is available to the public on the Group’s website at www.lloydstsb.com. 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. It manages and measures employees’ performance and contribution to collective goals and recognises the contribution of individuals in the context of the pay market and the performance of the business in which they work and rewards appropriately. Training and development. The Group believes that long-term success depends on the quality and skills of its staff and that it has a joint responsibility with employees for their personal and career development to improve current performance and to enhance future prospects. LLOYDS TSB GROUP 29 Operating and financial review and prospects Financial soundness Deﬁnition The risk of ﬁnancial failure arising from lack of liquidity or capital, poor management or poor quality/volatile earnings. Liquidity risk is deﬁned as the risk of a loss arising from the Group’s inability to meet its ﬁnancial obligations as they fall due. These obligations include the repayment of deposits on demand or at their contractual maturity; the repayment of loan capital and other borrowings as they mature; the payment of insurance policy beneﬁts, claims and surrenders; the payment of lease obligations as they become due; the payment of operating expenses and taxation; the payment of dividends to shareholders; the ability to fund new and existing loan commitments; and the ability to take advantage of new business opportunities. 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 FSA, are set out in detail on page 31. Control A policy is in place which requires a common methodology to 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. The Group complies with the FSA’s liquidity requirements and with similar liquidity policies in place across all trading centres worldwide. Compliance is monitored by regular liquidity returns to Group Treasury. Work is ongoing to ensure the Group’s compliance with the new liquidity framework being proposed by the FSA. 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. 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 Treasury. For non-linked funds investments are arranged to minimise the possibility of being a distressed seller whilst at the same time investing to meet policyholder obligations. For unit-linked business, deferral provisions are designed to give time to realise linked assets without being a forced seller. Lloyds TSB 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 2004. Informally, a further buffer is maintained. In addition, the board has agreed a maximum limit of the proportion of debt instruments in the capital base. Risk-weighted assets are monitored by businesses, while capital is controlled centrally. 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. The Group seeks to use appropriate accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates. 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. Group Finance requires businesses and reporting entities to follow common processes and reporting standards. Businesses or reporting entities have formal month-end and quarter-end procedures in place for preparation of management and ﬁnancial accounts respectively, review and approval of management accounts at a determined level of detail, ensuring consistency with ﬁnancial accounts, and preparation of forecasts and detailed annual budgets that are subject to formal review and approval. They are further required to implement measures to monitor performance at local level to identify signiﬁcant ﬂuctuations or unusual activity. Liquidity sources The principal sources of liquidity for Lloyds TSB Group plc are dividends received from its directly owned subsidiary company, Lloyds TSB Bank, and loans from this and other Lloyds TSB Group companies. The ability of Lloyds TSB Bank to pay dividends, or for Lloyds TSB Bank or other Lloyds TSB Group companies to make loans to Lloyds TSB Group plc, depends on a number of factors, including their own regulatory capital requirements, distributable reserves and ﬁnancial performance. Lloyds TSB Group plc is also able to raise funds by issuing loan capital or equity, although in practice Lloyds TSB Group plc has never issued equity for this purpose and the majority of Lloyds TSB Group’s loan capital has been issued by Lloyds TSB Bank. As at 31 December 2004, Lloyds TSB Group plc had £1,358 million of subordinated debt in issuance compared with £10,252 million for the consolidated Lloyds TSB Group. The cost and availability of subordinated debt ﬁnance are inﬂuenced by credit ratings. A reduction in these ratings could increase the cost and could reduce market access. At 31 December 2004, the credit ratings of Lloyds TSB Bank were as follows: Moody’s Standard & Poor’s Fitch Senior debt Aaa AA AA+ The ratings outlook from Moody’s and Fitch for Lloyds TSB Bank is stable. The Standard & Poor’s rating outlook is negative. These credit ratings are not a recommendation to buy, hold or sell any security; and each rating should be evaluated independently of every other rating. 30 LLOYDS TSB GROUP Operating and financial review and prospects A signiﬁcant part of the liquidity of the Group’s banking businesses arises from their ability to generate customer deposits. A substantial proportion of the customer deposit base is made up of current and savings accounts which, although repayable on demand, have traditionally provided a stable source of funding. During 2004, amounts deposited by customers increased by £5,566 million from £116,496 million at 31 December 2003 to £122,062 million at 31 December 2004. These customer deposits are supplemented by the issue of subordinated loan capital and wholesale funding sources in the capital markets, as well as from direct customer contracts. Wholesale funding sources include deposits taken on the inter-bank market, certiﬁcates of deposit, sale and repurchase agreements, a Euro Medium Term Note programme, of which £5,097 million had been utilised for senior funding at 31 December 2004, and a commercial paper programme, under which £3,281 million had been utilised at 31 December 2004. The ability to sell assets quickly is also an important source of liquidity for the Group’s banking businesses. The Group holds sizeable balances of marketable debt securities which could be disposed of to provide additional funding should the need arise. Capital ratios The international standard for measuring capital adequacy is the risk asset ratio, which relates regulatory capital to balance sheet assets and off-balance sheet exposures weighted according to broad categories of risk. The Group’s regulatory capital is divided into tiers deﬁned by the European Community Banking Consolidation Directive as implemented in the UK by the FSA’s Interim Prudential Sourcebook for Banks. Tier 1 comprises mainly shareholders’ funds, tier 1 capital instruments and minority interests, after deducting goodwill and other intangible assets. Tier 2 comprises general bad debt provisions, and qualifying subordinated loan capital, with restrictions on the amount of general provisions and loan capital which may be included. The amount of qualifying tier 2 capital cannot exceed that of tier 1 capital. Total capital is reduced by deducting investments in subsidiaries and associates which are not consolidated for regulatory purposes and investments in the capital of other credit/ﬁnancial institutions. In the case of Lloyds TSB Group, this means that the net assets of its life assurance and general insurance businesses are deducted from the Group’s regulatory capital. Risk-weighted assets are determined according to a broad categorisation of the nature of each asset or exposure and counterparty and, for the trading book, by taking into account market-related risks. Capital: Tier 1 Tier 2 Supervisory deductions Total regulatory capital Total risk-weighted assets Risk asset ratios: Total capital Tier 1 Post-tax return on average risk-weighted assets 31 December 2004 £m 11,725 8,800 20,525 (7,252) 13,273 132,173 10.0% 8.9% 2.01% 31 December 2003 £m 11,223 8,935 20,158 (6,898) 13,260 117,732 11.3% 9.5% 2.63% At 31 December 2004, the risk asset ratios were 10.0 per cent for total capital and 8.9 per cent for tier 1 capital. The 8.9 per cent tier 1 capital ratio appears higher than would perhaps be expected and reﬂects the higher level of supervisory deductions resulting from the Group’s signiﬁcant investment in its life assurance operations. The Group’s capital management policy is focused on optimising value for shareholders. There is a clear focus on delivering organic growth and expected capital retentions are sufﬁcient to support planned levels of growth. However, management also wishes to maintain the ﬂexibility to make value enhancing ‘in market’ acquisitions and therefore, at this stage, there are no plans to return capital to shareholders other than by way of dividend payments. Management will keep all options for the utilisation of capital under review. There are strict limits imposed by the regulatory authorities as to the proportion of the Group’s regulatory capital base that can be made up of subordinated debt and preferred securities. The Group’s capacity to raise new debt capital for regulatory purposes increases as proﬁts are retained; at 31 December 2004, the Group had capacity to raise approximately £2,900 million of tier 2 debt capital, compared to approximately £2,300 million at 31 December 2003. This increase reﬂects the effects of retained proﬁts and favourable exchange rate movements. The unpredictable nature of movements in the value of the investments supporting the long-term assurance funds could cause the amount of qualifying tier 2 capital to be restricted because of falling tier 1 resources. The Group seeks to ensure that even in the event of such restrictions the total capital ratio will remain adequate. During 2004, total capital for regulatory purposes increased by £13 million to £13,273 million. Tier 1 capital increased by £502 million, mainly as a result of proﬁt retentions. However, tier 2 capital decreased by £135 million largely due to the reduction in the Group’s general bad debt provision. There was an increase in supervisory deductions of £354 million, mainly as a result of an increase of £300 million in the long-term assurance business attributable to the shareholder to £6,781 million, from £6,481 million in December 2003. LLOYDS TSB GROUP 31 Operating and financial review and prospects Corporate responsibility Lloyds TSB Group has long recognised the importance of corporate responsibility (sometimes described as corporate social responsibility). It is one of the UK’s largest corporate givers; it has award winning policies in equality and diversity, employee relations and training and development; and, it has leading edge systems for the assessment of environmental risks in lending. This track record is reﬂected in sector leading performance in a variety of corporate responsibility indices, league tables and investor ratings. The Group recognises that social, ethical and environmental (SEE) issues bring both risks and opportunities. The Group’s full response to such issues is detailed in its separate corporate responsibility report, The community and our business, (see page 9 for details). The Group has a corporate responsibility steering committee chaired by the deputy group chief executive and comprising the senior executives of those businesses most directly affected by SEE issues. The committee meets quarterly to recommend strategy and direction. The board reviews overall corporate responsibility performance annually and individual issues are subject to board discussion throughout the year. During 2003, the Group introduced a human rights policy and in 2004 has conducted a self-assessment audit that conﬁrms compliance with the policy in all countries of operation. The board believes that the systems in place to manage signiﬁcant SEE risks are effective and provide adequate information to identify and assess the short and long-term risks arising from SEE matters. One of the most signiﬁcant risks is that posed by climate change, which affects the whole business of insurance – claims, regulation, investment returns and operating costs. Storm and ﬂood damage claims in the UK have doubled to £6 billion since 1998. Lloyds TSB Insurance recognises this risk and is working with the Association of British Insurers and the government to prevent further building on ﬂood plains. In addition it offers advice to homeowners on how to protect their properties against extreme weather conditions. These measures have ensured that Lloyds TSB Insurance is currently able to continue offering cover to renewing customers in areas considered prone to ﬂooding, while managing its exposure through pricing and underwriting controls. The board is satisﬁed that relevant corporate responsibility risks have been assessed during 2004 and that they do not pose a material threat to the Company. During 2004 the Group further embedded its balanced scorecard as a tool to support the business strategy and values and to provide a means to balance the needs of customers, staff and shareholders. The balanced scorecard seeks to ensure that staff performance is measured on customer service, building customer relationships, people management and assessment of risk as well as sales and ﬁnancial measures. Where appropriate, management remuneration and incentives are linked directly to speciﬁc areas of corporate responsibility performance: for example service quality. Robust internal audit systems are in place to review adherence to policies and procedures and environmental performance is subject to external independent veriﬁcation. Overall, the board is satisﬁed that the Company complies with its corporate responsibility related policies and procedures. 32 LLOYDS TSB GROUP Operating and financial review and prospects Future accounting developments International Financial Reporting Standards From 1 January 2005, the Group is using International Financial Reporting Standards (‘IFRS’) as its primary ﬁnancial reporting framework. The Group will report IFRS results for the ﬁrst time in its interim report for the six months to 30 June 2005 and in its 2005 annual report. Comparative information in these reports will be fully reconciled to reported UK GAAP numbers. As a 2005 ﬁrst-time adopter of IFRS, the Group is required to prepare an opening balance sheet as at 1 January 2004. Most accounting policy adjustments to apply IFRS retrospectively will be made against retained earnings in this opening balance sheet. However, transitional adjustments relating to those standards for which comparatives are not required to be restated will be made on 1 January 2005. Restated comparatives are not required for IAS 32 Financial Instruments: Disclosure and Presentation, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 4 Insurance Contracts. A steering committee has been overseeing the adoption of IFRS for the Group and has closely monitored developments in IFRS and the impact for the Group’s accounting policies and ﬁnancial position. Work streams evaluated the impact of speciﬁc accounting changes and undertook signiﬁcant work during 2004 including technical analysis, development of IFRS-compliant solutions and project management of necessary systems and process changes. The Group has been preparing its internal management accounts using IFRS since 1 January 2005. The overall impact on net assets and earnings up to 1 January 2005 is not expected to be signiﬁcant. From 1 January 2005 there will be impacts arising from changes in the fair values of ﬁnancial assets and liabilities, and volatility arising from ineffective hedges. The future impact for fee income, lease accounting and accounting for insurance business will depend on the mix of business and the rate of new business growth. The following areas have been identiﬁed as having the greatest impact upon the Group. Area of impact IFRS treatment Loan impairment Equity to debt reclassiﬁcation Fee income Goodwill Derivatives, hedging and investment securities IFRS adopts an incurred loss model for impairment losses on loans and provides guidance on the measurement of impairment. An allowance is raised for losses in respect of exposures that are known to be impaired. The required allowance is computed by comparing the book value of the loans with the net present value of the expected future cash ﬂows from the loans discounted at their effective interest rates or, as a practical expedient for variable rate loans, using observable market prices. Exposures found not to be impaired are placed into pools of similar assets with similar risk characteristics to be collectively assessed for losses that have been incurred, but not yet identiﬁed. For such exposures, the required allowance is estimated on the basis of historical loss experience for assets with credit risk characteristics similar to those in the collective pool. The historical loss experience is adjusted based on current observable data. These more prescriptive requirements are expected to lead to increased volatility in the charge made to the income statement. The classiﬁcation of the majority of the Group’s capital and subordinated debt instruments will continue to follow their current treatment. However, the limited voting ordinary shares of Lloyds TSB Group plc will be reclassiﬁed as debt. In addition, the Group’s preferred securities, which are treated as non-equity minority interests under UK GAAP, will be reclassiﬁed as debt. Distributions on these securities will be shown as interest expense rather than as minority interests. Revised rules governing the accounting for fee income will result in more fees being deferred on initial receipt, and recognised either as an adjustment to yield or over the period of service. Fees required to be treated as an adjustment to yield will be recognised in interest income rather than fee income. On initial application, certain fees that have previously been credited to the proﬁt and loss account under UK GAAP will be recognised in the balance sheet, with a corresponding reduction in retained earnings. The current Group policy of amortising goodwill arising on acquisitions after 1 January 1998, with the exception of the goodwill which arose on the acquisition of Scottish Widows, will cease. Instead, all goodwill will be subject to impairment testing annually, or more frequently if events or circumstances indicate that it might be impaired. This change in policy will result in increased volatility of future earnings in the event that impairment losses are identiﬁed. All derivatives contracts will be carried at fair value on the Group’s balance sheet and movements in their fair value reﬂected in the income statement. The resulting income statement volatility can be mitigated by the application of hedge accounting. IFRS permits the use of two kinds of hedge accounting: fair value and cash ﬂow hedge accounting. The Group is expected to make greater use of fair value hedge accounting which seeks to match, in the income statement, changes in the fair values of the hedged items with the changes in the fair value of the related derivatives. Cash ﬂow hedge accounting is expected to be used to a lesser extent; adjustments reﬂecting the movements in the fair values of the derivatives concerned are made to a separate reserve in equity and recycled to the income statement as the related cash ﬂows occur. IFRS contains detailed requirements for documentation of hedge relationships and testing their effectiveness. To the extent that a hedge is ineffective, the impact is reﬂected in the income statement. An adjustment will be made against retained earnings on transition to eliminate the effects of the asymmetrical accounting for derivative transactions entered into between the Group’s banking and trading activities. Investment securities are classiﬁed as either held-to-maturity investments, available-for-sale ﬁnancial assets or at fair value through proﬁt or loss. While many of the Group’s investment securities will be classiﬁed as available-for-sale and will be required to be measured at fair value with changes in their fair values going to a separate reserve in equity, investment securities backing insurance business will be designated at fair value through proﬁt or loss. Derecognition of ﬁnancial liabilities Under IFRS a ﬁnancial liability may only be derecognised after it has been settled or alternatively the debtor has been legally released from the liability, either by process of law or by the creditor. Upon adoption of IFRS, certain ﬁnancial liabilities previously released to the proﬁt and loss account will be reinstated. Consolidation of subsidiaries and Special Purpose Entities IFRS requires line-by-line consolidation for all subsidiaries. Consequently, the Group is no longer permitted to report the results and balances of the life assurance business on one line; instead these amounts must be broken down into their constituent parts and allocated to the appropriate line items. IFRS will also require consolidation of several entities that the Group was not required to consolidate under UK GAAP. These relate to the entities supporting the Group’s securitisation conduits, which facilitate customers’ own securitisations, and to Open Ended Investment Companies (OEICs) where the Group, through the Scottish Widows life funds, has an interest. This will have the effect of grossing-up the balances reported in the income statement and on the balance sheet. LLOYDS TSB GROUP 33 Operating and financial review and prospects Area of impact Netting Insurance Depreciation Dividends Capitalisation of software Leasing Share-based payments IFRS treatment IFRS prohibits ﬁnancial assets and ﬁnancial liabilities from being offset unless there is a legal right of set-off and the asset and liability are normally settled on a net basis. In the banking business, this will result in the grossing-up on the balance sheet of assets and liabilities subject to set-off arrangements that are presented net under UK GAAP. In the case of insurance business, insurance liabilities will be presented without offsetting them against related reinsurance assets. Under IFRS, investment contracts without discretionary participation features (DPF) do not meet the deﬁnition of an insurance contract and are accounted for as ﬁnancial instruments. The Group’s life assurance business will continue to account for insurance contracts and DPF investment contracts as it has under UK GAAP. The signiﬁcant IFRS impacts are the removal of that portion of the UK GAAP embedded value which represents the value of in-force business relating to investment contracts, the recognition of an asset for deferred acquisition costs (DAC) in connection with writing new investment contract business and the deferral of fee income (as discussed above), which for the life assurance business represents up-front income in respect of investment contracts sold. The DAC asset is amortised over the lives of the related contracts. For the Group’s general insurance operation, claims equalisation provisions are no longer permitted under IFRS. The majority of the required adjustments will be made against retained earnings at 1 January 2005. In addition to the impact for depreciation of operating lease assets outlined below, IFRS requires property, plant and equipment to be depreciated since the date of acquisition. Under UK GAAP, long leasehold and freehold properties have been depreciated only since 1 January 2000. There will be no effect upon the Group’s income statement until the properties concerned are disposed of at which point any gain on sale will increase or any loss will be reduced. Under IFRS equity dividends declared after the balance sheet date may not be included as a liability at the balance sheet date. Consequently, the 2003 ﬁnal dividend will be adjusted against opening retained earnings at 1 January 2004. Currently only software costs relating to separable new systems are capitalised. Under IFRS, costs relating to enhancements that lead to additional system functionality will also be capitalised. The impact on the Group’s income statement will depend on the level of IT expenditure and whether it meets the criteria for capitalisation. IFRS requires income from ﬁnance leases to be credited to the income statement so as to give a constant pre-tax rate of return on the net cash invested; UK GAAP requires a constant post-tax rate of return. In addition, IFRS requires depreciation on operating lease assets to be charged on the same basis as for tangible ﬁxed assets which for the Group is a straight-line basis. Under UK GAAP depreciation is charged so as to give a constant rate of return on the leased asset. IFRS requires that a cost be recognised in the ﬁnancial statements for all options granted under executive and employee Save-As-You-Earn share option schemes. The total cost recognised represents the fair value of the options (as determined using an option valuation model) at the grant date, as adjusted for the expected number of forfeitures and, for executive schemes, the probability that the performance target will not be met. This total cost is spread over the period to vesting. This will result in an increase in the costs recognised in the Group’s income statement as under UK GAAP only the intrinsic value of executive share options is charged to the proﬁt and loss account. 34 LLOYDS TSB GROUP Operating and financial review and prospects FRS 27 In December 2004 the UK Accounting Standards Board (‘ASB’) issued FRS 27 Life Assurance setting out changes to the way in which life assurance business should be accounted for and requiring certain additional disclosures; this standard is effective for accounting years ending on or after 23 December 2005. Although technically not applicable to those reporting under International Financial Reporting Standards in 2005, under the terms of a Memorandum of Understanding entered into between leading members of the life assurance and bancassurance sectors and the Association of British Insurers and the ASB, the Group has committed to implementing the requirements of FRS 27 in 2005 and providing additional disclosures in its 2004 accounts. These disclosures are set out below. Following the implementation of FRS 27 in 2005 the Group will be required to: • exclude from the value of in-force business recognised in the balance sheet any amounts that reﬂect future investment margins; and • measure the liabilities of the Scottish Widows With-Proﬁts Fund in accordance with the FSA’s realistic capital regime, subject to certain speciﬁed adjustments. Consequential adjustments are made to the related assets. The exclusion of future investment margins will result in an adjustment to retained earnings as at 1 January 2004 and will lead to increased volatility in the reported income from long-term assurance business. The principal subsidiaries involved in the Group’s life assurance operations during the year were Scottish Widows plc (‘Scottish Widows’, the Group’s principal provider of life assurance, pensions and investment products, which holds the only large with-proﬁts fund managed by the Group), Scottish Widows Annuities Limited (a subsidiary of Scottish Widows that accepts the reinsurance of annuity business from its parent), Abbey Life Assurance Company Limited (‘Abbey Life’) and Lloyds TSB Life Assurance Company Limited (‘Lloyds TSB Life’). Since March 2000 both Abbey Life and Lloyds TSB Life have continued to administer existing policies and have undertaken only limited new business. No change in this activity is anticipated in respect of Abbey Life. On 31 December 2004, Lloyds TSB Life ceased trading and transferred most of its assets and insurance business to Scottish Widows. Basis of determining regulatory capital of the life assurance business Available capital resources Available capital resources represent the excess of assets over liabilities calculated in accordance with detailed regulatory rules issued by the FSA. Different rules apply depending on the nature of the fund, as detailed below. Statutory basis. Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. With the express permission of the FSA, an intangible asset can be recognised which represents the present value of future releases of prudent margins on business written. The liabilities are calculated using a projection of future cash ﬂows after making prudent assumptions about matters such as investment return, expenses and mortality. Discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the FSA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for with-proﬁts policies that are at the discretion of the Company, but does include a value for policyholder options likely to be exercised. ‘Realistic’ basis. The FSA requires each life assurance company which contains a with-proﬁts fund in excess of £500 million, including Scottish Widows, to carry out a ‘realistic’ valuation of that fund. The word ‘realistic’ in this context reﬂects the terminology used for reporting to the FSA and is an assessment of the ﬁnancial position of a with-proﬁts fund calculated under a prescribed methodology. The methodology has the effect of limiting the assumed average future investment return to the risk free rate and represents a best estimate of a theoretical market value of the liabilities. The valuation of with-proﬁts assets in the With-Proﬁts Fund on a realistic basis differs from the valuation on a statutory basis as, in respect of non-proﬁts business written in the With-Proﬁts Fund, it includes the present value of the anticipated future release of the prudent margins for adverse deviation. The realistic valuation uses the market value of assets without the limit affecting the statutory basis noted above. The realistic valuation of liabilities is carried out using a stochastic simulation model which values liabilities on a basis consistent with tradable market option contracts (a ‘market-consistent’ basis). The model takes account of policyholder behaviour on a best-estimate basis and includes an adjustment to reﬂect future uncertainties where the exercise of options by policyholders might increase liabilities. Further details regarding the stochastic simulation model are given below in the section entitled ‘Options and guarantees’. Regulatory capital requirements Each life assurance company must retain sufﬁcient capital to meet the regulatory capital requirements mandated by the FSA; the basis of calculating the regulatory capital requirement is given below. For the companies described above, with the exception of Scottish Widows, the regulatory capital requirement is a combination of amounts held in respect of actuarial reserves and sums at risk (the Long-Term Insurance Capital Requirement) and amounts required to cover various stress tests. The regulatory capital requirement is deducted from the available capital resources to give ‘statutory excess capital’. For Scottish Widows, a further test is required in respect of the With-Proﬁts Fund which compares the level of ‘realistic excess capital’ to the ‘statutory excess capital’ of the With-Proﬁts Fund and, in circumstances where the ‘realistic excess capital’ position is less, the Company is required to hold additional capital to cover the shortfall. The ‘realistic excess capital’ is calculated as the difference between realistic assets and realistic liabilities of the With-Proﬁts Fund with a further deduction to cover various stress tests. Any additional capital requirement under this test is referred to as the With-Proﬁts Insurance Capital Component. The determination of realistic liabilities of the With-Proﬁts Fund in respect of Scottish Widows includes the value of internal transfers expected to be made from the With-Proﬁts Fund to the Non-Participating Fund of Scottish Widows. These internal transfers include charges on policies where the associated costs are borne by the Non-Participating Fund. The value of the transfers exceeds the value of the costs which, in the case of Scottish Widows, results in the somewhat artiﬁcial increase in the With-Proﬁts Insurance Capital Component of over £500 million. Constraints over available capital resources Scottish Widows was created following the demutualisation of Scottish Widows Fund and Life Assurance Society in 2000. The terms of the demutualisation are governed by a Court-approved Scheme of Transfer (the ‘Scheme’) which, inter alia, created a With-Proﬁts Fund and a Non-Participating Fund and established protected capital support for the with-proﬁts policyholders in existence at the date of demutualisation. Much of that capital support is held in the Non-Participating Fund and, as such, the capital held in that fund is subject to the constraints noted below. LLOYDS TSB GROUP 35 Operating and financial review and prospects Requirement to maintain a Support Account. The Scheme requires the maintenance of a ‘Support Account’ within the Non-Participating Fund. The quantum of the Support Account is calculated with reference to the value of assets backing current with-proﬁts policies which also existed at the date of demutualisation and must be maintained until the value of these assets reaches a minimum level. Assets can only be transferred from the Non-Participating Fund if the value of the remaining assets in the fund exceeds the value of the Support Account. Scottish Widows has obtained from the FSA permission to include the value of the Support Account in assessing the realistic value of assets available to the With-Proﬁts Fund. At 31 December 2004, the value of surplus admissible assets in the Non-Participating Fund was £2,222 million and the value of the Support Account was £1,265 million. Further Support Account. The Further Support Account is an extra tier of capital support for the with-proﬁts policies in existence at the date of demutualisation. The Scheme requires that assets can only be transferred from the Non-Participating Fund if the economic value of the remaining assets in the fund exceeds the aggregate of the Support Account and Further Support Account. Unlike the Support Account test, the economic value used for this test includes both admissible assets and the present value of future proﬁts of business written in the Non-Participating Fund or by any subsidiaries of that fund. The balance of the Further Support Account is expected to reduce to nil by the year 2030. At 31 December 2004, the net economic value of the Non-Participating Fund and its subsidiaries for the purposes of this test was £4,185 million and the combined value of the Support Account and Further Support Account was £2,704 million. Other restrictions in the Non-Participating Fund. The Scheme states that no amounts can be transferred from the Non-Participating Fund of Scottish Widows unless there are sufﬁcient assets within the Long-Term Fund to meet both policyholders reasonable expectations in light of liabilities in force at a year end and the new business expected to be written over the following year. Financial information calculated on a ‘realistic’ basis The estimated ﬁnancial position of the With-Proﬁts Fund of Scottish Widows at 31 December 2004, calculated on a ‘realistic’ basis, is given in the following table, in the form that the information will be reported to the FSA. As a result of the capital support arrangements, it is considered appropriate to also disclose the ‘realistic’ ﬁnancial position of the Long-Term Fund of Scottish Widows as a whole, which consists of both the With-Proﬁts Fund and the Non-Participating Fund. With-Proﬁts Fund £m Long-Term Fund £m Realistic value of assets of fund Support arrangement assets (value of ‘Support Account’) Realistic value of assets available to the fund Realistic value of liabilities of fund Working capital for fund Working capital ratio for fund 17,814 1,265 19,079 (18,108) 971 5.1% 22,012 – 22,012 (17,827) 4,185 19.0% Scottish Widows continues to be well capitalised with the working capital ratios for the With-Proﬁts Fund and the Long-Term Fund being an estimated 5.1 per cent and 19.0 per cent respectively. The realistic liabilities of the With-Proﬁts Fund disclosed above include amounts payable from the With-Proﬁts Fund to the Non-Participating Fund of Scottish Widows in respect of the shareholders’ share of future bonuses and other charges due as a result of the Scheme. The value of the liabilities excluding the shareholders’ share of future bonuses is £17,988 million. The value of the liabilities excluding the value placed on all interfund transfers is £17,353 million, and the value of excess assets in the With-Proﬁts Fund after eliminating those amounts (excluding the value of the Support Account) is £461 million. 36 LLOYDS TSB GROUP Operating and financial review and prospects The following table reconciles the value of the Long-Term Fund of Scottish Widows quoted above to the total shareholders’ funds attributable to the life assurance business of the Group, calculated on a modiﬁed statutory solvency basis: Total shareholders’ funds on a modiﬁed statutory solvency basis* (note 29) Adjustments to restate amounts onto an FSA statutory basis Available capital resources on an FSA statutory basis excluding the With-Proﬁts Fund Fund for future appropriations** Total available capital resources on an FSA statutory basis Capital resources held outside the Long-Term Fund of Scottish Widows Net effect of adjustments to restate amounts onto a realistic basis Excess assets in the Long-Term Fund of Scottish Widows on a realistic basis Life assurance business £m 4,581 (502) 4,079 1,354 5,433 (1,260) 12 4,185 * A reconciliation of the total shareholders’ funds on a modiﬁed statutory solvency basis (£4,581 million) to the amount included in the Group’s balance sheet on an embedded value basis (£6,781 million) is included in note 29(h) to the ﬁnancial statements. ** The fund for future appropriations included in the table relates to the With-Proﬁts Fund of Scottish Widows only; the ﬁgure disclosed in note 29(h) to the ﬁnancial statements (£1,379 million) includes £25 million in respect of the other life funds of the Group. Capital sensitivities Shareholders’ funds Shareholders’ funds outside the long-term business fund are mainly invested in assets that are less sensitive to market conditions. With-Proﬁts Fund The with-proﬁts realistic liabilities and the available capital for the With-Proﬁts Fund are sensitive to both market conditions and changes to a number of non-economic assumptions that affect the valuation of the liabilities of the fund. The available capital resources (and capital requirements) are most sensitive to the level of the stock market, with the position worsening at lower stock market levels as a result of the guarantees to policyholders increasing in value. An increase in the level of equity volatility implied by the market cost of equity put options also increases the market consistent value of the options given to policyholders and worsens the capital position. The most critical non-economic assumptions are the level of take-up of options inherent in the contracts (higher take up rates are more onerous), mortality rates (lower mortality rates are more onerous) and lapses prior to dates at which a guarantee would apply (lower lapse rates are generally more onerous where guarantees are in the money). The sensitivity of the capital position and capital requirements of the With-Proﬁts Fund is partly mitigated by the actions that can be taken by management. Other long-term funds Outside the With-Proﬁts Fund, assets backing actuarial reserves in respect of policyholder liabilities are invested so that the values of the assets and liabilities are broadly matched. The most critical non-economic assumptions are mortality rates in respect of annuity business written (lower mortality rates are more onerous). The Group has reduced its exposure to deteriorating mortality rates in respect of life assurance contracts through its reinsurance arrangements. In addition, poor cost control would gradually depreciate the available capital and lead to an increase in the valuation of the liabilities (through an increased allowance for future costs). Formal intra-group capital arrangements Scottish Widows has a formal arrangement with one of its subsidiary undertakings, Scottish Widows Unit Funds Limited, whereby the subsidiary company can draw down capital from Scottish Widows to ﬁnance new business which is reinsured from the parent to its subsidiary. Scottish Widows has also provided subordinated loans to its fellow group undertakings, Scottish Widows Annuities Limited and Scottish Widows Bank plc. LLOYDS TSB GROUP 37 Operating and financial review and prospects Options and guarantees The Group has sold insurance products that contain options and guarantees, both within the With-Proﬁts Fund and in other funds. Options and guarantees within the With-Proﬁts Fund The most signiﬁcant options and guarantees provided from within the With-Proﬁts Fund are in respect of guaranteed minimum cash beneﬁts on death, maturity, retirement or certain policy anniversaries, and guaranteed annuity options on retirement for certain pension policies. As noted above, under the realistic capital regime of the FSA, the liabilities of the With-Proﬁts Fund are valued using a market-consistent stochastic simulation model. This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value. The most signiﬁcant economic assumptions included in the model are: • Risk-free yield curve. This is derived from the yield on UK gilts, with an additional 0.1 per cent yield assumed to be risk-free; • Investment volatility. This is derived from derivatives where possible, or historical observed volatility where it is not possible to observe meaningful prices. As at 31 December 2004, the assumptions were set at 18 per cent for equities, 15 per cent for properties and 13 per cent for interest rates. The model includes a matrix of the correlations between each of the underlying modelled asset types. The correlations used are consistent with long-term historical returns. The most signiﬁcant non-economic assumptions included in the model are management actions (in respect of investment policy and bonus rates), guaranteed annuity option take up rates and assumptions regarding persistency (both of which are based on recent actual experience), and assumptions regarding mortality (which are based on recent actual experience and industry tables). Options and guarantees outside the With-Proﬁts Fund of Scottish Widows Abbey Life currently has a number of policies in-force which have a guaranteed annuity option. In total it holds statutory reserves of £288 million to cover this liability at 31 December 2004. These reserves have been determined using prudent future interest rate, mortality rate and rate of annuity option take-up assumptions and exceed the value that would be placed on them using a market-consistent stochastic model. It is estimated that a 0.5 per cent reduction in future interest rates would increase the liability by some £45 million. Under some of Abbey Life’s older contracts, the maturity value or the surrender value at the end of the selected period is guaranteed to be not less than total premiums paid or sums assured. The total provision for these options was £11 million at 31 December 2004 and was established using stochastic techniques after making prudent assumptions. In both Abbey Life and Scottish Widows, certain personal pension policyholders, for whom reinstatement to their occupational pension scheme was not an option, have been given a guarantee that their pension and other beneﬁts will correspond in value to the beneﬁts of the relevant occupational pension scheme. The key assumptions affecting the ultimate value of the guarantee are future salary growth, gilt yields at retirement, annuitant mortality at retirement, marital status at retirement and future investment returns. There is currently a provision, calculated on a deterministic basis, of £89 million in respect of those guarantees. If future salary growth were 0.5 per cent per annum greater than assumed, the liability would increase by some £6 million. If yields were 0.5 per cent lower than assumed, the liability would increase by some £15 million. 38 LLOYDS TSB GROUP Five year financial summary The ﬁnancial information set out in the table below has been derived from the annual reports and accounts of Lloyds TSB Group plc for each of the past ﬁve years adjusted for subsequent changes in accounting policy and presentation. The ﬁnancial statements for each of the years 2000 and 2001 were audited by PricewaterhouseCoopers, independent accountants; the ﬁnancial statements for each of the years 2002 to 2004 have been audited by their successor ﬁrm PricewaterhouseCoopers LLP, independent accountants. Proﬁt and loss account data for the year ended 31 December (£m) 1 Net interest income Other ﬁnance income Other income Trading surplus Provisions for bad and doubtful debts Proﬁt on ordinary activities before tax Proﬁt on ordinary activities after tax Proﬁt for the year attributable to shareholders Dividends Balance sheet data at 31 December (£m)1 Called-up share capital Shareholders’ funds (equity and non-equity) Customer accounts Undated subordinated loan capital Dated subordinated loan capital Loans and advances to customers Assets2 Total assets Share information 1 Basic earnings per ordinary share Diluted earnings per ordinary share Net asset value per ordinary share Dividends per ordinary share 3 Market price (year-end) Number of shareholders (thousands) Number of ordinary shares in issue (millions) 6 Financial ratios (%) 1,4 Dividend payout ratio Post-tax return on average shareholders’ equity Post-tax return on average assets Post-tax return on average risk-weighted assets Average shareholders’ equity to average assets Cost:income ratio 5 Capital ratios (%) 1 Total capital Tier 1 capital 2004 2003 2002 2001 2000 4,920 39 4,608 4,650 (866) 3,493 2,489 2,421 1,914 5,255 34 4,619 4,735 (950) 4,348 3,323 3,254 1,911 5,171 165 3,551 3,974 (1,029) 2,618 1,852 1,790 1,908 4,922 307 3,659 4,119 (747) 3,167 2,290 2,233 1,872 4,587 424 3,760 4,503 (541) 3,791 2,707 2,658 1,683 1,419 9,977 122,062 5,852 4,400 154,240 225,079 279,843 1,418 9,624 116,496 5,959 4,495 135,251 201,934 252,012 1,416 7,943 116,334 5,496 4,672 134,474 207,343 252,561 1,411 10,326 109,116 4,102 4,006 122,935 189,317 235,501 1,396 11,877 101,989 3,391 4,119 114,432 169,495 220,383 43.3p 43.0p 176p 34.2p 473p 953 5,596 79.1 24.3 1.17 2.01 4.7 51.4 10.0 8.9 58.3p 58.1p 170p 34.2p 448p 974 5,594 58.7 38.5 1.57 2.63 4.0 52.2 11.3 9.5 32.1p 32.0p 140p 34.2p 446p 973 5,583 106.6 16.8 0.93 1.62 5.4 55.3 9.6 7.7 40.4p 40.0p 183p 33.7p 746p 981 5,564 83.8 18.1 1.28 2.26 6.9 53.7 8.8 7.7 48.4p 47.9p 213p 30.6p 708p 1,026 5,507 63.3 21.2 1.68 3.08 7.8 48.7 8.6 7.9 1 Figures for 2002 and earlier years have been restated to reﬂect the implementation of UITF 37, Purchases and sales of own shares. UITF 38, Accounting for ESOP trusts, FRS 18, Accounting Policies, FRS 17, Retirement Beneﬁts, FRS 19 Deferred Tax, UITF 33 Obligations in Capital Instruments, detailed guidance from the Association of British Insurers for best practice in the preparation of results using the achieved proﬁts method of accounting and other minor adjustments. 2 Assets exclude long-term assurance assets attributable to policyholders. 3 Annual dividends comprise both interim and ﬁnal dividend payments. Final dividends (which are always paid in the following year) are included in the year to which they relate rather than in the year in which they are paid. 4 Averages are calculated on a monthly basis from the consolidated ﬁnancial data of Lloyds TSB Group. 5 The cost:income ratio is calculated as total operating expenses as a percentage of total income. 6 This ﬁgure excludes 79 million limited voting ordinary shares. LLOYDS TSB GROUP 39 The board (cid:2) + 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 62. David P Pritchard++ Deputy Chairman (leaving on 5 May 2005) Joined TSB Group in 1995 as group treasurer. Seconded to the Securities and Investments Board as head of supervision & standards, markets & exchanges, from 1996 to 1998. Appointed to the board in 1998, as group executive director, Wholesale and International Banking. Retired from executive duties in 2003, when he was appointed deputy chairman. Held senior and general management appointments with Citicorp from 1978 to 1986 and Royal Bank of Canada from 1986 to 1995. A non-executive director of LCH. Clearnet Group. Aged 60. Wolfgang C G Berndt ✠ †† Joined the board in 2003. Joined Procter and Gamble in 1967 and held a number of senior and general management appointments in Europe, South America and North America, before retiring in 2001. A non-executive director of Cadbury Schweppes and GfK AG. Board member of the Institute for the Future. Aged 62. Ewan Brown CBE FRSE (cid:4) **(cid:2) + Chairman of Lloyds TSB Scotland A director since 1999. A non-executive director of Lloyds TSB Scotland since 1997. Joined Noble Grossart in 1969 and was an executive director of that company until December 2003. Chairman of Transport Initiatives Edinburgh. A non-executive director of John Wood Group, Noble Grossart and Stagecoach Holdings. Aged 62. Gavin J N Gemmell CBE ✠ * Chairman of Scottish Widows Joined the board in 2002. A non-executive director of Scottish Widows, having been appointed to the board of that company before it became a member of the Lloyds TSB Group. 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 63. 40 LLOYDS TSB GROUP Non-executive directors Maarten A van den Bergh Christopher S Gibson-Smith David P Pritchard Sir Julian Horn-Smith Wolfgang C G Berndt DeAnne S Julius Ewan Brown Angela A Knight Gavin J N Gemmell Christopher S Gibson-Smith ✠ †(cid:2) (leaving on 5 May 2005) A director since 1999. Chairman of National Air Traffic Services and the London Stock Exchange. Joined BP in 1970, serving as managing director from 1997 to 2001, having held senior and general management appointments in the UK, USA, Canada and Europe. A non-executive director of The British Land Company. Aged 59. Sir Julian Horn-Smith✠ †+ Joined the board on 1 January 2005. Joined Vodafone in 1984 and held a number of senior and general management appointments before being appointed to the board of that company in 1996 and deputy chief executive officer in 2005. Previously held positions in Rediffusion from 1972 to 1982 and Mars GB from 1982 to 1984. A non-executive director of Smiths Group. Aged 56. DeAnne S Julius CBE ✠ †(cid:2) Joined the board in 2001. Held a number of senior appointments in the UK and USA with the World Bank, Royal Dutch/Shell Group and British Airways, before membership of the Bank of England Monetary Policy Committee from 1997 to 2001. Chaired HM Treasury’s banking services consumer codes review group in 2000/1. Chairman of the Royal Institute of International Affairs. A non-executive director of BP, Serco Group and Roche Holdings SA. Aged 55. Angela A Knight ✠ * Joined the board in 2003. Deputy chairman of Scottish Widows, having been appointed to the board of that company before it became a member of the Lloyds TSB Group. A member of parliament from 1992 to 1997 and Economic Secretary to the Treasury from 1995 to 1997. Chief Executive of the Association of Private Client Investment Managers and Stockbrokers. A non-executive director of LogicaCMG and the Port of London Authority. Aged 54. * Member of the audit committee ** Chairman of the audit committee (cid:2) Member of the nomination committee Chairman of the nomination committee † Member of the remuneration committee †† Chairman of the remuneration committee + Member of the risk oversight committee ++ Chairman of the risk oversight committee Independent director (cid:4) Senior independent director (cid:2) (cid:2) ✠ Executive directors J Eric Daniels G Truett Tate Michael E Fairey Helen A Weir Archie G Kane The board J Eric Daniels Group Chief Executive Joined the board in 2001 as group executive director, UK Retail Banking before his appointment as group chief executive in June 2003. Served with Citibank from 1975 and held a number of senior and general management appointments in the USA, South America and Europe before becoming chief operating officer of Citibank Consumer Bank in 1998. Following the Citibank/Travelers merger in 1998, he was chairman and chief executive officer of Travelers Life and Annuity until 2000. Chairman and chief executive officer of Zona Financiera from 2000 to 2001. Aged 53. 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. He is also acting as interim group executive director, UK Retail Banking. 