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.

Thank you, William. So, to recap, the group continues to deliver in a changing external environment. These changes have increased uncertainty for our customers and in response we've been proactive in providing support where necessary in line with our purpose of helping Britain prosper. At the same time, the group is performing well. This includes a robust financial performance in the first half of the year which supports enhanced guidance for 2023 and continued delivery on our strategic ambitions. Our confidence in the future is increasing and we expect to achieve both the revenue and cost benefits that we laid out at the start of this plan This will drive higher, more sustainable returns and capital generation. Taken together, our purpose-driven business, financial strength, resilient franchise, and continued strategic execution enable the group to better support customers both now and in the future. Thank you for listening. That concludes our presentation, and we're now happy to take any questions.

Thank you very much. As a reminder, if you wish to ask a question, please press star one on your telephone keypad. To withdraw your question, you may do so by pressing star two to cancel. There will be a brief pause whilst questions are being registered. Our first question today is from Guy Stebbings from Exane BNP Paribas. Your line is unmuted. Please go ahead.

Hi, morning, Charlie. Morning, William. Thanks for taking the questions. Really around the deposits, the hedge and margins. So if I come back to the guidance on the hedge contribution this year being unchanged versus prior guidance despite the higher swaps, can you help us think a little bit more in terms of what fall in notional balance of the hedge you're expecting and how this differs with the prior views? I think shortly after Q1 results, you're talking quite positively about deposit mix. So has that mixed, if gathered steam during the quarter, even more and more attractive term deposits on offer, etc.? ? And in that context, you see the quantum of outflows in current accounts and commercial deposits in Q2 as a sort of sensible run rate as we look forward, or would you expect that to moderate? And I don't know if you're able to share the slides for hedge and buffer now. And then just a sort of final big picture margin question. Thanks for the headline guidance revisions. Previously, you supplemented that with saying no quarter below. I don't know if that has moved up at all alongside the four-year guidance or still sits as it did before. Thank you.

Guy, just before we get going, can I just ask you to repeat the last question? I didn't quite catch it. The floor below 300 basis points.

The last question here. Yeah, sorry, Guy. I think I've got it. Are we saying, is that moving up as well, the floor of 300 basis points that we guided to in Q1? Yeah, fine. I think, Guy, most of those are women.

Sure. No, happy to answer that. Guy, thanks very much indeed for the question. In terms of modest reduction, we didn't define the term precisely, of course, but modest reduction is single digits, we expect. So let's see how we fare, but single digits, I think, is a decent guide. In terms of deposit performance, I think overall, actually, the deposit performance has been pretty pleasing, as I said in my comments, solid in Q2. So if you look at Q2 overall, it's down about 1%, about $3.3 billion. Within that, you've basically got flat retail performance and you've got a slight reduction in CB, but actually the reduction in CB was very substantially composed of the short-term placements that we flagged at Q1 and expected to come off in the course of Q2. Looking within that retail flat performance, as said, balance is overall flat. We saw PCAs down a nudge. We saw savings up. But actually, if you look at the flow of PCAs, the PCA performance in Q2 was slightly stronger than it was in Q1. Both outflows, to be clear, but about 2.7 billion in Q2 versus over 3 billion in Q1. So actually a flattening off in terms of PCAs. When we look at that overall, that gives us a view that as we look into H2, and this gets to a third of your questions, that we'll expect to see customers continue to make choices as to where they put their savings in the course of Q2, and we expect movements from PCA into savings to continue in Q2. But overall, in the context of fewer bank base rate changes than perhaps we've seen in H1, We would expect to see fewer prods, if you like, to those customers to instigate deposit movements going forward into the second half. Likewise, a lot of the money that is likely to move has moved to an extent already. So that works its way through. And alongside, of course, our instant access rates are getting progressively stronger and better for customers. So all of that means that we continue to expect to see PCA into savings moves into H2. Likewise, within savings, we expect to see moves to, but probably a flattening off in terms of the customer behaviors. And that leads us to, as said, suggest that the structural hedge change will be a modest reduction as we've defined. It is worth noting, just before moving on from that, the effect, if you like, on the structural edge earnings. As I said in my comments earlier on, Guy, any modest reduction is outweighed, in fact, as we stand today, probably more than outweighed by the interest rate changes that we've seen. And just to take a moment of that, If we looked at Q1 versus Q2 today, we've seen the three-year rate up over a percentage point higher. Likewise, we've seen the five-year rate up almost a percentage point higher. These are significant moves in terms of the earnings rates on the hedge at which we will be deploying maturities. So I don't think there's any lack of confidence in the structural hedge as a hedge. I don't think there's any lack of confidence in the earnings ability of the structural hedge as we move forward. Guys, this is more around tweaks around the edges. Second question, when we look at the base rate question that you asked and the floor around margins, as said, we've increased the margin guidance today from greater than 305 to greater than 310. That is off the back of bank base rate changes that we have seen being in excess of what we thought would happen at Q1. It is also complemented by deposit moves, perhaps being a bit more benign than we had expected at Q1, too, in line with the comments that I just made a second ago. As that flows through into the second half of this year, it is likely to lead to a margin performance for Q3 and Q4 that is a nudge ahead of where we had previously expected it and talked to you about either at the year end or at Q1. So in that sense, the improved margin guidance of credit in 310 does indeed flow through to a little nudge up in respect of Q3 and Q4, and we'd expect to see that play out.

Okay, thank you. Very helpful.

Thanks, Greg.

Thank you very much. Our next question today is from Chris Kant from Autonomous. Your line is unmuted. Please go ahead.

Good morning. Thank you for taking my questions. If I could just have a quick follow up on the previous question, I have another one. So the follow up is specifically thinking about what you've been seeing so far during July. Has there been any real change in the sort of pace of and terming out that you've seen, or has it really been sort of steady as she goes so far for the third quarter? The other thing I wanted to ask about was the controversy that I think you were referring to with your very initial remarks, Charlie. So do you see speed banking as an issue potentially becoming a conduct problem for the UK banks. There's obviously a lot of political focus on this at the moment. I'm very conscious that a lot of the decisions that you may have made in respect of customers may have been done for AML or other reasons, but there does seem to be some political steam building up behind this issue and I'm just wondering whether you see any potential conduct risk around decisions you may have made in the recent past.

