Lloyds Banking Group plc

Thank you for standing by and welcome to the Lloyds Banking Group 2023 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.

Thank you, and good morning, everyone, and thank you for joining our 2023 half-year results presentation, another dynamic media morning for us to do our results. I'll begin with a short overview of the group's financial and strategic performance. I'll also highlight some of the actions that we're taking to support customers given the ongoing changes in the macroeconomic environment. William will then provide the usual detail on our financials, and following a brief summary, we'll take your questions. Let me begin on slide three. The external environment continues to change significantly, with persistently high inflation and a higher than anticipated interest rate. Against this backdrop, I'd like to take away four key points from the presentation today. Firstly, uncertainty for our customers has increased, given the changes in the external environment. To this end, we've once again stepped up our support for customers, especially for those most in need. I'll discuss specific actions we'll be taking shortly. Secondly, in line with our guidance, our Q2 profits and net interest margin have stepped down versus our first quarter. This is due to the continued low margins on mortgages as well as passing on more to our savings customers. However, the group is performing well and our financial performance remains robust. As you'll hear later in the presentation, we've either reconfirmed or slightly enhanced our guidance for 2023. Thirdly, we're making good progress on delivering our strategy. We remain on track to deliver the strategic benefits we laid out in February of last year for both 2024 and 2026. This is despite a more challenging environment and, as a result, slower growth in AIEAs. Our performance in other income in the first half shows positive business momentum and is an example of the progress we're making. And finally, if you look ahead, our capital position and financial strength, together with our prudent approach to risk, positions us well. Regardless of future uncertainties, we are well-placed to support our customers, safeguard deposits, support the UK economy, and continue to deliver for our shareholders. On slide four, I'd now like to highlight how we've delivered for our customers and other stakeholders in the first half. We're playing our part to provide proactive and targeted support for customers through a period of increased uncertainty, whilst ensuring we provide good and fair outcomes for all. Increasing mortgage rates are a notable area where customers across the industry are experiencing challenges. To mitigate this, we've proactively contacted over 200,000 customers most affected to offer additional support. We've also committed to the government's mortgage charter and offer product transfers for all residential mortgage customers, even if they're in arrears. We're also keen to ensure that our deposit customers benefit from rising rates with a range of attractive savings options. We've used our significant reach to proactively encourage 10 million customers to review their savings rates through prompts within our mobile app, contributing to 1.9 million new savings accounts being opened in the first half of 2023. Our proactive support also extends to businesses, providing more than 550,000 customers with guidance on how to build their financial resilience. It should be noted that we continue to see significant resilience across our portfolio, with customers adapting to the environment. However, we deem these actions appropriate, prudent, and aligned to our purpose of helping Britain prosper. We also remain highly focused on our broader stakeholder objectives, such as building an inclusive society and supporting the transition to a low-carbon economy. For example, in the first half of the year, we announced a new goal to double the representation of colleagues in senior roles with a disability by 2025. And we continue to make great strides on our green financing initiatives. Our continued support for customers and other stakeholders is made possible by our robust financial performance. On slide five, I'll provide a brief overview of the trends that influenced our second quarter results. The group is performing in line with expectations. We reported a net interest margin of 314 basis points in the second quarter, consistent with guidance provided earlier in the year given expected headwinds. Customer deposits of 470 billion pounds reflect a resilient performance in a competitive market and amid the continued shift in mix across the industry. Our second quarter return on tangible equity of 13.6% was lower than Q1 as expected, but demonstrates that the group is performing well and provides us with confidence for the full year. As a result of this confidence, we have today announced an interim ordinary dividend that is 15% up on the first half of last year and represents an attractive return for shareholders. William will provide more information on how we expect financial performance to develop over the second half of the year, including our