Lloyds Banking Group plc

Good morning everybody and thank you for joining our Q3 results call. Let me start with an overview of the key messages on slide 2. As you all know, we're operating in a fast-evolving and uncertain environment. In this context, and as ever, we remain focused on supporting our customers. The group is performing well. During the third quarter, we saw further income growth, supported by the net interest rate environment and ongoing robust business volumes. We continue to observe strong asset quality and stable credit trends across the portfolio. Our robust financial performance is supporting the update to our guidance for 2022. Strengthening income from an increased NIM outlook alongside continued cost discipline enables us to maintain our ROTE guidance and to give further clarity on our strong capital bill. This is despite the tougher macroeconomic outlook, which drives the forward-looking impairment charge we're taking today. We continue to progress our net zero ambitions. Last week, we announced new sector-based emissions targets for 2030, alongside a new net zero ambition for our supply chain. These are important commitments as we continue to support the transition to a low-carbon economy. Our strategic delivery and robust business model position the group well for the future. We announced our new strategy in February and the associated investment is now well underway. We'll update the market on our progress in more detail at the full year. I'll now turn to slide three to look at what we're doing to support customers in the current environment. The vast majority of our customers are demonstrating resilience and adapting to the cost of living increases. However, we know many are concerned about the outlook and we're committed to proactively helping where it is most needed. In retail, for example, we're contacting vulnerable customers with advice and guidance on relevant product adjustments. In commercial, we're reaching out to business banking clients with specialist relationship manager support. In insurance, we're removing monthly interest charges on home insurance products, enabling customers to spread the cost of their policies. As said, we're committed to proactively supporting our customers. We remain vigilant for any signs of stress across the portfolios. Let me now turn to slide four to look at an overview of the financials. Lloyds Banking Group has delivered a robust financial performance in the first nine months of 2022. Net income of $13 billion is up 12% on the prior year. supported by a stronger net interest margin of 284 basis points, growth in other income and a continued low operating lease depreciation charge. We remain committed to our market leading efficiency. Operating costs of 6.4 billion are up 6% on the prior year. This includes stable BAU costs alongside higher planned strategic investments and the costs associated with our new businesses. Observed asset quality remains very strong. Impairment has increased to one billion, but this is largely driven by the weaker economic outlook and associated scenarios adopted in Q3. I'll go into this in more detail shortly. Taken together, this robust group performance resulted in statutory profit after tax of four billion in the first nine months and a return on tangible equity of 12.9%. Our financial performance alongside effective management of risk-weighted assets has resulted in capital generation of 191 basis points for the year to date. I'll now turn to slide five to look at the ongoing strength in our customer franchise during the third quarter. Our mortgage book continues to grow, including open book growth of 1.8 billion in Q3. Credit cards have continued their gradual recovery. Balances are up 0.1 billion in Q3, with improving spending levels, particularly in discretionary categories, although much of this is offset by customer repayments. Unsecured personal loans have increased 0.3 billion in the quarter, in part due to our enhanced pre-approval capabilities for attractive, low-risk customers in the intermediary channel. Commercial banking balances are up 0.6 billion in the quarter, We're seeing attractive growth opportunities within our corporate and institutional franchise, alongside the effect of FX movements. These are partly offset by repayments of government support scheme loans in SME. Looking briefly at the other side of the balance sheet, we continue to see inflows to our trusted brands. Retail deposits are up 1.5 billion in the quarter, building on the growth seen in the first half. Within this, current accounts are up 2.3 billion in Q3, more than offsetting lower savings balances in our tactical brands, with our relationship brands essentially flat. Commercial deposits are up 3.5 billion in the third quarter. Note that part of this growth is short-term placements, which are likely to reverse in Q4. Alongside, we continue to see good organic growth within our insurance business, including over 6 billion of net new money in the year to date. On that end, slide six