Thank you. Thanks, Chris. Maybe William will build on the first question, and then I'll take the second one.

Thanks, Charlie. Chris, the short answer to your question is no, no behavior changes in July that are of any note. I think, if anything, actually, it's probably tilting marginally in favor by customer behavior changes that are slightly better than we had expected from a deposit point of view. The reason I say that is because, as per my comments earlier on, we've seen probably better deposit performance in Q2 as a general matter. As we go into June and July, actually we're seeing some beneficial effects of some of the wage and salary changes that we've seen feeding through into our PCA balances, which is a nudge ahead of perhaps where we had previously thought. So, you know, it's a little too early to call that. But nonetheless, I think July, no noticeable changes with that slight, you know, bit of context around it. I'll perhaps stop there and hand over to Charlie.

Yeah, just one build on that, which I won't do on other comments. As William said, we've seen increased wage inflation in the range that we're all expecting, which is kind of the 6% to 8% increases. When you look at how customers are adapting their spend, we know inflation has obviously been higher, but spending on all of our current accounts and cards has also been in that kind of 6% to 8% range. So that's, I think, partly why we saw the stability in Q2. Just on your debanking issue or kind of when we look to exit customer relationships, it's a good question, Chris. I think the simple answer is no, I don't see that at this stage. I can't talk for UK banks. What I can talk for is Lloyds Banking Group. And we've always had a clear policy, and obviously I've gone back in the last few weeks and checked how our policy is being implemented, that didn't look at customers' personal or political beliefs, either at the point of onboarding or when we do periodic reviews, as we do with PEPs, or if there were a decision to exit customers. So I think in the specific issue where there's strong political sentiment, and obviously we're going to have a discussion with the Economic Secretary later today, and there'll be some regulatory oversight around this, I don't think that's an issue. And as you say, we exit customers today for very specific reasons. One of the examples is economic crime, so anti-money laundering, fraud and sanctions, and there's very specific obligations we have around that. So for Lloyds Banking Group, I'm comfortable our policy doesn't expose us to this risk. Obviously, what's in the minds of the regulations of government or what other banks are doing, I can't comment on, Chris. But thank you.

That was very helpful.

Thank you. Thanks, Chris.

Thank you very much.

Our next question is from Edward Firth from KBW.

Good morning, everybody. Yeah, thanks very much for the presentation this morning. My only question was really just picking up on your comments about wage inflation. running ahead of perhaps what we were expecting certainly earlier this year than we were expecting anyway. And I'm just asking that in the context that if I look at the consent costs of employees, they're still looking at about a 1% cost growth of 24 and 25, which feels like it would be a very impressive performance in the current inflationary environment. So I just wondered if you could just comment on that, what your thinking is about that. I mean, do you agree with that that's where the risks are? I mean, how do you think that might develop as we so much.

Yeah, thanks, Ed. Perhaps I'll take that question. On the wage inflation that we're seeing, as said, that's been benefiting the PCA balances. It's also composed not just of regular wage inflation, but also back payments. Don't forget, there's a lot of that going on right now, and that clearly overall benefits balances. Your question was about how that feeds into our cost base going forward. As you know, we have two cost targets out there right now, $9.1 billion in respect to 2023, which, as said in my comments, we expect to achieve, and $9.2 billion in respect to 2024, which, of course, stands. When we look at inflation in the costs over the planned period, we obviously took a look at this at the close of 2022 before coming to the market to present the full-year results. We see cost inflation in a variety of areas. We certainly see it in wages, and that is a big part of our overall OPEX, around 40%. We also see it in terms of technology suppliers, in terms of utilities, in terms of third-party services provided to us, including consultants. So there is a widespread of cost inflation sources. It comes from, if you like, a number of different places in addition to our overall wages bill. We also have a number of tools to try to offset cost inflation as a general matter. And you'll be familiar with these, whether it's the regular matrix cost management structure that we deploy, whether it's forward hedging of things like commodity prices and utilities expenses, whether it's some of the strategic initiatives that, as you know, we've had a target of $1 billion out there. We've now increased that target to $1.2 billion. These are all ways in which we try to tackle cost inflation, Ed. Let's be clear. It is tough. It is demanding. But the organization has a good track record of doing it. And as I said, that's what allows us to give the cost targets that we have given. And that's what allows us to continue to be committed to them in the environment that we're in.

Thanks so much.

Thank you. Our next caller is Jonathan Pierce from Numis. Your line is unmuted. Please go ahead.

Yeah, morning both. A couple of questions, please. First, just coming back to the structural hedge, I mean, there's a lot of focus on the size of the hedge notional. Just so I ensure I understand this properly, if you decide in the second half not to reinvest single-digit amounts of the maturities that are coming through, but the deposit base itself remains pretty stable, you're simply going to be essentially reinvesting those maturing hedges into floating rate assets rather than fixed rate assets. So the notional hedge size drops, but the income effect is actually a slight positive, as I thought, because the overnight rate is currently above the five-year swap rate. So I just want to check that thinking is correct. The second question is on the TNAV. I mean, obviously, the cash flow hedge reserve weighed down appreciably in the second quarter, but it looks like, and we don't have detailed enough disclosure to be sure of this, but it looks like the pension remeasurement was pretty big in Q2 as well, a big negative. Can you help us think about movements in TNAV going forward? What's the big driver of the pension remeasurement? Is it simply rates as well? So as we see rates start to come off in the third quarter, TNAV will get a bit of a kicker. And maybe just a supplementary to this, how much of the TNAV drop in Q2 is behind the ROTE improvements, or would you have been improving the ROTE to circa 14% today, even if that TNAV hadn't come off so much in Q2? Thanks very much.