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. President of The British Quality Foundation. Aged 56. Archie G Kane Group Executive Director, Insurance and Investments Joined TSB Commercial Holdings in 1986 and held a number of senior and general management appointments in Lloyds TSB Group before being appointed to the board in 2000, as group executive director, IT and Operations. Appointed group executive director, Insurance and Investments in October 2003. After some 10 years in the accountancy profession, joined General Telephone & Electronics Corporation in 1980, serving as finance director in the UK from 1983 to 1985. Aged 52. G Truett Tate Group Executive Director, Wholesale and International Banking Joined the Group in 2003 as managing director, Corporate Banking before being appointed to the board in 2004. Served with Citigroup from 1972 to 1999, where he held a number of senior and general management appointments in the USA, South America, Asia and Europe. He was president and chief executive officer of eCharge Corporation from 1999 to 2001 and co-founder and vice chairman of the board of Chase Cost Management Inc from 1996 to 2003. Aged 54. Helen A Weir Group Finance Director Joined the board in 2004. Group finance director of Kingfisher from 2000 to 2004. Previously finance director of B&Q from 1997, having joined that company in 1995, and held a senior position at McKinsey & Co from 1990 to 1995. Began her career at Unilever in 1983. A non-executive director of The City of London Investment Trust. Aged 42. Company Secretary Alastair J Michie FCIS FCIBS LLOYDS TSB GROUP 41 Directors’ report Results and dividends The consolidated proﬁt and loss account on page 59 shows a proﬁt attributable to shareholders for the year ended 31 December 2004 of £2,421 million. An interim dividend of 10.7p per ordinary share was paid on 6 October 2004 and a ﬁnal dividend of 23.5p per ordinary share will be paid on 4 May 2005. These dividends will absorb £1,914 million. Principal activities, business review and future developments 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. A review of the business and an indication of future developments are given on pages 5 to 38. Authority to purchase shares The authority for the Company to purchase, in the market, up to 567 million of its shares, representing some 10 per cent of the issued ordinary share capital, expires at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give a similar authority. Directors Biographical details of directors are shown on pages 40 and 41. Particulars of their emoluments and interests in shares in the Company are given on pages 47 to 57. The Earl of Selborne left the board at the annual general meeting in 2004. Mr Hampton, Mr Targett, Sir Tom McKillop and Mr Ayliffe left the board on 12 January 2004, 30 April 2004, 31 December 2004 and 31 January 2005, respectively. Dr Gibson-Smith and Mr Pritchard will leave the board at the annual general meeting in 2005. Mrs Weir joined the board on 26 April 2004 and was elected at the annual general meeting on 21 May 2004. Mr Tate and Sir Julian Horn-Smith joined the board on 1 August 2004 and 1 January 2005, respectively. In accordance with the articles of association, they offer themselves for election at the annual general meeting. Also in accordance with the articles of association, Mr Gemmell, Mr Fairey and Dr Julius retire at the annual general meeting and offer themselves for re-election. Employees The Lloyds TSB Group is committed to employment policies which follow best practice, based on equal opportunities for all employees irrespective of sex, race, national origin, religion, colour, disability, sexual orientation, age or marital status. In the UK, the Lloyds TSB Group supports Opportunity Now and is represented on the board of Race for Opportunity; campaigns to improve opportunities for women and ethnic minorities in the work place. The Lloyds TSB Group is a gold card member of the Employers’ Forum on Disability, in support of employment of people with disabilities. This recognises the need for ensuring fair employment practices in recruitment and selection, and the retention, training and career development of disabled staff. 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 Lloyds TSB Group. Donations The proﬁt and loss account includes a charge for charitable donations totalling £31,571,000 (2003: £31,712,000) including £31,230,000 (2003: £31,450,000) under deeds of covenant to the four Lloyds TSB Foundations, which will be paid during 2005. Policy and practice on payment of creditors The Company follows ‘The Better Payment Practice Code’ published by the Department of Trade and Industry, regarding the making of payments to suppliers. A copy of the code and information about it may be obtained from the Department of Trade and Industry as shown on page 113. 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 2004, the number of days required to be shown in this report, to comply with the provisions of the Companies Act 1985, is nil. Auditors Resolutions concerning the re-appointment of PricewaterhouseCoopers LLP as 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 Company Secretary 3 March 2005 42 LLOYDS TSB GROUP Corporate governance Compliance with the combined code The board considers that good governance is central to achieving the Group’s governing objective of maximising shareholder value over time. That has been uppermost in directors’ minds when applying the principles contained in the combined code on corporate governance annexed to the UK Listing Authority listing rules. The Group has complied with the provisions of the code, and has done so throughout the year regarding the code provisions whose requirements are of a continuing nature. The board and its committees The Group is led by a board comprising executive and non-executive directors with wide experience. The appointment of directors is considered by the board and, following the provisions in the articles of association, they must stand for election by the shareholders at the ﬁrst annual general meeting following their appointment and must retire, and may stand for re-election by the shareholders, at least every three years. Executive directors normally retire at age 60, as required by their service agreements. Independent non-executive directors are appointed for three-year renewable terms, which may be terminated without notice or payment of compensation. The board meets at least nine times a year. It has a programme designed to enable the directors regularly to review corporate strategy and the operations and results of the businesses and discharge their duties within a framework of prudent and effective controls relating to the assessing and managing of risk. The roles of the chairman, the group chief executive and the board and its governance arrangements, including the schedule of matters speciﬁcally reserved to the board for decision, are reviewed annually. The matters reserved to the board for decision include the approval of the annual report and accounts and any other ﬁnancial statements; the payment of dividends; the long-term objectives of the Group; the strategies necessary to achieve these objectives; the Group’s budgets and plans; signiﬁcant capital expenditure items; signiﬁcant investments and disposals; the basis of allocation of capital within the Group; the organisation structure of the Group; the arrangements for ensuring that the Group manages risks effectively; any signiﬁcant change in accounting policies or practices; the appointment of the Company’s main professional advisers; and the appointment of senior executives within the organisation and the related forward planning. The board has delegated to management the power to make decisions on operational matters, including those relating to credit, liquidity and market risk, within an agreed framework. All directors have access to the services of the company secretary, and independent professional advice is available to the directors at the Group’s expense, where they judge it necessary to discharge their duties as directors. The board evaluates its performance and that of its committees and individual directors. The process adopted, using an internally produced questionnaire, affords directors the opportunity, through their membership of boards of other companies, in the UK and overseas, to draw on their experience to endeavour to ensure that the Group follows best practice. It also enables directors to suggest how the board’s procedures may be improved; to assess strengths and weaknesses; and to address its balance of skills, knowledge and experience. The committees, themselves, assess their respective roles, performance and terms of reference and report accordingly to the board. The chairman’s performance is evaluated by the non-executive directors, led by the senior independent director, taking account of the views of executive directors. The remuneration committee reviews the performance of the chairman, the deputy chairman, the group chief executive and the other group executive directors, when considering their remuneration arrangements. The nomination committee reviews the performance of all the directors. Like all board committees, the nomination committee and remuneration committee report to the board on their deliberations, including the results of these performance evaluations. The chairman has a private discussion at least once a year with every director on a wide range of issues affecting the Group, including any matters which the directors, individually, wish to raise. There is an induction programme for all new directors, which is tailored to their speciﬁc requirements and includes visits to individual businesses and meetings with senior management. Additional training and updates on particular issues are arranged as appropriate. Meetings with shareholders In order to develop an understanding of the views of major shareholders, the board receives regular reports from the group ﬁnance director and the director of investor relations. The chairman, the group chief executive and the group ﬁnance director also have meetings with representatives of major shareholders and the senior independent director and the chairman of the audit committee attend some of these meetings. In addition, all directors are invited to attend investment analysts’ and stockbrokers’ brieﬁngs on the ﬁnancial results. All shareholders are encouraged to attend and participate in the Group’s annual general meeting. Each resolution considered at the annual general meeting in 2004 was decided on a poll. Votes representing some 50 per cent of the total number of shares in issue were cast and each resolution was passed by a substantial majority. Details of the poll results are available from the company secretary. The resolutions to be considered at the annual general meeting in 2005 will also be decided on a poll. Details of the results will be announced on our website, www.lloydstsb.com and will also be available from the company secretary. Audit committee The audit committee comprises Mr Brown (chairman), Mr Gemmell and Mrs Knight. The committee’s terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com. The audit committee met ﬁve times in 2004, during which it received reports from, and held discussions with, management and the auditors. In discharging its duties, the committee has reviewed the auditors’ remuneration and, in discussion with them, has assessed their independence and objectivity (more information about which is given in note 4 to the accounts, in relation to the procedure for approving fees for audit and non-audit work) and recommended their re-appointment at the annual general meeting. The committee also reviewed the ﬁnancial statements published in the name of the board and the quality and acceptability of the related accounting policies, practices and ﬁnancial reporting disclosures; the scope of the work of the Group’s internal audit department, reports from that department and the adequacy of its resources; the effectiveness of the systems for internal control, risk management and LLOYDS TSB GROUP 43 Corporate governance compliance with ﬁnancial services legislation and regulations (more information about which is given in the note about internal control on page 46); procedures by which staff may raise concerns in conﬁdence; the results of the external audit and its cost effectiveness; reports from the external auditors on audit planning and their ﬁndings on accounting and internal control systems; and the committee’s own role and performance. The committee also had a meeting with the auditors, without executives present, and a meeting with the head of internal audit alone. Chairman’s committee The chairman’s committee, comprising the chairman, the deputy chairman, the group chief executive and the deputy group chief executive, generally meets twice a month, to assist the chairman in preparing for board meetings. The committee may have speciﬁc powers delegated to it by the board from time to time and following the exercising of these powers, it reports to the board. Group executive committee The group executive committee, comprising the group chief executive, the deputy group chief executive, the group executive directors, the chief risk director, the group human resources director and the director of group IT and operations, meets to assist the group chief executive in performing his duties. Speciﬁcally, the committee considers the development and implementation of strategy, operational plans, policies and budgets; the monitoring of operating and ﬁnancial performance; the assessment and control of risk; the prioritisation and allocation of resources; and the monitoring of competitive forces in each area of operation. The committee, assisted by its sub-committees, the group business risk and group asset and liability committees, also supports the group chief executive in endeavouring to ensure the development, implementation and effectiveness of the Group’s risk management framework and the clear articulation of the Group’s risk policies, and in reviewing the Group’s aggregate risk exposures and concentrations of risk. The committee may have speciﬁc powers delegated to it by the board from time to time and following the exercising of these powers, it reports to the board. To comply with the Group’s articles of association, only committee members who are also directors of the Company participate in the exercising of any powers delegated by the board. Nomination committee The nomination committee, comprising Mr van den Bergh (chairman), Mr Brown, Dr Gibson-Smith and Dr Julius, reviews the composition of the board, taking into account the skills, knowledge and experience of directors and considers and makes recommendations to the board on potential candidates for appointment as directors. The committee also makes recommendations to the board concerning the re-appointment of any independent non-executive director by the board at the conclusion of his or her speciﬁed term; the re-election of any director by the shareholders under the retirement provisions of the articles of association; any matters relating to the continuation in ofﬁce of a director; and the appointment of any director to executive or other ofﬁce, other than the positions of chairman and group chief executive, the recommendation for which would be considered at a meeting of the non-executive directors regarding the position of group chief executive, and all the directors regarding the position of chairman. During the year, the committee met three times and recommended the appointment of two executive directors and one non-executive director. In that regard, detailed role speciﬁcations were drawn up, external search consultants were engaged and candidates were interviewed by committee members and other directors. The committee’s terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com. Remuneration committee The remuneration committee, which comprises Dr Berndt (chairman), Dr Gibson-Smith, Sir Julian Horn-Smith and Dr Julius, reviews the remuneration policy for the top management group, to ensure that members of the executive management are provided with appropriate incentives to encourage them to enhance the performance of the Group and that they are rewarded for their individual contribution to the success of the organisation. It is made aware of, and advises on, major changes to employee beneﬁt schemes and it also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated powers for setting remuneration for the chairman, the deputy chairman, the group executive directors, the company secretary and any Group employee whose salary exceeds a speciﬁed amount. All the independent non-executive directors are invited to attend meetings if they wish, and they receive the minutes and have the opportunity to comment and have their views taken into account before the committee’s decisions are implemented. The remuneration committee met ﬁve times in 2004 and further information about its membership and work is given in the directors’ remuneration report on pages 47 to 57. The committee’s terms of reference are available from the company secretary and are displayed on the Company’s website www.lloydstsb.com. Risk oversight committee The risk oversight committee comprises Mr Pritchard (chairman), Mr van den Bergh, Mr Brown and Sir Julian Horn-Smith. All non-executive directors are invited to attend meetings if they wish. The risk oversight committee’s duties include overseeing the development, implementation and maintenance of the Group’s overall risk governance framework, risk appetite, risk strategy and policies, to ensure they are in line with emerging regulatory, corporate governance and industry best practice. The committee also oversees the Group’s risk exposures; facilitates the involvement of non-executive directors in risk issues and aids their understanding of these issues; oversees adherence to Group risk policies and standards and considers any material amendments to them; and reviews the work of the Group Risk division. The risk oversight committee reports to the board on its deliberations after each meeting. 44 LLOYDS TSB GROUP Corporate governance Attendance at meetings The attendance of directors at board meetings and at meetings of the audit, nomination, remuneration and risk oversight committees during 2004 was as follows: Board Audit committee Nomination Remuneration Risk oversight committee committee committee 9 8 9 9 9 9 9 8 9 8 9 3 9 6 9 7 4 3 5 5 5 5 2 3 2 3 3 1 5 5 5 4 4 4 4 4 1 2 Number of meetings during the year Current directors who served during 2004 W C G Berndt Ewan Brown1 J E Daniels M E Fairey G J N Gemmell C S Gibson-Smith 2 D S Julius A G Kane A A Knight D P Pritchard G T Tate3 M A van den Bergh H A Weir4 Former directors who served during 2004 P G Ayliffe5 Sir Tom McKillop6 Lord Selborne7 S C Targett8 1 Appointed to the nomination committee from 3 March 2005 2 Appointed to the nomination committee from 21 May 2004 3 Appointed to the board from 1 August 2004 4 Appointed to the board from 26 April 2004 5 Left the board on 31 January 2005 6 Left the board on 31 December 2004 7 Left the board on 21 May 2004 8 Left the board on 30 April 2004 Statement of 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 Lloyds TSB Group (‘the Group’) as at the end of the year and of the proﬁt or loss for the year. The directors consider that in preparing the ﬁnancial statements on pages 59 to 112, the Company and the Group have 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 and the Group keep proper accounting records which disclose with reasonable accuracy the ﬁnancial position of the Company and the Group and which enable them to ensure that the ﬁnancial statements 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 Company and the Group and to prevent and detect fraud and other irregularities. A copy of the ﬁnancial statements of the Company is placed on the website of Lloyds TSB Group plc. The directors are responsible for the maintenance and integrity of statutory and audited information on the Company’s website. Information published on the internet is accessible in many countries with different legal requirements. Legislation in the United Kingdom governing the preparation and dissemination of ﬁnancial statements may differ from legislation in other jurisdictions. LLOYDS TSB GROUP 45 Corporate governance Internal control The board of directors is responsible for the establishment and review of the Lloyds TSB Group’s system of internal control, which is designed to ensure effective and efﬁcient operations, quality of internal and external reporting, internal control, and compliance with laws and regulations. It should be noted, however, that such a system is designed to manage, rather than eliminate, the risk of failure to achieve business objectives. In establishing and reviewing the system of internal control the directors have regard to the nature and extent of relevant risks, the likelihood of a loss being incurred and the costs of control. It follows, therefore, that the system of internal control can only provide reasonable but not absolute assurance against the risk of material loss. The directors and senior management are committed to maintaining a control-conscious culture across all areas of operation. This is communicated to all employees by way of published policies and procedures and regular management brieﬁngs. Key business risks are identiﬁed, and these are controlled by means of procedures such as physical controls, credit, trading and other authorisation limits and segregation of duties. In addition, there is an annual control self-assessment exercise under which the key businesses and head ofﬁce functions review speciﬁc controls and attest to the accuracy of their assessments. The material controls covered by this assessment include risk management, organisational control, legal and regulatory, ﬁnance and information technology. As in previous years, this exercise was completed for the year ended 31 December 2004. All returns have been satisfactorily completed and appropriately certiﬁed. There are well established budgeting and forecasting procedures in place and reports are presented regularly to the board detailing the results of each principal business, variances against budget and prior year, and other performance data. Internal controls contain procedures which assist the board in identifying new and emerging risks. 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 Lloyds TSB Group by its risk management function, including Group Compliance, and Group Audit. 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. Going concern The directors are satisﬁed that the Company and the Lloyds TSB 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. 46 LLOYDS TSB GROUP Directors’ remuneration report This is a report made by the board of Lloyds TSB Group plc, on recommendation of the remuneration committee. The role of the remuneration committee is shown on page 44. The remuneration committee The members of the remuneration committee during 2004 were Sir Tom McKillop (chairman until 31 December 2004), Dr Berndt, Dr Gibson-Smith, and Dr Julius. From 1 January 2005, Dr Berndt became chairman and Sir Julian Horn-Smith joined the committee. Towers, Perrin, Forster & Crosby, Inc. (TPFC) were appointed by the committee to advise it on matters relating to executive remuneration. TPFC also provide the management of the Company with competitive market data relating to other employees and administrative services for the Company’s ﬂexible beneﬁts plan for its employees. In addition, in 2004, Alithos Limited provided information for the testing of the total shareholder return (TSR) (calculated by reference to both dividends and growth in share price) performance conditions for the Company’s executive share option schemes. Mr van den Bergh, Mr Daniels, Mr Fairey, Mr Hijkoop (Director of Group Human Resources) and Mr Wilson (Compensation & Beneﬁts Director) provided advice to the committee (other than for their own remuneration). Directors’ remuneration policy Lloyds TSB Group’s remuneration policy is to ensure that individual rewards are aligned with Lloyds TSB Group’s performance and the interests of its shareholders, and that packages are provided which attract and retain executive directors and senior management of the highest calibre and motivate them to perform to the highest standards. The main principles are: • Basic salary reﬂects the market median of companies in the FTSE 30 and total compensation should be at the market upper quartile providing performance is at that level. • The majority of total compensation is linked to the achievement of stretching performance targets. • The long-term rewards are aligned to shareholders’ interests and executive directors are expected to build a shareholding in the Group over a period of four years equivalent to the value of one times the director’s annual basic salary. • The overall package reﬂects market practice and takes account of the terms and conditions applying to other employees of the Group. There is no intention to change these principles in 2005. Executive directors’ remuneration is made up of basic salary, annual bonus, long-term incentives, pensions and other beneﬁts. In 2005, approximately 75 per cent (82 per cent for the group chief executive) of an executive director’s potential direct remuneration (salary, annual bonus and long-term incentives) will be performance related (see illustrative charts below). The value of long-term incentives is the expected value calculated by using a ‘binomial’ model, which is a widely accepted methodology for this purpose. Group chief executive Other executive directors 18% 32% 50% Basic salary Annual incentives Long-term incentives 50% 25% 25% The chairman and deputy chairman receive remuneration which comprises basic salary and beneﬁts which are broadly similar to the executive directors, but they do not participate in the annual bonus and long-term incentive arrangements. The deputy chairman has pension beneﬁts which accrued during his service as an executive director and pension beneﬁts are accruing for the chairman as described on page 53. LLOYDS TSB GROUP 47 Directors’ remuneration report The fees of the independent non-executive directors are agreed by the board within a total amount determined by the shareholders. They may also receive fees, agreed by the board, for membership of board committees. The fees are designed to recognise the responsibilities of the role and to attract individuals with relevant skills, knowledge and experience. The fees are neither performance related nor pensionable and are comparable with those paid by other companies. The annual fees are listed below: Annual fees from 1 April 2005 Annual fees pre-April 2005 Board Audit committee chairmanship Audit committee membership Nomination committee membership Remuneration committee chairmanship Remuneration committee membership Risk oversight committee membership £50,000 £40,000 £15,000 £5,000 £20,000 £15,000 £15,000 £45,000 £15,000 £10,000 – £12,500 £10,000 – Independent non-executive directors who serve on boards of subsidiary companies may also receive fees from the subsidiaries. Basic salary Basic salaries are reviewed annually, usually in December, taking into account individual performance and market information (which is provided by TPFC) and then adjusted from 1 January of the following year. Basic salary increases for other employees across the Group will be in the range of 0-10 per cent, and the salary increases awarded to executive directors are consistent with this policy. Details of salaries payable to executive directors in 2005 are shown on page 50. Annual incentive and performance share plan The annual incentive scheme for executive directors