Lloyds Banking Group plc

Thank you for standing by and welcome to the Lloyds Banking Group 2022 half-year results call. At this time, all participants are in a listen-only mode. There will be presentations from Charlie Nunn and William Chalmers, followed by a question and answer session. If you wish to ask a question, you will need to press star 1 on your telephone. Please note this call is scheduled for 90 minutes and is being recorded. I will now hand over to Charlie Nunn. Please go ahead.

Morning everyone and thank you for joining our half-year results call. As you know, our purpose as an organisation is to help Britain prosper and despite the uncertain external environment, we see significant resilience within our customer franchise and our financial strength positions us well to continue to focus on this as we go forward. I'll talk more about this shortly, but let me begin, though, by turning to slide three. I'm going to take you through the key messages from the half, and then William will give the usual review of the group's financial performance before we open up for Q&A. There are five key messages that I'd like you to take away from today. First. in the context of the cost of living stress we are seeing our customers adapting their spending where needed and taking the decisions required to maintain their financial resilience we've delivered a strong financial performance in the first half of 2022 based on improved income increased investment and benign asset quality alongside continued business momentum our financial performance in half one has enabled us to enhance guidance for 2022 William will go through this in more detail later, although I should note that, as usual, we are not going to give updated guidance for 2023 or 2024 at the half year. We're confident in the future and executing well, but it's simply too early to update longer-term numbers. The financial performance has also enabled the Board to announce an interim ordinary dividend of 0.8 pence per share, up around 20% on last year. And finally, our strategic delivery and conservative risk business model position the group well for the future. So with that, I'll now turn to slide four to look at how we are well positioned to navigate the external uncertainties. It is clear that our customers are facing a challenging period with increases in the cost of living. However, given the nature of our customer base, the positioning of our balance sheet, and our conservative risk appetite, we see a resilient franchise today and looking forward. We're not currently seeing signs of stress in the portfolio, and our business is well placed. In retail, we have a representative sample of deposit customers from across society, while our lending exposure is focused on higher income segments. We know that inflation is significantly more impacting for low-income customers, and they have lower levels of borrowing from us we also see the majority of our lending within secured business lines with average loan-to-value ratios at historic lows around 40% in both our retail and commercial businesses. At the same time, our unsecured businesses are focused on prime customers, and we're not seeing any deterioration in their trends. It's also worth noting that on average, customers are entering this period in better financial health than pre-pandemic, having increased their savings pots and reduced their debt, In terms of customer behaviour, we're seeing increased levels of spend, most notably in higher income segments and within discretionary categories such as travel and entertainment. Customers are also adapting their finances to accommodate the rising cost of living. For example, we can see customers spending less on white goods and taking actions such as managing subscription services to accommodate the increased costs of energy, food and fuel. On the other hand, we see no increase in our customers cancelling insurance policies or opting out of auto-enrolment pensions. With that said, we remain very focused on supporting our customers where needed. We are fully resourced for this additional demand, although, as mentioned, the vast majority of our customers are continuing to demonstrate resilience. We've also taken early action to announce a one-off payment to all members of staff below the executive team. This was the right thing to do, By taking action quickly and not spreading the payment, we will give our colleagues a cash injection which will help ease the pressure they face. Now, turning to slide five to look at an overview of the business and financial performance in the half. Lloyds Banking Group delivered a strong performance in the first half, and our business model positions the group well for the future. Net income of £8.5 billion is up 12% year-on-year, supported by a higher net interest margin. BAU costs were stable, while operating costs are up 5%, driven by our increased strategic investment and new business lines. Asset quality remains benign, given the resilient customer base I've just touched upon. In turn, these support a return on tangible equity of 13.2%, capital generation of 139 basis points, and the increased interim dividend. This performance also enables us to enhance our guidance for 2022. Alongside our financial performance, we have seen some important business achievements in the half, including maintaining a leading net promoter score of plus 68. Employee engagement of 72% has held stable since the end of last year, while we are also continuing to make progress on our diversity goals, including now having 39% of senior roles held by women. There's always more to do, but this represents good progress. Finally, turning to slide six. It is five months since William and I set out the group's new strategy, and you will recall that we talked about three key pillars, grow, focus, and change. We're making good progress, and we've set out a few examples of our early achievements on this slide. Within our ambitions to grow the business, we've seen over £4 billion of net new money within insurance and wealth and a 1.5 percentage point increase in protection market share. In commercial, we've increased our percentage share of FX Wallet by 20% and delivered a 10% increase in new merchant services clients. Our green lending ambitions are also on track. We've provided around £4 billion of sustainable financing in our commercial businesses, And in retail, we're on track with our green mortgage lending and have increased our funding for electric vehicles by over £0.9 billion in the first half. Our strategy also targeted strengthened cost and capital efficiency under our focus pillar. We've continued to generate significant BAU cost savings, and you'll hear more about this from William in due course. Finally, under change, we've announced a new organization structure and leadership team aligned with our plans for delivery of the group's clear strategic objectives. We've also reorganized around 20,000 colleagues, which will enable us to deliver change and innovate our digital and technology assets faster and more effectively. And we've mobilized the skills and capabilities to deliver the incremental investments for our new strategy and have made 0.3 billion pounds of strategic investments to date. These are selected examples of the progress we've made, and we will provide a more detailed update to the market in the first half of 2023. So, in summary, I'm pleased with the progress we've made, and I'm confident we are well positioned for the future. With that, I'll hand over to William to go through the financials in more detail.

