Lloyds Banking Group plc

Thank you for joining our Q1 interim management call. As usual, I'll run through the group's financial performance in the first quarter of 2022 before we then open the line for Q&A. It is only nine weeks since Charlie and I outlined the group's new strategy alongside the full year results, so I did not intend to go through our strategic plans again today. I will nonetheless provide comments on this at the half year. Suffice to say, the group has embarked upon implementation of the plans we set out in February, Indeed, you may have seen the recent announcement on our new management structure, which is aligned with the new strategy and positions the group for delivery. Now, let me turn to the results presentation, starting with an overview of the financials on slide two. The group delivered a solid financial performance in Q1. Their income of 4.1 billion is up 12% from the prior year, supported by a stronger net interest margin of 268 basis points, other income of 1.3 billion, and a continued low operating lease appreciation charge. We remain committed to efficiency and retaining our market-leading cost position. Operating costs of 2.1 billion are up 3% year-on-year, reflecting stable BAU costs and planned higher investment. We remain on track for the circa 8.8 billion operating cost guidance for the full year. As the quality remains strong, 177 million net impairment charge reflects a low incurred charge, with new to arrears remaining very benign and below pre-pandemic levels. It also reflects our updated economic outlook, which I'll talk more about later on in the presentation. Given this solid performance, statutory profit off tax is 1.2 billion, return on tangible equity is 10.8%. Underlying this outcome, we've seen continued franchise and balance sheet growth. Capital build of 50 basis points in the quarter after the 230 basis points of regulatory headwinds on the 1st of January was strong. And this has enabled the group to make significant accelerated contributions to the defined benefit pension schemes. As of Q1, we made the full $800 million annual fixed deficit contribution, plus around half of the expected variable contributions relating to our year-end planned distributions. Finally, risk-weighted assets closed the quarter at $210 billion, following the regulatory inflation of $16 billion, which we outlined at the full year. Moving on to slide three and the continued recovery in customer activity and franchise growth seen in Q1. We continue to see good levels of activity in the UK mortgage market. Balances were up 1.2 billion in the quarter, given continued open mortgage book growth of 1.7 billion. Credit card balances were flat in the quarter. That is a reasonable performance given the normal seasonal repayments that we see in Q1. And added to this, we're seeing improving travel spend given lifting restrictions, which is an important component, as you know, of overall card spend. Elsewhere in consumer finance, motor finance is up 0.1 billion in the context of supply chain issues across the motor industry. Commercial banking balances, meanwhile, are up 2.6 billion, led by the growth of 2.9 billion in corporate and institutional, particularly higher financial institutions, balances. Taken together, average interest earning assets at 448 billion are up 8.6 billion on the prior year. AIEAs are down 1.4 billion on Q4, driven by lower trade and average term lending balances in commercial banking. However, for 2022 as a whole, we continue to expect low single-digit percentage growth in AIEAs. Now, looking briefly at the other side of the balance sheet. We continue to see deposit growth in Q1. Retail deposits are up 2.5 billion, reflecting resilient customer inflows across current accounts and relationship savings products. This further highlights the strength of our customer franchise. Commercial deposits are up 2.8 billion, driven by higher balances from SMEs and corporate and institutional clients. I'll now look at the group's strong revenue performance on slide 4. Net interest income of 2.9 billion is up 10% year-on-year and up 2% in the quarter. This was significantly driven by the stronger net interest margin of 268 basis points on average interest-earning assets of 448 billion. Q1 margin is up 19 basis points on Q1 2021 and up 11 basis points on Q4. This is the result of base rate changes, increased deposit volumes, and benefits from the structural hedge more than offsetting the dilutive impact of mortgage margins. As mentioned, we continue to see a competitive mortgage market with average completion margins in Q1 around 85 basis points. Application margins are below this level in the context of both pricing and swaps continuing to move upwards. We'll continue to monitor closely how this develops, recognising that we probably need to see a period of short stability to see where margins ultimately settle. Turning to the hedge. Structural hedge now has a nominal balance of 245 billion. We have approved capacity of 250 billion, up 10 billion in the quarter, including a little more of the substantial deposit growth that we've experienced through the pandemic. We continue to be cautious on hedge eligibility, with buffers of roughly three times pre-pandemic levels. In this context, gross income from hedge balances was 0.6 billion in the quarter. Given rising swap rates, we continue to expect 2022 hedge income to be higher than 2021, and then to increase modestly again in 2023 and 2024. We remain positively exposed to rising interest rates, We currently expect a 25 basis point parallel shift in the yield curve and the associated base rate rise to benefit interest income by around $175 million in year one. As you know, this is illustrative and based on the same assumptions as we have outlined previously, including the 50% pass-through. Clearly, in practice, a