is designed to reﬂect speciﬁc goals linked to the performance of the business. For executive directors except Mr Daniels, individual bonus awards for 2005 will be made from a bonus pool based on Group performance with pre-determined targets relating to proﬁt before tax and economic proﬁt. As in 2004, the maximum size of the bonus pool applicable to these executive directors will remain at 100 per cent of the aggregate of their basic salaries. An amount equal to 75 per cent of these executive directors’ basic salaries will form the bonus pool on the achievement of a stretching budget for 2005; failure to achieve at least 90 per cent of this budget will result in no bonus pool. These executive directors will be considered for awards based on individual targets which will include proﬁtability, franchise growth, risk, service and other speciﬁc goals that are relevant to improving overall business performance. The maximum level of any bonus award distributable from the pool to any individual has been set at 150 per cent (100 per cent for 2004) of salary for exceptional performance, to reﬂect the competitive market position for total earnings opportunity. The maximum annual bonus opportunity for 2005 for Mr Daniels has also been set at 150 per cent (125 per cent for 2004) of basic salary for exceptional peformance, to increase the proportion of pay which is performance linked and to reﬂect the competitive market position for total earnings opportunity. An amount equal to 112.5 per cent of basic salary will be available on the achievement of stretching budget targets relating to proﬁt before tax and economic proﬁt; failure to achieve at least 90 per cent of these performance targets would result in no bonus payment. The actual level of bonus award made will take account of individual performance and contribution. PricewaterhouseCoopers LLP check the calculation of the annual incentive payments for executive directors based on the achievement of performance against targets set. In respect of performance in 2004, bonuses ranging from 40 per cent to 125 per cent have been paid to the directors with an average payment of 89 per cent of salary. Under the performance share plan agreed at the annual general meeting in May 2004, executive directors are required to defer 50 per cent of any bonus payable into shares in the Company, known as bonus shares. The bonus shares will be held on behalf of the executive for a period of three years before release. The amounts deferred into bonus shares in respect of the 2004 bonus, before the deduction of income tax, will be: Name Amount J E Daniels £468,750 M E Fairey £259,000 A G Kane £180,000 G T Tate £93,750 H A Weir £135,000 Under the new plan, executives will be eligible for an award of free shares, to be known as performance shares, to match the bonus shares. The maximum match will be two performance shares for each bonus share, awarded at the end of the three year retention period. The number of performance shares actually awarded will depend on the Company’s TSR performance measured over the three year period ending 31 December 2007, compared with the TSR of the other companies in the comparator group listed below. The maximum of two performance shares for each bonus share will be awarded only if the Company’s TSR performance places it ﬁrst in the comparator group; one performance share will be awarded for each bonus share if the Company is placed ﬁfth; and one performance share for every two bonus shares if the Company is placed eighth (median). Between ﬁrst and ﬁfth positions and ﬁfth and eighth positions a sliding scale will apply. If the TSR performance is below median no performance shares will be awarded. There will be no retest. In December 2004, the Inland Revenue issued new guidance which will require income tax to be deducted before the deferral into bonus shares. This is a change that effectively would alter the balance under the long-term arrangements, and as a result would reduce any performance related match. Therefore, to avoid this inbalance, where a match with performance shares is justiﬁed it will be made on a notional deferral as if income tax had not been deducted at the outset. This maintains the intention of the original design of the plan. The other companies in the comparator group will be: Alliance & Leicester Bradford & Bingley Legal & General Royal & Sun Alliance Aviva Friends Provident Northern Rock Standard Chartered Banco Santander HBOS Prudential Barclays HSBC Holdings Royal Bank of Scotland The remuneration committee believes that the out-performance of Lloyds TSB Group’s TSR compared with that of the companies in the comparator group will demonstrate the success of the Group’s strategy. 48 LLOYDS TSB GROUP Directors’ remuneration report Long-term rewards Executive share option schemes In 2004, options were granted to executive directors and senior executives within the scheme limits. These limits relate to the number of shares under option and the price payable on exercise. The maximum limit for the grant of options to an executive director in any one year was one and a half times annual basic salary multiplied by a performance multiplier of 3.5 (although in exceptional circumstances, for example on the recruitment of a new executive, that could be increased to four times annual basic salary multiplied by 3.5). The table on pages 55 and 56 gives the number of options granted. A performance condition was set when the grant of options was made and the options will not normally be exercisable unless the condition is met. The performance condition requires the Company’s ranking, based on TSR over the relevant (three year) period, to be at least ninth within the comparator group. The full grant of options for executive directors will only become exercisable if the Company is ranked ﬁrst within the comparator group. The other constituents of the comparator group are: Abbey National Barclays HSBC Holdings Prudential ABN Amro Citigroup ING Royal Bank of Scotland Alliance & Leicester Fortis Legal & General Royal & Sun Alliance Aviva HBOS National Australia Bank Standard Chartered In 2005, options will be 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 three times annual basic salary, although in exceptional circumstances, for example on the recruitment of a new executive director, that could be increased to four times annual basic salary. A performance condition is set when the grant of options is made and the options cannot normally be exercised unless the condition has been met. The performance condition for options granted from 2005 will be based on TSR over the relevant (three year) period measured against the group of 14 ﬁnancial services companies listed on page 48. The options will become exercisable in full if the Company is placed fourth or above in the comparator group (at or above the upper quartile) and as to 30 per cent if the Company is placed eighth (i.e. median). The options will lapse if the Company is placed below eighth. A sliding scale will apply between fourth and eighth positions. There will be no retest. The following table illustrates the percentage of the grant which would be exercisable depending on the Company’s TSR ranking within the comparator group, shown on page 48. Ranking position within comparator group Per cent of option which may be exercised 1 2 3 4 5 6 7 8 9 or below 100 100 100 100 82.5 65 47.5 30 Nil – options not exercisable The remuneration committee believes that the out-performance of Lloyds TSB Group’s TSR compared with those of the companies in the comparator group will demonstrate the success of the Group’s strategy. The Company uses data provided by Alithos Limited to assess the Company’s performance against the comparator group for the purposes of the executive share option scheme and the performance share plan, and PricewaterhouseCoopers LLP check the results of the testing of the performance condition. Other share plans The executive directors, the chairman and the deputy chairman are also eligible to participate in the Lloyds TSB Group ‘sharesave’ scheme and the Lloyds TSB Group ’shareplan’. These are ‘all-employee’ share schemes and, therefore, performance conditions do not apply. LLOYDS TSB GROUP 49 Directors’ remuneration report Dilution The following charts illustrate the available dilution capacity for the Company’s share schemes. Dilution capacity – all schemes (10% in any consecutive 10 years) Dilution capacity – executive schemes (5% in any consecutive 10 years) 161.5 45.9 45.9 398.1 233.9 Shares used (million) Shares remaining (million) Pensions Executive directors are entitled to participate either in the Group’s deﬁned beneﬁt pension schemes (based on salary and length of service, with a maximum pension of two thirds of ﬁnal salary), or the Group’s deﬁned contribution scheme (under which their ﬁnal entitlement will depend on their contributions and the ﬁnal value of their fund). The deﬁned beneﬁt schemes are closed to new entrants on recruitment. Service agreements Lloyds TSB Group’s policy is for executive directors to have service agreements with notice periods of no more than one year. All current executive directors are entitled to receive 12 months’ notice from the Company, but would be required to give six months’ notice if they wished to leave. As the chairman and deputy chairman are regarded as employees, they are entitled to receive up to eight weeks’ notice. Notice to be given by the Company Salary from 1 January 2005 Date of service agreement J E Daniels M E Fairey A G Kane G T Tate H A Weir M A van den Bergh D P Pritchard 12 months 12 months 12 months 12 months 12 months 8 weeks 8 weeks £825,000 £545,000 £475,000 £475,000 £475,000 £475,000 £253,000 19 October 2001 28 August 1991 9 February 2000 29 July 2004 4 March 2004 28 July 2000 7 April 2003 It is now the Group’s policy (subject to existing contractual arrangements) that where compensation on early termination is due, it should be restricted to basic salary and bonus to the extent earned. Payments will be on a phased basis and mitigated in the event that alternative employment is secured. Bonus payments should relate to the period of actual service, rather than the full notice period, and will be determined on the basis of performance. Independent 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 Group recognises that executive directors may be invited to become non-executive directors of other publicly quoted companies and that these appointments may broaden their knowledge and experience, to the beneﬁt of the Lloyds TSB Group. Fees are normally retained by the individual directors as the post entails personal responsibility. Executive directors are generally allowed to accept one non-executive directorship. During 2004, one of the current executive directors received a fee of £11,300, which was retained, for serving as a non-executive director of another company. 50 LLOYDS TSB GROUP Directors’ remuneration report Performance graph The graph illustrates the performance of Lloyds TSB Group plc measured by TSR 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 TSR 31 Dec 1999 31 Dec 2000 31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 120 100 80 60 40 20 0 Lloyds TSB Group plc FTSE 100 Index Rebased to 100 on 31 December 1999 Source : Datastream LLOYDS TSB GROUP 51 Directors’ remuneration report Audited information Directors’ emoluments for 2004 Current directors who served during 2004 Executive directors J E Daniels M E Fairey A G Kane G T Tate H A Weir Non-executive directors M A van den Bergh D P Pritchard W C G Berndt Ewan Brown G J N Gemmell C S Gibson-Smith D S Julius A A Knight Former directors who served during 2004 P G Ayliffe P R Hampton Sir Tom McKillop Lord Selborne S C Targett Former directors who served during 2003 M D Ross Others Salaries/ fees £000 Other beneﬁts Cash £000 Non cash £000 Performance- Compensation for loss of ofﬁce £000 related payments £000 2004 Total £000 2003 £000 750 518 450 187 309 442 243 55 84 110 55 55 93 400 15 57 22 160 181 413 16 20 50 12 9 27 2 121 12 13 19 3 16 960 534 373 193 279 20 7 160 342 1 2 1,903 1,478 858 403 654 1,064 1,140 622 – – 454 279 55 84 110 55 55 93 588 359 57 22 283 435 377 32 70 100 45 45 58 328 733 49 42 587 683 635 332 356 688 4,005 851 86 2,838 698 8,478 7,045 The cash column under ‘other beneﬁts’ includes ﬂexible beneﬁts payments (4 per cent of basic salary), the housing allowance and tax planning allowance for Mr Daniels, pension contributions for those in the deﬁned contribution scheme (Mrs Weir and Mr Tate) and an additional payment in respect of the contribution to the separate fund relating to Mr Fairey’s pension. 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 cap relating to pensions, introduced by the Finance Act 1989. The amount shown for Mr Targett relates primarily to his relocation expenses. The non cash column includes amounts relating to the use of a company car, private medical insurance and life insurance cover. It also includes the value of any matching shares which are received under the terms of shareplan, through which employees have the opportunity to purchase shares up to a maximum of £125 per month and receive matching shares on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share. Performance-related payments relate to cash bonuses based on Group performance and the attainment of pre-determined targets relating to proﬁt before tax and economic proﬁt. For 2004, bonuses ranging from 40 per cent to 125 per cent are payable to the directors with an average payment of 89 per cent of salary. These payments also include the value of any award made under shareplan, the ﬁrst £3,000 of which is made in the form of shares in Lloyds TSB Group plc. Mr Ayliffe’s employment has been terminated from 31 March 2005 and the payments to which he is entitled will be settled in accordance with his contractual entitlement. Full details will be reported in the 2005 report and accounts. Mr Hampton’s employment was terminated on 12 January 2004. He has received payments in accordance with his contractual entitlement. The amount shown for Mr Ross reﬂects payments he received in accordance with his contractual entitlement. 52 LLOYDS TSB GROUP Directors’ remuneration report Audited information Directors’ pensions The executive directors are members of one of the pension schemes provided by the Lloyds TSB Group with beneﬁts either on a deﬁned beneﬁt or deﬁned contribution basis. Those directors who joined the Lloyds TSB Group after 1 June 1989 and are members of a deﬁned beneﬁt scheme, have pensions provided on salary in excess of the earnings cap either through membership of a funded unapproved retirement beneﬁts scheme (‘FURBS’) or by an unfunded pension promise. Retirement pensions accrue at rates of between 1/60 and 1/30 of basic salary. Directors have a normal retirement age of 60. In the event of death in service, a lump sum of four times salary is payable plus, for members of a deﬁned beneﬁt scheme, a spouse’s pension of two-thirds of the member’s prospective pension. On death in retirement, a spouse’s pension of two-thirds of the member’s pension is payable. The deﬁned beneﬁt schemes are non-contributory. Members of deﬁned contribution schemes are required to contribute. Deﬁned contribution scheme members Mr Targett was a member of a deﬁned contribution scheme. During the period 1 January 2004 to 30 April 2004 the employer made contributions totalling £24,000. As he left before completing two years service no beneﬁts will be vested under the deﬁned contribution scheme in respect of him. Mr Tate is a member of a deﬁned contribution scheme. He joined the Lloyds TSB Group on 4 August 2003. During the year to 31 December 2004, the employer has made contributions to the deﬁned contribution scheme in respect of him totalling £47,760 of which £24,843 related to the period since his appointment as a director. Mrs Weir is a member of a deﬁned contribution scheme. She joined the Lloyds TSB Group on 26 April 2004. During the year to 31 December 2004, the employer has made contributions to the deﬁned contribution scheme in respect of her totalling £26,224. Deﬁned beneﬁt scheme members Accrued pension at Accrued pension at 31 December 31 December 2003 £000 (b) 2004 £000 (a) Change in Transfer Transfer value at value at accrued 31 December 31 December 2004 2003 pension £000 £000 £000 (c) (d) (a)-(b) Change in Additional pension earned to transfer 31 December 2004 £000 (e) value £000 (c)-(d) P G Ayliffe J E Daniels M E Fairey P R Hampton A G Kane 132 77 226 28 216 98 51 186 17 170 34 26 40 11 46 1,780 1,139 3,996 365 3,029 1,245 711 3,052 208 2,233 535 428 944 157 796 30 24 34 10 41 Transfer value of the increase £000 (f) 406 358 609 133 582 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 10 7 3 136 85 51 3 42 Mr Hampton’s pension entitlement at 31 December 2004 includes an additional 12 months service in respect of his notice period in accordance with the terms of his contract. 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 2004 and 2003, 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 2004 based on factors supplied by the actuary of the relevant Lloyds TSB Group pension scheme in accordance with actuarial guidance note GN11. The underlying bases used to arrive at the factors have not changed during the year. Column (d) is the equivalent transfer value, but calculated as at 31 December 2003 on the assumption that the director left service at that date. 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 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 transfer value in column (f) can differ signiﬁcantly from the change in transfer value as required by the Companies Act because the additional pension accrued over the year calculated in accordance with the listing rules makes allowance for inﬂation and the change in the transfer value required by the Companies Act will be signiﬁcantly inﬂuenced by changes in the assumptions underlying the transfer value calculation at the beginning and end of the ﬁnancial year. Members of the Lloyds TSB 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. LLOYDS TSB GROUP 53 Directors’ remuneration report Directors’ interests The interests, all beneﬁcial, of those who were directors at 31 December 2004 in shares in Lloyds TSB Group were: Shares Executive directors J E Daniels M E Fairey A G Kane G T Tate H A Weir Non-executive directors M A van den Bergh D P Pritchard W C G Berndt Ewan Brown G J N Gemmell C S Gibson-Smith D S Julius A A Knight Former executive director P G Ayliffe At 1 January 2004 (or later date of appointment) At 31 December 2004 At 3 March 2005† 38,198 77,881 99,041 37,007 76,605 97,769 701 – 5,079 5,178 40,000 3,787 70,000 3,151 2,000 3,540 38,136 77,858 98,979 701 1,699 5,079 10,566 46,000 4,027 70,000 3,151 2,000 4,940 91,216 92,453 † The changes in beneﬁcial interests between 31 December 2004 and 3 March 2005 related to ‘partnership’ and ‘matching’ shares acquired under shareplan. Sir Julian Horn-Smith joined the board on 1 January 2005 and at 3 March 2005 he had a beneﬁcial interest in 5,000 shares in Lloyds TSB Group plc. Non-beneﬁcial interests Directors had non-beneﬁcial interests as follows: Mr Ayliffe, Mr Daniels, Mr Fairey, Mr Kane, Mr Pritchard, Mr Tate, Mr van den Bergh and Mrs Weir, together with some 77,000 other employees, were potential beneﬁciaries in the 1,364 and 1,467,422 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. 162,692 and 1,609,602 shares, respectively, were held by these trusts at the beginning of the year. These holdings were 1,364 and 1,453,954 respectively on 3 March 2005. In addition, the above directors, with the exception of Mr van den Bergh, together with some 77,000 other employees, were potential participants in shareplan and were, therefore, treated as interested in the 471,989 shares held at the end of the year by the trustee of the shareplan. 2,163,267 shares were held by the trustee at the beginning of the year. This holding was 582,350 on 3 March 2005. 54 LLOYDS TSB GROUP Directors’ remuneration report Audited information Interests in share options At 1 January 2004 (or later date of appointment) Granted during the year Exercised/ lapsed during the year At 31 December 2004 Current directors who served during 2004 J E Daniels M E Fairey A G Kane D P Pritchard G T Tate 939,177 555,992 523,255 4,687 907,780 330,419 3,327 599,239 305,232 797 54,000 48,000 57,000 85,896 10,931 42,884 148,618 345,104 1,330 531 663,157 25,000 40,000 50,000 27,000 64,786 11,841 34,759 118,178 275,349 5,783 529,105 4,687 50,000 40,000 71,519 10,385 36,374 127,131 286,363 348,837 268,336 Exercise price 694p 715p 284p 394.25p 430p 419.25p 474p 510p 859.5p 817p 549.5p 615.5p 655p 733p 715p 284p 348p 394.25p 419.25p 321p 510p 880p 887.5p 549.5p 615.5p 655p 733p 715p 284p 394.25p 419.25p 416p 859.5p 817p 549.5p 615.5p 655p 733p 715p 430p 419.25p 403p 424.75p 321p Exercise periods From To 1/11/2004 6/3/2005 1/6/2006 21/2/2006 14/8/2006 18/3/2007 1/11/2005 26/3/2000 15/5/2001 2/8/2002 6/3/2003 8/8/2003 6/3/2004 21/8/2004 6/3/2005 1/6/2006 1/11/2006 21/2/2006 18/3/2007 28/3/1999 26/3/2000 4/3/2001 4/3/2002 6/3/2003 8/8/2003 6/3/2004 21/8/2004 6/3/2005 1/6/2008 21/2/2006 18/3/2007 15/5/2001 2/8/2002 6/3/2003 8/8/2003 6/3/2004 21/8/2004 6/3/2005 14/8/2006 18/3/2007 12/8/2007 31/10/2011 5/3/2012 30/11/2006 20/2/2013 13/8/2013 17/3/2014 30/4/2006 25/3/2007 14/5/2008 1/8/2009 5/3/2010 7/8/2010 5/3/2011 20/8/2011 5/3/2012 30/11/2006 30/4/2007 20/2/2013 17/3/2014 27/3/2006 25/3/2007 3/3/2008 3/3/2009 5/3/2010 7/8/2010 5/3/2011 20/8/2011 5/3/2012 30/11/2008 20/2/2013 17/3/2014 14/5/2008 1/8/2009 5/3/2010 7/8/2010 5/3/2011 20/8/2011 5/3/2012 13/8/2013 17/3/2014 11/8/2014 29/4/2007 1/11/2009 28/4/2014 30/4/2010 Notes e, g, i e, h, i a, h e, h e, h e, h a, h, i c, f, i c, f, i c, g, i d, g, i d, g, i d, g, i e, g, i e, h, i a, h a, h e, h e, h c, f c, f, i c, f, i c, g, i d, g, i d, g, i d, g, i e, g, i e, h, i a, h e, h e, h j c, f, i c, g, i d, g, i d, g, i d, g, i e, g, i e, h, i e, h e, h e, h e, h a, h 907,780 330,419 3,327 599,239 305,232 939,177 797 54,000 48,000 57,000 85,896 10,931 42,884 148,618 345,104 1,330 531 663,157 555,992 25,000 40,000 50,000 27,000 64,786 11,841 34,759 118,178 275,349 5,783 529,105 523,255 – 50,000 40,000 71,519 10,385 36,374 127,131 286,363 348,837 268,336 195,409 556,208 5,093 H A Weir – 195,409 556,208 5,093 Share retention plan J E Daniels 216,763 216,763 (see page 57) 1/1/2005 30/6/2005 LLOYDS TSB GROUP 55 Exercise periods From To 1/6/2006 28/3/1999 26/3/2000 4/3/2001 4/3/2002 6/3/2003 8/8/2003 6/3/2004 21/8/2004 6/3/2005 21/2/2006 14/8/2006 18/3/2007 30/11/2006 27/3/2006 25/3/2007 3/3/2008 3/3/2009 5/3/2010 7/8/2010 5/3/2011 20/8/2011 5/3/2012 20/2/2013 13/8/2013 17/3/2014 Notes a, h c, f c, f, i c, f, i c, g, i d, g, i d, g, i d, g, i e, g, i e, h, i e, h e, h e, h Directors’ remuneration report Interests in share options (continued) Former directors who served during 2004 P G Ayliffe P R Hampton S C Targett Share plan 2003 S C Targett a) Sharesave. At 1 January 2004 Granted during the year Exercised/ lapsed during the year At 31 December 2004 (or earlier date of leaving the board) 3,327 13,000 12,000 20,000 3,000 23,657 10,560 16,717 44,562 104,895 218,769 177,034 326,351 3,327 642,739 759,036 2,658 429,338 558,139 326,351§ 3,327§ 642,739§ 759,036§ 2,658§ 558,139§ 331,125 331,125§ 3,327 13,000 12,000 20,000 3,000 23,657 10,560 16,717 44,562 104,895 218,769 177,034 429,338 – – – – – – – Exercise price 284p 321p 510p 880p 887.5p 549.5p 615.5p 655p 733p 715p 394.25p 430p 419.25p 740p 284p 394.25p 311.25p 348p 419.25p (see page 57) b) Executive option granted prior to March 1996. c) Executive option granted between March 1996 and August 1999. d) Executive option granted between March 2000 and March 2001. e) Executive option granted after March 2001. f) Exercisable. g) Not exercisable as the performance conditions had not been met. h) Not exercisable as the option has not been held for the period required by the relevant scheme. i) Market price of shares is below the share option exercise price. j) Market price on day of exercise was 426.5p. In that regard Mr Pritchard made a gain of £492. 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. § These share options lapsed when Mr Hampton and Mr Targett left the board on 12 January 2004 and 30 April 2004, respectively. The market price for a share in the Company at 1 January 2004 and 31 December 2004 was 448p and 473p, respectively. The range of prices between 1 January 2004 and 31 December 2004 was 391.75p to 476.25p. None of the other directors at 31 December 2004 had options to acquire shares in Lloyds TSB Group plc or its subsidiaries. 56 LLOYDS TSB GROUP Directors’ remuneration report The following table contains information on the performance conditions for executive options granted since 1996. The remuneration committee chose the relevant performance condition because it was felt to be challenging, aligned to shareholders’ interests and appropriate at the time. Options granted Performance conditions Prior to March 1996 None March 1996 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. March 1997 – August 1999 As for March 1996 plus a further condition that the Company’s ranking based on TSR over the relevant period should be in the top ﬁfty companies of the FTSE 100. March 2000 – March 2001 As for March 1997 – 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. August 2001 – August 2004 That the Company’s ranking based on TSR over the relevant period against a comparator group (17 UK and international ﬁnancial services companies including Lloyds TSB) must be at least ninth, when 14 per cent of the option will be exercisable. If the Company is ranked ﬁrst in the group, then 100 per cent of the option will be exercisable and if ranked tenth or below the performance condition is not met. At the end of 2004 Lloyds TSB Group was ranked: 10th after four years of the performance period for options granted in 2001; 14th after three years of the performance period for options granted in 2002; 15th after two years of the performance period for options granted in 2003; and 6th after one year of the performance period for options granted in 2004 Other share plans Share retention plan Mr Daniels is the only participant in this plan and holds an option, granted to him on 2 November 2001, to acquire 216,763 ordinary shares in Lloyds TSB Group plc for a total price of £1. The option was granted as part of the remuneration package considered necessary to attract him from the USA and was designed to encourage him to remain with Lloyds TSB Group plc. The option was not subject to any performance condition and vested on 31 December 2004, with a six month exercise period ﬁnishing on 30 June 2005. Full details of the plan were set out in the 2002 annual report. Lloyds TSB Group plc share plan 2003 The option granted to Mr Targett to acquire 331,125 ordinary shares when he joined the Group lapsed following his departure. None of those who were directors at the end of the year had any other interest in the capital of Lloyds TSB Group plc or its subsidiaries. The register of directors’ interests, which is open to inspection, contains full particulars of directors’ shareholdings and options to acquire shares in Lloyds TSB Group plc. On behalf of the board A J Michie Company Secretary 3 March 2005 LLOYDS TSB GROUP 57 Report of the independent auditors 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 65 to 68. 