enhanced 2023 guidance. I'll now briefly discuss our strategic progress. starting with slide six. We're now in the second year of our five-year strategic transformation and halfway towards our first strategic milestones at the end of 2024. You'll recall that at the full year, I highlighted that in 2022, we prioritized reorganizing the group and laying the foundations for our strategic success. Having achieved this, we're now building momentum across our strategic initiatives. This is supported by continued investment, with a further £0.6 billion invested in the first half of the year, bringing the total to £1.4 billion of additional strategic investments to date. I'm pleased to say that we are on track to deliver against our 2024 strategic outcomes, and in some cases have already surpassed these. This is translating into financial benefits, which will grow more meaningful in future periods. We're on course to deliver the circa 0.7 billion pounds of additional revenues from strategic initiatives by 2024, as well as the 1.2 billion pounds of gross cost savings, the target that we increased at the full year. On slide seven, I'll highlight some examples of the strategic priorities we've delivered in the first half. Our strategic pillars are focused on driving revenue growth and diversification, strengthening cost and capital efficiency, and maximizing the potential of our people, technology, and data. We're making good progress across our priority growth areas. This includes further increasing our unrivaled level of digital engagement. We're now operating with 20.6 million digitally active customers, surpassing our original target of greater than 20 million by the end of 2024. We've also made good progress in developing our mass affluent offering in the first half including the rollout of ready-made investments and tiered savings propositions. We're attracting new customers and increasing balances and expect to build greater momentum as we develop the offering further. Our enablers are critical to both our execution efforts and ensuring that we deliver a more cost-efficient and less capital-intensive business. We've now reduced our office footprint by around one-fifth since the start of the plan, Actions such as these have supported the delivery of approximately 50% of our 2024 gross cost savings target to date. Finally, we're increasing the number of new hires in both technology and data as we continue to improve our ways of working to better unlock the potential of our people. Turning now to future delivery on slide eight. Our progress to date increases our confidence in successfully executing our strategic transformation. In addition to our achievements in the first half, we have a clear pipeline of deliverables for the rest of 2023. This includes launching a new dedicated offering to support our mass affluent ambitions, as well as investing further in our markets capabilities to improve our competitiveness, support more client needs, and deliver other income growth. Alongside customer-focused developments, our disciplined approach to cost and capital efficiency will remain unchanged. We'll continue to progressively modernize our technology and data capabilities. I'll now end by opening remarks on slide 9 with a look ahead to future updates. As a reminder, it is our intention to provide you with a series of deep-dive seminars over the coming 12 months focused on four priority growth areas. They'll provide you with an opportunity to hear more from the respective management teams and to spend more time focusing on our progress to date and our vision for the future. We're really excited about sharing our ambitions with you and hope that you'll join these sessions starting in October with a look at our consumer franchise. Thanks for listening. I'll now hand over to William for the financials.

Thank you, Charlie. Good morning, everyone, and thanks again for joining. Let me start with an overview of the financials on slide 11. As you heard from Charlie, the business delivered a robust financial performance in H1 and in Q2. Statutory profit after tax of 2.9 billion is up 17% on the prior year. Return on tangible equity was 16.6%. Net income is up 11% year-on-year, supported by a margin of 318 basis points and growth in other income. Total costs including remediation of 4.5 billion are up 5% year on year, in line with expectations. Asset quality is resilient. The impairment charge of 662 million equates to an asset quality ratio of 29 basis points. Tangible net assets per share were 45.7 pence, down slightly in H1, given the sharp movement in rates in Q2. Capital generation of 111 basis points was strong and supported our increased interim dividend. With that, I'll turn to slide 12 to look at the customer franchise. The customer franchise continues to be resilient. Total lending balances stand at 451 billion, down slightly in the second quarter. Retail balances were essentially flat in the quarter. The small reduction in mortgages was largely offset by continued growth in cards, motor finance, and loans. Commercial banking balances were down 1 billion in the quarter. Continue to see net repayments significantly relating