Yeah, thanks, Jonathan. Three questions there, I think. One on the structural hedge, one on pensions remeasurement and relationship to TNAV, and then one on the sources of the ROTE improvements. In terms of structural hedge, a couple of comments to make. One is, as said, modest reduction means single digits. We have around 20 billion of maturities in the second half of this year, around 40 billion of maturities next year. So as you can see, maturity is very significantly outweighing whatever adjustment around the edges that we might make to the overall hedge balance. I think that's one point. The second point to the topic that you were raising there, Jonathan, it depends upon what happens to the deposits that we take out of the structural hedge. And on the assumption that those deposits stay with us, then, as you say, we're going to be putting them, let's say, at bank base rate, for the sake of argument, which is currently around 5%, which, as you know, is actually ahead of the five-year rate right now, which is more like 4.8%. So there's a marginal earnings improvement from putting those funds into the base rate as opposed to a five-year swap. Now, having said that, if it goes into a fixed-term deposit, we're clearly going to be swapping against that fixed-term exposure. And therefore, while we will make a margin on the fixed-term deposit for sure, we are making the margin of the difference between the customer pay rate versus the swap in which we invest the fixed term. So, you know, we should be clear about that. It depends upon where the money goes. The money sits on a balance sheet and just adds to the buffer, which, you know, has been the pattern to a degree so far. It earns a base rate. It's a net neutral, in fact, almost net positive change. If the money goes into a fixed term deposit, that's determined by the margin on the fixed term deposit. Second point, on the pensions remeasurement and how that plays into TNAV, as you know, we saw a TNAV reduction of 3.9 pence per share over the course of the second quarter of this year, a marginal reduction over the course of the first half. A number of factors played into that TNAV adjustment, a significant part of which was the rate. So if I just focus on the 3.9 pence per share in Q2, for example, about half of that was the cash flow hedge reserve adjustment to rates. And then you've got other effects, including the dividend being paid out, for example, but including the one that you mentioned, which is around the pensions remeasurement. And to come back to your question there, Jonathan, the rates impact is the primary mover of the pensions remeasurement. There are other pieces at play. GILT is clearly one of them. Obviously, that relates to rates, but also credit spreads likewise. These factors all go into the pensions remeasurement in any given quarter. But rates is, I would say, probably the most important and maybe the most consistent mover of the pensions remeasurement in any given quarter. Your third question on TNAV and the relationship of that to ROTE improvement. In short, we have seen some reasonably significant income additions and indeed earnings improvements to the business over the course of H1 and projecting into H2 versus what we might have expected at the beginning of the year. That's the R part of the ROT equation, clearly. Now, it also happens that, as you've seen in Q2 and H1, some of that return improvement has been offset by below-the-line volatility. which means that the share of the R component in improving the ROTE guidance has been somewhat dampened by that volatility component. The TNAV, meanwhile, as we've just discussed, has gone down a fraction over the half, 3.9 pence in the quarter, and that contributes to the ROTE improvement. So, Jonathan, the short answer to your question is that both returns and TNAV reduction have contributed to our guidance of in excess of 14% ROTE for this year, But on balance, it's probably a little bit more the TNAV reduction versus the earnings enhancement because of that volatility point that I just mentioned. Final point I'll make, Jonathan, is that these TNAV changes that we're talking about, they should unwind. And they will unwind for two main reasons. One is because, as you know, the rates projections that we have suggest that at some point, a little further out than we thought at Q1, but rates are going to come down. That's going to unwind the TNAV effects. The second is, as the structural hedge matures, you're going to see a lot of those balances repriced from 1.2%, which is roughly what they are right now, to something like the 4% to 5% rate environment that we're seeing. And as those structural hedges mature, again, $20 billion second half, $40 billion next year, that is going to rebuild the TNAV. So there's a pretty automatic unwinding process. at play there. It's just that it's hard to predict exactly what happens in any given quarter in a period of interest rate volatility.

Very comprehensive. Thanks a lot, William.

Thank you, Jonathan. Thank you very much. Our next question is from Aman Raka from Barclays Capital. Your line is unmuted. Please go ahead.

Good morning, Charlie. Good morning, William. Thanks very much for taking the questions. I wanted to, sorry, I wanted to label the questioning around the hedge. Can you just clarify what, I think something's gone on with the size of the hedge maturity profile in Q2 and H2. I think as at Q1, you talked about 35 billion pounds of maturities and forgive me if I'm wrong but I thought the best part of 30 billion was coming in H2 but obviously now that looks like it's more like 20 billion that's coming in H2 so it seems like there's some trading of the structural hedge that may have taken place in Q2 so could you clarify if that's kind of the correct reading of the situation because presumably you've kind of pulled forward some of the benefit of the hedge maturity gains and this year's NIM. And I guess as a related question, I'm just thinking about the tailwind of the structural hedge in 2024. So I think you talk about 800 million in 23 and a similar number in 24. That to me sounds quite low given the maturity profile that you're calling out, you know, 20 billion that will run right into next year, the 40 billion that you're calling out. I would have thought that that hedge tailwind could be 50% higher than that £800 million that you're kind of calling out. So can you help us to kind of understand what's going on there? And I guess, you know, just to close this off, I feel like your structural hedge is a really, really important driver of your medium-term earnings and longer-term earnings. You're clearly going through a period of adjustment around net interest income right now. There's an uncertainty around your deposit dynamic near-terms. But the thing that presumably gives you confidence longer term is this really quite substantial hedge tailwind. So any kind of color you can give us around your confidence there around the size and the income profile would be great. Thank you. Yeah.