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 directors’ emoluments, directors’ pensions and directors’ interests in share options (‘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 45. The directors are also responsible for preparing the directors’ remuneration report. Our responsibility is to audit the ﬁnancial statements and the auditable part of the directors’ remuneration report in accordance with relevant legal and regulatory requirements and United Kingdom Auditing Standards issued by the Auditing Practices Board. This report, including the opinion, has been prepared for and only for the Company’s members as a body in accordance with Section 235 of the United Kingdom Companies Act 1985 and for no other purpose. We do not, in giving this opinion, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or in to whose hands it may come save where expressly agreed by our prior consent in writing. We report to you our opinion, as to whether the ﬁnancial statements give a true and fair view and whether the ﬁnancial statements and the auditable part of the directors’ remuneration report have been properly prepared in accordance with the Companies Act 1985. We also report to you if, in our opinion, the directors’ report is not consistent with the ﬁnancial statements, if the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information speciﬁed by law regarding directors’ remuneration and transactions is not disclosed. 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 operating and ﬁnancial review and prospects, the unaudited part of the directors’ remuneration report and the corporate governance statement. We review whether the corporate governance statement on pages 43 to 46 reﬂects the Company’s compliance with the nine provisions of the 2003 Financial Reporting Council’s 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: • the ﬁnancial statements give a true and fair view of the state of affairs of the Company and the Group as at 31 December 2004 and of the proﬁt and cash ﬂows of the Group for the year then ended; • the ﬁnancial statements have been properly prepared in accordance with the Companies Act 1985; and • 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, England 3 March 2005 58 LLOYDS TSB GROUP Consolidated profit and loss account for the year ended 31 December 2004 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 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 Share of results of joint ventures (Loss) 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 Proﬁt for the year Earnings per share Diluted earnings per share * See note 6 Note 2004 £ million Continuing operations 2003 £ million Discontinued operations 2003* £ million Total 2003 £ million 423 9,972 5,475 4,920 39 3,124 (744) 271 715 554 688 4,608 9,567 4,284 633 4,917 4,650 224 953 (87) 866 52 3,508 – (15) 3,493 1,004 2,489 26 42 2,421 1,914 507 43.3p 43.0p 45 3 29 4 23,24 15 5 20 6 7 8 39 9 10 41 11 11 389 8,484 4,129 4,744 34 2,987 (688) 525 436 535 682 4,477 9,255 4,229 672 4,901 4,354 236 883 4 887 44 3,187 (22) – 3,165 63 1,213 765 511 – 112 (34) 35 17 – 12 142 653 247 25 272 381 – 63 – 63 – 318 – 865 1,183 452 9,697 4,894 5,255 34 3,099 (722) 560 453 535 694 4,619 9,908 4,476 697 5,173 4,735 236 946 4 950 44 3,505 (22) 865 4,348 1,025 3,323 22 47 3,254 1,911 1,343 58.3p 58.1p The accompanying notes are an integral part of the ﬁnancial statements. LLOYDS TSB GROUP 59 Consolidated balance sheet at 31 December 2004 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 Debt securities Equity shares Interests in joint ventures: Share of gross assets Share of gross liabilities Intangible ﬁxed assets Tangible ﬁxed assets Other assets Prepayments and accrued income Long-term assurance business attributable to the shareholder Long-term assurance assets attributable to policyholders Total assets The accompanying notes are an integral part of the ﬁnancial statements. The directors approved the accounts on 3 March 2005. Maarten A van den Bergh Chairman J Eric Daniels Group Chief Executive Helen A Weir Group Finance Director Note 2004 £ million 2003 £ million 12 13 14 17 18 20 23 24 27 28 29 29 1,078 1,462 92 23,565 154,240 25,194 215 1,195 1,447 539 15,547 135,251 28,669 458 84 (31) 53 2,425 4,181 3,220 2,573 6,781 85 (31) 54 2,513 3,918 3,944 1,918 6,481 225,079 54,764 201,934 50,078 279,843 252,012 60 LLOYDS TSB GROUP Consolidated balance sheet at 31 December 2004 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 and non-equity) Long-term assurance liabilities to policyholders Total liabilities Memorandum items Contingent liabilities: Acceptances and endorsements Guarantees and assets pledged as collateral security Other contingent liabilities Commitments The accompanying notes are an integral part of the ﬁnancial statements. Note 2004 £ million 2003 £ million 31 32 33 34 35 45 36 37 38 38 39 40 41 41 41 42 29 46 39,738 122,062 631 27,217 6,619 3,866 2,231 1,473 417 5,852 4,400 10,252 46 550 596 1,419 1,145 343 7,070 9,977 23,955 116,496 626 25,922 7,007 3,206 2,139 1,376 402 5,959 4,495 10,454 44 683 727 1,418 1,136 343 6,727 9,624 225,079 54,764 201,934 50,078 279,843 252,012 71 6,786 1,669 8,526 299 6,122 2,604 9,025 85,290 79,335 LLOYDS TSB GROUP 61 Company balance sheet at 31 December 2004 Fixed assets Investments: Shares in group undertakings Loans to group undertakings Current assets Debtors falling due within one year: Amounts owed by group undertakings Other debtors Cash balances with group undertakings Current liabilities Amounts falling due within one year: Amounts owed to group undertakings Other creditors Dividend payable 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 and non-equity) The accompanying notes are an integral part of the ﬁnancial statements. The directors approved the accounts on 3 March 2005. Maarten A van den Bergh Chairman J Eric Daniels Group Chief Executive Helen A Weir Group Finance Director Note 2004 £ million 2003 £ million 21 21 38 40 41 41 41 42 11,080 1,723 12,803 1,390 97 208 1,695 1,741 107 1,315 3,163 (1,468) 10,753 1,723 12,476 1,387 88 362 1,837 1,913 106 1,314 3,333 (1,496) 11,335 10,980 1,358 9,977 1,419 1,145 5,014 2,399 9,977 1,356 9,624 1,418 1,136 4,687 2,383 9,624 62 LLOYDS TSB GROUP Other statements Statement of total recognised gains and losses for the year ended 31 December 2004 Proﬁt attributable to shareholders Currency translation differences on foreign currency net investments Actuarial losses recognised in post-retirement beneﬁt schemes Deferred tax thereon Total recognised gains and losses relating to the year Prior year adjustments in respect of changes in accounting policy in 2003 Total gains and losses recognised during the year Historical cost proﬁts and losses for the year ended 31 December 2004 Note 2004 £ million 2003 £ million 45 2,421 (11) (237) 71 (166) 2,244 – 2,244 3,254 118 (6) 2 (4) 3,368 (29) 3,339 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 consolidated shareholders’ funds for the year ended 31 December 2004 Proﬁt attributable to shareholders Dividends Proﬁt for the year Currency translation differences on foreign currency net investments Actuarial losses recognised in post-retirement beneﬁt schemes Issue of shares Movements in relation to own shares Goodwill written back on sale of businesses Net increase in shareholders’ funds Shareholders’ funds at beginning of year Shareholders’ funds at end of year The accompanying notes are an integral part of the ﬁnancial statements. Note 45 40,41 43 6 2004 £ million 2,421 (1,914) 507 (11) (166) 10 10 3 353 9,624 9,977 2003 £ million 3,254 (1,911) 1,343 118 (4) 45 (2) 181 1,681 7,943 9,624 LLOYDS TSB GROUP 63 Consolidated cash flow statement for the year ended 31 December 2004 Net cash inﬂow from operating activities Dividends received from joint ventures and 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) 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 and maturities of ﬁxed asset investments – Additions to tangible ﬁxed assets – Disposals of tangible ﬁxed assets Net cash (outﬂow) inﬂow from capital expenditure and ﬁnancial investment Acquisitions and disposals: – Additions to interests in joint ventures – Acquisition of group undertakings and businesses – Disposal of group undertakings and businesses Net cash (outﬂow) inﬂow from acquisitions and disposals Equity dividends paid Net cash outﬂow before ﬁnancing Financing: – Issue of subordinated liabilities (loan capital) – Cash proceeds from issue of ordinary share capital and transactions in own shares held in respect of employee share schemes – Repayments of subordinated liabilities (loan capital) – Repayment of minority investment in subsidiaries – Capital element of ﬁnance lease rental payments Net cash (outﬂow) inﬂow from ﬁnancing Note 49a 49d 49d 49e 49g 49d 49d 49d 49d 2004 £ million 2003 £ million 3,469 2 (24) (44) (606) (674) (656) (107) (763) (10,088) 9,732 (1,183) 243 (1,296) – (16) (25) (41) 772 5 (14) (81) (600) (695) (598) (186) (784) (35,420) 36,281 (778) 287 370 (12) (1,106) 2,382 1,264 (1,913) (1,908) (1,216) (976) 699 11 (764) (132) (1) (187) 533 32 (75) – (1) 489 Decrease in cash 49c (1,403) (487) The accompanying notes are an integral part of the ﬁnancial statements. 64 LLOYDS TSB GROUP Notes to the accounts 1 Accounting policies Accounting policies are unchanged from 2003. In December 2004, the Accounting Standards Board (‘ASB’) issued Financial Reporting Standard 27 ‘Life Assurance’. The Group will implement the requirements of this standard in its 2005 accounts; however, in accordance with the Memorandum of Understanding entered into by leading members of the life assurance and bancassurance sectors and the Association of British Insurers with the ASB, certain additional disclosures have been given in ‘Operating and ﬁnancial review and prospects’ attached to these accounts. 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. 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. 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 44. 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, ‘Goodwill and Intangible Assets’, 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 life spans of the products; the extent to which the acquisition overcomes market entry barriers; and the expected future impact of competition on the business. As a result, the Scottish Widows goodwill is not being amortised through the proﬁt and loss account; however, it is subjected to annual impairment reviews in accordance with Financial Reporting Standard 11, ‘Impairment of Fixed Assets and Goodwill’. Impairment of the goodwill is evaluated by comparing the present value of the expected future cash ﬂows, excluding ﬁnancing and tax, (the ‘value-in-use’) to the carrying value of the underlying net assets and goodwill. If the net assets and goodwill were to exceed the value-in-use, an impairment would be deemed to have occurred and the resulting write-down in the goodwill would be charged to the proﬁt and loss account immediately. 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 2004 would be £92 million lower (2003: £93 million lower), with a corresponding reduction in reserves of £450 million (2003: £358 million); intangible assets on the balance sheet would also be £450 million lower (2003: £358 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. LLOYDS TSB GROUP 65 Notes to the accounts 1 Accounting policies (continued) 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 has general provisions, held 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 classiﬁed as non-performing when interest ceases to be credited to the proﬁt and loss account. There are two types of non-performing lending which are discussed further below. Accruing loans on which interest is being placed in suspense Where the customer continues to operate the account, but 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 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 advance is written down to its expected net realisable value and interest is no longer charged to the customer’s account as the likelihood of its recovery is considered remote. Interest is only taken to income if it is received. 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 and in the long-term assurance business (see o), 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 and in the long-term assurance business (see o), 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 circumstances where securities are transferred between the dealing and investment portfolios, 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. 66 LLOYDS TSB GROUP Notes to the accounts 1 Accounting policies (continued) 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 cash investment, taking into account tax and 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. Income from ﬁnance 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. Rental income from operating leases is credited to the proﬁt and loss account on an accruals basis. 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 both deﬁned beneﬁt and deﬁned contribution post-retirement beneﬁt schemes. Full actuarial valuations of the Group’s principal 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, or in the case of the Scottish Widows Retirement Beneﬁts Scheme, by a qualiﬁed actuary employed by Scottish Widows. 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 an AA 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 included only 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, after deducting 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 foreign exchange gains and losses, which arise from normal trading activities, are included in the proﬁt and loss account. o Long-term assurance business The Group accounts for its interest in long-term assurance business using the embedded value basis of accounting. The value of the shareholder’s interest in the long-term assurance business (‘the embedded value’) included in the Group’s balance sheet is an actuarially determined estimate of the economic value of the Group’s life assurance subsidiaries, excluding any value which may be attributed to future new business. The embedded value is comprised of the net tangible assets of the life assurance subsidiaries, including any surplus retained within the long-term business funds, which could be transferred to the shareholder, and the present value of the in-force business. The present value of the in-force business is calculated by projecting the future surpluses and other net cash ﬂows attributable to the shareholder arising from business written by the balance sheet date, using appropriate economic and actuarial assumptions, and discounting the result at a rate which reﬂects the shareholder’s overall risk premium attributable to this business. 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. 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 of the Group’s life assurance operations are legally owned by the Group, 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. LLOYDS TSB GROUP 67 Notes to the accounts 1 Accounting policies (continued) 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 Sale and repurchase transactions Securities which have been sold with an agreement to repurchase continue to be shown on the balance sheet and the sale proceeds recorded within deposits by banks or customer accounts as appropriate. Securities acquired in reverse sale and repurchase transactions are not recognised on the balance sheet and the purchase price is recorded within loans and advances. The difference between the sale price and repurchase price is accrued evenly over the life of the transaction and charged or credited to the proﬁt and loss account as interest payable or receivable. r 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 reasonable evidence of the intention to hedge at the outset of the transaction and the derivative substantially matches or eliminates a proportion of 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. 68 LLOYDS TSB GROUP Notes to the accounts 2 Segmental analysis The Group’s activities are organised into three businesses: UK Retail Banking, Insurance and Investments and Wholesale and International Banking. Services provided by UK Retail Banking encompass the provision of banking and other ﬁnancial services, private banking and mortgages to personal customers. Insurance and Investments offers life assurance, pensions and savings products, general insurance and fund management services. Wholesale and International Banking provides banking and related services for major UK and multinational companies, banks and ﬁnancial institutions, and small and medium-sized UK businesses. It also provides asset ﬁnance to personal and corporate customers, manages the Group’s activities in ﬁnancial markets through its Treasury function and provides banking and ﬁnancial services overseas. Life, pensions, unit trusts and asset insurance management £m General £m Insurance and Investments £m Wholesale and International Banking £m Central group items £m Continuing Discontinued operations £m operations§ £m Year ended 31 December 2004 Net interest income Other ﬁnance income Other operating income Total income Operating expenses Trading surplus (deﬁcit) General insurance claims Provisions for bad and doubtful debts Amounts written off ﬁxed asset investments Loss on sale of businesses UK Retail Banking £m 3,198 – 1,639 4,837 (2,513) 2,324 – (673) – – 44 – 497 541 (149) 392 (224) – – – Proﬁt (loss) before tax 1,651 168 Year ended 31 December 2003* Net interest income Other ﬁnance income Other operating income Total income Operating expenses Trading surplus (deﬁcit) General insurance claims Provisions for bad and doubtful debts Amounts written off ﬁxed asset investments Share of results of joint ventures Proﬁt on sale of businesses 3,137 – 1,533 4,670 (2,583) 2,087 – (594) – (22) – 38 – 505 543 (141) 402 (236) – – – – Proﬁt (loss) before tax 1,471 166 99 – 1,315 1,414 (272) 1,142 (224) – – – 1,966 – 1,641 3,607 (2,090) 1,517 – (193) (52) (15) (343) 39 13 (291) (42) (333) – – – – 4,920 39 4,608 9,567 (4,917) 4,650 (224) (866) (52) (15) 918 1,257 (333) 3,493 – – – – – – – – – – – Total £m 4,920 39 4,608 9,567 (4,917) 4,650 (224) (866) (52) (15) 3,493 81 – 1,084 1,875 – 1,561 1,165 (261) 3,436 (2,048) 904 (236) – – – – 1,388 – (306) (44) – – (349) 34 299 (16) (9) (25) – 13 – – – 4,744 34 4,477 9,255 (4,901) 4,354 (236) (887) (44) (22) – 511 – 142 5,255 34 4,619 653 (272) 9,908 (5,173) 381 – (63) – – 865 4,735 (236) (950) (44) (22) 865 668 1,038 (12) 3,165 1,183 4,348 55 – 818 873 (123) 750 – – – – 750 43 – 579 622 (120) 502 – – – – – 502 Geographical area:** 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 2004 £m International 2004 £m Total 2004 £m Domestic 2003 £m International 2003 £m Continuing Discontinued operations 2003 £m 2003 £m operations§ 9,992 39 2,980 249 715 554 682 403 – 144 22 – – 6 10,395 39 3,124 271 715 554 688 8,490 34 2,831 276 436 535 677 383 – 156 249 – – 5 8,873 34 2,987 525 436 535 682 1,276 – 112 35 17 – 12 Total 2003 £m 10,149 34 3,099 560 453 535 694 Total gross income 15,211 575 15,786 13,279 793 14,072 1,452 15,524 Proﬁt on ordinary activities before tax 3,295 198 3,493 2,810 355 3,165 1,183 4,348 LLOYDS TSB GROUP 69 Notes to the accounts 2 Segmental analysis (continued) Class of business UK Retail Banking Insurance and Investments: General insurance Life, pensions, unit trusts and asset management Wholesale and International Banking Central group items Geographical area** Domestic International Net Assets† 2004 £m Net Assets† 2003 £m Assets‡ 2004 £m Assets‡ 2003 £m 2,991 2,555 101,615 90,541 427 6,908 7,335 4,469 (4,772) 10,023 9,369 654 10,023 470 6,531 7,001 4,390 (4,278) 9,668 9,069 599 9,668 1,084 9,141 10,225 112,968 271 225,079 212,197 12,882 225,079 1,009 8,835 9,844 101,286 263 201,934 189,162 12,772 201,934 * From the beginning of 2004 the Group changed its UK branch and other distribution networks from cost centres to proﬁt centres and, consequently, amended the internal commission arrangements between these networks and the insurance product manufacturing businesses within the Group. The effect of this change has been to redistribute income from the insurance segments to UK Retail Banking and, to a lesser extent, to Wholesale. In addition, certain costs previously included in Central group items were reallocated to the operating segments. The 2003 segmental analysis has been restated to reﬂect these changes on a consistent basis. ** 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 (SSAP 25); it is not appropriate to relate it directly to the segmental proﬁts above because the business is not managed by the allocation of net assets to business units. ‡ Assets exclude long-term assurance assets attributable to policyholders. § Discontinued operations related to the Wholesale and International Banking segment. As the business of the Group is mainly that of banking and insurance, no segmental analysis of turnover is given. 3 Dealing proﬁts (before expenses) Foreign exchange trading income Securities and other gains 2004 £m 178 93 271 2003 £m 228 332 560 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. 4 Administrative expenses Salaries Social security costs Other pension costs (note 45) Staff costs Other administrative expenses The average number of persons on a headcount basis employed by the Group during the year was as follows: UK Overseas 2004 £m 2,069 140 338 2,547 1,737 4,284 74,924 3,372 78,296 2003 £m 2,092 143 353 2,588 1,888 4,476 73,814 10,288 84,102 The above staff numbers exclude 4,657 (2003: 5,202) staff employed in the long-term assurance business. Costs of £190 million (2003: £194 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 52 to 57. 70 LLOYDS TSB GROUP Notes to the accounts 4 Administrative expenses (continued) Statutory audit Other audit related fees: – Audit related regulatory reporting – Further assurance services Total other audit related fees Audit and audit related fees Tax advisory Other non-audit fees: – Due diligence services – Other Total other non-audit fees Total fees 2004 £m 5.2 0.9 6.4 7.3 12.5 0.8 0.9 0.3 1.2 14.5 2003 £m 5.5 0.9 3.3 4.2 9.7 1.6 0.7 0.2 0.9 12.2 The auditors’ remuneration for the holding company was £51,500 (2003: £51,500). During the year the auditors also earned fees of £0.6 million (2003: £0.6 million) in respect of the audit of unit trusts and pension schemes managed by the Group. Included in ’Other audit related fees’ are the costs of the advice provided in relation to the Group’s preparations for the implementation of International Financial Reporting Standards and the requirements of the Sarbanes-Oxley Act together with the costs of the audit of the Group’s Form 20-F ﬁling. It is the Group’s policy to use the auditors on assignments in cases where their knowledge of the Group means that it is neither efﬁcient nor cost effective to employ another ﬁrm of accountants. Such assignments typically relate to the provision of advice on tax issues, assistance in transactions involving the acquisition and disposal of businesses and accounting advice. The auditors are not permitted to provide management consultancy services to the Group. The Group has procedures to ensure that fees for audit and non-audit services are approved in advance. The audit committee has established de minimis fee limits for particular detailed types of service and has approved in advance all non-audit assignments where the fee falls below the relevant limit. All statutory audit work as well as non-audit assignments where the fee is expected to exceed the relevant limit are subject to individual pre-approval by the audit committee. On a quarterly basis, the audit committee receives a report detailing all pre-approved services and amounts paid to the auditors for such pre-approved services. 5 Amounts written off ﬁxed asset investments Debt securities Equity shares 2004 £m 43 9 52 2003 £m. 42 2 44 LLOYDS TSB GROUP 71 Notes to the accounts 6 (Loss) proﬁt before tax on sale of businesses Proﬁt on sale of businesses in Argentina (tax: £6 million) Loss on sale of businesses in Colombia (after charging £3 million of goodwill previously written off to reserves) (tax: nil) Loss on sale of businesses in Panama, Guatemala and Honduras (tax: £1 million) Loss on sale of French fund management and private banking businesses (tax: nil) Loss on sale of Brazilian businesses (after charging £161 million of goodwill previously written off to reserves) (tax: nil) Proﬁt on sale of New Zealand operations (after charging £20 million of goodwill previously written off to reserves) (tax: nil) 2004 £m 6 (20) (1) – – – (15) 2003 £m – – – (15) (41) 921 865 During 2004 the Group completed the sale, announced on 19 July 2004 and completed on 19 November 2004, of the business of the branch of Lloyds TSB Bank plc in Argentina; the sale, announced on 19 July 2004 and completed on 30 November 2004 of the Group’s principal businesses in Colombia comprising its interests in Lloyds TSB Bank S.A. and in Lloyds Trust S.A. and certain offshore assets; and the sales, announced on 1 December 2003, of substantially all of the businesses of the branches of Lloyds TSB Bank plc in Panama, Guatemala and Honduras which were completed on 30 April 2004, 4 June 2004 and 1 October 2004 respectively. During 2003 the Group completed the sales of its French fund management and private banking businesses, including its subsidiaries Lloyds Bank SA, Chaillot Assurances SA and Capucines Investissements SA; its Brazilian subsidiaries Banco Lloyds TSB S.A. and Losango Promotora de Vendas Ltda, together with substantially all of the business of the Brazilian branch of Lloyds TSB Bank plc and certain offshore Brazilian assets; and its subsidiary, NBNZ Holdings Limited, comprising the Group’s New Zealand banking and insurance operations. The trading results of the businesses sold in 2004 were not material to the Group. Discontinued operations in 2003 comprised the businesses in New Zealand, Brazil and France sold in that year. 7 Proﬁt on ordinary activities before tax Proﬁt on ordinary activities before tax is stated after taking account of: 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 Proﬁts less losses on disposal of investment securities Charges: Rental of premises Hire of equipment Interest on subordinated liabilities (loan capital) 2004 £m 3,742 422 126 212 17 601 2003 £m 3,495 446 47 220 18 622 72 LLOYDS TSB GROUP Notes to the accounts 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 Double taxation relief 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 2004 £m 841 (38) 803 (58) 745 119 (5) 114 859 146 (1) 1,004 2003 £m 1,079 (72) 1,007 (223) 784 144 (15) 129 913 119 (7) 1,025 The charge for tax on the proﬁt for the year is based on a UK corporation tax rate of 30 per cent (2003: 30 per cent). In addition to the tax charge in the proﬁt and loss account detailed above, £71 million (2003: £2 million) of deferred tax has been credited to the statement of total recognised gains and losses in respect of actuarial losses recognised in post-retirement beneﬁt schemes (note 45). 