to government-guaranteed loans. Total deposits stand at 470 billion. Performance was resilient, with retail essentially flat in the second quarter, and commercial down 2.9 billion, the latter driven by expected short-term placements flagged at Q1. Alongside, we continue to see steady growth in insurance, with around 1.4 billion of net new money in the quarter. Turning now to net interest income on slide 13. Net interest income performance was strong in H1. NII of 7 billion in the first half is up 14% year-on-year, although stable on H2 last year. Average interest-earning assets are down slightly in the quarter. Small reductions in the mortgage book and commercial banking were partly offset by growth in the other lending portfolios. The net interest margin of 318 basis points in the half includes 314 basis points in the second quarter. This fell eight basis points from Q1, given the mortgage and deposit pricing headwinds that we called out at that timeframe. Having said that, base rate changes were stronger than we expected then, implying the step down in margin was a little less. Looking forward, we expect AIEAs for 2023 as a whole to be slightly lower than Q4-22, as the unsecured growth is offset by lower mortgage balances and repayment of government-guaranteed loans. We now expect the margin for 2023 to be greater than 310 basis points. We're forecasting a peak base rate of 5.5%, significantly ahead of our previous expectations. This will support the margin through H2, in particular, driving stronger hedge income. Going the other way, mortgage margin pressures and deposit mix shift are both expected to continue in the second half. Non-banking NII was about 80 million in Q2. This is driven by volumes within our non-banking businesses, as well as rates. Given the increase in rates seen in Q2 and increasing level of activity, we expect non-banking NII funding costs to increase slightly from here and the run rate to be slightly higher, therefore, in the second half. Now, moving on to the mortgage portfolio on slide 14. The mortgage book is resilient and now stands at $306 billion. The open book is down 1.7 billion in H1, partly due to the legacy portfolio sale in the first quarter. The bank book continues to run down and is now around 39 billion. Customers continue to refinance their mortgages given higher rates. Indeed, we are actively supporting them in doing so. Mortgage pricing remains competitive. Front book maturities rolled off at about 180 basis points in Q2, while completion margins remain at around 50 basis points. We expect mortgage margins to remain around this level through the second half, but of course that will depend upon swap rate volatility and indeed margins in other parts of the balance sheet. That said, mortgage lending remains attractive from a returns and economic value perspective. Let me now look at the other lending books on slide 15. Consumer balances are performing well. Balances are at 1.8 billion and a half, including 1 billion in Q2. We continue to see credit card spend recovering, although repayments are still somewhat dampening interest-bearing balance growth. Motor finance is up 0.6 billion and a half, as industry supply issues continue to ease. Within commercial, corporate and institutional is up 0.6 billion, including client growth alongside FX impacts. As said previously, government-backed borrowing repayments alongside limited customer demand are impacting the net SMB performance. We expect this to continue. Now moving on to deposits on slide 16. Deposit performance in the half has been solid. Total customer deposits of $470 billion are down 1.2% in the half, or $5.5 billion. Retail deposits were down $4.9 billion in H1, and essentially flat in Q2, with current accounts down and savings up. The retail current account reduction in Q2 was a smaller movement than we saw in Q1. This reflects inflationary spend pressures offset by wage increases and transfers into savings as customer behaviours evolve. We estimate around 4 billion of current account outflows, or around two-thirds, have been retained within our savings proposition. Supported by this retention activity alongside new money, retail savings balances were up 3.1 billion in H1. Commercial deposits were flat across the half, albeit decreasing 2.9 billion in Q2. Notably, while this reflected expected outflows of some short-term placements from Q1, business banking current accounts were much more stable in Q2. Recognising that it's a fast-changing environment, we continue to expect total deposits to be broadly stable from here through the second half of 2023. Having said that, the mixed shift to term savings is likely to continue. As you know, the performance of our deposit franchise supports the structural hedge. I'll now look at this further on slide 17. Our structural hedge remains a significant tailwind to earnings. Today, the structural hedge capacity remains around 255 billion. The notional balance is fully invested. As you know, we manage the hedge prudently and maintain a buffer of hedgeable balances outside of the approved capacity. Given the deposit movements highlighted, this buffer is reduced. Accordingly, assuming