Thanks, Amant. There's three questions there around what happened to hedge maturities over the course of this year, around the tailwind looking into 2024, and around structural hedge drivers going forward. I'll answer all three, but I will turn to Charlie, actually, on some of the deposit dynamics, on the third in particular, to add further context. Amant, on the first question around structural hedge maturities, as said, it's maturities of around 20 billion looking into H2 as we stand today. I think at Q1, I probably talked about H2 maturities of around 25 billion, something like that number. What's gone on to reduce that 5 billion? It's effectively pre-hedging, Aman. So we managed a structural hedge according to principles of income stability in order to produce a predictable earnings profile, which in turn allows us to make predictable distributions to shareholders, the source of value. And the second principle being one of shareholder value. And so when we see opportunities to manage at the margin, if you like, then, you know, we'll lock in some of the hedges in accordance with that. And that's what we saw in the period during Q2. And as a result, the hedge maturities in Q3 and 4 have gone down from circa 25 billion to more like 20 billion as we have sought to lock in the shape of the curve in the interest of securing income on a stable basis for the group going forward. So it's pre-hedging in short, Aman. Second of your questions, for structural hedge tailwind going into 2024, as you say, we've put forward a circa 800 million further tailwind to the group looking in 2024 as a result of the 40 billion of structural hedge maturities that we expect to see. For those hedge maturities, I won't give you a precise number, but it will be a little bit in excess of the 1.2%, but it will be around that zone for the 2024 period. that suggests that based upon the rates that we looked at as of the 30th of June, that 800 million tailwind is what makes sense. Generally speaking, we managed this reasonably conservatively so that we can predict with confidence what we're going to deliver to you. that in turn is then subject to the volatilities of markets at any given point. And so if we overlay a kind of market implied analysis, if you like, on top of the hedge analysis that we give you, there's probably a little bit of conservatism built in there. But it's not 50%, to be clear, Aman. So, you know, it isn't going to be a question of delivering 1.2 billion versus 800 million. Based upon market implied analysis, it might be a nudge higher than 800 million, but not of the order of magnitude that you were indicating. Third point, structural hedge drivers. Let's be clear. What we're talking about here is around the edges, right? We are talking about a marginal reduction, a modest reduction, as we've termed it, in the overall size of the structural hedge of 255 billion. As I said earlier on, we've seen rate changes in between quarter one and quarter two for the three-year rate, for example, relevant, obviously, to the three-and-a-half-year waste average life of the hedge, of over 1%. if you take that as a proportion of what the rates were as of Q1, that's like 25% of the rates at Q1. So it's gone from roughly four and a quarter to roughly five and a quarter over that time period. That's a very significant, in fact, I would say overwhelming adjustment versus the type of modest reduction that we see in the overall size of the hedge. So that's the context to put it in. And then just final point before handing over to Charlie on this, Aman, is that, again, the deposits picture, it feels pretty robust. When we look at that, as I mentioned earlier on, the PCA performance in Q1 versus Q2, down from over 3 billion outflows to around 2.7 billion outflows, and then to Chris's question earlier on, some healthy signs during the course of the last few weeks or so. Looking forward, we're likely to have fewer bank base rate changes. Looking forward, much of the money that was going to move off the back of higher rates probably has moved or is moving over the course of quarter one and particularly quarter two. we're nudging interest, sorry, instant access rates up a little bit. Looking forward, the forward curve is likely to be a touch lower. And so the competitive offers will have to reflect that. Again, looking forward, we've got inflation on salaries. We've seen them so far. We'll continue to see them going forward. These are all reasons, I think, why we have confidence in the deposit base going forward, which in turn leads us to the guidance that we have on the structural hedge today. So I'm going to pause there and hand over to Charlie.

You know, the only thing I was going to add, William, but thanks for the question, Amal, is just kind of the investment thesis over the next three years. Definitely the structural edge is part of it, as you say, and we have real confidence around that, as William just laid out. There's two other things, though, I'd still mention, which are really important. First of all, as you know, we've committed to 1.5 billion of additional revenues linked to our strategic initiatives. You know, it's better to be lucky than good sometimes, and we got going on that before Russia invaded Ukraine, and we went through this rate cycle, and I hope what you can see today, and we'll give you another update at the end of the year, we've got momentum. The other operating income we think shows some green shoots of that, and that's a reason to believe that we will navigate the next three years very strongly. And then the second one is, you know, none of us can sit here and predict what the economy is going to do or what will happen to rates, but it's just really important. We know as rates go up and down what you need to deliver for shareholders and customers through that cycle. is a balance sheet that is well leveraged, is well diversified, and has a mix of assets across commercial and retail and secured and unsecured. And we've got the best balance sheet in the UK. So if rates were to come down, we'll be able to continue to compete and generate capital returns based on our assets. And we've got the structural hedge giving us a strong kind of driver underlying the business, as William just laid out. And we've committed to and we're reconfirming our strategic revenue growth initiative. So That's why we feel confident about the capital return that we've laid out over the next few years.

Thank you very much, Charlie. Thanks so much, William, for your really extensive answer.

Thank you, man. Thank you. Our next question is from Robin Down from HSBC. Your line is unmuted. Please go ahead.

Good morning. I'm not going to ask about the structural hedges, which I'll be pleased to hear. Yeah. Thank you, Robin.

And thank you for the question not being about structural hedge, actually, I should add. But nonetheless, it's OOI, as said in my comments earlier on, has been a source of decent performance, I would say, actually, in the first half. So what's behind it is your question. How do we look at H2 in that respect? When we look at what's behind it in respect of H1, it's contributions, really, from all of our three main business areas. So I look at retail, for example. And that has seen contributions during the half from a combination of customer activity in respect to PCAs, consumer finance business, the motor finance business, including not just Lex, the business that we already own, but also the acquisition of Tusker, especially in Q2. Those businesses all contributed to a decent performance. If you look at half one last year versus half one this year, it's up around 150 million. If you look at commercial, similar comparison, up around 125 million. What's leading to that? It's a combination of financial markets, i.e. flow-driven business, together with a developing capital markets business, in particular bond financing business, over the course of the first half of this year. To be fair, a touch stronger in Q1 than it was in Q2, but nonetheless a really decent performance year and a half. Moving on, insurance protection and investments, a number of moving pieces there. The three that I would point out in respect of a half-year performance are, first of all, the unwind of the CSM. That, as you know, has been an adjustment, IFRS 17 adjustment between 22 to 23. The CSM now stands around $4 billion pre-tax, around $3 billion post-tax. that CSM in addition to a further one billion of risk adjustment unwinds over time into our earnings and that has led to a stronger contribution during the course of the first half of 2023. Alongside of that, Robin, the general insurance business is doing better. The combined ratio is now below 100% within the general insurance business, and that, together with the absence of weather events, has allowed us to see decent, in fact, improved performance from the general insurance business. Obviously, the weather events have previously fed into a combined ratio which is higher than we would like to see on a long-term basis. Now it's adjusting back down. And then finally, the return on free assets, Robin, is a further factor. As we've moved into a higher rate environment, so the return on free assets in the insurance business has strengthened, and that's led to about a $90 million increase half last year versus half this year. So across each of those three elements, we're seeing some decent progress. There are always underlying elements. Second point, there are always underlying elements, Robin, within ROI. We like to strip those out internally and take a look at what's going on underneath the hood, as it were. When we look at that on an underlying basis, first half this year versus first half last year, we think we're seeing around a 7% underlying growth rate after stripping out any of the anomalies that you might see in any given quarter or any given half. So that's the overall picture, albeit that growth rate was less than 7% if you look at Q2 versus Q1, and that's the reasons that I mentioned around one or two of the individual business lines right there. When we look into H2, the second part of your question, Robin, We would expect the growth to continue as a function of two points, one being activity levels in the businesses as I described a second ago, and two is the gradual effect of some of the strategic investments being built into the overall operating performance of the business. We haven't guided on OI, so I'll be a bit careful about what I say in respect of the full year's expectations of that number, but I think we would expect to see Continual, let's say, measured growth going into the second half of this year, even if it's not quite as strong as the 7% year-on-year growth that I mentioned in H1.