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 – Speciﬁcally allowable, unallowable and non-taxable items – Net tax effect of disposals – Tax deductible coupons on non-equity minority interests – 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 Tax on proﬁt on ordinary activities Effective rate 2004 £m 3,493 1,048 9 (14) (5) (12) (12) (86) (60) (16) 7 859 86 60 (1) 1,004 28.7% 2003 £m 4,348 1,304 9 (9) (10) (276) (12) (105) (14) 16 10 913 105 14 (7) 1,025 23.6% LLOYDS TSB GROUP 73 Notes to the accounts 8 Tax on proﬁt on ordinary activities (continued) c Factors that may affect the future tax charge The current tax charge includes a charge of £199 million (2003: charge of £157 million) in respect of notional tax on the shareholder’s interest in the movement in value of the long-term assurance business (note 29b). 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. Future transfers from Scottish Widows plc’s long-term business fund to its shareholder’s fund will be subject to a shareholder tax charge. Under FRS 19, no provision is required to be made since the timing of such transfers is under Scottish Widows plc’s control. The potential deferred tax liability (undiscounted) not recognised on the balance sheet is approximately £230 million (2003: £110 million). 9 Proﬁt for the ﬁnancial year attributable to shareholders The proﬁt attributable to shareholders includes a proﬁt of £1,921 million (2003: £1,880 million) dealt with in the accounts of the parent company for which no proﬁt and loss account is shown as permitted by Section 230 of the Companies Act 1985. 10 Ordinary dividends Interim: paid Final: proposed 2004 pence per share 2003 pence per share 10.7 23.5 34.2 10.7 23.5 34.2 2004 £m 599 1,315 1,914 2003 £m 597 1,314 1,911 No dividends have been paid on the £100 of 6 per cent non-cumulative redeemable preference shares issued in the year (see note 40). Dividends are being accrued at the rate of 6 per cent per annum and the ﬁrst payment is due in March 2005. 11 Earnings per share 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 2004 £2,421m 5,590m 35m 5,625m 43.3p 43.0p 2003 £3,254m 5,581m 18m 5,599m 58.3p 58.1p † 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 6 million (2003: 8 million) ordinary shares representing the Group’s holdings of own shares (note 43). 74 LLOYDS TSB GROUP Notes to the accounts 12 Treasury bills and other eligible bills 2004 Balance sheet £m 2004 Valuation £m 2003 Balance sheet £m 2003 Valuation £m 75 13 88 4 92 – 18 74 92 – 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 Included above: Unamortised discounts net of premiums on investment securities Movements in investment securities: At 1 January 2004 Exchange and other adjustments Additions Bills sold or matured Adjustments on disposal of businesses Amortisation of premiums and discounts At 31 December 2004 77 13 90 4 94 Cost £m 528 (3) 430 (830) (37) – 88 308 222 530 9 539 336 70 133 539 2 Premiums and discounts £m 2 – – (5) – 3 – 305 218 523 9 532 Total £m 530 (3) 430 (835) (37) 3 88 Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. It is expected that tax of £1 million would be payable (2003: £2 million recoverable) if the investment securities were sold at their year end valuation. 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. 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 2004 £m 2,483 21,083 23,566 (1) 23,565 2,477 16,763 2,243 1,422 661 (1) 23,565 2003 £m 2,292 13,273 15,565 (18) 15,547 3,768 7,637 2,329 1,496 335 (18) 15,547 LLOYDS TSB GROUP 75 Notes to the accounts 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 Of which repayable on demand or at short notice 2004 £m 144,708 4,828 6,387 155,923 (1,662) (21) 154,240 28,748 9,878 35,301 81,996 (1,662) (21) 154,240 15,805 2003 £m 125,785 4,701 6,470 136,956 (1,677) (28) 135,251 23,284 9,458 31,384 72,830 (1,677) (28) 135,251 13,365 The cost of assets acquired during the year for letting to customers under ﬁnance leases and hire purchase contracts amounted to £5,472 million (2003: £4,478 million). Equipment leased to customers, which is stated after deducting £4,551 million (2003: £4,907 million) of unearned charges, is repayable as follows: 3 months or less 1 year or less but over 3 months 5 years or less but over 1 year Over 5 years 2004 £m 247 282 1,516 4,342 6,387 2003 £m 91 345 1,465 4,569 6,470 76 LLOYDS TSB GROUP Notes to the accounts 15 Provisions for bad and doubtful debts and non-performing lending At 1 January Exchange and other adjustments Adjustments on acquisitions and disposals Transfer from general to speciﬁc provisions Advances written off Recoveries of advances written off in previous years Charge (release) to proﬁt and loss account: New and additional provisions Releases and recoveries At 31 December In respect of: Loans and advances to banks Loans and advances to customers 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 2004 Speciﬁc £m 1,313 (11) (21) 3 (1,028) 174 1,571 (618) 953 1,383 1,663 1 1,662 1,663 2004 General £m 382 – (12) (3) – – 12 (99) (87) 280 2004 £m 567 673 1,240 (914) (21) 305 2003 Speciﬁc £m 1,334 (1) (49) 50 (1,145) 178 1,552 (606) 946 1,313 1,695 18 1,677 1,695 2003 General £m 433 – (5) (50) – – 9 (5) 4 382 2003 £m 633 585 1,218 (916) (28) 274 LLOYDS TSB GROUP 77 Notes to the accounts 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 USA Europe Rest of the world Total international Provisions for bad and doubtful debts* Interest held in suspense* 2004 £m 2,076 3,292 1,877 6,753 5,775 12,103 80,065 22,833 6,387 4,828 5,321 151,310 125 2,385 1,587 516 4,613 155,923 (1,662) (21) 154,240 2003 £m 2,025 3,211 1,497 4,741 4,577 9,652 70,750 20,139 6,470 4,701 3,351 131,114 557 2,681 1,981 623 5,842 136,956 (1,677) (28) 135,251 * 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. 78 LLOYDS TSB GROUP Notes to the accounts 17 Debt securities Investment securities Government 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 Corporate debt securities Mortgage backed securities Other asset backed 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 4,524 51 5,733 504 14 25,194 4,090 21,104 25,194 5,048 11,825 5,080 76 2,763 402 25,194 Unamortised discounts net of premiums on investment securities 56 Investment securities Listed Unlisted Other securities Listed Unlisted 8,925 5,443 14,368 10,378 448 10,826 2004 Balance sheet £m 2,211 1,901 2,581 2,774 3,761 1,140 2004 Valuation £m 2,213 1,902 2,587 2,781 3,756 1,141 2003 Balance sheet £m 1,895 2,515 1,895 2,211 3,942 1,283 2003 Valuation £m 1,902 2,515 1,890 2,212 3,951 1,284 14,368 14,380 13,741 13,754 4,524 51 5,733 504 14 25,206 8,931 5,449 14,380 10,378 448 10,826 7,253 106 6,785 664 120 28,669 5,045 23,624 28,669 5,232 15,949 5,130 98 1,994 266 28,669 341 8,162 5,579 13,741 14,374 554 14,928 7,253 106 6,785 664 120 28,682 8,173 5,581 13,754 14,374 554 14,928 LLOYDS TSB GROUP 79 Notes to the accounts 17 Debt securities (continued) Movements in investment securities: At 1 January 2004 Exchange and other adjustments Additions Transfers from other securities Securities sold or matured Adjustments on disposal of businesses Charge for the year Amortisation of premiums and discounts At 31 December 2004 Cost £m 13,731 (484) 9,637 281 (8,787) (23) – – 14,355 Premiums and discounts £m Provisions £m 109 – – – (2) – – 14 121 99 (2) – – (25) (7) 43 – 108 Total £m 13,741 (482) 9,637 281 (8,764) (16) (43) 14 14,368 Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. It is expected that tax of £4 million (2003: £3 million) would be payable if the investment securities were sold at their year end valuation. 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. 18 Equity shares Investment securities Listed Unlisted Other securities Listed Movements in investment securities: At 1 January 2004 Exchange and other adjustments Additions Disposals Adjustments on disposal of businesses Charge for the year At 31 December 2004 2004 Balance sheet £m 2004 Valuation £m 2003 Balance sheet £m 2003 Valuation £m 5 34 39 176 215 7 56 63 176 239 Cost £m 41 (1) 21 (12) (1) – 48 5 30 35 423 458 Provisions £m 6 (1) – (5) – 9 9 5 126 131 423 554 Total £m 35 – 21 (7) (1) (9) 39 Investment securities are those intended for use on a continuing basis in the activities of the Group and not for dealing purposes. If the investment securities were sold at their year end valuation no tax is expected to be payable as any such gains would be exempt or covered by available capital losses. 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. 80 LLOYDS TSB GROUP Notes to the accounts 19 Assets transferred under sale and repurchase transactions Assets subject to sale and repurchase agreements: Treasury bills and other eligible bills Debt securities 2004 £m 117 10,454 10,571 2003 £m 136 4,503 4,639 These investments have been sold to third parties but the Group is committed to reacquire them at a future date and at a predetermined price. At 31 December 2004 the Group held £12,783 million (2003: £2,643 million) of securities as collateral under reverse repurchase agreements. The above disclosure includes assets held through these agreements and subsequently resold as collateral for the Group’s own transactions. 20 Interests in joint ventures At 1 January 2004 Share of losses At 31 December 2004 The Group’s largest investments are in two joint ventures: Group interest iPSL GF Two Limited (formerly Goldﬁsh Holdings Limited) 19.5% of issued ordinary share capital 25.0% of issued ordinary share capital £m 54 (1) 53 Nature of business Cheque processing No longer trading In the year ended 31 December 2004 £16 million (2003: £25 million) of fees payable to iPSL have been included in the Group’s administrative expenses and £3 million (2003: £3 million) of charges to iPSL have been included in the Group’s income. The Group has also prepaid £17 million (2003: £13 million) of fees in respect of 2005 and this amount is included in prepayments and accrued income. GF One Limited (formerly Goldﬁsh Bank Limited, a wholly owned subsidiary of GF Two Limited) has lent £44 million (2003: nil) to the Group and this amount is included in customer accounts. Interest payable to GF One Limited of £1 million (2003: nil) has been charged to the Group’s proﬁt and loss account and capitalised in this balance. In the year ended 31 December 2003 £7 million of interest receivable from GF One Limited and £6 million of charges to GF One Limited in respect of administrative costs were included in the Group’s income. Included in the gross assets disclosed on the balance sheet is an investment of £3 million (2003: £3 million) in associated undertakings. 21 Interests in group undertakings At 1 January 2004 Revaluation Disposal At 31 December 2004 Shares in banks Shares in other group undertakings Total – all unlisted Shares £m 10,753 328 (1) 11,080 2004 £m 11,080 – 11,080 Loans £m 1,723 – – 1,723 2003 £m 10,752 1 10,753 On an historical basis, shares in group undertakings would have been included at cost of £6,066 million (2003: £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 disposal of substantial shareholding investments. LLOYDS TSB GROUP 81 Notes to the accounts 21 Interests in group undertakings (continued) 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: Country of registration/ incorporation Percentage of equity share capital and voting rights held Nature of business Lloyds TSB Bank plc Cheltenham & Gloucester plc Lloyds TSB Commercial Finance Limited Lloyds TSB Leasing Limited Lloyds TSB Private Banking Limited The Agricultural Mortgage Corporation PLC Lloyds TSB Offshore Limited Lloyds TSB Scotland plc Lloyds TSB General Insurance Limited Scottish Widows Investment Partnership Group Limited Abbey Life Assurance Company Limited Lloyds TSB Insurance Services Limited Lloyds TSB Asset Finance Division Limited Black Horse Limited Scottish Widows plc Scottish Widows Annuities Limited † Indirect interest England England England England England England Jersey Scotland England England England England England England Scotland Scotland 100% 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† 100%† Banking and ﬁnancial services Mortgage lending and retail investments Credit factoring Financial leasing Private banking Long-term agricultural ﬁnance Banking and ﬁnancial services Banking and ﬁnancial services General insurance Investment management Life assurance Insurance broking Consumer credit, leasing and related services Consumer credit, leasing and related services Life assurance Life assurance 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 Belgium, Dubai, Ecuador, Gibraltar, Hong Kong, Japan, Luxembourg, Malaysia, Monaco, Netherlands, Paraguay, Singapore, Spain, Switzerland, Uruguay, the USA and a representative ofﬁce in Iran. 82 LLOYDS TSB GROUP Notes to the accounts 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 Structured ﬁnance vehicles Proﬁt and loss account Interest receivable Interest payable Other operating income Total income Operating expenses (Loss) proﬁt on ordinary activities before taxation Tax on (loss) proﬁt on ordinary activities (Loss) proﬁt on ordinary activites after taxation Dividends paid (Loss) proﬁt for the year Balance sheet Assets: Loans and advances to customers Debt securities 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 from operating activities 23 Intangible ﬁxed assets Goodwill At 1 January 2004 Acquisition adjustment Adjustments on disposal of businesses Charge for the year At 31 December 2004 2004 £m – (74) 116 42 (57) (15) 5 (10) – (10) – – 1,742 49 1,791 1,527 – 260 4 1,791 388 2003 £m – (59) 93 34 (36) (2) 6 4 – 4 – – 1,408 23 1,431 1,309 – 108 14 1,431 132 Cost £m 2,626 (34) (14) – 2,578 2004 £m 132 (83) (8) 41 – 41 (5) 36 (24) 12 410 3,770 – 36 4,216 – 3,272 31 913 4,216 52 2003 £m 82 (52) (2) 28 – 28 (2) 26 _ 26 345 3,718 – 34 4,097 672 3,123 18 284 4,097 1,173 Amortisation £m Net book value £m 113 – (4) 44 153 2,513 (34) (10) (44) 2,425 LLOYDS TSB GROUP 83 Notes to the accounts 24 Tangible ﬁxed assets Cost: At 1 January 2004 Exchange and other adjustments Adjustments on disposal of businesses Additions Disposals At 31 December 2004 Depreciation: At 1 January 2004 Exchange and other adjustments Adjustments on disposal of businesses Charge for the year (£589 million in total; 2003: £646 million) Disposals At 31 December 2004 Balance sheet amount at 31 December 2004 Balance sheet amount at 31 December 2003 Balance sheet amount of premises comprises: Freeholds Leaseholds 50 years and over unexpired Leaseholds less than 50 years unexpired Land and buildings occupied for own activities Premises £m Equipment £m Operating lease assets £m 2,186 (1) (13) 262 (109) 2,325 1,296 (1) (8) 257 (81) 1,463 862 4,181 890 3,918 1,192 – (10) 73 (18) 1,237 416 – (4) 66 (5) 473 764 776 2004 £m 349 140 275 764 695 2,518 (46) – 801 (471) 2,802 266 (4) – 266 (281) 247 2,555 2,252 2003 £m 369 133 274 776 705 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 2004 £m 378 128 647 588 1,741 2003 £m 181 330 505 445 1,461 84 LLOYDS TSB GROUP Notes to the accounts 25 Lease commitments Annual commitments under non-cancellable operating lease agreements were: 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 Obligations under ﬁnance leases were: Amounts payable in: 1 year or less 5 years or less but over 1 year 26 Capital commitments 2004 Premises £m 6 26 176 208 2004 Premises £m 1 3 4 2004 Equipment £m – – – – 2004 Equipment £m 1 1 2 2003 Premises £m 7 29 190 226 2003 Premises £m – – – 2003 Equipment £m – – – – 2003 Equipment £m – – – Capital expenditure contracted but not provided for at 31 December 2004 amounted to £150 million (2003: £77 million) of which £146 million (2003: £71 million) relates to assets to be leased to customers under operating leases. 27 Other assets Balances arising from derivatives used for trading purposes (note 47) Balances arising from derivatives used for hedging purposes Settlement balances Other assets 28 Prepayments and accrued income Interest receivable Deferred expenditure incurred under cash gift and discount mortgage schemes Other debtors and prepayments 2004 £m 2,015 254 40 911 3,220 2004 £m 1,075 78 1,420 2,573 2003 £m 2,489 475 54 926 3,944 2003 £m 869 128 921 1,918 LLOYDS TSB GROUP 85 Notes to the accounts 29 Long-term assurance business a Analysis of embedded value 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 Movements in the embedded value balance: At 1 January Exchange and other adjustments Proﬁt after tax Adjustments on disposal of businesses Dividends At 31 December 2004 £m 3,842 2,939 6,781 2004 £m 6,481 (16) 516 – (200) 6,781 2003 £m 3,602 2,879 6,481 2003 £m 6,213 12 296 (38) (2) 6,481 b 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, less the costs of acquiring the business, including commissions paid to independent ﬁnancial advisers and other direct sales costs. 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; and • Customer remediation provisions (see c). Development costs. This represents the costs associated with new product development and implementation of the bancassurance strategy. 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. Operating proﬁt is adjusted by the following items to arrive at income from long-term assurance business: Investment variance: this represents (a) the difference between the actual investment return in the year on investments backing shareholder funds and the expected return based upon the economic assumptions made at the beginning of the year; (b) the effect of these ﬂuctuations on the value of in-force business; and (c) other effects of changes in extraneous economic circumstances beyond the control of management. Changes in economic assumptions: this represents the effect of changes in the economic assumptions referred to in e. 86 LLOYDS TSB GROUP Notes to the accounts 29 Long-term assurance business (continued) Income from long-term assurance business: New business contribution Existing business: Expected return Experience variances Assumption changes and other items Customer remediation provisions (see c) Development costs Investment earnings Operating proﬁt Investment variance Changes in economic assumptions (see e) Income from long-term assurance business before tax Attributed tax Income from long-term assurance business after tax 2004 £m 225 289 (41) (39) (12) 197 (11) 167 578 139 (2) 715 (199) 516 2003 £m 150 264 (16) (75) (100) 73 (13) 153 363 112 (22) 453 (157) 296 This analysis details the components of embedded value income for 2004 and the comparative period. These numbers are not comparable in all respects to the analysis of life and pensions proﬁtability given on page 16, in the operating and ﬁnancial review, since that analysis includes certain items which are accounted for outside of the embedded value calculations. In addition, comparatives in the operating and ﬁnancial review have been restated to reﬂect the impact of the introduction, in 2004, of the management of the Group’s distribution channels as proﬁt centres. c Customer remediation provisions Redress to past purchasers of pension policies Following an industry wide investigation in the 1990’s it was concluded that a large number of customers who had purchased personal pension products had been poorly advised by insurance companies and intermediaries; an action plan was established requiring the UK pensions industry to review all cases of possible misselling and, where appropriate, pay 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: At 1 January Accrual of interest on the provision Charge for the year Compensation paid At 31 December 2004 £m 25 – – (12) 13 2003 £m 37 2 44 (58) 25 The review is now nearing completion and management do not expect any further material changes in the provisioning requirement. LLOYDS TSB GROUP 87 Notes to the accounts 29 Long-term assurance business (continued) Mortgage endowments and other savings products During 2002, a review was carried out in conjunction with the FSA into sales of mortgage endowment and other long-term savings products made by the Abbey Life sales force between 1988 and its disposal by Lloyds TSB Group in February 2000. As a result of this review, the Group is required to pay compensation to customers in those cases where sales practices are found to have been deﬁcient. A provision has been established to meet the cost of the payments to those customers; a provision is also held against the estimated cost of redress payments to customers in respect of products sold by the Abbey Life sales force prior to 1988. During 2004 management has reviewed the adequacy of the provisions held in the light of experience and changing market conditions and an additional charge of £12 million (2003: £56 million) has been made. Movements in the provision over the last two years: At 1 January Accrual of interest on the provision Charge for the year Compensation paid At 31 December 2004 £m 149 3 12 (140) 24 2003 £m 165 5 56 (77) 149 Details of the provisions held in respect of the estimated cost of making redress payments to customers in respect of past product sales by the Group’s banking operations are given in note 37. d With-proﬁts options and guarantees In common with other organisations in the life assurance industry, prior to its demutualisation Scottish Widows wrote policies which contained potentially valuable options and guarantees, including guaranteed annuity option policies. Under the terms of the transfer of the Scottish Widows business, a separate memorandum account was created within the With-Proﬁts Fund called the Additional Account which is available, inter alia, to meet any additional costs of providing guaranteed beneﬁts on transferred policies; the Additional Account had a value at 31 December 2004 of £1.4 billion (2003: £1.4 billion). To the extent that the Additional Account is insufﬁcient to provide these beneﬁts any shortfall would be met by Lloyds TSB Group. Since demutualisation in 2000, Scottish Widows continued to write policies containing similar features, although the volume of products written has since reduced and is now not signiﬁcant. The Additional Account is not available to meet any additional cost of providing the beneﬁts on these policies. The eventual cost of providing beneﬁts on the policies written both pre and post demutualisation is dependent upon a large number of variables, including in particular: • future interest rate and equity market trends; • demographic factors, such as future persistency and mortality; and • the proportion of policyholders who seek to exercise their options. The ultimate cost, and any impact upon Lloyds TSB Group, will not be known for many years. However, Scottish Widows has developed, and will continue to develop, an actuarial model to assist in the management of the With-Proﬁts Fund and to meet regulatory requirements. The model allows management to estimate the effects of different economic scenarios upon the ﬁnancial position of the fund and consider the implications of different management actions. Output from this model indicates that the possible cost of providing beneﬁts on policies containing features such as options and guarantees varies widely and, depending on the economic scenario encountered, could result in Lloyds TSB Group incurring a liability. Based on the information available at present, having considered the range of possible outcomes, and after making allowance for the effect of proposed future management actions, Lloyds TSB Group currently considers that no provision is necessary. However, the model is subject to ongoing development and the position will be kept under review. e Assumptions In accordance with the Association of British Insurers’ detailed guidance for the preparation of ﬁgures using the achieved proﬁts method of accounting, the Group has reviewed the economic assumptions used in the embedded value calculations. The guidance requires that the assumptions should be reviewed at each reporting date. The principal economic assumptions have been revised at 31 December 2004 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 The revised assumptions have resulted in a net charge to the proﬁt and loss account of £2 million. 