deposit movements continue into H2, we expect a modest reduction in the hedge notional balance. This will be managed out of upcoming maturities. That said, the circle one percentage point movement in the curve over the last quarter means the expected income effects of this are negligible. The hedge will continue to provide a very material and a consistent income tailwind looking forward. In H1, we saw gross hedge income of 1.6 billion, an earnings rate of around 1.2%. Looking forward, we expect hedge income will be around 0.8 billion higher in 2023 than 2022. with a similar increase again in 2024. Now, moving to other income on slide 18. We continue to build confidence in our growth potential in other income across the franchise. Other income of 2.5 billion in the first half includes 1.3 billion in the second quarter. Retail is seeing improved current account and credit card performance alongside a growing contribution from motor finance. Commercial other income benefited in the first half from improved performance in markets and a successful bond franchise. Insurance, pensions and investments saw improved performance in life and pensions, general insurance and stockbroking, together driving higher income in H1. The operating lease appreciation charge of £356 million and a half included £216 million in the second quarter. After two years of low charges during the pandemic, it is now normalising. It picked up in Q2 as a result of higher value new vehicles and lower gains on sale, growth from the Tuscar acquisition, and an adjustment to take account of recent price declines in electric vehicles. As we look forward, we expect operating lease appreciation to be broadly stable at the Q2 level through the rest of 2023, with EV prices steadying but offset by growth in business volumes and normalising car prices. Overall, we expect other income to continue to develop, supported by our ongoing franchise investments. This is, of course, dependent on activity levels, but the underlying business trends are favourable. Moving on, let me focus on costs on slide 19. Cost management remains very close to our hearts. Operating costs of 4.4 billion for the half are up 6% given our planned strategic investments, the costs associated with our new businesses, and inflation. This gives us a cost-income ratio of 48.8%. In the context of persistent inflationary pressures, we remain focused We are on track to deliver operating costs of circa 9.1 billion in 2023. Alongside, remediation remains low, just 70 million in H1 and 51 million in Q2. Looking now at impairment on slide 20. Observed asset quality is resilient. This reflects our prime customer base and our prudent approach to risk. The 662 million charge in the first half is equivalent to an asset quality ratio of 29 basis points, in line with our guidance. The first half includes a small charge of 5 million in respect of updated macroeconomic scenarios, alongside the 657 million underlying charge. 419 million in the second quarter includes 84 million for updated economics. Excluding this, the pre-MES quarterly charge of $335 million is stable on Q1 and on Q4. Notably, this includes both the stage one provision roll forward into a more adverse economic environment and bank base rate effects on recoveries, which do not represent actual defaults. Together, this equates to an AQR of 29 basis points, again, in line with guidance. Our stock of ECLs increased marginally in the half to 5.4 billion. This provides coverage of 1.2% across the portfolio. Away from the assumptions, we are seeing sustained low levels of neutral arrears. Importantly, 92% of our Stage 2 balances are up to date. Alongside, Stage 3 balances were broadly stable during H1 and Q2. Based on our latest projections, we continue to expect the net asset quality ratio for 2023 to be around 30 basis points. Given the importance of our macroeconomic assumptions to the impairment outcome, let me now briefly look at our updated base case on slide 21. Overall, we see 2023 as better than expected at Q1, but slower growth thereafter, partly down to higher rates. We now expect base rates to peak at 5.5% in Q3 this year and for inflation to reduce more slowly than previously anticipated. We expect unemployment to remain low, but forecast a gradual increase to around 5.3% by 2025. After strong house price growth in 2022, we now model HPI declining 5% in 2023 and see a peak-to-trough decline of around 12%. Moving on, let me now turn to slide 22 to look at the performance across our lending portfolios. Performance across our portfolios is consistently reassuring. We've seen a modest increase in new to arrears in mortgages and to a lesser extent credit cards. However, this is from a very low base. The trends in most portfolios remain similar to or favourable to pre-pandemic levels. We continue to see stable trends in SME overdrafts, alongside RCF utilization remains more than 30% below pre-COVID levels. We have a very high-quality commercial portfolio. Around 90% of SME lending is secured, whilst more than 75% of commercial exposure is to investment-grade clients. We also have a modest and well-diversified commercial real estate portfolio. Net exposure after significant risk transfers is around 11 billion, and lending is focused on cash flows. 