Thank you, Charlie, and good morning, everyone, and again, thank you for joining. Let me turn first to an overview of the financials on slide 8. As Charlie said, Lloyds Banking Group delivered a strong financial performance and continued business momentum in the first half of this year. Net income of 8.5 billion is up 12% on prior year, supported by a higher net interest margin of 277 basis points and growth in other income. We remain committed to our market-leading efficiency. Operating costs of 4.2 billion are up 5% based on stable BAU costs before higher planned strategic investment and the costs associated with new businesses. Asset quality is in very good shape. The impairment charge of 377 million, equivalent to 17 basis points, is below pre-pandemic levels. Together, this strong performance resulted in statutory profit after tax of 2.8 billion and a return on tangible equity of 13.2%. Alongside, we continue to see balance sheet growth across our franchise areas. Meanwhile, tangible net assets per share of 54.8 pence are down 2.7 pence in half, largely as a result of the upward movement in rates. I'll touch on this further towards the end of my comments. A good earnings performance bolstered by a reduction in risk-weighted assets and insurance dividends has delivered capital generation of 139 basis points. This in turn allows the increased interim dividend that Charlie talked about earlier on. I'll now turn to slide nine to look at the continued recovery in customer activity and franchise growth that we've seen in H1. Our mortgage portfolio has continued to grow with balances up 2.2 billion in H1. Growth in the open book of 3.3 billion included 1.6 billion in the second quarter, demonstrating continued progress throughout the half. Encouragingly, we saw growth of 400 million in the credit card book, all in the second quarter, as a result of improving spending levels, particularly in travel, entertainment and retail. Led by transactors, this Q2 spend was 17% over the equivalent period in 2019. Looking forward, we expect the gradual growth in cards balances to continue over the coming quarters. Motor Finance is also up 200 million and a half, While we have a record order book, activity here remains impacted by the ongoing global supply chain issues affecting all vehicle manufacturers. As you can see, commercial banking balances are up 4.3 billion and a half. This is led by attractive sponsor opportunities within the corporate institutional franchise, some short-term refinancing business, and also by FX revaluations in the portfolio, particularly in Q2. This growth has more than offset repayments of government support scheme loans in SME. On the other side of the balance sheet, we continue to see inflows to our trusted brands. Retail deposits are up 3.3 billion and a half, with growth in both quarters. Commercial has seen some short-term placements reversing, as we expected, in Q2. And in total, group deposits are up 2 billion in H1, having grown almost 70 billion since the end of 2019. As you know, the substantial deposit growth offers the group strategic opportunities to build our franchise while increasing our pool of hedgeable balances. I'll touch on this again shortly. Alongside our banking business, we've seen good organic growth within insurance and wealth across business lines and including over 4 billion of net new money in the first half. I'll now turn to slide 10 and the improving net interest income performance in a little more detail. NII of £6.1 billion is up 13% versus the first half of 2021 and up 7% on the second half of that year. This has benefited from both a modest increase in average interest-earning assets and a higher net interest margin. AIEAs of £450 billion are up £1.3 billion in the half, with mortgage growth more than offsetting the timing-related reductions within commercial banking. Our H1 margin of 277 basis points increased 21 basis points on H221. The Q2 margin of 287 was up 19 basis points on the previous quarter. The positive impact from rate rises here has more than offset the ongoing impact of competitive mortgage pricing. Looking forward, we continue to expect low single-digit percentage growth in AIEAs in 2022. This will be driven by continued growth in mortgages and the gradual recovery in unsecured balances. We're now assuming that the base rate increases to 2% in Q4, providing a further tailwind this year. In the other direction, we expect the impact of mortgage repricing will continue to be felt within the group margin. But taken together, this remains a significant net positive, and hence expect margins to be sustainably higher than assumed in February. Indeed, today we are enhancing our margin guidance to greater than 280 basis points for 2022. Given the significant focus on interest rate sensitivities, let me turn to slide 11 and look at this in a little more detail. As you've heard us say many times, the Group is positively exposed to rising rates. We currently expect a 25 basis point parallel shift in the yield curve and associated base rate rise. to benefit interest income by about £175 million in year one. As you know, this number is illustrative and based