and the group's income growth in a little more detail. Net income of 13 billion is up 12% year on year with higher NII and other income alongside lower operating lease appreciation. Net interest income of 9.5 billion is up 15% on the prior year, benefiting from a stronger net interest margin and higher average interest earning assets. AIEAs of $451.4 billion are up $8.4 billion on Q3 2021. Within this, mortgage growth is more than offsetting the lower average balances in SME. The US today net interest margin of 284 basis points is up 32 basis points on the prior year. The margin in the third quarter was 298 basis points, benefiting from the bank base rate increases and favourable structural hedge reinvestment, more than offsetting the drag from mortgages. In respect of mortgages, completion margins were around 60 basis points in Q3, in the context of considerable swap volatility. It remains unclear exactly where margins will settle, but we're seeing persistent material pricing moves, compensating for the recent swap rate increases. Looking forward, our updated economic assumptions now include a year-end base rate of 4%. This will act as a tailwind to the margin. Indeed, with the benefit of this and other factors, we are seeing sustainably higher margins than previously expected. Accordingly, we are enhancing our 2022 net interest margin guidance to greater than 290 basis points. With respect to volumes, we continue to expect low single-digit percentage growth in AIEAs in 2022. Now turning briefly to other income. OI of 3.8 billion year-to-date is up 2% on the prior year, while 1.3 billion in the third quarter is roughly in line with recent periods. Within OI, retail other income is up 11% year-on-year, including improved current account and credit card performance. Commercial banking is up 3%, given financial markets and transaction banking income. Insurance, pensions and investments income is up 6%, reflecting a good performance in workplace pensions and bulk annuities. And finally, within our equity investment business, income is materially lower given the non-recurrence of exceptional gains in 2021 and one-off charges in Q2 2022 impacting the business growth fund. Going forward, we continue to expect other income as a whole to build gradually, supported by customer activity levels and our ongoing strategic investments. Of course, within this, you should remember that we will see an impact from the implementation of IFRS 17 in 2023. We'll go into this in more detail at the year end. Given the continued focus on interest rate impacts and the structural hedge, I'll now look at these in more detail on slide seven. The structural hedge has been a material net tailwind to group income in the first nine months of the year. Gross hedge income was $1.9 billion for the nine months, while Q3 alone was around $120 million higher than Q3 last year. Looking forward, in the current rates environment, we expect structural hedge income to be stronger in 2022 than in 2021, and to build significantly again into 2023 and 2024 as the hedgery prices increase. In this context, the nominal balance of the structural hedge remains around $250 billion, with a weighted average life of around 3.5 years. $65 billion growth of the hedge nominal balance since 2019 incorporates about $40 billion of the more than $70 billion of deposit growth since the end of 2019. This is alongside $17 billion of increased eligibility from previously existing deposits, and 9 billion in utilization of the previous buffer. As a result, as you can see, we've built a substantial buffer of balances, which represent deposits that have not yet been taken into the hedge. This buffer now stands at 31 billion, providing significant protection in the event that deposits prove more rate sensitive than expected. As you've heard many times, the group is positively exposed to rising rates, We currently expect a 25 basis time parallel shift in yield curve and associated base rate rise to benefit interest income by about 150 million in year one. This is lower than reported at the half year, reflecting the fact that we've deployed the hedge into the recent rising rate environment and hence have a lower level of maturities in Q4. I should also note that the sensitivity is likely to pick up again going forward, as we have over 38 billion of maturities expected in the remainder of 2022 and 2023. As you know, our sensitivity is illustrative and based on the same assumptions we have given before, including the 50% deposit pass-through. Clearly, the actual pass-through experience could differ from our 50% illustration. And for every 10 percentage point reduction versus the assumed pass-through, we expect an additional 50 million of NII in year one for a 25 basis point shift. As noted before, this is broadly linear, so you can double that sensitivity for a 50 basis point shift. Now moving to costs on slide eight. Operating costs of 6.4 billion are up 6% on prior year. As expected, essentially stable BAU costs are alongside planned higher