Sorry, just to clarify, when you say growth, do you mean growth versus H1 or growth versus H2 of last year?

I mean, well, I mean growth versus H2 of last year, Robin, but overall, it's the comparison, the weighting between H1 and H2 That growth expectation, if you like, may be slightly more heavily weighted toward H1.

Thank you. Our next question is from Raoul Sinner from JP Morgan. Your line is unmuted. Please go ahead.

Morning, Charlie. Morning, William. Thanks very much for taking my questions. Just given some of the recent rate hikes, you had a 50 basis point rate hike at the end of the quarter. I was just wondering if I could draw you a little bit more on the profile of the NIM in the second half of the year. And I guess within that, I was looking for a little bit more color in terms of how much deposit beta you have seen in terms of what you passed through so far, what you expect to pass through in terms of your assumptions. And if we think about the broader picture of NIM, You know, on one hand, you've got the mortgage churn headwinds. On the other hand, you obviously got the maturities on the hedge coming back. How far would we be from a sort of flattish margin trajectory in the second half of the year? Thanks so much.

Thanks, Raoul. To give you some thoughts on that, as you know, we saw the margin come down in Q2 from 3.22 in Q1 to 3.14 in Q2. There are a couple of things going on there, really. In terms of tailwinds, first of all, a little bit of tailwinds from funding and capital, but frankly, not very much. And as you know, the absence of the hedge in Q2 meant that not much was coming from there either. The headwinds that brought it down, as I said in my comments earlier on, predominantly mortgages, and then the deposit pass-on pertinent to your question. And that's what led to the eight basis point reduction in Q2. Now, when we look forward to the remainder of this year, As you know, we've increased the margin guidance from greater than 305 to greater than 310. That is partly off the recognition of what was achieved in H1 being a little bit stronger than we'd expected. And it is partly recognizing that what we think is going to be achieved in H2 is also going to be a little bit stronger than we expected. The headwinds and the tailwinds looking forward, Raoul, first of all, the tailwinds perhaps, the structural hedge starts to kick in. As said, 20 billion of maturities, less whatever modest reduction we might see, but nonetheless, a significant tailwind going into H2 of this year. Second, the headwinds as we look at them going into H2, again, it's a continued expectation around mixed shift within overall deposits. alongside the mortgage refinancing that we expect to see. We might see a bit of compression in margins in some of the other retail and CB assets, but again, it's basically those two. Deposit, mixed shift, number one, and mortgages refinancing, number two. That's the mix. What will that produce? We expect it to produce a margin that is slightly higher than we have previously indicated. At the year end, we talked about a floor, as I think Guy mentioned in his earlier question, of around 300. We expect it to perform a little bit better than that now, going into Q3 and Q4. The beta in that mix, Raoul, we haven't put a number on the beta in that mix. As you know, the pass-on decisions are basically determined by what offers best value to our customers, particularly in the context of consumer duty, clearly. What is the competition doing and how should we best respond to that? And what are the funding needs of the business? Those three are the criteria, if you like, that we use to assess the pass-on decision. It's safe to say two things, I think, Raoul. One is that so far we've been very much in line with the sector in terms of the overall pass on decision. Two is as we look forward and consistent with what I think Charlie and I have always said, we do expect the pass-on to increase as we get into a higher base rate environment. And indeed, we expect some of the pass-on to continue even after base rate changes have stopped. And so that will increase a little bit beyond where we are today. At the moment, we are below 50%, but we do expect it to increase towards that level as we go forward, consistent with the comments that I've just made. Tarell, I'll perhaps pause there. I hope that answers your question and let me know if it doesn't.

Thank you. Yeah, that's really helpful, William. I've got an unrelated question on the buy-to-let areas profile. I don't know if you're seeing anything specific around... I think you flagged the 2006-2008 vintage and did some helpful disclosure on the slides, but I guess my question is specifically around buy-to-let. If you're seeing... Any specific arrears trends within there? Would you call out anything in terms of that business going forward? Thank you.

I think the short answer is no, Raoul. As we look at the buy-to-let portfolio, it's obviously one of our portfolio's businesses. It's not seeing arrears trends that are significantly different to what we're calling out in the materials that we've provided today. As you know, today we called out a mortgage portfolio that is performing well inside of our 2019 new-to-arrears experience. The heritage portfolio is a little different from that, not terribly much so, but the reason why we put the slide in is just to provide further colour, if you like, on that point. buy to let isn't a particular portfolio that we call out as being any different to anything else that's going on. The one point I would make, Raoul, before concluding, is more of a flow point, actually, which is, I think, because of governmental changes, perhaps because of the rate environment and so forth, we are seeing buy to let as a proportion of new business on the portfolio go to very low levels. And so it is much more about the residential portfolio right now than it is about the buy to let. New to lending in buy to let is much smaller. smaller than it used to be.

Got it. Thank you.

Thanks, Ron.

Thank you. Our next question is from Rohith Chandra Rajan from Bank of America. Your line is unmuted. Please go ahead.