2004 % 7.40 7.17 4.57 3.76 2003 % 7.60 7.45 4.85 3.80 88 LLOYDS TSB GROUP Notes to the accounts 29 Long-term assurance business (continued) Other assumptions used to derive the embedded value are as follows: • Assumed rates of mortality and morbidity are taken from published tables adjusted for demographic differences. Assumptions in respect of lapse rates take into account both the effects of recent actual experience and future expectations of the companies concerned. • 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 (2003: 30 per cent). The normalised investment earnings have been grossed up at a composite longer term tax rate of 18 per cent (2003: 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 eligible bonus, in accordance with the terms of the transfer of the Scottish Widows business. f Sensitivities The table below shows the effect on both the embedded value at 31 December 2004 and the new business contribution for the year then ended of theoretical changes in the main economic assumptions. Embedded value £m New business contribution £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 g Balance sheet The long-term assurance assets attributable to policyholders comprise: Investments Premises and equipment Other assets Net tangible assets of life companies including surplus Investments shown above comprise: Fixed interest securities Stocks, shares and unit trusts Investment properties Other properties Mortgages and loans Deposits The liabilities to policyholders comprise: Technical provisions: – Long-term business provision (net of reinsurance) – Claims outstanding (net of reinsurance) Technical provisions for linked liabilities Fund for future appropriations Other liabilities 6,781 (189) 213 (84) 2004 £m 56,960 35 1,741 58,736 (3,842) 54,894 15,985 31,896 3,150 120 76 5,733 56,960 23,705 246 28,256 1,379 1,308 54,894 225 (26) 30 (12) 2003 £m 52,082 40 1,680 53,802 (3,602) 50,200 15,947 27,590 3,540 121 65 4,819 52,082 23,730 238 25,023 346 863 50,200 For the purposes of consolidating the long-term assurance policyholder assets and liabilities into the Group’s balance sheet a deduction has been made of £130 million (2003: £122 million) for own shares held within the with-proﬁt funds. LLOYDS TSB GROUP 89 Notes to the accounts 29 Long-term assurance business (continued) h 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 Unrealised gains on investments Other income Claims Change in technical provisions Expenses Realised gains (losses) on investments Unrealised losses on investments Other charges Tax attributable to long-term business Transfer to the fund for future appropriations Balance on the technical account – long-term business Tax attributable to balance on the technical account – long-term business Income in shareholder fund Proﬁt on ordinary activities before tax Tax on proﬁt on ordinary activities Proﬁt on ordinary activities after tax Dividends proposed Proﬁt for the ﬁnancial year 2004 £m 5,575 1,981 2,815 – 10,371 (5,222) (3,208) (535) 244 – – (110) (1,084) 456 155 55 666 (170) 496 (200) 296 Income from long-term assurance business after tax reconciles to the proﬁt calculated on a modiﬁed statutory solvency basis as follows: Income from long-term assurance business attributable to the shareholder after tax Increase in value-in-force taken to proﬁt Other differences: Movement in deferred acquisition costs Tax adjustment Other Proﬁt on ordinary activities after tax on a modiﬁed statutory solvency basis 2004 £m 516 (60) 456 89 7 (56) 496 2003 £m 5,139 2,073 4,833 6 12,051 (4,433) (4,540) (689) (1,679) (22) (4) (41) (414) 229 112 34 375 (125) 250 – 250 2003 £m 296 (2) 294 66 (60) (50) 250 90 LLOYDS TSB GROUP Notes to the accounts 29 Long-term assurance business (continued) A summarised balance sheet on a modiﬁed statutory solvency basis was as follows: 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 † Net of reinsurers’ share of technical provisions 2004 £m 29,069 28,256 1,992 59,317 4,581 1,379 23,705 28,256 1,396 59,317 2003 £m 27,468 25,023 2,018 54,509 4,234 346 23,730 25,023 1,176 54,509 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: 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 on a modiﬁed statutory solvency basis 30 Assets and liabilities denominated in foreign currencies Assets Denominated in sterling Denominated in other currencies Liabilities Denominated in sterling Denominated in other currencies 2004 £m 6,781 (2,939) 3,842 585 152 2 4,581 2004 £m 171,704 53,375 225,079 171,587 53,492 225,079 Assets and liabilities exclude long-term assurance assets attributable to policyholders and liabilities to policyholders. 2003 £m 6,481 (2,879) 3,602 496 145 (9) 4,234 2003 £m 153,775 48,159 201,934 153,769 48,165 201,934 LLOYDS TSB GROUP 91 Notes to the accounts 31 Deposits by banks 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 2004 £m 5,183 31,833 2,500 21 201 39,738 The breakdown of deposits by banks between the domestic and international ofﬁces of the Group is set out below: Domestic: Non-interest bearing Interest bearing International: Non-interest bearing Interest bearing 32 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 2004 £m 180 33,029 33,209 32 6,497 6,529 39,738 2004 £m 93,846 18,938 2,442 5,632 1,204 122,062 The breakdown of customer accounts between the domestic and international ofﬁces of the Group is set out below: 2004 £m 3,529 115,699 119,228 296 2,538 2,834 122,062 Domestic: Non-interest bearing Interest bearing International: Non-interest bearing Interest bearing 92 LLOYDS TSB GROUP 2003 £m 7,455 15,002 1,197 69 232 23,955 2003 £m 144 18,715 18,859 61 5,035 5,096 23,955 2003 £m 90,539 17,316 1,846 5,431 1,364 116,496 2003 £m 3,328 109,384 112,712 358 3,426 3,784 116,496 Notes to the accounts 33 Debt securities in issue 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 2004 £m 167 144 1,053 3,999 5,363 18,489 2,941 424 – 21,854 27,217 2003 £m 711 81 1,099 3,623 5,514 17,942 2,015 283 168 20,408 25,922 Debt securities in issue include certiﬁcates of deposit of £15,226 million (2003: £16,415 million) and commercial paper of £6,473 million (2003: £3,625 million). An amount of £5,097 million (2003: £5,184 million) relating to debt securities issued under the Group’s Euro Medium Term Note programme is included in these ﬁgures. 34 Other liabilities Balances arising from derivatives used for trading purposes (note 47) Balances arising from derivatives used for hedging purposes Current tax Dividends Settlement balances Other liabilities 35 Accruals and deferred income Interest payable Other creditors and accruals 2004 £m 3,135 667 399 1,315 38 1,065 6,619 2004 £m 1,581 2,285 3,866 2003 £m 3,499 503 503 1,314 40 1,148 7,007 2003 £m 1,216 1,990 3,206 LLOYDS TSB GROUP 93 Notes to the accounts 36 Deferred tax Short-term timing differences Accelerated depreciation allowances At 1 January 2004 Exchange and other adjustments Adjustments on disposal of assets Charge for the year At 31 December 2004 2003 £m (229) 1,605 1,376 2004 £m (196) 1,669 1,473 £m 1,376 (26) (23) 146 1,473 Deferred tax is recognised in respect of the retained earnings of overseas subsidiaries and associates only to the extent that, at the balance sheet date, dividends have been accrued as receivable or a binding agreement to distribute past earnings in the future has been entered into. Deferred tax balances have not been discounted. The deferred tax balance at 31 December 2004 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 £956 million (2003: £916 million) (note 45). 37 Other provisions for liabilities and charges At 1 January 2004 Exchange and other adjustments Adjustments on disposal of businesses Provisions applied Charge for the year At 31 December 2004 Customer remediation provisions Customer remediation provisions £m 97 – – (105) 100 92 Insurance provisions £m 219 (6) – (203) 224 234 Vacant leasehold property and other £m 86 – (1) (13) 19 91 Total £m 402 (6) (1) (321) 343 417 The Group establishes provisions for the estimated cost of making redress payments to customers in respect of past product sales, where the original sales processes are found to have been deﬁcient. During 2004 management have again reviewed the adequacy of the provisions held having regard to current complaint volumes and the level of payments being made and as a result an additional charge of £100 million (2003: £200 million) has been made. At 31 December 2004 the provisions held mainly related to past sales of mortgage endowment policies. Mortgage endowments were sold to customers through the branch network of Lloyds TSB Bank, Lloyds TSB Scotland and Cheltenham & Gloucester, and underwritten by life assurance companies within the Group and also by third parties. The principal assumptions that have been made in the calculation of the provision relate to the number of cases that are likely to require redress and the estimated average cost per case. The ultimate cost and timing of the payments remains highly uncertain and will be inﬂuenced by external factors beyond the control of management, such as regulatory actions, media interest and the performance of the ﬁnancial markets. However, it is expected that the majority of the expenditure will be incurred over the next two years. 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, a claims equalisation provision is maintained in relation to property business. The majority of provisions in respect of claims will be settled in the following year, although new provisions will then be required in respect of claims arising from that year. The level of the claims equalisation provision will be adjusted annually, taking into account the guidelines contained in the legislation, and such provisions will be held for as long as the Group continues to write the relevant types of general insurance business. 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 run off during the remaining life of the leases concerned; the run off period currently averages 5 years. Where a property is disposed of earlier than anticipated, any remaining balance in the provision relating to that property is released. 94 LLOYDS TSB GROUP Notes to the accounts 38 Subordinated liabilities Undated loan capital Dated loan capital Notes Group 2004 £m 5,852 4,400 Group 2003 £m 5,959 4,495 Total subordinated liabilities 10,252 10,454 Company 2004 £m 497 861 1,358 Company 2003 £m 497 859 1,356 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 (c750 million) 6.90% Perpetual Capital Securities callable 2007 (US$1,000 million) 55/8% Undated Subordinated Step-up Notes callable 2009 (c1,250 million) Undated Step-up Floating Rate Notes callable 2009 (c150 million) 65/8% Undated Subordinated Step-up Notes callable 2010 6.35% Step-up Perpetual Capital Securities callable 2013 (c500 million) 5.57% Undated Subordinated Step-up Coupon Notes callable 2015 (¥20,000 million) 5.125% Undated Subordinated Step-up Notes callable 2016 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 Dated loan capital 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 51/4% Subordinated Notes 2008 (DM 750 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) 61/4% Subordinated Notes 2010 (c400 million) Subordinated Floating Rate Notes 2010 (US$400 million) 12% Guaranteed Subordinated Bonds 2011 91/8% Subordinated Bonds 2011 43/4% Subordinated Notes 2011 (c850 million) 57/8% Subordinated Guaranteed Bonds 2014 (c750 million) 57/8% Subordinated Notes 2014 67/8% Subordinated Notes 2015 Subordinated Step-up Floating Rate Notes 2016 callable 2011 (c500 million) Subordinated Floating Rate Notes 2020 (c100 million) 95/8% Subordinated Bonds 2023 5.75% Subordinated Step-up Notes 2025 callable 2020 a b c g a f d, g h f f f f e a e a, i a i 389 259 311 100 526 512 877 105 407 350 101 497 267 199 455 497 419 279 335 100 523 550 874 105 407 349 104 496 267 199 455 497 5,852 5,959 – – – 250 299 270 100 100 – 281 207 100 149 582 462 148 345 353 70 338 346 5 400 100 249 299 269 100 100 279 281 223 100 149 578 461 148 345 – 70 339 – – – – – – – – – – – – – – – – 497 497 – – – 250 – – – – – – – – 149 – 462 – – – – – – – – – – – – – – – – – – – – – 497 497 – – – 249 – – – – – – – – 149 – 461 – – – – – – 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. † Any repayments of undated loan capital would require the prior consent of the Financial Services Authority. 4,400 4,495 861 859 LLOYDS TSB GROUP 95 Notes to the accounts 38 Subordinated liabilities (continued) 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. f) At the callable date the coupon on these Notes will be reset by reference to the applicable ﬁve year benchmark gilt rate. g) In the event that these Notes are not redeemed at the callable date, the coupon will be reset to a ﬂoating rate. h) 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. i) Issued during 2004 primarily to ﬁnance the general business of the Group. Dated subordinated liabilities are repayable as follows: 1 year or less 2 years or less but over 1 year 5 years or less but over 2 years Over 5 years 39 Non-equity minority interests Non-equity minority interests comprise: Group 2004 £m – 250 769 3,381 4,400 Euro Step-up Non-Voting Non-Cumulative Preferred Securities callable 2012 (c430 million)* Sterling Step-up Non-Voting Non-Cumulative Preferred Securities callable 2015** Capital instruments European Financial Institution Investments Partnership† LM ABS Investment Partnership‡ Group 2003 £m 505 – 917 3,073 4,495 2004 £m 302 248 550 – – 550 Company 2004 £m Company 2003 £m – 250 – 611 861 – – 249 610 859 2003 £m 301 248 549 100 34 683 * 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 233 basis points 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 350 basis points 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 constituted 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. During 2004 the partnership was dissolved and the capital returned to the partners. ‡ These securities constituted interests in LM ABS Investment Partnership, an English law general partnership in which the principal partner was Lime Street (Funding) Limited, a wholly owned subsidiary of the Group. During 2004 the partnership was dissolved and the capital returned to the partners. 96 LLOYDS TSB GROUP Notes to the accounts 40 Called-up share capital Authorised: Sterling 6,911 million Ordinary shares of 25p each 79 million Limited voting ordinary shares of 25p each 175 million Preference shares of 25p each US dollars 160 million Preference shares of US25 cents each Euro 160 million Preference shares of c25 cents each Japanese yen 50 million Preference shares of ¥25 each Issued and fully paid: Ordinary shares of 25p each At 1 January Issued under employee share schemes (3 million shares) At 31 December Limited voting ordinary shares of 25p each At 1 January and 31 December 2003 £m 1,728 20 44 1,792 US$m 40 cm 40 ¥m 1,250 2004 £m 1,728 20 44 1,792 US$m 40 ccm 40 ¥m 1,250 2004 £m 1,398 1 1,399 20 1,419 In addition, during the year the directors approved the allotment at par of 400 6 per cent non-cumulative redeemable preference shares of 25p each. The shares, which are redeemable at the option of the Company at any time, carry the rights to a ﬁxed rate non-cumulative preferential dividend at a rate of 6 per cent per annum; no dividend shall be payable in the event that the directors determine that prudent capital ratios would not be maintained if the dividend were paid. Upon winding up, the shares rank equally with any other preference shares issued by the Company. Number of shares in issue: Ordinary shares of 25p each Limited voting ordinary shares of 25p each 6% Non-Cumulative Redeemable Preference shares of 25p each 2004 5,596,397,111 78,947,368 400 2003 5,593,737,422 78,947,368 – 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 2004, options to acquire 162 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 2014. These include the option, described on page 57, to acquire 216,763 shares under the share retention plan: otherwise the options are exercisable at prices ranging from 243p to 888p per share. LLOYDS TSB GROUP 97 Notes to the accounts 41 Reserves Share premium account (the Group and the Company): At 1 January 2004 Premium arising on issue of shares At 31 December 2004 Merger reserve (the Group): At 1 January and 31 December 2004 Proﬁt and loss account (the Group): At 1 January 2004 Exchange and other adjustments Actuarial losses recognised in post-retirement beneﬁt schemes (note 45) Movements in relation to own shares (note 43) Goodwill written back on sale of businesses Proﬁt for the year At 31 December 2004 Revaluation reserve (the Company): At 1 January 2004 Transfer to proﬁt and loss account Increase in net tangible assets of subsidiary undertakings At 31 December 2004 Proﬁt and loss account (the Company): At 1 January 2004 Movements in relation to own shares (note 43) Transfer from revaluation reserve Proﬁt for the year At 31 December 2004 £m 1,136 9 1,145 343 6,727 (11) (166) 10 3 507 7,070 4,687 (1) 328 5,014 2,383 8 1 7 2,399 The proﬁt and loss account reserves of the Group at 31 December 2004 include approximately £1 billion (2003: £1 billion) not presently available for distribution representing the Group’s share of the value of long-term assurance business in force and the surplus retained within the long-term assurance funds. The Group’s proﬁt and loss account reserves at 31 December 2004 are stated after including a deﬁcit of £2,231 million relating to the Group’s post-retirement deﬁned beneﬁt schemes (2003: £2,139 million) and after deducting £31 million (2003: £39 million) in respect of own shares held. The cumulative amount of premiums on acquisitions written off against Group reserves during previous years amounts to £2,087 million (2003: £2,090 million) of which £1,682 million (2003: £1,662 million) was within the last 10 years. 42 Shareholders’ funds Equity Non-equity Group 2004 £m 9,977 – 9,977 Group 2003 £m 9,624 – 9,624 Company 2004 £m 9,977 – 9,977 Company 2003 £m 9,624 – 9,624 Non-equity shareholders’ funds comprise 400 non-cumulative redeemable preference shares of 25p each which were issued during 2004 at par. 98 LLOYDS TSB GROUP Notes to the accounts 43 Own shares The amounts deducted from proﬁt and loss account reserves in respect of own shares, which are held at cost, are comprised as follows: Own shares held in relation to employee shares schemes* Own shares – the Company Lloyds TSB Group interest in shares held by the long-term assurance funds† Own shares – the Group 2004 £m 14 14 17 31 2003 £m 22 22 17 39 * 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 Lloyds TSB Group. The Company has lent £20.6 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. At 31 December 2004, 1.5 million shares were held by the trustees with a cost of £11.5 million (2003: 1.6 million shares with a cost of £12.6 million). Lloyds TSB 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. At 31 December 2004, 1,364 shares were held by the QUEST (2003: 0.2 million shares with a cost of £0.7 million). Under the terms of the QUEST’s trust deed, the trustees have waived all but a nominal dividend on the shares they hold. The Lloyds TSB Group Shareplan (‘Shareplan’) has been established for the purpose of providing an enhanced remuneration package for employees. The shares are used to provide shares awarded to employees for no consideration, as a percentage of salaries by reference to the proﬁts of Lloyds TSB Group, together with partnership shares which are acquired by employees via monthly contributions; and matching shares, which are additional shares awarded for no consideration to employees acquiring partnership shares. At 31 December 2004, 0.5 million shares (2003: 2.2 million shares) were held but not allocated to individual employees by the Shareplan trustees with a cost to the Group of £2.3 million (2003: £9.2 million). The trustees have waived all but a nominal dividend on the shares they hold. In addition, a further 0.2 million ordinary shares were held by Lloyds TSB Group Holdings (Jersey) Limited at 31 December 2004 (2003: 0.4 million shares). These shares, on which the dividend entitlement has been waived, were gifted to Lloyds TSB Group some years ago at nil cost and are used to satisfy outstanding options or to meet commitments arising under other employee share schemes. † The long-term assurance funds of Scottish Widows hold 30.5 million shares (2003: 30.5 million shares) in Lloyds TSB Group plc which were bought prior to the acquisition of Scottish Widows by Lloyds TSB Group. Due to the structure of these funds, Lloyds TSB Group is effectively exposed to the risks and rewards of ownership of one tenth of these shares; the risks and rewards of ownership of the remaining nine tenths are borne by the policyholders. Movements in the amount deducted from reserves in respect of own shares have been as follows: The Group At 1 January 2004 Purchases of, and subscriptions for, shares Use of shares on exercise of employee options and for other employee share plans Shares forfeited in the year At 31 December 2004 The Company At 1 January 2004 Purchases of, and subscriptions for, shares Use of shares on exercise of employee options and for other employee share plans Shares forfeited in the year At 31 December 2004 £m 39 57 (67) 2 31 22 57 (67) 2 14 The credit of £10 million to Lloyds TSB Group’s proﬁt and loss account reserves represents the net reduction in the cost of own shares of £8 million and an increase in the accrual in respect of the free shares to be awarded in respect of Shareplan of £2 million. The credit of £8 million to the Company’s proﬁt and loss account reserves represents the net reduction in the cost of own shares. LLOYDS TSB GROUP 99 Notes to the accounts 44 Related party transactions a Transactions, arrangements and agreements involving directors and others At 31 December 2004, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons and with ofﬁcers included: 2004 Number of persons 2004 Total £000 2003 Number of persons 2003 Total £000 Loans and credit card transactions: Directors and connected persons Ofﬁcers 4 22 3,217 6,747 6 30 3,199 5,355 During 2003 one ofﬁcer purchased a car from the Group for a total consideration of £27,000. 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 2004 are also shown in note 20. d Long-term assurance business The Group enters into transactions with its long-term assurance businesses, which cannot be eliminated in the consolidated accounts because of the basis of accounting used for the Group’s long-term assurance businesses. After taking into account legally enforceable netting agreements, at 31 December 2004 Group entities owed £2,254 million (2003: £1,995 million) and were owed £97 million (2003: £136 million); these amounts are included in customer accounts and loans and advances to customers respectively. Furthermore Scottish Widows plc has provided £50 million (2003: £30 million) of subordinated loan capital to Scottish Widows Bank plc, which is included in other liabilities. In addition, fees of £201 million (2003: £107 million) were received, and fees of £49 million (2003: £71 million) were paid, in respect of distribution, asset management and other services. Certain administrative properties used by Scottish Widows are owned by the long-term assurance funds. During 2004 Scottish Widows paid rent to the long- term assurance funds amounting to £5 million (2003: £5 million). In addition, at 31 December 2004, the long-term assurance funds owned 30.5 million ordinary shares in the Company (2003: 30.5 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 2004, the Group’s pension funds had call deposits with Lloyds TSB Bank plc amounting to £14 million (2003: £16 million). 45 Pensions and other post-retirement beneﬁts The pension costs included in administrative expenses are comprised as follows: Deﬁned contribution schemes Deﬁned beneﬁt schemes 2004 £m 32 306 338 2003 £m 33 320 353 The majority of the Group’s employees are members of the deﬁned beneﬁt sections of Lloyds TSB Group Pension Schemes No’s 1 and 2. During 2003 and 2004, no contributions have been made to the Lloyds TSB Group Pension Scheme No. 2. However, with effect from 1 July 2003 the Group recommenced contributions to the Lloyds TSB Group Pension Scheme No. 1 at a rate of 31.7 per cent of pensionable salary; this was increased to 56.5 per cent of pensionable salary with effect from 1 January 2004. Since the deﬁned beneﬁt sections of these schemes are now closed to new members and the age proﬁle of the active members is increasing, under the projected unit method, the current service cost will increase as the members of the schemes approach retirement. The latest full valuations of these schemes were carried out as at 30 June 2002; these have been updated to 31 December 2004 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 2004 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 2004 % 31 December 2003 % 31 December 2002 % 2.60 4.14 2.60 5.30 2.50 4.04 2.50 5.40 2.30 3.83 2.30 5.60 100 LLOYDS TSB GROUP Notes to the accounts 45 Pensions and other post-retirement beneﬁts (continued) In addition, the Group operates a number of schemes which provide post-retirement healthcare beneﬁts to certain employees, retired employees and their dependent relatives. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post- retirement healthcare for all eligible former employees (and their dependents) who retired prior to 1 January 1996. For retirements subsequent to this date, the Group also met a reducing proportion of the cost until 31 December 2004, since which date the only obligation is in respect of the pre 1 January 1996 retirements. Included within other ﬁnance income is an interest cost of £4 million (2003: £5 million) in respect of these deﬁned beneﬁt post-retirement healthcare schemes. 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 2004 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 6.7 per cent. The assets of the Group’s deﬁned beneﬁt schemes and the expected rates of return are summarised as follows: Fair value at 31 December 2004 £m Expected long-term rate of return at 31 December 2004 % Fair value at 31 December 2003 £m Expected long-term rate of return at 31 December 2003 % Fair value at 31 December 2002 £m Expected long-term rate of return at 31 December 2002 % 8,042 550 561 941 959 611 11,664 8.2 4.6 4.3 5.3 6.9 3.6 7,454 551 545 1,033 713 307 10,603 8.1 4.8 4.4 5.4 7.1 3.5 7,175 557 – 491 791 69 9,083 Market values of scheme assets: Equities UK ﬁxed interest gilts UK index linked gilts Sterling non-government bonds Property Cash Total fair value of scheme assets Other ﬁnance income comprises: Expected return on scheme assets Interest cost of scheme liabilities The pension and other post-retirement beneﬁt cost in respect of deﬁned beneﬁt schemes comprises: Current service cost Past service costs Deﬁned beneﬁt costs The amounts recognised in the statement of total recognised gains and losses comprise: 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 2004 £m 764 (725) 39 2004 £m 289 17 306 2004 £m 369 (114) (492) (237) 71 (166) 8.4 4.5 – 5.6 6.9 3.8 2003 £m 696 (662) 34 2003 £m 269 51 320 2003 £m 802 94 (902) (6) 2 (4) LLOYDS TSB GROUP 101 Notes to the accounts 45 Pensions and other post-retirement beneﬁts (continued) The experience gains and losses recognised can also be analysed as follows: 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 2004 £m 369 3.2% (114) 0.8% (237) 1.6% The amounts reported on the Group’s balance sheet are comprised as follows: Market value of assets Present value of scheme liabilities Deﬁcit in the schemes Related deferred tax asset Net post-retirement beneﬁt liability The movements in the deﬁcit in the schemes over the last two years have been as follows: Deﬁcit at beginning of year Exchange and other adjustments Other ﬁnance income Current service costs Contributions Past service costs Actuarial loss Adjustments on disposal of businesses Deﬁcit at end of year 2003 £m 802 7.6% 94 0.7% (6) 0.0% 2004 £m 11,664 (14,851) (3,187) 956 (2,231) 2004 £m (3,055) (2) 39 (289) 374 (17) (237) – (3,187) 2002 £m (2,582) 28.4% (240) 2.0% (3,299) 27.5% 2001 £m (2,015) 18.1% (71) 0.7% (2,873) 26.9% 2003 £m 10,603 (13,658) (3,055) 916 (2,139) 2003 £m (2,931) (4) 34 (269) 138 (51) (6) 34 (3,055) 46 Contingent liabilities and commitments Acceptances and endorsements arise where the Lloyds TSB Group agrees to guarantee payment on a negotiable instrument drawn up by a customer. Guarantees include those given on behalf of a customer to stand behind the current obligations of the customer and to carry out those obligations should the customer fail to do so. Other items serving as direct credit substitutes include standby letters of credit, or other irrevocable obligations, serving as ﬁnancial guarantees where the Lloyds TSB Group has an irrevocable obligation to pay a third party beneﬁciary if the customer fails to repay an outstanding commitment; they also include acceptances drawn under letters of credit or similar facilities where the acceptor does not have speciﬁc title to an identiﬁable underlying shipment of goods. Performance bonds and other transaction related contingencies (which include bid or tender bonds, advance payment guarantees, VAT Customs & Excise bonds and standby letters of credit relating to a particular contract or non-ﬁnancial transaction) are undertakings where the requirement to make payment under the guarantee depends on the outcome of a future event. Where guarantees are issued on behalf of customers, Lloyds TSB Group usually holds collateral against the exposure or has a right of recourse to the customer. Lloyds TSB Group’s maximum exposure to loss is represented by the contractual nominal amount detailed in the table below. Consideration has not been taken of any possible recoveries from customers for payments made in respect of such guarantees under recourse provisions or from collateral held or pledged. 