investment and costs associated with our new businesses. We continue to expect 2022 operating expenses to be circa 8.8 billion. Our cost income ratio of 47.8% in Q3, including remediation, has significantly improved over recent quarters. Looking forward, like all organisations, we are impacted by inflationary pressures, but we retain our rigorous cost focus. We will look to offset higher costs wherever possible, as we have with the circa 65 million expense associated with the one-off payment to staff in Q3. We'll provide an update on the cost and investment outlook at the year end. I should just highlight at this point that the phasing of our strategic investment is expected to peak next year. As mentioned, remediation remains low, at 89 million for the year to date, and 10 million in Q3. Within this, there is no charge for HPOS reading, although uncertainties remain. Looking now at impairment on slide nine. Observed asset quality remains very strong. The net impairment charge for the third quarter is 668 million. This includes $618 million in respect of the updated macroeconomic outlook and associated scenarios, partly offset by the release of the remaining $200 million central COVID-related overlay. I should note that this Q3 MES charge is materially driven by a very severe downside case. This is a function of our methodology, but it is also an unlikely outcome. The Q3 charge for pre-updated economic scenarios of 250 million reflects a very strong observed credit quality. It is equivalent to 21 basis points for Q3 or 15 basis points year-to-date in line with our previous guidance. NES and observed charges together bring the net year-to-date impairment charge to approximately 1 billion, equating to an asset quality ratio of 30 basis points. As a result of the provision build in Q3, driven by the weaker economic outlook and associated scenarios, our stock of ETLs has increased to 5 billion. We now expect the net asset quality ratio to be around 30 basis points for 2022. Turning to slide 10, I'll consider customer behaviour across our businesses. We are seeing few signs of pressure in our customer base from cost of living increases. Credit card spend in September was up 16% compared to September 2019, driven by our middle and high-income customer bands. Indeed, our customer base is continuing to increase discretionary spending, providing further opportunities to adjust outgoings if needed. Alongside, regular minimum payers in the card portfolio remain at consistently low levels. We continue to see stable trends in SME overdrafts and revolving credit facilities. Indeed, RCF drawings remain at around 80% of pre-pandemic levels, while invoice financing data days have remained broadly stable throughout the year. Let me now turn to slide 11 and the resilience of our portfolios in the current environment. Our mortgage book now stands at $311 billion. This is a very high-quality portfolio. Average loans of value is 40.3%, and 96% of the book has an LTV below 80%. Just 0.5% has an LTV above 90%. We're now assuming a peak-to-trough house price reduction of 10%, but even after that, given the LTVs, our customers would retain significant equity. Our commercial portfolio is also very high quality. Over 70% of exposure is to investment-grade clients, while around 90% of SME lending is secured. Within commercial, the real estate portfolio has been significantly de-risked in recent years. Net exposure is now 10.9 billion, and the business has an average LTV of 39%, while just 11% have an LTV above 60%. Average interest cover of the portfolio is basically stable at 4.4 times. As you can see on the slide, there's a very slight increase in new to arrears and unsecured. However, these levels remain very low across our portfolios at or below historical averages and below pre-pandemic levels. In short, customers are showing resilience and performing strongly. Moving on, I'll now look at the Group's updated macroeconomic scenarios on slide 12. As mentioned earlier, the Group's updated macroeconomic scenarios are driving a surface 600 million charge in Q3, partly offset by a 200 million release of our central COVID adjustment. We now assume base rate peaks at 4% in Q4 2022, before starting to fall in early 2024 as inflation is brought under control. Inflation peaks at 10.7% in Q4, while unemployment is expected to increase to 5.5% in Q1 2024. We are now assuming a fall of 8% in house prices in 2023, or 10% peak to trough. Importantly, because of the strength of recent performance, This sees average house prices reverting to around the level of Q3 2021. This means the vast majority of customers will still have experienced net price gains during the life of their mortgage product, even after this adjustment. As ever, we've provided the full range of upside, base, downside and severe downside scenarios in the appendix. We've also provided the ECL by scenario. You can see the downside, and particularly the severe downside scenario, significantly impact our probability-weighted expected credit