Lloyds Banking Group plc

Thank you for standing by and welcome to the Lloyds Banking Group 2023 Q1 Interim Management Statement Call. At this time, all participants are in a listen-only mode. There will be a presentation from William Chalmers, followed by a question and answer session. If you are joining by phone and wish to ask a question, please press star 11. This call is scheduled for an hour and is being recorded. I will now hand over to William Chalmers. Please go ahead.

Thank you, operator. Good morning, everybody, and thank you for joining our Q1 results call. Let me start with an overview of our key messages on slide two. The group has continued to deliver in Q1. As ever, and particularly in the current environment, our purpose of helping Britain prosper is central to how we operate. Our purpose-driven business model enables the group to offer significant support to customers and colleagues. as they navigate the increased cost of living. We've also continued to deliver against our strategic ambitions for the group. You'll hear more about this at the half year and in our deep dive sessions in H2. Underpinning this, we delivered a solid financial performance in Q1, including strong income growth and capital generation. Our confidence in the group's business model, strategy, and continued financial performance are reflected in our maintained guidance for 2023. In an environment of change, our commitments have remained constant. Let's turn to the financials on slide three. Lloyds Banking Group delivered a solid financial performance in the first quarter of the year. Net income of £4.7 billion is up 15% on the prior year, supported by a net interest margin of 322 basis points, growth in other income, and a continued low operating lease depreciation charge. Operating costs of 2.2 billion are up 5% on the first quarter of 2022. This reflects our continued strategic investment alongside inflationary effects on the cost base. We remain committed to maintaining our market leading efficiency position and are on target to achieve our guidance of circa 9.1 billion for 2023. Asset quality is resilient. The impairment charge of 243 million is equivalent to an asset quality ratio of 22 basis points, supported by a small release relating to the improved macroeconomic outlook versus Q4. Consistent with recent periods, given the reporting changes we implemented a year ago, underlying and statutory profit before tax are now largely aligned. Statutory profit after tax for Q1 was 1.6 billion, and the return on tangible equity was 19.1%. This drove strong capital generation of 52 basis points, even after taking the full 800 million fixed pension contribution. Alongside, TNAV is up 3.1 pence per share after the IFRS 17 restatement. I'll now turn to slide four to look at our resilient customer franchise. Mortgage balances stand at 307.5 billion. This is down 3.7 billion in the quarter, largely driven by the 2.5 billion legacy portfolio exit that we mentioned at the full year. Excluding this, the open mortgage book was down 0.6 billion in the quarter, reflecting lower activity levels across the market. Alongside, we continue to see modest growth in our other retail businesses, with credit cards, loans and motor finance all showing progress. Likewise, we continue to take advantage of strategic growth opportunities within the corporate and institutional business, delivering growth of 0.7 billion in balances in Q1. As in previous quarters, this is offset by repayments of government support scheme loans within SME and some lower underlying balances. Turning to the deposit side of the balance sheet. Total deposits are down 2.2 billion in the first quarter, or roughly half a percent. This includes a reduction of 4.3 billion in retail and growth of 2.7 billion in commercial banking. The retail balance development includes an outflow of 3.5 billion in current accounts. This reflects unusually high seasonal outflows, mainly tax payments, higher spend given inflation and rates, and a more competitive market, including government NS&I offers and our own savings rates. Looking forward, it is likely that the higher customer spend levels, internal churn, and market competition continue, but we do not expect to see the circa 2 billion of tax payments repeating this year. Savings balances in Q1 were essentially flat, albeit with some expected movement from variable to fixed rate. In commercial banking, we saw modest SMB outflows due to spend increasing and corporate and institutional inflows. Some of these inflows were strategic. some likely short-term quarter imbalances. Across deposits as a whole and acknowledging uncertainties, we expect balances in 2023 to be broadly flat on 2022. Alongside, we continue to see good organic growth in insurance with circa 2 billion of net new money in the