pass-through could differ from this assumption, as indeed we saw in Q1. The group's interest rate sensitivity is lower than reported as a full year, given the increase in the size of the hedge. Higher rates over the last few weeks and a larger hedge means that we've locked in more interest income through the P&L rather than reporting a theoretical sensitivity. It's also worth noting that sensitivity, as always, does not consider potential asset spread compression, particularly in mortgages as a result of swap movements, again, as we've seen during the first quarter. In practice, what we're seeing is base rate changes benefit income today, and this is expected to persist through 2022, providing a net tailwind to the margin. The impact of mortgage repricing, if spreads remain low, will continue to build into the margin in the second half and, indeed, over the longer term. For 2022, the base rate changes we have seen so far this year and the very significant interest rate moves in the market in recent weeks, combined with our new year-end base rate assumptions, are resulting in an improved interest income outlook. We therefore now expect the group margin to be above 270 basis points for 2022. Now, looking briefly at other income. OOI continues to show signs of a recovery. £1.26 billion in the quarter is up 11% on prior year and in line with the last three quarters. As mentioned, we're seeing improving activity levels in retail and insurance, while market performance has also improved in Q1 over Q4. We saw an adverse impact of around £30 million in the quarter relating to the winter storms, although this was offset by a positive insurance methodology change. If you remove both of these items, the underlying run rate for the quarter was just over £1.2 billion. Operating lead depreciation at 94 million in the quarter remains low in the context of the reduced fleet size and continuing strength of used car prices. Now let me turn to slide 5 and the group's continued focus on efficiency. Operating costs of 2.1 million are up 3% on prior year. As mentioned, this includes stable VAU costs combined with planned higher investment. We outlined the group's new cost reporting basis at the full year. The restructuring costs and fraud charges that are now included within BAU operating costs are broadly in line with the prior year charges. Our cost-income ratio of 52.3% remains market-leading. As you can see on the slide, the cost-income ratio, excluding remediation, is 51%, consistent with previous quarters. Remediation charge of 52 million in Q1 reflects a continuation of existing programs and no further charge in respect of HBOS Ready. Q1 charge is in line with our expectation of an ongoing cost of 200 to 300 million per year. In sum, we're maintaining our focus on efficiency and our market leading cost position even after increased investment. We remain on track for the circa 8.8 billion operating cost guidance for 2022. Turning to slide six and the group's asset quality. Asset quality remains strong and neutral arrears remain very benign with underlying charges below pre-pandemic levels. The net impairment charge of 177 million for the first quarter reflects an underlying charge of 150 million plus 27 million in respect of our updated economic scenarios. We revised our base case economic assumptions at the quarter end They now include a slightly weaker GDP forecast, but given performance in the year to date, slightly stronger house price and unemployment outturns. Alongside this, we now also expect higher inflation. For 2022, we forecast CPI inflation of 7.5%, peaking in Q4, with 4.3% thereafter in 2023. We focused on the potential impact of higher inflation on our customers and the potential risks to asset quality. Our low-risk model means that we have limited direct exposure to customer segments which are most likely to experience near-term payment difficulties from cost-of-living pressures. However, we are proactively contacting customers where we feel they may need assistance and will continue to help with financial health checks and other support measures. While discussing asset quality, it is worth noting that we have no direct exposure to Russia or Ukraine. We are actively investigating and monitoring any indirect exposures and have not yet found anything of significant concern. Our clear UK-focused business model is helpful in this regard. Overall, abstinent material change and main effects on us of the current Ukraine crisis and attendant inflationary impact are likely to be second and third order, for example on overall levels of economic activity. We expect those to be captured by our macroeconomic forecasts, but of course we remain vigilant. Based on this outlook, the stock of ECLs remains stable, 4.5 billion at the end of Q1. This remains about 0.3 billion higher than at the end of 2019, before the onset of the pandemic. And within that ECL, we continue to hold just under 800 million COVID-related management judgments, including the central adjustments. We have also now added a further judgmental ECL provision of about 100 million to reflect potential affordability risks for our lower income customers. Touching briefly on our IFRS 9 staging. As we've discussed before, in Q1 we updated our models to reflect CRD 4 regulatory requirements. Notably, this includes changing the definition of default for mortgages from 180 to 90 days and updating our approach to past-term interest-only mortgages. Together, this has resulted in an increase in mortgage assets in Stage 2 and Stage 3. This change is presentational. It does not change the economics, and it has an immaterial impact on the ECLs. And indeed, excluding this regulatory change, the underlying movement in mortgage asset staging in the quarter has actually seen further improvements. In summary, and looking forward, given our performance to