Hi. Good morning. Thank you very much. I had a couple, please. The first one was just a follow-up actually on the deposit beta. So you sort of had said historically you thought over time a combination of pricing and a mix would move towards 50%. And it sounds like you just reiterated that, William. But obviously we're now talking about materially higher policy rates than we were all expecting previously. So that implies a much wider deposit spread than you might have been anticipating before. Just wondering if that's the correct read of that or whether actually over time you might think that deposit beta could overshoot the 50%. So that was the first one. And then just going back to the TNAV and thinking about the short term, if I look at five-year rates today versus the end of June, that would imply something like a third of the cash flow hedge reserve impact in in Q2 might actually flow back in Q3. So I just wanted to check if that was the right way to think about that, please, as well as the kind of maturities you talked about before. Thank you.

Yeah, yeah, thanks, Charles. I'll answer both, but Charlie will want to add, I think, on the positive point in particular, Rohit. So let me just start on that, hand over to Charlie, and then come back on the TNAV afterwards. In terms of the Deposit beta, it's worth first of all just saying that this is a cumulative number that is given. So when we talk about 50% deposit beta, it is cumulative over time. What that means is that in the early stages of rate rises, as you know, essentially all banks sought to rebuild the margin from what had been a very compressed level during the zero interest rate period. Not that much of the initial rate rises were passed on. As those rate rises have increased, so the cumulative beta has moved up. There's still a little way to go, as I indicated in my comments, Raoul, before we necessarily hit the 50% mark. As to whether it then exceeds it over time, I'll leave Charlie to comment further. But, you know, at the margins, it's not impossible. I think we have to see how things develop. But we're a little way off that right now. So, you know, that's not a concern for now. It's not a concern, I suspect, for this year. And indeed, our expectations as to the gathering pace of deposit beta are fully built into our margin expectations for this year, which, as you know, and by the way, and importantly to your question, have just increased from greater than 305 to greater than 310. That partly, I think, answers your questions. I'm going to pause there, hand over to Charlie, and then I'll come back on Tina.

Well, I know, actually, William, I think you said what you would have said. Strategically, when we gave you this guidance at the start, I'm thinking back 18 months now, my experience from having managed big deposit businesses through multiple rate cycles in the last 10 years is that you typically end up both through people valuing liquidity at the start of a rate cycle, i.e. when there's more uncertainty, they want instant access, And then there's the more confidence around the economic environment, being willing to ship some of their savings into fixed products. What you typically see is across the whole deposit base, about a 200 basis point spread between the bank base rate and the deposit base. So as we've been going through this last couple of years, I think we've had a couple of times, a 50% pass-through, which would take two or three years for our customers to adjust where they've got deposits. has always been what we thought made sense as we were thinking about rates at 300 or 400 basis points. The reality is we're now looking at rates which are a bit higher, of course, is the real question is how long do they stay at that rate and what are the expectations around it? And especially as you start to think about time deposits, that's obviously priced based on the one or two year curve. And actually, when we look at our forecast for rates, we're not going to stay at these highly elevated levels or higher levels for long. So I think the answer is we're building towards the 50 basis points. As William would say, we've got some way to go. That's because customers massively value liquidity, and we've got such a strong retail franchise and strong transactional capabilities and services. We should continue to expect that to shift. If we think that the rates and the yield curve and customer behavior is going to push us above that 50%, we'll tell you as we get there. I think what's good about that from our perspective for the shareholder is if we're in that environment, we're going to see other ways of optimizing our NIM. And that's what William just said. Despite the higher rates, we're guiding to higher NIM.

Just moving back to TNAV, Rohit, on the second of your... Sorry, Rohit, did you want to... Go ahead if you'd like to, Karen.

Let's come back on that very briefly before we move on, just to clarify a piece. So mechanically, if we were expecting rates to go from pretty much zero to 300, that would have been a 50% pass-through, would have been a 150 basis point spread. At 5%, that's 250. But I think, Charlie, what you're telling us is that because you don't expect rates to stay at that very elevated level for an ongoing significant period of time, but actually the fixed rate spreads would be lower than that, reflecting expectations of lower rates. Is that the right way to think about those comments?

Yeah, I know we're not being as specific as I think would be helpful. The reason is we're going to have to see how the competitive and customer behavior develops. What I can say is I've managed businesses like this through rate cycles over the last 10 years in other countries. And the broad theme I just laid out, which is at least 200 basis points of margin, it takes two to three years for customers to decide how they move their deposits and for the competition to play out. And when the landing point for rates is about 4%, that 50% is a good assumption. I'll give you an example in Mexico when it was 7%. you know, the 2% was compared to more like 4.5%, 5% pass-through after three or four years of that cycle. So, yes, you interpreted it right. We're not going to fill out a very, very detailed forecast around this because it's going to be down to customer behavior and competitive behavior. But our assumptions to date have been pretty helpful, I think, for you. We said people don't typically start moving money until they get to about 3% base rate, which is what we saw happen last November. And then we've guided that we will end up towards this 50% basis of pass-through. And our NIM guidance includes those assumptions around churn and pass-through. So, It's very hard to be more specific than that, Rohit, and so it's not us trying to be unhelpful, but I do hope that you feel we have some track record here and we have some confidence from other experience that's helpful to you as you develop your model here.

Yeah, that's helpful. Thank you.

Your question around TNAV. Again, just to repeat some of the inputs to that. As you know, the TNAV was down a fraction, well, about 0.7 pence in the course of the half, 3.9 pence in the course of the second quarter. As said in the discussion with Jonathan, the cash flow hedge reserve is responsible for about half of that. We had one or two other elements going on, notably the dividend, and then the offsetting impact between the buyback going out and the number of shares being reduced. That also is a modest net negative contributing to the 3.9 pence per share down before you get the pensions fund. Now, as we move forward, your question is about how does that evolve? A couple of points to make there. One is the sensitivity, which I think we disclosed, certainly at the half year, at the full year, rather, I think we disclosed. It's around 13 million, 12 to 13 million post-tax for a one basis point change in rates. So that will enable you to do a sensitivity based upon your expectation as to where rates will go. When we look at our expectations as to where rates will go, over the course of this year, we've given them to you in our forecast, at least. We do, as your question suggests, see quite a significant unwind in the context of the TNAV and particularly the cash flow hedge reserve in the second half of this year. Based upon that, based upon profitability, based upon our expectations as to the buyback, performance of the pension and so forth, We would expect to see the TNAV per share by the end of this year, I won't give you a precise number, but much closer to 50p than where we stand today. Now, I don't want to kind of be held captive by that remark because, of course, we can't dictate interest rates and exactly where they go. But based upon our forward look with those inputs that I've just given you, we're looking at a number that is much closer to 50p. Final point on the TNAV, which I think is worth stressing, Rohit, is that none of this has anything to do with capital. or distributions to you as shareholders and the market more generally. Whatever the movements are in TNAV, I appreciate they have been slightly volatile over the course of this half, but none of it has anything to do with capital generation or capital distributions. And I think that's just important and worthwhile for people to remember.