quarter. Moving on to slide five and the group's strong income performance. Net income of 4.7 billion is up 15% year-on-year, with higher NII and other income. Net interest income of 3.5 billion is 20% higher than the prior year, benefiting from a stronger net interest margin and higher average interest earning assets. The Q1 margin of 322 basis points is up 54 basis points year-on-year, but stable on Q4, as we had expected. As set out at the full year, we've seen continued pressure on asset margins, broadly offset by tailwinds from base rates, and benefits from the reinvestment of the structural hedge. Mortgage completion margins were around 50 basis points in the quarter. This average included slightly higher new business margins and slightly lower product transfer margins. As you can see, the nominal balance of the structural hedge remained at $255 billion, The weighted average life also remains around 3.5 years. Given an average yield of around 1.2% and currently prevailing swap rates, reinvestment of hedge maturities is expected to continue providing a healthy tailwind in the coming quarters. Looking forward, and as outlined in February, we continue to expect the net interest margin to reduce in Q2 before stabilising in the second half of the year. Overall, a base rate rise beyond our initial expectations has been offset by tighter product margins. We therefore continue to expect a full year margin in excess of 305 basis points. And alongside, we continue to expect broadly stable AIEAs in 2023. Turning briefly to other income. OI of 1.3 billion and a quarter is up 6% year-on-year and up 11% on Q4. We've continued to see activity build and benefits from investment, providing underlying growth. In addition, Q1 also benefited from benign weather and insurance compared to Q4 and a profit on sale of the legacy mortgage book. We continue to expect other income to build gradually, supported by customer activity, are ongoing strategic investments and releasing the store of insurance earnings within our CSM liability. A brief word on operating lease appreciation. The charge of £140 million in the quarter is higher than previous periods. The Lex car fleet grew and we recognise lower gains on sales in Q1 as new vehicle supply constraints eased. Augmented by Tusker, we expect this trend to continue through 2023-2021. and therefore to see the operating lease depreciation charge grow through the year. Now looking at costs on slide six. Operating costs of 2.2 billion are up 5% year on year. As you know, the increase is driven by our planned strategic investments, the costs associated with our new businesses, and inflationary effects on the cost base. The cost income ratio of 47.1% or 46.6% excluding remediation continues to be competitive. Looking forward, we will maintain our rigorous cost discipline and remain on track to deliver operating costs of circa 9.1 billion in 2023. Remediation was very low in Q1 at 19 million. There is no charge in respect of HBOS threading, although, as ever, uncertainties on this remain. We continue to have a base case for mediation charges of around 200 to 300 million per year. Let me now move on to asset quality on slide seven. Asset quality continues to show resilience across the group. Our retail businesses are performing well, with arrears at or below pre-pandemic levels. Meanwhile, commercial performance is strong, with the Q1 charges largely relating to cases that were already in Stage 3. The net impairment charge for Q1 was $243 million, equivalent to an asset quality ratio of 22 basis points. This includes a $322 million charge for the updated economic scenarios, roughly consistent with Q4, and equivalent to an AQR of 28 basis points. As you can see, there's a small release in respect of the updated macroeconomic scenarios. Stemming from reduced energy prices and a looser fiscal constraint, the base case represents a modestly improved outlook. As usual, the detail of our scenarios is in the appendix. The stock of the ECL on the balance sheet is marginally lower in the quarter, at 5.2 billion, with coverage levels remaining very strong. And given everything we can see, we continue to expect the net asset quality ratio to be around 30 basis points for 2023. Turning to slide eight and looking across our portfolios. Retail performance is resilient. We're seeing a modest increase in neutral arrears in some portfolios, but from a very low base. Movements are within, or in some cases better than, our expectations. The mortgage book is very high quality. The average loan-to-value is 42%, and 93% of the book is below 80%. We have seen a small uptick in arrears in the variable rate legacy books from 2006 to 2008, but the rest of the portfolio shows no noticeable movement. The unsecured book, meanwhile, is performing better than we had expected. In the