CHAIRMAN'S STATEMENT

Sir Victor Blank

THE HBOS TRANSACTION

Lloyds TSB and HBOS had, on a number of occasions over the years, discussed the possibility of a combination. It was only the unique circumstances of last autumn, however, that enabled this transaction to happen. When we decided to acquire HBOS, we were doing so at a time when the economy was already deteriorating with the prospect of further declines to come. We were very mindful of the difficult economic backdrop to this transaction. We were also very aware, however, of the compelling logic of this transaction, including the substantial market positions we would secure and the significant synergies that would be generated. In short, we see the deal as being strategically imperative for us. The size and scale of the new group is very significant indeed and it offers opportunities for growth for the future which a stand-alone Lloyds TSB might not have been in a position to deliver to the same degree. Our senior management team, given its track record and strength in depth, is very well placed to exploit these opportunities on behalf of all our shareholders.

We believe that the HBOS transaction will prove to be very successful for our shareholders and our other stakeholders as well. Lloyds Banking Group is now the largest financial services franchise in the UK with a range of leading market positions in important product lines, such as savings, current accounts, mortgages, insurance and long-term savings. We are also a leading player in the Small and Medium Enterprise (SME) and wholesale banking sectors. The Group clearly has a very significant retail banking footprint and, with approximately 3,000 branches, is present in more UK locations than any other financial institution. We will also have the benefit of substantial synergies.

There is no doubt that the immediate outlook is challenging as indeed it is for most other banks in the UK and overseas. Lloyds TSB's trading performance in 2008 was by no means immune from the continued turbulence in the global financial markets which contributed to the decline in profit before tax to £807 million. HBOS was adversely affected by the challenging market conditions, a sharp decline in asset values and the dramatic contraction in the wholesale markets. Taking all these factors together, HBOS recorded a loss of £10.8 billion. Against this backdrop, it is unsurprising that questions have been asked about the HBOS transaction. I think it is important to remember, as I have already mentioned, that we purchased HBOS when the economic downturn was already well underway. In short, the opportunity to acquire HBOS only came about in the middle of great economic adversity and in conditions which are unlikely to be repeated.

In purchasing HBOS we acquired £17.9 billion of net asset value for £7.7 billion so, as a board, we remain very much convinced that this is the right transaction for your company. The short-term outlook is indeed difficult. Your board believes, however, that the earnings potential of Lloyds Banking Group will be significant in the longer term.

THE ROLE OF GOVERNMENT

A great deal has been said in recent months about the nature of the Government's involvement with the banking sector. We believe that most of the Government's initiatives have been positive and well considered. In particular, we very much welcome the Government's interventions to stabilise the banking system, provide liquidity and to encourage more lending. The dramatic unfolding of events across the world following the collapse of Lehman's meant that the Government needed to take swift and decisive action. It did so. That is why, despite Lloyds TSB's relative strength, in October 2008 we, together with other UK banks, were required by the UK Government to strengthen capital ratios as part of an industry wide initiative to reduce the systemic risk in the UK banking system. This led to us raising an additional £5.5 billion in capital, (£4.5 billion in ordinary shares and £1 billion in preference shares). HBOS were also required under the recapitalisation scheme to raise £11.5 billion, (£8.5 billion in ordinary shares and £3 billion in preference shares). The UK Government, as part of the capital raising process, has now become a 43.4 per cent shareholder in the Group.

DIVIDEND

As part of the HM Treasury recapitalisation scheme, the Group was required to suspend the payment of cash dividends to ordinary shareholders until the HM Treasury preference shares issued as part of the scheme are repaid. In the meantime, however, as we indicated in our shareholder circular last year, the board has approved a capitalisation issue of one for 40 ordinary shares held.

OUR ROLE IN SOCIETY

At a time when there is a great deal of public debate about the role of the banking system, I think it is important to reflect on the contribution that banks, and Lloyds Banking Group in particular, make to our society. Our company is the largest provider of social banking accounts in the UK. We provide four million of these accounts and are proud of the way in which we help our low income customers to access the banking system and, where appropriate, move up to a full service current account. We also have a substantial community investment programme through activities within the Company as well as the four Lloyds TSB Foundations. Our overall community investment programme is now somewhere in the region of £100 million a year and is, as a result, one of the most significant contributions by any major corporate to UK society. We are determined to continue to play an important role in the many communities in which we operate up and down the country.

Turning to broader societal issues, a great deal has been said in recent months about the role of bonuses in the banking system. We recognise the legitimate public interest in this subject. We have worked closely with the Government to devise a bonus system which is fair to our colleagues and sensitive to the wider needs of society as a whole. We do think that a necessary process is now underway to reassess the way in which some incentives in the banking system were structured and awarded – typically in areas in which we don’t have a great deal of involvement. Specifically, we are very much a retail and commercial banking business with very little in the way of investment banking activity. We also recognise how important it is to align bonus and remuneration schemes with the interests of our shareholders, something we believe we have done over the years. From our perspective, it is particularly important that we retain our best talent both in the UK and overseas and we believe that it is an important factor that should also be taken into account when designing total reward systems.

OUR CORPORATE GOVERNANCE

We are committed to ensuring that the Group has a robust governance structure in place. Good corporate governance matters even more now than ever before. As we integrate HBOS we are now moving quickly to common governance standards. I believe this is important as there is a clear link between high quality governance and shareholder value creation.

During the year, we have continued the board's renewal process with the appointment of three new non-executive directors, each of whom brings a wealth of experience to the board. They are Carolyn McCall, Sir David Manning and Martin Scicluna and brief biographical details can be found in The Board – Non-Executive Directors section. In addition, Tim Ryan and Tony Watson will both join us on 1 March and 2 April 2009, respectively. These appointments ensure that your board has a broad range of skills and senior experience, qualities which I believe are even more important now than they might have been before the economic turmoil began.

In October, Tim Tookey was appointed our new group finance director following Helen Weir's move from this role to become group executive director, UK Retail Banking after Terri Dial's decision to leave the Group. Mike Fairey, deputy group chief executive, retired in June following a 17 year career with the Group. On behalf of the board, I would like to thank Mike for his invaluable contribution to the Group over such a long period of time and wish Terri well in her new career.

Outlook

The unprecedented market conditions which I sketched out at the start of this review have continued into 2009. At the same time, the economy is continuing to deteriorate; the debating point now is how deep the recession will be and how long will it take for it to end. One thing is certain – we are facing a prolonged period of economic difficulty for many households and companies up and down the country. As a bank with a strong focus on customer relationships, we are committed to helping our customers wherever possible to manage their way through these challenging times.

We know the short-term outlook for the enlarged Group is challenging. Whenever economic conditions do begin to normalise, however, we believe your company will be in a very strong position to reap the benefits. Our strong franchise across the whole range of product lines will enable us to do just that. In the meantime, our imperative is to manage your business as effectively as possible on your behalf during these challenging times. I believe we have the right people to do so.

One of the most important ways in which leading businesses differentiate themselves from their peers is through the quality of their people. I have no doubt that we at Lloyds Banking Group are very fortunate in having many of the best people in our industry working for us. The last 12 months, however, have been exceptionally difficult for many of our customers and colleagues alike. The unprecedented levels of market turbulence have meant that my colleagues have spent a great deal of time helping customers to understand what is happening and providing them with the necessary reassurance. The job that our colleagues do for our customers is very valuable and highly valued by us. I would therefore like to take this opportunity to thank them on our behalf for their outstanding contribution in 2008.

Sir Victor Blank
Chairman
26 February 2009