on the same assumptions, including a 50% deposit pass-through as those we have set out previously. Clearly, the pass-through could differ from our 50% illustration, as indeed we saw throughout the first half. That, in turn, makes a material difference to income. Taking the 25 basis point increase as an example, for every 10 percentage point reduction in the assumed pass-through, we expect an additional 50 million of net interest income in year one. So, if you assume a 40% pass-through, the sensitivity would be 225 million. I should also note here that the sensitivity does not assume asset spread compression, as we've seen again in the first half, most evidently in mortgage new business margins. Now, moving on to look at the individual asset portfolios, starting with mortgages on slide 12. As said, we continue to see mortgage growth in H1. The open mortgage book now stands at 297 billion, with growth of 3.3 billion and a half and 1.6 billion in Q2. The SBR book of around 57 billion is down 20% over the last 12 months. Q2 attrition levels were modestly higher than we've seen in previous quarters. Indeed, in the context of a rising interest rate environment, customers have re-fixed their mortgages, and we, in turn, are actively engaging with our customers to ensure that they are aware of their alternatives and to help with any consequent steps. As you know, mortgage pricing has been competitive over recent quarters. Q2 completion margins were around 60 basis points. But now, helpfully, the completion application margin dynamic is stabilising as customer pricing has increased in response to swap moves. Looking forward, we expect new business to continue to be priced below high yielding maturities in the context of our circa 90 billion of gross lending per year. With that said, at current margins, we still see mortgages as attractive from returns and from an economic value perspective. Now turning to our other asset books on slide 13. Consumer finance balances have increased one billion since year end. We're seeing a recovery in credit card spend, particularly in discretionary categories. This has translated into 400 million higher credit card balances, largely in the second quarter. And as mentioned earlier, motor finance is up 200 million, although this continues to be impacted by the wider motor industry issues. Commercial banking is up 4 billion and a half, as I said earlier. Indeed, the underlying commercial business has grown by 5.4 billion in H1. This is led by attractive growth opportunities, particularly in the corporate institutional business, as well as FX revaluations in the portfolio. Going the other way, we've seen a reduction of 1.1 billion in government-backed support scheme lending, largely within SME, as clients repay their COVID loans. Let's move to the other side of the balance sheet on slide 14. We continue to see deposits increase in the first half of 2022. Total deposits are up 2 billion in the half, although they reduced in Q2 as some short-term commercial placements reversed as we had expected. Importantly, we continue to see inflows to our trusted brands. Retail current account balances are up 1.9 billion, or 2% in the half, and 0.3 billion in Q2. Total group deposits are now almost 70 billion. In turn, gives the group strategic opportunities to further support customers, as indeed we seek to develop our wealth proposition, for example. The overall H1 deposit margin of 41 basis points is significantly higher than last year, given interest rate movements. Deposit growth also increases hedgeable balances. This is outlined on slide 15. Given the deposit growth of the last two years and the increased eligibility of existing deposits, structural hedge capacity has increased in recent periods, including by 10 billion in H1 to 250 billion. In the context of the favourable swap curve movement seen this year, the nominal balance of the structural hedge is now fully invested up to this approved capacity. The weighted average duration of the hedge is now around three and a half years, a little below the neutral position of around four years. We still have 13 billion of maturities in H2 and 35 billion in 2023, giving us significant flexibility. Given these, we've seen gross hedge income of 1.2 billion during the first half. Looking forward, we now expect structural hedge income to be stronger than 2022, stronger in 2022 than in 2021, and then continuing to build into 23 and 24. Now moving to other income on slide 16. Other income at 2.5 billion is up 5% on the prior year. We continue to see signs of recovering customer activity. Indeed, retail has seen an improving performance in current accounts and in credit cards founded upon this increased activity. Other incoming commercial was supported by improving transaction banking volumes and a resilient financial markets performance over the period as a whole. Insurance and wealth now includes a modest contribution from Embark and some assumption benefits. However, year-on-year growth is largely driven by improved new business income, for example in workplace pensions and bulk annuities, especially in Q2. The second quarter performance of £1.3 billion is in