commercial business, we continue to see stable SME overdraft and RCS utilization trends. Watch list and business support unit levels are stable to modestly down on year end. Our commercial portfolio is very high quality. Around 90% of SME lending is secured. whilst more than 75% of commercial exposure is to investment-grade clients. Within the commercial business, our net real estate exposure after significant risk transfers is 11 billion and has been significantly de-risked in recent years. Lending is focused on cash flows, with 84% having an interest cover of two times or more. The average LTV of the portfolio is 44%, while 95% have an LTV below 70%. The portfolio is also well diversified and subject to sector caps and limits. Our exposure to offices is around 14% of the portfolio, 10% to retail, and 11% to industrial assets. Across our businesses, we feel very comfortable on asset quality. Let me now move on to slide nine on the group's liquidity position. Given recent events, it would be remiss not to spend a moment on deposits and liquidity. The group continues to have a very well diversified deposit base and a very strong liquidity position. The net stable funding ratio at 129% and loans deposit ratio at 96% demonstrate the strength of the group's funding. We benefit from a predominantly retail-focused deposit base with around three-quarters of deposits coming from retail and a well-diversified portfolio of SMEs Over 90% of the deposit increase of circa $60 billion since the end of 2019 has been in the retail franchise. A very significant proportion of our customer deposits are insured, with over 80% of retail customer balances and 57% total deposits protected by insurance schemes such as the FSCS. The liquidity coverage ratio of 143% is stable and is well above both regulatory requirements and our internal risk appetite. Group liquidity remained robust throughout the recent volatility, with all liquidity measures well above internal thresholds at all times. Our liquidity pool of around $140 billion is held in high-quality liquid assets, with the majority held in cash and government bonds. The entire portfolio is hedged for interest rate risk, with only credit risk driving limited movements in fair value through other comprehensive income. And this was negligible both in 2022 and in Q1. Together with central bank facilities, this provides over 210 billion of available liquidity, a very strong position. Now, moving on, let's look at TNAV and capital on slide 10. Tangible net assets per share are 49.6 pence, up 3.1 pence in the quarter after the IFRS 17 restatement. This is largely driven by attributable profit, but also benefits from the cash flow hedge reserve movement and pension surface bill. Risk-weighted assets at $211 billion are flat in Q1 as we continue to benefit from portfolio optimization. We saw no impact from credit migration. We expect to receive an update on CRD4 models later this year and for this to result in an increase in risk-weighted assets. Having said that, this will still be consistent with our 2024 RWA guidance of 220 to 225 billion. Capital build remains strong at 52 basis points. Within this, we've now taken the full 800 million fixed pension contribution for the year. The CET1 capital ratio is stable in the quarter at 14.1%. This is after the impact of regulatory change, the acquisition of TSCA, and accruing for the dividend. we remain comfortably ahead of the Board's ongoing target of circa 12.5% plus a management buffer of circa 1%. Looking forward and including the strong performance in Q1, we continue to expect 2023 capital generation to be circa 175 basis points. Turning to slide 11 to wrap up. In sum, the group has delivered a solid financial performance in the first quarter, supporting strong income growth and capital generation. We are committed to supporting our customers. Our franchise and portfolios are demonstrating resilience. Looking forward, we're maintaining our guidance for 2023. We continue to expect net interest margin for 2023 to be greater than 305 basis points. Operating costs to be circa 9.1 billion. The asset quality ratio to be about 30 basis points. Return on tangible equity to be circa 13%. And capital generation to be about 175 basis points. You can see that in an environment of change, groups' commitments have remained constant. We remain well positioned for the future. That concludes my remarks for this morning, so thank you very much for listening. I'll now hand back to the operator for Q&A.

Thank you. If you wish to ask a question, please press star 11 on your telephone keypad. To withdraw your question, you may do so by pressing star 11 to cancel. There will be a brief pause while questions are being registered. The first question comes from the line of Raoul Sinner from JP Morgan. Please go ahead.