loss. This now drives a difference of almost 700 million between the actual ECL we hold versus our base case expectation, and it illustrates the conservatism of our approach. Moving on, I'll now turn to statutory profit on slide 13. Following the reporting changes set out at the 2021 year end, restructuring now reflects only M&A and integration costs. The charge of 69 million for the nine months includes the early integration costs relating to the acquisition of Embark. The volatility line includes 74 million of positive banking volatility year-to-date. This is more than offset by 144 million of negative insurance volatility, principally driven by rising interest rates. The line also includes the usual fair value unwind and amortization of purchase intangibles. Year-to-date statutory profit after tax of $4 billion and the return on tangible equity of 12.9% represent a robust performance. We continue to expect the ROTE for 2022 to be around 13%, even after the impairment and volatility charges that we've seen in Q3. A quick word on book value. Tangible net assets per share of 49 pence are down 5.8 pence in the quarter. This is very largely due to the impact of movements in the cash flow hedge reserve similar to the movement that you saw in the second quarter. As you know, this is a timing issue that will unwind and it has no effect on capital. Turning to slide 14 and looking at our RWA management and strong capital generation in the nine months. Risk-weighted assets of $211 billion are down $1 billion, excluding the regulatory inflation on 1 January. Underlying lending growth of $3 billion has been more than offset by model reductions and ongoing portfolio optimisation. As before, we are seeing no impact at this point from credit migration. Capital generation of 191 basis points year-to-date is strong, and it reflects robust financial performance. This includes 169 basis points of underlying banking generation, as well as the $300 million interim dividend from the insurance business. It is also after the full $800 million fixed pension contribution for 2022. The CET1 capital ratio of 15% is very strong and well ahead of our ongoing board target of circa 12.5% plus a management buffer of circa 1%. The capital ratio is after taking 60 basis points of dividend accruals, as well as substantially all of the expected 1 billion of variable pension contributions for 2022. As you'll be aware, the 2022 buyback programme was successfully completed in October, buying back over 6% of outstanding shares. Looking forward, we continue to expect 2022 closing RWAs to be around 210 billion. Based on this and the robust financial performance to date, we now expect capital generation for 2022 to be between 225 and 250 basis points. The Board remains committed to shareholder remuneration. As always, we will consider both the dividend and further capital distributions at the year end. Now turning to slide 15 to wrap up. In summary, the group is performing well and faces the future with confidence. The current environment is concerning for many people. As always, we are committed to maintaining the support we give to our customers. However, our franchises are resilient and our low-risk portfolios are well positioned for more challenging times. The Group has delivered a robust performance in the first nine months of 2022, with improving net interest income and cost discipline driving robust profitability, that is despite the revised macroeconomic outlook. Looking forward, the Group's robust financial performance and revised economic outlook are reflected in our updated guidance for 2022. We now expect the net interest margin to be in excess of 290 basis points. The asset quality ratio to be circa 30 basis points. And capital generation to be between 225 and 250 basis points. The rest of our guidance for 2022 remains unchanged. That concludes my comments for this morning. Thank you for listening. I'll now hand back to the operator for Q&A.

Thank you. If you wish to ask a question, please dial 01 on your telephone keypad now to enter the queue. Once your name is announced, you can ask your question. If you find your question is answered before it's your turn to speak, you can dial 02 to cancel. Our first question comes from the line of Joseph Dickerson at Jefferies. Please go ahead. Your line is open.

Hi. Good morning. Just a couple of quick questions. Thanks for the disclosures on slide seven for the additional sensitivity around the pass-through rate. Could you give us a sense of what the ballpark is on the current year-to-date pass-through rate? Presumably, this will start to shift as rates cross, let's say, 310 or some level like that. But I guess just what's been the experience thus far is the first question. And then similarly on net interest income, is the way to think about the 38 billion of maturities that you can earn probably a couple hundred basis points higher spread on those, plus whatever you decide to do with the 31 billion unutilized buffer. Is that probably the current rates? Thanks.