Thank you very much.

Thanks, Rohit.

Our next question is from Martin Lidkip. from Goldman Sachs. Your line is unmuted. Please go ahead.

Yes, good morning.

Can I have a follow-up on the outlook for net interest income? I was just wondering if you would be willing to comment on the trajectory for net interest income going forward. Obviously, multiple moving parts, the margin comments earlier, the comments on deposits, migration somewhat fading as we progressed. and also the impact of hedge tailwind or tailwinds and hedge rollover late in the year. Would it be fair to assume from your perspective that net interest income continues to build in absolute terms from here? And the second question, I was just wondering with regards to the health of the UK consumer, your disclosure on slide 23 in terms of average impact in terms of mortgage payments being up uh 200 pounds a month so far potentially rising closer to 400 pounds per year but but we also disclose that the average income um for this mortgage owner or hold us is actually uh well above average what do you say at 75 000. it's the message here that you see the uk consumer holding up well so that basically wage growth uh in this category is potentially more than offsetting some of the headwinds from higher mortgage rates and the outlook for the uk consumer overall being fairly benign. Thank you.

Yeah. Thanks, Martin. Why don't I take the first of those two questions, and then Charlie perhaps takes the second on mortgage payments. When we look at NII for 2023, we don't guide to a particular number in respect of NII. What we do is give you a sense as to what we think average interest-earning assets are, what we think the margin expectations are going to be, and then allow you to kind of draw your own conclusions around the NII contribution. So I won't breach that line, as it were. I won't go beyond that. Safe to say that when we look at the NII expectations, net interest income expectations, it is those factors, as given to you, that are at play. I would also highlight the non-banking interest income as part of this. We talked about it at Q1 clearly. It's gone to about 80 million versus I think it was 74 in Q1. So 80 million in Q2 versus 74 million in Q1. As said earlier on, because our activities are increasing, and by the way, that does generate income in OOI amongst other lines. But as those activities increase, the volumes of those activities increase, number one, and as rates increase and therefore the cost of funding them, number two, that will nudge up non-banking interest income a little bit in Q3 and Q4. Not terribly much, but we'll see a slight movement in non-banking interest income in accordance with that. And so those factors are at play in determining the net interest income over the course of this year. And today's obviously not the day, rather, to give guidance into 2024. But hopefully that's useful without breaching too many of our guidance guidelines.

Great. And then, Martin, thanks for the question on our mortgage customers. First thing, we included this slide because we thought and we'd heard that some of you would be keen just to get a forward look on our mortgage customers, given that we've seen a step up in mortgage payments. And the intent of this slide is to give you confidence that we think our mortgage customers can withstand the higher payments. One thing, which is probably more for the media than you, Martin, but just to be clear, I'm not saying it's easy for our mortgage customers. I'm just saying that we are confident they have the financial decisions and capacity to absorb the kind of difficult uptake in mortgage monthly, mortgage costs that we're talking about. Now, what's the reason for that? As you said, overall household income is significantly above the average, and you can do the math relatively quickly. Although we're talking about, for so many customers, £3,000 to £5,000 post-tax of incremental payments, people are able to make choices to offset other discretionary payments, We've done the stress test or the affordability test for our customers over the last 10 years. It's above 6.5%. So we know they have the capacity to absorb this. And bluntly, our experience and the data you can see over the last nine months, we've had elevated mortgage rates post the mini budget has shown that customers can absorb this cost. So not easy for our customers by any means. We also have a very sharp view as you'd expect from us and given our business model for those customers that have a more significant shock on their interest to income payments. One of the levels we've looked at historically is about 40% when the mortgage payment goes above 40% of their income. We know that's a moment in time that they sometimes are looking to support. We have a very modest percentage of our portfolio today in that level. And interestingly, when we model that going forward for the next two years, it doesn't grow very much as a percentage of our portfolio. And that's because a lot of those customers are on standard variable rates. So they've already experienced 5% of what we think will be a 5.5% base rate. So not easy for those customers, but we think the customers are well placed to make the difficult choices to deal with this. One other thought, and you can see this from the data, which is obviously A mortgage is very expensive in the context of UK consumers, and that's why the average income is £75,000. We also know that for that end of the market in the UK, people have broader financial resilience. And one of the indicators, as you know, is we've talked about the incremental savings that we have in our customers since COVID. We talked during COVID, that peaked at about £70 billion of growth in savings. we still have over £60 billion of those incremental savings, and that will tend to be for customers in the higher deciles of the wealth income distribution. So we know these customers have financial resilience, and that's then validated by the spend behaviour we're seeing more broadly. Thank you.

Thank you. Our next question is from Andrew Coombs from Citi. Your line is unmuted. Please go ahead.

Good morning. Two questions on mortgage trade. I'm certainly looking at the movement in the mortgage book. Perhaps you could just comment on what you're seeing both in terms of people repaying down on FDR, but also those taking advantage of the 10% window on the fixed interest. Are you seeing greater prepayment and how does that then feed through into your EIR assumption for the mortgage NII. And then the second question, previously you've given some color on the split between product transfer and new business margins within that 50 basis points. Anything you can say on that would also be interesting.