102 LLOYDS TSB GROUP Notes to the accounts 46 Contingent liabilities and commitments (continued) 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 deposits placed Undrawn formal standby facilities, credit lines and other commitments to lend: Less than 1 year maturity 1 year or over maturity 2004 £m 71 6,786 345 1,324 – 1,669 8,526 431 1,654 63,196 20,009 85,290 2003 £m 299 6,122 1,069 1,534 1 2,604 9,025 368 546 62,440 15,981 79,335 47 Derivatives and other ﬁnancial instruments Information about the Group’s use of ﬁnancial instruments and management of the associated risks is given on pages 24 to 26. a Derivatives Derivatives are used to meet the ﬁnancial needs of customers, as part of the Group’s trading activities and to reduce its own exposure to ﬂuctuations in interest and exchange rates. The principal derivatives used by the Group are interest rate and exchange rate contracts; 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. Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange ﬁxed and ﬂoating interest payments, based upon interest rates deﬁned in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a speciﬁed rate of interest and a reference rate, applied to a notional principal amount at a speciﬁc date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to ﬁx the rate of interest on a future loan or deposit, for a speciﬁed period and commencing on a speciﬁed future date. Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a speciﬁed amount of foreign currency on a speciﬁed future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell a speciﬁed amount of currency at an agreed rate of exchange on or before a speciﬁed future date. Equity derivatives are also used by the Group as part of its equity based retail product activity to eliminate the Group’s exposure to ﬂuctuations in various international stock exchange indices. Index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a speciﬁed amount of equities, or basket of equities in the form of published indices on or before a speciﬁed future date. Derivative contracts expose the Group to both market risk and credit risk. Only a few highly specialist trading centres within the Group are permitted to enter into derivative contracts and the level of exposure to interest rate and exchange rate movements and other market variables is strictly controlled and monitored within approved limits. LLOYDS TSB GROUP 103 Notes to the accounts 47 Derivatives and other ﬁnancial instruments (continued) Unlike on-balance sheet instruments the principal amount of the contract does not 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. 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. 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: Notional principal amount £m 113,601 11,386 2,059 1,922 128,968 275,547 62,797 9,679 7,430 48,278 403,731 4,239 Notional principal amount £m 76,368 10,329 1,678 1,542 89,917 236,956 54,213 10,475 5,265 38,626 345,535 5,407 Fair value assets £m Fair value liabilities £m 1,995 426 44 – 2,465 3,118 28 78 – – 3,224 282 (3,956) 2,015 Fair value assets £m 1,669 328 55 – 2,052 3,346 29 145 – – 3,520 693 (3,776) 2,489 2,632 581 – 41 3,254 3,631 24 – 163 – 3,818 19 (3,956) 3,135 Fair value liabilities £m 2,127 511 14 39 2,691 4,006 29 – 162 – 4,197 387 (3,776) 3,499 31 December 2004 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 and other contracts Effect of netting Balances arising from off-balance sheet ﬁnancial instruments 31 December 2003 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 and other contracts Effect of netting Balances arising from off-balance sheet ﬁnancial instruments 104 LLOYDS TSB GROUP Notes to the accounts 47 Derivatives and other ﬁnancial instruments (continued) 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 2004 Exchange rate contracts: Spot, forwards and futures Currency swaps Options purchased Interest rate contracts: Interest rate swaps Forward rate agreements Options written Effect of netting 31 December 2003 Exchange rate contracts: Spot, forwards and futures Currency swaps Interest rate contracts: Interest rate swaps Forward rate agreements Options written Effect of netting Notional principal amount £m 155 60 1 216 34,196 2,921 111 37,228 Notional principal amount £m 171 459 630 30,816 7,188 40 38,044 Fair value assets £m Fair value liabilities £m 3 2 – 5 143 6 – 149 (123) 31 3 – – 3 350 – – 350 (123) 230 Fair value assets £m Fair value liabilities £m 13 28 41 256 1 – 257 (165) 133 5 10 15 260 1 – 261 (165) 111 The aggregate carrying value of non-trading derivatives with a positive fair value was an asset of £96 million (2003: an asset of £132 million) and with a negative fair value was a liability of £35 million (2003: a liability of £71 million). The Company held non-trading derivatives with a notional principal amount of £1,393 million (2003: £1,892 million). LLOYDS TSB GROUP 105 Notes to the accounts 47 Derivatives and other ﬁnancial instruments (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 2004 Exchange rate contracts Notional principal amount Replacement cost Interest rate contracts Notional principal amount Replacement cost Equity and other contracts Notional principal amount Replacement cost Total Notional principal amount Replacement cost 31 December 2003 Exchange rate contracts Notional principal amount Replacement cost Interest rate contracts Notional principal amount Replacement cost Equity and other contracts Notional principal amount Replacement cost Total Notional principal amount Replacement cost 117,027 2,015 224,427 521 583 6 342,037 2,542 79,677 1,753 175,306 578 2,886 523 257,869 2,854 8,143 179 165,274 1,426 3,358 258 176,775 1,863 7,005 141 161,584 1,660 1,965 115 170,554 1,916 4,014 276 51,258 1,426 298 18 55,570 1,720 3,865 199 46,689 1,539 556 55 51,110 1,793 129,184 2,470 440,959 3,373 4,239 282 574,382 6,125 90,547 2,093 383,579 3,777 5,407 693 479,533 6,563 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. 2004 £m 855 1,191 2,046 (592) 1,454 2003 £m 1,272 1,350 2,622 (416) 2,206 OECD banks Other Net replacement cost Qualifying collateral held Potential credit risk exposure 106 LLOYDS TSB GROUP Notes to the accounts 47 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. The table 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 47a. 31 December 2004 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 43 19,663 99,216 8,193 121 6 months or less but over 3 months £m 1 year or less but over 6 months £m 5 years or less but over 1 year £m 40 1,351 6,443 1,009 – – 154 6,937 770 – 5 470 36,783 1,976 5 Over 5 years £m – 82 6,203 2,527 1 Non- interest bearing £m Trading book £m Total £m – 602 (1,655) (68) 17,375 4 1,243 313 11,002 4,271 92 23,565 154,240 25,409 21,773 Total assets 127,236 8,843 7,861 39,239 8,813 16,254 16,833 225,079 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 36,802 109,563 18,764 292 1,698 – (6,577) 2,009 1,083 1,848 – 458 – 635 289 823 1,171 – – – 129 122 5,639 1,435 – 1,884 – (3,330) 81 538 3,999 – 6,212 – (916) 212 3,825 – 9,008 – 10,550 – 223 591 – 5,937 – 23 10,059 39,738 122,062 27,217 15,237 10,252 10,573 – Total liabilities 160,542 6,033 2,412 5,750 9,914 23,595 16,833 225,079 Off-balance sheet items 13,254 (3,902) (2,424) (9,468) 2,540 – Interest rate repricing gap (20,052) (1,092) 3,025 24,021 1,439 (7,341) Cumulative interest rate repricing gap (20,052) (21,144) (18,119) 5,902 7,341 – – – – – – – 31 December 2003 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 408 10,686 88,298 8,718 101 6 months or less but over 3 months £m 1 year or less but over 6 months £m 5 years or less but over 1 year £m 48 1,311 4,680 606 – 65 463 5,549 279 16 6 746 30,777 1,856 8 Over 5 years £m 3 86 6,171 2,372 – Non- interest bearing £m Trading book £m Total £m – 366 (1,648) (55) 16,058 9 1,889 1,424 15,351 5,287 539 15,547 135,251 29,127 21,470 Total assets 108,211 6,645 6,372 33,393 8,632 14,721 23,960 201,934 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 22,254 104,236 18,375 300 2,088 – (11,528) 635 705 1,507 – 1,086 – (810) 262 876 1,040 – – – (412) 286 5,227 1,210 – 910 – (3,217) 99 1,173 3,790 – 6,370 – (820) 205 3,686 – 8,108 – 10,333 – 214 593 – 6,348 – 18 16,787 23,955 116,496 25,922 14,756 10,454 10,351 – Total liabilities 135,725 3,123 1,766 4,416 10,612 22,332 23,960 201,934 Off-balance sheet items 6,930 (1,365) (4,049) (2,596) 1,080 – Interest rate repricing gap (20,584) 2,157 557 26,381 (900) (7,611) Cumulative interest rate repricing gap (20,584) (18,427) (17,870) 8,511 7,611 – – – – – – – LLOYDS TSB GROUP 107 Notes to the accounts 47 Derivatives and other ﬁnancial instruments (continued) c Fair value analysis Financial instruments include ﬁnancial assets, ﬁnancial liabilities and derivatives. The fair value of a ﬁnancial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Wherever possible, fair values have been estimated using market prices for instruments held by the Group. Where market prices are not available, fair values have been estimated using quoted values for instruments with characteristics either identical or similar to those of the instruments held by the Group. In certain cases, where no ready markets currently exist, various techniques (such as discounted cash ﬂows, or observations of similar recent market transactions) have been developed to estimate what the approximate fair value of such instruments might be. These estimation techniques are necessarily subjective in nature and involve several assumptions. The fair values presented in the following table are at a speciﬁc date and may be signiﬁcantly different from the amounts which will actually be paid or received on the maturity or settlement date. Because a variety of estimation techniques are employed and signiﬁcant estimates made, comparisons of fair values between ﬁnancial institutions may not be meaningful. Readers of these accounts are thus advised to use caution when using this data to evaluate the Group’s ﬁnancial position. Fair value information is not provided for items that do not meet the deﬁnitions of a ﬁnancial instrument. These items include intangible assets, such as the value of the Group’s branch network, the long-term relationships with depositors and credit card relationships, premises and equipment and shareholders’ equity. These items are material and accordingly the Group believes that the fair value information presented does not represent the underlying value of the Group. The valuation technique for each major category of ﬁnancial instrument is discussed below: Treasury bills and other eligible bills Fair value is estimated using market prices, where available. Loans and advances to banks and customers The Group provides loans and advances to commercial, corporate and personal customers at both ﬁxed and variable rates. The carrying value of the variable rate loans and those relating to lease ﬁnancing is assumed to be their fair value. For ﬁxed rate lending, several different techniques are used to estimate fair value, as considered appropriate. For commercial and personal customers, fair value is principally estimated by discounting anticipated cash ﬂows (including interest at contractual rates) at market rates for similar loans offered by the Group and other ﬁnancial institutions. The fair value for corporate loans was estimated by discounting anticipated cash ﬂows at a rate which reﬂects the effects of interest rate changes, adjusted for changes in credit risk. Certain loans secured on residential properties are made at a ﬁxed rate for a limited period, typically two to ﬁve years, after which the loans revert to the relevant variable rate. The fair value of such loans has been estimated by reference to the market rates for similar loans of maturity equal to the remaining ﬁxed interest rate period. Debt securities and equity shares held for investment purposes Listed investment securities are valued at quoted mid-market prices. Unlisted securities and equity shares are valued based on discounted cash ﬂows, market prices of similar securities and other appropriate valuation techniques. Deposits by banks and customer accounts The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits and customer accounts was estimated using discounted cash ﬂows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities. Debt securities in issue and subordinated liabilities The fair value of short-term debt securities in issue is approximately equal to their carrying value. Fair value for other debt securities and for subordinated liabilities is estimated using quoted market prices. Financial commitments and contingent liabilities The Group considers that, given the lack of an established market, the diversity of fee structures and the difﬁculty of separating the value of the instruments from the value of the overall transaction, it is not meaningful to provide an estimate of the fair value of ﬁnancial commitments and contingent liabilities. These are therefore excluded from the following table. 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. 31 December 2004 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 Trading book Book value £m Trading book Fair value £m Non-trading book Book value £m Non-trading book Fair value £m 4 1,556 11,002 814 – – 4 1,556 11,002 814 – – 88 176,249 14,407 160,986 27,217 10,252 90 176,712 14,443 160,950 26,924 11,544 108 LLOYDS TSB GROUP Notes to the accounts 47 Derivatives and other ﬁnancial instruments (continued) 31 December 2003 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 Trading book Book value £m Trading book Fair value £m Non-trading book Book value £m Non-trading book Fair value £m 9 3,313 15,351 807 – – 9 3,313 15,351 807 – – 530 147,485 13,776 139,644 25,922 10,454 523 148,870 13,885 139,695 26,254 11,684 The disclosures in this note cover all on-balance sheet ﬁnancial instruments; fair values of all derivative instruments are disclosed in note 47a. Fair values are determined by reference to quoted market prices or, where no market price is available, using internal models which discount expected future cash ﬂows at prevailing interest rates. Fair values have not been calculated for sundry debtors and creditors in the trading book. d Currency exposures Structural currency exposures The Group’s main overseas operations are in the Americas and Europe. Details of the Group’s structural foreign currency exposures are as follows: Functional currency of Group operations Euro US dollar Swiss franc Other non-sterling Non-structural currency exposures 2004 £m 289 271 58 202 820 2003 £m 287 255 104 200 846 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 24 to 26. 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 2004, the unrecognised gains on ﬁnancial instruments used for hedging were £272 million (2003: £303 million) and unrecognised losses were £424 million (2003: £219 million). The net gains arising in 2003 and earlier years and recognised in 2004 amounted to £3 million. Net losses of £228 million arose in 2004 but were not recognised in the year. Of the net losses of £152 million at 31 December 2004, £49 million of net losses are expected to be recognised in the year ending 31 December 2005 and £103 million of net losses in later years. f Value at risk in trading activities Details of value at risk in the Group’s global trading activities are given on page 24. 48 Acquisitions During the year ended 31 December 2003, the Group completed the acquisition of the credit card and personal loan businesses of Goldﬁsh Bank Limited, together with the Goldﬁsh brand and loyalty programme, for a consideration of £1,096 million, settled in cash. The premium arising of £96 million from the effective payment to the majority shareholder was capitalised and is being written off to the proﬁt and loss account over its estimated useful life of 10 years. No signiﬁcant fair value adjustments were made. During the year ended 31 December 2002, the Group’s retail operations acquired the business of Accucard, a credit card technology development and marketing company. Further cash payments of £1 million in respect of this acquisition were made in each of 2003 and 2004. LLOYDS TSB GROUP 109 Notes to the accounts 49 Consolidated cash ﬂow statement The cash ﬂow statement reﬂects cash ﬂows attributable to the banking, life and general insurance businesses. Cash ﬂows from long-term assurance business attributable to the shareholder include the surplus emerging from the life and pension businesses; ‘Income from long-term assurance business’ reﬂects the movement in the value of long-term assurance business attributable to the shareholder (see note 29) as adjusted for dividends. Cash ﬂows relating to the long-term assurance business attributable to policyholders are not reﬂected within this statement. a Reconciliation of operating proﬁt to net cash inﬂow from operating activities Operating proﬁt (Increase) decrease 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 Customer remediation provision Customer remediation paid Amounts written off ﬁxed asset investments Income from long-term assurance business Net charge in respect of deﬁned beneﬁt schemes Contributions to deﬁned beneﬁt schemes Interest on subordinated liabilities (loan capital) Proﬁt on disposal of investment securities Depreciation and amortisation Other non-cash movements Net cash inﬂow from trading activities Net increase in loans and advances Net decrease in investments other than investment securities Net decrease in other assets Net increase (decrease) in deposits by banks Net increase in customer accounts Net increase in debt securities in issue Net decrease in other liabilities Net (increase) decrease in items in course of collection/transmission Other non-cash movements Net cash inﬂow from operating activities b Analysis of cash as shown in the balance sheet Cash and balances with central banks Loans and advances to banks repayable on demand 2004 £m 3,508 (721) 732 866 (854) 224 (203) 100 (105) 52 (715) 267 (374) 601 (126) 633 (3) 3,882 (28,921) 3,981 956 15,864 6,121 1,859 (115) (13) (145) 3,469 2004 £m 1,078 2,477 3,555 2003 £m 3,505 147 (226) 950 (967) 236 (231) 200 (119) 44 (453) 286 (138) 622 (47) 697 (131) 4,375 (11,710) 248 816 (1,000) 7,658 685 (645) 169 176 772 2003 £m 1,195 3,768 4,963 The Group is required to maintain balances with the Bank of England which, at 31 December 2004, amounted to £187 million (2003: £177 million). c Analysis of changes in cash during the year At 1 January Net cash outﬂow before adjustments for the effect of foreign exchange movements Effect of foreign exchange movements At 31 December 2004 £m 4,963 (1,403) (5) 3,555 2003 £m 5,453 (487) (3) 4,963 110 LLOYDS TSB GROUP Notes to the accounts 49 Consolidated cash ﬂow statement (continued) d Analysis of changes in ﬁnancing during the year Share capital (including premium and merger reserve): At 1 January Issue of share capital At 31 December 2004 £m 2,897 10 2,907 2003 £m 2,852 45 2,897 The amounts shown as cash inﬂows from ﬁnancing include proceeds in respect of the above issues of share capital together with a net cash inﬂow of £1 million (2003: outﬂow of £13 million) relating to transactions in own shares held in respect of employee share schemes. Equity minority interests: At 1 January Exchange and other adjustments Minority share of proﬁt after tax Dividends paid to minority shareholders At 31 December Non-equity minority interests: At 1 January Exchange and other adjustments Repayment of capital to minority shareholders Minority share of proﬁt after tax Payments to minority shareholders At 31 December Subordinated liabilities and ﬁnance leases: At 1 January Exchange and other adjustments Issue of subordinated liabilities Repayments of subordinated liabilities Lease ﬁnancing Finance lease capital repayments Adjustments on disposal At 31 December e Acquisition of group undertakings and businesses Cash consideration paid (see f) Payments to former members of Scottish Widows Fund and Life Assurance Society acquired during 2000 Cash consideration refunded in respect of acquisition in 2002 Deferred consideration in respect of acquisition in 2002 Net cash outﬂow 2004 £m 44 – 26 (24) 46 2004 £m 683 1 (132) 42 (44) 550 2004 £m 10,454 (137) 699 (764) 7 (1) – 10,258 2004 £m – 15 – 1 16 2003 £m 37 (1) 22 (14) 44 2003 £m 694 23 – 47 (81) 683 2003 £m 10,169 34 533 (75) – (1) (206) 10,454 2003 £m 1,096 14 (5) 1 1,106 LLOYDS TSB GROUP 111 Notes to the accounts 49 Consolidated cash ﬂow statement (continued) f Acquisition of group undertakings Net assets acquired: Loans and advances Other assets Tangible ﬁxed assets Deposits by banks, customer accounts and other liabilities Goodwill arising on consolidation The consideration of £1,096 million was settled in cash in 2003. g Disposal of group undertakings and businesses Cash Loans and advances to banks Loans and advances to customers Debt securities and treasury bills Intangible assets Deposits by banks Customer accounts Debt securities in issue Subordinated liabilities Other net assets (liabilities) Goodwill written back on sale of businesses (Loss) proﬁt on sale Cash consideration received Cash disposed of Net cash (outﬂow) inﬂow from disposals 2004 £m – – – – – – – 2004 £m 46 132 257 59 10 (42) (327) (111) – 9 3 36 (15) 21 (46) (25) 2003 £m 993 18 2 (13) 1,000 96 1,096 2003 £m 52 1,035 13,770 852 189 (519) (8,372) (5,108) (206) (305) 181 1,569 865 2,434 (52) 2,382 112 LLOYDS TSB GROUP Information for shareholders Analysis of shareholders at 31 December 2004 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 Shareholders Number of ordinary shares Number 72,622 423,490 283,044 136,727 20,108 14,251 809 1,105 511 952,667 % 7.62 44.45 29.71 14.35 2.11 1.50 0.09 0.12 0.05 Millions 2.4 143.9 186.7 268.3 136.9 256.2 54.4 367.5 4,180.1 % 0.04 2.57 3.34 4.79 2.45 4.58 0.97 6.57 74.69 100.00 5,596.4* 100.00 * Includes 747 million shares (13.35%) registered in the names of some 847,000 individuals. 222 million shares (3.97%) are held by over 78,000 staff and Group pensioners, or on their behalf by the trustee of the staff profit sharing schemes or by the trustee of the staff incentive plan. Substantial shareholdings At the date of this report notifications had been received that Legal & General Investment Management Limited and The Capital Group Companies had interests of 3% and 5.75%, respectively, of the nominal value of the issued share capital. No other notification has been received that anyone has an interest in 3% or more of the nominal value of the issued share capital. Share price information In addition to information published in the financial pages of the press, the latest price of Lloyds TSB shares on the London Stock Exchange can be obtained by telephoning 0906 877 1515. These telephone calls are charged at 50p per minute, including VAT, or for details visit www.londonstockexchange.com Share dealing facilities A full range of dealing services is available through Lloyds TSB Registrars. For internet dealing the current rate of commission for both purchases and sales is 0.5%, minimum £17.50. Visit www.shareview.co.uk/dealing for full details. For telephone dealing the current rate for both purchases and sales is 0.5%, minimum £20. For full details please contact Lloyds TSB Registrars on: Telephone 0870 850 0852. For postal dealing the current rate for both purchases and sales is 0.75%, no minimum. For full details please contact Lloyds TSB Registrars on: Telephone 0870 242 4244. 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 Services, PO Box 11258, Church Street Station, New York, NY 10286-1258. Telephone (1) 888 BNY ADRS (US toll free), international callers (1) 610 382 7836. For details visit www.adrbny.com or email shareowners@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 249, Haywards Heath, West Sussex RH16 3ZU. Telephone 0845 7418418. The community and our business A copy of the Group’s corporate responsibility report may be obtained by writing to Corporate Responsibility, Lloyds TSB Group plc, 25 Gresham Street, London EC2V 7HN. This information together with the Group’s code of business conduct is also available on the Group’s website. The Better Payment Practice Code A copy of the code and information about it may be obtained from the DTI Publications Orderline 0870 1502500, quoting ref URN 04/606. Alternatively, log on to www.payontime.co.uk for details. Shareholder enquiries The Company’s share register is maintained by Lloyds TSB Registrars, The Causeway, Worthing, West Sussex BN99 6DA. Telephone 0870 600 3990; textphone 0870 600 3950. 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. For details visit www.shareview.co.uk. Financial calendar 2005 4 March Results for 2004 announced 16 March Ex-dividend date for 2004 final dividend 18 March Record date for final dividend 6 April Final date for joining or leaving the dividend reinvestment plan for the final dividend 4 May Final dividend paid 5 May Annual general meeting in Glasgow 29 July Results for half-year to 30 June 2005 announced 10 August Ex-dividend date for 2005 interim dividend 12 August Record date for interim dividend 7 September Final date for joining or leaving the dividend reinvestment plan for the interim dividend 5 October Interim dividend paid Head office 25 Gresham Street London EC2V 7HN Telephone +44 (0)20 7626 1500 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 Telephone 0870 600 3990 Overseas +44 (0)121 415 7047 Internet www.lloydstsb.com Designed by Starling Design/The Team. Printed in the UK by Royle Corporate Print. This document is printed on paper produced from sustainable managed forests using an elemental chlorine free process by an ISO14001 and EMAS accredited mill. LLOYDS TSB GROUP 113

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