80% of the book has interest cover of two times or more. The average LTV of the portfolio is 44%, while around 91% have an LTV below 70. Given the focus on mortgages in recent weeks, let me now turn to slide 23 to give some further insight on the strength of that business. The mortgage book is very resilient. We're seeing a modest increase in new to arrears, but again from a very low level, and overall remaining below 2019 levels. The increase is also focused on the legacy, predominantly variable rate business, originated in 2006 to 2008. This legacy book now has an average LTV of 34%, an average loan size of around 100,000. Over two-thirds of this book are on variable rate products and so have been dealing with progressively higher rates for over a year now. Arrears remain at low levels and have stabilized over the last couple of months. The rest of the book remains very resilient with just 0.2% new to arrears. The average household income in our portfolio is over £75,000 per year. And in this context, average payments for customers refinancing on the fixed rate since October of last year have increased by £185 per month, or £2,200 per year. Looking forward, in H2 in 2024, an average capital repayment mortgage moving to a 6.5% pay rate from a fixed rate of 2% will see the customer paying an additional £390 per month. Our affordability testing in recent years means customers refinancing in 2023 have in fact been tested to over 6.5%. Most customers are finding these levels manageable. For any that have difficulties, we will, of course, support them. Alongside, our customers have significant equity in their homes. The average loan-to-value of the portfolio is 42%, and 92% of the book is below 80 LTV. Pulling it all together, based on our client profile, our lending criteria and security, and testified to by our experience, mortgage portfolio is very well positioned for higher interest rates. Let's now move to slide 24 and the below the line items in TNAV. Underlying and statutory profit continue to be convergent. Restructuring costs of 25 million reflect only M&A and integration costs. The volatility line includes 182 million of negative insurance volatility, largely driven by higher interest rates in the second quarter. Taken together, statutory profit after tax of 2.9 billion and the return on tangible equity of 16.6% in the first half constitute, as said, a robust performance. Looking forward, driven by both income performance and TNAV, we now expect the ROTE for 2023 to be greater than 14%. Turning to TNAV, tangible net assets per share were 45.7 pence, down 0.8 pence in the half, including 3.9 pence in the second quarter. The quarterly movement is significantly driven by higher rates impacting the cash flow hedge reserve. As we look forward, we continue to expect TNAP per share to grow as it benefits from the unwind of current headwinds over the medium term. Now turning to slide 25 and looking at risk-weighted assets and capital. We have seen strong capital generation so far in 2023. Risk-weighted assets ended the half at 215 billion, up 4.4 billion. This includes a 3 billion impact anticipated from CRD4 models and remains in line with our 2024 expectation of 220 to 225 billion RWAs. Capital generation of 111 basis points in the half was, as said, a strong result. This is after taking the full 800 million fixed pension contribution in Q1. If we deduct the CRD4 mortgage model changes and the phase unwind of IFRS 9 relief in January, capital generation was 75 basis points in the half. The closing CET1 ratio of 14.2% is also after 21 basis points for the acquisition of Tusker and 44 basis points for dividend accruals. We have a very strong capital position, well ahead of our ongoing target of around 13.5%. You will have also seen that the group passed the recent stress test comfortably. The strength of the group's capital position and prospects enables the Board to announce an increased interim dividend of 0.92 pence per share, up 15% on last year. As usual, we'll consider further capital distributions at year end. We continue to expect capital generation for 2023, even after CRD4 and the phase unwind of IFRS 9 release, to be around 175 basis points. This represents a very healthy level of capital generation from a strong business. I'll now move on to slide 26 to wrap up the financials. In summary, the group has delivered a robust financial performance in the half. Strong income and resilient credit trends support capital generation of 111 basis points and an increased interim dividend. Looking forward, we are enhancing our guidance for 2023 and now expect the net interest margin to be greater than 310 basis points. Operating costs to be around 9.1 billion. The asset quality ratio to be circa 30 basis points. the return on tangible equity to be more than 14%, and capital generation to be around 175 basis points. In a changing external environment, the group consistently performs well. I conclude my comments for this morning. Thank you for listening. I'll now hand back to Charlie to wrap up.