Andrew, sorry, the second question was on... Okay, fine. Yeah, sorry. Right. Thank you, Andrew. I'll make a couple of comments Charlie may want to add. On the SVR book, the SVR book, as noted in my comments, is now down to about $39 billion. That has seen, as a proportion of the book, some relatively high repayments. So I think we quoted a number of around 30% in the course of Q2, but actually if you look at the absolute number of repayments, that is much more stable. So what you're seeing is the absolute number is staying relatively stable, in fact, maybe even coming down a touch, but because it's against a smaller denominator as a percentage, it's accordingly a bit more. So what that means is that in absolute terms, Andrew, the pace of the SVR runoff, if you like, is reducing over time, as I think customers value in the SVR product the ability to repay whatever it is they want to repay at any point in time. And in the context of the SVR book, which by the way has pretty low average balances of less than $50,000, the incremental interest cost to them is not necessarily that much when you compare it to the convenience that they derive from being on an SVR that allows them to pay back again whatever it is they want to pay back whenever they want to pay back. We do keep in regular touch with our customers on the SVR book and make sure that they are aware of all of the opportunities to refinance or indeed pay back at any given moment. And there is no concept, if you like, of mortgage prisoners or anything like that in the SVR book and customers are free to do what they want. Hopefully that gives you a bit of a sense as to what's going on there. You asked about EIR. I'm not quite sure whether I caught the question or not, but if it's relevant to what went on recently in the EIR market, When we look at our EIR, first of all, the asset is less than 200 million. Second is we account for EIR. We do not take account of or accrue for any benefits that we might see off the back of the customer staying on SVR after they come off the fixed rate deal. So all of our EIR is accounted for up to and only up to the point at which the fixed rate deal stops. That means in turn that we are unlikely to see, in fact, I think it's conceptually impossible for us to see the type of issue that came up in the market most recently. Your second question, Andrew, around product transfer versus new business. Yes, you're right to point it out. We have a completion margin that is 50 basis points. That 50 basis points is a blended average based upon new business and based upon product transfer. Just to give you some idea without putting too precise numbers on it, but product transfer is materially ahead of that. Sorry, forgive me. New business is materially ahead of that 50 basis points completion margin. So quite a bit ahead of it. Product transfer is typically, we've seen it around sort of 35 to 40 basis points in that zone. The issue with both of these numbers, both new business and product transfer, Andrew, is that in a time of swaps volatility, the spreads go up and down in line with the swaps. So you have a price out there that then gets affected by the swaps, even though obviously we are hedging our exposures as best we can to make sure that we're not exposed. I think what we need, Andrew, in order to figure out what is the true equilibrium pricing within the mortgage market is a period of swap stability that then allows people to price with a degree of certainty as we go forward, which in turn will give us some insight as to what a true mortgage equilibrium margin looks like. as you know in the past we thought that it is north of 50 basis points i think we continue to think that in part in no small part because actually a 50 basis points completion margin is produced at a time of tremendous and mostly upwards swap volatility which is compressed margins so we continue to adhere to the view that over time if we do get that period of stability we should see margin spreads moving out from the 50 basis points that we're seeing. But to be clear, we're not banking on that and the guidance that we're giving you for group margins as we stand today.

Then you build, William, which I know you've said a few times, but just it's worth reinforcing in this context is because product transfers are for existing customers, we understand their risk. We can look at their broader relationship. We see good economic returns at the kind of rates that William's talking about. And so we're very comfortable with the returns on this margin. But I think the opportunity with that stability that we should see starting to come around swaps, let's see what happens. As William said, it's on the upside. Thanks, Andrew.

I think there may be one more question. And then there's one comment I'd like to make, actually, before we wrap up. But let's take the question first.

Thank you. As you know, this call is scheduled for 90 minutes, and we have now reached the end of the allotted time. So this will be the last question we have time for this morning. If you have any further questions, please contact the Lloyds Investor Relations team. Our final question is from Joseph Dickerson from Jefferies. Your line is unmuted. Please go ahead.

Hi. Thank you, gentlemen, for taking my questions. You've provided a very strong return on tangible equity guidance of greater than 14% this year, and I think your existing ROTE guidance for next year is greater than 13. I guess, is that stale at this point, or could you discuss the moving parts as to how we go from greater than 14 down to greater than 13? Is this a normalization of TNAV? Is it you know, lower rates and the impact on them. I guess what's the, what would be the drivers of that? Or is this one that's likely to be updated in the future? Thanks.

Yeah, thanks, Joe. A couple of points to make there. First, I'm afraid it's a bit predictable, which is to say that today we're not going to comment further on 2024 expectations beyond what we've already said. So we won't give precise guidance on 2024. I don't think that'll surprise you. Second, our ROT guidance that is extant for 2024, as we announced at the beginning of this year, is actually, just to be clear, circa 13% rather than greater than. It's a small point, but perhaps just worth mentioning. Third, just to give you a bit of a sense of direction as we move forward into 2023 and therefore kind of set the stage, I suppose, for 2024. We've talked about the expectations for ROT during the course of this year. That is a function of some of the banking earnings trends that we've mentioned, the margin, the AIA contributions, together with things like operating lease depreciation normalizing. Those in turn are likely to continue as we go into 2024 in terms of patterns. Again, we'll leave the guidance for the end of the year as we normally do. And then secondarily, we talked a lot about TNAV on this call, and TNAV is going to build in the second half of 2023 as our expectation. That gives you a stronger starting point for 2024. So, Joe, I apologize, it's not very detailed, but hopefully it gives you a bit of a sense as to the trends that we expect to see continuing into the next year. Before we wrap up, I mentioned that I just wanted to add, sorry, Joe, did you have any further questions on that, or does that address your query?

I'll let you go with your comment. I'll follow up later.

Thanks. Thank you. It's just a very small point, actually, which is that Robin Down asked a question as to whether or not OI was expected to grow off the back of H1 of this year or off the back of H2 of last year. I just wanted to clarify, looking back at the numbers, Robin, to address your question, the answer is both. So I think I answered your question as to H2 of last year. In fact, looking at my numbers, the answer is both. I think that wraps it up, Operator. So thank you to everybody for attending the call and taking the time. Yeah, thanks for the time.

Thank you. This concludes today's call. There will be a replay of the call on webcast available on the Lloyds Banking Group website. Thank you for participating. You may now disconnect your lines.