line with the last few quarters. The quarter is relatively straightforward, with one-off charges, including within equity investments, offset by insurance assumptions and asset sale benefits. Looking forward, we continue to expect the other income run rate to gradually build, This will clearly be dependent on customer activity levels in an uncertain macro, as well as our ongoing strategic investments. There's a temporary constraint on that pattern, and as mentioned previously, remember that we will see the impact of IFRS 17 in Q1 23. We'll talk more about this in future presentations. Moving on, the group has maintained its focus on efficiency during 2022. Let me talk more about this on slide 17. Operating costs of 4.2 billion are up 5% on prior year. As we guided to, this includes broadly stable BAU costs combined with higher planned investments and the costs associated with our new businesses. Our Q2 cost income ratio of 50.2% remains market leading. And as you can see on the slide, the cost income ratio excluding remediation is 49.6%, which is slightly better than previous quarters. We're obviously not immune from inflationary pressures, but we maintain our rigorous approach to cost management. We strive to offset inflation, including absorbing additional colleague compensation of 65 million in Q3, in respect of the one-off payment to staff. As a result, we continue to expect 2022 operating expenses to be circa 8.8 billion. Finally, on remediation. The charge of 79 million in H1 reflects a number of pre-existing programmes. There is no charge in the half in respect of HPOS for edding, albeit the final outcome remains uncertain. Going forward, we continue to expect an ongoing remediation cost of 200 to 300 million per year. Looking now at impairment on slide 18. The impairment story is benign. The net impairment charge of 377 million in H1 equates to an asset quality ratio of 17 basis points. Behind that number, asset quality remains strong and new to arrears remain low, with underlying charges below pre-pandemic levels. The underlying charge of 282 million includes charges of 315 million in retail and a release of 37 million in commercial. We then have a charge of 95 million in respect of our updated economic scenarios. Our new base case economic assumptions include a slightly weaker GDP and unemployment forecast alongside higher inflation. As part of the impact of economic assumptions, we have increased cost of living and other inflationary charges in retail and commercial within the half by 400 million. This includes both model impacts and judgments and is on top of the 60 million that we took at the end of last year. Against this, we released 300 million of the net COVID-related judgmental overlays in the second quarter, reflecting the reduced risks in this area. This includes 200 million of the 400 million central overlay. We therefore retain about 500 million of COVID-related provisions within our ACL, That is both centrally and within the portfolios. As a result of H1 performance and economic assumptions, our stock of ECLs remains stable at 4.5 billion, around 0.3 billion higher than at the end of 2019. In summary, we remain vigilant for any impacts from rising inflation. But the group is performing well and remains well positioned. As a result, we now expect the net asset quality ratio to be less than 20 basis points for 2022. Moving on, I'll turn to slide 19 and look at the resilience of our retail portfolio. As Charlie said earlier, we're very aware of the potential impact on our customers of higher... However, as Otto outlined, our low-risk approach means we have limited exposure to those segments most at risk. We are indeed proactively seeking to support customers where required, but we are not seeing meaningful signs of distress. As you can see on the chart, our retail businesses are seeing stable and benign arrears performance. Credit card expenditure is picking up, but it is led by discretionary sectors such as travel and entertainment. Around 90% of credit card spend is now from customers in middle and high income segments, up from around 80% in 2019. Furthermore, we're seeing the proportion of regular minimum payers hold very stable. It's another sign that our customers are spending within their means. As you know, our largest asset exposure is to mortgages, which is a high-quality, low-risk portfolio. Our book stands at £310 billion and has an average loan-to-value ratio of 40.2%. We now have just 3% of mortgage balances on an LTV of greater than 80% and 0.4% of balances with an LTV of greater than 90%. The significant de-risking undertaken in recent years, alongside favourable house price movements, means that our customers now have a lot of equity in their homes. Let me turn now to slide 20 and consider how our commercial portfolio is performing in the current environment. Within commercial, we're seeing stable SME overdraft and corporate revolving credit facility utilization trends, with RCF drawings at around 50% of the 2020 peak levels. We also see low and stable levels of transfers onto watch lists or into our business support units, again, below pre-pandemic levels. Across commercial, we