date and macroeconomic scenarios, we continue to expect the net asset quality ratio to be around 20 basis points 2022. Moving on to look below the line on slide seven. Following the change in cost reporting that we outlined at the full year, there's now very little difference between underlying and statutory profits. As you can see, restructuring costs of 24 million reflect only the remaining M&A and integration-related costs. The volatility line shows a charge of 138 million and includes negative insurance and banking volatility in addition to the usual fair value unwind and amortization of purchased intangibles. And after these items, statutory profits before tax of 1.6 billion and profit after tax of 1.2 billion both represent a solid financial performance. The return on tangible equity of 10.8% in the quarter, above our cost of capital, reflects this performance. Based largely on the stronger income outlook that I outlined earlier, we now expect the ROTE 2022 will be greater than 11%. Total net assets per share were 56.5 pence for Q1, up 4.1 pence on the prior year, but down 1 pence on Q4. The quarter-on-quarter movement largely reflects strength in the income contribution, offset by movements in the cash flow hedge reserve, given how rates moved during the quarter. Looking forward, you should remember that the 2021 final dividend will come out of TNAV in Q2, while the buyback impact of the program is conducted through the year. I'll now turn to slide eight and consider the group's capital position. Risk-raising assets of $210 billion are up $14 billion in the quarter, but down $2 billion, excluding the regulatory inflation of the 1st of January that we set out in the full-year results. Lending growth has been offset by optimization, and we've seen limited impact from credit migration, given our strong portfolio. Strong business-led contributions augmented by effective RWA management supported strong capital build of 50 basis points in the quarter and a closing CET1 ratio of 14.2%, both after the headwinds on the 1st of January. Importantly, and as previously mentioned, the healthy capital build has enabled the group to make significant accelerated pension contributions. We've already made the full annual $800 million fixed contribution, and this is included in the 50 basis points bill. In addition, we've made around half of the variable contributions relating to our planned year-end 2021 distributions, equivalent to $500 million. This is reflected in our 14.2% CE1 quarter-end position. It's an efficient use of capital, and it means the group will have greater free capital through the rest of 2022. In line with the guidance previously, continue to expect 2022 closing RWAs to be around 210 billion. This is driven by the expected balance sheet growth offset by optimization activity through the rest of 2022. And so based on our performance to date, our business model, and the outlook, we expect capital build to continue to be strong through the rest of this year. Finally, turning to slide nine. In summary, the Group has delivered a solid financial performance in Q1, with strong revenue growth supported by an increased margin and continued recovery in customer activity. At the same time, we've maintained our focus on costs, while asset quality remains robust. Capital build of 50 basis points in the quarter supports the Group's strong capital position and has enabled significant pension contributions. As mentioned, uncertainties persist in the current environment, most notably concerning the potential impact of inflation on our customers. In this context, we will provide effective support for our customers wherever we can. The Group's business model is resilient. Together with our new strategy, it positions the organisation well. This confidence is reflected in our updated guidance for 2022. As you've heard, we now expect the net interest margin to be greater than 270 basis points, and the return on tangible equity to be greater than 11%. All other guidance statements, including those for 2022 and the longer term, are reaffirmed. Outside of the financials, and as mentioned at the start of the call, the group has recently implemented a new management structure. This is fully aligned with our new strategy, and it helps to position the group to deliver higher, more sustainable returns and capital generation. That concludes my remarks this morning. Thank you very much for listening. Let me now turn the call back to the operator for Q&A. Operator, over to you.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. Thank you. And we take our first question from Omar Kinan with Credit Suisse. Please go ahead. Your line is open.

Good morning, everybody. Thank you for taking the questions. I had just some questions on net interest income, please. And I wanted to ask on the revised NIM guidance, which is now above 270 basis points. I understand that's a flaw rather than a target, but I wanted to understand what the minimum assumption changes that were there so we can make our judgment of how far above 270 bps it will be. Presumably at least it's the deposit beta experience from the December hike. and maybe including an extra Bank of England rate hike. But if you can clarify what those minimum conditions are, that'll be very helpful. And then just secondly, on the structural hedge, I can see that the duration has shortened a bit from three and a half years to between three and 3.5. And I guess the shape of the yield curve lets you do that without giving up any yield. What are the various debates that you're having at the moment in terms of how to position the structural hedge given what's going on in the fixed income markets. It looks like you think it's worth shortening a bit and say increasing your year two to four rate sensitivity if you think the bias to yields is ultimately higher. Thank you.