have strict tick-the-caps and have undertaken recent stringent reviews of all portfolios given the macro outlook. Indeed, our current impairment judgments are based on this work. In commercial real estate, our exposure has been significantly de-risked in recent years. Net exposure is 11.1 billion after taking into account risk transfer transactions. The business has an average LTV of 39%, while just 12% of clients have an LTV of greater than 60%. Average interest cover is greater than 4.5 times. Of course, we remain vigilant for signs of stress across our lending portfolios. Currently, customers are performing strongly, making discretionary choices with very high levels of security. Moving on, let me turn to slide 21 to look briefly at the below-the-line items. Following the reporting changes implemented at the year-end, and as intended, underlying and statutory profit are converging. The limited costs booked below the line include restructuring costs comprising M&A and integration. The half-year charge of £47 million includes the early integration costs relating to the acquisition of Embargo. Volatility in H1 includes favorable banking volatility, given recent rate and FX movements, partly offset by negative insurance volatility driven by rates. It also includes the usual fair value unwind and amortization of purchase intangibles. Given the prior year comparative includes significant impairment and tax credits, current period statutory PBT of 3.7 billion and PAT of 2.8 billion both represent strong financial performance. The resulting return on tangible equity for each one is 13.2%, well above our cost of capital. Given the improved income and impairment outlook, we now expect the ROTE for 2022 to be circa 13%. It's worth noting that this includes a benefit of just under one percentage point from movements in the cash flow hedge reserve, which we do not expect to occur in future years. A quick word on tangible net assets. TNAV per share of 54.8 pence was down 2.7 pence in the half. The contribution from attributable profit was strong, but this was outweighed by movements in the cash flow hedge reserve and distributions. As you know, the cash flow hedge reserve movement is linked to interest rate movements and has no effect on capital. Now, turning to slide 22 and looking at risk-weighted asset and capital developments during the first half of the year. Capital generation in H1 is strong. RWAs of 210 billion are down 2 billion, excluding the regulatory inflation of 16 billion on the 1st of January that we set out previously. Underlying lending growth has been more than offset by model reductions and ongoing portfolio optimisation. We've seen no increase in RWAs from credit migration. Looking forward, we continue to expect 2022 closing RWAs to be around 210 billion, given expected balance sheet growth broadly offset by continued optimisation. Looking at capital generation, the healthy banking profitability in the half is bolstered by lower RWAs. This was further supplemented by 300 million in dividends from the insurance business, benefiting from interest rate rises. In total, the 139 basis points of capital generation was, as said, a strong performance. As mentioned last quarter, our capital generation has enabled the Group to make significant accelerated pension contributions. The full fixed pension contribution of £800 million for 2022 is complete. There will now be the remaining variable contribution to make in the second half of the year. The strength of the group's performance and prospects enables the Board to announce an interim dividend of 0.8 pence per share, up around 20% on last year. As always, we remain committed to excess capital returns and will consider further distributions at the year-end as appropriate. Looking forward, and based on the performance to date, our business model and macroeconomic outlooks We now expect capital generation for 2022 as a whole to be in excess of 200 basis points. And finally, turning to slide 23. In summary, the group has delivered strong performance in H1, with net income up 12%, supported by the net interest margin of 277 basis points. Asset quality remains in very good shape. The AQR of 17 basis points reflects sustained low levels of neutral arrears and resilience looking forward. The return on tangible equity of 13.2% are healthy. And capital build of 139 basis points in the first half is a strong outcome. And together, these factors enable a significantly increased interim dividend of 0.8 pence per share in line with our progressive and sustainable dividend policy. As you know, uncertainties persist, particularly relating to the increased cost of living and the impact this could have on customers. However, the group faces the future with confidence. This is reflected in our enhanced guidance for 2022. We now expect the net interest margin to be in excess of 280 basis points. The asset quality ratio to be less than 20 basis points. The return on tangible equity to be circa 13%. and capital generation to be more than 200 basis points. That wraps up my comments for this morning. So thank you for listening. Let me now hand back to Charlie for his closing remarks.